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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number 1-13179
 
FLOWSERVE CORPORATION
(Exact name of registrant as specified in its charter)
 
     
New York
  31-0267900
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
5215 N. O’Connor Boulevard   75039
Suite 2300, Irving, Texas
  (Zip Code)
(Address of principal executive offices)
   
 
Registrant’s telephone number, including area code:
(972) 443-6500
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $1.25 Par Value   New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company.  Yes o     No þ
 
The aggregate market value of the common stock held by non-affiliates of the registrant, computed by reference to the closing price of the registrant’s common stock as reported on June 30, 2009 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $3,000,645,000. For purposes of the foregoing calculation only, all directors, executive officers and known 5% beneficial owners have been deemed affiliates.
 
Number of the registrant’s common shares outstanding as of February 18, 2010 was 55,724,453.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Certain information contained in the definitive proxy statement for the registrant’s 2010 Annual Meeting of Shareholders scheduled to be held on May 14, 2010 is incorporated by reference into Part III hereof.
 


 

 
FLOWSERVE CORPORATION
FORM 10-K

TABLE OF CONTENTS
 
                 
        Page
 
      Business     1  
      Risk Factors     16  
      Unresolved Staff Comments     24  
      Properties     24  
      Legal Proceedings     25  
      Submission of Matters to a Vote of Security Holders     25  
 
PART II
      Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     26  
      Selected Financial Data     29  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     30  
      Quantitative and Qualitative Disclosures About Market Risk     60  
      Financial Statements and Supplementary Data     62  
      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     122  
      Controls and Procedures     122  
      Other Information     123  
 
      Directors, Executive Officers and Corporate Governance     123  
      Executive Compensation     123  
      Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     123  
      Certain Relationships and Related Transactions, and Director Independence     123  
      Principal Accounting Fees and Services     124  
 
      Exhibits, Financial Statement Schedules     124  
    125  
 EX-10.20
 EX-10.23
 EX-10.32
 EX-10.66
 EX-10.67
 EX-10.68
 EX-10.69
 EX-10.70
 EX-10.71
 EX-21.1
 EX-23.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT


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PART I
 
ITEM 1.   BUSINESS
 
OVERVIEW
 
Flowserve Corporation is a world leading manufacturer and aftermarket service provider of comprehensive flow control systems. Under the name of a predecessor entity, we were incorporated in the State of New York on May 1, 1912. Flowserve Corporation as it exists today was created in 1997 through the merger of two leading fluid motion and control companies — BW/IP and Durco International. Over the years, we have evolved through organic growth and strategic acquisitions, and our 220-year history of Flowserve heritage brands serves as the foundation for the breadth and depth of our products and services today. Unless the context otherwise indicates, references to “Flowserve,” “the Company” and such words as “we,” “our” and “us” include Flowserve Corporation and its subsidiaries.
 
We develop and manufacture precision-engineered flow control equipment integral to the movement, control and protection of the flow of materials in our customers’ critical processes. Our product portfolio of pumps, valves, seals, automation and aftermarket services supports global infrastructure industries, including oil and gas, chemical, power generation and water management, as well as general industrial markets where our products and services add value. Through our manufacturing platform and global network of Quick Response Centers (“QRCs”), we offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting.
 
We sell our products and services to more than 10,000 companies, including some of the world’s leading engineering and construction firms, original equipment manufacturers, distributors and end users. Our products and services are used in several distinct industries having a broad geographic reach. Our bookings mix by industry in 2009 consisted of:
 
         
         
•   oil and gas
    36 %
•   power generation
    20 %
•   general industries(1)
    19 %
•   chemical
    18 %
•   water management
    7 %
  (1)  General industries also includes sales to distributors, whose end customers typically operate in the industries we primarily serve, as well as mining and ore processing, pharmaceuticals, pulp and paper, food and beverage and other smaller applications.
 
The breakdown of the geographic regions to which our sales were shipped in 2009 were as follows:
 
         
         
•   North America
    32 %
•   Europe
    25 %
•   Middle East and Africa
    15 %
•   Asia Pacific
    19 %
•   Latin America
    9 %
 
We have pursued a strategy of industry diversity and geographic breadth to mitigate the impact on our business of normal economic downturns in any one of the industries or in any particular part of the world we serve. For information on our sales and long-lived assets by geographic areas, see Note 18 to our consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” (“Item 8”) of this Annual Report on Form 10-K for the year ended December 31, 2009 (“Annual Report”).
 
Through December 31, 2009, we conducted our operations through three business segments:
 
  •  Flowserve Pump Division (“FPD”) for engineered pumps, industrial pumps and related services;


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  •  Flow Control Division (“FCD”) for engineered and industrial valves, control valves, actuators and controls and related services; and
 
  •  Flow Solutions Division (“FSD”) for precision mechanical seals and related products and services.
 
During the first quarter of 2010, we are reorganizing our divisional operations by combining FPD and FSD into the new Flow Solutions Group (“FSG”). We believe the combination of FPD and FSD enables us to continue building a strong customer focus for rotating equipment and related products and services, drive an enhanced customer-facing organization and further leverage best practices and capabilities. We expect the combined strength of FSG to provide greater efficiency for integrated component manufacturing, leverage in global spending and manufacturing resources and improve productivity through the use of common tools and processes to select, design, manufacture, distribute and service our product portfolio. FSG will be divided into two reportable segments based on type of product: Engineered and Industrial. Engineered will include the longer lead-time, highly engineered pump product operations of the former FPD and substantially all of the operations of the former FSD. Industrial will consist of the more standardized, general purpose pump product operations of the former FPD. FCD remains unchanged. The division reorganization described above had no effect on our reportable segments in 2009, which are described below, and is not reflected in any of the accompanying financial information included in this Annual Report. Beginning in 2010, our segment reporting will reflect the structure described above, and prior periods will be retrospectively adjusted to conform to our 2010 reportable segment structure presentation.
 
Strategies
 
Our overarching objective is to grow our position as a product and integrated solutions provider in the flow control industry. This objective includes continuing to sell products by building on existing sales relationships and leveraging the power of our portfolio of products and services. It also includes delivering specific end user solutions that help customers attain their business goals by ensuring maximum reliability at a decreased cost of ownership. We seek to drive sustainable, profitable growth by using strategies that are well communicated throughout our company. These strategies include: organic growth, globalization, process excellence, portfolio management, strategic acquisitions, organizational capability and technology/innovation. The key elements of these strategies are outlined below.
 
Organic Growth
 
Organic growth is an important initiative focused on growing revenues from the existing portfolio of products and services, as well as through the development of new customer-driven products and services. An overarching goal is to focus on opportunities that can maximize the organic growth from existing customers and to evaluate potential new customer-partnering initiatives that maximize the capture of the product’s total life cycle. We are one of the few pump, valve and seal companies that can offer customers a differentiated option of products and services, as well as offer additional options that include any combination of products and solution support packages across a broad portfolio. The combined pump and seal end user teams have historically been successful in delivering new solution programs and increasing organic aftermarket growth.
 
We seek to capture additional market share by creating mutually beneficial opportunities for us and our customers through sourcing and maintenance alliance programs where we provide all or an agreed-upon portion of customers’ parts and servicing needs. These customer alliances enable us to develop long-term professional relationships with our customers and serve as an effective platform for introducing new products and services to our customers and generating additional sales.
 
We also seek to continue to review our substantial installed pump, valve and seal base as a means to expand the aftermarket services business, as customers are increasingly using third-party aftermarket service providers to reduce their fixed costs and improve profitability. To date, the aftermarket services business has provided us with a steady source of revenues and cash flows at higher margins than original equipment sales. This allows us to be in frequent contact with customers, building on the knowledge of customer needs and providing cross-selling opportunities. We are building on our established presence through an extensive global QRC network to provide the immediate parts, service and technical support required to effectively manage and win the aftermarket business created from our installed base.


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Globalization
 
The globalization business initiative has several facets that include:
 
  •  expanding our global presence to capture business in developing geographic market areas;
 
  •  utilizing low-cost sourcing opportunities to remain competitive in the global economy; and
 
  •  attracting and retaining the global intellectual capital required to support our global growth plans in new geographical areas.
 
We believe there are attractive opportunities in international markets, particularly in China, India, Mexico, the Middle East and Latin America and we intend to continue to utilize our global presence and strategically invest to further penetrate these markets. In the aftermarket services business, we seek to strategically add QRC sites in order to provide rapid response, fast delivery and field repair on a global scale for our customers. In 2009, we added nine QRCs, expanding our ability to effectively deliver aftermarket support globally.
 
We believe that future success will be supported by investments made to establish indigenous operations to effectively serve the local market while taking advantage of low cost manufacturing, competent engineering and strategic sourcing where practical. We believe that this positions us well to support our global customers from project conception through commissioning and over the life of their operations.
 
We continue to develop and increase our manufacturing, engineering and sourcing functions in lower cost regions and emerging markets such as India, China, Mexico, Latin America, the Middle East and Eastern Europe as we drive higher value add from our supply base of materials and components and satisfy local content requirements. In 2009, these lower cost regions supplied the divisions with direct materials ranging from 16% to 33% of divisional spend.
 
Process Excellence
 
The process excellence initiative encapsulates ongoing programs that work to drive increased customer fulfillment and yield internal productivity. This initiative includes:
 
  •  driving improved customer fulfillment through metrics such as on-time delivery, cost reduction, quality, cycle time reduction and warranty cost reduction as a percentage of sales;
 
  •  continuing to develop a culture of continuous improvement that delivers maximum productivity and cost efficiencies; and
 
  •  implementing global functional competencies to drive standardized processes.
 
We seek to increase our operational efficiency through our Continuous Improvement Process (“CIP”) initiative, which utilizes tools such as six sigma methodology, lean manufacturing and capacity management to improve quality and processes, reduce product cycle times and lower costs. Recognizing that employees are our most valuable resource in achieving operational excellence goals, we have instituted broad CIP training. To date, more than 1,400 employees are CIP-trained or certified as “Green Belts,” “Black Belts” or “Master Black Belts,” and are deployed on CIP projects throughout our company in operations and the front office of the business. As a result of the CIP initiatives, we have developed and implemented processes to reduce our engineering and manufacturing process cycle time, improve on-time delivery and service response time, lower inventory levels and reduce costs. We have also experienced success in sharing and applying best practices achieved in one business segment and deploying those ideas to other segments of the business.
 
We continue to rationalize existing Enterprise Resource Planning (“ERP”) systems onto six strategic ERP systems. Going forward, these six strategic ERP systems will be maintained as core systems with standard tool sets, and will be enhanced as needed to meet the growing needs of the business in areas such as e-commerce, back office optimization and export compliance. Further investment in non-strategic ERP systems will be limited to compliance matters and conversion to strategic ERP systems.


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We also seek to improve our working capital utilization, with a particular focus on management of accounts receivable and inventory. See further discussion in the “Liquidity and Capital Resources” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report.
 
Portfolio Management
 
We drive our new product and service development through our product management organization, working in concert with engineering, operations and sales. The goal is to increase our revenues from new products and services developed during the last five years. The new product development process has made significant progress in demonstrating a pipeline of new and modified products and services.
 
The continued management of our portfolio of products and services is critical to our success. We will continue to rationalize our portfolio of products and services to ensure alignment with changing market requirements. We will continue to invest in research and development (“R&D”) to expand the scope of our product offerings and our deployment of advanced technologies.
 
Strategic Acquisitions
 
We continually evaluate acquisitions, joint ventures and other strategic investment opportunities to broaden our product portfolio, service capabilities, geographic presence or operational capabilities to meet the growing needs of our customers. We evaluate all investment opportunities through a decision filtering process to try to ensure a good strategic, financial and cultural fit.
 
In 2009, our acquisition and joint venture activities focused on adjacent technology and product capabilities. Effective April 21, 2009, FPD acquired Calder AG, a private Swiss company and supplier of energy recovery technology for use in the global desalination market, and we expect its acquisition will enable us to expand the products and advanced technologies we offer to the growing desalination markets. This transaction did not involve a significant amount of our assets nor was it an agreement upon which we are substantially dependent.
 
Organizational Capability
 
We focus on several elements in our strategic efforts to continuously enhance our organizational capability, including:
 
  •  institutionalizing our succession planning along with our leadership competencies and performance management capabilities, with a focus on key positions and critical talent pools;
 
  •  utilizing these capabilities to drive employee engagement through our training initiatives and leadership development programs and facilitate our cross-divisional and functional development assignments;
 
  •  developing talent acquisition programs such as our engineering recruitment program to address critical talent needs to support our emerging markets and global growth;
 
  •  capturing the intellectual capital in the current workforce, disseminating it throughout our company and sharing it with customers as a competitive advantage;
 
  •  creating a total compensation program that provides our associates with equitable opportunities that are competitive and linked to business and individual performance while promoting employee behavior consistent with our code of business conduct and risk tolerance; and
 
  •  building a diverse organization with a strong ethical and compliance culture based on transparency and trust.
 
We continue to focus on training through the distribution of electronic learning packages in multiple languages for our Code of Business Conduct, workplace harassment, facility safety, anti-bribery, export compliance and other regulatory and compliance programs. We continue to drive our training and leadership development programs through the deployment of General Management Development, Manager Competencies and a series of multi-lingual “course-in-a-box” programs that focus on enhancing people management skills.


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Technology/Innovation
 
The infusion of advanced technologies into new products and services continues to play a critical role in the ongoing evolution of our product portfolio. The objective is to improve the percentage of revenue derived from new products as a function of overall sales, utilizing technological innovation to improve overall product lifecycles and total cost of ownership for our customers. We employ a robust portfolio management and project execution process to pro-actively seek out new product and technology opportunities, evaluate their potential return on investment and allocate resources to their development on a prioritized basis. Each project is reviewed on a routine basis for such performance measures as time to market, net present value, budget adherence, technical and commercial risk and compliance with customer requirements. Technical skill sets and knowledge is deployed across business unit boundaries to make sure we bring the best capabilities to bear for each project. Collectively, the research and development portfolio is a key to our ability to differentiate our product and service offerings from other competitors in our target markets.
 
We are focused on exploring and commercializing new technologies in five major areas: Materials Science; Fluid Dynamics; Mechanical Design; Mechatronics; and Electronics and Software. Within each of these areas we are aggressively investing in new research, as well as pro-actively seeking out technologies that may already exist in other industries and evaluating how they may be applied in ours. Predictive diagnostics and asset management continue to be the biggest areas of effort for us across all our divisions. Building on the strength of our ValveSight and Technology Enabled Asset Management solutions introduced in late 2008, we have continued to deploy our diagnostics capabilities into more and more devices and expand on the number of host control systems and third party solutions with which we can achieve interoperability. These capabilities continue to provide a key source of competitive advantage in the market place, and are saving our customers time and money in keeping their plants running.
 
In many of our research areas, we are teaming with universities and experts in the appropriate scientific fields to accelerate the required learning and to shorten the development time in leveraging the value of applied technologies in our products and services. Our intent is to be a market leader in the application of advanced technology to improve product performance and return on investment for our customers.
 
Competition
 
Despite the consolidation trend in recent years, the markets for our products remain fragmented and highly competitive, with primary competitive drivers being price, reputation, timeliness of delivery and technical expertise, as well as contractual terms and previous installation history. In the pursuit of large capital projects, competitive drivers and competition vary depending on the industry and products involved. Industries experiencing slow growth generally tend to have a competitive environment more heavily influenced by price due to supply outweighing demand, and price competition tends to be more significant for original equipment orders than aftermarket services. Considering the domestic and global economic environments in 2009 and current forecasts for 2010, pricing was and may continue to be a particularly influential competitive factor. The unique competitive environments in each of our three business segments are discussed in more detail under the “Business Segments” heading below.
 
In the aftermarket portion of our business, we compete against large and well-established national and global competitors and, in some markets, against regional and local companies who produce low cost replications of spare parts. In the oil and gas industry, the primary competitors for aftermarket services tend to be customers’ own in-house capabilities. In the nuclear power generation industry, we possess certain competitive advantages due to our “N Stamp” certification, which is a prerequisite to serve customers in that industry, and our considerable base of proprietary knowledge. In other industries, the competitors for aftermarket services tend to be local independent repair shops and low cost replicators. Aftermarket competition for standardized products is aggressive due to the existence of common standards allowing for easier replacement or repair of the installed products.
 
In the sale of aftermarket products and services, we benefit from our large installed base of pumps, valves and seals, which continually require maintenance, repair and replacement parts due to the nature of the products and the conditions under which they operate. Timeliness of delivery, quality and the proximity of service centers are important customer considerations when selecting a provider for aftermarket products and services. In geographic


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regions where we are locally positioned to provide a quick response, customers have traditionally relied on us, rather than our competitors, for aftermarket products relating to our highly engineered and customized products.
 
Generally, our customers attempt to reduce the number of vendors from which they purchase, thereby reducing the size and diversity of their inventory. Although vendor reduction programs could adversely affect our business, we have been successful in establishing long-term supply purchasing agreements with a number of customers. While the majority of these agreements do not provide us with exclusive rights, they can provide us a “preferred” status with our customers and thereby increase opportunities to win future business. We also utilize our Lifecycle Advantage program to establish fee-based contracts to manage customers’ aftermarket requirements. These programs provide an opportunity to manage the customer’s installed base and expand the business relationship with the customer.
 
Our ability to use our portfolio of products, solutions and services to meet customer needs is a competitive strength. Our market approach is to create value for our customers throughout the lifecycle of their investments in flow management. We continue to explore and develop potential new offerings in conjunction with our customers. In the early phases of project design, we endeavor to create value in optimizing the selection of equipment for the customer’s specific application, as we are capable of providing technical expertise on product and system capabilities even outside the scope of our specific products, solutions and services. After the equipment is constructed and delivered to the customer’s site, we continue to create value through our aftermarket capabilities by optimizing the performance of the equipment over its operational life. Our skilled service personnel can provide these aftermarket services for our products, as well as many competitors’ products, within the installed base. This value is further enhanced by the global reach of our QRCs and, when combined with our other solutions for our customers’ flow management needs, allows us to create value for our customers during all phases of the capital expenditure cycle.
 
New Product Development
 
We spent $29.4 million, $34.0 million and $29.1 million during 2009, 2008 and 2007, respectively, on research and development initiatives. Our research and development group consists of engineers involved in new product development and improvement of existing products. Additionally, we sponsor consortium programs for research with various universities and jointly conduct limited development work with certain vendors, licensees and customers. We believe current expenditures are adequate to sustain our ongoing and necessary future research and development activities. In addition, we work closely with our customers on customer-sponsored research activities to help execute their research and development initiatives in connection with our products and services. New product development in each of our three business segments is discussed in more detail under the “Business Segments” heading below.
 
Customers
 
We sell to a wide variety of customers globally in several distinct industries: oil and gas; chemical; power generation; water management; and a number of other industries that are collectively referred to as “general industries.” No individual customer accounted for more than 10% of our consolidated 2009 revenues. Customer information relating to each of our three business segments is discussed in more detail under the “Business Segments” heading below.
 
We are not normally required to carry unusually high amounts of inventory to meet customer delivery requirements, although higher shipment levels and longer lead times usually require higher amounts of inventory. We have been working to increase our overall inventory efficiency to improve our operational effectiveness and reduce working capital needs. While we do provide cancellation policies through our contractual relationships, we generally do not provide rights of product return for our customers.
 
Selling and Distribution
 
We primarily distribute our products through direct sales by employees assigned to specific regions, industries or products. In addition, we use distributors and sales representatives to supplement our direct sales force in countries where it is more appropriate due to business practices or customs, or whenever the use of direct sales staff


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is not economically efficient. We generate a majority of our sales leads through existing relationships with vendors, customers and prospects or through referrals.
 
Intellectual Property
 
We own a number of trademarks and patents relating to the names and designs of our products. We consider our trademarks and patents to be an important aspect of our business. In addition, our pool of proprietary information, consisting of know-how and trade secrets related to the design, manufacture and operation of our products, is considered particularly valuable. Accordingly, we take proactive measures to protect such proprietary information. We generally own the rights to the products that we manufacture and sell and are unencumbered by licensing or franchise agreements. Our trademarks can typically be renewed indefinitely as long as they remain in use, whereas our existing patents generally expire 20 years from the dates they were filed, which has occurred at various times in the past. We do not believe that the expiration of any individual patent or any patents will have a material adverse impact on our business, financial condition or result of operations.
 
Raw Materials
 
The principal raw materials used in manufacturing our products are readily available and include bar stock, machined castings, fasteners, gaskets, motors, silicon and carbon faces and fluoropolymer components. While substantially all of our raw materials are purchased from outside sources, we have been able to obtain an adequate supply and anticipate no shortages of such materials in the future. We continually monitor the business conditions of our suppliers so as to avoid potential supply disruptions, and we continue to expand worldwide sourcing to capitalize on low cost sources of purchased goods balanced with efficient logistics.
 
We are a vertically-integrated manufacturer of certain pump and valve products. Certain corrosion-resistant castings for our pumps and valves are manufactured at our foundries. Other metal castings are either manufactured at our foundries or purchased from outside sources.
 
We also use highly-engineered corrosion resistant plastic parts for certain pump and valve product lines. These include rotomolding, as well as injection and compression molding, of a variety of fluoropolymer and other plastic materials. We believe that supply channels for these materials are currently adequate, and we do not anticipate difficulty in obtaining these raw materials in the future.
 
Concerning the products we supply to customers in the nuclear power generation industry, suppliers of raw materials for nuclear power generation markets must be qualified by the American Society of Mechanical Engineers. Supply channels for these materials are currently adequate, and we do not anticipate difficulty in obtaining such materials in the future.
 
Employees and Labor Relations
 
We have approximately 15,000 employees globally. In the U.S., a portion of the hourly employees at our pump manufacturing plant located in Vernon, California, our pump service center located in Cleveland, Ohio, our valve manufacturing plant located in Lynchburg, Virginia and our foundry located in Dayton, Ohio, are represented by unions. Additionally, some employees at select facilities in the following countries are unionized or have employee works councils: Argentina, Australia, Austria, Belgium, Brazil, Canada, Finland, France, Germany, Italy, Japan, Mexico, the Netherlands, Spain, Sweden, Switzerland and the United Kingdom. We believe relations with our employees throughout our operations are generally satisfactory, including those employees represented by unions and employee works councils. No unionized facility accounts for more than 10% of our revenues.
 
Environmental Regulations and Proceedings
 
We are subject to environmental laws and regulations in all jurisdictions in which we have operating facilities. These requirements primarily relate to the generation and disposal of wastes, air emissions and waste water discharges. We periodically make capital expenditures to enhance our compliance with environmental requirements, as well as to abate and control pollution. At present, we have no plans for any material capital expenditures for environmental control equipment at any of our facilities. However, we have incurred and continue to incur


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operating costs relating to ongoing environmental compliance matters. Based on existing and proposed environmental requirements and our anticipated production schedule, we believe that future environmental compliance expenditures will not have a material adverse effect on our financial condition, results of operations or cash flows.
 
We use hazardous substances and generate hazardous wastes in many of our manufacturing and foundry operations. Most of our current and former properties are or have been used for industrial purposes and some may require clean-up of historical contamination. During the due diligence phase of our acquisitions, we conduct environmental site assessments in an attempt to determine any potential environmental liability and to identify the need for any clean-up measures. We are currently conducting follow-up investigation and/or remediation activities at those locations where we have known environmental concerns. We have cleaned up a majority of the sites with known historical contamination and are addressing the remaining identified issues.
 
Over the years, we have been involved as one of many potentially responsible parties (“PRP”) at former public waste disposal sites that are or were subject to investigation and remediation. We are currently involved as a PRP at three Superfund sites. The sites are in various stages of evaluation by government authorities. Our total projected “fair share” cost allocation at these three sites is expected to be immaterial. See “Item 3. Legal Proceedings” included in this Annual Report for more information.
 
We have established reserves that we currently believe to be adequate to cover our currently identified on-site and off-site environmental liabilities.
 
Exports
 
Our export sales from the U.S. to foreign unaffiliated customers were $339.6 million in 2009, $344.3 million in 2008 and $267.7 million in 2007.
 
Licenses are required from U.S. and other government agencies to export certain products. In particular, products with nuclear power generation and/or military applications are restricted, as are certain other pump, valve and mechanical seal products.
 
We have voluntarily disclosed to applicable U.S. governmental authorities the results of an audit of our compliance with U.S. export control laws and are voluntarily self-disclosing the violations identified. Disclosure of such violations could result in substantial fines and other penalties. See “Item 3. Legal Proceedings” included in this Annual Report for more information.
 
BUSINESS SEGMENTS
 
In addition to the business segment information presented below, Note 18 to our consolidated financial statements in Item 8 of this Annual Report contains additional financial information about our business segments and geographic areas in which we have conducted business in 2009, 2008 and 2007.
 
FLOWSERVE PUMP DIVISION
 
Through FPD, we design, manufacture, distribute and service engineered and industrial pumps and pump systems, submersible motors, replacement parts and related equipment, principally to industrial markets. FPD’s products and services are primarily used by companies that operate in the oil and gas, chemical processing, power generation, water management and general industrial markets. We market our pump products through our worldwide sales force and our regional service and repair centers or through independent distributors and sales representatives. Our pump systems and components are currently manufactured at 30 plants worldwide, of which 13 are located in Europe, seven in North America, six in Asia Pacific and four in Latin America.
 
We also manufacture a portion of our products through strategic foreign joint ventures. We have three unconsolidated joint ventures that are located in Saudi Arabia, Japan and China where products are manufactured, assembled or serviced in these territories. These relationships provide numerous strategic opportunities, including increased access to our current and new markets, access to additional manufacturing capacity and expansion of our operational platform to support low-cost sourcing initiatives and capacity demands for other markets.


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FPD Products
 
We manufacture more than 150 different active pump models, ranging from simple fractional horsepower industrial pumps to high kilowatt (horsepower) engineered pumps. Our pumps are manufactured in a wide range of metal alloys and with a variety of configurations, including pumps that utilize mechanical seals (sealed pumps) and pumps that do not utilize mechanical seals (magnetic-drive and other pumps).
 
The following is a summary list of our pump products and globally recognized brands:
 
FPD Product Types
 
     
Overhung
 
Between Bearings
•   Chemical Process ANSI and ISO
  •   Single Case — Axially Split
•   API Process
  •   Single Case — Radially Split
•   Industrial Process
  •   Double Case
•   Slurry and Solids Handling
   
 
     
Vertical
 
Positive Displacement
•   Wet Pit
  •   Gear
•   Deep Well Submersible Motor
  •   Screw
•   Slurry and Solids Handling
  •   Multiphase
•   Sump
  •   Reciprocating
 
     
Specialty Products
   
 
•   Nuclear Pumps
  •   Power Recovery — Hydroturbine
•   Nuclear Seals
  •   Power Recovery — DWEER
•   Cryogenic Pumps
  •   Thruster
•   Cryogenic Liquid Expander
  •   Geothermal Deepwell
•   Submersible Pump
  •   CVP Concrete Volute Pumps
•   Hydraulic Decoking Systems
  •   Barge Pump
•   Molten Salt VTP Pump
   
 
FPD Brand Names
 
     
•   ACEC
  •   Pacific
•   Aldrich
  •   Pleuger
•   Byron Jackson
  •   Scienco
•   Calder Energy Recovery Devices
  •   Sier-Bath
•   Cameron
  •   TKL
•   Durco
  •   United Centrifugal
•   Flowserve
  •   Western Land Roller
•   IDP
  •   Wilson-Snyder
•   Jeumont-Schneider
  •   Worthington
•   Niigata Worthington
  •   Worthington-Simpson
 
FPD Services
 
We provide engineered aftermarket services through our global network of approximately 78 service centers and QRCs, some of which are co-located in a manufacturing facility, in 30 countries. Our FPD service personnel provide a comprehensive set of equipment maintenance services for flow management control systems, including repair, advanced diagnostics, installation, commissioning, re-rate and retrofit programs, machining and full service


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solution offerings. A large portion of our FPD service work is performed on a quick response basis, and we offer 24-hour service in all of our major markets.
 
