UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR ~~15(d)~~15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED ~~SEPTEMBER~~June 30, ~~2005~~2006


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

FOR THE TRANSITION PERIOD FROM to to.

Commission File No. 1-13179

FLOWSERVE CORPORATION

(Exact name of registrant as specified in its charter)


New York		31-0267900

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
~~incorporation or organization)~~

5215 N. O’Connor Blvd., Suite 2300, Irving Texas		75039

(Address of principal executive offices)		(Zip Code)

(972) 443-6500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.o Yesþ No

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


~~Large accelerated filer~~þ		Large accelerated filerþAccelerated filero Non-accelerated filer o		~~Non-accelerated filer~~o

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

As of ~~July 24,~~September 25, 2006, there were ~~56,503,473~~56,532,358 shares of the issuer’s common stock outstanding.

FLOWSERVE CORPORATION
FORM 10-Q

TABLE OF CONTENTS


			Page
		No.
EXPLANATORY NOTE		1

PART I –— FINANCIAL INFORMATION

Item 1.	Financial Statements.

	Condensed Consolidated Statements of ~~Operations –~~Income — Three Months Ended ~~September~~June 30, ~~2005~~2006 and ~~2004~~2005 (unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income — Three Months Ended June 30, 2006 and 2005 (unaudited)	2
	Condensed Consolidated Statements of Income — Six Months Ended June 30, 2006 and 2005 (unaudited)	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) ~~Income – Three~~— Six Months Ended ~~September~~June 30, ~~2005~~2006 and ~~2004~~2005 (unaudited)	3

	Condensed Consolidated ~~Statements of Operations – Nine Months Ended September~~Balance Sheets — June 30, ~~2005~~2006 and ~~2004~~December 31, 2005 (unaudited)	4

	~~Condensed Consolidated Statements of Comprehensive (Loss) Income – Nine Months Ended September 30, 2005 and 2004 (unaudited)~~	5

	~~Condensed Consolidated Balance Sheets - September 30, 2005 and December 31, 2004 (unaudited)~~	6

	Condensed Consolidated Statements of Cash Flows ~~- Nine~~— Six Months Ended ~~September~~June 30, ~~2005~~2006 and ~~2004~~2005 (unaudited)	7
		5
	Notes to Condensed Consolidated Financial Statements	8
		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	25
		22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	42
		37
Item 4.	Controls and Procedures.	43
		38
PART II –— OTHER INFORMATION

Item 1.	Legal Proceedings.	45
		40
Item 1A.	Risk Factors.	47
		42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	47
		43
Item 3.	Defaults Upon Senior Securities.	48
		44
Item 4.	Submission of Matters to a Vote of Security Holders.	48
		44
Item 5.	Other Information.	48
		44
Item 6.	Exhibits.	49
		45
SIGNATURES		5046
Certification Pursuant to Section 302
Certification Pursuant to Section 302
Certification Pursuant to Section 906
Certification Pursuant to Section 906

EXPLANATORY NOTE

As a result of the significant delay in completing our Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Annual Report”) , which was filed on June 30, 2006, and the obligations regarding internal control certification under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), we were unable to timely file with the Securities and Exchange Commission (“SEC”), this Quarterly Report on Form 10-Q for the quarterly period ended ~~September~~June 30, ~~2005~~2006 (“Quarterly Report”) ~~and certain other period reports. We continue to work toward becoming current in our quarterly filings with the SEC as soon as practicable after the filing of this Quarterly Report.~~.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF ~~OPERATIONS~~INCOME


							Three Months Ended
							June 30,
(Amounts in thousands, except per share data)	Three Months Ended September 30,						2006			2005
	2005			2004
Sales	$	649,485		$	623,426		$	752,859		$	691,165
Cost of sales		438,269			433,975			501,140			468,463

Gross profit		211,216			189,451			251,719			222,702
Selling, general and administrative expense		156,405			146,271			179,241			166,399

Operating income		54,811			43,180			72,478			56,303
Interest expense		(18,972	)		(21,025	)		(16,260	)		(19,861	)
Interest income		1,335			667			1,070			618
Loss on early extinguishment of debt		(27,856	)		(963	)
Other income (expense), net		365			(4,016	)		4,392			(5,866	)

Earnings before income taxes		9,683			17,843			61,680			31,194
Provision for income taxes		4,500			10,573			28,609			12,633

Income from continuing operations		5,183			7,270			33,071			18,561
Discontinued operations, net of tax		(15,133	)		(902	)		—			(611	)

Net (loss) earnings	$	(9,950	)	$	6,368
Net earnings							$	33,071		$	17,950


Earnings (loss) per share:
Basic:
Continuing operations	$	0.09		$	0.14		$	0.59		$	0.33
Discontinued operations		(0.27	)		(0.02	)		—			(0.01	)

Net (loss) earnings	$	(0.18	)	$	0.12
Net earnings							$	0.59		$	0.32

Diluted:
Continuing operations	$	0.08		$	0.13		$	0.57		$	0.33
Discontinued operations		(0.27	)		(0.02	)		—			(0.01	)

Net (loss) earnings	$	(0.19	)	$	0.11
Net earnings							$	0.57		$	0.32

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME


	Three Months Ended
	June 30,
(Amounts in thousands)	2006		2005

Net earnings	$	33,071	$	17,950

Other comprehensive income (expense) :
Foreign currency translation adjustments, net of tax		17,568		(16,438	)
Cash flow hedging activity, net of tax		944		(142	)

Other comprehensive income (loss)		18,512		(16,580	)

Comprehensive income	$	51,583	$	1,370

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF ~~COMPREHENSIVE (LOSS)~~ INCOME

(Amounts in thousands) Three Months Ended September 30,
2005 2004
Net (loss) earnings $ (9,950 ) $ 6,368

Other comprehensive income (expense):
Foreign currency translation adjustments, net of tax 690 3,362
Cash flow hedging activity, net of tax 1,178 (4,840 )

Other comprehensive income (loss) 1,868 (1,478 )

Comprehensive (loss) income $ (8,082 ) $ 4,890


	Six Months Ended June 30,
(Amounts in thousands, except per share data)	2006			2005

Sales	$	1,406,716		$	1,307,283
Cost of sales		940,605			893,438

Gross profit		466,111			413,845
Selling, general and administrative expense		356,113			331,715

Operating income		109,998			82,130
Interest expense		(31,941	)		(39,896	)
Interest income		2,153			1,462
Other income (expense), net		5,524			(8,579	)

Earnings before income taxes		85,734			35,117
Provision for income taxes		38,771			13,658

Income from continuing operations		46,963			21,459
Discontinued operations, net of tax		—			(7,523	)

Net earnings	$	46,963		$	13,936


Earnings (loss) per share:
Basic:
Continuing operations	$	0.84		$	0.39
Discontinued operations		—			(0.14	)

Net earnings	$	0.84		$	0.25

Diluted:
Continuing operations	$	0.81		$	0.38
Discontinued operations		—			(0.13	)

Net earnings	$	0.81		$	0.25

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)


	Six Months Ended June 30,
(Amounts in thousands)	2006		2005

Net earnings	$	46,963	$	13,936

Other comprehensive income (expense) :
Foreign currency translation adjustments, net of tax		22,961		(25,146	)
Cash flow hedging activity, net of tax		2,361		818

Other comprehensive income (loss)		25,322		(24,328	)

Comprehensive income (loss)	$	72,285	$	(10,392	)

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED ~~STATEMENTS OF OPERATIONS~~BALANCE SHEETS

(Amounts in thousands, except per share data) Nine Months Ended September 30,
2005 2004
Sales $ 1,956,767 $ 1,818,762
Cost of sales 1,331,708 1,264,618

Gross profit 625,059 554,144
Selling, general and administrative expense 488,120 428,527

Operating income 136,939 125,617
Interest expense (58,867 ) (60,596 )
Interest income 2,797 1,232
Loss on early extinguishment of debt (27,744 ) (1,048 )
Other expense, net (8,326 ) (8,771 )

Earnings before income taxes 44,799 56,434
Provision for income taxes 18,158 34,781

Income from continuing operations 26,641 21,653
Discontinued operations, net of tax (22,655 ) (1,870 )

Net earnings $ 3,986 $ 19,783

Earnings (loss) per share:
Basic:
Continuing operations $ 0.48 $ 0.39
Discontinued operations (0.41 ) (0.03 )

Net earnings $ 0.07 $ 0.36

Diluted:
Continuing operations $ 0.47 $ 0.39
Discontinued operations (0.40 ) (0.03 )

Net earnings $ 0.07 $ 0.36

~~See accompanying notes to condensed consolidated financial statements.~~

~~FLOWSERVE CORPORATION~~
~~(Unaudited)~~

~~CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME~~

(Amounts in thousands) Nine Months Ended September 30,
2005 2004
Net earnings $ 3,986 $ 19,783

Other comprehensive (expense) income:
Foreign currency translation adjustments, net of tax (24,457 ) (10,951 )
Cash flow hedging activity, net of tax 1,996 (4,433 )

Other comprehensive loss (22,461 ) (15,384 )

Comprehensive (loss) income $ (18,475 ) $ 4,399


	June 30,			December 31,
(Amounts in thousands, except per share data)	2006			2005

ASSETS
Current assets:
Cash and cash equivalents	$	58,247		$	92,864
Restricted cash		2,436			3,628
Accounts receivable, net of allowance for doubtful accounts of $15,614 and $14,271, respectively		506,107			472,946
Inventories, net		429,407			361,770
Deferred taxes		121,596			113,957
Prepaid expenses and other		37,160			26,034

Total current assets		1,154,953			1,071,199
Property, plant and equipment, net of accumulated depreciation of $484,868 and $444,701, respectively		421,893			397,622
Goodwill		844,870			834,863
Deferred taxes		17,462			34,261
Other intangible assets, net		146,576			146,251
Other assets, net		93,392			91,342

Total assets	$	2,679,146		$	2,575,538


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	321,143		$	316,713
Accrued liabilities		354,865			360,798
Debt due within one year		10,731			12,367
Deferred taxes		5,322			5,044

Total current liabilities		692,061			694,922
Long-term debt due after one year		644,875			652,769
Retirement obligations and other liabilities		429,555			396,013
Shareholders’ equity:
Series A preferred stock, $1.00 par value, 1,000 shares authorized, no shares issued		—			—
Common shares, $1.25 par value		72,018			72,018
Shares authorized — 120,000
Shares issued — 57,614
Capital in excess of par value		479,541			477,201
Retained earnings		493,126			446,163

		1,044,685			995,382
Treasury shares, at cost — 1,346 and 1,640 shares, respectively		(31,655	)		(37,547	)
Deferred compensation obligation		4,960			4,656
Accumulated other comprehensive loss		(105,335	)		(130,657	)

Total shareholders’ equity		912,655			831,834

Total liabilities and shareholders’ equity	$	2,679,146		$	2,575,538

See accompanying notes to condensed consolidated financial statements.

~~FLOWSERVE CORPORATION~~
~~(Unaudited)~~

~~CONDENSED CONSOLIDATED BALANCE SHEETS~~

September 30, December 31,
(Amounts in thousands, except per share data) 2005 2004

ASSETS

Current assets:
Cash and cash equivalents $ 35,234 $ 63,759
Restricted cash 2,159 —
Accounts receivable, net of allowance for doubtful accounts of $7,782 and $7,281, respectively 424,006 462,120
Inventories, net 405,298 388,402
Deferred taxes 113,044 81,225
Prepaid expenses and other 67,805 54,162

Total current assets 1,047,546 1,049,668
Property, plant and equipment, net of accumulated depreciation of $451,656 and $444,976, respectively 397,322 432,809
Goodwill 839,674 865,351
Deferred taxes 28,778 10,430
Other intangible assets, net 146,667 157,893
Other assets, net 110,041 117,884

Total assets $ 2,570,028 $ 2,634,035

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable $ 297,259 $ 316,545
Accrued liabilities 337,803 347,766
Debt due within one year 18,837 44,098
Deferred taxes 5,217 —

Total current liabilities 659,116 708,409
Long-term debt due after one year 680,347 657,746
Retirement obligations and other liabilities 367,832 397,655
Shareholders’ equity:
Serial preferred stock, $1.00 par value, 1,000 shares authorized, no shares issued — —
Common shares, $1.25 par value 72,018 72,018
Shares authorized – 120,000
Shares issued – 57,614
Capital in excess of par value 474,470 472,180
Retained earnings 438,314 434,328

984,802 978,526
Treasury shares, at cost –1,663 and 2,146 shares, respectively (37,818 ) (48,171 )
Deferred compensation obligation 5,124 6,784
Accumulated other comprehensive loss (89,375 ) (66,914 )

Total shareholders’ equity 862,733 870,225

Total liabilities and shareholders’ equity $ 2,570,028 $ 2,634,035

~~See accompanying notes to condensed consolidated financial statements.~~

FLOWSERVE CORPORATION
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


							Six Months Ended June 30,
(Amounts in thousands)	Nine Months Ended September 30,						2006			2005
	2005			2004
Cash flows – Operating activities:
Cash flows — Operating activities:
Net earnings	$	3,986		$	19,783		$	46,963		$	13,936
Adjustments to reconcile net earnings to net cash provided by operating activities:

Adjustments to reconcile net earnings to net cash provided (used) by operating activities:
Depreciation		45,694			46,650			29,291			31,395
Amortization		7,651			8,031			5,130			5,245
Amortization of deferred loan costs and discount		3,006			3,787			1,001			2,424
Write-off of unamortized deferred loan costs and discount		11,307			1,048
Loss on early extinguishment of debt		16,437			—
Net loss on the disposition of assets		801			314
Equity compensation expense		11,405			735
Equity income, net of dividends received		(5,143	)		4,694
Net (gain) loss on the disposition of assets								(503	)		396
Equity based compensation expense								9,321			9,568
Equity income in unconsolidated subsidiaries, net of dividends received								(1,737	)		(3,435	)
Impairment of assets		23,602			—			—			5,905
Change in assets and liabilities, net of acquisitions:
Change in assets and liabilities:
Accounts receivable, net		12,844			4,063			(14,841	)		1,643
Inventories, net		(38,815	)		(20,898	)		(52,155	)		(35,112	)
Prepaid expenses and other		(13,578	)		(5,625	)		(3,651	)		(12,531	)
Other assets, net		2,582			(4,313	)		(10,569	)		2,981
Accounts payable		2,976			7,590			(15,340	)		(4,389	)
Accrued liabilities and income taxes payable		3,658			18,685			(18,471	)		3,025
Retirement obligations and other liabilities		(34,711	)		7,226			22,377			(5,927	)
Net deferred taxes		(33,780	)		(4,926	)		11,126			(17,724	)

Net cash flows provided by operating activities		19,922			86,844
Net cash flows provided (used) by operating activities								7,942			(2,600	)


Cash flows – Investing activities:
Cash flows — Investing activities:
Capital expenditures		(25,522	)		(28,527	)		(29,458	)		(17,885	)
Cash received for disposal of assets		—			4,093
Cash paid for acquisition		—			(9,429	)
Change in restricted cash		(2,159	)		—			1,192			(1,736	)

Net cash flows used by investing activities		(27,681	)		(33,863	)		(28,266	)		(19,621	)


Cash flows – Financing activities:
Net repayments under other financing arrangements		(3,989	)		(355	)
Cash flows — Financing activities:
Net borrowings under lines of credit								—			1,070
Payments on long-term debt		—			(152,480	)		(15,856	)		—
Proceeds from issuance of long-term debt		600,000			85,000
Payment of deferred loan costs		(9,322	)		(665	)
Proceeds from stock option activity		1,111			2,487			—			1,111
Repurchase of term loans and senior subordinated notes (includes premiums paid of $16.5 million)		(607,043	)		—

Net cash flows used by financing activities		(19,243	)		(66,013	)
Net cash flows (used) provided by financing activities								(15,856	)		2,181
Effect of exchange rate changes on cash		(1,523	)		(7	)		1,563			(2,528	)

Net change in cash and cash equivalents		(28,525	)		(13,039	)		(34,617	)		(22,568	)
Cash and cash equivalents at beginning of year		63,759			53,522			92,864			63,759

Cash and cash equivalents at end of period	$	35,234		$	40,483		$	58,247		$	41,191

See accompanying notes to condensed consolidated financial statements.

FLOWSERVE CORPORATION

(Unaudited)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation and Accounting Policies

Basis of Presentation

The accompanying condensed consolidated balance sheet as of ~~September~~June 30, ~~2005,~~2006, and the related condensed consolidated statements of ~~operations~~income and comprehensive income (loss) ~~income~~ for the three and ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, and the condensed consolidated statements of cash flows for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, are unaudited. In management’s opinion, all adjustments comprising normal recurring adjustments necessary for a fair presentation of such condensed consolidated financial statements have been made.

The accompanying condensed consolidated financial statements and notes in this Quarterly Report are presented as permitted by Regulation S-X and do not contain certain information included in our annual financial statements and notes to the financial statements. Accordingly, the accompanying condensed consolidated financial information should be read in conjunction with the consolidated financial statements for the year ended December 31, 2005 presented in our ~~Annual Report on Form 10-K for the year ended December 31, 2005 (“~~2005 Annual ~~Report”), which was filed with the SEC on June 30, 2006.~~Report.

Certain reclassifications have been made to prior period amounts to conform with the current period presentation.

Stock-Based Compensation

~~We have several stock-based employee compensation plans, which~~Effective January 1, 2006, we account for under the recognition and measurement principles of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. It is our policy to set the exercise price of stock options at the closing price of our common stock on the New York Stock Exchange on the date such grants are authorized by our Board of Directors. For 2005 and prior years, no stock-based employee compensation cost is reflected in net earnings for stock option grants, as all options granted under those plans had an exercise price equal to or in excess of the market value of the underlying common stock on the date of grant. Should we elect to modify any of our existing stock option awards, APB No. 25, as interpreted by Financial Accounting Standards Board (“FASB”) Financial Interpretation (“FIN”) No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” requires us to recognize the intrinsic value of the underlying options at the date the modification becomes effective. Modifications could include accelerated vesting, a reduction in exercise prices or extension of the exercise period.

Awards of restricted stock are valued at the market price of our common stock on the grant date and recorded as unearned compensation within shareholders’ equity. The unearned compensation is amortized to compensation expense over the vesting period of the restricted stock. We have unearned compensation of $10.5 million and $5.2 million at September 30, 2005 and December 31, 2004, respectively. These amounts will be recognized into net earnings in prospective periods.

~~The following table illustrates the effect on net earnings and earnings per share if we had applied~~adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share—Based Payment” using the modified prospective application method, and therefore, have not restated results for prior periods. Under this method, stock based compensation expense for the first quarter of 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested at the date of adoption, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based ~~Compensation,~~Compensation.” toStock-based compensation expense for all stock-based ~~employee~~ compensation ~~calculated using~~awards granted after the ~~Black-Scholes option-pricing model.~~

Three Months Ended September 30,
(Amounts in thousands, except per share data) 2005 2004

Net (loss) earnings, as reported $ (9,950 ) $ 6,368
Restricted stock compensation expense included in net (loss) earnings, net of related tax effects 4,644 385
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects (5,297 ) (297 )

Pro forma net (loss) earnings $ (10,603 ) $ 6,456

Net (loss) earnings per share – basic:
As reported $ (0.18 ) $ 0.12
Pro forma (0.19 ) 0.12
Net (loss) earnings per share – diluted:
As reported $ (0.19 ) $ 0.11
Pro forma (0.19 ) 0.12

Nine Months Ended September 30,
(Amounts in thousands, except per share data) 2005 2004
Net earnings, as reported $ 3,986 $ 19,783
Restricted stock compensation expense included in net earnings, net of related tax effects 7,069 482
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects (9,017 ) (1,309 )

Pro forma net earnings $ 2,038 $ 18,956

Net earnings per share – basic:
As reported $ 0.07 $ 0.36
Pro forma 0.04 0.34
Net earnings per share – diluted:
As reported $ 0.07 $ 0.36
Pro forma 0.04 0.34

~~The above pro forma disclosures may not be representative~~date of ~~effects for future years, since~~adoption is based on the ~~determination of the~~grant-date fair value estimated in accordance with the provisions of ~~stock options granted includes an expected volatility factor and additional option grants are expected~~SFAS No. 123(R).

In conjunction with the adoption of SFAS No. 123(R), we selected the alternative transition method to ~~be made each year.~~determine the net excess tax benefits that would have qualified as such as of January 1, 2006. See Note 3 for further discussion on stock-based compensation.

Other Accounting Policies

~~Our~~Other significant accounting policies, for which no significant changes have occurred in the quarter ended ~~September~~June 30, ~~2005,~~2006, are detailed in Note 1 of our 2005 Annual Report.

Accounting Developments

Pronouncements Implemented

In December 2004, the ~~FASB~~Financial Accounting Standards Board (“FASB”) issued SFAS No. 153, “Exchanges of Non-monetary Assets,” which addresses the measurement of exchanges of non-monetary assets. SFAS No. 153 eliminates the exception from fair value measurement for non-monetary exchanges of similar productive assets, which was previously provided by APB No. 29, “Accounting for Non-monetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are

expected to change significantly as a result of the exchange. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 during 2005 had no impact on our consolidated financial position or results of operations.

~~In April 2005, the FASB issued FIN No. 47, “Accounting for Conditional Asset Retirement Obligations”~~123(R). FIN No. 47 clarifies that the term conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” requiring companies to recognize a liability for the fair value of an asset retirement obligation that may be conditional on a future event if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective as of the end of fiscal years ending after December 15, 2005. Our adoption of FIN No. 47, effective in the first quarter of 2005, did not have a material impact on our consolidated financial position or results of operation.

~~Pronouncements Not Yet Implemented~~

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”. SFAS No. 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of the compensation cost is to be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards are to be re-measured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123(R) is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” and supersedes APB No. 25. SFAS No. 123(R) is effective for public companies as of the first interim or annual reporting period of the first fiscal year beginning after June 15, 2005. We adopted SFAS No. 123(R) ~~effective~~on January 1, 2006 ~~using~~utilizing the modified prospective ~~transition~~application method. ~~The specific magnitude of~~See Note 3 for additional information regarding the ~~impact~~adoption of SFAS No. 123(R) on our results of operations for the year ended December 31, 2006 cannot be predicted at this time because it will depend on levels of share-based incentive awards granted in the future, as well as the effect of the pending modification discussed in Note 5. However, had we adopted SFAS No. 123(R) in prior periods, the impact would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in “Stock-Based Compensation” above..

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of Accounting Research Bulletin No. 43, Chapter 4.” SFAS No. 151 amends Accounting Research Bulletin ~~(“ARB”)~~ No. 43, Chapter 4 and seeks to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted materials by requiring those items to be recognized as current period charges. Additionally, SFAS No. 151 requires that fixed production overheads be allocated to conversion costs based on the normal capacity of the production facilities. SFAS No. 151 is effective prospectively for inventory costs incurred in fiscal years beginning after June 15, 2005. ~~We do not expect the~~Our adoption of SFAS No. 151, toeffective beginning in the first quarter of 2006, did not have a material ~~effect~~impact on our consolidated financial ~~position~~condition or results of ~~operations.~~operation.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 establishes new standards on accounting for changes in accounting principles. All such changes must be accounted for by retrospective application to

the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 replaces APB No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Periods.” However, it carries forward the guidance in those pronouncements with respect to accounting for changes in estimates, changes in the reporting entity and the correction of errors. ~~SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early~~Our adoption ~~permitted for changes and corrections made in years beginning after June 1, 2005. The application~~ of SFAS No. 154 ~~does not affect the transition provisions of any existing pronouncements, including those that are~~ in the ~~transition phase as~~first quarter of 2006 had no impact on our consolidated financial condition or results of operations.

