Flowserve Corporation — Q3 2014 Form 10-Q Summary
Business context and reporting period
Flowserve designs, manufactures and services pumps, valves, seals, automation products 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, Industrial Product Division and Flow Control Division. The filing covers the unaudited three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Sales | $1,204.0 million | $1,229.1 million | $3,496.5 million | $3,565.2 million |
| Gross profit | $421.5 million | $422.7 million | $1,228.9 million | $1,217.6 million |
| Gross margin | 35.0% | 34.4% | 35.1% | 34.2% |
| Operating income | $192.4 million | $193.4 million | $551.1 million | $547.4 million |
| Operating margin | 16.0% | 15.7% | 15.8% | 15.4% |
| Net earnings attributable to Flowserve | $128.6 million | $126.3 million | $359.8 million | $344.4 million |
| Diluted EPS | $0.93 | $0.90 | $2.60 | $2.41 |
| Operating cash flow | Not separately provided | Not separately provided | $126.2 million | $108.9 million |
Q3 bookings were $1,274.8 million, up 3.7%; nine-month bookings were $3,851.4 million, up 5.9%. Backlog was $2,822.3 million at September 30, 2014, up 10.4% from December 31, 2013, with approximately 25% related to aftermarket orders. Aftermarket sales represented approximately 41% of Q3 sales and 42% of nine-month sales, compared with 38% and 40%, respectively, in the prior-year periods.
Cash and cash equivalents were $162.9 million at September 30, 2014, compared with $363.8 million at year-end 2013. Nine-month investing cash flow was negative $35.2 million, including $83.6 million of capital expenditures and $46.8 million of net proceeds from the sale of the Naval business. Financing cash flow was negative $277.6 million, including $188.3 million of share repurchases, $63.3 million of dividends and $30.0 million of debt repayments.
Total debt was $1,166.8 million, including $54.1 million due within one year and $1,112.6 million due thereafter. The company had no borrowings under its revolving credit facility, $74.8 million of outstanding letters of credit and approximately $925.2 million of available revolving capacity. All applicable credit-facility covenants were satisfied.
Material changes versus the prior comparable period
- Sales declined 2.0% in Q3 and 1.9% for the first nine months, primarily because of lower original-equipment sales, unfavorable currency effects and weaker Europe and Middle East sales.
- Gross and operating margins improved in both comparison periods, driven by increased aftermarket mix, operational improvements, cost reductions and selective bidding.
- Net earnings and diluted EPS increased despite lower sales. The nine-month effective tax rate declined to 28.0% from 30.9%, versus 28.8% and 30.6% in Q3 2014 and Q3 2013, respectively.
- Interest expense increased $2.1 million in Q3 and $7.0 million year-to-date, primarily because of senior notes issued in the fourth quarter of 2013.
- The 2013 AIL joint-venture transactions generated $28.3 million of pre-tax gains in 2013 that did not recur. In 2014, the company sold its Naval business for $46.8 million of net cash proceeds and recorded a $13.4 million pre-tax gain.
- Operating cash flow increased to $126.2 million from $108.9 million, but cash declined substantially because of repurchases, dividends, capital spending, debt repayment and foreign-exchange effects.
- Other comprehensive loss was $95.7 million in Q3 and $80.6 million for nine months, primarily due to foreign-currency translation losses, especially the weakening euro.
Guidance, outlook, management commentary and risks
Management reported strengthening bookings in oil and gas and general industries, partially offset by weakness in power generation. North America and Europe remained stronger, while Asia Pacific bookings declined. Management expects 2014 capital expenditures of approximately $150 million to $160 million and believes operating cash flow, existing cash and revolving-credit availability will be sufficient for the next 12 months.
Management continues to emphasize aftermarket expansion through its global network of 172 Quick Response Centers, supply-chain improvements, lean manufacturing, cost control and localized customer support. The 2013 realignment program is expected to total $15.8 million of charges, with $12.5 million incurred through September 30, 2014; most remaining cash payments were expected by year-end 2014.
Principal risks include conversion of bookings and backlog into profitable sales, project cost overruns, customer capital spending, oil and gas and power-market conditions, raw-material costs, international political and economic conditions, foreign-exchange volatility, slower Latin American receivable collections, interest-rate exposure, supplier performance, litigation, environmental liabilities and tax audits. Venezuela remains subject to currency-market uncertainty; estimated additional remeasurement losses would be approximately $7 million using the SICAD I rate or $13 million using the SICAD II rate.
Material contingencies include asbestos-related claims, environmental remediation at five former waste sites, the French investigation relating to the United Nations Oil-for-Food Program and a related Iraq civil appeal. Management does not currently expect these matters to have a material adverse effect, although outcomes are inherently uncertain. The company also estimates that resolution of tax audits and statute expirations could reduce tax expense by approximately $9.2 million within the next 12 months.
Investor verification items
- Verify the sustainability of the higher aftermarket mix, margin expansion and elevated backlog conversion.
- Monitor working-capital requirements, including inventory growth, 84-day DSO and slower Latin American collections.
- Reconcile cash use from share repurchases and dividends with debt repayment and available liquidity.
- Assess foreign-currency exposure, particularly euro, British pound and Venezuelan currency risks, including the $27 million estimated nine-month earnings sensitivity to a 10% currency movement.
- Review debt maturities, floating-rate exposure, interest-rate swaps, letters of credit and compliance with credit covenants.
- Track the Naval disposition, Innomag contingent consideration, realignment charges and any nonrecurring gains or losses.
- Follow asbestos, Oil-for-Food, environmental and tax contingencies, including potential changes to recorded reserves or recoveries.
- Confirm that management’s $150 million to $160 million capital-expenditure expectation and stated 12-month liquidity assessment remain appropriate.