FPD New Product Development
 
Our investments in new product research and development continue to focus on increasing the capability of our products as customer applications become more advanced, demanding greater levels of production (flow, power and pressure) and under more extreme conditions beyond the level of traditional pump technology. In support of our subsea product development initiative, we have successfully completed development and test of a large submersible motor required to drive our multiphase pump currently under development in our Canadian manufacturing facility. The power rating achieved by this new motor provides us with a viable submersible motor solution for large submersible motor requirements including non-subsea pumping applications. Further, we continue to design solutions and close the technology gaps in developing products and components for pipeline, off-shore and downstream pump applications for the oil and gas market.
 
As new sources of energy generation are explored, we have been developing new product designs to support the most critical applications in the power generation market. New designs and qualification test programs are in process to support the critical services of the modern nuclear power generation plant. Along with the development initiatives of new products in the nuclear power generation industry, we continue to support our installed base with product improvements and design verifications that lead to expanded power capability of existing nuclear power generating plants. Our continued engagement with our end users is exemplified through completion of tests that demonstrate operational capability while pumping contaminated liquid and providing operational verification to support safety requirements. In addition, factory testing has been completed of our high temperature vertical pump developed for molten salt applications for solar power generating plants.
 
We continue to address our core products with design enhancements to improve performance and the speed at which we can deliver our products. Application of advanced computational fluid dynamics methods led to the development of a unique stage design for our multistage product, resulting in improved performance and an improved competitive position of the product. Our engineering teams continue to apply and develop sophisticated design technology and methods supporting continuous improvement of our proven technology.
 
In 2009, FPD continued to advance our Technology Advantage platform and created an integrated solutions organization. This platform utilizes a combination of our developed technologies and leading edge technology partners to increase our asset management and service capabilities for our end user customers. These technologies include intelligent devices, advanced communication and security protocols, wireless and satellite communications and web-enabled data convergence.
 
None of these newly developed pump products or services required the investment of a material amount of our assets or was otherwise material.
 
FPD Customers
 
Our customer mix is diversified, and includes leading engineering procurement and construction firms, original equipment manufacturers, distributors and end users. Our sales mix of original equipment products and aftermarket products and services diversifies our business and somewhat mitigates the impact of normal economic cycles on our business.
 
FPD Competition
 
The pump industry is highly fragmented, with hundreds of competitors. We compete, however, primarily with a limited number of large companies operating on a global scale. Competition amongst our closest competitors is generally driven by delivery times, expertise, price, breadth of product offerings, contractual terms, previous installation history and reputation for quality. Some of our largest pump industry competitors include ITT Industries, Ebara Corporation, KSB Inc. and Sulzer Pumps.
 
The pump industry continues to undergo considerable consolidation, which is primarily driven by (i) the need to lower costs through reduction of excess capacity and (ii) customers’ preference to align with global full service


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suppliers to simplify their supplier base. Despite the consolidation activity, the market remains highly competitive. Based on independent industry sources, we believe that we are the largest pump manufacturer serving the oil and gas, chemical and power generation industries and the third largest pump manufacturer overall. We believe that our strongest sources of competitive advantage rest with our extensive range of pumps for the oil and gas, chemical and power generation industries, our large installed base, our strong customer relationships, our more than 200 years of legacy experience in manufacturing and servicing pumping equipment and our reputation for providing quality engineering solutions.
 
FPD Backlog
 
FPD’s backlog of orders as of December 31, 2009 was $1.8 billion, compared with $2.3 billion as of December 31, 2008. We expect to ship over 95% of December 31, 2009 backlog during 2010.
 
FLOW CONTROL DIVISION
 
FCD, the second largest business segment within Flowserve, designs, manufactures, distributes and services a broad portfolio of industrial valve and automation solutions, including isolation and control valves, actuation, controls and related equipment. In addition, FCD offers energy management products such as steam traps and condensate recovery systems. FCD leverages its experience and application know-how by offering a complete menu of engineered services to complement its expansive product portfolio. FCD products used to control, direct and manage the flow of liquids and gases are an integral part of any flow control system. Our valve products are most often customized, being engineered to perform specific functions within each of our customers’ unique flow control environments.
 
Our flow control products are primarily used by companies that operate in the chemical (including pharmaceutical), power generation (nuclear, fossil, coal gasification and renewable), oil and gas, water management and general industries, including aerospace, pulp and paper and mining. FCD has 47 sites worldwide, including 19 principal manufacturing facilities, five of which are located in the United States (“U.S.”), and 28 QRCs. A small portion of our valves are also produced through an unconsolidated foreign joint venture in India.
 
FCD Products
 
We believe that our valve, automation and controls product and solutions portfolio represents one of the most comprehensive in the flow control industry. Our products are used in a wide variety of applications, from general industrial to the most severe and demanding of service, including those involving high levels of corrosion, extreme temperatures and/or pressures, zero fugitive emissions and nuclear power emergency shutdown.
 
FCD’s “smart” valve and diagnostics technologies, which integrate high technology sensors, microprocessor controls and digital positioners into high performance control valves, permit real-time system analysis, system warnings and remote services. These technologies have been developed in response to the growing demand for increased automation, improved process control efficiency and digital communications at the plant level. We are committed to further enhancing the quality of our product portfolio by continuing to upgrade our existing offerings with cutting-edge technologies.


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The following is a summary list of our generally available valve and automation products and globally recognized brands:
 
FCD Product Types
 
     
•   Valve Automation Systems
  •   Digital Positioners
•   Control Valves
  •   Pneumatic Positioners
•   Ball Valves
  •   Intelligent Positioners
•   Gate Valves
  •   Electric/Electronic Actuators
•   Globe Valves
  •   Pneumatic Actuators
•   Check Valves
  •   Hydraulic Actuators
•   Butterfly Valves
  •   Diaphragm Actuators
•   Lined Plug Valves
  •   Switches
•   Lubricated Plug Valves
  •   Steam Traps
•   Polyethylene Valves
  •   Condensate and Energy Recovery Systems
•   Smart Valves
  •   Boiler Controls
•   Diagnostic Software
  •   Digital Communications
•   Electro Pneumatic Positioners
  •   Valve and Automation Repair Services
 
FCD Brand Names
 
     
•   Accord
  •   NAF
•   Anchor/Darling
  •   NAVAL
•   Argus
  •   Noble Alloy
•   Atomac
  •   Norbro
•   Automax
  •   Nordstrom
•   Battig
  •   PMV
•   Durco
  •   P+W
•   Edward
  •   Serck Audco
•   Gestra
  •   Schmidt Armaturen
•   Kammer
  •   Valtek
•   Limitorque
  •   Vogt
•   McCANNA/MARPAC
  •   Worcester Controls
 
FCD Services
 
We provide aftermarket products and services through our network of 28 QRCs located throughout the world. Our service personnel provide a comprehensive set of equipment maintenance services for flow control systems, including advanced diagnostics, repair, installation, commissioning, retrofit programs and field machining capabilities. A large portion of our service work is performed on a quick response basis, which includes 24-hour service in all of our major markets. We also provide in-house repair and return manufacturing services worldwide through our production facilities. We believe our ability to offer this comprehensive set of services on short notice provides us with a unique competitive advantage and unparalleled access to our customers’ installed base of flow control products.
 
FCD New Product Development
 
Our research and development investment has been targeted in areas that will advance our technological leadership and further differentiate our competitive advantage from a product perspective. Investment has been focused on significantly enhancing the digital integration and interoperability of the valve top works (positioners, actuators, limit switches and associated accessories) with Distributed Control Systems (“DCS”). Our efforts in this


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area continue to pursue the development and deployment of next-generation hardware and software for valve diagnostics, and the integration of the resulting device intelligence through DCS to provide a practical and effective asset management capability for the end user. In addition to developing these new capabilities and value-added services, our investments also include product portfolio expansion and fundamental research in material sciences in order to increase the temperature, pressure and erosion-resistance limits of existing products, as well as noise reduction and emerging areas such as desalination. These investments are made by adding new resources and talent to the organization, as well as leveraging the experience of FPD and FSD and increasing our collaboration with third parties. We expect to continue our research and development investments in the areas discussed above.
 
None of these newly developed valve products or services required the investment of a material amount of our assets or was otherwise material.
 
FCD Customers
 
Our customer mix spans several industries, including the chemical, oil and gas, power generation, water management and general industries. Our product mix includes original equipment and aftermarket parts and services. FCD contracts with a variety of customers, ranging from engineering, procurement and construction companies, to distributors, end users and other original equipment manufacturers.
 
FCD Competition
 
While in recent years the valve market has undergone a significant amount of consolidation, in relative terms, the market remains highly fragmented. Some of the largest valve industry competitors include Tyco, Cameron, Emerson, Metso and Crane Co.
 
Our market research and assessments indicate that the top 10 global valve manufacturers collectively comprise less than 25% of the total valve market. Based on independent industry sources, we believe that we are the third largest industrial valve supplier on a global basis. We believe that our strongest sources of competitive advantage rest with our comprehensive portfolio of valve products and services, our focus on execution and our expertise in severe corrosion and erosion applications.
 
FCD Backlog
 
FCD’s backlog of orders as of December 31, 2009 was $485.3 million, compared with $482.9 million as of December 31, 2008. We expect to ship over 75% of December 31, 2009 backlog during 2010.
 
FLOW SOLUTIONS DIVISION
 
Through FSD, we design, manufacture and distribute mechanical seals, sealing systems and parts and provide related services, principally to process industries. The mechanical seals contained in rotating equipment operate in high stress conditions and require repair or replacement throughout the products’ useful lives, and the repair and replacement of mechanical seals is an integral part of our aftermarket services. Our mechanical seals are used on a variety of rotating equipment, including pumps, compressors, mixers, steam turbines and other specialty equipment, primarily in the oil and gas, chemical processing, mineral and ore processing and general industrial end user markets. The use of mechanical seals provides users both safety and environmental benefits, including reductions of liquid and gaseous emissions, including greenhouse gases, water management and electric power usage.
 
We manufacture mechanical seals at four plants in the U.S. and at six plants outside the U.S. A small portion of our products are also manufactured through an unconsolidated joint venture in South Korea. Additionally, we have two other unconsolidated joint ventures in Saudi Arabia and India where products are produced for sale in those territories. Through our global network of 80 QRCs, five of which are co-located in a manufacturing facility, and two authorized distribution centers, we provide service, repair and diagnostic services for maintaining components of seal support systems. Our mechanical seal products are primarily marketed to end users through our direct sales force and to distributors and, on a commission basis, sales representatives. A portion of our mechanical seal products is sold directly to original equipment manufacturers for incorporation into rotating equipment requiring mechanical seals.


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FSD Products
 
We design, manufacture and distribute approximately 185 different models of mechanical seals and sealing systems. We believe our ability to deliver engineered new seal product orders within 72 hours from the customer’s request through design, engineering, manufacturing, testing and delivery provides us with a leading competitive advantage. Mechanical seals are critical to the reliable operation of rotating equipment in that they prevent leakage and emissions of hazardous substances from the rotating equipment and reduce shaft wear on the equipment caused by the use of non-mechanical seals. We also manufacture a gas-lubricated mechanical seal that is used in high-speed compressors for gas pipelines and in the oil and gas production and process markets. We continually update our mechanical seals and sealing systems to integrate emerging technologies.
 
The following list summarizes our seal products and services and globally recognized brands:
 
FSD Product Types
 
     
•   Cartridge Seals
  •   Gas Barrier Seals
•   Dry-Running Seals
  •   Couplings
•   Metal Bellow Seals
  •   Service and Repair
•   Elastomeric Seals
  •   Sealing Support Systems and Auxiliaries
•   Slurry Seals
  •   Monitoring and Diagnostics
•   Split Seals
   
 
FSD Brand Names
 
     
•   BW Seals
  •   Interseal
•   Durametallic
  •   Pacific Wietz
•   Five Star Seal
  •   Pac-Seal
•   Flowserve
  •   QRCtm
•   Flowstar
  •   ReadySeal
•   GASPACtm
  •   LifeCycle Advantage
 
FSD Services
 
We provide aftermarket services through our network of 80 QRCs located throughout the world, including 24 sites in North America. We also provide asset management services and condition monitoring for rotating equipment through special contracts with many of our customers that reduce maintenance costs. This work is performed on a quick-response basis, and we offer 24-hour service in all of our major markets.
 
FSD New Product Development
 
Our investments in new product research and development focus on developing longer-lasting and more efficient products and value-added services. In addition to numerous product upgrades, our recent mechanical seal and seal system innovations include:
 
  •  standard cartridge seal product line that satisfies global requirements for general duty applications in process industries such as chemical, biofuel, water management, petrochemical and power generation;
 
  •  standardized sealing support system product line;
 
  •  pipeline pump seal that improves reliability in high pressure liquid pipeline applications including crude oil, refined hydrocarbons and specialty chemicals;
 
  •  economical pusher and metal bellows cartridge seal family that services the hydrocarbon processing industry and high end chemical markets;
 
  •  advanced surface treatment technology applied to mechanical seal faces that extends reliability and energy savings for new and retrofit applications;


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  •  heavy-duty mechanical seal for power plants that features exclusive anti-electro-corrosion technology to improve operational efficiency in hot water services; and
 
  •  a configuration and quotation tool that supports our sealing support system product line.
 
We also market “Flowstar.Net,” an interactive tool used to actively monitor and manage information relative to equipment performance. Flowstar.Net enhances our customers’ ability to make informed decisions and respond quickly to plant production problems, extends the life of their production equipment and lowers maintenance expenses. The functionality of Flowstar.Net has been expanded to present to our customers the lower maintenance costs provided by our services and to allow our distributors to use this tool with their customers.
 
None of these newly developed seal products or services required the investment of a material amount of our assets or was otherwise material.
 
FSD Customers
 
Our mechanical seal products and systems are sold directly to end users and to original equipment manufacturers for incorporation into pumps, compressors, mixers or other rotating equipment requiring mechanical seals. Our mechanical seal sales are diversified among several industries, including oil and gas, chemical, mineral and ore processing and general industries.
 
FSD Competition
 
We compete against a number of manufacturers in the sale and servicing of mechanical seals. Among our largest global mechanical seal competitors are John Crane, a unit of Smiths Group Plc., and Eagle Burgmann, Inc., which is a joint venture of two traditional global seal manufacturers, Chesterton and AES. Based on independent industry sources, we believe that we are the second largest industrial mechanical seals supplier in the world. We believe our ability to quickly manufacture customers’ requests for engineered seal products, from design to engineering, manufacturing, testing and delivery, is a major competitive advantage.
 
FSD Backlog
 
FSD’s backlog of orders as of December 31, 2009 was $96.4 million (including $22.8 million of interdivision backlog, which is eliminated and not included in consolidated backlog), compared with $118.2 million (including $18.6 million of interdivision backlog) as of December 31, 2008. We expect to ship approximately 95% of December 31, 2009 backlog during 2010.
 
AVAILABLE INFORMATION
 
We maintain an internet website at www.flowserve.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 are made available free of charge through the “Investor Relations” section of our Internet website as soon as reasonably practicable after we electronically file the reports with, or furnish the reports to, the U.S. Securities and Exchange Commission (“SEC”).
 
Also available on our Internet website are our Corporate Governance Guidelines for our Board of Directors and Code of Ethics and Business Conduct, as well as the charters of the Audit, Finance, Organization and Compensation and Corporate Governance and Nominating Committees of our Board of Directors. All of the foregoing documents may be obtained through our Internet website as noted above and are available in print without charge to shareholders who request them. Information contained on or available through our Internet website is not incorporated into this Annual Report or any other document we file with, or furnish to, the SEC.


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ITEM 1A.   RISK FACTORS
 
Any of the events discussed as risk factors below may occur. If they do, our business, financial condition, results of operations and cash flows could be materially adversely affected. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also impair our business operations. Because of these risk factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.
 
Our business depends on the levels of capital investment and maintenance expenditures by our customers, which in turn are affected by numerous factors, including the state of domestic and global economies, global energy demand, the cyclical nature of their markets, their liquidity and the condition of global credit and capital markets.
 
Demand for most of our products and services depends on the level of new capital investment and planned maintenance expenditures by our customers. The level of capital expenditures by our customers depends, in turn, on general economic conditions, availability of credit, economic conditions within their respective industries and expectations of future market behavior. Additionally, volatility in commodity prices can negatively affect the level of these activities and can result in postponement of capital spending decisions or the delay or cancellation of existing orders. The ability of our customers to finance capital investment and maintenance may also be affected by factors independent of the conditions in their industry, such as the condition of global credit and capital markets.
 
The businesses of many of our customers, particularly oil and gas companies, chemical companies and general industrial companies, are to varying degrees cyclical and have experienced periodic downturns. Our customers in these industries, particularly those whose demand for our products and services is primarily profit-driven, historically have tended to delay large capital projects, including expensive maintenance and upgrades, during economic downturns. For example, our chemical customers generally tend to reduce their spending on capital investments and operate their facilities at lower levels in a soft economic environment, which reduces demand for our products and services. Additionally, while oil and gas prices have recently recovered somewhat from their lows, fluctuating energy demand forecasts and lingering uncertainty concerning commodity pricing can cause our customers to be more conservative in their capital planning, which may reduce demand for our products and services. Reduced demand for our products and services could result in the delay or cancellation of existing orders or lead to excess manufacturing capacity, which unfavorably impacts our absorption of fixed manufacturing costs. This reduced demand may also erode average selling prices in our industry. Any of these results could adversely affect our business, financial condition, results of operations and cash flows.
 
Additionally, some of our customers may delay capital investment and maintenance even during favorable conditions in their markets. Disruptions in global financial markets and banking systems experienced in 2008 continue to create difficulties in accessing credit and capital markets, and the costs of newly raised debt have generally increased. Continued difficulty in accessing these markets and the increased associated costs can have a negative effect on investment in large capital projects, including necessary maintenance and upgrades, even during favorable market conditions. In addition, the liquidity and financial position of our customers could impact their ability to pay in full and/or on a timely basis. Any of these factors, whether individually or in the aggregate, could have a material adverse effect on our customers and, in turn, our business, financial condition, results of operations and cash flows.
 
Continuing volatility in commodity prices, prolonged credit and capital market disruptions and a sluggish global economic recovery could prompt customers to delay or cancel existing orders, which could adversely affect the viability of our backlog and could impede our ability to realize revenues on our backlog.
 
The increased levels of disruption experienced by credit and capital markets around the globe in the latter half of 2008 and continuing through 2009 has included, among other things, extreme volatility in securities prices, reduced levels of liquidity and credit availability and declining and uncertain valuations. These disruptions, when combined with the volatility in commodity prices that has also been experienced, have contributed to a significant


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decrease in the rate of general economic growth. While global economic conditions stabilized generally in the latter half of 2009, a sluggish global economic recovery or extended slowing of global economic activity could adversely affect the businesses of our customers, which could potentially result in delays or cancellations of orders for our products.
 
Our backlog represents the value of uncompleted customer orders. While we cannot be certain that reported backlog will be indicative of future results, our ability to accurately value our backlog can be adversely affected by numerous factors, including economic uncertainty. While we attempt to mitigate the financial consequences of order delays and cancellations through contractual provisions and other means, if we were to experience a significant increase in order delays or cancellations that can result from the aforementioned economic conditions, it could impede or delay our ability to realize anticipated revenues on our backlog. Such a loss of anticipated revenues could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
We may be unable to deliver our sizeable backlog on time, which could affect our revenues, future sales and profitability and our relationships with customers.
 
At December 31, 2009, backlog was $2.4 billion. In 2010, our ability to meet customer delivery schedules for backlog is dependent on a number of factors including, but not limited to, sufficient manufacturing plant capacity, adequate supply channel access to the raw materials and other inventory required for production, an adequately trained and capable workforce, project engineering expertise for certain large projects and appropriate planning and scheduling of manufacturing resources. Many of the contracts we enter into with our customers require long manufacturing lead times and contain penalty clauses related to on-time delivery. Failure to deliver in accordance with customer expectations could subject us to financial penalties, may result in damage to existing customer relationships and could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
We sell our products in highly competitive markets, which results in pressure on our profit margins and limits our ability to maintain or increase the market share of our products.
 
The markets for our products and services are fragmented and highly competitive. We compete against large and well-established national and global companies, as well as regional and local companies, low-cost replicators of spare parts and in-house maintenance departments of our end user customers. We compete based on price, technical expertise, timeliness of delivery, contractual terms, previous installation history and reputation for quality and reliability. While competitive environments in slow growth industries and for original equipment orders are inherently more influenced by pricing, domestic and global economic conditions during 2009 and current economic forecasts suggest that the competitive influence of pricing has broadened. Additionally, some of our customers have been attempting to reduce the number of vendors from which they purchase in order to reduce the size and diversity of their inventory. To remain competitive, we must invest in manufacturing, marketing, customer service and support and our distribution networks. No assurances can be made that we will have sufficient resources to continue to make the investment required to maintain or increase our market share or that our investments will be successful. If we do not compete successfully, our business, financial condition, results of operations and cash flows could be materially adversely affected.
 
If we are not able to execute and realize the expected financial benefits from our strategic realignment and other cost-saving initiatives, our business could be adversely affected.
 
At the outset of 2009, we announced a strategic realignment initiative intended to reduce and optimize certain non-strategic manufacturing facilities and our overall cost structure. This initiative was expanded in the latter half of 2009 to include additional realignment activities in the remainder of 2009 and continuing to a lesser extent into 2010, and involves structural changes in our global manufacturing footprint through additional migration to low-cost regions, additional consolidation of product manufacturing and further SG&A reductions. We also announced as part of our larger realignment strategy and to better serve our customers that, effective January 1, 2010, we consolidated the Flowserve Pump Division and Flow Solutions Division into the new Flow Solutions Group.


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While we anticipate significant financial benefits from our strategic realignment, anticipated cost savings are by their nature estimates that are difficult to predict and are necessarily inexact. Further, our integration of the Flowserve Pump and Flow Solutions Divisions and our additional realignment activities will place substantial demands on our management, which could divert attention from other business priorities. If we are unable to integrate our businesses successfully or execute these realignment activities effectively, then we may fail to realize the anticipated synergies, customer service improvements and cost savings of this strategic initiative. This failure could, in turn, materially adversely affect our business, financial condition, results of operations and cash flows.
 
Economic, political and other risks associated with international operations could adversely affect our business.
 
A substantial portion of our operations is conducted and located outside the U.S. We have manufacturing, sales or service facilities in more than 50 countries and sell to customers in over 70 countries, in addition to the U.S. Moreover, we primarily outsource certain of our manufacturing and engineering functions to, and source our raw materials and components from, China, Eastern Europe, India, Latin America and Mexico. Accordingly, our business and results of operations are subject to risks associated with doing business internationally, including:
 
  •  instability in a specific country’s or region’s political or economic conditions, particularly in emerging markets and the Middle East;
 
  •  trade protection measures, such as tariff increases, and import and export licensing and control requirements;
 
  •  potentially negative consequences from changes in tax laws or tax examinations;
 
  •  difficulty in staffing and managing widespread operations;
 
  •  difficulty of enforcing agreements and collecting receivables through some foreign legal systems;
 
  •  differing and, in some cases, more stringent labor regulations;
 
  •  partial or total expropriation;
 
  •  differing protection of intellectual property;
 
  •  inability to repatriate income or capital; and
 
  •  difficulty in administering and enforcing corporate policies, which may be different than the customary business practices of local cultures.
 
For example, political unrest or work stoppages could negatively impact the demand for our products from customers in affected countries and other customers, such as U.S. oil refineries, that could be affected by the resulting disruption in the supply of crude oil. Similarly, military conflicts in the Middle East could soften the level of capital investment and demand for our products and services. We are also investigating or have investigated certain allegations regarding foreign management engaging in unethical practices prohibited by our Code of Business Conduct, which could have inappropriately benefited them at our expense.
 
In order to manage our day-to-day operations, we must overcome cultural and language barriers and assimilate different business practices. In addition, we are required to create compensation programs, employment policies and other administrative programs that comply with laws of multiple countries. We also must communicate and monitor standards and directives across our global network. Our failure to successfully manage our geographically diverse operations could impair our ability to react quickly to changing business and market conditions and to enforce compliance with standards and procedures.
 
Our future success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Any of these factors could, however, materially adversely affect our international operations and, consequently, our financial condition, results of operations and cash flows.


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Our international operations and foreign subsidiaries are subject to a variety of complex and continually changing laws and regulations.
 
Due to the international scope of our operations, the system of laws and regulations to which we are subject is complex and includes, without limitation, the U.S. Foreign Corrupt Practices Act and regulations issued by the U.S. Customs and Border Protection, the U.S. Department of Commerce’s Bureau of Industry and Security, the U.S. Treasury Department’s Office of Foreign Assets Control and various foreign governmental agencies, including applicable export controls, customs, currency exchange control and transfer pricing regulations and various programs administered by the United Nations, as applicable. No assurances can be made that we will continue to be found to be operating in compliance with, or be able to detect violations of, any such laws or regulations. In addition, we cannot predict the nature, scope or effect of future regulatory requirements to which our international operations might be subject or the manner in which existing laws might be administered or interpreted.
 
We are also subject to risks associated with certain of our foreign subsidiaries autonomously making sales and providing related services, under their own local authority, to customers in countries that have been designated by the U.S. State Department as state sponsors of terrorism, including Iran, Syria and Sudan. Due to the growing political uncertainties associated with these countries, in 2006, our foreign subsidiaries began a voluntary withdrawal, on a phased basis, from conducting new business in these countries. The aggregate amount of all business done by our foreign subsidiaries for customers in Iran, Syria and Sudan accounted for less than 1% of our consolidated global revenue in 2009. While substantially all new business with these countries has been voluntarily phased out, our foreign subsidiaries may independently continue to honor certain existing contracts, commitments and warranty obligations in compliance with U.S. and other applicable laws and regulations.
 
Our international operations expose us to fluctuations in foreign currency exchange rates.
 
A significant portion of our revenue, and certain of our costs, assets and liabilities, are denominated in currencies other than the U.S. dollar. The primary currencies to which we have exposure are the Euro, British Pound, Mexican Peso, Argentina Peso, Japanese Yen, Australian Dollar, Canadian Dollar, Russian Ruble, Indian Rupee, Singapore Dollar, Swedish Krona and Venezuelan Bolivar. Certain of the foreign currencies to which we have exposure, such as the Argentinean Peso and the Venezuelan Bolivar, have undergone significant devaluation in the past, which can reduce the value of our local monetary assets, reduce the U.S. dollar value of our local cash flow, generate local currency losses that may impact our ability to pay future dividends from our subsidiary to the parent company and potentially reduce the U.S. dollar value of future local net income. Although we enter into forward exchange contracts to economically hedge some of our risks associated with transactions denominated in certain foreign currencies, no assurances can be made that exchange rate fluctuations will not adversely affect our financial condition, results of operations and cash flows.
 
