Flowserve Corporation — Q3 2017 Form 10-Q Summary
Business context and reporting period
Flowserve manufactures flow-control equipment and provides aftermarket services for oil and gas, chemical, power generation, water management and general industrial customers. Operations are conducted through the Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD), with approximately 17,000 employees and 177 quick-response centers in more than 50 countries. The filing covers the three and nine months ended September 30, 2017; financial statements are unaudited.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Sales | $883.4 million | $945.9 million | $2,626.8 million | $2,919.6 million |
| Gross profit / margin | $267.5 million / 30.3% | $278.0 million / 29.4% | $781.0 million / 29.7% | $903.8 million / 31.0% |
| Operating income / margin | $74.0 million / 8.4% | $0.1 million | $250.0 million / 9.5% | $164.8 million / 5.6% |
| Net earnings attributable to Flowserve | $47.6 million | $(15.8) million | $108.5 million | $72.4 million |
| Diluted EPS | $0.36 | $(0.12) | $0.83 | $0.55 |
- Q3 sales declined 6.6%; nine-month sales declined 10.0%. The filing attributes the reductions primarily to lower original-equipment demand and continued capital-spending weakness, especially in oil and gas.
- Q3 operating income benefited from a $75.0 million reduction in SG&A, including the absence of a $73.5 million Venezuelan receivable reserve recorded in Q3 2016, and a $10.9 million gain on the Vogt disposal.
- Nine-month operating income included $141.2 million of pre-tax gains from the Gestra and Vogt dispositions. The nine-month effective tax rate was 43.8%, compared with 40.2% in the prior-year period, partly due to taxes on the divestitures.
- Bookings were $892.9 million in Q3 and $2.820 billion for nine months, down 6.9% and 1.2%, respectively. Backlog was $2.135 billion at September 30, up 12.5% from December 31, 2016, with approximately 31% related to aftermarket orders.
- Aftermarket sales represented approximately 50% of Q3 sales and 49% of nine-month sales, compared with approximately 44% in each prior-year comparable period.
- Operating cash flow was $72.4 million for nine months, compared with $70.9 million in 2016. Investing cash flow was $171.1 million, primarily reflecting $208.8 million of proceeds from business disposals. Capital expenditures were $40.6 million.
- Cash and cash equivalents were $502.1 million at September 30, 2017, compared with $367.2 million at December 31, 2016. Debt totaled $1.587 billion, including $1.506 billion due after one year.
- The company had no borrowings under its revolving credit facility, $91.8 million of outstanding letters of credit and $708.2 million of available revolving capacity. It complied with all debt covenants.
- The quarterly dividend was $0.19 per share; no common-share repurchases were made during the quarter. Remaining repurchase authorization was $160.7 million.
Material changes versus the prior comparable period
- Profitability improved sharply in Q3, while revenue and bookings declined. Gross margin increased in Q3 but declined for the nine-month period because of lower fixed-cost absorption, lower-margin backlog shipments and a $16.9 million IPD contract charge related to Latin American oil and gas platform equipment.
- SG&A fell 26.7% in Q3 and 8.9% for nine months. The improvement reflects the nonrecurrence of the 2016 Venezuela reserve and benefits from the Realignment Programs.
- EPD returned to Q3 segment operating income of $51.8 million from a $22.0 million loss; IPD narrowed its operating loss to $3.6 million from $17.1 million; FCD operating income declined to $48.5 million from $53.7 million.
- Flowserve sold Gestra on May 2, 2017, generating a $130.2 million pre-tax gain, and sold the Vogt product line on July 6, 2017, generating a $10.9 million pre-tax gain. The disposed businesses generated approximately $101 million and $17 million of 2016 revenue, respectively.
- The company revised previously reported periods to correct immaterial accounting errors, primarily involving inventory, receivables, cost of sales and SG&A at two non-U.S. sites. The revised Q3 2016 net loss attributable to Flowserve was $(15.8) million, versus $(20.9) million as previously reported.
- Other comprehensive income was $17.2 million in Q3 and $84.8 million for nine months, driven primarily by foreign-currency translation gains.
Guidance, outlook, risks and unusual items
- Management expects the challenging capital-spending and pricing environment, particularly in oil and gas, to persist through 2017. The filing does not provide formal revenue or EPS guidance.
- The Realignment Programs are expected to require approximately $360 million of total investment and to continue through the remainder of 2017 and into 2018. Through September 30, cumulative charges were $282.6 million; management expects approximately $230 million of annualized run-rate savings upon completion and estimated approximately $150 million of savings during the first nine months of 2017.
- Management expects 2017 capital expenditures of $70 million to $80 million and believes operating cash flow, existing cash and revolving-credit availability will meet cash needs for the next 12 months.
- Brazil operations incurred a $26.0 million long-lived-asset impairment in Q2 2017. The company also recorded the $16.9 million Latin American contract charge noted above.
- Material risks include conversion of backlog and bookings into profitable sales, customer cancellations or delays, oil and gas and other industry spending, project cost overruns, foreign exchange volatility, emerging-market receivable collection, goodwill impairment, supplier performance, litigation, environmental liabilities, cybersecurity, regulatory compliance and execution of cost-saving initiatives.
- Flowserve remains involved in asbestos claims, environmental remediation at five former disposal sites, a French appeal related to the United Nations Oil-for-Food investigation and a DOJ/SEC matter involving a potential Foreign Corrupt Practices Act violation. Management does not currently expect these matters to have a material financial impact, but outcomes remain uncertain.
- Disclosure controls were deemed ineffective as of September 30, 2017 because previously identified material weaknesses in internal control over financial reporting remained outstanding. Management implemented remediation steps and was testing their effectiveness; the weaknesses were not yet considered fully remediated.
- The company expects to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. It expects potentially greater over-time revenue recognition and changes to receivables, inventory, contract assets and contract liabilities, but had not finalized the quantitative impact.
Most important facts for investors to verify
- Whether backlog growth converts into revenue and acceptable margins despite declining bookings and original-equipment demand.
- The sustainability and cash realization of the projected $230 million annualized Realignment Program savings, including remaining charges and execution timing.
- The recurring earnings profile excluding the $141.2 million divestiture gain, the Vogt gain and the nonrecurrence of the 2016 Venezuela reserve.
- IPD contract profitability, Brazil impairment and inventory exposures, and the potential for additional project or asset charges.
- Progress in remediating material weaknesses and whether future filings require additional revisions.
- Debt maturities, covenant headroom, foreign-held cash and the potential $5 million to $15 million U.S. tax cost if permanently reinvested foreign cash is repatriated.
- Outcomes and potential costs of asbestos, environmental, FCPA/SEC-DOJ and United Nations Oil-for-Food matters.