WASHINGTON, D.C. 20549

FORM 10-Q

     (Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     .

FLOWSERVE CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

New York		31-0267900
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
5215 N. O’Connor Blvd., Suite 2300, Irving Texas (Address of Principal Executive Offices)		75039 (Zip code)

(Registrant’s Telephone Number, Including Area Code)

     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 o No þ

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of April 21, 2006, there were 56,522,193 shares of the issuer’s common stock outstanding.

 

 

FLOWSERVE CORPORATION
FORM 10-Q


TABLE OF CONTENTS

		Page
		No.
EXPLANATORY NOTE			3
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Income — Three Months Ended September 30, 2004 and 2003 (unaudited)			4
Condensed Consolidated Statements of Comprehensive Income — Three Months Ended September 30, 2004 and 2003 (unaudited)			5
Condensed Consolidated Statements of Income — Nine Months Ended September 30, 2004 and 2003 (unaudited)			6
Condensed Consolidated Statements of Comprehensive Income — Nine Months Ended September 30, 2004 and 2003 (unaudited)			7
Condensed Consolidated Balance Sheets — September 30, 2004 and December 31, 2003 (unaudited)			8
Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2004 and 2003 (unaudited)			9
Notes to Condensed Consolidated Financial Statements			10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			33
Item 3. Quantitative and Qualitative Disclosures About Market Risk			51
Item 4. Controls and Procedures			52
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			54
Item 6. Exhibits			56
SIGNATURES			57
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification Pursuant to Section 906
Certification Pursuant to Section 906

EXPLANATORY NOTE

     As previously reported in our Annual Report on Form 10-K for the year ended December 31, 2004 (“2004 Annual Report”), we have restated our previously issued financial statements for 2002, 2003 and the first quarter of 2004. We refer to this restatement as the “2004 Restatement.”

     The condensed consolidated financial statements for the three months and nine months ended September 30, 2003 included in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004 (the “Quarterly Report”), and all amounts referenced in this Quarterly Report for prior periods and prior period comparisons, are presented on a restated basis. For a description of the restatement, see Note 2 to the accompanying condensed consolidated financial statements and Note 2 to the consolidated financial statements included in our 2004 Annual Report.

     As a result of the restatement and our obligations regarding internal controls under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), we delayed filing this Quarterly Report and certain of our other periodic reports. Due to this delay and the significant changes we have made to our business in the interim, certain information presented herein relating to our business relates to certain events that occurred subsequent to September 30, 2004, including the restatement of our financial statements, disclosures regarding our internal controls and procedures and updates to legal proceedings.

     On February 13, 2006, we filed our 2004 Annual Report and included therein our consolidated financial statements as of December 31, 2004 and for the year then ended and our restated consolidated financial statements as of December 31, 2003 and for the years ended December 31, 2003 and 2002. We did not amend our Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for periods affected by the restatement that ended on or prior to December 31, 2003, and the financial statements and related financial information contained in such reports should no longer be relied upon.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended September 30,
		2004				2003
(Amounts in thousands, except per share data)						(As restated)
Sales		$	652,134			$	555,955
Cost of sales			458,313				387,275
Gross profit			193,821				168,680
Selling, general and administrative expense			152,395				131,881
Integration expense			—				3,836
Operating income			41,426				32,963
Interest expense			(21,161	)			(20,874	)
Interest income			669				1,745
Loss on optional prepayments of debt			(963	)			(369	)
Other expense, net			(4,107	)			(1,353	)
Earnings before income taxes			15,864				12,112
Provision for income taxes			9,909				2,000
Income from continuing operations			5,955				10,112
Discontinued operations, net of tax			413				(238	)
Net earnings		$	6,368			$	9,874
Earnings per share:
Basic:
Continuing operations		$	0.11			$	0.18
Discontinued operations			0.01				—
Net earnings		$	0.12			$	0.18
Diluted:
Continuing operations		$	0.10			$	0.18
Discontinued operations			0.01				—
Net earnings		$	0.11			$	0.18

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Three Months Ended September 30,
		2004				2003
(Amounts in thousands)						(As restated)
Net earnings		$	6,368			$	9,874
Other comprehensive income (expense):
Foreign currency translation adjustments, net of tax			3,362				(5,244	)
Cash flow hedging activity, net of tax			(4,840	)			1,081
Other comprehensive loss			(1,478	)			(4,163	)
Comprehensive income		$	4,890			$	5,711

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

		Nine Months Ended September 30,
		2004				2003
(Amounts in thousands, except per share data)						(As restated)
Sales		$	1,905,760			$	1,721,324
Cost of sales			1,335,359				1,203,895
Gross profit			570,401				517,429
Selling, general and administrative expense			448,175				389,034
Integration expense			—				15,908
Restructuring expense			—				1,820
Operating income			122,226				110,667
Interest expense			(60,988	)			(63,313	)
Interest income			1,230				3,280
Loss on optional prepayments of debt			(1,048	)			(1,008	)
Other expense, net			(8,916	)			(5,551	)
Earnings before income taxes			52,504				44,075
Provision for income taxes			33,696				14,511
Income from continuing operations			18,808				29,564
Discontinued operations, net of tax			975				235
Net earnings		$	19,783			$	29,799
Earnings per share:
Basic:
Continuing operations		$	0.34			$	0.54
Discontinued operations			0.02				—
Net earnings		$	0.36			$	0.54
Diluted:
Continuing operations		$	0.33			$	0.54
Discontinued operations			0.02				—
Net earnings		$	0.35			$	0.54

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Nine Months Ended September 30,
		2004				2003
(Amounts in thousands)						(As restated)
Net earnings		$	19,783			$	29,799
Other comprehensive income (expense):
Foreign currency translation adjustments, net of tax			(10,951	)			32,655
Cash flow hedging activity, net of tax			(4,433	)			687
Other comprehensive (loss) income			(15,384	)			33,342
Comprehensive income		$	4,399			$	63,141