Noncompliance with U.S. export control laws could materially adversely affect our business.
 
In March 2006, we initiated a voluntary process to determine our compliance posture with respect to U.S. export control and economic sanctions laws and regulations. Upon initial investigation, it appeared that some product transactions and technology transfers were not handled in full compliance with U.S. export control laws and regulations. As a result, in conjunction with outside counsel, we conducted a voluntary systematic process to further review, validate and voluntarily disclose export violations discovered as part of this review process. We completed our comprehensive disclosures to the appropriate U.S. government regulatory authorities at the end of 2008, and we continue to work with those authorities to supplement and clarify specific aspects of those disclosures. Based on our review of the data collected, during the self-disclosure period of October 1, 2002 through October 1, 2007, a number of process pumps, valves, mechanical seals and parts related thereto were exported, in limited circumstances, without required export or reexport licenses or without full compliance with all applicable rules and regulations to a number of different countries throughout the world, including certain U.S. sanctioned countries. The foregoing information is subject to revision as we further review this submittal with applicable U.S. regulatory authorities.
 
Any self-reported violations of U.S. export control laws and regulations may result in civil or criminal penalties, including fines and/or other penalties. We are currently engaged in discussions with U.S. regulators about


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such penalties as part of our effort to resolve this matter; however, while we currently do not believe any such penalties will have a material adverse impact on our company, we are currently unable to definitively determine the full extent or nature or total amount of penalties to which we might be subject as a result of any such self-reported violations of the U.S. export control laws and regulations.
 
Terrorist acts, conflicts and wars may materially adversely affect our business, financial condition and results of operations and may adversely affect the market for our common stock.
 
As a major multi-national company with a large international footprint, we are subject to increased risk of damage or disruption to us, our employees, facilities, partners, suppliers, distributors, resellers or customers due to terrorist acts, conflicts and wars, wherever located around the world. The potential for future attacks, the national and international responses to attacks or perceived threats to national security, and other actual or potential conflicts or wars, including the Israeli-Hamas conflict and ongoing military operations in the Middle East at large, have created many economic and political uncertainties. In addition, as a major multi-national company with headquarters and significant operations located in the U.S., actions against or by the U.S. may impact our business or employees. Although it is impossible to predict the occurrences or consequences of any such events, they could result in a decrease in demand for our products, make it difficult or impossible to deliver products to our customers or to receive components from our suppliers, create delays and inefficiencies in our supply chain and pose risks to our employees, resulting in the need to impose travel restrictions, any of which could adversely affect our business, financial condition, results of operations and cash flows.
 
We are currently subject to a conditional securities class action litigation settlement, which if not finalized, could lead to continued litigation, the unfavorable outcome of which could have a material adverse effect on our financial condition, results of operations and cash flows.
 
A number of putative class action lawsuits were filed against us, certain of our former officers, our independent auditors and the lead underwriters of our most recent public stock offerings, alleging securities laws violations. By orders dated November 13, 2007 and January 4, 2008, the trial court denied the plaintiffs’ request for class certification and also granted summary judgment in favor of us and all other defendants on all of the plaintiffs’ claims. The plaintiffs appealed both rulings to the federal Fifth Circuit Court of Appeals, and on June 19, 2009, the Fifth Circuit issued an opinion vacating the trial court’s denial of class certification, reversing in part and vacating in part the trial court’s entry of summary judgment. As a result, the case was remanded to the trial court for further proceedings consistent with the opinion and further consideration of certain issues, including whether the plaintiffs can demonstrate that the case should be certified as a class action.
 
Following the issuance of the Court of Appeals’ opinion, we engaged in discussions among the parties in furtherance of an amicable resolution of the case, which resulted in a stipulation of settlement being executed and filed with the trial court. The settlement is subject to various customary conditions, including preliminary approval by the trial court, notice to class members, class member opt-out thresholds, a final hearing and final approval by the trial court. These conditions may not occur, and we must therefore be prepared to continue the case if they do not occur. If the litigation proceeds, we continue to strongly believe that we have valid defenses to the claims asserted, and we will continue to vigorously defend this case. In addition to the significant expense and burden we could then incur in further defending this litigation and any damages that we could suffer, our management’s attention and resources could be further diverted from ordinary business operations in order to address these claims. If the final resolution of this litigation is then unfavorable to us and our existing insurance coverage is either unavailable or inadequate to resolve the matter, our financial condition, results of operations and cash flows could be materially adversely affected.
 
Environmental compliance costs and liabilities could adversely affect our financial condition, results of operations and cash flows.
 
Our operations and properties are subject to regulation under environmental laws, which can impose substantial sanctions for violations. We must conform our operations to applicable regulatory requirements and adapt to changes in such requirements in all countries in which we operate.


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We use hazardous substances and generate hazardous wastes in many of our manufacturing and foundry operations. Most of our current and former properties are or have been used for industrial purposes, and some may require clean-up of historical contamination. We are currently conducting investigation and/or remediation activities at a number of locations where we have known environmental concerns. In addition, we have been identified as one of many PRPs at three Superfund sites. The projected cost of remediation at these sites, as well as our alleged “fair share” allocation, while not anticipated to be material, has been reserved. However, until all studies have been completed and the parties have either negotiated an amicable resolution or the matter has been judicially resolved, some degree of uncertainty remains.
 
We have incurred, and expect to continue to incur, operating and capital costs to comply with environmental requirements. In addition, new laws and regulations, stricter enforcement of existing requirements, the discovery of previously unknown contamination or the imposition of new clean-up requirements could require us to incur costs or become the basis for new or increased liabilities. Moreover, environmental and sustainability initiatives, practices, rules and regulations are under increasing scrutiny of both governmental and non-governmental bodies, which can cause rapid change in operational practices, standards and expectations and, in turn, increase our compliance costs. Any of these factors could have a material adverse effect on our financial condition, results of operations and cash flows.
 
We are party to asbestos-containing product litigation that could adversely affect our financial condition, results of operations and cash flows.
 
We are a defendant in a large number of lawsuits that seek to recover damages for personal injury allegedly resulting from exposure to asbestos-containing products formerly manufactured and/or distributed by us. Such products were used as components of process equipment, and we do not believe that there was any significant emission of asbestos-containing fibers during the use of this equipment. Although we are defending these allegations vigorously and believe that a high percentage of these lawsuits are covered by insurance or indemnities from other companies, there can be no assurance that we will prevail or that payments made by insurance or such other companies would be adequate. Unfavorable rulings, judgments or settlement terms could have a material adverse impact on our business, financial condition, results of operations and cash flows.
 
Our business may be adversely impacted by work stoppages and other labor matters.
 
As of December 31, 2009, we had approximately 15,000 employees, of which approximately 5,500 were located in the U.S. Approximately 7% of our U.S. employees are represented by unions. We also have unionized employees or employee work councils in Argentina, Australia, Austria, Belgium, Brazil, Canada, Finland, France, Germany, Italy, Japan, Mexico, the Netherlands, Spain, Sweden, Switzerland and the United Kingdom. No unionized facility produces more than 10% of our revenues. Although we believe that our relations with our employees are strong and we have not experienced any material strikes or work stoppages recently, no assurances can be made that we will not in the future experience these and other types of conflicts with labor unions, works councils, other groups representing employees or our employees generally, or that any future negotiations with our labor unions will not result in significant increases in our cost of labor.
 
Inability to protect our intellectual property could negatively affect our competitive position.
 
We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. We cannot guarantee, however, that the steps we have taken to protect our intellectual property will be adequate to prevent infringement on our rights or misappropriation of our technology. For example, effective patent, trademark, copyright and trade secret protection may be unavailable or limited in some of the foreign countries in which we operate. In addition, while we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, such confidentiality agreements could be breached or otherwise may not provide meaningful protection for our trade secrets and know-how related to the design, manufacture or operation of our products. If it became necessary for us to resort to litigation to protect our intellectual property rights, any proceedings could be burdensome and costly, and we may not prevail. Further, adequate remedies may not be available in the event of an unauthorized use or disclosure of our trade secrets and manufacturing expertise. If we fail to successfully enforce our intellectual


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property rights, our competitive position could suffer, which could harm our business, financial condition, results of operations and cash flows.
 
If we are unable to obtain raw materials at favorable prices, our operating margins and results of operations may be adversely affected.
 
We purchase substantially all electric power and other raw materials we use in the manufacturing of our products from outside sources. The costs of these raw materials have been volatile historically and are influenced by factors that are outside our control. In recent years, the prices for energy, metal alloys, nickel and certain other of our raw materials have been volatile. While we strive to offset our increased costs through supply chain management, contractual provisions and our CIP initiative, where gains are achieved in operational efficiencies, our operating margins and results of operations and cash flows may be adversely affected if we are unable to pass increases in the costs of our raw materials on to our customers or operational efficiencies are not achieved.
 
Significant changes in pension fund investment performance or assumptions changes may have a material effect on the valuation of our obligations under our defined benefit pension plans, the funded status of these plans and our pension expense.
 
We maintain defined benefit pension plans that are required to be funded in the U.S., India, Japan, Mexico, the Netherlands and the United Kingdom, and defined benefit plans that are not required to be funded in Austria, France, Germany and Sweden. Our pension liability is materially affected by the discount rate used to measure our pension obligations and, in the case of the plans that are required to be funded, the level of plan assets available to fund those obligations and the expected long-term rate of return on plan assets. A change in the discount rate can result in a significant increase or decrease in the valuation of pension obligations, affecting the reported status of our pension plans and our pension expense. Significant changes in investment performance or a change in the portfolio mix of invested assets can result in increases and decreases in the valuation of plan assets or in a change of the expected rate of return on plan assets. Changes in the expected return on plan assets assumption can result in significant changes in our pension expense and future funding requirements.
 
We continually review our funding policy related to our U.S. pension plan in accordance with applicable laws and regulations. The performance of global financial markets in 2008, and to a lesser extent in 2009, has reduced the value of investments held in trust to support pension plans. Additionally, U.S. regulations are continually increasing the minimum level of funding for U.S pension plans. The combined impact of these changes required significant contributions to our pension plans in 2009, which will continue, albeit to a lesser extent, in 2010. Contributions to our pension plans reduce the availability of our cash flows to fund working capital, capital expenditures, research and development efforts and other general corporate purposes.
 
We may incur material costs as a result of product liability and warranty claims, which could adversely affect our financial condition, results of operations and cash flows.
 
We may be exposed to product liability and warranty claims in the event that the use of one of our products results in, or is alleged to result in, bodily injury and/or property damage or our products actually or allegedly fail to perform as expected. While we maintain insurance coverage with respect to certain product liability claims, we may not be able to obtain such insurance on acceptable terms in the future, and any such insurance may not provide adequate coverage against product liability claims. In addition, product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of the ultimate outcome. An unsuccessful defense of a product liability claim could have an adverse affect on our business, financial condition, results of operations and cash flows. Even if we are successful in defending against a claim relating to our products, claims of this nature could cause our customers to lose confidence in our products and our company. Warranty claims are not generally covered by insurance, and we may incur significant warranty costs in the future for which we would not be reimbursed.


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The recording of increased deferred tax asset valuation allowances in the future could affect our operating results.
 
We currently have significant net deferred tax assets resulting from tax credit carry forwards, net operating losses and other deductible temporary differences that are available to reduce taxable income in future periods. Based on our assessment of our deferred tax assets, we determined, based on projected future income and certain available tax planning strategies, that approximately $226 million of our deferred tax assets will more likely than not be realized in the future, and no valuation allowance is currently required for this portion of our deferred tax assets. Should we determine in the future that these assets will not be realized, we will be required to record an additional valuation allowance in connection with these deferred tax assets and our operating results would be adversely affected in the period such determination is made.
 
Our outstanding indebtedness and the restrictive covenants in the agreements governing our indebtedness limit our operating and financial flexibility.
 
We are required to make scheduled repayments and, under certain events of default, mandatory repayments on our outstanding indebtedness, which may require us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, research and development efforts and other general corporate purposes, such as dividend payments and share repurchases, and could generally limit our flexibility in planning for, or reacting to, changes in our business and industry.
 
In addition, the agreements governing our bank credit facilities impose certain operating and financial restrictions on us and somewhat limit management’s discretion in operating our businesses. These agreements limit or restrict our ability, among other things, to: incur additional debt; change fiscal year; pay dividends and make other distributions; prepay subordinated debt, make investments and other restricted payments; enter into sale and leaseback transactions; create liens; sell assets; and enter into transactions with affiliates.
 
Our bank credit facilities also contain covenants requiring us to deliver to lenders certificates of compliance with leverage and interest coverage financial covenants and our audited annual and unaudited quarterly financial statements. Our ability to comply with these covenants may be affected by events beyond our control. Failure to comply with these covenants could result in an event of default which, if not cured or waived, may have a material adverse effect on our financial condition, results of operations and cash flows.
 
We may not be able to continue to expand our market presence through acquisitions, and any future acquisitions may present unforeseen integration difficulties or costs.
 
Since 1997, we have expanded through a number of acquisitions, and we may pursue strategic acquisitions of businesses in the future. Our ability to implement this growth strategy will be limited by our ability to identify appropriate acquisition candidates, covenants in our credit agreement and other debt agreements and our financial resources, including available cash and borrowing capacity. In addition, acquisitions of businesses may require additional debt financing, resulting in higher leverage and an increase in interest expense, and could result in the incurrence of contingent liabilities.
 
Should we acquire another business, the process of integrating acquired operations into our existing operations may create operating difficulties and may require significant financial and managerial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the more common challenges associated with acquisitions that we may experience include:
 
  •  loss of key employees or customers of the acquired company;
 
  •  conforming the acquired company’s standards, processes, procedures and controls, including accounting systems and controls, with our operations, which could cause deficiencies related to our internal control over financial reporting;
 
  •  coordinating operations that are increased in scope, geographic diversity and complexity;
 
  •  retooling and reprogramming of equipment;


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  •  hiring additional management and other critical personnel; and
 
  •  the diversion of management’s attention from our day-to-day operations.
 
Further, no guarantees can be made that we would realize the cost savings, synergies or revenue enhancements that we may anticipate from any acquisition, or that we will realize such benefits within the time frame that we expect. If we are not able to timely address the challenges associated with acquisitions and successfully integrate acquired businesses, or if our integrated product and service offerings fail to achieve market acceptance, our business could be adversely affected.
 
Forward-Looking Information is Subject to Risk and Uncertainty
 
This Annual Report and other written reports and oral statements we make from time-to-time include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts included in this Annual Report regarding our financial position, business strategy, plans and objectives of management for future operations, industry conditions, market conditions and indebtedness covenant compliance are forward-looking statements. In some cases forward looking statements can be identified by terms such as “may,” “should,” “expect,” “plans,” “forecasts,” “targets,” “seeks,” “anticipate,” “believe,” “estimate,” “predicts,” “potential,” “continue,” “intends,” or other comparable terminology. These statements are not historical facts or guarantees of future performance but instead are based on current expectations and are subject to significant risks, uncertainties and other factors, many of which are outside of our control.
 
We have identified factors that could cause actual plans or results to differ materially from those included in any forward-looking statements. These factors include those described above under this “Risk Factors” heading, or as may be identified in our other SEC filings from time to time. These uncertainties are beyond our ability to control, and in many cases, it is not possible to foresee or identify all the factors that may affect our future performance or any forward-looking information, and new risk factors can emerge from time to time. Given these risks and uncertainties, undue reliance should not be placed on forward-looking statements as a prediction of actual results.
 
All forward-looking statements included in this Annual Report are based on information available to us on the date of this Annual Report and the risk that actual results will differ materially from expectations expressed in this report will increase with the passage of time. We undertake no obligation, and disclaim any duty, to publicly update or revise any forward-looking statement or disclose any facts, events or circumstances that occur after the date hereof that may affect the accuracy of any forward-looking statement, whether as a result of new information, future events, changes in our expectations or otherwise. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995 and all of our forward-looking statements are expressly qualified in their entirety by the cautionary statements contained or referenced in this section.
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.   PROPERTIES
 
Our principal executive offices, including our global headquarters, are located at 5215 N. O’Connor Boulevard, Suite 2300, Irving, Texas 75039. Our global headquarters is a leased facility, which we began to occupy on January 1, 2004. The lease term is for 10 years, and we have the option to renew the lease for two additional five-year periods. We currently occupy 125,000 square feet at this facility.


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Our major manufacturing facilities (those with 50,000 or more square feet of manufacturing capacity) operating at December 31, 2009 are presented in the table below. See “Item 1. Business” in this Annual Report for further information with respect to all of our manufacturing and operational facilities, including QRCs:
 
                 
    Number
  Approximate
    of Plants   Square Footage
 
FPD
               
U.S. 
    6       1,162,000  
Non-U.S. 
    19       3,107,000  
FCD
               
U.S. 
    5       1,027,000  
Non-U.S. 
    11       1,332,000  
FSD
               
U.S. 
    1       130,000  
Non-U.S. 
    3       233,000  
 
We own the majority of our manufacturing facilities, and those manufacturing facilities we do not own are leased. We also maintain a substantial network of U.S. and foreign service centers and sales offices, most of which are leased. Our various leased facilities are generally covered by leases with terms in excess of seven years, with individual lease terms generally varying based on the facilities’ primary usage. We believe we will be able to extend leases on our various facilities as necessary, as they expire.
 
We believe that our current facilities are adequate to meet the requirements of our present and foreseeable future operations. We continue to review our capacity requirements as part of our strategy to optimize our global manufacturing efficiency. See Note 12 to the consolidated financial statements included in this Annual Report for additional information regarding our operating lease obligations.
 
ITEM 3.   LEGAL PROCEEDINGS
 
We are party to the legal proceedings that are described in Note 14 to our consolidated financial statements included in Item 8 of this Annual Report, and such disclosure is incorporated by reference into this “Item 3. Legal Proceedings.” In addition to the foregoing, we and our subsidiaries are named defendants in certain other routine lawsuits incidental to our business and are involved from time to time as parties to governmental proceedings, all arising in the ordinary course of business. Although the outcome of lawsuits or other proceedings involving us and our subsidiaries cannot be predicted with certainty, and the amount of any liability that could arise with respect to such lawsuits or other proceedings cannot be predicted accurately, management does not currently expect these matters, either individually or in the aggregate, to have a material effect on our financial position, results of operations or cash flows.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.


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ITEM 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information and Dividends
 
Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “FLS.” On February 18, 2010, our records showed 1,626 shareholders of record. The following table sets forth the range of high and low prices per share of our common stock as reported by the NYSE for the periods indicated.
 
PRICE RANGE OF FLOWSERVE COMMON STOCK
(Intraday High/Low Prices)
 
         
    2009   2008
 
First Quarter
  $61.18/$43.23   $111.41/$80.05
Second Quarter
  $85.00/$54.54   $138.53/$104.81
Third Quarter
  $102.42/$60.90   $141.35/$81.17
Fourth Quarter
  $108.85/$92.76   $87.50/$37.92
 
The table below presents declaration, record and payment dates, as well as the per share amounts, of dividends on our common stock during 2009 and 2008:
 
                         
Declaration Date   Record Date   Payment Date   Dividend Per Share
 
November 23, 2009
    December 23, 2009       January 6, 2010     $ 0.27  
August 25, 2009
    September 23, 2009       October 7, 2009       0.27  
May 15, 2009
    June 24, 2009       July 8, 2009       0.27  
February 25, 2009
    March 25, 2009       April 8, 2009       0.27  
 
                         
Declaration Date   Record Date   Payment Date   Dividend Per Share
 
November 20, 2008
    December 24, 2008       January 7, 2009     $ 0.25  
August 14, 2008
    September 24, 2008       October 8, 2008       0.25  
May 30, 2008
    June 25, 2008       July 9, 2008       0.25  
February 27, 2008
    March 26, 2008       April 9, 2008       0.25  
 
On February 23, 2009, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.25 per share to $0.27 per share payable quarterly beginning on April 8, 2009. On February 22, 2010, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.27 per share to $0.29 per share payable quarterly beginning on April 7, 2010. Any subsequent dividends will be reviewed by our Board of Directors on a quarterly basis and declared at its discretion dependent on its assessment of our financial situation and business outlook at the applicable time. Our credit facilities contain covenants that could restrict our ability to declare and pay dividends on our common stock. Please see the discussion of our credit facilities under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” of this Annual Report and in Note 12 to our consolidated financial statements included in Item 8 of this Annual Report.
 
Issuer Purchases of Equity Securities
 
On February 27, 2008, our Board of Directors announced the approval of a program to repurchase up to $300 million of our outstanding common stock, and the program commenced in the second quarter of 2008. The share repurchase program does not have an expiration date, and we reserve the right to limit or terminate the repurchase program at any time without notice.
 
During the quarter ended December 31, 2009, we repurchased a total of 131,500 shares of our common stock under the program for $13.4 million (representing an average cost of $102.11 per share). Since the adoption of this program, we have repurchased a total of 2,285,600 shares of our common stock for $205.9 million (representing an average cost of $90.09 per share). As of December 31, 2009, we had 58.9 million shares issued and outstanding


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(excluding the impact of treasury shares). We may repurchase up to an additional $94.1 million of our common stock under the stock repurchase program. The following table sets forth the repurchase data for each of the three months during the quarter ended December 31, 2009:
 
                                 
                      Maximum Number of
 
                      Shares (or
 
                Total Number of
    Approximate Dollar
 
    Total Number
          Shares Purchased as
    Value) That May Yet
 
    of Shares
    Average Price Paid
    Part of Publicly
    Be Purchased Under
 
Period
  Purchased     per Share     Announced Plan     the Plan  
                      (In millions)  
 
October 1-31
    269 (1)   $ 104.67           $ 107.5  
November 1-30
    134,864 (2)     102.10       131,500       94.1  
December 1-31
    11,055 (3)     98.05             94.1  
                                 
Total
    146,188     $ 101.79       131,500          
                                 
 
 
(1) Represents shares that were tendered by employees to satisfy minimum tax withholding amounts for restricted stock awards at an average price per share of $104.67.
 
(2) Includes a total of 2,163 shares that were tendered by employees to satisfy minimum tax withholding amounts for restricted stock awards at an average price per share of $101.92, and includes 1,201 shares of common stock purchased at a price of $100.50 per share by a rabbi trust that we maintain in connection with our director deferral plans pursuant to which non-employee directors may elect to defer directors’ quarterly cash compensation to be paid at a later date in the form of common stock.
 
(3) Represents shares that were tendered by employees to satisfy minimum tax withholding amounts for restricted stock awards at an average price per share of $98.05.


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Stock Performance Graph
 
The following graph depicts the most recent five-year performance of our common stock with the S&P 500 Index and S&P 500 Industrial Machinery (formerly referred to as Machinery (Diversified) — 500 Index). The graph assumes an investment of $100 on December 31, 2004, and assumes the reinvestment of any dividends over the following five years. The stock price performance shown in the graph is not necessarily indicative of future price performance.
 
(PERFORMANCE GRAPH)
 
                                                             
      Base
                             
      Period
                             
 Company/Index     2004     2005     2006     2007     2008     2009
Flowserve Corporation
    $ 100.00       $ 143.65       $ 183.26       $ 352.20       $ 190.82       $ 355.09  
S&P 500 Index
      100.00         104.91         121.48         128.15         80.74         102.11  
S&P 500 Industrial Machinery
      100.00         98.05         111.97         135.72         81.37         113.69  
                                                             


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ITEM 6.   SELECTED FINANCIAL DATA
 
                                         
    Year Ended December 31,  
    2009(a)     2008     2007     2006(b)     2005(c)  
    (Amounts in thousands, except per share data and ratios  
 
RESULTS OF OPERATIONS
                                       
Sales
  $ 4,365,262     $ 4,473,473     $ 3,762,694     $ 3,061,063     $ 2,695,277  
Gross profit
    1,548,132       1,580,312       1,247,722       1,007,302       870,561  
Selling, general and administrative expense
    (934,451 )     (981,597 )     (854,527 )     (781,172 )     (683,213 )
Operating income(d)
    629,517       615,678       411,890       240,948       199,883  
Interest expense
    (40,005 )     (51,293 )     (60,119 )     (65,688 )     (74,125 )
Provision for income taxes
    (156,460 )     (147,721 )     (104,294 )     (73,238 )     (40,583 )
Income from continuing operations
    427,887       442,413       255,774       115,367       52,480  
Income from continuing operations per share (diluted)
    7.59       7.71       4.44       2.02       0.93  
Net earnings of Flowserve Corporation
    427,887       442,413       255,774       115,032       17,074  
Net earnings per share of Flowserve Corporation common shareholders (diluted)(e)
    7.59       7.71       4.44       2.01       0.30  
Cash flows from operating activities
    431,277       408,790       417,668       163,186       127,445  
Cash dividends declared per share
    1.08       1.00       0.60              
FINANCIAL CONDITION
                                       
Working capital
  $ 1,041,239     $ 724,429     $ 646,591     $ 418,846     $ 398,356  
Total assets
    4,248,894       4,023,694       3,520,421       2,869,235       2,613,664  
Total debt
    566,728       573,348       557,976       564,569       665,136  
Retirement obligations and other liabilities
    449,691       495,883       419,229       403,998       391,986  
Total equity
    1,801,747       1,374,198       1,300,217       1,024,682       857,435  
FINANCIAL RATIOS
                                       
Return on average net assets
    18.2 %     20.4 %     13.8 %     8.1 %     5.7 %
Net debt to net capital ratio
    −5.1 %     6.9 %     12.4 %     32.5 %     39.9 %
 
 
(a) Results of operations in 2009 include costs of $68.1 million resulting from realignment initiatives, resulting in a reduction of after tax net earnings of $49.8 million.
 
(b) Results of operations in 2006 include stock option expense of $6.9 million as a result of adoption of Accounting Standards Codification (“ASC”) 718, “Compensation — Stock Compensation,” resulting in a reduction in after tax net earnings of $5.5 million.
 
(c) Results of operations in 2005 include a loss on debt extinguishment of $27.7 million and a $30.1 million impairment of assets held for sale related to our General Services Group, which is included in discontinued operations, resulting in a reduction in after tax net earnings of $40.2 million.
 
(d) Retrospective adjustments have been made to prior period information to conform to current period presentation. These retrospective adjustments result from our adoption of guidance related to noncontrolling interests under ASC 810, “Consolidation,” which was effective January 1, 2009.
 
(e) Retrospective adjustments have been made to prior period information to conform to current period presentation. These retrospective adjustments result from our adoption of guidance related to the two-class method of calculating earnings per share under ASC 260, “Earnings Per Share,” which was effective January 1, 2009.


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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis is provided to increase the understanding of, and should be read in conjunction with, the accompanying consolidated financial statements and notes. Please see “Risk Factors” and “Forward-Looking Statements” sections for a discussion of the risks, uncertainties and assumptions associated with these statements. Unless otherwise noted, all amounts discussed herein are consolidated.
 
EXECUTIVE OVERVIEW
 
Our Company
 
We believe that we are a world-leading manufacturer and aftermarket service provider of comprehensive flow control systems. We develop and manufacture precision-engineered flow control equipment integral to the movement, control and protection of the flow of materials in our customers’ critical processes. Our product portfolio of pumps, valves, seals, automation and aftermarket services supports global infrastructure industries, including oil and gas, chemical, power generation and water management, as well as general industrial markets where our products and services add value. Through our manufacturing platform and global network of Quick Response Centers (“QRCs”), we offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. We currently employ approximately 15,000 employees in more than 50 countries.
 
