Flowserve Corporation 2018 Form 10-K Summary
Business context and reporting period
Flowserve manufactures and services flow-control equipment, including pumps, valves, mechanical seals, automation products and aftermarket services. Its primary end markets are oil and gas, chemical, power generation, water management and general industries. The filing covers the fiscal year ended December 31, 2018, with fourth-quarter data also presented.
Through 2018, operations were reported through the Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD). Effective January 1, 2019, EPD and IPD were combined into the Flowserve Pump Division, with FCD remaining a separate segment.
Key financial metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Sales | $3,832.7 million | $3,660.8 million | Up 4.7% |
| Gross profit | $1,187.8 million | $1,089.0 million | Up 9.1% |
| Gross margin | 31.0% | 29.7% | Up 130 basis points |
| Operating income | $247.5 million | $341.1 million | Down 27.4% |
| Operating margin | 6.5% | 9.3% | Down 280 basis points |
| Net earnings attributable to Flowserve | $119.7 million | $2.7 million | Up $117.0 million |
| Diluted EPS | $0.91 | $0.02 | Up $0.89 |
| Operating cash flow | $190.8 million | $311.1 million | Down $120.2 million |
Net earnings benefited substantially from the 2017 period’s unusually high tax expense. The 2018 effective tax rate was approximately 29.1%, compared with 98.4% in 2017. The company reported $95.1 million of 2018 realignment and transformation costs, reducing after-tax earnings by approximately $72.4 million.
Fourth-quarter 2018 sales were $986.9 million, gross profit was $321.8 million, earnings before taxes were $78.6 million, net earnings attributable to Flowserve were $63.1 million and diluted EPS was $0.48. Fourth-quarter 2017 included a net loss attributable to Flowserve of $105.9 million, primarily reflecting tax-related effects.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $619.7 million at December 31, 2018, compared with $703.4 million a year earlier.
- Working capital was $1.302 billion; total assets were $4.616 billion and total equity was $1.661 billion.
- Total debt was $1.483 billion, consisting primarily of senior notes and a term loan. Debt declined from $1.575 billion at December 31, 2017.
- The company had no borrowings outstanding under its $800 million revolving credit facility, $92.9 million of letters of credit outstanding and $513.7 million of available capacity, subject to covenants.
- 2018 investing cash flow was an outflow of $81.5 million, including $84.0 million of capital expenditures. Financing cash flow was an outflow of $173.3 million, including $99.4 million of dividends and $60.0 million of debt repayment.
- Net debt to net capital was 34.2%, compared with 34.3% in 2017. The company was in compliance with all debt covenants at year-end.
- Contractual obligations totaled $2.963 billion, including debt, interest, leases, purchase obligations and pension obligations.
Material changes versus the prior comparable period
- Bookings increased 5.7% to $4.020 billion, driven primarily by oil and gas, general industries and chemical markets. Backlog decreased 7.0% to $1.892 billion, partly due to currency effects and the adoption of the new revenue standard.
- Aftermarket sales increased to approximately 50% of total sales from 48% in 2017, supporting gross-margin improvement.
- EPD sales increased 7.0% and segment operating income increased 30.0% to $206.9 million.
- IPD reduced its operating loss to $6.2 million from $48.8 million, although results included a $7.7 million loss on the divestiture of two locations and related product lines.
- FCD sales increased 2.3%, but operating income declined 37.8% because 2017 included a $141.3 million gain from the sale of the Gestra and Vogt businesses.
- Flowserve adopted ASC 606 using the modified retrospective method. The adoption increased 2018 sales by approximately $71.2 million and increased retained earnings at January 1, 2018 by approximately $19.6 million.
- Other comprehensive loss was $67.8 million, primarily due to unfavorable foreign-currency translation effects.
Guidance, outlook, risks and unusual items
Management expects 2019 results to benefit from the Flowserve 2.0 Transformation, aftermarket growth, cost management and improved working-capital execution, but remains cautious because of uncertain customer capital spending and international economic and political risks. Results are expected to be weighted toward the second half of 2019.
- 2019 capital expenditures are estimated at $90 million to $100 million, before acquisitions.
- Scheduled 2019 term-loan principal repayments are $60 million.
- Expected 2019 pension contributions are approximately $20 million for the U.S. plan and $9 million for non-U.S. plans.
- Management expects 2019 interest expense to be relatively consistent with 2018 and believes operating cash flow, cash balances and revolving-credit availability will fund anticipated needs.
- Flowserve incurred $41.2 million of Flowserve 2.0 Transformation expenses in 2018 and is still evaluating the program’s total investment and benefits. The substantially completed Realignment Programs generated estimated cumulative savings of approximately $230 million against approximately $347.8 million of charges incurred.
- Material risks include cyclical customer capital spending, oil and commodity-price volatility, intense pricing competition, raw-material costs, foreign-exchange exposure, tariffs and geopolitical developments, Brexit, cybersecurity, pension funding, debt covenants, goodwill impairment, asbestos litigation, environmental liabilities and product warranty claims.
- The company disclosed an ongoing DOJ and SEC matter related to a potential Foreign Corrupt Practices Act violation at an overseas subsidiary. Management does not currently expect a material financial impact, but monetary penalties and additional costs remain possible.
- The company is a defendant in asbestos-related litigation and is a potentially responsible party at five Superfund sites. Management believes existing reserves and insurance or indemnity recoveries are adequate, but outcomes remain uncertain.
Most important facts for investors to verify
- Whether Flowserve 2.0 produces the projected revenue growth, margin expansion and working-capital benefits without materially increasing restructuring or transformation costs.
- The sustainability of the 2018 gross-margin improvement and the proportion and profitability of aftermarket revenue.
- The timing and refinancing requirements for the $1.065 billion of debt maturing in 2022 and the $297.8 million maturing in 2023.
- Whether the $1.892 billion backlog converts to revenue as expected; management expects approximately 89% to ship during 2019, but backlog may be delayed, modified or canceled.
- Potential goodwill impairment, particularly for EPO and IPD reporting units, whose excess fair value over carrying value declined to approximately 60% and 40%, respectively.
- The financial effect of asbestos claims, the DOJ and SEC matter, environmental proceedings, tax audits and other contingencies.
- The effect of ASC 606 adoption and the January 1, 2019 lease-standard adoption, which management expected to add approximately $220 million of lease assets and liabilities without a material earnings or covenant impact.