SEC Filing | Flowserve Corporation

1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-13179 FLOWSERVE CORPORATION (Exact name of registrant as specified in its charter) NEW YORK 31-0267900 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 222 W. LAS COLINAS BOULEVARD SUITE 1500 IRVING, TEXAS 75039 ------------------------------- ------------------- (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 443-6500 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ---------------- COMMON STOCK, $1.25 PAR VALUE NEW YORK STOCK EXCHANGE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE Indicate by check mark 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 X No ------- ------ 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. [X] The aggregate market value of the Common Stock held by non-affiliates of the registrant as of February 23, 1999 (based on the closing sale price as reported on the New York Stock Exchange on such date) was approximately $632,068,000. The number of shares outstanding of the registrant's Common Stock as of February 23, 1999: 37,778,825 shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on or about April 22, 1999, are incorporated by reference into Part III of this Form 10-K. Portions of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1998, are incorporated by reference into Parts I, II and IV of this Form 10-K. ================================================================================

2 PART I ITEM 1. BUSINESS Flowserve Corporation ("Flowserve") was incorporated under the laws of the State of New York on May 1, 1912. On July 22, 1997, Flowserve (formerly known as Durco International Inc. and The Duriron Company, Inc.) merged with BW/IP, Inc. ("BW/IP") in a stock-for-stock merger of equals, accounted for as a pooling of interests, (hereafter the "Merger"). The Merger created one of the world's leading providers of industrial flow management services. All references herein to the "Company" or "Flowserve" refer collectively to Flowserve and its subsidiaries unless otherwise indicated by the context. Flowserve is principally engaged in the design, manufacture, distribution and service of industrial flow management equipment throughout the world. The Company provides pumps, valves and mechanical seals primarily for the refinery and pipeline segments of the petroleum industry, the chemical processing industry, the power generation industry and other industries requiring flow management products and services. Flowserve manufactures certain standard products, but specializes in the development of precision engineered equipment for critical service applications where high reliability is required. The Company's materials expertise, design and engineering capabilities and applications know-how have enabled it to develop product lines that are responsive to customers needs for manufacturing efficiency, reduced maintenance cost, and avoidance of premature equipment failure. An important element of Flowserve's business is its successful emphasis on providing aftermarket products and services. These consist of supplying parts, making repairs and providing a variety of technical services for the upgrade or retrofit of equipment to extend its useful life or improve its operating characteristics. The Company operates in three business segments: Rotating Equipment, Flow Control and Flow Solutions. Included in Note 12 to the consolidated financial statements on pages 35 through 38 of the 1998 Annual Report to Shareholders, provided as part of Item 8 of this Form 10-K and incorporated herein by reference, is information concerning the Company's sales, operating income and identifiable assets by business and geographic segment for each year in the three-year period ended December 31, 1998. For a significant portion of its products, the Company's domestic operations supply each other and the Company's foreign manufacturing subsidiaries with components and subassemblies. ROTATING EQUIPMENT PRODUCTS Through its Rotating Equipment Division business segment, the Company designs, manufactures and distributes pumps and related equipment. Pump products accounted for approximately 34.0%, 35.0% and 36.1% of the Company's sales to external customers in 1998, 1997 and 1996, respectively. Pumps are manufactured to industry-recognized standards, including those set by the American Petroleum Institute (API), the American National Standards Institute (ANSI) and the International Standards Organization (ISO). Pump products for the petroleum industry include horizontal double case pumps used especially for hot oils under high pressure, horizontal multi-stage pumps used in pipelines, vertical pumps used for low specific gravity applications, vertical circulating pumps used for cooling water, submersible pumps used for water or brine injection in oil fields, and submersible water pumps used on offshore platforms to supply water for fire fighting. 1

3 Pump products for chemical processing industries include metallic and nonmetallic pumps, varying in size, capacity, material components and sealant specifications. These pumps are used primarily to move liquids during processing activities, but also in auxiliary services such as waste removal, water treatment and pollution control. The pumps are modular in design and manufactured to withstand the abrasive and/or corrosive service fluids being processed by customers in these industries. Pump products for the power generating industry include a variety of pumps used in both nuclear and fossil fuel facilities to generate steam. Products for the fossil fuel power generation industry are horizontal double case pumps for high pressure boiler feed applications, horizontal multi-stage pumps for low pressure boiler feed applications, vertical double case pumps and vertical circulating pumps. The Company supplies pumps for other industrial uses, including without limitation industrial production, utility services, pollution control, mining operations and municipal water transport. MARKETING AND DISTRIBUTION Pumps or pump components are produced in plant facilities in the United States (one in California, one in Oklahoma, one in Ohio, two in New Mexico), Mexico, Argentina, Belgium and two in The Netherlands. Pump manufacturing facilities in The Netherlands and Belgium are key sources of pumps sold in Europe, Africa and the Middle East. The Argentine facility provides products primarily for Argentine customers, but also serves customers in other South American countries. The Company's Mexican operation manufactures pumps for export and for Mexican customers. Large vertical circulating pumps manufactured in Mexico are distributed worldwide. A majority-owned joint venture in India, which began production in late 1997, manufactures ANSI and ISO pump components which are assembled in Belgium. The two specialized component manufacturing facilities in New Mexico provide a significant portion of pump components (except for ANSI pump components). The component facilities also supply components to other Company plants outside of the U.S. on an economically selective basis. The Company's pump products are primarily marketed to end-users and engineering contractors through the Company's worldwide pump sales force, regional service centers, independent distributors and representatives and, for modular pumps, a national parts distribution center. The majority of the Company's sales of pump products in the nuclear power market are in the United States and Japan, where the Company's large installed base of equipment provides a continuing market for products and services to ensure safety and reliability, major customer concerns. A significant characteristic of the nuclear market worldwide is the stringent requirements that must be met in order to sell products to nuclear power plants. For example, the Company maintains a Nuclear Stamp ("N Stamp") from the American Society of Mechanical Engineers, which is required for qualification to supply certain kinds of products to the U.S. nuclear industry. The Company could face liability in excess of its own commercial or government provided insurance if any of its products were found to contribute to an accident at a nuclear power facility or at other industrial facilities. The Company does not maintain nuclear liability insurance for the United States or Canada, but maintains an aggregate of $15 million in nuclear liability insurance for all other countries. The Federal Price-Anderson Act of 1954 provides U.S. nuclear utilities with a system of no-fault insurance coverage in an amount up to about $8.7 billion for third party losses or damages resulting from a nuclear incident. 2

4 BACKLOG The Rotating Equipment Division's backlog of orders at December 31, 1998, was $162.7 million, compared to $169.4 million at December 31, 1997. The Company believes that a very high percentage of the current backlog will be shipped by December 31, 1999. FLOW CONTROL PRODUCTS Through its Flow Control Division business segment, the Company designs, manufactures and distributes quarter-turn manual valves, automatic control valves, actuators, and related components. Valve products accounted for approximately 27.3%, 26.5% and 25.0% of the Company's sales to external customers in 1998, 1997 and 1996, respectively. Valves are used to control the flow of liquids and gases. Valve products for industrial processing systems include plug and butterfly valves made of various metals, alloys and plastics and lined ball valves. Actuators and other control accessories manufactured by the Company are either sold independently or mounted on valves to move them from open to closed positions and to various specified positions in between. Valve products for the nuclear power market include a complete line of gate, globe and check valves (including valve actuators). Automatic control valves include high pressure valves, rotary valves, and anti-noise and anti-cavitation valves. These valves are generally sold with an actuator. "Smart" valve technologies have been incorporated into various control valve products to provide more efficient process control. Through a technology alliance with Honeywell Inc., a manufacturer of computerized control systems and software for process plants, the Company's "smart" and control valve technologies are being incorporated in Honeywell's distributed control systems. MARKETING AND DISTRIBUTION Valves are produced at facilities in the United States (two in Utah, one in Pennsylvania, and one in Tennessee), Australia, France, Germany (one in Ahaus, one in Essen) and Switzerland. Actuators are produced at facilities in the United States (Utah and Ohio), Germany, France, and Italy. Two Company majority-owned joint ventures in India (which began production in late 1997) manufacture valves for export to U.S., Asian and European markets. In 1998 the Company acquired Valtek Engineering Division of Rolls Royce plc, a former licensee with territorial rights covering certain Company control valves in parts of Europe, the Middle East and Africa. Manual valve products and valve actuators are distributed through the Company's sales personnel and through a network of independent stocking distributors. Automatic control valves are marketed through specialized sales offices with engineers and service centers or on a commission basis through independent manufacturing representatives in principal marketing centers throughout the United States and other countries. BACKLOG The Flow Control Division's backlog of orders at December 31, 1998 was $69.8 million, compared to $67.0 million at December 31, 1997. The Company believes that virtually all of the current backlog will be shipped by December 31, 1999. FLOW SOLUTIONS PRODUCTS Through its Flow Solutions Division business segment, the Company designs, manufactures and distributes mechanical seals and sealing systems and provides service and repair for flow control equipment used in 3

5 process industries. Mechanical seal products and flow management services and repairs accounted for approximately 38.7%, 36.0% and 36.9% of the Company's sales to external customers in 1998, 1997 and 1996, respectively. The mechanical seal is critical to the smooth operation of centrifugal pumps, compressors and mixers because mechanical seals help prevent leakage between a rotating shaft and a stationary casing. In doing so, mechanical seals reduce shaft wear on pumps, compressors and mixers used in many industries. The Company's seals are used on a variety of pumps, mixers, compressors, steam turbines and specialty equipment, principally in the oil refining and chemical processing industries. The Company also manufactures a dry gas seal used in gas transmission and oil and gas production markets. In 1998, the Company acquired its former licensee's seal manufacturing and service business in Australia and the remaining ownership interests in its seal manufacturing joint venture in Singapore. The Company has established a global network of service facilities throughout the world which have the capability to provide service, repair and diagnostics for rotating equipment, including pumps, turbines, mixers and compressors, as well as numerous types of valves and mechanical seals. In 1998, the Company has expanded its service network with the acquisition of two European valve repair companies: ARS Loheren NV in Belgium and ZAR Beheer BV in The Netherlands, plus the acquisition of the assets of a Canadian service repair facility. The Company sees the opportunity to expand this service repair business, as many of its customers look for alternatives to their own in-house maintenance capabilities or to small and independent service facilities with limited expertise. MARKETING AND DISTRIBUTION Mechanical seals are primarily produced in facilities in the United States (one in California, one in Michigan), The Netherlands, Germany, Mexico, Argentina, Brazil, Singapore, New Zealand, Australia and Japan. Seal manufacturing facilities in The Netherlands and Germany are key sources of seals sold in Europe, Africa and the Middle East. The Company's mechanical seal products are primarily marketed through the Company's worldwide seals sales force directly to end users and engineering and construction firms. A portion of the Company's seal products is sold directly to original equipment ("OE") manufacturers for incorporation into pumps, compressors, mixers or other rotary equipment requiring seals. Distributors, dealers, commissioned representatives and sales agents are also used in the distribution and sale of mechanical seal products. Fully equipped service centers provide equipment maintenance, including major repairs, advanced diagnostics, installation, commissioning, re-rate and retrofit programs and full machining capabilities. A network of quick response centers provides local engineering, manufacturing and assembly capabilities for mechanical seals, as well as seal inventory. BACKLOG The Flow Solutions Division's backlog of orders at December 31, 1998, was $56.4 million compared to $54.4 million at December 31, 1997. The Company believes that virtually all of the current backlog will be shipped by December 31, 1999. GENERAL BUSINESS COMPETITION The markets for the Company's products are highly competitive. Competition occurs on the basis of price, technical expertise, delivery, contractual terms, previous installation history and reputation for quality. 4

6 Delivery speed and the proximity of service centers are important with respect to aftermarket products. Customers are generally more likely to rely on the Company than competitors for aftermarket products relating to its more highly engineered and customized products than for its standard products. Price competition tends to be more significant for OE manufacturers than aftermarket services and has been generally increasing. In the aftermarket portion of its service business, the Company competes against both large and well-established national or global competitors and, in some markets, against smaller regional and local companies, as well as the in-house maintenance departments of the Company's end-user customers. In the sale of aftermarket products and services, the Company benefits from the large installed base of pumps which require maintenance, repair and replacement parts. In the petroleum industry, the competitors for aftermarket services tend to be the customers themselves because of their in-house capabilities. In other industries, except the nuclear power industry, the competitors for aftermarket services tend to be low cost replicators of spare parts and local independent repair shops for the Company's products. The Company has certain competitive advantages in the nuclear power industry because it maintains the N Stamp that is required to service customers in that industry and because the Company has a considerable base of proprietary knowledge. Customers for the Company's products are attempting to reduce the number of vendors from which they purchase in order to reduce the size and diversity of their inventory. Although vendor reduction programs could adversely affect the Company's business, the Company has been successful in entering into "alliance" arrangements with a number of customers both in the United States and overseas which provide competitive advantages to the Company. RESEARCH AND DEVELOPMENT The Company conducts research and development at its own facilities in various locations. In 1998, 1997, and 1996, the Company spent approximately $14.7 million, $14.8 million, and $13.9 million, respectively, on Company-sponsored research and development, primarily for new product development and extensions. The Company's research and development group consists of engineers involved in new product development as well as the support and improvement of existing products. Additionally, the Company sponsors consortium programs for research with various universities and conducts limited development work jointly with certain of its vendors, licensees and customers. Management believes current expenditures are adequate to sustain ongoing research and development activities. CUSTOMERS The Company sells to a wide variety of customers. No individual customer accounted for more than 10% of the Company's 1998 net sales. RISKS OF INTERNATIONAL BUSINESS In 1998 42% of the Company's sales were outside the United States. The Company's activities thus are subject to the customary risks of operating in an international environment, such as unstable political situations, local laws, the potential imposition of trade restrictions or tariff increases and the relationship of the U.S. dollar to other currencies. The impact of these conditions is mitigated somewhat by the strength and diversity of the Company's product lines and geographic coverage. To minimize the impact of foreign exchange rate movements on its operating results, the Company enters into forward exchange contracts to hedge specific foreign currency denominated transactions. See Note 1 to consolidated financial statements on pages 25 and 26 of the 1998 Annual Report to Shareholders, which is incorporated by reference in this Form 10-K. The Company conducts substantial business activities in the Middle East. 5

7 INTELLECTUAL PROPERTY The Company owns a number of trademarks and patents relating to the name and design of its products. The Company considers its trademarks Byron Jackson(R), Durco(R), United Centrifugal(R), Durametallic(R), BW Seals(R), GASPAC(R), Pacific Wietz(TM), Five Star Seal(R), Wilson-Snyder(R), Valtek(R), Kammer(R), Sereg(TM) and Automax(R) to be important to its business. The patents underlying much of the technology for the Company's products have been in the public domain for many years. Surviving patents are not considered, either individually or in the aggregate, to be material to the Company's business. However, the Company's pool of proprietary information, consisting of know-how and trade secrets relating to the design, manufacture and operation of its products and their use, is considered particularly important and valuable. Accordingly the Company protects such proprietary information. The Company, in general, is the owner of the rights to the products which it manufactures and sells, and the Company is not dependent in any material way upon any license or franchise to operate. RAW MATERIALS The principal raw materials used by the Company in the manufacture of its products are normally readily available. While substantially all raw materials are purchased from outside sources, the Company has been able to obtain an adequate supply of raw materials, and no shortage of such materials is currently anticipated. The Company intends to expand its use of worldwide sourcing to capitalize on low cost sources of purchased goods. The Company is a vertically-integrated manufacturer of certain pump and valve products. Certain corrosion-resistant castings for Company pumps and quarter-turn valves are manufactured at its Dayton, Ohio foundries; other metal castings are purchased from outside sources. The Company also produces most of its highly engineered corrosion resistant plastic parts for certain pump and valve product lines. This includes rotomolding as well as injection and compression molding of a variety of fluorocarbon and other plastic materials. Suppliers of raw materials for nuclear markets must be qualified by the American Society of Mechanical Engineers and, accordingly, are limited in number. However, the Company to date has experienced no significant difficulty in obtaining such materials. EMPLOYEES AND LABOR RELATIONS The Company and its subsidiaries employ approximately 7,000 persons of whom approximately 55% work in the United States. The Company's hourly employees at its three principal U.S. pump manufacturing plants in Vernon, California, Dayton, Ohio, and Tulsa, Oklahoma, plus those at its valve manufacturing plant in Williamsport, Pennsylvania and at its foundries in Dayton, Ohio are represented by unions. The Company's operations in Mexico, The Netherlands, Germany and Belgium are unionized. The Company believes employee relations throughout its operations are satisfactory, including those represented by unions. ENVIRONMENTAL REGULATIONS AND PROCEEDINGS The Company is subject to environmental laws and regulations in all jurisdictions in which it has operating facilities. The Company periodically makes capital expenditures for pollution abatement and control to meet environmental requirements. At present, the Company has no plans for any material capital expenditures for environmental control facilities. However, the Company has experienced and continues to experience 6

