Flowserve Corporation: 2016 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Flowserve designs, manufactures and services flow-control equipment, including pumps, valves, seals, automation and related aftermarket services. Its principal markets include oil and gas, chemical, power generation, water management and general industrial applications. Operations are organized into Engineered Product Division, Industrial Product Division and Flow Control Division. The filing covers the unaudited three months ended March 31, 2016, compared with the three months ended March 31, 2015.
Key Financial Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Sales | $947.2 million | $1,014.6 million | Down 6.6% |
| Gross profit | $308.0 million | $331.7 million | Down 7.1% |
| Gross margin | 32.5% | 32.7% | Down 20 bps |
| Operating income | $74.4 million | $93.4 million | Down 20.3% |
| Operating margin | 7.9% | 9.2% | Down 130 bps |
| Net earnings attributable to Flowserve | $37.9 million | $27.7 million | Up 36.9% |
| Diluted EPS | $0.29 | $0.20 | Up $0.09 |
| Net cash used in operating activities | $(8.0) million | $(93.2) million | Improved by $85.2 million |
The higher net earnings and EPS primarily reflected lower other expense, including the absence of the $18.5 million Venezuelan remeasurement loss recorded in Q1 2015, and a lower effective tax rate. The 2016 effective tax rate was 31.6%, compared with 49.0% in 2015.
- Bookings were $921.8 million, down 11.6%; the decrease included approximately $40 million of unfavorable currency effects.
- Backlog was $2.19 billion at March 31, 2016, up 0.8% from December 31, 2015; approximately 27% related to aftermarket orders.
- SG&A was $236.9 million, down 1.3%, but increased to 25.0% of sales from 23.6% because of lower sales leverage and higher incentive compensation.
- Cash and cash equivalents were $310.3 million, down from $366.4 million at December 31, 2015.
- Total debt was $1.636 billion, including $62.6 million due within one year and $1.573 billion due thereafter.
- The company had no borrowings under its revolving credit facility, $889.5 million of available capacity after letters of credit, and remained in compliance with its debt covenants.
- Capital expenditures were $20.2 million. Management expected full-year 2016 capital expenditures of $105 million to $115 million.
- The quarterly dividend increased to $0.19 per share from $0.18 per share.
Material Changes Versus the Prior Comparable Period
- Sales declined across the business, primarily because of lower original equipment demand, weaker oil and gas activity, customer spending deferrals and unfavorable currency effects of approximately $47 million.
- Gross and operating margins declined because of lower fixed-cost absorption, lower-margin projects shipping from backlog and continued market pressure.
- Industrial Product Division returned to operating profitability: operating income was $4.0 million versus a $13.3 million operating loss in Q1 2015, aided by lower realignment and SIHI-related costs.
- Engineered Product Division operating income fell to $58.4 million from $68.8 million, while Flow Control Division operating income fell to $38.9 million from $54.7 million.
- Realignment charges were $13.5 million versus $26.3 million in Q1 2015. Cumulative charges since program inception were $129.5 million.
- Other comprehensive income was $37.2 million versus a loss of $103.7 million, primarily due to favorable foreign-currency movements relative to Q1 2015.
- Operating cash flow improved materially but remained negative, while inventory increased by $92.6 million from year-end to $1.088 billion.
Outlook, Commentary, Risks and Unusual Items
Management expected the challenging environment to persist throughout 2016, citing broad-based capital-spending declines, oil and gas weakness, pricing pressure, unfavorable currency effects, geopolitical and economic conditions, and deferred aftermarket spending. The company expected its realignment programs to require approximately $400 million of total investment, with the majority of remaining charges incurred in 2016 and 2017. Management estimated approximately $16 million of savings in Q1 2016 and approximately $230 million of annualized run-rate savings upon completion. The programs were expected to reduce the global workforce by 15% to 20% relative to early-2015 levels.
- Venezuelan receivables represented approximately 7% of gross accounts receivable; management estimated that approximately 70% of the balance would not be collected within one year. Venezuela also remains exposed to exchange-rate, political, labor and remittance risks.
- Flowserve is subject to asbestos claims, environmental matters, ordinary-course litigation and a continuing DOJ and SEC matter related to a potential Foreign Corrupt Practices Act violation at an overseas subsidiary. Management did not expect these matters to have a material adverse financial impact, but penalties and additional costs remain possible.
- Tax audits and unrecognized tax benefits could reduce tax expense by approximately $12 million within the next 12 months, although the timing and outcome are uncertain.
- The company anticipated approximately $20 million of U.S. pension contributions in 2016, excluding direct benefits paid.
- Approximately $195.4 million of foreign cash was considered permanently reinvested; repatriation could create an estimated U.S. cash tax liability of $5 million to $15 million.
- Management believed operating cash flow, existing cash and revolving-credit availability would be sufficient for the next 12 months.
- Key exposures include order cancellations, backlog conversion and margins, oil and gas and other cyclical markets, raw-material costs, foreign exchange, receivable collections, project execution, debt financing, acquisitions, litigation, compliance, environmental liabilities, pensions, cybersecurity and realization of restructuring savings.
Most Important Facts for Investors to Verify
- Whether bookings and aftermarket activity stabilize, particularly in oil and gas, chemical and general industrial markets.
- Whether the $2.19 billion backlog converts into revenue at acceptable margins and without material cancellations or delays.
- Progress toward the approximately $230 million annualized realignment savings target versus remaining program costs of approximately $400 million.
- Inventory reduction, working-capital conversion and the ability to generate consistently positive operating cash flow.
- Debt maturities, including scheduled term-loan repayments, covenant compliance and continued revolving-credit availability.
- Collection timing and potential impairment of Venezuelan receivables.
- Developments in the DOJ/SEC investigation, asbestos claims, environmental matters and other contingencies.
- Actual tax-audit resolutions and whether the potential $12 million tax benefit is realized.