Flowserve Corporation 10-Q Summary
Reporting period: Quarterly period ended June 30, 2009; financial statements are unaudited. Flowserve designs, manufactures, distributes and services pumps, valves, mechanical seals and related flow-management equipment for oil and gas, chemical, power generation, water-management and other industrial markets. Operations are conducted through Flowserve Pump Division, Flow Control Division and Flow Solutions Division in more than 55 countries.
Financial Performance and Position
| Metric | Q2 2009 | Q2 2008 | Change |
| Sales | $1,090.4 million | $1,157.6 million | Down 5.8% |
| Gross profit | $386.3 million | $418.0 million | Down 7.6% |
| Gross margin | 35.4% | 36.1% | Down 70 basis points |
| Operating income | $158.8 million | $172.3 million | Down 7.8% |
| Operating margin | 14.6% | 14.9% | Down 30 basis points |
| Net earnings attributable to Flowserve | $108.2 million | $122.9 million | Down 11.9% |
| Diluted earnings per share | $1.92 | $2.12 | Down 9.4% |
| Six-month metric | 2009 | 2008 | Change |
| Sales | $2,115.1 million | $2,150.9 million | Down 1.7% |
| Gross profit | $754.1 million | $763.8 million | Down 1.3% |
| Gross margin | 35.7% | 35.5% | Up 20 basis points |
| Operating income | $305.9 million | $291.6 million | Up 4.9% |
| Operating margin | 14.5% | 13.6% | Up 90 basis points |
| Net earnings attributable to Flowserve | $200.5 million | $210.9 million | Down 4.9% |
| Diluted earnings per share | $3.56 | $3.65 | Down 2.5% |
- Bookings and backlog: Q2 bookings were $1,036.0 million, down 21.0% year over year; six-month bookings were $1,999.1 million, down 27.0%. Backlog was $2,714.8 million at June 30, 2009, down 3.9% from December 31, 2008.
- Cash flow: Six-month operating cash flow was negative $77.0 million versus negative $178.3 million in 2008. Investing cash flow was negative $92.6 million, including $64.3 million of capital expenditures and $28.4 million for the Calder AG acquisition. Financing cash flow was negative $46.3 million.
- Liquidity: Cash and cash equivalents were $251.5 million, down from $472.1 million at December 31, 2008. The $220.5 million reduction primarily reflected incentive payments, capital expenditures, dividends, pension funding, share repurchases, working-capital needs and the Calder acquisition.
- Debt: Total debt and capital lease obligations were $571.0 million, including $546.9 million under the term loan. Long-term debt due after one year was $542.6 million. No borrowings were outstanding under the $400.0 million revolving credit facility; available capacity was $287.9 million after letters of credit.
- Debt maturities and interest: The term loan and revolving facility mature in August 2012. Approximately 70% of term debt was fixed-rate after interest-rate swaps. The company complied with all debt covenants through June 30, 2009.
- Shareholder returns: The quarterly dividend increased to $0.27 per share from $0.25. Flowserve repurchased 281,500 shares for $16.2 million during the first six months and had $118.8 million remaining under its $300.0 million authorization.
Material Changes Versus the Prior Period
- Demand weakened across mature markets amid the global recession, credit-market disruption and lower oil and gas prices. Management reported some stabilization in the second quarter and no significant level of backlog cancellations.
- Q2 sales declines were driven primarily by lower Flow Control and Flow Solutions sales and lower Flowserve Pump aftermarket sales, partly offset by stronger Pump original-equipment sales.
- Six-month operating income increased despite lower sales, reflecting lower SG&A, cost controls, pricing and operating efficiencies. The comparison benefited from lower incentive compensation and other expense reductions.
- Foreign currency translation materially affected reported results. Q2 sales included approximately $110 million of negative currency effects; six-month sales included approximately $230 million.
- Other expense was $9.4 million for the six months compared with $17.1 million of other income in 2008, primarily because of lower foreign-exchange gains, higher transactional losses and the absence of a 2008 bargain-purchase gain.
- The effective tax rate increased to 27.2% in Q2 and 27.5% for the six months, compared with 23.6% and 26.2%, respectively, largely because favorable 2008 tax items did not recur.
Guidance, Outlook, Risks and Unusual Items
- Realignment program: The company expects approximately $39.6 million of total 2009 realignment charges, within its authorized limit of up to $40 million. Charges were $19.6 million in Q2 and $29.6 million for the first six months. Management expects approximately $29 million of cost savings in 2009 and approximately $56 million of annual savings after completion.
- Capital spending and pension funding: Full-year 2009 capital expenditures were expected to be approximately $100 million. Total 2009 U.S. pension contributions were expected to be $50 million to $80 million, including $25 million contributed in April and $21 million contributed in July.
- Acquisition: Calder AG was acquired on April 21, 2009 for up to $44.1 million, including $28.4 million paid at closing, $2.4 million paid after working-capital valuation and up to $13.3 million of contingent consideration. Calder supplies energy-recovery technology for desalination markets.
- Liquidity outlook: Management believed operating cash flow, existing cash and available revolving-credit capacity would be sufficient to meet cash needs for the next 12 months, while cautioning that financial-market volatility and the recession could affect access to capital and customer payments.
- Contingencies: The Fifth Circuit remanded shareholder securities litigation for further proceedings, including reconsideration of class certification. The company also faces asbestos-related claims, an Iraq civil lawsuit related to the United Nations Oil-for-Food Program, a possible French investigation, export-compliance matters and environmental remediation claims. Management believes current reserves and expected exposures are generally not material, but outcomes remain uncertain.
- Tax matters: Tax examinations were ongoing in multiple jurisdictions. The company estimated that resolution of uncertain tax matters could reduce tax expense by up to approximately $14.2 million within the following 12 months.
- Market risks: A 10% change in foreign exchange rates was estimated to affect six-month net earnings by approximately $26 million, excluding the effect of forward contracts. A 100-basis-point change in applicable variable interest rates would have changed six-month interest expense by approximately $0.9 million.
Investor Verification Checklist
- Verify the conversion of sharply lower bookings into revenue, margins and cash flow, particularly as backlog declined and original-equipment demand weakened.
- Assess whether the realignment program delivers the projected $29 million of 2009 savings and approximately $56 million of ongoing annual savings without disrupting operations.
- Monitor cash generation, working-capital requirements, pension contributions, capital expenditures and the decline in cash balances.
- Review debt maturities, revolving-credit availability, letters of credit and compliance with financial covenants.
- Evaluate foreign-exchange sensitivity and the effect of currency movements on reported sales, earnings and comprehensive income.
- Track the shareholder litigation, export-compliance review, Oil-for-Food matters, asbestos claims and environmental contingencies for potential financial impact.
- Review Calder AG’s post-acquisition performance and the potential $13.3 million contingent payment.