Flowserve Corporation — Form 10-Q Summary
Business context and reporting period
Flowserve is a global manufacturer and aftermarket service provider of pumps, valves, seals, automation and related flow-control systems 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 three and six months ended June 30, 2018; financial statements are unaudited.
Flowserve adopted ASC 606 revenue recognition on January 1, 2018 using the modified retrospective method, increasing retained earnings by approximately $20 million at adoption. Comparisons with 2017 therefore reflect different revenue recognition requirements.
Key financial metrics
| Metric | Three months ended June 30, 2018 | Three months ended June 30, 2017 | Six months ended June 30, 2018 | Six months ended June 30, 2017 |
|---|---|---|---|---|
| Sales | $973.1 million | $877.1 million | $1,893.1 million | $1,743.4 million |
| Gross profit | $286.1 million | $245.5 million | $557.5 million | $514.4 million |
| Gross margin | 29.4% | 28.0% | 29.4% | 29.5% |
| Operating income | $46.7 million | $126.9 million | $92.1 million | $177.5 million |
| Operating margin | 4.8% | 14.5% | 4.9% | 10.2% |
| Net earnings attributable to Flowserve | $13.2 million | $41.9 million | $28.4 million | $60.9 million |
| Diluted EPS | $0.10 | $0.32 | $0.22 | $0.46 |
- Bookings were $1,037.3 million in the second quarter, up 6.8%, and $1,965.8 million for the first six months, up 2.0%.
- Aftermarket sales represented approximately 50% of sales in both the quarter and year-to-date period, compared with approximately 49% and 48%, respectively, in the prior-year periods.
- Backlog was $1,829.2 million at June 30, 2018, down 10.0% from December 31, 2017. Approximately $1,335 million represented unsatisfied or partially unsatisfied performance obligations, including approximately $494 million subject generally to customer cancellation for convenience without penalty.
- Six-month operating cash flow was negative $56.7 million, compared with positive $46.6 million in 2017. Capital expenditures were $31.7 million, and financing cash outflows were $87.2 million, including $49.7 million of dividends and $30.0 million of debt repayments.
- Cash and cash equivalents were $517.4 million at June 30, 2018, versus $703.4 million at December 31, 2017.
- Total debt was $1,524.9 million, including $69.9 million due within one year. The company had no revolving credit borrowings and reported $432.6 million of available revolving capacity after letters of credit and covenant limitations.
- The quarterly and year-to-date effective tax rates were 47.8% and 41.4%, respectively, compared with 59.1% and 51.8% in the prior-year periods.
Material changes versus the prior comparable period
- Sales increased 10.9% in the second quarter and 8.6% year to date, aided by currency, stronger aftermarket activity and ASC 606. ASC 606 increased reported sales by approximately $11 million in the quarter and $81 million year to date.
- Gross margin improved in the quarter but was broadly stable year to date. The quarter benefited from the nonrecurrence of a $16.9 million 2017 contract charge, greater fixed-cost absorption and realignment savings, partly offset by a $7.7 million inventory write-down related to a planned IPD divestiture.
- Operating income and earnings declined substantially because the 2017 periods included a $131.3 million pretax gain on the sale of the Gestra business. Excluding that unusual gain, operating performance improved through higher gross profit and lower SG&A.
- SG&A declined 4.6% in the quarter and 0.9% year to date, reflecting lower realignment charges, the nonrecurrence of a $26.0 million Brazil facility impairment recorded in 2017, and operating leverage.
- Segment performance improved at EPD and IPD. EPD operating income increased to $51.0 million from $9.8 million in the quarter; IPD’s operating loss narrowed to $20.5 million from $28.6 million. FCD operating income declined to $46.4 million from $164.4 million because the prior period included the Gestra gain.
- Other comprehensive loss was $55.1 million in the quarter and $35.9 million year to date, driven primarily by foreign-currency translation losses.
Guidance, outlook, risks and unusual items
- Management said customer capital spending remained cautious, particularly in oil and gas, but expected stable oil prices to support maintenance and short-cycle investment during 2018.
- Flowserve launched its Flowserve 2.0 Transformation in the second quarter to improve operational execution, reduce complexity, accelerate growth and better leverage its global platform.
- The realignment programs are expected to require approximately $360 million of total investment. Inception-to-date charges were $327.1 million at June 30, 2018, with remaining charges expected through the rest of 2018. Management estimated approximately $230 million of eventual run-rate cost savings and an approximate 20% workforce reduction from early-2015 levels.
- Flowserve agreed to divest two IPD locations and related product lines. It recorded a $17.4 million pretax charge in the quarter and estimated an additional $5 million to $10 million pretax loss upon closing, then expected in the third quarter of 2018.
- Planned 2018 capital expenditures were $80 million to $90 million. Management believed cash, operating cash generation and revolving-credit availability would meet cash needs for the next 12 months, but noted sensitivity to operating performance and market conditions.
- Key risks include conversion of bookings and backlog at acceptable margins, project cost overruns, customer cancellations, exposure to oil and gas and other cyclical industries, foreign-exchange volatility, emerging-market collections, raw-material costs, international regulatory and political risks, litigation, asbestos claims, environmental liabilities, cybersecurity, pension obligations and execution of restructuring initiatives.
- Flowserve was cooperating with the DOJ and SEC regarding a potential Foreign Corrupt Practices Act matter involving an overseas subsidiary. Management did not expect a material financial impact but noted that penalties and additional costs remained possible.
- The company faced asbestos-related claims, environmental remediation matters and other litigation. Management believed recorded reserves and insurance or indemnification coverage were adequate for probable exposures, but outcomes remain uncertain.
- Effective July 1, 2018, Argentina was designated hyperinflationary and Flowserve will use the U.S. dollar as the subsidiary’s functional currency. Argentina represented approximately 1% of consolidated sales and assets.
Important facts for investors to verify
- Assess comparable operating performance excluding the $131.3 million 2017 Gestra gain and other unusual charges.
- Reconcile reported 2018 revenue, margins, backlog and working capital with the ASC 606 adoption effects, including the $81 million year-to-date sales increase and contract-asset balances.
- Monitor negative operating cash flow, inventory and contract-asset growth, cash reduction and scheduled term-loan repayments.
- Track the planned IPD divestiture, the estimated additional $5 million to $10 million loss and the effect on future revenue and profitability.
- Evaluate whether the Flowserve 2.0 and realignment programs deliver the projected savings and whether remaining restructuring charges are consistent with management’s estimates.
- Review tax audits, the potential approximately $15 million tax benefit within 12 months, FCPA-related developments, asbestos and environmental claims, and foreign-exchange exposure.