Flowserve Corporation: FY2012 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2012. The filing is an audited annual report; quarterly data for the fourth quarter is also disclosed. Flowserve manufactures pumps, valves, mechanical seals, automation systems and aftermarket services for oil and gas, chemical, power generation, water management and general industrial customers. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD).
Key Financial Metrics
| Metric | FY2012 | FY2011 | Change |
|---|---|---|---|
| Sales | $4,751.3 million | $4,510.2 million | +5.3% |
| Gross profit | $1,581.0 million | $1,513.6 million | +4.5% |
| Gross margin | 33.3% | 33.6% | -30 bps |
| Operating income | $675.8 million | $618.7 million | +9.2% |
| Operating margin | 14.2% | 13.7% | +50 bps |
| Net earnings attributable to Flowserve | $448.3 million | $428.6 million | +4.6% |
| Diluted EPS | $8.51 | $7.64 | +11.4% |
| Operating cash flow | $517.1 million | $218.2 million | +137.0% |
| Capital expenditures | $135.5 million | $108.0 million | +25.5% |
| Cash and equivalents | $304.3 million | $337.4 million | -9.8% |
| Total debt | $928.6 million | $505.2 million | +83.8% |
FY2012 net margin was approximately 9.4%, compared with approximately 9.5% in FY2011. The effective tax rate declined to 26.3% from 27.0%. Approximately 41% of sales came from aftermarket activities, which management identifies as generally higher margin than original equipment sales.
Fourth-Quarter Data
| Metric | Q4 2012 | Q4 2011 | Change |
|---|---|---|---|
| Sales | $1,328.2 million | $1,265.4 million | +5.0% |
| Gross profit | $447.6 million | $420.0 million | +6.6% |
| Earnings before taxes | $189.8 million | $180.2 million | +5.3% |
| Net earnings attributable to Flowserve | $141.6 million | $125.1 million | +13.2% |
| Diluted EPS | $2.83 | $2.25 | +25.8% |
Business and Segment Performance
- Bookings: $4.7 billion, up 1.1% despite approximately $204 million of unfavorable currency effects. Backlog was $2.649 billion at year-end, down 1.5% from 2011; approximately 24% was aftermarket-related.
- EPD: Sales of $2.403 billion and operating income of $396.1 million. Sales increased 3.5%, while operating margin declined to 16.5% from 17.0% due principally to lower-margin projects shipped from backlog. Year-end backlog was $1.400 billion.
- IPD: Sales of $953.9 million and operating income of $99.5 million. Sales increased 8.6% and operating income increased 58.2%, benefiting from operational improvements and the absence of 2011 recovery-plan charges. Year-end backlog was $593.0 million.
- FCD: Sales of $1.557 billion and operating income of $253.4 million. Sales increased 5.7% and operating income increased 8.6%, although bookings declined 4.8% because of project delays, particularly in oil and gas. Year-end backlog was $723.9 million.
- Geographic and industry mix: International customers represented 71% of sales. Oil and gas accounted for approximately 41% of bookings, general industries 22%, chemical 19%, power generation 14% and water management 4%.
Cash Flow, Debt and Liquidity
- Operating cash flow increased to $517.1 million, despite $72.7 million invested in inventory and $35.1 million used by accounts receivable. Fourth-quarter days sales outstanding remained 75 days; inventory turns declined to 3.2 from 3.4.
- Cash used in financing was $428.9 million, including $771.9 million of share repurchases, $73.8 million of dividends and $80.0 million of net debt repayments. Cash declined by $33.1 million during the year.
- Flowserve issued $500 million of 3.50% senior notes due 2022 and entered into a new $1.25 billion senior credit facility consisting of a $400 million term loan and an $850 million revolving facility due 2017.
- At year-end, the company reported $697.8 million of borrowing capacity under the revolving facility, including outstanding letters of credit. It was in compliance with debt covenants, including a maximum leverage ratio of 3.25 times and minimum interest coverage of 3.25 times.
- Approximately 70% of debt was fixed-rate after interest-rate swaps. The company expects 2013 interest expense to be higher because of increased debt.
- Management stated that operating cash flow, cash balances and revolver availability should be sufficient for the next 12 months and beyond, subject to business, market and currency risks.
Material Changes Versus FY2011
- Revenue and operating income increased, but gross margin declined modestly because of the shipment mix of lower-margin EPD projects.
- Operating margin improved because SG&A declined to 19.4% of sales from 20.3%, supported by cost management and a $10.4 million gain on the sale of the Rio de Janeiro manufacturing facility.
- Other expense increased to $21.6 million from $3.7 million of other income, primarily because of foreign-currency transaction losses.
- Debt increased substantially following the new financing structure, while equity declined primarily because of $771.9 million in share repurchases.
- Operating cash generation materially improved from the prior year, when working-capital increases and delayed collections significantly constrained cash flow.
- The quarterly dividend increased from $0.32 to $0.36 per share during 2012. In February 2013, the board approved an increase to $0.42 per share and a new $750 million repurchase authorization.
Outlook, Risks and Unusual Items
- Management expected a competitive and uncertain global economic environment in 2013, with results weighted toward the second half. No formal revenue or EPS guidance was provided.
- Management cited the aftermarket business, end-user strategy, disciplined cost control, customer diversity and global product portfolio as key supports for 2013.
- Expected 2013 investing cash outflows were $120 million to $130 million before acquisitions. Planned pension contributions were approximately $20 million for the U.S. plan and $10 million for non-U.S. plans.
- The company expected to ship 81% of EPD, 74% of IPD and 88% of FCD year-end backlog during 2013. Backlog remains exposed to cancellations, customer financing, commodity prices, capacity constraints, supply disruptions and delivery penalties.
- Major risks include cyclical customer capital spending, pricing pressure, raw-material cost volatility, foreign exchange exposure, international political and regulatory risks, debt covenants, pension assumptions, product liability, warranty claims, asbestos litigation and environmental obligations.
- At year-end, pension benefit obligations were $763.9 million, compared with plan assets of $553.4 million. Management expected 2013 pension expense to increase by approximately $10 million.
- The company reported no goodwill impairment in 2012 and stated that reporting-unit fair values substantially exceeded carrying values.
- Subsequent to year-end, Venezuela announced a currency devaluation. Flowserve estimated a preliminary after-tax charge of approximately $3 million in the first quarter of 2013; Venezuelan sales and assets were each less than 1% of consolidated amounts.
- Flowserve was involved in asbestos claims, an Oil-for-Food investigation and related litigation, Superfund sites and routine legal matters. Management did not expect these matters to have a material financial impact, although outcomes remain uncertain.
Investor Verification Checklist
- Verify whether backlog converts to revenue and margin as planned, particularly the lower-margin EPD projects and the percentage expected to ship in 2013.
- Assess the sustainability of the 2012 operating-margin improvement and IPD recovery, excluding the $10.4 million facility-sale gain.
- Monitor working-capital trends, including 75-day DSO, inventory turns and customer payment timing.
- Reconcile the higher debt balance with planned share repurchases, dividends, pension contributions and the company’s targeted 1.0x–2.0x gross leverage range.
- Evaluate sensitivity to foreign currency movements, raw-material prices, interest rates and customer capital-spending decisions.
- Review pension funding requirements, asbestos and environmental reserves, tax uncertainties and contractual letters of credit and surety-bond commitments.
- Confirm the effect and timing of the February 2013 dividend increase, repurchase authorization, proposed 3-for-1 stock split and Venezuelan devaluation charge.