Our business model is significantly influenced by the capital spending of global infrastructure industries for the placement of new products into service and aftermarket services for existing operations. The worldwide installed base of our products is an important source of aftermarket revenue, where products are expected to ensure the maximum operating time of many key industrial processes. Over the past several years, we have significantly invested in our aftermarket strategy to provide local support to maximize our customers’ investment in our offerings, as well as to provide business stability during various economic periods. The aftermarket business, which is served by more than 150 of our QRCs located around the globe, provides a variety of service offerings for our customers including spare parts, service solutions, product life cycle solutions and other value added services, and is generally a higher margin business and a key component of our profitable growth.
 
Through December 31, 2009, our operations were conducted through three business segments that are referenced throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”):
 
  •  Flowserve Pump Division (“FPD”): engineered and industrial pumps, pump systems, submersible motors and related services;
 
  •  Flow Control Division (“FCD”): engineered and industrial valves, control valves, actuators, controls and related services; and
 
  •  Flow Solutions Division (“FSD”): mechanical seals, auxiliary systems and parts and related services.
 
Our product portfolio is built on more than 50 well-respected brand names such as Worthington, IDP, Valtek, Limitorque and Durametallic, which we believe to be one of the most comprehensive in the industry. The products and services are sold either directly or through designated channels to more than 10,000 companies, including some of the world’s leading engineering and construction firms, original equipment manufacturers, distributors and end users.
 
We continue to build on our geographic breadth through our QRC network with the goal to be positioned as near to the customers as possible for service and support in order to capture this important aftermarket business. Along with ensuring that we have the local capability to sell, install and service our equipment in remote regions, it is equally imperative to continuously improve our global operations. We continue to expand our global supply chain capability to meet global customer demands and ensure the quality and timely delivery of our products. Significant efforts are underway to improve the supply chain processes across our divisions to find areas of synergy and cost reduction and to improve our supply chain management capability to ensure it can meet global customer demands. We continue to focus on improving on-time delivery and quality, while managing warranty costs as a percentage of


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sales across our global operations, through the assistance of a focused CIP initiative. The goal of the CIP initiative, which includes lean manufacturing, six sigma business management strategy and value engineering, is to maximize service fulfillment to customers through on-time delivery, reduced cycle time and quality at the highest internal productivity.
 
We experienced reduced demand for original equipment in 2009 as compared with 2008. This was a result of the impact from the global financial crisis and economic recession. Many of our oil and gas customers postponed major capital decisions from their original initiation dates in order to reevaluate the viability of the project, take advantage of the cost reduction in commodities, such as steel, or to better align the start up of operations with revised demand growth forecasts. In the chemical market, capital spending was reduced due to the adverse effects this industry experienced from the significant drop in consumer demand and the Gross Domestic Product (“GDP”) decline of many economic regions. Both the power generation and water management markets showed resiliency in their capital spending due to government stimulus investments, management of existing operations and the necessity to build infrastructure for developing markets. Capital spending directed at improving and optimizing existing operations provided growth opportunities across all of these industries in 2009, and the developing regions of the world continued capital investments despite the challenging global economy.
 
In 2009, we experienced stable conditions in our global aftermarket business. The demand growth in past years provided us the opportunity to increase our installed base of new products and drive recurring aftermarket sales. Over the past several years, we have significantly invested in our aftermarket strategy to provide local support to maximize our customers’ investment in our offerings, as well as to provide business stability during various economic periods. In 2009, we continued to execute on our strategy to increase our presence in all regions of the global market to capture these aftermarket opportunities.
 
We believe that with our customer relationships, our global presence and our highly regarded technical capabilities, we will continue to have opportunities in our core industries; however, we face challenges affecting many companies in our industry with a significant multinational presence, such as economic, political, currency and other risks.
 
Our Markets
 
The following discussion should be read in conjunction with the “Outlook for 2010” section included in this MD&A.
 
Our products and services are used in several distinct industries: oil and gas; chemical; power generation; water management; and a number of other industries that are collectively referred to as “general industries.”
 
Demand for most of our products depends on the level of new capital investment and planned and unplanned maintenance expenditures by our customers. The level of new capital investment depends, in turn, on capital infrastructure projects driven by the need for oil and gas, power and water, as well as general economic conditions. These drivers are generally related to the phase of the business cycle in their respective industries and the expectations of future market behavior. The levels of maintenance expenditures are additionally driven by the reliability of equipment, planned and unplanned downtime for maintenance and the required capacity utilization of the process.
 
Our customers include engineering contractors, original equipment manufacturers, end users and distributors. Sales to engineering contractors and original equipment manufacturers are typically for large project orders and critical applications, as are certain sales to distributors. Project orders are typically procured for customers either directly from us or indirectly through contractors for new construction projects or facility enhancement projects.
 
The quick turnaround business, which we also refer to as “book and ship,” is defined as orders that are received from the customer (booked) and shipped within three months of receipt. These orders are typically for more standardized, general purpose products, parts or services. Each of our three business segments generates certain levels of this type of business.
 
In the sale of aftermarket products and services, we benefit from a large installed base of our pumps, valves and seals, which require maintenance, repair and replacement parts. We use our manufacturing platform and global


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network of QRCs to offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. In geographic regions where we are positioned to provide quick response, we believe customers have traditionally relied on us, rather than our competitors, for aftermarket products due to our highly engineered and customized products. However, the aftermarket for standard products is competitive, as the existence of common standards allows for easier replacement of the installed products. As proximity of service centers, timeliness of delivery and quality are important considerations for all aftermarket products and services, we continue to expand our global QRC network to improve our ability to capture this important aftermarket business.
 
Oil and Gas
 
The oil and gas industry, which represented approximately 36% and 39% of our bookings in 2009 and 2008, respectively, experienced a measurable decline in new orders placed in 2009. Many of our clients postponed major projects due to the global financial crisis and the recession that followed. The delay of these projects was driven by the desire to take advantage of lower commodity costs, such as steel, the need to reevaluate the return on investment for a project or simply to better align the planned increased capacity with the revised timing of forecasted demand growth.
 
Global demand forecasts were revised downward in the later part of 2008 and through the first half of 2009. Mid-year forecasts turned more positive with recovery being supported by economic investment in developing regions such as China, India and the Middle East. These regions, along with Latin America, Africa and other parts of Asia, continue to plan for investments to grow their operating capacity, driven by the intent to become self-sufficient or to move into the more profitable products derived from refined oil.
 
The natural gas market experienced some reduction in spending on the upstream production side of the industry. This slowdown was influenced primarily by a drop in overall demand. Investments did continue in the liquefied natural gas expansion, as the need to prepare new gas field production for shipment to the consumer markets supported the need to complete the projects.
 
The outlook for the oil and gas industry is heavily dependent on the demand growth from both mature markets and developing geographies. We believe oil and gas companies will continue with upstream and downstream investment plans that are in line with projections of future demand growth and the production declines of existing operations. A projected decline in demand could cause oil and gas companies to reduce their overall level of spending, which could decrease demand for our products and services. However, we believe the long-term fundamentals for this industry remain solid based on current supply, projected depletion rates of existing fields and forecasted long-term demand growth.
 
Chemical
 
The chemical industry represented approximately 18% and 17% of our bookings in 2009 and 2008, respectively. This industry experienced adverse effects from the global financial crisis and recession, as consumer spending fell significantly and the GDP of many countries experienced declines for the first time in several years. Many of the major chemical companies were faced with restructuring their operations to align with current market conditions. In 2009, the industry experienced the closure or shut in of a large number of facilities around the globe, particularly in the mature markets. In developing regions, investments continued at a moderated pace compared to previous years. New plant investments are forecasted for developing regions as they build out capacity to meet their indigenous demand growth. Companies in the industry have generally increased their forecasts for maintenance and upgrades of continuing operations to ensure global competitiveness.
 
The outlook for the chemical industry remains heavily dependent on global economic conditions. As consumer spending and industrial manufacturing gain momentum, the chemical industry should recover as well. A stabilizing of the price of oil feedstock has the opportunity to promote investment, as companies can more effectively project potential financial return. We believe the chemical industry in the near-term will continue to invest in maintenance and upgrades for optimization of existing assets and that developing regions will continue investing in capital infrastructure to meet current and future indigenous demand. We believe our global presence and our localized aftermarket capabilities are well positioned to serve the potential growth opportunities in this industry.


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Power Generation
 
The power generation industry represented approximately 20% and 15% of our bookings in 2009 and 2008, respectively. This industry continued to see capital investment growth due to the increased demands for electricity in developing countries, such as China and India, and capacity increases in mature markets, including the United States (“U.S.”). Due to the need for increased power generating capacity and concerns about the environment, this industry did see a significant increase in the area of renewable power. Plans for nuclear power generation expanded measurably through the year, with countries such as China and India raising their planned capacity over the next decade. Expansion in solar power created opportunities in concentrated solar power applications where our products proved their ability to tolerate high temperatures and abrasive flow mediums. The drive for a cleaner environment also increased investments in the development of carbon capture and storage methodologies where our products and services are applicable.
 
We believe the outlook for the power generation industry remains favorable; however, a protracted economic recovery period could delay the demand for additional power, which may affect the timing of major capital project spending. Current legislative efforts to limit the emissions of carbon dioxide may have an adverse effect on investment plans depending on the potential requirements imposed and the timing of compliance by country. It is important to note that proposed methods of limiting carbon dioxide emissions offer business opportunities for our products and services. We believe the long-term fundamentals for the power generation industry remain solid based on projected increases in demand for electricity driven by global population growth, advancements of industrialization and growth of urbanization in developing markets. We also believe that our long-standing reputation in the power generation industry, our portfolio of offerings for the various generating methods, our advancements in serving the renewables market and carbon capture methodologies along with our global service and support structure position us well for the future opportunities in this important industry.
 
Water Management
 
The water management industry represented approximately 7% and 6% of our bookings in 2009 and 2008, respectively. Worldwide demand for fresh water and water treatment continues to create requirements for new facilities or for upgrades of existing systems, many of which require products that we offer, particularly pumps. We believe that the persistent demand for fresh water during all economic cycles supports continuing investments even in the current economic environment. Industry forecasts do indicate some potential funding challenges for municipal and government projects due to reduced tax revenues; however, several government stimulus programs are targeted at the maintenance and development of fresh water resources. These stimulus projects should generate demand and provide opportunities for pumps, valves, seals and actuation products.
 
The water management industry is facing a future supply/demand challenge relative to forecasted global population growth coupled with the advancement of industrialization and urbanization. Due to the limitations of usable fresh water around the globe, there continues to be an increased investment in desalination. This investment is forecasted to significantly increase over the next couple of decades. We believe we are a global leader in the desalination market, which is already an important source of fresh water in the Mediterranean region and the Middle East. We expect that this trend in desalination will expand from these traditional areas to other coastal areas around the globe, which we believe presents a significant market opportunity for pumps, valves, actuation products and energy recovery devices.
 
General Industries
 
General industries comprises a variety of different businesses, including mining and ore processing, pharmaceuticals, pulp and paper, food and beverage and other smaller applications, none of which individually represented more than 5% of total bookings in 2009 and 2008. General industries also include sales to distributors, whose end customers operate in the industries we primarily serve. General industries represented, in the aggregate, approximately 19% and 23% of our bookings in 2009 and 2008, respectively.
 
In 2009, we saw a general decline in all of these businesses. Pulp and paper along with mining and ore processing are two areas that experienced measured declines in business activity and investment due to a drop in demand for their products. This drop in demand was directly related to the significant decrease in the rate of general


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global economic growth. Other industries in this segment also experienced tougher market conditions when compared to previous years. The outlook for this group of industries is dependent upon the rate of economic recovery. We believe that our specialty product offerings designed for these industries and our aftermarket service capabilities will provide business opportunities in these industries today and as the global economy recovers.
 
The reporting of trends by product type, customer type and business type is based upon analytical review of individual operational results and knowledge of their respective businesses, as we do not formally track revenues by any of these categories. These trends are analyzed as a secondary reporting mechanism that is not derived directly from our general ledger system.
 
OUR RESULTS OF OPERATIONS
 
Throughout this discussion of our results of operations, we discuss the impact of fluctuations in foreign currency exchange rates. We have calculated currency effects by translating current year results on a monthly basis at prior year exchange rates for the same periods.
 
As discussed in Note 3 to our consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” (“Item 8”) of this Annual Report on Form 10-K for the year ended December 31, 2009 (“Annual Report”), FPD acquired Calder AG, a Swiss supplier of energy recovery technology, effective April 21, 2009, and Calder AG’s results of operations have been consolidated since the date of acquisition. Additionally, FPD acquired the remaining 50% interest in Niigata Worthington Company, Ltd. (“Niigata”), a Japanese manufacturer of pumps and other rotating equipment, effective March 1, 2008. The incremental interest acquired was accounted for as a step acquisition and Niigata’s results of operations have been consolidated since the date of acquisition. Prior to this transaction, our 50% interest in Niigata was recorded using the equity method of accounting. No pro forma information has been provided for either acquisition due to immateriality.
 
As discussed in Note 8 to our consolidated financial statements included in Item 8 of this Annual Report, in February 2009, we announced our intent to incur up to $40 million in realignment costs (the “Initial Realignment Program”) to reduce and optimize certain non-strategic manufacturing facilities and our overall cost structure by improving our operating efficiency, reducing redundancies, maximizing global consistency and driving improved financial performance. The Initial Realignment Program was substantially complete at December 31, 2009. In October 2009, we announced our intent to incur additional realignment costs (the “Subsequent Realignment Program”) to expand our efforts to optimize assets, reduce our overall cost structure, respond to reduced orders and drive an enhanced customer-facing organization. The Initial Realignment Program and the Subsequent Realignment Program are collectively referred to as our “Realignment Programs.” In January 2010, we announced our expectation that up to $20 million in charges related to our Realignment Programs would be incurred in 2010, which, when combined with the $68.1 million of charges incurred in 2009 (as disclosed in the table below), brings our total expected realignment charges to approximately $88 million. Unless otherwise stated, information about our Realignment Programs included in this MD&A is presented in total. For the individual impacts of each program, please see Note 8 to our consolidated financial statements included in Item 8 of this Annual Report.
 
The Realignment Programs consist of both restructuring and non-restructuring costs. Restructuring charges represent costs associated with the relocation of certain business activities, outsourcing of some business activities and facility closures. Non-restructuring charges are costs incurred to improve operating efficiency and reduce redundancies, which includes a reduction in headcount. Expenses are reported in Cost of Sales (“COS”) or Selling, General and Administrative Expense (“SG&A”), as applicable, in our consolidated statement of income.


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The following is a summary of our charges included in operating income in 2009 related to our Realignment Programs:
 
                                                 
                      Subtotal
             
    Flowserve
    Flow
    Flow
    Reportable
          Consolidated
 
Total Charges for 2009
  Pump     Control     Solutions     Segments     All Other     Total  
    (Amounts in millions)  
 
Restructuring Charges
                                               
COS
  $ 14.3     $ 0.5     $ 4.9     $ 19.7     $ 0.7     $ 20.4  
SG&A
    3.3       0.2       6.9       10.4       1.4       11.8  
                                                 
    $ 17.6     $ 0.7     $ 11.8     $ 30.1     $ 2.1     $ 32.2  
                                                 
Non-restructuring Charges
                                               
COS
  $ 9.4     $ 7.0     $ 4.6     $ 21.0     $ 0.1     $ 21.1  
                                                 
SG&A
    6.0       3.8       4.2       14.0       0.8       14.8  
                                                 
    $ 15.4     $ 10.8     $ 8.8     $ 35.0     $ 0.9     $ 35.9  
                                                 
Total Realignment Program Charges
                                               
COS
  $ 23.7     $ 7.5     $ 9.5     $ 40.7     $ 0.8     $ 41.5  
                                                 
SG&A
    9.3       4.0       11.1       24.4       2.2       26.6  
                                                 
    $ 33.0     $ 11.5     $ 20.6     $ 65.1     $ 3.0     $ 68.1  
                                                 
 
The following is a summary of charges related to identified initiatives under our Realignment Programs expected to be incurred in 2010:
 
                                                 
                      Subtotal —
             
    Flowserve
    Flow
    Flow
    Reportable
          Consolidated
 
Total Expected Charges for 2010(1)
  Pump     Control     Solutions     Segments     All Other     Total  
    (Amounts in millions)  
 
Restructuring Charges
                                               
COS
  $ 3.8     $     $ 0.9     $ 4.7     $     $ 4.7  
SG&A
    0.2                   0.2             0.2  
                                                 
    $ 4.0     $     $ 0.9     $ 4.9     $     $ 4.9  
                                                 
Non-restructuring Charges
                                               
COS
  $ 0.9     $ 1.9     $ 0.1     $ 2.9     $     $ 2.9  
SG&A
                                   
                                                 
    $ 0.9     $ 1.9     $ 0.1     $ 2.9     $     $ 2.9  
                                                 
Total Realignment Program Charges
                                               
COS
  $ 4.7     $ 1.9     $ 1.0     $ 7.6     $     $ 7.6  
SG&A
    0.2                   0.2             0.2  
                                                 
    $ 4.9     $ 1.9     $ 1.0     $ 7.8     $     $ 7.8  
                                                 
 
 
(1) As the execution of the Subsequent Realignment Program is in the early stages, actual charges incurred could vary from total charges expected to be incurred, which represent management’s best estimate based on initiatives identified to date. The amounts disclosed above do not include up to $12 million anticipated to be incurred for initiatives that are currently under consideration, the actual amount of which could differ materially from this estimate.
 
Based on actions under our Initial Realignment Program, we have realized savings of approximately $33 million for the year ended December 31, 2009. Upon completion of our Initial Realignment Program, we expect annual cost savings of approximately $70 million. Approximately two-thirds of savings were and will be realized in COS, with the remainder in SG&A.


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Upon completion of currently identified initiatives under our Subsequent Realignment Program, we expect additional annual cost savings of approximately $40 million. Approximately half of savings are expected to be realized in COS, with the remainder in SG&A. As the execution of the Subsequent Realignment Program is in the early stages, actual savings realized could vary from expected savings, which represent management’s best estimate to date.
 
Generally, the charges presented were or will be paid in cash, except for asset write-downs, which are non-cash charges. Asset write-down charges (including accelerated depreciation of fixed assets, accelerated amortization of intangible assets and inventory write-downs) of $6.4 million were recorded during the year ended December 31, 2009. Approximately $10 million of cash payments related to our Initial Realignment Program and most of the cash payments related to our Subsequent Realignment Program will be incurred in 2010.
 
The following discussion should be read in conjunction with the “Outlook for 2010” section included in this MD&A.
 
Bookings and Backlog
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Bookings
  $ 3,885.3     $ 5,105.7     $ 4,318.7  
Backlog (at period end)
    2,371.2       2,825.1       2,276.6  
 
We define a booking as the receipt of a customer order that contractually engages us to perform activities on behalf of our customer with regard to manufacture, service or support. Bookings recorded and subsequently canceled within the year-to-date period are excluded from year-to-date bookings. Bookings in 2009 decreased by $1,220.4 million, or 23.9%, as compared with 2008. The decrease includes negative currency effects of approximately $216 million. These decreases are primarily attributable to declines in the oil and gas and general industries and reflect lower demand and customer-driven project delays due to a significant decrease in the rate of general global economic growth as compared with 2008. The decrease consists of declines in original equipment bookings in FPD, including the impacts of $110.9 million of thruster orders and the impact of the $85 million Abu Dhabi Crude Oil Pipeline order that were recorded in the same period in 2008 and did not recur, as well as declines in original equipment bookings by FSD. The decrease is also attributable to declines in the chemical industry and orders from distributors in FCD, partially offset by orders of more than $45 million in FCD to supply valves to four Westinghouse Electric Co. nuclear power units in North America.
 
Bookings in 2008 increased by $787.0 million, or 18.2%, as compared with 2007. The increase included currency benefits of approximately $181 million. The increase was attributable to strength in the oil and gas and general industries, especially in FPD, primarily in Europe, the Middle East and Africa (“EMA”), as well as continued strength in the chemical industry, especially in FCD, and the power generation industry in FPD and FCD and $68.5 million in bookings provided by Niigata. Historically, the fourth quarter has been a strong bookings quarter for us. However, bookings in the fourth quarter of 2008 were lower than bookings in each of the first, second and third quarters of 2008, reflecting our customers’ responses to concerns regarding recent disruptions in the credit and capital markets, global economic conditions and recent declines in oil and gas prices.
 
Backlog represents the accumulation of uncompleted customer orders. Backlog of $2.4 billion at December 31, 2009 decreased by $453.9 million, or 16.1%, as compared to December 31, 2008. Currency effects provided an increase of approximately $87 million (currency effects on backlog are calculated using the change in period end exchange rates). The overall net decrease includes the impact of cancellations of $41.2 million. By the end of 2010, we expect to ship over 90% of our December 31, 2009 backlog. Backlog of $2.8 billion at December 31, 2008 increased by $548.5 million, or 24.1%, as compared to December 31, 2007. Currency effects provided a decrease of approximately $185 million. During the fourth quarter of 2008, we had cancellations of $32.2 million, approximately $25 million of which was related to a single booking recorded by FPD in the third quarter of 2008.
 
Sales
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Sales
  $ 4,365.3     $ 4,473.5     $ 3,762.7  


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Sales in 2009 decreased by $108.2 million, or 2.4%, as compared with 2008. The decrease includes negative currency effects of approximately $208 million. The overall net decrease is attributable to decreased chemical and general industries sales and sales to distributors in FCD and decreased original equipment and aftermarket sales by FSD. These decreases were mostly offset by increased sales in FPD, primarily in the oil and gas and general industries, driven by shipments of large original equipment project orders that were booked in 2008. In 2009, original equipment sales decreased approximately 4% as compared with 2008 and aftermarket sales were comparable to 2008.
 
Sales in 2008 increased by $710.8 million, or 18.9%, as compared with 2007. The increase includes currency benefits of approximately $113 million. The increase was attributable to strength in the oil and gas and power generation markets in FPD, primarily in EMA and Asia Pacific, and growth in all markets in FCD, primarily in EMA and Asia Pacific, as well as $87.0 million in sales provided by Niigata. In 2008, original equipment and aftermarket sales increased approximately 22% and 13%, respectively, as compared with 2007.
 
Sales to international customers, including export sales from the U.S., were approximately 73% of sales in 2009 compared with 69% of sales in 2008 and 66% of sales in 2007. Sales to EMA were approximately 40%, 39% and 38% of total sales in 2009, 2008 and 2007, respectively. Sales into the Asia Pacific region were approximately 20%, 18%, and 16% of total sales in 2009, 2008 and 2007, respectively. Sales to Latin America were approximately 9%, 8% and 7% of total sales in 2009, 2008 and 2007, respectively.
 
Gross Profit and Gross Profit Margin
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Gross profit
  $ 1,548.1     $ 1,580.3     $ 1,247.7  
Gross profit margin
    35.5 %     35.3 %     33.2 %
 
Gross profit in 2009 decreased by $32.2 million, or 2.0%, as compared with 2008. The decrease includes the effect of $41.5 million in charges resulting from our Realignment Programs in 2009. Gross profit margin in 2009 of 35.5% was comparable with 2008. Improved pricing on original equipment orders that were booked by FPD and FCD in 2008 and shipped in 2009, increased utilization of low cost regions by FCD and FSD, various CIP initiatives and savings realized from our Initial Realignment Program were offset by a sales mix shift toward lower margin original equipment in FPD. Original equipment generally carries a lower margin than aftermarket. The sale of specialty pumps, which carry a higher margin, contributed to higher gross profit margins in both 2009 and 2008.
 
Gross profit in 2008 increased by $332.6 million, or 26.7%, as compared with 2007. Gross profit margin in 2008 of 35.3% increased from 33.2% in 2007. The increase was primarily attributable to FPD, whose gross profit margin increased due primarily to improved original equipment pricing implemented in 2007, increased throughput and increased sales, which favorably impacted our absorption of fixed manufacturing costs, and reduced warranty costs as a percentage of sales, as well as the impact of CIP initiatives. Additionally, gross profit margin was favorably impacted by specialty pumps, which had a higher margin. Partially offsetting these improvements was the significant growth in original equipment sales. While both original equipment and aftermarket sales increased, original equipment sales growth exceeded that of aftermarket sales growth during 2008. As a result, original equipment sales increased to approximately 65% of total sales as compared with approximately 63% in 2007. Original equipment generally carries a lower margin than aftermarket.
 
Selling, General and Administrative Expense (“SG&A”)
 
                         
    2009   2008   2007
    (Amounts in millions)
 
SG&A
  $ 934.5     $ 981.6     $ 854.5  
SG&A as a percentage of sales
    21.4 %     21.9 %     22.7 %
 
SG&A is impacted by growth in our underlying business, various initiatives to improve organizational capability, compliance and systems and infrastructure improvements. SG&A in 2009 decreased by $47.1 million, or 4.8%, as compared with 2008. SG&A includes the effect of $26.6 million in charges resulting from our Realignment Programs in 2009. Currency effects provided a decrease of approximately $32 million. The decrease was primarily


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attributable to a $42.6 million decrease in selling and marketing-related expenses, which is consistent with decreased bookings and sales. Cash recoveries of bad debts of $5.0 million that were reserved in 2008, a $4.4 million benefit from the adjustment of contingent consideration related to the acquisition of Calder AG (see Note 3 to our consolidated financial statements included in Item 8 of this Annual Report), strict cost control actions and savings realized from our Initial Realignment Program were partially offset by an increase in legal fees and accrued resolution costs related to shareholder litigation (see Note 14 to our consolidated financial statements included in Item 8 of this Annual Report) and charges resulting from our Realignment Programs. SG&A as a percentage of sales in 2009 improved 50 basis points as compared with 2008, primarily as a result of decreased selling and marketing-related expenses.
 
SG&A in 2008 increased by $127.1 million, or 14.9%, as compared with 2007. Currency effects provided an increase of approximately $21 million. The increase in SG&A was primarily attributable to a $61.5 million increase in selling and marketing-related expenses in support of increased bookings and sales and overall business growth. The increase was also attributable to a $47.0 million increase in other employees’ costs due to annual and long-term incentive compensation plans, including equity compensation, arising from improved performance and a higher stock price as of the date of grant and annual merit increases, $9.8 million of SG&A incurred by Niigata and a $11.1 million increase in bad debt expense, primarily in FCD, partially offset by a $10.3 million decrease in legal fees and expenses due to legal matters incurred in 2007 that did not recur. SG&A as a percentage of sales in 2008 improved 80 basis points as compared with the same period in 2007, primarily as a result of leverage from increased sales.
 
Net Earnings from Affiliates
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Net earnings from affiliates
  $ 15.8     $ 17.0     $ 18.7  
 
Net earnings from affiliates represents our net income from investments in seven joint ventures (one located in each of China, Japan, South Korea, Saudi Arabia and the United Arab Emirates and two located in India) that are accounted for using the equity method of accounting. Net earnings from affiliates in 2009 decreased by $1.2 million as compared with 2008, primarily attributable to our FCD joint venture in India and the impact of the consolidation of Niigata in the first quarter of 2008 when we purchased the remaining 50% interest. Net earnings from affiliates in 2008 decreased by $1.7 million as compared with 2007, primarily attributable to the impact of the consolidation of Niigata in the first quarter of 2008 when we purchased the remaining 50% interest.
 