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED BALANCE SHEETS

		September 30,				December 31,
(Amounts in thousands, except per share data)		2004				2003
ASSETS
Current assets:
Cash and cash equivalents		$	40,483			$	53,522
Accounts receivable, net of allowance for doubtful accounts of $14,061 and $18,641			500,828				505,949
Inventories, net			436,096				412,374
Deferred taxes			79,244				64,585
Prepaid expenses and other			31,472				26,091
Total current assets			1,088,123				1,062,521
Property, plant and equipment, net of accumulated depreciation of $439,224 and $411,836			431,831				443,864
Goodwill			872,271				871,960
Deferred taxes			20,941				31,741
Other intangible assets, net			160,694				169,084
Other assets, net			91,770				101,342
Total assets		$	2,665,630			$	2,680,512
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	267,669			$	250,614
Accrued liabilities			312,920				286,433
Debt due within one year			70,636				71,035
Total current liabilities			651,225				608,082
Long-term debt due after one year			811,401				879,766
Retirement obligations and other liabilities			372,951				370,201
Shareholders’ equity:
Serial preferred stock, $1.00 par value, 1,000 shares authorized, no shares issued			—				—
Common shares, $1.25 par value			72,018				72,018
Shares authorized — 120,000
Shares issued — 57,614
Capital in excess of par value			471,505				477,443
Retained earnings			429,911				410,128
			973,434				959,589
Treasury stock, at cost — 2,344 and 2,775 shares			(52,676	)			(62,575	)
Deferred compensation obligation			6,675				7,445
Accumulated other comprehensive loss			(97,380	)			(81,996	)
Total shareholders’ equity			830,053				822,463
Total liabilities and shareholders’ equity		$	2,665,630			$	2,680,512

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine Months Ended September 30,
		2004				2003
(Amounts in thousands)						(As restated)
Cash flows — Operating activities:
Net earnings		$	19,783			$	29,799
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation			46,650				45,157
Amortization			8,031				7,873
Amortization of deferred loan costs and discount			3,787				3,745
Write-off of unamortized deferred loan costs and discount			1,048				1,008
Net loss on the disposition of assets			314				965
Impairment of assets			—				695
Restricted stock compensation expense			735				451
Change in assets and liabilities, net of acquisitions:
Accounts receivable			4,063				67,262
Inventories			(20,898	)			14,083
Prepaid expenses and other			(5,625	)			3,003
Other assets			381				(13,553	)
Accounts payable			7,590				(26,327	)
Accrued liabilities and income taxes payable			18,685				(685	)
Retirement obligations and other liabilities			7,226				(23,577	)
Net deferred taxes			(4,926	)			5,631
Net cash flows provided by operating activities			86,844				115,530
Cash flows — Investing activities:
Capital expenditures			(28,527	)			(19,117	)
Cash received for disposal of assets			4,093				2,207
Cash paid for acquisition			(9,429	)			—
Net cash flows used by investing activities			(33,863	)			(16,910	)
Cash flows — Financing activities:
Net (repayments) borrowings under lines of credit			(355	)			5,339
Payments on long-term debt			(152,480	)			(125,000	)
Proceeds from issuance of long-term debt			85,000				—
Payment of deferred loan costs			(665	)			(1,767	)
Proceeds from sale of common shares			2,487				—
Net cash flows used by financing activities			(66,013	)			(121,428	)
Effect of exchange rate changes on cash			(7	)			6,991
Net change in cash and cash equivalents			(13,039	)			(15,817	)
Cash and cash equivalents at beginning of year			53,522				48,991
Cash and cash equivalents at end of period		$	40,483			$	33,174

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation and Accounting Policies

Basis of Presentation

     The accompanying condensed consolidated balance sheet as of September 30, 2004, and the related condensed consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2004 and 2003, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2004 and 2003, are unaudited. In management’s opinion, all adjustments comprising normal recurring adjustments necessary for a fair presentation of such condensed consolidated financial statements have been made.

     The accompanying condensed consolidated financial statements and notes in this Quarterly Report are presented as permitted by Regulation S-X and do not contain certain information included in our annual financial statements and notes to the financial statements. Accordingly, the accompanying condensed consolidated financial information should be read in conjunction with the restated consolidated financial statements for the year ended December 31, 2003 presented in our 2004 Annual Report, which was filed with the Securities and Exchange Commission (“SEC”) on February 13, 2006.

Stock-Based Compensation

     We have several stock-based employee compensation plans, which we account for under the recognition and measurement principles of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. For 2004 and prior years, no stock-based employee compensation cost is reflected in net earnings for stock option grants, as all options granted under those plans had an exercise price equal to or in excess of the market value of the underlying common stock on the date of grant. Should we elect to modify any of our existing stock option awards, APB No. 25, as interpreted by Financial Accounting Standards Board (“FASB”) Financial Interpretation (“FIN”) No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” requires us to recognize the intrinsic value of the underlying options at the date the modification becomes effective. Modifications could include accelerated vesting, a reduction in exercise prices or extension of the exercise period.

     Awards of restricted stock are valued at the market price of our common stock on the grant date and recorded as unearned compensation within shareholders’ equity. The unearned compensation is amortized to compensation expense over the vesting period of the restricted stock. We have unearned compensation of $6.1 million and $0.9 million at September 30, 2004 and December 31, 2003, respectively. These amounts will be recognized into net earnings in prospective periods.

     The following table illustrates the effect on net earnings and earnings per share if we had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to all stock-based employee compensation, calculated using the Black-Scholes option-pricing model.

		Quarter Ended September 30,
		2004				2003
(Amounts in thousands, except per share data)						(As restated)
Net earnings, as reported		$	6,368			$	9,874
Restricted stock compensation expense (income) included in net earnings, net of related tax effects			385				172
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects			(297	)			(1,233	)
Pro forma net earnings		$	6,456			$	8,813
Net earnings per share — basic:
As reported		$	0.12			$	0.18
Pro forma			0.12				0.16
Net earnings per share — diluted:
As reported		$	0.11			$	0.18
Pro forma			0.12				0.16

		Nine Months Ended September 30,
		2004				2003
(Amounts in thousands, except per share data)						(As restated)
Net earnings, as reported		$	19,783			$	29,799
Restricted stock compensation expense (income) included in net earnings, net of related tax effects			482				296
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects			(1,309	)			(2,407	)
Pro forma net earnings		$	18,956			$	27,688
Net earnings per share — basic:
As reported		$	0.36			$	0.54
Pro forma			0.34				0.50
Net earnings per share — diluted:
As reported		$	0.35			$	0.54
Pro forma			0.34				0.50

     The above pro forma disclosures may not be representative of effects for future years, since the determination of the fair value of stock options granted includes an expected volatility factor and additional option grants are expected to be made each year.

Other Accounting Policies

     Our significant accounting policies, for which no significant changes have occurred in the quarter ended June 30, 2004, are detailed in Note 1 of our 2004 Annual Report.

