Flowserve Corporation 2019 Q1 Form 10-Q Summary
Business Context and Reporting Period
Flowserve manufactures and services flow-control equipment, including pumps, valves, seals, automation products and aftermarket services for oil and gas, chemical, power generation, water management and general industrial customers. The report covers the unaudited three months ended March 31, 2019, compared with the three months ended March 31, 2018.
Operations are reported in two segments: Flowserve Pump Division (FPD) and Flow Control Division (FCD). The company reorganized and combined its former pump-related segments into FPD; the change did not affect consolidated historical results. Flowserve employed approximately 17,000 people in more than 50 countries and operated approximately 170 Quick Response Centers.
Financial Performance and Key Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $890.1 million | $920.0 million | Down 3.3% |
| Gross profit | $294.1 million | $271.4 million | Up 8.4% |
| Gross margin | 33.0% | 29.5% | Up 350 basis points |
| Operating income | $91.2 million | $45.4 million | Up 100.9% |
| Operating margin | 10.2% | 4.9% | Up 530 basis points |
| Net earnings attributable to Flowserve | $57.3 million | $15.1 million | Up 278.2% |
| Diluted EPS | $0.44 | $0.12 | Up $0.32 |
| Operating cash flow | $38.5 million | $(120.7) million | Improved $159.2 million |
Aftermarket sales were approximately 53% of total sales versus 49% in the prior-year quarter. Management attributed margin improvement to higher-margin project revenue, a more favorable aftermarket mix and operational efficiencies. SG&A declined 10.5% to $205.2 million, or 23.1% of sales versus 24.9% previously.
Bookings increased 14.9% to $1.07 billion, including approximately $40 million of unfavorable currency impact. Backlog was $2.07 billion at March 31, 2019, up 9.2% from December 31, 2018; approximately 36% related to aftermarket orders.
FPD bookings rose 24.2% to $750.2 million, while sales declined 5.4% to $609.4 million. FPD operating margin increased to 13.2% from 5.4%. FCD bookings declined 2.3% to $319.8 million, while sales increased 1.8% to $282.1 million; FCD operating margin increased to 15.7% from 12.2%.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $637.7 million at March 31, 2019, versus $619.7 million at December 31, 2018.
- Operating cash flow was $38.5 million; capital expenditures were $10.6 million.
- Investing cash flow was $28.6 million, including $39.2 million of asset-disposal proceeds, primarily from non-strategic manufacturing facilities.
- Financing cash flow was $(43.8) million, including $24.9 million of dividends and $15.0 million of term-loan repayments.
- Total debt and finance lease obligations were $1.46 billion, including $1.39 billion of debt due after one year. Interest expense was $14.0 million.
- No revolving credit borrowings were outstanding. Available borrowing capacity under the $800 million revolving facility was $575.3 million after letters of credit and covenant limitations.
- All applicable credit-facility covenants were satisfied. The facility matures in October 2020, and scheduled term-loan repayments of $15 million were due in each of the next four quarters.
- Management stated that operating cash flow, existing cash and revolver availability should be sufficient to meet cash needs for the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue declined because of lower original-equipment sales, unfavorable currency effects of approximately $33 million and the absence of approximately $11 million of sales from businesses divested in 2018.
- Profitability improved substantially despite lower sales. Gross profit increased $22.7 million, SG&A decreased $24.0 million and operating income increased $45.8 million.
- The effective tax rate declined to 21.8% from 34.2%, contributing to higher net earnings.
- Operating cash flow shifted from a $120.7 million use to $38.5 million provided, primarily because of improved working-capital movements.
- Flowserve adopted the new lease standard on January 1, 2019, recording approximately $210 million of operating lease right-of-use assets and liabilities at adoption. The adoption did not materially affect earnings or cash flows.
Guidance, Outlook, Commentary and Risks
Management reported stabilization in business conditions and continued momentum in selected markets. With oil prices at improved levels, large-project activity was showing signs of recovery, and management expected customers to increase maintenance and short-cycle investment during 2019. The company expected 2019 capital expenditures of $90 million to $100 million and anticipated approximately $20 million of U.S. pension contributions, excluding direct benefits paid.
The Flowserve 2.0 Transformation generated $8.4 million of expenses in Q1 2019 versus $0.5 million in Q1 2018, primarily for professional services and project management. The substantially completed Realignment Programs generated a net benefit of $11.9 million in Q1 2019, primarily from gains on sales of non-strategic manufacturing facilities, compared with $11.5 million of charges in Q1 2018. Total inception-to-date Realignment Program charges were $335.8 million.
Material risks include conversion of bookings and backlog into profitable sales, project cost overruns, dependence on oil and gas and other cyclical industries, raw-material inflation, foreign-exchange volatility, international political and regulatory risks, customer receivable aging, supplier performance, competition, pension obligations, goodwill impairment, cybersecurity and litigation.
Contingencies include asbestos-related claims, remediation obligations at five former waste-disposal sites and a potential Foreign Corrupt Practices Act matter under review by the Department of Justice and SEC. Management currently believes these matters will not have a material adverse financial impact, but monetary penalties, additional costs or unfavorable litigation outcomes remain possible. Tax audits could reduce tax expense by approximately $18.2 million within the next 12 months, although the timing and outcome are uncertain.
Important Facts for Investors to Verify
- Whether the strong bookings and backlog growth convert into revenue and sustained margins, particularly in FPD.
- Whether Q1 margin gains are repeatable after excluding facility-sale gains, divestiture effects and other unusual realignment items.
- Progress, total investment and realized benefits from the Flowserve 2.0 Transformation.
- Working-capital trends, including inventory growth, 79-day DSO and cash conversion.
- Debt maturities, scheduled term-loan repayments and refinancing requirements before the October 2020 credit-facility maturity.
- Resolution and financial exposure from asbestos claims, environmental matters and the DOJ/SEC investigation.
- The impact of foreign-exchange movements, customer demand in cyclical end markets and the effective tax rate.