8 operating costs relating to environmental matters, although certain costs have been offset by the Company's successful waste minimization programs. The Company believes that future environmental compliance expenditures will not have a material adverse effect on its financial position and has established allowances which it believes to be adequate to cover potential environmental liabilities. EXPORTS Licenses are required from U.S. government agencies to export certain of the Company's products from the United States. In particular, products with nuclear applications are restricted, although limitations are placed on the export of certain other pump, valve and mechanical seal products. The Company's export sales from the United States to foreign unaffiliated customers were $130,766 in 1998, $146,704 in 1997 and $140,842 in 1996. - -------------------------------------------------------------------------------- FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY This 1998 Annual Report on Form 10-K, including Management's Discussion and Analysis, contains various forward-looking statements and includes assumptions about the Company's future market conditions, operations and results. These statements are based on current expectations and are subject to significant risks and uncertainties. They are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Among the many factors that could cause actual results to differ materially from the forward-looking statements are: further changes in the already competitive environment for the Company's products or competitors' responses to the Company's strategies; political risks or trade embargoes affecting important country markets; the health of the petroleum, chemical and power industries; economic turmoil in areas outside the United States; continued economic growth within the United States; unanticipated difficulties or costs or reduction in benefits associated with the implementation of the Company's "Flowserver" business process improvement initiative, including software; the impact of the "Year 2000" computer issue; and the recognition of significant expenses associated with adjustments to realign the combined Company's facilities and other capabilities with its strategic and business conditions. The Company undertakes no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise. - -------------------------------------------------------------------------------- 7

9 ITEM 2. PROPERTIES The Company's corporate headquarters is a leased facility in Irving, Texas encompassing approximately 34,000 square feet. The location, size and products manufactured at the Company's principal manufacturing facilities are as follows: LOCATION SQUARE FOOTAGE PRODUCTS MANUFACTURED -------- -------------- --------------------- DOMESTIC: Dayton, Ohio 600,000 Castings and pumps Tulsa, Oklahoma 320,000 Pumps Vernon, California 273,000 Pumps Cookeville, Tennessee 190,000 Valves Williamsport, Pennsylvania 141,000 Valves Springville, Utah 140,000 Valves and actuators Kalamazoo, Michigan 137,000 Mechanical seals Temecula, California 64,000 Mechanical seals Springboro, Ohio 50,000 Plastic components for pumps and valves Albuquerque, New Mexico 50,000 Components for pumps INTERNATIONAL: Etten-Leur, The Netherlands 175,000 Pumps Santa Clara, Mexico 154,000 Pumps and mechanical seals Mendoza, Argentina 81,000 Pumps and mechanical seals Dortmund, Germany 70,000 Mechanical seals Ahaus, Germany 68,000 Valves Petit Rechain, Belgium 65,000 Pumps and valves Essen, Germany 50,000 Valves and actuators Hengelo, The Netherlands 49,400 Pumps Roosendaal, The Netherlands 48,400 Mechanical seals All of the Company's principal manufacturing facilities are owned with the exception of the facilities in Springboro, Ohio; Hengelo, The Netherlands; and Dortmund, Germany. On the average, the Company utilizes approximately 80% to 90% of its manufacturing capacity, although there is a variation in usage rate among the facilities. The Company could, in general, increase its capacity through the purchase of new or additional manufacturing equipment without obtaining additional facilities. The Company maintains a substantial network of domestic and foreign service centers and sales offices most of which are leased. ITEM 3. LEGAL PROCEEDINGS The Company is involved in ordinary routine litigation incidental to its business, none of which it believes to be material to its financial condition. For further information about such litigation, see Note 9 of the Financial Statements, provided as part of Item 8 of this Form 10-K and incorporated herein by reference. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 8

10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock of the Company (FLS) is traded on the New York Stock Exchange. In February 1999, the Company's records showed approximately 2,300 shareholders of record. Based on these records plus requests from brokers and nominees listed as shareholders of record, the Company estimates there are approximately 11,200 beneficial owners of its common stock. In 1998 and 1997, the Company paid a dividend of fourteen cents per share each calendar quarter. PRICE RANGE OF FLOWSERVE COMMON STOCK (INTRADAY HIGH/LOW PRICES) 1998 1997 ---- ---- First Quarter $33.75/$26.50 $27.13/$21.88 Second Quarter $32.44/$24.25 $30.00/$21.25 Third Quarter $25.50/$17.75 $36.69/$28.63 Fourth Quarter $20.38/$15.38 $30.69/$26.00 During 1998, 1997 and 1996, the Company issued 10,165, 21,700 and 29,900 shares of restricted common stock, respectively, pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933. Shares were issued for the benefit of directors and officers of the Company subject to restrictions on transfer. ITEM 6. SELECTED FINANCIAL DATA Selected financial data for the five years ended December 31, 1998, which appears on page 39 of the 1998 Annual Report to Shareholders, is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS Management's Discussion and Analysis appears on pages 14 through 20 of the 1998 Annual Report to Shareholders and is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Disclosure about market risk appears on page 18 of the Company's 1998 Annual Report to Shareholders under the heading "Market Risks Associated With Financial Instruments" and is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements appearing on pages 21 through 38 of the 1998 Annual Report to Shareholders, together with the report thereon of Ernst & Young LLP, dated February 9, 1999, appearing on page 13 of the 1998 Annual Report to Shareholders, and supplementary data appearing on page 38 of the 1998 Annual Report to Shareholders are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 9

11 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained under the heading "Election of Directors" in the definitive Proxy Statement for the Annual Meeting of Shareholders to be held on or about April 22, 1999, (the "1999 Proxy Statement") is incorporated herein by reference. The executive officers of the Company, all positions and offices presently held by each person named, their ages as of February 15, 1999, and their business experience during the last five years are stated below. Executive officers serve at the discretion of the Board of Directors. Name and Position Age Principal Occupation During Past Five Years ----------------- --- ------------------------------------------- Bernard G. Rethore 57 Chairman of the Board of Directors and Chief Executive Chairman of the Board of Directors, Officer since 1997 and President since 1998; Chairman President and Chief Executive Officer of the Board of Directors of BW/IP in 1997 and President and Chief Executive Officer and a Director of BW/IP from 1995 to 1997; Senior Vice President of Phelps Dodge Corporation and President of Phelps Dodge Industries, its diversified international manufacturing business, from 1989 to 1995. Renee J. Hornbaker 46 Vice President and Chief Financial Officer since Vice President and December 1997; Vice President, Business Development Chief Financial Officer and Chief Information Officer in 1997; Vice President, Finance and Chief Financial Officer of BW/IP in 1997; Vice President, Business Development of BW/IP from 1996 to 1997; Director-Business Analysis and Planning of Phelps Dodge Industries, the diversified international manufacturing business of Phelps Dodge Corporation in 1996 and Director Financial Analysis and Control from 1991 to 1996. Rick L. Johnson 46 Vice President, Business Development since January 1998 Vice President, and Controller since November 1998; Vice President and Business Development and Controller Controller of the Industrial Products Division from 1997 to January 1998; Industrial Products Group Vice President and Controller from 1995 to 1997; President Durco Valtek (Singapore) from 1993 to 1995; Corporate Controller 1991 to 1993. Rory E. MacDowell 48 Vice President and Chief Information Officer since Vice President and 1998; Chief Information Officer of Keystone International, Chief Information Officer Inc., a manufacturer and distributor of flow control products from 1993 to 1997; various information technology management positions in the oilfield services division of Schlumberger from 1985 to 1993. Cheryl D. McNeal 48 Vice President, Human Resources since 1996; Assistant Vice President, Vice President, Human Resources and other Human Human Resources Resource management positions at NCR from 1978 to 1996. 10

12 George A. Shedlarski 54 President, Flow Solutions Division since January 1999; President, Flow Solutions Division President, Fluid Sealing Division from 1997 to 1999; President, ServiceRepair Division in 1997; President Rotating Equipment Group in 1997; Group Vice President, Industrial Products Group from 1994 to 1997; Vice President U.S. Operations from 1990 to 1994. Ronald F. Shuff 46 Vice President since 1990 and Secretary and General Vice President, Secretary and Counsel since 1989 . General Counsel Mark E. Vernon 46 President, Flow Control Division since 1997; President, President, Flow Control Division Industrial Products Division in 1997; Group Vice President, Flow Control Group from 1993 to 1997. Howard D. Wynn 51 President, Rotating Equipment Division since 1997; President, Rotating Equipment Division Vice President of BW/IP and President, Pump Division from 1996 to 1997; Vice President of the BW/IP Pump Division from 1993 to 1996. Scott E. Messel 40 Treasurer since 1998; Vice President and Director, International Treasurer Treasury from 1994 to December 1997, plus other increasingly responsible management positions from 1983 to 1994, at Ralston Purina Company, a manufacturer of pet foods, food-related products and battery products. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is set forth in the 1999 Proxy Statement and is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is set forth in the 1999 Proxy Statement under the heading "Security Ownership" and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13 is set forth to the extent applicable in the 1999 Proxy Statement and is incorporated herein by reference. 11

13 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements The financial statements, appearing on pages 21 through 38 of the 1998 Annual Report to Shareholders, together with the report thereon of Ernst & Young LLP, dated February 9, 1999, appearing on page 13 of the 1998 Annual Report to Shareholders, and the report of Price Waterhouse LLP dated January 28, 1997, listed in the accompanying index on page F-1, are incorporated herein by reference. 2. Financial Statement Schedules The required financial statement schedule together with the reports thereon of Ernst & Young LLP dated February 9, 1999, and Price Waterhouse LLP dated January 28, 1997, listed in the accompanying index on page F-1, is filed as part of this Form 10-K. 3. Exhibits The exhibits listed on the accompanying index to exhibits on pages 13 through 18 are filed as part of this Form 10-K. (b) Reports on Form 8-K None. (c) See Item 14(a) 3 above. (d) See Item 14(a) 2 above. 12

14 INDEX TO EXHIBITS* EXHIBIT DESCRIPTION NO. 2.1 Agreement and Plan of Merger dated as of May 6, 1997, among the Company, Bruin Acquisition Corp. and BW/IP, Inc. ("BW/IP") was filed as Annex 1 to the Joint Proxy Statement/Prospectus which is part of the Registration Statement on Form S-4, dated June 19, 1997. 3.1 1988 Restated Certificate of Incorporation of The Duriron Company, Inc. was filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988. 3.2 1989 Amendment to Certificate of Incorporation was filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989. 3.3 By-Laws of The Duriron Company, Inc. (as restated) were filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987. 3.4 1996 Certificate of Amendment of Certificate of Incorporation was filed as Exhibit 3.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 3.5 Amendment No. 1 to Restated Bylaws was filed as Exhibit 3.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 3.6 April 1997 Certificate of Amendment of Certificate of Incorporation was filed as part of Annex VI to the Joint Proxy Statement/Prospectus which is part of the Registration Statement on Form S-4, dated June 19, 1997. 3.7 July 1997 Certificate of Amendment of Certificate of Incorporation was filed as Exhibit 3.6 to the Company's Quarterly Report on Form 10-Q, for the Quarter ended June 30, 1997. 4.1 Lease agreement and indenture, dated as of January 1, 1995 and bond purchase agreement dated January 27, 1995, in connection with an 8% Taxable Industrial Development Revenue Bond, City of Albuquerque, New Mexico. (Relates to a class of indebtedness that does not exceed 10% of the total assets of the Company. The Company will furnish a copy of the documents to the Commission upon request.) 4.2 Rights Agreement dated as of August 1, 1986 between the Company and BankOne, N.A., as Rights Agent, which includes as Exhibit B thereto the Form of Rights Certificate which was filed as Exhibit 1 to the Company's Registration Statement on Form 8-A on August 13, 1986. 4.3 Amendment dated August 1, 1996, to Rights Agreement was filed as Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. 13

15 4.4 Amendment No. 2 dated as of June 1, 1998, to the Rights Agreement dated as of August 13, 1986, and amended as of August 1, 1996, was filed as Exhibit 1 to the Company's Form 8-A/A dated June 11, 1998. 4.5 Interest Rate and Currency Exchange Agreement between the Company and Barclays Bank PLC dated November 17, 1992 in the amount of $25,000,000 was filed as Exhibit 4.9 to Company's Annual Report on Form 10-K for year ended December 31, 1992. 4.6 Credit Agreement dated as of November 26, 1997, among Flowserve Corporation, Bank of America National Trust and Savings Association as Agent and Letter of Credit Issuing Bank and the other Financial Institutions Party thereto was filed as Exhibit 4.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 4.7 Material Subsidiary Guarantee, dated as of November 26, 1997, by BW/IP International, Inc. in favor of and for the benefit of Bank of America National Trust and Savings Association, as Agent, was filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 4.8 Rate Swap Agreement in the amount of $25,000,000 between the Company and National City Bank dated November 14, 1996 was filed as Exhibit 4.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 4.9 Rate Swap Agreement in the amount of $25,000,000 between the Company and Key Bank National Association dated October 28, 1996 was filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 4.10 Guaranty, dated August 1, 1997 between Flowserve Corporation and ABN-AMRO Bank N.V. was filed as Exhibit 4.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. 4.11 Credit Agreement, dated as of September 10, 1993, between BW/IP International B.V. and ABN/AMRO was filed as Exhibit 10.dd to BWIP's Annual Report on Form 10-K for the year ended December 31, 1993. 4.12 Note Agreement, dated as of November 15, 1996, between BW/IP International, Inc. and the Note Purchasers named therein, with respect to $30,000,000 principal amount of 7.14% Senior Notes, Series A, due November 15, 2006, and $20,000,000 principal amount of 7.17% Senior Notes, Series B, due March 31, 2007, was filed as Exhibit 4.1 to BW/IP's Registration Statement on Form S-8 (Registration No. 333-21637) as filed February 12, 1997. 4.13 Note Agreement, dated as of April 15, 1992, between BW/IP International, Inc. and the Note Purchasers named therein, with respect to $50,000,000 principal amount of 7.92% Senior Notes due May 15, 1999, filed as Exhibit 4.a to BW/IP's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992. 10.1 Flowserve Corporation Incentive Compensation Plan (the "Incentive Plan") for Senior Executives, as amended and restated effective January 1, 1994, was filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 14

16 10.2 Amendment No. 1 to the Incentive Plan was filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.3 Amendment No. 2 to the Incentive Plan was filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.** 10.4 Amendment No. 3 to the Incentive Plan (filed herewith).** 10.5 Supplemental Pension Plan for Salaried Employees was filed with the Commission as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.** 10.6 Flowserve Corporation amended and restated Director Deferral Plan was filed as Attachment A to the Company's definitive 1996 Proxy Statement filed with the Commission on March 10, 1996.** 10.7 Form of Change in Control Agreement between all executive officers and the Company was filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 10.8 First Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.** 10.9 Amendment No. 1 to the first Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.10 Amendment No. 2 to First Master Benefit Trust Agreement was filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.11 Second Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.** 10.12 First Amendment to Second Master Benefit Trust Agreement was filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.13 Long-Term Incentive Plan (the "Long-Term Plan"), as amended and restated effective November 1, 1993 was filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.14 Amendment No. 1 to the Long-Term Plan was filed as Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.15 Flowserve Corporation 1989 Stock Option Plan as amended and restated effective January 1, 1997 was filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 15

17 10.16 Flowserve Corporation Second Amendment to the 1989 Stock Option Plan as previously amended and restated was filed as Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.** 10.17 Flowserve Corporation 1989 Restricted Stock Plan (the "1989 Restricted Stock Plan") as amended and restated effective January 1, 1997 was filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 10.18 Flowserve Corporation Retirement Compensation Plan for Directors ("Director Retirement Plan") was filed as Exhibit 10.15 to the Company's Annual Report to Form 10-K for the year ended December 31, 1988.** 10.19 Amendment No. 1 to Director Retirement Plan was filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.20 The Company's Benefit Equalization Pension Plan (the "Equalization Plan") was filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.** 10.21 Amendment # 1 dated December 15, 1992 to the Equalization Plan was filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.22 The Company's Equity Incentive Plan as amended and restated effective July 21, 1995 was filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.23 Supplemental Pension Agreement between the Company and William M. Jordan dated January 18, 1993 was filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.24 1979 Stock Option Plan, as amended and restated April 23, 1991, and Amendment #1 thereto dated December 15, 1992, was filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.25 Flowserve Corporation Deferred Compensation Plan for Executives was filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.26 Executive Life Insurance Plan of Flowserve Corporation was filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.27 Executive Long-Term Disability Plan of The Duriron Company, Inc. was filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.28 Employee Protection Plan, as revised effective March 1, 1997 (which provides certain severance benefits to employees upon a change of control of the Company) was filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 16

18 10.29 Flowserve Corporation 1997 Stock Option Plan was included as Exhibit A to the Company's 1997 Proxy Statement which was filed with the Commission on March 17, 1997.** 10.30 Flowserve Corporation First Amendment to 1997 Stock Option Plan was filed as Exhibit 10.28 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. ** 10.31 BW/IP International, Inc. Supplemental Executive Retirement Plan as amended and restated was filed as Exhibit 10.27 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.** 10.32 Flowserve Corporation 1998 Restricted Stock Plan was included as Exhibit A to the Company's 1998 Proxy Statement which was filed with the Commission on April 9, 1998.** 10.33 Form of Employment Agreement between the Company and certain executive officers was filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. ** 10.34 Amendment No. 1 to the amended and restated Director Deferral Plan was filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. ** 10.35 Amendment No. 2 to the amended and restated Director Deferral Plan was filed as Exhibit 10.34 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.** 10.36 Amendment No. 1 to the 1989 Restricted Stock Plan as amended and restated was filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.** 10.37 Employment Agreement, effective July 22, 1997, between the Company and Bernard G. Rethore was filed as Exhibit 10.53 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. ** 10.38 Employment Agreement, effective July 22, 1997, between the Company and William M. Jordan was filed as Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. ** 10.39 Amendment No. 1 to Employment Agreement between the Company and William M. Jordan was filed as Exhibit 10.38 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.** 13.1 1998 Annual Report to Shareholders (filed herewith as part of this report to the extent incorporated herein by reference). 18.1 Letter from Ernst & Young LLP regarding change in accounting principles (filed herewith). 21.1 Subsidiaries of the Company (filed herewith). 17

