Flowserve Corporation — Form 10-Q Summary
Business context and reporting period
Flowserve is a global manufacturer and aftermarket service provider of pumps, valves, seals, automation products and related services for oil and gas, chemical, power generation, water management and industrial customers. It operates through Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD), with approximately 18,000 employees, more than 50 countries and 177 quick-response centers.
This unaudited filing covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. Approximately 70% of sales were to international customers. The company completed a three-for-one stock split in June 2013; historical share and per-share data were retrospectively adjusted.
Financial performance and key metrics
| Metric | Q3 2013 | Q3 2012 | Change |
|---|---|---|---|
| Sales | $1,229.1 million | $1,165.9 million | +5.4% |
| Gross profit | $422.7 million | $389.6 million | +8.5% |
| Gross margin | 34.4% | 33.4% | +100 basis points |
| Operating income | $193.4 million | $165.7 million | +16.7% |
| Operating margin | 15.7% | 14.2% | +150 basis points |
| Net earnings attributable to Flowserve | $126.3 million | $106.3 million | +18.8% |
| Diluted EPS | $0.90 | $0.69 | +30.4% |
| Metric | First nine months 2013 | First nine months 2012 | Change |
|---|---|---|---|
| Sales | $3,565.2 million | $3,423.1 million | +4.2% |
| Gross profit | $1,217.6 million | $1,133.4 million | +7.4% |
| Gross margin | 34.2% | 33.1% | +110 basis points |
| Operating income | $547.4 million | $473.0 million | +15.7% |
| Operating margin | 15.4% | 13.8% | +160 basis points |
| Net earnings attributable to Flowserve | $344.4 million | $306.7 million | +12.3% |
| Diluted EPS | $2.41 | $1.91 | +26.2% |
Q3 bookings were $1,229.8 million, up 3.7%; year-to-date bookings were $3,635.4 million, essentially unchanged from 2012. Backlog was $2,700.1 million at September 30, 2013, up 1.9% from December 31, 2012, with approximately 25% related to aftermarket orders.
Q3 SG&A was $231.6 million, or 18.8% of sales, versus 19.5% in 2012. The nine-month SG&A ratio was 19.8% versus 19.7%. The effective tax rate increased to 30.6% in Q3 and 30.9% year to date, compared with 26.1% and 26.8%, respectively, in 2012.
Segment performance was mixed. Q3 EPD sales increased 14.8% and operating income increased 31.0%; IPD sales declined 8.7% and operating income declined 5.3%; FCD sales were essentially flat while operating income increased 12.3%. For the first nine months, EPD sales increased 7.5%, IPD sales declined 2.3% and FCD sales increased 2.5%.
Cash flow, liquidity and debt
- Operating cash flow for the first nine months was $108.9 million, down from $122.6 million in 2012.
- Investing cash flow was an outflow of $57.6 million, including $94.7 million of capital expenditures, $10.1 million for the AIL plug-valve business and $46.2 million of proceeds from selling the AIL equity interest.
- Financing cash flow was an outflow of $237.0 million, including $370.1 million of share repurchases and $57.3 million of dividends, partially offset by $196.0 million of short-term borrowings.
- Cash declined to $113.8 million from $304.3 million at December 31, 2012. Inventory increased by $101.7 million and accounts payable declined by $127.0 million during the nine months.
- Total debt was $1,108.2 million at September 30, 2013, including $498.2 million of 3.50% senior notes, $380.0 million of term debt and $196.0 million drawn on the revolving facility.
- The company had $535.6 million of remaining borrowing capacity after outstanding revolver borrowings and letters of credit. It complied with all debt covenants.
- On October 4, 2013, after quarter-end, the credit agreement was amended to extend maturity to October 2018, increase revolving capacity to $1.0 billion and remove the performance-letter-of-credit sublimit.
Material changes, outlook and unusual items
- Management cited operational improvements, cost control and disciplined order selection as key drivers of margin expansion. Aftermarket remained a higher-margin and strategically important business, although its share of Q3 sales declined to approximately 38% from 39%.
- The March 2013 exit from the Audco India joint venture generated pre-tax gains of $15.3 million from remeasurement of acquired assets and $13.0 million from selling the equity interest. These gains materially benefited year-to-date results and are not expected to recur at the same level.
- Management expected 2013 capital expenditures of $120 million to $130 million before acquisitions. The filing does not provide explicit revenue or earnings guidance.
- Management stated that operating cash flow, existing cash and available revolver capacity should be sufficient to meet cash needs for the next 12 months, subject to business and market risks.
- The company repurchased 1.1 million shares for $63.8 million in Q3 and had $472.6 million remaining under its repurchase authorization at September 30, 2013. The quarterly dividend was $0.14 per share.
- Venezuela’s February 2013 currency devaluation produced a $4.0 million first-quarter loss. Venezuelan operations represented less than 1% of consolidated sales and assets.
- Material risk areas include global industrial demand, order cancellations or delays, fixed-fee project cost overruns, raw-material costs, foreign currency exposure, international political and regulatory risks, litigation, environmental obligations, pension obligations and access to debt financing.
- Outstanding legal matters include asbestos claims, a French investigation related to the United Nations Oil-for-Food Program, an appealed Iraq civil suit and environmental remediation obligations. Management does not currently expect these matters to have a material adverse effect, although outcomes remain uncertain.
Most important facts for investors to verify
- Whether margin gains from operational improvements are sustainable after the nonrecurring AIL transaction gains are excluded.
- Conversion of the $2.7 billion backlog into revenue and cash flow, including cancellation, delay and margin risks.
- Working-capital trends, particularly inventory growth and lower accounts payable, and their effect on operating cash generation.
- Debt maturities, floating-rate exposure, revolver availability and the effect of the October 2013 credit-facility amendment.
- The sustainability of share repurchases and dividends given reduced cash balances and increased debt.
- Exposure to foreign-exchange movements, including the filing’s estimate that a 10% currency movement could affect nine-month net earnings by approximately $25 million before considering forward contracts.
- Resolution and reserve adequacy for asbestos, environmental, tax and other legal contingencies.