UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number 1-13179

 

FLOWSERVE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(972) 443-6500

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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):

 

 

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, 2010 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $4,041,000,000. 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, 2011 was 55,729,475.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information contained in the definitive proxy statement for the registrant’s 2011 Annual Meeting of Shareholders scheduled to be held on May 19, 2011 is incorporated by reference into Part III hereof.

 

 

FLOWSERVE CORPORATION
FORM 10-K

TABLE OF CONTENTS

 

 

 

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, procurement 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 2010 consisted of:

 

•   oil and gas			42	%
•   general industries(1)			20	%
•   power generation			17	%
•   chemical			16	%
•   water management			5	%

 

The breakdown of the geographic regions to which our sales were shipped in 2010 were as follows:

 

•   North America			31	%
•   Europe			26	%
•   Asia Pacific			18	%
•   Middle East and Africa			15	%
•   Latin America			10	%

 

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 17 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, 2010 (“Annual Report”).

 

As previously disclosed in our 2009 Annual Report on Form 10-K and our 2010 Quarterly Reports on Form 10-Q, we reorganized our divisional operations by combining the former Flowserve Pump Division (“FPD”) and former Flow Solutions Division (“FSD”) into the Flow Solutions Group (“FSG”), effective January 1, 2010.

FSG was divided into two reportable segments: FSG Engineered Product Division and FSG Industrial Product Division. Flow Control Division was not affected. We have retrospectively adjusted prior period financial information to reflect our current reporting structure.

 

We conduct our operations through three business segments based on type of product and how we manage the business:

 

 

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 increasing enterprise value by using strategies that are well communicated throughout the company. These strategies include: disciplined profitable growth, customer intimacy, innovation and portfolio management, strategic localization, operational excellence, employee focus and sustainable business model. The key elements of these strategies are outlined below.

 

Disciplined Profitable Growth

 

Disciplined profitable growth is an important initiative focused on growing revenues profitably from our existing portfolio of products and services, as well as through the development or acquisition 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 across a broad portfolio, as well as offer additional options that include any combination of products and solution support packages.

 

We also seek to continue to review our substantial installed pump, valve and seal base as a means to expand the aftermarket parts and services business, as customers are increasingly using third-party aftermarket parts and 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. 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.

 

Customer Intimacy

 

Customer intimacy defines our approach to being prepared to serve the needs of our current and future customers better than our competition. Through our ongoing relationships with our customers, we seek to gain a rich understanding of their business objectives and how our portfolio of offerings can help them succeed. We collaborate with our customers on the front end engineering and design work to drive flow management solutions that effectively generate the desired business outcomes. As we progress through original equipment projects, we work closely with our customers to understand and prepare for the long-term support needs for the operations with the intent of maximizing total life cycle value for our customers’ investments.

 

We seek to capture additional aftermarket business 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.

 

Innovation and Portfolio Management

 

The ongoing management of our portfolio of products and services is critical to our success. As part of managing our portfolio, we continue to rationalize our portfolio of products and services to ensure alignment with changing market requirements. We also continue to invest in research and development (“R&D”) to expand the scope of our product offerings and our deployment of advanced technologies. The infusion of advanced technologies into new products and services continues to play a critical role in the ongoing evolution of our product portfolio. Our 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 life cycle and total cost of ownership for our customers.

 

We employ a robust portfolio management and project execution process to 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 are deployed across business unit boundaries to make sure we bring the best capabilities to bear for each project. Collectively, the R&D 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 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.

 

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 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 operations running.

 

We continually evaluate acquisitions, joint ventures and other strategic investment opportunities to broaden our product portfolio, service capabilities, geographic presence and operational capabilities to meet the growing needs of our customers. We evaluate all investment opportunities through a decision filtering process to ensure a good strategic, financial and cultural fit.

 

In 2010, our acquisition and joint venture activities focused on adjacent technology and product capabilities. Effective July 16, 2010, we acquired for inclusion in FCD, 100% of Valbart Srl (“Valbart”), a privately-owned Italian valve manufacturer, in a share purchase for cash of $199.4 million, which included $33.8 million of existing Valbart net debt (defined as Valbart’s third party debt less cash on hand) that was repaid at closing. Valbart manufactures trunnion-mounted ball valves used primarily in upstream and midstream oil and gas applications, which enables us to offer a more complete valve product portfolio to our oil and gas project customers.

 

Strategic Localization

 

Strategic localization describes our global growth strategy. We recognize that as a multi-national company it will take more than a few years to become truly global. Therefore, our strategy focuses on advancing our presence appropriately in geographies deemed to be critical to our future success as a company. This business initiative continues to focus on areas in line with our previous “globalization” strategy. These include:

 

 

 

We believe there are attractive opportunities in international markets, particularly in China, India, the Middle East, Russia 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 2010, 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 2010, these lower cost regions supplied our divisions with direct materials ranging from 17% to 34% of divisional spending.

 

Operational Excellence

 

The operational excellence initiative encapsulates ongoing programs that work to drive increased customer fulfillment and yield internal productivity. This initiative includes:

 

 

We seek to increase our operational efficiency through our Continuous Improvement Process (“CIP”) initiative, which utilizes tools such as value analysis, value engineering, 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 CIP training tailored to maximize the impact on our business. To date, more than 1,600 active 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, as well as in the front office of the business. As a result of the CIP initiative, we have developed and implemented processes to reduce our engineering and manufacturing process cycle time, improve on-time delivery and service response time, optimize 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.

 

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.

Employee Focus

 

We focus on several elements in our strategic efforts to continuously enhance our organizational capability, including:

 

 

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.

 

Sustainable Business Model

 

The sustainable business model initiative is focused on all of the areas that have the potential of adversely affecting our reputation, limiting our financial flexibility or creating unnecessary risk for any of our stakeholders. We proactively manage an enterprise risk management program with regular reviews of high level matters with our Board of Directors. We work with our capital sourcing partners to ensure that our credit facilities and terms are appropriately aligned with our business strategy. We also train our associates on and monitor all matters of a legal or ethical nature to support understanding and compliance on a global basis.

 

Competition

 

Despite consolidation activities in past years, the markets for our products remain highly competitive, with primary competitive drivers being price, reputation, timeliness of delivery, quality, proximity to service centers 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 2010 and current forecasts for 2011, 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 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, although we are seeing increased competition in this area.

 

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 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 life cycle of their investments in flow control 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 control management needs, allows us to create value for our customers during all phases of the capital expenditure cycle.

 

New Product Development

 

We spent $29.5 million, $29.4 million and $34.0 million during 2010, 2009 and 2008, respectively, on R&D initiatives. Our R&D 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 R&D activities. In addition, we work closely with our customers on customer-sponsored research activities to help execute their R&D 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 2010 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 backlog levels and longer lead times generally 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 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 valuable assets 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 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 ferrous and non-ferrous metals in the form of bar stock, machined castings, fasteners, forgings and motors, as well as silicon, carbon faces, gaskets and fluoropolymer components. A substantial volume of our raw materials are purchased from outside sources, and we have been able to develop a robust supply chain and anticipate no shortages of such materials in the future. We continually monitor the business conditions of our suppliers to manage competitive market conditions and to avoid potential supply disruptions. We continue to expand global sourcing to capitalize on localization in emerging markets and low-cost sources of purchased goods balanced with efficient consolidated and compliant 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 qualified and approved foundry sources.

 

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 United States (“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, Brazil, Canada, Finland, France, Germany, Italy, Japan, Mexico, the Netherlands, Poland, Spain, Sweden 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 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 to identify potential environmental liabilities and required 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 four Superfund sites. The sites are in various stages of evaluation by government authorities. Our total projected “fair share” cost allocation at these four 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 $300.3 million in 2010, $339.6 million in 2009 and $344.3 million in 2008.

 

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. While disclosure of such violations could result in substantial fines and other penalties, we believe we have adequate accruals for such matters. 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 17 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 2010, 2009 and 2008.

 

FSG ENGINEERED PRODUCT DIVISION

 

Our largest business segment is EPD, through which we design, manufacture, distribute and service engineered pumps and pump systems, mechanical seals, auxiliary systems, replacement parts and related equipment. The business consists of long lead-time, highly engineered, custom configured products, which require extensive test requirements and superior project management skills. EPD products and services are primarily used by companies that operate in the oil and gas, power generation, petrochemical, water management and general industries. We market our pump and mechanical seal products through our worldwide sales force and our regional service and repair centers or through independent distributors and sales representatives. A portion of our mechanical seal products is sold directly to original equipment manufacturers for incorporation into rotating equipment requiring mechanical seals.

Our pump products are manufactured in a wide range of metal alloys and with a variety of configurations to meet the critical operating demands of our customers. 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. Our products are currently manufactured at 26 plants worldwide, nine of which are located in Europe, nine in North America, four in Asia Pacific and four in Latin America.

 

We also conduct business through strategic foreign joint ventures. We have six unconsolidated joint ventures that are located in China, India, Japan, Saudi Arabia, South Korea and the United Arab Emirates, where a portion of our 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.

