Business Context and Reporting Period
Flowserve Corporation filed an unaudited Form 10-Q for the three months ended March 31, 2010, compared with the three months ended March 31, 2009. Flowserve designs, manufactures, distributes and services pumps, mechanical seals, valves, actuators, controls and related aftermarket services for oil and gas, chemical, power generation, water management and other industrial markets. 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-period segment information retrospectively adjusted.
Financial Performance and Liquidity
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Sales | $958.9 million | $1,024.7 million | Down 6.4% |
| Gross profit | $348.3 million | $367.8 million | Down 5.3% |
| Gross margin | 36.3% | 35.9% | Up 0.4 percentage points |
| Operating income | $142.2 million | $147.1 million | Down 3.3% |
| Operating margin | 14.8% | 14.4% | Up 0.4 percentage points |
| Net earnings attributable to Flowserve | $80.2 million | $92.3 million | Down 13.1% |
| Diluted earnings per share | $1.42 | $1.64 | Down 13.4% |
| Effective tax rate | 28.4% | 27.9% | Up 0.5 percentage points |
Bookings increased 10.7% to $1,071.6 million, including approximately $49 million of favorable currency effects. Backlog was $2,423.8 million at March 31, 2010, up 2.2% from December 31, 2009, although currency effects reduced backlog by approximately $62 million. Aftermarket sales represented approximately 39% of total sales, compared with approximately 36% in the prior-year quarter.
- EPD: Bookings increased 23.4% to $592.4 million; sales declined 1.4% to $531.8 million; operating income increased 2.6% to $102.4 million.
- IPD: Bookings declined 9.7% to $194.4 million; sales declined 8.5% to $196.1 million; operating income declined 8.7% to $21.0 million.
- FCD: Bookings increased 5.3% to $318.9 million; sales declined 13.8% to $256.1 million; operating income declined 15.8% to $40.1 million.
Net cash used in operating activities improved to $149.0 million from $180.0 million in Q1 2009, but operating cash flow remained negative because of working-capital uses, including increases in receivables and inventory and reductions in accounts payable and accrued liabilities. Investing cash flow used $7.0 million, including $14.9 million of capital expenditures. Financing cash flow used $13.2 million, including $15.0 million of dividends and $12.0 million of share repurchases.
Cash and cash equivalents declined to $468.4 million from $654.3 million at December 31, 2009. Total debt and capital lease obligations were $566.1 million, including $542.6 million of term debt. No amounts were outstanding under the revolving credit facility; available borrowing capacity was $288.8 million after letters of credit. The company reported compliance with all debt covenants through March 31, 2010.
Material Changes Versus the Prior Comparable Period
- Sales and earnings declined primarily because of lower original-equipment demand and lower beginning backlog following the 2009 global recession, particularly in FCD and IPD.
- Gross and operating margins improved despite lower sales, supported by a higher aftermarket mix, cost controls, Continuous Improvement Process initiatives and realignment savings.
- Other expense increased to $21.5 million from $9.3 million, principally because of a $12.4 million loss from Venezuela’s currency devaluation and higher losses on forward exchange contracts. The Venezuelan loss was partially offset by $3.5 million of foreign-exchange gains on certain U.S.-dollar liabilities.
- Interest expense decreased to $9.0 million from $10.1 million, primarily due to lower average interest rates.
- Foreign currency translation produced a $37.5 million comprehensive-loss adjustment in Q1 2010, compared with $39.7 million in Q1 2009.
- The company acquired Calder AG in April 2009; its results were included in the 2010 quarter, but management stated the acquisition was immaterial for pro forma reporting.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management described market conditions as generally more positive than in 2009, with increased activity in oil and gas, stabilization in chemicals, continuing power-generation investment and growth potential in water management and desalination. Aftermarket demand remained favorable, supported by Flowserve’s global Quick Response Center network.
- Management expected full-year 2010 capital expenditures of $110 million to $125 million, excluding acquisition activity.
- The company expected 2010 contributions to its U.S. pension plan of $30 million to $40 million, including $10 million contributed in April 2010.
- Realignment programs generated approximately $18 million of savings in Q1 2010. Management expected approximately $95 million of savings during 2010 and approximately $110 million of annual savings after completion.
- Expected identified realignment charges were approximately $73.2 million, excluding approximately $15 million of additional initiatives under consideration. Management expected the identified programs to continue through 2010.
- Venezuela was designated hyperinflationary beginning January 1, 2010, and the Bolivar was devalued in January. The company continues to monitor remittance restrictions, import classifications, recoverability of exchange losses and further government actions.
- Tax audits and statute expirations could reduce tax expense by an estimated $9.5 million to $22.9 million within the following 12 months, although the timing and amount were uncertain.
- Material risk areas include global demand and order cancellations, backlog conversion and project cost overruns, raw-material prices, foreign-exchange volatility, international political and regulatory risks, export-compliance matters, pension obligations, litigation, environmental liabilities and potential goodwill or intangible-asset impairment.
- Pending matters include a shareholder litigation settlement subject to final court approval, asbestos-related claims, a French investigation and related civil litigation involving the United Nations Oil-for-Food Program, and self-reported export-control violations. The company stated that the ultimate exposure for certain matters cannot be determined with certainty.
Important Facts for Investors to Verify
- Whether higher bookings and backlog convert into sales and cash flow, particularly in EPD and FCD.
- The sustainability of margin improvement as original-equipment demand, pricing and fixed-cost absorption evolve.
- Actual versus expected realignment charges and savings, including the additional approximately $15 million of initiatives under consideration.
- Cash conversion, receivables collection, inventory levels and the impact of planned pension contributions and capital expenditures.
- Venezuela’s continuing currency, remittance and operating impacts, including whether additional losses arise.
- Debt maturity and refinancing requirements before the August 2012 credit-facility expiration, as well as available revolving capacity and letter-of-credit obligations.
- Final approval and funding of the shareholder litigation settlement and potential penalties or liabilities from export-compliance, Oil-for-Food, asbestos and environmental matters.
- Whether the stated tax benefit range, market outlook and other forward-looking estimates are realized; the filing does not provide formal earnings or revenue guidance.