Operating Income
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Operating income
  $ 629.5     $ 615.7     $ 411.9  
Operating income as a percentage of sales
    14.4 %     13.8 %     10.9 %
 
Operating income in 2009 increased by $13.8 million, or 2.2%, as compared with 2008. The increase includes the effect of approximately $68.1 million in charges from our Realignment Programs in 2009, mostly offset by savings realized from our Initial Realignment Program. The increase includes negative currency effects of approximately $48 million. The overall net increase was primarily a result of the $47.1 million decrease in SG&A, partially offset by the $32.2 million decrease in gross profit, discussed above.
 
Operating income in 2008 increased by $203.8 million, or 49.5%, as compared with 2007. The increase included currency benefits of approximately $20 million. The increase was primarily a result of the $332.6 million increase in gross profit, partially offset by the $127.1 million increase in SG&A, discussed above.


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Interest Expense and Interest Income
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Interest expense
  $ (40.0 )   $ (51.3 )   $ (60.1 )
Interest income
    3.2       8.4       4.3  
 
Interest expense decreased by $11.3 million in 2009 as compared with 2008, primarily as a result of decreased interest rates. Interest expense in 2008 decreased by $8.8 million as compared with 2007, primarily as a result of lower average outstanding debt and decreased interest rates. At December 31, 2009 approximately 71% of our debt was at fixed rates, including the effects of $385.0 million of notional interest rate swaps.
 
Interest income in 2009 decreased by $5.2 million as compared with 2008 due to decreased interest rates. Interest income in 2008 increased by $4.1 million as compared with 2007 due primarily to a higher average cash balance.
 
Other (Expense) Income, net
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Other (expense) income, net
  $ (8.0 )   $ 20.2     $ 5.9  
 
Other (expense) income, net in 2009 decreased to net other expense of $8.0 million, as compared with net other income of $20.2 million in 2008, primarily due to a $13.5 million increase in net losses arising from transactions in currencies other than our sites’ functional currencies, an $11.0 million decrease in net gains on forward exchange contracts (primarily the Euro and British Pound) and $2.8 million gain in 2008 on the bargain purchase of the remaining 50% interest in Niigata, as discussed in Note 3 to our consolidated financial statements included in Item 8 of this Annual Report, that did not recur.
 
Other (expense) income, net in 2008 increased by $14.3 million to net other income of $20.2 million as compared with 2007. This increase was primarily due to a $9.2 million increase in net gains on forward exchange contracts and a $1.1 million increase in net gains on transactions denominated in currencies other than our functional currencies, as well as the $2.8 million gain on the bargain purchase of the remaining 50% interest in Niigata, as discussed in Note 3 to our consolidated financial statements included in Item 8 of this Annual Report, as well as other individually immaterial items.
 
Tax Expense and Tax Rate
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Provision for income taxes
  $ 156.5     $ 147.7     $ 104.3  
Effective tax rate
    26.8 %     24.9 %     28.8 %
 
The 2009 effective tax rate differed from the federal statutory rate of 35% primarily due to the net impact of foreign operations, which includes the impacts of lower foreign tax rates and changes in our reserves established for uncertain tax positions.
 
The 2008 effective tax rate differed from the federal statutory rate of 35% primarily due to the net impact of foreign operations, which includes the impacts of lower foreign tax rates, changes in our reserves established for uncertain tax positions, benefits arising from our permanent reinvestment in foreign subsidiaries, changes in valuation allowance estimates and a favorable tax ruling in Luxembourg. The net impact of discrete items included in the discussion above was approximately $22 million, which lowered the effective tax rate by approximately 3.7%.
 
The 2007 effective tax rate differed from the federal statutory rate of 35% primarily due to the net impact of foreign operations and changes in valuation allowance estimates, as well as changes in tax law and net favorable results from various tax audits, partially offset by additional reserves established for uncertain tax positions pursuant to our adoption of Accounting Standards Codification (“ASC”) 740, “Income Taxes.” See additional


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discussion of uncertain tax positions in Note 17 to our consolidated financial statements included in Item 8 of this Annual Report.
 
We have operations in Asian countries that provide various tax incentives. During 2004, we received a 5-year, 10% tax rate in Singapore for income in excess of a prescribed base amount generated from certain regional headquarter activities, subject to certain employment and investment requirements. In 2008, the 10% tax rate in Singapore was extended through 2011. In India, we were granted 100% tax exemptions for profits derived from export sales and certain manufacturing operations in prescribed areas for a period of 10 years. The exemption for profits derived from export sales will expire in 2011, and the manufacturing operations exemption expired in 2007.
 
On May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 was signed into law, creating an exclusion from U.S. taxable income for certain types of foreign related party payments of dividends, interest, rents and royalties that, prior to 2006, have been subject to U.S. taxation. This exclusion was effective for the years 2006 through 2009, and applied to certain of our related party payments.
 
Our effective tax rate is based upon current earnings and estimates of future taxable earnings for each domestic and international location. Changes in any of these and other factors, including our ability to utilize foreign tax credits and net operating losses or results from tax audits, could impact the tax rate in future periods. As of December 31, 2009 we have foreign tax credits of $9.8 million, expiring in 2018 through 2019 against which we recorded $0.4 million in valuation allowances. Additionally, we have recorded other U.S. net deferred tax assets of $97.7 million, which relate to net operating losses, tax credits and other deductible temporary differences that are available to reduce taxable income in future periods, most of which do not have a definite expiration. Should we not be able to utilize all or a portion of these credits and losses, our effective tax rate would be negatively impacted.
 
Net Earnings and Earnings Per Share
 
                         
    2009   2008   2007
    (Amounts in millions, except per share amounts)
 
Net earnings of Flowserve Corporation
  $ 427.9     $ 442.4     $ 255.8  
Net earnings per share — diluted
    7.59       7.71       4.44  
Average diluted shares
    56.4       57.4       57.6  
 
Net earnings in 2009 decreased by $14.5 million to $427.9 million, or $7.59 per diluted share, as compared with 2008. The decrease was primarily attributable to the $28.2 million increase in other expense and an $8.8 million increase in tax expense, partially offset by the $13.8 million increase in operating income and an $11.3 million decrease in interest expense, as discussed above.
 
Net earnings in 2008 increased by $186.6 million to $442.4 million, or $7.71 per diluted share, as compared with 2007. The increase was primarily attributable to the $203.8 million increase in operating income, partially offset by the $43.4 million increase in tax expense, as discussed above.
 
Other Comprehensive Income (Expense)
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Other comprehensive income (expense)
  $ 63.0     $ (190.8 )   $ 70.4  
 
Other comprehensive income (expense) in 2009 increased by $253.8 million to income of $63.0 million as compared with 2008. The increase was due primarily to the weakening of the U.S. dollar exchange rate versus the Euro at December 31, 2009 as compared with December 31, 2008, as well as a decrease in pension and other postretirement expense, due primarily to events in 2008 that did not recur. and an increase in results from interest rate hedging activity.
 
Other comprehensive (expense) income in 2008 decreased by $261.2 million to expense of $190.8 million as compared with 2007. This was primarily due to the strengthening of the U.S. dollar exchange rate versus the Euro and the British Pound at December 31, 2008 as compared with December 31, 2007, as well as a decrease in pension


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and other postretirement income, which primarily reflects actuarial net losses resulting from returns on plan assets that were lower than anticipated.
 
Business Segments
 
Through December 31, 2009, we conducted our business through three business segments that represent our major product areas. We evaluate segment performance and allocate resources based on each segment’s operating income. See Note 18 to our consolidated financial statements included in Item 8 of this Annual Report for further discussion of our segments. The key operating results for our three business segments, FPD, FCD and FSD, are discussed below.
 
Flowserve Pump Division Segment Results
 
Through FPD, we design, manufacture, distribute and service engineered and industrial pumps and pump systems and submersible motors (collectively referred to as “original equipment”). FPD also manufactures replacement parts and related equipment, and provides a full array of support services (collectively referred to as “aftermarket”). FPD has 30 manufacturing facilities worldwide, 13 of which are located in Europe, seven in North America, six in Asia and four in Latin America. FPD also has 78 service centers, including those co-located in a manufacturing facility, in 30 countries. We operate primarily in the oil and gas, chemical and power generation industries.
 
                         
    Flowserve Pump Division
    2009   2008   2007
    (Amounts in millions)
 
Bookings
  $ 2,207.6     $ 3,040.3     $ 2,551.4  
Sales
    2,649.6       2,514.8       2,095.4  
Gross profit
    840.6       786.0       596.6  
Gross profit margin
    31.7 %     31.3 %     28.5 %
Segment operating income
    441.6       391.6       274.8  
Segment operating income as a percentage of sales
    16.7 %     15.6 %     13.1 %
Backlog (at period end)
    1,823.5       2,253.1       1,775.3  
 
Bookings in 2009 decreased by $832.7 million, or 27.4%, as compared with 2008. The decrease includes negative currency effects of approximately $142 million. The decrease in bookings reflects lower demand and customer-driven large project delays due to a significant decrease in the rate of general global economic growth as compared with 2008. The decrease consists of declines in original equipment bookings on major projects, which was driven by declines in the oil and gas, general, water management and chemical industries, and includes the impacts of $110.9 million in thruster orders and the $85 million order to supply a variety of pumps to build the Abu Dhabi Crude Oil Pipeline, which were booked in 2008 and did not recur. Bookings in EMA, North America and Latin America decreased $516.4 million (including negative currency effects of approximately $89 million), $283.0 million and $122.4 million (including negative currency effects of approximately $35 million), respectively. Of the $2.2 billion of bookings in 2009, approximately 43% were from oil and gas, 23% from power generation, 10% from water management, 8% from chemical and 16% from general industries.
 
Bookings in 2008 increased by $488.9 million, or 19.2%, as compared with 2007. The increase included currency benefits of approximately $115 million. The increase was attributable to EMA, North America and Asia Pacific, which increased $251.1 million (including currency benefits of approximately $106 million), $109.3 million and $109.2 million (including currency benefits of approximately $14 million), respectively. Bookings for original equipment and aftermarket increased approximately 20% and 16%, respectively. Original equipment bookings were driven by the oil and gas, power generation, water management and general industries. Niigata provided an increase of $68.5 million to total bookings and represented approximately 14% of the total bookings increase. The bookings increase also includes an order of approximately $85 million to supply a variety of pumps to build the Abu Dhabi Crude Oil Pipeline. These pumps will largely be supplied from our European operations and are scheduled to ship in 2010. Of the $3.0 billion in total bookings in 2008, approximately 49% were from oil and gas, 16% from power generation, 9% from water management, 8% from chemical and 18% from general industries.


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Sales in 2009 increased by $134.8 million, or 5.4%, as compared with 2008. The increase includes negative currency effects of approximately $127 million. The increase was driven by shipments of original equipment large project orders that were booked in 2008 when the oil and gas and power generation industries were stronger and prices were more favorable, which contributed to the increase of approximately 10% in original equipment sales in 2009 as compared with 2008. EMA, Asia Pacific and Latin America increased $119.0 million (including negative currency effects of approximately $87 million), $39.5 million (including negative currency effects of approximately $4 million) and $23.0 million (including negative currency effects of approximately $33 million), respectively. These increases were partially offset by a decrease in North America of $40.8 million, which was attributable to a decline in aftermarket sales, primarily in the chemical and general industries.
 
Sales in 2008 increased by $419.4 million, or 20.0%, as compared with 2007. The increase included currency benefits of approximately $67 million. The increase is primarily attributable to EMA, Asia Pacific and Latin America, which increased $212.9 million (including currency benefits of approximately $51 million), $91.9 million (including currency benefits of approximately $15 million) and $28.6 million (currency had a negligible impact), respectively. Original equipment sales increased by approximately 22%, while aftermarket sales grew by approximately 17% compared to 2007. As noted above, the strong growth in our served markets over the past two years, predominantly oil and gas and power generation, have been the key drivers of the increases in sales in 2008. The increase in sales was also attributable to increased throughput resulting from capacity expansion, price increases initiated in 2007 and sales of $87.0 million provided by Niigata.
 
Gross profit in 2009 increased by $54.6 million, or 6.9%, as compared with 2008. The increase includes the effect of $23.7 million in charges resulting from our Realignment Programs in 2009. Gross profit margin in 2009 of 31.7% increased from 31.3% in 2008. Increases provided by improved pricing on original equipment orders shipped in 2009 that were booked in late 2007 and early 2008, supply chain initiatives, operating efficiency improvements and savings realized from our Initial Realignment Program were partially offset by a sales mix shift toward original equipment. Original equipment generally carries a lower margin than aftermarket. As a result of the sales mix shift, original equipment sales increased to approximately 64% of total sales, as compared with approximately 61% of total sales in 2008. Gross profit margin was also favorably impacted by an increase in sales in 2009 of specialty pumps, which have a higher margin, as compared with 2008.
 
Gross profit in 2008 increased by $189.4 million, or 31.7%, as compared with 2007 and includes gross profit attributable to Niigata of $20.9 million. Gross profit margin in 2008 of 31.3% increased from 28.5% in 2007. This increase was primarily due to improved original equipment pricing implemented in 2007, increased throughput and increased sales, which favorably impact our absorption of fixed manufacturing costs, and reduced warranty costs as a percentage of sales, as well as the impact of CIP initiatives. Additionally, gross profit margin was favorably impacted by specialty pumps, which had a higher margin. Partially offsetting these improvements was the significant growth in original equipment sales. While both original equipment and aftermarket sales increased, original equipment growth exceeded that of aftermarket growth during 2008. As a result, original equipment sales increased to approximately 61% of total sales as compared with approximately 60% of total sales in 2007. Original equipment generally carries a lower margin than aftermarket.
 
Operating income in 2009 increased by $50.0 million, or 12.8%, as compared with 2008. Operating income includes the effect of $33.0 million in charges resulting from our Realignment Programs in 2009. The increase includes negative currency effects of approximately $31 million. The increase was due primarily to increased gross profit of $54.6 million, which includes the effect of savings realized from our Initial Realignment Program, as discussed above, partially offset by an increase in SG&A. The increase in SG&A is attributable to charges resulting from our Realignment Programs, partially offset by strict cost control actions, a $4.4 million benefit from the adjustment of contingent consideration related to the acquisition of Calder AG (see Note 3 to our consolidated financial statements included in Item 8 of this Annual Report) and savings realized from our Initial Realignment Program.
 
Operating income in 2008 increased by $116.8 million, or 42.5%, as compared with 2007. The increase included currency benefits of approximately $11 million. The increase was due primarily to increased gross profit of $189.4 million, partially offset by a $69.5 million increase in SG&A (including negative currency effects of approximately $10 million) primarily related to a $24.9 million increase in selling and marketing-related expense in


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support of increased bookings and sales and overall business growth. The increase was also attributable to an $18.9 million increase in other employees’ costs due to annual and long-term incentive compensation plans, including equity compensation, arising from improved performance and a higher stock price as of the date of grant and annual merit increases and $9.8 million of SG&A incurred by Niigata. Operating margin improved 250 basis points as compared with 2007 due primarily to the increase in gross profit margin of 280 basis points.
 
Backlog of $1.8 billion at December 31, 2009 decreased by $429.6 million, or 19.1%, as compared to December 31, 2008. Currency effects provided an increase of approximately $74 million. The overall net decrease includes the impact of cancellations of $39.0 million of orders booked during the prior year. The acquisition of Calder AG resulted in a $6.2 million increase in backlog. Backlog of $2.3 billion at December 31, 2008 increased by $477.8 million, or 26.9%, as compared to December 31, 2007. Currency effects provided a decrease of approximately $149 million.
 
Flow Control Division Segment Results
 
Our second largest business segment is FCD, which designs, manufactures and distributes a broad portfolio of engineered-to-order and configure-to-order isolation valves, control valves, valve automation products, boiler controls and related services. FCD leverages its experience and application know-how by offering a complete menu of engineered services to complement its expansive product portfolio. FCD has a total of 47 manufacturing facilities and QRCs in 22 countries around the world, with only five of its 19 manufacturing operations located in the U.S. Based on independent industry sources, we believe that we are the third largest industrial valve supplier on a global basis.
 
                         
    Flow Control Division
    2009   2008   2007
    (Amounts in millions)
 
Bookings
  $ 1,198.3     $ 1,486.4     $ 1,245.7  
Sales
    1,203.2       1,381.7       1,163.2  
Gross profit
    445.2       497.7       405.8  
Gross profit margin
    37.0 %     36.0 %     34.9 %
Segment operating income
    204.1       218.7       163.8  
Segment operating income as a percentage of sales
    17.0 %     15.8 %     14.1 %
Backlog (at period end)
    485.3       482.9       414.8  
 
Bookings in 2009 decreased by $288.1 million, or 19.4%, as compared with 2008. The decrease includes negative currency effects of approximately $53 million. The decrease in bookings is primarily attributable to Europe and North America, which decreased approximately $135 million and $70 million, respectively, driven by an overall decrease in orders from distributors and the chemical industry, as well as customer-driven delays in large projects in the oil and gas market. The decline in orders from distributors in Europe was driven by a decrease in general industries due to uncertainty surrounding global economic conditions. The decline in orders from distributors in North America was due to inventory destocking, but has recently exhibited evidence of stabilization. The chemical industry represents the largest global market decline, especially in Europe and North America, while oil and gas bookings declined due to customer-driven large project delays. Bookings in Asia Pacific decreased approximately $40 million, attributable to customer-driven delays on large projects in the chemical industry, and bookings in Latin America decreased approximately $26 million due to large pulp and paper projects in the first quarter of 2008 that did not recur. These decreases were partially offset by an increase in nuclear power orders, which included orders recorded in the third quarter of 2009 of more than $45 million to supply valves to four Westinghouse Electric Co. nuclear power units in North America, new project bookings in the emerging solar market, reflecting future growth opportunities, growth in the Middle East through expansion of QRC and joint venture activities and increased aftermarket repair and replacement orders. Of the $1.2 billion of bookings in 2009, approximately 29% were from chemical, 28% from general industries, 23% from power generation and 20% from oil and gas.
 
Bookings in 2008 increased by $240.7 million, or 19.3%, as compared with 2007. The increase included currency benefits of approximately $51 million. The growth in bookings was primarily attributable to strength in


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Europe and Asia Pacific, which increased approximately $79 million and $89 million, respectively. These regions continued to be a focus for growth opportunities. North America and Latin America combined increased approximately $54 million. Key growth areas included chemicals and nuclear power generation. Of the $1.5 billion of bookings in 2008, approximately 34% were from chemical, 31% from general industries, 18% from oil and gas and 17% from power generation.
 
Sales in 2009 decreased by $178.5 million, or 12.9%, as compared with 2008. This decrease includes negative currency effects of approximately $56 million. Sales in Europe and North America decreased approximately $91 million and $56 million, respectively, driven by an overall decline in sales to distributors and the chemical industry, as well as customer-driven delays in large projects in the oil and gas industry. Due to the short lead-time for our products, the drivers of the decline in sales are consistent with the drivers of the decline in bookings discussed above.
 
Sales in 2008 increased by $218.5 million, or 18.8%, as compared with 2007. This increase included currency benefits of approximately $34 million. Asia Pacific, which increased approximately $64 million, continued to show substantial sales growth in the chemical market, especially in China. Sales across our markets in Europe demonstrated growth of approximately $48 million. North American sales also produced growth of approximately $42 million. Oil and gas market sales reflected steady increases in all regions, especially in Europe and the Middle East. Latin America sales increased approximately $34 million, which was due primarily to growth in the pulp and paper market, which was not expected to continue in the near term.
 
Gross profit in 2009 decreased by $52.5 million, or 10.5%, as compared with 2008. The decrease includes the effect of $7.5 million in charges resulting from our Realignment Programs in 2009. Gross profit margin in 2009 of 37.0% increased from 36.0% for 2008. The increase in gross profit margin is attributable to improved pricing on large projects booked in 2008 that shipped in 2009, increased aftermarket repair and replacement business, materials cost savings, various CIP initiatives, improved utilization of low cost regions, volume-related cost control actions and savings realized from our Initial Realignment Program. These improvements were partially offset by pricing pressure and the negative impact of decreased sales on absorption of fixed manufacturing costs.
 
Gross profit in 2008 increased by $91.9 million, or 22.6%, as compared with 2007. Gross profit margin in 2008 of 36.0% increased from 34.9% in 2007. The increase reflected higher sales levels, which favorably impacted our absorption of fixed manufacturing costs. Price increases, CIP, materials saving initiatives, investment in new products and increased absorption continued to drive margin improvement and offset the inflationary impact of our raw materials. The impact of metal price increases and transportation fuel surcharges were minimized through supply chain initiatives.
 
Operating income in 2009 decreased by $14.6 million, or 6.7% as compared with 2008. The decrease includes the effect of $11.5 million in charges resulting from our Realignment Programs in 2009. The decrease includes negative currency effects of approximately $10 million. The decrease is attributable to the $52.5 million decrease in gross profit, which includes the effect of savings realized from our Initial Realignment Program, partially offset by a $41.2 million decrease in SG&A. Reduced SG&A was attributable to decreased selling and marketing-related expenses, strict cost control actions, $5.0 million in cash recoveries of bad debts reserved in 2008 and savings realized from our Initial Realignment Program in 2009.
 
Operating income in 2008 increased by $54.9 million, or 33.5%, as compared with 2007. This increase included currency benefits of approximately $6 million. The increase was primarily attributable to the $91.9 million improvement in gross profit, offset in part by higher SG&A, which increased $38.3 million (including negative currency effects of approximately $7 million). Increased SG&A is primarily due to $17.3 million in higher selling and marketing costs and $4.9 million in increased R&D costs, as well as a $7.3 million bad debt expense related to two customers. Partially offsetting these cost increases was the reversal of a net $2.3 million accrual due to a contract settlement and a $1.2 million increase in net earnings from affiliates generated by our joint venture in India, which was driven by growth in the oil and gas markets in the Middle East. SG&A as a percentage of sales improved 60 basis points, primarily attributable to leverage from increased sales.
 
Backlog of $485.3 million at December 31, 2009 was comparable to December 31, 2008. Currency effects provided an increase of approximately $9 million. Backlog of $482.9 million at December 31, 2008 increased by


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$68.1 million, or 16.4%, as compared to December 31, 2007. Currency effects provided a decrease of approximately $21 million.
 
Flow Solutions Division Segment Results
 
Through FSD, we engineer, manufacture and sell mechanical seals, auxiliary systems and parts, and provide related services, principally to process industries and general industrial markets, with similar products sold internally in support of FPD. FSD has added to its global operations and has ten manufacturing operations, four of which are located in the U.S. FSD operates 80 QRCs worldwide (including six that are co-located in a manufacturing facility), including 24 sites in North America, 20 in EMA, 19 in Latin America and 17 in Asia. Our ability to rapidly deliver mechanical sealing technology through global engineering tools, locally sited QRCs and on-site engineers represents a significant competitive advantage. This business model has enabled FSD to establish a large number of alliances with multi-national customers. Based on independent industry sources, we believe that we are the second largest mechanical seal supplier in the world.
 
                         
    Flow Solutions Division
    2009   2008   2007
    (Amounts in millions)
 
Bookings
  $ 553.9     $ 668.8     $ 592.5  
Sales
    579.2       653.7       564.5  
Gross profit
    264.8       299.1       252.6  
Gross profit margin
    45.7 %     45.8 %     44.7 %
Segment operating income
    102.7       129.2       112.7  
Segment operating income as a percentage of sales
    17.7 %     19.8 %     20.0 %
Backlog (at period end)
    96.4       118.2       109.4  
 
Bookings in 2009 decreased by $114.9 million, or 17.2%, as compared with 2008. This decrease includes negative currency effects of approximately $21 million. The decrease in bookings reflects lower demand and customer-driven project delays due to a significant decrease in the rate of general global economic growth as compared with 2008. A $106.0 million decrease in customer bookings was due primarily to decreases in both project and aftermarket bookings. An $8.9 million decrease in interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) also contributed to the decrease. The decrease in customer bookings of original equipment and aftermarket was primarily attributable to North America, driven by the oil and gas, chemical and general industries, as well as decreases in the oil and gas and general industries across all other regions. Of the $489.3 million of customer bookings in 2009, approximately 42% were from oil and gas, 31% from chemical and 27% from general industries.
 
Bookings in 2008 increased by $76.3 million, or 12.9%, as compared with 2007. This increase included currency benefits of approximately $15 million. A $65.4 million increase in customer bookings was due primarily to increased original equipment bookings in EMA, North America and Latin America, as well as increased aftermarket bookings in Latin America, North America and Asia Pacific. A $10.9 million increase in interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) also contributed to the increase. Of the $595.8 million of customer bookings in 2008, approximately 45% were from oil and gas, 24% from chemical and 31% from general industries.
 
Sales in 2009 decreased by $74.5 million, or 11.4%, as compared with 2008. The decrease includes negative currency effects of approximately $24 million. The decrease in sales reflects lower demand and project delays due to a significant decrease in the rate of general global economic growth as compared with 2008. The decrease was driven by declines in customer sales of both original equipment and aftermarket in all regions, as well as a $12.0 million decrease in interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above). The decrease in customer sales of original equipment and aftermarket was primarily attributable to North America, driven by the oil and gas, chemical and general industries, as well as decreases in the oil and gas and general industries across all other regions.


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Sales in 2008 increased by $89.2 million, or 15.8%, as compared with 2007. The increase included currency benefits of approximately $12 million. A $74.0 million increase in customer sales was primarily attributable to increased original equipment sales in EMA, North America and Latin America, as well as to increased aftermarket sales in North America, Latin America and Asia Pacific. A $15.2 million increase in interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) also contributed to the increase.
 
Gross profit in 2009 decreased by $34.3 million, or 11.5%, as compared with 2008. The decrease includes the effect of $9.5 million in charges resulting from our Realignment Programs in 2009. Gross profit margin in 2009 of 45.7% was comparable with 2008. A sales mix shift toward more profitable aftermarket sales and savings realized from our Initial Realignment Program, strict cost control actions and increased utilization of low cost regions were offset by the impact of decreased sales, which negatively impacts our absorption of fixed manufacturing costs.
 
Gross profit in 2008 increased by $46.5 million, or 18.4%, as compared with 2007. Gross profit margin in 2008 of 45.8% increased from 44.7% in 2007. The improvements reflected the increase in sales, which favorably impacted our absorption of fixed manufacturing costs, as well as the impact of cost savings initiatives throughout the year. These improvements were partially offset by a sales mix shift to original equipment business in North America and EMA. Increases in materials costs were largely offset through supply chain management efforts and price increases in mid-2007 and early 2008.
 
Operating income in 2009 decreased by $26.5 million, or 20.5%, as compared with 2008. The decrease includes the effect of $20.6 million in charges resulting from our Realignment Programs. The decrease includes negative currency effects of approximately $8 million. The decrease is due to the $34.3 million decrease in gross profit discussed above, partially offset by a $7.3 million decrease in SG&A. The decrease in SG&A was due to strict cost control actions in 2009 and savings realized from our Initial Realignment Program in 2009.
 