19 23.1 Consent of Ernst & Young LLP (filed herewith). 23.2 Consent of PricewaterhouseCoopers LLP (filed herewith). 27.1 Financial Data Schedule submitted to the SEC in electronic format (filed herewith). 27.2 Restated Financial Data Schedule submitted to the SEC in electronic format (filed herewith). "*" For exhibits of the Company incorporated by reference into this Annual Report on Form 10-K from a previous filing with the Commission, the Company's file number with the Commission since July 1997 is "1-13179" and the previous file number was "0-325". All filings of BW/IP, Inc. incorporated by reference in this Annual Report on Form 10-K cover the periods prior to July 22, 1997. "**" Management contracts and compensatory plans and arrangements required to be filed as exhibits to this Annual Report on Form 10-K. 18

20 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 19th day of February 1999. FLOWSERVE CORPORATION (Registrant) By: /s/ Bernard G. Rethore ------------------------------------------------ Bernard G. Rethore Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. SIGNATURE TITLE DATE - --------- ----- ---- /s/ BERNARD G. RETHORE Chairman, President and February 19, 1999 - --------------------------------- Chief Executive Officer Bernard G. Rethore (Principal Executive Officer) /s/ RENEE J. HORNBAKER Vice President and Chief Financial Officer February 19, 1999 - --------------------------------- (Principal Financial Officer) Renee J. Hornbaker /s/ RICK L. JOHNSON Vice President Business Development February 19, 1999 - --------------------------------- And Controller Rick L. Johnson (Principal Accounting Officer) /s/ WILLIAM C. RUSNACK Director, Chairman of Audit/Finance Committee February 19, 1999 - --------------------------------- William C. Rusnack /s/ DIANE C. HARRIS Director, Member Audit/Finance Committee February 19, 1999 - --------------------------------- Diane C. Harris /s/ CHARLES M. RAMPACEK Director, Member Audit/Finance Committee February 19, 1999 - ----------------------- Charles M. Rampacek /s/ JAMES O. ROLLANS Director, Member Audit/Finance Committee February 19, 1999 - --------------------------------- James O. Rollans /s/ R. ELTON WHITE Director, Member Audit/Finance Committee February 19, 1999 - --------------------------------- R. Elton White 19

21 FLOWSERVE CORPORATION INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES ITEM 14(a)(1) AND (2) ANNUAL REPORT ANNUAL REPORT TO ON SHAREHOLDERS FORM 10-K ------------ ------------- Flowserve Corporation Consolidated Financial Statements Reports of Independent Auditors 13 F-2 Consolidated Balance Sheets at 22 December 31, 1998 and 1997 For each of the three years in the period ended December 31, 1998: Consolidated Statements of Income 21 Consolidated Statements of Comprehensive Income 21 Consolidated Statements of Shareholders' Equity 23 Consolidated Statements of Cash Flows 24 Notes to Consolidated Financial Statements 25-38 Flowserve Corporation Financial Statement Schedule for each of the three years in the period ended December 31, 1998 Reports of Independent Auditors on Financial Statement Schedule F-3 - F-4 Schedule II - Valuation and Qualifying Accounts F-5 Financial statement schedules not included in this Annual Report on Form 10-K have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto. F-1

22 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of BW/IP, Inc. In our opinion, the consolidated statements of income and retained earnings and of cash flows of BW/IP, Inc. (not presented separately herein) present fairly, in all material respects, the results of operations and cash flows of BW/IP, Inc. and its subsidiaries for the year ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Los Angeles, California January 28, 1997 F-2

23 REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Shareholders Flowserve Corporation We have audited the consolidated financial statements of Flowserve Corporation and subsidiaries as of December 31, 1998 and 1997, and for each of the three years in the period ending December 31, 1998, and have issued our report thereon dated February 9, 1999 appearing on page 13 of the 1998 Annual Report (which report and consolidated financial statements are incorporated by reference in this Form 10-K). Our audits also included the financial statement schedule listed in Item 14(a) of this Form 10-K. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the schedule based on our audits. We did not audit the 1996 financial statements of BW/IP, Inc., a wholly owned subsidiary, which statements reflect total assets constituting 49% of the related consolidated total as of December 31, 1996, and total revenues constituting 45% of the related totals for the year ended December 31, 1996. We have been furnished with the report of other auditors with respect to the financial statement schedule listed in item 14(a) of the Form 10-K of BW/IP, Inc. In our opinion, based on our audits and the report of other auditors, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/Ernst & Young LLP Dallas, Texas February 9, 1999 F-3

24 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors of BW/IP, Inc. Our audit of the consolidated financial statements (not presented separately herein) referred to in our report dated January 28, 1997, of BW/IP, Inc. appearing on page F-2 of this Annual Report on Form 10-K also included an audit of the Financial Statement Schedules of BW/IP, Inc. for the year ended December 31, 1996 (not presented separately herein). In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PRICE WATERHOUSE LLP Los Angeles, California January 28, 1997 F-4

25 FLOWSERVE CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS) Column A Column B Column C Column D Column E -------- -------- -------- -------- -------- Balance at Additions Deductions Balance at beginning Charged to from reserve end of of year Earnings year Description Year ended December 31, 1998: Allowance for doubtful accounts (a): $ 5,059 $ 333 $ 859 $ 4,533 ======= ======= ======= ======= Year ended December 31, 1997: Allowance for doubtful accounts (a): $ 4,826 $ 2,458 $ 2,225 $ 5,059 ======= ======= ======= ======= Year ended December 31, 1996: Allowance for doubtful accounts (a): $ 5,183 $ 1,786 $ 2,143 $ 4,826 ======= ======= ======= ======= Year ended December 31, 1998: Inventory reserves (b): $17,045 $ 3,388 $ 4,742 $16,051 ======= ======= ======= ======= Year ended December 31, 1997: Inventory reserves (b): $13,716 $ 4,308 $ 619 $17,405 ======= ======= ======= ======= Year ended December 31, 1996: Inventory reserves (b): $16,252 $ 860 $ 3,396 $13,716 ======= ======= ======= ======= (a) Deductions from reserve represent accounts written off net of recoveries. (b) Deductions from reserve represent inventory written off. F-5

26 INDEX TO EXHIBITS* EXHIBIT DESCRIPTION NO. 2.1 Agreement and Plan of Merger dated as of May 6, 1997, among the Company, Bruin Acquisition Corp. and BW/IP, Inc. ("BW/IP") was filed as Annex 1 to the Joint Proxy Statement/Prospectus which is part of the Registration Statement on Form S-4, dated June 19, 1997. 3.1 1988 Restated Certificate of Incorporation of The Duriron Company, Inc. was filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988. 3.2 1989 Amendment to Certificate of Incorporation was filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989. 3.3 By-Laws of The Duriron Company, Inc. (as restated) were filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987. 3.4 1996 Certificate of Amendment of Certificate of Incorporation was filed as Exhibit 3.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 3.5 Amendment No. 1 to Restated Bylaws was filed as Exhibit 3.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. 3.6 April 1997 Certificate of Amendment of Certificate of Incorporation was filed as part of Annex VI to the Joint Proxy Statement/Prospectus which is part of the Registration Statement on Form S-4, dated June 19, 1997. 3.7 July 1997 Certificate of Amendment of Certificate of Incorporation was filed as Exhibit 3.6 to the Company's Quarterly Report on Form 10-Q, for the Quarter ended June 30, 1997. 4.1 Lease agreement and indenture, dated as of January 1, 1995 and bond purchase agreement dated January 27, 1995, in connection with an 8% Taxable Industrial Development Revenue Bond, City of Albuquerque, New Mexico. (Relates to a class of indebtedness that does not exceed 10% of the total assets of the Company. The Company will furnish a copy of the documents to the Commission upon request.) 4.2 Rights Agreement dated as of August 1, 1986 between the Company and BankOne, N.A., as Rights Agent, which includes as Exhibit B thereto the Form of Rights Certificate which was filed as Exhibit 1 to the Company's Registration Statement on Form 8-A on August 13, 1986. 4.3 Amendment dated August 1, 1996, to Rights Agreement was filed as Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. 4.4 Amendment No. 2 dated as of June 1, 1998, to the Rights Agreement dated as of August 13, 1986, and amended as of August 1, 1996, was filed as Exhibit 1 to the Company's Form 8-A/A dated June 11, 1998.

27 4.5 Interest Rate and Currency Exchange Agreement between the Company and Barclays Bank PLC dated November 17, 1992 in the amount of $25,000,000 was filed as Exhibit 4.9 to Company's Annual Report on Form 10-K for year ended December 31, 1992. 4.6 Credit Agreement dated as of November 26, 1997, among Flowserve Corporation, Bank of America National Trust and Savings Association as Agent and Letter of Credit Issuing Bank and the other Financial Institutions Party thereto was filed as Exhibit 4.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 4.7 Material Subsidiary Guarantee, dated as of November 26, 1997, by BW/IP International, Inc. in favor of and for the benefit of Bank of America National Trust and Savings Association, as Agent, was filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 4.8 Rate Swap Agreement in the amount of $25,000,000 between the Company and National City Bank dated November 14, 1996 was filed as Exhibit 4.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 4.9 Rate Swap Agreement in the amount of $25,000,000 between the Company and Key Bank National Association dated October 28, 1996 was filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 4.10 Guaranty, dated August 1, 1997 between Flowserve Corporation and ABN-AMRO Bank N.V. was filed as Exhibit 4.12 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. 4.11 Credit Agreement, dated as of September 10, 1993, between BW/IP International B.V. and ABN/AMRO was filed as Exhibit 10.dd to BWIP's Annual Report on Form 10-K for the year ended December 31, 1993. 4.12 Note Agreement, dated as of November 15, 1996, between BW/IP International, Inc. and the Note Purchasers named therein, with respect to $30,000,000 principal amount of 7.14% Senior Notes, Series A, due November 15, 2006, and $20,000,000 principal amount of 7.17% Senior Notes, Series B, due March 31, 2007, was filed as Exhibit 4.1 to BW/IP's Registration Statement on Form S-8 (Registration No. 333-21637) as filed February 12, 1997. 4.13 Note Agreement, dated as of April 15, 1992, between BW/IP International, Inc. and the Note Purchasers named therein, with respect to $50,000,000 principal amount of 7.92% Senior Notes due May 15, 1999, filed as Exhibit 4.a to BW/IP's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992. 10.1 Flowserve Corporation Incentive Compensation Plan (the "Incentive Plan") for Senior Executives, as amended and restated effective January 1, 1994, was filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.2 Amendment No. 1 to the Incentive Plan was filed as Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.3 Amendment No. 2 to the Incentive Plan was filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.** 10.4 Amendment No. 3 to the Incentive Plan (filed herewith).**

28 10.5 Supplemental Pension Plan for Salaried Employees was filed with the Commission as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.** 10.6 Flowserve Corporation amended and restated Director Deferral Plan was filed as Attachment A to the Company's definitive 1996 Proxy Statement filed with the Commission on March 10, 1996.** 10.7 Form of Change in Control Agreement between all executive officers and the Company was filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 10.8 First Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.** 10.9 Amendment No. 1 to the first Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.10 Amendment No. 2 to First Master Benefit Trust Agreement was filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.11 Second Master Benefit Trust Agreement dated October 1, 1987 was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987.** 10.12 First Amendment to Second Master Benefit Trust Agreement was filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.13 Long-Term Incentive Plan (the "Long-Term Plan"), as amended and restated effective November 1, 1993 was filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.** 10.14 Amendment No. 1 to the Long-Term Plan was filed as Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.15 Flowserve Corporation 1989 Stock Option Plan as amended and restated effective January 1, 1997 was filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 10.16 Flowserve Corporation Second Amendment to the 1989 Stock Option Plan as previously amended and restated was filed as Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.** 10.17 Flowserve Corporation 1989 Restricted Stock Plan (the "1989 Restricted Stock Plan") as amended and restated effective January 1, 1997 was filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 10.18 Flowserve Corporation Retirement Compensation Plan for Directors ("Director Retirement Plan") was filed as Exhibit 10.15 to the Company's Annual Report to Form 10-K for the year ended December 31, 1988.**

29 10.19 Amendment No. 1 to Director Retirement Plan was filed as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.20 The Company's Benefit Equalization Pension Plan (the "Equalization Plan") was filed as Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.** 10.21 Amendment # 1 dated December 15, 1992 to the Equalization Plan was filed as Exhibit 10.18 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.22 The Company's Equity Incentive Plan as amended and restated effective July 21, 1995 was filed as Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.23 Supplemental Pension Agreement between the Company and William M. Jordan dated January 18, 1993 was filed as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.24 1979 Stock Option Plan, as amended and restated April 23, 1991, and Amendment #1 thereto dated December 15, 1992, was filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.25 Flowserve Corporation Deferred Compensation Plan for Executives was filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.** 10.26 Executive Life Insurance Plan of Flowserve Corporation was filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.27 Executive Long-Term Disability Plan of The Duriron Company, Inc. was filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.** 10.28 Employee Protection Plan, as revised effective March 1, 1997 (which provides certain severance benefits to employees upon a change of control of the Company) was filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996.** 10.29 Flowserve Corporation 1997 Stock Option Plan was included as Exhibit A to the Company's 1997 Proxy Statement which was filed with the Commission on March 17, 1997.** 10.30 Flowserve Corporation First Amendment to 1997 Stock Option Plan was filed as Exhibit 10.28 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. ** 10.31 BW/IP International, Inc. Supplemental Executive Retirement Plan as amended and restated was filed as Exhibit 10.27 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.** 10.32 Flowserve Corporation 1998 Restricted Stock Plan was included as Exhibit A to the Company's 1998 Proxy Statement which was filed with the Commission on April 9, 1998.**

30 10.33 Form of Employment Agreement between the Company and certain executive officers was filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. ** 10.34 Amendment No. 1 to the amended and restated Director Deferral Plan was filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. ** 10.35 Amendment No. 2 to the amended and restated Director Deferral Plan was filed as Exhibit 10.34 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.** 10.36 Amendment No. 1 to the 1989 Restricted Stock Plan as amended and restated was filed as Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.** 10.37 Employment Agreement, effective July 22, 1997, between the Company and Bernard G. Rethore was filed as Exhibit 10.53 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. ** 10.38 Employment Agreement, effective July 22, 1997, between the Company and William M. Jordan was filed as Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. ** 10.39 Amendment No. 1 to Employment Agreement between the Company and William M. Jordan was filed as Exhibit 10.38 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.** 13.1 1998 Annual Report to Shareholders (filed herewith as part of this report to the extent incorporated herein by reference). 18.1 Letter from Ernst & Young LLP regarding change in accounting principles (filed herewith). 21.1 Subsidiaries of the Company (filed herewith). 23.1 Consent of Ernst & Young LLP (filed herewith). 23.2 Consent of PricewaterhouseCoopers LLP (filed herewith). 27.1 Financial Data Schedule submitted to the SEC in electronic format (filed herewith). 27.2 Restated Financial Data Schedule submitted to the SEC in electronic format (filed herewith). "*" For exhibits of the Company incorporated by reference into this Annual Report on Form 10-K from a previous filing with the Commission, the Company's file number with the Commission since July 1997 is "1-13179" and the previous file number was "0-325". All filings of BW/IP, Inc. incorporated by reference in this Annual Report on Form 10-K cover the periods prior to July 22, 1997. "**" Management contracts and compensatory plans and arrangements required to be filed as exhibits to this Annual Report on Form 10-K.

