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, 2001 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:
PART I ITEM 1. BUSINESS Flowserve Corporation ("Flowserve") was incorporated in the State of New York on May 1, 1912. Except where otherwise indicated and unless the context otherwise requires, the terms "Flowserve," "Company," "we," "us," "our" and "our company" refer collectively to Flowserve Corporation and its subsidiaries. We believe that we are the largest manufacturer and aftermarket service provider of comprehensive flow control systems throughout the world. Our Company develops and manufactures precision-engineered flow control equipment for critical service applications where high reliability is required. The flow control system components we produce include pumps, valves and mechanical seals. The Company's products and services are used in several industries, including petroleum, chemical, power generation and water treatment. We conduct our operations through three segments that encompass our primary product types: (1) Pump Division, (2) Flow Solutions Division and (3) Flow Control Division. Our Pump Division supplies engineered pumps. Our Flow Control Division supplies valves and related products. Our Flow Solutions Division provides mechanical seals and aftermarket services. Through each of our segments, we provide aftermarket replacement parts. PUMP DIVISION Through our Pump Division, we design, manufacture and distribute engineered and industrial pumps and pump systems, replacement parts and related equipment principally to industrial markets. Pump's products and services are primarily used by companies that operate in the petroleum, chemical processing, power generating, water treatment and general industrial markets. We manufacture our pump systems and components at eight plants in the United States, one in Canada, three in Latin America, ten in Europe and one in Asia. We also manufacture a small portion of our pumps through several foreign joint ventures. We market our pump products, which are primarily sold to end users and engineering and construction companies, through our worldwide sales force, regional service and repair centers, independent distributors and sales representatives. PUMP PRODUCTS We manufacture more than 350 different pump models, of which approximately 60-70% are highly engineered and designed for customized applications. These high horsepower engineered pumps are manufactured with a wide range of metal alloys and in a variety of configurations including pumps that utilize seals (sealed) and pumps that do not (sealless). The following is a summary list of Pump's general product types and globally recognized brands: PRODUCT TYPES Centrifugal Pumps - - Chemical Process ANSI and ISO - - Petroleum Process API 610 - - Horizontal Between Bearing Single-stage - - Horizontal Between Bearing Multi-stage - - Vertical - - Submersible Motor - - Specialty - - Nuclear Positive Displacement Pumps - - Reciprocating - - Gear - - Twin Screw BRAND NAMES - - ACEC - - Aldrich - - Byron Jackson(R) - - Cameron - - Durco(R) - - Flowserve(R) - - Jeumont-Schneider - - Pacific - - Pleuger - - PolyChem - - Scienco - - Sier-Bath - - Simpson - - Stork - - United Centrifugal(R) - - Western Land Roller - - Wilson-Snyder(R) - - Worthington(R) 1
PUMP NEW PRODUCT DEVELOPMENTS Our investments in new product research and development have consistently led to producing longer lasting and more efficient pumps. The majority of our new products and enhancements are driven by our customers' needs to achieve higher throughput at lower costs. As a result, we continually work with our customers to develop better pump products to improve their operations. PUMP CUSTOMERS Pump sells its products to more than 1,000 customers including leading engineering and construction firms, original equipment manufacturers (OEM), distributors and end users. Pump sales are diversified across several industries including petroleum, power, chemical and water. Our sales mix of original equipment products and aftermarket replacement parts diversifies our business and mitigates somewhat the impact of an economic downturn on our business. PUMP COMPETITION The industry is highly fragmented with more than 500 competitors. We compete, however, primarily against a relatively limited number of large companies operating on a global scale. Competition is generally based on price, expertise, delivery times, breadth of product offerings, contractual terms, previous installation history and reputation for quality. Price competition for original equipment tends to be more intense than for aftermarket services. The pump industry has undergone consolidation in recent years. The two primary causes for the consolidation trend are: (1) the need to lower costs through reduction of excess capacity in the market and (2) customers' preference to align with global full service suppliers and simplify their supplier base. Despite the consolidation activity, the market remains highly competitive. PUMP BACKLOG The Pump Division's backlog of orders at December 31, 2001 was $520.9 million, compared with $526.4 million at December 31, 2000. We believe that a high percentage of the current backlog will be shipped by December 31, 2002. FLOW SOLUTIONS DIVISION Through our Flow Solutions Division ("FSD"), we design, manufacture and distribute mechanical seals and sealing systems and provide parts, repair and services for flow control equipment used in process industries. Flow control products require mechanical seals to be replaced throughout the products' useful lives. The replacement of mechanical seals is an integral part of aftermarket services. Our mechanical seals are used on a variety of pumps, mixers, compressors, steam turbines and specialty equipment, primarily in the petroleum, chemical processing, power generation, water treatment industries and general industrial end-markets. We manufacture mechanical seals through two plants in the United States, three in Europe and the Middle East, two in Latin America and three in Asia. Through FSD's global network of service and quick response centers, we provide service, repair and diagnostic services for maintaining flow control systems components. Our mechanical seal products are primarily marketed through our sales force directly to end users. A portion of our mechanical seal products is sold directly to OEMs for incorporation into pumps, compressors, mixers or other rotating equipment requiring mechanical seals. Distributors and sales agents are also used in the sale of mechanical seals. FSD PRODUCTS AND SERVICES MECHANICAL SEALS. We design, manufacture and distribute approximately 180 different models of mechanical seals and sealing systems, of which approximately 65% are highly engineered and designed for customized applications. We believe our ability to turn around engineered new seal product orders within 72 hours from the customer's request, through design, engineering, manufacturing, testing and delivery, provides us with a competitive advantage. The mechanical seal is critical to the reliable operation of pumps, compressors and mixers for prevention of leakage and emissions of hazardous substances and the reduction of shaft wear caused by non-mechanical seals. We also manufacture a 2
gas-lubricated mechanical seal used in high-speed compressors for gas transmission and oil and gas production markets. We continually update our mechanical seals and sealing systems for new technologies. The following is a summary list of FSD's general product types and globally recognized brands: PRODUCT TYPES - - Cartridge - - Dry-Running - - Metal Bellow - - Elastomeric - - Split - - Gas Barrier - - Service and Repair - - Monitoring and Diagnostics BRAND NAMES - - BW Seals(R) - - Durametallic(R) - - Five Star Seal(R) - - GASPAC(R) - - Pacific Wietz(TM) - - Pac-Seal(R) SERVICE. We provide aftermarket services through our global network of approximately 150 service and quick response centers in 30 countries. Our service personnel provide a comprehensive set of equipment maintenance services for flow control systems, including repair, advanced diagnostics, installation, commissioning, re-rate and retrofit programs and full machining capabilities. A large portion of our service work is performed on a quick response basis, and we offer 24-hour service in all of our major markets. FSD NEW PRODUCT DEVELOPMENTS Our investments in new product research and development are focused on developing products that last longer and work more efficiently. Approximately 30% of our original equipment mechanical seal sales for 2001 were sales of products developed within the past five years. Our latest mechanical seal and seal system innovations include a double gas bellows seal, a high pressure compressor seal, a steam turbine gas seal, a modular cartridge seal platform, a modular mixer seal platform and a flushless heavy duty slurry seal, as well as numerous product upgrades and improvements. FSD CUSTOMERS Our mechanical seal products are sold to OEMs for incorporation into pumps, compressors, mixers or other rotating equipment requiring mechanical seals, and directly to end-users. FSD's mechanical seal sales are diversified among several industries, including petroleum, chemical, power generation and other industries. Our aftermarket services are provided to many of the same end-users that we serve for pump, valve and mechanical seal products. We have established alliances with over 200 customers. These alliances provide significant benefits to us, as well as to our customers, by creating a more efficient supply chain through the reduction of procurement costs and increased communication with our customers. Our alliances enable us to provide products and services to our customers in a timely and cost-effective manner. FSD COMPETITION We compete against a number of manufacturers in the sale of mechanical seals. Our largest global mechanical seal competitor is John Crane, a unit of Smiths Group Plc. In the service business, we often compete against the customers' in-house maintenance departments and locally owned and operated repair shops. FSD BACKLOG FSD's backlog of orders at December 31, 2001 was $73.8 million, compared with $69.4 million at December 31, 2000. We believe that virtually all of the current backlog will be shipped by December 31, 2002. FLOW CONTROL DIVISION Through our Flow Control Division ("FCD"), we design, manufacture and distribute manual valves, control valves, actuators and related equipment. FCD's valve products are an integral part of a flow control system and are used to control the flow of liquids and gases. Substantially all of FCD's valves are specialized and engineered to perform specific functions within a flow control system. 3
FCD's products are primarily used by companies that operate in the petroleum, chemical and power generation industries. We manufacture valves and actuators through four plants in the United States, six in Europe and three in other regions. We also manufacture a small portion of our valves through a foreign joint venture. Manual valve products and valve actuators are distributed through our sales force personnel and a network of distributors. Automatic control valves are marketed through sales engineers and service and repair centers or on a commission basis through sales representatives in our principal markets. FCD PRODUCTS We manufacture approximately 50 different valves, actuators and automated valve accessories, of which approximately 65% are highly engineered and designed for customized applications. Our valves are used in a wide variety of applications from general service to highly corrosive environments, as well as in environments experiencing extreme temperatures and/or pressures and applications requiring zero leakage. In addition to traditional valves, we also produce valves under the Valtek(R) brand that incorporate "smart" valve technologies. "Smart" valve technology packages integrate high technology sensors, microprocessor controls and digital positioners into a high performance control valve, which permits real time system analysis, system warnings and remote services. We were the first company to introduce "smart" valve technologies in response to demands for increased plant automation, more efficient process control and digital communications. We offer a growing line of digital products and are incorporating digital technologies into existing products to upgrade performance. The following is a summary list of FCD's general product types and globally recognized brands: PRODUCT TYPES - - Actuator Accessories - - Control Valves - - Digital Communications - - Manual Quarter-Turn Valves - - Valve Automation Systems - - Valve/Actuator Software - - Nuclear Valves - - Quarter-Turn Actuators BRAND NAMES - - Accord(R) - - Anchor/Darling - - Atomac(TM) - - Automax(R) - - Battig - - Durco(R) - - Kammer(R) - - Sereg(TM) - - Valtek(R) FCD NEW PRODUCT DEVELOPMENTS Our investments in new product research and development are focused on maintaining our technological leadership position and differentiating our product offering. When necessary, we invest in the redesign of existing products in an effort to improve their performance and continually meet customer needs. Our latest product innovations include the Logix digital positioner which enhances performance, speed and accuracy of pneumatic control valves and provides for quick calibration and setup; the BUSwitch which enables control and monitoring of automated on/off quarter-turn valves through FOUNDATION fieldbus technology; and the Mach 1 high performance plug valve for higher temperature and pressure applications in the chemical processing industry. FCD CUSTOMERS FCD's customer mix is diversified within several industries including chemical, petroleum, power and other industries. We sell a mix of original equipment and aftermarket parts. FCD COMPETITION Like the industrial pump market, the industrial valve market is highly fragmented and has undergone a significant amount of consolidation in recent years. Within the valves segment, we believe that the top ten domestic manufacturers generate less than 25% of domestic sales. FCD BACKLOG FCD's backlog of orders at December 31, 2001 was $68.0 million, compared with 4
