Flowserve Corporation 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 organized into Engineered Product Division, Industrial Product Division and Flow Control Division. The filing covers the unaudited three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Financial performance and key metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Sales | $1,224.4 million | $1,239.5 million | $2,292.5 million | $2,336.1 million |
| Gross profit | $430.3 million | $421.6 million | $807.4 million | $794.9 million |
| Gross margin | 35.1% | 34.0% | 35.2% | 34.0% |
| Operating income | $194.3 million | $183.5 million | $358.6 million | $354.0 million |
| Operating margin | 15.9% | 14.8% | 15.6% | 15.2% |
| Net earnings attributable to Flowserve | $123.5 million | $120.4 million | $231.2 million | $218.2 million |
| Diluted EPS | $0.90 | $0.84 | $1.67 | $1.51 |
Bookings increased 12.6% year over year in the second quarter to $1,384.2 million and increased 7.0% for the first six months to $2,577.7 million. Backlog was $2,849.8 million at June 30, 2014, up 11.5% from December 31, 2013, with approximately 25% attributable to aftermarket orders. Aftermarket sales represented approximately 41% of second-quarter sales and 42% of first-half sales.
Six-month operating cash flow was negative $11.3 million, compared with negative $32.8 million in 2013, primarily reflecting working-capital investment. Capital expenditures were $53.7 million. Financing cash outflows were $200.0 million, including $153.1 million of share repurchases, $41.4 million of dividends and $20.0 million of debt repayment.
Cash and cash equivalents were $143.6 million at June 30, 2014, compared with $363.8 million at December 31, 2013. Total debt was $1,189.6 million, consisting primarily of senior notes and the term loan facility. The company had no borrowings under its revolving credit facility, $920.0 million of available capacity after letters of credit, and complied with applicable debt covenants.
Material changes versus the prior comparable period
- Second-quarter sales declined 1.2%, while first-half sales declined 1.9%, mainly because of lower original-equipment sales and weaker activity in Europe and certain other international markets.
- Gross and operating margins improved, driven by a greater aftermarket mix, operational improvements, cost controls and selectivity in accepting orders.
- Interest expense increased by $1.9 million in the quarter and $5.0 million year to date, primarily because of senior notes issued in the fourth quarter of 2013.
- First-half net earnings from affiliates declined to $5.6 million from $33.8 million because 2013 included $28.3 million of gains from transactions involving the AIL joint venture.
- Flowserve sold its Naval business effective March 31, 2014, receiving $46.8 million of net proceeds and recording a $13.4 million pretax gain. The business contributed $8.2 million of first-quarter 2014 sales before the sale.
- The company repurchased 2.0 million shares for $153.1 million during the first six months and had $231.3 million remaining under its repurchase authorization at June 30, 2014. The quarterly dividend increased to $0.16 per share from $0.14.
- Accounts receivable increased modestly and inventory rose to $1,160.2 million from $1,060.7 million at year-end. Days sales outstanding increased to 85 days from 78 days at June 30, 2013.
Outlook, risks, contingencies and unusual items
Management reported strengthening bookings across industries, particularly oil and gas and chemical, and improving conditions in Europe, North America, the Middle East and Africa. The company expects 2014 capital expenditures of $130 million to $140 million, before acquisitions, and anticipates approximately $13 million of additional U.S. pension contributions. Management stated that operating cash flow, existing cash and revolving-credit availability should be sufficient for the next 12 months.
- Key risks include conversion of backlog into profitable sales, order cancellations or delays, fixed-fee project cost overruns, dependence on capital spending in core industries, raw-material costs, competition and supplier performance.
- International exposure creates risks from foreign exchange, political and economic conditions, sanctions, export controls and currency restrictions. A 10% currency movement was estimated to affect six-month net earnings by approximately $15 million, before considering foreign-exchange contracts.
- Venezuelan currency controls and exchange-rate changes could produce an estimated loss of approximately $4 million using the SICAD I rate or $8 million using the SICAD II rate on the June 30 net monetary asset position.
- Asbestos claims, environmental remediation at five former disposal sites, product liability matters and the United Nations Oil-for-Food investigation remain contingencies. Management does not currently expect these matters to have a material adverse effect, although outcomes are inherently uncertain.
- The 2013 realignment program is expected to total $15.8 million of charges; $12.6 million had been incurred through June 30, 2014, with most remaining cash payments expected by year-end.
- Income tax examinations could result in a reduction of tax expense of approximately $10.9 million within the next 12 months, although timing and outcome are uncertain.
- The company adopted several accounting updates without material impact and was evaluating the future revenue-recognition standard, ASU 2014-09.
Important facts for investors to verify
- Whether strong bookings and the $2.85 billion backlog convert into sales and cash flow at the reported margins.
- Progress in reducing inventory, improving collections and reversing negative operating cash flow.
- Debt repayment requirements, floating-rate exposure and continued availability under the revolving credit facility.
- The sustainability of margin improvement from aftermarket mix and operational initiatives.
- Foreign-exchange, Venezuela and Latin American receivables exposure.
- Potential impacts from asbestos, environmental, Oil-for-Food, tax and other legal contingencies.
- Future share repurchases, dividends and capital expenditures relative to liquidity and leverage.