Operating income in 2008 increased by $16.5 million, or 14.6%, as compared with 2007. The increase included currency benefits of approximately $3 million. The improvement in 2008 reflected the $46.5 million increase in gross profit discussed above, partially offset by a $29.8 million increase in SG&A (including negative currency effects of approximately $4 million) due primarily to a $15.5 million increase related to sales and engineering and related expenses and approximately $1 million of realignment costs, as well as to increased infrastructure costs to support the global growth of our business. SG&A as a percentage of sales in 2008 increased 110 basis points as compared with 2007, resulting from investment in our global selling footprint and engineering support in anticipation of future sales.
 
Backlog of $96.4 million at December 31, 2009 decreased by $21.8 million, or 18.4%, as compared to December 31, 2008. Currency provided an increase of approximately $4 million. Backlog at December 31, 2009 includes $22.8. million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above). Backlog of $118.2 million at December 31, 2008 increased by $8.8 million, or 8.0%, as compared with 2007. Currency effects provided a decrease of approximately $5 million. Backlog at December 31, 2008 included $18.6 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above).
 
LIQUIDITY AND CAPITAL RESOURCES
 
Cash Flow Analysis
 
                         
    2009   2008   2007
    (Amounts in millions)
 
Net cash flows provided by operating activities
  $ 431.3     $ 408.8     $ 417.7  
Net cash flows used by investing activities
    (138.6 )     (119.6 )     (77.9 )
Net cash flows used by financing activities
    (107.1 )     (185.5 )     (50.1 )
 
Existing cash generated by operations and borrowings available under our existing revolving line of credit are our primary sources of short-term liquidity. Our sources of operating cash generally include the sale of our products and services and the conversion of our working capital, particularly accounts receivable and inventories. Our total cash balance at December 31, 2009 was $654.3 million, compared with $472.1 million at December 31, 2008 and $373.2 million at December 31, 2007.


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Working capital increased in 2009 due primarily to lower accrued liabilities of $106.8 million resulting primarily from reductions in accruals for long-term and broad-based annual incentive program payments and reductions in advanced cash received from customers and lower accounts payable of $104.7 million. These decreases were partially offset by lower inventory of $74.7 million and lower accounts receivable of $50.7 million. During 2009, we contributed $83.1 million to our U.S. pension plan. Working capital increased in 2008 due primarily to higher inventory of $195.5 million, especially project-related inventory required to support future shipments of products in backlog, and higher accounts receivable of $195.1 million, resulting primarily from higher sales and a $63.9 million reduction in factored receivables resulting from the discontinuation of our factoring program in early 2008. During 2008, we contributed $50.8 million to our U.S. pension plan.
 
Our goal for days’ sales receivables outstanding (“DSO”) is 60 days. For the fourth quarter of 2009, we achieved a DSO of 59 days as compared with 62 days for the same period in 2008. For reference purposes based on 2009 sales, a DSO improvement of one day could provide approximately $13 million in cash. Decreases in inventory provided $74.7 million of cash flow for 2009 compared with a use of cash of $195.5 million and $101.8 million in 2008 and 2007, respectively. Inventory turns were 4.0 times at December 31, 2009, compared with 3.6 times at December 31, 2008 and 4.4 times at December 31, 2007. For reference purposes based on 2009 data, an improvement of one turn could yield approximately $160 million in cash.
 
Cash outflows for investing activities were $138.6 million, $119.6 million and $77.9 million in 2009, 2008 and 2007, respectively, due primarily to capital expenditures. Cash outflows for 2009 also include $30.8 million for the acquisition of Calder AG, as discussed below in “Acquisitions and Dispositions.” Capital expenditures during 2009 were $108.4 million, a decrease of $18.5 million as compared with 2008. Our capital expenditures have been focused on capacity expansion, including expansion of our QRC network, nuclear capabilities and low-cost sourcing; enterprise resource planning application upgrades; information technology infrastructure; and cost reduction opportunities.
 
Cash outflows for financing activities were $107.1 million in 2009 compared with $185.5 million in 2008 and $50.1 million in 2007. Cash outflows during 2009 resulted primarily from the payment of $59.2 million in dividends and $40.9 million for the repurchase of common shares. Cash outflows during 2008 resulted primarily from the repurchase of common shares for $165.0 million and the payment of $51.5 million of dividends.
 
On February 23, 2009, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.25 per share to $0.27 per share payable quarterly beginning on April 8, 2009. On February 22, 2010, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.27 per share to $0.29 per share payable quarterly beginning on April 7, 2010. Generally, our dividend date-of-record is in the last month of the quarter, and the dividend is paid the following month. Any subsequent dividends will be reviewed by our Board of Directors on a quarterly basis and declared at its discretion dependent on its assessment of our financial situation and business outlook at the applicable time.
 
On February 26, 2008, our Board of Directors approved a program to repurchase up to $300.0 million of our outstanding common stock, and the program commenced in the second quarter of 2008. The share repurchase program does not have an expiration date, and we reserve the right to limit or terminate the repurchase program at any time without notice. We repurchased 544,500 and 1,741,100 shares for $40.9 million and $165.0 million during 2009 and 2008, respectively. To date, we have repurchased a total of 2,285,600 shares for $205.9 million under this program.
 
Our cash needs for the next 12 months are expected to be slightly lower as compared with 2009, resulting from decreases in pension contributions and incentive compensation payments, partially offset by a small anticipated increase in capital expenditures and an increase in cash dividends. We believe cash flows from operating activities, combined with availability under our revolving line of credit and our existing cash balances, will be sufficient to enable us to meet our cash flow needs for the next 12 months. However, cash flows from operations could be adversely affected by the decrease in the rate of general global economic growth, as well as economic, political and other risks associated with sales of our products, operational factors, competition, regulatory actions, fluctuations in foreign currency exchange rates and fluctuations in interest rates, among other factors. We believe that cash flows from operating activities and our expectation of continuing availability to draw upon our revolving credit agreements are also sufficient to meet our cash flow needs for periods beyond the next 12 months.


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Payments for Acquisitions
 
We regularly evaluate acquisition opportunities of various sizes. The cost and terms of any financing to be raised in conjunction with any acquisition, including our ability to raise economical capital, is a critical consideration in any such evaluation.
 
As discussed in Note 3 to our consolidated financial statements included in Item 8 of this Annual Report, effective April 21, 2009, FPD acquired Calder AG, a private Swiss company and a supplier of energy recovery technology for use in the global desalination market, for up to $44.1 million, net of cash acquired. Of the total purchase price, $28.4 million was paid at closing and $2.4 million was paid after the working capital valuation was completed in early July 2009. During 2008, we acquired the remaining 50% interest in Niigata, effective March 1, 2008, for $2.4 million in cash. During 2007, we completed one small acquisition for $2.3 million.
 
Financing
 
Debt, including capital lease obligations, consisted of:
 
                 
    December 31,  
    2009     2008  
    (Amounts in thousands)  
 
Term Loan, interest rate of 1.81% and 2.99% at December 31,2009 and 2008, respectively
  $ 544,016     $ 549,697  
Capital lease obligations and other borrowings
    22,712       23,651  
                 
Debt and capital lease obligations
    566,728       573,348  
Less amounts due within one year
    27,355       27,731  
                 
Total debt due after one year
  $ 539,373     $ 545,617  
                 
 
Credit Facilities
 
Our credit facilities, as amended, are comprised of a $600.0 million secured term loan maturing on August 10, 2012 and a $400.0 million revolving line of credit, which can be utilized to provide up to $300.0 million in letters of credit, expiring on August 10, 2012. We refer to these credit facilities collectively as our “Credit Facilities.” At both December 31, 2009 and 2008, we had no amounts outstanding under the revolving line of credit. We had outstanding letters of credit of $123.1 million and $104.2 million at December 31, 2009 and 2008, respectively, which reduced our borrowing capacity to $276.9 million and $295.8 million, respectively.
 
Borrowings under our Credit Facilities bear interest at a rate equal to, at our option, either (1) the base rate (which is based on greater of the prime rate most recently announced by the administrative agent under our Credit Facilities or the Federal Funds rate plus 0.50%) or (2) London Interbank Offered Rate (“LIBOR”) plus an applicable margin determined by reference to the ratio of our total debt to consolidated Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), which as of December 31, 2009 was 0.875% and 1.50% for borrowings under our revolving line of credit and term loan, respectively. In connection with our Credit Facilities, we have entered into $385.0 million of notional amount interest rate swaps at December 31, 2009 to hedge exposure of floating interest rates. See Note 12 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on our Credit Facilities.
 
European Letter of Credit Facilities
 
Our ability to issue additional letters of credit under our previous European Letter of Credit Facility (“Old European LOC Facility”), which had a commitment of €110.0 million, expired November 9, 2009. We paid annual and fronting fees of 0.875% and 0.10%, respectively, for letters of credit written against the Old European LOC Facility. We had outstanding letters of credit written against the Old European LOC Facility of €77.9 million ($111.5 million) and €104.0 million ($145.2 million) as of December 31, 2009 and 2008, respectively.
 
On October 30, 2009, we entered into a new 364-day unsecured European Letter of Credit Facility (“New European LOC Facility”) with an initial commitment of €125.0 million. The New European LOC Facility is


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renewable annually and, consistent with the Old European LOC Facility, is used for contingent obligations in respect of surety and performance bonds, bank guarantees and similar obligations with maturities up to five years. We pay fees of 1.35% and 0.40% for utilized and unutilized capacity, respectively, under our New European LOC Facility. We had outstanding letters of credit drawn on the New European LOC Facility of €2.8 million ($4.0 million) as of December 31, 2009.
 
Certain banks are parties to both facilities and are managing their exposures on an aggregated basis. As such, the commitment under the New European LOC Facility is reduced by the face amount of existing letters of credit written against the Old European LOC Facility prior to its expiration. These existing letters of credit will remain outstanding, and accordingly offset the €125.0 million capacity of the New European LOC Facility until their maturity, which, as of December 31, 2009, was approximately two years for the majority of the outstanding existing letters of credit. After consideration of outstanding letters of credit under both facilities, the available capacity under the New European LOC Facility was €69.1 million as of December 31, 2009.
 
Debt Prepayments and Repayments
 
We made scheduled repayments under our Credit Facilities of $5.7 million, $5.7 million, and $2.8 million in 2009, 2008 and 2007, respectively. We made no mandatory repayments or optional prepayments in 2009, 2008 or 2007.
 
We may prepay loans under our Credit Facilities in whole or in part, without premium or penalty, at any time.
 
Debt Covenants and Other Matters
 
Our Credit Facilities contain, among other things, covenants restricting our and our subsidiaries’ ability to dispose of assets, merge, pay dividends, repurchase or redeem capital stock and indebtedness, incur indebtedness and guarantees, create liens, enter into agreements with negative pledge clauses, make certain investments or acquisitions, enter into sale and leaseback transactions, enter into transactions with affiliates, make capital expenditures, or engage in any business activity other than our existing business. Our Credit Facilities also contain covenants requiring us to deliver to lenders our audited annual and unaudited quarterly financial statements and leverage and interest coverage financial covenant certificates of compliance. The maximum permitted leverage ratio is 3.25 times total debt to consolidated EBITDA. The minimum interest coverage is 3.25 times consolidated EBITDA to total interest expense. Compliance with these financial covenants under our Credit Facilities is tested quarterly.
 
Our Credit Facilities include events of default customary for these types of credit facilities, including nonpayment of principal or interest, violation of covenants, incorrectness of representations and warranties, cross defaults and cross acceleration, bankruptcy, material judgments, Employee Retirement Income Security Act of 1974, as amended (“ERISA”), events, actual or asserted invalidity of the guarantees or the security documents and certain changes of control of our company. The occurrence of any event of default could result in the acceleration of our and the guarantors’ obligations under the Credit Facilities. We complied with all covenants under our Credit Facilities through December 31, 2009.
 
Our European letter of credit facilities contain covenants restricting the ability of certain foreign subsidiaries to issue debt, incur liens, sell assets, merge, consolidate, make certain investments, pay dividends, enter into agreements with negative pledge clauses or engage in any business activity other than our existing business. The European letter of credit facilities also incorporate by reference the covenants contained in our Credit Facilities.
 
Our European letter of credit facilities include events of default usual for these types of letter of credit facilities, including nonpayment of any fee or obligation, violation of covenants, incorrectness of representations and warranties, cross defaults and cross acceleration, bankruptcy, material judgments, ERISA events, actual or asserted invalidity of the guarantees and certain changes of control of our company. The occurrence of any event of default could result in the termination of the commitments and an acceleration of our obligations under the European letter of credit facilities. We complied with all covenants under our European letter of credit facilities through December 31, 2009.


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Liquidity Analysis
 
Our cash balance increased by $182.3 million to $654.3 million as of December 31, 2009 as compared with December 31, 2008. The increase in cash was due primarily to strong cash flow from operations, including working capital changes primarily related to collections of receivables, partially offset by significant cash uses, including approximately $115 million in long-term and broad-based annual incentive program payments related to prior period performance, $108.4 million in capital expenditures, $59.2 million in dividend payments, $83.1 million in contributions to our U.S. pension plan, $40.9 million of share repurchases and the funding of increased working capital requirements, as well as $30.8 million for the acquisition of Calder AG. We monitor the depository institutions that hold our cash and cash equivalents on a regular basis, and we believe that we have placed our deposits with creditworthy financial institutions.
 
Approximately 1% of our term loan is due to mature in 2010 and approximately 25% in 2011. As noted above, our term loan and our revolving line of credit both mature in August 2012. After the effects of $385.0 million of notional interest rate swaps, approximately 71% of our term debt was at fixed rates at December 31, 2009. As of December 31, 2009, we had a borrowing capacity of $276.9 million on our $400.0 million revolving line of credit, and we had available capacity under the New European LOC Facility of €69.1 million. Our revolving line of credit and our European letter of credit facilities are committed and are held by a diversified group of financial institutions.
 
We contributed $83.1 million to our U.S. pension plan in 2009 to maintain our pension funding at or above the fully-funded threshold prescribed by the ERISA, as amended. We experienced significant declines in the values of our U.S. pension plan assets in 2008 resulting primarily from declines in global equity markets. The decline is being recognized into earnings over the remaining service period. In 2009, we experienced increases in the values of our U.S. pension plan assets. After consideration of the impact of our contributions in 2009, the partial recovery in 2009 of asset value declines in 2008 and our intent to remain fully-funded, we currently anticipate that our contribution to our U.S. pension plan in 2010 will be between $30 million and $40 million, excluding direct benefits paid. We continue to maintain an asset allocation consistent with our strategy to maximize total return, while reducing portfolio risks through asset class diversification.
 
Disruptions in financial markets and banking systems experienced in 2008 continue to create difficulties in accessing credit and capital markets, and the costs of newly raised debt have generally increased. Continuing disruptions in the functioning of credit and capital markets, a sluggish global economic recovery or extended slowing of global economic activity could potentially materially impair our and our customers’ ability to access these markets and increase associated costs, as well as our customers’ ability to pay in full and/or on a timely basis. There can be no assurance that we will not be materially adversely affected by these factors, and we continue to monitor and evaluate the implications of these factors on our current business, our customers and suppliers and the state of the global economy.
 
OUTLOOK FOR 2010
 
Our future results of operations and other forward-looking statements contained in this Annual Report, including this MD&A, involve a number of risks and uncertainties — in particular, the statements regarding our goals and strategies, new product introductions, plans to cultivate new businesses, future economic conditions, revenue, pricing, gross profit margin and costs, capital spending, depreciation and amortization, research and development expenses, potential impairment of investments, tax rate and pending tax and legal proceedings. Our future results of operations may also be affected by the amount, type and valuation of share-based awards granted, as well as the amount of awards forfeited due to employee turnover. In addition to the various important factors discussed above, a number of other factors could cause actual results to differ materially from our expectations. See the risks described in “Item 1A. Risk Factors” of this Annual Report.
 
Our bookings decreased 23.9% in 2009 as compared with 2008, and our backlog at December 31, 2009 decreased 16.1% as compared to December 31, 2008, which may drive reduced revenue in 2010 as compared with 2009, excluding currency fluctuations. Because a booking represents a contract that can be modified or canceled, and can include varying lengths between the time of booking and the time of revenue recognition, there is no guarantee that the decrease in bookings will result in a comparable decrease in revenues or otherwise be indicative of future results. Historically, the fourth quarter has been a strong bookings quarter for us. Bookings in the fourth quarter of 2009 were slightly lower than bookings in each of the first, second and third quarters of 2009, reflecting


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continued customer delays in booking large project orders and our management discipline surrounding pricing. Although we believe that our primary markets continue to provide opportunities, we remain cautious in our outlook for 2010 given the booking levels in the fourth quarter of 2009 and backlog as of December 31, 2009 and the continuing uncertainty of global economic conditions. For additional discussion on our markets and our opportunities therein, see the “Business Overview — Our Markets” section of this MD&A.
 
We could experience increased external pressures on gross profit margin in 2010 as compared with 2009 and 2008 due to price competition associated with current global economic conditions. Additionally, a shift in our sales mix away from higher margin specialty pumps could negatively impact our margins in 2010 as compared with 2009 and 2008. We expect these gross profit margin pressures to be partially offset by operational improvements, continuation of our end user strategy, the strength of our aftermarket business, selective contract bidding and savings achieved from our Realignment Programs. As part of our previously communicated Realignment Programs, we plan to incur up to $20 million in realignment costs in 2010 as a result of these activities.
 
All of our borrowings under our Credit Facilities carry a floating rate of interest. As of December 31, 2009, we had $385.0 million of derivative contracts to convert a portion of floating interest rates to fixed interest rates to reduce our exposure to interest rate volatility. As a result of reducing the volatility, we may not fully benefit from a decrease in interest rates. We expect our interest expense in 2010 will be comparable to 2009. However, because a portion of our debt carries a floating rate of interest, the debt is subject to volatility in rates, which could negatively impact interest expense. Our results of operations may also be impacted by unfavorable foreign currency exchange rate movements. See “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” of this Annual Report.
 
We expect to generate sufficient cash from operations to fund our working capital, capital expenditures, dividend payments, share repurchases, debt payments, pension plan contributions and Realignment Programs in 2010. We seek to improve our working capital utilization, with a particular focus on improving the management of accounts receivable and inventory, and requiring progress payments from customers on long lead time projects. However, the amount of cash generated or consumed by working capital is dependent on our level of revenues, backlog, customer acceptance and other factors. Additionally, tightening in our end markets may limit our ability to require progress payments from customers on new orders. In 2010, our cash flows for investing activities will be focused on strategic initiatives to pursue new markets, geographic expansion, ERP application upgrades, information technology infrastructure and cost reduction opportunities and are expected to be between $110 million and $125 million, before consideration of any acquisition activity. We have $5.7 million in scheduled repayments in 2010 under our Credit Facilities, and we expect to comply with the covenants under our Credit Facilities in 2010. See the “Liquidity and Capital Resources” section of this MD&A for further discussion of our debt covenants.
 
We currently anticipate that our minimum contribution to our qualified U.S. pension plan will be between $30 million and $40 million, excluding direct benefits paid, in 2010 in order to maintain fully funded status, as defined by the Pension Protection Act, for 2010. We currently anticipate that our contributions to our non-U.S. pension plans will be approximately $10 million in 2010.
 
Venezuela — On January 8, 2010, the Venezuelan government announced its intention to devalue its currency (Bolivar) and move to a two-tier exchange structure effective January 11, 2010. The official exchange rate is expected to move from 2.15 to 4.30 Bolivars to the U.S. Dollar for non-essential items and to 2.60 Bolivars to the U.S. Dollar for essential items. Additionally, effective January 1, 2010, Venezuela has been designated as hyperinflationary, and as a result, we began to use the U.S. Dollar as our functional currency in Venezuela effective January 1, 2010. In accordance with hyperinflationary accounting, all future currency fluctuations between the Bolivar and the U.S. Dollar will be recorded in our statements of income. Our operations in Venezuela generally consist of a service center that imports equipment and parts from certain of our other locations for re-sale to third parties within Venezuela and performs service and repair activities. Our Venezuelan subsidiary’s sales in 2009 and total assets at December 31, 2009 represented approximately 1% or less of our consolidated sales and total assets for the same periods.
 
Although approvals by Venezuela’s Commission for the Administration of Foreign Exchange have slowed, we have historically been able to remit dividends and other payments at the official rate, and we currently anticipate doing so in the future. Accordingly, at December 31, 2009, we used the official rate of 2.15 Bolivars to the U.S. Dollar for re-measurement and translation of our Venezuelan financial statements. Our preliminary assessment of the impact of the devaluation is that we will incur an after-tax charge of approximately $14 million in the first


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quarter of 2010 as a result of re-measuring monetary assets and liabilities using the official rate of 4.30 Bolivars to the U.S. Dollar. We are currently assessing the ongoing impact of the currency devaluation on our Venezuelan operations and imports into the market, including the Venezuelan subsidiary’s ability to remit cash for dividends and other payments at the official rate, the potential ability of our imported products to be classified as essential items and the ability to recover exchange losses, as well as further actions of the Venezuelan government and economic conditions in Venezuela, such as inflation and capital spending. The hyperinflationary designation and currency devaluation had no impact on our financial position or results of operations as of and for the year ended December 31, 2009 included in this Annual Report.
 
Segment Reorganization — During the first quarter of 2010, we are reorganizing our divisional operations by combining FPD and FSD into the new Flow Solutions Group (“FSG”). We believe the combination of FPD and FSD enables us to continue building a strong customer focus for rotating equipment and related products and services, drive an enhanced customer-facing organization and further leverage best practices and capabilities. We expect the combined strength of FSG to provide greater efficiency for integrated component manufacturing, leverage in global spending and manufacturing resources and improve productivity through the use of common tools and processes to select, design, manufacture, distribute and service our product portfolio. FSG will be divided into two reportable segments based on type of product: Engineered and Industrial. Engineered will include the longer lead-time, highly engineered pump product operations of the former FPD and substantially all of the operations of the former FSD. Industrial will consist of the more standardized, general purpose pump product operations of the former FPD. FCD remains unchanged. This division reorganization had no effect on our reportable segments in 2009 and is not reflected in any of the accompanying financial information included in this Annual Report. Beginning in 2010, our segment reporting will reflect the structure described above, and prior periods will be retrospectively adjusted to conform to our 2010 reportable segment structure presentation.
 
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
 
The following table presents a summary of our contractual obligations at December 31, 2009:
 
                                         
    Payments Due By Period  
                      Beyond 5
       
    Within 1 Year     1-3 Years     3-5 Years     Years     Total  
    (Amounts in millions)  
 
Long-term debt
  $ 5.7     $ 538.3     $     $     $ 544.0  
Fixed interest payments(1)
    5.5       (0.4 )                 5.1  
Variable interest payments(2)
    10.0       13.2                   23.2  
Capital lease obligations
    21.7       1.0                   22.7  
Operating leases
    42.6       64.9       36.0       30.6       174.1  
Purchase obligations:(3)
                                       
Inventory
    538.1       9.1       3.9       0.9       552.0  
Non-inventory
    47.4       8.1       2.0             57.5  
Pension and postretirement benefits(4)
    50.6       101.0       108.0       294.1       553.7  
                                         
Total
  $ 721.6     $ 735.2     $ 149.9     $ 325.6     $ 1,932.3  
                                         
 
 
(1) Fixed interest payments represent net incremental payments under interest rate swap agreements.
 
(2) Variable interest payments under our Credit Facilities were estimated using a base rate of three-month LIBOR as of December 31, 2009.
 
(3) Purchase obligations are presented at the face value of the purchase order, excluding the effects of early termination provisions. Actual payments could be less than amounts presented herein.
 
(4) Retirement and postretirement benefits represent estimated benefit payments for our U.S. and non-U.S. defined benefit plans and our postretirement medical plan, as more fully described below and in Note 13 to our consolidated financial statements included in this Annual Report.


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As of December 31, 2009, the gross liability for uncertain tax positions was $130.2 million. We do not expect a material payment related to these obligations to be made within the next twelve months. We are unable to provide a reasonably reliable estimate of the timing of future payments relating to the uncertain tax positions.
 
The following table presents a summary of our commercial commitments at December 31, 2009:
 
                                         
    Commitment Expiration By Period  
                      Beyond 5
       
    Within 1 Year     1-3 Years     3-5 Years     Years     Total  
    (Amounts in millions)  
 
Letters of credit
  $ 398.1     $ 143.3     $ 38.4     $ 4.9     $ 584.7  
Surety bonds
    40.0       6.3       2.3             48.6  
                                         
Total
  $ 438.1     $ 149.6     $ 40.7     $ 4.9     $ 633.3  
                                         
 
We expect to satisfy these commitments through performance under our contracts.
 
PENSION AND POSTRETIREMENT BENEFITS OBLIGATIONS
 
Our pension plans and postretirement benefit plans are accounted for using actuarial valuations required by ASC 715 “Compensation — Retirement Benefits.” In accounting for retirement plans, management is required to make significant subjective judgments about a number of actuarial assumptions, including discount rates, salary growth, long-term rates of return on plan assets, retirement rates, turnover, health care cost trend rates and mortality rates. Depending on the assumptions and estimates used, the pension and postretirement benefit expense could vary within a range of outcomes and have a material effect on reported earnings. In addition, the assumptions can materially affect benefit obligations and future cash funding.
 
Plan Descriptions
 
We and certain of our subsidiaries have defined benefit pension plans and defined contribution plans for regular full-time and part-time employees. Approximately 72% of total defined benefit pension plan assets and approximately 57% of defined benefit pension obligations are related to the U.S. qualified plan as of December 31, 2009. The assets for the U.S. qualified plan are held in a single trust with a common asset allocation. Unless specified otherwise, the references in this section are to all of our U.S. and non-U.S. plans.
 
Benefits under our defined benefit pension plans are based primarily on participants’ compensation and years of credited service. Assets under our defined benefit pension plans consist primarily of equity and fixed-income securities. At December 31, 2009, the estimated fair market value of U.S. and non-U.S. plan assets for our defined benefit pension plans increased to $427.2 million from $289.0 million at December 31, 2008. Assets were allocated as follows:
 
                 
    U.S. Plan  
Asset category
  2009     2008  
 
U.S. Large Cap
    39 %        
U.S. Small Cap
    6 %        
International Large Cap
    11 %        
                 
Equity securities
     56 %      66 %
                 
Long-Term Government / Credit
    11 %        
Intermediate Bond
    32 %        
                 
Fixed income
    43 %     30 %
                 
Multi-strategy hedge fund
    1 %        
Other
    0 %        
                 
Other
    1 %     4 %
                 
 


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    Non-U.S. Plans  
Asset category
  2009     2008  
 
North American Companies
    5 %        
U.K. Companies
    27 %        
European Companies
    8 %        
Asian Pacific Companies
    5 %        
Global Equity
    3 %        
Emerging Markets
    0 %        
                 
Equity securities
     48 %      47 %
                 
U.K. Government Gilt Index
    19 %        
U.K. Corporate Bond Index
    15 %        
Global Fixed Income Bond
    15 %        
                 
Fixed income
    49 %     51 %
                 
Other
    3 %     2 %
                 
 
The projected benefit obligation (“Benefit Obligation”) for our defined benefit pension plans was $606.7 million and $532.4 million as of December 31, 2009 and 2008, respectively.
 