Pronouncements Not Yet Implemented

In February 2006, the ~~effective date of~~FASB issued SFAS No. ~~154.~~155, “Accounting for Certain Hybrid Financial Instruments,” which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 improves the financial reporting of certain hybrid financial instruments and simplifies the accounting for these instruments. In particular, SFAS No. 155:

	•		permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation;

	•		clarifies which interest-only and principal-only strips are not subject to the requirements of SFAS No. 133;

	•		establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation;

	•		clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and

	•		amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.

SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS No. ~~154~~155 to have a material ~~effect~~impact on our consolidated financial condition and results of operations.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets — an amendment of Statement No. 140.” SFAS No. 156 clarifies when an obligation to service financial assets should be separately recognized as a servicing asset or a servicing liability, requires that a separately recognized servicing asset or servicing liability be initially measured at fair value and permits an entity with a separately recognized servicing asset or servicing liability to choose either the amortization method or fair value method for subsequent measurement. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS No. 156 to have a material impact on our financial condition and results of operations.

In July 2006, the FASB issued Financial Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, as well as guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with FIN No. 48 is a two-step process. The first step is a recognition process whereby the enterprise determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is a measurement process whereby a tax position that meets the more-likely-than-not recognition threshold is calculated to determine the amount of benefit to recognize in the financial statements. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. We are still evaluating the impact of FIN No. 48 on our consolidated financial statements and results of operations.

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

2. Discontinued Operations

General Services Group— During the first quarter of 2005 we made a definitive decision to divest certain non-core service operations, collectively called the General Services Group (“GSG”), and accordingly, evaluated impairment pursuant

to a held for sale concept as opposed to the previously held and used concept. As part of our decision to sell, we allocated $12.3 million of goodwill to GSG based on its relative fair value to the total reporting unit’s estimated fair value. We recognized impairment charges aggregating $30.1 million during 2005 ~~of which $5.9 million and $17.6 million were recorded during the first and third quarters, respectively,~~ relating to GSG as the number of potential buyers diminished to one purchaser during the bidding process, and the business underperformed during the year due to the pending sale. Of the $30.1 million impairment, $0 and $5.9 million was recorded during the three and six months ended June 30, 2005, respectively. Effective December 31, 2005, we sold GSG to Furmanite, a unit of Dallas-based Xanser Corporation for approximately $16 million in gross cash proceeds, including $2 million held in escrow pending final settlement, subject to final working capital ~~adjustments, excluding~~adjustments. The sale excluded approximately $12 million of net accounts receivable ~~generating~~and resulted in a pre-tax loss of $3.8 million, which was recognized in the fourth quarter of 2005. The ~~pre-tax loss on the sale~~ultimate purchase price of GSG is subject to final working capital adjustments, which remain under ~~negotiation.~~negotiation, and is expected to be resolved in the fourth quarter of 2006. The outcome of such negotiations could result in a change in the ultimate loss on sale in the period of resolution. We used approximately $11 million of the net cash proceeds to reduce our indebtedness in January 2006. We have allocated estimated interest expense related to this repayment to each period presented based upon then prevailing interest rates. As a result of this sale, we have presented the results of operations of GSG as discontinued operations for all periods presented.

GSG generated the following results of ~~operations:~~operations for the three months ended June 30, 2005 (in millions):


(Amounts in millions)	Three Months Ended September 30,
	2005			2004
Sales	$	21.6		$	28.7		$	27.3
Cost of sales		20.0			24.3			21.2
Selling, general and administrative expense		22.3			6.1			7.1
Interest expense		0.2			0.2			0.2
Other expense, net		—			(0.1	)

Earnings (loss) before income taxes		(20.9	)		(2.0	)
Earnings before income taxes								(1.2	)
Income tax benefit		(5.8	)		(0.6	)		(0.6	)

Results for discontinued operations, net of tax	$	(15.1	)	$	(1.4	)		(0.6	)

(Amounts in millions) Nine Months Ended September 30,
2005 2004
Sales $ 76.3 $ 87.0
Cost of sales 63.6 70.7
Selling, general and administrative expense 42.4 19.6
Interest expense 0.6 0.4
Other expense, net (0.1 ) (0.2 )

Earnings before income taxes (30.4 ) (3.9 )
Income tax benefit (7.7 ) (1.0 )

Results for discontinued operations, net of tax $ (22.7 ) $ (2.9 )

GSG generated the following results of operations for the six months ended June 30, 2005 (in millions):


Sales	$	54.7
Cost of sales		43.6
Selling, general and administrative expense		20.0
Interest expense		0.4
Other income, net		(0.1	)

Earnings before income taxes		(9.4	)
Income tax benefit		(1.9	)

Results for discontinued operations, net of tax	$	(7.5	)

3. Stock-Based Compensation Plans

We adopted SFAS No. 123(R) on January 1, 2006. Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method as set forth in Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and related interpretations as permitted by SFAS No. 123. Accordingly, we recognized compensation expense for restricted stock and other equity awards over the applicable vesting period, however we did not recognize compensation expense for stock options for the three or six months ended June 30, 2005, because the options were granted at market value on the date of grant.

118

~~GSG’s assets~~

The following tables illustrate the effect of stock-based compensation on net earnings and ~~liabilities~~earnings per share for the three and six months ended June 30, 2005, if we had applied the fair value recognition provisions of SFAS No. 123 to all stock-based employee compensation, calculated using the Black-Scholes option-pricing model.


	Three Months Ended
(Amounts in thousands, except per share data)	June 30, 2005

Net earnings, as reported	$	17,950
Restricted stock compensation expense included in net earnings, net of tax		1,685
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of tax		(2,522	)

Pro forma net earnings	$	17,113


Net earnings per share — basic:
As reported	$	0.32
Pro forma		0.31
Net earnings per share — diluted:
As reported	$	0.32
Pro forma		0.30


	Six Months Ended
(Amounts in thousands, except per share amounts)	June 30, 2005

Net earnings, as reported	$	13,936
Restricted stock compensation expense included in net earnings, net of tax		2,426
Less: Stock-based employee compensation expense determined under fair value method for all awards, net of tax		(3,720	)

Pro forma net earnings	$	12,642


Net earnings per share — basic:
As reported	$	0.25
Pro forma		0.23
Net earnings per share — diluted:
As reported	$	0.25
Pro forma		0.22

We adopted SFAS No. 123(R) under the modified prospective application method. Under this method, we recorded stock-based compensation expense of $3.9 million ($5.4 million pre-tax) and $6.7 million ($9.3 million pre-tax) for the three and six months ended June 30, 2006, respectively, for all awards granted on or after the date of adoption and for the portion of previously granted awards that remain unvested at the date of adoption over the remaining vesting period. Accordingly, prior period amounts have not been restated. In accordance with SFAS No. 123(R), we adjust share-based compensation on a quarterly basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. Currently, our stock-based compensation relates to stock options, restricted stock and other equity-based awards. It is our policy to set the exercise price of stock options at the closing price of our common stock on the New York Stock Exchange on the date such grants are authorized by our Board of Directors. Options granted to officers, other employees and directors allow for the purchase of common shares at or above the fair market value of our stock on the date the options are granted, although no options have been ~~reclassified~~granted above fair market value. Generally, options become exercisable over a staggered period ranging from one to ~~prepaid expenses and other, other assets, net and accounts payable~~five years (most typically from one to ~~reflect discontinued operations. As of September 30, 2005 and December 31, 2004, GSG’s assets and liabilities consisted~~three years). Options generally expire ten years from the date of the ~~following:~~grant or within a short period of time following the termination of employment or cessation of services by an option holder; however, as described in greater detail under “Modifications” below, the expiration provisions relating to certain outstanding option awards that have been modified.

Stock Options —Information related to stock options issued to officers, other employees and directors under all plans is presented in the following table:

(Amounts in millions) September 30, December 31,
2005 2004
Accounts receivable, net $ 19.7 $ 23.0
Inventory, net 12.0 13.3
Prepaid expenses and other 0.4 0.4

Total current assets 32.1 36.7
Property, plant and equipment, net 6.2 17.5
Other intangible assets, net 0.1 0.1

Total assets (1) $ 38.4 $ 54.3

Accounts payable $ 5.5 $ 8.3
Accrued liabilities 4.3 1.7

Total current liabilities 9.8 10.0
Long-term liabilities 0.1 0.1

Total liabilities (2) $ 9.9 $ 10.1


	Six Months Ended June 30, 2006
				Weighted		Remaining		Aggregate
				Average		Contractual Life		Intrinsic Value
	Shares			Exercise Price		(in years)		(in millions)

Number of shares under option:
Outstanding — beginning of year		2,966,326		$	23.00
Granted		270,350			49.28
Exercised		—			—
Cancelled		(5,573	)		37.26
Modified (1)		89,404			24.55

Outstanding — end of period		3,320,507		$	25.16		4.1	$	105.4

Exercisable — end of period		2,473,120		$	22.04		2.4	$	86.2


(1)		~~Excludes $12.3 million of goodwill allocated to GSG~~Options expiring in 2005 that had their expiration dates extended contingent upon ~~classification of GSG~~shareholder approval, which was obtained on August 24, 2006, as ~~assets held for sale.~~

~~(2)~~		~~Excludes $10.9 million of debt retired with net proceeds from the sale of GSG.~~discussed below in “Modifications”.

~~Government Marine Business Unit~~~~– In~~The weighted average fair value per share of options granted was $27.61 and $13.15 for the ~~first quarter~~three months ended June 30, 2006 and 2005, respectively, and $24.77 and $12.13 for the six months ended June 30, 2006 and 2005, respectively. For purposes of ~~2004,~~pro forma disclosure, the estimated fair value of the options is amortized to expense over the options’ vesting periods. The “fair value” for these options at the date of grant was estimated using the Black-Scholes option pricing model.

The assumptions used in calculating the expense for stock option awards are as follows:


	Six Months Ended June 30,
	2006			2005
Risk-free interest rate		5.1	%		4.2	%
Dividend yield		—			—
Stock volatility		42.1	%		43.9	%
Average expected life (years)		6.5			6.7
Forfeiture rate		9.3	%		9.7	%

As of June 30, 2006, we ~~made~~have $8.3 million of unrecognized compensation cost related to outstanding unvested stock option awards, which is expected to be recognized over a definitive decision to sell our Government Marine Business Unit (“GMBU”), a business within our Flowserve Pump Division (“FPD”). As a result, we reclassified the operation to discontinued operations in the first quarter of 2004. In November 2004, we sold GMBU to Curtiss-Wright Electro-Mechanical Corporation for approximately $28 million, generating a pre-tax gain of $7.4 million after the allocationweighted-average period of approximately $81.9 years. The total intrinsic value of stock options exercised during the three months ended June 30, 2006 and 2005 was $0 and $0.1 million, ~~of FPD goodwill~~respectively, and $1$0 and $0.3 million ~~of intangible assets. GMBU, which provided pump technology~~exercised during the six months ended June 30, 2006 and service for U.S. Navy submarines and aircraft carriers, did not serve our core market and represented only a small part of our total pump business. We used net proceeds from the disposition of GMBU to reduce our outstanding indebtedness. As a result of this sale, we have presented the assets, liabilities and results of operations of the GMBU as discontinued operations for all periods included.2005, respectively.

1210

~~GMBU generated~~Incremental stock-based compensation expense related solely to stock options recognized for the ~~following results of operations:~~

Three Months
Ended
(Amounts in millions) September 30,
2004
Sales $ 7.4
Cost of sales 6.0
Selling, general and administrative expense 0.7

Earnings (loss) before income taxes 0.7
Provision (benefit) for income taxes 0.2

Results for discontinued operations, net of tax $ 0.5

Nine Months
Ended
(Amounts in millions) September 30,
2004
Sales $ 19.1
Cost of sales 15.3
Selling, general and administrative expense 2.3

Earnings before income taxes 1.5
Provision for income taxes 0.5

Results for discontinued operations, net of tax $ 1.0

~~3. Acquisition~~

~~We acquired the remaining 75% interest in Thompsons, Kelly~~three and ~~Lewis, Pty. Ltd (“TKL”), an Australian manufacturer and supplier of pumps, during March 2004. The incremental interests acquired were accounted for~~six months ended June 30, 2006 as a ~~step acquisition~~result of adoption of SFAS No. 123(R) was as follows:


	Three Months Ended
(Amounts in thousands, except per share data)	June 30, 2006

Stock-based compensation expense, before taxes	$	1,975
Related income tax benefit		(482	)

Stock-based compensation expense, net of tax	$	1,493


Earnings per share — basic:	$	0.03
Earnings per share — diluted:		0.03


	Six Months Ended
(Amounts in thousands, except per share data)	June 30, 2006

Stock-based compensation expense, before taxes	$	3,547
Related income tax benefit		(866	)

Stock-based compensation expense, net of tax	$	2,681


Earnings per share — basic:	$	0.05
Earnings per share — diluted:		0.05

Restricted Stock —Awards of restricted stock are valued at the closing market price of our common stock on the grant date and ~~TKL’s results of operations have been consolidated since~~recorded as unearned compensation within shareholders’ equity. The unearned compensation is amortized to compensation expense over the ~~date of acquisition. The estimated fair value~~vesting period of the ~~net assets acquired (including approximately $2.2 million~~restricted stock. We have unearned compensation of ~~cash acquired) exceeded the cash paid of $12~~$19.2 million and ~~accordingly, no goodwill~~$9.1 million at June 30, 2006 and December 31, 2005, respectively. These amounts will be recognized into net earnings in prospective periods as the awards vest.

Stock-based compensation expense related to restricted stock recognized was ~~recognized.~~$2.4 million ($3.5 million pre-tax) and $4.0 million ($5.8 million pre-tax) for the three and six months ended June 30, 2006, respectively. Stock-based compensation expense related to restricted stock recognized was $1.5 million ($2.1 million pre-tax) and $2.3 million ($3.3 million pre-tax) for the three and six months ended June 30, 2005, respectively.

~~4. Goodwill~~ The following tables summarize information regarding the restricted stock plans:

(Amounts in thousands) Flowserve Flow Flow
Pump Solutions Control Total

Balance as of December 31, 2004 $ 459,896 $ 33,618 $ 371,837 $ 865,351
Impairment of GSG (1) — — (12,327 ) (12,327 )
Currency translation (3,014 ) (2,069 ) (8,267 ) (13,350 )

Balance as of September 30, 2005 $ 456,882 $ 31,549 $ 351,243 $ 839,674


	Six Months Ended June 30, 2006
				Weighted Average
	Shares			Grant-Date Fair Value
Number of unvested shares:
Outstanding — beginning of year		583,455		$	25.65
Granted		332,990			48.26
Lapsed		(93,144	)		49.02
Cancelled		(10,543	)		47.50

Unvested restricted stock		812,758		$	31.95

~~(1)~~

As discussed in Note 2 above, in the first quarter of 2005 we classified GSG as a discontinued operation, and we allocated goodwill of $12.3 million to GSG. Based on the fair value of GSG at March 31, 2005, we recorded a goodwill impairment of $5.9 million. We recorded an impairment of the remainder of the goodwill allocated to GSG during the three months ended September 30, 2005.

~~5. Stock Plans~~

Modifications— During 2005, we made a number of modifications to our stock plans, including the acceleration of ~~the~~ vesting of certain restricted stock grants and outstanding options, as well as the extension of the exercise period associated with certain outstanding options. These modifications resulted from severance agreements with former executives and from our decision to temporarily suspend option exercises. As a result of the modifications primarily ~~related to~~associated with the severance agreements with former

executives, we recorded additional stock-based compensation ~~expenses~~expense in 2005 of ~~approximately~~ $7.2 million ~~of which $0 and $6.2 million were recorded in the three and nine months ended September 30, 2005, respectively,~~ based upon the intrinsic values of the awards on the dates the modifications were ~~made.~~made of which $0 and $6.2 million was recorded during the three and six months ended June 30, 2005, respectively.

On June 1, 2005, we took action to extend to December 31, 2006, the regular term of certain options granted to employees, including executive officers, qualified retirees and directors, which were scheduled to expire in 2005. Subsequently, we took action on November 4, 2005, to further extend the exercise date of these options, and options expiring in 2006, to January 1, 2009. We thereafter concluded, however, that recent regulatory guidance issued under Section 409A of the Internal Revenue Code might cause the ~~recipients’~~recipients of these extended options to become subject to unintended adverse tax consequences under Section 409A. Accordingly, effective December 14, 2005, the Organization and Compensation Committee of the Board of Directors partially rescinded, in accordance with the regulations, the extensions of the regular term of these options, to provide as follows:

	(i)		the regular term of options otherwise expiring in 2005 will expire 30 days after the options first become exercisable when our SEC filings have become current and an effective SEC Form S-8 Registration Statement has been filed with the SEC, and

	(ii)		the regular term of options otherwise expiring in 2006 will expire on the later of:

	(1)		75 days after the regular term of the option as originally granted expires, or

	(2)		December 31, 2006 (assuming the options become exercisable in 2006 for the reasons included in (i) above).

These extensions ~~are~~were subject to ~~our shareholders approving certain~~shareholder approval of applicable plan amendments, which was obtained at our ~~next~~ annual shareholders’ meeting, ~~scheduled for~~held in August ~~24,~~ 2006. ~~If shareholders do not approve the plan amendments as currently posed in our proxy statement, these extension actions will become void. If~~The approval of such plan amendments ~~are approved at our next annual shareholders’ meeting, the extensions will be~~is considered as a stock modification for financial reporting purposes subject to the recognition of a non-cash compensation charge in accordance with SFAS No. 123(R)~~. Our actual~~ and we recorded a charge of approximately $6 million, which will be ~~contingent upon many factors, including future share price volatility, risk free interest rate, option maturity, strike price, share price and dividend yield.~~recognized in the third quarter of 2006.

The earlier extension actions also extended the option exercise period available following separation from employment for reasons of death, disability and termination not for cause or certain voluntary separations. These separate extensions were partially rescinded at the December 14, 2005, meeting of the Organization and Compensation Committee of the Board of Directors, and as so revised are currently effective and not subject to shareholder approval. The exercise period available following such employment separations has been extended to the later of (i) 30 days after the options first became exercisable when our SEC filings have become current and an effective SEC Form S-8 Registration Statement ~~on Form S-8~~ has been filed with the SEC, or (ii) the period available for exercise following separation from employment under the terms of the option as originally granted. This extension is considered for financial reporting purposes as a stock modification subject to the recognition of a non-cash compensation ~~change~~charge in accordance with APB No. 25, of $1.0 million in 2005, none of which was recorded in the ~~nine~~six months ended ~~September~~June 30, 2005. The extension of the exercise period following separation from employment does not apply to option exercise periods governed by a separate separation contract or agreement.

6.4. Derivative Instruments and Hedges

We enter into forward contracts to hedge our risk associated with transactions denominated in currencies other than the local currency of the operation engaging in the transaction. Our risk management and derivatives policy ~~specify~~specifies the conditions in which we enter into derivative contracts. As of ~~September~~June 30, ~~2005,~~2006, we had approximately ~~$210.5~~$295 million of notional amount in outstanding contracts with third parties. As of ~~September~~June 30, ~~2005,~~2006, the maximum length of any forward contract in place was 23 months.

~~Certain~~The fair market value adjustments of certain of our forward contracts ~~do not qualify for hedge accounting.~~are recognized directly in our results of operations. The fair value of these outstanding forward contracts at ~~September~~June 30, ~~2005~~2006 was a net asset of $4.0 million and a net liability of ~~$3.0 million and an asset of $3.4~~$2.3 million at December 31, ~~2004.~~2005. Unrealized gains (losses) from the changes in the fair value of these forward contracts of ~~$0.2~~$6.2 million and ~~$3,000 for the quarters ended September 30, 2005 and 2004, respectively, and $(5.8) million and $4.6~~$(3.8) million for the ~~nine~~three months ended ~~September~~June 30, 2006 and 2005, respectively, and ~~2004,~~$6.4 million and $(5.6) million for the six months ended June 30, 2006 and 2005, respectively, are included in other income (expense), net in the consolidated statements of ~~operations.~~income. The fair value

of outstanding forward contracts qualifying for hedge accounting at ~~September~~June 30, ~~2005~~2006 was ana net asset of ~~$85,000~~$0.2 million and a net liability of ~~$2.3 million~~$7,000 at December 31, ~~2004.~~2005. Unrealized gains (losses) from the changes in the fair value of qualifying forward contracts and the associated underlying exposures of ~~$0.3~~$0.2 million and ~~$(49,000),~~$(0.3) million, net of tax, for the ~~quarters~~three months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, and $0.2 million and ~~$86,000,~~$(0.1) million, net of tax, for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, are included in other comprehensive income (loss) ~~income.~~.

Also as part of our risk management program, we enter into interest rate swap agreements to hedge exposure to floating interest rates on certain portions of our debt. As of ~~September~~June 30, ~~2005,~~2006, we ~~have $325~~had $385.0 million of notional amount in outstanding interest rate swaps with third parties. As of ~~September~~June 30, ~~2005,~~2006, the maximum remaining length of any interest rate contract in place was approximately 3930 months. The fair value of the interest rate swap agreements was a ~~liability~~net asset of ~~$0.8~~$4.4 million and ~~$3.4~~$0.9 million at ~~September~~June 30, ~~2005~~2006 and December 31, ~~2004,~~2005, respectively. Unrealized gains from the changes in fair value of our interest rate swap agreements, net of

reclassifications, of ~~$1.3~~$0.8 million and ~~$2.1~~$0.2 million, net of tax, for the ~~quarters~~three months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, and $2.2 million and ~~$1.8~~$0.9 million, net of tax, for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, are included in other comprehensive income (loss) ~~income.~~.

During the third quarter of 2004, we entered into a compound derivative contract to hedge exposure to both currency translation and interest rate risks associated with our European Investment Bank (“EIB”) loan. The notional amount of the derivative was ~~$85~~$85.0 million, and it served to convert floating rate interest rate risk to a fixed rate, as well as United States (“U.S.”) dollar currency risk to Euros. The derivative matures in 2011. At ~~September~~June 30, ~~2005~~2006 and December 31, ~~2004,~~2005, the fair value of this derivative was a net liability of ~~$6.0~~$6.3 million and ~~$15.9~~$2.8 million, respectively. This derivative did not qualify for hedge accounting. The unrealized gain (loss) on the derivative, offset with the foreign currency translation ~~gain~~effect on the underlying loan aggregates to ~~$1.0~~$1.4 million and ~~$(3.1)~~$(2.5) million for the ~~quarters~~three months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, and ~~$(1.7)~~$3.6 million and ~~$(3.1)~~$(2.7) million for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, and is included in other income (expense), net in the consolidated statements of ~~operations.~~income.