1 Exhibit 10.4 AMENDMENT NO. 3 TO THE FLOWSERVE CORPORATION ANNUAL INCENTIVE PLAN FOR SENIOR EXECUTIVES (AS RESTATED JANUARY 1, 1994) The second sentence of Section VIII (B) shall be revised and restated in its entirety as follows: "Effective January 1, 1998, any Award so elected by the Participant to be paid in the form of Shares or such deferred shares shall be increased by fifteen per cent (15%) over an Award otherwise payable in cash." The remainder of the Plan shall remain in full force and effect as currently stated. Date: February 19, 1998. /s/ Ronald F. Shuff ----------------------------- Ronald F. Shuff Vice President, Secretary and General Manager

1 EXHIBIT 13 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Flowserve Corporation We have audited the accompanying consolidated balance sheets of Flowserve Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 financial statements of BW/IP, Inc., a wholly owned subsidiary, which statements reflect total revenues constituting 45% of the related totals for the year ended December 31, 1996. Those statements were audited by other auditors whose report thereon dated January 28, 1997, has been furnished to us, and our opinion, insofar as it relates to data included for BW/IP, Inc., is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Flowserve Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In 1998, as discussed in Note 5 to the consolidated financial statements, the Company changed its method of accounting for costing its inventory, and as discussed in Note 7, changed its method of accounting for certain defined compensation arrangements. /s/ ERNST & YOUNG LLP Ernst & Young LLP Dallas, Texas February 9, 1999 REPORT OF MANAGEMENT The Company's management is responsible for preparation of the accompanying consolidated financial statements. These statements have been prepared in conformity with generally accepted accounting principles and include amounts that are based on management's best estimates and business judgment. Management maintains a system of internal controls, which in management's opinion provides reasonable assurance that assets are safeguarded and transactions properly recorded and executed in accordance with management's authorization. The internal control system is supported by internal audits and is tested and evaluated by the independent accountants in connection with their annual audit. The Board of Directors pursues its responsibility for financial information through an Audit and Finance Committee consisting entirely of independent directors. This committee regularly meets not only with management, but also separately with representatives of the independent accountants. /s/ BERNARD G. RETHORE /s/ RENEE J. HORNBAKER Bernard G. Rethore Renee J. Hornbaker Chairman, President and Vice President and Chief Executive Officer Chief Financial Officer FLOWSERVE 1998 ANNUAL REPORT 13

2 MANAGEMENT'S DISCUSSION AND ANALYSIS OVERVIEW The following discussion and analysis are provided to increase understanding of, and should be read in conjunction with, the consolidated financial statements and accompanying notes. Flowserve Corporation was created on July 22, 1997, through a merger of equals between BW/IP, Inc. and Durco International Inc., which was accounted for under the "pooling of interests" method of accounting. Accordingly, all historical information has been restated, giving effect to the transaction as if the two companies had been combined at the beginning of all periods presented. Flowserve produces engineered pumps, precision mechanical seals, automated and manual quarter-turn valves, control valves and valve actuators, and provides a range of related flow management services worldwide, primarily for the process industries. Equipment manufactured and serviced by the Company is used in industries that deal with difficult-to-handle and often corrosive fluids in environments with extreme temperature, pressure, horsepower and speed. Flowserve's businesses are affected by economic conditions in the United States and other countries where its products are sold and serviced, by the relationship of the U.S. dollar to other currencies and by the demand and pricing for customers' products. The impact of these conditions is somewhat mitigated by the strength and diversity of Flowserve's product lines and geographic coverage. RESULTS OF OPERATIONS In general, 1998 results were lower than those of the two previous years due to the downturn of economic conditions in the global markets in which the Company participates. The economic turmoil that started in Asia in the second half of 1997 spread to other parts of the world, including Latin America. The profitability of our chemical and petroleum customers, which collectively represent about two-thirds of our business, was negatively impacted by the economic weakness. This economic weakness contributed to a supply/demand imbalance of chemicals and an oil price that averaged $11.12 per barrel in 1998, compared with $17.78 per barrel in 1997 and $18.46 per barrel in 1996. As a result, our customers reduced expenditures by delaying or canceling new projects and reducing maintenance spending. BOOKINGS SALES -------- ----- 1998 $1,083 $1,083 1997 $1,172 $1,152 1996 $1,142 $1,098 Bookings (incoming orders for which there are purchase commitments) were lower in 1998 at $1,082.5 million, compared with $1,172.4 million in 1997 and $1,141.6 million in 1996. Sales decreased to $1,083.1 million in 1998 from $1,152.2 million in 1997 and $1,097.6 million in 1996. Bookings and sales declines in 1998 were largely a result of the economic and market factors previously discussed. There were several other factors that affected the comparisons. A stronger U.S. dollar, in relation to other currencies in which the Company conducts its business, had the effect of reducing both bookings and sales when compared with the prior year. The negative translation effect reduced 1998 bookings and sales by about 2% and 1997 bookings and sales by about 4%. Comparisons are also impacted by the divestitures of several businesses in 1997 that contributed approximately $18 million to both bookings and sales in 1997 and $24 million in 1996. Several acquisitions affected the comparability as well. Acquisitions made in 1998 added approximately $14 million to 1998 bookings and sales, compared with 1997 and 1996. Acquisitions made in late 1996 and early 1997 added about $45 million to 1997 bookings and sales compared with 1996. In total, sales outside the United States were 42% in 1998, compared with 48% in 1997 and 52% in 1996. These sales declined due to weaker economies in Asia and Latin America and negative currency translation effect. BUSINESS SEGMENTS Flowserve manages its operations through three business segments: Rotating Equipment Division (RED) for engineered pumps; Flow Control Division (FCD) for automated quarter-turn valves, control valves and valve actuators; and Flow Solutions Division (FSD) for precision mechanical seals and flow management services. FLOWSERVE 1998 ANNUAL REPORT 14

3 Sales and operating income before special items, as defined below, for each of the three business segments are: ROTATING EQUIPMENT DIVISION --------------------------------- (in millions of dollars) 1998 1997 1996 ------- ------- ------- Sales $ 375.5 $ 412.8 $ 402.8 Operating income 41.1 51.0 49.0 Sales of pumps and pump parts for the Rotating Equipment Division (RED) decreased to $375.5 million from $412.8 million in 1997 and $402.8 million in 1996. The sales decline was generally due to reduced demand for chemical process pumps as our chemical industry customers lowered their capital and maintenance spending in response to weaker demand and pricing for their products. The Company believes that the chemical market will continue to be weak in 1999. RED sales were also lower due to reduced demand for nuclear parts and replacements. RED sales increased in 1997 from 1996 due to the acquisition of the engineered pump business of Stork Pompen, B.V. in January 1997. Operating income before special items, as a percentage of RED sales, declined to approximately 11% in 1998 from about 12% in the previous two years. The decline was due to the lower volume of more profitable chemical process pumps, nuclear products and other parts and replacement business that more than offset the benefits of the merger integration program. FLOW CONTROL DIVISION --------------------------------- (in millions of dollars) 1998 1997 1996 ------- ------- ------- Sales $ 303.0 $ 317.2 $ 286.4 Operating income 41.7 47.0 37.1 Sales of valves and valve automation products for the Flow Control Division (FCD) declined to $303.0 million in 1998 from $317.2 million in 1997. The decrease was due to the weaker chemical market that reduced demand and placed downward pressure on selling prices. The sales decrease was partly offset by the acquisition of Valtek Engineering (United Kingdom licensee) in July 1998. FCD sales were higher in 1997 than the $286.4 million recorded in 1996 due to internal growth from control valves and the acquisition of Anchor/Darling Valves in December 1996. Operating income before special items, as a percentage of sales, was 13.8% in 1998, compared with 14.8% in 1997 and 13.0% in 1996. The decline in 1998 was generally due to the lower sales volume. Operating income in 1998 was also affected by lower selling prices and a reduced volume of higher-profit spare parts. The improvement in 1997 over 1996 was due to sales growth and higher margins from control valves and the Anchor/Darling Valves business. FLOW SOLUTIONS DIVISION --------------------------------- (in millions of dollars) 1998 1997 1996 ------- ------- ------- Sales $ 433.6 $ 430.1 $ 421.9 Operating income 66.1 62.7 55.5 Sales of services and seal products for the Flow Solutions Division (FSD) increased to $433.6 million in 1998, compared with $430.1 million in 1997 and $421.9 million in 1996. Sales related to service activities increased about 11% in 1998 and 9% in 1997, despite the challenging market environment, due to an increased focus on this business. These increases were partly offset by reduced demand for seals due to economic weakness in Asia and Latin America, softness in the chemical and petroleum markets and technological improvements in the Company's seals that have reduced their mean time between failure. Operating income before special items, as a percentage of sales, increased to 15.2% from 14.6% in 1997 and 13.2% in 1996. The improved margins were generally due to the leveraging of a higher volume of sales and the benefits of the merger integration program, partly offset by a seal product mix change to lower margin products. EARNINGS PER SHARE AFTER SPECIAL ITEMS SPECIAL ITEMS TOTAL ------------------- ------------- ----- 1998 $1.23 $0.65 $1.88 1997 $1.26 $0.75 $2.01 1996 $1.72 $0.07 $1.79 Earnings after special items were $48.9 million ($1.23 per share) in 1998, compared with $51.6 million ($1.26 per share) in 1997 and $71.1 million ($1.72 per share) in 1996. Special items included restructuring charges, merger integration expense, merger transaction expense, costs associated with an obligation under an executive employment agreement, a gain on the sale of a subsidiary and the cumulative effect of a change in accounting principle. Earnings before special items were $74.9 FLOWSERVE 1998 ANNUAL REPORT 15

4 million ($1.88 per share) in 1998, compared with $82.1 million ($2.01 per share) in 1997 and $74.1 million ($1.79 per share) in 1996. The decline in earnings in 1998 was largely due to the decline in sales and a lower gross profit margin. The Company's share repurchase program contributed about $0.03 per share to earnings in 1998, compared with the two prior years. The restructuring charges of $32.6 million in 1997 were related to the Company's merger integration program, and the restructuring charges of $5.8 million in 1996 were related to the consolidation of certain operations in Europe and Asia. Merger integration expense was $38.3 million in 1998 and $7.0 million in 1997. Merger integration expense was principally related to the consolidation of the business units and headquarters, plant closings and the formation of the Services Group of the Flow Solutions Division. Merger transaction expense of $11.9 million in 1997 was for severance and other expenses triggered by the merger, and investment banking, legal and other costs required to effect the merger. In 1998, the Company recognized an obligation under an executive employment agreement of $3.8 million recorded in selling and administrative expense. In 1997, the Company sold its Metal Fab subsidiary and realized a pretax gain of $11.4 million. The change in accounting principle resulted in a one-time cumulative net-of-tax benefit of $1.2 million in 1998. The accounting change was due to the required adoption of EITF 97-14, "Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested." Gross profit margin, gross profit as a percentage of sales, declined to 38.3% in 1998 from 39.0% in 1997 and 39.1% in 1996. The lower margin in 1998 was generally related to valve price discounting and a seal product mix change toward lower margin products. These reductions were partly offset by savings related to the Company's merger integration program that reduced cost of sales by approximately $9 million. These factors and lower sales contributed to a decline in gross profit dollars to $415.3 million in 1998 from $448.9 million in 1997 and $428.9 million in 1996. Selling and administrative expense declined to $265.6 million in 1998 from $285.9 million in 1997 and $283.4 million in 1996. Selling and administrative expense in 1998 included $3.8 million in one-time costs associated with an obligation under an executive employment agreement. As a percentage of sales, selling and administrative expense was 24.5% (24.2% when adjusted for the executive employment agreement) in 1998, compared with 24.8% in 1997 and 25.8% in 1996. Reductions in selling and administrative expense were generally due to savings from merger integration activities of about $12 million and lower sales. Research, engineering and development expense was $26.4 million in 1998, compared with $26.9 million in 1997 and $24.5 million in 1996. The slight decline in this expense in 1998 was principally due to savings realized from merger integration activities. Interest expense was $13.2 million in 1998, compared with $13.3 million in 1997 and $12.1 million in 1996. Interest expense in 1998 was essentially the same as the 1997 amount as the additional expense due to increased borrowings throughout the year was offset by lower interest rates on the Company's variable rate debt. The increase in 1997 over 1996 was primarily related to a full year of expense on borrowings entered into during 1996. The effective tax rate before special items was 34.9% in 1998, compared with 36.9% in 1997 and 34.4% in 1996. The decrease in 1998 was due to the geographic mix of earnings and post-merger restructuring of operations. The effective tax rate after special items in 1998 was the same as the effective tax rate excluding special items. In 1997, the effective tax rate after special items was 42.6% due to the nondeductibility of certain merger transaction expenses, partly offset by certain tax benefits realized from the sale of a subsidiary. The rate in 1996, after special items, was 34.4% due to one-time benefits associated with the restructuring of certain European operations and utilization of tax loss carryforwards. MERGER INTEGRATION PROGRAM In 1997, the Company developed a program designed to achieve the synergies planned for the merger of BW/IP and Durco. The program included facility rationalizations in North America and Europe, organizational realignments at the corporate and division levels, procurement initiatives, investments in training and support for service operations. In the fourth quarter of 1997, the Company recognized a one-time restructuring charge of $32.6 million in connection with this program. Other nonrecurring expenses related to the merger were incurred in 1998 and 1997 in order to achieve the planned synergies. These expenses of $38.3 million in 1998 and $7.0 million in 1997 were principally costs for consultants, relocations and training. In 1998, the Company also spent $11.0 million in capital expenditures related to this program. FLOWSERVE 1998 ANNUAL REPORT 16

5 In 1998, the Company realized approximately $21 million of operating income benefit related to the merger. In the fourth quarter of 1998, the Company realized operating income benefits at a $28 million annualized rate. By 2001, the Company expects to achieve the $45 million to $55 million of annual operating income benefit planned from this program. The benefits result from eliminating cost redundancies, capturing procurement savings and realizing earnings increases from sales synergies. BUSINESS PROCESS IMPROVEMENT INITIATIVE (FLOWSERVER) In July 1998, the Company's Board of Directors approved an $18 million expenditure for the first phase of Flowserver, a business process improvement initiative. This program has costs and benefits incremental to the initial merger integration program. The Flowserver initiative includes the standardization of the Company's processes and the implementation of a global information system to facilitate common best practices. The investment in this business process improvement initiative is expected to approximate $120 million over a four-year period. Approximately half of the expenditures associated with this initiative are expected to be capitalized, with the balance expensed. Completion of Flowserver is expected to result in more than $40 million of annual operating income benefit in the first full year following completion of the program and about a $100 million reduction in working capital requirements. In 1998, the Company incurred costs associated with this project of $5.1 million recorded as merger integration expense and $1.5 million as capital expenditures. LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS FROM OPERATIONS (in millions of dollars) AFTER SPECIAL ITEMS SPECIAL ITEMS TOTAL ------------------- ------------- ----- 1998 $54.1 $ 23.7 $ 77.8 1997 $90.0 $ 25.3 $115.3 1996 $88.4 $ 3.7 $ 92.1 Cash flows from operations and financing available under existing credit agreements are the Company's primary sources of short-term liquidity. Cash flows from operating activities in 1998 decreased to $54.1 million, compared with $90.0 million in 1997 and $88.4 million in 1996. The decrease in cash flows in 1998 was primarily due to cash expended for restructuring and lower operating profits. The increase in 1997 cash flows over 1996 resulted primarily from increased earnings (before the noncash portion of the restructuring reserve). CAPITAL EXPENDITURES (in millions of dollars) 1998 $38.2 1997 $39.6 1996 $35.7 Capital expenditures, net of disposals, were $38.2 million in 1998, compared with $39.6 million in 1997 and $35.7 million in 1996. Capital expenditures were funded by operating cash flows. For each of the three years, capital expenditures were invested in machinery and equipment, replacements and upgrades. Capital expenditures in 1998 included about $11.0 million related to the merger integration projects and $1.5 million related to Flowserver. In 1997, the amount increased over 1996 predominately due to investments in low-cost manufacturing facilities in India. During the second quarter of 1998, the Company initiated a $100 million share repurchase program. In 1998, the Company spent approximately $64.5 million to repurchase approximately 2.8 million, or 7.1%, of its outstanding shares. The Company generally used credit facilities to fund the purchases. The timing of future repurchases depends on market conditions, the market price of Flowserve's common stock and management's assessment of the Company's liquidity and cash flow needs. FLOWSERVE 1998 ANNUAL REPORT 17

6 The Company has a $150 million revolving credit agreement of which $124 million was utilized at December 31, 1998. The Company also had other short-term credit facilities under which $55.0 million was available for borrowing. At December 31, 1998, total debt was 37.2% of the Company's capital structure, compared with 27.1% at December 31, 1997. The ratio increased as planned due to the share repurchase program. The interest coverage ratio of the Company's indebtedness was 6.6 times interest at December 31, 1998, compared with 7.8 times interest at December 31, 1997. The Company believes that internally generated funds, together with access to external capital resources, will be sufficient to satisfy existing commitments and plans, and to provide adequate financial flexibility to take advantage of potential strategic business opportunities should they arise. The return on average net assets based on results for 1998, before special items, was 12.6%, compared with 13.7% for 1997. The decline is due to the lower earnings discussed previously. Including the impact of special items, the return on average net assets was 8.6% for 1998, compared with 9.0% for 1997. The return on average shareholders' equity, before special items, was 20.0% in 1998, compared with 20.4% in 1997. Return on shareholders' equity, including special items, was 13.1% for 1998 and 13.0% for 1997. Acquisitions are an important part of the Company's strategy to increase its earnings and build shareholder value. Accordingly, in 1998 the Company acquired 100% of its joint venture in Singapore (previously 51% owned by the Company), acquired certain assets and liabilities related to the business of two licensees located in the United Kingdom and Australia and acquired the outstanding shares of a valve-repair organization with operations in Belgium and the Netherlands. Payments for acquisitions, net of cash acquired, were $20.0 million in 1998. Inflation during the past three years had little impact on the Company's consolidated financial performance. Foreign currency translation had the effect of reducing the Company's sales and earnings by 2% in 1998 and 4% in 1997. MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS The Company has certain market-sensitive financial instruments, including long-term debt and investments in foreign subsidiaries. To evaluate the risks associated with these instruments, the Company considered the impact of unfavorable changes in the rates or values of these instruments as of December 31, 1998. The market changes, assumed to occur as of December 31, 1998, to measure potential risk, are a 100 basis-point increase in market interest rates, a 10% adverse change in all foreign currency exchange rates and a 10% decline in the value of the Company's net investment in foreign subsidiaries. The Company considered the impact of a 100 basis-point increase in interest rates and determined such an increase would not materially affect the Company's earnings. The Company employs a foreign currency hedging strategy to minimize potential losses in earnings or cash flows from unfavorable foreign currency exchange rate movements. Foreign currency exposures arise from transactions, including firm commitments and anticipated transactions, denominated in a currency other than an entity's functional currency and from foreign denominated revenues and profits translated back into U.S. dollars. The primary currencies to which the Company has exposures are the German mark, British pound, Dutch guilder and other European currencies; the Canadian dollar; the Mexican peso; the Japanese yen; the Singapore dollar; and, the Australian dollar. Exposures are hedged primarily with foreign currency forward contracts that generally have maturity dates less than one year. Company policy allows foreign currency coverage only for identifiable foreign currency exposures and, therefore, the Company does not enter into foreign currency contracts for trading purposes where the objective is to generate profits. The potential loss in fair value at December 31, 1998, based on year-end positions of outstanding foreign currency contracts resulting from a hypothetical 10% adverse change in all foreign currency exchange rates would not be material. The potential loss would exclude hedges of existing balance sheet exposures. The losses in these contracts would be offset by exchange gains in the underlying net monetary exposures for which the contracts are designated as hedges. The Company generally views its investments in foreign subsidiaries from a long-term perspective and, therefore, does not generally hedge these investments. The Company uses capital structuring techniques to manage its investment in foreign subsidiaries as deemed necessary. The Company's net investment in foreign subsidiaries and affiliates, translated into U.S. dollars using year-end exchange rates, was $106.4 million at December 31,1998. A potential loss in value of the Company's net investment in foreign subsidiaries resulting from a hypothetical 10% adverse change in quoted foreign exchange rates at the end of 1998 would approximate $10.6 million. FLOWSERVE 1998 ANNUAL REPORT 18

