Flowserve Corporation — Q3 2015 Form 10-Q Summary
Business context and reporting period
Flowserve manufactures and services flow-control equipment, including pumps, valves, seals, automation products and aftermarket services, serving oil and gas, chemical, power generation, water management and general industrial markets. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD). The filing covers the unaudited three and nine months ended September 30, 2015, compared with the corresponding 2014 periods.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Sales | $1,096.5 million | $1,204.0 million | $3,273.3 million | $3,496.5 million |
| Gross profit | $388.8 million | $421.5 million | $1,089.6 million | $1,228.9 million |
| Gross margin | 35.5% | 35.0% | 33.3% | 35.1% |
| Operating income | $167.8 million | $192.4 million | $388.8 million | $551.1 million |
| Operating margin | 15.3% | 16.0% | 11.9% | 15.8% |
| Net earnings attributable to Flowserve | $93.6 million | $128.6 million | $196.3 million | $359.8 million |
| Diluted EPS | $0.70 | $0.93 | $1.46 | $2.60 |
Nine-month operating cash flow was $131.0 million versus $129.9 million in 2014. Capital expenditures were $138.5 million, acquisition spending was $353.7 million, dividends paid were $70.0 million and share repurchases were $249.7 million. Cash and cash equivalents declined to $237.8 million from $450.4 million at December 31, 2014.
Total debt and capital lease obligations were $1.679 billion at September 30, 2015, including $1.610 billion due after one year, compared with $1.155 billion at December 31, 2014. The increase primarily reflects the $526.3 million issuance of 1.25% euro senior notes due 2022. No revolving credit facility borrowings were outstanding; available revolving capacity was $903.1 million after letters of credit. Flowserve complied with its debt covenants.
Material changes versus the prior comparable period
- Q3 sales declined 8.9% and nine-month sales declined 6.4%; bookings declined 17.1% and 16.6%, respectively. Management attributed the declines primarily to weaker oil and gas capital spending, pricing pressure, deferred aftermarket spending and unfavorable currency translation.
- Excluding SIHI, Q3 sales declined 15.0% and nine-month sales declined 12.6%. The SIHI acquisition contributed approximately $73.7 million of Q3 sales and $217.8 million of nine-month sales.
- Q3 gross margin improved to 35.5%, helped by a higher aftermarket mix and lower incentive compensation. Nine-month margin fell to 33.3%, primarily due to SIHI purchase-accounting adjustments, realignment charges, lower-margin projects and reduced fixed-cost absorption.
- Nine-month operating income fell 29.5%, and net earnings attributable to Flowserve fell 45.4%. Results included $55.6 million of realignment expense, $8.7 million of SIHI acquisition-related costs and a $20.6 million Venezuelan currency remeasurement loss, of which $18.5 million was recorded in other expense.
- Backlog was $2.560 billion at September 30, 2015, down 5.3% from December 31, 2014, including an estimated $130 million currency impact. Approximately 26% of backlog related to aftermarket orders.
- EPD nine-month sales and operating income declined 13.1% and 22.5%, respectively. IPD sales increased 22.4% including SIHI, but operating income declined 75.4%. FCD sales and operating income declined 10.6% and 20.6%, respectively.
Guidance, outlook, commentary and risks
Management expected the weak market environment to persist into 2016, citing broad-based capital-spending declines, particularly in oil and gas, lower aftermarket activity, currency pressure and challenging economic and geopolitical conditions in Latin America, the Middle East and China.
Flowserve initiated two realignment programs. The company estimated approximately $175 million of near-term investment, including projects not yet approved, an approximately 10% reduction in the global workforce and annualized run-rate savings of approximately $145 million. The company expected most remaining charges to occur through the remainder of 2015 and early 2016. Actual savings may differ from estimates.
The SIHI acquisition, completed January 7, 2015 for $341.5 million, expanded IPD but generated a nine-month operating loss of approximately $48.8 million, including acquisition-related and realignment costs. Management also cited execution, integration and purchase-accounting risks.
- Foreign-exchange exposure remains significant. Nine-month foreign-currency losses included the Venezuelan remeasurement, and management estimated that a 10% currency movement could affect net earnings by approximately $8 million, excluding hedging effects.
- Venezuela represented less than 0.5% of consolidated sales and assets, but its national oil company receivable represented approximately 8% of gross accounts receivable; collection delays caused a portion to be classified as long-term.
- Material contingencies include asbestos claims, environmental remediation obligations, an appealed French Oil-for-Food investigation dismissal, and a self-reported potential Foreign Corrupt Practices Act matter under review by the DOJ and SEC. Management did not expect these matters to have a material financial impact, but outcomes remain uncertain.
- Other risks include weaker customer capital spending, backlog cancellations or delays, project cost overruns, slower receivable collections, raw-material costs, competition, pension obligations, goodwill impairment, cybersecurity incidents and failure to achieve realignment savings.
Most important facts for investors to verify
- Whether bookings and backlog stabilize amid continued oil and gas weakness and whether aftermarket demand recovers.
- Progress, remaining charges and realized savings from the SIHI integration and the two realignment programs.
- IPD profitability excluding SIHI-related acquisition, purchase-accounting and restructuring effects.
- Cash conversion, inventory growth, receivable aging and liquidity after share repurchases, dividends, capital expenditures and debt service.
- Foreign-exchange effects, particularly Venezuela and Latin America, and the sensitivity of earnings to currency movements.
- Future debt maturities, covenant compliance and the company’s capacity to continue repurchases and dividends.
- Developments in asbestos, environmental, FCPA/SEC, French Oil-for-Food and tax matters.