 

EPD Products

 

EPD manufactures more than 40 different active pumps and approximately 185 different models of mechanical seals and sealing systems. The following is a summary list of our EPD products and globally recognized brands:

 

EPD Product Types

 

Between Bearings Pumps		Overhung Pumps
•   Single Case — Axially Split		•   API Process
•   Single Case — Radially Split
•   Double Case

 

Positive Displacement Pumps		Mechanical Seals and Seal Support Systems
•   Multiphase		•   Gas Barrier Seals
•   Reciprocating		•   Dry-Running Seals
•   Screw

 

Specialty Products
•   Nuclear Pumps		•   Power Recovery — DWEER
•   Nuclear Seals		•   Power Recovery — Hydroturbine
•   Cryogenic Pumps		•   Energy Recovery Devices
•   Cryogenic Liquid Expander		•   CVP Concrete Volute Pumps
•   Hydraulic Decoking Systems

EPD Brand Names

 

•   BW Seals		•   LifeCycle Advantage
•   Byron Jackson		•   Niigata Worthington
•   Calder Energy Recovery Devices		•   QRCtm
•   Cameron		•   Pacific
•   Durametallic		•   Pacific Weits
•   Five Star Seal		•   Pac-Seal
•   Flowserve		•   ReadySeal
•   Flowstar		•   United Centrifugal
•   GASPACtm		•   Western Land Roller
•   IDP		•   Wilson-Snyder
•   Interseal		•   Worthington
•   Jeumont-Schneider		•   Worthington-Simpson

 

EPD Services

 

We provide engineered aftermarket services through our global network of 117 service centers and QRCs, some of which are co-located in manufacturing facilities, in 39 countries. Our EPD service personnel provide a comprehensive set of equipment services for flow management control systems, including installation, commissioning, repair, advanced diagnostics, re-rate and retrofit programs, machining and comprehensive asset management solutions. We provide asset management services and condition monitoring for rotating equipment through special contracts with many of our customers that reduce maintenance costs. A large portion of EPD’s service work is performed on a quick response basis, and we offer 24-hour service in all of our major markets.

 

EPD New Product Development

 

Our investments in new product R&D 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 technology. We continue to design solutions and close the technology gaps in developing products and components for pipeline, off-shore and downstream applications for the oil and gas market. Our subsea product development continues in a newly constructed test facility where our multiphase pump and submersible motor have been brought together for complete unit testing.

 

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. With the acquisition of Calder AG (“Calder”) in 2009, our technology team has been investigating advances in power recovery work exchanger designs for the reverse osmosis market, optimizing the size and range for specific applications.

 

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. Recently formalized advanced technology collaboration agreements provide a channel for expanding our technology reach in Computational Fluid Dynamics and sophisticated acoustic simulations.

In 2010, EPD continued to advance our Technology Advantage platform through the Integrated Solutions Organization (“ISO”). 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.

 

Our investments in new product R&D 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:

 

 

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 products or services required the investment of a material amount of our assets or was otherwise material.

 

EPD Customers

 

Our customer mix is diversified and includes end users, distributors, leading engineering, procurement and construction firms and original equipment manufacturers. 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. Our sales are diversified among several industries, including oil and gas, power generation, petrochemical, water management and general industries.

 

EPD Competition

 

The pump and mechanical seal 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 among 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 industry competitors include: Sulzer Pump; Ebara Corporation; Eagle Burgmann, which is a joint venture of two traditional global seal manufacturers, Chesterton and AES; John Crane, a unit of Smiths Group Plc; and Clyde Union.

 

The pump and mechanical seal 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 suppliers to simplify their supplier base. Despite the consolidation activity, the market remains highly competitive.

We believe that our strongest sources of competitive advantage rest with our extensive range of pumps for the oil and gas, petrochemical 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, our reputation for providing quality engineering solutions and our ability to deliver engineered new seal product orders within 72 hours from the customer’s request through design, engineering, manufacturing, testing and delivery.

 

EPD Backlog

 

EPD’s backlog of orders as of December 31, 2010 was $1.4 billion (including $25.5 million of interdivision backlog, which is eliminated and not included in consolidated backlog), compared with $1.4 billion (including $30.0 million of interdivision backlog) as of December 31, 2009. We expect to ship 80% of December 31, 2010 backlog during 2011.

 

FSG INDUSTRIAL PRODUCT DIVISION

 

Through IPD we design, manufacture, distribute and service pre-configured pumps and pump systems, including submersible motors for industrial markets. Our globalized operating platform, low-cost sourcing and continuous improvement initiatives are essential aspects of this business. IPD’s standardized, general purpose pump products are primarily utilized by the oil and gas, chemical, water management, power generation and general industries. Our products are currently manufactured at 13 plants worldwide, three of which are located in the U.S. and six in Europe. IPD operates 21 QRCs worldwide, including 11 sites in Europe and four in the U.S., including those co-located in manufacturing facilities.

 

IPD Products

 

IPD manufactures approximately 40 different active pumps. Our pump products are manufactured in a wide range of metal alloys and non-metallics with a variety of configurations to meet the critical operating demands of our customers. The following is a summary list of our IPD products and globally recognized brands:

 

IPD Pump Product Types

 

Overhung		Between Bearings
•   Chemical Process ANSI and ISO		•   Single Case — Axially Split
•   Industrial Process		•   Single Case — Radially Split
•   Slurry and Solids Handling

 

Specialty Products		Vertical
•   Molten Salt VTP Pump		•   Wet Pit
•   Submersible Pump		•   Deep Well Submersible Motor
•   Thruster		•   Slurry and Solids Handling
•   Geothermal Deepwell		•   Sump
•   Barge Pump

 

Positive Displacement

•   Gear

IPD Brand Names

 

•   Aldrich		•   Sier Bath
•   Durco		•   TKL
•   IDP		•   Western Land Roller
•   Pacific		•   Worthington
•   Pleuger		•   Worthington-Simpson
•   Scienco

 

IPD Services

 

We market our pump products through our worldwide sales force and our regional service and repair centers or through independent distributors and sales representatives. We provide an array of aftermarket services including product installation and commissioning services, spare parts, repairs, re-rate and upgrade solutions, advanced diagnostics and maintenance solutions through our global network of 21 QRCs, some of which are co-located in manufacturing facilities, in 11 countries.

 

IPD New Product Development

 

Our IPD development projects target product feature enhancements, design improvements and sourcing opportunities that will improve the competitive position of our industrial pump product lines. We continue to address our core products with design enhancements to improve performance and the speed at which we can deliver our products. Introduction of permanent magnet motor technology into our submersible motor designs is resulting in improved product efficiency. Extending the capability of products as demonstrated by successful installation of our vertical pumps in the high temperature molten salt service is one example of our focus to apply technology where specific design solutions are required. Additionally, cost reduction projects incorporating product rationalization, value engineering, LEAN manufacturing and overhead reduction are key drivers for IPD.

 

None of these newly developed products or services required the investment of a material amount of our assets or was otherwise material.

 

IPD 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 helps mitigate the impact of normal economic cycles on our business. Our sales are diversified among several industries, including oil and gas, water management, chemical, power generation and general industries.

 

IPD Competition

 

The industrial pump industry is highly fragmented, with many competitors. We compete, however, primarily with a limited number of large companies operating on a global scale. Competition among 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 industry competitors include ITT Industries, KSB Inc. and Sulzer Pumps.

 

We believe that our strongest sources of competitive advantage rest with our extensive range of pumps for the chemical and petrochemical 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.

 

IPD Backlog

 

IPD’s backlog of orders as of December 31, 2010 was $568.0 million (including $38.5 million of interdivision backlog, which is eliminated and not included in consolidated backlog), compared with $555.6 million (including

$19.8 million of interdivision backlog) as of December 31, 2009. We expect to ship 88% of December 31, 2010 backlog during 2011.

 

FLOW CONTROL DIVISION

 

FCD 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, boiler controls and condensate and energy recovery systems. FCD leverages its experience and application know-how by offering a complete menu of engineering and project management services to complement its expansive product portfolio. FCD products are used to control, direct and manage the flow of liquids and gases and are an integral part of any flow control system. Our valve products are most often customized and engineered to perform specific functions within each customer’s unique flow control environment.

 

Our flow control products are primarily used by companies operating in the chemical (including pharmaceutical), power generation (nuclear, fossil and renewable), oil and gas, water management and general industries, including aerospace, pulp and paper and mining. FCD has 54 sites worldwide, including 25 principal manufacturing facilities (five of which are located in the U.S.) and 29 QRCs, including three consolidated joint ventures. A small portion of our valves is also produced through an unconsolidated foreign joint venture in India.

 

FCD Products

 

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 service to the most severe and demanding services, including those involving high levels of corrosion, extreme temperatures and/or pressures, zero fugitive emissions and emergency shutdown.

 

Our “smart” valve and diagnostic technologies integrate sensors, microprocessor controls and software into high performance integrated control valves, digital positioners and switchboxes for automated on/off valve assemblies and electric actuators. These technologies permit real-time system analysis, system warnings and remote indication of asset health. These technologies have been developed in response to the growing demand for reduced maintenance, 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.

 

Our valve automation products encompass a broad range of pneumatic, electric, hydraulic and stored energy actuation designs to take advantage of whatever power source the customer has available. FCD’s actuation products can even utilize the process fluid flowing through the pipeline as a source of power to actuate the valve. Our actuation products also cover one of the widest ranges of output torques in the industry, providing the ability to automate anything from the smallest linear globe valve to the largest multi-turn gate valve. Most importantly, FCD combines best-in-class mechanical designs with the latest in digital controls in order to provide complete integrated automation solutions that optimize the combined valve-actuator-controls package.

