Flowserve Corporation — Form 10-Q Summary
Business Context and Reporting Period
Flowserve designs, manufactures, distributes and services pumps, valves, mechanical seals, automation products and related flow-management solutions for oil and gas, chemical, power generation, water management and other industrial markets. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD). The filing covers the unaudited three and nine months ended September 30, 2012, compared with the corresponding 2011 periods.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Sales | $1,165.9 million | $1,121.8 million | $3,423.1 million | $3,244.8 million |
| Gross profit | $389.6 million | $376.6 million | $1,133.4 million | $1,093.6 million |
| Gross margin | 33.4% | 33.6% | 33.1% | 33.7% |
| Operating income | $165.7 million | $155.0 million | $473.0 million | $425.3 million |
| Operating margin | 14.2% | 13.8% | 13.8% | 13.1% |
| Net earnings attributable to Flowserve | $106.3 million | $107.8 million | $306.7 million | $303.5 million |
| Diluted EPS | $2.07 | $1.92 | $5.73 | $5.40 |
Q3 sales increased 3.9% and nine-month sales increased 5.5%. Reported results included significant negative currency effects. Bookings rose 2.3% in Q3 and 3.1% for the nine months, to $1,186.1 million and $3,635.4 million, respectively. Backlog was $2.881 billion at September 30, 2012, up 7.1% from December 31, 2011; aftermarket backlog was $713.5 million, up 12.7%.
Cash provided by operations was $122.6 million for the first nine months of 2012, compared with cash used of $150.1 million in 2011. Investing cash use was $80.5 million, including $84.2 million of capital expenditures. Financing cash use was $164.9 million, driven primarily by $533.9 million of share repurchases, $55.6 million of dividends and debt repayments, partially offset by debt issuance.
Cash and cash equivalents were $217.4 million at September 30, 2012, compared with $337.4 million at December 31, 2011. Total debt was $928.0 million, including $498.1 million of 3.50% senior notes due 2022 and a $400.0 million term loan. The company reported $693.7 million of available borrowing capacity under its revolving credit facility, after consideration of letters of credit. Management stated that operating cash flow, available revolver capacity and existing cash should meet cash needs for the next 12 months.
Material Changes Versus the Prior Comparable Period
- Operating income increased 6.9% in Q3 and 11.2% for the first nine months, while operating margins expanded by 40 and 70 basis points, respectively.
- Gross margins declined 20 basis points in Q3 and 60 basis points for the nine months, primarily because of a mix shift toward original equipment and the shipment of large, lower-margin projects.
- SG&A as a percentage of sales improved to 19.5% in Q3 from 20.1% and to 19.7% for the nine months from 21.0%, reflecting cost management and operational improvements.
- Net earnings attributable to Flowserve declined modestly in Q3 despite higher operating income, primarily because of higher interest expense, higher taxes and unfavorable other expense. Nine-month net earnings increased slightly.
- Other expense was $9.2 million in Q3 and $22.2 million for the nine months, compared with $6.6 million of expense and $7.9 million of income, respectively, in 2011. The change primarily reflected foreign-currency transaction and hedging losses.
- IPD was the strongest segment, with nine-month operating income up 73.0%. FCD nine-month operating income increased 7.7%, while EPD increased 1.4% and experienced lower Q3 operating income.
- Flowserve refinanced its debt structure, issuing $500.0 million of senior notes and entering into a new $1.25 billion senior credit facility. The $250.0 million bridge loan used to fund share repurchases was repaid in Q3.
- The company repurchased $533.9 million of common stock during the first nine months, including a $300.0 million accelerated share repurchase program. Remaining authorization was $523.7 million at September 30, 2012.
Guidance, Outlook, Commentary and Risks
Management did not provide a specific earnings or revenue guidance figure in the filing. Capital expenditures were expected to total $125 million to $135 million for 2012, excluding potential acquisitions. Management anticipated a $7.0 million U.S. pension contribution for 2012 and stated that no additional contribution was currently expected after consideration of funded status.
Management reported stable oil and gas conditions, increased chemical-industry activity in Asia Pacific, the Middle East and North America, continued favorable aftermarket conditions and slowing power-generation investment pending regulatory clarity. Europe remained challenged, with modestly lower bookings. A large IPD booking exceeding $90 million is expected to supply offshore oil and gas platform equipment over five years.
Key risks include conversion of backlog into sales at acceptable margins, project cost overruns, customer cancellations or delays, dependence on oil and gas, chemical, power and water markets, raw-material inflation, foreign-exchange volatility, international political and regulatory risks, supplier disruptions, competition, pension obligations, environmental liabilities, asbestos claims and litigation related to the United Nations Oil-for-Food investigation. Management stated that no material changes had occurred in the risk factors disclosed in the 2011 Form 10-K.
Asbestos-related claims remain material in volume, although management believes most existing claims are covered by insurance or indemnities and currently considers a materially adverse outcome remote. The French Oil-for-Food investigation proceeded through a formal review process after an adverse procedural ruling in July 2012; management did not expect material additional resolution costs, but penalties remain possible. Tax audits in multiple jurisdictions could reduce tax expense by an estimated $7.8 million to $22.6 million within the next 12 months.
Management reported no direct investments in European sovereign or non-sovereign debt and no direct measurable disruption from the European sovereign debt crisis during the period. Disclosure controls were assessed as effective, and no material changes in internal control over financial reporting were reported.
Investor Verification Checklist
- Verify the sustainability of backlog growth, including the conversion timing and margins of the large offshore oil and gas orders.
- Assess whether gross-margin pressure from original-equipment mix and lower-margin project shipments persists.
- Monitor working-capital requirements, particularly inventory growth, accounts receivable, DSO of 85 days and inventory turns of 2.7 times.
- Reconcile total debt, floating-rate exposure, interest-rate swaps, covenant limits and available revolver capacity.
- Track the remaining $523.7 million share-repurchase authorization, ASR settlement and the effect of buybacks on EPS and leverage.
- Evaluate foreign-exchange sensitivity, including the filing’s estimate that a 10% currency movement could affect nine-month net earnings by approximately $22 million before considering forward contracts.
- Review developments in asbestos claims, the Oil-for-Food proceedings, environmental sites and international tax audits.