Flowserve Corporation: Q1 2020 Form 10-Q Summary
Business context and reporting period
Flowserve manufactures and services flow-control systems, including pumps, valves, seals, automation products and aftermarket services, serving oil and gas, chemical, power generation, water management and general industrial markets. The company operates through the Flowserve Pump Division (FPD) and Flow Control Division (FCD), with approximately 17,000 employees in more than 50 countries.
The filing covers the unaudited three months ended March 31, 2020, compared with the three months ended March 31, 2019. Results were materially affected by the COVID-19 pandemic, oil-price volatility and reduced customer activity.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Sales | $894.5 million | $890.1 million | Up 0.5% |
| Gross profit | $266.0 million | $294.1 million | Down 9.6% |
| Gross margin | 29.7% | 33.0% | Down 330 bps |
| Operating income | $25.6 million | $91.2 million | Down 71.9% |
| Operating margin | 2.9% | 10.2% | Down 730 bps |
| Net earnings attributable to Flowserve | $(0.6) million | $57.3 million | Declined to a loss |
| Basic and diluted EPS | $0.00 | $0.44 | Declined |
| Cash flow from operations | $47.3 million | $38.5 million | Up $8.8 million |
SG&A increased to $243.6 million from $205.2 million, or 27.2% of sales versus 23.1%. The increase included an $8.5 million write-down of receivables and contract assets related to a Latin American oil and gas customer, and the absence of favorable facility-sale gains recorded in 2019. Other income, net was $23.5 million versus an expense of $3.1 million, primarily due to foreign-exchange gains.
The effective tax rate was 96.1%, compared with 21.8% in the prior-year period, primarily because the company established a valuation allowance against certain deferred tax assets in light of COVID-19 and distressed oil prices.
Cash and cash equivalents were $622.3 million at March 31, 2020, compared with $671.0 million at December 31, 2019. Net cash used in investing activities was $6.6 million, including $17.3 million of capital expenditures. Net cash used in financing activities was $63.9 million, including $32.1 million of share repurchases and $26.0 million of dividends. Management expected 2020 capital expenditures to be below $60 million.
Total debt and finance lease obligations were $1.37 billion, including $1.35 billion of senior notes. The company had no revolving loans outstanding, $79.0 million of letters of credit and $721.0 million available under its $800.0 million unsecured senior credit facility, which matures in July 2024. The company reported compliance with all applicable debt covenants.
Material changes versus the prior comparable period
- Bookings declined 8.4% to $976.9 million, including approximately $20 million of unfavorable currency effects, driven primarily by lower original-equipment bookings in oil and gas and other industrial markets.
- Backlog increased 1.2% from December 31, 2019 to $2.18 billion, despite approximately $57 million of unfavorable currency effects. Approximately 33% of backlog related to aftermarket orders.
- Aftermarket sales represented approximately 49% of sales, down from approximately 53%, contributing to lower margins and a less favorable sales mix.
- FPD sales increased 4.3% to approximately $635.7 million, but segment operating income fell 50.7% to $39.7 million and operating margin declined to 6.2% from 13.2%.
- FCD sales declined 7.7% to approximately $260.3 million; segment operating income fell 62.4% to $16.7 million and operating margin declined to 6.4% from 15.7%.
- Other comprehensive loss was $75.0 million, compared with income of $8.2 million, primarily due to foreign-currency translation losses.
- The company adopted the current expected credit loss standard on January 1, 2020, recording a $7.3 million after-tax reduction to opening retained earnings. The short-term receivables allowance increased to $66.3 million from $53.4 million at year-end.
Guidance, outlook, commentary and unusual items
Management did not provide formal revenue or earnings guidance in the filing. It expected the pandemic and oil-and-gas market weakness to continue adversely affecting bookings, sales, aftermarket activity, manufacturing utilization, supply chains and financial performance for the duration of the pandemic. As of May 6, 2020, approximately 95% of facilities were operational, although some facilities had experienced temporary closures.
Management planned approximately $100 million of 2020 cost reductions versus 2019, including a hiring freeze for non-essential positions, cancellation of merit-based payroll increases, reduced capital expenditures and lower discretionary spending. Management stated that available cash, operating cash flow and credit-facility capacity were expected to provide sufficient liquidity for the next 12 months, with total liquidity exceeding $1.3 billion at March 31, 2020.
Unusual or non-recurring items included $16.4 million of combined realignment and Flowserve 2.0 transformation charges, $8.4 million of COVID-related underutilized manufacturing capacity costs, the $8.5 million receivable and contract-asset write-down, substantial foreign-exchange gains, and the deferred-tax valuation allowance. Realignment programs were substantially complete, with $362.4 million of cumulative charges since inception.
Key risks include the uncertain duration and severity of COVID-19, oil and gas capital-spending reductions, customer credit and collection risk, supply-chain disruption, foreign-exchange volatility, backlog cancellations or delays, underutilized manufacturing capacity, goodwill or deferred-tax-asset impairment, asbestos and other litigation, and pension, cyber-security and regulatory exposures. The company reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether COVID-19 and oil-market weakness produce additional declines in bookings, backlog conversion, aftermarket demand and operating margins.
- Whether the planned $100 million of cost reductions are achieved and whether further restructuring or transformation charges are required.
- The recoverability of receivables, contract assets, deferred tax assets and goodwill, particularly in oil and gas and emerging-market exposures.
- Liquidity trends, covenant compliance, credit-facility availability and debt maturities beginning with the 2022 senior notes.
- The sustainability of dividends and share repurchases given the Q1 net loss, pandemic uncertainty and remaining $113.6 million repurchase authorization.
- Foreign-exchange effects, including the $81.4 million translation loss and the sensitivity of earnings to currency movements.
- Potential asbestos, tax-audit and other litigation outcomes beyond recorded reserves and insurance or indemnity recoveries.