Flowserve Corporation: Q2 2019 Form 10-Q Summary
Business Context and Reporting Period
Flowserve Corporation manufactures and services engineered flow-control equipment, including pumps, valves, seals, automation products and related aftermarket services. Operations are reported through the Flowserve Pump Division (FPD) and Flow Control Division (FCD). The filing covers the unaudited quarter and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Flowserve employed approximately 17,000 people in more than 50 countries and operated 171 Quick Response Centers. International customers represented approximately 63% of sales in both six-month periods.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Sales | $990.1 million | $973.1 million | $1,880.1 million | $1,893.1 million |
| Gross profit | $318.0 million | $286.1 million | $612.1 million | $557.5 million |
| Gross margin | 32.1% | 29.4% | 32.6% | 29.4% |
| Operating income | $98.0 million | $46.7 million | $189.2 million | $92.1 million |
| Operating margin | 9.9% | 4.8% | 10.1% | 4.9% |
| Net earnings attributable to Flowserve | $58.2 million | $13.2 million | $115.4 million | $28.4 million |
| Diluted EPS | $0.44 | $0.10 | $0.88 | $0.22 |
| Operating cash flow | Not separately provided | Not separately provided | $49.4 million | $(56.7) million |
At June 30, 2019, cash and cash equivalents were $596.5 million, compared with $619.7 million at December 31, 2018. Total debt and finance lease obligations were $1.458 billion, including $1.386 billion due after one year. The company had no revolving loans outstanding at quarter-end, $82.4 million of letters of credit, and reported $692.0 million of available borrowing capacity under its existing facility. Debt maturities included senior notes due in 2022 and 2023.
Six-month capital expenditures were $25.3 million, and management expected full-year 2019 capital expenditures of $90 million to $100 million. Dividends paid during the first six months totaled $49.8 million; the quarterly dividend was $0.19 per share. No share repurchases were made, and $160.7 million remained available under the repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Q2 sales increased 1.7%, while six-month sales declined 0.7%. Management cited unfavorable currency effects of approximately $28 million in Q2 and $62 million year to date.
- Q2 gross profit increased 11.1% and the gross margin expanded 270 basis points. Six-month gross profit increased 9.8% and margin expanded 320 basis points.
- Operating income more than doubled in both periods, aided by higher gross profit, lower SG&A, improved operational efficiency and the absence of certain 2018 divestiture-related charges.
- SG&A declined 7.1% in Q2 and 8.8% year to date; SG&A as a percentage of sales improved to 22.6% from 24.7% in Q2 and to 22.8% from 24.8% year to date.
- The effective tax rate fell to 27.0% from 47.8% in Q2 and to 24.5% from 41.4% year to date, primarily reflecting differences in foreign tax effects, BEAT and state taxes.
- Bookings increased 6.5% in Q2 to $1.105 billion and 10.1% year to date to $2.165 billion. Backlog reached $2.156 billion at June 30, up 14.0% from December 31, 2018; approximately 34% was aftermarket.
- FPD produced the largest improvement, with Q2 segment operating margin rising to 11.3% from 4.7%. FCD Q2 operating margin declined to 14.6% from 15.1%, although its six-month margin improved to 15.1% from 13.8%.
- Operating cash flow improved from an outflow of $56.7 million to an inflow of $49.4 million, primarily due to improved working-capital movements.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management reported stabilization in business conditions and improving momentum in certain markets. It expected customers to increase maintenance and short-cycle investment in the second half of 2019, supported by relatively stable oil prices. Management also cited higher demand in oil and gas, chemical and water management markets, while general industrial demand was comparatively weaker.
The Flowserve 2.0 Transformation generated $7.6 million of expense in Q2 and $16.0 million year to date, compared with $2.9 million and $3.4 million, respectively, in 2018. Total realignment and transformation charges were $13.9 million in Q2 and $10.4 million year to date. Cumulative Realignment Program charges were $342.1 million, against an estimated total investment of approximately $350 million. The 2018 divestiture of two FPD locations also produced $17.4 million of Q2 2018 charges that did not recur.
On July 16, 2019, after quarter-end, Flowserve entered a new $800 million unsecured revolving credit facility maturing July 16, 2024, borrowed approximately $75 million to repay the prior facility, transferred outstanding letters of credit and terminated the old facility.
Management believed operating cash flow, cash on hand and available borrowing capacity would be sufficient for the next 12 months. It anticipated approximately $20 million of U.S. pension contributions in 2019, excluding direct benefits paid.
- Key risks include conversion of bookings and backlog into profitable sales, project cost overruns, customer capital spending, oil and gas and other cyclical end markets, raw-material costs, foreign-exchange volatility, tariffs and geopolitical conditions.
- Other material risk areas include asbestos claims, environmental remediation, product liability, the ongoing DOJ and SEC matter related to a potential Foreign Corrupt Practices Act violation, pension obligations, goodwill impairment, cybersecurity and supplier or labor disruptions.
- Flowserve was in compliance with applicable debt covenants at June 30, 2019. Management stated that litigation and the regulatory matter were not currently expected to have a material financial impact, but outcomes remain uncertain.
- The company adopted the new lease standard on January 1, 2019, recording approximately $210 million of lease right-of-use assets and liabilities without a material effect on earnings or cash flow.
- The company estimated an approximately $18 million potential reduction in tax expense within the following 12 months from audit resolutions or statute expirations, although timing and realization were uncertain.
Most Important Facts for Investors to Verify
- Whether the significant margin and earnings improvement is sustainable after excluding transformation costs, divestiture-related comparisons and other unusual items.
- Whether the $2.156 billion backlog converts into revenue and cash flow at expected margins, particularly the $487 million of longer-duration unsatisfied performance obligations.
- Progress and remaining costs of the Flowserve 2.0 Transformation and whether targeted operational benefits materialize.
- Working-capital trends, especially inventory growth, receivables collection, contract assets and the 3.9 inventory-turn rate.
- Debt refinancing terms, interest-rate exposure and liquidity after implementation of the new credit facility.
- Potential cash exposure from asbestos claims, environmental matters and the DOJ/SEC investigation.
- Foreign-exchange sensitivity: management estimated that a 10% movement in currencies could affect six-month net earnings by approximately $10 million, before considering foreign-exchange contracts.
- The filing text does not provide formal full-year revenue or earnings guidance.