Accounting Developments

Pronouncements Implemented

     In December 2003, the FASB issued FIN No. 46(R), “Consolidation of Variable Interest Entities,” which addresses the consolidation of variable interest entities (“VIEs”) by business enterprises that are the primary beneficiaries. A VIE is an entity: 1) that does not have sufficient equity investment at risk to permit it to finance its activities without additional subordinated financial support, or 2) whose equity investors lack the characteristics of a controlling financial interest, or

3) whose equity investors have voting rights that are not proportionate to their economic interests, and the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. The primary beneficiary of a VIE is the enterprise that has the majority of the risks or rewards associated with the VIE. We believe we have no interests in VIEs that require disclosure or consolidation under FIN No. 46(R), and therefore its implementation had no significant effect on our consolidated results of operations or financial position.

Pronouncements Not Yet Implemented

     In May 2004, the FASB issued FASB Staff Position (“FSP”) No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the “Medicare Act”). The Medicare Act provides for certain federal subsidies on drug benefits provided under retiree health plans. In the third quarter of fiscal 2004, we adopted FSP No. 106-2, retroactive to December 8, 2003, the date of the enactment of the Medicare Act. The expected subsidy reduced our accumulated postretirement benefit obligation by approximately $4.5 million, which we recognized as a reduction in the unrecognized net actuarial loss and will be amortized over the average remaining service life of the employees eligible for postretirement benefits. The adoption of FSP No. 106-2 did not have a material impact on our consolidated financial position or results of operations.

     Although there are no other final pronouncements recently issued that we have not adopted and that we expect to impact reported financial information or disclosures, accounting promulgating bodies have a number of pending projects which may directly impact us. We continue to evaluate the status of these projects and as these projects become final, we will provide disclosures regarding the likelihood and magnitude of their impact, if any.

2. Restatement

     For the errors discussed below, we restated our condensed consolidated financial statements for the three and nine months ended September 30, 2003 presented herein.

     The following table sets forth the nature of significant restatement errors and their impact on the previously reported net earnings:

Summary of Restatement Issues Affecting Net Earnings
For the Three and Nine Months Ended September 30, 2003

		Three months ended				Nine months ended
(Amounts in thousands)		September 30, 2003				September 30, 2003
Net earnings, as previously reported		$	10,599			$	32,067
Long-term contract accounting			(2,817	)			(2,817	)
Inventory valuation			(764	)			1,505
Unclaimed property			(432	)			(676	)
Financial derivatives			(314	)			(1,476	)
Intercompany reconciliations			(239	)			(1,808	)
Pension expense			91				903
Fixed assets and intangibles			—				(863	)
Other			27				723
Tax matters			3,723				2,241
Net earnings, as restated		$	9,874			$	29,799

     Inventory Valuation — We corrected our financial statements for inconsistencies in the application of our accounting policy for obsolete and slow moving inventory, errors in our last-in, first-out (“LIFO”) calculations, and errors in adjusting for lower-of-cost-or-market considerations. The inconsistencies related to (i) obsolete and slow moving inventory mainly resulting from limitations in our systems and processes that did not effectively identify excess inventory quantities; and (ii) the inventories of acquired businesses where our identification of slow moving items was not performed timely. The errors in LIFO and lower-of-cost-or-market resulted from inaccurate calculations.

     Long-Term Contract Accounting — We identified one long-term contract that was accounted for using the percentage of completion method in which we did not include the estimated cost of the work performed by subcontractors as part of our total estimated costs in determining the percentage of completion accounting for the overall contract. We also identified a long-term contract in which costs related to the contracts were not recorded in the appropriate periods and resulted in corrections to cost of sales in prior periods.

     Intercompany Reconciliations — Our accounting for intercompany transactions was adversely affected by information technology system conversions, acquisitions, and changes in corporate processes for recording intercompany transactions. Our initial analysis of intercompany transactions was expanded to include an assessment of intercompany balance differences at each of the reporting dates. Certain reconciling items were identified through this assessment that required adjustment to the consolidated statements of operations.

     Pension Expense — As part of a comprehensive review of our pension plans, we identified errors in the accounting for non-U.S. pension plans. Certain plan obligations had not been measured at the actuarially determined present value, which resulted in errors in our annual pension expense and related liabilities.

     Fixed Assets and Intangibles — As part of a comprehensive physical observation and assessment of fixed assets, we identified errors in our fixed asset processes related to disposals and abandonments that were not recorded in our accounting records necessitating adjustments to report the gains or losses on disposal in the appropriate periods. We also identified errors that resulted from not adjusting for the impact of purchase accounting within the general ledgers at certain locations of recently acquired businesses, amortization of leasehold improvements over periods in excess of the related lease terms, and errors in the amortization of intangible assets. These errors affected amounts reported for fixed assets, goodwill, other intangible assets, depreciation and amortization, loss on disposals, and foreign currency translation accounts.

     Financial Derivatives — We identified errors in our accounting for financial derivatives related to foreign currency forward exchange contracts, which consisted of incorrectly recording unrealized gains and losses in other comprehensive loss for certain contracts that did not meet the criteria for hedge accounting. We also identified errors related to the recording of balances underlying the financial derivatives.

     Unclaimed Property — We identified errors in accounting for unclaimed property primarily for unapplied cash and customer credits related to accounts receivable and for checks issued to vendors and to other payees that were not presented for payment. We previously recorded such items as income and removed these amounts from our balance sheet accounts. The correction reinstates such amounts within accrued liabilities as we began a process of filing with various states under voluntary disclosure agreements.

     Other — We identified other errors as part of the restatement where the individual impact on net earnings was not as significant, which resulted from the following:

	•		errors in the original allocation of the purchase price for acquired businesses to property, plant and equipment, goodwill, accrued liabilities and deferred income taxes;
	•		errors in reconciliations of account balances;
	•		errors in accounting for equity investments that were based on foreign accounting standards rather than accounting principles generally accepted in the United States of America (“GAAP”); and
	•		other errors which were not deemed individually significant for separate disclosure.

     Tax Matters — Due to significant employee turnover, information technology system limitations, corporate legal restructurings, several multinational acquisitions, and inadequate reconciliations, we identified errors in the amounts recorded in current and deferred income taxes. We undertook a process to identify our tax basis amounts, for both domestic and international locations, and performed a comprehensive review of our purchase accounting for recent acquisitions. This process included a detailed compilation of our book and tax differences at each of the reporting dates, as well as reconciliations of our income tax payable accounts to tax returns, as filed or as amended.