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		•   Direct Gas and Gas-over-Oil Actuators
•   Lined Ball Valves		•   Limit Switches
•   Lubricated Plug Valves		•   Steam Traps
•   Non-Lubricated Plug Valves		•   Condensate and Energy Recovery Systems
•   Integrated Valve Controllers		•   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
•   Durco		•   PMV
•   Edward		•   Serck Audco
•   Flowserve		•   Schmidt Armaturen
•   Gestra		•   Valbart
•   Kammer		•   Valtek
•   Limitorque		•   Vogt
•   McCANNA/MARPAC		•   Worcester Controls

 

FCD Services

 

We provide aftermarket products and services through our network of 29 QRCs located around the world. Our service personnel provide comprehensive 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 manufacturing facilities. We believe our ability to offer comprehensive, quick turnaround services provides us with a unique competitive advantage and unparalleled access to our customers’ installed base of flow control products.

 

FCD New Product Development

 

Our R&D investment is focused on 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 valve top works (e.g., positioners, actuators, limit switches

and associated accessories) with Distributed Control Systems (“DCS”). We 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 the 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 corrosion/erosion-resistance limits of existing products, as well as noise and cavitation reduction. These investments are made by adding new resources and talent to the organization, as well as leveraging the experience of EPD and IPD and increasing our collaboration with third parties. We expect to continue our R&D 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 markets, including the chemical, oil and gas, power generation, water management, pulp and paper, mining and other 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 firms, 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, the market remains highly fragmented. Some of the largest valve industry competitors include Tyco, Cameron, Emerson, General Electric 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 fourth largest industrial valve supplier in the world. 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, 2010 was $658.5 million, compared with $485.3 million as of December 31, 2009. We expect to ship 83% of December 31, 2010 backlog during 2011.

 

AVAILABLE INFORMATION

 

We maintain an Internet web site 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 web site 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 web site 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 and other important governance documents. All of the foregoing documents may be obtained through our Internet web site as noted above and are available in print without charge to shareholders who request them. Information contained on or available through our Internet web site is not incorporated into this Annual Report or any other document we file with, or furnish to, the SEC.

 

 

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, 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. Lingering effects of global financial markets and banking systems disruptions experienced in 2008 and 2009 continue to make credit and capital markets difficult for some companies to access, and the costs of newly raised debt for most companies have generally increased. Any 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.

 

Volatility in commodity prices, effects from 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.

 

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 the health of our customers’ businesses and their access to capital, volatility in commodity prices and 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, 2010, backlog was $2.6 billion. In 2011, 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 geographically diverse 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. Competitive environments in slow growth industries and for original equipment orders have been inherently more influenced by pricing and domestic and global economic conditions during 2010, 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 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.

 

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 2011. This initiative involved structural changes in our global manufacturing footprint through additional migration to low-cost regions, additional consolidation of product manufacturing and further Selling, General and Administrative Expense (“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 former Flowserve Pump Division and former Flow Solutions Division into the Flow Solutions Group.

 

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, integration and realignment

activities can place substantial demands on management, which could divert attention from other business priorities. While our activities concerning these initiatives are substantially complete, the lingering adverse effects from our integration and our execution of realignment activities could interfere with our realization of anticipated synergies, customer service improvements and cost savings from these strategic initiatives. 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 90 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:

 

 

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.

 

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, 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, 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 0.5% of our consolidated global revenue in 2010. 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, Brazilian real, Indian rupee, Japanese yen, Singapore dollar, Argentine peso, Canadian dollar, Chinese yuan, Colombian peso, Chilean peso and South African rand. 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.

 

We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws and regulations.

 

The U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws and regulations in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to non-U.S. government officials for the purpose of obtaining or retaining business or securing an improper business advantage. Our policies mandate compliance with these anti-bribery laws. We operate in many parts of the world and sell to industries that have experienced corruption to some degree. If we are found to be liable for FCPA or other similar anti-bribery law or regulatory violations, whether due to our or others’ actions or inadvertence, we could be subject to civil and criminal penalties or other sanctions that could have a material adverse impact on our business, 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.

 

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 such penalties as part of our effort to resolve this matter; however, we currently do not believe any such penalties will have a material adverse impact on our company.

 

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.

 

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.

 

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 four 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 substantial 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 internal 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, 2010, we had approximately 15,000 employees, of which approximately 5,000 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, Brazil, Canada, Finland, France, Germany, Italy, Japan, Mexico, the Netherlands, Poland, Spain, Sweden 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 of 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 property rights, our competitive position could suffer, which could harm our business, financial condition, results of operations and cash flows.

 

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 impact of the performance of global financial markets in recent years 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 has required significant contributions to our pension plans in recent years, which is likely to continue, albeit to a lesser extent, in 2011. 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 effect 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.

 

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 carryforwards, 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 $225 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; 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 business, 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. Acquisitions may require additional debt financing,

resulting in higher leverage and an increase in interest expense. In addition, acquisitions may require large one-time charges and can result in the incurrence of contingent liabilities, adverse tax consequences, substantial depreciation or deferred compensation charges, the amortization of identifiable purchased intangible assets or impairment of goodwill, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

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:

 

 

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,” “expects,” “could,” “intends,” “projects,” “predicts,” “plans,” “anticipates,” “estimates,” “believes,” “forecasts” 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.

 

 

None.

 

 

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.

 

Our major manufacturing facilities (those with 50,000 or more square feet of manufacturing capacity) operating at December 31, 2010 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:

 

 

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 11 to our consolidated financial statements included in Item 8 of this Annual Report for additional information regarding our operating lease obligations.

 

 

We are party to the legal proceedings that are described in Note 13 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. We have established reserves covering exposures relating to contingencies to the extent believed to be reasonably estimable and probable based on past experience and available facts.

 

 

Market Information and Dividends

 

Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “FLS.” On February 18, 2011, our records showed 1,555 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)

 

 

The table below presents declaration, record and payment dates, as well as the per share amounts, of dividends on our common stock during 2010 and 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. On February 21, 2011, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.29 per share to $0.32 per share payable quarterly beginning on April 14, 2011. 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. 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 11 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 $300.0 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.

 

During the quarter ended December 31, 2010, we repurchased a total of 112,500 shares of our common stock under the program for $11.9 million (representing an average cost of $106.14 per share). Since the adoption of this program, we have repurchased a total of 2,735,600 shares of our common stock for $251.9 million (representing an

average cost of $92.08 per share). As of December 31, 2010, we had 58.9 million shares issued and outstanding (excluding the impact of treasury shares). We may repurchase up to an additional $48.1 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, 2010:

 

 

 

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. The graph assumes an investment of $100 on December 31, 2005, 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.

 

 

 

 

 

 

 

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. See “Item 1A. Risk Factors” and the “Forward-Looking Statements” section therein 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.

 

As previously disclosed in our 2009 Annual Report on Form 10-K and our 2010 Quarterly Reports on Form 10-Q, we reorganized our divisional operations by combining the former Flowserve Pump Division and former Flow Solutions Division into Flow Solutions Group (“FSG”), effective January 1, 2010. FSG has been divided into two reportable segments based on type of product and how we manage the business: FSG Engineered Product Division (“EPD”) and FSG Industrial Product Division (“IPD”). Flow Control Division (“FCD”) was not affected. We have retrospectively adjusted prior period financial information to reflect our current reporting structure.

 

Our operations are conducted through three business segments that are referenced throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”):

 

 

The reputation of 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, procurement 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. We continue to devote resources to improving 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 sales across our global operations, through the assistance of a focused Continuous Improvement Process (“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 improved demand for original equipment in 2010 as compared with 2009. As the effects from the global recession began to diminish, several demand forecasts improved, which promoted increased capital investment spending and planning. The oil and gas industry saw improved conditions as the developing regions’ economic growth plans rekindled projections of demand growth for oil and natural gas. Pipeline and refining investments were driven by infrastructure expansion plans in these growing regions. The developing regions also experienced improved conditions in the investment in chemical processing and power generation. In the mature regions, all three of these industries experienced a moderate level of investment. In the area of power generation, uncertainty over environmental regulations challenged spending levels, while overcapacity in oil refining affected capital investments. The water management industry displayed stability in its spending levels, as investments in this market persist in varying economic conditions.

 

In 2010, we experienced improved demand in our global aftermarket business as compared with 2009. This was driven by our customers’ need to maintain continuing operations across several industries and the expansion of our aftermarket capabilities provided through our new integrated solutions offerings. Customers’ desire to gain operational efficiencies and increase throughput from existing facilities provided opportunities to leverage our engineering knowledge and technological capabilities to design solutions that produce the desired business result. A critical component of our growth strategy remains our investment in expanding our aftermarket capabilities to provide local support to maximize our customers’ investment in our offerings, as well as to provide business stability during various economic periods. In 2010, we continued to execute on our strategy to increase our presence in all regions of the global market to capture 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 multi-national presence, such as economic, political, currency and other risks.

 

Our Markets

 

The following discussion should be read in conjunction with the “Outlook for 2011” 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 management, 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, procurement and construction firms, original equipment manufacturers, end users and distributors. Sales to engineering, procurement and construction firms 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 original equipment, which requires maintenance, repair and replacement parts. We use our manufacturing platform and global 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 42% and 36% of our bookings in 2010 and 2009, respectively, experienced increased capital spending activity compared to the previous year due to improved demand outlook and the need to start the infrastructure build in order to bring future capacity on line in time. The majority of investment by the major oil companies was focused on the upstream production activities; however, there were improved levels of spending in both mid-stream pipeline and downstream refining operations particularly in the developing markets. Refining overcapacity remained a concern throughout the year in the mature regions as overall demand for oil fell in these regions. Aftermarket opportunities in this industry remained stable throughout the year. Opportunities presented by our integrated solutions offering helped to offset a reduction in service related business as many refineries performed this work with their own personnel.

