Flowserve Corporation 2017 Form 10-K Summary
Business Context and Reporting Period
Flowserve Corporation manufactures and services flow-control equipment, including engineered and industrial pumps, mechanical seals, valves, automation products and aftermarket services. Its principal end markets are oil and gas, chemical, power generation, water management and general industries. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD).
The filing covers the fiscal year ended December 31, 2017, with comparative results for 2016 and 2015. The filing was signed February 28, 2018. Flowserve had approximately 17,000 employees, served customers in more than 90 countries and generated approximately 64% of sales from international customers.
Financial Performance and Position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Sales | $3.661 billion | $3.990 billion | Down 8.3% |
| Gross profit | $1.085 billion | $1.231 billion | Down 11.8% |
| Gross margin | 29.6% | 30.9% | Down 130 bps |
| Operating income | $335.4 million | $268.0 million | Up 25.1% |
| Operating margin | 9.2% | 6.7% | Up 250 bps |
| Net earnings attributable to Flowserve | $2.7 million | $132.5 million | Down 98.0% |
| Diluted EPS | $0.02 | $1.01 | Down $0.99 |
| Operating cash flow | $311.1 million | $240.5 million | Up $70.6 million |
| Capital expenditures | $61.6 million | $89.7 million | Down $28.1 million |
| Cash and equivalents | $703.4 million | $367.2 million | Up $336.3 million |
| Total debt | $1.575 billion | $1.571 billion | Relatively flat |
The 2017 effective tax rate was 98.4%, compared with 36.3% in 2016, primarily because of a $115.3 million provisional tax charge related to the U.S. Tax Cuts and Jobs Act, foreign tax valuation allowances and taxes associated with business dispositions. The company reported $100.1 million of dividends declared, or $0.76 per share.
At December 31, 2017, working capital was $1.316 billion and total equity was $1.671 billion. Net debt to net capital was 34.3%, compared with 42.4% in 2016. The company had no revolving loans outstanding and $94.8 million of letters of credit under its $800 million revolving credit facility; reported borrowing capacity was $644.8 million.
Fourth-Quarter Information
Fourth-quarter 2017 sales were $1.034 billion, compared with $1.071 billion in the fourth quarter of 2016. Gross profit was $304.4 million, compared with $327.3 million. Flowserve reported a fourth-quarter net loss attributable to the company of $105.9 million, or $(0.81) per diluted share, compared with net earnings of $60.0 million, or $0.46 per diluted share, in the prior-year quarter. Fourth-quarter earnings were materially affected by tax-related items.
Segment Results and Backlog
| Segment | 2017 Sales | 2017 Operating Income (Loss) | Year-End Backlog |
|---|---|---|---|
| EPD | $1.738 billion | $156.8 million | $1.028 billion |
| IPD | $739.7 million | $(49.5) million | $424.3 million |
| FCD | $1.183 billion | $321.2 million | $617.4 million |
Consolidated bookings increased 1.2% to $3.804 billion, and backlog increased 6.9% to $2.033 billion. Approximately 92% of year-end backlog was expected to ship in 2018. Aftermarket sales increased to approximately 48% of total sales from 45% in 2016.
EPD sales declined 11.1% and operating income declined 6.3%. IPD sales declined 7.2%, and its operating loss widened to $49.5 million. FCD sales declined 3.7%, but operating income increased substantially because of business-disposition gains.
Material Changes Versus the Prior Comparable Period
- Sales declined $329.7 million, primarily because of lower original-equipment activity, continued capital-spending weakness and unfavorable market conditions in served industries.
- Gross margin fell because of lower fixed-cost absorption, lower-margin projects shipped from backlog and a $16.9 million charge related to an oil and gas platform equipment contract in Latin America.
- Operating income benefited from a $141.3 million pre-tax gain on the sale of the Gestra and Vogt businesses and lower SG&A.
- Flowserve recorded a $26.0 million impairment charge related to a manufacturing facility in Brazil.
- Operating cash flow improved because of lower accounts receivable and inventory and higher accounts payable.
- Net earnings were substantially reduced by the $115.3 million provisional Tax Cuts and Jobs Act charge and other tax valuation adjustments.
- Flowserve identified prior-period accounting errors at two non-U.S. sites involving inventory, accounts receivable, cost of sales and SG&A. Management determined the errors were not material to prior periods but revised previously issued comparative financial information.
- The company reported that prior material weaknesses in internal control over financial reporting had been remediated. Management and the independent auditor concluded controls were effective as of December 31, 2017.
Guidance, Outlook, Risks and Unusual Items
Management expected a continued competitive environment in 2018, with results weighted toward the second half of the year. It remained cautious because of uncertainty in customer capital spending and global economic conditions, while expecting support from aftermarket demand, cost management, customer diversity and the product portfolio.
- Realignment Programs are expected to require approximately $360 million of total investment, with $294.8 million incurred through 2017 and most remaining charges expected in 2018. Management estimates approximately $200 million of savings had been achieved by year-end 2017 and expects approximately $230 million of annualized run-rate savings upon completion.
- Management estimated 2018 capital expenditures of $80 million to $90 million, scheduled debt repayments of $60.0 million, and pension contributions of approximately $30 million.
- Management expected 2018 interest expense to remain relatively consistent with 2017 and believed operating cash flow, cash balances and revolver availability would fund expected needs for at least the next 12 months.
- The company adopted the new revenue standard effective January 1, 2018 using the modified retrospective method. It expected revenue recognized using the percentage-of-completion method to increase to approximately 30% to 40% of consolidated sales from approximately 5% to 10% historically, with an estimated $20 million reduction to opening retained earnings.
- Key risks include cyclical customer capital spending, oil and gas and commodity-price volatility, backlog cancellations or delivery penalties, pricing pressure, raw-material costs, foreign exchange, international political and regulatory risks, cybersecurity, labor matters, pension obligations, goodwill impairment and restrictive debt covenants.
- Flowserve remains exposed to asbestos-related litigation, environmental matters, product liability claims and a self-reported potential Foreign Corrupt Practices Act matter. Management stated that material adverse impacts were not currently expected, but outcomes remain uncertain.
- The company had approximately $1.218 billion of goodwill. No goodwill impairment was recorded, but EPO and IPD goodwill valuations remain sensitive to oil and gas conditions and discount-rate assumptions.
Most Important Facts for an Investor to Verify
- Whether 2018 revenue and margin improvement offsets the 2017 decline in original-equipment sales and the continued pressure on IPD.
- Whether Realignment Program savings reach the expected $230 million run rate and whether additional restructuring charges remain within the projected investment.
- The final tax accounting for the Tax Cuts and Jobs Act and its effect on future effective tax rates, cash taxes and deferred tax assets.
- The effect of Topic 606 adoption on revenue timing, contract assets and liabilities, backlog conversion and reported earnings.
- Debt covenant compliance, scheduled maturities and available revolver capacity, particularly as the 2020 facility maturity approaches.
- Whether backlog converts as expected, including the stated 92% 2018 shipment estimate, without material cancellations, delays or penalties.
- Potential financial exposure from asbestos, environmental, product liability, FCPA and other legal contingencies.
- The sustainability of cash generation and dividends given low reported net earnings, pension funding requirements and ongoing realignment costs.