Flowserve Corporation — Q1 2011 Form 10-Q Summary
Business context and reporting period
Flowserve designs, manufactures, distributes and services pumps, valves, mechanical seals, automation products and related flow-control solutions for oil and gas, chemical, power generation, water management and other industrial markets. Operations comprise the Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD). The filing covers the unaudited three months ended March 31, 2011, compared with the three months ended March 31, 2010.
Key financial metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Sales | $997.2 million | $958.9 million | Up 4.0% |
| Gross profit | $347.7 million | $348.3 million | Down 0.2% |
| Gross margin | 34.9% | 36.3% | Down 140 bps |
| Operating income | $130.3 million | $142.2 million | Down 8.4% |
| Operating margin | 13.1% | 14.8% | Down 170 bps |
| Net earnings attributable to Flowserve | $97.0 million | $80.2 million | Up 20.9% |
| Diluted EPS | $1.72 | $1.42 | Up 21.1% |
| Operating cash flow | $(228.2) million | $(149.0) million | Greater use of cash |
Net earnings benefited materially from other income of $8.5 million versus other expense of $21.5 million in the prior-year quarter, primarily reflecting foreign-exchange gains and the absence of the 2010 Venezuela devaluation-related loss. The effective tax rate was 25.7%, compared with 28.4%.
Cash and cash equivalents were $288.9 million at March 31, 2011, down from $557.6 million at December 31, 2010. The cash decline reflected working-capital investment, annual incentive payments, capital expenditures, dividends and share repurchases. Accounts receivable were $909.3 million and inventories were $1.02 billion. Total debt was $525.1 million, including $54.3 million due within one year and $470.9 million due thereafter.
The company had no borrowings under its revolving credit facility and reported $366.0 million of remaining borrowing capacity after letters of credit. Credit facilities mature in December 2015, and the company was in compliance with its debt covenants. Approximately 70% of term debt was fixed-rate after interest-rate swaps.
Material changes versus the prior comparable period
- Bookings increased 8.5% to $1.16 billion, including approximately $19 million of currency benefit. Backlog increased 8.4% from December 31, 2010 to $2.81 billion.
- Sales growth was led by FCD, which benefited from the Valbart acquisition, recovery in oil and gas markets and shipments of previously delayed projects. FCD sales rose 31.8% to $337.6 million and operating income rose 18.5% to $47.5 million.
- EPD sales declined 1.5% to $523.8 million and operating income declined 10.4% to $91.8 million. IPD sales declined 10.1% to $176.3 million and operating income declined 37.6% to $13.1 million.
- Consolidated gross margin declined because of less favorable backlog pricing, lower fixed-cost absorption, commodity-cost increases and a shift toward lower-margin original-equipment sales, particularly in FCD. Aftermarket sales nevertheless increased to approximately 43% of sales from 39%.
- SG&A increased 5.4% to $222.6 million, reflecting higher selling and marketing costs and investment in personnel and growth markets.
- Operating cash use increased primarily because inventory consumed $106.7 million, accounts payable consumed $125.3 million and receivables consumed $43.8 million. Inventory turns declined to 2.5 from 3.0, and DSO increased to 82 days from 77 days.
- Other comprehensive income was $48.6 million versus an expense of $34.1 million, primarily due to foreign-currency translation.
Outlook, commentary, risks and unusual items
Management described market conditions as improved as the global recession stabilized, with favorable oil and gas, chemical and aftermarket trends. Management expected delayed North Africa shipments to be released throughout the remainder of 2011. It projected 2011 capital expenditures of $120 million to $135 million, expected approximately $115 million of realignment savings in 2011 and estimated approximately $120 million of annual run-rate savings when the programs are completed.
Realignment charges were $0.8 million in the quarter; approximately $3 million of additional charges were expected, bringing total approved-program charges to approximately $90 million. The company also expected 2011 U.S. pension contributions of $7 million to $10 million, excluding direct benefits paid. No formal earnings guidance was provided in the filing.
North Africa shipment delays reduced first-quarter operating income by an estimated $2.5 million. The earthquake and tsunami in Japan had not caused significant first-quarter disruption, but potential effects on customers, suppliers and the civilian nuclear market remained under review. Valbart contributed $30.0 million of sales and incurred a $1.4 million operating loss; management did not expect that loss to continue as acquired backlog was delivered and operations were integrated.
Key risks include conversion of bookings and backlog at acceptable margins, raw-material inflation, fixed-price project overruns, international political and currency exposure, export-control compliance, supplier interruptions, customer capital spending, litigation, asbestos claims, environmental liabilities, pension obligations and the integration of acquisitions. The company continued to face asbestos-related claims, an Oil-for-Food investigation and export-compliance proceedings, but management did not expect these matters to have a material adverse effect based on current information. Tax audits could reduce tax expense by an estimated $5.5 million to $18.0 million within the next 12 months.
The company increased its quarterly dividend from $0.29 to $0.32 per share and repurchased 112,500 shares for $13.8 million during the quarter. Management believed existing cash, operating cash flow and revolver availability would meet liquidity needs for the next 12 months, subject to operating, economic, political, currency and interest-rate risks.
Important facts for investors to verify
- Whether backlog converts into revenue without further margin deterioration, particularly in EPD and IPD.
- Inventory reduction, receivables collection and restoration of positive operating cash flow.
- FCD performance after Valbart integration and the end of lower-margin acquired backlog.
- Realignment savings versus remaining charges and cash payments.
- Developments affecting North Africa, the Middle East, Japan, Venezuela and other international operations.
- Changes in commodity costs, pricing and original-equipment versus aftermarket mix.
- Debt maturities, revolver availability, letters of credit and compliance with credit covenants.
- Resolution and potential financial impact of asbestos, export-compliance, Oil-for-Food, environmental and tax matters.