The estimated prior service benefit for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2010 is $1.2 million. The estimated actuarial net loss for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2010 is $12.3 million. We amortize estimated prior service benefits and estimated net losses over the remaining expected service period or over the remaining expected lifetime of inactive participants for plans with only inactive participants.
 
None of our common stock is directly held by these plans.
 
We sponsor defined benefit postretirement medical plans covering certain current retirees and a limited number of future retirees in the U.S. These plans provide for medical and dental benefits and are administered through insurance companies. We fund the plans as benefits are paid, such that the plans hold no assets in any period presented. Accordingly, we have no investment strategy or targeted allocations for plan assets. The benefits under the plans are not available to new employees or most existing employees.
 
The Benefit Obligation for our defined benefit postretirement medical plans was $40.2 million and $43.1 million as of December 31, 2009 and 2008, respectively. The estimated prior service benefit for the defined benefit postretirement medical plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2010 is $1.9 million. The estimated actuarial net benefit for the defined benefit postretirement medical plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2010 is $2.3 million. We amortize estimated prior service benefits and estimated net gain over the remaining expected service period.
 
Accrual Accounting and Significant Assumptions
 
We account for pension benefits using the accrual method, recognizing pension expense before the payment of benefits to retirees. The accrual method of accounting for pension benefits necessarily requires actuarial assumptions concerning future events that will determine the amount and timing of the benefit payments.
 
Our key assumptions used in calculating our cost of pension benefits are the discount rate, the rate of compensation increase, and the expected long-term rate of return on plan assets. We, in consultation with our actuaries, evaluate the key actuarial assumptions and other assumptions used in calculating the cost of pension and postretirement benefits, such as discount rates, expected return on plan assets for funded plans, mortality rates, retirement rates and assumed rate of compensation increases, and determine such assumptions as of December 31 of each year to calculate liability information as of that date and pension and postretirement expense for the following

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year. Depending on the assumptions used, the pension and postretirement expense could vary within a range of outcomes and have a material effect on reported earnings. In addition, the assumptions can materially affect Benefit Obligations and future cash funding. Actual results in any given year may differ from those estimated because of economic and other factors. See discussion of our assumptions related to pension and postretirement benefits in the “Our Critical Accounting Estimates” section of this MD&A.
 
In 2009, net pension expense for our defined benefit pension plans included in income from continuing operations was $35.7 million compared with $29.5 million in 2008 and $32.1 million in 2007. The postretirement benefit (gain) expense for the postretirement medical plans was $(2.3) million in 2009 compared with $1.1 million in 2008 and $(0.1) million in 2007.
 
The following are assumptions related to our defined benefit pension plans as of December 31, 2009:
 
                 
    U.S. Plan   Non-U.S. Plans
 
Weighted average assumptions used to determine Benefit Obligations:
               
Discount rate
    5.50 %     5.41 %
Rate of increase in compensation levels
    4.80       3.58  
Weighted average assumptions used to determine 2009 net pension expense:
               
Long-term rate of return on assets
    7.75 %     4.38 %
Discount rate
    6.75       5.47  
Rate of increase in compensation levels
    4.80       3.07  
 
The following provides a sensitivity analysis of alternative assumptions on the U.S. qualified and aggregate non-U.S. pension plans and U.S. postretirement plans.
 
Effect of Discount Rate Changes and Constancy of Other Assumptions:
 
                 
    0.5%
  0.5%
    Increase   Decrease
    (Amounts in millions)
 
U.S. defined benefit pension plan:
               
Effect on net pension expense
  $ (1.0 )   $ 1.0  
Effect on Benefit Obligation
    (12.3 )     13.2  
Non-U.S. defined benefit pension plans:
               
Effect on net pension expense
    (1.0 )     1.2  
Effect on Benefit Obligation
    (20.3 )     21.8  
U.S. Postretirement medical plans:
               
Effect on postretirement medical expense
    (0.1 )     0.1  
Effect on Benefit Obligation
    (1.0 )     1.1  


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Effect of Changes in the Expected Return on Assets and Constancy of Other Assumptions:
 
                 
    0.5%
  0.5%
    Increase   Decrease
    (Amounts in millions)
 
U.S. defined benefit pension plan:
               
Effect on net pension expense
  $ (1.4 )   $ 1.4  
Effect on Benefit Obligation
    N/A       N/A  
Non-U.S. defined benefit pension plans:
               
Effect on net pension expense
    (0.5 )     0.5  
Effect on Benefit Obligation
    N/A       N/A  
U.S. Postretirement medical plans:
               
Effect on postretirement medical expense
    N/A       N/A  
Effect on Benefit Obligation
    N/A       N/A  
 
As discussed below, accounting principles generally accepted in the U.S. (“GAAP”) provide that differences between expected and actual returns are recognized over the average future service of employees.
 
At December 31, 2009, as compared to December 31, 2008, we decreased our discount rate for the U.S. plan from 6.75% to 5.50% based on an analysis of publicly-traded investment grade U.S. corporate bonds, which had a lower yield due to current market conditions. We decreased our average rate for non-U.S. plans from 5.47% to 5.41% based primarily on lower applicable iBoxx corporate AA bond indices for the United Kingdom and the Euro zone. We maintained our average assumed rate of compensation increase at 4.8% for the U.S. plan and increased the average rate of compensation increase for our Non-US plans from 3.07% to 3.58%. To determine the 2009 pension expense, we decreased the expected rate of return on U.S. plan assets from 8.00% to 7.75% and we increased our average rate of return on non-U.S. plan assets from 4.35% to 4.38%, primarily based on our target allocations and expected long-term asset returns. As the expected rate of return on plan assets is long-term in nature, short-term market changes do not significantly impact the rates.
 
We expect that the net pension expense for our defined benefit pension plans included in earnings before income taxes will be $0.3 million higher in 2010 than the $35.7 million in 2009, reflecting, among other things, the increased amortization of the actuarial net loss. We expect the 2010 benefit for the postretirement medical plan to be $2.2 million, primarily reflecting amortization of the increased actuarial net gain.
 
We have used discount rates of 5.50% and 5.25% at December 31, 2009, in calculating our estimated 2010 cost of pension benefits and cost of other postretirement benefits for U.S. plans, respectively.
 
The assumed ranges for the annual rates of increase in health care costs were 9.0% for 2009, 7.8% for 2008 and 8.8% for 2007, with a gradual decrease to 5.0% for 2031 and future years. If actual costs are higher than those assumed, this will likely put modest upward pressure on our expense for retiree health care.
 
Plan Funding
 
Our funding policy for defined benefit plans is to contribute at least the amounts required under applicable laws and local customs. We contributed $101.2 million, $71.0 million and $30.1 million to our defined benefit plans in 2009, 2008 and 2007, respectively. After consideration of the impact of our contributions in 2009, the partial recovery in 2009 of asset value declines in 2008 and our intent to remain fully-funded, we currently anticipate that our contribution to our U.S. pension plan in 2010 will be between $30 million and $40 million, excluding direct benefits paid, and we expect to contribute approximately $10 million to our non-U.S. pension plans.
 
For further discussions on pension and postretirement benefits, see Note 13 to our consolidated financial statements included in Item 8 of this Annual Report.
 
OUR CRITICAL ACCOUNTING ESTIMATES
 
The process of preparing financial statements in conformity with GAAP requires the use of estimates and assumptions to determine reported amounts of certain assets, liabilities, revenues and expenses and the disclosure of


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related contingent assets and liabilities. These estimates and assumptions are based upon information available at the time of the estimates or assumptions, including our historical experience, where relevant. The most significant estimates made by management include: timing and amount of revenue recognition; deferred taxes, tax valuation allowances and tax reserves; reserves for contingent losses; retirement and postretirement benefits; and valuation of goodwill, indefinite-lived intangible assets and other long-lived assets. The significant estimates are reviewed quarterly by management, and management presents its views to the Audit Committee of our Board of Directors. Because of the uncertainty of factors surrounding the estimates, assumptions and judgments used in the preparation of our financial statements, actual results may differ from the estimates, and the difference may be material.
 
Our critical accounting policies are those policies that are both most important to our financial condition and results of operations and require the most difficult, subjective or complex judgments on the part of management in their application, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that the following represent our critical accounting policies. For a summary of all of our significant accounting policies, see Note 1 to our consolidated financial statements included in Item 8 of this Annual Report. Management and our external auditors have discussed our critical accounting policies with the Audit Committee of our Board of Directors.
 
Revenue Recognition
 
Revenues for product sales are recognized when the risks and rewards of ownership are transferred to the customers, which is based on the contractual delivery terms agreed to with the customer and fulfillment of all but inconsequential or perfunctory actions. In addition, our policy requires persuasive evidence of an arrangement, a fixed or determinable sales price and reasonable assurance of collectability. For contracts containing multiple elements, each having a determinable fair value, we recognize revenue in an amount equal to the element’s pro rata share of the contract’s fair value in accordance with the contractual delivery terms for each element. We defer the recognition of revenue when advance payments are received from customers before performance obligations have been completed and/or services have been performed. Freight charges billed to customers are included in sales and the related shipping costs are included in cost of sales in our consolidated statements of income.
 
Revenues for long-term contracts, which include contracts that exceed certain internal thresholds regarding the size and duration of the project and provide for the receipt of progress billings from the customer, are recorded on the percentage of completion method with progress measured on a cost-to-cost basis. Percentage of completion revenue represents less than 12% of our consolidated sales in 2009.
 
Revenue on service and repair contracts is recognized after services have been agreed to by the customer and rendered. Revenues generated under fixed fee service and repair contracts are recognized on a ratable basis over the term of the contract. These contracts can range in duration, but generally extend for up to five years. Fixed fee service contracts represent less than 1% of our consolidated sales in 2009.
 
In certain instances, we provide guaranteed completion dates under the terms of our contracts. Failure to meet contractual delivery dates can result in late delivery penalties or non-recoverable costs. In instances where the payment of such costs are deemed to be probable, we perform a project profitability analysis accounting for such costs as a reduction of realizable revenues, which could potentially cause estimated total project costs to exceed projected total revenues realized from the project. In such instances, we would record reserves to cover such excesses in the period they are determined, which would adversely affect our results of operations and financial position. In circumstances where the total projected reduced revenues still exceed total projected costs, the incurrence of unrealized incentive fees or non-recoverable costs generally reduces profitability of the project at the time of subsequent revenue recognition. Our reported results would change if different estimates were used for contract costs or if different estimates were used for contractual contingencies.
 
Deferred Taxes, Tax Valuation Allowances and Tax Reserves
 
We recognize valuation allowances to reduce the carrying value of deferred tax assets to amounts that we expect are more likely than not to be realized. Our valuation allowances primarily relate to the deferred tax assets established for certain tax credit carryforwards and net operating loss carryforwards for U.S. and non-U.S. subsidiaries, and we evaluate the realizability of our deferred tax assets by assessing the related valuation allowance


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and by adjusting the amount of these allowances, if necessary. We assess such factors as our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets in determining the sufficiency of our valuation allowances. Failure to achieve forecasted taxable income in the applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in our effective tax rate on future earnings. Implementation of different tax structures in certain jurisdictions could, if successful, result in future reductions of certain valuation allowances.
 
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Significant judgment is required in determining income tax provisions and evaluating tax positions. We establish reserves for open tax years for uncertain tax positions that may be subject to challenge by various tax authorities. The consolidated tax provision and related accruals include the impact of such reasonably estimable losses and related interest and penalties as deemed appropriate. Tax benefits recognized in the financial statements from uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.
 
We believe we have adequately provided for any reasonably foreseeable outcome related to these matters, and our future results may include favorable or unfavorable adjustments to our estimated tax liabilities. To the extent that the expected tax outcome of these matters changes, such changes in estimate will impact the income tax provision in the period in which such determination is made.
 
Reserves for Contingent Loss
 
Liabilities are recorded for various contingencies arising in the normal course of business when it is both probable that a loss has been incurred and such loss is estimable. Assessments of reserves are based on information obtained from our independent and in-house experts, including recent legal decisions and loss experience in similar situations. The recorded legal reserves are susceptible to changes due to new developments regarding the facts and circumstances of each matter, changes in political environments, legal venue and other factors. Recorded environmental reserves could change based on further analysis of our properties, technological innovation and regulatory environment changes.
 
Estimates of liabilities for unsettled asbestos-related claims are based on known claims and on our experience during the preceding two years for claims filed, settled and dismissed, with adjustments for events deemed unusual and unlikely to recur, and are included in retirement obligations and other liabilities in our consolidated balance sheets. A substantial majority of our asbestos-related claims are covered by insurance or indemnities. Estimated receivables from insurance carriers for unsettled claims and receivables for settlements and legal fees paid by us for asbestos-related claims are estimated using our historical experience with insurance recovery rates and estimates of future recoveries, which include estimates of coverage and financial viability of our insurance carriers. Estimated receivables are included in other assets, net in our consolidated balance sheets. Changes in claims filed, settled and dismissed and differences between actual and estimated settlement costs and insurance or indemnity recoveries could impact future expense.
 
Pension and Postretirement Benefits
 
We provide pension and postretirement benefits to certain of our employees, former employees, and their beneficiaries. The assets, liabilities and expenses we recognize and disclosures we make about plan actuarial and financial information are dependent on the assumptions used in calculating such amounts. The assumptions include factors such as discount rates, health care cost trend rates, inflation, expected rates of return on plan assets, retirement rates, mortality rates, rates of compensation increases and other factors.
 
The assumptions utilized to compute expense and benefit obligations are shown in Note 13 to our consolidated financial statements included in Item 8 of this Annual Report. These assumptions are assessed annually as of December 31 and adjustments are made as needed. In our review we evaluate prevailing market conditions and local laws and requirements in countries where plans are maintained, including appropriate rates of return, interest rates and medical inflation rates. We also compare our significant assumptions with our peers. The methodology to set our assumptions are:
 
  •  Discount rates are estimated using high quality debt securities based on corporate or government bond yields with a duration matching the expected benefit payments. For the U.S. the discount rate is obtained from an


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  analysis of publicly-traded investment-grade corporate bonds to establish a weighted average discount rate. For plans in the United Kingdom and the EURO zone we use the most applicable iBoxx corporate AA bond indices. For other countries or regions without a corporate AA bond market, government bond rates are used. Our discount rate assumptions are impacted by changes in general economic and market conditions that affect interest rates on long-term high-quality debt securities, as well as the duration of our plans’ liabilities.
 
  •  Health care cost trend rates are developed based upon historical retiree cost trend data, long-term health care outlook and industry benchmarks.
 
  •  The inflation assumptions are based upon both our specific trends and nationally expected trends.
 
  •  The expected rates of return on plan assets are derived from reviews of asset allocation strategies, expected long-term performance of asset classes, risks and other factors adjusted for our specific investment strategy. These rates are impacted by changes in general market conditions, but because they are long-term in nature, short-term market changes do not significantly impact the rates. Changes to our target asset allocation also impact these rates.
 
  •  Retirement rates are based upon actual and projected plan experience.
 
  •  Mortality rates are based on published actuarial tables relevant to the countries in which we have plans.
 
  •  The expected rates of compensation increase reflect estimates of the change in future compensation levels due to general price levels, seniority, age and other factors.
 
We evaluate the funded status of each retirement plan using current assumptions and determine the appropriate funding level considering applicable regulatory requirements, tax deductibility, reporting considerations, cash flow requirements and other factors, and discuss our funding assumptions with the Finance Committee of our Board of Directors.
 
Valuation of Goodwill, Indefinite-Lived Intangible Assets and Other Long-Lived Assets
 
The initial recording of goodwill and intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets. We test the value of goodwill and indefinite-lived intangible assets for impairment as of December 31 each year or whenever events or circumstances indicate such assets may be impaired. The test for goodwill impairment involves significant judgment in estimating projections of fair value generated through future performance of each of the reporting units, which correlate to our operating segments. The test of indefinite-lived intangibles involves significant judgment in estimating projections of future sales levels.
 
Impairment losses for goodwill are recognized whenever the implied fair value of goodwill is less than the carrying value. We estimate the fair value of our reporting units based on an income approach, whereby we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. A discounted cash flow analysis requires us to make various judgmental assumptions about future sales, operating margins, growth rates and discount rates, which are based on our budgets, business plans, economic projections, anticipated future cash flows and marketplace data. Assumptions are also made for varying perpetual growth rates for periods beyond the long-term business plan period. We did not record an impairment of goodwill in 2009, 2008 or 2007.
 
We also consider our market capitalization in our evaluation of the fair value of our goodwill. Our market capitalization increased in 2009 and did not indicate a potential impairment of our goodwill as of December 31, 2009.
 
Impairment losses for intangible assets are recognized whenever the estimated fair value is less than the carrying value. Fair values are calculated for trademarks using a “relief from royalty” method, which estimates the fair value of the trademarks by determining the present value of the royalty payments that are avoided as a result of owning the trademark. This method includes judgmental assumptions about sales growth and discount rates that are consistent with the assumptions used to determine the fair value of our reporting units discussed above. We did not record an impairment of our trademarks in 2009, 2008 or 2007.
 
The net realizable value of other long-lived assets, including property, plant and equipment, is reviewed periodically, when indicators of potential impairments are present, based upon an assessment of the estimated future cash flows related to those assets, utilizing a methodology similar to that for goodwill. Additional considerations


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related to our long-lived assets include expected maintenance and improvements, changes in expected uses and ongoing operating performance and utilization.
 
Due to uncertain market conditions and potential changes in strategy and product portfolio, it is possible that forecasts used to support asset carrying values may change in the future, which could result in non-cash charges that would adversely affect our financial condition and results of operations.
 
ACCOUNTING DEVELOPMENTS
 
We have presented the information about accounting pronouncements not yet implemented in Note 1 to our consolidated financial statements included in Item 8 of this Annual Report.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We have market risk exposure arising from changes in interest rates and foreign currency exchange rate movements. We are exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, including interest rate swaps and forward exchange contracts, but we currently expect all counterparties will continue to meet their obligations given their current creditworthiness.
 
Interest Rate Risk
 
Our earnings are impacted by changes in short-term interest rates as a result of borrowings under our Credit Facilities, which bear interest based on floating rates. At December 31, 2009, after the effect of interest rate swaps, we had $159.0 million of variable rate debt obligations outstanding under our Credit Facilities with a weighted average interest rate of 1.81%. A hypothetical change of 100 basis points in the interest rate for these borrowings, assuming constant variable rate debt levels, would have changed interest expense by $1.6 million for the year ended December 31, 2009. At both December 31, 2009 and 2008, we had $385.0 of notional amount in outstanding interest rate swaps with third parties with varying maturities through December 2010.
 
Foreign Currency Exchange Rate Risk
 
A substantial portion of our operations are conducted by our subsidiaries outside of the U.S. in currencies other than the U.S. dollar. Almost all of our non-U.S. subsidiaries conduct their business primarily in their local currencies, which are also their functional currencies. Foreign currency exposures arise from translation of foreign-denominated assets and liabilities into U.S. dollars and from transactions, including firm commitments and anticipated transactions, denominated in a currency other than a non-U.S. subsidiary’s functional currency. Generally, we view our investments in foreign subsidiaries from a long-term perspective and, therefore, do not hedge these investments. We use capital structuring techniques to manage our investment in foreign subsidiaries as deemed necessary. We realized net gains (losses) associated with foreign currency translation of $63.0 million, $(126.7) million and $50.2 million for the years ended December 31, 2009, 2008 and 2007, respectively, which are included in other comprehensive income (expense).
 
Based on a sensitivity analysis at December 31, 2009, a 10% change in the foreign currency exchange rates for the year ended December 31, 2009 would have impacted our net earnings by approximately $31.2 million, due primarily to the Euro. This calculation assumes that all currencies change in the same direction and proportion relative to the U.S. dollar and that there are no indirect effects, such as changes in non-U.S. dollar sales volumes or prices. This calculation does not take into account the impact of the foreign currency forward exchange contracts discussed below. See discussion of the impact in 2010 of the devaluation of the Venezuelan Bolivar in Note 21 to our consolidated financial statements included in Item 8 of this Annual Report.
 
We employ a foreign currency risk management strategy to minimize potential changes in cash flows from unfavorable foreign currency exchange rate movements. Where available, the use of forward exchange contracts allows us to mitigate transactional exposure to exchange rate fluctuations as the gains or losses incurred on the forward exchange contracts will offset, in whole or in part, losses or gains on the underlying foreign currency exposure. Our policy allows foreign currency coverage only for identifiable foreign currency exposures, and changes in the fair values of these instruments are included in other income, net in the accompanying consolidated


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statements of income. As of December 31, 2009, we had a U.S. dollar equivalent of $309.6 million in aggregate notional amount outstanding in forward exchange contracts with third parties, compared with $555.7 million at December 31, 2008.
 
Transactional currency gains and losses arising from transactions outside of our sites’ functional currencies and changes in fair value of certain forward exchange contracts are included in our consolidated results of operations. We recognized foreign currency net (losses) gains of $(7.8) million, $16.6 million and $6.3 million for the years ended December 31, 2009, 2008, and 2007, respectively, which is included in other (expense) income, net in the accompanying consolidated statements of income.
 
Hedging related transactions, which are related to interest rate swaps and recorded to other comprehensive (expense) income, net of deferred taxes, are summarized below:
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (Amounts in thousands)  
 
(Loss) gain reclassified from accumulated other comprehensive income into income for settlements, net of tax
  $ (5,980 )   $ 2,863     $ (1,553 )
(Loss) gain recognized in other comprehensive income, net of tax
    (2,473 )     (1,243 )     (5,458 )
                         
Cash flow hedging activity, net of tax
  $ 3,507     $ (4,106 )   $ (3,905 )
                         
 
We expect to recognize (losses) gains of $(3.5) million and $0.3 million, net of deferred taxes, into earnings in 2010 and 2011, respectively, related to interest rate swap agreements based on their fair values at December 31, 2009.


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ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To The Board of Directors and Shareholders of Flowserve Corporation:
 
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Flowserve Corporation and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it calculates earnings per share and the manner in which it accounts for noncontrolling interests in 2009 and changed the manner in which it accounts for uncertain tax positions in 2007.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
/s/  PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Dallas, Texas
February 24, 2010


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FLOWSERVE CORPORATION
 
CONSOLIDATED BALANCE SHEETS
                 
    December 31,  
    2009     2008  
    (Amounts in thousands, except per share data)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 654,320     $ 472,056  
Accounts receivable, net
    791,722       808,522  
Inventories, net
    795,233       834,612  
Deferred taxes
    145,864       126,890  
Prepaid expenses and other
    112,183       90,345  
                 
Total current assets
    2,499,322       2,332,425  
Property, plant and equipment, net
    560,472       547,235  
Goodwill
    864,927       828,395  
Deferred taxes
    31,324       32,561  
Other intangible assets, net
    124,678       121,919  
Other assets, net
    168,171       161,159  
                 
Total assets
  $ 4,248,894     $ 4,023,694  
                 
 
LIABILITIES AND EQUITY
Current liabilities:
               
Accounts payable
  $ 493,306     $ 598,498  
Accrued liabilities
    916,945       967,099  
Debt due within one year
    27,355       27,731  
Deferred taxes
    20,477       14,668  
                 
Total current liabilities
    1,458,083       1,607,996  
Long-term debt due after one year
    539,373       545,617  
Retirement obligations and other liabilities
    449,691       495,883  
Commitments and contingencies
           
Shareholders’ equity:
               
Common shares, $1.25 par value
    73,594       73,477  
Shares authorized — 120,000
               
Shares issued — 58,875 and 58,781, respectively
               
Capital in excess of par value
    611,745       586,371  
Retained earnings
    1,526,774       1,159,634  
                 
      2,212,113       1,819,482  
Treasury shares, at cost — 3,919 and 3,566 shares, respectively
    (275,656 )     (248,073 )
Deferred compensation obligation
    8,684       7,678  
Accumulated other comprehensive loss
    (149,028 )     (211,320 )
Noncontrolling interests
    5,634       6,431  
                 
Total equity
    1,801,747       1,374,198  
                 
Total liabilities and equity
  $ 4,248,894     $ 4,023,694  
                 
 
See accompanying notes to consolidated financial statements.


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FLOWSERVE CORPORATION
 
CONSOLIDATED STATEMENTS OF INCOME
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (Amounts in thousands, except per share data)  
 
Sales
  $ 4,365,262     $ 4,473,473     $ 3,762,694  
Cost of sales
    (2,817,130 )     (2,893,161 )     (2,514,972 )
                         
Gross profit
    1,548,132       1,580,312       1,247,722  
Selling, general and administrative expense
    (934,451 )     (981,597 )     (854,527 )
Net earnings from affiliates
    15,836       16,963       18,695  
                         
Operating income
    629,517       615,678       411,890  
Interest expense
    (40,005 )     (51,293 )     (60,119 )
Interest income
    3,247       8,392       4,324  
Other (expense) income, net
    (7,968 )     20,163       5,947  
                         
Earnings before income taxes
    584,791       592,940       362,042  
Provision for income taxes
    (156,460 )     (147,721 )     (104,294 )
                         
Net earnings, including noncontrolling interests
    428,331       445,219       257,748  
Less: Net earnings attributable to noncontrolling interests
    (444 )     (2,806 )     (1,974 )
                         
Net earnings of Flowserve Corporation
  $ 427,887     $ 442,413     $ 255,774  
                         
Net earnings per share of Flowserve Corporation common shareholders:
                       
Basic
  $ 7.66     $ 7.75     $ 4.48  
Diluted
    7.59       7.71       4.44  
Cash dividends declared per share
  $ 1.08     $ 1.00     $ 0.60  
 
See accompanying notes to consolidated financial statements.


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FLOWSERVE CORPORATION
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (Amounts in thousands)  
 
Net earnings, including noncontrolling interests
  $ 428,331     $ 445,219     $ 257,748  
                         
Other comprehensive income (expense):
                       
Foreign currency translation adjustments, net of tax
    63,049       (126,703 )     50,151  
Pension and other postretirement effects, net of tax
    (3,603 )     (59,977 )     24,183  
Cash flow hedging activity, net of tax
    3,507       (4,106 )     (3,905 )
                         
Other comprehensive income (expense)
    62,953       (190,786 )     70,429  
                         
Comprehensive income, including noncontrolling interests
    491,284       254,433       328,177  
Comprehensive income attributable to noncontrolling interests
    (1,105 )     (1,956 )     (3,447 )
                         
Comprehensive income of Flowserve Corporation
  $ 490,179     $ 252,477     $ 324,730  
                         
 
See accompanying notes to consolidated financial statements.


