Business Context and Reporting Period
Company: Flowserve Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 1998
Background: Flowserve was formed on July 22, 1997, via a "pooling of interests" merger between BW/IP Inc. and Durco International Inc. The company manufactures engineered pumps, valves, and flow management services for process industries. Historical data is restated to reflect the merger.
Key Financial Metrics
| Metric (in thousands) | Q2 1998 | Q2 1997 | YTD 1998 | YTD 1997 |
|---|---|---|---|---|
| Net Sales | $280,728 | $300,658 | $539,044 | $563,169 |
| Gross Profit | $105,992 | $121,210 | $207,189 | $225,359 |
| Gross Margin % | 37.8% | 40.3% | 38.4% | 40.0% |
| Operating Income | $21,667 | $40,261 | $43,653 | $69,474 |
| Net Earnings | $12,449 | $24,875 | $25,560 | $41,680 |
| Earnings Per Share (Diluted) | $0.31 | $0.61 | $0.63 | $1.02 |
| Cash and Equivalents | $20,849 | (Balance Sheet: Dec 31, 1997: $58,602) | ||
| Total Debt (Current + Long-term) | $174,156 | (Balance Sheet: Dec 31, 1997: $146,789) | ||
| Operating Cash Flow (YTD) | ($3,250) | $29,472 | (Used by operating activities) |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 6.6% in Q2 and 4.3% YTD compared to 1997. Management attributes approximately $9.0 million (Q2) and $15.0 million (YTD) of the decline to unfavorable currency translation due to a stronger U.S. dollar. An additional $6.0 million (Q2) and $12.0 million (YTD) is due to businesses sold in 1997. Remaining declines are linked to low petroleum spending and the Asian economic crisis.
- Margin Compression: Gross profit margins declined from 40.3% to 37.8% in Q2. Causes include reduced high-margin parts sales, under-absorption of costs due to lower volume, and price discounting on valves.
- Merger Integration Expenses: The company incurred $11.9 million in merger integration expenses in Q2 1998 (none in Q2 1997). This includes costs for closing facilities in San Jose, Charleroi, and Guelph, as well as start-up costs for a new business process improvement initiative.
- Cash Flow Reversal: Operating cash flow turned negative ($3.25 million used) for the first six months of 1998, compared to $29.5 million generated in the same period in 1997. This was driven by lower operating profits and working capital changes (specifically a $35.5 million decrease in accounts payable and accrued liabilities).
- Share Repurchases: The company initiated a $100 million share repurchase program in Q2, buying back 1.3 million shares (3% of outstanding) at a cost of $36.6 million.
Guidance, Outlook, and Risks
- Merger Synergies: Management expects the merger integration program to generate $45 million to $55 million in annual operating income savings by the end of three years. Realized savings were $3.8 million (pre-tax) in Q2 1998.
- Business Process Improvement: In July 1998, the Board approved an $18 million expenditure for the first phase of a global initiative expected to cost $120 million over multiple years, with an anticipated $40 million in first-year savings post-completion.
- Acquisition: In July 1998, Flowserve acquired the Valtek Engineering Division from Rolls Royce plc, a business with approximately $20 million in 1997 sales.
- Liquidity and Debt: Total debt increased to 31.8% of the capital structure (from 27.1% at year-end 1997). The company plans to file a $250 million public debt shelf registration to access additional credit markets.
- Risks: Forward-looking statements are subject to risks including competitive pressures, political risks, trade embargoes, continued economic turmoil in Asia/Pacific, and integration difficulties. Net earnings are dependent on global economic conditions.
Investor Verification Checklist
- Merger Integration Costs: Verify the remaining timeline and total cost of the $92.4 million integration program and the new $120 million business process initiative to assess future earnings impact.
- Currency Exposure: Assess the sensitivity of future earnings to U.S. dollar strength, given that 50% of sales are international and currency translation significantly impacted Q2 results.
- Working Capital Trends: Investigate the $35.5 million reduction in accounts payable and accrued liabilities to determine if this was a one-time timing issue or a structural change in supplier terms.
- Share Repurchase Sustainability: Evaluate the company's ability to continue the $100 million buyback program given the negative operating cash flow in the first half of 1998.
- Valtek Acquisition: Monitor the integration and performance of the newly acquired Valtek Engineering Division to ensure it meets the projected contribution to sales.