7 EURO CONVERSION On January 1, 1999, 11 European Union member states (Germany, France, the Netherlands, Austria, Italy, Spain, Finland, Ireland, Belgium, Portugal and Luxembourg) adopted the Euro as their common national currency. Until January 1, 2002, either the Euro or a participating country's national currency will be accepted as legal tender. Beginning on January 1, 2002, Euro-denominated bills and coins will be issued, and by July 1, 2002, only the Euro will be accepted as legal tender. The Company does not expect future balance sheets, statements of earnings or statements of cash flows to be materially impacted by the Euro conversion. YEAR 2000 COSTS The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer systems that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in normal business activities. The Company has assessed how it might be impacted by the Year 2000 issue and has formulated and commenced implementation of a comprehensive plan to address all known aspects of the issue. The Company's plan encompasses its information systems and production and other equipment that utilize date or time-oriented software or computer chips, products, vendors and customers. The plan is being carried out in four phases: 1) assessment and plan development; 2) remediation; 3) testing; and, 4) implementation. The Company's plan includes the use of independent experts as considered necessary. The Company has engaged independent experts to evaluate its Year 2000 plan and to assist in related issue identification, assessment, remediation and testing efforts. With regard to information systems, production, and other equipment and products, the Company is 100 percent complete with the assessment and plan development phase. Planned remediation efforts are approximately 80 percent complete. Testing is about 65 percent complete and implementation is about 50 percent complete. The Company expects that efforts in these areas will be substantially complete by July 1999. The Company also is working with its vendors and customers to ensure Year 2000 compliance throughout its supply chain. The Company developed a questionnaire that is used to survey vendors regarding compliance. In addition, the Company has prepared a standard letter outlining the importance of, and commitment to, resolving the Year 2000 issue in a timely manner, and this letter is used to respond to inquiries from customers. Although the review is continuing, the Company is not currently aware of any vendor or customer circumstances that may have a material adverse impact on the Company. The Company will seek alternative suppliers where circumstances warrant. The Company can provide no assurance that Year 2000 compliance plans will be successfully completed by suppliers and customers in a timely manner. The Company's preliminary estimate of the total cost for Year 2000 compliance is approximately $7.0 million, of which approximately $5.6 million had been incurred through December 31, 1998. Virtually all of the amounts spent to date relate to the cost to repair or replace software and associated hardware. The Company's cost estimates include the amount specifically related to remedying Year 2000 issues, as well as costs for improved systems that are Year 2000 compliant and would have been acquired in the ordinary course of business, but whose acquisition has been accelerated to ensure compliance by the Year 2000. Incremental spending in addition to the $7.0 million has not been, and is not expected to be, material because most Year 2000 compliance costs include items that are part of the standard procurement and maintenance of the Company's information systems and production and facilities equipment. Other non-Year 2000 efforts have not been materially delayed or impacted by the Company's Year 2000 initiatives. The Company has begun, but has not yet completed, a comprehensive analysis of the operational problems and costs (including loss of revenues) that would be likely to result from the failure by the Company and certain third parties to complete efforts necessary to achieve Year 2000 compliance on a timely basis. A contingency plan has not been developed for dealing with the most likely worst-case scenario, as such a scenario has not yet been clearly identified. The Company plans to complete such analysis and contingency planning by April 1999. The Company believes that the Year 2000 issue will not pose significant operational problems for the Company. However, if all Year 2000 issues are not properly identified, or assessment, remediation and testing are not completed in a timely manner with respect to problems that are identified, there can be no assurance that the Year 2000 issue will not have a material adverse impact on the Company's results of operations or relationships with customers, vendors or others. Additionally, there can be no assurance that the Year 2000 issues of other entities will not have a material adverse impact on the Company's systems or results of operations. FLOWSERVE 1998 ANNUAL REPORT 19

8 ACCOUNTING DEVELOPMENTS In 1998, the Company adopted Statement of Financial Accounting Standards, (SFAS) No. 130, "Reporting Comprehensive Income"; SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information"; and SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 130 established standards for the presentation and display of comprehensive income. SFAS No. 131 required public enterprises to disclose information about their reporting segments consistent with the way management operates the business. SFAS No. 132 consolidated the disclosures about pensions, settlement and curtailment of pension plans and retirement benefits other than pensions into a single set of requirements. In addition, the Company adopted EITF 97-14, "Accounting for Defined Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested." In 1998, the Financial Accounting Standards Board also issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This standard is effective for fiscal periods beginning after June 15, 1999. It establishes accounting and reporting standards for derivative instruments and hedging activities and is not expected to materially impact Flowserve's reported financial position, results of operations or cash flows. FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY This 1998 Annual Report, including Management's Discussion and Analysis and the Letter to Shareholders, contains various forward-looking statements and includes assumptions about Flowserve's future market conditions, operations and results. These statements are based on current expectations and are subject to significant risks and uncertainties. They are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Among the many factors that could cause actual results to differ materially from the forward-looking statements are: further changes in the already competitive environment for the Company's products or competitors' responses to Flowserve's strategies; political risks or trade embargoes affecting important country markets; the health of the petroleum, chemical and power industries; economic turmoil in areas outside the United States; continued economic growth within the United States; unanticipated difficulties or costs or reduction in benefits associated with the implementation of the Company's "Flowserver" business process improvement initiative, including software; the impact of the "Year 2000" computer issue; and the recognition of significant expenses associated with adjustments to realign the combined Company's facilities and other capabilities with its strategic and business conditions. The Company undertakes no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise. FLOWSERVE 1998 ANNUAL REPORT 20

9 CONSOLIDATED STATEMENTS OF INCOME Year ended December 31, --------------------------------------------- (Amounts in thousands, except per share data) 1998 1997 1996 ----------- ----------- ----------- Sales $ 1,083,086 $ 1,152,196 $ 1,097,645 Cost of sales 667,753 703,319 668,718 ----------- ----------- ----------- Gross profit 415,333 448,877 428,927 Selling and administrative expense 265,556 285,890 283,360 Research, engineering and development expense 26,372 26,893 24,522 Restructuring and merger transaction expenses -- 44,531 5,778 Merger integration expense 38,326 6,982 -- ----------- ----------- ----------- Operating income 85,079 84,581 115,267 Interest expense 13,175 13,275 12,144 Other income, net (1,253) (7,107) (5,228) Gain on sale of subsidiary -- (11,376) -- ----------- ----------- ----------- Earnings before income taxes 73,157 89,789 108,351 Provision for income taxes 25,502 38,223 37,254 ----------- ----------- ----------- Earnings before cumulative effect of change in accounting principle 47,655 51,566 71,097 Cumulative effect of change in accounting principle, net (1,220) -- -- ----------- ----------- ----------- Net earnings $ 48,875 $ 51,566 $ 71,097 =========== =========== =========== Earnings per share (diluted and basic) Before cumulative effect of change in accounting principle $ 1.20 $ 1.26 $ 1.72 Cumulative effect of change in accounting principle, net .03 -- -- ----------- ----------- ----------- Net earnings per share $ 1.23 $ 1.26 $ 1.72 =========== =========== =========== Average shares outstanding 39,898 40,896 41,363 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year ended December 31, ------------------------------- (Amounts in thousands) 1998 1997 1996 ------- ------- ------- Net earnings $48,875 $51,566 $71,097 Other comprehensive expense Foreign currency translation adjustments 9,861 24,002 8,918 Nonqualified pension plan adjustment -- -- 229 ------- ------- ------- Other comprehensive expense 9,861 24,002 9,147 ------- ------- ------- Comprehensive income $39,014 $27,564 $61,950 ======= ======= ======= See accompanying notes to consolidated financial statements. FLOWSERVE 1998 ANNUAL REPORT 21

10 CONSOLIDATED BALANCE SHEETS December 31, ------------------------ (Amounts in thousands, except per share data) 1998 1997 --------- --------- ASSETS Current assets Cash and cash equivalents $ 24,928 $ 58,602 Accounts receivable, net 234,191 234,437 Inventories 199,286 184,944 Prepaids and other current assets 28,885 36,681 --------- --------- Total current assets 487,290 514,664 Property, plant and equipment, net 209,032 209,509 Intangible assets, net 91,384 79,748 Other assets 82,491 76,104 --------- --------- Total assets $ 870,197 $ 880,025 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable $ 76,745 $ 68,241 Notes payable 3,488 5,644 Income taxes 17,472 15,548 Accrued liabilities 107,028 128,802 Long-term debt due within one year 14,393 12,209 --------- --------- Total current liabilities 219,126 230,444 Long-term debt due after one year 186,292 128,936 Post-retirement benefits and deferred items 120,015 125,372 Commitments and contingencies Shareholders' equity Serial preferred stock, $1.00 par value, no shares issued -- -- Common shares, $1.25 par value Shares authorized - 120,000 Shares issued and outstanding - 41,484 51,856 51,856 Capital in excess of par value 70,698 70,655 Retained earnings 353,249 326,681 --------- --------- 475,803 449,192 Treasury stock, at cost - 3,817 and 881 shares (90,404) (23,145) Accumulated other comprehensive expense (40,635) (30,774) --------- --------- Total shareholders' equity 344,764 395,273 --------- --------- Total liabilities and shareholders' equity $ 870,197 $ 880,025 ========= ========= See accompanying notes to consolidated financial statements. FLOWSERVE 1998 ANNUAL REPORT 22

11 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY 1998 1997 1996 ------------------------------------------------------------------------------------ (Amounts in thousands) Shares Amount Shares Amount Shares Amount --------- --------- --------- --------- --------- --------- Common shares Beginning balance - January 1 41,484 $ 51,856 41,482 $ 51,854 41,320 $ 51,650 Stock activity under stock plans -- -- 2 2 162 204 --------- --------- --------- --------- --------- --------- Ending balance - December 31 41,484 $ 51,856 41,484 $ 51,856 41,482 $ 51,854 --------- --------- --------- --------- --------- --------- Capital in excess of par value Beginning balance - January 1 $ 70,655 $ 72,434 $ 70,669 Stock activity under stock plans 43 (1,779) 1,765 --------- --------- --------- --------- --------- --------- Ending balance - December 31 $ 70,698 $ 70,655 $ 72,434 --------- --------- --------- --------- --------- --------- Retained earnings Beginning balance - January 1 $ 326,681 $ 298,563 $ 250,762 Stock activity under stock plans -- 3 -- Net earnings 48,875 51,566 71,097 Cash dividends declared (22,307) (23,451) (23,296) --------- --------- --------- --------- --------- --------- Ending balance - December 31 $ 353,249 $ 326,681 $ 298,563 --------- --------- --------- --------- --------- --------- Treasury stock Beginning balance - January 1 (881) $ (23,145) (1,081) $ (27,455) (8) $ (210) Stock activity under stock plans 184 4,782 200 4,310 -- -- Treasury stock repurchases (2,841) (64,508) -- -- (1,073) (27,245) Rabbi Trust adjustment (279) (7,533) -- -- -- -- --------- --------- --------- --------- --------- --------- Ending balance - December 31 (3,817) $ (90,404) (881) $ (23,145) (1,081) $ (27,455) --------- --------- --------- --------- --------- --------- Accumulated other comprehensive expense Beginning balance - January 1 $ (30,774) $ (6,772) $ 2,375 Foreign currency translation adjustment (9,861) (24,002) (8,918) Nonqualified pension plan adjustment -- -- (229) --------- --------- --------- --------- --------- --------- Ending balance - December 31 $ (40,635) $ (30,774) $ (6,772) --------- --------- --------- --------- --------- --------- Total Shareholders' Equity Beginning balance - January 1 40,603 $ 395,273 40,401 $ 388,624 41,312 $ 375,246 Net changes in shareholders' equity (2,936) (50,509) 202 6,649 (911) 13,378 --------- --------- --------- --------- --------- --------- Ending balance - December 31 37,667 $ 344,764 40,603 $ 395,273 40,401 $ 388,624 ========= ========= ========= ========= ========= ========= See accompanying notes to consolidated financial statements. FLOWSERVE 1998 ANNUAL REPORT 23

12 CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31, ------------------------------------ (Amounts in thousands) 1998 1997 1996 -------- -------- -------- Cash flows - Operating activities: Net earnings $ 48,875 $ 51,566 $ 71,097 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 35,110 35,277 33,452 Amortization 4,189 3,656 3,213 Gain on sale of subsidiary, net of income taxes -- (7,417) -- Loss on the sale of fixed assets 57 33 551 Cumulative effect of change in accounting principle (1,220) -- -- Change in assets and liabilities, net of effects of acquisitions and dispositions: Accounts receivable 3,015 (18,401) (8,645) Inventories (11,507) (9,943) (1,565) Prepaid expenses 8,718 (10,287) (1,014) Other assets (11,066) (13,232) 103 Accounts payable 5,654 1,574 (7,239) Accrued liabilities (25,848) 48,806 (5,677) Income taxes 1,051 (2,005) 147 Post-retirement benefits and deferred items (3,709) 13,195 5,855 Net deferred taxes 1,033 (1,477) 1,901 Other (248) (1,342) (3,824) -------- -------- -------- Net cash provided by operating activities 54,104 90,003 88,355 -------- -------- -------- Cash flows - Investing activities: Capital expenditures, net of disposals (38,249) (39,560) (35,691) Payments for acquisitions, net of cash acquired (19,951) (10,461) (13,240) Proceeds from sale of subsidiary -- 18,793 -- Other (427) 1,777 (258) -------- -------- -------- Net cash flows used by investing activities (58,627) (29,451) (49,189) -------- -------- -------- Cash flows - Financing activities: Net repayments under lines of credit (2,314) 576 (12,720) Payments on long-term debt (20,212) (15,760) (71) Proceeds from long-term debt 76,950 929 36,296 Repurchase of common stock (64,508) -- (27,838) Proceeds from issuance of common stock 4,764 2,584 2,467 Dividends paid (22,307) (26,121) (23,296) -------- -------- -------- Net cash flows used by financing activities (27,627) (37,792) (25,162) -------- -------- -------- Effect of exchange rate changes (1,524) (3,091) (3,667) -------- -------- -------- Net change in cash and cash equivalents (33,674) 19,669 10,337 Cash and cash equivalents at beginning of year 58,602 38,933 28,596 -------- -------- -------- Cash and cash equivalents at end of year $ 24,928 $ 58,602 $ 38,933 ======== ======== ======== Taxes paid $ 23,579 $ 27,636 $ 31,493 Interest paid $ 11,190 $ 13,420 $ 12,269 See accompanying notes to consolidated financial statements. FLOWSERVE 1998 ANNUAL REPORT 24

13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands, except per share data) NOTE 1: SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries. Intercompany profits, transactions and balances have been eliminated. Investments in unconsolidated affiliated companies, which represent all nonmajority ownership interests, are carried on the equity basis, which approximates the Company's equity interest in their underlying net book value. USE OF ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. BASIS OF COMPARISON Certain amounts in 1997 and 1996 have been reclassified to conform with the 1998 presentation. BUSINESS COMBINATIONS Business combinations accounted for under the pooling of interests method of accounting combine the assets, liabilities and shareholders' equity of the acquired entity with the Company's respective accounts at recorded values. Prior-period financial statements have been restated to give effect to the transactions as if they had occurred at the beginning of all periods presented. Business combinations accounted for under the purchase method of accounting include the results of operations of the acquired business from the date of acquisition. Net assets of the companies acquired are recorded at their fair value to the Company at the date of acquisition and any excess of purchase price over fair value is recorded as goodwill. REVENUE RECOGNITION Revenues and costs are generally recognized as units are shipped. Revenue for certain longer-term contracts is recognized based on the percentage of completion. Progress billings are generally shown as a reduction of inventory unless such billings are in excess of accumulated costs, in which case such balances are included in accrued liabilities. SHORT-TERM INVESTMENTS AND CREDIT RISK The Company places its temporary cash investments with financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. These investments, with an original maturity of three months or less when purchased, are classified as cash equivalents. They are highly liquid with principal values not subject to significant risk of change due to interest rate fluctuations. Credit risk related to accounts receivable is also limited due to the large number of customers in the Company's customer base, the Company's diverse product line and the dispersion of the Company's customers across many geographic regions. As of December 31, 1998, the Company does not believe that it had significant concentrations of credit risk. ACCOUNTS RECEIVABLE Accounts receivable are stated net of the allowance for doubtful accounts of $4,533 and $5,059 at December 31, 1998 and 1997, respectively. INVENTORIES Inventories are stated at lower of cost or market. Cost is determined for certain inventories by the last-in, first-out (LIFO) method and for other inventories by the first-in, first-out (FIFO) method. PROPERTY, PLANT AND EQUIPMENT, AND DEPRECIATION Property, plant and equipment are stated on the basis of cost. Depreciation is computed by the straight-line method based on the estimated useful lives of the depreciable assets for financial statement purposes and by accelerated methods for income tax purposes. The estimated useful lives of the assets are: Buildings, improvements, furniture and fixtures 5 to 35 years Machinery and equipment 3 to 12 years Capital leases 5 to 25 years INTANGIBLES The excess cost over the fair value of net assets acquired (goodwill) is amortized on a straight-line basis over 15 to 40 years. The carrying value of goodwill is reviewed as the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, the Company's carrying value of the goodwill will be adjusted accordingly. Intangibles are stated net of accumulated amortization of $6,426 and $5,266 as of December 31, 1998 and 1997, respectively. FLOWSERVE 1998 ANNUAL REPORT 25