     We also identified errors that occurred in applying purchase accounting to businesses acquired, including income tax liabilities arising in years prior to the acquisitions, which were corrected in the related balance sheet accounts. We also

identified errors in our U.S. federal income tax returns filed for 1999 through 2001 as a result of an Internal Revenue Service examination of those years. We amended our tax returns for those years and reflected the impact of those amendments within current and deferred domestic income tax balance sheet accounts at each of the annual reporting dates through December 31, 2004.

     Tax matters also includes the results of assessing the other restatement entries to determine which amounts had a corresponding impact on our provision for income taxes.

     The following table presents the impact of the restatement adjustments, further described below, and of the business classified as discontinued operations in 2004 that is described in Note 3, on our consolidated statements of operations for the three and nine months ended September 30, 2003:

Consolidated Statements of Operations Information
For the Three and Nine Months Ended September 30, 2003

		Three months ended September 30, 2003												Nine months ended September 30, 2003
										As Restated												As Restated
		As								with												with
(Amounts in thousands,		Previously								Discontinued				As Previously								Discontinued
except per share data)		Reported				As Restated				Operations				Reported				As Restated				Operations
Sales		$	565,146			$	561,777			$	555,955			$	1,743,193			$	1,738,320			$	1,721,324
Cost of sales			392,253				392,978				387,275				1,220,830				1,218,684				1,203,895
Gross profit			172,893				168,799				168,680				522,363				519,636				517,429
Selling, general and administrative expense			132,942				132,378				131,881				391,713				390,868				389,034
Integration expense			3,836				3,836				3,836				15,908				15,908				15,908
Restructuring expense			—				—				—				1,820				1,820				1,820
Operating income			36,115				32,585				32,963				112,922				111,040				110,667
Interest expense			(20,874	)			(20,874	)			(20,874	)			(63,313	)			(63,313	)			(63,313	)
Interest income			1,722				1,745				1,745				3,211				3,280				3,280
Loss on debt repayment and extinguishment			(369	)			(369	)			(369	)			(1,008	)			(1,008	)			(1,008	)
Other expense, net			(412	)			(1,353	)			(1,353	)			(2,855	)			(5,551	)			(5,551	)
Earnings before income taxes			16,182				11,734				12,112				48,957				44,448				44,075
Provision for income taxes			5,583				1,860				2,000				16,890				14,649				14,511
Income from continuing operations			10,599				9,874				10,112				32,067				29,799				29,564
Discontinued operations, net of tax			—				—				(238	)			—				—				235
Net earnings		$	10,599			$	9,874			$	9,874			$	32,067			$	29,799			$	29,799
Net earnings per share — basic:
Continuing operations		$	0.19			$	0.18			$	0.18			$	0.58			$	0.54			$	0.54
Discontinued operations			—				—				—				—				—				—
Net earnings		$	0.19			$	0.18			$	0.18			$	0.58			$	0.54			$	0.54
Net earnings per share — diluted:
Continuing operations		$	0.19			$	0.18			$	0.18			$	0.58			$	0.54			$	0.54
Discontinued operations			—				—				—				—				—				—
Net earnings		$	0.19			$	0.18			$	0.18			$	0.58			$	0.54			$	0.54

     Our restatement corrects the consolidated statements of operations for the following errors:

	•		Sales decreased $3.4 million and $4.9 million for the three and nine months ended September 30, 2003, respectively, primarily due to an error in the application of percentage of completion accounting for one long-term contract that includes subcontractors ($3.7 million for both the three and nine months ended September 30, 2003), and errors that reported sales in a period later than determined in accordance with GAAP for which there is no significant impact on net earnings in the periods presented ($0.5 million increase and $1.0 million decrease for the three and nine months ended September 30, 2003, respectively) and errors in other account reconciliations.
	•		Cost of sales increased for the three months ended September 30, 2003 and decreased for the nine months ended September 30, 2003, primarily due to errors in the following (in thousands):

		Three months				Nine months
Inventory valuation		$	764			$	(1,505	)
Pension expense			(388	)			(1,164	)
Intercompany reconciliations			239				1,803
Other (mainly errors in account reconciliations)			110				(1,280	)
Total cost of sales		$	725			$	(2,146	)

•

Selling, general and administrative expense decreased for the three and nine months ended September 30, 2003, primarily due to errors in the following (in thousands):

		Three months				Nine months
Long-term contract accounting		$	(876	)		$	(876	)
Pension expense			297				261
Fixed assets and intangibles			—				888
Other (mainly errors in account reconciliations)			15				(1,118	)
Total selling, general and administrative expense		$	(564	)		$	(845	)

	•		Other expense, net increased $0.9 million and $2.7 million for the three and nine months ended September 30, 2003, respectively, primarily due to errors in the accounting for foreign currency forward contracts that did not meet the criteria for hedge accounting ($0.3 million and $1.5 million for the three and nine months ended September 30, 2003, respectively), unclaimed property ($0.3 million in each of the three and nine months ended September 30, 2003) and other individually insignificant errors.
	•		Provision for income taxes decreased $3.7 million and $2.2 million for the three and nine months ended September 30, 2003, respectively, primarily due to corrections in deferred tax accounts and the income tax effect of the errors described above. Included in this was $1.6 million for both the three and nine months ended September 30, 2003 due to the tax impact on the restatement items.

The following table presents the impact of the restatement adjustments on our consolidated statements of comprehensive income for the three and nine months ended September 30, 2003:

Consolidated Statements of Comprehensive Income Information
For the Three and Nine Months Ended September 30, 2003

		Three months ended								Nine months ended
		September 30, 2003								September 30, 2003
		As Previously								As Previously
(Amounts in thousands)		Reported				As Restated				Reported				As Restated
Net earnings		$	10,599			$	9,874			$	32,067			$	29,799
Other comprehensive income (expense):
Foreign currency translation adjustments, net of tax			(4,577	)			(5,244	)			27,483				32,655
Cash flow hedging activity, net of tax			1,429				1,081				164				687
Other comprehensive (loss) income			(3,148	)			(4,163	)			27,647				33,342
Comprehensive income		$	7,451			$	5,711			$	59,714			$	63,141

     Our consolidated statement of cash flows for the nine months ended September 30, 2003, was also restated for the items discussed above. The following table presents the major subtotals in our 2003 consolidated statements of cash flows and the related impact of the restatement adjustments discussed above:

Condensed Consolidated Statements of Cash Flows Information
For the Nine Months Ended September 30, 2003

		Nine months ended
		September 30, 2003
		As
		Previously
(Amounts in thousands)		Reported				As Restated
Net cash flows provided (used) by:
Operating activities		$	113,367			$	115,530
Investing activities			(16,910	)			(16,910	)
Financing activities			(122,767	)			(121,428	)
Effect of exchange rate changes on cash			6,991				6,991
Net change in cash and cash equivalents			(19,319	)			(15,817	)
Cash and cash equivalents at beginning of year			49,293				48,991
Cash and cash equivalents at end of period		$	29,974			$	33,174

     The footnotes contained in these condensed consolidated financial statements also reflect the impact of the restatement discussed in this footnote.