$62.9 million at December 31, 2000. We believe that 85% to 90% of the current backlog will be shipped by December 31, 2002. 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. 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 its competitors for the Company's aftermarket products relating to its more highly engineered and customized products than for its standard products. Price competition tends to be more significant for OEMs 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 2001, 2000 and 1999, the Company spent approximately $23.4 million, $24.8 million, and $25.6 million, respectively, on Company-sponsored research and development, primarily for new product development and extensions of existing products. 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 2001 net sales. RISKS OF INTERNATIONAL BUSINESS In 2001, 43% of our sales originated outside the United States. Sales to foreign destinations, including U.S. export sales, were 48% of our sales in 2001, and included substantial business activity in the Middle East. Our 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 5
movements on its operating results, the Company often enters into forward exchange contracts to hedge specific foreign currency denominated transactions. See Note 1 to consolidated financial statements on pages 36 to 39 of the 2001 Annual Report to Shareholders, which is incorporated by reference in this Form 10-K. 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 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 we use in manufacturing our products are readily available. The main raw materials we use include bar stock and structural steel, castings, fasteners, gaskets, motors, silicon and carbon faces and Teflon(R). While substantially all raw materials are purchased from outside sources, we have been able to obtain an adequate supply of raw materials, and no shortage of such materials is currently anticipated. We intend to expand our use of worldwide sourcing to capitalize on low cost sources of purchased goods. We are a vertically-integrated manufacturer of certain pump and valve products. Certain corrosion-resistant castings for Company pumps and quarter-turn valves are manufactured at our Dayton, Ohio foundries. Other metal castings are manufactured at our two other foundries or are purchased from outside sources. We also produce most of our 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, to date we have experienced no significant difficulty in obtaining such materials. EMPLOYEES AND LABOR RELATIONS We employ approximately 11,000 persons of whom approximately 50% work in the United States. Our hourly employees at our Vernon, California pump manufacturing plant, plus those at our valve manufacturing plant in Williamsport, Pennsylvania and at our foundry in Dayton, Ohio are represented by unions. Our operations in the following countries are unionized: Argentina, Austria, Belgium, Brazil, Canada, France, Germany, Italy, Mexico, The Netherlands, Spain and the United Kingdom. We believe employee relations throughout our operations are generally satisfactory, including those represented by unions. ENVIRONMENTAL REGULATIONS AND PROCEEDINGS We are subject to environmental laws and regulations in all jurisdictions in which we have operating facilities. We periodically make capital expenditures for pollution abatement and control to meet environmental requirements. At present, we have no plans for any material capital expenditures for environmental control facilities. However, we have experienced and continue to experience operating costs relating to environmental matters, although certain costs have been offset by our successful waste minimization programs. Based on information currently available, we believe that future environmental compliance expenditures will not have a material adverse effect on our financial position. We have established reserves which we believe to be adequate to cover potential environmental liabilities. 6
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 $167.3 million in 2001, $148.1 million in 2000 and $142.7 million in 1999. FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY This Annual Report on Form 10-K, and other written reports and oral statements made from time-to-time by the Company, contain various forward-looking statements and include 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: changes in the financial markets and the availability of capital; changes in the already competitive environment for the Company's products or competitors' responses to Flowserve's strategies; the Company's ability to integrate past and future acquisitions into its management and operations; political risks or trade embargoes affecting important country markets; the health of the petroleum, chemical, water treatment, and power generation industries; economic conditions and the extent of economic growth in areas inside and outside the United States; unanticipated difficulties or costs associated with the implementation of systems, including software; the Company's ability to meet the financial covenants and other requirements of its financing agreements; repercussions from the terrorist attacks of September 11, 2001, and the response of the United States to those attacks; technological developments in the Company's products as compared to those of its competitors; changes in the prevailing interest rates and the effective interest cost which the Company bears; and adverse changes in the regulatory climate and other legal obligations imposed on Flowserve. 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
ITEM 2. PROPERTIES The Company's corporate headquarters is a leased facility in Irving, Texas encompassing approximately 49,000 square feet. Information on the principal manufacturing facilities, by segment after giving effect to facility closings completed in 2001, is as follows:
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. On February 15, 2002, the Company's records showed approximately 1,800 shareholders of record. Based on these records plus requests from brokers and nominees listed as shareholders of record, the Company estimates there are approximately 12,100 beneficial owners of its common stock. The company did not pay a dividend on its shares of common stock in 2001 and has no current plans to begin paying dividends. PRICE RANGE OF FLOWSERVE COMMON STOCK (INTRADAY HIGH/LOW PRICES)
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 April 18, 2002, (the "2002 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, 2002, and their business experience during the last five years are stated below. Executive officers serve at the discretion of the Board of Directors.
ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is set forth in the 2002 Proxy Statement and is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The information required by this Item 12 is set forth in the 2002 Proxy Statement and is incorporated herein by this reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13 is set forth to the extent applicable in the 2002 Proxy Statement and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements The financial statements listed on the accompanying Index to Financial Statements and Financial Statement Schedule, on page F-1 hereof, are filed as part of this Form 10-K. 2. Financial Statement Schedule The required financial statement schedule, together with the report thereon of PricewaterhouseCoopers LLP dated February 5, 2002, listed in the accompanying Index to Financial Statements and Financial Statement Schedule on page F-1 hereof, is filed as part of this Form 10-K. 3. Exhibits The exhibits listed on the accompanying Index to Exhibits on pages 13 through 17 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
INDEX TO EXHIBITS*
"*" 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." "**" Management contracts and compensatory plans and arrangements required to be filed as exhibits to this Annual Report on Form 10-K. 18
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 21st day of February 2002. FLOWSERVE CORPORATION (Registrant) By: /s/ C. Scott Greer --------------------------------------- C. Scott Greer 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.
FLOWSERVE CORPORATION INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Item 14(a)(1) and (2)
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors and Shareholders of Flowserve Corporation: Our audits of the consolidated financial statements referred to in our report dated February 5, 2002 appearing in the 2001 Annual Report to Shareholders of Flowserve Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K as of December 31, 2001 and 2000 and for each of the two years then ended. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The financial statement schedule of the Company as of December 31, 1999 and for the year then ended was audited by other independent auditors whose report dated February 10, 2000 expressed an unqualified opinion on the financial statement schedule. /s/PricewaterhouseCoopers LLP Dallas, Texas February 5, 2002 F-2
FLOWSERVE CORPORATION Schedule II - Valuation and Qualifying Accounts (dollars in thousands)
EXHIBIT 10.43 FLOWSERVE CORPORATION FIRST AMENDMENT TO CREDIT AGREEMENT This FIRST AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is dated as of November 9, 2001 and entered into by and among Flowserve Corporation, a New York corporation (the "Borrower"), the Lenders (as defined in Article I of the Credit Agreement) executing this Agreement, Credit Suisse First Boston, a bank organized under the laws of Switzerland, acting through its New York branch ("CSFB"), as syndication agent (the "Syndication Agent") and Bank of America, N.A., a national banking association ("BofA"), as swingline lender (in such capacity, the "Swingline Lender"), as administrative agent (in such capacity, the "Administrative Agent") and as collateral agent (in such capacity, the "Collateral Agent") for the Lenders, and is made with reference to that certain Credit Agreement dated as of August 8, 2000 (the "Credit Agreement"), by and among the Borrower, the Lenders, the Syndication Agent and the Administrative Agent. Capitalized terms used herein without definition shall have the same meanings herein as set forth in the Credit Agreement. RECITALS WHEREAS, the Borrower and the Lenders desire to amend the Credit Agreement in certain respects; NOW, THEREFORE, in consideration of the premises and the agreements, provisions and covenants herein contained, the parties hereto agree as follows: SECTION 1. AMENDMENTS TO THE CREDIT AGREEMENT 1.1 AMENDMENTS TO ARTICLE I: DEFINITIONS A. Section 1.1 of the Credit Agreement is hereby amended by adding thereto the following definition, which shall be inserted in proper alphabetical order: "Fall 2001 Equity Issuance" means a public offering of the Borrower's common stock made by the Borrower on or before December 31, 2001 resulting in gross cash proceeds of at least $150,000,000. B. The definition of "Consolidated Interest Expense" is hereby amended by adding the following parenthetical phrase immediately after the phrase "premium payments" in the third line: "(other than premium payments associated with the repurchase or prepayment of the Subordinated Notes from proceeds of the Fall 2001 Equity Issuance)". C. The definition of "Excess Cash Flow" is hereby amended by adding the following phrase at the end of the parenthetical phrase in clause (b)(iv) thereof: (Flowserve Corporation First Amendment to Credit Agreement)
"and other than repurchases or prepayments of the Subordinated Notes out of proceeds of the Fall 2001 Equity Issuance". 1.2 AMENDMENTS TO ARTICLE II: THE CREDITS A. Section 2.13(b) of the Credit Agreement is hereby amended by deleting the word "fifth" in the first line and substituting in lieu thereof the word "tenth". B. Section 2.13 of the Credit Agreement is hereby further amended by deleting clause (c) in its entirety and substituting in lieu thereof the following: "(c) Subject to paragraph (j) below, in the event and on each occasion that an Equity Issuance occurs, the Borrower shall, substantially simultaneously with (and in any event not later than the fifth Business Day next following) the occurrence of each Equity Issuance, apply 75% of the Net Cash Proceeds therefrom to prepay outstanding Term Loans in accordance with Section 2.13(g); provided, however, that in the event the Leverage Ratio on the date of such Equity Issuance (and after giving effect thereto and to the use of the proceeds thereof) is less than 3.0 to 1.0, such amount shall be reduced to 50%; provided further that with respect to the Fall 2001 Equity Issuance, (i) the Borrower may apply the Net Cash Proceeds therefrom to repurchase Subordinated Notes and/or to prepay principal of, interest on and premium, if any, on the Subordinated Notes, up to an aggregate amount equal to the sum of (x) the maximum principal amount of Subordinated Notes that may be repurchased or prepaid pursuant to the optional redemption provisions of the Subordinated Note Indentures, and (y) the 12.25% prepayment premium associated therewith (plus the amount of accrued interest on the principal amount so repurchased or prepaid), and (ii) 100% of any Net Cash Proceeds therefrom in excess of the amount so applied to repurchase and/or prepay the Subordinated Notes shall be applied to prepay outstanding Term Loans in accordance with Section 2.13(g)." C. Section 2.23(c) of the Credit Agreement is hereby amended by deleting the number "180" in the second line and substituting in lieu thereof the number "360". D. Section 2.23(c) of the Credit Agreement is hereby further amended by deleting the amount "$20,000,000" in clause (i) thereof and inserting in lieu thereof the amount "$40,000,000". 1.3 AMENDMENTS TO ARTICLE VI: NEGATIVE COVENANTS A. Section 6.05(b) of the Credit Agreement is hereby amended by adding the following proviso at the end of such section: "provided that the limitations set forth in this clause (iii) shall not apply to the non-recourse factoring of accounts receivable by Foreign Subsidiaries, provided that the aggregate outstanding amount of accounts receivable (assuming each such account receivable remains (Flowserve Corporation First Amendment to Credit Agreement) 2
