Flowserve Corporation — Q1 2012 Form 10-Q Summary
Business context and reporting period
Flowserve designs, manufactures, distributes and services industrial flow-management equipment, including pumps, valves, seals, automation products and aftermarket services. Its principal markets include oil and gas, chemical, power generation, water management and general industry. Operations are organized into Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD). This unaudited report covers the three months ended March 31, 2012, compared with the three months ended March 31, 2011.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Sales | $1,075.0 million | $997.2 million | +7.8% |
| Gross profit | $359.2 million | $347.7 million | +3.3% |
| Gross margin | 33.4% | 34.9% | -150 bps |
| Operating income | $142.5 million | $130.3 million | +9.4% |
| Operating margin | 13.3% | 13.1% | +20 bps |
| Net earnings attributable to Flowserve | $93.1 million | $97.0 million | -4.0% |
| Diluted EPS | $1.69 | $1.72 | -1.7% |
| Operating cash flow | $(107.9) million | $(228.2) million | Improved $120.3 million |
Bookings increased 7.1% to $1,245.0 million, including approximately $27 million of unfavorable currency impact. Backlog rose 6.2% from December 31, 2011 to $2,856.7 million; approximately 24% was aftermarket-related. International customers represented approximately 70% of sales.
Gross margin declined primarily because of lower-margin shipments from certain large EPD projects and a shift toward original equipment sales, which generally carry lower margins than aftermarket sales. SG&A declined 0.3% to $221.9 million, and SG&A as a percentage of sales improved to 20.6% from 22.3%.
Cash and cash equivalents were $172.7 million at March 31, 2012, down from $337.4 million at year-end 2011. The decline reflected working-capital investment, annual incentive compensation payments, capital expenditures, dividends and share repurchases. Inventory increased to $1,141.3 million from $1,008.4 million, while accounts payable declined to $501.5 million from $597.3 million.
Total debt was $499.4 million, consisting primarily of a $468.8 million term loan and $30.7 million of capital lease obligations and other borrowings. The company had $346.4 million of borrowing capacity under its revolving credit facility after outstanding letters of credit. Management stated that it complied with all debt covenants and expects cash, operating cash flow and available revolving capacity to meet cash needs for the next 12 months.
Capital expenditures were $28.7 million. Management expects 2012 investing cash flows for strategic initiatives, expansion, information technology and cost reduction opportunities to be $125 million to $135 million, excluding potential acquisitions. The company repurchased 185,000 shares for $22.0 million and paid $17.4 million in dividends during the quarter. The quarterly dividend was increased from $0.32 to $0.36 per share beginning with the April 2012 payment.
Material changes versus the prior comparable period
- Sales and bookings increased, driven principally by original equipment demand in the chemical and oil and gas industries, with growth across all divisions.
- Operating income improved despite lower gross margin, supported by cost controls, lower SG&A and a $10.4 million gain on the sale of a Rio de Janeiro manufacturing facility.
- Net earnings declined because other income of $8.5 million in Q1 2011 became other expense of $4.9 million in Q1 2012. The change primarily reflected foreign-exchange contract and transactional currency losses.
- The effective tax rate increased to 27.5% from 25.7%.
- Operating cash use improved substantially year over year but remained negative because of inventory growth and lower accounts payable.
- Segment sales increased 2.1% in EPD, 20.9% in IPD and 7.8% in FCD. FCD operating margin improved to 15.3%, while EPD and IPD gross margins declined.
- The October 2011 acquisition of Lawrence Pumps was included in consolidated results; no pro forma information was provided because management considered the acquisition immaterial.
Guidance, outlook, commentary and risks
Management reported improved long-cycle project bookings, stable oil and gas conditions, increased chemical-industry activity in Asia Pacific and the Middle East, and favorable aftermarket conditions. Power-industry investment remained moderate while customers awaited greater clarity on environmental regulations. Management also reported no operating-income impact from prior North Africa shipment delays during the quarter.
Management anticipates 2012 U.S. pension contributions of $20 million to $25 million, excluding direct benefits paid. It expects potential reductions in tax expense of $14.7 million to $28.4 million within the next 12 months from tax audits and statute-of-limitations expirations, although the timing and outcome are uncertain.
Key risks include conversion of bookings and backlog into profitable sales, project cost overruns, customer cancellations or delays, dependence on oil and gas, chemical, power and water markets, raw-material costs, foreign currency volatility, international political and regulatory developments, supplier performance, competition, acquisitions, goodwill impairment, pension obligations and litigation.
Material contingencies include asbestos-related claims, the United Nations Oil-for-Food investigation and related civil litigation, and remediation obligations at seven former waste-disposal sites. Management believes existing reserves, insurance and indemnities are adequate for probable and estimable exposures and does not currently expect these matters to have a material adverse effect, but unfavorable outcomes could materially affect results.
Important facts for investors to verify
- Whether the $2.86 billion backlog converts to revenue at expected margins, particularly given lower-margin large-project shipments.
- Whether inventory and accounts-payable trends normalize and operating cash flow turns positive.
- The sustainability of FCD margin improvement and the margin recovery prospects for EPD and IPD.
- The effect of foreign-exchange movements and derivative losses on earnings and cash flow.
- Actual 2012 capital expenditures, pension contributions and shareholder returns relative to management expectations and policy.
- The timing and amount of any tax benefits from audits and statute-of-limitations expirations.
- Developments in asbestos claims, Oil-for-Food matters, environmental sites and other litigation.
- Revolver availability, letters of credit, debt repayments and compliance with credit-facility covenants.