14 HEDGING/FORWARD CONTRACTS The Company is party to forward contracts for purposes of hedging certain transactions denominated in foreign currencies. The Company has a risk-management and derivatives policy statement outlining the conditions in which the Company can enter into hedging or forward transactions. Gains and losses on forward contracts qualifying as hedges are deferred and included in the measurement of the related foreign currency transaction. Gains and losses on hedges of existing assets or liabilities are included in the carrying amounts of those assets or liabilities and are ultimately recognized in income as part of those carrying amounts. Gains and losses related to hedges of anticipated transactions are recognized in income as the transactions occur. The Company is exposed to credit-related losses in the event of nonperformance by counterparties to financial instruments, but it expects all counterparties to meet their obligations given their high credit ratings. As of December 31, 1998, the Company had no significant outstanding hedges or forward contracts with third parties. The carrying amounts of the financial instruments (primarily accounts receivable and long-term debt), approximate fair value as defined under Statement of Financial Accounting Standards (SFAS) No. 107, "Disclosures about Fair Value of Financial Instruments." Fair value is estimated by reference to quoted prices by financial institutions. FOREIGN CURRENCY TRANSLATION Assets and liabilities of the Company's foreign affiliates, other than those located in highly inflationary countries, are translated at current exchange rates, while income and expenses are translated at average rates for the period. For entities in highly inflationary countries, a combination of current and historical rates is used to determine currency gains and losses resulting from financial-statement translation and those resulting from transactions. Translation gains and losses are reported as a component of shareholders' equity, except for those associated with highly inflationary countries, which are reported directly in the consolidated statements of income. ACCOUNTING DEVELOPMENTS In 1998, the Company adopted Statement of Financial Accounting Standards, (SFAS) No. 130, "Reporting Comprehensive Income"; SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information"; and SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 130 established standards for the presentation and display of comprehensive income. SFAS No. 131 required public enterprises to disclose information about their reporting segments consistent with the way management operates the business. SFAS No. 132 consolidated the disclosures about pensions, settlement and curtailment of pension plans and retirement benefits other than pensions into a single set of requirements. In addition, the Company adopted EITF 97-14, "Accounting for Defined Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested." In 1998, the Financial Accounting Standards Board also issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This standard is effective for fiscal periods beginning after June 15, 1999. It establishes accounting and reporting standards for derivative instruments and hedging activities and is not expected to materially impact Flowserve's reported financial position, results of operations or cash flows. EARNINGS PER SHARE In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," that established standards for computing and presenting earnings per share. SFAS 128 requires dual presentation of basic and diluted earnings per share on the face of the income statement and requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation. The Company's potentially dilutive common stock equivalents have been immaterial for all periods presented. Accordingly, basic earnings per share is equal to diluted earnings per share and is presented on the same line for income statement presentation. INCOME TAXES The Company accounts for income taxes under the asset and liability method in accordance with SFAS No. 109, "Accounting for Income Taxes." This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. STOCK-BASED COMPENSATION The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), and related interpretations in accounting for its employee stock options. Under APB No. 25, no compensation expense is recorded if the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant. Accordingly, the Company has no compensation expense recorded. FLOWSERVE 1998 ANNUAL REPORT 26

15 NOTE 2: MERGER On July 22, 1997, shareholders of Durco International Inc. (Durco) and BW/IP, Inc. (BW/IP) voted to approve a merger of the companies in a stock-for-stock merger of equals that was accounted for as a pooling of interests transaction (the merger). As part of the merger agreement, the Company changed its name from Durco to Flowserve Corporation. The Company issued approximately 16,914,000 shares of common stock in connection with the merger. BW/IP shareholders received 0.6968 shares of the Company's common stock for each previously owned share of BW/IP stock. The consolidated financial statements, including the accompanying notes thereto, have been restated for all periods prior to the merger to include the financial position, results of operations, and cash flows of BW/IP and Durco as if the merger had occurred at the beginning of all periods presented. In connection with the merger, the Company recorded a one-time charge of $11,900 for merger-related expenses in 1997. These expenses included severance and other expenses triggered by the merger and investment banking fees, legal fees and other costs related to the merger, which were primarily nondeductible for tax purposes. In 1997, the Company developed a merger integration program that includes facility rationalizations in North America and Europe, organizational realignments at the corporate and division levels, procurement initiatives, investments in training and support for the service operations. In the fourth quarter of 1997, the Company recognized a one-time restructuring charge of $32,600 related to this program. Other nonrecurring expenses related to the merger (merger integration expense) were incurred in 1998 and 1997 in order to achieve the planned synergies. These expenses of $38,300 in 1998 and $7,000 in 1997 were principally for costs for consultants, relocation and training. In 1998, the Company also spent $11,000 in capital expenditures related to this program. Merger-related transactions were: Year ended December 31, 1998 1997 ------- ------- Integration expense $38,300 $ 7,000 Restructuring expense -- 32,600 Transaction expense -- 11,900 Capital expenditures 11,000 -- Through December 31, 1998, the Company paid severance relating to approximately 275 employees. Expenditures charged to the restructuring reserve were: Other Exit Severance Costs Total ----------- ----------- ----------- Balance at October 27, 1997 $ 22,400 $ 10,200 $ 32,600 Cash expenditures (3,400) (500) (3,900) Noncash expenditures -- (1,200) (1,200) ----------- ----------- ----------- Balance at December 31, 1997 19,000 8,500 27,500 Cash expenditures (16,300) (3,100) (19,400) Noncash expenditures -- (5,400) (5,400) ----------- ----------- ----------- Balance at December 31, 1998 $ 2,700 $ -- $ 2,700 =========== =========== =========== In July 1998, the Company's Board of Directors approved an $18 million expenditure for the first phase of "Flowserver." This business process improvement program has costs and benefits incremental to the initial merger integration program. Flowserver includes the standardization of the Company's processes and the implementation of a global information system to facilitate common best practices. The investment in this business process improvement initiative is expected to approximate $120 million over a four-year period. Approximately half of the costs associated with this program are expected to be capitalized, with the balance expensed. In 1998, the Company incurred costs associated with this project of $5.1 million recorded as merger integration expense and $1.5 million as capital expenditures. NOTE 3: ACQUISITIONS AND DISPOSITIONS In July 1998, the Company purchased certain assets and liabilities of the Valtek Engineering Division of Allen Power Engineering, Limited, from Rolls-Royce plc. The Valtek Engineering Division was the British licensee for many of Flowserve's control valve products, with exclusive territorial rights for portions of Europe, the Middle East and Africa since 1971. In September 1998, the Company acquired the remaining 49% ownership interest in Durametallic Asia Pte. Ltd., a fluid sealing manufacturer in Singapore, from its joint-venture partner. Also in 1998, the Company acquired the outstanding shares of ARS Lokeren NV, a Belgian company, and ZAR Beheer BV, a Dutch company, which specialize in the service and repair of industrial valves, with service and repair facilities near Rotterdam, the Netherlands, and Ghent and Antwerp, Belgium. FLOWSERVE 1998 ANNUAL REPORT 27

16 In 1997, the Company purchased the 49% remaining shares of its joint venture in Argentina, Byron Jackson Argentina I.C.S.A., and purchased the engineered pump business of Stork Pompen, B.V. In 1996, the Company acquired certain assets and liabilities of Anchor/Darling Valves. The Company sold its wholly owned subsidiary, Metal Fab Machine Corporation, for $18,793 in December 1997, and realized a pretax gain of $11,376. In addition, in 1997, the Company sold its Filtration Systems Division. NOTE 4: STOCK PLANS The Company maintains a shareholder-approved stock option plan, which provides for the grant of 1,500,000 options to purchase shares of the Company's common stock. At December 31, 1998, approximately 439,000 options were available for grant. Options have been granted to officers and employees to purchase shares of common stock at a price equal to fair market value at the date of grant. Generally, these options, whether granted from the current or prior plans, become exercisable over staggered periods, but may not be exercised after 10 years from the date of the grant. The aggregate number of shares exercisable was 1,703,171 at December 31, 1998; 1,707,677 at December 31, 1997; and 915,509 at December 31, 1996. Stock options issued to officers and other employees were: 1998 1997 1996 ---------------------------------------------------------------------------------------- WEIGHTED Weighted Weighted AVERAGE Average Average EXERCISE Exercise Exercise SHARES PRICE Shares Price Shares Price ---------- ---------- ---------- ---------- ---------- ---------- Number of shares under option: Outstanding at beginning of year 2,246,557 $ 25.05 1,842,239 $ 22.83 1,558,119 $ 20.98 Granted 794,240 18.50 690,270 26.53 433,591 24.85 Exercised (167,867) 20.32 (285,952) 14.30 (149,471) 9.37 Cancelled (41,316) 25.80 -- -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- Outstanding at end of year 2,831,614 $ 23.49 2,246,557 $ 25.05 1,842,239 $ 22.83 ========== ========== ========== ========== ========== ========== The weighted average contractual life of options outstanding is 8.6 years. Additional information relating to the range of options outstanding at December 31, 1998, is as follows: Options Outstanding Options Exercisable ---------------------------------------------------------------------------------------- Weighted Average Weighted Weighted Remaining Average Number Average Range of Exercise Prices Contractual Number Exercise Price Exercisable at Exercise Price Per Share Life Outstanding Per Share December 31, 1998 Per Share - ------------------------------------------------------------------------------------------------------------------ $ 5.95 - $11.76 2.4 49,205 $ 8.57 49,205 $ 8.57 $11.76 - $27.44 7.3 2,001,860 $20.76 1,103,757 $21.99 $27.44 - $39.20 6.5 780,549 $31.43 550,209 $32.05 --------- --------- 2,831,614 1,703,171 ========= ========= FLOWSERVE 1998 ANNUAL REPORT 28

17 Pro forma information regarding net earnings and earnings per share is required by SFAS No. 123, which also requires that the information be determined as if the Company had accounted for its stock options granted subsequent to December 31, 1994, under the fair value method of that Statement. The "fair value" for these options at the date of grant was estimated using a binomial option pricing model (a modified Black-Scholes model). The assumptions used in this valuation are as follows: Year ended December 31, 1998 1997 1996 -------- -------- -------- Risk-free interest rate 5.6% 5.5% 6.2% Dividend yield 3.3% 2.0% 2.1% Stock volatility 34.1% 35.5% 36.6% Average expected life (years) 8.6 8.1 6.7 The options granted had a weighted average "fair value" per share on date of grant of $6.14 in 1998, $10.69 in 1997 and $10.42 in 1996. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the options vesting periods. The Company's pro forma information is as follows: Year ended December 31, 1998 1997 1996 ---------- ---------- ---------- Net earnings As reported $ 48,875 $ 51,566 $ 71,097 Pro forma 47,030 48,224 69,156 Earnings per share (diluted and basic) As reported $ 1.23 $ 1.26 $ 1.72 Pro forma 1.18 1.18 1.67 Because the determination of the fair value of all options granted includes an expected volatility factor and because additional option grants are expected to be made each year, the above pro forma disclosures are not representative of pro forma effects for future years. The restricted stock plan approved by shareholders in 1998 authorized the grant of up to 800,000 shares of the Company's common stock. The 1989 restricted stock plan, which expired following the 1998 annual meeting of shareholders, authorized the grant of up to 337,500 shares of the Company's common stock. In general, the shares cannot be transferred for a period of at least one but not more than 10 years and are subject to forfeiture during the restriction period. The fair value of the shares is amortized to compensation expense over the periods in which the restrictions lapse. Restricted stock grants were 10,165 shares in 1998, 21,700 shares in 1997 and 29,900 shares in 1996. The weighted average fair value of the restricted stock grants at date of grant was $24.07 in 1998, $27.73 in 1997 and $25.84 in 1996. Total compensation expense recognized in the income statement for all stock-based awards was $485 in 1998, $510 in 1997 and $584 in 1996. NOTE 5: DETAILS OF CERTAIN CONSOLIDATED BALANCE SHEET CAPTIONS INVENTORIES Inventories and the method of determining cost were: December 31, 1998 1997 --------- --------- Raw materials $ 26,088 $ 18,082 Work in process and finished goods 226,843 216,377 Less: Progress billings (15,024) (10,903) --------- --------- 237,907 223,556 LIFO reserve (38,621) (38,612) --------- --------- Net inventory $ 199,286 $ 184,944 ========= ========= Percent of inventory accounted for by LIFO 61% 43% Percent of inventory accounted for by FIFO 39% 57% The percentage of inventory accounted for by the last-in first-out (LIFO) method increased in 1998 as the U.S. operations of the former BW/IP changed its method of accounting for inventories to LIFO during the year. Because the December 31, 1997, BW/IP inventory valued at FIFO is the opening LIFO inventory, there is neither a cumulative effect to January 1, 1998, nor pro forma amounts of retroactively applying the change to LIFO. The effect of the change in 1998 was not significant. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment were: December 31, 1998 1997 --------- --------- Land $ 17,856 $ 18,703 Buildings, improvements, furniture and fixtures 179,588 151,004 Machinery, equipment, capital leases and construction in progress 290,730 291,559 --------- --------- 488,174 461,266 Less: Accumulated depreciation (279,142) (251,757) --------- --------- Net property, plant and equipment $ 209,032 $ 209,509 ========= ========= FLOWSERVE 1998 ANNUAL REPORT 29

18 OTHER ASSETS Other assets were: December 31, 1998 1997 -------- -------- Pension assets $ 11,461 $ 8,695 Deferred tax assets 22,098 25,903 Deferred compensation funding 10,408 9,299 Investments in unconsolidated affiliates 5,331 3,844 Patents and other intangibles 8,491 4,431 Long-term notes receivable 2,914 3,363 Other 21,788 20,569 -------- -------- Total $ 82,491 $ 76,104 ======== ======== ACCRUED LIABILITIES Accrued liabilities were: December 31, 1998 1997 -------- -------- Wages and other compensation $ 62,249 $ 66,208 Accrued restructuring, current portion 2,730 18,048 Accrued commissions and royalties 7,494 3,386 Other 34,555 41,160 -------- -------- Total $107,028 $128,802 ======== ======== POST-RETIREMENT BENEFITS AND DEFERRED ITEMS Post-retirement benefits and deferred items were: December 31, 1998 1997 -------- -------- Post-retirement benefits $ 64,311 $ 65,028 Deferred compensation 13,231 8,246 Deferred taxes 16,977 15,946 Other 25,496 36,152 -------- -------- Total $120,015 $125,372 ======== ======== NOTE 6: DEBT AND LEASE OBLIGATIONS Long-term debt, including capital lease obligations, consisted of: December 31, 1998 1997 -------- -------- Senior Notes, interest of 7.14% to 7.92% $ 58,333 $ 66,667 Revolving credit agreement, interest at 5.5% in 1998 and 7.04% in 1997 124,000 50,000 Loan, due annually through 2002, interest at 8.94% 12,321 14,438 Floating rate revolving notes -- 5,952 Credit agreements, average interest rate 6.2% in 1998 and 6.0% in 1997 2,935 678 Capital lease obligations and other 3,096 3,410 -------- -------- 200,685 141,145 Less amounts due within one year 14,393 12,209 -------- -------- Total long-term debt $186,292 $128,936 ======== ======== Maturities of long-term debt, including capital lease obligations, for the next five years are: 1999 $ 14,393 2000 3,125 2001 3,125 2002 8,946 2003 10,000 Thereafter 161,096 -------- Total $200,685 ======== In 1997, the Company entered into a $150,000 revolving credit agreement with the option to increase borrowings up to $200,000. As of December 31, 1998, $124,000 was outstanding. The Company has an interest-rate swap that fixes $50,000 usage of the revolving credit facility at 6.74%. In connection with a German acquisition, the Company converted a deutsche-mark obligation through a currency swap agreement against its U.S. dollar private placement to fund the acquisition. The effective rate on the loan swap was 8.94%. The maturity and repayment terms of the swap match precisely the maturity and repayment term of the underlying debt. FLOWSERVE 1998 ANNUAL REPORT 30