3. Discontinued Operations

     In the first quarter of 2004, we made a definitive decision to sell our Government Marine Business Unit (“GMBU”), a business within our Flowserve Pump Division (“FPD”). As a result, we reclassified the operation to discontinued operations in the first quarter of 2004. In November 2004, we sold GMBU to Curtiss-Wright Electro-Mechanical Corporation for approximately $28 million, generating a pre-tax gain of $7.4 million after the allocation of approximately $8 million of FPD goodwill and $1 million of intangible assets. GMBU, which provided pump technology and service for U.S. Navy submarines and aircraft carriers, did not serve our core market and represented only a small part of our total pump business. We used net proceeds from the disposition of GMBU to reduce our outstanding indebtedness. As a result of this sale, we have presented the assets, liabilities and results of operations of the GMBU as discontinued operations for all periods included.

     GMBU generated the following results of operations:

		Three Months Ended September 30,
		2004				2003
(Amounts in millions)						(As restated)
Sales		$	7.4			$	5.8
Cost of sales			6.0				5.7
Selling, general and administrative expense			0.7				0.5
Earnings (loss) before income taxes			0.7				(0.4	)
Provision (benefit) for income taxes			0.2				(0.1	)
Results for discontinued operations, net of tax		$	0.5			$	(0.3	)

		Nine Months Ended September 30,
		2004				2003
(Amounts in millions)						(As restated)
Sales		$	19.1			$	17.0
Cost of sales			15.3				14.8
Selling, general and administrative expense			2.3				1.8
Earnings before income taxes			1.5				0.4
Provision for income taxes			0.5				0.1
Results for discontinued operations, net of tax		$	1.0			$	0.3

     GMBU’s assets and liabilities have been reclassified to prepaid expenses and other, property, plant and equipment, net, accounts payable and accrued liabilities to reflect discontinued operations. As of September 30, 2004 and December 31, 2003, GMBU’s assets and liabilities consisted of the following:

		September 30,				December 31,
(Amounts in millions)		2004				2003
Accounts receivable, net		$	3.3			$	3.9
Inventory, net			6.4				5.7
Property, plant and equipment, net			1.3				1.6
Goodwill			7.8				7.8
Other intangible assets, net			1.4				1.4
Total assets		$	20.2			$	20.4
Accounts payable		$	2.6			$	3.3
Accrued liabilities			0.2				2.0
Total liabilities		$	2.8			$	5.3

4. Acquisition

     We acquired the remaining 75% interest in Thompsons, Kelly and Lewis, Pty. Ltd (“TKL”) an Australian manufacturer and supplier of pumps, during March 2004. The incremental interests acquired were accounted for as a step acquisition and TKL’s results of operations have been consolidated since the date of acquisition. The estimated fair value of the net assets acquired (including approximately $2.2 million of cash acquired) exceeded the cash paid of $12 million and, accordingly, no goodwill was recognized.

5. Derivative Instruments and Hedges

     We enter into forward contracts to hedge our risk associated with transactions denominated in currencies other than the local currency of the operation engaging in the transaction. Our risk management and derivatives policy specify the conditions in which we enter into derivative contracts. As of September 30, 2004, we have approximately $83.4 million of notional

amount in outstanding contracts with third parties. As of September 30, 2004, the maximum length of any forward contract in place was 20 months.

     Certain of our forward contracts do not qualify for hedge accounting. The fair value of these outstanding forward contracts at September 30, 2004 was an asset of $0.8 million and an asset of $4.7 million at December 31, 2003. Unrealized losses from the changes in the fair value of these forward contracts of $3,000 and $0.3 million for the quarters ended September 30, 2004 and 2003, respectively, and $4.6 million and $1.5 million for the nine months ended September 30, 2004 and 2003, respectively, are included in other expense, net in the consolidated statements of operations. The fair value of outstanding forward contracts qualifying for hedge accounting at September 30, 2004 was an asset of $0.1 million and a liability of $2.3 million at December 31, 2003. Unrealized gains (losses) from the changes in the fair value of qualifying forward contracts and the associated underlying exposures of $(49,000) and $144,000, net of tax, for the quarters ended September 30, 2004 and 2003, respectively, and $86,000 and $189,000, net of tax, for the nine months ended September 30, 2004 and 2003, respectively, are included in other comprehensive income (loss).

     Also as part of our risk management program, we enter into interest rate swap agreements to hedge exposure to floating interest rates on certain portions of our debt. As of September 30, 2004, we have $125 million of notional amount in outstanding interest rate swaps with third parties. As of September 30, 2004, the maximum remaining length of any interest rate contract in place was approximately 26 months. The fair value of the interest rate swap agreements was a liability of $4.6 million and $7.6 million at September 30, 2004 and December 31, 2003, respectively. Unrealized gains from the changes in fair value of our interest rate swap agreements, net of reclassifications, of $2.1 million and $1.0 million, net of tax, for the quarters ended September 30, 2004 and 2003, respectively, and $1.8 million and $0.2 million, net of tax, for the nine months ended September 30, 2004 and 2003, respectively, are included in other comprehensive income (loss).

     During the third quarter of 2004, we entered into a compound derivative contract to hedge exposure to both currency translation and interest rate risks associated with our European Investment Bank (“EIB”) loan. The notional amount of the derivative was $85 million, and it served to convert floating rate interest rate risk to a fixed rate, as well as U.S. dollar currency risk to Euros. The derivative matures in 2011. At September 31, 2004, the fair value of this derivative was a liability of $6.0 million. This derivative did not qualify for hedge accounting. The unrealized loss on the derivative, offset with the foreign currency translation gain on the underlying loan aggregates to $3.1 million for the three months ended September 30, 2004, and is included in other expense, net in the consolidated statements of operations.

     We are exposed to risk from credit-related losses resulting from nonperformance by counterparties to our financial instruments. We perform credit evaluations of our counterparties under forward contracts and interest rate swap agreements and expect all counterparties to meet their obligations. We have not experienced credit losses from our counterparties. Additionally, we are exposed to risk of our derivative contracts not qualifying for hedge accounting.

