Flowserve Corporation — Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended September 30, 2010; filed October 27, 2010. Flowserve designs, manufactures, distributes and services pumps, valves, seals, automation products and related aftermarket services for oil and gas, chemical, power generation, water management and other industrial markets. The company employed approximately 15,000 people in more than 50 countries. Operations were reported under the reorganized EPD, IPD and FCD segments.
Financial Performance and Position
| Metric | Q3 2010 | Q3 2009 | Change |
|---|
| Sales | $971.7 million | $1,051.1 million | Down 7.6% |
| Gross profit | $333.5 million | $385.2 million | Down 13.4% |
| Gross margin | 34.3% | 36.6% | Down 230 bps |
| Operating income | $129.2 million | $161.2 million | Down 19.9% |
| Operating margin | 13.3% | 15.3% | Down 200 bps |
| Net earnings attributable to Flowserve | $103.9 million | $116.9 million | Down 11.1% |
| Diluted EPS | $1.84 | $2.07 | Down 11.1% |
| Dividend per share | $0.29 | $0.27 | Up $0.02 |
| Metric | Nine months 2010 | Nine months 2009 | Change |
|---|
| Sales | $2,891.7 million | $3,166.2 million | Down 8.7% |
| Gross profit | $1,025.2 million | $1,139.3 million | Down 10.0% |
| Gross margin | 35.5% | 36.0% | Down 50 bps |
| Operating income | $417.4 million | $467.1 million | Down 10.6% |
| Operating margin | 14.4% | 14.8% | Down 40 bps |
| Net earnings attributable to Flowserve | $275.8 million | $317.5 million | Down 13.1% |
| Diluted EPS | $4.89 | $5.63 | Down 13.1% |
- Bookings and backlog: Q3 bookings increased 2.6% to $1,000.3 million; nine-month bookings increased 8.7% to $3,202.2 million. September 30 backlog was $2,708.8 million, up 14.2% from December 31, 2009.
- Cash flow: Nine-month operating cash flow was negative $16.6 million versus positive $4.8 million in 2009. Investing cash flow was negative $234.8 million, including the Valbart acquisition; financing cash flow was negative $68.4 million.
- Liquidity: Cash and equivalents declined to $310.6 million from $654.3 million at December 31, 2009. The company had $564.4 million of total debt, including $28.5 million due within one year, and no borrowings under its revolving credit facility. Revolver availability was $283.8 million after letters of credit.
- Working capital: Accounts receivable increased $47.9 million and inventory increased $112.5 million in operating cash flow uses. DSO increased to 78 days from 72 days, and inventory turns declined to 2.7 from 3.0.
- Tax: Effective tax rates were 25.5% for Q3 and 26.8% for the nine-month period, compared with 26.5% and 27.2%, respectively, in 2009.
- Foreign exchange: Q3 other income included $18.5 million of net other income, including forward-contract gains and a $2.6 million investment-sale gain. Nine-month other expense was $15.3 million, including the $12.4 million Venezuela devaluation loss.
Material Changes Versus Prior Comparable Period
- Sales declined despite stronger bookings because of lower beginning backlog, customer project delays, currency effects and weakness in original-equipment demand.
- Margins declined primarily because of less favorable backlog pricing, lower fixed-cost absorption and operational issues, partly offset by higher-margin aftermarket sales, cost reductions and continuous-improvement initiatives.
- Aftermarket sales increased to approximately 39% of total sales in both the quarter and nine-month period, versus approximately 37% and 36%, respectively, in 2009.
- EPD bookings rose 14.1% year to date, but sales and operating income declined 5.6% and 7.1%, respectively. IPD sales declined 18.4% and operating income declined 39.7%. FCD bookings increased 7.9%, while sales declined 6.2% and operating income declined 13.8%.
- On July 16, 2010, FCD acquired Valbart, an Italian ball-valve manufacturer, for $199.4 million, including repayment of $33.8 million of Valbart net debt. Valbart contributed $12.3 million of Q3 sales but reduced operating income by approximately $4.3 million, including acquisition-related costs and purchase-accounting effects.
- Realignment charges were $2.1 million in Q3 and $10.2 million for the first nine months. Total incurred charges reached $78.3 million against expected charges of approximately $87.5 million. Management reported approximately $65 million of nine-month savings and expected approximately $115 million of annual savings after completion.
- The reporting structure was reorganized effective January 1, 2010, with prior-period segment information retrospectively adjusted.
Outlook, Risks and Unusual Items
- Management reported improving activity in developing regions, particularly in oil and gas, and improved aftermarket opportunities. It expected favorable demand growth over the next five years, concentrated primarily in developing regions, while mature markets could experience moderate growth or slight declines.
- Management expected 2010 capital expenditures of approximately $100 million, excluding acquisitions, and stated that cash, operating cash flow and available revolver capacity should meet cash needs for the next 12 months.
- Key risks include conversion of bookings and backlog into profitable sales, customer cancellations and project delays, dependence on oil and gas, chemical, power and water markets, raw-material costs, execution of realignment initiatives, foreign exchange volatility, international political and regulatory risks, supplier performance, competition and potential impairment of goodwill or intangible assets.
- Venezuela became hyperinflationary in 2010 and its currency was devalued; Flowserve recognized a one-time $12.4 million loss and continues to monitor remittance restrictions, import classifications and further government action.
- Contingencies include asbestos claims, the Iraq civil lawsuit related to the United Nations Oil-for-Food Program, a French investigation, export-compliance matters, environmental sites and ordinary product-liability litigation. Management generally believes reserves are adequate and potential exposures are not expected to be material, but outcomes remain uncertain.
- The company estimated a possible $7.4 million to $19.1 million reduction in tax expense within the following 12 months from audit resolutions and statute expirations.
- Interest-rate swaps covered $380.0 million of notional debt, leaving approximately $159.8 million of variable-rate debt. A 100-basis-point rate increase would have affected nine-month interest expense by approximately $1.2 million.
Investor Verification Checklist
- Verify whether higher bookings and the $2.7 billion backlog convert into sales and operating-margin recovery, particularly in EPD and IPD.
- Assess working-capital normalization, especially inventory, receivables, DSO and operating cash flow.
- Review Valbart integration, purchase-accounting amortization, acquisition-related costs and expected strategic benefits.
- Track remaining realignment charges, cash expenditures and whether projected $115 million annual savings are realized.
- Monitor liquidity after the acquisition, debt maturities, revolver availability, letters of credit and covenant compliance.
- Evaluate foreign-exchange exposure, Venezuela-related developments and the effect of currency movements on reported earnings and comprehensive income.
- Review the status and potential financial impact of export-compliance penalties, litigation, environmental matters and tax audits.