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

7.5. Debt

Debt, including capital lease obligations, consisted of:

(Amounts in thousands) September 30, December 31,
2005 2004
Term Loan interest rate of 5.81% $ 600,000 $ —
Term Loan Tranche A:
U.S. Dollar Tranches, interest rate of 5.02% — 76,240
Euro Tranche, interest rate of 4.69% — 13,257
Term Loan Tranche C, interest rate of 5.20% — 233,851
Senior Subordinated Notes, net of discount, coupon of 12.25%:
U.S. Dollar denominated — 187,004
Euro denominated — 87,484
EIB loan, interest rate of 3.80% in 2005 and 2.39% in 2004 85,000 85,000
Receivable securitization and factoring obligations 12,369 17,635
Capital lease obligations and other 1,815 1,373

Debt and capital lease obligations 699,184 701,844
Less amounts due within one year 18,837 44,098

Total debt due after one year $ 680,347 $ 657,746


	June 30,		December 31,
(Amounts in thousands)	2006		2005

Term Loan, interest rate of 7.23% in 2006 and 6.36% in 2005	$	562,644	$	578,500
EIB loan, interest rate of 5.26% in 2006 and 4.42% in 2005		85,000		85,000
Capital lease obligations and other		7,962		1,636


Debt and capital lease obligations		655,606		665,136
Less amounts due within one year		10,731		12,367

Total debt due after one year	$	644,875	$	652,769

New Credit Facilities

In March 2005, we obtained consents from our major lenders that enhanced our flexibility under our 2000 Credit Facilities (described below) to among other things permit the August 2005 refinancing of our 2000 Credit Facilities and the repurchase of our 12.25% Senior Subordinated Notes. On August 12, 2005, we entered into credit facilities comprised of a ~~$600~~$600.0 million term loan expiring on August 10, 2012 and a ~~$400~~$400.0 million revolving line of credit, which can be utilized to provide up to ~~$300~~$300.0 million in letters of credit, expiring on August 12, 2010. We refer to these credit facilities collectively as our New ~~Credit Facilities. The proceeds of borrowings under our New Credit Facilities were used to call our 12.25% Senior Subordinated Notes and retire our indebtedness outstanding under our 2000~~ Credit Facilities. We also replaced the letter of credit agreement guaranteeing our obligations under the EIB credit facility (described below) with a letter of credit issued under the new revolving line of credit. We had outstanding letters of credit of ~~$142.6~~$180.7 million at ~~September~~June 30, ~~2005~~2006 under the revolving line of credit, which reduced borrowing capacity to ~~$257.4~~$219.3 million, compared with a borrowing capacity of ~~$248.7~~$234.2 million at December 31, ~~2004 under our 2000 Credit Facilities.~~2005. During the ~~nine~~three and six months ended ~~September~~June 30, ~~2005,~~2006, we made ~~no payments under our New Credit Facilities. During~~mandatory repayments of $0 and $10.9 million, respectively, using the ~~remainder~~net proceeds from the sale of ~~2005,~~GSG, and optional prepayments of $5.0 million and $5.0 million, respectively. In addition, we made ~~scheduled payments~~a mandatory repayment of ~~$1.5 million and optional payments of $38.4 million.~~

~~We incurred $9.3~~$0.9 million in ~~fees related to the New Credit Facilities, of which $0.8 million were expensed~~July 2006 using excess cash flows. We have no scheduled repayments due in the third quarter of 2005. Prior to the refinancing, we had $11.8 million of unamortized deferred loan costs related to the 2000 Credit Facilities and the Senior Subordinated Notes. Based upon the final syndicate of financial institutions for the New Credit Facilities, we expensed $10.5 million of these unamortized deferred loan costs in the third quarter of 2005. In addition to the total loan costs of $11.3 million that were expensed, we recorded a charge of $16.4 million for premiums paid to call the Senior Subordinated Notes, for a total loss on extinguishment of $27.7 million recorded in the third quarter of 2005. The remaining $8.5 million of fees related to the New Credit Facilities were capitalized and combined with the remaining $1.3 million of previously unamortized deferred loan costs for a total of $9.8 million in deferred loan costs included in other assets, net. These costs are being amortized over the term of the New Credit Facilities.2006.

Borrowings under our New Credit Facilities bear interest at a rate equal to, at our option, either (1) the base rate (which is based on the greater of the prime rate most recently announced by the administrative agent under our New Credit Facilities or the Federal Funds rate plus 0.50%) or (2) London Interbank Offered Rate (“LIBOR”) plus an applicable margin determined by reference to the ratio of our total debt to consolidated Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), which at ~~September~~June 30, ~~2005~~2006 was 1.75% for LIBOR borrowings. In addition, we pay lenders under the New Credit Facilities a commitment fee equal to a percentage, determined by reference to the ratio of our total debt to consolidated EBITDA, of the unutilized portion of the revolving line of credit, and letter of credit fees with respect to each financial standby letter of credit outstanding under our New Credit Facilities equal to a percentage based on the applicable margin in effect for LIBOR borrowings under the new revolving line of credit. The fee for performance standby letters of credit is 0.5% lower than the fee for financial standby letters of credit.

In connection with the New Credit Facilities entered into in August 2005, we entered into $275 million of notional amount of interest rate swaps to hedge exposure of floating interest rates. Of this total notional amount of $275 million, $130 million carried a start date of September 30, 2005 and $145 million carried a start date of December 30, 2005. These swaps, combined with the $135 million of interest rates swaps held by us at the time of the refinancing, total $410 million of notional amount of interest rate swaps outstanding at December 31, 2005.

Our obligations under the New Credit Facilities are unconditionally guaranteed, jointly and severally, by substantially all of our existing and subsequently acquired or organized domestic subsidiaries and 65% of the capital stock of certain foreign subsidiaries. In addition, prior to our ~~obtaining~~attaining and maintaining investment grade credit ratings, our and the guarantors’ obligations under the New Credit Facilities are collateralized by substantially all of our and the guarantors’ assets.

The loans under our New Credit Facilities are subject to mandatory repayment with, in general:

	•		100% of the net cash proceeds of asset sales; and

	•		Unless we attain and maintain investment grade credit ratings:

	◦•		75% of our excess cash flow, subject to a reduction based on the ratio of our total debt to consolidated EBITDA;

	◦•		50% of the proceeds of any equity offerings; and

	◦•		100% of the proceeds of any debt issuances (subject to certain exceptions).

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

Our New Credit Facilities contain covenants requiring us to deliver to lenders leverage and interest coverage financial covenants and our audited annual and unaudited quarterly financial statements. Under the leverage covenant, the maximum permitted leverage ratio steps down beginning with the fourth quarter of 2006, with a further step-down beginning with the fourth quarter of 2007. Under the interest coverage covenant, the minimum required interest coverage ratio steps up beginning with the fourth quarter of 2006, with a further step-up beginning with the fourth quarter of 2007. Compliance with these financial covenants under our New Credit Facilities is tested quarterly, and we ~~have complied~~were in compliance with the financial covenants as of ~~December 31, 2005. Further, we~~June 30, 2006.

We are required to furnish to our lenders within 50 days of the end of each of the first three quarters of each year our consolidated balance sheet, and related statements of operations, shareholders’ equity and cash flows.

Our New Credit Facilities also contain covenants restricting our and our subsidiaries’ ability to dispose of assets, merge, pay dividends, repurchase or redeem capital stock and indebtedness, incur indebtedness and guarantees, create liens, enter into agreements with negative pledge clauses, make certain investments or acquisitions, enter into sale and leaseback transactions, enter into transactions with affiliates, make capital expenditures, engage in any business activity other than our existing business or any business activities reasonably incidental thereto. We ~~are currently~~were in compliance with all debt covenants under the New Credit ~~Facilities.~~Facilities as of June 30, 2006.

EIB Credit Facility

On April 14, 2004, we and one of our European subsidiaries, Flowserve B.V., entered into an agreement with EIB, pursuant to which EIB agreed to loan us up to€7070.0 million, with the ability to draw funds in multiple currencies, to finance in part specified research and development projects undertaken by us in Europe. Borrowings under the EIB credit facility bear interest at a fixed or floating rate of interest agreed to by us and EIB with respect to each borrowing under the facility. Loans under the EIB credit facility are subject to mandatory repayment, at EIB’s discretion, upon the occurrence of certain events, including a change of control or prepayment of certain other indebtedness. In addition, the EIB credit facility contains covenants that, among other things, limit our ability to dispose of assets related to the financed project and require us to deliver to EIB our audited annual financial statements within 30 days of publication. In August 2004, we borrowed ~~$85~~$85.0 million at a floating interest rate based on 3-month U.S. LIBOR that resets quarterly. As of ~~September~~June 30, ~~2005,~~2006, the interest rate was ~~3.80%~~5.26%. The maturity of the amount drawn is June 15, 2011, but may be repaid at any time without penalty. Our obligations under the EIB credit facility are guaranteed by a letter of credit outstanding under our New Credit ~~Facilities.~~

~~2000 Credit~~ Facilities,

As of December 31, 2004, our credit facilities were composed of Tranche A and Tranche C term loans and a revolving line of credit. Tranche A consisted of a United States (“U.S.”) dollar denominated tranche and a Euro denominated tranche, the latter of which ~~was a term note due in 2006. We refer to these credit facilities collectively as our 2000 Credit Facilities.~~

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

As part of the 2000 Credit Facilities, we also had a $300 million revolving line of credit that was set to expire in June 2006. The revolving line of credit allowed us to issue up to $200 million in letters of credit. We had no amounts outstanding under the revolving line of credit at December 31, 2004.

We were required, under certain circumstances as defined in the 2000 Credit Facilities, to use a percentage of excess cash generated from operations to reduce the outstanding principal of the term loans in the following year. Based upon the annual calculations performed at December 31, 2004, no additional principal payments became due in 2005 under this provision. Amounts outstanding under the 2000 Credit Facilities were repaid in August 2005 using the proceeds from the New Credit Facilities.

~~Senior Subordinated Notes~~

At September 30, 2005, we had no Senior Subordinated Notes outstanding. The Senior Subordinated Notes were originally issued in 2000 at a discount to yield 12.5%, but had a coupon interest rate of 12.25%. Interest on these notes was payable semi-annually in February and August. In August 2005, all remaining Senior Subordinated Notes outstanding were called by us at 106.125% of face value as specified in the loan agreement and repaid, along with accrued interest.

~~Accounts Receivable Securitization~~

In October 2004, Flowserve US Inc., one of our wholly owned subsidiaries, and Flowserve Receivables Corporation (“FRC”), a wholly owned subsidiary of Flowserve US Inc., entered into a receivables purchase agreement (“RPA”) with Jupiter Securitization Corporation (“Jupiter”) and JPMorgan Chase Bank, N.A. (successor by merger to Bank One, NA) whereby FRC could obtain up to $75 million in financing on a revolving basis by securitizing certain U.S.-based trade receivables.

To obtain financing, Flowserve US Inc. transferred certain receivables to FRC, which was formed solely for this accounts receivable securitization program. Pursuant to the RPA, FRC then sold undivided purchaser interests in these receivables to Jupiter, which then pooled these interests with other unrelated interests and issued short-term commercial paper, which was repaid from cash flows generated by collections on the receivables. Flowserve US Inc. continued to service the receivables for a servicing fee of 0.5% of the average net receivable balance. No servicing liability was recognized at December 31, 2004 because the amount was immaterial due to the short-term average collection period of the securitized receivables. FRC has no recourse against Flowserve US Inc. for failure of the debtors to pay when due. As of December 31, 2004, FRC had secured $60 million in financing under the program. The proceeds were used to repay $16 million and $44 million of Tranche A and Tranche C bank term loans, respectively, outstanding under our 2000 Credit Facilities. As of September 30, 2005, FRC had repaid $11.6 million and had outstanding financing under the program of $48.4 million.

We account for this transaction in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities-a Replacement of FASB Statement No. 125.” Under this guidance borrowings under the facility in excess of $11.3 million are excluded from our debt balance in the consolidated balance sheets but included for purposes of covenant calculations under the 2000 Credit Facilities.

FRC retains a subordinate interest in the receivables, which represents the amount in excess of purchaser interests transferred to Jupiter. As of September 30, 2005 the short-term portion of $87.9 million of this subordinate interest is included in accounts receivable, net on the consolidated balance sheet. The long-term portion of $2.9 million of this subordinate interest is included in the other assets, net on the consolidated balance sheet. Our retained interest in the receivables is recorded at the present value of its estimated net realizable value based on an assumed days sales outstanding (“DSO”) of 60 days and a discount rate of 5.4%.

During the third quarter of 2005 Flowserve US Inc. transferred $215.5 million of receivables to FRC which then sold undivided purchaser interests in the receivables to Jupiter. In the third quarter of 2005, FRC collected $217.9 million in cash that was used to purchase additional receivables from Flowserve US Inc. and return invested capital to Flowserve US Inc. Losses on the sales of purchaser interests totaled $0.5 million and $1.5 million for the three and nine months ended September 30, 2005, respectively. FRC also recorded interest expense of $0.1 million and $0.3 million for the three and nine months ended September 30, 2005, respectively.

On October 31, 2005, we terminated the RPA. In connection with this, we borrowed approximately $48 million under our New Credit Facilities and repurchased outstanding receivable interests from Jupiter.costs 1.75% per annum.

Accounts Receivable Factoring

Through our European subsidiaries, we engage in non-recourse factoring of certain accounts receivable. The various agreements have different terms, including options for renewal and mutual termination clauses. Under our ~~2000~~New Credit Facilities, such factoring ~~was~~is generally limited to ~~$50~~$75.0 million, based on due date of the factored receivables. ~~The limit on factoring was raised to $75 million under the New Credit Facilities entered into in August 2005.~~

1814

8.6. Inventories

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

~~Inventories and the method of determining costs were:~~


	September 30,			December 31,			June 30,			December 31,
(Amounts in thousands)	2005			2004			2006			2005

Raw materials	$	122,106		$	123,149		$	134,466		$	114,636
Work in process		224,395			197,850			269,668			195,585
Finished goods		222,053			214,929			247,141			219,610
Less: Progress billings		(69,297	)		(59,048	)		(116,398	)		(71,065	)
Less: Excess and obsolete reserve		(59,214	)		(58,181	)		(60,744	)		(57,106	)

		440,043			418,699			474,133			401,660
LIFO reserve		(34,745	)		(30,297	)		(44,726	)		(39,890	)

Net inventory	$	405,298		$	388,402
Inventories, net							$	429,407		$	361,770


Percent of inventory accounted for by:
LIFO		44	%		42	%		44	%		49	%
FIFO		56	%		58	%		56	%		51	%

9.7. Earnings Per Share

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


	Three Months Ended September 30,					Three Months Ended June 30,
(Amounts in thousands, except per share amounts)	2005			2004		2006		2005

Income from continuing operations	$	5,183		$	7,270	$	33,071	$	18,561

Net (loss) earnings	$	(9,950	)	$	6,368
Net earnings						$	33,071	$	17,950

Denominator for basic earnings per share — weighted average shares		55,139			55,174		55,699		55,610
Effect of potentially dilutive securities		1,346			553		2,188		1,027

Denominator for diluted earnings per share — weighted average shares		56,485			55,727		57,887		56,637

Net earnings per share:
Basic:
Continuing operations	$	0.09		$	0.14	$	0.59	$	0.33
Net (loss) earnings		(0.18	)		0.12
Net earnings							0.59		0.32
Diluted:
Continuing operations	$	0.08		$	0.13	$	0.57	$	0.33
Net (loss) earnings		(0.19	)		0.11
Net earnings							0.57		0.32

1915


	Nine Months Ended September 30,				Six Months Ended June 30,
(Amounts in thousands, except per share amounts)	2005		2004		2006		2005

Income from continuing operations	$	26,641	$	21,653	$	46,963	$	21,459

Net earnings	$	3,986	$	19,783	$	46,963	$	13,936

Denominator for basic earnings per share — weighted average shares		55,439		54,976		55,593		55,478
Effect of potentially dilutive securities		1,131		552		2,137		942

Denominator for diluted earnings per share — weighted average shares		56,570		55,528		57,730		56,420

Net earnings per share:
Basic:
Continuing operations	$	0.48	$	0.39	$	0.84	$	0.39
Net earnings		0.07		0.36		0.84		0.25
Diluted:
Continuing operations	$	0.47	$	0.39	$	0.81	$	0.38
Net earnings		0.07		0.36		0.81		0.25

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

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


	Three Months Ended June 30,
	2006		2005

Total number excluded		26,000		305,458


	Six Months Ended June 30,
	2006		2005

Total number excluded		33,000		586,029

~~10.~~8. Legal Matters and Contingencies

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

On February 4, 2004, we received an informal inquiry from the SEC requesting the voluntary production of documents and information related to our February 3, 2004 announcement that we would restate our financial results for the nine months ended September 30, 2003 and the full years 2002, 2001 and 2000. On June 2, 2004, we were advised that the SEC had issued a formal order of private investigation into issues regarding this restatement and any other issues that arise from the investigation. On May 31, 2006, we were informed by the staff of the SEC that it had concluded this investigation without recommending any enforcement action against us.

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

during the one-year time period has the right to require an issuer to repurchase the securities acquired by the investor at the price paid by the investor for the securities (or if such security has been disposed of, to receive damages with respect to any loss on such disposition), plus interest from the date of acquisition. These rights may apply to affected participants in our 401(k) plan. Based on our current stock price, we believe that our current potential liability for rescission claims is not material to our financial condition or results of operations; however, our potential liability could become material in the future if our stock price were to fall below participants’ acquisition prices for their interest in our stock fund during the one-year period following the unregistered acquisitions.

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

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

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

~~11. Retirement and Postretirement Benefits~~

~~Components of the net periodic cost (benefit) for the three months ended September 30, 2005 and 2004 were as follows:~~

U.S. Non-U.S. Postretirement
(Amounts in millions) Defined Benefit Plans Defined Benefit Plans Medical Benefits
Net periodic cost (benefit) 2005 2004 2005 2004 2005 2004
Service cost $ 3.7 $ 3.5 $ 0.8 $ 0.9 $ — $ 0.1
Interest cost 3.9 3.8 2.6 2.2 1.0 1.3
Expected return on plan assets (4.1 ) (4.3 ) (1.4 ) (1.1 ) — —
Curtailments/settlements (0.1 ) 0.6 — — — —
Amortization of unrecognized net loss 1.3 0.6 0.3 0.3 0.2 0.4
Amortization of prior service costs/ (benefit) (0.4 ) (0.3 ) — — (1.0 ) (0.8 )

Net cost recognized $ 4.3 $ 3.9 $ 2.3 $ 2.3 $ 0.2 $ 1.0

~~Components of the net periodic cost (benefit) for the nine months ended September 30, 2005 and 2004 were as follows:~~

U.S. Non-U.S. Postretirement
(Amounts in millions) Defined Benefit Plans Defined Benefit Plans Medical Benefits
Net periodic cost (benefit) 2005 2004 2005 2004 2005 2004
Service cost $ 11.1 $ 10.4 $ 2.5 $ 2.5 $ 0.1 $ 0.1
Interest cost 11.6 11.6 7.7 6.6 3.1 4.0
Expected return on plan assets (12.3 ) (13.0 ) (4.3 ) (3.3 ) — —
Curtailments/settlements (0.2 ) 0.6 — — — —
Amortization of unrecognized net loss 3.8 1.9 1.1 1.0 0.5 1.1
Amortization of prior service costs (1.1 ) (1.0 ) — — (3.1 ) (2.3 )

Net cost recognized $ 12.9 $ 10.5 $ 7.0 $ 6.8 $ 0.6 $ 2.9

~~12. Income Taxes~~

For the three months ended September 30, 2005, we earned $9.7 million before taxes and provided for income taxes of $4.5 million, resulting in an effective tax rate of 46.5%. For the nine months ended September 30, 2005, we earned $44.8 million before taxes and provided for income taxes of $18.2 million, resulting in an effective tax rate of 40.5%. The effective tax rate varied from the U.S. federal statutory rate for the three and nine months ended September 30, 2004 primarily due to the net impact of foreign operations.

For the three months ended September 30, 2004, we earned $17.8 million before taxes and provided for income taxes of $10.6 million, resulting in an effective tax rate of 59.3%. For the nine months ended September 30, 2004, we earned $56.4 million before taxes and provided for income taxes of $34.8 million, resulting in an effective tax rate of 61.6%. The effective tax rate varied from the U.S. federal statutory rate for the three and nine months ended September 30, 2004 primarily due to the impact of increased foreign earnings repatriation used to pay down U.S. debt.

~~13. Segment Information~~

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

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

	•		~~Flowserve Pump Division;~~

	•		~~Flow Solutions Division; and~~

	•		~~Flow Control Division.~~

Each division manufactures different products and is defined by the type of products and services provided. Each division has a President, who reports directly to our Chief Executive Officer, and a Division Controller, who reports directly to our Chief Accounting Officer. For decision-making purposes, our Chief Executive Officer and other members of senior executive management use financial information generated and reported at the division level. Our corporate headquarters does not constitute a separate division or business segment.

We evaluate segment performance and allocate resources based on each segment’s operating income. Amounts classified as All Other include the corporate headquarters costs and other minor entities that do not constitute separate segments. Intersegment sales and transfers are recorded at cost plus a profit margin, with the margin on such sales eliminated with consolidation.

~~The following is a summary of the financial information of the reportable segments reconciled to the amounts reported in the condensed consolidated financial statements.~~

~~Three Months Ended September 30, 2005~~

Subtotal –
Flowserve Flow Flow Reportable Consolidated
(Amounts in thousands) Pump Solutions Control Segments All Other Total
Sales to external customers $ 321,156 $ 103,338 $ 223,613 $ 648,107 $ 1,378 $ 649,485
Intersegment sales 810 9,852 1,076 11,738 (11,738 ) -
Segment operating income 28,971 23,006 25,280 77,257 (22,446 ) 54,811

~~Three Months Ended September 30, 2004~~

Subtotal –
Flowserve Flow Flow Reportable Consolidated
(Amounts in thousands) Pump Solutions Control Segments All Other Total
Sales to external customers $ 322,468 $ 88,749 $ 210,772 $ 621,989 $ 1,437 $ 623,426
Intersegment sales 1,362 7,143 1,052 9,557 (9,557 ) —
Segment operating income 23,482 18,761 18,765 61,008 (17,828 ) 43,180

~~Nine Months Ended September 30, 2005~~

Subtotal –
Flowserve Flow Flow Reportable Consolidated
(Amounts in thousands) Pump Solutions Control Segments All Other Total
Sales to external customers $ 992,061 $ 300,993 $ 660,020 $ 1,953,074 $ 3,693 $ 1,956,767
Intersegment sales 3,040 26,950 3,050 33,040 (33,040 ) —
Segment operating income 84,355 65,891 71,456 221,702 (84,763 ) 136,939

~~Nine Months Ended September 30, 2004~~

Subtotal –
Flowserve Flow Flow Reportable Consolidated
(Amounts in thousands) Pump Solutions Control Segments All Other Total
Sales to external customers $ 935,615 $ 266,309 $ 612,649 $ 1,814,573 $ 4,189 $ 1,818,762
Intersegment sales 4,328 22,297 3,405 30,030 (30,030 ) —
Segment operating income 64,620 54,524 53,712 172,856 (47,239 ) 125,617

~~14. Subsequent Events~~

~~Legal Matters~~

On October 6, 2005, a shareholder derivative lawsuit was filed purportedly on our behalf in the 193rd Judicial District of Dallas County, Texas. The lawsuit names as defendants Mr. Greer, Ms. Hornbaker, and current board members Hugh K. Coble, George T. Haymaker, Jr., William C. Rusnack, Michael F. Johnston, Charles M. Rampacek, Kevin E. Sheehan, Diane C. Harris, James O. Rollans and Christopher A. Bartlett. We are named as a nominal defendant. Based primarily on the purported misstatements alleged in the above-described federal securities case, the plaintiff asserts claims against the defendants for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment. The plaintiff alleges that these purported violations of state law occurred between April 2000 and the date of suit. The plaintiff seeks on our behalf an unspecified amount of damages, injunctive relief and/or the imposition of a constructive trust on defendants’ assets, disgorgement of compensation, profits or other benefits received by the defendants from us, and recovery of attorneys’ fees and costs. We strongly believe that the suit was improperly filed and have filed a motion seeking dismissal of the case.

In addition, one of our foreign subsidiary’s operations is cooperating with a foreign governmental investigation of that site’s involvement in the United Nations Oil-for-Food program. This cooperation has included responding to an investigative trip by foreign authorities to the foreign subsidiary’s site, providing relevant documentation to these authorities and answering their questions. We are unable to predict how or if the foreign authorities will pursue this matter in the future.

