Flowserve Corporation 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
Flowserve Corporation manufactures and services flow-control equipment, including pumps, valves, seals, automation products and related aftermarket services. Its principal markets include oil and gas, chemical, power generation, water management and general industrial applications. Operations are reported through the Flowserve Pump Division (FPD) and Flow Control Division (FCD). The filing covers the unaudited three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Sales | $996.5 million | $952.7 million | $2,876.7 million | $2,845.8 million |
| Gross profit | $333.7 million | $308.5 million | $945.8 million | $866.0 million |
| Gross margin | 33.5% | 32.4% | 32.9% | 30.4% |
| Operating income | $109.6 million | $62.2 million | $298.8 million | $154.3 million |
| Operating margin | 11.0% | 6.5% | 10.4% | 5.4% |
| Net earnings attributable to Flowserve | $68.4 million | $28.2 million | $183.9 million | $56.6 million |
| Diluted EPS | $0.52 | $0.21 | $1.40 | $0.43 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $144.0 million | $26.3 million |
At September 30, 2019, cash and cash equivalents were $547.3 million, compared with $619.7 million at December 31, 2018. Debt and finance lease obligations totaled $1.360 billion, including $1.350 billion due after one year. Working capital included $687.2 million of inventory and $258.3 million of current contract assets.
Capital expenditures were $44.6 million during the first nine months, and management expected full-year 2019 capital expenditures of approximately $75 million to $85 million. The company paid $74.7 million of dividends and repurchased $5.4 million of common stock during the nine-month period.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 4.6%; nine-month sales increased 1.1%. Management cited aftermarket growth, partially offset by unfavorable currency effects.
- Q3 gross margin increased 110 basis points, and nine-month gross margin increased 250 basis points. Drivers included higher-margin projects, a greater aftermarket mix, operational improvements and lower realignment charges.
- Q3 operating income rose 76.2%, while nine-month operating income rose 93.6%. Results benefited from improved gross profit, lower SG&A, lower transformation costs and the absence of the $7.7 million 2018 business-divestiture loss.
- SG&A as a percentage of sales declined to 22.7% in Q3 from 25.4% and to 22.8% for nine months from 25.0%.
- The effective tax rate declined to 26.7% in Q3 from 33.6% and to 25.3% for nine months from 37.9%, primarily reflecting differences in foreign operations, the BEAT provision and state taxes.
- Operating cash flow improved to $144.0 million from $26.3 million, although inventory growth used $68.7 million of cash during the first nine months.
- Bookings increased 1.3% in Q3 and 7.2% for nine months. Backlog was $2.138 billion at September 30, up 13.0% from December 31, 2018, including approximately 33% aftermarket orders.
Segment Performance
| Segment | Q3 Sales | Q3 Operating Income | Q3 Operating Margin | 9M Operating Income |
|---|---|---|---|---|
| FPD | $682.7 million | $85.5 million | 12.5% | $242.1 million |
| FCD | $314.8 million | $50.0 million | 15.9% | $140.6 million |
FPD produced strong booking and margin growth, supported by aftermarket sales and improved execution. FCD sales increased, but Q3 gross margin and operating income declined because of a mix shift toward lower-margin original equipment orders. FCD nine-month operating income increased modestly and its operating margin was unchanged at 15.4%.
Guidance, Outlook, Risks and Unusual Items
- Management described business conditions as stabilizing, with signs of recovery in large projects as oil prices remained at improved levels. Geopolitical uncertainty was expected to continue affecting maintenance and short-cycle investment.
- Management expected operating cash flows, existing cash and available revolver capacity to meet cash needs for the next 12 months. The filing does not provide formal earnings guidance.
- In July 2019, Flowserve entered into an $800 million unsecured revolving credit facility maturing in 2024. Available capacity was $720.5 million at September 30, 2019, and the company was in compliance with applicable covenants. A temporary $75 million borrowing used to refinance the prior facility was repaid in September.
- The Flowserve 2.0 Transformation generated $5.1 million of Q3 expense and $21.0 million for nine months, versus $24.0 million and $27.4 million, respectively, in 2018. Realignment and transformation charges totaled $9.9 million in Q3 and $20.2 million for nine months.
- The company adopted the new lease standard on January 1, 2019, recording approximately $210 million of operating lease right-of-use assets and liabilities. The adoption did not materially affect earnings or cash flows.
- Material exposures include project cost overruns, customer cancellations, dependence on capital spending in oil and gas and other cyclical industries, foreign exchange, raw-material costs, international political and regulatory risks, receivable collection, litigation, asbestos claims, environmental matters, cybersecurity and potential impairment of goodwill or other intangible assets.
- Flowserve remains involved in asbestos-related claims, environmental remediation matters, routine litigation and a previously disclosed DOJ and SEC matter concerning a potential Foreign Corrupt Practices Act violation. Management stated that these matters were not expected to have a material adverse financial impact, although outcomes remain uncertain.
Important Facts for Investors to Verify
- Whether backlog and bookings convert into revenue at expected margins, particularly given customer cancellation, delay and project-execution risks.
- Whether improved gross margins and operating performance are sustainable after transformation, realignment and divestiture-related benefits subside.
- Inventory, contract assets and receivables growth, including the effect on future operating cash flow and working-capital requirements.
- Debt maturities, revolver availability, covenant compliance and the effect of currency movements on Euro-denominated debt and earnings.
- The resolution and ultimate financial exposure from asbestos, environmental, tax, litigation and regulatory matters.
- Management’s stated full-year capital expenditure range of $75 million to $85 million and the absence of formal earnings guidance in the filing.