6. Debt

     Debt, including capital lease obligations, consisted of:

		September 30,				December 31,
(Amounts in thousands)		2004				2003
Term Loan Tranche A:
U.S. Dollar Tranches, interest rate of 4.47% in 2004 and 3.74% in 2003		$	138,524			$	200,004
Euro Tranche, interest rate of 4.62% in 2004 and 4.65% in 2003			12,152				12,292
Term Loan Tranche C, interest rate of 4.67% in 2004 and 4.00% in 2003			374,473				465,473
Senior Subordinated Notes, net of discount, coupon of 12.25%:
U.S. Dollar denominated			186,938				186,739
Euro denominated			80,162				80,998
EIB loan, interest rate of 1.76% in 2004			85,000				—
Receivable factoring obligations			4,189				4,543
Capital lease obligations and other			599				752
Debt and capital lease obligations			882,037				950,801
Less amounts due within one year			70,636				71,035
Total debt due after one year		$	811,401			$	879,766

2000 Credit Facilities

     As of September 30, 2004 and December 31, 2003, our 2000 Credit Facilities were composed of Tranche A and Tranche C term loans and a revolving line of credit. Tranche A consisted of a U.S. dollar denominated tranche and a Euro denominated tranche, the latter of which was a term note due in 2006. During the nine months ended September 30, 2004, we made scheduled, mandatory and optional debt payments of $27.5 million, $85.0 million and $40.0 million, respectively. During the remainder of 2004, we made mandatory and optional principal payments of $82.9 million and $120.0 million, respectively.

     The Tranche A and Tranche C loans had ultimate maturities of June 2006 and June 2009, respectively. The term loans bore floating interest rates based on the London Interbank Offered Rate (“LIBOR”) plus a borrowing spread, or the prime rate plus a borrowing spread, at our option. The borrowing spread for the senior credit facilities can increase or decrease based on the leverage ratio as defined in the credit facility and on our public debt ratings.

     As part of the 2000 Credit Facilities, we also had a $300 million revolving line of credit that was set to expire in June 2006. The revolving line of credit allows us to issue up to $200 million in letters of credit. No amounts were outstanding under the revolving line of credit at September 30, 2004 or December 31, 2003. We had outstanding letters of credit of $48.2 million at September 30, 2004 under the revolving line of credit, which reduced borrowing capacity to $251.8 million, compared with a borrowing capacity of $257.3 million at December 31, 2003.

     We were required, under certain circumstances as defined in the 2000 Credit Facilities, to use a percentage of excess cash generated from operations to reduce the outstanding principal of the term loans in the following year. Based upon the annual calculations performed at December 31, 2003, no additional principal payments became due in 2004 under this provision.

Senior Subordinated Notes

     At September 30, 2004, we had $188.5 million and €65 million (equivalent to $80.8 million at September 30, 2004) face value of Senior Subordinated Notes outstanding. The Senior Subordinated Notes were originally issued in 2000 at a discount to yield 12.5%, but have a coupon interest rate of 12.25%. Interest on these notes was payable semi-annually in February and August. In August 2005, all remaining Senior Subordinated Notes outstanding were called by us at 106.125% of face value as specified in the loan agreement and repaid, along with accrued interest.

EIB Credit Facility

     On April 14, 2004, we and one of our European subsidiaries, Flowserve B.V., entered into an agreement with EIB, pursuant to which EIB agreed to loan us up to €70 million, with the ability to draw funds in multiple currencies, to finance in part specified research and development projects undertaken by us in Europe. Borrowings under the EIB credit facility bear

interest at a fixed or floating rate of interest agreed to by us and EIB with respect to each borrowing under the facility. Loans under the EIB credit facility are subject to mandatory repayment, at EIB’s discretion, upon the occurrence of certain events, including a change of control or prepayment of certain other indebtedness. In addition, the EIB credit facility contains covenants that, among other things, limit our ability to dispose of assets related to the financed project and require us to deliver to EIB our audited annual financial statements within 30 days of publication. Our obligations under the EIB credit facility are guaranteed by a letter of credit outstanding under our New Credit Facilities.

     In August 2004, we borrowed $85 million at a floating interest rate based on 3-month U.S. LIBOR that resets quarterly. As of September 30, 2004, the interest rate was 1.76%. The maturity of the amount drawn is June 15, 2011, but may be repaid at any time without penalty. Concurrent with borrowing the $85 million we entered into a derivative contract with a third party financial institution, swapped this principal amount to €70.6 million and fixed the LIBOR portion of the interest rate to a fixed interest rate of 4.19% through the scheduled repayment date. We have not applied hedge accounting to the derivative contract, and the unrealized loss on the derivative, offset with the foreign currency translation gain on the underlying loan aggregates to $3.1 million for the three months ended September 30, 2004, and is included in other expense, net in the consolidated statements of operations.

Accounts Receivable Securitization

     In October 2004, one of our wholly owned subsidiaries entered into an accounts receivable securitization whereby we could obtain up to $75 million in financing by securitizing certain U.S.-based receivables with a third party. In October 2005, we terminated this accounts receivable securitization facility. In connection with the termination, we borrowed approximately $48 million under our New Credit Facilities to repurchase our receivables then held by such third party.

Debt Covenants

     Our 2000 Credit Facilities that have now been refinanced, the letter of credit facility guaranteeing our obligations under the EIB credit facility, and the agreements governing our domestic receivables program each required us to deliver to creditors thereunder our audited annual consolidated financial statements within a specified number of days following the end of each fiscal year. In addition, the indentures governing our 12.25% Senior Subordinated Notes required us to timely file with the SEC our annual and quarterly reports.

7. Inventories

     Inventories are stated at lower of cost or market. Cost is determined for principally all U.S. inventories by the LIFO method and for other inventories by the first-in, first-out (“FIFO”) method.