outstanding for the number of days provided in the applicable invoice for non-delinquent payment) at any time which have been so factored shall not exceed $25,000,000." B. Section 6.09(b) of the Credit Agreement is hereby amended by adding the following proviso at the end of such section: "provided that the Borrower may repurchase and/or prepay the Subordinated Notes to the extent provided in the final proviso of Section 2.13(c)." SECTION 2. CONDITIONS TO EFFECTIVENESS 2.1 AMENDMENT OTHER THAN SECTION 1. This Amendment (other than Section 1 of this Amendment) shall become effective upon receipt by the Administrative Agent on or before November 16, 2001 of all of the following, in form and substance satisfactory to the Administrative Agent: A. AMENDMENT. This Amendment executed by the Borrower, the Agents and the Required Lenders; B. PAYMENT OF AMENDMENT FEE. Evidence of payment to the Administrative Agent for the account of each Lender that executes this Amendment on or before November 9, 2001 of an amendment fee equal to 0.125% of the sum of such Lender's Revolving Credit Commitment and the principal amount Term Loans held by such Lender. C. PAYMENT OF FEES. Evidence of payment by the Borrower of all accrued and unpaid fees, costs and expenses to the extent then due and payable on the date hereof, together with attorney costs of BofA to the extent invoiced prior to date hereof. D. BORROWER CERTIFICATE. A certificate signed by a Responsible Officer of the Borrower, dated as of the date hereof, stating that: (i) the representations and warranties contained in Section 3 hereof and in Article III of the Credit Agreement are true and correct on and as of such date, as though made on and as of such date; and (ii) no Default or Event of Default exists and no Default or Event of Default existed as of September 30, 2001. 2.2 EFFECTIVENESS OF SECTION 1. Section 1 of this Amendment shall become effective upon satisfaction of the conditions set forth in Section 2.1 and receipt by the Administrative Agent on or before December 31, 2001 of all of the following, in form and substance satisfactory to the Administrative Agent, it being understood and agreed that if such conditions are not satisfied on (Flowserve Corporation First Amendment to Credit Agreement) 3
or prior to December 31, 2001, Section 1 of this Amendment shall not be effective (the date of satisfaction of such conditions being referred to herein as the "First Amendment Effective Date"): A. EVIDENCE OF FALL 2001 EQUITY ISSUANCE AND REDUCTION OF INDEBTEDNESS. Evidence satisfactory to the Administrative Agent that (i) the Fall 2001 Equity Issuance has been consummated and that the Borrower has received the Net Cash Proceeds thereof, and (ii) such Net Cash Proceeds have been applied in the manner set forth in the final proviso of Section 2.13(c). B. PAYMENT OF FEES. Evidence of payment by the Borrower of all accrued and unpaid fees, costs and expenses to the extent then due and payable on the First Amendment Effective Date, together with attorney costs of BofA to the extent invoiced prior to or on the First Amendment Effective Date. C. BORROWER CERTIFICATE. A certificate signed by a Responsible Officer of the Borrower, dated as of the First Amendment Effective Date, stating that: (iii) the representations and warranties contained in Section 3 hereof and in Article III of the Credit Agreement are true and correct on and as of such date, as though made on and as of such date; and (iv) no Default or Event of Default exists. SECTION 3. BORROWER'S REPRESENTATIONS AND WARRANTIES In order to induce the Lenders to enter into this Amendment and to amend the Credit Agreement in the manner provided herein, the Borrower represents and warrants to each Lender that the following statements are true, correct and complete: A. DUE INCORPORATION, VALID EXISTENCE AND GOOD STANDING; CORPORATE POWER AND AUTHORITY. The Borrower is a corporation duly incorporated, validly existing and in good standing under the laws of the State of New York. The Borrower has all requisite corporate power and authority to enter into this Amendment and to carry out the transactions contemplated by, and perform its obligations under, the Credit Agreement as amended by this Amendment (the "Amended Agreement"). B. AUTHORIZATION OF AGREEMENTS. The execution and delivery of this Amendment and the performance of the Amended Agreement have been duly authorized by all necessary corporate action on the part of the Borrower. C. NO CONFLICT. The execution and delivery by the Borrower of this Amendment and the performance by the Borrower of the Amended Agreement do not and will not (i) violate any provision of any law or any governmental rule or regulation applicable to the Borrower or any of its Subsidiaries, the certificate or articles of incorporation or by-laws of the Borrower or any of its Subsidiaries or any order, judgment or decree of any court or other agency of government binding on the Borrower or any of its Subsidiaries, (ii) conflict with, result in a (Flowserve Corporation First Amendment to Credit Agreement) 4
breach of or constitute (with due notice or lapse of time or both) a default under any contractual obligation, agreement or other instrument of the Borrower or any of its Subsidiaries, (iii) result in or require the creation or imposition of any Lien upon any of the properties or assets of the Borrower or any of its Subsidiaries (other than Liens created under any of the Loan Documents in favor of Administrative Agent on behalf of Lenders), or (iv) require any approval of stockholders or any approval or consent of any person under any contractual obligation, agreement or other instrument of the Borrower or any of its Subsidiaries. D. GOVERNMENTAL CONSENTS. The execution and delivery by the Borrower of this Amendment and the performance by the Borrower of the Amended Agreement do not and will not require any registration with, consent or approval of, or notice to, or other action to, with or by, any federal, state or other governmental authority or regulatory body. E. BINDING OBLIGATION. This Amendment has been duly executed and delivered by the Borrower and this Amendment and the Amended Agreement are the legally valid and binding obligations of the Borrower, enforceable against the Borrower in accordance with their respective terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or limiting creditors' rights generally or by equitable principles relating to enforceability. F. ABSENCE OF DEFAULT. No event has occurred and is continuing or will result from the consummation of the transactions contemplated by this Amendment that would constitute an Event of Default or a Default. SECTION 4. MISCELLANEOUS A. REFERENCE TO AND EFFECT ON THE CREDIT AGREEMENT AND THE OTHER LOAN DOCUMENTS. (i) On and after the First Amendment Effective Date, each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of like import referring to the Credit Agreement, and each reference in the other Loan Documents to the "Credit Agreement", "thereunder", "thereof" or words of like import referring to the Credit Agreement shall mean and be a reference to the Amended Agreement. (ii) Except as specifically amended by this Amendment, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (iii) The execution, delivery and performance of this Amendment shall not, except as expressly provided herein, constitute a waiver of any provision of, or operate as a waiver of any right, power or remedy of the Administrative Agent or any Lender under, the Credit Agreement or any of the other Loan Documents. (Flowserve Corporation First Amendment to Credit Agreement) 5
B. FEES AND EXPENSES. The Borrower acknowledges that all costs, fees and expenses as described in the Credit Agreement incurred by the Administrative Agent and its counsel with respect to this Amendment and the documents and transactions contemplated hereby shall be for the account of the Borrower. C. HEADINGS. Section and subsection headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purpose or be given any substantive effect. D. APPLICABLE LAW. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF NEW YORK, WITHOUT REGARD TO CONFLICTS OF LAWS PRINCIPLES. E. COUNTERPARTS. This Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed an original, but all such counterparts together shall constitute but one and the same instrument; signature pages may be detached from multiple separate counterparts and attached to a single counterpart so that all signature pages are physically attached to the same document. (Flowserve Corporation First Amendment to Credit Agreement) 6
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their respective officers thereunto duly authorized as of the date first written above. FLOWSERVE CORPORATION, By /s/ Dave Chavenson ---------------------------------------- Name: Dave Chavenson Title: Vice President and Treasurer BANK OF AMERICA, N.A., individually and as Administrative Agent, Collateral Agent and Swingline Lender By /s/ Dan Killian ---------------------------------------- Name: Dan M. Killian Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
CREDIT SUISSE FIRST BOSTON, individually and as Syndication Agent, By /s/ William S. Lutkins ---------------------------------------- Name: William S. Lutkins Title: Vice President By /s/ David M. Koczan ---------------------------------------- Name: David M. Koczan Title: Associate (Flowserve Corporation First Amendment to Credit Agreement)
ABN AMRO BANK N.V., By /s/ Mary L. Honda ---------------------------------------- Name: Mary L. Honda Title: Group Vice President By /s/ Wendy E. Pace ---------------------------------------- Name: Wendy E. Pace Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
BANK ONE, NA, By /s/ Kathy Turner ---------------------------------------- Name: Kathy Turner Title: Director (Flowserve Corporation First Amendment to Credit Agreement)
BANK OF CHINA, LOS ANGELES BRANCH, By /s/ Liu, Haiping ---------------------------------------- Name: Liu, Haiping Title: Branch Manager (Flowserve Corporation First Amendment to Credit Agreement)
BANK OF MONTREAL By /s/ S. Valia ---------------------------------------- Name: S. Valia Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
THE BANK OF TOKYO-MITSUBISHI, LTD., By /s/ Doug Barnell ---------------------------------------- Name: D. Barnell Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
CITICORP USA INC. By /s/ F. Rockwell Lowe ---------------------------------------- Name: F. Rockwell Lowe Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
COMERICA BANK, By /s/ T. Bancroft Mattei ---------------------------------------- Name: T. Bancroft Mattei Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
THE DAI ICHI KANGYO BANK, LIMITED By /s/ Tsutomu Yamamoto ---------------------------------------- Name: Tsutomu Yamamoto Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
HSBC BANK USA, By /s/ James McClintock ---------------------------------------- Name: James McClintock Title: First Vice President (Flowserve Corporation First Amendment to Credit Agreement)
LLOYDS TSB BANK PLC, By /s/ Ian Dimmock ---------------------------------------- Name: Ian Dimmock Title: Vice President Acquisition Finance D080 By /s/ Peter Hart ---------------------------------------- Name: Peter Hart Title: Assistant Director Structured Finance H002 (Flowserve Corporation First Amendment to Credit Agreement)
NATEXIS BANQUES POPULAIRES, By /s/ Timothy L. Polvado ---------------------------------------- Name: Timothy L. Polvado Title: Vice President and Group Manager By /s/ Renaud J. d'Herbes ---------------------------------------- Name: Renaud J. d'Herbes Title: Senior Vice President and Regional Manager (Flowserve Corporation First Amendment to Credit Agreement)
NATIONAL WESTMINSTER BANK PLC By: NatWest Capital Markets Limited, its Agent By: Greenwich Capital Markets, Inc. its Agent By /s/ Harry Paschalidis ---------------------------------------- Name: Harry Paschalidis Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
ORIX FINANCIAL SERVICES, INC. By /s/ Michael J. Cox ---------------------------------------- Name: Michael J. Cox Title: Senior Vice President (Flowserve Corporation First Amendment to Credit Agreement)
THE SUMITOMO TRUST & BANKING CO., LTD., NEW YORK BRANCH, By /s/ Elizabeth A. Quiric ---------------------------------------- Name: Elizabeth A. Quiric Title: Vice-President (Flowserve Corporation First Amendment to Credit Agreement)
TORONTO DOMINION (NEW YORK), INC., By /s/ Dana Schwalie ---------------------------------------- Name: Dana Schwalie Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
LANDMARK CDO LIMITED, By: Aladdin Asset Management LLC as Manager By /s/ Joseph A. Moroney ---------------------------------------- Name: Joseph A. Moroney Title: Vice President Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AIMCO CDO SERIES 2000-A By /s/ unable to read signature ---------------------------------------- Name: ------------------------------ Title: ------------------------------ By /s/ unable to read signature ------------------------------------- Name: ------------------------------ Title: ------------------------------ (Flowserve Corporation First Amendment to Credit Agreement)
ALLSTATE LIFE INSURANCE COMPANY By /s/ unable to read signature ------------------------------------- Name: ------------------------------ Title: ------------------------------ By /s/ unable to read signature ------------------------------------- Name: ------------------------------ Title: ------------------------------ (Flowserve Corporation First Amendment to Credit Agreement)
KZH STERLING LLC, By /s/ Susan Lee ------------------------------------- Name: Susan Lee Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
AMMC CDO II, LIMITED, By: American Money Management Corp., as Collateral Manager /s/ David P. Meyer ------------------------------------- Name: David P. Meyer Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
ARES LEVERAGED INVESTMENT FUND II, L.P. By: ARES Management II, L.P. Its: General Partner /s/ David A. Sachs ------------------------------------- Name: David A. Sachs Title: Vice President ARES III CLO LTD. By: ARES CLO Management, LLC Its: Investment Manager /s/ David A. Sachs ------------------------------------- Name: David A. Sachs Title: Vice President ARES IV CLO LTD. By: ARES CLO Management IV, L.P. Investment Manager By: Ares CLO GP IV, LLC Its: Managing Member /s/ David A. Sachs ------------------------------------- Name: David A. Sachs Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
CARAVELLE INVESTMENT FUND II, L.L.C. By Trimaran Advisors, L.L.C. /s/ Dean T. Criares ------------------------------------- Name: Dean T. Criares Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
CARLYLE-HIGH YIELD PARTNERS II, LTD By /s/ Linda M. Pace ------------------------------------- Name: Linda M. Pace Title: Vice President CARLYLE-HIGH YIELD PARTNERS III, LTD By /s/ Linda M. Pace ------------------------------------- Name: Linda M. Pace Title: Vice President CARLYLE-HIGH YIELD PARTNERS, LP By /s/ Linda M. Pace ------------------------------------- Name: Linda M. Pace Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