19 In 1992, the Company issued $50,000 Senior Notes requiring annual payments of $8,333 through 1999, bearing interest at 7.92%, of which $8,333 was outstanding at December 31, 1998. In 1996, the Company issued $30,000 Senior Notes requiring annual principal payments of $6,000 commencing in 2002, bearing interest of 7.14%. In 1997, the Company issued $20,000 in Senior Notes, bearing interest of 7.17% with principal payments of $4,000 due annually, commencing in 2003. The provisions of the credit agreements require the Company to meet or exceed specified financial covenants that are defined in the agreements. The agreements also contain limitations or restrictions relating to new indebtedness and liens, disposition of assets and payment of dividends or other distributions. All such covenants were met in each of the years presented. The most restrictive of these include a debt-to-capital ratio and a minimum tangible net worth requirement. As of December 31, 1998, the Company had $9,897 of contingent obligations relating to bank guarantees and performance bonds outstanding. At December 31, 1998 and 1997, the Company had short-term credit facilities available from banks under which it could borrow at local market rates up to $58,500 and $61,521, respectively. These facilities are presented as notes payable on the Company's consolidated balance sheets. Under these facilities, the Company had borrowings outstanding of $3,488 at December 31, 1998, and $5,644 at December 31, 1997. The weighted average interest rate on these borrowings was 6.0% at December 31, 1998, and was 4.8% at December 31, 1997. Borrowings against these facilities were primarily to support the operations of foreign subsidiaries. The Company has noncancelable operating leases for certain offices, service and quick response centers, certain manufacturing and operations facilities, and machinery, equipment and automobiles. Rental expense relating to operating leases was $11,798 in 1998, $15,000 in 1997 and $15,100 in 1996. The future minimum lease payments under noncancelable operating leases are: 1999 $10,345 2000 7,520 2001 5,480 2002 2,524 2003 1,940 Thereafter 3,778 ------- Total $31,587 ======= NOTE 7: DEFERRED COMPENSATION - RABBI TRUST In September 1998, the Company adopted the provisions of EITF No. 97-14 "Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested." This standard established new guidelines for deferred compensation arrangements where amounts earned by an employee are invested in the employer's stock that is placed in a Rabbi Trust. The EITF requires that the Company's stock held in the trust be recorded at historical cost, the corresponding deferred compensation liability recorded at the current fair value of the Company's stock and the stock held in the Rabbi Trust classified as treasury stock. The difference between the historical cost of the stock and the fair value of the liability at September 30, 1998, has been recorded as a cumulative effect of a change in accounting principle of $1,220, net of tax. Prior-year financial statements have not been restated to reflect the change in accounting principle. The effect of the change on 1997 income before the cumulative effect would have been a reduction of $490. The effect of the change on 1996 income would not have been material. NOTE 8: RETIREMENT BENEFITS The Company sponsors several noncontributory defined benefit pension plans, covering approximately 60% of U.S. employees, which provide benefits based on years of service and compensation. Retirement benefits for all other employees are provided through defined contribution pension plans and government-sponsored retirement programs. All defined benefit pension plans are funded based on independent actuarial valuations to provide for current service and an amount sufficient to amortize unfunded prior service over periods not to exceed 30 years. FLOWSERVE 1998 ANNUAL REPORT 31

20 Net defined benefit pension expense (including both qualified and nonqualified plans) was: Year ended December 31, 1998 1997 1996 -------- -------- -------- Service cost-benefits earned during the period $ 6,411 $ 5,627 $ 5,481 Interest cost on projected benefit obligations 14,704 13,931 13,179 Expected gain on plan assets (18,086) (16,284) (21,908) Unrecognized prior service cost 537 (427) 7,001 Unrecognized net (asset) obligation (499) 576 (541) -------- -------- -------- Net defined benefit pension expense $ 3,067 $ 3,423 $ 3,212 ======== ======== ======== The following table reconciles the plans' funded status to amounts recognized in the Company's consolidated balance sheets: December 31, 1998 1997 --------- --------- Projected benefit obligations $ 226,463 $ 210,878 Plan assets, at fair value 225,260 219,860 --------- --------- Plan assets (less than) in excess of projected benefit obligations (1,203) 8,982 Unrecognized net transition asset (942) (1,735) Unrecognized net gain (622) (10,047) Unrecognized prior service benefit 2,612 2,932 --------- --------- Net pension (liability) asset $ (155) $ 132 ========= ========= Discount rate 6.75% 7.25% Rate of increase in compensation levels 4.0%-8.0% 4.0%-8.0% Long-term rate of return on assets 9.5% 8.0%-10.0% Following is a reconciliation of the defined benefit pension obligations: December 31, 1998 1997 --------- --------- Beginning benefit obligation $ 210,878 $ 183,220 Service cost 6,410 6,156 Interest cost 14,704 13,766 Plan amendments -- 607 Actuarial loss 7,726 19,784 Benefits paid (13,154) (12,383) Curtailments (101) (272) --------- --------- Ending benefit obligation $ 226,463 $ 210,878 ========= ========= Following is a reconciliation of the defined benefit pension assets: December 31, 1998 1997 --------- --------- Beginning plan assets $ 219,860 $ 197,523 Return on plan assets 18,093 34,282 Company contributions 462 438 Benefits paid (13,155) (12,383) --------- --------- Ending plan assets $ 225,260 $ 219,860 ========= ========= The Company sponsors several defined contribution pension plans covering substantially all U.S. and Canadian employees and certain other foreign employees. Employees may contribute to these plans, and these contributions are matched in varying amounts by the Company. The Company may also make additional contributions for eligible employees. Defined contribution pension expense for the Company was $7,309 in 1998, $7,733 in 1997 and $6,903 in 1996. The Company also sponsors several defined benefit post-retirement health care plans covering approximately 77% of future retirees and most current retirees in the United States. These plans are for medical and dental benefits and are provided through insurance companies and health maintenance organizations. The plans include participant contributions, deductibles, co-insurance provisions and other limitations, and are integrated with Medicare and other group plans. The plans are funded as insured benefits and health maintenance organization premiums are incurred. FLOWSERVE 1998 ANNUAL REPORT 32

21 Net post-retirement benefit expense comprised: Year ended December 31, 1998 1997 1996 ------- ------- ------- Service cost - benefits earned during the period $ 882 $ 916 $ 843 Interest cost on accumulated post-retirement benefit obligations 3,749 3,652 3,556 Amortization of unrecognized prior service cost (1,497) (2,012) (1,613) ------- ------- ------- Net post-retirement benefit expense $ 3,134 $ 2,556 $ 2,786 ======= ======= ======= Following is a reconciliation of the accumulated post-retirement benefits obligations: December 31, 1998 1997 -------- -------- Beginning accumulated post-retirement benefit obligation $ 53,072 $ 49,703 Service cost 882 916 Interest cost 3,749 3,652 Actuarial loss 3,460 1,977 Benefits paid (3,850) (3,176) Ending accumulated post-retirement -------- -------- benefit obligation $ 57,313 $ 53,072 ======== ======== The following table presents the components of post-retirement benefit amounts recognized in the Company's consolidated balance sheet: December 31, 1998 1997 -------- -------- Actuarial present value of accumulated post-retirement benefit obligations: $ 57,313 $ 53,072 Unrecognized prior service benefit 7,369 8,866 Unrecognized net (loss) gain (371) 3,090 -------- -------- Accrued post-retirement benefits $ 64,311 $ 65,028 ======== ======== Discount rate 6.75% 7.25% The assumed annual rates of increase in per capita costs for periods prior to Medicare were 8.0% for 1998 with a gradual decrease to 6.0% for 2002 and future years, and for periods after Medicare, 6.0% for 1998 with a gradual decrease to 5.0% for 2000 and future years. Increasing the assumed rate of increase in post-retirement benefit costs by 1.0% in each year would increase net post-retirement benefit expense by approximately $297 and accumulated post-retirement benefit obligations by $3,689. Reducing the assumed rate of decrease in post-retirement benefit costs by 1.0% in each year would reduce net post-retirement benefit expense by approximately $273 and accumulated benefit obligations by $3,553. The Company made contributions to the defined benefit post-retirement plan of $3,849 in 1998 and $3,176 in 1997. NOTE 9: CONTINGENCIES As of December 31, 1998, the Company was involved as a "potentially responsible party" (PRP) at six 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 remediating these sites, as well as the Company's 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 been similarly 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 the Company's preliminary information about the waste disposal practices at these sites and the environmental regulatory process in general, the Company believes 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. The Company is a defendant in numerous pending lawsuits (which include, in many cases, multiple claimants) that seek to recover damages for personal injury allegedly resulting from exposure to asbestos-containing products formerly manufactured and distributed by the Company. All such products were used within self-contained process equipment, and management does not believe that there was any emission of ambient asbestos fiber during the use of this equipment. FLOWSERVE 1998 ANNUAL REPORT 33

22 The Company is also a defendant in several other products liability lawsuits that are insured, subject to the applicable deductibles, and certain other noninsured lawsuits received in the ordinary course of business. Management believes that the Company has adequately accrued estimated losses for such lawsuits. No insurance recovery has been projected for any of the insured claims, because management currently believes that all will be resolved within applicable deductibles. The Company is also a party to other noninsured litigation that is incidental to its business, and, in management's opinion, will be resolved without a material impact on the Company's financial statements. Although none of the aforementioned gives rise to any additional liability that can now be reasonably estimated, the Company believes such costs will be immaterial. The Company will continue to evaluate these contingent loss exposures and, if they develop, recognize expense as soon as such losses can be reasonably estimated. NOTE 10: SHAREHOLDERS' EQUITY In 1997, the Company increased its authorized $1.25 par value common stock from 60,000,000 to 120,000,000 shares. The authorized shares were increased in connection with the merger of Durco and BW/IP resulting in the formation of Flowserve Corporation. At both December 31, 1998 and 1997, the Company had authorized 1,000,000 shares of $1.00 par value preferred stock. Each share of the Company's common stock contains a preferred stock purchase right. These rights are not currently exercisable and trade in tandem with the common stock. The rights become exercisable and trade separately in the event of certain significant changes in common stock ownership or on the commencement of certain tender offers that, in either case, may lead to a change of control of the Company. Upon becoming exercisable, the rights provide shareholders the opportunity to acquire a new series of Company preferred stock to be then automatically issued at a pre-established price. In the event of certain forms of acquisition of the Company, the rights also provide Company shareholders the opportunity to purchase shares of the acquiring company's common stock from the acquirer at a 50% discount from the current market value. The rights are redeemable for $0.022 per right by the Company at any time prior to becoming exercisable and will expire in August 2006. At December 31, 1998, approximately 3,511,000 shares of common stock were reserved for exercise of stock options and for grants of restricted stock. NOTE 11: INCOME TAXES The provision for taxes on income consisted of the following: Year ended December 31, 1998 1997 1996 -------- -------- -------- Current: U.S. federal $ 1,226 $ 30,461 $ 15,009 Non-U.S. 13,798 17,752 15,643 State and local 438 5,485 4,127 -------- -------- -------- Total current 15,462 53,698 34,779 -------- -------- -------- Deferred: U.S. federal 7,915 (15,585) 3,446 Non-U.S. 1,409 1,012 (895) State and local 716 (902) (76) -------- -------- -------- Total deferred 10,040 (15,475) 2,475 -------- -------- -------- Total provision $ 25,502 $ 38,223 $ 37,254 ======== ======== ======== The provision for taxes on income differed from the U.S. federal statutory tax rate due to the following: Year ended December 31, 1998 1997 1996 -------- -------- -------- U.S. federal income tax rate 35.0% 35.0% 35.0% Non-U.S. tax rate differential and utilization of operating loss carryforwards 2.6 2.2 (0.5) Merger transaction expenses -- 3.7 -- State and local income taxes, net 1.4 3.2 2.4 Utilization of tax credits (1.5) (2.7) (1.4) Foreign sales corporation (2.6) (1.8) (1.0) Other net -- 3.0 (0.1) -------- -------- -------- Effective tax rate 34.9% 42.6% 34.4% ======== ======== ======== FLOWSERVE 1998 ANNUAL REPORT 34

23 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's consolidated deferred tax assets and liabilities were: December 31, 1998 1997 -------- -------- Deferred tax assets related to: Post-retirement benefits $ 17,556 $ 24,824 Net operating loss carryforwards 11,553 7,370 Compensation accruals 8,131 9,849 Inventories 7,892 1,278 Credit carryforwards 3,679 614 Loss on dispositions 2,462 2,437 Warranty and accrued liabilities 1,258 4,666 Restructuring charge 988 9,413 Other 9,914 6,135 -------- -------- Total deferred tax assets 63,433 66,586 Less valuation allowances 8,655 9,007 -------- -------- Net deferred tax assets 54,778 57,579 -------- -------- Deferred tax liabilities related to: Property, plant and equipment 13,563 13,511 Goodwill 12,225 5,071 Pension benefits -- 2,444 Other 5,376 3,692 -------- -------- Total deferred tax liabilities 31,164 24,718 -------- -------- Deferred tax assets, net $ 23,614 $ 32,861 ======== ======== The Company has recorded valuation allowances to reflect the estimated amount of deferred tax assets that may not be realized due to the expiration of net operating loss and foreign tax credit carryforwards. The net changes in the valuation allowances were attributable to utilization and expiration of net operating loss carryforwards partially offset by an increase in expected nonutilization of net operating loss and credit carryforwards. The Company had approximately $26,400 of net operating loss carryforwards at December 31, 1998, the majority of which were generated in non-U.S. jurisdictions in which net operating losses do not expire. Earnings before income taxes comprised: Year ended December 31, 1998 1997 1996 -------- -------- -------- U.S. $ 27,326 $ 48,897 $ 63,238 Non-U.S. 45,831 40,892 45,113 -------- -------- -------- $ 73,157 $ 89,789 $108,351 ======== ======== ======== Undistributed earnings of the Company's non-U.S. subsidiaries amounted to approximately $187,000 at December 31, 1998. These earnings are considered to be indefinitely reinvested and, accordingly, no additional U.S. income taxes or non-U.S. withholding taxes have been provided. Determination of the amount of additional taxes that would be payable if such earnings were not considered indefinitely reinvested is not practical. NOTE 12: SEGMENT INFORMATION Flowserve is principally engaged in the worldwide design, manufacture, distribution and service of industrial flow management equipment. The Company provides pumps, valves, mechanical seals and service primarily for the refinery and pipeline segments of the petroleum industry, the chemical-processing industry, the power-generation industry and other industries requiring flow management products. The Company has three divisions, each of which constitutes a business segment. Each division manufactures different products and is defined by the type of products and services provided. Each division has a president, who reports directly to the Chief Executive Officer of the Company, and a division controller. For decision-making purposes, the Chief Executive Officer, Chief Financial Officer and other members of upper management use financial information generated and reported at the division level. The Rotating Equipment Division designs, manufactures and distributes pumps and related equipment. The Flow Control Division designs, manufactures and distributes automated and manual quarter-turn valves, control valves and valve actuators, and related components. The Flow Solutions Division designs, manufactures and distributes mechanical seals and sealing systems and provides service and repair for flow control equipment used in process industries. The Company also has a corporate headquarters that does not constitute a separate division or business segment. Amounts classified as All Other include minor entities that are not considered separate segments and businesses subsequently divested. See Note 3: Acquisitions and Dispositions. FLOWSERVE 1998 ANNUAL REPORT 35

24 The Company evaluates segment performance and allocates resources based on operating income or loss before special items and taxes. The accounting policies of the reportable segments are the same as described in Note 1: Significant Accounting Policies. Intersegment sales and transfers are recorded at cost plus a profit margin. This intersegment profit is eliminated in consolidation. ROTATING FLOW FLOW CONSOLIDATED YEAR ENDED DECEMBER 31, 1998 EQUIPMENT CONTROL SOLUTIONS ALL OTHER TOTAL ---------- ---------- ---------- ---------- ---------- Sales to external customers $ 368,451 $ 295,371 $ 418,953 $ 311 $1,083,086 Intersegment sales 7,000 7,626 14,671 (29,297) -- Segment operating income (before special items) 41,058 41,732 66,124 (25,509) 123,405 Depreciation and amortization 11,535 11,290 13,186 3,288 39,299 Identifiable assets $ 285,990 $ 234,551 $ 266,485 $ 83,171 $ 870,197 Capital expenditures 13,416 9,284 15,049 500 38,249 Rotating Flow Flow Consolidated Year ended December 31, 1997 Equipment Control Solutions All Other Total ---------- ---------- ---------- ---------- ---------- Sales to external customers $ 403,801 $ 305,150 $ 415,321 $ 27,924 $1,152,196 Intersegment sales 9,000 12,001 14,780 (35,781) -- Segment operating income (before special items) 50,969 46,981 62,728 (24,584) 136,094 Depreciation and amortization 9,767 9,160 13,286 6,720 38,933 Identifiable assets $ 301,176 $ 219,074 $ 257,531 $ 102,244 $ 880,025 Capital expenditures 14,623 8,140 11,733 5,064 39,560 Rotating Flow Flow Consolidated Year ended December 31, 1996 Equipment Control Solutions All Other Total ---------- ---------- ---------- ---------- ---------- Sales to external customers $ 395,824 $ 274,641 $ 405,303 $ 21,877 $1,097,645 Intersegment sales 7,000 11,798 16,634 (35,432) -- Segment operating income (before special items) 48,973 37,103 55,500 (20,531) 121,045 Depreciation and amortization 9,933 8,841 14,064 3,827 36,665 Identifiable assets $ 284,840 $ 201,373 $ 263,314 $ 80,249 $ 829,776 Capital expenditures 17,117 3,758 12,433 2,383 35,691 FLOWSERVE 1998 ANNUAL REPORT 36

