Flowserve Corporation Form 10-Q Summary
Reporting period: Quarterly and six-month periods ended June 30, 2013; filed July 24, 2013. Financial statements are unaudited. Flowserve manufactures and services pumps, valves, seals, automation and related aftermarket products for oil and gas, chemical, power generation, water management and industrial customers. Operations comprise Engineered Product Division, Industrial Product Division and Flow Control Division, with approximately 17,000 employees in more than 50 countries.
Financial Performance and Position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Sales | $1,239.5 million | $1,182.2 million | $2,336.1 million | $2,257.2 million |
| Gross profit | $421.6 million | $384.6 million | $794.9 million | $743.8 million |
| Gross margin | 34.0% | 32.5% | 34.0% | 33.0% |
| Operating income | $183.5 million | $164.8 million | $354.0 million | $307.3 million |
| Operating margin | 14.8% | 13.9% | 15.2% | 13.6% |
| Net earnings attributable to Flowserve | $120.4 million | $107.3 million | $218.2 million | $200.4 million |
| Diluted EPS | $0.84 | $0.66 | $1.51 | $1.22 |
- Q2 sales increased 4.8%; six-month sales increased 3.5%. International customers represented approximately 70% of Q2 sales and 69% of six-month sales.
- Q2 operating income increased 11.3%, while six-month operating income increased 15.2%. Six-month results included $28.3 million of pretax gains from the exit of the Audco India joint venture.
- Q2 net earnings increased 12.2%; six-month net earnings increased 8.9%. Effective tax rates increased to 29.4% in Q2 and 31.1% year to date, versus 26.7% and 27.1%, respectively.
- SG&A increased 7.3% in Q2 and 6.5% year to date, with higher legal, bad-debt and research and development costs. The 2012 comparison also benefited from a $10.4 million gain on a Brazil facility sale that did not recur.
- Cash flow from operations was an outflow of $32.8 million year to date versus inflow of $60.4 million in 2012, primarily reflecting inventory growth of $120.7 million and lower accounts payable of $94.3 million.
- Capital expenditures were $61.2 million year to date. Management expects full-year capital expenditures of $120 million to $130 million, before acquisitions.
- Cash and cash equivalents declined to $104.7 million from $304.3 million at December 31, 2012. Debt totaled $1.127 billion, including $277.9 million due within one year and $849.2 million due thereafter.
- At June 30, the company had $499.2 million of available capacity under its revolving credit facility after outstanding borrowings and letters of credit, plus €42.0 million of net capacity under its European letter-of-credit facility. The company complied with all debt covenants.
Material Changes Versus Prior Period
- Bookings increased 1.3% in Q2 to $1,229.0 million but declined 1.7% for the first six months to $2,409.3 million, partly because of unfavorable currency effects.
- Backlog was $2.6645 billion at June 30, up 0.6% from December 31, 2012 after a reported $63 million currency reduction; approximately 25% related to aftermarket orders.
- Flow Control Division produced the strongest operating improvement, with six-month operating income up 37.9% to $160.0 million and operating margin of 20.1%, supported by aftermarket growth, mix and cost initiatives.
- Industrial Product Division six-month operating income rose 25.7% to $51.8 million despite a 12.3% decline in bookings.
- Engineered Product Division six-month operating income declined 2.4% to $182.8 million, reflecting lower bookings and higher SG&A.
- Flowserve exited its 50% Audco India joint venture, sold the interest for $46.2 million and acquired the plug-valve manufacturing business for $10.1 million. The transactions generated pretax gains of $13.0 million and $15.3 million.
- The company completed a three-for-one stock split effective June 21, 2013. Share and per-share data were retrospectively adjusted.
- Share repurchases totaled $306.3 million for the first six months, and $536.4 million remained available under the repurchase authorization at June 30. The quarterly dividend increased to $0.14 per share.
Outlook, Risks and Unusual Items
Management reported stronger Q2 bookings and continued aftermarket growth, particularly in oil and gas and chemical markets. No large original-equipment capital projects were recorded during the quarter. Power markets remained difficult, the Middle East faced project delays, Europe and Latin America strengthened, and the company continued to face a competitive and uncertain global macroeconomic environment. Management stated that operating cash flow, existing cash and revolving-credit availability should be sufficient for the next 12 months.
- Key risks include order cancellations or delays, conversion of backlog at acceptable margins, cost overruns on fixed-price projects, raw-material inflation, competition and dependence on oil and gas, chemical, power and water markets.
- International exposure creates foreign-exchange, political, economic, sanctions, export-control and import-law risks. A 10% currency movement was estimated to affect six-month net earnings by approximately $6 million, excluding forward-contract effects.
- Venezuela’s February 2013 currency devaluation generated a $4.0 million pretax loss in the first quarter. Management continues to monitor repatriation restrictions and broader economic effects.
- Asbestos claims, environmental remediation at six former waste sites, product liability matters and routine litigation remain contingencies. Management believes reserves and insurance or indemnity recoveries are adequate, but additional exposure cannot be estimated with certainty.
- The company is involved in a French investigation and an appealed Iraq civil action relating to the United Nations Oil-for-Food Program; management does not currently expect a material financial impact.
- Tax audits could result in a reduction of tax expense of approximately $14 million within the next 12 months, although timing and realization remain uncertain.
- Interest-rate swaps covered $225.0 million of exposure at June 30. Total forward foreign-exchange contract notional value was $577.0 million.
Investor Verification Items
- Reconcile reported earnings growth with the $28.3 million Audco India transaction gains and assess normalized earnings.
- Monitor cash conversion, inventory levels, accounts payable, working-capital requirements and the decline in cash balances.
- Verify debt maturities, revolving-credit availability, letters of credit and compliance with financial covenants.
- Assess the sustainability of gross-margin gains and segment performance, particularly Flow Control Division strength and Engineered Product Division weakness.
- Track backlog conversion, cancellations, bookings by industry and region, and the mix between original equipment and higher-margin aftermarket work.
- Evaluate currency exposure, Venezuela developments, tax-audit outcomes and litigation or environmental contingencies.
- Confirm the effect of ongoing share repurchases and the increased dividend on leverage and liquidity.