CENTURION CDO II, LTD By: American Express Asset Management Group Inc, as Collateral Manager /s/ Michael M. Leyland ------------------------------------- Name: Michael M. Leyland Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
CONTINENTAL CASUALTY COMPANY, By /s/ Marilou R. McGirr ------------------------------------- Name: Marilou R. McGirr Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
PROMETHEUS INVESTMENT FUNDING NO. 1, CPF ASSET ADVISORY, LLC AS INVESTMENT MANAGER By /s/ Elizabeth H. Tallmadge ------------------------------------- Name: Elizabeth H. Tallmadge Title: Managing Director Chief Investment Officer By /s/ Steven Simons ------------------------------------- Name: Steven Simons Title: Associate Director (Flowserve Corporation First Amendment to Credit Agreement)
CYPRESSTREE INVESTMENT PARTNERS I, LTD, By: CypressTree Investment Management Company, Inc., as Portfolio Manager /s/ Peter Campo ------------------------------------- Name: Peter Campo Title: Investment Analyst CYPRESSTREE INVESTMENT PARTNERS II, LTD, By: CypressTree Investment Management Company, Inc., as Portfolio Manager By /s/ Peter Campo ------------------------------------- Name: Peter Campo Title: Investment Analyst CYPRESSTREE INVESTMENT MANAGEMENT COMPANY, INC. As: Attorney-in-Fact and on behalf of First Allmerica Financial Life Insurance Company as Portfolio Manager By /s/ Peter Campo ------------------------------------- Name: Peter Campo Title: Investment Analyst (Flowserve Corporation First Amendment to Credit Agreement)
GRAYSON & CO, By: BOSTON MANAGEMENT AND RESEARCH, as Investment Advisor, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President SENIOR DEBT PORTFOLIO, By: BOSTON MANAGEMENT AND RESEARCH, as Investment Advisor, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President EATON VANCE CDO II, LTD, By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President EATON VANCE CDO III, LTD, By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
EATON VANCE CDO IV, LTD, By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President CONSTANITINUS EATON VANCE CDO V, LTD., By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President EATON VANCE INSTITUTIONAL SENIOR LOAN FUND, By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President OXFORD STRATEGIC INCOME FUND, By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
EATON VANCE SENIOR INCOME TRUST, By: EATON VANCE MANAGEMENT, AS INVESTMENT ADVISOR, By /s/ Scott H. Page ------------------------------------- Name: Scott H. Page Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
FC CBO II, LIMITED By /s/ Mike McCarthy ------------------------------------- Name: Mike McCarthy Title: Manager (Flowserve Corporation First Amendment to Credit Agreement)
FLAGSHIP CLO-2001-1, By /s/ Mark S. Pelletier ------------------------------------- Name: Mark S. Pelletier Title: Director (Flowserve Corporation First Amendment to Credit Agreement)
FREMONT INVESTMENT & LOAN, By /s/ Maria Chachere ------------------------------------- Name: Maria Chachere Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
GOLDMAN SACHS CREDIT PARTNERS L.P. By /s/ Robert S. Fanelli ------------------------------------- Name: Robert S. Fanelli Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
GRAYSTON CLO 2001-01 LTD. By: Bear Stearns Asset Management Inc. as its Collateral Manager By /s/ Niell D. Rosenberg ------------------------------------- Name: Niell D. Rosenberg Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
HARCH CLO I LIMITED, By /s/ Michael E. Hewitt ------------------------------------- Name: Michael E. Hewitt Title: (Flowserve Corporation First Amendment to Credit Agreement)
INDOUEZ CAPITAL FUNDING IV, L.P. By: Indosuez Capital as Portfolio Advisor By /s/ Jack C. Henry ------------------------------------- Name: Jack C. Henry Title: Vice President and Portfolio Manager INDOUEZ CAPITAL FUNDING VI, LIMITED By: Indosuez Capital as Collateral Manager By /s/ Jack C. Henry ------------------------------------- Name: Jack C. Henry Title: Vice President and Portfolio Manager (Flowserve Corporation First Amendment to Credit Agreement)
ARCHIMEDES FUNDING III, LTD. By: ING Capital Advisors LLC, as Collateral Manager By /s/ Greg M. Masuda ------------------------------------- Name: Greg M. Masuda Title: Vice President ARCHIMEDES FUNDING IV (CAYMAN), LTD. By: ING Capital Advisors LLC, as Collateral Manager By /s/ Greg M. Masuda ------------------------------------- Name: Greg M. Masuda Title: Vice President THE ING CAPITAL SENIOR SECURED HIGH INCOME HOLDINGS FUND, LTD. By: ING Capital Advisors LLC, as Investment Manager By /s/ Greg M. Masuda ------------------------------------- Name: Greg M. Masuda Title: Vice President SEQUILS-ING I (HBDGM), LTD. By: ING Capital Advisors LLC, as Collateral Manager By /s/ Greg M. Masuda ------------------------------------- Name: Greg M. Masuda Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
SWISS LIFE US RAINBOW LIMITED By: ING Capital Advisors LLC, as Collateral Manager By /s/ Greg M. Masuda ------------------------------------- Name: Greg M. Masuda Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
INVESCO CBO 2000-1 LTD. By: INVESCO Senior Secured Management, Inc. As Portfolio Advisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AERIES FINANCE-II LTD. By: INVESCO Senior Secured Management, Inc. As Sub-Managing Agent By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AMARA 2 FINANCE, LTD. By: INVESCO Senior Secured Management, Inc. As Sub-Advisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AMARA-1 FINANCE, LTD. LTD. By: INVESCO Senior Secured Management, Inc. As Sub-advisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AVALON CAPITAL LTD. By: INVESCO Senior Secured Management, Inc. As Portfolio Advisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AVALON CAPITAL LTD. 2 By: INVESCO Senior Secured Management, Inc. As Portfolio Advisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
CERES II FINANCE LTD. By: INVESCO Senior Secured Management, Inc. As Sub-Manging Agent (Financial) By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
CHARTER VIEW PORTFOLIO By: INVESCO Senior Secured Management, Inc. As Investment Advisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
AIM FLOATING RATE FUND By: INVESCO Senior Secured Management, Inc. As Attorney in fact By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
OASIS COLLATERALIZED HIGH INCOME PORTFOLIO-1, LTD. By: INVESCO Senior Secured Management, Inc. As Subadvisor By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
SEQUILS LIBERTY, LTD. By: INVESCO Senior Secured Management, Inc. As Collateral Manager By /s/ Gregory Stoeekle ---------------------------------------- Name: Gregory Stoeekle Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
JUPITER FUNDING TRUST, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
KATONAH I, LTD., By /s/ Ralph Della Rocca ------------------------------------- Name: Ralph Della Rocca Title: Authorized Officer KATONAH II, LTD., By /s/ Ralph Della Rocca ------------------------------------- Name: Ralph Della Rocca Title: Authorized Officer (Flowserve Corporation First Amendment to Credit Agreement)
KZH CNC LLC, By /s/ Susan Lee ------------------------------------- Name: Susan Lee Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
KZH CYPRESSTREE-1 LLC, By /s/ Susan Lee ------------------------------------- Name: Susan Lee Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
MAGNETITE ASSET INVESTORS III, L.L.C, By /s/ M. Williams ------------------------------------- Name: M. Williams Title: Director MAGNETITE ASSET INVESTORS, L.L.C, By /s/ M. Williams ------------------------------------- Name: M. Williams Title: Director (Flowserve Corporation First Amendment to Credit Agreement)
MONY LIFE INSURANCE COMPANY, By /s/ Suzanne E. Walton ------------------------------------- Name: Suzanne E. Walton Title: Managing Director MONY LIFE INSURANCE COMPANY OF AMERICA, By /s/ Suzanne E. Walton ------------------------------------- Name: Suzanne E. Walton Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
MORGAN STANLEY PRIME TRUST, By /s/ Peter Gewirtz ------------------------------------- Name: Peter Gewirtz Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
MUIRFIELD TRADING LLC, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
OAK HILL CREDIT PARTNERS I, LIMITED, BY OAK HILL CLO MANAGEMENT I, LLC AS INVESTMENT MANAGER By /s/ Scott D. Krase ------------------------------------- Name: Scott D. Krase Title: Authorized Signatory (Flowserve Corporation First Amendment to Credit Agreement)
OLYMPIC FUNDING TRUST, SERIES 1999-1, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
SENIOR FLOATING RATE FUND, By /s/ David Foxhoven ------------------------------------- Name: David Foxhoven Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
PPM SPYGLASS FUNDING TRUST, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
PVT DIVERSIFIED INCOME, By /s/ John R. Verani ------------------------------------- Name: John R. Verani Title: Vice President PUTNAM HIGH YIELD TRUST, By /s/ John R. Verani ------------------------------------- Name: John R. Verani Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
RIVIERA FUNDING LLC, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
SAWGRASS TRADING LLC, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Assistant Vice President (Flowserve Corporation First Amendment to Credit Agreement)
SCUDDER FLOATING RATE FUND, By /s/ Kenneth Weber ------------------------------------- Name: Kenneth Weber Title: Senior Vice President (Flowserve Corporation First Amendment to Credit Agreement)
KZH RIVERSIDE LLC, By /s/ Susan Lee ------------------------------------- Name: Susan Lee Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
SEABOARD CLO 2000 LTD. BY ORIX CAPITAL MARKETS, LLC ITS COLLATERAL MANAGER /s/ Sheppard H.C. Davis, Jr. ------------------------------------- Name: Sheppard H.C. Davis, Jr. Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
SEQUILS-CENTURION V, LTD By American Express Asset Manager Group Inc, as Collateral Manager /s/ Michael M. Leyland ------------------------------------- Name: Michael M. Leyland Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
SEQUILS-CUMBERLAND I, LTD., By: Deerfield Management LLC, as its Collateral Manager, /s/ Dale Burrow ------------------------------------- Name: Dale Burrow Title: Senior Vice President (Flowserve Corporation First Amendment to Credit Agreement)
SIERRA CLO I, LTD., By /s/ unable to read signature ------------------------------------- Name: ---------------------------- Title: ---------------------------- (Flowserve Corporation First Amendment to Credit Agreement)
LIBERTY-STEIN ROE ADVISOR FLOATING RATE ADVANTAGE FUND By: Stein Roe & Farnham Incorporated, as Advisor, By /s/ Brian W. Good ------------------------------------- Name: Brian W. Good Title: Sr. Vice President & Portfolio Manager (Flowserve Corporation First Amendment to Credit Agreement)
GALAXY CLO 1999-1, LTD., By: SAI Investment Adviser, Inc., its Collateral Manager, By /s/ Thomas G. Brandt ------------------------------------- Name: Thomas G. Brandt Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
KZH SOLEIL LLC, By /s/ Susan Lee ------------------------------------- Name: Susan Lee Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
KZH SOLEIL-2 LLC, By /s/ Susan Lee ------------------------------------- Name: Susan Lee Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
TEXTRON FINANCIAL CORPORATION, By /s/ Matthew J. Colgan ------------------------------------- Name: Matthew J. Colgan Title: Director (Flowserve Corporation First Amendment to Credit Agreement)
COLUMBUS LOAN FUNDING LTD. BY TRAVELERS ASSET MANAGEMENT INTERNATIONAL COMPANY, LLC By /s/ Matthew J. McInerny ------------------------------------- Name: Matthew J. McInerny Title: Assistant Investment Officer TRAVELERS CORPORATE LOAN FUND INC., BY TRAVELERS ASSET MANAGEMENT INTERNATIONAL COMPANY, LLC By /s/ Matthew J. McInerny ------------------------------------- Name: Matthew J. McInerny Title: Assistant Investment Officer THE TRAVELERS INSURANCE COMPANY By /s/ Matthew J. McInerny ------------------------------------- Name: Matthew J. McInerny Title: Assistant Investment Officer (Flowserve Corporation First Amendment to Credit Agreement)
APEX (TRIMARAN) CDO I, LTD., By Trimaran Advisors, L.L.C. By /s/ Dean T. Criares ------------------------------------- Name: Dean T. Criares Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
TYLER TRADING, INC., By /s/ Don C. Day ------------------------------------- Name: Don C. Day Title: Vice President (Flowserve Corporation First Amendment to Credit Agreement)
VAN KAMPEN CLO II, LIMITED BY: VAN KAMPEN MANAGEMENT INC., AS COLLATERAL MANAGER By /s/ Darvin D. Pierce ------------------------------------- Name: Darvin D. Pierce Title: Executive Director VAN KAMPEN PRIME RATE INCOME TRUST BY: VAN KAMPEN INVESTMENT ADVISORY CORP. By /s/ Darvin D. Pierce ------------------------------------- Name: Darvin D. Pierce Title: Executive Director VAN KAMPEN SENIOR INCOME TRUST BY: VAN KAMEPN INVESTMENT ADVISORY CORP. By /s/ Darvin D. Pierce ------------------------------------- Name: Darvin D. Pierce Title: Executive Director (Flowserve Corporation First Amendment to Credit Agreement)
WHITNEY CASHFLOW FUND II, By /s/ Michael Deflorio ------------------------------------- Name: Michael Deflorio Title: Managing Director WHITNEY PRIVATE DEBT FUND L.P., By /s/ Michael Deflorio ------------------------------------- Name: Michael Deflorio Title: Managing Director (Flowserve Corporation First Amendment to Credit Agreement)
WINGED FOOT FUNDING TRUST, By /s/ Ann E. Morris ------------------------------------- Name: Ann E. Morris Title: Authorized Agent (Flowserve Corporation First Amendment to Credit Agreement)
EXHIBIT 10.45 H. D. WYNN: SUMMARY OF SEPARATION BENEFITS Continuation of employment in a consulting role from July 27, 2001, until retirement on February 28, 2002, at base pay in effect on July 27, 2001, with no change in benefits. Severance pay equal to annual base salary as of the date of termination plus the average of the annual bonuses actually paid for 1999 and 2000, payable in monthly installments over a 12-month period, beginning on March 1, 2002. Vesting in unvested portion of transitional supplemental executive retirement benefit.
