Business Context and Reporting Period
Company: FLOWSERVE CORP
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2005
Filing Date: July 27, 2006 (Delayed due to restatement and Section 404 compliance issues)
Business Overview: Flowserve designs, manufactures, and services industrial flow management equipment (pumps, valves, mechanical seals) primarily for the petroleum, chemical, power, and water industries. The company operates through three segments: Flowserve Pump Division, Flow Solutions Division, and Flow Control Division.
Key Financial Metrics
Amounts in thousands, except per share data.
| Metric | Three Months Ended June 30, 2005 |
Three Months Ended June 30, 2004 |
Six Months Ended June 30, 2005 |
Six Months Ended June 30, 2004 |
|---|---|---|---|---|
| Sales | $691,165 | $618,276 | $1,307,283 | $1,195,335 |
| Gross Profit | $222,702 | $191,698 | $413,845 | $364,692 |
| Gross Margin | 32.2% | 31.0% | 31.7% | 30.5% |
| Operating Income | $56,303 | $42,930 | $82,130 | $82,435 |
| Net Earnings | $17,950 | $6,272 | $13,936 | $13,414 |
| Diluted EPS (Net) | $0.32 | $0.11 | $0.25 | $0.24 |
| Cash & Equivalents | $41,191 (as of June 30, 2005) | |||
| Total Debt | $691,427 (as of June 30, 2005) | |||
| Operating Cash Flow | N/A (Quarterly) | $(2,600) | $36,090 |
Material Changes vs. Prior Period
- Revenue Growth: Sales increased 9.2% in the quarter and 6.7% in the six-month period compared to 2004, driven by improved markets in oil & gas, power, and water sectors, and the impact of the TKL acquisition.
- Profitability: Operating income increased 26.7% in the quarter but was flat for the six-month period. Gross margins improved across all segments due to higher sales of engineered products and services.
- Discontinued Operations: The General Services Group (GSG) was classified as discontinued operations. A $5.9 million impairment charge was recorded in the first quarter of 2005 related to GSG. Net earnings for the six months were impacted by a $7.5 million loss from discontinued operations.
- SG&A Expenses: Selling, general, and administrative expenses increased significantly (15.2% for six months) due to higher employee-related costs, including $6.2 million in stock option modification expenses for former executives and increased professional fees.
- Tax Rate: The effective tax rate decreased significantly from 62.7% in the prior year six-month period to 38.9% in 2005, primarily due to the net impact of foreign operations.
Guidance, Outlook, Risks, and Unusual Items
- Refinancing (Subsequent Event): In August 2005, the company entered into new credit facilities ($600M term loan, $400M revolver) to refinance the 2000 Credit Facilities and call the 12.25% Senior Subordinated Notes. This resulted in a $27.7 million loss on extinguishment of debt recorded in Q3 2005.
- Legal Proceedings:
- SEC Investigation: The SEC concluded its investigation into the 2004 financial restatement in May 2006 without recommending enforcement action.
- Securities Litigation: A consolidated securities class action lawsuit is pending, set for trial in March 2007.
- Oil-for-Food Program: The company is under investigation by the SEC and foreign authorities regarding goods and services delivered to Iraq between 1996 and 2003. The company is conducting an internal investigation.
- Export Controls: An internal review initiated in March 2006 suggests potential non-compliance with U.S. export control laws, which could result in penalties.
- Internal Controls: Management concluded that disclosure controls and procedures were not effective as of June 30, 2005. Material weaknesses were identified in the control environment, financial reporting processes, and stock-based compensation accounting.
- Stock Options: Due to delayed SEC filings, stock options were unexercisable. The company expects to reopen the exercise program in 2006, which could impact cash flow and EPS.
Investor Verification Checklist
- Debt Covenant Compliance: Verify the status of the new credit facilities entered in August 2005 and compliance with leverage and interest coverage covenants.
- Legal Exposure: Monitor the outcome of the SEC and foreign investigations regarding the UN Oil-for-Food program and the status of the securities class action lawsuit.
- Internal Control Remediation: Review progress on remediation of material weaknesses in internal controls over financial reporting, specifically regarding stock-based compensation and revenue recognition.
- Discontinued Operations: Confirm the final settlement of the GSG divestiture and any remaining working capital adjustments.
- Export Compliance: Assess the potential financial impact of the ongoing review of U.S. export control law compliance.