Business Context and Reporting Period
Company: Flowserve Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2008
Business Overview: Flowserve designs, manufactures, and services industrial flow management equipment (pumps, valves, mechanical seals) for oil and gas, chemical, power, and water industries. The company operates through three segments: Flowserve Pump Division (FPD), Flow Control Division (FCD), and Flow Solutions Division (FSD).
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2008 |
Three Months Ended June 30, 2007 |
Six Months Ended June 30, 2008 |
Six Months Ended June 30, 2007 |
|---|---|---|---|---|
| Sales | $1,157,605 | $930,677 | $2,150,924 | $1,734,077 |
| Gross Profit | $417,970 | $302,415 | $763,816 | $567,889 |
| Gross Margin | 36.1% | 32.5% | 35.5% | 32.7% |
| Operating Income | $171,581 | $96,908 | $290,271 | $164,331 |
| Operating Margin | 14.8% | 10.4% | 13.5% | 9.5% |
| Net Earnings | $122,864 | $63,205 | $210,931 | $96,819 |
| Diluted EPS | $2.13 | $1.11 | $3.66 | $1.69 |
| Cash & Equivalents (Balance Sheet) | $136,742 (as of June 30, 2008) | |||
| Total Debt (Current + Long-term) | $571,545 (as of June 30, 2008) | |||
| Operating Cash Flow (6 Months) | $(178,253) used |
Material Changes vs. Prior Period
- Revenue Growth: Sales increased 24.4% for the quarter and 24.0% for the six months compared to 2007. Growth was driven by strength in oil and gas, power, and chemical markets, as well as currency benefits (approx. $85M for the quarter, $155M for six months).
- Margin Expansion: Gross profit margins improved significantly (36.1% vs. 32.5% for the quarter) due to improved pricing implemented in 2007, a higher mix of aftermarket sales, and specialty pump production.
- Operating Income: Operating income surged 77.1% for the quarter and 76.7% for the six months, primarily due to gross profit increases outpacing SG&A growth.
- Acquisition: On March 1, 2008, Flowserve acquired the remaining 50% interest in Niigata Worthington Company, Ltd. for $2.4 million. This resulted in a $3.4 million bargain purchase gain included in "Other income, net."
- Cash Flow: Operating cash flow turned negative ($178.3M used for six months) compared to $61.7M used in the prior year. This was driven by a $176.9M decrease in working capital cash flows, specifically higher inventory ($165.2M) and accounts receivable ($211.0M) to support backlog and sales growth.
Guidance, Outlook, and Risks
- Outlook: Management believes the outlook remains favorable, supported by high oil and gas prices driving capital investment. However, they note that oil price volatility could negatively impact business.
- Capital Expenditures: Expected to be between $115 million and $125 million for the full year 2008, focused on capacity expansion and IT infrastructure.
- Dividends and Buybacks: Quarterly dividend increased to $0.25 per share. A $300 million share repurchase program was authorized; $35 million was spent in Q2 2008.
- Legal and Regulatory Risks:
- Oil-for-Food Program: SEC and DOJ investigations resolved with penalties totaling approx. $10.6 million. A French investigation remains ongoing, and a civil suit was filed by the Republic of Iraq in June 2008.
- Export Compliance: A voluntary review of export control compliance is ongoing, with results expected by end of 2008. Potential penalties remain uncertain.
- Asbestos Litigation: Numerous pending claims, though the company believes a high percentage are covered by insurance.
- Market Risks: Significant exposure to foreign currency fluctuations (10% change could impact net income by $9.8M) and interest rate changes on variable debt.
Investor Verification Checklist
- Working Capital Trends: Verify the sustainability of the increase in Days Sales Outstanding (DSO) to 72 days and inventory turns dropping to 3.3x, which significantly impacted operating cash flow.
- Legal Contingencies: Monitor the status of the ongoing French investigation regarding the Oil-for-Food program and the outcome of the civil suit filed by the Republic of Iraq.
- Export Compliance Penalties: Track the conclusion of the voluntary export compliance review expected by year-end 2008 to assess potential fines.
- Margin Sustainability: Assess whether the improved gross margins (driven by pricing and aftermarket mix) can be maintained amidst potential raw material inflation.
- Debt Covenants: Confirm continued compliance with credit facility covenants, particularly the debt-to-EBITDA ratio, given the cash flow volatility.