Flowserve Corporation — Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended June 30, 2016. The filing is unaudited. Flowserve manufactures and services flow-control equipment, including pumps, valves, seals, automation products and aftermarket services, serving oil and gas, chemical, power generation, water management and general industrial markets.
Financial Performance and Position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Sales | $1,026.2 million | $1,162.2 million | $1,973.5 million | $2,176.9 million |
| Gross profit | $324.7 million | $369.1 million | $632.7 million | $700.8 million |
| Gross margin | 31.6% | 31.8% | 32.1% | 32.2% |
| Operating income | $98.0 million | $127.6 million | $172.4 million | $221.0 million |
| Operating margin | 9.5% | 11.0% | 8.7% | 10.2% |
| Net earnings attributable to Flowserve | $63.0 million | $75.0 million | $100.9 million | $102.7 million |
| Diluted EPS | $0.48 | $0.56 | $0.77 | $0.76 |
| Operating cash flow | Not separately provided | Not separately provided | $3.3 million | $18.1 million |
- Bookings: $975.4 million in Q2, down 12.6%; $1,896.7 million year to date, down 12.1%. Declines were concentrated in original equipment, particularly oil and gas.
- Backlog: $2.10 billion at June 30, 2016, down 3.2% from December 31, 2015; approximately 29% was aftermarket.
- Liquidity: Cash and equivalents were $266.0 million, down from $366.4 million at year-end 2015. Operating cash flow was constrained by working-capital uses, including inventory and accrued liabilities.
- Debt: Total debt and capital lease obligations were $1.61 billion, including $70.7 million due within one year. No revolving credit borrowings were outstanding; available revolver capacity was $877.3 million. The company complied with all debt covenants.
- Capital allocation: Six-month dividends paid were $48.2 million. The quarterly dividend increased to $0.19 per share. No common shares were repurchased during the quarter; $160.7 million remained under the repurchase authorization.
- Balance sheet: Inventories increased to $1.06 billion from $995.6 million at December 31, 2015, while accounts receivable declined to $946.0 million.
Material Changes Versus Prior Comparable Period
- Sales declined 11.7% in Q2 and 9.3% year to date, including negative currency effects of approximately $23 million and $70 million, respectively.
- Operating income declined 23.2% in Q2 and 22.0% year to date. Lower sales, reduced fixed-cost absorption, lower-margin backlog shipments and execution inefficiencies affected profitability.
- Gross margins were broadly stable but declined modestly. Aftermarket sales increased to approximately 44% of sales from 42% in Q2 2015 and 43% year to date in 2015.
- Net earnings were lower in Q2 but year-to-date diluted EPS increased to $0.77 from $0.76, helped by a lower effective tax rate and reduced share count.
- Other income improved materially, partly because the $18.5 million Venezuelan remeasurement loss recognized in Q1 2015 did not recur. The six-month effective tax rate fell to 29.7% from 35.9%.
- Six-month investing cash outflows declined sharply to $40.5 million from $453.5 million, primarily because the prior-year period included the $341.5 million SIHI acquisition.
- Realignment charges were $20.1 million in Q2 and $33.6 million year to date, compared with $32.5 million and $59.0 million, respectively, in the comparable periods. Cumulative charges since inception reached $149.7 million.
Outlook, Commentary, Risks and Unusual Items
- Management expects the difficult operating environment to persist through 2016, citing reduced global capital spending, oil and gas weakness, pricing pressure, foreign-exchange effects, geopolitical conditions and deferred customer maintenance spending.
- The realignment programs are expected to require approximately $400 million of total investment and produce approximately $230 million of annualized run-rate savings when completed. Management expects most remaining charges in 2016 and 2017 and a 15% to 20% workforce reduction from early-2015 levels.
- Management estimated approximately $43 million of cost savings from the programs during the first six months of 2016. Savings and ultimate charges may differ from current estimates.
- Capital expenditures for 2016 were expected to be $105 million to $115 million; $36.9 million had been spent through June 30.
- Management stated that cash, operating cash flow and revolver availability should be sufficient for the next 12 months, subject to operating, market, currency and geopolitical risks.
- Venezuelan receivables represented approximately 7% of gross accounts receivable. Approximately 69% of that balance was classified as long term because of delayed collections. Management believed collection remained probable but identified material uncertainty.
- The company divested a non-strategic foundry business in Q2, generating a $7.7 million loss and $5.1 million cash outflow.
- Material contingencies include asbestos claims, environmental remediation sites, an SEC and DOJ investigation concerning a potential Foreign Corrupt Practices Act violation, product liability matters and other litigation. Management did not expect these matters to have a material adverse financial impact, but outcomes remain uncertain.
- Foreign-exchange exposure remains significant. A 10% change in exchange rates was estimated to affect six-month net earnings by approximately $6 million, excluding the effect of foreign-exchange contracts.
Most Important Facts to Verify
- Whether bookings and backlog stabilize despite continued weakness in oil and gas and original-equipment markets.
- Whether the realignment programs deliver the projected $230 million annualized savings and whether remaining charges remain near management’s estimates.
- Cash conversion, inventory levels, receivable aging and collection of Venezuelan accounts receivable.
- Compliance with debt covenants, scheduled term-loan repayments and available revolver capacity.
- The sustainability of margins, particularly given lower sales volume, fixed-cost absorption, pricing pressure and project mix.
- Potential penalties or costs from the SEC and DOJ investigation, asbestos litigation, environmental matters and other contingencies.
- The effect of foreign-currency movements and future tax-audit resolutions, including the potential $11 million tax benefit management estimated could be recognized within 12 months.