Flowserve Corporation 10-Q Summary
Business Context and Reporting Period
Flowserve designs, manufactures, distributes and services pumps, valves, mechanical seals, automation products and related aftermarket services for oil and gas, chemical, power generation, water management and other industrial markets. The filing covers the unaudited three and six months ended June 30, 2010, compared with the corresponding 2009 periods. Effective January 1, 2010, the company reorganized its reporting structure into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD), with prior periods retrospectively adjusted.
Financial Performance and Liquidity
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Sales | $961.1 million | $1,090.4 million | $1,920.0 million | $2,115.1 million |
| Gross profit | $343.4 million | $386.3 million | $691.7 million | $754.1 million |
| Gross margin | 35.7% | 35.4% | 36.0% | 35.7% |
| Operating income | $146.0 million | $158.8 million | $288.2 million | $305.9 million |
| Operating margin | 15.2% | 14.6% | 15.0% | 14.5% |
| Net earnings attributable to Flowserve | $91.6 million | $108.2 million | $171.9 million | $200.5 million |
| Diluted EPS | $1.62 | $1.92 | $3.04 | $3.56 |
- Q2 sales declined 11.9% and six-month sales declined 9.2%, primarily because of lower original-equipment demand, reduced beginning backlog and customer project delays.
- Bookings improved 9.5% in Q2 to $1,134.2 million and 10.3% year to date to $2,204.9 million. Backlog at June 30, 2010 was $2,500.7 million, up 5.5% from December 31, 2009, despite approximately $159 million of adverse currency effects.
- Aftermarket sales increased to approximately 38% of Q2 sales and 39% of six-month sales, compared with 35% and 36%, respectively, in the prior-year periods. The higher-margin mix, cost savings and realignment actions supported margin expansion despite lower volume.
- Net cash used in operating activities improved to $52.7 million from $76.9 million in the first half of 2009, but remained negative. Investing cash use was $17.3 million and financing cash use was $39.2 million.
- Cash and cash equivalents were $503.5 million at June 30, 2010, down from $654.3 million at December 31, 2009. Working capital was affected by incentive compensation payments, lower customer advances, reduced accounts payable and higher inventory investment.
- Total debt and capital lease obligations were $565.9 million, including $541.2 million of term debt. The company had no borrowings under its revolving facility and $287.8 million of available revolving borrowing capacity after letters of credit.
- The company declared quarterly dividends of $0.29 per share and repurchased $23.1 million of common stock during the first six months.
Material Changes Versus the Prior Comparable Period
- EPD Q2 sales declined 9.6%, while operating margin improved to 20.3% from 19.6%. Six-month EPD operating income declined 2.2%.
- IPD was the weakest segment: Q2 sales fell 17.8%, gross margin declined to 25.0% from 27.8%, and operating income fell 44.2%. Six-month operating income declined 28.3%.
- FCD Q2 sales declined 11.1%, but gross margin increased to 37.2% from 36.0%; six-month operating income declined 12.9%.
- Other expense increased materially to $12.3 million in Q2 and $33.8 million for the first half, compared with $0.1 million and $9.4 million, respectively, in 2009. The increase primarily reflected foreign-exchange losses, including losses on forward contracts.
- Foreign currency translation produced other comprehensive losses of $58.3 million in Q2 and $92.4 million for the first half, compared with gains in the prior-year periods.
- Realignment charges were $7.6 million in Q2 and $8.1 million for the first half, versus $19.6 million and $29.6 million in the prior-year periods. Cumulative charges reached $76.2 million against an expected total of approximately $87.8 million.
Guidance, Outlook, Risks and Unusual Items
- Management reported improving demand forecasts in oil and gas, power generation, water management and chemical markets, particularly in China and India, while noting that recession-related challenges and project delays remained.
- Management expected approximately $92 million of realignment savings in 2010 and approximately $110 million of annual savings after completion. Actual charges and savings could differ from estimates.
- Full-year 2010 capital expenditures, excluding acquisitions, were expected to be $100 million to $115 million.
- Management believed cash, operating cash flow and available revolving credit would be sufficient for the next 12 months, but identified economic conditions, customer spending, foreign exchange, interest rates and credit-market access as liquidity risks.
- Effective July 16, 2010, after the quarter end, FCD acquired Valbart Srl for approximately €156 million, or about $200 million, including approximately €25 million of assumed net debt that was repaid at closing. Valbart reported approximately €81 million of fiscal 2010 sales.
- Venezuela’s currency devaluation generated a one-time $12.4 million loss in the first quarter, with additional foreign-exchange gains recognized on certain settlements. Venezuela represented approximately 1% or less of consolidated sales and assets.
- Pending matters include asbestos claims, an Iraq civil action and a French investigation related to the United Nations Oil-for-Food Program, export-control disclosures under regulatory review, environmental sites and ordinary-course litigation. Management generally does not expect these matters to be material, but outcomes remain uncertain.
- The previously disclosed shareholder securities litigation was finally settled and dismissed in May 2010. Flowserve contributed $13.5 million, funded from a previously established reserve, and insurers contributed $40 million.
- Management stated that disclosure controls were effective as of June 30, 2010 and that no material changes to internal control over financial reporting occurred during the quarter.
Most Important Facts for Investors to Verify
- Whether stronger bookings and the $2.5 billion backlog convert into sales and operating cash flow, particularly given continued project delays and cancellations.
- Whether IPD’s reduced margins and operating income stabilize, and whether EPD and FCD margin improvements persist after current cost actions.
- The cash-flow impact and financing capacity following the approximately $200 million Valbart acquisition.
- Actual foreign-exchange exposure, including the effect of Euro movements, Venezuela and the $392.0 million of forward-contract notional amounts.
- Progress toward completing the realignment program, the remaining cash charges and the realization of projected savings.
- Potential liabilities or penalties related to asbestos claims, export-control matters, the Oil-for-Food investigation and related litigation.
- The company’s ability to maintain dividends, share repurchases, pension contributions and debt-service obligations while operating cash flow remains negative.