     Inventories and the method of determining costs were:

		September 30,				December 31,
(Amounts in thousands)		2004				2003
Raw materials		$	127,818			$	115,695
Work in process			216,252				229,049
Finished goods			246,511				230,234
Less: Progress billings			(81,759	)			(92,490	)
Less: Excess and obsolete reserve			(44,958	)			(43,354	)
			463,864				439,134
LIFO reserve			(27,768	)			(26,760	)
Net inventory		$	436,096			$	412,374
Percent of inventory accounted for by:
LIFO			51	%			50	%
FIFO			49	%			50	%

8. Restructuring Costs — IFC

Restructuring Costs

     In conjunction with the acquisition of the Flow Control Division of Invensys plc (“IFC”) during 2002, we initiated a restructuring program designed to reduce costs and eliminate excess capacity by closing 18 valve facilities, including 10 service facilities, and reducing sales and related support personnel. Our actions, some of which were approved and committed to in 2002 with the remaining actions approved and committed to in 2003, are expected to result in a gross reduction of approximately 889 positions and a net reduction of approximately 662 positions. Net position eliminations represent the gross positions eliminated from the closed facilities offset by positions added at the receiving facilities, which are required to produce the products transferred into the receiving facilities.

     We established a restructuring program reserve upon acquisition of IFC, and recognized additional accruals of $4.5 million in 2003 for this program, including $3.2 million during the first nine months, primarily related to the closure of certain valve service facilities and the related reductions in workforce. Cash expenditures against the accrual were $11.6 million in 2003, including $9.5 million during the first nine months, and $2.7 million during the first nine months of 2004. The remaining accrual of $6.6 million reflects payments to be made in 2004 and beyond for severance obligations due to terminated personnel in Europe of $4.0 million as well as lease and other contract termination and exit costs of $2.6 million.

     Cumulative costs associated with the closure of Flowserve facilities of $7.2 million through December 31, 2003, have been recognized as restructuring expense in operating results, whereas cumulative costs associated with the closure of IFC facilities of $17.9 million, including related deferred taxes of $6.2 million, became part of the purchase price allocation of the transaction. The effect of these closure costs increased the amount of goodwill otherwise recognizable as a result of the IFC acquisition.

     The following illustrates activity related to the IFC restructuring reserve:

		Other Exit
(Amounts in millions)		Severance				Costs				Total
Balance at January 1, 2003		$	10.7			$	5.7			$	16.4
Additional accruals			3.8				0.7				4.5
Cash expenditures			(8.8	)			(2.8	)			(11.6	)
Balance at December 31, 2003			5.7				3.6				9.3
Cash expenditures			(0.9	)			(0.4	)			(1.3	)
Balance at March 31, 2004			4.8				3.2				8.0
Cash expenditures			(0.4	)			(0.3	)			(0.7	)
Balance at June 30, 2004			4.4				2.9				7.3
Cash expenditures			(0.4	)			(0.3	)			(0.7	)
Balance at September 30, 2004		$	4.0			$	2.6			$	6.6

Integration Costs – IFC

     We did not incur acquisition-related integration expenses in 2004. During the three and nine months ended September 30, 2003, we incurred acquisition-related integration expense in conjunction with IFC, which is summarized below:

		Three Months				Nine Months
		ended September 30,				ended September 30,
(Amounts in millions)		2003				2003
Personnel and related costs		$	1.0			$	7.3
Transfer of product lines			0.7				4.1
Asset impairments			—				0.8
Other			2.1				3.7
IFC integration expense		$	3.8			$	15.9
Cash expense		$	3.1			$	14.3
Non-cash expense			0.7				1.6
IFC integration expense		$	3.8			$	15.9

     The acquisition-related activities resulted in integration costs as categorized above and further defined as follows. Personnel and related costs include payroll, benefits, consulting fees, and retention and integration performance bonuses paid to our employees and contractors for the development, management and execution of the integration plan. Transfer of product lines includes costs associated with the transfer of product lines as well as realignment required in the receiving facilities. Asset impairments reflect the loss on disposal of property, plant and equipment at the facilities closed and disposal of inventory for discontinued product lines when the facilities were combined. The other category includes costs associated with information technology integration, legal entity consolidations, legal entity name changes, signage, new product literature and others. None of these items individually amounted to greater than $0.5 million.

Remaining Restructuring and Integration Costs – IFC

     At December 31, 2003, we largely completed restructuring and integration activities related to IFC, except for payments to be made for certain European activities. We expect to incur no additional restructuring and integration costs related to this integration program. Payments from the restructuring accrual will continue throughout 2004 and into 2005 due to the timing of severance obligations in Europe.

9. Earnings Per Share

     Basic and diluted earnings per weighted average share outstanding were calculated as follows:

		Quarter Ended September 30,
		2004				2003
(Amounts in thousands, except per share amounts)						(As restated)
Income from continuing operations		$	5,955			$	10,112
Net earnings		$	6,368			$	9,874
Denominator for basic earnings per share — weighted average shares			55,174				55,148
Effect of potentially dilutive securities			607				227
Denominator for diluted earnings per share — weighted average shares			55,781				55,375
Net earnings per share:
Basic:
Continuing operations		$	0.11			$	0.18
Net earnings			0.12				0.18
Diluted:
Continuing operations		$	0.10			$	0.18
Net earnings			0.11				0.18

		Nine Months Ended September 30,
		2004				2003
(Amounts in thousands, except per share amounts)						(As restated)
Income from continuing operations		$	18,808			$	29,564
Net earnings		$	19,783			$	29,799
Denominator for basic earnings per share — weighted average shares			54,976				55,138
Effect of potentially dilutive securities			552				104
Denominator for diluted earnings per share — weighted average shares			55,528				55,242
Net earnings per share:
Basic:
Continuing operations		$	0.34			$	0.54
Net earnings			0.36				0.54
Diluted:
Continuing operations		$	0.33			$	0.54
Net earnings			0.35				0.54

     Options outstanding with an exercise price greater than the average market price of the common stock were not included in the computation of diluted earnings per share.

     The following summarizes options to purchase common stock that were excluded from the computations of potentially dilutive securities:

		Quarter Ended September 30,
		2004				2003
Total number excluded			926,960				1,240,679
Weighted average exercise price		$	27.40			$	27.12

		Nine Months Ended September 30,
		2004				2003
Total number excluded			1,040,346				3,063,360
Weighted average exercise price		$	26.52			$	21.91

10. Legal Matters and Contingencies

     We are a defendant in a large number of pending lawsuits (which include, in many cases, multiple claimants) that seek to recover damages for personal injury allegedly caused by exposure to asbestos containing products manufactured and/or distributed by us in the past. Any such products were encapsulated and used only as components of process equipment, and we do not believe that any emission of respirable asbestos fibers occurred during the use of this equipment. We believe that a high percentage of the applicable claims are covered by applicable insurance or indemnities from other companies.