 

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. With our long standing reputation in providing successful solutions for upstream, mid-stream and downstream applications, along with the advancements in our portfolio of offerings, we believe that we continue to be well positioned to pursue the opportunities in this industry around the globe.

 

Chemical

 

The chemical industry represented approximately 16% and 18% of our bookings in 2010 and 2009, respectively. This industry continued to experience challenges relative to capital investment due to the persistent uncertainty around the global economies and lingering recessionary effects in the mature regions. Projected demand growth and economic growth plans within the developing regions supported capital investment for capacity expansion and improvements, although the level of spending remained low compared to previous years. Agriculture was a leading driver of global chemical investment as the population of developing economies required greater food supply increasing the long-term need for fertilizer based products. The aftermarket opportunities remained stable for the majority of the year with signs of improvement in the latter part of the year.

 

The outlook for the chemical industry remains heavily dependent on global economic conditions. As global economies stabilize and unemployment conditions improve, a rise in consumer spending should follow. An increase in spending will drive greater demand for chemical based products supporting improved levels of capital investment. 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.

 

Power Generation

 

The power generation industry represented approximately 17% and 20% of our bookings in 2010 and 2009, respectively. The power industry continued to experience some softness in capital spending in the mature regions driven by the uncertainty related to environmental regulations. In the developing regions, capital investment remained in place driven by increased demand forecasts for electricity in countries such as China and India. Global concerns about the environment continue to support an increase in desired future capacity from renewable and nuclear power. The majority of the active and planned construction throughout the year continued to utilize designs based on fossil fuels. Natural gas increased its percentage of utilization driven by market prices for gas remaining low and relatively stable. With the potential of unconventional sources of gas, such as shale gas, the power industry is forecasting an increased use of this form of fuel for generating plants.

 

We believe the outlook for the power generation industry remains favorable. 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 5% and 7% of our bookings in 2010 and 2009, 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.

 

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 2010 and 2009. General industries also include sales to distributors, whose end customers operate in the industries we primarily serve. General industries represented, in the aggregate, approximately 20% and 19% of our bookings in 2010 and 2009, respectively.

 

In 2010, we saw improving conditions in the majority of these businesses. Pulp and paper, mining and ore processing, as well as food and beverage, all saw improved conditions compared to 2009. This was generally supported by the improving economic conditions in several parts of the world. We also experienced increased business levels through our distribution network as business conditions improved and inventory levels required replenishment.

The outlook for this group of industries is heavily dependent upon the condition of global economies and the level of consumer confidence. The long-term fundamentals of many of these industries remain sound as many of the products produced by these industries are common staples of industrialized and urbanized economies. We believe that our specialty product offerings designed for these industries and our aftermarket service capabilities will provide future business opportunities.

 

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 2 to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the year ended December 31, 2010 (“Annual Report”), we acquired for inclusion in FCD, Valbart Srl (“Valbart”), a privately-owned Italian valve manufacturer, effective July 16, 2010. Valbart’s results of operations have been consolidated since the date of acquisition. We acquired for inclusion in EPD, Calder AG (“Calder”), a Swiss supplier of energy recovery technology, effective April 21, 2009. Calder’s results of operations have been consolidated since the date of acquisition. No pro forma information has been provided for either acquisition due to immateriality.

 

As discussed in Note 7 to our consolidated financial statements included in Item 8 of this Annual Report, beginning in 2009, we initiated realignment programs 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, as well as expanding our efforts to optimize assets, responding to reduced orders and driving an enhanced customer-facing organization (“Realignment Programs”). To date, we have incurred charges related to our Realignment Programs of $86.4 million, including $18.3 million in 2010 and $68.1 million in 2009. We expect to incur approximately $5 million of additional charges for total expected Realignment Programs charges of approximately $91 million for approved plans.

 

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 statements of income.

 

Charges are presented net of adjustments relating to changes in estimates of previously recorded amounts. Net adjustments recorded in 2010 were $5.8 million.

The following is a summary of our charges, net of adjustments, included in operating income in 2010 related to our Realignment Programs:

 

 

The following is a summary of our charges, net of adjustments, included in operating income in 2009 related to our Realignment Programs:

 

The following is a summary of total charges, net of adjustments, related to identified initiatives under our Realignment Programs expected to be incurred:

 

 

 

 

Based on actions under our Realignment Programs, we have realized savings of approximately $93 million for the year ended December 31, 2010. Upon completion of our Realignment Programs, we expect run rate cost savings of approximately $115 million. Approximately two-thirds of the savings from the Realignment Programs were and will be realized in COS and the remainder in SG&A. 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 and $6.1 million were recorded during the years ended December 31, 2010 and 2009, respectively.

 

The following discussion should be read in conjunction with the “Outlook for 2011” section included in this MD&A.

 

Bookings and Backlog

 

 

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 2010 increased by $343.6 million, or 8.8%, as compared with 2009. The increase included negative currency effects of approximately $12 million. The overall net increase was primarily attributable to increased original equipment and aftermarket bookings in EPD, principally in the oil and gas industry, including the impact of an order in excess of $80 million for crude oil pumps, seals and related support services received in the second quarter of 2010. The increase is also attributed to higher bookings in FCD, driven by the oil and gas and general industries. These increases were partially

offset by the impact of orders of more than $45 million to supply valves to four Westinghouse Electric Co. nuclear power units booked in 2009 that did not recur and decreased original equipment bookings in IPD.

 

Bookings in 2009 decreased by $1,220.4 million, or 23.9%, as compared with 2008. The decrease included negative currency effects of approximately $216 million. These decreases were 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 consisted of declines in original equipment bookings in EPD and IPD, including the impacts of the $85 million Abu Dhabi Crude Oil Pipeline order and the $110.9 million of thruster orders, respectively, that were recorded in 2008 and did not recur. The decrease was 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.

 

Backlog represents the accumulation of uncompleted customer orders. Backlog of $2.6 billion at December 31, 2010 increased by $223.5 million, or 9.4%, as compared to December 31, 2009. Currency effects provided a decrease of approximately $51 million (currency effects on backlog are calculated using the change in period end exchange rates). The overall net increase included the impact of cancellations of $18.1 million of orders booked in prior years. By the end of 2011, we expect to ship 82% of our December 31, 2010 backlog. 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. The overall net decrease included the impact of cancellations in 2009 of $41.2 million of orders booked in prior years.

 

Sales

 

 

Sales in 2010 decreased by $333.3 million, or 7.6%, as compared with 2009. The decrease included negative currency effects of approximately $32 million. The decrease was primarily attributable to decreased original equipment orders across all divisions, primarily driven by lower beginning backlog in the oil and gas and general industries for 2010, as compared with 2009, reflecting lower demand and customer-driven project delays due to a significant decrease in the rate of general global economic growth in 2009. These decreases were slightly offset by increased aftermarket sales in EPD, driven by Latin America and Asia Pacific, and in FCD by sales provided by Valbart of $38.3 million. Aftermarket sales increased to approximately 39% of total sales in 2010 as compared with 36% in 2009.

 

Sales in 2009 decreased by $108.2 million, or 2.4%, as compared with 2008. The decrease included negative currency effects of approximately $208 million. The overall net decrease was attributable to decreased chemical and general industries sales, decreased sales to distributors in FCD and decreased aftermarket sales by EPD. These decreases were mostly offset by increased original equipment sales in EPD, 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 to international customers, including export sales from the United States (“U.S.”), were approximately 73% of sales in 2010 compared with 73% of sales in 2009 and 69% of sales in 2008. Sales to Europe, the Middle East and Africa (“EMA”) were approximately 40%, 40% and 39% of total sales in 2010, 2009 and 2008, respectively. Sales into the Asia Pacific region were approximately 18%, 20% and 18% of total sales in 2010, 2009 and 2008, respectively. Sales to Latin America were approximately 10%, 9% and 8% of total sales in 2010, 2009 and 2008, respectively.

Gross Profit and Gross Profit Margin

 

 

Gross profit in 2010 decreased by $138.4 million, or 8.9%, as compared with 2009. The decrease included the effect of approximately $37 million in increased savings realized and a decrease of $27.0 million in charges resulting from our Realignment Programs as compared with 2009. Gross profit margin in 2010 of 35.0% decreased from 35.5% in 2009. The decrease was primarily attributable to less favorable pricing from beginning of year backlog in EPD and IPD as compared with 2009 and the negative impact of decreased sales on our absorption of fixed manufacturing costs, the effects of which were partially offset by a sales mix shift toward higher margin aftermarket sales in EPD and IPD, increased utilization of low-cost regions by FCD, positive impacts of our Realignment Programs and various CIP initiatives. Aftermarket sales generally carry a higher margin than original equipment sales. Aftermarket sales increased to approximately 39% of total sales in 2010, as compared with approximately 36% of total sales in 2009.