EXHIBIT 13.1 FINANCIAL REVIEW
FLOWSERVE 2001 / ANNUAL REPORT 22 REPORT OF INDEPENDENT ACCOUNTANTS To The Board of Directors and Shareholders of Flowserve Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive loss, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Flowserve Corporation and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, 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 audits provide a reasonable basis for our opinion. As discussed in Note 5 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," on January 1, 2001. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Dallas, Texas February 5, 2002 - -------------------------------------------------------------------------------- REPORT OF INDEPENDENT AUDITORS To The Board of Directors and Shareholders of Flowserve Corporation We have audited the accompanying consolidated statement of operations, comprehensive loss, shareholders' equity, and cash flows of Flowserve Corporation and subsidiaries for the year ended December 31, 1999. 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 in accordance with auditing standards generally accepted in the United States. 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Flowserve Corporation and subsidiaries for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Ernst & Young LLP Dallas, Texas February 10, 2000, except for Note 8 as to which date is July 14, 2000 - -------------------------------------------------------------------------------- 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 accounting principles generally accepted in the United States of America 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 auditors in connection with their annual audit. The Board of Directors pursues its responsibility for financial information through an Audit/ Finance Committee comprised entirely of independent directors. This committee regularly meets not only with management, but also separately with representatives of the independent external and internal auditors. /s/ C. SCOTT GREER C. Scott Greer Chairman, President and Chief Executive Officer /s/ RENEE J. HORNBAKER Renee J. Hornbaker Vice President and Chief Financial Officer /s/ KATHLEEN A. GIDDINGS Kathleen A. Giddings Vice President and Chief Accounting Officer
FLOWSERVE 2001 / ANNUAL REPORT 23 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 produces engineered and industrial 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 predominately 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, the cyclical nature of the petroleum, chemical, power and other industries served, by the relationship of the U.S. dollar to other currencies, and by the demand for and pricing of customers' products. The Company believes the impact of these conditions is somewhat mitigated by the strength and diversity of Flowserve's product lines, geographic coverage and significant installed base, which provides potential for an annuity stream of revenue from parts and services. RESULTS OF OPERATIONS In general, 2001 results were higher than the prior year due to the Company's acquisition of Ingersoll-Dresser Pump Company (IDP) on August 8, 2000. That acquisition plus the Company's acquisition of Innovative Valve Technologies, Inc. (Invatec) on January 12, 2000 generally resulted in 2000 results greater than those of 1999. These acquisitions are discussed in further detail in the Liquidity and Capital Resources section of this Management Discussion and Analysis. Pro forma results referenced throughout this discussion give effect as if the Company's August 2000 acquisition of IDP had been completed on January 1, 2000 and includes purchase accounting adjustments and estimated financing costs. Special items include integration expense, restructuring expense, extraordinary items and, in 1999, other special items for asset impairment, executive separation contracts and facilities closure costs. Sales increased 24.7% to $1,917.5 million in 2001, compared with $1,538.3 million in 2000. Pro forma sales in 2000 were $1,960.1 million. Sales for 2001 compared to the prior year on a pro forma basis were adversely affected by an unfavorable currency translation of approximately 1.9%, the divestiture of product lines in late 2000 to comply with the Department of Justice consent decree to acquire IDP and the closure or sale of several service operations. Additionally, sales in 2001 were adversely impacted by the disruption following September 11th and its resultant impact on an already weakening U.S. economy, which contributed to a reduction in quick turnaround business. Sales increased 44.9% to $1,538.3 million in 2000, compared with $1,061.3 million in 1999. This increase was largely a result of the acquisitions. The change in sales is discussed further in the following section on Business Segments. SALES AND BOOKINGS (In millions of dollars)
FLOWSERVE 2001 / ANNUAL REPORT 24 MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) and the negative impact of currency translation. Sales to destinations outside the United States were 48%, unchanged from the prior year. BUSINESS SEGMENTS Flowserve manages its operations through three business segments: Flowserve Pump Division for engineered and industrial pumps; Flow Solutions Division for precision mechanical seals and flow management services; and Flow Control Division for automated and manual quarter-turn valves, control valves, nuclear valves and valve actuators. Sales, including intersegment sales, and operating income before special items, for each of the three business segments follows:
FLOWSERVE 2001 / ANNUAL REPORT 25 FCD operating income in 2001 of $31.5 million, before special items, increased 9.4% from 2000 results of $28.8 million. FCD operating income, before special items, in 2000 increased 14.7% from 1999 results of $25.1 million. Operating income before special items, as a percentage of FCD sales was 11.3% in 2001, compared with 10.4% in 2000 and 8.5% in 1999. The improved operating margin in 2001 was primarily due to efficiency improvements, which resulted in cost reductions. The increase in 2000 was primarily due to the benefits of the 1999 restructuring program. CONSOLIDATED RESULTS The gross profit of $614.6 million in 2001 increased 21.2% compared with 2000 reflecting the IDP acquisition. The gross profit in 2001 increased 2.5% compared with 2000 on a pro forma basis, despite a 2.2% reduction in pro forma sales. Gross profit margin, gross profit as a percentage of sales, was 32.0% in 2001, 33.0% in 2000 and 34.2% in 1999. The decrease in 2001 and 2000 gross profit as reported was primarily due to the acquisition of IDP, as IDP's margins historically are lower than those for the balance of the Company. The Company's margin in 2001 increased 140 basis points when compared with the 2000 pro forma margin of 30.6%. This improvement primarily resulted from IDP manufacturing integration synergies that resulted from closing, divesting or significantly downsizing a number of pump manufacturing facilities and numerous service and repair facilities. Additionally, the Company benefitted from the consolidation of its North American seal business and consolidation of certain other valve businesses throughout 2000. The benefits were partially offset by a less profitable product mix of chemical process pumps, manual valves, seals and service which was caused by the slowdown in quick turnaround business. Inventories are stated at the lower of cost or market. Cost is determined for U.S. inventories by the last-in, first-out (LIFO) method and for other inventories by the first-in, first-out (FIFO) method. The Company's LIFO reserve for U.S. inventories declined to $33.9 million at December 31, 2001 from $37.5 million at December 31, 2000 due primarily to a reduction in the FIFO cost caused by deflation in materials cost in 2001. Therefore, the impact of this reduction on 2001 earnings was insignificant. Selling, general and administrative expense was $410.6 million in 2001, compared with $360.3 million in 2000 and $301.5 million in 1999. The increased expense in 2001 and 2000 was due to the acquisitions and period costs associated with the Company's various facility consolidation projects. Selling, general and administrative expense of $410.6 million in 2001 declined 9.3% from 2000 on a pro forma basis. Selling and administrative expense in 1999 included $5.8 million in special items for executive separation contracts and certain costs relating to fourth-quarter 1999 facility closings. On a comparable operations basis without IDP and Invatec, the expense in 2000 was down over 8%, compared with 1999 (excluding the results of IDP and Invatec). Selling, general and administrative expense as a percentage of net sales was 21.4% in 2001, compared with 23.4% in 2000 as reported and 23.1% in 2000 on a pro forma basis, and 27.9% in 1999, excluding $5.8 million in special items for executive separation contracts and certain costs relating to fourth-quarter 1999 facility closings. The decrease in 2001 from the 2000 and 1999 percentages is due to IDP integration savings, including sales force reductions, the IDP headquarters closure, productivity improvements, a reduction in incentive compensation due to lower than planned performance and other cost reduction initiatives. Operating income of $204.0 million, before special items, in 2001 increased 39.2% over 2000 and 38.4% over 2000 on a pro forma basis. Operating income of $146.6 million, before special items, in 2000 increased 101.7% over 1999. The improvements generally reflect synergy benefits related to the acquisition and integration of IDP, offset in part by the impact of the aforementioned product mix shift. The 2001 restructuring benefit of $1.2 million and 2000 restructuring charge of $19.4 million were realized as part of the IDP integration program. The benefit resulted from a change in estimate in 2001. The charge of $15.9 million in 1999 was related to the 1999 restructuring program. Integration expense was $63.0 million in 2001, $35.2 million in 2000, and $14.2 million in 1999. Integration expense in 2001 and 2000 related to the acquisition of IDP. The 1999 expense related solely to the Flowserver program, a business process improvement program, which was an extension of the 1997 and 1998 Flowserve merger integration program. As part of the 1999 restructuring program, the Company also recorded special items of $5.1 million in cost of sales for inventory and fixed asset impairments and special items of $5.8 million in selling, general and administrative expense for executive separation contracts and certain costs related to fourth-quarter 1999 facility closures. Net interest expense was $118.1 million in 2001, compared with $70.3 million in 2000 and $14.7 million in 1999. The 2001 and 2000 amounts reflect the increased interest costs associated with the financing of the Invatec and IDP acquisitions partially offset by lower borrowing rates during 2001. About two-thirds of the debt at December 31, 2001 is floating rate debt and can be impacted by market interest rate changes. The effective tax rate, before extraordinary items, was 36.2% in 2001, compared with 34.0% in 2000 and 33.3% in 1999. The increased tax rates in 2001 and 2000 reflect the acquisition of IDP, which has a greater mix of business in higher taxed foreign countries. In 2001, the Company recognized a net of tax extraordinary item of $17.9 million, or $0.46 per share, related to the prepayment premium, other direct costs, and write-off of unamortized prepaid financing fees
FLOWSERVE 2001 / ANNUAL REPORT 26 MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) and discount as a result of the early extinguishment of $133 million of 12.25% senior subordinated notes with proceeds from a sale of the Company's common shares. In 2000, the Company recognized a net of tax extraordinary item which totaled $0.05 per share, related to the prepayment of its outstanding indebtedness which was required as part of the financing to acquire IDP. EARNINGS PER SHARE Earnings (loss) after special items were a loss of $1.5 million ($0.04 per share) in 2001, compared with earnings of $13.2 million ($0.35 per share) in 2000 and earnings of $12.2 million ($0.32 per share) in 1999. Special items include extraordinary items, restructuring expenses (benefit), integration expenses and, in 1999, inventory and fixed asset impairments, and costs associated with obligations under executive employment and separation agreements. Earnings before special items were $55.8 million ($1.42 per share) in 2001, compared with $51.0 million ($1.35 per share) in 2000 and $39.5 million ($1.04 per share) in 1999. Earnings before special items were $10.7 million ($0.28 per share) in 2000 on a pro forma basis. The increase in earnings before special items in 2001 and 2000 was due to the acquisitions during 2000, synergy benefits related to the acquisitions, as well as the benefits of Flowserve's restructuring program initiated at the end of 1999. Operating results before special items and pro forma results should not be considered an alternative to operating results calculated in accordance with generally accepted accounting principles. RESTRUCTURING In August 2000, in conjunction with the acquisition of IDP, the Company initiated a restructuring program designed to reduce costs and to eliminate excess capacity by consolidating facilities. The Company's actions, approved and committed to in the third quarter of 2000, resulted in the net reduction of approximately 1,100 positions and have resulted in at least $90 million in annual synergy savings at full run-rates. The Company expects the cost of achieving these synergies will be approximately $158 million, net of the Tulsa reversal and excluding capital expenditures associated with the integration. The program included the closure of IDP's former headquarters, the closure, divestiture or significant downsizing of a number of pump manufacturing facilities and service and repair centers, and a reduction of sales and sales support personnel. The Company's current estimate of $65 million in restructuring cost is comprised of approximately $42 million which relates to the IDP operations acquired, of which $26 million has been capitalized in goodwill as part of the purchase price of IDP ($42 million of estimated costs less deferred tax effect of $16 million), while the remaining cost of $23 million relates to the Flowserve operations and was recorded as restructuring expense. This expense was offset by a reversal of a restructuring charge of $5.3 million recorded in 1999 for the Company's Tulsa facility. As part of an agreement with the Department of Justice to acquire IDP, the Company was required to sell its Tulsa facility. This facility had been previously targeted for closure in 1999. Additionally, during 2000 and 2001, the Company recorded non-cash reductions to reclassify certain retirement obligations and other liabilities from the restructuring reserve and to recognize changes in estimate in the restructuring reserve. The balance of the $158 million in cost was recorded as integration expense as incurred. During 2001 and 2000, the Company incurred $63.0 million and $35.2 million, respectively, in integration costs in conjunction with this program. The Company has substantially completed its integration activities as of December 31, 2001. Expenditures charged to the 2000 restructuring reserve were:
FLOWSERVE 2001 / ANNUAL REPORT 27 non-cash reduction of the existing 1999 restructuring reserve of $5.3 million in 2000. The 1999 restructuring program resulted in a net reduction of approximately 261 employees at a cost of $8.5 million. In addition, exit costs associated with the facilities closings were $1.9 million. Expenditures charged to the 1999 restructuring reserve were:
FLOWSERVE 2001 / ANNUAL REPORT 28 MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS FROM OPERATIONS Cash flows from operations and borrowings available under the Company's existing credit agreement are its primary sources of short-term liquidity. Cash flows used in operating activities in 2001 were $47.9 million, compared with providing $18.4 million in 2000 and $84.1 million in 1999. Cash flows from operating activities for 2001 were significantly below 2000 cash flows, generally due to payments associated with the IDP integration program, including restructuring and integration payments, higher interest payments attributable to the August 2000 acquisition of IDP and increases in working capital. The primary reasons for the increase in working capital were an increase in inventories in support of backlog for future shipments, increased finished goods safety stock to meet customer deliveries during the integration process, and a systems conversion at a valve plant. At December 31, 2001, the Company had drawn $70.0 million of revolving credit primarily to fund integration activities and increases in working capital. The Company believes cash flows from operating activities would have provided approximately $6 million in 2001 if not for funding the costs of the restructuring activities, integration of IDP and the extraordinary items. The decrease in operating cash flow in 2000 from 1999 primarily resulted from an increase in accounts receivable due to the high volume of FPD shipments late in the year. FPD shipments, on a pro forma basis including IDP, have been historically weighted toward the fourth quarter each year. The Company expects improved cash flows from operating activities in 2002 due to reduced restructuring and integration payments, a full year of synergy benefits, lower interest payments and an increased focus on working capital management. The Company believes improved cash flows from operating activities combined with availability under its existing credit agreement will be sufficient to enable the Company to meet its cash flow needs during 2002. However, cash flows from operations could be adversely affected by economic, political and other risks associated with international sales and operations, intense competition, fluctuations in foreign exchange rates and fluctuations in interest rates, among other factors. PAYMENTS FOR ACQUISITIONS In January 2000, the Company acquired Invatec, a company principally engaged in providing comprehensive maintenance, repair, replacement and value-added distribution services for valves, piping systems, instrumentation and other process-system components for industrial customers. The purchase involved acquiring all of the outstanding stock of Invatec and assuming Invatec's existing debt and related obligations. The transaction was accounted for under the purchase method of accounting and was financed by utilizing available funds. The results of operations for Invatec are included in the Company's consolidated financial statements from the date of acquisition. The purchase price was approximately $16.6 million in cash for shares tendered. Net debt of $87.7 million was simultaneously paid off through borrowings under the Company's revolving credit agreement. In August 2000, the Company completed the acquisition of IDP, a leading manufacturer of pumps with a diverse mix of pump products and customers with operations in 30 countries, for $775 million in cash. As part of the purchase, the Company acquired $25 million in cash. The seller also agreed to provide for severance for certain employees and costs related to the accelerated closure of several U.S. facilities which the Company estimated at $52 million. The transaction, which was accounted for as a purchase, was financed with a combination of senior secured term loans and issuance of senior subordinated notes. Upon closing of the transaction, the existing Company debt was also refinanced into the new senior secured credit facility. The Company regularly evaluates acquisition opportunities of various sizes. Its ability to raise additional capital through debt or equity financing is a critical consideration in any such evaluation. CAPITAL EXPENDITURES Capital expenditures were $35.2 million in 2001, compared with $27.8 million in 2000 and $40.5 million in 1999. Capital expenditures were funded primarily by operating cash flows and bank borrowings. For each of the three years, capital expenditures were invested in new and replacement machinery and equipment, information technology, integration activities including structures and realignment and equipment required at receiving facilities. Capital expenditures included $4.8 million in 2000 and $11.4 million in 1999 related to Flowserver. Cash proceeds on the disposal of assets associated with the IDP integration activities were $8.7 million in 2001. Cash proceeds from the sale of Tulsa and disposal of other assets were $5.4 million in 2000.
FLOWSERVE 2001 / ANNUAL REPORT 29 FINANCING During the third quarter of 2000, in connection with the acquisition of IDP, the Company entered into a Senior Secured Credit Facility (the Credit Facility) which included a $275 million term loan (Tranche A) due June 2006, a $475 million term loan (Tranche B) due June 2008, and a $300 million revolving credit facility with a final maturity of June 2006. The Credit Facility is secured by substantially all domestic assets of the Company and a pledge of 65% of the stock of the foreign subsidiaries. The term loans bear floating interest rates based on LIBOR plus a credit spread, or the Prime Rate plus a credit spread, at the option of the Company. The credit spread can increase or decrease based on the Company's leverage ratio as defined. At December 31, 2001 the interest rates on the term loans were 4.69%, 4.88% and 5.06% relating to Tranche A and 5.63% and 5.81% relating to Tranche B. As of December 31, 2001, $70.0 million of the revolving credit was drawn and $726.9 million of the term loans were outstanding. The term loans require scheduled principal payments which began June 30, 2001. At December 31, 2001, the Company had repaid $23 million of the term loans. The scheduled principal payments of the term loans outstanding at December 31, 2001 are summarized as follows: $44.5 million in 2002, $59.4 million in 2003, $63.3 million in 2004, $67.3 million in 2005, $105.9 million in 2006, $257.5 million in 2007 and $129.1 million in 2008. Effective December 31, 2001, the Company is required to use a percentage of excess cash from operations, as defined in the Credit Facility and the indenture, to reduce the outstanding principal of the term loans in the following year. No additional principal payments are due in 2002 under this provision. The revolving credit facility allows the Company to issue up to $200 million in letters of credit. As of December 31, 2001, $27.4 million of letters of credit had been issued under the facility. As letters of credit issued under the facility reduce availability, the Company had $202.6 million remaining in unused borrowing capacity at December 31, 2001 under the revolving credit facility. The Company also issued 10 year senior subordinated notes on August 8, 2000 in a U.S. dollar tranche and a Euro tranche. Proceeds of $285.9 million from the dollar tranche and EUR 98.6 million from the Euro tranche, equivalent to $89.2 million, were also used in completing the IDP acquisition. The notes, issued at a fixed rate of 12.25%, were originally priced at a discount to yield 12.50%, and have no scheduled principal payment prior to maturity in August 2010. Beginning in August 2005, the notes become callable at a fixed redemption price. The notes can also be redeemed by the Company under certain circumstances and have mandatory redemption features under certain circumstances, including a change in control as defined. Interest on the notes is payable semi-annually in February and August. A portion of these notes was repaid in 2001 as described in the next paragraph. During 2001, the Company completed an offering of approximately 6.9 million shares of its common stock for net proceeds of approximately $154 million. These proceeds were used to prepay $101.5 million of the U.S. dollar tranche, EUR 35 million of the Euro tranche of the senior subordinated notes, and to pay associated prepayment premiums and other direct costs. The Company recorded an extraordinary item of $17.9 million, net of tax, comprised of the prepayment premiums, other direct costs, and the write-off of unamortized prepaid financing fees and discount for the portion of the senior subordinated notes that was prepaid. The Company recognizes that it has incurred significant indebtedness for the recent acquisitions that is substantial in relation to shareholders' equity. This indebtedness increases the Company's vulnerability to adverse economic and industry conditions, requires the Company to dedicate a substantial portion of cash flow from operating activities to payments on the indebtedness and could limit its ability to borrow additional funds and/or raise additional capital. The provisions of the Credit Facility require the Company to meet or exceed specified financial covenants that are defined in the Credit Facility. These covenants include a leverage ratio, an interest coverage ratio, and a fixed charge coverage ratio. Further, the provisions of the Credit Facility and the senior subordinated notes require limitations or restrictions on indebtedness, liens, sale and leaseback transactions, acquisitions, asset sales, payment of dividends or other distributions, capital expenditures, and other customary restrictions. At December 31, 2001, the Company was in compliance with these covenants. At December 31, 2001, net debt was 71.3% of the Company's capital structure, compared with 78.1% at December 31, 2000 and 35.7% at December 31, 1999. The ratio decreased in 2001 due to the repayment of a portion of the senior subordinated notes and the term loans combined with an increase in shareholders' equity due to the common stock offering. The ratio increased in 2000 due to the financing incurred for the 2000 acquisitions. The interest coverage ratio of the Company's indebtedness, as defined in the Credit Facility, was 1.7 times interest at December 31, 2001, compared with 2.0 times interest at December 31, 2000 and 4.3 times interest at December 31, 1999. Maturities of the Company's long-term debt, and future capital lease and operating lease obligations at December 31, 2001 are summarized as follows: $57 million in 2002, $69 million in 2003, $70 million in 2004, $73 million in 2005, $179 million in 2006 and $635 million thereafter. The return on average net assets, before special items, based on results for 2001 was 7.8%, compared with 8.9% for 2000 and 7.7% for 1999. Including the impact of special items, the return on average net assets was 4.4% for 2001, compared with 5.5% for 2000 and 3.4%
FLOWSERVE 2001 / ANNUAL REPORT 30 MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) for 1999. The decrease in the return on average net assets both before and after special items in 2001 compared with 2000 is generally due to the goodwill and other intangible assets associated with the IDP acquisition. The increase in 2000 compared with 1999 is due to the benefits of the 1999 restructuring program and a disproportionate share of IDP's 2000 earnings included during the period from the acquisition date through December 31, 2000 due to the seasonality of its business. The return on average shareholders' equity before special items was 18.5% for 2001, compared with 16.7% for 2000 and 11.7% for 1999. The increases in return on average shareholders' equity before special items in 2001 compared with 2000 and in 2000 compared with 1999 are due to improved earnings before special items and the reduction in shareholders' equity due to other comprehensive expense (principally for cumulative translation adjustment). The return on shareholders' equity, including special items, was (0.5)% for 2001, 4.4% for 2000 and 3.6% for 1999. The decrease in return on average shareholders' equity including special items in 2001 compared with 2000 is generally due to an increase in special items. The increase in return on average shareholders' equity including special items in 2000 compared with 1999 is generally due to earnings from IDP, partially offset by increased special items. 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 by 2% and earnings before income taxes by 9% in 2001, sales by 5% and earnings before income taxes by 12% in 2000 and sales by 1% and earnings before income taxes by 9% in 1999. RETIREMENT BENEFITS The Company sponsors several defined benefit pension plans and post-retirement health care plans. The Company's recorded liability for these plans was $146.8 million at December 31, 2001 and $122.2 million at December 31, 2000. The increase in the liability in 2001 reflects a decline in the fair value of pension plan assets due to weak market performance and increased benefits payments due to personnel reductions in recent years. The Company expects to fund contributions to the plans from operating cash flows. MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS The Company has market risk exposure arising from changes in interest rates and foreign currency exchange rate movements. The Company's earnings are impacted by changes in short-term interest rates as a result of borrowings under its Credit Facility, which bear interest based on floating rates. At December 31, 2001, after the effect of interest rate swaps held by the Company, the Company had approximately $650 million of variable-rate debt obligations outstanding with a weighted average interest rate of 5.79%. A hypothetical change of 100-basis points in the interest rate for these borrowings, assuming debt levels at December 31, 2001, would change interest expense by approximately $6.5 million for the year ended December 31, 2001. The Company, as part of its risk management program, is party to interest rate swap agreements for the purpose of hedging its exposure to floating interest rates on certain portions of its debt. The Company is exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, but it expects all counterparties to meet their obligations given their creditworthiness. As of December 31, 2001 and 2000, the Company had $150 million and $75 million of notional amount in outstanding interest rate swaps with third parties with maturities of up to 5 years. 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. Based on the sensitivity analysis at December 31, 2001, a 10% adverse change in the foreign currency exchange rates could impact the Company's results of operation by $3.0 million. The primary currencies to which the Company has exposure are the Euro, British pound, Canadian dollar, Mexican peso, Japanese yen, Singapore dollar, Brazilian real and 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. As of December 31, 2001 and 2000, the Company had an U.S. dollar equivalent of $69.4 million and $103.9 million in outstanding forward contracts with third parties. Generally, the Company views its investments in foreign subsidiaries from a long-term perspective, and therefore, does not hedge these investments. The Company uses capital structuring techniques to manage its investment in foreign subsidiaries as deemed necessary. The Company incurred foreign currency translation losses of $37.6 million in 2001, $20.7 million in 2000 and $20.9 million in 1999. These losses, included in other comprehensive expense, were the result of a general strengthening of the U.S. dollar versus the Euro and other currencies of the Company's foreign subsidiaries.