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FLOWSERVE CORPORATION
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
 
                                                                                 
                Capital
                            Accumulated
             
                in Excess
                      Deferred
    Other
             
    Common Stock     of Par
    Retained
    Treasury Stock     Compensation
    Comprehensive
    Noncontrolling
    Total
 
    Shares     Amount     Value     Earnings     Shares     Amount     Obligation     Loss     Interests     Equity  
    (Amounts in thousands)  
 
Balance — January 1, 2007
    58,631     $ 73,289     $ 543,159     $ 582,767       (2,609 )   $ (95,262 )   $ 6,973     $ (90,340 )   $ 4,096     $ 1,024,682  
                                                                                 
Stock activity under stock plans
    84       105       (19,164 )           910       33,031                         13,972  
Stock-based compensation
                25,306       40                                     25,346  
Tax benefit associated with stock-based compensation
                12,431                                           12,431  
Adoption of accounting for uncertain tax positions
                      (29,819 )                                   (29,819 )
Net earnings
                      255,774                               1,974       257,748  
Cash dividends declared
                      (34,396 )                                   (34,396 )
Repurchase of common shares
                            (707 )     (39,550 )                       (39,550 )
Increases to obligation for new deferrals
                                        416                   416  
Compensation obligations satisfied
                                        (739 )                 (739 )
Foreign currency translation adjustments, net of tax
                                              48,678       1,473       50,151  
Pension and other postretirement effects, net of tax
                                              24,183             24,183  
Cash flow hedging activity, net of tax
                                              (3,905 )           (3,905 )
Sale of shares to noncontrolling interests
                                                    1,577       1,577  
Dividends paid on noncontrolling interests
                                                    (1,880 )     (1,880 )
                                                                                 
Balance — December 31, 2007
    58,715     $ 73,394     $ 561,732     $ 774,366       (2,406 )   $ (101,781 )   $ 6,650     $ (21,384 )   $ 7,240     $ 1,300,217  
                                                                                 
Stock activity under stock plans
    66       83       (20,200 )           581       18,658                         (1,459 )
Stock-based compensation
                32,642       61                                     32,703  
Tax benefit associated with stock-based compensation
                12,197                                           12,197  
Net earnings
                      442,413                               2,806       445,219  
Cash dividends declared
                      (57,206 )                                   (57,206 )
Repurchase of common shares
                            (1,741 )     (164,950 )                       (164,950 )
Increases to obligation for new deferrals
                                        1,544                   1,544  
Compensation obligations satisfied
                                        (516 )                 (516 )
Foreign currency translation adjustments, net of tax
                                              (125,853 )     (850 )     (126,703 )
Pension and other postretirement effects, net of tax
                                              (59,977 )           (59,977 )
Cash flow hedging activity, net of tax
                                              (4,106 )           (4,106 )
Purchase of shares from noncontrolling interests
                                                    (874 )     (874 )
Dividends paid on noncontrolling interests
                                                    (1,891 )     (1,891 )
                                                                                 
Balance — December 31, 2008
    58,781     $ 73,477     $ 586,371     $ 1,159,634       (3,566 )   $ (248,073 )   $ 7,678     $ (211,320 )   $ 6,431     $ 1,374,198  
                                                                                 
Stock activity under stock plans
    94       117       (15,733 )           192       13,372                         (2,244 )
Stock-based compensation
                40,660       91                                       40,751  
Tax benefit associated with stock-based compensation
                447                                           447  
Net earnings
                      427,887                               444       428,331  
Cash dividends declared
                      (60,838 )                                     (60,838 )
Repurchase of common shares
                              (545 )     (40,955 )                       (40,955 )
Increases to obligation for new deferrals
                                        1,406                   1,406  
Compensation obligations satisfied
                                        (400 )                 (400 )
Foreign currency translation adjustments, net of tax
                                                62,388       661       63,049  
Pension and other postretirement effects, net of tax
                                              (3,603 )           (3,603 )
Cash flow hedging activity, net of tax
                                              3,507             3,507  
Sale of shares to noncontrolling interests
                                                    327       327  
Dividends paid on noncontrolling interests
                                                    (2,229 )     (2,229 )
                                                                                 
Balance — December 31, 2009
    58,875     $ 73,594     $ 611,745     $ 1,526,774       (3,919 )   $ (275,656 )   $ 8,684     $ (149,028 )   $ 5,634     $ 1,801,747  
                                                                                 
 
See accompanying notes to consolidated financial statements.


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FLOWSERVE CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (Amounts in thousands)  
 
Cash flows — Operating activities:
                       
Net earnings, including noncontrolling interests
  $ 428,331     $ 445,219     $ 257,748  
Adjustments to reconcile net earnings to net cash provided by operating activities:
                       
Depreciation
    85,585       71,584       67,836  
Amortization of intangible and other assets
    9,860       9,858       9,875  
Amortization of deferred loan costs
    2,208       1,822       1,752  
Write-off of unamortized deferred loan costs and discount
                429  
Net loss (gain) on the disposition of assets
    864       (5,688 )     (7,613 )
Gain on acquisition-related contingent consideration
    (4,448 )            
Gain on bargain purchase
          (2,809 )      
Excess tax benefits from stock-based payment arrangements
    (1,174 )     (12,531 )     (11,936 )
Stock-based compensation
    40,751       32,703       25,345  
Net earnings from affiliates, net of dividends received
    (4,189 )     (8,519 )     (10,616 )
Change in assets and liabilities, net of acquisitions:
                       
Accounts receivable, net
    50,730       (195,097 )     (82,372 )
Inventories, net
    74,674       (195,529 )     (101,783 )
Prepaid expenses and other
    20,840       (21,664 )     (26,568 )
Other assets, net
    1,559       (18,179 )     (9,790 )
Accounts payable
    (104,679 )     99,768       75,200  
Accrued liabilities and income taxes payable
    (106,810 )     228,944       230,559  
Retirement obligations and other liabilities
    (71,623 )     31,501       17,285  
Net deferred taxes
    8,798       (52,593 )     (17,683 )
                         
Net cash flows provided by operating activities
    431,277       408,790       417,668  
                         
Cash flows — Investing activities:
                       
Capital expenditures
    (108,448 )     (126,932 )     (88,975 )
Proceeds from disposal of assets
    556       7,311       13,404  
Payments for acquisitions, net of cash acquired
    (30,750 )           (2,312 )
                         
Net cash flows used by investing activities
    (138,642 )     (119,621 )     (77,883 )
                         
Cash flows — Financing activities:
                       
Excess tax benefits from stock-based payment arrangements
    1,174       12,531       11,936  
Payments on long-term debt
    (5,682 )     (5,682 )     (2,841 )
Payment of deferred loan costs
    (2,764 )           (1,399 )
Net (payments) borrowings under other financing arrangements
    (684 )     14,938       (3,751 )
Repurchase of common shares
    (40,955 )     (164,950 )     (44,798 )
Payments of dividends
    (59,204 )     (51,481 )     (25,681 )
Proceeds from stock option activity
    2,939       11,940       16,693  
Dividends paid to noncontrolling interests
    (2,229 )     (1,891 )     (1,880 )
Sale (purchase) of shares to/from noncontrolling interests
    327       (874 )     1,577  
                         
Net cash flows used by financing activities
    (107,078 )     (185,469 )     (50,144 )
Effect of exchange rate changes on cash
    (3,293 )     (4,882 )     13,140  
                         
Net change in cash and cash equivalents
    182,264       98,818       302,781  
Cash and cash equivalents at beginning of year
    472,056       373,238       70,457  
                         
Cash and cash equivalents at end of year
  $ 654,320     $ 472,056     $ 373,238  
                         
Income taxes paid (net of refunds)
  $ 189,520     $ 112,545     $ 64,663  
Interest paid
    38,067       49,634       59,550  
 
See accompanying notes to consolidated financial statements.


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FLOWSERVE CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2009 AND 2008 AND FOR THE
THREE YEARS ENDED DECEMBER 31, 2009
 
1.   SIGNIFICANT ACCOUNTING POLICIES AND ACCOUNTING DEVELOPMENTS
 
We produce engineered and industrial pump and pump systems, engineered and industrial valves, control valves, actuators, controls, mechanical seals, auxiliary systems and provide a range of related flow management services worldwide, primarily for the process industries. Equipment manufactured and serviced by us is predominantly used in industries that deal with difficult-to-handle and corrosive fluids, as well as environments with extreme temperatures, pressure, horsepower and speed. Our business is affected by economic conditions in the United States (“U.S.”) and other countries where our products are sold and serviced, by the cyclical nature of the oil and gas, chemical, power generation, water management and other industries served, by the relationship of the U.S. dollar to other currencies and by the demand for and pricing of our customers’ end products.
 
Certain reclassifications and retrospective adjustments have been made to prior period information to conform to current period presentation. These reclassifications and retrospective adjustments primarily result from our adoption of guidance related to (1) noncontrolling interests under Accounting Standards Codification (“ASC”) 810, “Consolidation,” and (2) the two-class method of calculating Earnings Per Share (“EPS”) under ASC 260, “Earnings Per Share.”
 
Principles of Consolidation — The consolidated financial statements include the accounts of our company and our wholly and majority-owned subsidiaries. In addition, we consolidate any variable interest entities for which we are deemed to be the primary beneficiary. Minority interests of non-affiliated parties have been recognized for all majority-owned consolidated subsidiaries. Intercompany profits, transactions and balances among consolidated entities have been eliminated from our consolidated financial statements. Investments in unconsolidated affiliated companies, which represent non-controlling ownership interests between 20% and 50%, are accounted for using the equity method, which approximates our equity interest in their underlying equivalent net book value under accounting principles generally accepted in the United States of America (“GAAP”). Investments in interests where we own less than 20% of the investee are accounted for by the cost method, whereby income is only recognized in the event of dividend receipt. Investments accounted for by the cost method are tested annually for impairment.
 
Use of Estimates — The process of preparing financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues and expenses. Management believes its estimates and assumptions are reasonable; however, actual results may differ materially from such estimates. The most significant estimates and assumptions made by management are used in determining:
 
  •  Revenue recognition, net of liquidated damages and other delivery penalties;
 
  •  Income taxes, deferred taxes, tax valuation allowances and tax reserves;
 
  •  Reserves for contingent loss;
 
  •  Retirement and postretirement benefits; and
 
  •  Valuation of goodwill, indefinite-lived intangible assets and other long-lived assets.
 
Revenue Recognition — Revenues for product sales are recognized when the risks and rewards of ownership are transferred to the customers, which is based on the contractual delivery terms agreed to with the customer and fulfillment of all but inconsequential or perfunctory actions. In addition, our policy requires persuasive evidence of an arrangement, a fixed or determinable sales price and reasonable assurance of collectibility. For contracts containing multiple elements, each having a determinable fair value, we recognize revenue in an amount equal to the element’s pro rata share of the contract’s fair value in accordance with the contractual delivery terms for each element. We defer the recognition of revenue when advance payments are received from customers before performance obligations have been completed and/or services have been performed. Freight charges billed to


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customers are included in sales and the related shipping costs are included in cost of sales in our consolidated statements of income.
 
Revenues for long-term contracts, which include contracts that exceed certain internal thresholds regarding the size and duration of the project and provide for the receipt of progress billings from the customer, are recorded on the percentage of completion method with progress measured on a cost-to-cost basis. Percentage of completion revenue represents less than 12% of our consolidated sales for each year presented.
 
Revenue on service and repair contracts is recognized after services have been agreed to by the customer and rendered. Revenues generated under fixed fee service and repair contracts are recognized on a ratable basis over the term of the contract. These contracts can range in duration, but generally extend for up to five years. Fixed fee service contracts represent less than 1% of consolidated sales for each year presented.
 
In certain instances, we provide guaranteed completion dates under the terms of our contracts. Failure to meet contractual delivery dates can result in late delivery penalties or non-recoverable costs. In instances where the payment of such costs are deemed to be probable, we perform a project profitability analysis accounting for such costs as a reduction of realizable revenues, which could potentially cause estimated total project costs to exceed projected total revenues realized from the project. In such instances, we would record reserves to cover such excesses in the period they are determined, which would adversely affect our results of operations and financial position. In circumstances where the total projected reduced revenues still exceed total projected costs, the incurrence of unrealized incentive fees or non-recoverable costs generally reduces profitability of the project at the time of subsequent revenue recognition. Our reported results would change if different estimates were used for contract costs or if different estimates were used for contractual contingencies.
 
Cash and Cash Equivalents — We place temporary cash investments with financial institutions and, by policy, invest in those institutions and instruments that have minimal credit risk and market risk. These investments, with an original maturity of three months or less when purchased, are classified as cash equivalents. They are highly liquid and principal values are not subject to significant risk of change due to interest rate fluctuations.
 
Allowance for Doubtful Accounts and Credit Risk — The allowance for doubtful accounts is established based on estimates of the amount of uncollectible accounts receivable, which is determined principally based upon the aging of the accounts receivable, but also customer credit history, industry and market segment information, economic trends and conditions, credit reports and customer financial condition. Customer credit issues, customer bankruptcies or general economic conditions may also impact our estimates.
 
Credit risks are mitigated by the diversity of our customer base across many different geographic regions and industries and performing creditworthiness analyses on such customers. Additionally, we mitigate credit risk through letters of credit and advance payments received from our customers. As of December 31, 2009, and 2008, we do not believe that we have any significant concentrations of credit risk.
 
Inventories and Related Reserves — Inventories are stated at the lower-of-cost or market. Cost is determined by the first-in, first-out method. Reserves for excess and obsolete inventories are based upon our assessment of market conditions for our products determined by historical usage and estimated future demand. Due to the long life cycles of our products, we carry spare parts inventories that have historically low usage rates and provide reserves for such inventory based on demonstrated usage and aging criteria.
 
Income Taxes, Deferred Taxes, Tax Valuation Allowances and Tax Reserves — We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are calculated using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. We record valuation allowances to


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FLOWSERVE CORPORATION
 
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reflect the estimated amount of deferred tax assets that may not be realized based upon our analysis of existing deferred tax assets, net operating losses and tax credits by jurisdiction and expectations of our ability to utilize these tax attributes through a review of past, current and estimated future taxable income and establishment of tax strategies. These estimates could be impacted by changes in the amount and geographical source of future income and the results of implementation or alteration of tax planning strategies.
 
We provide deferred taxes for the temporary differences associated with our investment in foreign subsidiaries that have a financial reporting basis that exceeds tax basis, unless we can assert permanent reinvestment in foreign jurisdictions. Financial reporting basis and tax basis differences in investments in foreign subsidiaries consist of both unremitted earnings and losses, as well as foreign currency translation adjustments.
 
The amount of income taxes we pay is subject to ongoing audits by federal, state, and foreign tax authorities, which often result in proposed assessments. Significant judgment is required in determining income tax provisions and evaluating tax positions. We establish reserves for open tax years for uncertain tax positions that may be subject to challenge by various tax authorities. The consolidated tax provision and related accruals include the impact of such reasonably estimable losses and related interest and penalties as deemed appropriate.
 
On January 1, 2007, we adopted ASC 740, “Income Taxes,” which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities. The determination is based on the technical merits of the position and presumes that each uncertain tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.
 
While we believe we have adequately provided for any reasonably foreseeable outcome related to these matters, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities. To the extent that the expected tax outcome of these matters changes, such changes in estimate will impact the income tax provision in the period in which such determination is made.
 
Legal and Environmental Accruals — Legal and environmental reserves are recorded based upon a case-by-case analysis of the relevant facts and circumstances and an assessment of potential legal obligations and costs. Amounts relating to legal and environmental liabilities are recorded when it is probable that a loss has been incurred and such loss is estimable. Assessments of legal and environmental costs are based on information obtained from our independent and in-house experts and our loss experience in similar situations. These estimates may change in the future due to new developments regarding the facts and circumstances of each matter.
 
Estimates of liabilities for unsettled asbestos-related claims are based on known claims and on our experience during the preceding two years for claims filed, settled and dismissed, and are included in accrued liabilities and retirement obligations and other liabilities, as applicable, in our consolidated balance sheets. A substantial majority of our asbestos-related claims are covered by insurance or indemnities. Estimated recoveries from insurance carriers for unsettled claims and receivables for settlements and legal fees paid by us for asbestos-related claims are estimated using our historical experience with insurance recovery rates and estimates of future recoveries, which include estimates of coverage and financial viability of our insurance carriers. Estimated recoveries are included in other assets, net in our consolidated balance sheets. Changes in claims filed, settled and dismissed, with adjustments for events deemed unusual and unlikely to recur, and differences between actual and estimated settlement costs and insurance or indemnity recoveries could impact future expense.
 
Warranty Accruals — Warranty obligations are based upon product failure rates, materials usage, service delivery costs, an analysis of all identified or expected claims and an estimate of the cost to resolve such claims. The estimates of expected claims are generally a factor of historical claims and known product issues. Warranty obligations based on these factors are adjusted based on historical sales trends for the preceding 24 months. Changes


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in claim rates, differences between actual and expected warranty costs, and sales trends could impact warranty obligation estimates, which might have adverse effects on our consolidated results of operations and financial position.
 
Insurance Accruals — Insurance accruals are recorded for wholly or partially self-insured risks such as medical benefits and workers’ compensation and are based upon an analysis of our claim loss history, insurance deductibles, policy limits and other relevant factors and are included in accrued liabilities in our consolidated balance sheets. The estimates are based upon information received from actuaries, insurance company adjusters, independent claims administrators or other independent sources. Changes in claims and differences between actual and expected claim losses could impact future accruals. Receivables from insurance carriers are estimated using our historical experience with insurance recovery rates and estimates of future recoveries, which include estimates of coverage and financial viability of our insurance carriers. Estimated receivables are included in accounts receivable, net and other assets, net, as applicable, in our consolidated balance sheets.
 
Pension and Postretirement Obligations — Determination of retirement and postretirement benefits obligations is based on estimates made by management in consultation with independent actuaries and investment advisors. Inherent in these valuations are assumptions including discount rates, expected rates of return on plan assets, retirement rates, mortality rates and rates of compensation increase and other factors. Current market conditions, including changes in rates of return, interest rates and medical inflation rates, are considered in selecting these assumptions.
 
Actuarial gains and losses and prior service costs are recognized in accumulated other comprehensive loss as they arise and we amortize these costs into net pension expense over the remaining expected service period.
 
Valuation of Goodwill, Indefinite-Lived Intangible Assets and Other Long-Lived Assets — The value of goodwill and indefinite-lived intangible assets is tested annually for impairment at December 31 or whenever events or circumstances indicate such assets may be impaired. Impairment for goodwill and indefinite-lived intangibles is assessed at the reporting unit level, which correlates to our operating segments. We consider each of our operating segments to constitute a business with discrete financial information that management regularly reviews. The net realizable value of other long-lived assets, including property, plant and equipment, is reviewed periodically, when indicators of potential impairment conditions are present, based upon an assessment of the estimated future cash flows related to those assets.
 
Property, Plant, and Equipment, and Depreciation — Property, plant and equipment are stated at historical cost, less accumulated depreciation. If asset retirement obligations exist, they are capitalized as part of the carrying amount of the asset and depreciated over the remaining useful life of the asset. The useful lives of leasehold improvements are the lesser of the remaining lease term or the useful life of the improvement. When assets are retired or otherwise disposed of, their costs and related accumulated depreciation are removed from the accounts and any resulting gains or losses are included in income from operations for the period. Depreciation is computed by the straight-line method based on the estimated useful lives of the depreciable assets. Generally, the estimated useful lives of the assets are:
 
         
Buildings and improvements
    10 to 40 years  
Furniture and fixtures
    3 to 7 years  
Machinery and equipment
    3 to 12 years  
Capital leases (based on lease term)
    3 to 25 years  
 
Costs related to routine repairs and maintenance are expensed as incurred.
 
Internally Developed Software — We capitalize certain costs associated with the development of internal-use software. Generally, these costs are related to significant software development projects and are amortized over their estimated useful life, typically three to five years, upon implementation of the software.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Intangible Assets — Intangible assets, excluding trademarks (which are considered to have an indefinite life), consist primarily of engineering drawings, distribution networks, software, patents and other items that are being amortized over their estimated useful lives generally ranging from 3 to 40 years. These assets are reviewed for impairment whenever events and circumstances indicate impairment may have occurred.
 
Deferred Loan Costs — Deferred loan costs, consisting of fees and other expenses associated with debt financing, are amortized over the term of the associated debt using the effective interest method. Additional amortization is recorded in periods where optional prepayments on debt are made.
 
Fair Values of Financial Instruments — The carrying amounts of our financial instruments approximated fair value at December 31, 2009. The carrying amounts of our financial instruments approximated fair value at December 31, 2008, except for our Term Loan. The interbank market for our Term Loan implied a fair value of approximately $495 million at December 31, 2008, as compared with a carrying value of $549.7 million. We believe this is reflective of the general global economic conditions as of December 31, 2008.
 
Assets and liabilities recorded at fair value in our consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Hierarchical levels, as defined by ASC 820, “Fair Value Measurements and Disclosures,” are directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities. An asset or a liability’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. Hierarchical levels are as follows:
 
Level I — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
 
Level II — Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
 
Level III — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
 
Derivatives and Hedging Activities — As part of our risk management strategy, we enter into derivative contracts to mitigate certain financial risks related to foreign currencies and interest rates. We have a risk-management and derivatives policy outlining the conditions under which we can enter into financial derivative transactions.
 
We employ a foreign currency economic hedging strategy to minimize potential losses in earnings or cash flows from unfavorable foreign currency exchange rate movements. This strategy also minimizes potential gains from favorable exchange rate movements. Foreign currency exposures arise from transactions, including firm commitments and anticipated transactions, denominated in a currency other than an entity’s functional currency and from translation of foreign-denominated assets and liabilities into U.S. dollars. The primary currencies in which we operate, in addition to the U.S. Dollar, are the Argentina Peso, Australian Dollar, Brazilian Real, British Pound, Canadian Dollar, Chinese Yuan, Colombian Peso, Euro, Indian Rupee, Japanese Yen, Mexican Peso, Singapore Dollar, Swedish Krona and Venezuelan Bolivar. We enter into interest rate swap agreements for the purpose of hedging our exposure to floating interest rates on certain portions of our debt.
 
Our policy to achieve hedge accounting treatment requires us to document all relationships between hedging instruments and hedged items, our risk management objective and strategy for entering into hedges and whether we intend to designate a formal hedge accounting relationship. This process includes linking all derivatives that are designated in a formal hedge accounting relationship as fair value, cash flow or foreign currency hedges of (1) specific assets and liabilities on the balance sheet or (2) specific firm commitments or forecasted transactions. In cases where we designate a hedge, we assess (both at the inception of the hedge and on an ongoing basis) whether the derivatives have been highly effective in offsetting changes in the fair value or cash flows of hedged items and


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
whether those derivatives may be expected to remain highly effective in future periods. Failure to demonstrate effectiveness in offsetting exposures retroactively or prospectively would cause us to deem the hedge ineffective.
 
All derivatives are recognized on the balance sheet at their fair values. For derivatives that do not qualify for hedge accounting or for which we have not elected to apply hedge accounting, which includes substantially all of our forward exchange contracts, the changes in the fair values of these derivatives are recognized in other (expense) income, net in the consolidated statements of income.
 
At the inception of a new derivative contract for which formal hedge accounting has been elected, our policy requires us to designate the derivative as (1) a hedge of (a) a forecasted transaction or (b) the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge); or (2) a foreign currency fair value (a “foreign currency”) hedge. Changes in the fair value of a derivative that is highly effective, documented, designated, and qualified as a cash flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income (loss), until earnings are affected by the variability of cash flows of the hedged transaction. Changes in the fair value of foreign currency hedges are recorded in other comprehensive income (loss) since they satisfy the accounting criteria for a cash flow hedge. Any hedge ineffectiveness (which represents the amount by which the changes in the fair value of the derivative do not mirror the change in the cash flow of the forecasted transaction) is recorded in current period earnings. For effective hedges, the changes in the value of the hedged item are also recorded as a component of other comprehensive income (loss), if the underlying has been recognized on the balance sheet. Upon settlement, realized gains and losses are recognized in other income in the consolidated statements of income.
 
We discontinue hedge accounting when:
 
  •  we deem the hedge to be ineffective and determine that the designation of the derivative as a hedging instrument is no longer appropriate;
 
  •  the derivative no longer effectively offsets changes in the cash flows of a hedged item (such as firm commitments or contracts);
 
  •  the derivative expires, terminates or is sold; or
 
  •  occurrence of the contracted or committed transaction is no longer probable, or will not occur in the originally expected period.
 
When hedge accounting is discontinued and the derivative remains outstanding, we carry the derivative at its estimated fair value on the balance sheet, recognizing changes in the fair value in current period earnings. If a cash flow hedge becomes ineffective, any deferred gains or losses on the cash flow hedge remain in accumulated other comprehensive loss until the exposure relating to the item underlying the hedge is recognized. If it becomes probable that a hedged forecasted transaction will not occur, deferred gains or losses on the hedging instrument are recognized in earnings immediately.
 
Foreign Currency Translation — Assets and liabilities of our foreign subsidiaries are translated to U.S. dollars at exchange rates prevailing at the balance sheet date, while income and expenses are translated at average rates for each month. Translation gains and losses are generally reported as a component of accumulated other comprehensive loss.
 
Transaction and translation gains and losses arising from intercompany balances are reported as a component of accumulated other comprehensive loss when the underlying transaction stems from a long-term equity investment or from debt designated as not due in the foreseeable future. Otherwise, we recognize transaction gains and losses arising from intercompany transactions as a component of income. Where intercompany balances are not long-term investment related or not designated as due beyond the foreseeable future, we may mitigate risk associated with foreign currency fluctuations by entering into forward exchange contracts. See Note 8 for further discussion of these forward exchange contracts.


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FLOWSERVE CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Transactional currency gains and losses arising from transactions in currencies other than our sites’ functional currencies and changes in fair value of forward exchange contracts that do not qualify for hedge accounting are included in our consolidated results of operations. For the years ended December 31, 2009, 2008 and 2007, we recognized net (losses) gains of $(7.8) million, $16.6 million and $6.3 million of such amounts in other (expense) income, net in the accompanying consolidated statements of income.
 
Stock-Based Compensation — Stock-based compensation is measured at the grant — date fair value. It is our policy to set the exercise price of stock option awards and the value of restricted share, restricted share unit and performance-based unit awards (collectively referred to as “Restricted Shares”) at the closing price of our common stock on the New York Stock Exchange on the date of grant, which is the date such grants are authorized by our Board of Directors. Restricted share units and performance-based units refer to restricted awards that do not have voting rights and accrue dividends, which are forfeited if vesting does not occur.
 
Options are expensed using the graded vesting model, whereby we recognize compensation cost over the requisite service period for each separately vesting tranche of the award. We adjust share-based compensation at least annually for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The intrinsic value of Restricted Shares, which is typically the product of share price at the date of grant and the number of Restricted Shares granted, is amortized on a straight-line basis to compensation expense over the periods in which the restrictions lapse based on the expected number of shares that will vest. The forfeiture rate is based on unvested Restricted Shares forfeited compared with original total Restricted Shares granted over a 4-year period, excluding significant forfeiture events that are not expected to recur.
 
Earnings Per Share — Effective January 1, 2009, we adopted the two-class method of calculating EPS. We have retrospectively adjusted earnings per common share for all prior periods presented. The “two-class” method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security as if all earnings for the period had been distributed. Unvested restricted share awards that earn non-forfeitable dividend rights qualify as participating securities and, accordingly, are now included in the basic computation as such. Our unvested restricted shares participate on an equal basis with common shares; therefore, there is no difference in undistributed earnings allocated to each participating security. Accordingly, the presentation below is prepared on a combined basis and is presented as earnings per common share. Previously, such unvested restricted shares were not included as outstanding within basic earnings per common share and were included in diluted earnings per common share pursuant to the treasury stock method. The following is a reconciliation of net earnings of Flowserve Corporation and weighted average shares for calculating basic net earnings per common share.


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FLOWSERVE CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Earnings per weighted average common share outstanding was calculated as follows:
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (Amounts in thousands, except per share data)  
 
Net earnings of Flowserve Corporation
  $ 427,887     $ 442,413     $ 255,774  
Dividends on restricted shares not expected to vest
    23       28       20