Flowserve Corporation 2016 Q3 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 markets. Operations are conducted through Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD), with approximately 18,000 employees and 185 quick-response centers in more than 50 countries. This unaudited filing covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Sales | $943.3 million | $1,096.5 million | $2,916.8 million | $3,273.3 million |
| Gross profit / margin | $265.4 million / 28.1% | $388.8 million / 35.5% | $898.2 million / 30.8% | $1,089.6 million / 33.3% |
| Operating income (loss) / margin | $(2.8) million / (0.3)% | $167.8 million / 15.3% | $169.6 million / 5.8% | $388.8 million / 11.9% |
| Net earnings attributable to Flowserve | $(20.9) million | $93.6 million | $79.9 million | $196.3 million |
| Diluted EPS | $(0.16) | $0.70 | $0.61 | $1.46 |
| Operating cash flow | Not separately provided | Not separately provided | $58.2 million | $131.0 million |
Bookings declined 9.2% in the quarter to $959.5 million and 11.1% year to date to $2,855.0 million. Backlog was $2,137.7 million at September 30, 2016, down 1.6% from December 31, 2015; approximately 30.4% was aftermarket-related. Aftermarket sales represented approximately 44% of sales in both the quarter and year-to-date period, compared with approximately 42% and 43%, respectively, in the prior-year periods.
Cash and cash equivalents were $260.9 million at September 30, 2016, down from $366.4 million at year-end 2015. Total debt and capital lease obligations were $1.611 billion, including $75.2 million due within one year and $1.536 billion due thereafter. The company had no revolving credit borrowings, $608.8 million of available revolving capacity, and complied with all debt covenants. The quarterly dividend was $0.19 per share; no common shares were repurchased during the quarter or first nine months.
Material Changes Versus the Prior Comparable Period
- Q3 sales decreased 14.0% and nine-month sales decreased 10.9%, including negative currency effects of approximately $20 million and $90 million, respectively. Declines were concentrated in original equipment and reflected weaker customer spending across most regions and industries.
- Q3 gross margin fell 740 basis points, while nine-month gross margin fell 250 basis points. Drivers included lower volume and fixed-cost absorption, lower-margin backlog shipments, operational inefficiencies from restructuring, realignment charges and a Brazil inventory write-down.
- SG&A increased 21.5% in Q3 and 4.3% year to date. The primary Q3 driver was a $63.2 million reserve for potentially uncollectible Venezuelan receivables, including a $60.9 million charge in EPD.
- Q3 operating results moved from $167.8 million of income to a $2.8 million loss. Nine-month operating income declined 56.4% to $169.6 million.
- Operating cash flow decreased by $72.8 million year to date, although investing cash use improved substantially because the $353.7 million SIHI acquisition payment in 2015 did not recur.
Guidance, Outlook, Risks and Unusual Items
Management expected the challenging environment to persist through 2016, citing broad-based capital-spending declines, oil and gas weakness, pricing pressure, adverse currency effects, geopolitical and economic conditions, and deferred customer maintenance spending. The filing does not provide formal revenue or earnings guidance.
Realignment programs are expected to require approximately $400 million of total investment. Through September 30, 2016, cumulative charges were $188.8 million, including $70.5 million during the first nine months. Management estimated approximately $80 million of savings for the nine-month period and expects annualized run-rate savings of approximately $230 million after completion, with most remaining charges expected in 2016 and 2017. The programs are expected to reduce the global workforce by 15% to 20% from early-2015 levels.
The Venezuela reserve followed significant payment delays, deteriorating economic and political conditions, and a customer bond downgrade to CC. Approximately 7% of gross accounts receivable related to this customer at September 30, 2016, and the filing states that the company continued pursuing payment while conducting business on a prepayment basis.
Other unusual items included a $14.1 million Brazil inventory write-down, a $7.7 million loss on the divestiture of a non-strategic foundry business, and $18.5 million of Venezuelan currency-remeasurement loss recorded in the first quarter of 2015 that did not recur. Management reported no current goodwill impairment indicators but noted deterioration in EPO and IPD results and planned its annual impairment test as of December 31, 2016.
Management believed existing cash, operating cash flow and revolving-credit availability would meet cash needs for the next 12 months. Capital expenditures for 2016 were expected to be $105 million to $115 million. Key risks include customer order cancellations, oil and gas and industrial-cycle exposure, project cost overruns, foreign exchange, emerging-market collections, goodwill impairment, litigation and asbestos claims, environmental liabilities, regulatory investigations, cybersecurity, debt access and execution of the realignment programs.
Investor Verification Checklist
- Verify the sustainability of bookings, backlog conversion and aftermarket mix, particularly as original-equipment demand remains weak.
- Assess whether realignment savings and operating efficiencies offset the remaining approximately $400 million program investment and near-term margin pressure.
- Monitor Venezuelan receivable recoveries and any further exposure in Latin America.
- Review debt maturities, covenant compliance, revolving-credit availability and the effect of interest-rate changes on floating-rate borrowings.
- Evaluate potential goodwill or long-lived-asset impairment in EPO and IPD at the December 31, 2016 annual test.
- Track asbestos claims, the Foreign Corrupt Practices Act matter, environmental sites and other contingencies for developments beyond recorded reserves.
- Confirm the effect of foreign exchange movements, tax audits and possible tax benefits estimated at approximately $10 million within the following 12 months.