 

Gross profit in 2009 decreased by $32.2 million, or 2.0%, as compared with 2008. The decrease included 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 EPD and FCD in 2008 and shipped in 2009, increased utilization of low-cost regions by FCD and EPD, various CIP initiatives and savings realized from our Realignment Programs were offset by a sales mix shift toward lower margin original equipment in EPD and IPD. Original equipment generally carries a lower margin than aftermarket. The sales of specialty pumps, which carry a higher margin, by EPD contributed to higher gross profit margins in 2009.

 

Selling, General and Administrative Expense (“SG&A”)

 

 

SG&A in 2010 decreased by $89.5 million, or 9.6%, as compared with 2009. Currency effects yielded a decrease of approximately $2 million. The decrease included the effect of approximately $23 million in increased savings realized and a decrease of $22.8 million in charges resulting from our Realignment Programs as compared with 2009. The decrease was primarily attributable to positive impacts from our Realignment Programs, decreased selling and marketing-related expenses, strict cost control actions in 2010 and legal fees and accrued resolution costs in 2009 related to shareholder class action litigation (which was resolved in the second quarter of 2010) that did not recur, partially offset by cash recoveries of bad debt and the adjustment of contingent consideration in 2009 noted below that did not recur. SG&A as a percentage of sales in 2010 improved 40 basis points as compared with 2009.

 

SG&A in 2009 decreased by $47.1 million, or 4.8%, as compared with 2008. SG&A included 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 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 (see Note 2 to our consolidated financial statements included in Item 8 of this Annual Report), strict cost control actions and savings realized from our Realignment Programs were partially offset by an increase in legal fees and accrued resolution costs related to now-resolved shareholder class action litigation 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.

Net Earnings from Affiliates

 

 

Net earnings from affiliates represents our net income from investments in seven joint ventures (one located in each of China, Japan, Saudi Arabia, South Korea 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 2010 increased by $0.8 million, or 5.1%, as compared with 2009, primarily due to increased earnings of our EPD joint ventures in South Korea and India, partially offset by decreased earnings of our FCD joint venture in India and our EPD joint venture in Japan. 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 Worthington Company, Ltd. (“Niigata”) in the first quarter of 2008 when we purchased the remaining 50% interest.

 

Operating Income

 

 

Operating income in 2010 decreased by $48.1 million, or 7.6% as compared with 2009. Operating income included the effect of approximately $60 million in increased savings realized and a decrease of $49.8 million in charges resulting from our Realignment Programs as compared with 2009, and included negative currency effects of approximately $4 million. The overall net decrease was primarily a result of the $138.4 million decrease in gross profit, which was partially offset by the $89.5 million decrease in SG&A, as discussed above.

 

Operating income in 2009 increased by $13.8 million, or 2.2%, as compared with 2008. The increase included the effect of $68.1 million in charges from our Realignment Programs in 2009, mostly offset by savings realized from our Realignment Programs. The increase included 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.

 

Interest Expense and Interest Income

 

 

Interest expense in 2010 decreased by $5.7 million as compared with 2009 primarily as a result of decreased interest rates. Interest expense decreased by $11.3 million in 2009 as compared with 2008, primarily as a result of decreased interest rates. At December 31, 2010, approximately 68% of our debt was at fixed rates, including the effects of $350.0 million of notional interest rate swaps.

 

Interest income in 2010 decreased by $1.6 million as compared with 2009 due primarily to decreased interest rates. Interest income in 2009 decreased by $5.2 million as compared with 2008 due to decreased interest rates.

 

Other (Expense) Income, net

 

 

Other (expense) income, net in 2010 increased $10.3 million, or 128.8%, to expense of $18.3 million, as compared with 2009, primarily due to a $13.9 million increase in losses on forward exchange contracts and a $4.8 million increase in losses arising from transactions in currencies other than our sites’ functional currencies. Both of the above-mentioned changes primarily reflected the strengthening of the U.S. dollar exchange rate versus

the Euro. Also included in the increase in losses arising from transactions in currencies other than our site’s functional currencies is the impact of the $12.4 million loss during the first quarter of 2010 as a result of Venezuela’s devaluation of the Bolivar, partially offset by realized foreign currency exchange gains of $4.8 million related to the settlement of U.S. dollar denominated liabilities at the more favorable essential items rate of 2.60 Bolivars to the U.S. dollar. See Note 1 to our consolidated financial statements included in Item 8 of this Annual Report for additional details on the impact of Venezuela’s currency devaluation. In addition, we expensed $1.6 million in loan costs associated with the refinancing of our credit facilities in the fourth quarter of 2010. The above losses were partially offset by miscellaneous gains and income, the largest of which was a $3.1 million gain on the sale of an investment in a joint venture in 2010 that was accounted for under the cost method.

 

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 a $2.8 million gain in 2008 on the bargain purchase of the remaining 50% interest in Niigata, as discussed in Note 2 to our consolidated financial statements included in Item 8 of this Annual Report, that did not recur.

 

Tax Expense and Tax Rate

 

 

The 2010 and 2009 effective tax rates differed from the federal statutory rate of 35% primarily due to the net impact of foreign operations, which included 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 included 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%.

 

We have operations in certain 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, had been subject to U.S. taxation. This exclusion is effective for the years 2006 through 2011, and applies 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, 2010 we have foreign tax credits of $29.5 million, expiring in 2018 through 2020 against which we recorded no valuation allowances. Additionally, we have recorded other U.S. net deferred tax assets of $47.9 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 increase.

Net Earnings and Earnings Per Share

 

 

Net earnings in 2010 decreased by $39.6 million to $388.3 million, or $6.88 per diluted share, as compared with 2009. The decrease was primarily attributable to $48.1 million decrease in operating income and a $10.3 million increase in other (expense) income, net, partially offset by a $5.7 million decrease in interest expense, as discussed above, and a $14.9 million decrease in tax expense.

 

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) income, net 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.

 

Other Comprehensive (Expense) Income

 

 

Other comprehensive (expense) income in 2010 decreased by $64.4 million to expense of $1.4 million, primarily reflecting the strengthening of the U.S. dollar exchange rate versus the Euro at December 31, 2010 as compared with December 31, 2009, partially offset by a further decrease in pension and other postretirement expense in 2010.

 

Other comprehensive (expense) income 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 interest rate hedging activity.

 

Business Segments

 

We conduct our operations through three business segments based on type of product and how we manage the business. We evaluate segment performance and allocate resources based on each segment’s operating income. See Note 17 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, EPD, IPD and FCD, are discussed below.

 

FSG Engineered Product Division Segment Results

 

Our largest business segment is EPD, through which we design, manufacture, distribute and service engineered pumps and pump systems, mechanical seals, auxiliary systems and provide related services (collectively referred to as “original equipment”). EPD includes longer lead-time, highly engineered pump products and mechanical seals. EPD also manufactures replacement parts and related equipment and provides a full array of replacement parts, repair and support services (collectively referred to as “aftermarket”). EPD primarily operates in the oil and gas, petrochemical and power generation industries. EPD operates in 39 countries with 26 manufacturing facilities

worldwide, nine of which are located in Europe, nine in North America, four in Asia and four in Latin America, and it has 117 service centers, including those co-located in manufacturing facilities.

 

 

Bookings in 2010 increased by $266.0 million, or 13.5%, as compared with 2009. The increase included currency benefits of approximately $13 million. The increase in bookings reflects higher demand for our products in the oil and gas and general industries across all regions, including the impact of an order in excess of $80 million for crude oil pumps, seals and related support services received in the second quarter of 2010. Customer bookings increased $114.9 million (including currency benefits of approximately $13 million) in Latin America, $78.2 million in North America (including currency benefits of approximately $8 million), $63.4 million (including negative currency effects of approximately $26 million) in EMA and $23.8 million (including currency benefits of approximately $18 million) in Asia Pacific. These increases were attributable to original equipment and aftermarket bookings on major projects in the oil and gas, general, mining, power generation and chemical industries, partially offset by decreased bookings in the water management industry and decreased aftermarket bookings in EMA. Of the $2.2 billion of bookings in 2010, approximately 54% were from oil and gas, 19% from power generation, 12% from chemical, 1% from water management and 14% from general industries. Interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) increased $12.4 million.

 

Bookings in 2009 decreased by $647.5 million, or 24.7%, as compared with 2008. The decrease included negative currency effects of approximately $113 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 consisted of declines in original equipment bookings on major projects, which were driven by declines in the oil and gas, general, mining and water management industries, and included the impact of the $85 million order to supply a variety of pumps to build the Abu Dhabi Crude Oil Pipeline, which was booked in 2008 and did not recur. Customer bookings decreased $282.0 million (including negative currency effects of approximately $61 million) in EMA, $249.0 million in North America and $127.4 million (including negative currency effects of approximately $41 million) Latin America. Interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) increased $25.4 million. Of the $2.0 billion of bookings in 2009, approximately 49% were from oil and gas, 22% from power generation, 13% from chemical, 4% water management and 12% from general industries.

 

Sales in 2010 decreased $163.6 million, or 7.1%, as compared with 2009. The decrease included negative currency effects of approximately $4 million. Customer sales decreased in EMA by $131.3 million (including negative currency effects of approximately $43 million) and North America by $79.8 million (including currency benefits of approximately $8 million), primarily driven by original equipment sales. These decreases were partially offset by increases of customer sales in Latin America of $32.5 million (including currency benefits of $14 million) and Asia Pacific of $10.2 million (including currency benefits of approximately $17 million), primarily driven by increased aftermarket sales. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) decreased $1.4 million.