25 RECONCILIATION OF SEGMENT INFORMATION TO CONSOLIDATED AMOUNTS Significant items from the Company's reportable segments can be reconciled to the consolidated amounts as follows: Year Ended December 31, --------------------------------------------- Sales 1998 1997 1996 ----------- ----------- ----------- Total sales for reportable segments $1,082,775 $ 1,124,272 $ 1,075,768 Total intersegment sales for reportable segments 29,297 35,781 35,432 Other sales 311 27,924 21,877 Elimination of intersegment sales (29,297) (35,781) (35,432) ----------- ----------- ----------- Total sales $ 1,083,086 $ 1,152,196 $ 1,097,645 =========== =========== =========== Year Ended December 31, --------------------------------------------- Profit or Loss 1998 1997 1996 ----------- ----------- ----------- Total segment operating income (before special items) $ 148,914 $ 160,678 $ 141,576 Corporate expenses and other 25,509 24,584 20,531 Merger restructuring and transaction expenses -- 44,531 5,778 Merger integration expense 38,326 6,982 -- Interest expense 13,175 13,275 12,144 Other income (1,253) (7,107) (5,228) Gain on sale of subsidiary -- (11,376) -- ----------- ----------- ----------- Earnings before income taxes $ 73,157 $ 89,789 $ 108,351 =========== =========== =========== Year Ended December 31, --------------------------------------------- Assets 1998 1997 1996 ----------- ----------- ----------- Total assets for reportable segments $ 787,026 $ 777,781 $ 749,527 Other assets 104,749 125,826 99,737 Elimination of intercompany receivables (21,578) (23,582) (19,488) ----------- ----------- ----------- Total assets $ 870,197 $ 880,025 $ 829,776 =========== =========== =========== FLOWSERVE 1998 ANNUAL REPORT 37

26 Geographic Information The Company attributes sales to different geographic areas based on the point of sale. Long-lived assets are classified based on the geographic area in which the assets are located. Sales related to and investment in long-lived assets by geographic area are as follows: LONG-LIVED YEAR ENDED DECEMBER 31, 1998 SALES ASSETS ---------- ---------- United States $ 629,117 $ 250,999 Europe 279,117 81,058 Other(1) 174,852 28,751 ---------- ---------- Consolidated total $1,083,086 $ 360,808 ========== ========== Long-lived Year ended December 31, 1997 Sales Assets ---------- ---------- United States $ 691,337 $ 228,056 Europe 261,289 78,400 Other(1) 199,570 32,991 ---------- ---------- Consolidated total $1,152,196 $ 339,447 ========== ========== Long-lived Year ended December 31, 1996 Sales Assets ---------- ---------- United States $ 654,581 $ 226,672 Europe 257,889 92,694 Other(1) 185,175 24,932 ---------- ---------- Consolidated total $1,097,645 $ 344,298 ========== ========== (1) Includes Canada, Latin America and Asia/Pacific. No individual geographic segment within this group represents 10% or more of consolidated totals. MAJOR CUSTOMER INFORMATION The Company has not received revenues from any customer that represent 10% or more of consolidated revenues for any of the years presented. NOTE 13: UNAUDITED QUARTERLY FINANCIAL DATA (Amounts in millions, except per share data) 1998(a) 1997(b) ------------------------------------------------------------------------------------------- Quarter 4th 3rd 2nd 1st 4th 3rd 2nd 1st ------- ------- ------- ------- ------- ------- ------- ------- Net sales $ 279.3 $ 264.8 $ 280.7 $ 258.3 $ 307.2 $ 282.0 $ 300.5 $ 262.5 Gross profit 108.5 99.6 106.0 101.2 116.2 107.4 121.2 104.1 Net earnings before special items 19.0 17.6 20.2 18.1 23.2 17.3 24.8 16.8 Net earnings 7.2 16.1 12.5 13.1 2.9 7.1 24.8 16.8 Earnings per share before special items (diluted and basic) $ 0.50 $ 0.44 $ 0.50 $ 0.44 $ 0.57 $ 0.42 $ 0.61 $ 0.41 Earnings per share (diluted and basic) 0.20 0.40 0.31 0.32 0.07 0.17 0.61 0.41 (a) Net earnings in 1998 included the following special items: merger expenses of $38.3 million before tax and an obligation under an executive employment agreement of $3.8 million (included in selling and administrative expense), before tax; and the benefit of the cumulative effect of an accounting change of $1.2 million, net of tax. These special items resulted in a reduction in net earnings of $26.0 million, or $0.65 per share after tax. (b) Net earnings in the third quarter of 1997 included restructuring and merger expenses of $10.2 million before tax, or $0.25 per share after tax. Net earnings in the fourth quarter of 1997 included merger-related expenses and a gain on the sale of a subsidiary that totaled $30.0 million before tax, or $0.50 per share after tax. Excluding special items, net earnings for the year ended December 31, 1997, were $82.1 million, or $2.01 per share. FLOWSERVE 1998 ANNUAL REPORT 38

27 FIVE-YEAR SELECTED FINANCIAL DATA December 31, (Amounts in thousands, except --------------------------------------------------------------------------- per share data and ratios) 1998 1997 1996 1995 1994 ----------- ----------- ----------- ----------- ----------- Results of Operations Sales $ 1,083,086 $ 1,152,196 $ 1,097,645 $ 983,917 $ 909,226 Cost of sales 667,753 703,319 668,718 591,550 554,707 ----------- ----------- ----------- ----------- ----------- Gross profit 415,333 448,877 428,927 392,367 354,519 Selling and administrative expense 265,556 285,890 283,360 264,426 241,131 Research, engineering and development expense 26,372 26,893 24,522 24,649 24,528 Merger transaction and restructuring expenses -- 44,531 5,778 5,042 -- Merger integration expense 38,326 6,982 -- -- -- ----------- ----------- ----------- ----------- ----------- Operating income 85,079 84,581 115,267 98,250 88,860 Interest expense 13,175 13,275 12,144 12,293 12,214 Other income (1,253) (7,107) (5,228) (2,455) (4,187) Gain on sale of subsidiary -- (11,376) -- -- -- ----------- ----------- ----------- ----------- ----------- Earnings before income taxes 73,157 89,789 108,351 88,412 80,833 Provision for income taxes 25,502 38,223 37,254 34,391 29,601 ----------- ----------- ----------- ----------- ----------- Earnings from continuing operations 47,655 51,566 71,097 54,021 51,232 Cumulative effect of change in accounting principle (1,220) -- -- -- -- ----------- ----------- ----------- ----------- ----------- Net earnings $ 48,875 $ 51,566 $ 71,097 $ 54,021 $ 51,232 =========== =========== =========== =========== =========== Average shares outstanding 39,898 40,896 41,363 41,652 41,626 Net earnings per share (diluted and basic) $ 1.23 $ 1.26 $ 1.72 $ 1.30 $ 1.23 Dividends paid per share 0.56 0.65 0.57 0.51 0.45 Bookings 1,082,484 1,172,431 1,141,614 1,013,861 930,863 Ending backlog 291,082 291,568 287,076 249,562 237,598 Performance Ratios (as a percent of sales) Gross profit margin 38.3% 39.0% 39.1% 39.9% 39.0% Selling and administrative expense 24.5% 24.8% 25.8% 26.9% 26.5% Research, engineering and development expense 2.4% 2.3% 2.2% 2.5% 2.7% Operating income 7.9% 7.3% 10.5% 10.0% 9.8% Net earnings 4.5% 4.5% 6.5% 5.5% 5.6% Financial Condition Cash and cash equivalents $ 24,928 $ 58,602 $ 38,933 $ 28,596 $ 28,777 Working capital 268,164 284,220 279,972 251,774 222,798 Net property, plant and equipment 209,032 209,509 211,738 209,974 197,844 Intangibles and other assets 173,875 155,852 149,003 139,204 113,824 Total assets 870,197 880,025 829,776 801,120 712,160 Capital expenditures 38,249 39,560 35,691 39,928 26,506 Depreciation and amortization 39,299 38,933 36,665 34,451 34,054 Long-term debt 186,292 128,936 143,962 125,931 95,971 Post-retirement benefits and deferred items 120,015 125,372 108,127 99,775 98,228 Shareholders' equity 344,764 395,273 388,624 375,246 340,267 Financial Ratios Return on average shareholders' equity 13.1% 13.0% 18.6% 15.1% 15.8% Return on average net assets 8.6% 9.0% 12.5% 10.4% 11.2% Debt to capital ratio 37.2% 27.1% 30.0% 27.9% 25.9% Cash dividends paid as a percent of ending shareholders' equity 6.5% 6.6% 6.0% 5.6% 5.5% Current ratio 2.2 2.2 2.5 2.3 2.3 Interest coverage ratio 6.6 7.8 9.9 8.2 7.6 FLOWSERVE 1998 ANNUAL REPORT 39

28 BOARD OF DIRECTORS Left to right: [PICTURE OF DIANE C. HARRIS((2)), President, Hypotenuse Enterprises, BOARD OF Inc.; HUGH K. COBLE(1),(3), Vice Chairman Emeritus, Fluor DIRECTORS] Corporation; BERNARD G. RETHORE(3), Chairman, President and Chief Executive Officer, Flowserve Corporation; GEORGE T. HAYMAKER, JR.(1), Chairman and Chief Executive Officer, Kaiser Aluminum Corporation; CHARLES M. RAMPACEK(2), President and Chief Executive Officer, Lyondell-Citgo Refining LP; WILLIAM C. RUSNACK(2),(3), President and Chief Executive Officer, Clark Refining & Marketing, Inc.; R. ELTON WHITE(2), Former President, NCR Corporation; KEVIN E. SHEEHAN(1),(3), General Partner, CID Equity Partners; JAMES O. ROLLANS(2), Senior Vice President and Chief Financial Officer, Fluor Corporation; and MICHAEL F. JOHNSTON(1), President, Americas Automotive Group, Johnson Controls, Inc. (1) Compensation Committee (2) Audit and Finance Committee (3) Executive Committee OFFICERS Left to right: [PICTURE OF MICHAEL S. DUNN, Assistant Vice President and Director of OFFICERS] Taxes; RICK L. JOHNSON, Vice President, Business Development and Corporate Controller; CHERYL D. MCNEAL, Vice President, Human Resources; HOWARD D. WYNN, Vice President, Division President, Rotating Equipment Division; RORY E. MACDOWELL, Vice President and Chief Information Officer; SCOTT E. MESSEL, Corporate Treasurer; RENEE J. HORNBAKER, Vice President and Chief Financial Officer; BERNARD G. RETHORE, Chairman, President and Chief Executive Officer; RONALD F. SHUFF, Vice President, Secretary and General Counsel; MARK E. VERNON, Vice President, Division President, Flow Control Division; and GEORGE A. SHEDLARSKI, Vice President, Division President, Flow Solutions Division. 40

1 Exhibit 18.1 February 9, 1999 Board of Directors and Shareholders The Flowserve Corporation 222 West Las Colinas Blvd. Irving, Texas 75039 Dear Sirs: Note 5 of Notes to the Consolidated Financial Statements of the Flowserve Corporation and Subsidiaries (the "Company" or "Flowserve") incorporated by reference in its Annual Report on Form 10-K for the year ended December 31, 1998 describes a change in the method of accounting for inventories at certain of the Company's domestic locations. The Company has changed from the first-in, first-out to the last-in first-out ("LIFO") method of accounting for these inventories representing twenty-three percent of the Company's inventories on a FIFO basis at December 31, 1998. You have advised us that you believe that the change is to a preferable method in your circumstances because: 1) The LIFO method will provide for a better matching of current production costs with current revenues as the most recently incurred costs will be expensed as inventory is sold. 2) Adoption of LIFO at the former BW/IP, Inc. locations will improve consistency among the domestic operations of Flowserve, as all U.S. operations will then be using the LIFO method. There are no authoritative criteria for determining a preferable inventory cost-flow method based on the particular circumstances; however, we conclude that the change in the method of accounting for inventories at the former BW/IP, Inc. locations is an acceptable alternative method which, based on your business judgment to make this change for the reasons cited above, is preferable in your circumstances. Very truly yours, /s/ Ernst & Young LLP

1 Exhibit 21.1 FLOWSERVE CORPORATION LIST OF SUBSIDIARIES JURISDICTION PERCENTAGE NAME OF SUBSIDIARY OF INCORPORATION OWNED - ------------------ ---------------- ----- Byron Jackson Argentina I.C.S.A. Argentina 100% Durametallic Argentina S.A. Argentina 100% Flowserve FSD Pty. Ltd. Australia 100% Flowserve Australia Pty. Ltd. Australia 100% Flowserve Pty. Ltd. Australia 100% Flowserve Dichtungstechnik Gesellschaft m.b.H Austria 100% Flowserve (Barbados), Ltd. Foreign Sales Corporation Barbados 100% Flowserve SRD S.A. Belgium 100% Flowserve FSD N.V. Belgium 100% Durco Europe S.A. Coordination Center Belgium 100% Flowserve RED S.A. Belgium 100% Flowserve Ltda Brazil 100% Flowserve Inc. Canada 100% Flowserve S.A.S France 100% Flowserve Essen GmbH Germany 100% Flowserve Dortmund Verwaltungs GmbH Germany 100% Flowserve Dortmund GmbH & Co. KG Germany 100% Flowserve Ahaus GmbH Germany 100% Flowserve Microfinish Pumps Pvt. Ltd. India 76% Flowserve India Controls Pvt. Ltd. India 95% Flowserve Microfinish Valves Pvt. Ltd. India 76% PT Flowserve Indonesia 75% Flowserve Ireland Limited Ireland 100% Flowserve Spa Italy 100% Byron Jackson K.K. Japan 100% Flowserve Japan K.K. Japan 100% Ebara-ByronJackson K.K. Japan 50% Flowserve Sdn. Bhd. Malaysia 70% Flowserve (Mauritius) Corporation Mauritius 100% Flowserve S.A. de C.V. Mexico 100% Flowserve B.V. Netherlands 100% 1

2 JURISDICTION PERCENTAGE NAME OF SUBSIDIARY OF INCORPORATION OWNED - ------------------ ---------------- ----- Flowserve Services B.V. Netherlands 100% Flowserve International B.V. Netherlands 100% Flowserve New Zealand Limited New Zealand 100% Flowserve Abahsain Co.Ltd. Saudi Arabia 60% Flowserve Pte. Ltd. Singapore 100% Valtek South Africa (Proprietary) Limited South Africa 100% Flowserve, S.A. Spain 100% Flowserve S.A. Switzerland 100% Flowserve Siam Co., Ltd. Thailand 60% Flowserve International Limited United Kingdom 100% Flowserve Limited. United Kingdom 100% Flowserve International, Inc. U.S. - Delaware 100% Flowserve FSD Corporation U.S. - Delaware 100% Flowserve FCD Corporation U.S. - Delaware 100% Flowserve RED Corporation U.S.- Delaware 100% Flowserve Holdings, Inc. U. S. - Delaware 100% Flowserve Management Company (Business Trust) U. S. - Delaware 100% Durametallic Australia Holding Company U.S. - Michigan 100% Flowserve New Mexico, Inc. U.S. - New Mexico 100% Durametallic Uruguary Uruguay 100% Flowserve Venezuela S.A. Venezuela 100% 2

1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Flowserve Corporation of our report dated February 9, 1999, included in the 1998 Annual Report to Shareholders of Flowserve Corporation. We also consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-28497) pertaining to the 1989 Stock Option Plan, (Form S-8 No. 33-28497) pertaining to the Duriron Company, Inc. Savings and Thrift Plan, (Form S-8 No. 33-72372) pertaining to the Valtek Incorporated Retirement Plan and Trust, (Form S-8 No. 333-50667) pertaining to the BW/IP, Inc. 1996 Long-Term Incentive Plan, the BW/IP, Inc. 1996 Directors' Stock and Deferred Compensation Plan, the BW/IP International, Inc. 1992 Long-Term Incentive Plan, the BW/IP Holding, Inc. Non-Employee Directors' Stock Option Plan, and the BW/IP International, Inc. Capital Accumulation Plan, and (Form S-8 No. 333-57773) pertaining to The Duriron Company, Inc. Pump and Foundry Divisions Hourly Employees Savings and Thrift Plan of our reports dated February 9, 1999, with respect to the consolidated financial statements and schedule of Flowserve Corporation included or incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1998. /s/Ernst & Young LLP Dallas, Texas March 12, 1999

1 Exhibit 23.2 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-28497, 33-72372, 333-50667 and 333-57773) of Flowserve Corporation of our report (relating to BW/IP, Inc. and its subsidiaries) dated January 28, 1997 appearing on page F-2 in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report (relating to BW/IP, Inc. and its subsidiaries) on the Financial Statement Schedules, which appears on page F-4 of this Form 10-K. PRICEWATERHOUSECOOPERS LLP Los Angeles, California March 12, 1999

5 YEAR DEC-31-1998 DEC-31-1998 24,928 0 234,191 4,533 199,286 487,290 488,174 279,142 870,197 219,126 186,292 0 0 51,856 292,908 870,197 1,083,086 1,083,086 667,753 959,681 37,073 0 13,175 73,157 25,502 47,655 0 0 1,220 48,875 1.23 1.23

5 YEAR YEAR DEC-31-1997 DEC-31-1996 DEC-31-1997 DEC-31-1996 58,602 38,933 0 0 234,437 223,274 5,059 4,826 184,944 182,423 514,664 469,035 461,266 455,049 251,757 243,311 880,025 829,776 230,444 189,063 128,936 143,962 0 0 0 0 51,856 51,854 343,417 336,770 880,025 829,776 1,152,196 1,097,645 1,152,196 1,097,645 703,319 668,718 1,016,102 976,600 33,030 550 0 0 13,275 12,144 89,789 108,351 38,223 37,254 51,566 71,097 0 0 0 0 0 0 51,566 71,097 1.26 1.72 1.26 1.72