Business Context and Reporting Period
Company: FLOWSERVE CORP
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Reporting Status: The filing was significantly delayed due to a delay in completing the Annual Report on Form 10-K for the year ended December 31, 2005, and obligations regarding internal control certification under Section 404 of the Sarbanes-Oxley Act. The company was not current in its SEC filings as of the filing date (July 27, 2006).
Key Financial Metrics
Amounts in thousands, except per share data.
| Metric | Three Months Ended Sep 30, 2005 | Three Months Ended Sep 30, 2004 | Nine Months Ended Sep 30, 2005 | Nine Months Ended Sep 30, 2004 |
|---|---|---|---|---|
| Sales | $649,485 | $623,426 | $1,956,767 | $1,818,762 |
| Gross Profit | $211,216 | $189,451 | $625,059 | $554,144 |
| Gross Margin | 32.5% | 30.4% | 31.9% | 30.5% |
| Operating Income | $54,811 | $43,180 | $136,939 | $125,617 |
| Net (Loss) Earnings | $(9,950) | $6,368 | $3,986 | $19,783 |
| Diluted EPS (Net) | $(0.19) | $0.11 | $0.07 | $0.36 |
| Cash and Equivalents | $35,234 (as of Sep 30, 2005) | |||
| Total Debt | $699,184 (as of Sep 30, 2005) |
Material Changes vs. Prior Period
- Revenue Growth: Sales increased 3.4% for the quarter and 5.5% for the nine-month period compared to 2004, driven by strong market conditions in oil and gas, power, and chemical industries.
- Profitability Decline: Despite higher operating income, Net Earnings turned to a loss for the quarter ($(9.95)M) and dropped significantly for the nine months ($3.99M vs $19.78M). This was primarily due to:
- Discontinued Operations: A $15.1M loss in the quarter and $22.7M loss for the nine months related to the General Services Group (GSG), which was classified as held for sale and subsequently sold in December 2005. Impairment charges of $17.6M were recorded in the third quarter.
- Debt Extinguishment: A $27.9M loss on early extinguishment of debt in the quarter (and $27.7M for nine months) resulting from refinancing 12.25% Senior Subordinated Notes and 2000 Credit Facilities with new lower-cost debt.
- SG&A Expenses: Increased 6.2% for the quarter and 12.1% for the nine months, driven by higher professional fees (audit/tax) and employee-related costs (including stock option modifications).
- Cash Flow: Operating cash flow decreased significantly to $19.9M for the nine months (vs $86.8M in 2004), largely due to a $38.8M increase in inventory and a $34.7M decrease in retirement obligations (pension funding).
Guidance, Outlook, Risks, and Unusual Items
- Refinancing: In August 2005, the company entered into new credit facilities ($600M term loan, $400M revolving) to replace high-cost debt. This reduced interest expense but triggered significant one-time charges.
- Divestiture: The General Services Group (GSG) was sold in December 2005 for approximately $16M. Results are reported as discontinued operations.
- Legal and Regulatory Risks:
- SEC Investigation: An SEC investigation regarding the restatement of prior financial results concluded in May 2006 without enforcement action. However, a separate SEC subpoena was received in February 2006 regarding goods delivered to Iraq during the UN Oil-for-Food program (1996-2003).
- Export Controls: The company initiated a review in March 2006 regarding potential non-compliance with U.S. export control laws, which could result in penalties.
- Securities Litigation: A consolidated securities class action lawsuit is set for trial in March 2007. Shareholder derivative lawsuits were also filed in late 2005 and early 2006.
- Internal Controls: Management concluded that disclosure controls and procedures were not effective as of September 30, 2005, citing material weaknesses in the control environment, financial reporting processes, and stock-based compensation accounting.
- Stock Options: Due to non-current filing status, stock options were unexercisable. The company expects to reopen exercises in 2006, which could impact cash flow and EPS dilution.
Investor Verification Checklist
- Internal Control Remediation: Verify the progress of remediation efforts for the 20 identified material weaknesses in internal controls over financial reporting.
- Legal Exposure: Monitor the outcome of the SEC investigation into the UN Oil-for-Food program and the U.S. export control compliance review for potential fines or penalties.
- Discontinued Operations: Confirm the final working capital adjustments and ultimate loss on the sale of the General Services Group (GSG).
- Debt Covenants: Review compliance with the new credit facility covenants, specifically leverage and interest coverage ratios, which step down/up in 2006 and 2007.
- Stock Option Impact: Assess the potential cash flow impact and EPS dilution when the stock option exercise program reopens in 2006.