     On February 4, 2004, we received an informal inquiry from the SEC requesting the voluntary production of documents and information related to our February 3, 2004 announcement that we would restate our financial results for the nine months ended September 30, 2003 and the full years 2002, 2001 and 2000. On June 2, 2004, we were advised that the SEC had issued a formal order of private investigation into issues regarding this restatement and any other issues that arise from the investigation. We continue to cooperate with the SEC in this matter.

     During the quarter ended September 30, 2003, related lawsuits were filed in federal court in the Northern District of Texas (the “Court’’), alleging that we violated federal securities laws. Since the filing of these cases, which have been consolidated, the lead plaintiff has amended its complaint several times. The lead plaintiff’s current pleading is the fifth consolidated amended complaint (“Complaint’’). The Complaint alleges that federal securities violations occurred between February 6, 2001 and September 27, 2002 and names as defendants Mr. C. Scott Greer, our former Chairman, President and Chief Executive Officer, Ms. Renee J. Hornbaker, our former Vice President and Chief Financial Officer, PricewaterhouseCoopers LLP, our

independent registered public accounting firm, and Banc of America Securities LLC and Credit Suisse First Boston LLC, which served as underwriters for two of our public stock offerings during the relevant period. The Complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, and Sections 11 and 15 of the Securities Act of 1933. The lead plaintiff seeks unspecified compensatory damages, forfeiture by Mr. Greer and Ms. Hornbaker of unspecified incentive-based or equity-based compensation and profits from any stock sales, and recovery of costs. On November 22, 2005, the Court entered an order denying the defendants’ motions to dismiss the Complaint on the pleadings in their entirety. The case is currently set for trial on March 27, 2007. We continue to believe that the lawsuit is without merit and are vigorously defending the case.

     We have been involved as a potentially responsible party (“PRP’’) at former public waste disposal sites that may be subject to remediation under pending government procedures. The sites are in various stages of evaluation by federal and state environmental authorities. The projected cost of remediation at these sites, as well as our alleged “fair share’’ allocation, is uncertain and speculative until all studies have been completed and the parties have either negotiated an amicable resolution or the matter has been judicially resolved. At each site, there are many other parties who have similarly been identified, and the identification and location of additional parties is continuing under applicable federal or state law. Many of the other parties identified are financially strong and solvent companies that appear able to pay their share of the remediation costs. Based on our information about the waste disposal practices at these sites and the environmental regulatory process in general, we believe that it is likely that ultimate remediation liability costs for each site will be apportioned among all liable parties, including site owners and waste transporters, according to the volumes and/or toxicity of the wastes shown to have been disposed of at the sites. We believe that our exposure for existing disposal sites will be less than $100,000.

     We are also a defendant in several other lawsuits, including product liability claims, that are insured, subject to the applicable deductibles, arising in the ordinary course of business. Based on currently available information, we believe that we have adequately accrued estimated probable losses for such lawsuits. We are also involved in a substantial number of labor claims, including one case where we had a confidential settlement reflected in our results of operations for the second quarter of 2004.

     Although none of the aforementioned potential liabilities can be quantified with absolute certainty, we have established reserves covering these exposures, which we believe to be reasonable based on past experience and available facts. While additional exposures beyond these reserves could exist, they currently cannot be estimated. We will continue to evaluate these potential contingent loss exposures and, if they develop, recognize expense as soon as such losses become probable and can be reasonably estimated.

     We are also involved in ordinary routine litigation incidental to our business, none of which we believe to be material to our business, operations or overall financial condition. However, resolutions or dispositions of claims or lawsuits by settlement or otherwise could have a significant impact on our operating results for the reporting period in which any such resolution or disposition occurs.

11. Retirement and Postretirement Benefits

     Components of the net periodic cost (benefit) for the three months ended September 30, 2004 and 2003 were as follows:

		U.S.								Non-U.S.								Postretirement
		Defined Benefit Plans								Defined Benefit Plans								Medical Benefits
(Amounts in millions)		2004				2003				2004				2003				2004				2003
Net periodic cost (benefit)
Service cost		$	3.5			$	3.4			$	0.9			$	0.6			$	0.1			$	—
Interest cost			3.8				4.0				2.2				1.9				1.3				1.5
Expected return on plan assets			(4.3	)			(4.3	)			(1.1	)			(0.9	)			—				—
Curtailments/settlements			0.6				0.7				—				—				—				—
Amortization of unrecognized net loss			0.6				0.2				0.3				0.4				0.4				0.3
Amortization of prior service costs			(0.3	)			(0.3	)			—				—				(0.8	)			(0.8	)
Net cost recognized		$	3.9			$	3.7			$	2.3			$	2.0			$	1.0			$	1.0

     Components of the net periodic cost (benefit) for the nine months ended September 30, 2004 and 2003 were as follows:

		U.S.								Non-U.S.								Postretirement
		Defined Benefit Plans								Defined Benefit Plans								Medical Benefits
(Amounts in millions)		2004				2003				2004				2003				2004				2003
Net periodic cost (benefit)
Service cost		$	10.4			$	10.1			$	2.5			$	1.9			$	0.1			$	0.2
Interest cost			11.6				11.9				6.6				5.8				4.0				4.4
Expected return on plan assets			(13.0	)			(12.9	)			(3.3	)			(2.8	)			—				—
Curtailments/settlements			0.6				0.5				—				0.1				—				—
Amortization of unrecognized net loss			1.9				0.6				1.0				1.0				1.1				1.0
Amortization of prior service costs			(1.0	)			(1.0	)			—				—				(2.3	)			(2.5	)
Net cost recognized		$	10.5			$	9.2			$	6.8			$	6.0			$	2.9			$	3.1

12. Income taxes

     For the three months ended September 30, 2004, we earned $15.9 million before taxes and provided for income taxes of $9.9 million, resulting in an effective tax rate of 62.5%. For the nine months ended September 30, 2004, we earned $52.5 million before taxes and provided for income taxes of $33.7 million, resulting in an effective tax rate of 64.2%. The effective tax rate varied from the U.S. federal statutory rate for the three and nine months ended September 30, 2004 primarily due to the impact of increased foreign earnings repatriation used to pay down U.S. debt.

13. Segment Information

     We are principally engaged in the worldwide design, manufacture, distribution and service of industrial flow management equipment. We provide pumps, valves and mechanical seals primarily for the petroleum industry, chemical-processing industry, power-generation industry, water industry, general industry and other industries requiring flow management products.

     We have the following three divisions, each of which constitutes a business segment:

	•		Flowserve Pump Division;
	•		Flow Control Division; and
	•		Flow Solutions Division.