FLOWSERVE 2001 / ANNUAL REPORT 31 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 its future financial condition, results of operations or cash flows to be materially impacted by the Euro conversion. ACCOUNTING DEVELOPMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. Additionally, SFAS No. 141 establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition and is effective for the Company on January 1, 2002. The most significant changes made by SFAS No. 142 require that goodwill and indefinite lived intangible assets no longer be amortized and be tested for impairment at least on an annual basis. Additionally, the amortization period for intangible assets will no longer be limited to forty years. The Company is currently assessing the impact of SFAS 141 and 142 and has not yet determined the full effects these statements will have on its consolidated financial position or results of operations. However, the Company has estimated that the reduction in annual amortization expense for goodwill and indefinite lived intangible assets will total approximately $19 million, or approximately $14 million or $0.30 per share after-tax. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for the Company on January 1, 2003. The Company is currently assessing the impact of SFAS No. 143 and has not yet determined the effects, if any, it will have on its consolidated financial position or results of operations. FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY This Annual Report and other written reports and oral statements made from time-to-time by the Company contain various forward-looking statements and include 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: changes in the financial markets and the availability of capital; changes in the already competitive environment for the Company's products or competitors' responses to Flowserve's strategies; the Company's ability to integrate past and future acquisitions into its management and operations; political risks or trade embargoes affecting important country markets; the health of the petroleum, chemical and power industries; economic conditions and the extent of economic growth in areas inside and outside the United States; unanticipated difficulties or costs associated with the implementation of systems, including software; the Company's ability to meet the financial covenants and other requirements of its financing agreements; repercussions from the terrorist attacks of September 11, 2001, and the response of the United States to those attacks; technological developments in the Company's products as compared to those of its competitors; changes in prevailing interest rates and the effective interest costs which the Company bears; and adverse changes in the regulatory climate and other legal obligations imposed on the Company. 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 2001 / ANNUAL REPORT 32 CONSOLIDATED STATEMENTS OF OPERATIONS
FLOWSERVE 2001 / ANNUAL REPORT 33 Consolidated Balance Sheets
FLOWSERVE 2001 / ANNUAL REPORT 34 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FLOWSERVE 2001 / ANNUAL REPORT 35 CONSOLIDATED STATEMENTS OF CASH FLOWS
FLOWSERVE 2001 / ANNUAL REPORT 36 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 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. Significant estimates made by management include the allowance for doubtful accounts, inventory valuation, deferred tax asset valuation allowances, restructuring accruals, warranty accruals, legal and environmental accruals, insurance accruals, and retirement benefit obligations. The Company's estimates for uncollectible accounts receivable are based upon an analysis of the Company's prior collection experience, customer creditworthiness and current economic trends, including changes in the industries served by the Company. Estimates are determined for inventory valuation reserves based upon management's assessment of the market conditions for its products. The Company has recorded valuation allowances to reflect the estimated amount of deferred tax assets that may not be realized based upon the Company's analysis of existing net operating losses and tax credits by jurisdiction and expectations of the Company's ability to utilize these tax attributes through a review of future taxable income and establishment of tax strategies. These estimates could be impacted by changes in future taxable income and the results of the tax strategies. Warranty obligations are contingent upon product failure rates, materials usage or service delivery costs. The Company estimates its warranty provisions based upon an analysis of all identified or expected claims and an estimate of the cost to resolve those claims. Legal and environmental reserves are recorded based upon a case by case analysis of the facts, circumstances and related costs. Insurance reserves are recorded based upon an analysis of the Company's claim loss history and an estimate of incurred but not recorded claims. Retirement benefit obligations are affected by a number of estimates made by management in consultation with independent actuaries, including the discount rate, long-term rate of return on assets, and assumed rate of increase in health care costs. These estimates and assumptions are based upon the best available information and are subject to change as conditions within and beyond the control of the Company change, including but not limited to economic conditions, the availability of additional information and actual experience rates different from those used in the Company's estimates. Accordingly, actual results could differ from those estimates. BASIS OF COMPARISON Certain amounts in 2000 and 1999 have been reclassified to conform with the 2001 presentation. BUSINESS COMBINATIONS 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 of the identifiable net assets is recorded as goodwill. REVENUE RECOGNITION Revenues and costs are generally recognized based on the shipping terms agreed to with the customer and fulfillment of all but inconsequential or perfunctory actions required of the Company. Revenue for certain longer-term contracts is recognized based on the percentage of completion method. Shipping and handling costs are reported in cost of sales and amounts billed to customers for these costs are included in revenues. 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 The Company places its temporary cash investments with financial institutions and, by policy, invests in those institutions and instruments that have minimal credit and market risk. These investments, with an original maturity of three months or less when purchased, are classified as cash equivalents. They are highly liquid with principal values not subject to significant risk of change due to interest rate fluctuations. ACCOUNTS RECEIVABLE AND CREDIT RISK Accounts receivable are stated net of the allowance for doubtful accounts of $20,800 and $18,481 at December 31, 2001 and 2000, respectively. Credit risk is mitigated by the large number of customers in the Company's customer base across many different geographic regions and an analysis of the creditworthiness of such customers. As of December 31, 2001, the Company does not believe that it had significant concentrations of credit risk.
