Flowserve Corporation — 2014 Q1 Form 10-Q Summary
Business Context and Reporting Period
Flowserve is a global manufacturer and aftermarket service provider of pumps, valves, seals, automation products and related services serving oil and gas, chemical, power generation, water management and general industrial markets. Operations are managed through the Engineered Product Division, Industrial Product Division and Flow Control Division. The filing covers the unaudited three months ended March 31, 2014, compared with the three months ended March 31, 2013.
- Approximately 18,000 employees operate in more than 50 countries.
- Aftermarket sales represented approximately 43% of consolidated sales, compared with approximately 42% in the prior-year quarter.
- Bookings were $1,193.9 million, up 0.3%; backlog was $2,688.8 million at March 31, 2014, up 5.2% from December 31, 2013.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Sales | $1,068.1 million | $1,096.6 million | Down 2.6% |
| Gross profit | $377.1 million | $373.3 million | Up 1.0% |
| Gross margin | 35.3% | 34.0% | Up 130 basis points |
| Operating income | $164.3 million | $170.5 million | Down 3.6% |
| Operating margin | 15.4% | 15.5% | Down 10 basis points |
| Net earnings attributable to Flowserve | $107.7 million | $97.8 million | Up 10.2% |
| Diluted EPS | $0.78 | $0.67 | Up $0.11 |
| Effective tax rate | 25.9% | 33.0% | Down 710 basis points |
| Operating cash flow | $(84.7) million | $(108.1) million | Improved by $23.4 million |
| Capital expenditures | $31.7 million | $34.3 million | Down $2.6 million |
| Cash and cash equivalents | $164.4 million | $363.8 million at Dec. 31, 2013 | Down $199.4 million |
Gross margin benefited from operational improvements, disciplined booking selectivity and a higher aftermarket mix. SG&A declined 7.8% to $216.2 million, partly reflecting the $13.4 million gain on the sale of the Naval business. Net earnings benefited from the lower tax rate, lower other expense and the absence of the $4.0 million Venezuelan devaluation loss recorded in Q1 2013.
Liquidity, Debt and Capital Allocation
- Total debt and capital lease obligations were $1,192.3 million, including $75.1 million due within one year and $1,117.2 million due thereafter.
- The company had no borrowings under its revolving credit facility and reported $904.1 million of available capacity after outstanding letters of credit.
- The company complied with all applicable credit facility covenants at March 31, 2014.
- Financing cash outflows were $129.2 million, including $109.6 million of share repurchases, $19.4 million of dividends and $10.0 million of term-loan repayments.
- The Board increased the quarterly dividend from $0.14 to $0.16 per share, beginning with the April 11, 2014 payment.
- Flowserve repurchased 1,436,423 shares for $109.6 million under its repurchase program; $274.8 million remained authorized at quarter-end.
- Management expects 2014 capital expenditures of approximately $130 million to $140 million, excluding acquisitions, and anticipates approximately $20 million of U.S. pension contributions.
Material Changes Versus the Prior Comparable Period
- Sales declined because of lower original equipment sales, especially in the Middle East, Europe and Africa, and approximately $14 million of unfavorable currency effects.
- Bookings increased modestly, driven primarily by aftermarket bookings and strength in the chemical industry; no large original equipment project orders were received during the quarter.
- Operating income declined despite improved gross profit because Q1 2013 included $28.3 million of pre-tax gains related to the Audco India joint venture exit.
- Flowserve sold its Naval business effective March 31, 2014, receiving $46.8 million of net cash proceeds and recording a $13.4 million pre-tax gain. Naval contributed $8.2 million of Q1 2014 sales.
- Q1 2014 results included $1.0 million of realignment charges. Total approved charges under the 2013 Realignment Program were expected to be $15.8 million, with $11.8 million incurred through March 31, 2014.
- Interest expense increased $3.0 million because of senior notes issued in the fourth quarter of 2013.
- Net earnings from affiliates fell to $3.4 million from $31.7 million because the prior-year period included gains from the Audco India transactions.
- Segment operating income increased in Industrial Product Division but declined in Engineered Product Division and Flow Control Division. Flow Control margins improved substantially, but operating income was affected by the nonrecurrence of the 2013 Audco India gains.
Outlook, Risks, Contingencies and Unusual Items
Management stated that aftermarket conditions remained favorable and that bookings showed a slight increase despite competitive conditions and global macroeconomic uncertainty. Management believes operating cash flow, existing cash and available revolving-credit capacity will be sufficient to meet cash needs for the next 12 months. The filing does not provide a specific earnings or revenue forecast.
- Foreign-exchange exposure is significant. A hypothetical 10% currency movement would have affected Q1 net earnings by approximately $3.9 million, before considering the impact of forward contracts.
- Venezuela remains a risk because of multiple exchange mechanisms and restrictions on cash remittances. Remeasuring Venezuelan net monetary assets at the SICAD I rate would have produced an estimated loss of approximately $3 million at March 31, 2014.
- Approximately $94.4 million of cash held by foreign subsidiaries was considered permanently reinvested outside the United States. Repatriation could generate an estimated U.S. cash tax liability of $5 million to $15 million.
- Tax audits and expiring statutes of limitation could reduce tax expense by approximately $12.2 million within the next 12 months, although the timing and outcome are uncertain.
- Material risk areas include backlog conversion and cancellations, project cost overruns, demand in oil and gas and other cyclical industries, raw-material costs, international political and economic conditions, currency volatility, supply-chain execution, litigation, environmental liabilities, pensions, cybersecurity or compliance matters, and goodwill or intangible-asset impairment.
- Flowserve remains involved in asbestos-related claims, a United Nations Oil-for-Food investigation and related litigation, environmental remediation matters at five former waste sites, and other routine litigation. Management currently believes these matters are not likely to have a material adverse effect, but litigation outcomes are inherently uncertain.
- Disclosure controls and procedures were assessed as effective as of March 31, 2014, with no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether the improved bookings and $2.69 billion backlog convert into sales and cash flow at expected margins, particularly given the lower quarterly sales volume.
- The sustainability of margin gains from aftermarket mix, cost reductions, sourcing and operational improvements.
- The effect of share repurchases, dividends, scheduled debt amortization and working-capital requirements on cash balances and leverage.
- Future currency, Venezuela-related and international political exposures, including the availability and repatriation of foreign cash.
- The resolution and potential financial impact of asbestos claims, Oil-for-Food matters, environmental sites and other contingencies.
- The timing and amount of potential tax benefits, as well as the actual 2014 capital expenditures and pension contributions.