 

Sales in 2009 increased by $64.1 million, or 2.9%, as compared with 2008. The increase included negative currency effects of approximately $102 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 in original equipment sales in 2009 as compared with 2008. Customer sales increased $82.8 million (including negative currency effects of approximately $58 million) in

EMA, $28.4 million (including negative currency effects of approximately $2 million) in Asia Pacific and $3.7 million (including negative currency effects of approximately $39 million) in Latin America. These increases were partially offset by a decrease in North America of $53.3 million, which was attributable to a decline in aftermarket customer sales, primarily in the chemical and general industries. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) decreased $0.3 million.

 

Gross profit in 2010 decreased by $60.6 million, or 7.2%, as compared with 2009. Gross profit margin in 2010 of 36.4% was comparable with the same period in 2009. Gross profit margin was negatively impacted by less favorable pricing from beginning of year backlog as compared with 2009 and the negative impact of decreased sales on our absorption of fixed manufacturing costs. The decrease in gross profit margin was mostly offset by a sales mix shift towards higher margin aftermarket sales, increased savings realized and decreased charges resulting from our Realignment Programs as compared with 2009, as well as operational efficiencies and savings realized from our supply chain initiatives.

 

Gross profit in 2009 increased by $31.7 million, or 3.9%, as compared with 2008. The increase included the effect of $24.3 million in charges resulting from our Realignment Programs in 2009. Gross profit margin in 2009 of 36.4% increased from 36.0% 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 Realignment Programs were partially offset by a sales mix shift toward original equipment. Original equipment generally carries a lower margin than aftermarket. 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.

 

Operating income in 2010 decreased by $22.2 million, or 5.1%, as compared with 2009. The decrease included negative currency effects of less than $1 million. The overall net decrease was due primarily to reduced gross profit of $60.6 million, as discussed above, partially offset by decreased SG&A of $36.0 million, which was due to increased savings realized and a decrease in charges resulting from our Realignment Programs as compared with 2009, decreased selling and marketing-related expenses and strict cost control actions in 2010. Additionally, the $4.4 million benefit from the adjustment of contingent consideration in 2009 related to the acquisition of Calder, discussed below, did not recur.

 

Operating income in 2009 increased by $33.0 million, or 8.2%, as compared with 2008. Operating income included the effect of $42.4 million in charges resulting from our Realignment Programs in 2009. The overall net increase included negative currency effects of approximately $31 million. The increase was due primarily to increased gross profit of $31.7 million, which included the effect of savings realized from our Realignment Programs, as discussed above, partially offset by an increase in SG&A. The increase in SG&A was 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 (see Note 2 to our consolidated financial statements included in Item 8 of this Annual Report) and savings realized from our Realignment Programs.

 

Backlog of $1.4 billion at December 31, 2010 increased by $53.4 million, or 3.9%, as compared to December 31, 2009. Currency effects provided a decrease of approximately $14 million. The overall net increase included the impact of cancellations of $9.8 million of orders booked during the prior years. Backlog of $1.4 billion at December 31, 2010 included $25.5 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above). Backlog of $1.4 billion at December 31, 2009 decreased by $343.7 million, or 19.9%, as compared to December 31, 2008. Currency effects provided an increase of approximately $48 million. Backlog at December 31, 2009 includes $29.9 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above). The overall net decrease included the impact of cancellations of $36.4 million of orders booked in prior years. The acquisition of Calder in April 2009 resulted in a $6.2 million increase in backlog.

 

FSG Industrial Product Division Segment Results

 

Through IPD we design, manufacture, distribute and service pre-configured pumps and pump systems, including submersible motors (collectively referred to as “original equipment”). Additionally, IPD manufactures

replacement parts and related equipment, and provides a full array of support services (collectively referred to as “aftermarket”). IPD includes standardized, general purpose pump products and primarily operates in the oil and gas, chemical, water management, power generation and general industries. IPD operates 13 manufacturing facilities, three of which are located in the U.S and six in Europe, and it operates 21 QRCs worldwide, including 11 sites in Europe and four in the U.S., including those co-located in manufacturing facilities.

 

 

Bookings in 2010 increased by $4.4 million, or 0.5%, as compared with 2009. The increase includes negative currency effects of approximately $11 million. The overall net increase was primarily driven by an increase in customer bookings of $57.1 million in the Americas and an increase in interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) of $20.2 million, mostly offset by decreased customer bookings of $74.3 million in EMA and Australia. The overall net decrease in customer bookings was primarily driven by decreased orders of original equipment in the power generation, mining and chemical industries, partially offset by increased customer bookings in the oil and gas markets, primarily in Europe. Of the $827.5 million of bookings in 2010, approximately 31% were from oil and gas, 21% from water management, 10% from chemical, 9% from power generation and 29% from general industries.

 

Bookings in 2009 decreased by $317.8 million, or 27.9%, as compared with 2008. This decrease included negative currency effects of approximately $50 million. The decrease in bookings reflects lower demand due to a significant decrease in the rate of general global economic growth as compared with 2008. The $310.7 million decrease in customer bookings was due to decreases in both original equipment and aftermarket customer bookings, driven by the oil and gas, chemical, water management and general industries and included the impact of $110.9 million in thruster orders that were recorded in the same period in 2008 that did not recur. The decrease was driven by declines in customer bookings of $236.6 million in EMA and Australia and $77.1 million in the Americas. A decrease in interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) accounted for the remaining decrease of $7.1 million. Of the $823.1 million of customer bookings in 2009, approximately 29% were from oil and gas, 20% from water management, 14% from power generation, 11% from chemical and 26% from general industries.

 

Sales in 2010 decreased by $170.8 million, or 17.6%, as compared with 2009. The decrease included negative currency effects of approximately $9 million. The decreases in customer sales was primarily attributable to a decline in sales of $133.0 million in EMA and Australia and $30.5 million in the Americas. The declines, primarily in the power generation, mining and chemical industries, were attributable to lower backlog as compared with 2009 and included the impact of thruster sales for orders booked in 2008 that did not recur in 2010. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) decreased $6.3 million.

 

Sales in 2009 increased by $14.3 million, or 1.5%, as compared with 2008. The increase included negative currency effects of approximately $48 million. The overall net increase was driven by an increase of customer sales of original equipment in EMA and Australia, and an increase of $8.3 million in interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above). These decreases were partially offset by decreased original equipment and aftermarket customer sales in the Americas.

 

Gross profit in 2010 decreased by $57.8 million, or 22.0%, as compared with 2009. Gross profit margin in 2010 of 25.6% decreased from 27.0% in 2009. The decrease was primarily attributable to the negative impact of decreased sales on our absorption of fixed manufacturing costs and less favorable pricing from backlog as compared

with 2009, partially offset by a sales mix shift toward more profitable aftermarket sales and increased savings realized and lower charges resulting from our Realignment Programs as compared with the same period in 2009.

 

Gross profit in 2009 decreased by $12.5 million, or 4.6%, as compared with 2008. The decrease included the effect of $9.0 million in charges resulting from our Realignment Programs in 2009. Gross profit margin in 2009 of 27.0% decreased from 28.7% in 2008. Charges related to our Realignment Programs and a sales mix shift toward less profitable original equipment sales were partially offset by savings realized from our Realignment Programs, strict cost control actions and increased utilization of low-cost regions.

 

Operating income for 2010 decreased by $39.4 million, or 36.5%, as compared with 2009. The decrease included negative currency effects of approximately $3 million. The decrease is due to the $57.8 million decrease in gross profit discussed above, partially offset by an $18.4 million decrease in SG&A. The decrease in SG&A is due to decreased selling-related expenses, strict cost control actions in 2010 and increased savings realized and lower charges resulting from our Realignment Programs as compared with 2009.

 

Operating income in 2009 decreased by $9.2 million, or 7.9%, as compared with 2008. The decrease included the effect of $11.3 million in charges resulting from our Realignment Programs. The decrease included negative currency effects of approximately $7 million. The decrease is due to the $12.5 million decrease in gross profit discussed above, partially offset by a $3.3 million decrease in SG&A. The decrease in SG&A was due to strict cost control actions in 2009 and savings realized from our Realignment Programs in 2009.

 

Backlog of $568.0 million at December 31, 2010 increased by $12.4 million, or 2.2%, as compared to December 31, 2009. Currency effects provided a decrease of approximately $24 million. Backlog at December 31, 2010 included $38.5 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above). Backlog of $555.6 million at December 31, 2009 decreased by $123.7 million, or 18.2%, as compared to December 31, 2008. Currency effects provided an increase of approximately $30 million. Backlog at December 31, 2009 included $19.8 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above).

 

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 configured-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 54 manufacturing facilities and QRCs in 23 countries around the world, with only five of its 25 manufacturing operations located in the U.S. Based on independent industry sources, we believe that we are the fourth largest industrial valve supplier on a global basis.

 

 

As discussed in Note 2 to our consolidated financial statements included in Item 8 of this Annual Report, we acquired for inclusion in FCD, Valbart, a privately-owned Italian valve manufacturer, effective July 16, 2010. Valbart’s results of operations have been consolidated since the date of acquisition and are included in FCD’s segment results of operations above. No pro forma information has been provided for the acquisition due to immateriality. The impact of the acquisition of Valbart on FCD’s results of operations for the year ended December 31, 2010 includes bookings of $54.6 million, sales of $38.3 million, gross profit (loss) of $(0.9) million,

operating loss of $12.4 million (including acquisition-related costs of $2.7 million) and period end backlog of $94.8 million. The gross profit (loss) margin of (2.3%) and operating loss primarily resulted from the negative impact of low margins on acquired backlog, acquisition-related costs, certain integration costs and amortization of assets acquired at fair value (“Purchase Accounting Adjustments”). We do not expect these losses to continue as we work to fully integrate Valbart’s operations.

