Flowserve Corporation 2017 Q1 Form 10-Q Summary
Business Context and Reporting Period
Flowserve is a global manufacturer and aftermarket service provider of flow-control systems, including pumps, valves, seals, automation products and related services. Its principal markets include oil and gas, chemical, power generation, water management and general industrial applications. Operations are reported through the Engineered Product Division (EPD), Industrial Product Division (IPD) and Flow Control Division (FCD).
This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. The company employed approximately 18,000 people in more than 50 countries and operated 182 Quick Response Centers.
Financial and Operating Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $863.6 million | $947.2 million | Down 8.8% |
| Gross profit | $263.9 million | $308.0 million | Down 14.3% |
| Gross margin | 30.6% | 32.5% | Down 190 basis points |
| Operating income | $47.0 million | $74.4 million | Down 36.8% |
| Operating margin | 5.4% | 7.9% | Down 250 basis points |
| Net earnings attributable to Flowserve | $14.8 million | $37.9 million | Down 60.8% |
| Diluted EPS | $0.11 | $0.29 | Down $0.18 |
| Effective tax rate | 31.0% | 31.6% | Down 60 basis points |
| Operating cash flow | $3.9 million | $(5.7) million | Improved $9.6 million |
Bookings increased 3.9% to $958.2 million, including an approximately $80 million Hengli Integrated Refining Complex order in China. Backlog was $2.004 billion at March 31, 2017, up 5.6% from December 31, 2016; approximately 31.1% related to aftermarket orders. Aftermarket sales represented approximately 47% of sales, compared with approximately 45% in the prior-year quarter.
Cash and cash equivalents were $325.8 million at March 31, 2017, compared with $367.2 million at year-end 2016. Investing cash outflows were $15.5 million, including $15.9 million of capital expenditures. Financing cash outflows were $38.8 million, including $24.8 million of dividends and $15.0 million of long-term debt repayments.
Total debt was $1.568 billion, consisting of $90.6 million due within one year and $1.478 billion due thereafter. No borrowings were outstanding under the revolving credit facility; effective available capacity was $419.8 million, subject to covenant limitations and letters of credit. The company complied with all applicable debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because of lower original-equipment shipments and continued weakness in capital spending, particularly in oil and gas markets. Negative currency effects reduced sales by approximately $10 million.
- Gross margin contracted because lower sales reduced fixed-cost absorption and lower-margin projects shipped from backlog. The impact was partly offset by a greater aftermarket mix and lower realignment charges.
- SG&A declined 6.3% to $222.0 million, but SG&A as a percentage of sales increased to 25.7% from 25.0% because of lower sales leverage.
- Other expense increased to $11.1 million from $4.5 million, primarily because of greater foreign-currency transaction losses.
- EPD sales declined 10.9% and segment operating income declined 23.6%. IPD sales declined 9.7% and shifted from $4.0 million of operating income to a $14.2 million operating loss. FCD sales declined 6.2%, but operating income increased 3.1% and margin improved to 14.3%.
- Realignment charges decreased to $10.5 million from $13.5 million. Cumulative realignment charges since inception were $233.1 million.
- Operating cash flow improved to $3.9 million from negative $5.7 million, primarily because of lower working-capital cash uses. Accounts receivable provided $66.3 million of cash, while inventory used $22.7 million.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management expected the challenging capital-spending and pricing environment to continue throughout 2017, with potential improvement in the second half. The company expected 2017 capital expenditures of $80 million to $90 million and anticipated approximately $20 million of U.S. pension contributions, excluding direct benefits paid.
The realignment programs target manufacturing optimization, facility consolidation, workforce reductions, transfers to lower-cost regions and divestitures of non-strategic assets. Management expects a 15% to 20% workforce reduction relative to early-2015 levels, approximately $400 million of total program investment and approximately $230 million of annualized run-rate savings upon completion. The company estimated $44 million of savings in Q1 2017 and expected the majority of remaining charges to occur during 2017.
On March 31, 2017, Flowserve signed a conditional agreement to sell its Gestra business for €186 million. The transaction was expected to close in May 2017, with an estimated gain in excess of €40 million, subject to closing-date conditions and balance-sheet adjustments.
Material risks include weak customer capital spending, oil and gas exposure, order cancellations or delays, project cost overruns, pricing pressure, foreign-exchange volatility, aging receivables, raw-material costs, supplier performance, debt and covenant limitations, goodwill impairment, pension obligations, litigation, environmental liabilities, cybersecurity, and the ability to realize projected realignment savings.
Flowserve continues to face asbestos-related claims, environmental remediation matters at five former waste sites, a French Oil-for-Food investigation appeal and a self-reported potential Foreign Corrupt Practices Act violation involving an overseas subsidiary. Management did not expect these matters to have a material adverse financial impact, but stated that outcomes remain uncertain. The company also continued to monitor goodwill impairment risk in EPD and IPD because of reduced estimated fair values and ongoing oil and gas market pressure.
Management stated that existing cash, operating cash flow and available revolving-credit capacity should be sufficient to meet cash needs for the next 12 months. Approximately $304.0 million of cash was held by foreign subsidiaries, including $178.7 million considered permanently reinvested outside the United States; repatriation of that amount could generate estimated U.S. cash taxes of $5 million to $15 million.
Important Facts for Investors to Verify
- Whether bookings growth and the $2.004 billion backlog convert into revenue at acceptable margins, particularly given weaker sales and lower gross margins.
- The timing, cash cost and final scope of the realignment programs, and whether the projected $230 million annualized savings are achieved.
- The severity and duration of weakness in oil and gas and other capital-spending markets, including the outlook for the second half of 2017.
- The closing of the Gestra sale and the actual proceeds and gain compared with management’s estimate.
- IPD’s return to profitability after its $14.2 million Q1 operating loss.
- Debt maturities, covenant headroom and the effective $419.8 million revolving-credit availability.
- Potential changes from tax examinations, foreign-cash repatriation, asbestos claims, environmental matters and the FCPA-related investigation.
- Whether foreign-exchange movements continue to pressure earnings and other expense.