~~We believe that both the SEC and foreign authorities are investigating other companies from their actions arising from the United Nations Oil-for-Food program.~~

We are in the process of reviewing and responding to the SEC subpoena and assessing the implications of the foreign investigation, including the continuation of a thorough internal investigation. Our investigation is in the early stages and has included and will include a detailed review of contracts with the Iraqi government during the period in question and certain payments associated therewith. Additionally, we have and will continue to conduct interviews with employees with knowledge of the contracts and payments in question. We are in the early phases of our internal investigation and as a result are unable to make any definitive determination whether any inappropriate payments were made and accordingly are unable to predict the ultimate outcome of this matter.

We will continue to fully cooperate in both the SEC and the foreign investigations. Both investigations are in progress but, at this point, are incomplete. Accordingly, if the SEC and/or the foreign authorities take enforcement action with regard to these investigations, we may be required to pay fines, consent to injunctions against future conduct or suffer other penalties which could potentially materially impact our business financial statements and cash flows.

On March 14, 2006, a shareholder derivative lawsuit was filed purportedly on our behalf in federal court in the Northern District of Texas. The lawsuit names as defendants Mr. Greer, Ms. Hornbaker, and current board members Mr. Coble, Mr. Haymaker, Jr., Lewis M. Kling, Mr. Rusnack, Mr. Johnston, Mr. Rampacek, Mr. Sheehan, Ms. Harris, Mr. Rollans and Mr. Bartlett. We are named as a nominal defendant. Based primarily on certain of the purported misstatements alleged in the above-described federal securities case, the plaintiff asserts claims against the defendants for breaches of fiduciary duty. The plaintiff alleges that the purported breaches of fiduciary duty occurred between 2000 and 2004. The plaintiff seeks on our behalf an unspecified amount of damages, disgorgement by Mr. Greer and Ms. Hornbaker of salaries, bonuses, restricted stock and stock options, and recovery of attorneys’ fees and costs. We strongly believe that the suit was improperly filed and have filed a motion seeking dismissal of the case.

As of May 1, 2005, due to the non-current status of our filings with the SEC in accordance with the Securities Exchange Act of 1934, our Registration Statements on Form S-8 were no longer available to cover offers and sales of securities to our employees and other persons. Since that date, the acquisition of interests in our common stock fund under our Flowserve Corporation Retirement Savings Plan (“401(k) Plan”) by plan participants may have been subject to the registration requirements of the Securities Act of 1933 or applicable state securities laws and may not have qualified for an available exemption from such requirements. Federal securities laws generally provide for a one-year rescission right for an investor who acquires unregistered securities in a transaction that is subject to registration and for which no exemption was available. As such, an investor successfully asserting a rescission right during the one-year time period has the right to require an issuer to repurchase the securities acquired by the investor at the price paid by the investor for the securities (or if such security has been disposed of, to receive damages with respect to any loss on such disposition), plus interest from the date of acquisition. The remedies and statute of limitations under state securities laws vary and depend upon the state in which the shares were purchased. These rights may apply to affected participants who acquired an interest in our common stock fund in our 401(k) Plan during this period. Based on our current stock price, we believe that our current potential liability for rescission claims is not material to our financial condition, results of operations or cash flows; however, our potential liability could become material in the future if our stock price were to fall significantly below prices at which participants acquired their interest in our common stock fund during the one-year period following such unregistered acquisitions.

On February 7, 2006, we received a subpoena from the SEC regarding goods and services that certain foreign subsidiaries delivered to Iraq from 1996 through 2003 during the United Nations Oil-for-Food program. This investigation includes a review of whether any inappropriate payments were made to Iraqi officials in violation of the Foreign Corrupt Practices Act. The investigation includes periods prior to, as well as subsequent to our acquisition of the foreign operations involved in the investigation. We may be subject to liabilities if violations are found regardless of whether they relate to periods before or subsequent to our acquisition. In addition, one of our foreign subsidiary’s operations is cooperating with a foreign governmental investigation of that site’s involvement in the United Nations Oil-for-Food program. This cooperation has included responding to an investigative trip by foreign authorities to the foreign subsidiary’s site, providing relevant documentation to these authorities and answering their questions. We are unable to predict how or if the foreign authorities will pursue this matter in the future. We believe that both the SEC and foreign authorities are investigating other companies from their actions arising from the United Nations Oil-for-Food program. We also understand that the U.S. Department of Justice is conducting its own investigation of the same events underlying the SEC inquiry. We are in the process of reviewing and responding to the SEC subpoena and assessing the implications of the foreign investigation, including the continuation of a thorough internal investigation. Our investigation remains ongoing. The investigation has included and will include

a detailed review of contracts with the Iraqi government during the period in question and certain payments associated therewith, as well as other documents and information that might relate to Oil-for-Food transactions. Additionally, we have and will continue to conduct interviews with employees with knowledge of the contracts and payments in question. While we have made substantial progress in our internal investigation, we are still unable to make any definitive determination whether any inappropriate payments were made and accordingly are unable to predict the ultimate outcome of this matter. We will continue to fully cooperate in both the SEC and the foreign investigations. Both investigations are in progress but, at this point, are incomplete. Accordingly, if the SEC and/or the foreign authorities take enforcement action with regard to these investigations, we may be required to pay fines, take remedial compliance measures, further improve our existing compliance program, consent to injunctions against future conduct or suffer other penalties which could potentially materially impact our business financial statements and cash flows.

In March 2006, we initiated a process to determine our compliance posture with respect to U.S. export control laws and regulations. Upon initial investigation, it appears that some product transactions and technology transfers may technically not be in compliance with U.S. export control laws and regulations and require further review. With assistance from outside counsel, we are currently involved in a systematic process to conduct further review, which we believe will take about 1815 months to complete given the complexity of the export laws and the comprehensive scope of our investigation. Any potential violations of U.S. export control laws and regulations that are identified may result in civil or criminal penalties, including fines and/or other penalties. Because our review into this issue is ongoing, we are currently unable to determine the full extent of potential violations or the nature or amount of potential penalties to which we might be subject to in the future. Given that the resolution of this matter is uncertain at this time, we are not able to reasonably estimate the maximum amount of liability that could result from final resolution of this matter. We cannot currently predict whether the ultimate resolution of this matter will have a material adverse effect on our business, including our ability to do business outside the U.S, or on our financial condition.

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

We are also a defendant in several other lawsuits, including product liability claims, that are insured, subject to the applicable deductibles, arising in the ordinary course of business. Based on currently available information, we believe that we have adequately accrued estimated probable losses for such lawsuits. We are also involved in a substantial number of labor claims. We are also involved in ordinary routine litigation incidental to our business, none of which we believe to be material to our business, operations or overall financial condition. However, resolutions or dispositions of claims or lawsuits by settlement or otherwise could have a significant impact on our operating results for the reporting period in which any such resolution or disposition occurs.

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

~~Other Matters~~9. Retirement and Postretirement Benefits

Components of the net periodic cost for the three months ended June 30, 2006 and 2005 were as follows:


	U.S.						Non-U.S.						Postretirement
	Defined Benefit Plans						Defined Benefit Plans						Medical Benefits
(Amounts in millions)	2006			2005			2006			2005			2006			2005
Net periodic cost
Service cost	$	3.7		$	3.7		$	0.9		$	0.8		$	—		$	—
Interest cost		3.8			3.9			2.5			2.6			1.0			1.0
Expected return on plan assets		(3.9	)		(4.1	)		(1.4	)		(1.4	)		—			—
Curtailments/settlements		—			(0.1	)		—			—			—			—
Amortization of unrecognized net loss		1.6			1.3			0.6			0.3			0.3			0.2
Amortization of prior service cost (benefit)		(0.3	)		(0.4	)		—			—			(1.1	)		(1.0	)

Net cost recognized	$	4.9		$	4.3		$	2.6		$	2.3		$	0.2		$	0.2

Components of the net periodic cost for the six months ended June 30, 2006 and 2005 were as follows:


	U.S.						Non-U.S.						Postretirement
	Defined Benefit Plans						Defined Benefit Plans						Medical Benefits
(Amounts in millions)	2006			2005			2006			2005			2006			2005
Net periodic cost
Service cost	$	7.4		$	7.4		$	1.8		$	1.7		$	—		$	0.1
Interest cost		7.6			7.8			5.0			5.1			2.0			2.1
Expected return on plan assets		(7.8	)		(8.2	)		(2.8	)		(2.9	)		—			—
Curtailments/settlements		—			(0.2	)		—			—			—			—
Amortization of unrecognized net loss		3.2			2.5			1.2			0.7			0.6			0.3
Amortization of prior service costs (benefit)		(0.6	)		(0.7	)		—			—			(2.2	)		(2.1	)

Net cost recognized	$	9.8		$	8.6		$	5.2		$	4.6		$	0.4		$	0.4

10. Income Taxes

For the three months ended June 30, 2006, we earned $61.7 million before taxes and provided for income taxes of $28.6 million, resulting in an effective tax rate of 46.4%. For the six months ended June 30, 2006, we earned $85.7 million before taxes and provided for income taxes of $38.8 million, resulting in an effective tax rate of 45.2%. The effective tax rate varied from the U.S. federal statutory rate for the three and six months ended June 30, 2006 primarily due to the tax impact of operating activities in certain non-U.S. jurisdictions, including higher losses incurred in the second quarter of 2006 as compared with the same period in 2005, for which a tax benefit has not been recognized.

For the three months ended June 30, 2005, we earned $31.2 million before taxes and provided for income taxes of $12.6 million, resulting in an effective tax rate of 40.5%. For the six months ended June 30, 2005, we earned $35.1 million before taxes and provided for income taxes of $13.7 million, resulting in an effective tax rate of 38.9%. The effective tax rate varied from the U.S. federal statutory rate for the three and six months ended June 30, 2005 primarily due to the net impact of foreign operations.

The Internal Revenue Service (“IRS”) substantially concluded its audit of our U.S. federal income tax returns for the years 1999 through 2001 during December 2005. Based on its audit work, the IRS has issued proposed adjustments to increase taxable income during 1999 through 2001 by $12.8 million, and to deny foreign tax credits of $2.4 million in the aggregate. The tax liability resulting from these proposed adjustments will be offset with foreign tax credit carryovers and other refund claims, which was approved by the Joint Committee on Taxation on July 24, 2006, and therefore should not result in a material future cash ~~payment, pending final review by the Joint Committee on Taxation.~~payment. We anticipate the final cash settlement of this ~~review~~examination will be completed by December 31, 2006. The effect of the adjustments to current and deferred taxes has been reflected in ~~the~~previously filed consolidated financial statements for the applicable periods.

of the audit of 2002 through 2004. The audit of 2002 through 2004 may result in additional tax payments by us, the amount of which may be material, but will not be known until that IRS audit is finalized.

In the course of the tax audit for the years 1999 through 2001, we identified record keeping issues that existed during the periods, which caused us to incur significant expense to substantiate our tax return items and address information and document requests made by the IRS. We expect to incur similar expenses in future periods with respect to the upcoming IRS audit of the years 2002 through 2004.

Due to the record keeping issues referred to above, the IRS has issued a Notice of Inadequate Records for the years 1999 through 2001 and may issue a similar notice for the years 2002 through 2004. While the IRS has agreed not to assess penalties for inadequacy of records with respect to the years 1999 through 2001, no assurances can be made that the IRS will not seek to assess such penalties or other types of penalties with respect to the years 2002 through 2004. Such penalties could result in a material impact to the consolidated results of operations. Additionally, the record keeping issues noted above may result in future U.S. state and local, as well as non-U.S., tax assessments of tax, penalties and interest which could have a material impact to the consolidated results of operations.

11. Segment Information

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

	•		Flowserve Pump Division;

	•		Flow Control Division; and

	•		Flow Solutions Division.

Each division manufactures different products and is defined by the type of products and services provided. Each division has a President, who reports directly to our Chief Executive Officer, and a Division V.P. — Finance, who reports directly to our Chief Accounting Officer. For decision-making purposes, our Chief Executive Officer and other members of senior executive management use financial information generated and reported at the division level. Our corporate headquarters does not constitute a separate division or business segment.

The following is a summary of the financial information of the reportable segments reconciled to the amounts reported in the condensed consolidated financial statements.

Three Months Ended June 30, 2006


							Subtotal —
	Flowserve		Flow		Flow		Reportable					Consolidated
(Amounts in thousands)	Pump		Control		Solutions		Segments		All Other			Total
Sales to external customers	$	385,516	$	251,715	$	114,158	$	751,389	$	1,470		$	752,859
Intersegment sales		1,442		635		10,818		12,895		(12,895	)		—
Segment operating income		46,929		29,310		27,346		103,585		(31,107	)		72,478

Three Months Ended June 30, 2005


							Subtotal —
	Flowserve		Flow		Flow		Reportable					Consolidated
(Amounts in thousands)	Pump		Control		Solutions		Segments		All Other			Total
Sales to external customers	$	359,099	$	227,674	$	103,126		689,899	$	1,266		$	691,165
Intersegment sales		1,140		1,177		8,775		11,092		(11,092	)		—
Segment operating income		37,749		26,171		24,234		88,154		(31,851	)		56,303

Six Months Ended June 30, 2006


							Subtotal —
	Flowserve		Flow		Flow		Reportable					Consolidated
(Amounts in thousands)	Pump		Control		Solutions		Segments		All Other			Total
Sales to external customers	$	712,952	$	468,758	$	222,374	$	1,404,084	$	2,632		$	1,406,716
Intersegment sales		2,066		1,390		20,813		24,269		(24,269	)		—
Segment operating income		71,384		53,389		50,642		175,415		(65,417	)		109,998

Six Months Ended June 30, 2005


							Subtotal —
	Flowserve		Flow		Flow		Reportable					Consolidated
(Amounts in thousands)	Pump		Control		Solutions		Segments		All Other			Total
Sales to external customers	$	670,905	$	436,407	$	197,654	$	1,304,966	$	2,317		$	1,307,283
Intersegment sales		2,230		1,974		17,098		21,302		(21,302	)		—
Segment operating income		55,384		46,175		42,885		144,444		(62,314	)		82,130

12. Subsequent Events

Our Shareholder Rights Plan and Series A Preferred Stock expired in August 2006. As a result of the expiration, we amended our Certificate of Incorporation and the New York Stock Exchange delisted the Series A Preferred Stock.

On September 29, 2006, the Board of Directors authorized a program to repurchase up to two million shares of our outstanding common stock. Shares will be repurchased to offset potentially dilutive effects of stock options issued under our stock-based compensation programs. We expect to commence the program after our planned November filing of our third quarter 2006 Form 10-Q.

At our annual shareholders’ meeting on August 24, 2006, our shareholders approved certain applicable amendments to our stock option and incentive plans. See Note 3 for further discussion of this matter.

Updates to legal matters in existence at June 30, 2006, and new legal matters that have arisen since June 30, 2006 are discussed in Note 8.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with ~~the information contained in the~~our condensed consolidated financial statements, and notes thereto, and the other financial data included elsewhere in this Quarterly ~~Report and our 2005 Annual~~ Report.

~~OVERVIEW~~

We produce engineered and industrial pumps, industrial valves, control valves, nuclear valves, valve actuation and precision mechanical seals, and provide a range of related flow management services worldwide, primarily for the process industries. Equipment manufactured and serviced by us is predominately used The following discussion should also be read in industries that deal with difficult-to-handle and corrosive fluids as well as environments with extreme temperature, pressure, horsepower and speed. Our businesses are affected by economic conditions in the U.S. and other countries where our products are sold and serviced, by the cyclical nature of the petroleum, chemical, power, water 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. We believe the impact of these conditions is somewhat mitigated by the strength and diversity of our product lines, geographic coverage and significant installed base, which provides potential for an annuity stream of revenue from parts and services.

~~RECENT DEVELOPMENTS~~

~~In an effort to better align our business portfolio~~conjunction with our ~~core strategic objectives, in the first quarter of 2005, we made a definitive decision to divest the General Services Group (“GSG”), non-core service operations which provide online repair~~audited consolidated financial statements, and ~~other third-party services,~~notes thereto, and we engaged an investment banking firm to commence marketing. As a result, we reclassified the group to discontinued operations in the first quarter of 2005. Sales for GSG were $103 million and $116 million in 2005 and 2004, respectively. We performed an impairment analysis of GSG at March 31, 2005 on a held for sale basis and, after the allocation of goodwill, we recognized an impairment charge of $5.9 million during the first quarter of 2005. The initial estimated fair value at March 31, 2005 was based upon investment banker’s valuation of GSG’s estimated fair value as well as initial bids received from potential purchasers. As the year progressed, the number of potential buyers diminished to one potential purchaser and the business underperformed due to the pending sale. As a result, the lone bidder reduced its initial offer and accordingly, we recognized additional impairment charges aggregating approximately $24.2 million throughout 2005, of which $0 and $17.6 million were recorded in the second and third quarters, respectively, for total impairment charges in 2005 of $30.1 million. GSG was sold on December 31, 2005 for approximately $16 million in gross cash proceeds, including $2 million held in escrow pending final settlement, subject to final working capital adjustments that remain under negotiation, while retaining approximately $12 million of net accounts receivable. We used approximately $11 million of the net cash proceeds to reduce our outstanding indebtedness in January 2006.

~~For further discussion of other recent developments, see “Item 7. Management’s~~“Management’s Discussion and Analysis of Financial Condition and Results of ~~Operations.”~~Operations” included in our 2005 Annual Report.

EXECUTIVE OVERVIEW

We are an established leader in the fluid motion and control business, with a strong portfolio of pumping systems, valves, sealing solutions, automation and services in support of the power, oil and gas, chemical, water, mining and other general industrial markets. These products are critical in the movement, control and protection of fluids in our customers’ processes, regardless of the particular industry. Our business model is heavily influenced by the capital spending of these industries for the placement of new products into service and for maintenance on existing facilities. The worldwide installed base of our products is an important source of revenue where our products are expected to ensure the maximum operating time of the many key industrial processes. The aftermarket business includes parts, service solutions, product life cycle solutions and other value added services, and is generally a higher margin business and a key component to our profitable growth.

We have experienced steadily improving conditions in 2005 and 2006 in several core markets, including oil and gas, chemical, power and general industries. The rise of the price of crude oil and natural gas in particular has spurred capital investment in the oil and gas market, resulting in many new projects and expansion opportunities. Although feedstock costs have been rising in the chemical market, greater global demand is allowing companies to pass through pricing and strengthen the global market. We have also seen a resurgence of nuclear power, particularly in the Asian market and an increase in coal-fired power plants across the globe. The opportunity to increase our installed base of new products and drive recurring aftermarket business in future years is a critical by-product of these favorable market conditions.

We currently have approximately 13,000 employees in more than 56 countries. We continue to implement new Quick Response Centers (“QRCs”) to be better positioned as near to our customers as possible for service and support, as a means to capture the important aftermarket business. Our markets have improved and we see corresponding growth in our business, much of which is in non-traditional areas of the world where new oil and gas reserves have been discovered. While we have experienced increased demand for our products and services in recent periods, we continue to monitor our core industries for changes and track global issues that could impact our performance. We and our customers are seeing rapid growth in Asia and the Middle East, with China providing a source of significant project growth. We have a strategy in place to increase our presence in China to capture the aftermarket business with our current installed base as well as to support new plant construction and expansions. In 2006, we expanded our presence in China through two new QRCs in Shenzhen and Shanghai, as well as a new greenfield manufacturing operation in Suzhou to support local service and low cost sourcing.

Along with ensuring that we have the local capability to sell, install and service our equipment in remote regions, it becomes more imperative to continuously improve our global operations. Our global supply chain capability is being expanded to meet the global customer demands and ensure the quality and timely delivery of our products while minimizing our input costs. Significant efforts are underway to reduce the supply base and drive processes across the business to find areas of synergy and cost reduction. In addition, we are improving our supply chain management capability to ensure we meet global customer demands. We continue to focus on improving on-time delivery and quality, while reducing warranty costs across our global operations through a focused Continuous Improvement Process (“CIP”) initiative. The goal of the CIP initiative is to maximize service fulfillment to our customers (such as on-time delivery, reduced cycle time and quality) at the highest internal productivity. This program is a key factor in our margin expansion plans.

RECENT DEVELOPMENTS

The IRS substantially concluded its audit of our U.S. federal income tax returns for the years 1999 through 2001 during December 2005. Based on its audit work, the IRS issued proposed adjustments to increase taxable income during 1999 through 2001 by $12.8 million, and to deny foreign tax credits of $2.4 million in the aggregate. The tax liability resulting from these proposed adjustments will be offset with foreign tax credit carryovers and other refund claims, which were approved by the Joint Committee on Taxation on July 24, 2006, and therefore should not result in a material future cash payment. We anticipate the final cash settlement of

this examination will be completed by December 31, 2006. The effect of the adjustments to current and deferred taxes has been reflected in previously filed consolidated financial statements for the applicable periods.

During the third quarter of 2006, the IRS commenced an audit of our U.S. federal income tax returns for the years 2002 through 2004. While we expect that the upcoming IRS audit will be similar in scope to the recently completed examination, the upcoming audit may be broader. Furthermore, the preliminary results from the audit of 1999 through 2001 are not indicative of the future result of the audit of 2002 through 2004. The audit of 2002 through 2004 may result in additional tax payments by us, the amount of which may be material, but will not be known until that IRS audit is finalized.

RESULTS OF OPERATIONS –— Three and ~~Nine~~Six Months ended ~~September~~June 30, ~~2005~~2006 and ~~2004~~2005

Consolidated Results

Bookings, Sales and Backlog


	Three Months Ended September 30,				Three Months Ended June 30,
(Amounts in millions)	2005		2004		2006		2005

Bookings	$	794.2	$	664.7
Bookings — continuing operations					$	912.0	$	696.1
Bookings — discontinued operations						—		27.2

Total bookings						912.0		723.3
Sales		649.5		623.4		752.9		691.2
Backlog		994.9		896.6


	Nine Months Ended September 30,				Six Months Ended June 30,
(Amounts in millions)	2005		2004		2006		2005

Bookings	$	2,230.1	$	1,997.7
Bookings — continuing operations					$	1,790.6	$	1,381.7
Bookings — discontinued operations						—		54.1

Total bookings						1,790.6		1,435.8
Sales		1,956.8		1,818.8		1,406.7		1,307.3
Backlog		994.9		896.6

We define a booking as the receipt of a customer order that contractually engages us to perform activities on behalf of our customer with regard to manufacture, service or support. ~~Bookings~~Total bookings for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$123.1~~$188.7 million, or ~~18.5%~~26.1%, ~~excluding currency benefits of approximately $6 million,~~ as compared with the same period in ~~2004. Bookings for the nine months ended September 30, 2005 increased by $191.5 million, or 9.6%, excluding~~2005. The increase includes currency benefits of approximately ~~$41~~$2 million. Total bookings for the six months ended June 30, 2006 increased by $354.8 million, or 24.7%, as compared with the same period in ~~2004.~~2005. The increase includes negative currency effects of approximately $36 million. Total bookings for the three and six months ended June 30, 2005 include $27.2 million and $54.1 million, respectively, of bookings for GSG, our discontinued operations. Bookings for continuing operations for the three months ended June 30, 2006 increased by $215.9 million, or 31.0%, as compared with the same period in 2005. Bookings for continuing operations for the six months ended June 30, 2006 increased by $408.9 million, or 29.6%, as compared with the same period in 2005. The increases are primarily attributable to the strong ~~industry conditions across all of our divisions, particularly the~~ oil and gas ~~power,~~industry, particularly in our Flowserve Pump and ~~chemical industries.~~Flow Control Divisions.

Sales for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$21.1~~$61.7 million, or ~~3.4%~~8.9%, ~~excluding currency benefits of approximately $5 million,~~ as compared with the same period in ~~2004. Sales for the nine months ended September 30, 2005 increased by $100.6 million, or 5.5%, excluding~~2005. The increase includes currency benefits of approximately ~~$37~~$4 million. Sales for the six months ended June 30, 2006 increased by $99.4 million, or 7.6%, as compared with the same period in ~~2004. Consistent with the increases in bookings, the~~2005. The increase includes negative currency effects of approximately $19 million. The increases are primarily attributable to ~~strong market conditions across all of our divisions, particularly~~the strength in the engineered pump products and services market, particularly in the Middle East, improved ~~Russian and Asian~~ valve markets and expansion into the ~~oil and gas seal industry.~~Asia Pacific region.

Net sales to international customers, including export sales from the U.S., were approximately 65% and 64% of sales for ~~both~~ the three and ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006, respectively, compared with ~~67% in~~64% for each of the same periods in ~~2004. Weaker non-U.S. currency effects was the primary factor for the~~2005. The increase in ~~2005.~~2006 is due primarily to a growth in sales to the Middle East and expansion in the Asia Pacific region.

Backlog represents the accumulation of uncompleted customer orders. Backlog of $1.4 billion at ~~September~~June 30, ~~2005~~2006 increased by ~~$152.6~~$402.5 million, or ~~17.0%~~40.5%, ~~excluding negative currency effects of approximately $54 million,~~ as compared with ~~September 30, 2004.~~December 31, 2005. The increase includes currency benefits of approximately $55 million. The backlog increase compared with the prior year resulted from increased bookings during the ~~nine~~six months ended ~~September~~June 30, ~~2005.~~2006 as discussed above. The increase in total bookings reflects an increase in orders of engineered products, which naturally have longer lead times, as well as expanded lead times at the request of certain customers.

Gross Profit and ~~Gross Profit~~Operating Margin


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Gross profit	$	211.2		$	189.5		$	251.7		$	222.7
Gross profit margin		32.5	%		30.4	%		33.4	%		32.2	%


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Gross profit	$	625.1		$	554.1		$	466.1		$	413.8
Gross profit margin		31.9	%		30.5	%		33.1	%		31.7	%

Gross profit margin of ~~32.5%~~33.4% for the three months ending ~~September~~June 30, ~~2005~~2006 increased from ~~30.4%~~32.2% for the same period in ~~2004.~~2005. The increase is a result of increased sales, which favorably impacts our absorption of fixed costs, and cost savings achieved through our CIP initiative, both of which have positively impacted each of our divisions.

Gross profit margin of ~~31.9%~~33.1% for the ~~nine~~six months ending ~~September~~June 30, ~~2005~~2006 increased from ~~30.5%~~31.7% for the same period in ~~2004.~~2005. The ~~increases are~~increase is a result of increased sales, which favorably impacts our absorption of ~~engineered parts~~fixed costs, and ~~services,~~cost savings achieved through our CIP initiative, both of which have positively impacted each of our divisions. The increase is also attributable to increased sales of aftermarket products, which generally have a higher margin, by our Flowserve Pump ~~Divisions and cost savings achieved through our Continuous Improvement Process (“CIP”) initiative.~~Division.

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


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

SG&A expense	$	156.4		$	146.3		$	179.2		$	166.4
SG&A expense as a percentage of sales		24.1	%		23.5	%		23.8	%		24.1	%


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

SG&A expense	$	488.1		$	428.5		$	356.1		$	331.7
SG&A expense as a percentage of sales		24.9	%		23.6	%		25.3	%		25.4	%

SG&A for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$9.0~~$12.8 million, or ~~6.2%~~7.7%, ~~excluding currency effects of approximately $1 million,~~ as compared with the same period in ~~2004.~~2005. The increase includes negative currency effects of less than $1 million. The increase in SG&A is ~~due primarily~~attributable to ~~an increase in professional fees of $5.5 million generally related to audit and tax consulting fees. In addition, we had~~ an increase in employee-related costs of ~~$2.9~~$7.7 million, which includes ~~sales commissions,~~increased incentive compensation and equity incentive programs ~~($1.1 million)~~arising from improved performance and ~~severance~~higher stock price and ~~transition~~development of in-house capabilities for: tax, Section 404 compliance, internal

audit, and financial planning and analysis, as well as expansion in Asia. The increase is also due to an increase in travel expenses ~~($1.0 million).~~of $3.4 million, due to increased global marketing activity and expansion in Asia.

SG&A for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$52.0~~$24.4 million, or ~~12.1%~~7.4%, ~~excluding currency effects of approximately $8 million,~~ as compared with the same period in ~~2004,~~2005. SG&A for the three months ended June 30, 2006 reflects a reduction of approximately $4 million resulting from currency effects. The increase is due ~~primarily~~ to ~~increases~~an increase in ~~employee related~~employee-related costs ~~and professional fees. Employee-related costs increased by $31.1~~of $14.4 million, which includes ~~sales commissions,~~increased incentive compensation and equity incentive programs ~~($11.3 million), severance~~arising from improved performance and ~~transition expenses ($3.9 million)~~higher stock price and ~~modification~~development of ~~stock option expiration terms for former executives, current~~in-house capabilities for: tax, Section 404 compliance, internal audit, and ~~former employees~~financial planning and ~~board of directors ($6.2 million). Professional fees increased primarily~~analysis, as well as expansion in Asia. The increase is also due to an increase ~~of $12.4 million~~ in audit fees ~~and $12.8~~of $7.0 million, ~~in fees~~primarily related to ~~tax consulting, accounting~~the 2004 and ~~internal audit assistance.~~2005 audits, which were completed in February 2006 and June 2006, respectively, and an increase in travel expenses of $5.3 million, due to increased global marketing activity and expansion in Asia. These ~~were~~increases are partially offset by a ~~$10.0~~decrease of $2.6 million ~~decrease~~ in legal fees and expenses.

Operating Income


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Operating income	$	54.8		$	43.2		$	72.5		$	56.3
Operating income as a percentage of sales		8.4	%		6.9	%		9.6	%		8.1	%


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Operating income	$	136.9		$	125.6		$	110.0		$	82.1
Operating income as a percentage of sales		7.0	%		6.9	%		7.8	%		6.3	%

Operating income for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$10.8~~$16.2 million, or ~~25.0%~~28.8%, ~~excluding~~as compared with the same period in 2005. The increase includes currency benefits of approximately $1 million. Operating income for the six months ended June 30, 2006 increased by $27.9 million, or 34.0%, as compared with the same period in 2005. The increase includes negative currency effects of approximately $2 million. The increases are primarily a result of the increases in gross profit, partially offset by the increases in SG&A discussed above.

Interest Expense and Interest Income


	Three Months Ended June 30,
(Amounts in millions)	2006			2005

Interest expense	$	(16.3	)	$	(19.9	)
Interest income		1.1			0.6


	Six Months Ended June 30,
(Amounts in millions)	2006			2005

Interest expense	$	(31.9	)	$	(39.9	)
Interest income		2.2			1.5

Interest expense for the three months ended June 30, 2006 decreased by $3.6 million, as compared with the same period in ~~2004. Operating income~~2005. Interest expense for the ~~nine~~six months ended ~~September~~June 30, ~~2005 increased~~2006 decreased by ~~$6.9 million, or 5.5%, excluding currency benefits of approximately $4~~$8.0 million, as compared with the same period in ~~2004. The increases are primarily a result of the increase in gross profit discussed above, partially offset by the increase in SG&A discussed above.~~

~~Interest Expense, Interest Income and Loss on Repayment of Debt~~

Three Months Ended September 30,
(Amounts in millions) 2005 2004

Interest expense $ (19.0 ) $ (21.0 )
Interest income 1.3 0.7
Loss on early extinguishment of debt (27.9 ) (1.0 )

Nine Months Ended September 30,
(Amounts in millions) 2005 2004

Interest expense $ (58.9 ) $ (60.6 )
Interest income 2.8 1.2
Loss on early extinguishment of debt (27.7 ) (1.0 )

Interest expense for the three months ended September 30, 2005 decreased by $2.0 million as compared with the same period in 2004. Interest expense for the nine months ended September 30, 2005 decreased by $1.7 million, as compared with the same period in 2004.2005. The decreases are primarily attributable to the refinancing in August 2005 of our 12.25% Senior Subordinated Notes with the proceeds of borrowings under our New Credit Facilities. Approximately ~~37.9%~~72% of our debt was at fixed rates at ~~September~~June 30, ~~2005,~~2006, including the effects of ~~$265~~$470.0 million notional interest rate swaps.

Interest income was higher for both the three and ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006, as compared with the same periods in ~~2004~~2005, due to a higher average cash balance in ~~2005.~~2006, as well as increased interest rates.

For the three and nine months ended September 30, 2005, we recognized $27.9 million and $27.7 million, respectively, in expenses related to the write-off of unamortized prepaid financing fees, primarily due to our refinancing. See further discussion of our refinancing in the “Liquidity and Capital Resources” section of this Management’s Discussion and Analysis and in Note 7 to our condensed consolidated financial statements included in this Quarterly Report. For the same periods in 2004, we recognized expenses of $1.0 million, for the write-off of unamortized prepaid financing fees related to optional debt repayments of $40.0 million.

Other Income (Expense), net


	Three Months Ended September 30,					Three Months Ended June 30,
(Amounts in millions)	2005		2004			2006		2005

Other income (expense), net	$	0.4	$	(4.0	)	$	4.4	$	(5.9	)


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006		2005

Other income (expense), net	$	(8.3	)	$	(8.8	)	$	5.5	$	(8.6	)

Other ~~expense,~~income (expense), net for the three months ended ~~September~~June 30, ~~2005 decreased~~2006 increased by $10.3 million, to income of $4.4 million, as compared with the same period in ~~2004~~2005, primarily due to ~~a decrease~~an increase in unrealized gains on forward exchange contracts, slightly offset by an increase in foreign currency transaction losses.

Other ~~expense,~~income (expense), net for the ~~nine~~six months ended ~~September~~June 30, ~~2005 decreased~~2006 increased by ~~$0.5~~$14.1 million, to income of $5.5 million, as compared with the same period in ~~2004~~2005, primarily due to ~~decreases~~an increase in unrealized gains on forward exchange contracts, slightly offset by an increase in foreign currency transaction ~~losses, partially offset by increases in unrealized losses on forward exchange contracts.~~losses.

Tax Expense and Tax Rate


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Provision for income tax	$	4.5		$	10.6		$	28.6		$	12.6
Effective tax rate		46.5	%		59.3	%		46.4	%		40.5	%


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Provision for income tax	$	18.2		$	34.8		$	38.8		$	13.7
Effective tax rate		40.5	%		61.6	%		45.2	%		38.9	%

Our effective tax rate of ~~46.5%~~46.4% for the three months ended ~~September~~June 30, ~~2005 decreased~~2006 increased from ~~59.3%~~40.5% for the same period in ~~2004.~~2005. Our effective tax rate of ~~40.5%~~45.2% for the ~~nine~~six months ended ~~September~~June 30, ~~2005 decreased~~2006 increased from ~~61.6%~~38.9% for the same period in ~~2004.~~2005. The ~~decreases~~increases are due primarily to the ~~net~~tax impact of ~~foreign operations.~~operating activities in certain non-U.S. jurisdictions, including higher losses incurred in the second quarter of 2006 as compared with the same period in 2005, for which a tax benefit has not been recognized.

Net ~~(Loss)~~ Earnings and ~~(Loss)~~ Earnings Per Share


	Three Months Ended September 30,					Three Months Ended June 30,
(Amounts in millions)	2005			2004
(Amounts in millions, except per share data)						2006		2005

Income from continuing operations	$	5.2		$	7.3	$	33.1	$	18.6
Net (loss) earnings		(10.0	)		6.4
Net earnings							33.1		18.0
Net earnings per share from continuing operations — diluted		0.08			0.13		0.57		0.33
Net (loss) earnings per share — diluted		(0.19	)		0.11
Net earnings per share — diluted							0.57		0.32
Average diluted shares		56.5			55.7		57.9		56.6


	Nine Months Ended September 30,				Six Months Ended June 30,
(Amounts in millions)	2005		2004
(Amounts in millions, except per share data)					2006		2005

Income from continuing operations	$	26.6	$	21.7	$	47.0	$	21.5
Net earnings		4.0		19.8		47.0		13.9
Net earnings per share from continuing operations — diluted		0.47		0.39		0.81		0.38
Net earnings per share — diluted		0.07		0.36		0.81		0.25
Average diluted shares		56.6		55.5		57.7		56.4

Income from continuing operations for the three and six months ended ~~September~~June 30, ~~2005 decreased as compared to the same period in 2004 primarily as a result of the loss on early extinguishment of debt recorded in connection with our refinancing, partially offset~~2006 increased by ~~the increase in operating income~~$14.5 million and ~~decrease in provision for income tax discussed above. The increase in income from continuing operations for the nine months ended September 30, 2005~~$25.5 million, respectively, as compared with the same ~~period~~periods in ~~2004 is~~2005. The increases are a result of the ~~increase~~increases in operating income, ~~combined with the decrease~~decreases in ~~the tax provision~~interest expense and increases in other income (expense), net discussed above, partially offset by the increase in ~~loss on early extinguishment of debt recorded in conjunction with our refinancing.~~tax expense.

~~The net loss~~Net income for the ~~three~~six months ended ~~September~~June 30, 2005 was ~~significantly~~ lower than income from continuing operations ~~for~~due to the ~~same period.~~loss from discontinued operations. This is primarily attributable to a ~~$17.6~~$5.9 million impairment recorded in the ~~third~~first quarter of 2005 for assets held for ~~sale, which is included in discontinued operations. Net earnings~~sale.

Other Comprehensive Income (Loss)


	Three Months Ended June 30,
(Amounts in millions)	2006		2005

Other comprehensive income (loss)	$	18.5	$	(16.6	)


	Six Months Ended June 30,
(Amounts in millions)	2006		2005

Other comprehensive income (loss)	$	25.3	$	(24.3	)

Other comprehensive income (loss) for the ~~nine~~three months ended ~~September~~June 30, 2005 ~~was significantly lower than~~increased by $35.1 million to income ~~from continuing operations for the same period due primarily to an aggregate $23.5~~of $18.5 million ~~impairment recorded during the period for assets held for sale, which is included in discontinued operations.~~

~~Average diluted shares were relatively flat in the first nine months of 2005~~as compared with the same period in ~~2004.~~

~~Other Comprehensive Income (Loss)~~

Three Months Ended September 30,
(Amounts in millions) 2005 2004

Other comprehensive income (loss) $ 1.9 $ (1.5 )

Nine Months Ended September 30,
(Amounts in millions) 2005 2004

Other comprehensive income (loss) $ (22.5 ) $ (15.4 )

2005. Other comprehensive income (loss) ~~changed from a loss of $1.5 million~~ for the ~~quarter~~six months ended ~~September~~June 30, ~~2004~~2005 increased by $49.6 million to income of ~~$1.9~~$25.3 million ~~for~~as compared with the ~~quarter ended September 30, 2005~~same period in 2005. The increases primarily ~~reflecting an increase in unrealized gain on hedging activity partially offset by~~reflect a strengthening of the Euro and British pound during the three and six months ended ~~September~~June 30, ~~2005.~~

~~Other comprehensive loss for the nine months ended September 30, 2005 increased $7.1 million~~2006, as compared with a weakening during the same ~~period~~periods in ~~2004, reflecting a strengthening of the Euro and British pound during the nine-month period ended September 30, 2005, as compared with the same period in 2004.~~2005.

Business Segments

We conduct our business through three business segments that represent our major product areas:

	•		Flowserve Pump Division (“FPD”) for engineered pumps, industrial pumps ~~and related services; Flow Control Division (“FCD”) for industrial valves, manual valves, control valves, nuclear valves, valve actuators and related services;~~ and related services;

	•		Flow Control Division (“FCD”) for industrial valves, manual valves, control valves, nuclear valves, valve actuators and related services; and

	•		Flow Solutions Division (“FSD”) for precision mechanical seals and related services.

We evaluate segment performance and allocate resources based on each segment’s operating income. See Note 13 to our condensed consolidated financial statements included in this Quarterly Report for further discussion of our segments. The key operating results for our three business segments, FPD, FCD and FSD are discussed below.

Flowserve Pump Division

Through FPD, we design, manufacture, distribute and service engineered and industrial pumps and pump systems, replacement parts and related equipment, principally to industrial markets. FPD has 27 manufacturing facilities worldwide, of which nine are located in North America, 11 in Europe, four in South America and three in Asia. FPD also has more than 50 service centers, which are either free standing or co-located in a manufacturing facility. In March 2004, we acquired the remaining 75% interest in TKL, a leading Australian designer, manufacturer and supplier of centrifugal pumps, railway track work products and steel castings. As a result of this acquisition, we strengthened our product offering in the mining industry, broadened our manufacturing capacity in the Asia Pacific region and gained foundry capacity.


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Bookings	$	436.5		$	349.7		$	529.6		$	342.8
Sales		322.0			323.8			387.0			360.2
Gross profit		90.0			82.9			109.4			98.9
Gross profit margin		27.9	%		25.6	%		28.3	%		27.5	%
Operating income		29.0			23.5			46.9			37.7
Operating income as a percentage of sales		9.0	%		7.3	%		12.1	%		10.5	%
Backlog		690.9			628.3

3027


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Bookings	$	1,138.6		$	1,011.1		$	1,025.2		$	702.1
Sales		995.1			939.9			715.0			673.1
Gross profit		268.2			235.7			201.2			178.2
Gross profit margin		27.0	%		25.1	%		28.1	%		26.5	%
Operating income		84.4			64.6			71.4			55.4
Operating income as a percentage of sales		8.5	%		6.9	%		10.0	%		8.2	%
Backlog		690.9			628.3

Bookings for the three months ended ~~September~~June 30, ~~2005~~2006, increased by ~~$82.1~~$186.8 million, or ~~23.5%~~54.5%, ~~excluding currency benefits of approximately $5 million,~~ as compared with the same period in ~~2004. All regions contributed~~2005. The increase includes currency benefits of approximately $1 million. The increase is primarily attributable to Europe, the Middle East and Africa (“EMA”), which increased by $152.7 million due to the ~~increased bookings, due to strong market conditions for~~continued strength in the oil and gas ~~power, and chemical products.~~industry.

Bookings for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$104.8~~$323.1 million, or ~~10.4%~~46.0%, ~~excluding currency benefits of approximately $23 million,~~ as compared with the same period in ~~2004 . Continued improvement~~2005. The increase includes negative currency effects of approximately $22 million. The increase is primarily attributable to EMA, which increased by $238.5 million, including negative currency effects of approximately $23 million, due to strength in the oil and gas, power and water ~~and power markets resulted in improved bookings across all regions.~~markets.

Sales for the three months ended ~~September~~June 30, ~~2005 decreased~~2006 increased by ~~$5.4~~$26.8 million, or ~~1.7%~~7.4%, ~~excluding currency benefits of approximately $4 million,~~ as compared with the same period in ~~2004.~~2005. The ~~decrease~~increase includes currency benefits of approximately $2 million. The increase is primarily attributable to EMA, which increased by $22.2 million due ~~primarily~~ to ~~a number of large projects that were~~the continued strength in ~~process during~~ the ~~period~~oil and ~~shipped subsequent~~gas industry. The Middle East has contributed the most significant growth to ~~September 30, 2005.~~EMA.

Sales for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$34.1~~$41.9 million, or ~~3.6%~~6.2%, ~~excluding currency benefits of approximately $21 million,~~ as compared with the same period in ~~2004.~~2005. The ~~addition~~increase includes negative currency effects of ~~TKL~~approximately $10 million. The increase is primarily attributable to EMA, which increased by $19.7 million, including negative currency effects of approximately $11 million. The Middle East has contributed the most significant growth to EMA. North America increased by $20.6 million. The increases in ~~March 2004~~EMA and ~~improved markets for engineered products~~North America are due to strength in the oil and ~~services were the primary drivers of the increase.~~gas industry.

Gross profit margin of ~~27.9%~~28.3% for the three months ~~ending September~~ended June 30, ~~2005~~2006 increased from ~~25.6%~~27.5% for the same period in ~~2004 as a result of a more favorable product mix.~~

~~Gross profit margin of 27.0% for the nine months ending September 30, 2005 increased from 25.1% for the same period in 2004.~~2005. The increase is ~~a result of a more profitable product mix and~~primarily attributable to increased sales, which favorably impacts our absorption of fixed costs.

Gross profit margin of 28.1% for the six months ended June 30, 2006 increased from 26.5% for the same period in 2005. The increase is attributable to increased sales, which favorably impacts our absorption of fixed costs. The improvement is also attributable to a product and services mix that resulted in the aftermarket business increasing from 46.6% of sales for the six months ended June 30, 2006 as compared with 45.9% for the same period in 2005. The aftermarket business consistently provides more favorable gross margins than original equipment sales.

Operating income for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$5.5~~$9.2 million, or ~~23.4%~~24.4%, as compared with the same period in ~~2004. Currency had a negligible impact on operating income for~~2005. The increase includes currency benefits of less than $1 million. The increase is primarily attributable to the ~~quarter. The~~$10.5 million improvement ~~was a result if increased~~in gross ~~profit for the period as described above.~~profit.

Operating income for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$17.6~~$16.0 million, or ~~27.2%~~28.9%, ~~excluding currency benefits of approximately $2 million,~~ as compared with the same period in ~~2004. Increased~~2005. The increase includes negative currency effects of less than $1 million. The increase is primarily attributable to the $23.0 million improvement in gross profit, ~~positively impacted operating income, as described above,~~ partially offset by an increase in SG&A, which is due primarily to ~~increased marketing~~an increase in employee-related costs and information technology costs.

Backlog of $1.0 billion at June 30, 2006 increased by $317.1 million, or 45.1%, as compared with December 31, 2005. The increase includes currency benefits of approximately $42 million. Backlog growth is primarily a result of the growth in bookings. The increase in bookings reflects an increase in orders of engineered products, which naturally have longer lead times, as well as expanded lead times at the request of certain customers.

Flow Control Division

Our second largest business segment is FCD, which designs, manufactures and distributes a broad portfolio of industrial valve products, including modulating and finite valves, actuators and controls. FCD leverages its experience and application know-how by offering a complete menu of engineered services to complement its expansive product portfolio. FCD has ~~more than 4,000 employees at its~~ manufacturing and service facilities in 19 countries around the world, with only five of its 22 manufacturing operations located in the U.S.


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Bookings	$	250.6		$	228.9
Bookings — continuing operations							$	273.9		$	240.9
Bookings — discontinued operations								—			27.2

Total bookings								273.9			268.1
Sales		224.7			211.8			252.3			228.9
Gross profit		72.1			65.1			86.0			74.0
Gross profit margin		32.1	%		30.7	%		34.1	%		32.3	%
Operating income		25.3			18.8			29.3			26.2
Operating income as a percentage of sales		11.3	%		8.9	%		11.6	%		11.4	%
Backlog		246.5			234.6


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Bookings	$	770.3		$	725.6
Bookings — continuing operations							$	541.6		$	465.6
Bookings — discontinued operations								—			54.1

Total bookings								541.6			519.7
Sales		663.1			616.1			470.1			438.4
Gross profit		216.0			192.7			160.2			143.9
Gross profit margin		32.6	%		31.3	%		34.1	%		32.8	%
Operating income		71.5			53.7			53.4			46.2
Operating income as a percentage of sales		10.8	%		8.7	%		11.4	%		10.5	%
Backlog		246.5			234.6

~~Bookings~~Total bookings for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$21.7~~$5.8 million, or ~~9.5%~~2.2%, as compared with the same period in ~~2004.~~2005. Currency had a ~~nominal effect~~negligible impact on bookings for the ~~period.~~quarter. Total bookings for the three months ended June 30, 2005 includes $27.2 million of bookings for GSG, our discontinued operations. Bookings for continuing operations for the three months ended June 30, 2006 increased by $33.0 million, or 13.7%, as compared with the same period in 2005. The increase in bookings is primarily attributable to the process valve market, which realized continued success in the coal degasification business in China, as well as improved delivery performance in the North American oil and gas market. We also experienced increased activity in the control valve QRC and aftermarket businesses, and continued strength in the power business, particularly with Russian district heating.

Total bookings for the six months ended June 30, 2006 increased by $21.9 million, or 4.2%, as compared with the same period in 2005. The increase includes negative currency effects of approximately $12 million. Total bookings for the six months ended June 30, 2005 includes $54.1 million of bookings for GSG, our discontinued operations. Bookings for continuing operations for the six months ended June 30, 2006 increased by $76.0 million, or 16.3%, as compared with the same period in 2005. The increase in bookings is primarily attributable to the continued strengthening of several of the division’s key ~~end-markets, most notably the chemical~~end markets, such as oil and ~~mining markets in Asia.~~

~~Bookings for the nine months ended September 30, 2005 increased by $32.1 million, or 4.4%, excluding currency benefits of approximately $13 million~~gas and coal degasification, as ~~compared with the same period in 2004. This increase is due to higher demand in the industrial and commercial markets and~~well as increased project sales ~~particularly~~ in ~~Asia and Russia.~~all of our markets.

Sales for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$12.9~~$23.4 million, or ~~6.1%~~10.2%, as compared with the same period in ~~2004. Currency had~~2005. The increase includes currency benefits of less than $1 million. The increase is principally a ~~nominal effect~~result of stronger performance in all of our primary markets. We realized notable improvements in both the North American and European control valve markets for petroleum products, increased process valve Maintenance/Repairs/Operation activity in the chemical and general industries, and improvements in the parts and service business related to power valves.

Sales for the ~~period.~~six months ended June 30, 2006 increased by $31.7 million, or 7.2%, as compared with the same period in 2006. The increase includes negative currency effects of approximately $8 million. This increase is principally attributable to the

aforementioned improved economic conditions in several of our key markets, most notably North American petroleum markets and Asian chemical and general industries.

Gross profit margin of 34.1% for the three months ended June 30, 2006 increased from 32.3% for the same period in 2005. This increase results from the aforementioned improvement in sales causing an improved absorption of fixed manufacturing cost, strong focus on capturing the aftermarket of our installed base and our successful implementation of various CIP and supply chain initiatives.

Gross profit margin of 34.1% for the six months ended June 30, 2006 increased from 32.8% for the same period in 2005. The increase in ~~sales~~gross profit margin is primarily the result of the aforementioned increase in sales causing an improved absorption of fixed manufacturing cost, as well as the realization of higher margins on control valve projects, and the impact of broad-based price increases implemented in the latter half of ~~2004, higher Asian chemical sales and improved U.S. petrochemical and Russian power markets.~~

Sales for the nine months ended September 30, 2005 increased by $35.3 million, or 5.7%, excluding currency benefits of approximately $12 million as compared with the same period in 2004. This increase is a result of the aforementioned continued strengthening of key-end markets, particularly within Asia and Russia, as well as the positive impact of the price increases implemented in the latter half of 2004.

Gross profit margin of 32.1% for the three months ended September 30, 2005 increased from 30.7% for the same period in 2004. Gross profit margin of 32.6% for the nine months ended September 30, 2005 increased from 31.3% for the same period in 2004. The improvements reflect the benefit of operating efficiencies realized as a result of our various initiatives to reduce manufacturing costs and to achieve cost savings via supply chain, offset in part by an increase in the original equipment manufacturer business, which has a comparatively lower margin than the aftermarket business.2005.

Operating income for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$6.5~~$3.1 million, or ~~34.6%~~11.8%, as compared with the same period in ~~2004.~~2005. Currency had a ~~nominal effect~~negligible impact on operating income for the period. This increase is driven by the $12.0 million improvement in gross profit, ~~while partially~~mostly offset by higher ~~value of~~ SG&A costs primarily associated with bad debt for a single customer, increased headcount and ~~higher information technology costs, although the decrease in SG&A as a percentage of~~equity incentive compensation and increased sales ~~contributed 100 basis points to operating margin.~~commissions resulting from increased bookings.

Operating income for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$16.4~~$7.2 million, or ~~30.6%~~15.6%, ~~excluding currency benefits of approximately $1 million~~ as compared with the same period in ~~2004.~~2005. The increase includes negative currency effects of approximately $1 million. This increase is driven by the $16.3 million improvement in gross profit, partially offset ~~partially~~ by the aforementioned higher ~~value of~~ SG&A costs primarily associated with bad debt for a single customer, increased

headcount and ~~higher information technology costs, although~~equity incentive compensation and increased sales commissions resulting from increased bookings.

Backlog of $318.7 million at June 30, 2006 increased by $78.8 million, or 32.8%, as compared with backlog at December 31, 2005. The increase includes currency benefits of approximately $11 million. This increase is attributable to the ~~decrease~~impact of increased bookings during the first half of 2006, which should yield increased sales in ~~SG&A~~the coming months, as ~~a percentage~~well as expanded lead times at the request of ~~sales contributed 80 basis points to operating margin.~~certain customers.

Flow Solutions Division

Through FSD, we design, manufacture and distribute mechanical seals, sealing systems and parts, and provide related services, principally to industrial markets. FSD has seven manufacturing operations, three of which are located in the U.S. FSD operates 64 QRCs worldwide, including 25 sites in North America, 14 in Europe, and the remainder in South America and Asia. Our ability to manufacture engineered seal products within 72 hours from the customer’s request — through design, engineering, manufacturing, testing and delivery — is a significant competitive advantage. Based on independent industry sources, we believe that we are the second largest mechanical seal supplier in the world.


	Three Months Ended September 30,						Three Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Bookings	$	116.5		$	98.5		$	122.7		$	124.2
Sales		113.2			95.9			125.0			111.9
Gross profit		50.0			42.2			56.7			49.9
Gross profit margin		44.1	%		44.0	%		45.4	%		44.6	%
Operating income		23.0			18.8			27.3			24.2
Operating income as a percentage of sales		20.3	%		19.6	%		21.8	%		21.6	%
Backlog		67.0			46.6


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Bookings	$	353.1		$	294.0		$	250.6		$	236.6
Sales		327.9			288.6			243.2			214.8
Gross profit		144.3			126.3			108.2			94.4
Gross profit margin		44.0	%		43.8	%		44.5	%		43.9	%
Operating income		65.9			54.5			50.6			42.9	��
Operating income as a percentage of sales		20.1	%		18.9	%		20.8	%		20.0	%
Backlog		67.0			46.6

Bookings for the three months ended ~~September~~June 30, ~~2005 increased~~2006 decreased by ~~$16.8~~$1.5 million, or ~~17.0%~~1.2%, ~~excluding currency benefits of approximately $1 million,~~ as compared with the same period in ~~2004.~~2005. The decrease includes currency benefits of less than $1 million. The decrease is due primarily to a $5.3 million decrease in customer bookings, which is attributable to all regions, partially offset by an increase of $3.8 million in intersegment bookings (which are eliminated and are not included in consolidated bookings as disclosed above).

Bookings for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$53.3~~$14.0 million, or ~~18.1%~~5.9%, ~~excluding currency benefits of approximately $6 million,~~ as compared with the same period in ~~2004.~~2005. The ~~bookings’ improvements generally reflect FSD’s emphasis on end user business~~increase includes negative currency effects of approximately $2 million. The increase is primarily attributable to increased demand from oil and ~~success~~gas and chemical markets, primarily in ~~establishing longer-term customer alliance programs. Increased market conditions~~North America, Latin America and ~~a focus on customer service also contributed to the increase.~~Europe.

Sales for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$16.4~~$13.1 million, or ~~17.1%~~11.7%, ~~excluding currency benefits of approximately $1 million,~~ as compared with the same period in ~~2004. Sales for the nine months ended September 30, 2005 increased by $34.7 million, or 12.0%, excluding~~2005. The increase includes currency benefits of approximately $5$1 million. Sales for the six months ended June 30, 2006 increased by $28.4 million, or 13.2%, as compared with the same period in ~~2004. As discussed above,~~2005. The increase includes negative currency effects of approximately $1 million. The increases are attributable to all regions, and are primarily a result of increased bookings during the ~~improved market conditions, combined with heightened levels~~first three months of ~~service and customer alliance programs have contributed to the sales growth.~~2006.

Gross profit margin of ~~44.1% and 44.0%~~45.4% for the three ~~and nine~~ months ending ~~September~~June 30, ~~2005, respectively, were relatively flat as compared with~~2006, increased from 44.6% for the same period in ~~2004.~~2005. Gross profit margin of 44.5% for the six months ending June 30, 2006, increased from 43.9% for the same period in 2005. The increases are attributable to increased sales, which favorably impacts our absorption of fixed costs.

Operating income for the three months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$4.2~~$3.1 million, or ~~22.3%~~12.8%, as compared with the same period in ~~2004.~~2005. Currency had a negligible impact on operating income for the ~~quarter.~~period. The increase is primarily attributable to the $6.8 million increase in gross profit, partially offset by an increase in marketing, information technology and research and development costs.

Operating income for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 increased by ~~$10.3~~$7.7 million, or ~~18.9%~~17.9%, ~~excluding currency benefits of approximately~~

~~$1 million,~~ as compared with the same period in ~~2004. These improvements reflect~~2005. Currency had a negligible impact on operating income for the first six months of 2006. The increase is primarily attributable to the $13.8 million increase in gross profit, partially offset by an increase in marketing, information technology and research and development costs.

Backlog of $71.7 million at June 30, 2006 increased by $10.5 million, or 17.2%, as compared with December 31, 2005. The increase includes currency benefits of ~~increased~~approximately $2 million. Backlog growth is primarily a result of the growth in bookings discussed above. Capacity expansions that began during the quarter helped to significantly increase shipments, primarily in North America, and have helped to begin a reduction in backlog. Additional capacity expansion in all regions for the remainder of the year is anticipated to continue in order to support our sales ~~as well as~~growth and reduce the ~~operating efficiencies resulting from our CIP initiative.~~backlog to prior year levels.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow Analysis


	Nine Months Ended September 30,						Six Months Ended June 30,
(Amounts in millions)	2005			2004			2006			2005

Net cash flows provided by operating activities	$	19.9		$	86.8
Net cash flows provided (used) by operating activities							$	7.9		$	(2.6	)
Net cash flows used by investing activities		(27.7	)		(33.9	)		(28.3	)		(19.6	)
Net cash flows used by financing activities		(19.2	)		(66.0	)
Net cash flows (used) provided by financing activities								(15.9	)		2.2

Cash generated by operations and borrowings available under our existing revolving credit facility are our primary sources of short-term liquidity. Our ~~sources of operating cash include the sale of our products and services. Our~~ cash balance at ~~September~~June 30, ~~2005~~2006 was ~~$35.2~~$58.2 million, as compared with ~~$63.8~~$92.9 million at December 31, ~~2004.~~2005.

Cash flows provided by operating activities induring the ~~first nine~~six months ~~of 2005 were $19.9~~ended June 30, 2006 was $7.9 million, as compared with ~~$86.8 million in the first nine months of 2004. Working capital, excluding cash, was~~ a use of ~~operating cash flow~~$2.6 million for the same period in 2005. Net income growth of ~~$32.9~~$33.0 million was offset by an unfavorable working capital impact of $57.1 million. The increase in working capital during the first ~~nine~~six months of ~~2005, compared with a source of $3.8 million~~2006 was due primarily to increases in ~~the prior year period. Working capital for the current period primarily reflects an increase of $38.8 million in inventories versus the prior year,~~inventory and accounts receivable, which corresponds to record demand levels for our products and the increase in business volume and sales activity and a decrease of $34.7 million in retirement obligations and other liabilities due primarily to increased funding of pension plans (see below). These were partially offset by a decrease in accounts receivable of $12.8 million primarily due to improving collections.

during the period. We have made ~~the following quarterly~~no material contributions to our U.S. ~~defined benefit~~ pension ~~plans:~~plans during the six months ended June 30, 2006. However, we contributed approximately $36 million to our U.S. pension plans during September 2006.

Quarter ending: 2005 2004
(Amounts in millions)
March 31 $ 4.1 $ 0.2
June 30 7.7 8.1
September 30 32.0 5.3
December 31 1.0 1.7

$ 44.8 $ 15.3

During the first half of the year, increases in working capital reduce cash flow. We have historically derived a greater portion of our operating profit during the second half of the year, which is consistent with our customers’ buying patterns. Costs are incurred evenly throughout the year. As a result, our operating cash flows generally increase as the year progresses. Therefore, we do not expect operating cash flows for the six months ended June 30 to be indicative of full year results.

Cash flows used by investing activities induring the ~~first nine~~six months ~~of 2005~~ended June 30, 2006 were ~~$27.7~~$28.3 million, as compared with ~~$33.9~~$19.6 million for the same period in 2005. Capital expenditures during the ~~first nine~~six months ended June 30, 2006 were $29.5 million, an increase of ~~2004. Cash outflows~~$11.6 million as compared with the same period in 2005, which reflects increased spending to support capacity expansion, enterprise resource planning application upgrades and ~~2004 were due primarily to capital expenditures, as well as the acquisition of TKL in March 2004 (described below).~~information technology infrastructure.

Cash flows used by financing activities induring the ~~first nine~~six months ~~of 2005~~ended June 30, 2006 were ~~$19.2~~$15.9 million, as compared with ~~$66.0~~a source of $2.2 million for the same period in ~~the first nine months of 2004.~~2005. Cash outflows in ~~both periods~~2006 were primarily due to net payments ofon long-term debt.

We believe cash flows from operating activities combined with availability under our existing revolving credit agreement and our existing cash balance will be sufficient to enable us to meet our cash flow needs for the next 12 months. Cash flows from operations could be adversely affected by economic, political and other risks associated with sales of our products, operational factors, competition, fluctuations in foreign exchange rates and fluctuations in interest rates, among other factors. See “Cautionary Note Regarding Forward-Looking Statements.”

We have a substantial number of outstanding stock options granted in past years to employees under our stock option plans which have been unexercisable for an extended period due to our non-current filing status of all our required SEC ~~financial reports.~~public filings. These outstanding options include options for 809,667 shares held by our former Chairman, President and Chief Executive Officer, C. Scott Greer. Given the significant increase in our share price during the period in which optionees have been unable to exercise their options, it is possible that many holders may want to exercise soon after they are first able to do so. We will reopen our stock option exercise program and allow optionees to exercise their options once we become current

with our SEC ~~financial~~ reporting obligations and have registered with the ~~issuance of our~~SEC the common shares to be issued upon exercise of such stock ~~options with the SEC.~~options. We currently expect this to occur in the fourth quarter of 2006. If the holders of a large number of these options promptly exercise following such reopening, there would be some dilutive impact on our earnings per share. We anticipate that a significant number of stock option exercises at one time would positively impact our cash flow, however ~~we are still evaluating~~ the extent of such impact and alternatives to satisfy our obligation under the stock option program, up to and including repurchasing shares on the market to offset some or all of the dilutive impact on our earnings per share which could negatively impact our cash flow. The impacts on our cash flow and earnings per share are dependent upon share price, the number of shares exercised and strike price of shares exercised.

On September 29, 2006, our Board of Directors authorized a program to repurchase up to two million shares of our outstanding common stock. Shares will be repurchased to offset potentially dilutive effects of stock options issued under our stock-based compensation programs. We expect to commence the program after our planned November filing of our third quarter 2006 Form 10-Q. We expect to fund the program using existing cash and cash provided by operations, borrowings and stock option exercises.

Acquisitions

We regularly evaluate acquisition opportunities of various sizes. The cost and terms of any financing to be raised in conjunction with any acquisition, including our ability to raise economical capital, is a critical consideration in any such evaluation.

In March 2004, we acquired the remaining 75% interest in TKL for approximately $12 million. We paid for the acquisition with cash generated by operations. Prior to the acquisition, we held a 25% interest in TKL. As a result of this acquisition, we strengthened our product offering in the mining industry, broadened our manufacturing capacity in the Asia Pacific region and gained foundry capacity.

Capital Expenditures

Capital expenditures were ~~$25.5~~$29.5 million for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 compared with ~~$28.5~~$17.9 million for the same period in ~~2004.~~2005. Capital expenditures were funded primarily by operating cash flows. Capital expenditures in 2006 are focused on capacity expansion, enterprise resource planning application upgrades (Project STAR: Simplification and Teamwork Accelerates Results), information technology infrastructure and cost reduction opportunities. Capital expenditures in 2005 were focused on new product development, information technology infrastructure and cost reduction opportunities. ~~Capital expenditures in 2004 were invested in new and replacement machinery and equipment and information technology.~~ For the full year ~~2005,~~2006, our capital expenditures ~~were~~are expected to be approximately ~~$49~~$75 million. Certain of our facilities may face capacity constraints in the foreseeable future, which may lead to higher capital expenditure levels.

~~We received cash on disposal of a divestiture of a small distribution business of $3.6 million in the first quarter of 2004.~~

Financing

New Credit Facilities

On August 12, 2005, we entered into New Credit Facilities comprised of a $600.0 million term loan maturing on August 10, 2012 and a $400.0 million revolving line of credit, which can be utilized to provide up to $300.0 million in letters of credit, expiring on August 12, 2010. ~~We used the proceeds of borrowings under our New Credit Facilities to refinance our 12.25% Senior Subordinated Notes and indebtedness outstanding under our 2000 Credit Facilities.~~ Further, we replaced the letter of credit agreement that guaranteed our EIB credit facility (described below) with a letter of credit issued as part of the New Credit Facilities.

The loans under our New Credit Facilities are subject to mandatory repayment with, in general:

	•		100% of the net cash proceeds of asset sales; and

	•		Unless we attain and maintain investment grade credit ratings:

	◦•		75% of our excess cash flow, subject to a reduction based on the ratio of our total debt to consolidated EBITDA;

	◦•		50% of the proceeds of any equity offerings; and

	◦•		100% of the proceeds of any debt issuances (subject to certain exceptions).

We may prepay loans under our New Credit Facilities in whole or in part, without premium or penalty. During the ~~fourth quarter of 2005,~~three and six months ended June 30, 2006, we made ~~scheduled~~mandatory repayments of $0 and $10.9 million, respectively, using the net proceeds from the sale of GSG and optional ~~principal payments~~prepayments of ~~$1.5~~$5.0 million and ~~$38.4~~$5.0 million, respectively. In addition we made a mandatory repayment of $0.9 million in July 2006 using excess cash flows. We have no scheduled repayments due in 2006.

EIB Credit Facility

On April 14, 2004, we and one of our European subsidiaries, Flowserve B.V., entered into an agreement with EIB, pursuant to which EIB agreed to loan us up to€7070.0 million, with the ability to draw funds in multiple currencies, to finance in part specified research and development projects undertaken by us in Europe. Borrowings under the EIB credit facility bear interest at a fixed or floating rate of interest agreed to by us and EIB with respect to each borrowing under the facility. Loans under the EIB credit facility are subject to mandatory repayment, at EIB’s discretion, upon the occurrence of certain events, including a change of control or prepayment of certain other indebtedness. In addition, the EIB credit facility contains covenants that, among other things, limit our ability to dispose of assets related to the financed project and require us to deliver to EIB our audited annual financial statements within 30 days of publication. Our obligations under the EIB credit facility are guaranteed by a letter of credit outstanding under our New Credit ~~Facilities.~~Facilities, which costs 1.75% per annum.

In August 2004, we borrowed ~~$85~~$85.0 million at a floating interest rate based on 3-month U.S. LIBOR that resets quarterly. As of ~~September~~June 30, ~~2005,~~2006, the interest rate was ~~3.80%~~5.26%. The maturity of the amount drawn is June 15, 2011, but may be repaid at any time without penalty. Concurrent with borrowing the ~~$85~~$85.0 million we entered into a derivative contract with a third party financial institution, swapped this principal amount to€70.6 million and fixed the LIBOR portion of the interest rate to a fixed interest rate of 4.19% through the scheduled repayment date. Additional discussion of the derivative is included in Note 64 to our condensed consolidated financial statements, included in this Quarterly Report.

Additional discussion of our New Credit Facilities, EIB credit facility, including amounts outstanding and ~~2000 Credit Facilities,~~applicable interest rates, is included in Note 75 to our condensed consolidated financial statements, included in this Quarterly Report.

We have entered into interest rate and currency swap agreements to hedge our exposure to cash flows related to the credit facilities discussed above. These agreements are more fully described in ~~“Item 3. Quantitative and Qualitative Disclosures about Market Risk.”~~

~~Accounts Receivable Securitization~~

In October 2004, one of our wholly owned subsidiaries entered into an accounts receivable securitization whereby we could obtain up to $75 million in financing by securitizing certain U.S.-based receivables with a third party. In October 2005, we terminated this accounts receivable securitization facility. In connection with the termination, we borrowed approximately $48 million under our New Credit Facilities to repurchase our receivables then held by such third party. See additional discussion of our accounts receivable securitization program in Note 74 to our condensed consolidated financial statements, included in this Quarterly ~~Report.~~

~~2000 Credit Facilities~~

On August 8, 2000, we entered into senior credit facilities comprised of a $275.0 million Tranche A term loan, a $475.0 million Tranche B term loan and a $300.0 million revolving line of credit, hereinafter collectively referred to as our “2000 Credit Facilities.” In connection with our acquisition of Invensys’ flow control division in May 2002, we amended and restated our 2000 Credit Facilities to provide for (1) an incremental $95.3 million Tranche A term loan and (2) a $700.0 million Tranche C term loan. The proceeds of the incremental Tranche A term loan and the Tranche C term loan were used to finance a portion of the acquisition purchase price and to repay in full the Tranche B term loan.

Borrowings under our 2000 Credit Facilities bore interest at a rate equal to, at our option, either (1) the base rate (which was based on the prime rate most recently announced by the administrative agent under our 2000 Credit Facilities or the Federal Funds rate plus 0.50%) or (2) London Interbank Offered Rate (“LIBOR”), plus, in the case of Tranche A term loan and loans under the revolving line of credit, an applicable margin determined by reference to the ratio of our total debt to consolidated EBITDA,Report, and in ~~the case of Tranche C term loan, an applicable margin based on our long-term debt ratings.~~“Item 3. Quantitative and Qualitative Disclosures about Market Risk.”

3633

~~Amounts outstanding under the 2000 Credit Facilities were repaid in August 2005 using the proceeds from the New Credit Facilities.~~

~~Senior Subordinated Notes~~

At September 30, 2005, we had no amounts outstanding on our Senior Subordinated Notes. The Senior Subordinated Notes were originally issued in 2000 at a discount to yield 12.5%, but have a coupon interest rate of 12.25%. Interest on these notes was payable semi-annually in February and August. In August 2005, all remaining Senior Subordinated Notes outstanding were called by us at 106.125% of face value as specified in the loan agreement and repaid, along with accrued interest.

Debt Covenants and Other Matters

Our 2000 Credit Facilities that have now been refinanced, the letter of credit facility guaranteeing our obligations under the EIB credit facility, and the agreements governing our domestic receivables program each required us to deliver to creditors thereunder our audited annual consolidated financial statements within a specified number of days following the end of each fiscal year. In addition, the indentures governing our 12.25% Senior Subordinated Notes required us to timely file with the SEC our annual and quarterly reports. As a result of the restatement of our prior period financial statements as disclosed in our 2004 Annual Report and the new obligations regarding internal controls attestation under Section 404, we did not timely issue our financial statements for the year ended December 31, 2004 and 2005 and the quarterly periods ended June 30, 2004, September 30, 2004, March 31, 2005, June 30, 2005, September 30, 2005 and March 31, 2006, and were unable to timely file with the SEC our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q for such periods. Prior to the refinancing of our 2000 Credit Facilities and the replacement of the standby letter of credit facility, we obtained waivers thereunder extending the deadline for the delivery of our financial statements to the lenders under our 2000 Credit Facilities and the letter of credit facility guaranteeing the EIB credit facility and, as a result of obtaining such waivers, we were not in default as a result of the delay in the delivery of our financial statements. We did not seek or obtain a waiver under the indentures governing our 12.25% Senior Subordinated Notes with respect to our inability to timely file with the SEC the required reports and, prior to the refinancing of our 12.25% Senior Subordinated Notes, were in default thereunder.

Our New Credit Facilities contain covenants requiring us to deliver to lenders leverage and interest coverage financial covenants and our audited annual and unaudited quarterly financial statements. Under the leverage covenant, the maximum permitted leverage ratio steps down beginning with the fourth quarter of 2006, with a further step-down beginning with the fourth quarter of 2007. Under the interest coverage covenant, the minimum required interest coverage ratio steps up beginning with the fourth quarter of 2006, with a further step-up beginning with the fourth quarter of 2007. Compliance with these financial covenants under our New Credit Facilities is tested quarterly, and we have complied with the financial covenants as of ~~December 31, 2005. Further, we~~June 30, 2006.

We are required to furnish within 50 days of the end of each of the first three quarters of each year our consolidated balance sheet, and related statements of operations, shareholders’ equity and cash flows.

Our New Credit Facilities also contain covenants restricting our and our subsidiaries’ ability to dispose of assets, merge, pay dividends, repurchase or redeem capital stock and indebtedness, incur indebtedness and guarantees, create liens, enter into agreements with negative pledge clauses, make certain investments or acquisitions, enter into sale and leaseback transactions, enter into transactions with affiliates, make capital expenditures, engage in any business activity other than our existing business or any business activities reasonably incidental thereto. ~~With the waiver for delivery of the December 31, 2004 audited financial statements, we~~We are currently in compliance with all debt covenants under the New Credit Facilities.

~~CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS~~

~~The following table presents a summary of our contractual obligations at September 30, 2005:~~

Payments Due By Period
Remainder of 2010 &
(Amounts in millions) 2005 2006 – 2007 2008 – 2009 Beyond Total

Long-term debt $ 1.5 $ 12.0 $ 12.0 $ 659.5 $ 685.0
Fixed interest payments (1) 1.5 13.1 10.4 7.5 32.5
Variable interest payments (2) 8.6 68.1 67.0 76.6 220.3
Capital lease obligations 0.2 0.4 — — 0.6
Operating leases 4.7 29.5 16.1 19.3 69.6
Purchase obligations: (3)
Inventory 189.7 0.6 0.0 — 190.3
Non-inventory 11.6 1.0 0.4 — 13.0


~~(1)~~		~~Fixed interest payments include payments on fixed and synthetically fixed rate debt.~~

~~(2)~~		~~Variable interest payments under our New Credit Facilities were estimated using a base rate of three-month LIBOR as of September 30, 2005.~~

~~(3)~~		~~Purchase obligations are presented at the face value of the purchase order, excluding the effects of early termination provisions. Actual payments could be less than amounts presented herein.~~

~~The following table presents a summary of our commercial commitments at September 30, 2005:~~

Commitment Expiration By Period
Remainder of 2010 &
(Amounts in millions) 2005 2006 – 2007 2008 – 2009 Beyond Total

Letters of credit $ 53.3 $ 250.9 $ 18.6 $ 1.3 $ 324.1
Surety bonds 2.3 27.8 1.1 — 31.2

~~We expect to satisfy these commitments through performance under our contracts.~~

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management’s discussion and analysis are based on our condensed consolidated financial statements and related footnotes contained within this ~~report.~~Quarterly Report. Our more critical accounting policies used in the preparation of the consolidated financial statements were discussed in our 2005 Annual Report. These critical policies, for which no significant changes have occurred in the ~~nine~~first six months of ~~2005,~~2006, include:

	•		Revenue Recognition;

	•		Allowance for Doubtful Accounts;

	•		Inventories and Related Reserves;

	•		Deferred Taxes and Tax Valuation Allowances;

	•		Tax Reserves;

	•		~~Restructuring and Integration Expense;~~

	•		Legal and Environmental Accruals;

	•		Warranty Accruals;

	•		Retirement and Postretirement Benefits; and

	•		Valuation of Goodwill, Indefinite-Lived Intangible Assets and Other Long-Lived Assets.

Based on an assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe that our condensed consolidated financial statements provide a meaningful and fair perspective of our financial ~~position~~condition and results of operations. This is not to suggest that other general risk factors, such as changes in worldwide demand, changes in material costs, performance of acquired businesses and others, could not adversely impact our consolidated financial ~~position,~~condition, results of operations and cash flows in future periods.

The process of preparing financial statements in conformity with ~~GAAP~~accounting principles generally accepted in the U.S. (“GAAP”) requires the use of estimates and assumptions to determine certain of the assets, liabilities, revenues and expenses. These estimates and assumptions are based upon what we believe is the best information available at the time of the estimates or assumptions. The estimates and assumptions could change materially as conditions within and beyond our control change. Accordingly, actual results could differ materially from those estimates. The significant estimates are reviewed quarterly with our Audit ~~Committee.~~Committee of the Board of Directors.

ACCOUNTING DEVELOPMENTS

We have presented the information about accounting pronouncements not yet implemented in Note 1 to our condensed consolidated financial statements included in this Quarterly Report.

Cautionary Note Regarding Forward-Looking ~~Information is Subject to Risk and Uncertainty~~Statements

This Quarterly Report ~~and other written reports and oral~~includes forward-looking statements ~~we make from time-to-time contain various “forward-looking statements”~~ within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, ~~and the Private Securities Litigation Reform Act of 1995 and~~as amended. Such statements include ~~assumptions about our~~statements concerning future financial performance, future debt and ~~market conditions,~~financing levels, investment objectives, implications of litigation and regulatory investigations, and other plans and objectives of management for future operations ~~and results. In some cases forward looking~~or economic performance, or assumptions or forecasts related thereto. These statements ~~can be~~are only predictions. We caution that forward-looking statements are not guarantees. Actual events or our results of operations could differ materially from those expressed or implied, but not limited to, in forward-looking statements. Forward-looking statements are typically identified by the use of terms such as, “may,” ~~“will,”~~ “should,” “expect,” ~~“plans,~~“could,” ~~“seeks,~~“intend,” “plan,” “anticipate,” ~~“believe,”~~ “estimate,” ~~“predicts,” “potential,~~“believe,” “continue,” ~~“intends,~~“predict,” “potential” or the negative of such terms and other comparable terminology. ~~These~~

The forward-looking statements ~~are not historical facts or guarantees of future performance but instead~~included in this Quarterly Report are based on our current expectations, plans, estimates, assumptions and beliefs that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are ~~subject~~difficult or impossible to ~~significant risks, uncertainties~~predict accurately and ~~other factors,~~ many of which are ~~outside of~~beyond our control. ~~Among~~Any of the ~~many factors~~assumptions underlying forward-looking statements could be inaccurate. To the extent that our assumptions differ from actual results, our ability to meet such forward-looking statements may be significantly hindered.

The following are some of the risks and uncertainties, although not all of the risks and uncertainties, which could cause actual results to differ materially from ~~the~~those presented in certain forward-looking ~~statements are:~~statements:

	•		~~we have~~ material weaknesses in our internal control over financial ~~reporting;~~reporting that could adversely affect our ability to report our financial condition and results of operations accurately and on a timely basis;

	•		~~continuing delays in~~ our ~~filing~~failure to comply with the requirements of ~~our periodic public reports and any SEC, New York Stock Exchange or debt rating agencies’ actions resulting therefrom;~~Section 404 of the Sarbanes-Oxley Act;

	•		~~the possibility of~~potential adverse consequences ~~of the pending~~resulting from securities class action litigation and ~~on-going SEC investigations;~~other litigation to which we are a party, such as litigation involving asbestos-containing material claims;

	•		~~we may be exposed to product liability~~SEC and ~~warranty claims if~~foreign government investigations regarding our participation in the ~~use of our products results, or is alleged to result, in bodily injury and/or property damage or our products fail to perform as expected;~~United Nations Oil-for-Food Program;

	•		~~the possibility of adverse consequences of governmental tax audits of~~ our ~~tax returns, including the IRS audit of our~~potential non-compliance with U.S. ~~tax returns for the years 2002 through 2004;~~export control, economic sanctions and import laws and regulations;

	•		~~there are a substantial amount~~our risk associated with certain of ~~outstanding stock options~~our foreign subsidiaries autonomously conducting, under their own local authority, business operations and sales, which have recently generated between 1-2% of our consolidated global revenue in certain countries that have been ~~unexercisable for an extended period due~~identified by the U.S. State Department as state sponsors of terrorism. Although these foreign subsidiaries are planning to ~~our non-current filing status of all our SEC financial reports. Given~~voluntarily withdraw from conducting new business in these countries in the ~~significant increase~~near future, they will continue to honor existing contracts and warranty obligations that are in our share price during this exercise unavailability period, it is possible that many holders may want to exercise promptly when first able to do so. We currently expect to allow stock options to be exercised in late 2006. If the holders of a large number of these shares do then promptly exercise once they are able to do so, there would be some dilutive impact on the outstanding shares. We are still evaluating the impact of the reopening the stock option exercise program on our cash flows;compliance with U.S. laws and regulations;

	•		increased tax liabilities resulting from a recent audit of our tax returns by the U.S. Internal Revenue Service, as well as potential costs ~~of energy, metal alloys, nickel~~ and ~~other raw materials have increased and our operating margins and results of operations could~~liabilities that may be ~~adversely affected if we are unable to pass such increases on to our customers;~~associated with likely future audits;

	•		~~all~~a portion of our bookings may not lead to completed sales, ~~therefore~~and we may not be able to convert bookings into revenues at acceptable ~~if any,~~ profit margins, since such profit margins cannot be assured nor can they be necessarily assumed to follow historical trends;

	•		~~our business depends on~~ the ~~levels~~recording of ~~capital investment and maintenance expenditures by our customers, which~~increased deferred tax asset valuation allowances in ~~turn are affected by~~ the ~~cyclical nature of their markets and liquidity;~~future;

	•		~~work stoppages and~~an impairment in the carrying value of goodwill or other ~~labor matters~~intangibles could adversely impact our ~~business;~~

	•		~~changes in the~~consolidated financial ~~markets~~condition and ~~the availability~~results of ~~capital could adversely impact our business~~ operations;

	•		~~we sell our products in highly competitive markets, which puts pressure on our profit margins and limits our ability to maintain or increase the market share of our products;~~

	•		~~we may not be able to continue to expand our market presence through acquisitions, and any future acquisitions may present unforeseen integration difficulties or costs;~~

	•		~~a substantial portion of our operations is conducted and located outside of the U.S. and~~ economic, political and other risks associated with ~~international operations could adversely affect our business in the U.S. and other countries and regions;~~

	•		~~our ability to comply with the laws and regulations affecting~~ our international operations, including ~~the U.S. export laws, and the effect of any noncompliance;~~

	•		~~political risks,~~ military actions or trade embargoes ~~affecting~~that could affect customer markets, including the continuing conflict in Iraq and its potential impact on Middle Eastern markets and global petroleum producers;


	•		our sales are substantially dependent upon the petroleum, chemical, power and water industries and any significant down turn in any one of these industries could adversely impact such sales;

	•		~~a substantial portion of~~ our ~~business consists of international~~ operations ~~and therefore an adverse movement in currency exchange rates could adversely impact our profits;~~

	•		~~we operate and manage our business on a number of different computer systems, including several aging Enterprise Resource Planning systems that rely on manual processes, which~~are dependent upon third-party suppliers whose failure to perform timely could adversely affect our ~~ability to accurately report our financial condition, results of operations and cash flows;~~business operations;

	•		our ~~relative geographical profitability and its impact~~dependence on our customers’ ability to ~~utilize foreign tax credits;~~make required capital investment and maintenance expenditures;

	•		risks associated with cost overruns on fixed-fee projects;

	•		the ~~recognition of significant expenses associated with realigning operations of acquired companies with those of our company;~~highly competitive markets in which we operate;

	•		environmental compliance costs and liabilities;

	•		work stoppages and other labor matters;

	•		our ~~ability~~inability to ~~meet~~protect our intellectual property in the ~~financial covenants and other restrictive covenants~~U.S., as well as in ~~our debt agreements may limit our operating and financial flexibility;~~foreign countries;

	•		the loss of ~~services of any of our~~senior executives and other key ~~personnel could adversely affect our ability to implement our business strategy;~~personnel;

	•		~~any terrorist attacks and~~ difficulties in obtaining raw materials at favorable prices;

	•		obligations under our defined benefit pension plans;

	•		liabilities, including rescission rights, potentially resulting from issuances of interests in our Flowserve Corporation Retirement Savings Plan;

	•		the ~~response~~impact of a significant number of stock option exercises following the removal of the ~~U.S. to such attacks or to~~current suspension on the ~~threat~~exercise of ~~such attacks could adversely impact our business operations, including~~outstanding stock options that is somewhat mitigated by the ~~ability to deliver our products;~~stock repurchase program that was approved by the Board of Directors, which will be implemented during the fourth quarter of 2006;

	•		liabilities that result from product liability and warranty claims;

	•		our ~~ability to protect our intellectual property affects our competitive position;~~

	•		~~changes in prevailing interest rates~~outstanding indebtedness and ~~our effective interest costs could make borrowing more costly~~the restrictive covenants in the ~~future;~~agreements governing our indebtedness limit our operating and financial flexibility; and

	•		~~compliance with regulatory~~our inability to continue to expand our market presence through acquisitions, and ~~other legal obligations could require substantial~~unforeseen integration difficulties or costs ~~and prohibit or restrict our operations.~~resulting from acquisitions we do complete.

~~A detailed discussion of these~~These risks are more fully discussed in, and ~~other risks and uncertainties that could cause actual results and events to differ materially from such~~all forward-looking statements ~~is included~~should be read in light of, all of the factors discussed in Part I. “Item 1A. Risk ~~Factors.” of~~Factors” included in this Quarterly Report and in our 2005 Annual ~~Report, filed with the SEC on June 30, 2006. It is not possible to foresee or identify all the factors that may affect our future performance or any forward-looking information, and new~~Report. The updated risk factors ~~can emerge from time to time. Given these risks and uncertainties, you should not place undue reliance on forward-looking statements as a prediction of actual results.~~

~~All forward-looking statement~~ included in this Quarterly Report are ~~based~~presented in addition to the risk factors disclosed in the 2005 Annual Report.

You are cautioned not to place undue reliance on ~~information available to us on~~any forward-looking statements included in this Quarterly Report. All forward-looking statements are made as of the date of this Quarterly ~~Report. We undertake no obligation to revise~~Report and the risk that actual results will differ materially from the expectations expressed in this Quarterly Report may increase with the passage of time. In light of the significant uncertainties inherent in the forward-looking statements included in this Quarterly Report, the inclusion of such forward-looking statements should not be regarded as a representation by us or ~~update~~ any ~~forward-looking statement or disclose any facts, events or circumstances~~other person that ~~occur after~~ the ~~date hereof that may affect the accuracy of any forward-looking statement.~~objectives and plans set forth in this Quarterly Report will be achieved.

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All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by reference to these risks and uncertainties. Each forward-looking statement speaks only as of the date of the particular statement, and we do not undertake to update any forward-looking statement.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

We have market risk exposure arising from changes in interest rates and foreign currency exchange rate movements.

Our earnings are impacted by changes in short-term interest rates as a result of borrowings under our ~~2000~~New Credit Facilities, which bear interest based on floating rates. At ~~September~~June 30, ~~2005,~~2006, after the effect of interest rate swaps, we have approximately ~~$420.0~~$177.6 million of variable rate debt obligations outstanding with a weighted average interest rate of ~~5.8%~~7.23%. A hypothetical change of 100-basis points in the interest rate for these borrowings, assuming constant variable rate debt levels, would have changed interest expense by approximately ~~$3.2~~$0.9 million for the ~~nine~~six months ended ~~September~~June 30, ~~2005.~~2006.

We are exposed to credit-related losses in the event of non-performance by counterparties to financial instruments including interest rate swaps, but we expect all counterparties will continue to meet their obligations given their creditworthiness. As of ~~September~~June 30, ~~2005,~~2006, we ~~have $265~~had $470.0 million of notional amount in outstanding interest rate swaps with third parties with maturities through June 2011 compared to ~~$210~~$160.0 million as of ~~the same period in 2004.~~June 30, 2005.

We employ a foreign currency hedging strategy to minimize potential losses in earnings or cash flows from unfavorable foreign currency exchange rate movements. These strategies also minimize potential gains from favorable exchange rate movements. Foreign currency exposures arise from transactions, including firm commitments and anticipated transactions, denominated in a currency other than an entity’s functional currency and from foreign-denominated revenues and profits translated back into U.S. dollars. Based on a sensitivity analysis at ~~September~~June 30, ~~2005,~~2006, a 10% adverse change in the foreign currency exchange rates could impact our results of operations for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 by ~~$7.7~~$5.9 million as shown below:


(Amounts in millions)

Swiss franc			$	1.6
British pound				0.9
Euro	$	2.4		0.9
Swiss franc		0.9
Indian rupee				0.6
Canadian dollar		0.7		0.4
Singapore dollar		0.7		0.4
Indian rupee		0.6
Venezuelan bolivar		0.5
Mexican peso				0.3
Australian dollar		0.3		0.2
British pound		0.3
Mexican peso		0.3
Argentina peso		0.3		0.1
Brazil real		0.3
All other		0.4		0.5

Total	$	7.7	$	5.9

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, we do not enter into foreign currency contracts for trading purposes where the objective would be to generate profits. As of ~~September~~June 30, ~~2005,~~2006, we ~~have~~had a U.S. dollar equivalent of ~~$210.5~~$295.2 million in outstanding forward contracts with third parties compared with ~~$83.4~~$236.0 million at ~~September 30, 2004.~~December 31, 2005.

Generally, we view our investments in foreign subsidiaries from a long-term perspective, and therefore, do not hedge these investments. We use capital structuring techniques to manage our investment in foreign subsidiaries as deemed necessary.

We realized gains (losses) associated with foreign currency translation of ~~$0.7~~$17.6 million and ~~$3.4~~$(16.4) million for the three months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, and ~~$(24.5)~~$23.0 million and ~~$(11.0)~~$(25.1) million for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, which are included in other comprehensive income (loss). Transactional currency gains and losses arising from transactions outside of our sites’ functional currencies and changes in fair value of certain forward contracts ~~that do not qualify for hedge accounting~~ are included in our consolidated results of operations. We realized foreign currency ~~losses~~gains (losses) of ~~$(1.0)~~$4.8 million and ~~$4.6~~$(6.7) million for the three months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, and

~~$8.2~~ $6.8 million and ~~$10.4~~$(9.2) million for the ~~nine~~six months ended ~~September~~June 30, ~~2005~~2006 and ~~2004,~~2005, respectively, which is included in other ~~(income) expense,~~income (expense), net in the accompanying consolidated statements of ~~operations. The currency losses in 2005 compared with 2004 reflect strengthening of the Euro and the Singapore dollar versus the U.S. dollar.~~income.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are controls and other procedures that are designed to provide reasonable assurance that the information that we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

In connection with the preparation of this Quarterly Report, our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of ~~September~~June 30, ~~2005.~~2006. In making this evaluation, our management considered the ~~matters relating to the~~ material weaknesses described in our ~~2004~~2005 Annual Report, ~~and our 2005 Annual Report.~~which was filed with the SEC on June 30, 2006. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of ~~September~~June 30, ~~2005.~~2006.

A material weakness is a control deficiency, or combination of control deficiencies, that ~~result~~results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. As more fully described in “Management’s Report on Internal Control Over Financial Reporting” in Item 9A of our ~~2004~~2005 Annual Report, management identified the following material weaknesses in our internal control over financial reporting as of December 31, ~~2004,~~2005, which also existed as of ~~September~~June 30, ~~2005:~~2006:

We did not ~~maintain~~maintain: (1) ~~an effective control environment, (2) effective monitoring controls to determine the adequacy of its internal control over financial reporting and related policies and procedures, (3)~~ effective controls over ~~certain of~~ our period-end financial ~~close and~~ reporting processes, ~~(4)~~including monitoring; (2) effective segregation of duties over automated and manual transaction processes, (5) effective controls over the preparation, review and approval of account reconciliations, (6) effective controls over the complete and accurate recording and monitoring of intercompany accounts, (7) effective controls over the recording of journal entries, both recurring and non-recurring, (8) effective controls over the existence, completeness and accuracy of fixed assets and related depreciation and amortization expense, (9) effective controls over the completeness and accuracy of revenue, deferred revenue, accounts receivable and accrued liabilities, (10) effective controls over the completeness, accuracy, valuation and existence of our inventory and related cost of sales accounts, (11) effective controls over the completeness and accuracy of our reporting of certain non-U.S. pension plans, (12) effective controls over the complete and accurate recording of rights and obligations associated with our accounts receivable factoring and securitization transactions, (13) effective controls over our accounting for certain derivative transactions, (14) effective controls over our accounting for equity investments, (15) effective controls over our accounting for income taxes, including income taxes payable, deferred income tax assets and liabilities and the related income tax provision, (16) effective controls over our accounting for mergers and acquisitions, (17) effective controls over the completeness and accuracy of certain accrued liabilities and the related operating expense accounts, (18)processes; (3) effective controls over the completeness, accuracy and validity of ~~payroll~~revenue; (4) effective controls over the completeness, accuracy, validity and ~~accounts payable disbursements to ensure that they were adequately reviewed~~valuation of our inventory and ~~approved prior to being recorded and reported, (19)~~related cost of sales transactions; (5) effective controls over the completeness, accuracy and validity of ~~spreadsheets used in~~ our ~~financial reporting process to ensure that access was restricted to appropriate personnel,~~accounts payable and ~~that unauthorized modification of the data or formulas within spreadsheets was prevented, and (20)~~related disbursements; (6) effective controls over ~~the accuracy, valuation~~accounting for certain derivative transactions; and ~~disclosure of our goodwill and intangible asset accounts and the related amortization and impairment expense accounts, based on criteria established in~~~~Internal Control — Integrated Framework~~~~issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).~~

As more fully described in “Management’s Report on Internal Control Over Financial Reporting” included in Item 9A of our 2005 Annual Report, management identified the following material weakness in our internal control over financial reporting as of December 31, 2005, which also existed as of September 30, 2005: we did not maintain

(7) effective controls over the completeness, accuracy and valuation of stock-based employee compensation expense, based on criteria established inInternal Control — Integrated Frameworkissued by ~~COSO.~~the Committee of Sponsoring Organizations of the Treadway Commission.

In light of the material weaknesses ~~identified~~described above, we performed additional analyses and other procedures to ensure that our unaudited condensed consolidated financial statements included in this Quarterly Report were prepared in accordance with GAAP. As a result of these procedures, we believe that the unaudited condensed consolidated financial statements included in this Quarterly Report present fairly, in all material respects, our financial ~~position,~~condition, results of operations and cash flows for the periods presented in conformity with GAAP.

~~Plan for~~ Remediation of Material Weaknesses

In response to the identified material weaknesses, ~~our management,~~we, with oversight from our audit committee, ~~has~~have dedicated significant resources ~~including the engagement of external consultants,~~ to support management in its efforts ~~to improve our control environment and~~ to remedy the identified material weaknesses. As more fully described in theCompleted Remediationsection of Item 9A of our ~~2004~~2005 Annual Report, the remediation that occurred prior to December 31, 2005 focused on: (i) appointed a chief compliance officer; (ii) expanded and strengthened our finance organization by creating and filling new positions in the areas of financial reporting, controls compliance, accounting policies, financial planning and analysis, and tax; (iii) expanded and strengthened our internal audit organization; (iv) enhanced our accounting policy program; (v) strengthened our centrally managed internal controls and financial review program; (vi) improved our communication of accounting policy and control requirements; (vii) expanded and enhanced our financial disclosure control and certification process; (viii) enhanced our anti-fraud program; and (ix) improved our information technology general controls.

As more fully described in theContinuing Remediationsection of Item 9A of our 2005 Annual Report, the ongoing remediation efforts subsequent to December 31, ~~2004 are~~2005 have been focused onon: (i) ~~expanding our organizational capabilities~~implementing or upgrading ERP systems to ~~improve our control environment;~~increase the level of automated controls; (ii) implementing a global web-based financial controls management solution to facilitate the documentation and

assessment of accounting and financial reporting controls; (iii) strengthening our segregation of duties and application security policy, and updating our spreadsheet controls policy; (iv) updating our account reconciliation policy, issuing training materials defining the specific requirements regarding account reconciliation preparation, review and approval, and further communicating the requirements of account reconciliations as part of our regional accounting and finance organization training sessions; (v) designing and implementing additional revenue cycle, inventory cycle and accounts payable process ~~changes~~controls, including the establishment of additional review and verification procedures, updating policies as necessary, and providing training to ~~strengthen~~ our ~~internal control~~global finance organization; (vi) implementing new procedures and ~~monitoring activities;~~controls to ensure technical compliance with derivative accounting provisions; and ~~(iii)~~(vii) designing and implementing ~~adequate information technology general controls.~~enhanced controls to ensure proper accounting for stock-based employee compensation transactions.

We believe that ~~these remediation efforts~~theCompleted Remediationactions described above have further improved our internal control over financial reporting, as well as our disclosure controls and procedures. We also believe that theContinuing Remediationactions described above will continue to improve our internal control over financial reporting, as well as our disclosure controls and procedures. ~~However, not all of the material weaknesses described above were remediated by December 31, 2005, our next reporting “as of” date under Section 404.~~ Our management, with the oversight of our ~~audit committee,~~Audit Committee, will continue to take steps to remedy known material weaknesses as expeditiously as possible.

Changes in Internal Control over Financial Reporting

There have been no material changes in our internal control over financial reporting during the three months ended ~~September~~June 30, ~~2005~~2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II –— OTHER INFORMATION

Item 1. Legal Proceedings.

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

During the quarter ended September 30, 2003, related lawsuits were filed in federal court in the Northern District of Texas (the “Court”), alleging that we violated federal securities laws. Since the filing of these cases, which have been consolidated, the lead plaintiff has amended its complaint several times. The lead plaintiff’s current pleading is the fifth consolidated amended complaint (the “Complaint”). The Complaint alleges that federal securities violations occurred between February 6, 2001 and September 27, 2002 and names as defendants our company, C. Scott Greer, our former Chairman, President and Chief Executive Officer, Renee J. Hornbaker, our former Vice President and Chief Financial Officer, PricewaterhouseCoopers LLP, our independent registered public accounting firm, and Banc of America Securities LLC and Credit Suisse First Boston LLC, which served as underwriters for our two public stock offerings during the relevant period. The Complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, and Sections 11 and 15 of the Securities Act of 1933. The lead plaintiff seeks unspecified compensatory damages, forfeiture by Mr. Greer and Ms. Hornbaker of unspecified incentive-based or equity-based compensation and profits from any stock sales, and recovery of costs. On November 22, 2005, the Court entered an order denying the defendants’ motions to dismiss the Complaint. The case is currently set for trial on ~~March 27,~~June 11, 2007. We continue to believe that the lawsuit is without merit and are vigorously defending the case.

qualified for an available exemption from such requirements. Federal securities laws generally provide for a one-year rescission right for an investor who acquires unregistered securities in a transaction that is subject to registration and for which no exemption was available. As such, an investor successfully asserting a rescission right during the one-year time period has the right to require an issuer to repurchase the securities acquired by the investor at the price paid by the investor for the securities (or if such security has been disposed of, to receive damages with respect to any loss on such disposition), plus interest from the date of acquisition. The remedies and statute of limitations under state securities laws vary and depend upon the state in which the shares were purchased. These rights may apply to affected participants who acquired an interest in our common stock fund in our 401(k) Plan during this period. Based on our current stock price, we believe that our current potential liability for rescission claims is not material to our financial condition, results of operations or cash flows; however, our potential liability could become material in the future if our stock price were to fall significantly below prices at which participants acquired their interest in our common stock fund during the one-year period following such unregistered acquisitions.

includes a review of whether any inappropriate payments were made to Iraqi officials in violation of the Foreign Corrupt Practices Act. The investigation includes periods prior, to as well as subsequent to our acquisition of the foreign operations involved in the investigation. We may be subject to liabilities if violations are found regardless of whether they relate to periods before or subsequent to our acquisition.

We believe that both the SEC and foreign authorities are investigating other companies from their actions arising from the United Nations Oil-for-Food program.

We also understand that the U.S. Department of Justice is conducting its own investigation of the same events underlying the SEC inquiry. We are in the process of reviewing and responding to the SEC subpoena and assessing the implications of the foreign investigation, including the continuation of a thorough internal investigation. Our investigation ~~is in the early stages and~~remains ongoing. The investigation has included and will include a detailed review of contracts with the Iraqi government during the period in question and certain payments associated ~~therewith.~~therewith, as well as other documents and information that might relate to Oil-for-Food transactions. Additionally, we have and will continue to conduct interviews with employees with knowledge of the contracts and payments in question. ~~We are~~While we have made substantial progress in ~~the early phases of~~ our internal investigation, ~~and as a result~~we are still unable to make any definitive determination whether any inappropriate payments were made and accordingly are unable to predict the ultimate outcome of this matter.

We will continue to fully cooperate in both the SEC and the foreign investigations. Both investigations are in progress but, at this point, are incomplete. Accordingly, if the SEC and/or the foreign authorities take enforcement action with regard to these investigations, we may be required to pay fines, take remedial compliance measures, further improve our existing compliance program, consent to injunctions against future conduct or suffer other penalties which could potentially materially impact our business financial statements and cash flows.

In March 2006, we initiated a process to determine our compliance posture with respect to U.S. export control laws and regulations. Upon initial investigation, it appears that some product transactions and technology transfers may not technically been in compliance with U.S. export control laws and regulations and require further review. With assistance from outside counsel, we are currently involved in a systematic process to conduct further review which we believe will take about 1815 months to complete given the complexity of the export laws and the comprehensive scope of the investigation. Any potential violations of U.S. export control laws and regulations that are identified may result in civil or criminal penalties, including fines and/or other penalties. Because our review into this issue is ongoing, we are currently unable to determine the full extent of potential violations or the nature or amount of potential penalties to which we might be subject to in the future. Given that the resolution of this matter is uncertain at this time, we are not able to reasonably estimate the maximum amount of liability that could result from final resolution of this matter. We cannot currently predict whether the ultimate resolution of this matter will have a material adverse effect on our business, including our ability to do business outside the United States, or on our financial condition.

As of May 1, 2005, due to the non-current status of our filings with the SEC in accordance with the Securities Exchange Act of 1934, our Registration Statements on Form S-8 were no longer available to cover offers and sales of securities to our employees and other persons. Since that date, the acquisition of interests in our common stock fund under our 401(k) plan by plan participants may have been subject to the registration requirements of the Securities Act of 1933 or applicable state securities laws and may not have qualified for an available exemption from such requirements. Federal securities laws generally provide for a one-year rescission right for an investor who acquires unregistered securities in a transaction that is subject to registration and for which no exemption was available. As such, an investor successfully asserting a rescission right during the one-year time period has the right to require an issuer to repurchase the securities acquired by the investor at the price paid by the investor for the securities (or if such security has been disposed of, to receive damages with respect to any loss on such disposition), plus interest from the date of acquisition. These rights may apply to affected participants in our 401(k) plan. Based on our current stock price, we believe that our current potential liability for rescission claims is not material to our financial condition or results of operations; however, our potential liability could become material in the future if our stock price were to fall below participants’ acquisition prices for their interest in our stock fund during the one-year period following the unregistered acquisitions.

environmental authorities. The projected cost of remediation at these sites, as well as our alleged “fair share” allocation, is uncertain and speculative until all studies have been completed and the parties have either negotiated an amicable resolution or the matter has been judicially resolved. At each site, there are many other parties who have similarly been identified, and the identification and location of additional parties is continuing under applicable federal or state law. ~~Many~~We believe that many of the other parties identified are financially strong and solvent companies that appear able to pay their share of the remediation costs. Based on our information about the waste disposal practices at these sites and the environmental regulatory process in general, we believe that it is likely that ultimate remediation liability costs for each site will be apportioned among all liable parties, including site owners and waste transporters, according to the

volumes and/or toxicity of the wastes shown to have been disposed of at the sites. We believe that our exposure for existing disposal sites will be less than $100,000.

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

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

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

Item 1A. Risk Factors.

~~There have been no material changes to the~~This Quarterly Report provides updates on two previously disclosed risk factors that were presented in ~~“Item 1A. Risk Factors.” included in~~ our ~~2005~~ Annual Report on Form 10-K for the year ended December 31, 2005, which was filed with the SEC on June 30, 2006. The updated risk factors noted below are presented in addition to the other risk factors disclosed in the 2005 Annual Report. All of our disclosed risk factors could materially affect our business, financial condition or future results. The risks described in our Quarterly Report and 2005 Annual Report are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

We are currently subject to securities class action litigation, the unfavorable outcome of which might have a material adverse effect on our financial condition, results of operations and cash flows.

A number of putative class action lawsuits have been filed against us, certain of our former officers, our independent auditors and the lead underwriters of our most recent public stock offerings, alleging securities laws violations. We believe that these lawsuits, which have been consolidated, are without merit and are vigorously defending them and have notified our applicable insurers. We cannot, however, determine with certainty the outcome or resolution of these claims or the timing for their resolution. The consolidated securities case is currently set for trial on June 11, 2007. In addition to the expense and burden incurred in defending this litigation and any damages that we may suffer, our management’s efforts and attention may be diverted from the ordinary business operations in order to address these claims. If the final resolution of this litigation is unfavorable to us, our financial condition, results of operations and cash flows might be materially adversely affected if our existing insurance coverage is unavailable or inadequate to resolve the matter.

The ongoing SEC and foreign government investigation regarding our participation in the United Nations Oil-for-Food Program could materially adversely affect our Company.

In addition, one of our foreign subsidiary’s operations is cooperating with a foreign governmental investigation of that site’s involvement in the United Nations Oil-for-Food Program. This cooperation has included responding to an investigative trip by foreign authorities to the foreign subsidiary’s site, providing relevant documentation to these authorities and answering their questions. We are unable to predict how or if the foreign authorities will pursue this matter in the future.

We believe that both the SEC and this foreign authority are investigating other companies from their actions arising from the “Oil-for-Food” program.

We will continue to fully cooperate in both the SEC and the foreign investigations. Both investigations are in progress but, at this point, are incomplete. Accordingly, if the SEC and/or the foreign authorities take enforcement action with regard to these investigations, we may be required to pay fines, consent to injunctions against future conduct or suffer other penalties which could have a material adverse impact our financial condition, results of operations and cash flows.

Potential noncompliance with U.S. export control laws could materially adversely affect our business.

We have notified applicable U.S. governmental authorities of our plans to investigate, analyze and, if applicable, disclose past potential violations of the U.S. export control laws through, in general, the export of products, services and technologies without the licenses possibly required by such authorities. If and to the extent violations are identified, confirmed and so disclosed, we could be subject to substantial fines and other penalties affecting our ability to do business outside the United States.

Our risks involved in conducting our international business operations include, without limitation, the risks associated with certain of our foreign subsidiaries autonomously conducting, under their own local authority and consistent with U.S. export laws, business operations and sales, which constitute approximately 1-2% of our consolidated global revenue, in countries that have been designated by the U.S. State Department as state sponsors of terrorism. Due to the growing political uncertainties associated with these countries, we have been planning to voluntarily withdraw, on a phased basis, from conducting new business in these countries since early in 2006. However, these subsidiaries will continue to honor existing contracts and warranty obligations that are in compliance with U.S. laws and regulations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

As of May 1, 2005, due to the non-current status of our filings with the SEC in accordance with the Securities Exchange Act of 1934, our Registration Statements on Form S-8 were no longer available to cover offers and sales of securities to our employees and other persons. Since that date, the acquisition of interests in our common stock fund under our 401(k) ~~plan~~Plan by plan participants may have been subject to the registration requirements of the Securities Act of 1933 or applicable state securities laws and may not have qualified for an available exemption from such requirements. Federal securities laws generally provide for a one-year rescission right for an investor who acquires unregistered securities in a transaction that is subject to registration and for which no exemption was available. As such, an investor successfully asserting a rescission right during the one-year time period has the right to require an issuer to repurchase the securities acquired by the investor at the price paid by the investor for the securities (or if such security has been disposed of, to receive damages with respect to any loss on such disposition), plus interest from the date of acquisition. The remedies and statute of limitations under state securities laws vary and depend upon the state in which the shares were purchased. These rights may apply to affected participants who acquired an interest in our common stock fund in our 401(k) ~~plan~~Plan and their affected interest in this plan may involve up to 270,000 shares of our common stock acquired pursuant to the 401(k) ~~plan~~Plan during 2005 and an ~~indeterminate number of~~additional 75,000 shares acquired during the three months ended June 30, 2006. Based on our current stock price, we believe that our current potential liability for rescission claims is not material to our financial condition, or results of ~~operations;~~operations or cash flows; however, our potential liability could become material in the future if our stock price were to fall below participants’ acquisition prices for their interest in our common stock fund during the one-year period following the unregistered acquisitions. We are currently exploring various options to limit this potential liability.

During the ~~third~~second quarter of ~~2005,~~2006, we issued an aggregate of ~~140,800~~3,900 shares of restricted stock to employees pursuant to the 2004 Stock Compensation Plan. We believe these securities are not subject to registration under the “no sale” principle or were otherwise issued pursuant to exemptions from registration under Section 4(2) of the Securities Act of 1933 as transactions by an issuer not involving a public offering.

4743

Issuer Purchases of Equity Securities

Total Number of Shares Maximum Number of
Total Number Weighted Purchased as Part of Shares That May Yet Be
of Shares Average Price Publicly Announced Purchased Under the
Period Purchased (1) Paid per Share Plan (2) Plan (2)
July 1-31, 2005 12,588 $ 30.74 N/A N/A
August 1-31, 2005 2,861 35.93 N/A N/A
September 1-30, 2005 — — N/A N/A

Total 15,449 $ 31.70 N/A N/A

Total Number of

Maximum Number of

Total Number

Weighted

Purchased as Part of

Shares That May Yet Be

of Shares

Average Price

Publicly Announced

Purchased Under the

Period

Purchased (1)

Paid per Share

Plan (2)

April 1-30, 2006

4,631

56.31

N/A

May 1-31, 2006

3,301

53.80

N/A

June 1-30, 2006

265

49.47

N/A

Total

8,197

55.08

N/A


(1)		Represents ~~12,633~~5,425 shares that were tendered by employees to satisfy minimum tax withholding amounts for restricted stock awards and ~~2,816~~2,772 shares of common stock purchased by a rabbi trust that we established in connection with our director deferral plans pursuant to which non-employee directors may elect to defer directors’ cash compensation to be paid at a later date in the form of common stock.

(2)		~~We do not have~~Our Board of Directors has approved a ~~publicly announced~~ program ~~for~~to repurchase ofup to two million shares of our outstanding common ~~stock.~~stock; however, such plan will not be implemented until after our planned November filing of our third quarter 2006 Form 10-Q.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

Item 5. Other Information.

None.

4844

Item 6. Exhibits.

Set forth below is a list of exhibits included as part of this Quarterly Report:


Exhibit No.		Description
3.1		~~1988~~ Restated Certificate of Incorporation of ~~The Duriron Company, Inc.,~~Flowserve Corporation, filed as Exhibit ~~3.1~~3(i) to ~~Flowserve Corporation’s (f/k/a The Duriron Company) Annual~~the Company’s Current Report on Form ~~10-K for the year ended December 31, 1988.~~

~~3.2~~		~~1989 Amendment to Certificate of Incorporation, filed as Exhibit 3.2 to Flowserve Corporation’s Annual Report on Form 10-K for the year ended December 31, 1989.~~

~~3.3~~		~~1996 Certificate of Amendment of Certificate of Incorporation, filed as Exhibit 3.4 to Flowserve Corporation’s Annual Report on Form 10-K for the year ended December 31, 1995.~~

~~3.4~~		April 1997 Certificate of Amendment of Certificate of Incorporation, filed as part of Annex VI to the Joint Proxy Statement/ Prospectus, which is part of Flowserve Corporation’s Registration Statement on Form S-4,8-K/A, dated ~~June 19, 1997.~~

~~3.5~~		~~July 1997 Certificate of Amendment of Certificate of Incorporation, filed as Exhibit 3.6 to Flowserve Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.~~August 16, 2006.

3.6		Amended and Restated By-Laws of Flowserve Corporation, as amended, filed as Exhibit 3.9 to Flowserve Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.

10.1		Second Amendment dated as of May 8, 2006 and effective as of May 16, 2006 to that certain Credit Agreement, dated as of August 12, 2005, by and among the Company, the ~~lenders referred~~financial institutions from time to ~~therein,~~time party thereto (collectively, the “Lenders”), and Bank of America, N.A., as ~~swingline lender, administrative agent~~Swingline Lender, Administrative Agent and ~~collateral agent,~~Collateral Agent for the Lenders, filed as Exhibit 10.1 to the Company’s Current Report on Form ~~8-K~~8-k, dated ~~as of August 12, 2005.~~

~~10.2~~		~~Employment Agreement between the Company and Lewis M. Kling, dated July 28, 2005, filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated as of July 28, 2005.~~May 16, 2006.

31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

4945

SIGNATURES

Pursuant to the requirements 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.


		FLOWSERVE CORPORATION (Registrant)
Date: September 29, 2006	/s/ Lewis M. Kling
	Lewis M. Kling
	President and Chief Executive Officer

		~~(Registrant)~~
Date: September 29, 2006	/s/ Mark A. Blinn
	Mark A. Blinn
	Vice President and Chief Financial Officer


~~Date: July 27, 2006~~		~~/s/ Lewis M. Kling~~

		~~Lewis M. Kling~~
		~~President and Chief Executive Officer~~

~~Date: July 27, 2006~~		~~/s/ Mark A. Blinn~~

		~~Mark A. Blinn~~
		~~Vice President and Chief Financial Officer~~

Exhibits Index


Exhibit No.		Description
3.1		~~1988~~ Restated Certificate of Incorporation of ~~The Duriron Company, Inc.,~~Flowserve Corporation, filed as Exhibit ~~3.1~~3(i) to ~~Flowserve Corporation’s (f/k/a The Duriron Company) Annual~~the Company’s Current Report on Form ~~10-K for the year ended December 31, 1988.~~

~~3.2~~		~~1989 Amendment to Certificate of Incorporation, filed as Exhibit 3.2 to Flowserve Corporation’s Annual Report on Form 10-K for the year ended December 31, 1989.~~

~~3.3~~		~~1996 Certificate of Amendment of Certificate of Incorporation, filed as Exhibit 3.4 to Flowserve Corporation’s Annual Report on Form 10-K for the year ended December 31, 1995.~~

~~3.4~~		April 1997 Certificate of Amendment of Certificate of Incorporation, filed as part of Annex VI to the Joint Proxy Statement/ Prospectus, which is part of Flowserve Corporation’s Registration Statement on Form S-4,8-K/A, dated ~~June 19, 1997.~~

~~3.5~~		~~July 1997 Certificate of Amendment of Certificate of Incorporation, filed as Exhibit 3.6 to Flowserve Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.~~August 16, 2006.

3.6		Amended and Restated By-Laws of Flowserve Corporation, as amended, filed as Exhibit 3.9 to Flowserve Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.

10.1		Second Amendment dated as of May 8, 2006 and effective as of May 16, 2006 to that certain Credit Agreement, dated as of August 12, 2005, by and among the Company, the ~~lenders referred~~financial institutions from time to ~~therein,~~time party thereto (collectively, the “Lenders”), and Bank of America, N.A., as ~~swingline lender, administrative agent~~Swingline Lender, Administrative Agent and ~~collateral agent,~~Collateral Agent for the Lenders, filed as Exhibit 10.1 to the Company’s Current Report on Form ~~8-K~~8-k, dated ~~as of August 12, 2005.~~

~~10.2~~		~~Employment Agreement between the Company and Lewis M. Kling, dated July 28, 2005, filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated as of July 28, 2005.~~May 16, 2006.

31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

5147


	Three Months
	Ended
(Amounts in millions)	September 30,
	2004
Sales	$	7.4
Cost of sales		6.0
Selling, general and administrative expense		0.7

Earnings (loss) before income taxes		0.7
Provision (benefit) for income taxes		0.2

Results for discontinued operations, net of tax	$	0.5


	Nine Months
	Ended
(Amounts in millions)	September 30,
	2004
Sales	$	19.1
Cost of sales		15.3
Selling, general and administrative expense		2.3

Earnings before income taxes		1.5
Provision for income taxes		0.5

Results for discontinued operations, net of tax	$	1.0


							Subtotal –
	Flowserve		Flow		Flow		Reportable					Consolidated
(Amounts in thousands)	Pump		Solutions		Control		Segments		All Other			Total
Sales to external customers	$	321,156	$	103,338	$	223,613	$	648,107	$	1,378		$	649,485
Intersegment sales		810		9,852		1,076		11,738		(11,738	)		-
Segment operating income		28,971		23,006		25,280		77,257		(22,446	)		54,811


Quarter ending:	2005		2004
	(Amounts in millions)
March 31	$	4.1	$	0.2
June 30		7.7		8.1
September 30		32.0		5.3
December 31		1.0		1.7

	$	44.8	$	15.3


	Payments Due By Period
	Remainder of						2010 &
(Amounts in millions)	2005		2006 – 2007		2008 – 2009		Beyond		Total

Long-term debt	$	1.5	$	12.0	$	12.0	$	659.5	$	685.0
Fixed interest payments (1)		1.5		13.1		10.4		7.5		32.5
Variable interest payments (2)		8.6		68.1		67.0		76.6		220.3
Capital lease obligations		0.2		0.4		—		—		0.6
Operating leases		4.7		29.5		16.1		19.3		69.6
Purchase obligations: (3)
Inventory		189.7		0.6		0.0		—		190.3
Non-inventory		11.6		1.0		0.4		—		13.0


	Commitment Expiration By Period
	Remainder of						2010 &
(Amounts in millions)	2005		2006 – 2007		2008 – 2009		Beyond		Total

Letters of credit	$	53.3	$	250.9	$	18.6	$	1.3	$	324.1
Surety bonds		2.3		27.8		1.1		—		31.2