Flowserve Corporation — Q3 2011 Form 10-Q Summary
Business context and reporting period
Flowserve designs, manufactures, distributes and services pumps, valves, seals, automation products and related flow-management solutions for oil and gas, chemical, power generation, water management and general industrial markets. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD). The filing covers the three and nine months ended September 30, 2011, compared with the same periods in 2010. The financial statements are unaudited.
Financial performance and key metrics
| Metric | Q3 2011 | Q3 2010 | Change |
|---|---|---|---|
| Sales | $1,121.8 million | $971.7 million | +15.4% |
| Gross profit | $376.6 million | $333.5 million | +12.9% |
| Gross margin | 33.6% | 34.3% | Down 70 bps |
| Operating income | $155.0 million | $129.2 million | +20.0% |
| Operating margin | 13.8% | 13.3% | Up 50 bps |
| Net earnings attributable to Flowserve | $107.8 million | $103.9 million | +3.7% |
| Diluted EPS | $1.92 | $1.84 | +4.3% |
| Cash dividend per share | $0.32 | $0.29 | Increased |
| Metric | Nine months 2011 | Nine months 2010 | Change |
|---|---|---|---|
| Sales | $3,244.8 million | $2,891.7 million | +12.2% |
| Gross profit | $1,093.6 million | $1,025.2 million | +6.7% |
| Gross margin | 33.7% | 35.5% | Down 180 bps |
| Operating income | $425.3 million | $417.4 million | +1.9% |
| Operating margin | 13.1% | 14.4% | Down 130 bps |
| Net earnings attributable to Flowserve | $303.5 million | $275.8 million | +10.0% |
| Diluted EPS | $5.40 | $4.89 | +10.4% |
Q3 sales growth reflected increased original-equipment sales in FCD and aftermarket sales in EPD and FCD. Aftermarket sales represented approximately 41% of sales, compared with approximately 39% in the prior-year quarter. International sales were approximately 73% of Q3 sales and 72% of nine-month sales.
Q3 operating income benefited from higher gross profit, lower SG&A as a percentage of sales and approximately $4 million of additional realignment savings. Nine-month operating income growth was limited by lower gross margins, higher SG&A, lower EPD profitability and IPD recovery-plan charges.
Cash flow, balance sheet, debt and liquidity
- Cash used in operating activities was $150.1 million for the nine months, compared with $16.6 million used in 2010. Working capital consumed cash primarily through increases of $201.6 million in accounts receivable and $206.1 million in inventory.
- Cash used in investing activities was $68.5 million, including $71.2 million of capital expenditures. Management expected full-year capital expenditures of $125 million to $135 million, excluding acquisitions.
- Cash used in financing activities was $110.0 million, including $51.8 million of dividends, $41.1 million of share repurchases and $18.8 million of debt repayments.
- Cash and cash equivalents declined to $227.9 million at September 30, 2011 from $557.6 million at December 31, 2010.
- Total debt and capital lease obligations were $507.9 million, including $481.3 million under the term loan. Debt due within one year was $50.0 million and long-term debt was $457.9 million.
- The company had no borrowings under its $500 million revolving credit facility and had $355.2 million of borrowing capacity after outstanding letters of credit. The credit facilities mature in December 2015, and all covenants were satisfied through September 30, 2011.
- Approximately 70% of term debt was fixed-rate after interest-rate swaps. Management believed cash, operating cash flow and available revolver capacity would meet cash needs for the next 12 months.
- Days sales outstanding increased to 82 days from 78 days a year earlier. Management cited shipment delays, project-documentation disputes, slower customer payments and longer contractual payment terms.
Material changes versus the prior comparable period
- Bookings increased 15.9% in Q3 to $1,159.7 million and 10.1% for the nine months to $3,526.6 million. Backlog reached $2,812.7 million at September 30, 2011, up 8.4% from December 31, 2010.