FLOWSERVE 2001 / ANNUAL REPORT 37 INVENTORIES Inventories are stated at the lower-of-cost or market. Cost is determined for U.S. 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:
FLOWSERVE 2001 / ANNUAL REPORT 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company discontinues hedge accounting prospectively when (1) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedge item (including hedged items such as firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) it is no longer probable that the forecasted transaction will occur; or (4) management determines that designating the derivative as a hedging instrument is no longer appropriate. When the Company discontinues hedge accounting because it is no longer probable that the forecasted transaction will occur in the originally expected period, the gain or loss on the derivative remaining in accumulated other comprehensive income is reclassified into earnings. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will carry the derivative at its fair value on the balance sheet, recognizing changes in the fair value in current period earnings. Prior to 2001, gains and losses on forward contracts qualifying as hedges were deferred and included in the measurement of the related foreign currency transaction. Gains and losses on hedges of existing assets or liabilities were included in the carrying amounts of those assets or liabilities and were ultimately recognized in income as part of those carrying amounts. Gains and losses related to hedges of anticipated transactions were recognized in income as the transactions occurred. Gains and losses on swap agreements were recognized in interest expense as they were realized. FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying amounts of the Company's financial instruments approximate fair value at December 31, 2001, except for long-term debt, which had a carrying value of $1,041 million and an estimated fair value of $1,077 million. The carrying amounts of all of the Company's financial instruments approximate fair value at December 31, 2000. FOREIGN CURRENCY TRANSLATION Assets and liabilities of the Company's foreign affiliates, other than those located in highly inflationary countries, if any, 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 accumulated other comprehensive loss, except for those associated with highly inflationary countries, which are reported directly in the consolidated statements of operations. RESEARCH AND DEVELOPMENT EXPENSE Research and development costs are charged to expense when incurred. Research and development costs were $23.4 million in 2001, $24.8 million in 2000 and $25.6 million in 1999. EARNINGS PER SHARE Basic and diluted earnings per share were calculated as follows:
FLOWSERVE 2001 / ANNUAL REPORT 39 STOCK-BASED COMPENSATION The Company accounts for stock options granted to employees and directors using the intrinsic-value method. Under the intrinsic-value method, no compensation expense is recorded if the exercise price of the Company's stock options is equal to or greater than the market price of the underlying stock on the date of grant. ACCOUNTING DEVELOPMENTS In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. Additionally, SFAS No. 141 establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition and is effective for the Company on January 1, 2002. The most significant changes made by SFAS No. 142 require that goodwill and indefinite lived intangible assets no longer be amortized and be tested for impairment at least on an annual basis. Additionally, the amortization period for intangible assets will no longer be limited to 40 years. The Company is currently assessing the impact of SFAS No. 141 and No. 142 and has not yet determined the full effects these statements will have on its consolidated financial position or results of operations. However, the Company has estimated that the reduction in annual amortization expense will total approximately $19 million, or approximately $14 million or $0.30 per share after-tax. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for the Company on January 1, 2003. The Company is currently assessing the impact of SFAS No. 143 and has not yet determined the effects, if any, it will have on its consolidated financial position or results of operations. NOTE 2: ACQUISITIONS In January 2000, the Company acquired Innovative Valve Technologies, Inc. (Invatec), a company principally engaged in providing comprehensive maintenance, repair, replacement and value-added distribution services for valves, piping systems, instrumentation and other process-system components for industrial customers. The purchase involved acquiring all of the outstanding stock of Invatec and assuming Invatec's existing debt and related obligations. The transaction was accounted for under the purchase method of accounting and was financed by utilizing funds from the Company's working capital. The purchase price was approximately $16.6 million in cash for shares tendered. Net debt of $87.7 million was simultaneously paid off through borrowings under the Company's revolving credit agreement. In August 2000, the Company completed the acquisition of Ingersoll-Dresser Pump Company (IDP), a leading manufacturer of pumps with a diverse mix of pump products and customers with operations in 30 countries, for $775 million in cash. The transaction, which was accounted for as a purchase, was financed with a combination of senior secured term loans and issuance of senior subordinated notes. Upon closing of the transaction, the existing Company debt was also refinanced into the new senior secured credit facility. (See Note 7, Debt and Lease Obligations, for information on the debt incurred to finance the acquisition). The purchase price has been allocated to assets acquired and liabilities assumed based on estimated fair market value at the date of the acquisition. These allocations include $137.6 million for intangibles and $401.3 million recorded as goodwill. The operating results of these acquired businesses have been included in the consolidated statements of operations from the dates of acquisition. The table below reflects unaudited pro forma results of the Company, Invatec and IDP as if the acquisitions had taken place at the beginning of fiscal years 2000 and 1999, including purchase accounting adjustments and estimated financing costs. PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FLOWSERVE 2001 / ANNUAL REPORT 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In October 1999, the Company purchased certain assets and liabilities of Honeywell's industrial control-valve product line and production equipment. The Company completed the phased move of this operation to its existing control-valve manufacturing facilities in Europe in March of 2000. This business generated revenues of about $7 million in 1999. NOTE 3: RESTRUCTURING AND ACQUISITION RELATED CHARGES In August 2000, in conjunction with the acquisition of IDP, the Company initiated a restructuring program designed to reduce costs and to eliminate excess capacity by consolidating facilities. The Company's actions, approved and committed to in the third quarter of 2000, have resulted in the net reduction of approximately 1,100 positions, which was consistent with the plan. The program includes the closure of IDP's former headquarters, the closure or significant downsizing of a number of pump manufacturing facilities and service and repair centers, and a reduction of sales and sales support personnel. The Company currently estimates that the costs associated with the restructuring portion of the program will be approximately $65 million. The Company had originally estimated these costs to be approximately $61 million. The changes from the original estimate are primarily due to updated actuarial information for post-retirement and pension expense relating to a plant closure. This increase was offset by a non-cash reclassification from the restructuring accrual to retirement benefit obligations and other liabilities which resulted in a net reduction to the accrual of $8.8 million in 2000 and $2.5 million during 2001. In the fourth quarter of 2001, the Company reduced the restructuring reserve by $2.9 million due to lower than previously estimated costs related to employee severance and relocation expenses. The $2.9 million reduction includes $1.2 million related to Flowserve operations that was recorded as a reduction of restructuring expense, while the remaining $1.7 million related to IDP operations and was recorded as a reduction of goodwill. The Company's current estimate of $65 million in restructuring cost is comprised of approximately $42 million which relates to the IDP operations acquired, of which $26 million has been capitalized in goodwill as part of the purchase price of IDP ($42 million of estimated costs less deferred tax effect of $16 million), while the remaining cost of $23 million relates to the Flowserve operations and was recorded as restructuring expense. This expense was offset by a reversal of a restructuring charge of $5.3 million recorded in 1999 for the Company's Tulsa facility. As part of an agreement with the Department of Justice to acquire IDP, the Company was required to sell its Tulsa facility. This facility had been previously targeted for closure in 1999. During 2001 and 2000, the Company also incurred $63.0 million and $35.2 million, respectively, in integration costs in conjunction with this program. The total costs of integrating IDP were $158 million, net of the Tulsa reversal and excluding capital expenditures associated with the integration. The balance of the $158 million in costs was recorded as integration expense as incurred. The Company has substantially completed its integration activities as of December 31, 2001. Expenditures charged to the 2000 restructuring reserve were:
FLOWSERVE 2001 / ANNUAL REPORT 41 NOTE 4: STOCK PLANS The Company maintains shareholder-approved stock option plans to purchase shares of the Company's common stock. At December 31, 2001, approximately 413,783 options were available for grant. Options under these plans have been granted to officers, other employees and directors to purchase shares of common stock at or above the 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 expire after 10 years from the date of the grant. The plan provides that any option may include a stock appreciation right; however, none has been granted since 1989. The aggregate number of exercisable shares was 2,065,006 at December 31, 2001, 2,195,599 at December 31, 2000, and 2,117,816 at December 31, 1999. Information concerning stock options issued to officers, other employees and directors is presented in the following table:
FLOWSERVE 2001 / ANNUAL REPORT 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Disclosure of pro forma information regarding net earnings and earnings per share as if the Company had accounted for its stock options granted subsequent to December 31, 1994, under a fair value method is required. 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:
FLOWSERVE 2001 / ANNUAL REPORT 43 The Company expects that within the next twelve months it will reclassify as expense $2.6 million, net of deferred tax, of the amount recorded in accumulated other comprehensive loss for contracts that will settle during the period. NOTE 6: DETAILS OF CERTAIN CONSOLIDATED BALANCE SHEET CAPTIONS INVENTORIES Inventories and the method of determining cost were:
FLOWSERVE 2001 / ANNUAL REPORT 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 7: DEBT AND LEASE OBLIGATIONS Long-term debt, including capital lease obligations, consisted of:
Flowserve 2001 / Annual Report 45 In 2000, the Company recorded an extraordinary item of $2.1 million, which is net of tax of $1.2 million, for prepayment premiums and the write-off of prepaid financing fees associated with the prepayment of certain long-term debt. 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 $14,041 in 2001, $13,020 in 2000, and $11,648 in 1999. The future minimum lease payments due under noncancelable operating leases are:
FLOWSERVE 2001 / ANNUAL REPORT 46 CONSOLIDATING STATEMENT OF OPERATIONS
FLOWSERVE 2001 / ANNUAL REPORT 47 CONSOLIDATING STATEMENT OF OPERATIONS
FLOWSERVE 2001 / ANNUAL REPORT 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) CONSOLIDATING BALANCE SHEET
FLOWSERVE 2001 / ANNUAL REPORT 49 CONSOLIDATING BALANCE SHEET
FLOWSERVE 2001 / ANNUAL REPORT 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) CONSOLIDATING STATEMENT OF CASH FLOWS
FLOWSERVE 2001 / ANNUAL REPORT 51 CONSOLIDATING STATEMENTS OF CASH FLOWS CONSOLIDATING STATEMENT OF CASH FLOWS
FLOWSERVE 2001 / ANNUAL REPORT 52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) CONSOLIDATING STATEMENT OF CASH FLOWS
FLOWSERVE 2001 / ANNUAL REPORT 53 NOTE 9: DEFERRED COMPENSATION - RABBI TRUST The Company has established deferred compensation plans under which a portion of amounts earned by employees are invested in the Company's common stock and placed in a Rabbi Trust. Effective October 1, 2000, the Company amended the provisions of the deferred compensation plans. As amended, the stock deferred compensation plans do not allow diversification and require the obligation for the deferred compensation amounts held in Company stock be settled by the delivery of a fixed number of shares of Company stock. Accordingly, the deferred compensation obligation to be settled with stock is reflected in shareholders' equity. Prior to these amendments, the Company recorded net expense of $923 in 2000 and $243 in 1999 to reflect the change in fair value of the deferred compensation liability for Company stock. NOTE 10: RETIREMENT BENEFITS The Company sponsors several noncontributory defined benefit pension plans, covering substantially all domestic employees and certain foreign employees, which provide benefits based on years of service and compensation. Retirement benefits for all other employees are provided through defined contribution pension plans, cash balance 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. Net defined benefit pension expense for domestic pension plans (including both qualified and nonqualified plans) was:
FLOWSERVE 2001 / ANNUAL REPORT 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table reconciles the foreign plans' funded status to amounts recognized in the Company's consolidated balance sheets:
FLOWSERVE 2001 / ANNUAL REPORT 55 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 by the Company as insured benefits and health maintenance organization premiums are incurred. The benefits are no longer available to new employees and certain existing employees. Net post-retirement benefit expense comprised:
FLOWSERVE 2001 / ANNUAL REPORT 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company is a defendant in numerous pending lawsuits (which include, in many cases, multiple claimants) that seek to recover damages for alleged personal injury allegedly resulting from exposure to asbestos-containing products formerly manufactured and/or 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-containing fiber during the use of this equipment. 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 adverse impact on the Company's financial statements. Although none of the aforementioned potential liabilities can be quantified with any certainty, the Company has established reserves covering these possible exposures, which management believes are reasonable based on past experience and available facts. While additional exposures beyond these reserves could exist, none gives rise to any additional liability that can now be reasonably estimated, and the Company believes any such costs will not have a material adverse impact on the Company. The Company will continue to evaluate these potentially additional contingent loss exposures and, if they develop, recognize expense as soon as such losses can be reasonably estimated. NOTE 12: SHAREHOLDERS' EQUITY 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. NOTE 13: INCOME TAXES The provision (benefit) for income taxes consisted of the following:
FLOWSERVE 2001 / ANNUAL REPORT 57 The provision for income taxes on earnings before extraordinary items was different from the statutory corporate rate due to the following:
FLOWSERVE 2001 / ANNUAL REPORT 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) management use financial information generated and reported at the division level. The Flowserve Pump Division designs, manufactures and distributes pumps and related equipment. 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 Flow Control Division designs, manufactures and distributes automated and manual quarter-turn valves, control valves and valve actuators, and related components. The Company also has a corporate headquarters that does not constitute a separate division or business segment. Amounts classified as All Other include Corporate headquarter costs and other minor entities that are not considered separate segments. The results for Invatec and IDP are included in the Flow Solutions Division and Flowserve Pump Division, respectively, from the date of acquisition. The Company evaluates segment performance and allocates resources based on profit or loss excluding integration, restructuring and interest expense, other income and income 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. Minor reclassifications have been made to certain previously reported information to conform to the current business configuration.
FLOWSERVE 2001 / ANNUAL REPORT 59 RECONCILIATION OF SEGMENT INFORMATION TO CONSOLIDATED AMOUNTS Significant items from the Company's reportable segments can be reconciled to the consolidated amounts as follows:
FLOWSERVE 2001 / ANNUAL REPORT 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 15: UNAUDITED QUARTERLY FINANCIAL DATA
FLOWSERVE 2001 / ANNUAL REPORT 61 FIVE-YEAR SELECTED FINANCIAL DATA
EXHIBIT 21.1 FLOWSERVE CORPORATION LIST OF SUBSIDIARIES
EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-62044) and to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-28497, 333-82081, 33-28497, 333-50667, and 333-46234) of Flowserve Corporation of our report dated February 5, 2002 relating to the financial statements, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 5, 2002 relating to the financial statement schedule, which appears in this Form 10-K. PricewaterhouseCoopers LLP Dallas, Texas March 8, 2002
EXHIBIT 23.2 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 10, 2000 (except for Note 8, as to which date is July 14, 2000), with respect to the consolidated statements of operations, comprehensive loss, shareholders' equity and cash flows of Flowserve Corporation and subsidiaries for the year ended December 31, 1999, included in the 2001 Annual Report to Shareholders of Flowserve Corporation for the year ended December 31, 2001. Our audit also included the financial statement schedule of Flowserve Corporation for the year ended December 31, 1999, listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. 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.333-82081) and (Form S-8 No. 33-28497) pertaining to Flowserve Corporation Retirement Savings Plan (formerly the Duriron Company, Inc. Saving and Thrift Plan), (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 and the BWIP Holding, Inc. Non-Employee Directors' Stock Option Plan, (Form S-8 No. 333-46234) pertaining to the 1997 and 1999 Stock Option Plans, and (Form S-3 No. 333-62044) and in the related Prospectus of our report dated February 10, 2000 (except for Note 8, as to which date is July 14, 2000), with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of Flowserve Corporation. /s/ Ernst & Young LLP Dallas, Texas March 8, 2002