FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
----------
For Quarter Ended June 30, 2002 Commission File Number 1-13179
FLOWSERVE CORPORATION
(Exact name of Registrant as specified in its charter)
NEW YORK
(State or other jurisdiction of incorporation or organization)
31-0267900
(I.R.S. Employer Identification Number)
222 W. LAS COLINAS BLVD., SUITE 1500, IRVING, TEXAS 75039
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) (972) 443-6500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------ -------
SHARES OF COMMON STOCK, $1.25 PAR VALUE,
outstanding as of July 31, 2002 55,204,776
FLOWSERVE CORPORATION
INDEX
<Table>
<Caption>
Page
No.
----
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Operations -
Three Months Ended June 30, 2002 and 2001 (unaudited) 3
Consolidated Statements of Comprehensive Income/(Loss) -
Three Months Ended June 30, 2002 and 2001 (unaudited) 3
Consolidated Statements of Operations -
Six Months Ended June 30, 2002 and 2001 (unaudited) 4
Consolidated Statements of Comprehensive Income/(Loss) -
Six Months Ended June 30, 2002 and 2001 (unaudited) 4
Consolidated Balance Sheets -
June 30, 2002 (unaudited) and December 31, 2001 5
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2002 and 2001 (unaudited) 6
Notes to Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS 27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS 45
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS 46
SIGNATURE 47
</Table>
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FLOWSERVE CORPORATION
(UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
(Amounts in thousands, except per share data) Three Months Ended June 30,
---------------------------
2002 2001
--------- ---------
Sales $ 592,728 $ 464,579
Cost of sales 410,703 308,901
--------- ---------
Gross profit 182,025 155,678
Selling, general and administrative expense 122,019 103,572
Integration expense 2,005 16,944
Restructuring expense 644 --
--------- ---------
Operating income 57,357 35,162
Net interest expense 23,892 31,361
Other expense (income), net 1,645 (265)
--------- ---------
Earnings before income taxes 31,820 4,066
Provision for income taxes 11,138 1,464
--------- ---------
Net earnings before extraordinary items 20,682 2,602
Extraordinary items, net of income taxes (6,337) --
--------- ---------
Net earnings $ 14,345 $ 2,602
========= =========
Net earnings per share (basic):
Before extraordinary items $ 0.40 $ 0.07
Extraordinary items, net of income taxes (0.12) --
--------- ---------
Net earnings per share $ 0.28 $ 0.07
========= =========
Net earnings per share (diluted):
Before extraordinary items $ 0.39 $ 0.07
Extraordinary items, net of income taxes (0.12) --
--------- ---------
Net earnings per share $ 0.27 $ 0.07
========= =========
Average shares outstanding - basic 51,920 38,058
Average shares outstanding - diluted 52,679 38,796
</Table>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
<Table>
<Caption>
(Amounts in thousands) Three Months Ended June 30,
---------------------------
2002 2001
--------- ---------
Net earnings $14,345 $ 2,602
--------- ---------
Other comprehensive income (expense):
Foreign currency translation adjustments 39,772 (14,296)
Hedging transactions, net of taxes of $(1,006)
in 2002 and $308 in 2001 1,864 (487)
--------- ---------
Other comprehensive income (expense) 41,636 (14,783)
--------- ---------
Comprehensive income (loss) $ 55,981 $ (12,181)
========= =========
</Table>
See accompanying notes to consolidated financial statements.
3
FLOWSERVE CORPORATION
(UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
(Amounts in thousands, except per share data) Six Months Ended June 30,
----------------------------
2002 2001
----------- -----------
Sales $ 1,039,779 $ 908,614
Cost of sales 715,718 615,362
----------- -----------
Gross profit 324,061 293,252
Selling, general and administrative expense 222,175 203,676
Integration expense 2,005 36,083
Restructuring expense 644 --
----------- -----------
Operating income 99,237 53,493
Net interest expense 45,712 63,172
Other expense (income), net 2,110 (400)
----------- -----------
Earnings (loss) before income taxes 51,415 (9,279)
Provision (benefit) for income taxes 17,995 (3,341)
----------- -----------
Net earnings (loss) before extraordinary items 33,420 (5,938)
Extraordinary items, net of income taxes (6,337) --
----------- -----------
Net earnings (loss) $ 27,083 $ (5,938)
=========== ===========
Net earnings (loss) per share (basic):
Before extraordinary items $ 0.69 $ (0.16)
Extraordinary items, net of income taxes (0.13) --
----------- -----------
Net earnings (loss) per share (basic) $ 0.56 $ (0.16)
=========== ===========
Net earnings (loss) per share (diluted):
Before extraordinary items $ 0.68 $ (0.16)
Extraordinary items, net of income taxes (0.13) --
----------- -----------
Net earnings (loss) per share (diluted) $ 0.55 $ (0.16)
=========== ===========
Average shares outstanding - basic 48,541 37,912
Average shares outstanding - diluted 49,238 38,468
</Table>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
<Table>
<Caption>
(Amounts in thousands) Six Months Ended June 30,
---------------------------
2002 2001
----------- -----------
Net earnings (loss) $ 27,083 $ (5,938)
----------- -----------
Other comprehensive income (expense):
Foreign currency translation adjustments 24,938 (53,440)
Cumulative effect of change in accounting principle,
net of tax of $472 (See footnote 4) -- 840
Hedging transactions, net of taxes of $(1,586)
in 2002 and $2,401 in 2001 2,726 (4,207)
----------- -----------
Other comprehensive income (expense) 27,664 (56,807)
----------- -----------
Comprehensive income (loss) $ 54,747 $ (62,745)
=========== ===========
</Table>
See accompanying notes to consolidated financial statements.
4
FLOWSERVE CORPORATION
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
JUNE 30, December 31,
(Amounts in thousands, except per share data) 2002 2001
----------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 81,516 $ 21,533
Accounts receivable, net 557,992 455,861
Inventories 486,855 347,591
Current deferred tax asset 31,000 36,316
Prepaid expenses 42,642 36,838
----------- -----------
Total current assets 1,200,005 898,139
Property, plant and equipment, net 508,941 362,388
Goodwill 732,443 515,175
Other intangible assets, net 186,042 131,079
Other assets 144,221 145,194
----------- -----------
Total assets $ 2,771,652 $ 2,051,975
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 215,604 $ 178,480
Income taxes 12,599 --
Accrued liabilities 210,930 193,768
Long-term debt due within one year 73,420 44,523
----------- -----------
Total current liabilities 512,553 416,771
Long-term debt due after one year 1,204,607 996,222
Retirement benefits and other liabilities 293,678 227,963
Commitments and contingencies
Shareholders' equity:
Serial preferred stock, $1.00 par value, 1,000 shares
authorized, no shares issued -- --
Common stock, $1.25 par value 72,018 60,518
Shares authorized - 120,000
Shares issued - 57,614 and 48,414
Capital in excess of par value 477,624 211,113
Retained earnings 383,081 355,998
----------- -----------
932,723 627,629
Treasury stock, at cost - 2,885 and 3,622 shares (65,539) (82,718)
Deferred compensation obligation 8,118 8,260
Accumulated other comprehensive loss (114,488) (142,152)
----------- -----------
Total shareholders' equity 760,814 411,019
----------- -----------
Total liabilities and shareholders' equity $ 2,771,652 $ 2,051,975
=========== ===========
</Table>
See accompanying notes to consolidated financial statements.
5
FLOWSERVE CORPORATION
(Unaudited)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
(Amounts in thousands) Six Months Ended June 30,
-------------------------
2002 2001
--------- ---------
CASH FLOWS - OPERATING ACTIVITIES:
Net earnings (loss) $ 27,083 $ (5,938)
Adjustments to reconcile net earnings (loss) to net cash
provided (used) by operating activities:
Depreciation 26,172 25,154
Amortization 3,618 12,187
Amortization of prepaid financing fees and discount 2,725 3,389
Write-off of unamortized prepaid financing fees 9,176 --
Other direct costs of long-term debt repayment 726 --
Net gain on the disposition of fixed assets (72) (322)
Change in assets and liabilities, net of acquisitions:
Accounts receivable 4,931 17,000
Inventories (7,562) (54,942)
Prepaid expenses 8,589 (3,915)
Other assets (2,635) (7,058)
Accounts payable (9,106) (317)
Accrued liabilities (16,021) (49,907)
Income taxes 12,509 (679)
Retirement benefits and other liabilities 3,550 (5,110)
Net deferred taxes 16,385 (2,548)
--------- ---------
Net cash flows provided (used) by operating activities, net of acquisitions 80,068 (73,006)
--------- ---------
CASH FLOWS - INVESTING ACTIVITIES:
Capital expenditures (14,767) (22,417)
Cash received for disposal of assets 1,672 7,361
Payments for acquisitions, net of cash acquired (529,716) --
--------- ---------
Net cash flows used by investing activities (542,811) (15,056)
--------- ---------
CASH FLOWS - FINANCING ACTIVITIES:
Net repayments under lines of credit (70,000) --
Proceeds from long-term debt 795,306 71,000
Payments of long-term debt (495,591) (11,781)
Payment of prepaid financing fees (4,953) --
Other direct costs of long-term debt repayment (726) --
Proceeds from issuance of common stock 275,925 --
Net proceeds from stock option activity 16,849 6,239
Other (110) 1,411
--------- ---------
Net cash flows provided by financing activities 516,700 66,869
Effect of exchange rate changes 6,026 (3,998)
--------- ---------
Net change in cash and cash equivalents 59,983 (25,191)
Cash and cash equivalents at beginning of year 21,533 42,341
--------- ---------
Cash and cash equivalents at end of period $ 81,516 $ 17,150
========= =========
</Table>
See accompanying notes to consolidated financial statements.
6
FLOWSERVE CORPORATION
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)
1. ACCOUNTING POLICIES - BASIS OF PRESENTATION
The accompanying consolidated balance sheet as of June 30, 2002, and the
related consolidated statements of operations and comprehensive income/(loss)
for the three months and six months ended June 30, 2002 and 2001, and the
consolidated statements of cash flows for the six months ended June 30, 2002 and
2001, are unaudited. In management's opinion, all adjustments comprising normal
recurring adjustments necessary for a fair presentation of such consolidated
financial statements have been made. The accompanying consolidated financial
statements and notes in this Form 10-Q are presented as permitted by Regulation
S-X and do not contain certain information included in the Company's annual
financial statements and notes to the financial statements. Accordingly, the
accompanying consolidated financial information should be read in conjunction
with the Company's 2001 Annual Report. Interim results are not necessarily
indicative of results to be expected for a full year. Certain amounts in 2001
have been reclassified to conform with the 2002 presentation.
2. RECENT ACCOUNTING DEVELOPMENTS
In August 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations". SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs.
SFAS No. 143 is effective for the Company on January 1, 2003. The Company
is currently assessing the impact of SFAS No. 143 and has not yet determined the
effects, if any, it will have on its consolidated financial position or results
of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." The most significant impact of
SFAS 145 is to eliminate the requirement that gains and losses from the
extinguishment of debt be classified as an extraordinary item unless these items
are infrequent and unusual in nature. SFAS 145 is effective for the Company on
January 1, 2003. Upon adoption of SFAS 145, the Company will reclassify
previously reported extraordinary items as a component of earnings before income
taxes.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities".
SFAS 146 requires that a liability for a cost associated with an exit or
disposal activity be recognized initially at fair value when the liability is
incurred. SFAS No. 146 is effective for the Company on January 1, 2003 and will
be applied on a prospective basis.
7
3. GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS No. 141, "Business
Combinations," and No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141
requires that all business combinations be accounted for using the purchase
method. Additionally, SFAS No. 141 establishes specific criteria for the
recognition of intangible assets separately from goodwill. SFAS No. 142
primarily addresses the accounting for goodwill and intangible assets subsequent
to their acquisition. The most significant changes made by SFAS No. 142 require
that goodwill and indefinite lived intangible assets no longer be amortized and
be tested for impairment at least on an annual basis. Additionally, the
amortization period of intangible assets is no longer limited to forty years.
Upon implementation of SFAS 141 and 142, the Company reclassified acquired
workforce intangible assets with a net carrying value of $18.5 million to
goodwill as that asset does not meet the new criteria for recognition apart from
goodwill. The Company also determined that certain acquired trademark intangible
assets have indefinite useful lives and is no longer amortizing these intangible
assets.
Under SFAS 142, goodwill is no longer amortized and instead is tested for
impairment at the reporting unit level annually and whenever events or
circumstances indicate goodwill may be impaired. The Company has completed the
required transitional goodwill and indefinite lived intangible asset impairment
tests and determined these assets were not impaired. Amortization of goodwill,
workforce intangible assets reclassified to goodwill and trademark intangible
assets with indefinite useful lives totaled $4.8 million and $9.5 million on a
pretax basis for the three months ended June 30, 2001 and for the six months
ended June 30, 2001, respectively. Such amortization for the 12 months ended
December 31, 2001 was $19.7 million.
The following table reflects consolidated results in the second quarter of
2001 adjusted as though the implementation of SFAS No. 141 and No. 142 occurred
on January 1, 2001:
<Table>
<Caption>
Three Six Months
Months Ended Ended
June 30, June 30,
2001 2001
------------ -----------
Net income (loss):
As reported $2,602 $ (5,938)
Goodwill amortization 2,877 5,705
Workforce intangible asset amortization 435 870
Trademark intangible asset amortization 146 292
------ ---------
Adjusted net income $6,060 $ 929
====== =========
Net income (loss) per share (basic and diluted):
As reported $ 0.07 $ (0.16)
Goodwill amortization 0.08 0.15
Workforce intangible asset amortization 0.01 0.02
Trademark intangible asset amortization -- 0.01
------ ---------
Adjusted net income per share $ 0.16 $ 0.02
====== =========
</Table>
8
The following tables provide information about acquired intangible assets:
<Table>
<Caption>
As of December 31, 2001 As of June 30, 2002
----------------------- -----------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
--------- ------------ --------- ------------
Amortized intangible assets:
Engineering drawings $ 63,500 $ (4,267) $ 90,620 $ (5,775)
Distribution network 13,700 (1,051) 13,700 (1,507)
Software 5,900 (833) 5,900 (1,128)
Patents 2,690 (1,430) 22,750 (1,790)
Other (1) 27,610 (5,800) 8,531 (2,928)
--------- --------- --------- ---------
$ 113,400 $ (13,381) $ 141,501 $ (13,128)
========= ========= ========= =========
Unamortized intangible assets - Trademarks $ 31,060 $ 57,669
========= =========
</Table>
(1) Other amortized intangible assets as of December 31, 2001 includes
acquired workforce intangible assets of $18,501 that were
reclassified to goodwill upon the implementation of SFAS 141 and 142.
<Table>
Amortization expense:
Actual for six months ended June 30, 2002 $3,618
Estimated for six months ending December 31, 2002 $4,180
Estimated for year ending December 31, 2003 $8,359
Estimated for year ending December 31, 2004 $8,359
Estimated for year ending December 31, 2005 $7,129
Estimated for year ending December 31, 2006 $6,669
Estimated for year ending December 31, 2007 $6,634
</Table>
As a result of the acquisition of Invensys plc's flow control division as
more fully described in Note 5, the Company acquired an estimated $78.3 million
of intangible assets. Of this amount, $26.6 million was assigned to registered
trademarks that have an indefinite life and are not subject to amortization. The
remaining $51.7 million of acquired intangible assets have a weighted average
useful life of approximately nine years. The intangible assets that make up that
amount include engineering drawings of $27.2 million (10 year weighted average
life), patents of $20.1 million (11 year weighted average life) and other
intangible assets of $4.4 million (3 year weighted average life). The amounts
assigned to the acquired intangible assets arising from the acquisition are
preliminary. Further refinements will be made based on the completion of final
valuation studies.
9
The changes in the carrying amount of goodwill for the six months ended June
30, 2002 are as follows:
<Table>
<Caption>
FLOWSERVE FLOW FLOW
PUMP SOLUTIONS CONTROL OTHER TOTAL
--------- --------- --------- --------- ---------
Balance as of December 31, 2001 $ 393,577 $ 67,915 $ 34,214 $ 19,469 $ 515,175
Reclassification of workforce intangible assets 18,501 -- -- -- 18,501
Acquisition (see Note 5) -- -- 190,009 -- 190,009
Other reclassifications 9,704 4,784 5,915 (19,469) 934
Currency translation 348 3,160 4,316 -- 7,824
--------- --------- --------- --------- ---------
BALANCE AS OF JUNE 30, 2002 $ 422,130 $ 75,859 $ 234,454 $ -- $ 732,443
========= ========= ========= ========= =========
</Table>
Other reclassifications include the allocation of previously unallocated
goodwill to the Company's reporting units and other reclassifications from
intangible assets in connection with the implementation of SFAS No. 142.
10
4. ADOPTION OF SFAS NO. 133 - ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and the corresponding amendments on January 1, 2001. In
accordance with the transition provisions of SFAS 133, the Company recorded a
cumulative-effect adjustment in other comprehensive income as of January 1, 2001
of $0.8 million, net of deferred tax of $0.5 million, representing the current
fair value of hedging instruments. Of the asset amount of $1.3 million, $3.4
million related to foreign currency forward contracts, offset by a liability of
$2.1 million related to interest rate swap agreements.
5. ACQUISITIONS
On May 2, 2002, the Company completed its acquisition of Invensys plc's flow
control division (IFC) for an aggregate purchase price of $535 million (the IFC
Acquisition), subject to adjustment pursuant to the terms of the purchase and
sale agreement. IFC is a manufacturer of valves, actuators and associated flow
control products, and provides the Company with a more balanced mix of revenue
among pumps, valves, and seals and more diversified geographic and end markets.
The Company financed the acquisition and associated transaction costs with a
combination of bank financing, as more fully described in Note 6, and net
proceeds of approximately $276 million received from the issuance of 9.2 million
common shares in April 2002. The Company also used $40 million from the proceeds
of the equity offering to reduce amounts outstanding under the Company's
revolving credit facility.
The purchase price has been allocated to assets acquired and liabilities
assumed based on estimated fair market values at the date of acquisition. These
allocations include $78.3 million for acquired intangible assets and $190
million recorded as goodwill.
The purchase price allocation for these acquisitions is preliminary and
further refinements will be made based on the completion of final valuation
studies. The operating results of IFC have been included in the consolidated
statement of operations from the date of acquisition.
The table below reflects unaudited pro forma results of the Company and IFC
as if the acquisition had taken place at the beginning of 2002 and 2001,
including estimated purchase accounting adjustments and financing costs.
PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
<Table>
<Caption>
Three Months ended June 30,
---------------------------
(Amounts in thousands, except per share data) 2002 2001
---------- ----------
Net sales $ 621,350 $ 590,327
Net earnings before extraordinary items 19,382 5,622
Net earnings 13,045 5,622
Net earnings per share (basic):
Before extraordinary items $ .35 $ .12
Net earnings .24 .12
Net earnings per share (diluted):
Before extraordinary items $ .35 $ .12
Net earnings .23 .12
</Table>
<Table>
<Caption>
Six Months ended June 30,
---------------------------
(Amounts in thousands, except per share data) 2002 2001
---------- ----------
Net sales $1,197,116 $1,171,498
Net earnings before extraordinary items 43,909 8,362
Net earnings 37,572 8,362
Net earnings per share (basic):
Before extraordinary items $ .80 $ .18
Net earnings .69 .18
Net earnings per share (diluted):
Before extraordinary items $ .79 $ .18
Net earnings .68 .18
</Table>
The pro forma information does not purport to represent what the Company's
results of income actually would have been had such transactions or events
occurred on the dates specified, or to project the Company's results of
operations for any future period.
11
6. DEBT
In the second quarter of 2002, in connection with the IFC acquisition, the
Company agreed with its lenders under its existing senior credit facilities to
amend the terms of such facilities that, effective as of the closing of the IFC
Acquisition, provided for: (1) an incremental Tranche A term loan in an
aggregate principal amount of $95.3 million and (2) a new Tranche C term loan
facility of $700 million, to be used to repay all of the existing Tranche B term
loan facility of $468.8 million, repay $11.3 million of the existing Tranche A
term loan and provide funds to be used to finance the IFC acquisition. The
Tranche A term loan has a final maturity in June 2006. Terms of the new Tranche
C term loan include maturity in 2009, rather than 2008 for the former Tranche B
term loan and reduced spreads resulting in lower interest rates. As part of the
amended and restated senior credit facility, several covenants were modified,
including various financial ratios to allow for the IFC Acquisition and other
matters. The senior credit facilities are collateralized by substantially all of
the Company's domestic assets and a pledge of 65% of the stock of the foreign
subsidiaries. As a result of repaying the Tranche B term loan facility, an
extraordinary expense of $6.3 million, net of tax, was recorded in the second
quarter of 2002 related to the write-off of the unamortized balance of prepaid
financing fees related to the Tranche B term loan and other related fees.
The term loans require scheduled principal payments, which began on June 30,
2001 for the Tranche A loan and will begin September 30, 2002 for the Tranche C
loan. In addition to the payments made in connection with the refinancing of the
senior credit facility, the Company had repaid $15.5 million of the term loans
(during the first half of 2002). The scheduled principal payments of the term
loans outstanding at June 30, 2002 are summarized as follows: $36.7 million in
the remainder of 2002, $78.7 million in 2003, $84.0 million in 2004, $89.3
million in 2005, $56.0 million in 2006, $100.0 million in 2007, $388.0 million
in 2008 and $194.0 million in 2009. The Company is required to use a percentage
of excess cash from operations under certain circumstances, as defined in the
Credit Facility and the indenture, to reduce the outstanding principal of the
term loans in the following year. No additional principal payments have been or
are due in 2002 under this provision.
The term loans bear floating interest rates based on LIBOR plus a credit
spread, or the prime rate plus a credit spread, at the option of the Company.
The credit spread for Tranche A can increase or decrease based on the leverage
ratio as defined in the credit facility agreement. At June 30, 2002, the
interest rates on the term loans were 4.6713%, 4.6250%, 4.6875% and 4.6250%
relating to the Tranche A term loan facility, 6.1395% related to a Euro
denominated portion of the Tranche A and 4.750% and 4.875% relating to the
Tranche C term loan facility.
Under the amended and restated credit facility, the Company has a $300
million revolving credit facility due June 2006. A portion of the incremental
Tranche C term loan was used to repay $40.0 million of the outstanding
indebtedness under the revolving credit facility. At June 30, 2002, no
borrowings were outstanding on the revolving credit facility. The revolving
credit facility allows the Company to issue up to $200 million in letters of
credit. As of June 30, 2002, $38.2 million of letters of credit had been issued
under the facility. As letters of credit issued under the facility reduce
availability, the Company had $261.8 million remaining in unused borrowing
capacity at June 30, 2002 under the revolving credit facility. In addition to
the letters of credit issued under the facility, there were $7.8 million of
letters of credit outside the facility at June 30, 2002.
The provisions of the credit facility require the Company to meet or exceed
specified defined financial covenants. These covenants include a leverage ratio,
an interest coverage ratio, and a fixed charge coverage ratio. Further, the
provisions of the credit facility and the Senior Subordinated Notes contain
limitations or restrictions on indebtedness, liens, sale and leaseback
transactions, asset sales, payment of
12
dividends, capital expenditures, and other customary restrictions. As of June
30, 2002, the Company was in compliance with these covenants.
7. INVENTORIES
Inventories are stated at lower of cost or market. Cost is determined for
U.S. inventories by the last-in, first-out (LIFO) method and for other
inventories by the first-in, first-out (FIFO) method.
Inventories and the method of determining costs were:
<Table>
<Caption>
JUNE 30, December 31,
2002 2001
--------- ---------
Raw materials $ 132,455 $ 62,818
Work in process 231,942 146,494
Finished goods 277,102 258,856
Less: Progress billings (76,395) (43,655)
Less: Excess and obsolete reserve (44,826) (42,986)
--------- ---------
520,278 381,527
LIFO reserve (33,423) (33,936)
--------- ---------
Net inventory $ 486,855 $ 347,591
========= =========
Percent of inventory accounted for by LIFO 59% 62%
Percent of inventory accounted for by FIFO 41% 38%
</Table>
Inventory balances increased primarily as a result of the IFC Acquisition
and due to foreign currency translations, primarily due to the strengthening of
the Euro in June 2002. Inventory balances excluding the acquisition of IFC at
June 30, 2002 were as follows: raw materials of $76.2 million; work in process
of $206.2 million; finished goods of $241.3 million; progress billings of $76.4
million; excess and obsolete reserve of $44.8 million; and LIFO reserve of $33.4
million.
8. RESTRUCTURING AND ACQUISITION RELATED CHARGES
In June 2002, in conjunction with the IFC Acquisition, the Company initiated
a restructuring program designed to reduce costs and eliminate excess capacity
in North America by consolidating facilities. The Company's actions, approved
and committed to in the second quarter of 2002, are expected to result in a
gross reduction of approximately 450 positions and a net reduction of
approximately 225 positions.
This program includes the announced closure of six valve facilities and a
reduction of sales and sales support personnel. The Company established a
restructuring reserve of $11.0 million for this program in the second quarter of
2002 and expects the majority of the reductions and closures to occur before
March 2003. Costs associated with the closure of Flowserve facilities of $0.6
million have been charged to restructuring expense in the income statement and
costs associated with the closure of IFC facilities of $10.4 million along with
related deferred taxes were accounted for in the purchase accounting for IFC.
<Table>
<Caption>
Other
Exit
Severance Costs Total
--------- --------- ---------
BALANCE AT JUNE 5, 2002 $ 6,880 $ 4,160 $ 11,040
CASH EXPENDITURES (146) (8) (154)
--------- --------- ---------
BALANCE AT JUNE 30, 2002 $ 6,734 $ 4,152 $ 10,886
========= ========= =========
</Table>
During the second quarter of 2002, the Company also incurred $2.0 million of
integration expense in conjunction with the program. Expenses classified as
integration generally represent period costs associated with acquisition related
reorganizations such as performance and retention bonuses, idle manufacturing
costs, costs related to the integration team and asset impairments.
Additional restructuring and integration expense related to the IFC
acquisition are expected in subsequent quarters. The impact of additional
restructuring activities will be recorded as programs are detailed, approved and
announced.
13
In August 2000, in conjunction with the acquisition of Ingersoll-Dresser
Pump Company (IDP), the Company initiated a restructuring program designed to
reduce costs and to eliminate excess capacity by consolidating facilities. The
Company's actions, approved and committed to in the third quarter of 2000, have
resulted in the net reduction of approximately 1,100 positions, which was
consistent with the plan. The program includes the closure of IDP's former
headquarters, the closure or significant downsizing of a number of pump
manufacturing facilities, service and repair centers, and reduction of sales and
sales support personnel. The Company established a restructuring reserve for
this program in the third quarter of 2000.
In the second quarter of 2001 and for the six months ended June 30, 2001,
the Company incurred integration expense in conjunction with the program of
$16.9 million and $36.1 million, respectively. The Company substantially
completed its integration activities during 2001. Expenditures charged to the
2000 restructuring reserve were:
<Table>
<Caption>
Other
Exit
Severance Costs Total
--------- -------- --------
Balance at August 16, 2000 $ 45,980 $ 14,832 $ 60,812
Cash expenditures (18,645) (2,434) (21,079)
Net non-cash reduction (8,849) -- (8,849)
-------- -------- --------
Balance at December 31, 2000 18,486 12,398 30,884
Cash expenditures (13,267) (6,712) (19,979)
Net non-cash reduction (2,817) (2,567) (5,384)
-------- -------- --------
Balance at December 31, 2001 2,402 3,119 5,521
CASH EXPENDITURES (269) (112) (381)
-------- -------- --------
BALANCE AT MARCH 31, 2002 $ 2,133 $ 3,007 $ 5,140
-------- -------- --------
CASH EXPENDITURES (93) (301) (394)
-------- -------- --------
BALANCE AT JUNE 30, 2002 $ 2,040 $ 2,706 $ 4,746
======== ======== ========
</Table>
9. EARNINGS PER SHARE
Basic and diluted earnings per share were calculated as follows:
<Table>
<Caption>
THREE MONTHS Three Months
ENDED Ended
JUNE 30, 2002 June 30, 2001
------------- -------------
Net earnings $ 14,345 $ 2,602
------------- -------------
Denominator for basic earnings per share - weighted average shares 51,920 38,058
Effect of dilutive securities 759 738
------------- -------------
Denominator for diluted earnings per share - weighted average shares
adjusted for dilutive securities 52,679 38,796
============= =============
Earnings per share
- basic $ 0.28 $ 0.07
- diluted $ 0.27 $ 0.07
------------- -------------
</Table>
<Table>
<Caption>
SIX MONTHS Six Months
ENDED Ended
JUNE 30, 2002 June 30, 2001
------------- -------------
Net earnings (loss) $ 27,083 $ (5,938)
------------- -------------
Denominator for basic earnings per share - weighted average shares 48,541 37,912
Effect of dilutive securities 697 557
------------- -------------
Denominator for diluted earnings per share - weighted average shares
adjusted for dilutive securities 49,238 38,468
============= =============
Earnings (loss) per share
- basic $ 0.56 $ (0.16)
- diluted $ 0.55 $ (0.16)
------------- -------------
</Table>
14
Options outstanding with an exercise price greater than the average market
price of the common stock were not included in the computation of diluted
shares. Options to purchase 108,414 shares of common stock and 371,926 shares of
common stock were not included for the three month and six month periods ended
June 30, 2002, respectively. Options to purchase 435,849 shares of common stock
were not included in the computation for the three month period ended June 30,
2001. For the six months ended June 30, 2001, the computation of diluted net
loss per ordinary share was antidilutive, and therefore, the amounts reported
for basic and diluted net loss per ordinary share were the same.
15
10. SEGMENT INFORMATION
The Company has three divisions, each of which constitutes a business
segment. Each division manufactures different products and is defined by the
type of products and services provided. Each division has a President, who
reports directly to the Chief Executive Officer, and a Division Controller. For
decision-making purposes, the Chief Executive Officer and other members of upper
management use financial information generated and reported at the division
level. The Company also has a corporate headquarters that does not constitute a
separate division or business segment.
Amounts classified as All Other include Corporate Headquarters costs and
other minor entities that are not considered separate segments. The Company
evaluates segment performance and allocates resources based on profit or loss
excluding integration expenses, interest expense, other income or expense,
income taxes and extraordinary items. Intersegment sales and transfers are
recorded at cost plus a profit margin. Several valve distribution centers were
transferred from the Flow Solutions Division to the Flow Control Division in
2002. Amounts reported for these distribution centers for 2001 have been
reclassified to conform to the current business configuration.
<Table>
<Caption>
FLOWSERVE FLOW CONSOLIDATED
THREE MONTHS ENDED JUNE 30, 2002 PUMP SOLUTIONS FLOW CONTROL ALL OTHER TOTAL
- -------------------------------------------------- --------- --------- ------------ --------- ------------
SALES TO EXTERNAL CUSTOMERS $ 280,430 $ 149,117 $ 161,576 $ 1,605 $ 592,728
INTERSEGMENT SALES 1,963 6,312 2,073 (10,348) --
SEGMENT OPERATING INCOME (BEFORE SPECIAL ITEMS)(1) 36,607 18,148 15,761 (7,862) 62,654
IDENTIFIABLE ASSETS $1,279,961 $ 412,271 $ 917,971 $ 161,449 $2,771,652
</Table>
<Table>
<Caption>
Flowserve Flow Consolidated
Three months ended June 30, 2001 Pump Solutions Flow Control All Other Total
- -------------------------------------------------- --------- --------- ------------ --------- ------------
Sales to external customers $ 237,107 $ 150,397 $ 75,560 $ 1,516 $ 464,579
Intersegment sales 1,528 5,740 2,555 (9,824) --
Segment operating income (before special items) (2) 29,856 21,990 9,153 (8,894) 52,106
Identifiable assets $1,292,897 $ 428,835 $ 223,267 $ 123,287 $2,068,286
</Table>
(1) Special items reflect costs associated with the IFC Acquisition
including a negative purchase accounting adjustment associated with the
required write-up and sale of inventory of $2.6 million (recorded as a
component of cost of sales), integration expense of $2.0 million and
restructuring expense of $0.6 million.
(2) Special items reflect integration expense associated with the
acquisition and integration of IDP of $16.9 million.
A reconciliation of total segment operating income before special items to
consolidated earnings before income taxes follows:
<Table>
<Caption>
Three Months Ended June 30,
--------------------------
2002 2001
-------- --------
Total segment operating income (before special items) $ 70,516 $ 61,000
Corporate expenses and other 7,862 8,894
Purchase accounting adjustment associated with the required write-up of inventory 2,648 --
Integration expense 2,005 16,944
Restructuring expense 644 --
Net interest expense 23,892 31,361
Other expense (income) 1,645 (265)
-------- --------
Earnings before income taxes $ 31,820 $ 4,066
======== ========
</Table>
16
<Table>
<Caption>
FLOWSERVE FLOW CONSOLIDATED
SIX MONTHS ENDED JUNE 30, 2002 PUMP SOLUTIONS FLOW CONTROL ALL OTHER TOTAL
- -------------------------------------------------- --------- --------- ------------ --------- ------------
SALES TO EXTERNAL CUSTOMERS $ 512,149 $ 291,071 $ 233,250 $ 3,309 $1,039,779
INTERSEGMENT SALES 3,592 11,454 3,862 (18,908) --
SEGMENT OPERATING INCOME (BEFORE SPECIAL ITEMS)(1) 62,668 35,128 20,985 (14,247) 104,534
IDENTIFIABLE ASSETS $1,279,961 $ 412,271 $ 917,971 $ 161,449 $2,771,652
</Table>
<Table>
<Caption>
Flowserve Flow Consolidated
Six months ended June 30, 2001 Pump Solutions Flow Control All Other Total
- -------------------------------------------------- --------- --------- ------------ --------- ------------
Sales to external customers $ 460,604 $ 293,439 $ 152,049 $ 2,522 $ 908,614
Intersegment sales 2,729 10,498 4,707 (17,934) --
Segment operating income (before special items)(2) 47,972 38,968 18,612 (15,976) 89,576
Identifiable assets $1,292,897 $ 428,835 $ 223,267 $ 123,287 $2,068,286
</Table>
(1) Special items reflect costs associated with the IFC Acquisition including a
negative purchase accounting adjustment associated with the required
write-up and sale of inventory of $2.6 million (recorded as a component of
cost of sales), integration expense of $2.0 million and restructuring
expense of $0.6 million.
(2) Special items reflect integration expense associated with the acquisition
and integration of IDP of $36.1 million
A reconciliation of total segment operating income before special items to
consolidated earnings before income taxes follows:
<Table>
<Caption>
Six Months Ended June 30,
-------------------------
2002 2001
--------- ---------
Total segment operating income (before special items) $ 118,781 $ 105,552
Corporate expenses and other 14,247 15,976
Purchase accounting adjustment associated with the required write-up of inventory 2,648 --
Integration expense 2,005 36,083
Restructuring expense 644 --
Net interest expense 45,712 63,172
Other expense (income) 2,110 (400)
--------- ---------
Earnings (loss) before income taxes $ 51,415 $ (9,279)
========= =========
</Table>
Effective July 1, 2002, the Company realigned its operating segments. Under
the new organization, the Flow Solutions Division will only include the
Company's seal operations, while the Company's pump and valve service businesses
will be included, as appropriate, in the Flowserve Pump Division and Flow
Control Division, respectively. Segment information will be reported under the
new organization structure beginning in the third quarter of 2002 when the
Company begins to operate under this new organization structure.
17
11. GUARANTOR AND NONGUARANTOR FINANCIAL STATEMENTS
In connection with the IDP acquisition and as part of the related financing,
the Company and a newly formed Dutch subsidiary, Flowserve Finance B.V., issued
an aggregate of $375 million of senior subordinated notes (the U.S. dollar Notes
and the Euro Notes). The U.S. dollar Notes and the Euro Notes are general
unsecured obligations of the Company and of Flowserve Finance B.V.,
respectively, subordinated in right of payment to all existing and future senior
indebtedness of the Company and of Flowserve Finance B.V., respectively, and
guaranteed on a full, unconditional, joint and several basis by the Company's
wholly-owned domestic subsidiaries and, in the case of the Euro Notes, by the
Company. These Notes are included in the Company's balance sheet and are
classified as "long-term debt due after one year".
The following consolidating financial information presents:
(1) Consolidating balance sheet as of June 30, 2002 and the related statements
of operations for the six months and the three months ended June 30, 2002
and June 30, 2001 and cash flows for the six months ended June 30, 2002 and
2001 of (a) Flowserve Corporation, the parent, (b) Flowserve Finance B.V.,
(c) the guarantor subsidiaries, (d) the nonguarantor subsidiaries, and the
Company on a consolidated basis, and
(2) Consolidating balance sheet as of December 31, 2001 of (a) Flowserve
Corporation, the parent, (b) Flowserve Finance B.V., (c) the guarantor
subsidiaries, (d) the nonguarantor subsidiaries, and the Company on a
consolidated basis, and
(3) Elimination entries necessary to consolidate Flowserve Corporation, the
parent, with Flowserve Finance, B.V., guarantor and nonguarantor
subsidiaries.
Investments in subsidiaries are accounted for by the parent using the
equity method of accounting. The guarantor and nonguarantor subsidiaries are
presented on a combined basis. The principal elimination entries eliminate
investments in subsidiaries and intercompany balances and transactions. Separate
financial statements for the guarantor subsidiaries and the nonguarantor
subsidiaries are omitted because of immateriality.
18
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
----------- ----------- ------------ ------------ ------------ ------------
Sales $ -- $ -- $ 333,280 $ 282,379 $ (22,931) $ 592,728
Cost of sales -- -- 246,429 187,205 (22,931) 410,703
----------- ----------- ----------- ----------- ----------- -----------
Gross profit -- -- 86,851 95,174 -- 182,025
Selling, general and administrative
expense -- -- 79,525 42,494 -- 122,019
Integration expense -- -- 1,579 426 -- 2,005
Restructuring expense -- -- 644 -- -- 644
----------- ----------- ----------- ----------- ----------- -----------
Operating income -- -- 5,103 52,254 -- 57,357
Net interest expense 1,698 3,360 17,221 1,613 -- 23,892
Other expense (income), net 34 -- (3,757) 5,368 -- 1,645
Equity in earnings of subsidiaries (21,774) -- -- -- 21,774 --
----------- ----------- ----------- ----------- ----------- -----------
Earnings (loss) before income taxes 20,042 (3,360) (8,361) 45,273 (21,774) 31,820
Provision (benefit) for income taxes (640) -- (3,093) 14,871 -- 11,138
----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss) before extraordinary
items 20,682 (3,360) (5,268) 30,402 (21,774) 20,682
Extraordinary items, net of tax (6,337) -- -- -- -- (6,337)
----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss) $ 14,345 $ (3,360) $ (5,268) $ 30,402 $ (21,774) $ 14,345
=========== =========== =========== =========== =========== ===========
</Table>
19
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2001
(UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
----------- ----------- ------------ ------------ ------------ ------------
Sales $ -- $ -- $ 288,982 $ 205,785 $ (30,188) $ 464,579
Cost of sales -- -- 196,875 142,214 (30,188) 308,901
----------- ----------- ----------- ----------- ----------- -----------
Gross profit -- -- 92,107 63,571 -- 155,678
Selling, general and administrative
expense (7) -- 72,574 31,005 -- 103,572
Integration expense -- -- 13,520 3,424 -- 16,944
----------- ----------- ----------- ----------- ----------- -----------
Operating income 7 -- 6,013 29,142 -- 35,162
Net interest expense 5,051 211 23,156 2,409 534 31,361
Other expense (income), net (273) -- (9,773) 10,315 (534) (265)
Equity in earnings of subsidiaries (6,518) -- -- -- 6,518 --
----------- ----------- ----------- ----------- ----------- -----------
Earnings (loss) before income taxes 1,747 (211) (7,370) 16,418 (6,518) 4,066
Provision (benefit) for income taxes (855) -- (7,386) 9,705 -- 1,464
----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss) before extraordinary
items $ 2,602 $ (211) $ 16 $ 6,713 $ (6,518) $ 2,602
=========== =========== =========== =========== =========== ===========
</Table>
20
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
----------- ----------- ------------ ------------ ------------ ------------
Sales $ -- $ -- $ 610,975 $ 475,993 $ (47,189) $ 1,039,779
Cost of sales -- -- 444,080 318,827 (47,189) 715,718
----------- ----------- ----------- ----------- ----------- -----------
Gross profit -- -- 166,895 157,166 -- 324,061
Selling, general and administrative
expense -- -- 148,399 73,776 -- 222,175
Integration expense -- -- 1,579 426 -- 2,005
Restructuring expense -- -- 644 -- -- 644
----------- ----------- ----------- ----------- ----------- -----------
Operating income -- -- 16,273 82,964 -- 99,237
Net interest expense 301 3,023 37,103 5,285 -- 45,712
Other expense (income), net 34 -- (7,953) 10,029 -- 2,110
Equity in earnings of subsidiaries (33,631) -- -- -- 33,631 --
----------- ----------- ----------- ----------- ----------- -----------
Earnings (loss) before income taxes 33,296 (3,023) (12,877) 67,650 (33,631) 51,415
Provision (benefit) for income taxes (124) -- (4,764) 22,883 -- 17,995
----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss) before extraordinary
items 33,420 (3,023) (8,113) 44,767 (33,631) 33,420
Extraordinary items, net of tax (6,337) -- -- -- -- (6,337)
----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss) $ 27,083 $ (3,023) $ (8,113) $ 44,767 $ (33,631) $ 27,083
=========== =========== =========== =========== =========== ===========
</Table>
21
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
----------- --------- ------------ ------------ ------------ ------------
Sales $ -- $ -- $ 588,121 $ 376,581 $ (56,088) $ 908,614
Cost of sales -- -- 414,591 256,859 (56,088) 615,362
--------- --------- --------- --------- --------- ---------
Gross profit -- -- 173,530 119,722 -- 293,252
Selling, general and administrative
expense -- -- 141,539 62,137 -- 203,676
Integration expense -- -- 28,968 7,115 -- 36,083
--------- --------- --------- --------- --------- ---------
Operating income -- -- 3,023 50,470 -- 53,493
Net interest expense 12,012 435 44,486 6,310 (71) 63,172
Other (income) expense, net (273) 3 (13,971) 13,770 71 (400)
Equity in loss of subsidiaries 5 -- -- -- (5) --
--------- --------- --------- --------- --------- ---------
Net (loss) earnings before income taxes (11,744) (438) (27,492) 30,390 5 (9,279)
(Benefit) provision for income taxes (5,806) -- (12,786) 15,251 -- (3,341)
--------- --------- --------- --------- --------- ---------
Net (loss) earnings $ (5,938) $ (438) $ (14,706) $ 15,139 $ 5 $ (5,938)
========= ========= ========= ========= ========= =========
</Table>
22
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATING BALANCE SHEET
JUNE 30, 2002
(UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
----------- ----------- ------------ ----------- ------------ -----------
Current assets:
Cash and cash equivalents $ -- $ -- $ 28,000 $ 53,516 $ -- $ 81,516
Intercompany receivables 128,183 3,756 68,747 36,126 (236,812) --
Accounts receivable, net -- -- 257,260 300,732 -- 557,992
Inventories -- -- 273,915 212,940 -- 486,855
Current deferred tax ass et -- -- 29,358 1,642 -- 31,000
Prepaid expenses -- -- 17,711 24,931 -- 42,642
----------- ----------- ----------- ----------- ----------- -----------
Total current assets 128,183 3,756 674,991 629,887 (236,812) 1,200,005
Property, plant and equipment, net -- -- 301,507 207,434 -- 508,941
Investment in subsidiaries 1,109,173 279,558 116,234 -- (1,504,965) --
Intercompany receivables 721,870 78,236 268,460 191,395 (1,259,961) --
Goodwill -- -- 549,531 182,912 -- 732,443
Other intangible assets, net -- -- 183,915 2,127 -- 186,042
Other assets 16,469 2,787 97,617 27,348 -- 144,221
----------- ----------- ----------- ----------- ----------- -----------
Total assets $ 1,975,695 $ 364,337 $ 2,192,255 $ 1,241,103 $(3,001,738) $ 2,771,652
=========== =========== =========== =========== =========== ===========
Current liabilities:
Accounts payable $ -- $ -- $ 98,310 $ 117,294 $ -- $ 215,604
Intercompany payables (193) 5,665 201,096 30,244 (236,812) --
Income taxes (1,257) -- (4,107) 17,963 -- 12,599
Accrued liabilities 12,183 2,960 109,309 86,478 -- 210,930
Long-term debt due within one year 73,326 -- (27) 121 -- 73,420
----------- ----------- ----------- ----------- ----------- -----------
Total current liabilities 84,059 8,625 404,581 252,100 (236,812) 512,553
Long-term debt due after one year 1,130,823 63,621 420 9,743 -- 1,204,607
Intercompany payables -- 304,337 806,871 148,753 (1,259,961) --
Retirement benefits and other liabilities -- -- 178,453 115,225 -- 293,678
Shareholders' equity:
Serial preferred stock -- -- -- -- -- --
Common stock 72,018 -- 2 182,331 (182,333) 72,018
Capital in excess of par value 477,624 -- 586,922 441,366 (1,028,288) 477,624
Retained earnings (deficit) 383,080 (11,220) 229,638 206,535 (424,952) 383,081
----------- ----------- ----------- ----------- ----------- -----------
932,722 (11,220) 816,562 830,232 (1,635,573) 932,723
Treasury stock at cost (65,539) -- -- -- -- (65,539)
Deferred compensation obligation 8,118 -- -- -- -- 8,118
Accumulated other comprehensive (loss)
income (114,488) (1,026) (14,632) (114,950) 130,608 (114,488)
----------- ----------- ----------- ----------- ----------- -----------
Total shareholders' equity 760,813 (12,246) 801,930 715,282 (1,504,965) 760,814
----------- ----------- ----------- ----------- ----------- -----------
Total liabilities and shareholders'
equity $ 1,975,695 $ 364,337 $ 2,192,255 $ 1,241,103 $(3,001,738) $ 2,771,652
=========== =========== =========== =========== =========== ===========
</Table>
23
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2001
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------- ---------- ------------ ------------ ------------ ------------
Current assets:
Cash and cash equivalents $ -- $ -- $ -- $ 21,533 $ -- $ 21,533
Intercompany receivables 82,513 -- 62,875 77,513 (222,901) --
Accounts receivable, net -- -- 231,484 224,377 -- 455,861
Inventories -- -- 201,707 145,884 -- 347,591
Current deferred tax asset -- -- 33,727 2,589 -- 36,316
Prepaid expenses -- -- 22,981 13,857 -- 36,838
---------- ---------- ---------- ---------- ----------- ----------
Total current assets 82,513 -- 552,774 485,753 (222,901) 898,139
Property, plant and equipment, net -- -- 201,595 160,793 -- 362,388
Investment in subsidiaries 399,026 -- 464,633 -- (863,659) --
Intercompany receivables 901,675 85,254 6,198 34,003 (1,027,130) --
Goodwill, net -- -- 414,465 100,710 -- 515,175
Other intangible assets, net -- -- 115,123 15,956 -- 131,079
Other assets 29,094 2,693 100,320 13,087 -- 145,194
---------- ---------- ---------- ---------- ----------- ----------
Total assets $1,412,308 $ 87,947 $1,855,108 $ 810,302 $(2,113,690) $2,051,975
========== ========== ========== ========== =========== ==========
Current liabilities:
Accounts payable $ 145 $ -- $ 85,861 $ 92,474 $ -- $ 178,480
Intercompany payables 4,240 (1,191) 45,004 174,848 (222,901) --
Income taxes (1,257) -- (15,606) 16,863
Accrued liabilities 15,034 2,665 107,191 68,878 -- 193,768
Long-term debt due within one --
year 44,521 -- 2 -- -- 44,523
---------- ---------- ---------- ---------- ----------- ----------
Total current liabilities 62,683 1,474 222,452 353,063 (222,901) 416,771
Long-term debt due after one year 938,606 57,163 420 33 -- 996,222
Intercompany payables -- 37,115 939,245 50,770 (1,027,130) --
Retirement benefits and other
liabilities -- -- 172,483 55,480 -- 227,963
Shareholders' equity:
Serial preferred stock -- -- -- -- -- --
Common stock 60,518 -- 2 182,331 (182,333) 60,518
Capital in excess of par value 211,113 -- 313,221 72,991 (386,212) 211,113
Retained earnings (deficit) 355,998 (8,198) 237,279 162,241 (391,322) 355,998
---------- ---------- ---------- ---------- ----------- ----------
627,629 (8,198) 550,502 417,563 (959,867) 627,629
Treasury stock at cost (82,718) -- -- -- -- (82,718)
Deferred compensation obligation 8,260 -- -- -- -- 8,260
Accumulated other comprehensive (loss)
income (142,152) 393 (29,994) (66,607) 96,208 (142,152)
---------- ---------- ---------- ---------- ----------- ----------
Total shareholders' equity 411,019 (7,805) 520,508 350,956 (863,659) 411,019
---------- ---------- ---------- ---------- ----------- ----------
Total liabilities and shareholders'
equity $1,412,308 $ 87,947 $1,855,108 $ 810,302 $(2,113,690) $2,051,975
========== ========== ========== ========== =========== ==========
</Table>
24
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN THOUSANDS)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 (UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
--------- --------- ------------ ------------ ------------ ------------
CASH FLOWS - OPERATING ACTIVITIES:
Net earnings (loss) $ 27,083 $ (3,023) $ (7,642) $ 44,296 $ (33,631) $ 27,083
Adjustments to reconcile net earnings
(loss) to cash (used) provided by operating
activities:
Depreciation -- -- 15,157 11,015 -- 26,172
Amortization -- -- 3,322 296 -- 3,618
Amortization of prepaid financing
fees and discount 2,304 421 -- -- -- 2,725
Write-off of unamortized prepaid
financing fees 9,176 -- -- -- -- 9,176
Other direct costs of long-term debt
repayment 726 -- -- -- -- 726
Net (gain) loss on disposition of
fixed assets -- -- (248) 176 -- (72)
Change in operating assets and liabilities:
Accounts receivable -- -- 11,991 (7,060) -- 4,931
Inventories -- -- (7,277) (285) -- (7,562)
Intercompany receivable and payable 121,442 260,887 (38,692) (406,976) 63,339 --
Prepaid expenses -- 720 9,066 (1,197) -- 8,589
Other assets (193) (234) 7,234 (9,442) -- (2,635)
Accounts payable (15) -- (6,466) (2,625) -- (9,106)
Accrued liabilities (2,034) 260 (20,741) 6,494 _ (16,021)
Income taxes -- -- 11,570 939 -- 12,509
Retirement benefits and other liabilities -- -- 5,971 (2,421) -- 3,550
Net deferred taxes 6,290 -- 9,934 161 -- 16,385
--------- --------- --------- --------- --------- ---------
Net cash (used) provided by operating
activities, net of acquisitions 164,779 259,031 (6,821) (366,629) 29,708 80,068
--------- --------- --------- --------- --------- ---------
CASH FLOWS - INVESTING ACTIVITIES:
Capital expenditures -- -- (8,279) (6,488) -- (14,767)
Cash received for disposal of assets -- -- 1,672 -- -- 1,672
Payments for acquisitions, net of
cash acquired -- -- (313,291) (216,425) -- (529,716)
Change in investments in subsidiaries (743,778) (258,438) 356,936 32,907 612,373 --
--------- --------- --------- --------- --------- ---------
Net cash flows (used) provided by investing
activities (743,778) (258,438) 37,038 (190,006) 612,373 (542,811)
--------- --------- --------- --------- --------- ---------
CASH FLOWS - FINANCING ACTIVITIES:
Net repayments under lines of credit (70,078) -- (28) 106 -- (70,000)
Proceeds from long-term debt 786,561 51 (2,189) 10,883 -- 795,306
Payments of long-term debt (495,591) -- -- -- -- (495,591)
Payment of prepaid financing fees (4,953) -- -- -- -- (4,953)
Other direct costs of long-term debt
repayment (726) -- -- -- -- (726)
Proceeds from issuance of common stock 275,925 -- -- -- -- 275,925
Net proceeds from stock option
activity 16,849 -- -- -- -- 16,849
Other 71,012 (644) -- 571,603 (642,081) (110)
--------- --------- --------- --------- --------- ---------
Net cash flows provided (used) by
financing activities 578,999 (593) (2,217) 582,592 (642,081) 516,700
Effect of exchange rate changes -- -- -- 6,026 -- 6,026
--------- --------- --------- --------- --------- ---------
Net change in cash and cash equivalents -- -- 28,000 31,983 -- 59,983
Cash and cash equivalents at beginning of
year -- -- -- 21,533 -- 21,533
--------- --------- --------- --------- --------- ---------
Cash and cash equivalents at end of period $ -- $ -- $ 28,000 $ 53,516 $ -- $ 81,516
========= ========= ========= ========= ========= =========
</Table>
25
FLOWSERVE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)
<Table>
<Caption>
FLOWSERVE
FINANCE GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT B.V. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
--------- --------- ------------ ------------ ----------- ------------
CASH FLOWS-OPERATING ACTIVITIES:
Net (loss) earnings $ (5,938) $ (438) $ (14,706) $ 15,139 $ 5 $ (5,938)
Adjustments to reconcile net earnings to
cash provided (used) by operating
activities:
Depreciation 14 -- 15,046 10,094 -- 25,154
Amortization -- -- 10,400 1,787 -- 12,187
Amortization of prepaid financing fees 3,086 303 -- -- -- 3,389
Net (gain) on disposition of fixed
assets -- -- (101) (221) -- (322)
Change in operating assets and liabilities:
Accounts receivable (200) -- (9,368) 26,568 -- 17,000
Inventories (5,759) -- (21,844) (27,339) -- (54,942)
Intercompany receivable and payable 34,216 (218) 64,468 (98,456) (10) --
Prepaid expenses 877 -- (813) (3,979) -- (3,915)
Other assets 2,956 (63) (12,032) 2,081 -- (7,058)
Accounts payable 4,376 -- 17,648 (18,100) (4,241) (317)
Accrued liabilities 10,936 135 (26,156) (34,822) -- (49,907)
Income taxes (5,619) -- (1,673) 6,613 -- (679)
Retirement benefits and other
liabilities (16,982) -- (2,503) 14,375 -- (5,110)
Net deferred taxes (238) -- (2,969) 659 -- (2,548)
--------- --------- --------- --------- --------- ---------
Net cash (used) provided by operating
activities 21,725 (281) 15,397 (105,601) (4,246) (73,006)
--------- --------- --------- --------- --------- ---------
CASH FLOWS-INVESTING ACTIVITIES:
Capital expenditures (266) -- (12,355) (9,796) -- (22,417)
Cash received for disposal of assets -- -- 5,854 1,507 -- 7,361
--------- --------- --------- --------- --------- ---------
Net cash flows used by investing
activities (266) -- (6,501) (8,289) -- (15,056)
--------- --------- --------- --------- --------- ---------
CASH FLOWS-FINANCING ACTIVITIES:
Proceeds from long-term debt 71,681 -- (2) (679) -- 71,000
Payments on long-term debt (11,781) -- (123) 123 -- (11,781)
Net proceeds from stock option activity 6,239 6,239
Other (87,598) 281 (8,771) 98,457 (958) 1,411
--------- --------- --------- --------- --------- ---------
Net cash flows provided (used) by
financing activities (21,459) 281 (8,896) 97,901 (958) 66,869
Effect of exchange rate changes -- -- -- (3,998) -- (3,998)
--------- --------- --------- --------- --------- ---------
Net change in cash and cash equivalents -- -- -- (19,987) (5,204) (25,191)
Cash and cash equivalents at beginning of
year -- -- -- 50,239 (7,898) 42,341
--------- --------- --------- --------- --------- ---------
Cash and cash equivalents at end of period $ -- $ -- $ -- $ 30,252 $ (13,102) $ 17,150
========= ========= ========= ========= ========= =========
</Table>
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion and analysis are provided to increase understanding
of, and should be read in conjunction with, the accompanying consolidated
financial statements and notes.
Flowserve produces engineered and industrial pumps, industrial valves,
control valves, nuclear valves, valve actuators and controls and precision
mechanical seals, and provides a range of related flow management services
worldwide, primarily for the process industries. Equipment manufactured and
serviced by the Company is predominately used in industries that deal with
difficult-to-handle and corrosive fluids as well as environments with extreme
temperature, pressure, horsepower and speed. Flowserve's businesses are affected
by economic conditions in the United States and other countries where its
products are sold and serviced, by the 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. The Company believes the impact of these conditions is somewhat
mitigated by the strength and diversity of Flowserve's product lines, geographic
coverage and significant installed base, which provides potential for an annuity
stream of revenue from parts and services.
In general, results for the second quarter of 2002 and the six months ended
June 30, 2002 were higher than the corresponding period in the previous year due
to the Company's acquisition of Invensys' flow control division (IFC) on May 2,
2002. The results for IFC subsequent to the acquisition are included in the
results for the Company's Flow Control Division. This acquisition was financed
through a combination of debt and proceeds from a common stock offering as
discussed in further detail in the Liquidity and Capital Resources section of
this Management Discussion and Analysis.
Special items incurred for the second quarter of 2002 reflect costs
associated with the acquisition of IFC including the following: integration
expense of $2.0 million; restructuring expense of $0.6 million; a negative
purchase accounting adjustment of $2.6 million (included in cost of sales)
associated with the required write-up and subsequent sale of inventory; and an
extraordinary charge of $6.3 million, net of tax, reflecting the write-off of
unamortized prepaid financing and other related fees resulting from the
refinancing of the Company's senior credit facility. Special items in 2001
include integration expense of $16.9 million for the second quarter and $36.1
million for the six month period associated with the August 2000 acquisition of
Ingersoll-Dresser Pump Co. (IDP).
Operating results before special items should not be considered an
alternative to operating results calculated in accordance with generally
accepted accounting principles.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The process of preparing financial statements in conformity with accounting
principles generally accepted in the U.S. requires the use of estimates and
assumptions to determine certain of the assets, liabilities, revenues and
expenses. These estimates and assumptions are based upon the best information
available at the time of the estimates or assumptions. The estimates and
assumptions could change materially as conditions within and beyond the
Company's control change. Accordingly, actual results could differ materially
from those estimates. The most significant estimates made by management include
the allowance for doubtful accounts receivable, reserves for excess and obsolete
inventories, deferred tax asset valuation allowances, restructuring accruals,
legal and environmental accruals, warranty accruals, insurance accruals, pension
and postretirement benefit obligations, and valuation of goodwill and other
long-lived assets. Most of these estimates are reviewed quarterly with the
Company's Audit/Finance Committee. The following is a discussion of the critical
accounting policies and the related management estimates and assumptions
necessary in determining the value of related assets or liabilities.
27
REVENUE RECOGNITION
Revenues and costs are generally recognized based on the shipping terms
agreed to with the customer and fulfillment of all but inconsequential or
perfunctory actions required of the Company. Revenue for certain longer-term
contracts is recognized based on the percentage of completion method calculated
on a cost to cost basis. Shipping and handling costs are reported in cost of
sales and amounts billed to customers for these costs are included in revenues.
Progress billings are generally shown as a reduction of inventory unless such
billings are in excess of accumulated costs, in which case such balances are
included in accrued liabilities.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
An allowance for doubtful accounts receivable is established based on
estimates of the amount of uncollectible accounts receivable. The amount of the
required allowance is determined based upon the aging of the receivable,
customer credit history, industry and market segment information, economic
trends and conditions, credit reports and customer financial condition. Customer
credit issues, customer bankruptcies or general economic conditions can affect
the estimates.
INVENTORIES
Inventories are stated at the lower-of-cost of market. Cost is determined
for U.S. inventories by the last-in, first-out (LIFO) method and for other
inventories by the first-in, first-out (FIFO) method. Provisions for excess and
obsolete inventories are based on an assessment of slow-moving and obsolete
inventories. A factor of historical usage and estimated future demand provide
the basis for the estimates. These estimates are generally not subject to
significant volatility due to the relatively long life cycle of the Company's
products except for product rationalizations, which may occur in conjunction
with an acquisition.
DEFERRED TAX ASSET VALUATION
Deferred tax assets and liabilities are established based on the profits or
losses in each jurisdiction in which the Company operates. Associated valuation
allowances reflect the likelihood of the recoverability of these assets. The
judgment of the recoverability of these assets is based primarily on the
estimate of current and expected future earnings and prudent and feasible tax
planning strategies. These estimates could be impacted by changes in future
taxable income and the results of tax strategies.
RESTRUCTURING
Restructuring reserves are generally established in conjunction with an
acquisition. The reserve reflects many estimates including those pertaining to
employee separation costs, settlements of contractual obligations and other
costs associated with exiting a facility. Restructuring costs related to
facilities and employees of an acquired business are generally recorded in
goodwill whereas all others are recorded as restructuring expense in the
Consolidated Statement of Operations. Reserve requirements for each individual
plan are reassessed quarterly and could change due to revisions of cost
estimates and changes in planned restructuring activities.
LEGAL AND ENVIRONMENTAL ACCRUALS
The costs relating to legal and environmental liabilities are estimated and
recorded when it is probable that a loss has been incurred and such loss is
estimable. The Company has a formal and established process for assessing the
facts and circumstances and recording such contingencies on a case-by-case
basis. Probable legal and environmental costs are based on information obtained
from the Company's experts plus the Company's loss experience in similar
situations. The estimates may vary in the future due to new developments
regarding the facts and circumstances of each matter.
28
WARRANTY ACCRUALS
Warranty obligations are based upon product failure rates, materials usage
or service delivery costs. The Company estimates its warranty provisions based
upon an analysis of all identified or expected claims and an estimate of the
cost to resolve those claims. The estimates of expected claims are generally a
factor of historical claims. Changes in claim rates, differences between actual
and expected warranty costs and the Company's facility rationalization
activities could impact these estimates.
INSURANCE ACCRUALS
Insurance accruals are recorded based upon an analysis of the Company's
claim loss history and an estimate of incurred but not recorded claims. The
estimates are based upon information received from the Company's external
insurers. Changes in claim rates and differences between actual and expected
claim losses could impact the accrual in the future.
PENSION AND POSTRETIREMENT BENEFITS OBLIGATIONS
Determination of the value of the pension and postretirement benefits
liabilities is based on actuarial valuations. Inherent in these valuations are
key assumptions including discount rates, market value of plan assets, expected
return on plan assets and assumed rate of increase in wages or in health care
costs. Current market conditions, including changes in rates of returns,
interest rates and medical inflation rates are considered in selecting these
assumptions. Changes in the related pension and postretirement benefit costs may
occur in the future due to changes in the assumptions used and changes resulting
from fluctuations in the Company's related headcount.
VALUATION OF GOODWILL AND OTHER LONG-LIVED ASSETS
The value of the Company's goodwill and indefinite lived intangible assets
are tested annually for impairment or whenever events or circumstances indicate
goodwill may be impaired. The test involves significant judgments based upon
projections of future performance of each of the Company's reporting units. The
net realizable value of other long-lived assets is reviewed periodically, when
indicators of potential impairments are present, based upon an assessment of the
estimated future cash flows related to those assets. Due to uncertain market
conditions and potential changes in strategy and product portfolio, it is
possible that forecasts used to support these assets may change in the future
which could result in non-cash charges that would adversely affect the Company's
results of operations and financial condition.
Based on a critical assessment of its accounting policies and the underlying
judgments and uncertainties affecting the application of those policies,
management believes that the Company's consolidated financial statements provide
a meaningful and fair perspective of the Company. This is not to suggest that
other general risk factors, such as changes in worldwide growth objectives,
changes in material costs, performance of acquired businesses and others, could
not adversely impact the Company's consolidated financial position, results of
operations and cash flows in future periods.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2002
Sales increased 27.6% to $592.7 million for the three months ended June 30,
2002, compared with $464.6 million for the same period in 2001. The increase is
primarily associated with the IFC acquisition, which contributed $88.1 million
of sales in the second quarter, and a higher volume of engineered project sales
in the petroleum and water markets. Sales on a comparable basis, excluding IFC,
increased 8.6% to $504.6 million primarily due to a higher volume of project
sales. Currency translation had virtually no impact on second quarter 2002
sales. Net sales to international customers, including export sales from the
U.S., were 52% of sales, compared with
29
45% in the second quarter of 2001. IFC's proportionately higher mix of
international sales contributed to the increase.
Bookings, or incoming orders for which there are purchase commitments,
increased 5.8% to $572.3 million compared with $540.8 million in the prior year.
Excluding the $79.1 million of bookings contributed by IFC, bookings declined
8.8% to $493.2 million compared with the prior year period. The decline in
bookings from comparable operations reflects weakness in quick turnaround
business for the chemical and general industrial sectors (predominately for
industrial pumps and valves) and weakness in the service businesses. That
weakness was partially offset by a valve order of approximately $20 million from
a nuclear power customer. Currency translation had virtually no impact on second
quarter 2002 bookings. At June 30, 2002, backlog was $799.5 million, an increase
of 8.2% compared with the second quarter of 2001 and an increase of 20.6%
compared with year-end 2001. The increase reflects the inclusion of IFC, which
contributed $97.4 million to backlog in the current quarter. Excluding IFC,
backlog was $702.1 million, down about 5.2% from $738.7 million at June 30,
2001, primarily due to lower backlogs in the chemical and general industrial
sectors.
BUSINESS SEGMENTS
Flowserve manages its operations through three business segments: Flowserve
Pump Division (FPD) for engineered and industrial pumps; Flow Solutions Division
(FSD) for precision mechanical seals and flow management services; and Flow
Control Division (FCD) for industrial valves, control valves, nuclear valves and
valve actuators and controls. Several valve distribution centers were
transferred from FSD to FCD in 2002. Amounts reported for these distribution
centers in the second quarter of 2001 have been reclassified to conform to the
current business configuration.
Effective July 1, 2002, the Company realigned its operating segments. Under
the new organization, the Flow Solutions Division will only include the
Company's seal operations, while the Company's pump and valve service businesses
will be included as appropriate in the Flowserve Pump Division and Flow Control
Division, respectively. Segment information will be reported under the new
organization structure beginning in the third quarter of 2002 when the Company
begins to operate under this new organization. A supplemental financial table of
select financial data for the current and previous five quarters reclassified to
conform to the new organization structure has been presented under the
Supplemental Segment Information section of this management discussion and
analysis.
Sales and operating income before special items for each of the three
business segments follows:
<Table>
<Caption>
FLOWSERVE PUMP DIVISION
------------------------
Three Months Ended
June 30,
-----------------------
(In millions of dollars) 2002 2001
- --------------------------------------- ------ -------
Sales $282.4 $ 238.6
Operating income (before special items) 36.6 29.9
</Table>
The 18.4% increase in sales for pumps and pump parts for Flowserve Pump
Division (FPD) in the second quarter of 2002 compared with the second quarter of
2001 was largely due to improved sales of engineered pumps for projects in the
petroleum and water markets. These improvements were partially offset by a lower
volume of sales to the weak chemical and general industrial markets.
Operating income, before special items, increased 22.4% to $36.6 million
from the prior period of $29.9 million. Operating income, before special items,
would have been $33.1 million after implementation of SFAS 141 and 142 for the
second quarter of 2001. Operating income, before special items, as a percentage
of sales increased to 13.0% in the second quarter of 2002 from 12.5% in the
prior year period. Operating income, before special items as a percentage of
sales in 2002 would have decreased from 13.9% in the prior year period had SFAS
141 and 142 been implemented. Operating income, before special items, reflects
30
the benefit of improved sales volume and incremental synergy benefits related to
the capture of approximately $90 million of run rate savings associated with the
integration of IDP. These benefits were partially offset by the impact of a
decline in the chemical and industrial sectors, which historically are more
profitable than the aforementioned engineered pump project mix. In addition,
unfavorable manufacturing burden variances impacted results due to lower volumes
and finished goods inventory reductions in the facilities that manufacture the
chemical and general industrial products. Unfavorable currency translation also
negatively impacted operating income before special items by approximately 3%.
<Table>
<Caption>
FLOW SOLUTIONS DIVISION
-----------------------
Three Months Ended
June 30,
-----------------------
(In millions of dollars) 2002 2001
- --------------------------------------- ------ ------
Sales $155.4 $156.1
Operating income (before special items) 18.1 22.0
</Table>
Sales of seals and services for the Flow Solutions Division for the three
months ended June 30, 2002 of $155.4 million were similar to sales for the three
months ended June 30, 2001. Sales increases in the seal component of the
business of 7.2% were offset by weakness in the service business resulting from
a decline in the power and industrial sectors.
Operating income before special items of $18.1 million was down 17.7% from
the prior year. Operating income before special items in 2002 includes the
favorable benefit from the implementation of SFAS 141 and 142 and would have
been $23.0 million on a comparable basis in second quarter of 200l. Operating
income before special items, as a percentage of sales decreased from 14.1% in
the prior year period (14.8% had SFAS 141 and 142 been implemented in the prior
year period) to 11.6% in the current year period. The decline in profitability
reflects weakness in the service business that was exacerbated by unfavorable
volume variances. This was partially offset by improvements in the seal
business. Additionally, currency translation had an unfavorable impact of
approximately 8%.
<Table>
<Caption>
FLOW CONTROL DIVISION
---------------------
Three Months Ended
June 30,
---------------------
(In millions of dollars) 2002 2001
- --------------------------------------- ------ ------
Sales $163.6 $ 78.1
Operating income (before special items) 15.8 9.2
</Table>
Sales of valves and related products for the Flow Control Division increased
by 109.5% to $163.6 million in the second quarter of 2002 compared with $78.1
million in the prior year. The sales increase was primarily due to the
acquisition of IFC. FCD sales excluding IFC were $75.5 million or 3.3% lower
than the prior year period. Sales excluding IFC were impacted by weakness in the
chemical and general industrial sectors.
Operating income, before special items, was $15.8 million in the second
quarter of 2002 compared with $9.2 million in the prior year period. Operating
income, before special items, on a comparable basis excluding IFC was $5.5
million in the second quarter. Operating income before special items in 2002
includes the favorable benefit from the implementation of SFAS 141 and 142 and
would have been $9.7 million on a comparable basis in the second quarter of
2001. Operating income, before special items, as a percentage of sales, was 9.6%
in the second quarter of 2002, compared with 11.8% in 2001 (12.4% had SFAS 141
and 142 been implemented in the prior period). The decline in profitability
reflects weak conditions in the chemical and general industrial markets, lower
production throughput due to lower sales volume combined with a reduction of
finished goods inventories, which resulted in unfavorable manufacturing
absorption variances.
CONSOLIDATED RESULTS
Gross profit of $182.0 million increased 16.9% compared with the prior year
period primarily due to the acquisition of IFC. The gross profit margin was
30.7% for the three months ended June 30,
31
2002, compared with 33.5% for the same period in 2001. Excluding the impact of
IFC, gross profit and gross profit margin were $156.8 million and 31.1%,
respectively. Gross profit was negatively impacted by an unfavorable product
mix, which contained a lower mix of historically more profitable quick
turnaround business, including lower volumes of chemical and industrial pumps,
industrial valves and service related activities. In addition, gross profit was
adversely impacted by unfavorable manufacturing absorption variances, which were
attributable to lower production throughput due to lower sales volumes and
efforts to reduce finished goods inventories at the facilities that manufacture
products for the chemical and general industrial markets. Gross profit was also
impacted in the second quarter of 2002 by a negative $2.6 million purchase
accounting adjustment associated with the required write-up and subsequent sale
of inventory as a result of the acquisition of IFC. A similar additional
negative adjustment of approximately $2.6 million will also be recorded in the
third quarter of 2002. These negative impacts were partially offset by
incremental IDP synergy savings. The impact on gross profit of no longer
amortizing intangible assets with indefinite useful lives was about $0.3 million
in the second quarter of 2002.
Inventories are stated at the lower of cost or market net of progress
billings for work in process. Cost is determined for U.S. inventories by the
last-in, first-out (LIFO) method and for other inventories by the first-in,
first-out (FIFO) method. The Company's LIFO reserve for U.S. inventories was
$33.4 million at June 30, 2002 compared with $33.9 million at December 31, 2001.
Selling, general and administrative expense was $122.0 million in the second
quarter of 2002 and $104.4 million excluding IFC. These compare with $103.6
million in the second quarter of 2001 or $99.2 million if SFAS 141 and 142 had
been implemented in that period. The increase reflects higher sales commissions
resulting from an increase in engineered product sales and higher incentive
compensation accrual levels as a result of better performance against plan. As a
percentage of sales, selling, general and administrative expense was 20.6% in
the second quarter of 2002 compared with 22.3% in the second quarter of 2001.
The improvement reflects a higher level of sales and the benefit of
implementation of SFAS 141 and 142.
Operating income before special items increased 20.2% to $62.6 million in
the second quarter of 2002 compared with $52.1 million in the year ago period.
Operating income before special items as a percentage of sales was 10.6 % in the
second quarter compared with 11.2% in the prior year period. Excluding IFC,
operating income before special items was up slightly from the prior year at
$52.5 million. Operating income before special items was benefited by $4.8
million in the second quarter of 2002 from the implementation of SFAS 141 and
142. Additionally, results were improved by the incremental synergy benefits
related to the capture of approximately $90 million of run rate savings
associated with the integration of IDP. A less favorable product mix resulting
from the weakened chemical and general industrial sectors and the resultant
unfavorable absorption variances from the lower volume and reduction in finished
goods inventories negatively impacted operating income before special items
during the period. In addition, unfavorable currency translation of 5%
contributed to the decline due to weakening of various Latin American currencies
throughout the quarter partially offset by strengthening of the Euro at quarter
end.
Restructuring expense of $0.6 million and integration expense of $2.0
million related to the integration of IFC into the Flow Control Division were
recognized in the second quarter of 2002. Additional expense is expected in
subsequent quarters. Restructuring expense represents severance and other exit
costs directly related to Flowserve facility closures and reductions in force.
Integration expense represents period costs associated with acquisition related
reorganizations such as performance and retention bonuses, idle manufacturing
costs, costs related to
32
the integration team and asset impairments. Integration expense of $16.9 million
was recognized in the prior year period related to the integration of IDP into
the Flowserve Pump Division. See section titled Restructuring and Acquisition
Related Charges in this Management's Discussion and Analysis for further
discussion of restructuring and integration expense.
Net interest expense during the second quarter of 2002 declined 23.9% to
$23.9 million, compared with $31.4 million in the same period in 2001. The
reduction of net interest expense resulted from lower debt levels associated
with the repayment of one-third of the then outstanding senior subordinated
notes in the fourth quarter of 2001 with proceeds from a sale of the Company's
common shares, lower borrowing spreads associated with the renegotiation of the
Company's revolving credit facility and lower interest rates on the Company's
variable rate debt. However, these factors were partially offset by additional
borrowings of approximately $260 million associated with the purchase of IFC.
Other expense was $1.6 million for the second quarter of 2002 compared with
income of $0.3 million in the prior year. The expense in 2002 reflects a higher
amount of foreign currency transaction losses.
The Company's effective tax rate for the second quarter of 2002 was 35.0%
compared with 36.0% in the second quarter of 2001. The reduction primarily
reflects the elimination of goodwill amortization resulting from the
implementation of SFAS 141 and 142 not deductible for income tax purposes. The
effective tax rate is based upon an estimate of future earnings for each
domestic and international location as well as the estimated impact of tax
planning strategies. Changes in any of these and other factors could impact the
tax rate in future periods.
In the second quarter of 2002, the Company recognized an extraordinary
expense of $6.3 million, net of tax, or $0.12 per share, related to the
write-off of unamortized prepaid financing and other related fees resulting from
the refinancing of the Company's senior credit facility for the IFC acquisition
in May 2002.
Net earnings increased in the second quarter of 2002 to $14.3 million, or
$0.28 per share, compared with earnings of $2.6 million, or $0.07 per share, in
the second quarter of 2001. Excluding special items, net earnings were $24.1
million reflecting an increase of 79.9% compared with $13.4 million in the prior
year quarter. The implementation of SFAS 141 and 142 resulted in an increase of
$3.5 million or $0.07 per share, in earnings in 2002. Special items in the
second quarter of 2002 negatively impacted net earnings by $0.18 per share,
including the $0.12 per share extraordinary loss. Special items in 2001
negatively impacted net earnings by $0.28 per share.
Average diluted shares increased by 35.6% to 52.6 million in the second
quarter of 2002 compared with 38.8 million in the prior year period. The
increase in shares reflects the impact from the issuance of 9.2 million common
shares in late April 2002 to finance the IFC acquisition and the full impact of
the equity offering in November 2001 used to retire debt.
Comprehensive income improved to $56.0 million in the second quarter of 2002
compared with a comprehensive loss of $12.2 million in the prior year due to
improved net earnings and a favorable foreign currency translation adjustment of
$39.8 million resulting from the strengthening of the Euro in June partially
offset by weaker Latin American currencies.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2002
Sales increased 14.4% to $1,039.8 million for the six months ended June 30,
2002, compared with $908.6 million for the same period in 2001. The IFC
acquisition and a higher volume of engineered project sales in the petroleum and
water markets positively impacted sales. IFC contributed $88.1 million of sales
since the date of acquisition. Sales on a comparable basis, excluding IFC, would
have increased 4.7% to $951.7 million. Currency translation had an
33
approximate 3% negative impact on sales for the first six months of 2002 due to
weakening of the Latin American currencies and Euro in the first quarter of 2002
compared with the prior year partially offset by strengthening of the Euro in
June. Net sales to international customers, including export sales from the
U.S., were 50% of sales in 2002, compared with 45% in the prior period. IFC's
proportionately higher mix of international operations contributed to the
increase.
Bookings, or incoming orders for which there are purchase commitments,
increased approximately 1% to $1,046.1 million compared with $1,037.1 million in
the prior year. Excluding the $79.1 million of bookings contributed by IFC,
bookings declined 6.8% to $967.0 million compared with the year ago period. The
decline in bookings from comparable operations reflects weakness in the quick
turnaround business for the chemical and general industrial sectors, which
predominately impacted industrial pumps and valves and weakness in the service
businesses. That weakness was partially offset by a valve order of approximately
$20 million from a nuclear power customer in the second quarter of 2002.
Currency translation negatively impacted bookings by about 2% in the first half
of 2002 compared with the prior year. At June 30, 2002, backlog was $799.5
million, an increase of 8.2% compared with the second quarter of 2001 and an
increase of 20.6% compared with year-end 2001. The increase reflects the
inclusion of IFC, which contributed $97.4 million to backlog in the current
quarter offset partially by lower backlog in the chemical and general industrial
sectors. Excluding IFC, backlog was $702.1 million, down 5.2% from $738.7
million at June 30, 2001, primarily due to lower backlogs in the chemical and
general industrial sectors.
BUSINESS SEGMENTS
Sales and operating income before special items for each of the three
business segments prior to the July 1, 2002 realignment follows:
<Table>
<Caption>
FLOWSERVE PUMP DIVISION
-----------------------
Six Months Ended
June 30,
-----------------------
(In millions of dollars) 2002 2001
- --------------------------------------- ------ ------
Sales $515.7 $ 463.3
Operating income (before special items) 62.7 48.0
</Table>
Sales of pumps and pump parts for the Flowserve Pump Division (FPD) for the
six months ended June 30, 2002 increased 11.3% to $515.7 million compared with
$463.3 million in the prior year. The increase was largely due to higher sales
of engineered pumps for the petroleum and water markets due in part to a higher
backlog than at the beginning of 2001. These improvements were partially offset
by declines in products sold to the chemical and general industrial markets and
unfavorable currency translation of approximately 4%.
Operating income, before special items, for the six months ended June 30,
2002 of $62.7 million increased 30.6% from the prior period of $48.0 million.
Operating income, before special items, would have been $51.3 million after the
implementation of SFAS 141 and 142 in the six month period ended June 30, 2001.
Operating income, before special items, as a percentage of sales increased to
12.2% for the first six months of 2002 from 10.4% in the prior year period
(11.1% had SFAS 141 and 142 been implemented in the prior year period).
Operating income, before special items, reflects the benefit of higher sales
volume, incremental synergy benefits related to the capture of approximately $90
million of run rate savings associated with the integration of IDP. These
benefits were partially offset by the impact of the declines in chemical and
industrial businesses, which historically are more profitable than engineered
pump projects. In addition, unfavorable manufacturing burden variances impacted
results due to lower volumes and finished goods
34
inventory reductions in the facilities that manufacture for the chemical and
general industrial industries. Unfavorable currency translation also negatively
impacted operating income before special items by approximately 5%.
<Table>
<Caption>
FLOW SOLUTIONS DIVISION
-----------------------
Six Months Ended
June 30,
-----------------------
(In millions of dollars) 2002 2001
- --------------------------------------- ------ ------
Sales $302.5 $303.9
Operating income (before special items) 35.1 39.0
</Table>
Sales of seals and services for the Flow Solutions Division for the six
months ended June 30, 2002 of $302.5 million were about flat with same prior
year period. Revenues for seals increased about 6%, while the service business
was down by about 8% due to the decline in the power and industrial business.
Currency translation unfavorably impacted sales by about 2%.
Operating income before special items of $35.1 million decreased 10.0% from
the prior year. Operating income before special items includes the favorable
benefit from the implementation of SFAS 141 and 142 and would have been $40.0
million on a comparable basis in for the six months ended June 30, 2001.
Operating income before special items, as a percentage of sales decreased from
12.8% in the prior year (13.2% had SFAS 141 and 142 been implemented in the
prior period) to 11.6% in the current year period. The decline in profitability
reflects weakness in the service business, despite improvements in the seals
business, that was exacerbated by unfavorable volume variances due to the
overall general economic decline and lower service sales to the power market.
Additionally, unfavorable currency translation impacted operating income before
special items by about 7%.
<Table>
<Caption>
FLOW CONTROL DIVISION
-----------------------
Six Months Ended
June 30,
-----------------------
(In millions of dollars) 2002 2001
- --------------------------------------- ------ ------
Sales $237.1 $156.8
Operating income (before special items) 20.9 18.6
</Table>
Sales of valves and related products for the Flow Control Division increased
51.3% to $237.1 million for the six months ended June 30, 2002 compared with
$156.8 million in the prior year. The sales increase was due to the acquisition
of IFC. FCD sales excluding IFC were $149.0 million or down 5.0% from the prior
year. Sales excluding IFC were impacted by weakness in the chemical and general
industrial sectors.
Operating income, before special items, was $20.9 million for the six months
ended June 30, 2002 compared with $18.6 million in the prior year period.
Operating income, before special items, on a comparable basis excluding IFC was
$10.7 million for the six months ended June 30, 2002. Operating income before
special items includes the favorable benefit from the implementation of SFAS 141
and 142 and would have been $19.3 million on a comparable basis first half of
2001. Operating income, before special items, as a percentage of sales, was 8.8%
for the six month period ended June 30, 2002, compared with 11.9% in 2001. The
decline in profitability reflects weak conditions in the chemical and general
industrial markets. This was compounded by lower production throughput due to
lower sales volume combined with a reduction of finished goods inventories,
which resulted in unfavorable manufacturing absorption variances.
CONSOLIDATED RESULTS
Gross profit increased 10.5% to $324.1 million for the six months ended June
30, 2002 compared with the prior year period reflecting the acquisition of IFC.
The gross profit margin was 31.2% for the six months ended June 30, 2002,
compared with 32.3% for the same period in 2001. Excluding the impact of IFC,
gross profit and gross profit margin were $298.8 and 31.4%, respectively. Gross
profit was negatively
35
impacted by an unfavorable product mix, which contained a lower mix of
historically more profitable quick turnaround business, including lower volumes
of chemical and industrial pumps, industrial valves and service related
activities. In addition, gross profit was adversely impacted by unfavorable
manufacturing absorption variances, which were attributable to lower production
throughput due to lower sales volumes and efforts to reduce finished goods
inventories at the facilities that manufacture products for the chemical and
general industrial markets. Gross profit for the six months ended June 30, 2002
was also impacted by a negative $2.6 million IFC related purchase accounting
adjustment associated with the required write-up and subsequent sale of
inventory. A similar additional negative impact of approximately $2.6 million
will also be recorded in the third quarter of 2002. These negative impacts were
partially offset by incremental IDP synergy benefits related to the capture of
the full run rate of savings. The impact of no longer amortizing intangible
assets with indefinite useful lives on gross profit was $0.7 for the six months
ended June 30, 2002.
Selling, general and administrative expense was $222.2 million in the first
half of 2002 and $204.6 million excluding IFC. These amounts compare with $203.7
million in the first half of 2001 or $194.9 million if the implementation of
SFAS 141 and 142 had been applied in that period. The increase reflects higher
sales commissions resulting from an increase in engineered product sales and
higher incentive compensation accrual levels as a result of better performance
against plan. As a percentage of sales, selling, general and administrative
expense was 21.4% in the six months ended June 30, 2002 compared with 22.4%
(21.5% had SFAS 141 and 142 been implemented in the prior year period) in the
six months ended June 30, 2001. The improvement reflects a higher level of sales
and the benefit of implementation of SFAS 141 and 142.
Operating income before special items increased 16.6% to $104.5 million for
the six months ended June 30, 2002 compared with $89.6 million in the prior
period. Operating income before special items as a percentage of sales was 10.1%
for the six months ended June 30, 2002 compared with 9.9% in the prior year.
Excluding IFC, operating income before special items was up 5.1% from the prior
year at $94.2 million. Operating income before special items benefited by $9.4
million in the first half of 2002 from implementation of SFAS 141 and 142.
Additionally, results were improved by the incremental synergy benefits related
to the capture of the approximately $90 million of run rate savings associated
with the integration of IDP. A less favorable product mix resulting from the
weakened chemical and industrial business and the resultant unfavorable
absorption variances from the lower volume and reduction in finished goods
inventories negatively impacted operating income before special items during the
period. In addition, unfavorable currency translation of 6% negatively impacted
operating income before special items due to weakening of the Latin American
currencies throughout the year and a weaker Euro in the first five months of
2002 compared with the prior year despite strengthening of the Euro in June.
Restructuring expense of $0.6 million and integration expense of $2.0
million were recognized in the second quarter of 2002 related to the integration
of IFC into the Flow Control Division. Additional expense is expected in
subsequent quarters of 2002. Restructuring expense represents severance and
other exit costs directly related to Flowserve facility closures and reductions
in force. Integration expense represents period costs associated with
acquisition related reorganizations such as performance and retention bonuses,
idle manufacturing costs, costs related to the integration team and asset
impairments. Integration expense of $36.0 million related to the integration of
IDP into the Flowserve Pump Division was recognized in the prior year six month
period. See section titled Restructuring and
36
Acquisition Related Charges in this Management's Discussion and Analysis for
further discussion of restructuring and integration expense.
Net interest expense during the first six months of 2002 declined 27.7% to
$45.7 million, compared with $63.2 million in the same period in 2001. The
reduction of net interest expense resulted from lower debt levels associated
with the repayment of one-third of the then outstanding senior subordinated
notes in the fourth quarter of 2001 with proceeds from a sale of the Company's
common shares, lower interest rates associated with the renegotiation of the
Company's revolving credit facility and lower borrowing spreads on the Company's
variable rate debt. However, these factors were partially offset by additional
borrowings of approximately $260 million associated with the purchase of IFC.
Other expense was $2.1 million for the six months ended June 30, 2002
compared with income of $.4 million in the prior year. The increase in expense
reflects a higher amount of foreign currency transaction losses.
The Company's effective tax rate for the first half of 2002 was 35.0%
compared with 36.0% for the first half of 2001. The reduction primarily reflects
the elimination of goodwill amortization resulting from the implementation of
SFAS 141 and 142 not deductible for income tax purposes. The effective tax rate
is based upon an estimate of future earnings for each domestic and international
location as well as the estimated impact of tax planning strategies. Changes in
any of these and other factors could impact the tax rate in future periods.
In the second quarter of 2002, the Company recognized an extraordinary
expense of $6.3 million, net of tax, or $0.13 per share, related to the
write-off of unamortized prepaid financing fees and other related fees resulting
from the refinancing of the Company's senior credit facility for the IFC
acquisition in May 2002.
Net earnings of $27.1 million, or $0.56 per share, for the six month period
ended June 30, 2002 were up significantly from a loss of $5.9 million, or a loss
of $0.16 per share in the prior year. Excluding special items, net earnings were
$36.8 million reflecting an increase of 66.7% compared with $17.2 million in the
prior year quarter. The implementation of SFAS 141 and 142 resulted in an
increase of $6.9 million or $0.14 per share, to earnings in 2002. Special items
in the first half of 2002 negatively impacted net earnings by $0.20 per share
including the $0.13 per share extraordinary loss. Special items in 2001
negatively impacted net earnings by $0.61 per share.
Average diluted shares increased by 27.8% to 49.2 million for the six months
ended June 30, 2002 compared with 38.5 million in the prior year period. The
increase in shares reflects the average weighted impact for the six month period
from the equity offering completed in late April to finance the IFC acquisition
and the full impact of the equity offering in November 2001, used to retire
debt.
Comprehensive income improved to $54.8 million for the six months ended June
30, 2002 from a comprehensive loss of $62.7 million in the prior year. The
improvement reflects improved net earnings and a favorable foreign currency
translation adjustment resulting from the strengthening of the Euro in June
partially offset by weaker Latin America currencies.
RESTRUCTURING AND ACQUISITION RELATED CHARGES
In June 2002, in conjunction with the acquisition of IFC, the Company
initiated a restructuring program designed to reduce costs and to eliminate
excess capacity by consolidating facilities. The Company's actions approved and
committed to in the second quarter of 2002 are expected to result in a gross
reduction of approximately 450 positions and a net reduction of approximately
225 positions. The program includes the announced closure of six valve
facilities and reduction of sales and sales support personnel. The Company
established a reserve of $11.0 million for this program in the second quarter of
2002 and expects the majority of the reductions and closures to occur before
March 2003. Costs
37
associated with the closure of Flowserve facilities of $0.6 million have been
charged to restructuring expense in the income statement and costs associated
with the closure of IFC facilities of $10.4 million along with related deferred
taxes were accounted for in the purchase accounting for IFC.
In the second quarter of 2002, the Company also incurred $2.0 million of
integration expense in conjunction with the program. Expenses classified as
integration generally represent period costs associated with acquisition related
reorganizations such as performance and retention bonuses, idle manufacturing
costs, costs related to the integration team and asset impairments.
Additional restructuring and integration expense related to the IFC
acquisition are expected in subsequent quarters. The impact of additional
restructuring activities will be recorded as programs are detailed, approved and
announced.
Expenditures charged to the 2002 restructuring reserve were:
<Table>
<Caption>
Other
Exit
Severance Costs Total
--------- -------- --------
Balance at June 5, 2002 $ 6,880 $ 4,160 $ 11,040
Cash expenditures (146) (8) (154)
-------- -------- --------
Balance at June 30, 2002 $ 6,734 $ 4,152 $ 10,886
======== ======== ========
</Table>
Similarly, in August 2000, in conjunction with the acquisition of IDP, the
Company initiated a restructuring program designed to reduce costs and to
eliminate excess capacity by consolidating facilities. The Company's actions,
approved and committed to in the third quarter of 2000, have resulted in the net
reduction of approximately 1,100 positions, which was consistent with the plan.
The program included the closure of IDP's former headquarters, the closure or
significant downsizing of a number of pump manufacturing facilities, service and
repair centers, and reduction of sales and sales support personnel. The Company
established a restructuring reserve for this program in the third quarter of
2000.
In the second quarter and for the six months ended 2001, the Company
incurred integration expense in conjunction with the program of $16.9 million
and $36.1 million, respectively. The Company substantially completed its
integration activities during 2001.
Expenditures charged to the 2000 restructuring reserve were:
<Table>
<Caption>
Other
Exit
Severance Costs Total
--------- -------- --------
Balance at August 16, 2000 $ 45,980 $ 14,832 $ 60,812
Cash expenditures (18,645) (2,434) (21,079)
Net non-cash reduction (8,849) -- (8,849)
-------- -------- --------
Balance at December 31, 2000 18,486 12,398 30,884
Cash expenditures (13,267) (6,712) (19,979)
Net non-cash reduction (2,817) (2,567) (5,384)
-------- -------- --------
Balance at December 31, 2001 2,402 3,119 5,521
Cash expenditures (269) (112) (381)
-------- -------- --------
Balance at March 31, 2002 $ 2,133 $ 3,007 $ 5,140
-------- -------- --------
CASH EXPENDITURES (93) (301) (394)
-------- -------- --------
BALANCE AT JUNE 30, 2002 $ 2,040 $ 2,706 $ 4,746
======== ======== ========
</Table>
LIQUIDITY AND CAPITAL RESOURCES
Cash flows from operations and borrowings available under the Company's
existing revolving credit facility are its primary sources of short-term
liquidity. Cash flows provided by operating activities in the second quarter of
2002 were $50.6 million, reflecting an improvement of $61.1 million compared
with a use of $10.5 million in the prior year. Cash flows provided by operating
activities for the six months ended June 30, 2002 were $80.1 million, reflecting
an improvement of $153.1 million compared with a use of funds of $73.0 million
in the prior year six month period. Additionally, the Company's cash balance at
June 30, 2002 was $81.5 million, an increase of $60.0 million since year-end
2001. The Company expects to use a portion of the current cash balance to repay
debt during the second half of 2002.
The improved operating cash flow reflects higher earnings due to lower
interest expense, lower acquisition related integration and restructuring costs
and improved working capital
38
utilization in 2002 compared with the prior year. Additionally, cash flow from
operations in the second quarter of 2002 also benefited from a $23 million tax
refund related to the utilization of net operating loss carrybacks under the new
U.S. tax laws.
The Company believes cash flows from operating activities combined with
availability under its existing revolving credit agreement will be sufficient to
enable the Company to meet its cash flow needs for the next 12 months. However,
cash flows from operations could be adversely affected by economic, political
and other risks associated with sales of the Company's products, operational
factors, competition, fluctuations in foreign exchange rates and fluctuations in
interest rates, among other factors.
Capital expenditures were $8.7 million for the second quarter of 2002 and
$14.8 million for the first six months of 2002. This compares with $18.9 million
for the second quarter of 2001 and $22.4 million for the first six months of
2001. For each period, capital expenditures were invested in new and replacement
machinery and equipment, information technology and, in 2001, IDP integration
activities including structures and equipment required at receiving facilities.
Cash proceeds from the disposal of fixed assets were $1.7 million for the first
six months of 2002 compared with $7.4 million in the prior year. The disposals
in both years relate primarily to the sale of facilities and equipment no longer
being utilized.
PAYMENTS FOR ACQUISITIONS
On May 2, 2002, the Company completed its acquisition of Invensys plc's flow
control division (IFC) for an aggregate purchase price of $535 million (the IFC
Acquisition), subject to adjustment pursuant to the terms of the purchase and
sale agreement. IFC is one of the world's foremost manufacturers of valves,
actuators and associated flow control products. With this acquisition, Flowserve
believes that it will be the second largest manufacturer of valves. The Company
financed the acquisition and associated transaction costs by issuing 9.2 million
shares of common stock in April 2002 for net proceeds of approximately $276
million and through new borrowings under its senior secured credit facilities.
The Company also used $40 million from the proceeds of the equity financing to
reduce amounts outstanding under the Company's revolving credit facility.
The purchase price has been allocated to assets acquired and liabilities
assumed based on estimated fair market value at the date of the acquisition.
These allocations include $78.3 million for intangibles and $190 million
recorded as goodwill.
The purchase price allocation for these acquisitions is preliminary and
further refinements are likely to be made based on the completion of final
valuation studies. The operating results of these acquired businesses have been
included in the consolidated statements of operations from the date of
acquisition.
The Company regularly evaluates acquisition opportunities of various sizes.
The cost and terms of any financing to be raised in conjunction with any
acquisition is a critical consideration in any such evaluation.
FINANCING
In the second quarter of 2002, in connection with the IFC acquisition, the
Company agreed with its lenders under its existing senior credit facilities to
amend the terms of such facilities effective as of the closing of the IFC
acquisition to provide for: (1) an incremental Tranche A term loan in an
aggregate principal amount of $95.3 million and (2) a new Tranche C term loan of
$700 million, to be used to repay all of the existing Tranche B term loan of
$468.8 million, repay $11.3 million of the existing Tranche A term loan and
provide funds to be used to finance the IFC acquisition. The Tranche A loan has
a final maturity date of June 2006. Terms of the new Tranche C term loan include
a final maturity in 2009, rather than 2008 for the former Tranche B term loan
and reduced borrowing
39
spreads. As part of the amended and restated senior credit facility, several
covenants were modified, including various financial ratios, to allow for the
IFC acquisition and other matters. The senior credit facilities are
collateralized by substantially all of the Company's domestic assets and a
pledge of 65% of the stock for the foreign subsidiaries. As a result of repaying
the Tranche B term loan facility, an extraordinary expense of $6.3 million, net
of tax, was recorded in the second quarter of 2002 related to the write-off of
the balance of unamortized prepaid financing fees related to the Tranche B term
loan and other related fees.
The term loans require scheduled principal payments, which began June 30,
2001 for the Tranche A loan and will begin September 30, 2002 for the Tranche C
loan. In addition to the payments made in connection with the refinancing of the
senior credit facility, the Company had repaid $15.5 million of the term loans
(during the first half of 2002). The scheduled principal payments of the term
loans outstanding at June 30, 2002 are summarized as follows: $36.7 million in
the remainder of 2002, $78.7 million in 2003, $84.0 million in 2004, $89.3
million in 2005, $56.0 million in 2006, $100.0 million in 2007, $388.0 million
in 2008 and $194.0 million in 2009. The Company is required to use a percentage
of excess cash from operations under certain circumstances, as defined in the
Credit Facility and the Indenture, to reduce the outstanding principal of the
term loans in the following year. No additional principal payments have been or
are due in 2002 under this provision.
The term loans bear 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 Tranche A can increase or decrease based on the leverage ratio as
defined. At June 30, 2002, the interest rates on the term loans were 4.6713%,
4.6250%, 4.6875% and 4.6250% relating to the Tranche A term loan facility,
6.1395% related to a Euro denominated portion of the Tranche A and 4.750% and
4.875% relating to the Tranche C term loan facility. The Company expects a
reduction in the Tranche A borrowing spread in August 2002 in accordance with
the terms of the amended and restated credit facility. The borrowing spread for
Tranche C can increase or decrease based upon the Company's credit rating from
the two major rating agencies.
Under the amended and restated credit facility, the Company has a $300
million revolving credit facility due June 2006. A portion of the incremental
Tranche C term loan was used to repay $40.0 million of the outstanding
indebtedness under the revolving credit facility. At June 30, 2002, no
borrowings were outstanding on the revolving credit facility. The revolving
credit facility allows the Company to issue up to $200 million in letters of
credit. As of June 30, 2002, $38.2 million of letters of credit had been issued
under the facility. As letters of credit issued under the facility reduce
availability, the Company had $261.8 million remaining in unused borrowing
capacity at June 30, 2002 under the revolving credit facility. In addition to
the letters of credit issued under the facility, there were $7.8 million of
letters of credit outside the facility, at June 30, 2002.
In connection with the acquisition of IDP, the Company issued 10-year senior
subordinated notes on August 8, 2000 in a U.S. dollar tranche and a Euro
tranche. Proceeds of $285.9 million from the dollar tranche and EUR 98.6 million
from the Euro tranche, equivalent to $89.2 million, were used in completing the
IDP acquisition. The balance of the dollar tranche and Euro tranche was $186.3
million and $63.6 million, respectively, at June 30, 2002. The notes, issued at
a fixed rate of 12.25%, were originally priced at a discount to yield 12.50%,
and have no scheduled principal payment prior to maturity in August 2010.
Beginning in August 2005, the notes become callable at a fixed redemption price.
The notes can also be redeemed by the Company under certain circumstances and
have mandatory redemption features under certain circumstances, including a
change in control as defined. Interest on the notes is payable semi-annually in
February and August. About one-third of these notes were called at a premium in
December
40
2001 utilizing the proceeds of an equity offering of 6.9 million shares
according to the mandatory redemption provisions of the Company's indenture.
Although the ratio has decreased over the past year, the Company has
significant indebtedness in relation to shareholders' equity. The Company's
level of indebtedness increases its vulnerability to adverse economic and
industry conditions, may require it to dedicate a substantial portion of cash
flow from operating activities to payments on the indebtedness and could limit
its ability to borrow additional funds and/or raise additional capital. While
the IFC acquisition increased the absolute level of indebtedness, the Company
believes that its ability to service its debt, as measured by various ratios,
has improved.
The provisions of the Company's senior credit facilities require the Company
to meet or exceed specified financial covenants that are defined in the amended
and restated senior credit facility. These covenants include a leverage ratio,
an interest coverage ratio, and a fixed charge coverage ratio. Further, the
provisions of the senior credit facilities and the senior subordinated notes
contain limitations or restrictions on indebtedness, liens, sale and leaseback
transactions, acquisitions, asset sales, payment of dividends or other
distributions, capital expenditures, and other customary restrictions. At June
30, 2002, the Company was in compliance with these financial covenants as
follows: 1) leverage ratio was 3.5 compared with a maximum of 4.0; 2) interest
coverage ratio was 3.6 compared with a minimum of 2.0; 3) and fixed charge ratio
was 1.9 compared with a minimum of 1.1. While the Company expects to comply with
such covenants in the future, there can be no assurance that it will do so.
At June 30, 2002, net debt was 61.1% of the Company's capital structure
compared with 71.3% at December 31, 2001 and 82.3% at June 30, 2001. The ratio
decreased due to the impact of the common stock offering, an increase in
shareholders' equity resulting from improved earnings and favorable currency
translation, repayments of term loans and a reduction in revolving credit
borrowings.
RECENT ACCOUNTING DEVELOPMENTS
On January 1, 2002, the Company adopted SFAS No. 141, "Business
Combinations," and No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141
requires that all business combinations be accounted for using the purchase
method. Additionally, SFAS No. 141 establishes specific criteria for the
recognition of intangible assets separately from goodwill. SFAS No. 142
primarily addresses the accounting for goodwill and intangible assets subsequent
to their acquisition. The most significant changes made by SFAS No. 142 require
that goodwill and indefinite lived intangible assets no longer be amortized and
be tested for impairment at least on an annual basis. Additionally, the
amortization period of intangible assets is no longer limited to forty years.
Upon implementation of SFAS 141 and 142, the Company reclassified acquired
workforce intangible assets with a net carrying value of approximately $18.5
million to goodwill that do not meet the new criteria for recognition apart from
goodwill. The Company also determined that certain acquired trademark intangible
assets have indefinite useful lives and is no longer amortizing these intangible
assets. Under SFAS 142, goodwill is no longer amortized and instead is tested
for impairment annually at the reporting unit level or whenever events or
circumstances indicate goodwill may be impaired. The Company has completed the
required transitional goodwill and indefinite lived intangible asset impairment
tests and determined these assets were not impaired.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 is effective for
the Company on January 1, 2003. The Company
41
is currently assessing the impact of SFAS No. 143 and has not yet determined the
effects, if any, it will have on its consolidated financial position or results
of operations.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." The most significant impact of
SFAS 145 is to eliminate the requirement that gains and losses from the
extinguishments of debt be classified as an extraordinary item unless these
items are infrequent and unusual in nature. SFAS 145 is effective for the
Company on January 1, 2003. The Company will reclassify previously reported
extraordinary items as a component of earnings before income taxes effective
with compliance in 2003.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities".
SFAS 146 requires that a liability for a cost associated with an exit or
disposal activity be recognized initially at fair value when the liability is
incurred. SFAS No. 146 is effective for the Company on January 1, 2003, and will
be applied on a prospective basis.
42
SUPPLEMENTAL SEGMENT INFORMATION
Effective July 1, 2002, the Company realigned its operating segments. Under
the new organization, the Flow Solutions Division will only include the
Company's seal operations, while the Company's pump and valve service businesses
will be included as appropriate in the Flowserve Pump Division and Flow Control
Division, respectively. Segment information will be reported under the new
organization structure beginning in the third quarter of 2002 when the Company
begins to operate under this new organization structure. The following
supplemental financial table contains selected segment financial data for the
current and previous five quarters reclassified to conform to the new
organization structure.
<Table>
<Caption>
Flowserve Flow Flow All Consolidated
Three months ended June 30, 2002 Pump Solutions Control Other Total
- ----------------------------------------- --------- --------- -------- -------- ------------
Sales to external customers $315,623 $ 82,472 $193,028 $ 1,605 $592,728
Intersegment sales 2,792 5,682 1,432 (9,906) --
Segment operating income (before special
items) (1) 42,412 16,468 11,636 (7,862) 62,654
</Table>
<Table>
<Caption>
Flowserve Flow Flow All Consolidated
Three months ended March 31, 2002 Pump Solutions Control Other Total
- ----------------------------------------- --------- --------- -------- -------- ------------
Sales to external customers $264,655 $ 79,662 $101,030 $ 1,703 $447,500
Intersegment sales 1,878 4,967 1,696 (8,541) --
Segment operating income 29,953 14,432 3,880 (6,386) 41,879
</Table>
<Table>
<Caption>
Flowserve Flow Flow All Consolidated
Three months ended December 31, 2001 Pump Solutions Control Other Total
- ----------------------------------------- --------- --------- -------- -------- ------------
Sales to external customers $354,971 $ 75,490 $107,316 $ 1,511 $539,288
Intersegment sales 2,580 4,818 1,895 (9,293) --
Segment operating income (before special
items) (2) 56,195 9,163 5,313 (7,574) 63,097
</Table>
<Table>
<Caption>
Flowserve Flow Flow All Consolidated
Three months ended September 30, 2001 Pump Solutions Control Other Total
- ----------------------------------------- --------- --------- -------- -------- ------------
Sales to external customers $278,313 $ 79,759 $110,191 $ 1,342 $469,605
Intersegment sales 2,569 5,025 2,102 (9,696) --
Segment operating income (before special
items) (2) 31,961 16,231 10,788 (7,664) 51,316
</Table>
<Table>
<Caption>
Flowserve Flow Flow All Consolidated
Three months ended June 30, 2001 Pump Solutions Control Other Total
- ----------------------------------------- --------- --------- -------- -------- ------------
Sales to external customers $272,115 $ 77,188 $113,760 $ 1,516 $464,579
Intersegment sales 2,905 5,203 1,994 (10,102) --
Segment operating income (before special
items) (2) 34,893 13,980 12,127 (8,894) 52,106
</Table>
<Table>
<Caption>
Flowserve Flow Flow All Consolidated
Three months ended March 31, 2001 Pump Solutions Control Other Total
- ----------------------------------------- --------- --------- -------- -------- ------------
Sales to external customers $255,852 $ 75,655 $111,522 $ 1,006 $444,035
Intersegment sales 923 4,871 2,706 (8,500) --
Segment operating income (before special
items) (2) 21,411 12,128 11,015 (7,085) 37,469
</Table>
(1) Special items in 2002 reflect costs associated with the acquisition of IFC
including a negative purchase accounting write-up of inventory, integration
expense and restructuring expense.
(2) Special items in 2001 reflect costs associated with the integration of IDP.
43
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
This Report on Form 10-Q and other written reports and oral statements made from
time-to-time by the Company contain various forward-looking statements and
include assumptions about Flowserve's future market conditions, operations and
results. These statements are based on current expectations and are subject to
significant risks and uncertainties. They are made pursuant to safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Among the
many factors that could cause actual results to differ materially from the
forward-looking statements are: changes in the financial markets and the
availability of capital, changes in the already competitive environment for the
Company's products or competitors' responses to Flowserve's strategies; the
Company's ability to integrate past and future acquisitions into its management
and operations; political risks or trade embargoes affecting important country
markets; the health of the petroleum, chemical and power industries; economic
conditions and the extent of economic growth in areas inside and outside the
United States; unanticipated difficulties or costs associated with the
implementation of systems, including software; the recognition of expenses
associated with adjustments to realign the combined Company and IFC facilities
and other capabilities with its strategic and business conditions, including,
without limitation, expenses incurred in restructuring the Company's operations
to incorporate IFC facilities, the Company's ability to meet the financial
covenants and other requirements of its financing agreements; repercussions from
the terrorist attacks of September 11, 2001, and the response of the United
States to those attacks; technological developments in the Company's products as
compared with those of its competitors; changes in prevailing interest rates and
the effective interest costs which the Company bears; and adverse changes in the
regulatory climate and other legal obligations imposed on the Company. The
Company undertakes no obligation to publicly update or revise any
forward-looking statement as a result of new information, future events or
otherwise.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
The Company has market risk exposure arising from changes in interest rates
and foreign currency exchange rate movements.
The Company's earnings are impacted by changes in short-term interest rates
as a result of borrowings under its Credit Facility, which bear interest based
on floating rates. At June 30, 2002, after the effect of interest rate swaps
held by the Company, the Company had approximately $877.5 million of
variable-rate debt obligations outstanding with a weighted average interest rate
of 4.77%. A hypothetical change of 100-basis points in the interest rate for
these borrowings, assuming debt levels at June 30, 2002, would change interest
expense by approximately $2.2 million for the quarter ended June 30, 2002.
The Company, as part of its risk management program, is party to interest
rate swap agreements for the purpose of hedging its exposure to floating
interest rates on certain portions of its debt. The Company is exposed to
credit-related losses in the event of non-performance by counterparties to
financial instruments, but it expects all counterparties to meet their
obligations given their creditworthiness. As of June 30, 2002, the Company had
$150.0 million of notional amount in outstanding interest rate swaps with third
parties with maturities through November 2006.
The Company employs a foreign currency hedging strategy to minimize
potential losses in earnings or cash flows from unfavorable foreign currency
exchange rate movements. Foreign currency exposures arise from transactions,
including firm commitments and anticipated transactions, denominated in a
currency other than an entity's functional currency and from foreign-denominated
revenues and profits translated back into U.S. dollars. Based on the sensitivity
analysis at June 30, 2002, a 10% adverse change in the foreign currency exchange
rates could impact the Company's results of operations by $1.9 million. The
primary currencies to which the Company has exposure are the Euro, British
pound, Canadian dollar, Mexican peso, Japanese yen, Singapore dollar, Brazilian
real, Australian dollar, Argentine peso and Venezuelan bolivar.
Exposures are hedged primarily with foreign currency forward contracts that
generally have maturity dates less than one year. Company policy allows foreign
currency coverage only for identifiable foreign currency exposures and,
therefore, the Company does not enter into foreign currency contracts for
trading purposes where the objective is to generate profits. As of June 30,
2002, the Company had an U.S. dollar equivalent of $50.1 million in outstanding
forward contracts with third parties.
Generally, the Company views its investments in foreign subsidiaries from a
long-term perspective, and therefore, does not hedge these investments. The
Company uses capital structuring techniques to manage its investment in foreign
subsidiaries as deemed necessary.
45
PART II OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the second quarter of 2002, the Company issued 5,000 shares of
restricted common stock pursuant to an exemption from registration under
Section 4(2) of the Securities Act of 1933. Shares were issued for the benefit
of outside directors, subject to restrictions on transfer and vesting.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
(a) The Annual meeting of Shareholders of the Company was held on
April 18, 2002.
(b) A proposal to approve re-election of three Directors to the
Board of Directors, in each case for a term of three years,
was approved as follows with respect to each nominee for office:
<Table>
<Caption>
VOTES VOTES
FOR WITHHELD
---------- --------
Michael F. Johnston 38,923,994 203,483
Charles M. Rampacek 38,803,758 323,719
Kevin E. Sheehan 38,914,606 212,871
</Table>
ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K
(a) Exhibits 99.1 and 99.2
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed with the Securities
and Exchange Commission during the quarterly period covered by this
report:
Current Report on Form 8-K filed on April 5, 2002, pursuant to Item 9
Regulation FD Disclosure) announcing preliminary first quarter 2002
financial information.
Current Report on Form 8-K filed on April 3, 2002, pursuant to Item 5
(Other Events) announcing a public offering of Flowserve Corporation
common stock.
Current Report on Form 8-K filed on May 13, 2002, pursuant to Item 2
(Acquisition or Disposition of Assets) to announce completion of the
acquisition of the Flow Control Division of Invensys plc (IFC) and Item 7
(Financial Statements, Pro Forma Financial Information and Exhibits) to
file and incorporate by reference into the Current Report on Form 8-K
dated as of April 3, 2002, the unaudited condensed combined financial
statements of IFC.
46
SIGNATURE
Pursuant to the requirements of the Securities and 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)
/s/ Renee J. Hornbaker
---------------------------------------------
Renee J. Hornbaker
Vice President and Chief Financial Officer
Date: August 14, 2002
47
EXHIBITS INDEX
<Table>
<Caption>
Exhibit Number Description
- -------------- -----------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes Oxley Act
of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes Oxley Act
of 2002.
</Table>