 

Bookings in 2010 increased $108.3 million, or 9.0% as compared with 2009. The increase included negative currency effects of approximately $14 million. The overall net increase in bookings was attributable to bookings provided by Valbart of $54.6 million, strength in the oil and gas industry, primarily in EMA and North America, increased bookings in general industries, driven by growth in the district heating market in Russia, and growing aftermarket repair and replacement orders. Inventory restocking orders from distributors were a key driver in the North American market recovery. Increased bookings were partially offset by decreases in the power generation industry, driven by orders of more than $45 million to supply valves to four Westinghouse Electric Co. nuclear power units booked in the same period in 2009 that did not recur, and customer-driven large project delays in the chemical and oil and gas industries. Of the $1.3 billion of bookings in 2010, approximately 27% were from oil and gas, 27% from chemical, 26% from general industries 18% from power generation and 2% from water management.

 

Bookings in 2009 decreased by $288.1 million, or 19.4%, as compared with 2008. The decrease included negative currency effects of approximately $53 million. The decrease in bookings was 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. The chemical industry represented 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.

 

Sales in 2010 decreased $5.7 million, or 0.5%, as compared with 2009. The decrease included negative currency effects of approximately $19 million. A decrease in sales in EMA of approximately $27 million, which included the impact of sales provided by Valbart of $38.3 million, was primarily driven by a decline in sales in the chemical industry, as well as customer-driven delays in large projects in the oil and gas industry. This decrease was partially offset by an increase in sales of approximately $17 million in Asia Pacific, primarily driven by the nuclear and fossil power markets in China.

 

Sales in 2009 decreased by $178.5 million, or 12.9%, as compared with 2008. This decrease included 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. During 2009, the drivers of the decline in sales were consistent with the drivers of the decline in bookings discussed above.

 

Gross profit in 2010 decreased by $22.9 million, or 5.1% as compared with 2009. Gross profit margin in 2010 of 35.3% decreased from 37.0% for the same period in 2009. The decrease is primarily attributable to the negative impact of low margins on acquired Valbart backlog, as well as decreased sales on our absorption of fixed manufacturing costs, partially offset by favorable product mix and increased savings realized and decreased charges resulting from our Realignment Programs as compared with 2009, as well as various CIP initiatives and improved utilization of low-cost regions.

Gross profit in 2009 decreased by $52.5 million, or 10.5%, as compared with 2008. The decrease included 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 was 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 Realignment Programs. These improvements were partially offset by pricing pressure and the negative impact of decreased sales on absorption of fixed manufacturing costs.

 

Operating income in 2010 decreased by $23.7 million, or 11.6%, as compared with 2009. The decrease included negative currency effects of approximately $1 million. The decrease was principally attributable to the $22.9 million decrease in gross profit discussed above, partially offset by a $0.8 million decrease in SG&A. Decreased SG&A is attributable to decreased selling and marketing-related expenses and increased savings realized and decreased charges resulting from our Realignment Programs as compared with 2009, partially offset by $5.0 million in bad debt recoveries from the same period in 2009 that did not recur and $2.7 million in Valbart acquisition-related costs. Valbart provided a net operating loss of $12.4 million, including the impact of acquisition-related costs.

 

Operating income in 2009 decreased by $14.6 million, or 6.7% as compared with 2008. The decrease included the effect of $11.5 million in charges resulting from our Realignment Programs in 2009. The decrease included negative currency effects of approximately $10 million. The decrease was attributable to the $52.5 million decrease in gross profit, which included the effect of savings realized from our 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 Realignment Programs in 2009.

 

Backlog of $658.5 million at December 31, 2010 increased by $173.2 million, or 35.7% as compared to December 31, 2009. Currency effects provided a decrease of approximately $13 million. The overall net increase included backlog related to the acquisition of Valbart of $94.8 million. Backlog of $485.3 million at December 31, 2009 was comparable to December 31, 2008. Currency effects provided an increase of approximately $9 million.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash Flow Analysis

 

 

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, 2010 was $557.6 million, compared with $654.3 million at December 31, 2009 and $472.1 million at December 31, 2008.

 

Working capital increased in 2010 due primarily to lower accrued liabilities of $125.6 million resulting primarily from reductions in accruals for long-term and broad-based annual incentive program payments, higher inventory of $52.9 million and higher accounts receivable of $52.0 million, partially offset by higher accounts payable of $70.7 million. During 2010, we contributed $33.4 million to our U.S. pension plan. 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.

Our goal for days’ sales receivables outstanding (“DSO”) is 60 days. For the fourth quarter of 2010, our DSO was 66 days as compared with 59 days and 62 days for the same periods in 2009 and 2008, respectively. For reference purposes based on 2010 sales, a DSO improvement of one day could provide approximately $13 million in cash. An increase in inventory used $52.9 million of cash flow for 2010 compared with providing cash of $74.7 million in 2009 and using cash of $195.5 million in 2008. Inventory turns were 3.4 times at December 31, 2010, compared with 4.0 times at December 31, 2009 and 3.6 times at December 31, 2008. For reference purposes based on 2010 data, an improvement of one turn could yield approximately $201 million in cash.

 

Cash outflows for investing activities were $286.7 million, $138.6 million and $119.6 million in 2010, 2009 and 2008, respectively, due primarily to capital expenditures and cash paid for acquisitions. Cash outflows for 2010 also included $199.4 million for the acquisition of Valbart, as discussed below in “Payments for Acquisitions.” Capital expenditures during 2010 were $102.0 million, a decrease of $6.4 million as compared with 2009. 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 $142.9 million in 2010 compared with $107.1 million in 2009 and $185.5 million in 2008. Cash outflows during 2010 resulted primarily from the payment of $63.6 million in dividends, $46.0 million for the repurchase of common shares and approximately $40 million to liquidate debt in completing a new credit agreement in December 2010 (discussed below under “Credit Facilities”). 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.

 

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. On February 21, 2011, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.29 per share to $0.32 per share payable quarterly beginning on April 14, 2011. 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 450,000, 544,500 and 1,741,100 shares for $46.0 million, $40.9 million and $165.0 million during 2010, 2009 and 2008, respectively. To date, we have repurchased a total of 2,735,600 shares for $251.9 million under this program.

 

Our cash needs for the next 12 months are expected to be in line with 2010, resulting from an expected decrease in pension contributions, a small decrease in incentive compensation payments, along with 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 credit agreements are also sufficient to meet our cash flow needs for periods beyond the next 12 months.

 

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 2 to our consolidated financial statements included in Item 8 of this Annual Report, effective July 16, 2010, we acquired for inclusion in FCD, 100% of Valbart, a privately-owned Italian valve manufacturer, in a share purchase for cash of $199.4 million, which included $33.8 million of existing Valbart net debt (defined as Valbart’s third party debt less cash on hand) that was repaid at closing. Valbart manufactures trunnion-mounted ball valves used primarily in upstream and midstream oil and gas applications, which enables us to offer a more complete valve product portfolio to our oil and gas project customers. The acquisition included Valbart’s portion of the joint venture with us that we entered into in December 2009 that was not operational during 2010. Under the terms of the purchase agreement, we deposited $5.8 million into escrow to be held and applied against any breach of representations, warranties or indemnities for 30 months. At the expiration of the escrow period, any residual amounts will be released to the sellers in satisfaction of the purchase price. Effective April 21, 2009, we acquired for inclusion in EPD, Calder, a private Swiss company and a supplier of energy recovery technology for use in the global desalination market, for $30.8 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 for inclusion in EPD the remaining 50% interest in Niigata, effective March 1, 2008, for $2.4 million in cash.

 

Financing

 

Debt, including capital lease obligations, consisted of:

 

 

Credit Facilities

 

On December 14, 2010 (the “Closing Date”), we entered into a new credit agreement (“Credit Agreement”) with Bank of America, N.A., as swingline lender, letter of credit issuer and administrative agent, and the other lenders party thereto (together, the “Lenders”), for term debt (“New Term Loan”) and a revolving credit facility (“New Revolving Credit Facility”). The Credit Agreement provides for an aggregate commitment of $1.0 billion, including a $500.0 million New Term Loan facility with a maturity date of December 14, 2015 and a $500.0 million New Revolving Credit Facility with a maturity date of December 14, 2015 (collectively referred to as “New Credit Facilities”). The New Revolving Credit Facility includes a $300.0 million sublimit for the issuance of letters of credit. Subject to certain conditions, we have the right to increase the amount of the New Revolving Credit Facility by an aggregate amount not to exceed $200.0 million.

 

We used all of the proceeds advanced under the New Term Loan, along with approximately $40 million of cash on hand, to repay all outstanding indebtedness under our then-existing credit agreement dated as of August 12, 2005, as amended, which included a $600.0 million term loan (“Old Term Loan”) and a $400.0 million revolving line of credit (collectively referred to as the “Old Credit Agreement”). In connection with this repayment, our outstanding letters of credit under the Old Credit Agreement were transferred to the New Revolving Credit Facility, and we terminated the Old Credit Agreement on the Closing Date. The proceeds of the Credit Agreement will be used to fund capital expenditures and other working capital needs. Future draws under the New Revolving Credit Facility are subject to various conditions, including the existence of no default under the Credit Agreement.