- FCD was the primary growth contributor. Nine-month FCD sales increased 30.5% and operating income increased 33.9%, including contributions from the Valbart acquisition.
- EPD nine-month operating income declined 10.3%, while IPD nine-month operating income declined 15.5%. EPD was affected by low-margin large projects and project execution issues; IPD was affected by material costs, unfavorable pricing, operational issues and recovery-plan charges.
- Other income and expense was volatile. Q3 2011 included $6.6 million of net other expense versus $18.6 million of income in Q3 2010, primarily because foreign-exchange contract results shifted from an $18.5 million gain to a $9.9 million loss.
- Nine-month other income was $7.9 million versus a $15.3 million expense in 2010, partly because 2010 included an $8.4 million Venezuela currency-devaluation loss.
- Other comprehensive income shifted to a $105.5 million expense in Q3, primarily from foreign-currency translation, compared with $95.9 million of income in the prior-year quarter.
- Realignment charges were $3.3 million for the nine months, compared with $10.2 million in 2010. Total realignment charges incurred through September 30 were $89.7 million, with approximately $2 million of additional charges expected. Management estimated 2011 savings of approximately $116 million and an eventual annual run-rate of approximately $120 million.
Guidance, outlook, commentary, risks and unusual items
- Management reported improved bookings and favorable aftermarket conditions, supported by oil and gas, chemical and general-industry demand, but cited continuing global macroeconomic uncertainty.
- North Africa shipment delays resulted in estimated lost or delayed operating-income opportunities of $3.9 million in Q3 and $9.0 million for the nine months. If conditions persisted, the unfavorable impact on 2011 bookings could approximate $25 million.
- The Japan earthquake and tsunami had not caused significant shipment, collection or supply-chain disruption through September 30. Management expected near-term reductions in nuclear orders, although other power-generation opportunities could benefit.
- On October 4, 2011, Flowserve agreed to acquire Lawrence Pumps for approximately $89 million in cash, subject to closing conditions, with funding expected from cash on hand. Lawrence Pumps reported approximately $44 million of 2010 sales and $8 million of EBITDA.
- A new $300 million share-repurchase authorization was approved for commencement in Q4 2011. The prior $300 million program was expected to conclude in Q4 after $293 million of repurchases to date.
- Flowserve entered into settlements with BIS and OFAC regarding export-compliance disclosures, agreeing to approximately $3 million of combined civil penalties and a one-time compliance audit. The amount was covered by an existing reserve.
- Material risks include project cost overruns and margin deterioration, raw-material inflation, customer cancellations or delayed backlog conversion, working-capital and collection pressure, foreign-exchange volatility, political and economic disruption in international markets, nuclear-industry exposure, supplier performance, acquisitions, asbestos claims and other litigation.
- Potential tax-audit resolutions and statute expirations could reduce tax expense by an estimated $17.5 million to $27.6 million within the following 12 months.
- Asbestos claims remain substantial, although management believes most existing claims are covered by insurance or indemnities and currently considers a material adverse outcome remote. Environmental and routine litigation exposures were considered immaterial based on available information.
Most important facts for investors to verify
- Whether working-capital consumption, elevated receivables and inventory normalize and operating cash flow returns to positive levels.
- Whether EPD and IPD recover their nine-month margin and operating-income declines, including the effects of low-margin projects, material costs and the IPD recovery plan.
- Whether FCD growth and Valbart integration continue without further margin dilution.
- Whether North Africa and Middle East conditions cause additional shipment delays, bookings reductions or collection issues.
- Whether the Lawrence Pumps acquisition closes at the stated approximately $89 million cost and its effect on liquidity and earnings.
- Whether management achieves the projected $116 million of 2011 realignment savings and approximately $120 million annual run-rate savings.
- Whether foreign-exchange movements materially affect reported earnings, comprehensive income and debt or liquidity metrics.
- The status and financial impact of asbestos claims, export-compliance obligations, tax examinations and other contingencies.