Flowserve Corporation 2016 Form 10-K Summary
Business context and reporting period
Flowserve manufactures and services pumps, valves, mechanical seals, automation equipment and related flow-control systems for oil and gas, chemical, power generation, water management and general industrial customers. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD), with approximately 18,000 employees and operations in more than 50 countries.
The filing covers the fiscal year ended December 31, 2016. The fourth quarter is also presented in the filing but is unaudited.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Sales | $3,991.5 million | $4,561.0 million | Down 12.5% |
| Gross profit | $1,231.6 million | $1,487.3 million | Down 17.2% |
| Gross margin | 30.9% | 32.6% | Down 170 basis points |
| Operating income | $277.5 million | $525.6 million | Down 47.2% |
| Operating margin | 7.0% | 11.5% | Down 450 basis points |
| Net earnings attributable to Flowserve | $145.1 million | $267.7 million | Down 45.8% |
| Diluted EPS | $1.11 | $2.00 | Down 44.5% |
| Operating cash flow | $227.6 million | $418.1 million | Down 45.6% |
| Capital expenditures | $89.7 million | $181.9 million | Down 50.7% |
| Total debt | $1,570.6 million | $1,621.0 million | Down $50.4 million |
| Cash and cash equivalents | $367.2 million | $366.4 million | Up $0.7 million |
Fourth-quarter 2016 sales were $1,074.8 million, compared with $1,287.7 million in the fourth quarter of 2015. Fourth-quarter net earnings attributable to Flowserve were $65.1 million, or $0.50 diluted EPS, compared with $71.4 million, or $0.54 diluted EPS. Fourth-quarter earnings before taxes included $29.8 million of realignment charges.
Material changes versus the prior comparable period
- Bookings declined 10.0% to $3.76 billion, and year-end backlog declined 12.7% to $1.90 billion. Approximately 88% of year-end backlog was expected to ship during 2017.
- Sales declines were concentrated in original equipment and reflected lower customer capital spending, particularly in oil and gas, heightened pricing pressure and unfavorable currency effects of approximately $114 million.
- Aftermarket sales increased to approximately 45% of total sales from 43% in 2015, supporting mix and margin resilience, although aftermarket activity was also affected by delayed customer maintenance spending.
- Segment operating income declined to $170.1 million for EPD, $1.0 million for IPD and $198.2 million for FCD. IPD operating margin fell to approximately 0.1%.
- Realignment charges were $104.3 million in 2016, following $118.3 million in 2015. Cumulative charges since program inception were $222.6 million, with most remaining charges expected in 2017.
- The company recorded a $63.2 million reserve for potentially uncollectible receivables from its primary Venezuelan customer and a $1.9 million reserve for related inventory exposures. It also recorded a $15.5 million Brazil inventory write-down.
- Operating cash flow fell substantially, while working-capital cash usage reflected lower accounts payable and accrued liabilities. Capital spending and debt repayments were reduced, and no common-stock repurchases were made during 2016.
Debt, liquidity and capital allocation
Debt consisted principally of $1.31 billion of senior notes and $224.3 million under the term loan facility. The company had no revolving loans outstanding, $102.6 million of letters of credit outstanding and approximately $553.5 million of effective borrowing availability under the $1.0 billion revolving credit facility, subject to covenant limitations. Flowserve reported compliance with its debt covenants at December 31, 2016.
Cash from operations, existing cash and available revolver capacity were expected to fund working capital, capital expenditures, dividends, debt service and pension contributions. The company paid $97.7 million of dividends in 2016, declared dividends of $0.76 per share, and had $160.7 million remaining under its share-repurchase authorization.
Guidance, outlook, risks and unusual items
- Management expected 2017 sales to decline between 6% and 11% because of lower backlog and continued competitive pressure. Results were expected to be weighted toward the second half of 2017.
- 2017 capital expenditures were estimated at $80 million to $90 million, with scheduled term-loan principal repayments of $60 million and expected pension contributions of approximately $26 million.
- Realignment programs were expected to require approximately $400 million of total investment and produce approximately $230 million of annualized run-rate savings when completed. Management estimated approximately $120 million of annual savings had been achieved by year-end 2016.
- Key risks include further weakness in oil and gas and other capital-spending markets, backlog delays or cancellations, pricing pressure, raw-material costs, foreign exchange, international political and economic conditions, debt covenants, pension obligations, cybersecurity, environmental liabilities, asbestos litigation and product warranty claims.
- Goodwill impairment was not recorded, but the estimated fair values of the EPO and IPD reporting units had declined. Management stated that a 100-basis-point increase in cost of capital would reduce the estimated fair values of both reporting units by approximately 13%, potentially increasing future impairment risk.
- The company self-reported a potential Foreign Corrupt Practices Act violation involving an overseas subsidiary to the Department of Justice and SEC and continued to cooperate with both agencies. Management did not expect a material financial impact but could not provide assurance that penalties or additional costs would not arise.
- PricewaterhouseCoopers issued an unqualified audit opinion, and management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2016.
Important facts for investors to verify
- Whether the projected 2017 sales decline and second-half recovery assumptions are supported by bookings, backlog conversion and customer spending trends.
- The timing, cash cost and realized savings from the remaining realignment actions.
- The collectibility and potential further exposure related to Venezuelan receivables and inventory.
- IPD’s ability to recover profitability and the sensitivity of EPO and IPD goodwill to oil-market conditions, operating performance and discount rates.
- Debt covenant headroom, scheduled maturities, revolver availability and the effect of variable interest rates.
- Potential outcomes of asbestos claims, environmental matters, the FCPA-related investigation and other contingencies.
- The effect of foreign exchange movements and the future adoption of new revenue-recognition and lease-accounting standards.