FLS

Business Context and Reporting Period

Company: Flowserve Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and Six Months Ended June 30, 2000
Business Overview: Flowserve operates through three segments: Rotating Equipment (pumps), Flow Control (valves and actuators), and Flow Solutions (seals and services). The period was significantly impacted by the January 2000 acquisition of Innovative Valve Technologies, Inc. (Invatec) and the announcement of a definitive agreement to acquire Ingersoll-Dresser Pumps (IDP).

Key Financial Metrics

Note: Debt figures derived from Balance Sheet line items "Notes payable," "Long-term debt due within one year," and "Long-term debt due after one year."

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 7.3% year-over-year for the six months ended June 30, 2000. This growth was primarily driven by the Invatec acquisition; organic sales (excluding Invatec) were down 8.0%.
• Profitability: Net earnings rose 30.0% to $24.5 million. Operating income increased 31.6% to $47.8 million, aided by the elimination of $7.8 million in merger integration expenses recorded in 1999.
• Cash Flow Deterioration: Operating cash flow swung from a positive $22.1 million in 1999 to a negative $6.6 million in 2000. This was due to increased working capital requirements (inventories and receivables) and cash expenditures related to the restructuring program and Invatec acquisition.
• Debt Levels: Total debt increased significantly to fund the Invatec acquisition and prepare for the IDP transaction. Debt represented 50.0% of the capital structure at June 30, 2000, up from 39.6% at year-end 1999.

Outlook, Risks, and Management Commentary

• Acquisition of IDP: On August 8, 2000, Flowserve completed the acquisition of Ingersoll-Dresser Pumps (IDP) for $775 million. The deal was financed with $1.425 billion in new debt (including $375 million in 12.25% Senior Subordinated Notes), which repaid all existing Flowserve debt.
• Dividend Suspension: The Company suspended its cash dividend in the first quarter of 2000 to comply with financing covenants related to the IDP acquisition.
• Restructuring: A restructuring program initiated in late 1999 is ongoing. As of June 30, 2000, 149 of the targeted 300 employee reductions had been completed. The company expects $20 million in annual operating income benefits starting in 2001, though 2000 benefits are expected to be offset by integration costs.
• Segment Performance:
  • Rotating Equipment: Sales declined due to lower backlog and unfavorable currency translation, though margins improved.
  • Flow Control: Sales declined due to reduced backlog, but operating margins improved to 12.0% (six months) due to cost reductions.
  • Flow Solutions: Sales increased significantly due to Invatec, though margins decreased slightly due to Invatec's historically lower gross margins.
• Risks: Key risks include the successful integration of IDP and Invatec, interest rate fluctuations, economic conditions in the petroleum/chemical/power industries, and the ability to service increased debt levels.

Investor Verification Checklist

• Debt Servicing: Verify the Company's ability to service the new $1.425 billion debt load incurred for the IDP acquisition, particularly given the suspension of dividends.
• Integration Synergies: Monitor the realization of projected $20 million annual savings from the restructuring program and synergies from the IDP acquisition.
• Organic Growth: Distinguish between growth driven by acquisitions (Invatec/IDP) and organic performance, as organic sales were down 8.0% in the first half of 2000.
• Cash Flow Recovery: Track the recovery of operating cash flows, which turned negative in the first half of 2000 due to working capital and restructuring outflows.
• Interest Rate Exposure: Assess the impact of variable interest rates on the new credit facilities (LIBOR + spreads) following the IDP financing.