 

We incurred $11.6 million in fees related to the Credit Agreement. Prior to the refinancing, we had $2.7 million of unamortized deferred loan costs related to the Old Credit Agreement. Based upon the syndicate of financial institutions for the Credit Agreement, we expensed $1.5 million of these unamortized deferred loan costs and

$0.1 million in fees related to the Credit Agreement in other (expense) income, net in 2010. The remaining $11.5 million of fees related to the Credit Agreement were capitalized, along with the remaining $1.2 million of previously unamortized deferred loan costs, for a total of $12.7 million in deferred loan costs included in other assets, net. These costs are being amortized over the term of the Credit Agreement and are recorded in interest expense.

 

At both December 31, 2010 and 2009, we had no amounts outstanding under the New Revolving Credit Facility or the revolving line of credit under the Old Credit Agreement, as applicable. We had outstanding letters of credit of $133.9 million and $123.1 million at December 31, 2010 and 2009, respectively, which reduced our borrowing capacity to $366.1 million and $276.9 million, respectively.

 

Borrowings under our New Credit Facilities, other than in respect of swingline loans, bear interest at a rate equal to, at our option, either (1) London Interbank Offered Rate (“LIBOR”) plus 1.75% — 2.50%, as applicable, depending on our consolidated leverage ratio, or (2) the base rate (which is based on greater of the prime rate most recently announced by the administrative agent under our New Credit Facilities or the Federal Funds rate plus 0.50%, or (3) a daily rate equal to the one month LIBOR plus 1.0% plus, as applicable, an applicable margin of 0.75% — 1.50% determined by reference to the ratio of our total debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”). The applicable interest rate as of December 31, 2010 was 2.3% for borrowings under our New Credit Facilities. In connection with our New Credit Facilities, we have entered into $350.0 million of notional amount of interest rate swaps at December 31, 2010 to hedge exposure to floating interest rates.

 

We pay the Lenders under the New Credit Facilities a commitment fee equal to a percentage ranging from 0.30% to 0.50%, determined by reference to the ratio of our total debt to consolidated EBITDA, of the unutilized portion of the New Revolving Credit Facility, and letter of credit fees with respect to each standby letter of credit outstanding under our New Credit Facilities equal to a percentage based on the applicable margin in effect for LIBOR borrowings under the New Revolving Credit Facility. The fees for financial and performance standby letters of credit are 2.0% and 1.0%, respectively.

 

Our obligations under the Credit Agreement are unconditionally guaranteed, jointly and severally, by substantially all of our existing and subsequently acquired or organized domestic subsidiaries and 65% of the capital stock of certain foreign subsidiaries, subject to certain controlled company and materiality exceptions. The Lenders have agreed to release the collateral if we achieve an Investment Grade Rating (as defined in the Credit Agreement) by both Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services for our senior unsecured, non-credit-enhanced, long-term debt (in each case, with an outlook of stable or better), with the understanding that identical collateral will be required to be pledged to the Lenders anytime following a release of the collateral that an Investment Grade Rating is not maintained. In addition, prior to our obtaining and maintaining investment grade credit ratings, our and the guarantors’ obligations under the Credit Agreement are collateralized by substantially all of our and the guarantors’ assets. We have not achieved these ratings as of December 31, 2010.

 

European Letter of Credit Facilities

 

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 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 renewed the New European LOC Facility in October 2010 consistent with its terms for an additional 364-day period. 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 €55.7 million ($74.5 million) and €2.8 million ($4.0 million) as of December 31, 2010 and 2009, respectively.

 

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 €33.3 million ($44.5 million) and €77.9 million ($111.5 million) as of December 31, 2010 and 2009, respectively.

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, 2010, was approximately two years for the majority of the outstanding existing letters of credit. After consideration of outstanding commitments under both facilities, the available capacity under the New European LOC Facility was €102.3 million as of December 31, 2010, of which €55.7 million has been drawn.

 

Debt Prepayments and Repayments

 

We made scheduled repayments under our Old Credit Agreement of $4.3 million, $5.7 million and $5.7 million in 2010, 2009 and 2008, respectively. We made no mandatory repayments or optional prepayments in 2010, 2009 or 2008, with the exception of the proceeds advanced under the New Term Loan Facility, along with approximately $40 million of cash on hand to repay all outstanding indebtedness under our Old Credit Agreement.

 

We may prepay loans under our New Credit Facilities in whole or in part, without premium or penalty, at any time.

 

Debt Covenants and Other Matters

 

Our New 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 New 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 New Credit Facilities is tested quarterly.

 

Our New 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 New Credit Facilities. We complied with all covenants under our New Credit Facilities through December 31, 2010.

 

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 New 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, 2010.

Liquidity Analysis

 

Our cash balance decreased by $96.7 million to $557.6 million as of December 31, 2010 as compared with December 31, 2009. The cash draw was primarily due to the acquisition of Valbart for $199.4 million in cash during the third quarter of 2010 and planned significant cash uses in 2010, including broad-based annual employee incentive compensation program payments related to prior period performance, $102.0 million in capital expenditures, $63.6 million in dividend payments, $46.0 million of share repurchases, the use of approximately $40 million of cash on hand to repay outstanding indebtedness under our prior credit agreement and the funding of increased working capital requirements. 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 5% of our New Term Loan is due to mature in both 2011 and 2012. As noted above, our New Term Loan and our New Revolving Credit Facility both mature in December 2015. After the effects of $350.0 million of notional interest rate swaps, approximately 68% of our term debt was at fixed rates at December 31, 2010. As of December 31, 2010, we had a borrowing capacity of $366.1 million on our $500.0 million New Revolving Credit Facility (due to outstanding letters of credit), and we had net available capacity under the New European LOC Facility of €46.6 million. Our New Revolving Credit Facility and our New European LOC Facility are committed and are held by a diversified group of financial institutions.

 

In 2010 and 2009, we experienced increases in the values of our U.S. pension plan assets. We experienced significant declines in the values of our U.S. pension plan assets in 2008 resulting primarily from declines in global equity markets. After consideration of the impact of our contributions in 2009, the partial recovery in 2009 and 2010 of asset value declines in 2008 and our intent to become fully-funded, we contributed $33.4 million to our U.S. pension plan in 2010. We continue to maintain an asset allocation consistent with our strategy to maximize total return, while reducing portfolio risks through asset class diversification.

 

We continue to monitor and evaluate the implications of lingering effects of global financial markets and banking systems disruptions experienced in 2008 and 2009 on our current business (including our access to capital), our customers and suppliers and the state of the global economy. While credit and capital markets have stabilized in recent months, additional disruptions or lingering uncertainty in the functioning of these markets could potentially materially impair our and our customers’ ability to access these markets and further increase associated costs, as well as our customers’ ability to pay in full and/or on a timely basis.

 

OUTLOOK FOR 2011

 

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 increased 8.8% in 2010 as compared with 2009, and our backlog at December 31, 2010 increased 9.4% as compared to December 31, 2009, which is expected to drive increased revenue in 2011 as compared with 2010, excluding currency fluctuations. Because a booking represents a contract that can be, in certain circumstances, 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 increase in bookings will result in a comparable increase in revenues or otherwise be indicative of future results. While we believe that our primary markets continue to provide opportunities, as evidenced by nine consecutive quarters of approximately $1 billion in bookings and the year-over-year increase in our backlog, we remain cautious in our outlook for 2011 given the continuing uncertainty of global economic conditions. While we have not experienced a disruption to our business resulting from recent developing political and economic conditions in the Middle East, we will continue to closely monitor the

conditions. For additional discussion on our markets and our opportunities, see the “Business Overview — Our Markets” section of this MD&A.

 

We expect to experience increased external pressures on gross profit margin in 2011 as compared with 2010 and 2009 due to price competition associated with current global economic conditions. We expect these gross profit margin pressures to be at least partially offset by planned increases in shipments, operational improvements, continuation of our end user strategy, the strength of our aftermarket business, supply chain initiatives, disciplined contract bidding and savings achieved from our Realignment Programs. As part of our previously communicated Realignment Programs, we plan to incur up to $5.0 million in realignment costs in 2011 as a result of these activities.

 

All of our borrowings under our New Credit Facilities carry a floating rate of interest. As of December 31, 2010, we had $350.0 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 2011 will be comparable to 2010. 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 and pension plan contributions in 2011. We seek to improve our working capital utilization, with a particular focus on improving the management of accounts receivable and inventory. However, the amount of cash generated or consumed by working capital is dependent on our level of revenues, backlog, customer acceptance and other factors. In 2011, our cash flows for investing activities will be focused on strategic initiatives to pursue new markets, geographic expansion, information technology infrastructure and cost reduction opportunities and are expected to be between $120 million and $130 million, before consideration of any potential acquisition activity. We have $25.0 million in scheduled repayments in 2011 under our New Credit Facilities, and we expect to comply with the covenants under our New Credit Facilities in 2011. 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 $7 million and $10 million, excluding direct benefits paid, in 2011 in order to maintain fully funded status, as defined by the U.S. Pension Protection Act, for 2011. We currently anticipate that our contributions to our non-U.S. pension plans will be approximately $10 million in 2011.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

 

The following table presents a summary of our contractual obligations at December 31, 2010: