UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-13179
FLOWSERVE CORPORATION
(Exact name of registrant as specified in its charter)

 flslogo.gif
New York
 
31-0267900
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
5215 N. O’Connor Boulevard
75039
Suite 2300, Irving, Texas
 (Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code:
(972) 443-6500
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $1.25 Par Value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
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 þ     No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes þ     No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller Reporting company o
Emerging growth company o
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
The aggregate market value of the common stock held by non-affiliates of the registrant, computed by reference to the closing price of the registrant’s common stock as reported on June 29, 2018 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $2,439,873,483. For purposes of the foregoing calculation only, all directors, executive officers and known 5% beneficial owners have been deemed affiliates.
Number of the registrant’s common shares outstanding as of February 13, 2019 was 130,982,978.

DOCUMENTS INCORPORATED BY REFERENCE
Certain information contained in the definitive proxy statement for the registrant’s 2019 Annual Meeting of Shareholders scheduled to be held on May 23, 2019 is incorporated by reference into Part III hereof.

 
 
 


FLOWSERVE CORPORATION
FORM 10-K

TABLE OF CONTENTS
 
 
Page
 
Item 9B.
 
 
Item 16.


i


PART I
ITEM 1.
BUSINESS
OVERVIEW
Flowserve Corporation is a world leading manufacturer and aftermarket service provider of comprehensive flow control systems. Flowserve Corporation as it exists today was created in 1997 through the merger of two leading fluid motion and control companies — BW/IP and Durco International. Under the name of a predecessor entity, we were incorporated in the State of New York on May 1, 1912, but some of our heritage product brand names date back to our founding in 1790. Over the years, we have evolved through organic growth and strategic acquisitions, and our over 225-year history of Flowserve heritage brands serves as the foundation for the breadth and depth of our products and services today. Unless the context otherwise indicates, references to "Flowserve," "the Company" and such words as "we," "our" and "us" include Flowserve Corporation and its subsidiaries.
We develop and manufacture precision-engineered flow control equipment integral to the movement, control and protection of the flow of materials in our customers’ critical processes. Our product portfolio of pumps, valves, seals, automation and aftermarket services supports global infrastructure industries, including oil and gas, chemical, power generation (including nuclear, fossil and renewable) and water management, as well as certain general industrial markets where our products and services add value. Through our manufacturing platform and global network of Quick Response Centers ("QRCs"), we offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting.
We sell our products and services to more than 10,000 companies, including some of the world’s leading engineering, procurement and construction firms ("EPC"), original equipment manufacturers, distributors and end users. Our products and services are used in several distinct industries having a broad geographic reach. Our bookings mix by industry in 2018 and 2017 consisted of:
 
2018
 
2017
•   oil and gas
38
%
 
38
%
•   general industries(1)
25
%
 
24
%
•   chemical(2)
22
%
 
21
%
•   power generation
11
%
 
13
%
•   water management
4
%
 
4
%
(1)
General industries include mining and ore processing, pulp and paper, food and beverage and other smaller applications, as well as sales to distributors whose end customers typically operate in the industries we primarily serve.
(2)Chemical industry is comprised of chemical-based and pharmaceutical products.
 
We have pursued a strategy of industry diversity and geographic breadth to mitigate the impact on our business of normal economic downturns in any one of the industries or in any particular part of the world we serve. For events that may occur and adversely impact our business, financial condition, results of operations and cash flows, refer to "Item 1A. Risk Factors" of this Annual Report on Form 10-K for the year ended December 31, 2018 ("Annual Report"). For information on our sales and long-lived assets by geographic areas, see Note 17 to our consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" ("Item 8") of this Annual Report.
 
Through December 31, 2018, we conducted our operations through three segments: Engineered Product Division ("EPD"), Industrial Product Division ("IPD") and Flow Control Division ("FCD"). Sales to external customers, intersegment sales, operating profit and the presentation of certain other financial information by segment are reported in Note 17 to our consolidated financial statements included in Item 8 of this Annual Report and in the Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Our business segments share a focus on industrial flow control technology and benefit from our global footprint and our economies of scale in reducing administrative and overhead costs to serve customers more cost effectively. EPD and IPD have a high number of common customers and complementary product offerings and technologies that are often combined in applications that provide us a net competitive advantage. All segments share certain resources and functions, including elements of research and development ("R&D"), supply chain, safety, quality assurance and administrative functions that provide efficiencies and an overall lower cost structure.

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Our operations leadership reports to our Chief Executive Officer and the segments share leadership for operational support functions such as R&D, marketing and supply chain. We believe this leadership structure positions the Company to leverage operational excellence, cost reduction initiatives and internal synergies across our entire operating platform to drive further growth and increase shareholders' value.
In the second quarter of 2018, we launched and committed resources to our Flowserve 2.0 Transformation ("Flowserve 2.0 Transformation"), a program designed to transform our business model to drive operational excellence, reduce complexity, accelerate growth, expand margins, increase capital efficiency and improve organizational health. During the latter part of 2018 and in connection with the Flowserve 2.0 Transformation, we determined that there are meaningful operational synergies and benefits to combining our EPD and IPD reportable segments into one reportable segment, the Flowserve Pump Division ("FPD"). The reorganization will be effective as of January 1, 2019 and as a result, beginning in 2019 we will report a two operating segment structure, FPD and FCD, and prior periods will be retrospectively adjusted to reflect the new reportable segment structure. For further discussion of the Flowserve 2.0 Transformation program refer to Note 19 to our consolidated financial statements included in Item 8 of this Annual Report.
Strategies
Our overarching objectives are to be a leader in each of the market segments we serve and become the employer of choice in the flow control industry. Additionally, we seek to be recognized by our customers as the most trusted brand in terms of reliability and quality, which we believe will help maximize shareholder value.
In pursuit of these objectives, we maintain a rolling, five-year strategic plan that takes a balanced approach to integrating both short-term and long-term initiatives in four key areas: People, Process & Technology, Customer and Finance.
People
With the goal of developing and maintaining a people-first culture that produces the finest talent, we focus on several elements in our strategic efforts to continuously enhance our organizational capability, including: (i) fully committing to providing a safe work environment for all our associates, worldwide, (ii) upholding a high-performance workforce, that is empowered, accountable, and flexible, (iii) becoming the employer of choice by fostering a people-first culture and (iv) recruiting, developing, and retaining a global and diverse workforce.
Process and Technology
With the goal of improving our productivity and delivering a continuous stream of innovating solutions to our customers, we focus on select strategies relating to: (i) developing and maintaining an enterprise-first business approach across all operating units and functional organizations, (ii) simplifying our business processes and optimizing corporate structural costs, (iii) significantly reducing our product cost and rationalizing our product portfolio and (iv) becoming the technical leader in the flow control industry.
Customer
With the goal of achieving the highest level of customer satisfaction amongst our peers, we focus on select strategies related to rigorous and disciplined selection of target markets and customers, while maintaining competitive lead times and emphasizing the highest levels of on-time delivery and quality. We seek to provide an outstanding experience for our customers over the entire product lifecycle by providing unique, integrated flow-control solutions that solve real-world application problems in our customers’ facilities.
Finance
With the goal of growing the value of our enterprise, we focus on select strategies we believe will increase our revenue above the rate of market growth, while optimizing performance in terms of gross margin, selling, general and administrative ("SG&A") expense, operating margin, cash flow and primary working capital.
Flowserve 2.0 Transformation
The goals of the Flowserve 2.0 Transformation are to (i) accelerate revenue growth, (ii) drive margin expansion, (iii) increase capital efficiency and (iv) improve organizational health. The Flowserve 2.0 Transformation consists of over a hundred of individual projects spread over six work-streams (operations, commercial, growth, aftermarket, cost structure and working capital). A majority of these projects are primarily focused on accelerating revenue growth, while the balance are

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primarily focused on cost reduction and capital efficiency. The projects include elements of organizational design, business process definition, process automation and metrics. Individual projects vary in terms of time to execute, ranging from one year for simple quick-fix efforts to five years for more complex infrastructure efforts. A structured process has been created to ensure that each project follows common milestones and delivers value over its lifecycle, with a governance process that oversees the portfolio to ensure that time-phased trade-offs between cost and benefits are proactively managed. The project portfolio is actively covered by a dedicated transformation office to ensure that projects are managed from inception to execution to protect the long-term value of the transformation.
Competition
Despite consolidation activities in past years, the markets for our products remain highly competitive, with primary competitive drivers being price, reputation, project management, timeliness of delivery, quality, proximity to service centers and technical expertise, as well as contractual terms and previous installation history. In the pursuit of large capital projects, competitive drivers and competition vary depending on the industry and products involved. Industries experiencing slow growth generally tend to have a competitive environment more heavily influenced by price due to supply outweighing demand and price competition tends to be more significant for original equipment orders than aftermarket services. Considering the current forecasts for 2019, pricing for original equipment orders may continue to be a particularly influential competitive factor. The unique competitive environments in each of our three business segments are discussed in more detail under the “Business Segments” heading below.
In the aftermarket portion of our business, we compete against large, well-established national and global competitors and, in some markets, against regional and local companies. In the oil and gas and chemical industries, the primary competitors for aftermarket services tend to be customers’ own in-house capabilities. In the nuclear power generation industry, we possess certain competitive advantages due to our "N Stamp" certification, which is a prerequisite to serve customers in that industry, as well as our considerable base of proprietary knowledge. Aftermarket competition for standardized products is aggressive due to the existence of common standards allowing for easier replacement or repair of the installed products.
In the sale of aftermarket products and services, we benefit from our large installed base of pumps, valves and seals, which continually require maintenance, repair and replacement parts due to the nature of the products and the conditions under which they operate. Timeliness of delivery, quality and the proximity of service centers are important customer considerations when selecting a provider for aftermarket products and services. In geographic regions where we are locally positioned to provide a quick response, customers have traditionally relied on us, rather than our competitors, for aftermarket products relating to our highly-engineered and customized products, although we are seeing increased competition in this area.
Generally, our customers attempt to reduce the number of vendors from which they purchase, thereby reducing the size and diversity of their supply chain. Although vendor reduction programs could adversely affect our business, we have been successful in establishing long-term supply agreements with a number of customers. While the majority of these agreements do not provide us with exclusive rights, they can provide us a "preferred" status with our customers and thereby increase opportunities to win future business. We also utilize our LifeCycle Advantage program to establish fee-based contracts to manage customers’ aftermarket requirements. These programs provide an opportunity to manage the customer’s installed base and expand the business relationship with the customer.
Our ability to use our portfolio of products, solutions and services to meet customer needs is a competitive strength. Our market approach is to create value for our customers throughout the life cycle of their investments in flow control management. We continue to explore and develop potential new offerings in conjunction with our customers. In the early phases of project design, we endeavor to create value in optimizing the selection of equipment for the customer’s specific application, as we are capable of providing technical expertise on product and system capabilities even outside the scope of our specific products, solutions and services. After the equipment is constructed and delivered to the customer’s site, we continue to create value through our aftermarket capabilities by optimizing the performance of the equipment over its operational life. Our skilled service personnel can provide these aftermarket services for our products, as well as many competitors’ products, within the installed base. This value is further enhanced by the global reach of our QRCs and, when combined with our other solutions for our customers’ flow control management needs, allows us to create value for our customers during all phases of the capital and operating expenditure cycles.
 

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Customers
We sell to a wide variety of customers globally including leading EPC firms, original equipment manufacturers, distributors and end users in several distinct industries: oil and gas, chemical, power generation, water management and general industries. We do not have sales to any individual customer that represent 10% or more of consolidated 2018 revenues. Customer information relating to each of our three business segments is discussed in more detail under the "Business Segments" heading below.
We are not normally required to carry unusually high amounts of inventory to meet customer delivery requirements, although higher backlog levels and longer lead times generally require higher amounts of inventory. We typically require advance cash payments from customers on longer lead time projects to help offset our investment in inventory. We have initiated programs targeted at improving our operational effectiveness to reduce our overall working capital needs. While we do provide cancellation policies through our contractual relationships, we generally do not provide rights of product return for our customers.
Selling and Distribution
We primarily distribute our products through direct sales by employees assigned to specific regions, industries or products. In addition, we use distributors and sales representatives to supplement our direct sales force in countries where it is more appropriate due to business practices or customs, or whenever the use of direct sales staff is not economically efficient. We generate a majority of our sales leads through existing relationships with vendors, customers and prospects or through referrals.
Intellectual Property
We own a number of trademarks and patents relating to the names and designs of our products. We consider our trademarks and patents to be valuable assets of our business. In addition, our pool of proprietary information, consisting of know-how and trade secrets related to the design, manufacture and operation of our products, is considered particularly valuable. Accordingly, we take proactive measures to protect such proprietary information. We generally own the rights to the products that we manufacture and sell and are unencumbered by licensing or franchise agreements. Our trademarks can typically be renewed indefinitely as long as they remain in use, whereas our existing patents generally expire 10 to 20 years from the dates they were filed, which has occurred at various times in the past. We do not believe that the expiration of any individual patent will have a material adverse impact on our business, financial condition or results of operations.
Raw Materials
The principal raw materials used in manufacturing our products are readily available and include ferrous and non-ferrous metals in the form of bar stock, machined castings, fasteners, forgings and motors, as well as silicon, carbon faces, gaskets and fluoropolymer components. A substantial volume of our raw materials is purchased from outside sources, and we have been able to develop a robust supply chain and anticipate no significant shortages of such materials in the future. We continually monitor the business conditions of our suppliers to manage competitive market conditions and to avoid potential supply disruptions. We continue to expand global sourcing to capitalize on localization in emerging markets and low-cost sources of purchased goods balanced with efficient consolidated and compliant logistics.
Metal castings used in the manufacture of our pump, valve, and mechanical seals are purchased from qualified and approved foundry sources. We remain vertically integrated with metal castings in certain strategic product families.   
Concerning the products we supply to customers in the nuclear power generation industry, suppliers of raw materials for nuclear power generation markets must be qualified to meet the requirements of nuclear industry standards and governmental regulations. Supply channels for these materials are currently adequate, and we do not anticipate difficulty in obtaining such materials in the future.
Employees and Labor Relations
We have approximately 17,000 employees globally as of December 31, 2018. In the United States ("U.S."), a portion of the hourly employees at our pump manufacturing plant located in Vernon, California, our valve manufacturing plant located in Lynchburg, Virginia and our pattern storage facility located in Dayton, Ohio, are represented by unions. Additionally, some employees at select facilities in the following countries are unionized or have employee works councils: Argentina, Australia, Austria, Brazil, Finland, France, Germany, India, Italy, Japan, Mexico, The Netherlands, South Africa, Spain, Sweden and the United Kingdom ("U.K."). We believe relations with our employees throughout our operations are generally satisfactory,

4


including those employees represented by unions and employee works councils. No unionized facility accounted for more than 10% of our consolidated 2018 revenues.
Environmental Regulations and Proceedings
We are subject to environmental laws and regulations in all jurisdictions in which we have operating facilities. These requirements primarily relate to the generation and disposal of waste, air emissions and waste water discharges. We periodically make capital expenditures to enhance our compliance with environmental requirements, as well as to abate and control pollution. At present, we have no plans for any material capital expenditures for environmental control equipment at any of our facilities. However, we have incurred and continue to incur operating costs relating to ongoing environmental compliance matters. Based on existing and proposed environmental requirements and our anticipated production schedule, we believe that future environmental compliance expenditures will not have a material adverse effect on our financial condition, results of operations or cash flows.
We use hazardous substances and generate hazardous wastes in many of our manufacturing and foundry operations. Most of our current and former properties are or have been used for industrial purposes and some may require clean-up of historical contamination. During the due diligence phase of our acquisitions, we conduct environmental site assessments to identify potential environmental liabilities and required clean-up measures. We are currently conducting follow-up investigation and/or remediation activities at those locations where we have known environmental concerns. We have cleaned up a majority of the sites with known historical contamination and are addressing the remaining identified issues.
Over the years, we have been involved as one of many potentially responsible parties ("PRP") at former public waste disposal sites that are or were subject to investigation and remediation. We are currently involved as a PRP at five Superfund sites. The sites are in various stages of evaluation by government authorities. Our total projected "fair share" cost allocation at these five sites is expected to be immaterial. See "Item 3. Legal Proceedings" included in this Annual Report for more information.
We have established reserves that we currently believe to be adequate to cover our currently identified on-site and off-site environmental liabilities.
Exports
Our export sales from the U.S. to foreign unaffiliated customers were $234.3 million in 2018, $258.3 million in 2017 and $259.1 million in 2016.
Licenses are required from U.S. and other government agencies to export certain products. In particular, products with nuclear power generation and/or military applications are restricted, as are certain other pump, valve and seal products.
BUSINESS SEGMENTS
In addition to the business segment information presented below, Note 17 to our consolidated financial statements in Item 8 of this Annual Report contains additional financial information about our business segments and geographic areas in which we have conducted business in 2018, 2017 and 2016.
ENGINEERED PRODUCT DIVISION
Our largest business segment is EPD, through which we design, manufacture, distribute and service specialty, custom and other highly-engineered pumps and pump systems, mechanical seals, auxiliary systems, replacement parts and upgrades and related aftermarket services. EPD includes longer lead time, highly-engineered specialty pump products and systems and mechanical seals that are generally manufactured within shorter lead times. EPD also manufactures replacement pumps and upgrades and provides a full array of replacement parts, repair and support services (collectively referred to as "aftermarket"). EPD products and services are primarily used by companies that operate in the oil and gas, petrochemical, chemical, power generation, water management and other general industries. We market our pump and mechanical seal products through our global sales force and our regional QRCs and service and repair centers or through independent distributors and sales representatives. A portion of our mechanical seal products are sold directly to other original equipment manufacturers for incorporation into their rotating equipment requiring mechanical seals.
Our engineered pump products are manufactured in a wide range of metal alloys and with a variety of configurations to reliably meet the operating requirements of our customers. Mechanical seals are critical to the reliable operation of rotating equipment in that they prevent leakage and emissions of hazardous substances from the rotating equipment and reduce shaft

5


wear on the equipment caused by the use of non-mechanical seals. We also manufacture a gas-lubricated mechanical seal that is used in high-speed compressors for gas pipelines and in the oil and gas production and process markets. Our products are currently manufactured at 28 plants worldwide, eight of which are located in Europe, nine in North America, six in Asia Pacific and five in Latin America, including those co-located in manufacturing facilities and/or shared with IPD.
We also conduct business through strategic foreign joint ventures. We have five unconsolidated joint ventures that are located in China, India, Saudi Arabia, South Korea and the United Arab Emirates, where a portion of our products are manufactured, assembled or serviced in these territories. These relationships provide numerous strategic opportunities, including increased access to our current and new markets, access to additional manufacturing capacity and expansion of our operational platform to support best-cost sourcing initiatives and balance capacity demands for other markets.
EPD Products
We manufacture more than 40 different active types of pumps and approximately 185 different models of mechanical seals and sealing systems. The following is a summary list of our EPD product types and globally recognized brands:
EPD Product Types
Single and Multistage Between Bearings Pumps
 
Single Stage Overhung Pumps
•   Single Case — Axially Split
 
•   API Process
•   Single Case — Radially Split
 
 
•   Double Case
 
 
Positive Displacement Pumps
 
Mechanical Seals and Seal Support Systems
•   Rotary Multiphase
 
•   Dry-Running Seals
•   Rotary Screw
 
•   Gas Barrier Seals
 
 
•   Standard Cartridge Seals
Vertical Pumps
 
•   Mixer Seals
•   Vertical inline
 
•   Compressor Seals
•   Vertical line shaft
 
•   Seal Support Systems
•   Vertical canned shaft
 
•   Bearing Isolators
 
 
•   Barrier Fluids and Lubricants
Specialty Products
 
 
•   Nuclear Pumps
 
•   Power Recovery — DWEER
•   Nuclear Seals
 
•   Power Recovery — Hydro turbine
•   Cryogenic Pumps
 
•   Energy Recovery Devices
•   Concrete Volute Pumps
 
•   Hydraulic Decoking Systems
•   Wireless Transmitters
 
•   API Slurry Pumps
•   Ebullator recycle pumps
 
 


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EPD Brand Names
•   BW Seals
 
•   Niigata Worthington
•   Calder Energy Recovery Devices
 
•   QRC™
•   Durametallic
 
•   Pacific
•   Five Star Seal
 
•   Pacific Weitz
•   Flowserve
 
•   Pac-Seal
•   GASPAC™
 
•   ReadySeal
•   IDP
 
•   United Centrifugal
•   Interseal
 
•   Western Land Roller
•   Lawrence
 
•   Wilson-Snyder
•   LifeCycle Advantage
 
•   Worthington
 
 
•   Worthington-Simpson

EPD Services
We provide engineered aftermarket services through our global network of 119 QRCs, some of which are co-located in manufacturing facilities, in 47 countries. Our EPD service personnel provide a comprehensive set of equipment services for flow management control systems, including installation, commissioning, repair, advanced diagnostics, re-rate and retrofit programs, machining and comprehensive asset management solutions. We provide asset management services and condition monitoring for rotating equipment through special contracts with many of our customers that reduce maintenance costs. A large portion of EPD’s service work is performed on a quick response basis, and we offer 24-hour service in all of our major markets.
EPD New Product Development
Our investments in new product R&D continue to focus on increasing the capability of our products as customer applications become more advanced, demanding greater levels of production (i.e., flow and power) and under more extreme conditions (i.e., erosive, corrosive and temperature) beyond the level of traditional technology. We continue to develop innovations that improve our competitive position in the engineered equipment industry, specifically upstream, offshore and downstream applications for the oil and gas market. Continued engagement with our end users is exemplified through completion of advancements that significantly improve energy efficiency, reduce total cost-of-ownership and enhance safety.
As new sources of energy generation are explored, we continue to develop new product designs to support the most critical applications in the power generation market. New designs and qualification test programs continue to support the critical services found in the coal fired, combined cycle, small modular nuclear and concentrated solar power generation plant.
We continue to address our core products with design enhancements that improve performance, reduce acquisition costs, extend operating life between required maintenance periods and reduce the lead times in which we can deliver our products. Our engineering teams continue to apply and develop sophisticated design technology and methods supporting continuous improvement of our proven technology. Additionally, we are incentivizing our operations and tracking the R&D projects more closely, which is leading to broader engagement in developing new products.
In 2018, EPD continued to advance our Intelligent Performance Solutions ("IPS") Insight platform. This platform utilizes a combination of our developed technologies and leading edge technology partners to increase our remote monitoring, diagnostics, asset management and service capabilities for our end-user customers. These technologies include intelligent devices, advanced communication and security protocols, wireless and satellite communications and web-enabled data convergence. Additionally, we have been exploring additive manufacturing opportunities in our products and auxiliary systems.
None of these newly developed products or services required the investment of a material amount of our assets or was otherwise material to our business.

7


EPD Customers
Our customer mix is diversified and includes leading EPC firms, major national oil companies, international oil companies, equipment end users in our served markets, other original equipment manufacturers, distributors and end users. Our sales mix of original equipment products and aftermarket products and services diversifies our business and helps mitigate the impact of normal economic cycles on our business. Our sales are diversified among several industries, including oil and gas, petrochemical, chemical, power generation, water management and other general industries.
EPD Competition
The pump and mechanical seal industry is highly fragmented, with thousands of competitors globally. We compete, however, primarily with a limited number of large companies operating on a global scale. There are also a number of smaller, newer entrants in some of our emerging markets. Competition among our closest competitors is generally driven by delivery times, application knowledge, experience, expertise, price, breadth of product offerings, contractual terms, previous installation history and reputation for quality. Some of our largest industry competitors include: Sulzer Pumps; Ebara Corp.; SPX FLOW, Inc.; Eagle Burgmann, which is a joint venture of two traditional global seal manufacturers, A. W. Chesterton Co. and AES Corp.; John Crane Inc., a unit of Smiths Group Plc; Weir Group Plc.; ITT Industries; and KSB SE & Co. KGaA.
The pump and mechanical seal industry continues to undergo considerable consolidation, which is primarily driven by (i) the need to lower costs through reduction of excess capacity and (ii) customers’ preference to align with global full service suppliers to simplify their supplier base. Despite the consolidation activity, the market remains highly competitive.
We believe that our strongest sources of competitive advantage rest with our extensive range of pumps for the oil and gas, petrochemical, chemical and power generation industries, our large installed base of products, our strong customer relationships, our high technology, our more than 225 years of experience in manufacturing and servicing pumping equipment, our reputation for providing quality engineering solutions and our ability to deliver engineered new seal product orders within 72 hours from the customer’s request.
EPD Backlog
EPD’s backlog of orders as of December 31, 2018 was $922.6 million (including $15.3 million of interdivision backlog, which is eliminated and not included in consolidated backlog), compared with $1,027.7 million (including $16.0 million of interdivision backlog) as of December 31, 2017. The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $181 million at January 1, 2018. We expect to ship approximately 92% of December 31, 2018 backlog during 2019.
INDUSTRIAL PRODUCT DIVISION
Through IPD we design, manufacture, pre-test, distribute and service engineered and pre-configured industrial pumps and pump systems, for variety of markets. Our globalized operating platform, low-cost sourcing and continuous improvement initiatives are essential aspects of this business. IPD’s standardized, general purpose pump products are primarily utilized by the chemical, oil and gas, water resources, power and general industrial (i.e. Mining, Steel and Paper) industries. Our products are currently manufactured in 16 manufacturing facilities, five of which are located in the U.S and six in Europe and four in Asia. IPD operates 29 QRCs worldwide, including 18 sites in Europe, five in the U.S., three in Asia Pacific and two in Latin America, including those co-located in manufacturing facilities and/or shared with EPD.
IPD Products
We manufacture approximately 40 different active types of pumps, which are available in a wide range of metal alloys and non-metallics with a variety of configurations to meet the critical operating demands of our customers. The following is a summary list of our IPD products and globally recognized brands:

8


IPD Pump Product Types
Overhung
 
Between Bearings
•   Chemical Process ASME and ISO
 
•   Side Channel Multistage
•   Industrial Process
 
•   Segmental Channel Multistage
•   Slurry and Solids Handling
 
•   Split Case — Axially Split
•   Metallic & Lined Magnetic Drive Process
 
•   Split Case — Radially Split
Specialty Products
 
Vertical
•   Ag Chem
 
•   Wet Pit, Double case API & Double
•   Molten Salt Pump
 
•   Deepwell Submersible Pump
•   Submersible Pump
 
•   Slurry and Solids Handling
•   Geothermal Deepwell
 
•   Sump & Cantilever
•   Barge Pump
 
 
•   Solids Handling Submersible
 
Vacuum Systems
 
 
•   Liquid Ring
Positive Displacement
 
•   LR Systems
•   Gear
 
•   Dry Systems
 
 
 
 
 
 
IPD Brand Names
•   Byron Jackson
 
•   Pacific
•   Durco
 
•   Scienco
•   Flowserve
 
•   Sier Bath
•   Halberg
 
•   SIHI
•   IDP
 
•   TKL
•   Innomag
 
•   Western Land Roller
•   Labour
 
•   Worthington
•   Meregalli
 
•   Worthington-Simpson
 
 
 

IPD Services
We market our pump products through our worldwide sales force, regional service and repair centers through independent distributors and sales representatives. We provide an array of aftermarket services including product installation and commissioning services, seal systems spare parts, repairs, re-rate and upgrade solutions, advanced diagnostics and maintenance solutions through our global network of QRCs.
IPD New Product Development
Our IPD development projects target product feature enhancements, design improvements and sourcing opportunities that we believe will improve the competitive position of our industrial pump product lines. We will invest in our Durco and SIHI chemical product platform to expand and enhance our products offered to the global chemical industry.
We continue to address our core products with design enhancements to improve performance and the speed at which we can deliver our products. We continue to further our energy efficiency initiatives in response to various global governmental directives. Cost reduction projects incorporating product rationalization, value engineering, lean manufacturing and overhead reduction continue to be key drivers for IPD.
None of these newly developed products or services required the investment of a material amount of our assets or was otherwise material.

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IPD Customers
Our customer mix is diversified and includes leading EPC firms, original equipment manufacturers, distributors and end users. Our sales mix of original equipment products and aftermarket products and services diversifies our business and helps mitigate the impact of normal economic cycles on our business. Our sales are diversified among several industries, including chemical, oil and gas, water resources, power and general industry industries.
IPD Competition
The industrial pump industry is highly fragmented, with many competitors. We compete, however, primarily with a limited number of large companies operating on a global scale. Competition among our closest competitors is generally driven by delivery times, expertise, price, breadth of product offerings, contractual terms, previous installation history and reputation for quality. Some of our largest industry competitors include ITT Industries, KSB SE & Co. KGaA and Sulzer Pumps.
We believe that our strongest sources of competitive advantage rest with our extensive range of pumps for the chemical industry, our large installed base, our strong customer relationships, our more than 200 years of legacy experience in manufacturing and servicing pumping equipment and our reputation for providing quality engineering solutions.
IPD Backlog
IPD’s backlog of orders as of December 31, 2018 was $394.0 million (including $17.2 million of interdivision backlog, which is eliminated and not included in consolidated backlog), compared with $424.3 million (including $17.3 million of interdivision backlog) as of December 31, 2017. The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $34 million at January 1, 2018. We expect to ship approximately 85% of December 31, 2018 backlog during 2019.
FLOW CONTROL DIVISION
FCD designs, manufactures, distributes and services a broad portfolio of engineered and industrial valve and automation solutions, including isolation and control valves, actuation, controls and related equipment. FCD leverages its experience and application know-how by offering a complete menu of engineering and project management services to complement its expansive product portfolio. FCD products are used to control, direct and manage the flow of liquids and gases and are an integral part of any flow control system. Our valve products are most often customized and engineered to perform specific functions within each customer’s unique flow control environment.
Our flow control products are primarily used by companies operating in the chemical, power generation, oil and gas, water management and general industries. Our products are currently manufactured in 21 principal manufacturing facilities, five of which are located in the U.S., 10 located in Europe and five located in Asia Pacific. FCD operates 26 QRCs worldwide, including six sites in Europe, nine in North America, nine in Asia Pacific and two in Latin America, including those co-located in manufacturing facilities.
FCD Products
Our valve, automation and controls product and solutions portfolio represents one of the most comprehensive in the flow control industry. Our products are used in a wide variety of applications, from general service to the most severe and demanding services, including those involving high levels of corrosion, extreme temperatures and/or pressures, zero fugitive emissions and emergency shutdown.
Our “smart” valve and diagnostic technologies integrate sensors, microprocessor controls and software into high performance integrated control valves, digital positioners and switchboxes for automated on/off valve assemblies and electric actuators. These technologies permit real-time system analysis, system warnings and remote indication of asset health. These technologies have been developed in response to the growing demand for reduced maintenance, improved process control efficiency and digital communications at the plant level. We are committed to further enhancing the quality of our product portfolio by continuing to upgrade our existing offerings with cutting-edge technologies.

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Our valve automation products encompass a broad range of pneumatic, electric, hydraulic and stored energy actuation designs to take advantage of whatever power source the customer has available. FCD’s actuation products can utilize the process fluid flowing through the pipeline as a source of power to actuate the valve. Our actuation products also cover one of the widest ranges of output torques in the industry, providing the ability to automate anything from the smallest linear globe valve to the largest multi-turn gate valve. Most importantly, FCD combines best-in-class mechanical designs with the latest in digital controls in order to provide complete integrated automation solutions that optimize the combined valve-actuator-controls package.
The following is a summary list of our valve and automation products and globally recognized brands:
FCD Product Types
•   Valve Automation Systems
 
•   Electro Pneumatic Positioners
•   Control Valves
 
•   Digital Positioners
•   Ball Valves
 
•   Pneumatic Positioners
•   Gate Valves
 
•   Intelligent Positioners
•   Globe Valves
 
•   Electric/Electronic Actuators
•   Check Valves
 
•   Pneumatic Actuators
•   Butterfly Valves
 
•   Hydraulic Actuators
•   Lined Plug Valves
 
•   Diaphragm Actuators
•   Lined Ball Valves
 
•   Direct Gas and Gas-over-Oil Actuators
•   Lubricated Plug Valves
 
•   Limit Switches
•   Non-Lubricated Plug Valves
 
•   Digital Communications
•   Integrated Valve Controllers
 
•   Valve and Automation Repair Services
•   Diagnostic Software
 
 
FCD Brand Names
•   Accord
 
•   NAF
•   Anchor/Darling
 
•   Noble Alloy
•   Argus
 
•   Norbro
•   Atomac
 
•   Nordstrom
•   Automax
 
•   PMV
•   Durco
 
•   Serck Audco
•   Edward
 
•   Schmidt Armaturen
•   Flowserve
 
•   Valbart
•   Kammer
 
•   Valtek
•   Limitorque
 
•   Worcester Controls
•   McCANNA/MARPAC
 
 

FCD Services
Our service personnel provide comprehensive equipment maintenance services for flow control systems, including advanced diagnostics, repair, installation, commissioning, retrofit programs and field machining capabilities. A large portion of our service work is performed on a quick response basis, which includes 24-hour service in all of our major markets. We also provide in-house repair and return manufacturing services worldwide through our manufacturing facilities. We believe our ability to offer comprehensive, quick turnaround services provides us with a unique competitive advantage and unparalleled access to our customers’ installed base of flow control products.

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FCD New Product Development
Our R&D investment is focused on areas that will advance our technological leadership and further differentiate our competitive advantage from a product perspective. Investment has been focused on significantly enhancing the digital integration and interoperability of valve top-works (e.g., positioners, actuators, limit switches and associated accessories) with Distributed Control Systems ("DCS"). We continue to pursue the development and deployment of next-generation hardware and software for valve diagnostics and the integration of the resulting device intelligence through the DCS to provide a practical and effective asset management capability for the end user. In addition to developing these new capabilities and value-added services, our investments also include product portfolio expansion and fundamental research in material sciences in order to increase the temperature, pressure and corrosion/erosion-resistance limits of existing products, as well as noise and cavitation reduction. These investments are made by adding new resources and talent to the organization, as well as leveraging the experience of EPD and IPD and increasing our collaboration with third parties. We expect to continue our R&D investments in the areas discussed above.
None of these newly developed valve products or services required the investment of a material amount of our assets or was otherwise material.
FCD Customers
Our customer mix spans several markets, including the chemical, power generation, oil and gas, water management, pulp and paper, mining and other general industries. Our product mix includes original equipment and aftermarket parts and services. FCD contracts with a variety of customers, ranging from EPC firms, to distributors, end users and other original equipment manufacturers.
FCD Competition
While in recent years the valve market has undergone a significant amount of consolidation, the market remains highly fragmented. Some of the largest valve industry competitors include Cameron International Corp. (a Schlumberger company), Emerson Electric Co., General Electric Co., Rotork plc and Crane Co.
Our market research and assessments indicate that the top 10 global valve manufacturers collectively comprise less than 15% of the total valve market. Based on independent industry sources, we believe that we are the third largest industrial valve supplier in the world. We believe that our strongest sources of competitive advantage rest with our comprehensive portfolio of valve products and services, our ability to provide complementary pump and aftermarket products and services, our focus on execution and our expertise in severe corrosion and erosion applications.
FCD Backlog
FCD’s backlog of orders as of December 31, 2018 was $608.4 million, compared with $617.4 million as of December 31, 2017. The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $35 million at January 1, 2018. We expect to ship approximately 88% of December 31, 2018 backlog during 2019.
AVAILABLE INFORMATION
We maintain an Internet web site at www.flowserve.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 are made available free of charge through the “Investor Relations” section of our Internet web site as soon as reasonably practicable after we electronically file the reports with, or furnish the reports to, the U.S. Securities and Exchange Commission ("SEC"). Reports, proxy statements and other information filed or furnished with the SEC are also available at www.sec.gov.
Also available on our Internet web site are our Corporate Governance Guidelines for our Board of Directors and Code of Ethics and Business Conduct, as well as the charters of the Audit, Finance, Organization and Compensation and Corporate Governance and Nominating Committees of our Board of Directors and other important governance documents. All of the foregoing documents may be obtained through our Internet web site as noted above and are available in print without charge to shareholders who request them. Information contained on or available through our Internet web site is not incorporated into this Annual Report or any other document we file with, or furnish to, the SEC.


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ITEM 1A.
RISK FACTORS
Any of the events discussed as risk factors below may occur. If they do, our business, financial condition, results of operations and cash flows could be materially adversely affected. While we believe all known material risks are disclosed, additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also impair our business operations. Because of these risk factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.
Our business depends on the levels of capital investment and maintenance expenditures by our customers, which in turn are affected by numerous factors, including the state of domestic and global economies, global energy demand, the cyclical nature of their markets, their liquidity and the condition of global credit and capital markets.
Demand for most of our products and services depends on the level of new capital investment and planned maintenance expenditures by our customers. The level of capital expenditures by our customers depends, in turn, on general economic conditions, availability of credit, economic conditions within their respective industries and expectations of future market behavior. Additionally, volatility in commodity prices can negatively affect the level of these activities and can result in postponement of capital spending decisions or the delay or cancellation of existing orders. The ability of our customers to finance capital investment and maintenance may also be affected by factors independent of the conditions in their industry, such as the condition of global credit and capital markets.
The businesses of many of our customers, particularly oil and gas companies, chemical companies and general industrial companies, are to varying degrees cyclical and have experienced periodic downturns. Our customers in these industries, particularly those whose demand for our products and services is primarily profit-driven, historically have tended to delay large capital projects, including expensive maintenance and upgrades, during economic downturns. For example, our chemical customers generally tend to reduce their spending on capital investments and operate their facilities at lower levels in a soft economic environment, which reduces demand for our products and services. Additionally, fluctuating energy demand forecasts and lingering uncertainty concerning commodity pricing, specifically the price of oil, can cause our customers to be more conservative in their capital planning, which may reduce demand for our products and services. Reduced demand for our products and services could result in the delay or cancellation of existing orders or lead to excess manufacturing capacity, which unfavorably impacts our absorption of fixed manufacturing costs. This reduced demand may also erode average selling prices in our industry. Any of these results could adversely affect our business, financial condition, results of operations and cash flows.
Additionally, some of our customers may delay capital investment and maintenance even during favorable conditions in their industries or markets. Despite these favorable conditions, the general health of global credit and capital markets and our customers' ability to access such markets may impact investments in large capital projects, including necessary maintenance and upgrades. In addition, the liquidity and financial position of our customers could impact capital investment decisions and their ability to pay in full and/or on a timely basis. Any of these factors, whether individually or in the aggregate, could have a material adverse effect on our customers and, in turn, our business, financial condition, results of operations and cash flows.
Volatility in commodity prices, effects from credit and capital market conditions and global economic growth forecasts could prompt customers to delay or cancel existing orders, which could adversely affect the viability of our backlog and could impede our ability to realize revenues on our backlog.
Our backlog represents the value of uncompleted customer orders. While we cannot be certain that reported backlog will be indicative of future results, our ability to accurately value our backlog can be adversely affected by numerous factors, including the health of our customers' businesses and their access to capital, volatility in commodity prices (e.g., copper, nickel, stainless steel) and economic uncertainty. While we attempt to mitigate the financial consequences of order delays and cancellations through contractual provisions and other means, if we were to experience a significant increase in order delays or cancellations that can result from the aforementioned economic conditions or other factors beyond our control, it could impede or delay our ability to realize anticipated revenues on our backlog. Such a loss of anticipated revenues could have a material adverse effect on our business, financial condition, results of operations and cash flows.

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We may be unable to deliver our backlog on time, which could affect our revenues, future sales and profitability and our relationships with customers.
At December 31, 2018, backlog was $1.9 billion. In 2019, our ability to meet customer delivery schedules for backlog is dependent on a number of factors including, but not limited to, sufficient manufacturing plant capacity, adequate supply channel access to the raw materials and other inventory required for production, an adequately trained and capable workforce, project engineering expertise for certain large projects and appropriate planning and scheduling of manufacturing resources. Our manufacturing plant operations and capacity may be disrupted as a result of equipment failure, natural disaster, power outage, fire, explosion, terrorism, cyber-based attack, adverse weather conditions, labor disputes, acts of God, or other reasons. We may also encounter capacity limitations due to changes in demand despite our forecasting efforts. Many of the contracts we enter into with our customers require long manufacturing lead times and contain penalty clauses related to late delivery. Failure to deliver in accordance with contract terms and customer expectations could subject us to financial penalties, may result in damage to existing customer relationships, could increase our costs, could reduce our sales and could have a material adverse effect on our business, financial condition, results of operations and cash flows.
If we are not able to successfully execute and realize the expected financial benefits from our transformation and strategic realignment and other cost-saving initiatives, our business could be adversely affected.
In the second quarter of 2018, we launched and committed resources to our Flowserve 2.0 Transformation ("Flowserve 2.0 Transformation"), a program designed to transform our business model to drive operational excellence, reduce complexity, accelerate growth, improve organizational health and better leverage our existing global platform.
While we expect significant financial benefits from our Flowserve 2.0 Transformation, we may not realize the full benefits that we currently expect within the anticipated time frame or at all. Adverse effects from our execution of transformation and realignment activities could interfere with our realization of anticipated synergies, customer service improvements and cost savings from these strategic initiatives. Additionally, our ability to fully realize the benefits and implement the transformation and realignment programs may be limited by the terms of our credit facilities and other contractual commitments. Moreover, because such expenses are difficult to predict and are necessarily inexact, we may incur substantial expenses in connection with the execution of our transformation and realignment plans in excess of what is currently forecast. Further, transformation and realignment activities are a complex and time-consuming process that can place substantial demands on management, which could divert attention from other business priorities or disrupt our daily operations. Any of these failures could, in turn, materially adversely affect our business, financial condition, results of operations and cash flows, which could constrain our liquidity.
If these measures are not successful or sustainable, we may undertake additional realignment and cost reduction efforts, which could result in future charges. Moreover, our ability to achieve our other strategic goals and business plans may be adversely affected, and we could experience business disruptions with customers and elsewhere if our transformation and realignment efforts prove ineffective.
We sell our products in highly competitive markets, which results in pressure on our profit margins and limits our ability to maintain or increase the market share of our products.
The markets for our products and services are geographically diverse and highly competitive. We compete against large and well-established national and global companies, as well as regional and local companies, low-cost replicators of spare parts and in-house maintenance departments of our end-user customers. We compete based on price, technical expertise, timeliness of delivery, contractual terms, previous installation history and reputation for quality and reliability. Competitive environments in slow-growth industries and for original equipment orders have been inherently more influenced by pricing and domestic and global economic conditions and current economic forecasts suggest that the competitive influence of pricing has broadened. Additionally, some of our customers have been attempting to reduce the number of vendors from which they purchase in order to reduce the size and diversity of their supply chain. To remain competitive, we must invest in manufacturing, technology, marketing, customer service and support and our distribution networks. No assurances can be made that we will have sufficient resources to continue to make the investment required to maintain or increase our market share or that our investments will be successful. In addition, negative publicity or other organized campaigns critical of us, through social media or otherwise, could negatively affect our reputation. If we do not compete successfully, our business, financial condition, results of operations and cash flows could be materially adversely affected.
We may be unable to successfully develop and introduce new products, which could limit our ability to grow and maintain our competitive position and adversely affect our financial condition, results of operations and cash flow.

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The success of new and improved products and services depends on their initial and continued acceptance by our customers. Our businesses are affected by varying degrees of technological change and corresponding shifts in customer demand, which result in unpredictable product transitions, shortened life cycles and increased importance of being first to market with new products and services. We may experience difficulties or delays in the research, development, production and/or marketing of new products and services which may negatively impact our operating results and prevent us from recouping or realizing a return on the investments required to continue to bring these products and services to market.
If we are unable to obtain raw materials at favorable prices, our operating margins and results of operations may be adversely affected.
We purchase substantially all electric power and other raw materials we use in the manufacturing of our products from outside sources. The costs of these raw materials have been volatile historically and are influenced by factors that are outside our control. In recent years, the prices for energy, metal alloys, nickel and certain other of our raw materials have been volatile. While we strive to offset our increased costs through supply chain management, contractual provisions and our Continuous Improvement Process initiative, where gains are achieved in operational efficiencies, our operating margins and results of operations and cash flows may be adversely affected if we are unable to pass increases in the costs of our raw materials on to our customers or operational efficiencies are not achieved.
Economic, political and other risks associated with international operations could adversely affect our business.
A substantial portion of our operations is conducted and located outside the U.S. We have manufacturing, sales or service facilities in more than 50 countries and sell to customers in over 90 countries, in addition to the U.S. Moreover, we primarily outsource certain of our manufacturing and engineering functions to, and source our raw materials and components from, China, Eastern Europe, India and Latin America. Accordingly, our business and results of operations are subject to risks associated with doing business internationally, including:
instability in a specific country's or region's political or economic conditions, particularly economic conditions in Europe, and political conditions in Russia, the Middle East, Asia, North Africa, Latin America and other emerging markets;
trade protection measures, such as tariff increases, and import and export licensing and control requirements;
political, financial market or economic instability relating to the Brexit referendum in the United Kingdom;
uncertainties related to any geopolitical, economic and regulatory effects or changes due to recent domestic and international elections;
the imposition of governmental economic sanctions on countries in which we do business, including Russia and Venezuela;
potentially negative consequences from changes in tax laws or tax examinations;
difficulty in staffing and managing widespread operations;
increased aging and slower collection of receivables, particularly in Latin America and other emerging markets;
difficulty of enforcing agreements and collecting receivables through some foreign legal systems;
differing and, in some cases, more stringent labor regulations;
potentially negative consequences from fluctuations in foreign currency exchange rates;
partial or total expropriation;
differing protection of intellectual property;
inability to repatriate income or capital; and
difficulty in administering and enforcing corporate policies, which may be different than the customary business practices of local cultures.
For example, political unrest or work stoppages could negatively impact the demand for our products from customers in affected countries and other customers, such as U.S. oil refineries, that could be affected by the resulting disruption in the

15


supply of crude oil. Similarly, military conflicts in Russia, the Middle East, Asia and North Africa could soften the level of capital investment and demand for our products and services.
In order to manage our day-to-day operations, we must overcome cultural and language barriers and assimilate different business practices. In addition, we are required to create compensation programs, employment policies and other administrative programs that comply with laws of multiple countries. We also must communicate and monitor standards and directives across our global network. In addition, emerging markets pose other uncertainties, including challenges to our ability to protect our intellectual property, pressure on the pricing of our products and increased risk of political instability, and may prefer local suppliers because of existing relationships or local restrictions or incentives. Our failure to successfully manage our geographically diverse operations could impair our ability to react quickly to changing business and market conditions and to enforce compliance with standards and procedures.
Our future success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Any of these factors could, however, materially adversely affect our international operations and, consequently, our financial condition, results of operations and cash flows.
Our operations may be impacted by the United Kingdom’s proposed exit from the European Union.
The United Kingdom’s June 2016 referendum in which voters approved an exit from the European Union (commonly referred to as “Brexit”) and subsequent negotiations related to the referendum has caused and may continue to cause volatility in the global stock markets, currency exchange rate fluctuations and global economic uncertainty, which could adversely affect our customers’ ability to invest in capital expenditures, which may in turn reduce demand for our products and services. In addition, there may be greater restrictions on imports and exports between the U.K. and other E.U. countries and additional regulatory complexities. The uncertainties related to the Brexit referendum and its impact on the global economic climate could have a material adverse effect on our operations, financial condition, results of operations and cash flows.
Our operations are subject to a variety of complex and continually changing laws and regulations, both internationally and domestically.
Due to the international scope of our operations, the system of laws and regulations to which we are subject is complex and includes, without limitation, regulations issued by the U.S. Customs and Border Protection, the U.S. Department of Commerce's Bureau of Industry and Security, the U.S. Treasury Department's Office of Foreign Assets Control and various foreign governmental agencies, including applicable export controls, customs, currency exchange control and transfer pricing regulations, as applicable. No assurances can be made that we will continue to be found to be operating in compliance with, or be able to detect violations of, any such laws or regulations. In addition, we cannot predict the nature, scope or effect of future regulatory requirements to which our international operations might be subject or the manner in which existing laws might be administered or interpreted.
There is uncertainty related to the current U.S. administration’s support or plans for new or existing treaty and trade relationships with other countries, such as the January 2017 U.S. withdrawal from the Trans-Pacific Partnership, which may affect restrictions or tariffs imposed on products we buy or sell. These factors, together with other key global events during 2018 (such as the continuing uncertainty arising from the Brexit transition, as well as ongoing terrorist activity), may adversely impact the ability or willingness of non-U.S. companies to transact business in the U.S. This uncertainty may also affect regulations and trade agreements affecting U.S. companies, global stock markets (including the NYSE, on which our common shares are traded), currency exchange rates, and general global economic conditions. All of these factors are outside of our control, but may nonetheless cause us to adjust our strategy in order to compete effectively in global markets.
In addition, in December 2017 the Tax Cuts and Jobs Act of 2017 (the “Tax Reform Act”) was passed in the United States, which significantly changed U.S. tax law and affected, among other items, the Company’s U.S. federal income tax rate. The impacts from the Tax Reform Act may differ, possibly materially, from the tax estimates we have recorded due to, among other things, additional analysis, changes from interpretations enacted and assumptions the Company has made, and additional regulatory guidance that may be issued. As a result, this (and other) tax legislation could adversely affect our financial condition, results of operations and cash flows.
Implementation of new tariffs and changes to or uncertainties related to tariffs and trade agreements could adversely affect our business.
The U.S. has recently announced the implementation of certain new tariffs on steel and aluminum imported into the country, and is reportedly also considering additional tariffs. In response, certain foreign governments have implemented or

16


are reportedly considering implementing additional tariffs on U.S. goods. In addition, there have been recent changes to trade agreements, like the U.S. withdrawal from the Trans-Pacific Partnership and the replacement of the North American Free Trade Agreement with the United States-Mexico-Canada Agreement. Uncertainties with respect to tariffs, trade agreements, or any potential trade wars could negatively impact the global economic markets and could affect our customers’ ability to invest in capital expenditures, which may in turn result in reduced demand for our products and services, and could have a material adverse effect on our financial condition, results of operations and cash flows. Changes in tariffs could also result in changes in supply and demand of our raw material needs and could affect our manufacturing capabilities and could lead to increased prices that we may not be able to effectively pass on to customers, each of which could materially adversely affect our operating margins, results of operations and cash flows.
Our international operations expose us to fluctuations in foreign currency exchange rates.
A significant portion of our revenue and certain of our costs, assets and liabilities, are denominated in currencies other than the U.S. dollar. The primary currencies to which we have exposure are the Euro, British pound, Mexican peso, Brazilian real, Indian rupee, Japanese yen, Singapore dollar, Argentine peso, Canadian dollar, Australian dollar, Chinese yuan, Colombian peso, Chilean peso and South African rand. Certain of the foreign currencies to which we have exposure, such as the Venezuelan bolivar and Argentine peso, have undergone significant devaluation in the past, which can reduce the value of our local monetary assets, reduce the U.S. dollar value of our local cash flow, generate local currency losses that may impact our ability to pay future dividends from our subsidiary to the parent company and potentially reduce the U.S. dollar value of future local net income. Although we enter into forward exchange contracts to economically hedge some of our risks associated with transactions denominated in certain foreign currencies, no assurances can be made that exchange rate fluctuations will not adversely affect our financial condition, results of operations and cash flows.
We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws and regulations.
The U.S. Foreign Corrupt Practices Act ("FCPA") and similar anti-bribery laws and regulations in other jurisdictions, such as the UK Bribery Act, generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business or securing an improper advantage. Because we operate in many parts of the world and sell to industries that have experienced corruption to some degree, our policies mandate compliance with applicable anti-bribery laws worldwide. If we are found to be in violation of the FCPA or other similar anti-bribery laws or regulations, whether due to our or others' actions or inadvertence, we could be subject to civil and criminal penalties or other sanctions that could have a material adverse impact on our business, financial condition, results of operations and cash flows. In addition, actual or alleged violations could damage our reputation or ability to do business.
Terrorist acts, conflicts and wars may materially adversely affect our business, financial condition and results of operations and may adversely affect the market for our common stock.
As a global company with a large international footprint, we are subject to increased risk of damage or disruption to us, our employees, facilities, partners, suppliers, distributors, resellers or customers due to terrorist acts, conflicts and wars, wherever located around the world. The potential for future attacks, the national and international responses to attacks or perceived threats to national security, and other actual or potential conflicts or wars, such as the Israeli-Hamas conflict and ongoing instability in Syria and Egypt, have created many economic and political uncertainties. In addition, as a global company with headquarters and significant operations located in the U.S., actions against or by the U.S. may impact our business or employees. Although it is impossible to predict the occurrences or consequences of any such events, they could result in a decrease in demand for our products, make it difficult or impossible to deliver products to our customers or to receive components from our suppliers, create delays and inefficiencies in our supply chain and pose risks to our employees, resulting in the need to impose travel restrictions, any of which could adversely affect our business, financial condition, results of operations and cash flows.
Regulatory and customer focus on environmental, social and governance responsibility could expose us to additional costs or risks.
Regulators, shareholders, customers and other interested parties have focused increasingly on the environmental, social and governance practices of companies. This has led to an increase in regulations and may continue to cause us to be subject to additional regulations in the future. Our customers or other interested parties may also require us to implement certain environmental, social or governance procedures or standards before doing or continuing to do business with us. This increased

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attention on environmental, social and governance practices could have a material adverse effect on our business, financial condition and results of operations.
Environmental compliance costs and liabilities could adversely affect our financial condition, results of operations and cash flows.
Our operations and properties are subject to regulation under environmental laws, which can impose substantial sanctions for violations. We must conform our operations to applicable regulatory requirements and adapt to changes in such requirements in all countries in which we operate.
We use hazardous substances and generate hazardous wastes in many of our manufacturing and foundry operations. Most of our current and former properties are or have been used for industrial purposes, and some may require clean-up of historical contamination. We are currently conducting investigation and/or remediation activities at a number of locations where we have known environmental concerns. In addition, we have been identified as one of many PRPs at five Superfund sites. The projected cost of remediation at these sites, as well as our alleged "fair share" allocation, while not anticipated to be material, has been reserved. However, until all studies have been completed and the parties have either negotiated an amicable resolution or the matter has been judicially resolved, some degree of uncertainty remains.
We have incurred, and expect to continue to incur, operating and capital costs to comply with environmental requirements. In addition, new laws and regulations, stricter enforcement of existing requirements, the discovery of previously unknown contamination or the imposition of new clean-up requirements could require us to incur costs or become the basis for new or increased liabilities. Moreover, environmental and sustainability initiatives, practices, rules and regulations are under increasing scrutiny of both governmental and non-governmental bodies, which can cause rapid change in operational practices, standards and expectations and, in turn, increase our compliance costs. Any of these factors could have a material adverse effect on our financial condition, results of operations and cash flows.
We are exposed to certain regulatory and financial risks related to climate change which could adversely affect our financial condition, results of operations and cash flows.
Climate change is receiving ever increasing attention worldwide. Many scientists, legislators and others attribute global warming to increased levels of greenhouse gases, including carbon dioxide, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions. The U.S. Congress, state and foreign legislatures and federal, state, local and foreign governmental agencies have been considering legislation and regulatory proposals that would regulate and limit greenhouse gas emissions. It is uncertain whether, when and in what form mandatory carbon dioxide emissions reduction program may be adopted. Similarly, certain countries have adopted the Kyoto Protocol and/or the Paris Climate Agreement and these and other existing international initiatives or those under consideration could affect our international operations. To the extent our customers, particularly those involved in the oil and gas, power generation, petrochemical processing or petroleum refining industries, are subject to any of these or other similar proposed or newly enacted laws and regulations, we are exposed to risks that the additional costs by customers to comply with such laws and regulations could impact their ability or desire to continue to operate at similar levels in certain jurisdictions as historically seen or as currently anticipated, which could negatively impact their demand for our products and services. In addition, new laws and regulations that might favor the increased use of non-fossil fuels, including nuclear, wind, solar and bio-fuels or that are designed to increase energy efficiency, could dampen demand for oil and gas production or power generation resulting in lower spending by customers for our products and services. These actions could also increase costs associated with our operations, including costs for raw materials and transportation. Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future financial condition, results of operations and cash flows.
We are party to asbestos-containing product litigation that could adversely affect our financial condition, results of operations and cash flows.
We are a defendant in a substantial number of lawsuits that seek to recover damages for personal injury allegedly resulting from exposure to asbestos-containing products formerly manufactured and/or distributed by us. Such products were used as internal components of process equipment, and we do not believe that there was any significant emission of asbestos-containing fibers during the use of this equipment. Although we are defending these allegations vigorously and believe that a high percentage of these lawsuits are covered by insurance or indemnities from other companies, there can be no assurance that we will prevail or that coverage or payments made by insurance or such other companies would be adequate. Unfavorable rulings, judgments or settlement terms could have a material adverse impact on our business, financial condition, results of operations and cash flows.

18


Our business may be adversely impacted by work stoppages and other labor matters.
As of December 31, 2018, we had approximately 17,000 employees, of which approximately 5,000 were located in the U.S. Approximately 5% of our U.S. employees are represented by unions. We also have unionized employees or employee work councils in Argentina, Australia, Austria, Brazil, Finland, France, Germany, India, Italy, Japan, Mexico, The Netherlands, South Africa, Spain, Sweden and the U.K. No individual unionized facility produces more than 10% of our revenues. Although we believe that our relations with our employees are generally satisfactory and we have not experienced any material strikes or work stoppages recently, no assurances can be made that we will not in the future experience these and other types of conflicts with labor unions, works councils, other groups representing employees or our employees generally, or that any future negotiations with our labor unions will not result in significant increases in our cost of labor. If we are unsuccessful in negotiating new and acceptable agreements when the existing agreements with employees covered by collective bargaining expire, we could experience business disruptions or increased costs.
Our ability to implement our business strategy and serve our customers is dependent upon the continuing ability to employ talented professionals and attract, train, develop and retain a skilled workforce. We are subject to the risk that we will not be able to effectively replace the knowledge and expertise of an aging workforce as workers retire. Without a properly skilled and experienced workforce, our costs, including productivity costs and costs to replace employees may increase, and this could negatively impact our earnings.
In addition, our policies prohibit harassment or discrimination in the workplace. Notwithstanding our conducting training and taking disciplinary action or other actions against or in response to alleged violations, we may encounter additional costs from claims made and/or legal proceedings brought against us, and we could suffer reputational harm.
We depend on key personnel, the loss of whom would harm our business.
Our future success will depend in part on the continued service of key executive officers and personnel. The loss of the services of any key individual could harm our business. Our future success also depends on our ability to recruit, retain and engage our personnel sufficiently, both to maintain our current business and to execute our strategic initiatives. Competition for officers and employees in our industry is intense and we may not be successful in attracting and retaining such personnel.
Inability to protect our intellectual property could negatively affect our competitive position.
We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. We cannot guarantee, however, that the steps we have taken to protect our intellectual property will be adequate to prevent infringement of our rights or misappropriation of our technology. For example, effective patent, trademark, copyright and trade secret protection may be unavailable or limited in some of the foreign countries in which we operate. In addition, while we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, such confidentiality agreements could be breached or otherwise may not provide meaningful protection for our trade secrets and know-how related to the design, manufacture or operation of our products. If it became necessary for us to resort to litigation to protect our intellectual property rights, any proceedings could be burdensome and costly, and we may not prevail. Further, adequate remedies may not be available in the event of an unauthorized use or disclosure of our trade secrets and manufacturing expertise. If we fail to successfully enforce our intellectual property rights, our competitive position could suffer, which could harm our business, financial condition, results of operations and cash flows.
Significant changes in pension fund investment performance or assumptions changes may have a material effect on the valuation of our obligations under our defined benefit pension plans, the funded status of these plans and our pension expense.
We maintain defined benefit pension plans that are required to be funded in the U.S., Belgium, Canada, India, Mexico, The Netherlands, Switzerland and the U.K., and defined benefit plans that are not required to be funded in Austria, France, Germany, Italy, Japan and Sweden. Our pension liability is materially affected by the discount rate used to measure our pension obligations and, in the case of the plans that are required to be funded, the level of plan assets available to fund those obligations and the expected long-term rate of return on plan assets. A change in the discount rate can result in a significant increase or decrease in the valuation of pension obligations, affecting the reported status of our pension plans and our pension expense. Significant changes in investment performance or a change in the portfolio mix of invested assets can result in increases and decreases in the valuation of plan assets or in a change of the expected rate of return on plan assets. This impact may be particularly prevalent where we maintain significant concentrations of specified investments, such as the U.K. equity and fixed income securities in our non-U.S. defined benefit plans. Changes in the expected return on plan assets assumption can result in significant changes in our pension expense and future funding requirements.

19


We continually review our funding policy related to our U.S. pension plan in accordance with applicable laws and regulations. U.S. regulations have increased the minimum level of funding for U.S pension plans in prior years, which has at times required significant contributions to our pension plans. Contributions to our pension plans reduce the availability of our cash flows to fund working capital, capital expenditures, R&D efforts and other general corporate purposes.
We may incur material costs as a result of product liability and warranty claims, which could adversely affect our financial condition, results of operations and cash flows.
We may be exposed to product liability and warranty claims in the event that the use of one of our products results in, or is alleged to result in, bodily injury and/or property damage or our products actually or allegedly fail to perform as expected. Some of our products are designed to support the most critical, severe service applications in the markets that we serve and any failure of such products could result in significant product liability and warranty claims, as well as damage to our reputation in the marketplace. While we maintain insurance coverage with respect to certain product liability claims, we may not be able to obtain such insurance on acceptable terms in the future, and any such insurance may not provide adequate coverage against product liability claims. In addition, product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of the ultimate outcome. An unsuccessful defense of a product liability claim could have an adverse effect on our business, financial condition, results of operations and cash flows. Even if we are successful in defending against a claim relating to our products, claims of this nature could cause our customers to lose confidence in our products and our company. Warranty claims are not generally covered by insurance, and we may incur significant warranty costs in the future for which we would not be reimbursed.
The recording of increased deferred tax asset valuation allowances in the future or the impact of tax law changes on such deferred tax assets could affect our operating results.
We currently have significant net deferred tax assets resulting from tax credit carryforwards, net operating losses and other deductible temporary differences that are available to reduce taxable income in future periods. Based on our assessment of our deferred tax assets, we determined, based on projected future income and certain available tax planning strategies, that approximately $116 million of our deferred tax assets will more likely than not be realized in the future, and no valuation allowance is currently required for this portion of our deferred tax assets. Should we determine in the future that these assets will not be realized we will be required to record an additional valuation allowance in connection with these deferred tax assets and our operating results would be adversely affected in the period such determination is made. In addition, tax law changes could negatively impact our deferred tax assets.
Our outstanding indebtedness and the restrictive covenants in the agreements governing our indebtedness limit our operating and financial flexibility.
We are required to make scheduled repayments and, under certain events of default, mandatory repayments on our outstanding indebtedness, which may require us to dedicate a substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, R&D efforts and other general corporate purposes, such as dividend payments and share repurchases, and could generally limit our flexibility in planning for, or reacting to, changes in our business and industry. In addition, we may need new or additional financing in the future to expand our business or refinance our existing indebtedness. Our current senior credit facility matures on October 14, 2020 and our senior notes are due in 2022 and 2023, respectively. For additional information regarding our current indebtedness refer to Note 11 to our consolidated financial statements included in Item 8 of this Annual Report. If we are unable to timely access capital on satisfactory terms, including as a result of market disruptions, we may not be able to expand our business as desired, and may be limited in our ability to refinance our indebtedness.
In addition, the agreements governing our indebtedness impose certain operating and financial restrictions on us and somewhat limit management's discretion in operating our businesses. These agreements limit or restrict our ability, among other things, to: incur additional debt; fully utilize the capacity under the Senior Credit Facility; pay dividends and make other distributions; prepay subordinated debt; make investments and other restricted payments; create liens; sell assets; and enter into transactions with affiliates.
We are also required to maintain certain debt ratings, comply with leverage and interest coverage financial covenants and deliver to our lenders audited annual and unaudited quarterly financial statements. Our ability to comply with these covenants may be affected by events beyond our control. Failure to comply with these covenants could result in an event of default which, if not cured or waived, may have a material adverse effect on our business, financial condition, results of operations and cash flows.

20


We may not be able to continue to expand our market presence through acquisitions, and any future acquisitions may present unforeseen integration difficulties or costs.
Since 1997, we have expanded through a number of acquisitions, and we may pursue strategic acquisitions of businesses in the future. Our ability to implement this growth strategy will be limited by our ability to identify appropriate acquisition candidates, covenants in our credit agreement and other debt agreements and our financial resources, including available cash and borrowing capacity. Acquisitions may require additional debt financing, resulting in higher leverage and an increase in interest expense. In addition, acquisitions may require large one-time charges and can result in the incurrence of contingent liabilities, adverse tax consequences, substantial depreciation or deferred compensation charges, the amortization of identifiable purchased intangible assets or impairment of goodwill, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Should we acquire another business, the process of integrating acquired operations into our existing operations may create operating difficulties and may require significant financial and managerial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the more common challenges associated with acquisitions that we may experience include:
loss of key employees or customers of the acquired company;
conforming the acquired company's standards, processes, procedures and controls, including accounting systems and controls, with our operations, which could cause deficiencies related to our internal control over financial reporting;
coordinating operations that are increased in scope, geographic diversity and complexity;
retooling and reprogramming of equipment;
hiring additional management and other critical personnel; and
the diversion of management's attention from our day-to-day operations.
Further, no guarantees can be made that we would realize the cost savings, synergies or revenue enhancements that we may anticipate from any acquisition, or that we will realize such benefits within the time frame that we expect. If we are not able to timely address the challenges associated with acquisitions and successfully integrate acquired businesses, or if our integrated product and service offerings fail to achieve market acceptance, our business could be adversely affected.
Goodwill impairment could negatively impact our net income and stockholders' equity.
Goodwill is not amortized, but is tested for impairment at the reporting unit level, which is an operating segment or one level below an operating segment. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying value. Reductions in or impairment of the value of our goodwill or other intangible assets will result in charges against our earnings, which could have a material adverse effect on our reported results of operations and financial position in future periods.
There are numerous risks that may cause the fair value of a reporting unit to fall below its carrying amount, which could lead to the measurement and recognition of goodwill impairment. These risks include, but are not limited to, lowered expectations of future financial results, adverse changes in the business climate, increase in the discount rate, an adverse action or assessment by a regulator, the loss of key personnel, a more-likely-than-not expectation that all or a significant portion of a reporting unit may be disposed of, failure to realize anticipated synergies from acquisitions, a sustained decline in the Company’s market capitalization, and significant, prolonged negative variances between actual and expected financial results. In recent years, the estimated fair value of EPO and IPD have fluctuated, partially due to broad-based capital spending declines and heightened pricing pressures experienced in the oil and gas markets. Although we have concluded that there is no impairment on the goodwill associated with our EPO and IPD reporting units as of December 31, 2018, we will continue to monitor their performance and related market conditions for future indicators of potential impairment. For additional information, see the discussion in Item 7 of this Annual Report and under Note 1 to our consolidated financial statements included in Item 8 of this Annual Report.
Our information technology infrastructure could be subject to service interruptions, data corruption, cyber-based attacks or network security breaches, which could disrupt our business operations and result in the loss of critical and confidential information.
Our information technology networks and related systems and devices are critical to the operation of our business and essential to our ability to successfully perform day-to-day operations. These information technology networks and related systems and devices may be susceptible to damage, disruptions or shutdowns due to failures during the process of upgrading

21


or replacing software, databases or components or suffer from power outages, hardware failures or computer viruses. If these information technology systems and related systems and devices suffer severe damage, disruption or shutdown and business continuity plans do not effectively resolve the issues in a timely manner, our business, financial condition, results of operations, and liquidity could be materially adversely affected.
In addition, cybersecurity breaches could expose us to a risk of loss, misuse, or interruption of sensitive and critical information and functions, including our proprietary information and information related to our customers, suppliers and employees. It is also possible a security breach could result in theft of trade secret or other intellectual property. While we devote substantial resources to maintaining adequate levels of cybersecurity, there can be no assurance that we will be able to prevent all of the rapidly evolving forms of increasingly sophisticated and frequent cyberattacks. The potential consequences of a material cybersecurity incident include reputational damage, litigation with third parties, regulatory actions, theft of intellectual property, disruption of manufacturing plant operations and increased cybersecurity protection and remediation costs. If we are unable to prevent, detect or adequately respond to security breaches, our operations could be disrupted and our business could be materially and adversely affected.
Recent legal developments in Europe could result in changes to our business practices, penalties, increased cost of operations, or otherwise harm our business. To conduct our operations, we regularly move data across national borders and must comply with increasingly complex and rigorous regulatory standards enacted to protect business and personal data in the U.S. and elsewhere. For example, the E.U. recently adopted the General Data Protection Regulation (the “GDPR”). The GDPR imposes additional obligations on companies regarding the handling of personal data and provides certain individual privacy rights to persons whose data is stored. Compliance with existing, proposed and recently enacted laws and regulations can be costly; any failure to comply with these regulatory standards could subject us to legal and reputational risks, including proceedings against the Company by governmental entities or others, fines and penalties, damage to our reputation and credibility and could have a negative impact on our business and results of operations.
Ineffective internal controls could impact the accuracy and timely reporting of our business and financial results.
Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and financial results could be harmed and we could fail to meet our financial reporting obligations. For example, during its evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2016 management concluded that a deficiency in our internal controls related to the control environment primarily related to the operation of certain inventory controls or recording of unsupported manual journal entries at one of the non-U.S. sites and the design and maintenance of effective business performance reviews represented material weaknesses in our internal control over financial reporting and, therefore, that we did not maintain effective internal control over financial reporting as of December 31, 2016. Management actively engaged in the planning and implementation of remediation efforts to address these material weaknesses and to strengthen the overall internal control related to the control environment at the one non-U.S. site and the business review controls and believes that such remediation efforts have effectively remediated the material weaknesses.
Changes in accounting principles and guidance could result in unfavorable accounting charges or effects.
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. A change in these principles can have a significant effect on our reported financial position and financial results. The adoption of new or revised accounting principles may require us to make changes to our systems, processes and internal controls, which could have a significant effect on our reported financial results and internal controls, cause unexpected financial reporting fluctuations, retroactively affect previously reported results or require us to make costly changes to our operational processes and accounting systems upon our following the adoption of these standards.
Forward-Looking Information is Subject to Risk and Uncertainty
This Annual Report and other written reports and oral statements we make from time-to-time include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts included in this Annual Report regarding our financial position, business strategy, plans and objectives of management for future operations, industry conditions, market conditions and indebtedness covenant compliance are forward-looking statements. Forward-looking statements may include, among others, statements about our goals and strategies, new product introductions, plans to cultivate new businesses, future economic conditions, revenue, pricing, gross profit margin and costs, capital spending,

22


expected cost savings from our realignment programs, depreciation and amortization, research and development expenses, potential impairment of assets, tax rate and pending tax and legal proceedings. In some cases forward-looking statements can be identified by terms such as "may," "should," "expects," "could," "intends," "projects," "predicts," "plans," "anticipates," "estimates," "believes," "forecasts," "seeks" or other comparable terminology. These statements are not historical facts or guarantees of future performance, but instead are based on current expectations and are subject to significant risks, uncertainties and other factors, many of which are outside of our control.
We have identified factors that could cause actual plans or results to differ materially from those included in any forward-looking statements. These factors include those described above under this "Risk Factors" heading, or as may be identified in our other SEC filings from time to time. These uncertainties are beyond our ability to control, and in many cases, it is not possible to foresee or identify all the factors that may affect our future performance or any forward-looking information, and new risk factors can emerge from time to time. Given these risks and uncertainties, undue reliance should not be placed on forward-looking statements as a prediction of actual results.
All forward-looking statements included in this Annual Report are based on information available to us on the date of this Annual Report and the risk that actual results will differ materially from expectations expressed in this report will increase with the passage of time. We undertake no obligation, and disclaim any duty, to publicly update or revise any forward-looking statement or disclose any facts, events or circumstances that occur after the date hereof that may affect the accuracy of any forward-looking statement, whether as a result of new information, future events, changes in our expectations or otherwise. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995 and all of our forward-looking statements are expressly qualified in their entirety by the cautionary statements contained or referenced in this section.

ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.

ITEM 2.
PROPERTIES
Our principal executive offices, including our global headquarters, are located at 5215 N. O'Connor Boulevard, Suite 2300, Irving, Texas 75039. Our global headquarters is a leased facility, which we began to occupy on January 1, 2004. In December 2018, we extended our original lease term an additional 10 years to December 2028. We have the option to renew the current lease for two additional five-year periods. We currently occupy 125,000 square feet at this facility.
Our major manufacturing facilities (those with 50,000 or more square feet of manufacturing capacity) operating at December 31, 2018 are presented in the table below. See "Item 1. Business" in this Annual Report for further information with respect to all of our manufacturing and operational facilities, including QRCs.

 
Number
of Facilities
 
Approximate
Aggregate
Square Footage
EPD
 
 
 
U.S.
3
 
600,000

Non-U.S.
13
 
2,439,000

IPD
 
 
 

U.S.
4
 
603,000

Non-U.S.
9
 
1,444,000

FCD
 
 
 

U.S.
5
 
1,129,000

Non-U.S.
11
 
1,627,000


We own the majority of our manufacturing facilities, and those manufacturing facilities we do not own are leased. We also maintain a substantial network of U.S. and foreign service centers and sales offices, most of which are leased. The majority of our manufacturing leased facilities are covered by lease agreements with terms ranging from two to seven years, with individual lease terms generally varying based on the facilities’ primary usage. We believe we will be able to extend leases on our various facilities as necessary, as they expire.

23


We believe that our current facilities are adequate to meet the requirements of our present and foreseeable future operations. We continue to review our capacity requirements as part of our strategy to optimize our global manufacturing efficiency. See Note 11 to our consolidated financial statements included in Item 8 of this Annual Report for additional information regarding our operating lease obligations.

ITEM 3.
LEGAL PROCEEDINGS

We are party to the legal proceedings that are described in Note 13 to our consolidated financial statements included in Item 8 of this Annual Report, and such disclosure is incorporated by reference into this Item 3. In addition to the foregoing, we and our subsidiaries are named defendants in certain other routine lawsuits incidental to our business and are involved from time to time as parties to governmental proceedings, all arising in the ordinary course of business. Although the outcome of lawsuits or other proceedings involving us and our subsidiaries cannot be predicted with certainty, and the amount of any liability that could arise with respect to such lawsuits or other proceedings cannot be predicted accurately, management does not currently expect these matters, either individually or in the aggregate, to have a material effect on our financial position, results of operations or cash flows. We have established reserves covering exposures relating to contingencies to the extent believed to be reasonably estimable and probable based on past experience and available facts.

ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.


ITEM 5.
MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the New York Stock Exchange ("NYSE") under the symbol "FLS" and our CUSIP number is number is 34354P105. On February 13, 2019, our records showed 1,002 shareholders of record.
 
 
 
Issuer Purchases of Equity Securities
During the quarter ended December 31, 2018, we had no repurchases of common stock as part of publicly announced plans. As of December 31, 2018, we have $160.7 million of remaining capacity under our current share repurchase program. The following table sets forth the repurchase data for each of the three months during the quarter ended December 31, 2018:

24


Period
 
Total Number
of Shares Purchased
(4)
 
Average Price Paid per Share
 
Total Number of
Shares Purchased as
Part of Publicly Announced Plan
(3)(4)
 
Maximum Number of
Shares (or
Approximate Dollar
Value) That May Yet
Be Purchased Under the Plan
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
 
October 1 - 31
 
1,211

(1)
$
50.31

 

 
$
160.7

 
November 1 - 30
 
1,902

(2)
49.45

 

 
160.7

 
December 1 - 31
 
483

(1)
38.30

 

 
160.7

 
Total
 
3,596

 
$
48.24

 

 
 

 
_______________________________________
(1)
Shares tendered by employees to satisfy minimum tax withholding amounts for Restricted Shares.
(2)
Represents 42 shares that were tendered by employees to satisfy minimum tax withholding amounts for Restricted Shares at an average price per share of $49.78, and 1,860 shares purchased at a price of $49.44 per share by a rabbi trust that we established in connection with our director deferral plans, pursuant to which non-employee directors may elect to defer directors’ quarterly cash compensation to be paid at a later date in the form of common stock.
(3)
On November 13, 2014, our Board of Directors approved a $500.0 million share repurchase authorization. Our share repurchase program does not have an expiration date, and we reserve the right to limit or terminate the repurchase program at any time without notice.
(4)
Note 15 to our consolidated financial statements included in Item 8 of this Annual Report provides additional information regarding our share repurchase activity and payment of quarterly dividends on our common stock.

















25


Stock Performance Graph
The following graph depicts the most recent five-year performance of our common stock with the S&P 500 Index and S&P 500 Industrial Machinery. The graph assumes an investment of $100 on December 31, 2013, and assumes the reinvestment of any dividends over the following five years. The stock price performance shown in the graph is not necessarily indicative of future price performance.
chart-f37009d40480594dac4.jpg
 
Base Period
December 31,
Company/Index
2013
2014
2015
2016
2017
2018
Flowserve Corporation

$100.00


$76.59


$54.70


$63.46


$56.36


$51.74

S&P 500 Index
100.00

113.68

115.24

129.02

157.17

150.27

S&P 500 Industrial Machinery
100.00

105.05

100.89

128.07

170.93

145.07


26


ITEM 6.
SELECTED FINANCIAL DATA
 
Year Ended December 31,
 
2018(b)
 
2017(a)(c)
 
2016(a)(d)
 
2015(a)(e)
 
2014(a)(f)
 
(Amounts in thousands, except per share data and ratios)
RESULTS OF OPERATIONS
 

 
 

 
 

 
 

 
 

Sales
$
3,832,666

 
$
3,660,831

 
$
3,990,487

 
$
4,557,791

 
$
4,877,885

Gross profit
1,187,836

 
1,088,953

 
1,236,798

 
1,481,125

 
1,716,058

Selling, general and administrative expense
(943,714
)
 
(901,727
)
 
(965,376
)
 
(970,608
)
 
(933,463
)
Gain (loss) on sale of businesses
(7,727
)
 
141,317

 
(7,664
)
 

 

Operating income
247,538

 
341,135

 
276,684

 
520,377

 
794,710

Interest expense
(58,160
)
 
(59,730
)
 
(60,137
)
 
(65,270
)
 
(60,322
)
Provision for income taxes(g)
(51,224
)
 
(258,679
)
 
(77,380
)
 
(148,351
)
 
(209,311
)
Net earnings attributable to Flowserve Corporation
119,671

 
2,652

 
132,455

 
258,411

 
513,372

Net earnings per share of Flowserve Corporation common shareholders (basic)
0.91

 
0.02

 
1.02

 
1.94

 
3.75

Net earnings per share of Flowserve Corporation common shareholders (diluted)
0.91

 
0.02

 
1.01

 
1.93

 
3.72

Cash flows from operating activities
190,831

 
311,066

 
240,476

 
440,759

 
594,481

Cash dividends declared per share
0.76

 
0.76

 
0.76

 
0.72

 
0.64

FINANCIAL CONDITION
 
 
 

 
 

 
 

 
 

Working capital
$
1,302,170

 
$
1,315,837

 
$
1,119,251

 
$
1,106,946

 
$
1,164,381

Total assets
4,616,277

 
4,910,474

 
4,708,923

 
4,963,106

 
4,844,667

Total debt
1,483,047

 
1,575,257

 
1,570,623

 
1,620,996

 
1,145,658

Retirement obligations and other liabilities
459,693

 
496,954

 
407,839

 
387,786

 
362,970

Total equity
1,660,780

 
1,670,954

 
1,637,388

 
1,664,382

 
1,930,246

FINANCIAL RATIOS
 
 
 

 
 

 
 

 
 

Return on average net assets(h)
5.4
%
 
0.2
%
 
5.2
%
 
9.4
%
 
17.9
%
Net debt to net capital ratio(i)
34.2
%
 
34.3
%
 
42.4
%
 
43.0
%
 
26.4
%
_______________________________
(a)
Retrospective adjustments were made to prior period information to conform to current period presentation. These retrospective adjustments resulted from our adoption ASU No. 2017-07, "Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost," which was effective January 1, 2018. Refer to Note 1 included in this Annual Report for a discussion on the adoption of the standard.
(b)
Results of operations in 2018 include costs of $95.1 million resulting from realignment and transformation initiatives, resulting in a reduction of after tax net earnings of $72.4 million.
(c)
Results of operations in 2017 include costs of $71.3 million resulting from realignment initiatives, resulting in a reduction of after tax net earnings of $54.3 million.
(d)
Results of operations in 2016 include costs of $94.8 million resulting from realignment initiatives, resulting in a reduction of after tax net earnings of $75.8 million.
(e)
Results of operations in 2015 include costs of $108.1 million resulting from realignment initiatives, resulting in a reduction of after tax net earnings of $85.0 million.
(f)
Results of operations in 2014 include costs of $10.7 million resulting from realignment initiatives, resulting in a reduction of after tax net earnings of $7.6 million.
(g)
Provision for income taxes in 2017 was impacted by the Tax Reform Act. See Note 16 to our consolidated financial statements included in Item 8 of this Annual Report.
(h)
Calculated as adjusted net income divided by adjusted net assets, where (i) adjusted net income is the sum of earnings before income taxes, plus interest expense, multiplied by one minus our effective tax rate, and (ii) adjusted net assets is the average of beginning of year and end of year net assets, excluding cash and cash equivalents and debt due in one year.

27


(i)
Calculated as total debt minus cash and cash equivalents divided by the sum of total debt and shareholders' equity minus cash and cash equivalents.

ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is provided to increase the understanding of, and should be read in conjunction with, the accompanying consolidated financial statements and notes. See “Item 1A. Risk Factors” and the section titled “Forward-Looking Information is Subject to Risk and Uncertainty” included in this Annual Report on Form 10-K for the year ended December 31, 2018 ("Annual Report") for a discussion of the risks, uncertainties and assumptions associated with these statements. Unless otherwise noted, all amounts discussed herein are consolidated.

EXECUTIVE OVERVIEW
Our Company
We believe that we are a world-leading manufacturer and aftermarket service provider of comprehensive flow control systems. We develop and manufacture precision-engineered flow control equipment integral to the movement, control and protection of the flow of materials in our customers’ critical processes. Our product portfolio of pumps, valves, seals, automation and aftermarket services supports global infrastructure industries, including oil and gas, chemical, power generation and water management, as well as general industrial markets where our products and services add value. Through our manufacturing platform and global network of Quick Response Centers ("QRCs"), we offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. We employ approximately 17,000 employees in more than 50 countries as of December 31, 2018.
Our business model is significantly influenced by the capital spending of global infrastructure industries for the placement of new products into service and maintenance spending for aftermarket services for existing operations. The worldwide installed base of our products is an important source of aftermarket revenue, where products are expected to ensure the maximum operating time of many key industrial processes. Over the past several years, we have significantly invested in our aftermarket strategy to provide local support to drive customer investments in our offerings and use of our services to replace or repair installed products. The aftermarket portion of our business also helps provide business stability during various economic periods. The aftermarket business, which is primarily served by our network of 171 QRCs located around the globe, provides a variety of service offerings for our customers including spare parts, service solutions, product life cycle solutions and other value-added services. Over the past several years, we have significantly focused on our aftermarket strategy to provide local support to drive customer investments in our offerings and use of our services to replace or repair installed base. It is generally a higher margin business compared to our original equipment business and a key component of our profitable growth strategy.
Through December 31, 2018, our operations were conducted through three business segments that are referenced throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"):
EPD for long lead time, custom and other highly-engineered pumps and pump systems, mechanical seals, auxiliary systems and replacement parts and related services;
IPD for engineered and pre-configured industrial pumps and pump systems and related products and services; and
FCD for engineered and industrial valves, control valves, actuators and controls and related services.
Our business segments share a focus on industrial flow control technology and have a high number of common customers. These segments also have complementary product offerings and technologies that are often combined in applications that provide us a net competitive advantage. Our segments also benefit from our global footprint, our economies of scale in reducing administrative and overhead costs to serve customers more cost effectively and shared leadership for operational support functions, such as research and development, marketing and supply chain.
The reputation of our product portfolio is built on more than 50 well-respected brand names such as Worthington, IDP, Valtek, Limitorque, Durco, Argus, Edward, Valbart and Durametallic, which we believe to be one of the most comprehensive in the industry. Our products and services are sold either directly or through designated channels to more than 10,000 companies, including some of the world’s leading engineering, procurement and construction ("EPC") firms, original equipment manufacturers, distributors and end users.

28


We continue to leverage our QRC network to be positioned as near to customers as possible for service and support in order to capture valuable aftermarket business. Along with ensuring that we have the local capability to sell, install and service our equipment in remote regions, it is equally imperative to continuously improve our global operations. We also continue to expand our global supply chain capability to meet global customer demands and ensure the quality and timely delivery of our products. We are focusing on our ongoing low-cost sourcing, including greater use of third-party suppliers and increasing our lower-cost, emerging market capabilities. Additionally, we continue to devote resources to improving the supply chain processes across our business segments to find areas of synergy and cost reduction and to improve our supply chain management capability to ensure it can meet global customer demands. We also remain focused on improving on-time delivery and quality, while managing warranty costs as a percentage of sales across our global operations, through the assistance of a focused Continuous Improvement Process ("CIP") initiative. The goal of the CIP initiative, which includes lean manufacturing, six sigma business management strategy and value engineering, is to maximize service fulfillment to customers through on-time delivery, reduced cycle time and quality at the highest internal productivity.
Over the past year we have experienced a stabilization in business and improved conditions in certain of our key markets.  With continued stability in oil prices at improved levels beginning in the second half of 2017 through the middle of 2018, our large-project business is showing continued signs of recovery and we anticipate that customers will continue to invest in maintenance and short cycle equipment during 2019. During 2016 and 2017, we were challenged by broad-based capital spending declines, originating in the oil and gas industry, heightened pricing pressures and negative currency impacts caused by a stronger U.S. dollar.
In the second quarter of 2018, we launched and committed resources to our Flowserve 2.0 Transformation, a program designed to transform our business model to drive operational excellence, reduce complexity, accelerate growth, expand margins, increase capital efficiency and improve organizational health. For further information regarding our Flowserve 2.0 Transformation, see “Our Results of Operations” below and Note 19 to our consolidated financial statements included in Item 8 of this Annual Report. During the latter part of 2018 and in connection with the Flowserve 2.0 Transformation, we determined that there are meaningful operational synergies and benefits to combining our EPD and IPD reportable segments into one reportable segment, the Flowserve Pump Division ("FPD"). The reorganization will be effective as of January 1, 2019 and as a result, beginning in 2019 we will report a two operating segment structure, FPD and FCD, and prior periods will be retrospectively adjusted to reflect the new reportable segment structure.
Our Markets
The following discussion should be read in conjunction with the "Outlook for 2019" section included below in this MD&A.
Our products and services are used in several distinct industries: oil and gas, chemical, power generation, water management, and several other industries, such as mining, steel and paper, that are collectively referred to as "general industries."
Demand for most of our products depends on the level of new capital investment as well as planned and unplanned maintenance expenditures by our customers. The level of new capital investment depends, in turn, on capital infrastructure projects driven by the need for products that rely on oil and gas, chemicals, power generation and water resource management, as well as general economic conditions. These drivers are generally related to the phase of the business cycle in their respective industries and the expectations of future market behavior. The levels of maintenance expenditures are additionally driven by the reliability of equipment, planned and unplanned downtime for maintenance and the required capacity utilization of the process.
Sales to EPC firms and original equipment manufacturers are typically for large project orders and critical applications, as are certain sales to distributors. Project orders are typically procured for customers either directly from us or indirectly through contractors for new construction projects or facility enhancement projects.
The quick turnaround business, which we also refer to as "short-cycle," is defined as orders that are received from the customer (booked) and shipped generally within six months of receipt. These orders are typically for more standardized, general purpose products, parts or services. Each of our three business segments generate certain levels of this type of business.
In the sale of aftermarket products and services, we benefit from a large installed base of our original equipment, which requires periodic maintenance, repair and replacement parts. We use our manufacturing platform and global network of QRCs to offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. In geographic regions where we are positioned to provide quick response, we believe customers have traditionally relied on us, rather than our competitors, for aftermarket products due to our highly engineered and customized products. However, the

29


aftermarket for standard products is competitive, as the existence of common standards allows for easier replacement of the installed products. As proximity of service centers, timeliness of delivery and quality are important considerations for all aftermarket products and services, we continue to selectively expand our global QRC capabilities to improve our ability to capture this important aftermarket business.
Oil and Gas
The oil and gas industry, which represented approximately 38% of our bookings in both 2018 and 2017, experienced an increase in capital spending in 2018 compared to the previous year. The increase was primarily due to increased broad-based maintenance and short cycle investment. Aftermarket opportunities in this industry solidified throughout 2018 due to catch up of deferred spending on our customers' repair and maintenance budgets from previous years.
The outlook for the oil and gas industry is heavily dependent on the demand growth from both mature markets and developing geographies as well as changes in the regulatory environment. In the short-term, we believe that stable oil prices will support oil and gas upstream and mid-stream investment and we further expect increased investment in later cycle downstream projects due to emerging market growth and certain regulatory requirements, such as IMO 2020. A recovery in the overall level of spending by oil and gas companies could continue to increase demand for our aftermarket products and services. We believe the medium and long-term fundamentals for this industry remain attractive, and see a stabilized environment as the industry works through current excess supply. In addition, we believe projected depletion rates of existing fields and forecasted long-term demand growth will require additional investments. With our long-standing reputation in providing successful solutions for upstream, mid-stream and downstream applications, along with the advancements in our portfolio of offerings, we believe that we continue to be well-positioned to assist our customers in this improving environment.
Chemical
The chemical industry represented approximately 22% and 21% of our bookings in 2018 and 2017, respectively. The chemical industry is comprised of chemical-based and pharmaceutical products. Capital spending in 2018 increased primarily due to global economic growth and forecasted demand for chemical-based products. The aftermarket opportunities solidified throughout 2018 due to catch up of deferred spending of our customers' repair and maintenance budgets from previous years.
The outlook for the chemical industry remains heavily dependent on global economic conditions. As global economies stabilize and unemployment conditions improve, a rise in consumer spending should follow. An increase in spending would drive greater demand for chemical-based products supporting improved levels of capital investment. We believe the chemical industry in the near-term will continue to invest in North America and Middle East capacity additions, maintenance and upgrades for optimization of existing assets and that developing regions will selectively invest in capital infrastructure to meet current and future indigenous demand. We believe our global presence and our localized aftermarket capabilities are well-positioned to serve the potential growth opportunities in this industry.
Power Generation
The power generation industry represented approximately 11% and 13% of our bookings in 2018 and 2017, respectively. In 2018, the power generation industry continued to experience softness in thermal power generation capital spending in the mature and key developing markets.  China continued to curtail the construction of new coal-fired power generation over the last year, while in India and southeast Asia capital investment remained in place driven by increased demand forecasts.
Natural gas-fired combined cycle (“NGCC”) plants increased its share of the energy mix, driven by market prices for gas remaining low and stable (partially due to the increasing global availability of liquefied natural gas (“LNG”)), low capital expenditures, and the ability of NGCC to stabilize unpredictable renewable sources. With the potential of unconventional sources of gas, the global power generation industry is forecasting an increased use of this form of fuel for power generation plants.
Despite fewer new nuclear plants being constructed, nuclear power remains an important contributor to the global energy mix. We continue to support our significant installed base in the global nuclear fleet by providing aftermarket and life extension products and services. Due to our extensive history, we believe we are well positioned to take advantage of this ongoing source of aftermarket and new construction opportunities.
Political efforts to limit the emissions of carbon dioxide may have some adverse effect on thermal power investment plans depending on the potential requirements imposed and the timing of compliance by country. However, many proposed methods of capturing and limiting carbon dioxide emissions offer business opportunities for our products and services. At

30


the same time, we continue to take advantage of new investments in concentrated solar power generating capacity, where our pumps, valves, and seals are uniquely positioned for both molten salt applications as well as the traditional steam cycle.
We believe the long-term fundamentals for the power generation industry remain solid based on projected increases in demand for electricity driven by global population growth, growth of urbanization in developing markets and the increased use of electricity driven transportation. We also believe that our long-standing reputation in the power generation industry, our portfolio of offerings for the various generating methods, our advancements in serving the renewable energy market and carbon capture methodologies, as well as our global service and support structure, position us well for the future opportunities in this important industry.
Water Management
The water management industry represented approximately 4% our bookings in both 2018 and 2017. Water management industry activity levels increased in 2018 as worldwide demand for fresh water, water treatment and re-use, desalination and flood control continued to create requirements for new facilities or for upgrades of existing systems, many of which require products that we offer, particularly pumps. Capital and aftermarket spending is on the rise in developed and emerging markets with governments and private industry providing funding for critical projects.
The proportion of people living in regions that find it difficult to meet water requirements is expected to double by 2025. We believe that the persistent demand for fresh water during all economic cycles supports continued investments, especially in North America and developing regions.
General Industries
General industries represented, in the aggregate, approximately 25% and 24% of our bookings in 2018 and 2017, respectively. General industries comprise a variety of different businesses, including mining and ore processing, pulp and paper, food and beverage and other smaller applications, none of which individually represented more than 5% of total bookings in 2018 and 2017. General industries also include sales to distributors, whose end customers operate in the industries we primarily serve.
The outlook for this group of industries is heavily dependent upon the condition of global economies and consumer confidence levels. The long-term fundamentals of many of these industries remain sound, as many of the products produced by these industries are common staples of industrialized and urbanized economies. We believe that our specialty product offerings designed for these industries and our aftermarket service capabilities will provide continued business opportunities.

OUR RESULTS OF OPERATIONS

Effective January 1, 2018, we adopted ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" and all related ASUs ("New Revenue Standard"), using the modified retrospective method for transition. For a discussion related to our adoption of the New Revenue Standard requirements refer to Note 2 to our consolidated financial statements included in Item 8 of this Annual Report.
Throughout this discussion of our results of operations, we discuss the impact of fluctuations in foreign currency exchange rates. We have calculated currency effects on operations by translating current year results on a monthly basis at prior year exchange rates for the same periods.
Effective August 9, 2018, we divested two IPD locations and associated product lines, including the related assets and liabilities, which included a manufacturing facility in Germany and a related assembly facility in France. The sale was to a private company. In 2017, net sales related to the divested business totaled approximately $42 million, although the business produced an operating loss in each of the last two fiscal years.
Effective July 6, 2017, we sold our FCD Vogt product line and related assets and liabilities to a privately held company. In 2016, sales related to the Vogt business totaled approximately $17 million, with earnings before interest and taxes of approximately $4 million.
Effective May 2, 2017 we sold our FCD Gestra AG business to a leading provider of steam system solutions. In 2016, Gestra recorded sales of approximately $101 million with earnings before interest and taxes of approximately $17 million.
Note 3 to our consolidated financial statements included in Item 8 of this Annual Report discusses the details of the above dispositions.

31


In the second quarter of 2018, we launched and committed resources to our Flowserve 2.0 Transformation, a program designed to transform our business model to drive operational excellence, reduce complexity, accelerate growth, expand margins, increase capital efficiency and improve organizational health, which is further discussed in Note 19 to our consolidated financial statements included in Item 8 of this Annual Report. We anticipate that the Flowserve 2.0 Transformation will continue to incur restructuring charges, non-restructuring charges and other related transformation expenses (such as professional services, project management and related travel and expense). For the year ended December 31, 2018, we incurred Flowserve 2.0 Transformation related expenses of $41.2 million, primarily consisting of professional services and project management costs recorded in SG&A. We are currently evaluating the total investment in and financial benefits of the various initiatives associated with this program.
In 2015, we initiated Realignment Programs that consist of both restructuring and non-restructuring charges that are further discussed in Note 19 to our consolidated financial statements included in Item 8 of this Annual Report. As of December 31, 2018 the Realignment Programs are substantially complete. The total charges for Realignment Programs by segment are detailed below for the years ended December 31, 2018 and 2017:
 
December 31, 2018
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Total Realignment Program Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
34,050

 
$
5,427

 
$
3,221

 
$
42,698

 
$

 
$
42,698

     SG&A
4,189

 
1,721

 
(294
)
 
5,616

 
5,618

 
11,234

     Income tax expense
(1,000
)
 

 

 
(1,000
)
 

 
(1,000
)
Total
$
37,239

 
$
7,148

 
$
2,927

 
$
47,314

 
$
5,618

 
$
52,932

    
 
December 31, 2017
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Total Realignment Program Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
18,364

 
$
13,983

 
$
11,600

 
$
43,947

 
$

 
$
43,947

     SG&A
7,376

 
11,311

 
2,870

 
21,557

 
5,751

 
27,308

     Income tax expense
1,000

 

 

 
1,000

 

 
1,000

Total
$
26,740

 
$
25,294

 
$
14,470

 
$
66,504

 
$
5,751

 
$
72,255

We anticipate a total investment in these Realignment Programs of approximately $360 million, of which we have incurred charges of $347.8 million inception to date. Based on actions under our Realignment Programs, we estimate that we have achieved cost savings of approximately $230 million as of December 31, 2018, as compared with approximately $200 million as of December 31, 2017. Approximately $169 million of those savings are in COS with the remainder in SG&A. The Realignment Programs are substantially complete.
Bookings and Backlog
 
2018
 
2017
 
2016
 
(Amounts in millions)
Bookings
$
4,019.8

 
$
3,803.9

 
$
3,760.4

Backlog (at period end)
1,891.6

 
2,033.4

 
1,901.8


We define a booking as the receipt of a customer order that contractually engages us to perform activities on behalf of our customer in regards to the manufacture, delivery, and/or support of products or the delivery of service. Bookings recorded and subsequently canceled within the same fiscal period are excluded from reported bookings. Bookings of $4.0 billion in

32


2018 increased by $215.9 million, or 5.7%, as compared with 2017. The increase included currency benefits of approximately $30 million. The increase was primarily driven by the oil and gas, general and chemical industries, partially offset by a decrease in the power generation industry. The increase was more heavily-weighted towards customer aftermarket bookings.
    
Bookings of $3.8 billion in 2017 increased by $43.5 million, or 1.2%, as compared with 2016. The increase included currency benefits of approximately $27 million. The increase was primarily driven by the oil and gas industry, partially offset by a decrease in the power generation industry. The increase was more heavily weighted towards customer original equipment bookings.
Backlog represents the aggregate value of booked but uncompleted customer orders and is influenced primarily by bookings, sales, cancellations and currency effects. Backlog of $1.9 billion at December 31, 2018 decreased by $141.8 million, or 7.0%, as compared with December 31, 2017. Currency effects provided a decrease of approximately $83 million (currency effects on backlog are calculated using the change in period end exchange rates). The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $237 million on January 1, 2018. Backlog related to aftermarket orders was approximately 36% and 31% of the backlog at December 31, 2018 and 2017, respectively. We expect to ship approximately 89% of December 31, 2018 backlog during 2019. Backlog includes our unsatisfied (or partially unsatisfied) performance obligations related to contracts having an original expected duration in excess of one year of approximately $450 million as discussed in Note 2 to our consolidated financial statements included in Item 8 of this Annual Report.
Backlog of $2.0 billion at December 31, 2017 increased by $131.6 million, or 6.9%, as compared with December 31, 2016. Currency effects provided an increase of approximately $110 million. Backlog related to aftermarket orders was approximately 31% and 30% of the backlog at December 31, 2017 and 2016, respectively. We expected to ship approximately 92% of December 31, 2017 backlog during 2018.
Sales
 
2018
 
2017
 
2016
 
(Amounts in millions)
Sales
$
3,832.7

 
$
3,660.8

 
$
3,990.5


Sales in 2018 increased by $171.9 million, or 4.7%, as compared with 2017. The increase included currency benefits of approximately $31 million. The increase was more heavily-weighted to aftermarket sales, with increased sales into North America, Asia Pacific and Africa, partially offset by decreased sales in the Middle East and Europe. The impact of the adoption of the New Revenue Standard increased sales by approximately $71 million for the year ended December 31, 2018.

Sales in 2017 decreased by $329.7 million, or 8.3%, as compared with 2016. The decrease included currency benefits of approximately $34 million. The decrease was more heavily weighted toward original equipment sales. Sales decreased into every region.

Sales to international customers, including export sales from the U.S., were approximately 63% of total sales in 2018 and 64% for both 2017 and 2016. Sales into Europe, the Middle East and Africa ("EMA") were approximately 32%, 36% and 35% of total sales in 2018, 2017 and 2016, respectively. Sales into Asia Pacific were approximately 20% of total sales for 2018 and 19% for both 2017 and 2016. Sales into Latin America were approximately 6% of total sales in both 2018 and 2017 and 7% for 2016.
Gross Profit and Gross Profit Margin
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
Gross profit
$
1,187.8

 
$
1,089.0

 
$
1,236.8

Gross profit margin
31.0
%
 
29.7
%
 
31.0
%

Gross profit in 2018 increased by $98.8 million, or 9.1%, as compared with 2017. Gross profit margin in 2018 of 31.0% increased from 29.7% in 2017. The impact of the adoption of the New Revenue Standard had an immaterial impact on gross profit margin for the year ended December 31, 2018. The increase in gross profit margin was primarily attributable to a $16.9 million charge for costs related to a contract to supply oil and gas platform equipment to an end user in Latin

33


America in 2017 that did not recur, revenue recognized on higher margin projects, a mix shift to higher margin aftermarket sales, favorable impact of increased sales on our absorption of fixed manufacturing costs and increased savings related to our Realignment Programs, partially offset by a $7.7 million charge for cost incurred related to the write-down of inventory associated with the divestiture of two IPD locations and related product lines in the second quarter of 2018.  Aftermarket sales increased to approximately 50% of total sales, as compared with approximately 48% of total sales in 2017.

Gross profit in 2017 decreased by $147.8 million, or 12.0%, as compared with 2016. Gross profit margin in 2017 of 29.7% decreased from 31.0% in 2016. The decrease in gross profit and gross profit margin was primarily attributable to the negative impact of decreased sales on our absorption of fixed manufacturing costs, lower margin projects that shipped from backlog and a $16.9 million charge for costs incurred related to a contract to supply oil and gas platform equipment to an end user in Latin America, partially offset by $10.9 million of charges to write down inventory in Brazil in 2016 that did not recur, a mix shift to higher margin aftermarket sales and lower charges and increased savings related to our Realignment Programs. Aftermarket sales increased to approximately 48% of total sales, as compared with approximately 45% of total sales in 2016.
SG&A
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
SG&A
$
943.7

 
$
901.7

 
$
965.4

SG&A as a percentage of sales
24.6
%
 
24.6
%
 
24.2
%

SG&A in 2018 increased by $42.0 million, or 4.7%, as compared with 2017. Currency effects yielded an increase of approximately $7 million. In 2018, SG&A as a percentage of sales remained relatively unchanged as compared with 2017. SG&A was favorably impacted by increased sales leverage, a $26.0 million impairment charge related to our manufacturing facility in Brazil in 2017 that did not recur, lower stock-based compensation expense, lower bad debt expense and lower charges and increased savings related to our Realignment Programs. These favorable cost impacts were substantially offset by charges related to the Flowserve 2.0 Transformation program, implementation costs associated with our adoption of the New Revenue Standard, increased accrued broad-based annual incentive compensation expense and an impairment charge of $9.7 million related to the long-lived assets associated with the divestiture of two IPD locations and related product lines in the second quarter of 2018.

SG&A in 2017 decreased by $63.7 million, or 6.6%, as compared with 2016. Currency effects yielded an increase of approximately $6 million. SG&A as a percentage of sales in 2017 increased 40 basis points as compared with 2016 due to a $26.0 million impairment charge related to our manufacturing facility in Brazil, increased accrued broad-based annual incentive compensation and lower sales leverage, partially offset by the $73.5 million reserve established for our primary Venezuelan customer in 2016 that did not recur and savings related to our Realignment Programs.
(Loss) Gain on Sale of Businesses
 
2018
 
2017
 
2016
 
(Amounts in millions)
(Loss) gain on sale of businesses
$
(7.7
)
 
$
141.3

 
$
(7.7
)

The loss on sale of businesses in 2018 of $7.7 million resulted from the divestiture of two IPD locations and related product lines. The gain on sale of businesses in 2017 was the result of the $141.3 million gain from the sales of the Gestra and Vogt businesses. See Note 3 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on these sales. The $7.7 million loss in 2016 resulted from the sale of a non-strategic foundry business.
Net Earnings from Affiliates
 
2018
 
2017
 
2016
 
(Amounts in millions)
Net earnings from affiliates
$
11.1

 
$
12.6

 
$
12.9



34


Net earnings from affiliates represents our net income from investments in seven joint ventures (one located in each of Chile, India, Saudi Arabia, South Korea and the United Arab Emirates and two in China) that are accounted for using the equity method of accounting. Net earnings from affiliates in 2018 decreased by $1.5 million, or 11.9%, as compared to the prior year, primarily as a result of decreased earnings of our EPD joint venture in South Korea. Net earnings from affiliates in 2017 remained relatively constant compared to the prior year.
Operating Income
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
Operating income
$
247.5

 
$
341.1

 
$
276.7

Operating income as a percentage of sales
6.5
%
 
9.3
%
 
6.9
%
Operating income in 2018 decreased by $93.6 million, or 27.4%, as compared with 2017. The decrease included negative currency effects of approximately $2 million. The decrease was primarily a result of the $141.3 million gain from the sales of the Gestra and Vogt businesses in 2017 that did not recur, the $42.0 million increase in SG&A and the loss of $7.7 million from the divestiture of two IPD locations and related product lines, partially offset by the $98.8 million increase in gross profit discussed above.

Operating income in 2017 increased by $64.4 million, or 23.3%, as compared with 2016. The increase included currency benefits of approximately $2 million. The increase was primarily a result of the $141.3 million pre-tax gain from the sales of the Gestra and Vogt businesses and the $63.7 million decrease in SG&A, partially offset by the $147.8 million decrease in gross profit discussed above.

Interest Expense and Interest Income
 
2018
 
2017
 
2016
 
(Amounts in millions)
Interest expense
$
(58.2
)
 
$
(59.7
)
 
$
(60.1
)
Interest income
6.5

 
3.4

 
2.8

Interest expense in 2018 decreased by $1.5 million as compared with 2017. The decrease was primarily attributable to lower borrowings in 2018, as compared to the same period in 2017. Interest expense in 2017 decreased by $0.4 million as compared with 2016. The decrease was primarily attributable to decreased borrowings under our Revolving Credit Facility in 2017, as compared to the same period in 2016.
Interest income in 2018 increased by $3.1 million as compared with 2017. The increase in interest income was primarily attributable to higher average cash balances compared with 2017. Interest income in 2017 increased by $0.6 million as compared with 2016.
Other Expense, net
 
2018
 
2017
 
2016
 
(Amounts in millions)
Other expense, net
$
(19.6
)
 
$
(21.8
)
 
$
(6.4
)
Other expense, net decreased $2.2 million as compared to 2017, due to a $6.4 million decrease in net periodic benefit costs for pensions and post retirement obligations, partially offset by a $5.3 million increase in losses from foreign exchange contracts.  The net change in transactions in currencies and foreign exchange contracts was primarily due to the foreign currency exchange rate movements in the Euro, Indian rupee, Mexican peso and Argentinian peso in relation to the U.S. dollar during the year ended December 31, 2018, as compared with the same period in 2017.
Other expense, net increased $15.4 million in 2017, due primarily to a $13.2 million increase in losses arising from transactions in currencies other than our sites' functional currencies and a $3.6 million increase in losses from foreign exchange contracts. The net change was primarily due to the foreign currency exchange rate movements in the Mexican peso, Euro, Brazilian real and British pound in relation to the U.S. dollar during the year ended December 31, 2017, as compared with the same period in 2016.

35


Tax Expense and Tax Rate
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
Provision for income taxes
$
51.2

 
$
258.7

 
$
77.4

Effective tax rate
29.0
%
 
98.4
%
 
36.3
%

On December 22, 2017, the U.S. enacted the Tax Reform Act, which significantly changed U.S. tax law. The Tax Reform Act, among other things, lowered the Company’s U.S. statutory federal income tax rate from 35% to 21% effective January 1, 2018, while imposing a deemed repatriation tax on deferred foreign income and implementing a modified territorial tax system. The Tax Reform Act also provides for a one-time transition tax on certain foreign earnings and the acceleration of depreciation for certain assets placed into service after September 27, 2017 as well as prospective changes which began in 2018, including repeal of the domestic manufacturing deduction, capitalization of research and development expenditures, additional limitations on executive compensation and limitations on the deductibility of interest. The Tax Reform Act also provides for two new anti-base erosion provisions, the global intangible low-taxed income (“GILTI”) provision and the base-erosion and anti-abuse tax (“BEAT”) provision which effectively creates a new minimum tax on certain future foreign earnings.
The 2018 tax rate differed from the federal statutory rate of 21% primarily due to the net impact of foreign operations, including losses in certain foreign jurisdictions for which no tax benefit was provided. Our effective tax rate of 29.1% for the year ended December 31, 2018 decreased from 98.4% in 2017 due to a change in the U.S. statutory tax rate for 2018, taxation of previously unremitted earnings for the year ended December 31, 2017 imposed as a result of the Tax Reform Act that did not reoccur in 2018, and the net impact of foreign operations. The 2017 tax rate differed from the federal statutory rate of 35% primarily due to the impacts pursuant to enactment of the Tax Reform Act, the net impact of foreign operations, the establishment of a valuation allowance against our deferred tax assets in various foreign jurisdictions, primarily Germany and Mexico, and taxes related to the sale of the Gestra and Vogt businesses. The 2016 tax rate differed from the federal statutory rate of 35% primarily due to the net impact of foreign operations, tax impacts from our Realignment Programs and losses in certain foreign jurisdictions for which no tax benefit was provided.
Our effective tax rate is based upon current earnings and estimates of future taxable earnings for each domestic and international location. Changes in any of these and other factors, including our ability to utilize foreign tax credits and net operating losses or results from tax audits, could impact the tax rate in future periods. As of December 31, 2018, we have foreign tax credits of $16.1 million, expiring in 2026 and 2028 tax years, against which we recorded a valuation allowance of $16.1 million. Additionally, we have recorded other net deferred tax assets of $44.7 million, which relate to net operating losses, tax credits and other deductible temporary differences that are available to reduce taxable income in future periods, most of which do not have a definite expiration. Should we not be able to utilize all or a portion of these credits and losses, our effective tax rate would increase.
Net Earnings and Earnings Per Share
 
2018
 
2017
 
2016
 
(Amounts in millions, except per share amounts)
Net earnings attributable to Flowserve Corporation
$
119.7

 
$
2.7

 
$
132.5

Net earnings per share — diluted
$
0.91

 
$
0.02

 
$
1.01

Average diluted shares
131.3

 
131.4

 
131.0


Net earnings in 2018 increased by $117.0 million to $119.7 million, or to $0.91 per diluted share, as compared with 2017. The increase was primarily attributable to a $207.5 million decrease in tax expense, a $2.2 million decrease in other expense net, and a $1.5 million decrease in interest expense, partially offset by a decrease in operating income of $93.6 million.

Net earnings in 2017 decreased by $129.8 million to $2.7 million, or to $0.02 per diluted share, as compared with 2016. The decrease was primarily attributable to a $181.3 million increase in tax expense and a $18.4 million increase in other expense, partially offset by a $67.4 million increase in operating income and a $0.4 million decrease in interest expense.

36


Other Comprehensive (Loss) Income
 
2018
 
2017
 
2016
 
(Amounts in millions)
Other comprehensive (loss) income
$
(67.8
)
 
$
119.8

 
$
(85.8
)

Other comprehensive loss in 2018 increased by $187.6 million to $67.8 million from income of $119.8 million in 2017. The loss was primarily due to foreign currency translation adjustments resulting primarily from exchange rate movements of the Euro, Argentinian peso, Indian rupee and British pound versus the U.S. dollar at December 31, 2018 as compared with 2017. For a discussion related to hyperinflation in Argentina, refer to Note 1 to our consolidated financial statements included in Item 8 of this Annual Report.
Other comprehensive income in 2017 increased by $205.6 million to $119.8 million from a loss of $85.8 million in 2016. The income was primarily due to foreign currency translation adjustments resulting primarily from exchange rate movements of the Euro, British pound and Indian rupee versus the U.S. dollar at December 31, 2017 as compared with 2016.
Business Segments
We conduct our operations through three business segments based on type of product and how we manage the business. We evaluate segment performance and allocate resources based on each segment’s operating income (loss). See Note 17 to our consolidated financial statements included in Item 8 of this Annual Report for further discussion of our segments. The key operating results for our three business segments, EPD, IPD and FCD, are discussed below.
Engineered Product Division Segment Results
Our largest business segment is EPD, through which we design, manufacture, distribute and service custom and other highly-engineered pumps and pump systems, mechanical seals and auxiliary systems (collectively referred to as "original equipment"). EPD includes longer lead time, highly-engineered pump products and mechanical seals that are generally manufactured within shorter lead times. EPD also manufactures replacement parts and related equipment and provides aftermarket services. EPD primarily operates in the oil and gas, petrochemical, chemical, power generation, water management and other general industries. EPD operates in 47 countries with 28 manufacturing facilities worldwide, eight of which are located in Europe, nine in North America, six in Asia and five in Latin America, and it has 119 QRCs, including those co-located in manufacturing facilities.
 
EPD
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
Bookings
$
1,995.1

 
$
1,842.1

 
$
1,823.8

Sales
1,899.2

 
1,775.4

 
1,996.0

Gross profit
586.0

 
545.9

 
624.0

Gross profit margin
30.9
%
 
30.7
%
 
31.3
%
SG&A
390.5

 
399.3

 
457.6

Loss on sale of business

 

 
(7.7
)
Segment operating income
206.9

 
159.1

 
171.1

Segment operating income as a percentage of sales
10.9
%
 
9.0
%
 
8.6
%
Backlog (at period end)
922.6

 
1,027.7

 
966.8


Bookings in 2018 increased by $153.0 million, or 8.3%, as compared with 2017, which included 2017 bookings for an order of approximately $80 million to provide pumps and related equipment for the Hengli Integrated Refining Complex Project in China that did not recur. The increase included currency benefits of approximately $7 million. The increase in customer bookings was primarily driven by the oil and gas, water management and general industries. Increased customer bookings of $78.1 million into Europe, $64.8 million into the Middle East and $58.3 million into North America were partially offset by decreased customer bookings of $27.1 million into Asia Pacific and $18.3 million into Africa. The increase was driven by increased customer aftermarket bookings. Of the $2.0 billion of bookings in 2018, approximately 51% were from oil and gas, 17% from chemical, 17% from general industries, 12% from power generation and 3% from water management.

37


Interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) decreased $1.3 million.
Bookings in 2017 increased by $18.3 million, or 1.0%, as compared with 2016 and included an order for approximately $80 million to provide pumps and related equipment for the Hengli Integrated Refining Complex Project in China. The increase included currency benefits of approximately $11 million. The increase in customer bookings was primarily driven by the oil and gas and chemical industries, partially offset by a decrease in the power generation and general industries. Customer bookings increased $112.8 million into Asia Pacific and $39.0 million into Africa and were partially offset by decreased customer bookings of $60.1 million into the Middle East, $46.9 million into Europe, $20.0 million into North America and $18.4 million into Latin America. The increase was driven by customer original equipment bookings. Of the $1.8 billion of bookings in 2017, approximately 51% were from oil and gas, 19% from chemical, 17% from general industries and 13% from power generation. Interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) increased $6.6 million.
Sales in 2018 increased $123.8 million, or 7.0%, as compared with 2017. The increase included currency benefits of approximately $12 million. The increase was more heavily-weighted towards aftermarket sales, resulting from increased customer sales of $57.7 million into Asia Pacific, $51.9 million into Africa, $50.6 million into Latin America and $49.2 million into North America that were partially offset by decreased sales of $73.0 million into the Middle East and $11.4 million into the Europe. The impact of the adoption of the New Revenue Standard increased sales by approximately $44 million for the year ended December 31, 2018. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) increased $1.4 million.
Sales in 2017 decreased $220.6 million, or 11.1%, as compared with 2016. The decrease included currency benefits of approximately $13 million. The decrease was more heavily weighted towards customer original equipment sales, resulting from decreased customer sales of $129.2 million into North America, $64.0 million into Latin America, $15.0 million into Europe, $11.2 million into the Middle East and $6.3 million into Africa. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) increased $4.5 million.
Gross profit in 2018 increased by $40.1 million, or 7.3%, as compared with 2017. Gross profit margin in 2018 of 30.9% increased from 30.7% in 2017. The increase in gross profit margin was primarily attributable to the favorable impact of increased sales on our absorption of fixed manufacturing costs and increased savings achieved related to our Realignment Programs, partially offset by increased charges related to our Realignment Programs and revenue recognized on lower margin projects. The impact of the adoption of the New Revenue Standard had a slightly favorable impact on gross profit margin.
Gross profit in 2017 decreased by $78.1 million, or 12.5%, as compared with 2016. Gross profit margin in 2017 of 30.7% decreased from 31.3% in 2016. The decrease in gross profit margin was primarily attributable to the negative impact of decreased sales on our absorption of fixed manufacturing costs and lower margin projects that shipped from backlog, partially offset by lower costs and increased savings related to our Realignment Programs, a mix shift to higher margin aftermarket sales and $10.9 million of charges to write down inventory in Brazil in 2016 that did not recur.
SG&A in 2018 decreased by $8.8 million, or 2.2%, as compared with 2017. Currency effects provided an increase of approximately $2 million. The decrease in SG&A is primarily attributable to a $26.0 million impairment charge related to our manufacturing facility in Brazil in 2017 that did not recur, lower bad debt expense and decreased charges related to our Realignment Programs, partially offset by higher selling and administrative related expenses.
SG&A in 2017 decreased by $58.3 million, or 12.7%, as compared with 2016. Currency effects provided an increase of approximately $2 million. The decrease in SG&A is primarily due to EPD's $71.2 million portion of the $73.5 million reserve established for our primary Venezuelan customer in the third quarter of 2016 that did not recur and increased savings related to our Realignment Programs, partially offset by a $26.0 million impairment charge in the second quarter of 2017 related to our manufacturing facility in Brazil.
Operating income in 2018 increased by $47.8 million, or 30.0%, as compared with 2017. The increase included currency benefits of approximately $1 million. The increase was due to the $40.1 million increase in gross profit and the $8.8 million decrease in SG&A.
Operating income in 2017 decreased by $12.0 million, or 7.0%, as compared with 2016. The decrease included currency benefits of approximately $1 million. The decrease was due to the $78.1 million decrease in gross profit, partially offset by a $58.3 million decrease in SG&A .
Backlog of $922.6 million at December 31, 2018 decreased by $105.1 million, or 10.2%, as compared with December 31, 2017. The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $181

38


million at January 1, 2018. Currency effects provided a decrease of approximately $53 million. Backlog at December 31, 2018 included $15.3 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above). Backlog of $1.0 billion at December 31, 2017 increased by $58.9 million, or 6.1%, as compared with December 31, 2016. Currency effects provided an increase of approximately $52 million. Backlog at December 31, 2017 included $16.0 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above).
Industrial Product Division Segment Results
Through IPD we design, manufacture, distribute and service engineered and pre-configured industrial pumps and pump systems, collectively referred to as "original equipment." Additionally, IPD manufactures replacement parts and related equipment, and provides a full array of support services, collectively referred to as "aftermarket". IPD primarily operates in the chemical, oil and gas, water resources, power and general industries. IPD operates 16 manufacturing facilities, five of which are located in the U.S and six in Europe and four in Asia and it operates 29 QRCs worldwide, including 18 sites in Europe and five in the U.S., three in Asia and two in Latin America and including those co-located in manufacturing facilities and/or shared with EPD.
 
IPD
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
Bookings
$
838.5

 
$
821.7

 
$
797.7

Sales
799.4

 
775.2

 
835.1

Gross profit
189.4

 
144.1

 
183.2

Gross profit margin
23.7
 %
 
18.6
 %
 
21.9
 %
SG&A
188.4

 
193.7

 
189.3

Loss on sale of business
(7.7
)
 

 

Segment operating loss
(6.2
)
 
(48.8
)
 
(5.2
)
Segment operating loss as a percentage of sales
(0.8
)%
 
(6.3
)%
 
(0.6
)%
Backlog (at period end)
394.0

 
424.3

 
375.6


Bookings in 2018 increased by $16.8 million, or 2.0%, as compared with 2017. The increase included currency benefits of approximately $12 million and was partially offset by approximately $23 million in reduced bookings due to the divestiture of two IPD locations and related product lines in the third quarter of 2018. The increase in customer bookings was primarily driven by the chemical, power generation, and general industries, partially offset by a decrease in the water management industry. Increased customer bookings of $22.0 million into Asia Pacific and $13.4 million into Europe were partially offset by decreased bookings of $14.6 million into North America and $7.4 million into Latin America. The increase was in both customer original equipment and aftermarket bookings. Of the $838.5 million of bookings in 2018, approximately 44% were from general industries, 21% from chemical, 16% from oil and gas, 12% from water management and 7% from power generation. Interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) increased $6.9 million.

Bookings in 2017 increased by $24.0 million, or 3.0%, as compared with 2016. The increase included currency benefits of approximately $7 million. The increase in customer bookings was primarily driven by the oil and gas and general industries, partially offset by a decrease in the chemical industry. Bookings increased $23.8 million into Europe, $19.3 million into Latin America and $12.6 million into North America and were partially offset by decreased bookings of $22.5 million into the Middle East and $18.2 million into Asia Pacific. The increase was driven by customer original equipment bookings. Of the $821.7 million of bookings in 2017, approximately 45% were from general industries, 19% from chemical, 17% from oil and gas, 13% from water management and 6% from power generation. Interdivision bookings (which are eliminated and are not included in consolidated bookings as disclosed above) increased $1.7 million.
Sales in 2018 increased by $24.2 million, or 3.1%, as compared with 2017. The increase included currency benefits of approximately $11 million and was partially offset by approximately $19 million in reduced sales due to the divestiture of two IPD locations and related product lines in the third quarter of 2018. The increase was more heavily-weighted towards aftermarket sales. Customer sales increased $16.9 million into North America, $8.9 million into Europe and $3.9 million into Africa, partially offset by decreased sales of $9.4 million into the Middle East. The impact of the adoption of the New

39


Revenue Standard increased sales by approximately $19 million for the year ended December 31, 2018. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) increased $3.9 million.

Sales in 2017 decreased by $59.9 million, or 7.2%, as compared with 2016. The decrease included currency benefits of approximately $8 million and was driven by decreased customer original equipment sales. Customer sales decreased $35.0 million into Asia Pacific, $26.0 million into North America, $14.1 million into Africa and $5.7 million into Latin America, partially offset by increased sales of $10.0 million into the Middle East and $7.4 million into Europe. Interdivision sales (which are eliminated and are not included in consolidated sales as disclosed above) increased $0.4 million.
Gross profit in 2018 increased by $45.3 million, or 31.4%, as compared with 2017. Gross profit margin in 2018 of 23.7% increased from 18.6% in 2017. The increase in gross profit margin was primarily attributable to a $16.9 million charge for costs related to a contract to supply oil and gas platform equipment to an end user in Latin America in 2017 that did not recur, lower charges and increased savings related to our Realignment Programs and revenue recognized on higher margin projects, partially offset by a $7.7 million charge for cost incurred related to the write-down of inventory associated with the divestiture of two IPD locations and related product lines.
Gross profit in 2017 decreased by $39.1 million, or 21.3%, as compared with 2016. Gross profit margin in 2017 of 18.6% decreased from 21.9% in 2016. The decrease in gross profit margin was primarily attributable to a $16.9 million charge in the second quarter of 2017 for costs incurred related to a contract to supply oil and gas platform equipment to an end user in Latin America and the negative impact of decreased sales on our absorption of fixed manufacturing costs, partially offset by lower charges and increased savings related to our Realignment Programs.
SG&A in 2018 decreased by $5.3 million, or 2.7%, as compared with 2017. Currency effects provided an increase of $3.0 million. The decrease in SG&A was primarily due to lower charges and increased savings related to our Realignment Programs compared to 2017, partially offset by an impairment charge on long-lived assets related to the divestiture of two IPD locations and related product lines of $9.7 million.
SG&A in 2017 increased by $4.4 million, or 2.3%, as compared with the same period in 2016. Currency effects provided an increase of approximately $2 million. The increase in SG&A is primarily due to increased charges related to our Realignment Programs which were partially offset by increased savings related to our Realignment Programs.
The loss on sale of businesses in 2018 of $7.7 million resulted from the divestiture of two IPD locations and related product lines. Refer to Note 3 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on this divestiture.
Operating loss for 2018 decreased by $42.6 million, or 87.3%, as compared with 2017. The decrease included negative currency effects of approximately $2 million. The decrease was primarily due to the $45.3 million increase in gross profit and a $5.3 million decrease in SG&A, partially offset by a $7.7 million loss from the divestiture of two IPD locations and related product lines.
Operating loss for 2017 increased by $43.6 million, or 838.5%, as compared with 2016. The increase included negative currency effects of approximately $1 million. The increase was primarily due to the $39.1 million decrease in gross profit and a $4.4 million increase in SG&A.
Backlog of $394.0 million at December 31, 2018 decreased by $30.3 million, or 7.1%, as compared with December 31, 2017. The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $34 million at January 1, 2018. Currency effects provided a decrease of approximately $13 million. Backlog at December 31, 2018 included $17.2 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above). Backlog of $424.3 million at December 31, 2017 increased by $48.7 million, or 13.0%, as compared with December 31, 2016. Currency effects provided an increase of approximately $38 million. Backlog at December 31, 2017 included $17.3 million of interdivision backlog (which is eliminated and not included in consolidated backlog as disclosed above).
Flow Control Division Segment Results
Our second largest business segment is FCD, which designs, manufactures and distributes a broad portfolio of engineered-to-order and configured-to-order isolation valves, control valves, valve automation products, boiler controls and related services. FCD leverages its experience and application know-how by offering a complete menu of engineered services to complement its expansive product portfolio. FCD has a total of 47 manufacturing facilities and QRCs in 21 countries around the world, with five of its 21 manufacturing operations located in the U.S., 10 located in Europe and five located in Asia Pacific. Based on independent industry sources, we believe that FCD is the third largest industrial valve supplier on a global basis.

40


 
FCD
 
2018
 
2017
 
2016
 
(Amounts in millions, except percentages)
Bookings
$
1,274.3

 
$
1,225.7

 
$
1,216.8

Sales
1,215.8

 
1,188.1

 
1,233.7

Gross profit
416.9

 
396.7

 
429.9

Gross profit margin
34.3
%
 
33.4
%
 
34.8
%
SG&A
215.0

 
213.6

 
226.9

Gain on sale of businesses

 
141.3

 

Segment operating income
201.2

 
323.7

 
202.6

Segment operating income as a percentage of sales
16.5
%
 
27.2
%
 
16.4
%
Backlog (at period end)
608.4

 
617.4

 
584.5


Bookings in 2018 increased $48.6 million, or 4.0%, as compared with 2017. The increase included currency benefits of approximately $11 million. The increase in customer bookings in the general, oil and gas and chemical industries were partially offset by decreases in the power generation and water management industries. Increased customer bookings of $78.7 million into North America and $17.4 million into Asia Pacific were partially offset by decreased bookings of $27.7 million into Europe and $18.0 million into the Middle East. The increase was driven by both customer original equipment and aftermarket bookings. Of the $1.3 billion of bookings in 2018, approximately 33% were from oil and gas, 29% from chemical, 27% from general industries and 11% from power generation.

Bookings in 2017 increased $8.9 million, or 0.7%, as compared with 2016. The increase included currency benefits of approximately $9 million. The increase in customer bookings was primarily driven by the oil and gas, water management and power generation industries and was partially offset by decreased customer bookings in general industries. Increased customer bookings of $43.2 million into North America, $39.4 million into Asia Pacific and $10.0 million into Africa were largely offset by decreased bookings of $66.8 million into Europe and $18.8 million into Latin America. The increase was driven by customer aftermarket bookings. Of the $1.2 billion of bookings in 2017, approximately 32% were from oil and gas, 29% from chemical, 21% from general industries, 16% from power generation and 2% from water management.
Sales in 2018 increased by $27.7 million, or 2.3%, as compared with 2017. The increase included currency benefits of approximately $8 million and was driven by increased customer original equipment sales. Sales increased $62.4 million into North America, $40.1 million into Asia Pacific and $7.9 million into Africa, partially offset by a decreased customer sales of $46.0 million into Europe, $25.1 million into the Middle East and $10.8 million into Latin America. The impact of the adoption of the New Revenue Standard increased sales by approximately $8 million for the year ended December 31, 2018.

Sales in 2017 decreased by $45.6 million, or 3.7%, as compared with 2016. The decrease included currency benefits of approximately $13 million and was driven by decreased customer original equipment sales. Sales decreased $21.4 million into Europe, $17.7 million into the Middle East and $16.1 million into Latin America, partially offset by an increase of $6.8 million into Asia Pacific.
Gross profit in 2018 increased by $20.2 million, or 5.1%, as compared with 2017. Gross profit margin in 2018 of 34.3% increased from 33.4% in 2017. The increase in gross profit margin was primarily attributable to the positive impact of increased sales on our absorption of fixed manufacturing costs and decreased charges and increased savings achieved related to our Realignment Programs compared to the same period in 2017. The impact of the adoption of the New Revenue Standard had a slightly unfavorable impact on gross profit margin.

Gross profit in 2017 decreased by $33.2 million, or 7.7%, as compared with 2016. Gross profit margin in 2017 of 33.4% decreased from 34.8% in 2016. The decrease in gross profit margin was primarily attributable to the negative impact of decreased sales on our absorption of fixed manufacturing costs and lower margin projects shipped from backlog, partially offset by increased savings achieved related to our Realignment Programs compared to the same period in 2016.

SG&A in 2018 increased by $1.4 million, or 0.7% as compared with 2017. Currency effects provided an increase of approximately $2 million. The increase in SG&A was primarily due to higher selling and administrative related expenses, partially offset by lower charges and increased savings related to our Realignment Programs compared to 2017.

41



SG&A in 2017 decreased by $13.3 million, or 5.9%, as compared with 2016. Currency effects provided an increase of approximately $1 million. The decrease in SG&A was primarily due to reduced sales-related expenses and savings achieved related to our Realignment Programs compared to the same period in 2016.
The gain on sale of businesses in 2017 was the result of the $141.3 million gain from the sales of the Gestra and Vogt businesses. See Note 3 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on these sales.
Operating income in 2018 decreased by $122.5 million, or 37.8%, as compared with 2017. The decrease included negative currency effects of approximately $1 million. The decrease was due to the $141.3 million gain from the sales of the Gestra and Vogt businesses in 2017, which was partially offset by the $20.2 million increase in gross profit.
Operating income in 2017 increased by $121.1 million, or 59.8%, as compared with 2016. The increase included currency benefits of approximately $2 million. The increase was primarily attributable to the $141.3 million of gain from the sales of the Gestra and Vogt businesses and a decrease in SG&A of $13.3 million, partially offset by the $33.2 million decrease in gross profit.
Backlog of $608.4 million at December 31, 2018 decreased by $9.0 million, or 1.5%, as compared with December 31, 2017. The impact of the initial adoption of the New Revenue Standard reduced backlog by approximately $35 million at January 1, 2018. Currency effects provided a decrease of approximately $17 million. Backlog of $617.4 million at December 31, 2017 increased by $32.9 million, or 5.6%, as compared with December 31, 2016. Currency effects provided an increase of approximately $20 million.


LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Analysis
 
2018
 
2017
 
2016
 
(Amounts in millions)
Net cash flows provided by operating activities
$
190.8

 
$
311.1

 
$
240.5

Net cash flows (used) provided by investing activities
(81.5
)
 
176.6

 
(91.5
)
Net cash flows used by financing activities
(173.3
)
 
(185.4
)
 
(143.7
)

Existing cash, cash generated by operations and borrowings available under our existing revolving credit facility are our primary sources of short-term liquidity. We monitor the depository institutions that hold our cash and cash equivalents on a regular basis, and we believe that we have placed our deposits with creditworthy financial institutions. Our sources of operating cash generally include the sale of our products and services and the conversion of our working capital, particularly accounts receivable and inventories. Our total cash balance at December 31, 2018 was $619.7 million, compared with $703.4 million at December 31, 2017 and $367.2 million at December 31, 2016.
Our cash provided by operating activities was $190.8 million, $311.1 million and $240.5 million in 2018, 2017 and 2016, respectively, which provided cash to support short-term working capital needs. Cash flow used by working capital increased in 2018 due primarily to cash used by higher inventory of $29.3 million, higher accounts receivable of $25.4 million, higher contract assets of $23.7 million and lower accrued liabilities and income taxes payable of $18.2 million, partially offset by cash provided by higher contract liabilities of $33.7 million. Cash flow provided by working capital increased in 2017 due primarily to cash provided by lower accounts receivable of $60.2 million, lower inventory of $48.6 million and higher accounts payable of $12.4 million. During 2018, we contributed $48.1 million to our defined benefit pension plans as compared to $44.9 million in 2017.
Increases in accounts receivable used $25.4 million of cash flow in 2018, as compared with cash provided of $60.2 million in 2017 and $36.9 million in 2016. The increase in cash used by accounts receivable in 2018 was partially attributable to higher sales during the period as compared to the same period in 2017. For the fourth quarter of 2018 our days' sales outstanding ("DSO") was 72 days as compared to 75 days for 2017 and 74 days for 2016. The adoption of the New Revenue Standard as of January 1, 2018 had an estimated favorable impact of 3 days on DSO as of December 31, 2018. We have not experienced a significant increase in customer payment defaults in 2018.

42


Increases in inventory used $29.3 million of cash flow in 2018 as compared with cash provided of $48.6 million and $52.9 million in 2017 and 2016, respectively. The use of cash from inventory in 2018 was primarily due to decreased progress billings and in 2017 the cash provided was due to decreased work in process and finished goods inventory. Inventory turns were 4.2 times at December 31, 2018, as compared with 3.3 times for both 2017 and 2016. The adoption of the New Revenue Standard as of January 1, 2018 had an estimated favorable impact of approximately 1.1 times on our inventory turn calculation as of December 31, 2018. Our calculation of inventory turns does not reflect the impact of advanced cash received from our customers.
Increases in contract assets used $23.7 million of cash flow and increases in contact liabilities provided $33.7 million of cash flow in 2018.
Decreases in accounts payable used $4.8 million of cash flow in 2018 compared with cash provided of $12.4 million in 2017 and cash used of $71.0 million in 2016. Decreases in accrued liabilities and income taxes payable used $18.2 million of cash flow in 2018 compared with $3.4 million in 2017 and $88.8 million in 2016.
Cash flows used by investing activities were $81.5 million in 2018, as compared to cash provided of $176.6 million and cash used of $91.5 million in 2017 and 2016, respectively. The decrease of cash provided in 2018 was primarily due to $232.8 million in net proceeds from the sale of our Gestra and Vogt businesses in 2017 that did not recur. Capital expenditures were $84.0 million, $61.6 million and $89.7 million in 2018, 2017 and 2016, respectively. In 2019, we currently estimate capital expenditures to be between $90 million and $100 million before consideration of any acquisition activity.
Cash flows used by financing activities were $173.3 million in 2018 compared to $185.4 million and $143.7 million in 2017 and 2016, respectively. Cash outflows during 2018 resulted primarily from $99.4 million of dividend payments and $60.0 million in payments on long-term debt. Cash outflows during 2017 resulted primarily from $99.2 million of dividend payments and $60.0 million in payments on long-term debt. Cash outflows during 2016 resulted primarily from $97.7 million of dividend payments and $60.0 million in payments on long-term debt.
We have maintained our previously-announced policy of annually returning 40% to 50% of running two-year average net earnings to shareholders following attainment of the previously announced target leverage ratio. We had no share repurchase activity in 2018, 2017 or 2016 and as of December 31, 2018 we had $160.7 million of remaining capacity under our share repurchase plan previously approved by the Board of Directors. While we intend to adhere to this policy for the foreseeable future, any future returns of cash through dividends and/or share repurchases, will be reviewed individually, declared by our Board of Directors and implemented by management at its discretion, depending on our financial condition, business opportunities and market conditions at such time.
Our cash needs for the next 12 months are expected to be lower than those of 2018 due to our Realignment Programs being substantially completed and anticipated benefits from working capital reductions. We believe cash flows from operating activities, combined with availability under our Revolving Credit Facility and our existing cash balances, will be sufficient to enable us to meet our cash flow needs for the next 12 months. However, cash flows from operations could be adversely affected by a decrease in the rate of general global economic growth and an extended decrease in capital spending of our customers, as well as economic, political and other risks associated with sales of our products, operational factors, competition, regulatory actions, fluctuations in foreign currency exchange rates and fluctuations in interest rates, among other factors. We believe that cash flows from operating activities and our expectation of continuing availability to draw upon our credit agreements are also sufficient to meet our cash flow needs for periods beyond the next 12 months.
Dispositions
We regularly evaluate acquisition opportunities of various sizes. The cost and terms of any financing to be raised in conjunction with any acquisition, including our ability to raise economical capital, is a critical consideration in any such evaluation.
Note 3 to our consolidated financial statements included in Item 8 of this Annual Report contains a discussion of our disposition activity.
Financing
Our amended credit agreement provides for a $195.0 million term loan (“Term Loan Facility”) and a $800.0 million revolving credit facility (“Revolving Credit Facility” and, together with the Term Loan Facility, the “Senior Credit Facility”) with a maturity of October 14, 2020. The current Senior Credit Facility includes the following: (i) leverage ratio of 4.00 times debt to total Consolidated EBITDA through June 30, 2019, with a step-down to 3.75 for any fiscal quarter ending after July

43


1, 2019, (ii)a pricing level on our senior unsecured long-term debt ratings at or below Ba2/BB, with an interest rate margin for LIBOR loans of 2.00% and for base rate loans of 1.00% and (iii) maximum principal amount of priority debt up to 7.5% of the consolidated tangible assets and a maximum amount of receivables that can be securitized of $100 million. Subject to certain conditions, including lender approval, we have the right to increase the amount of the Term Loan Facility or the Revolving Credit Facility by an aggregate amount not to exceed $400.0 million. A discussion of our debt and related covenants is included in Note 11 to our consolidated financial statements included in Item 8 of this Annual Report. We were in compliance with all covenants as of December 31, 2018.
Certain financing arrangements contain provisions that may result in an event of default if there was a failure under other financing arrangements to meet payment terms or to observe other covenants that could result in an acceleration of payment due. Such provisions are referred to as "cross default" provisions. The Senior Credit Facility and the Senior Notes as described in Note 11 to our consolidated financial statements included in Item 8 of this Annual Report are cross-defaulted to each other.
The rating agencies assign credit ratings to certain of our debt. Our access to capital markets and costs of debt could be directly affected by our credit ratings. Any adverse action with respect to our credit ratings could generally cause borrowing costs to increase and the potential pool of investors and funding sources to decrease. In particular, a decline in credit ratings would increase the cost of borrowing under our Senior Credit Facility.
Liquidity Analysis
Our cash balance decreased by $83.8 million to $619.7 million as of December 31, 2018 as compared with December 31, 2017. The cash decrease included $84.0 million in capital expenditures, $99.4 million in dividend payments and $60.0 million in payments on long-term debt, partially offset by $190.8 million in operating cash inflows.
Approximately 57% of our currently outstanding Term Loan Facility and $13.5 million of other short-term borrowings are due to mature in 2019 and 2020. Our Senior Credit Facility matures in October 2020. Our borrowing capacity is subject to financial covenant limitations based on the terms of our Senior Credit Facility and is also reduced by outstanding letters of credit. As of December 31, 2018, we had an available capacity of $513.7 million, no borrowings outstanding and $92.9 million of letters of credit outstanding under our Revolving Credit Facility. Our Revolving Credit Facility is committed and held by a diversified group of financial institutions. For additional information on our Senior Credit Facility, see Note 11 to our consolidated financial statements included in Item 8 of this Annual Report.
At December 31, 2018 and 2017, as a result of the values of the plan’s assets and our contributions to the plan, our U.S. pension plan was fully-funded as defined by applicable law. After consideration of our intent to maintain fully funded status, we contributed $20.0 million to our U.S. pension plan in 2018, excluding direct benefits paid of $3.3 million. We continue to maintain an asset allocation consistent with our strategy to maximize total return, while reducing portfolio risks through asset class diversification.

OUTLOOK FOR 2019
Our future results of operations and other forward-looking statements contained in this Annual Report, including this MD&A, involve a number of risks and uncertainties — in particular, the statements regarding our goals and strategies, new product introductions, plans to cultivate new businesses, future economic conditions, revenue, pricing, gross profit margin and costs, capital spending, expected cost savings from our transformation and realignment programs, global economic and political risk, depreciation and amortization, research and development expenses, potential impairment of assets, tax rate and pending tax and legal proceedings. Our future results of operations may also be affected by employee incentive compensation including our annual program and the amount, type and valuation of share-based awards granted, as well as the amount of awards forfeited due to employee turnover. In addition to the various important factors discussed above, a number of other factors could cause actual results to differ materially from our expectations. See the risks described in "Item 1A. Risk Factors" as well as the section titled “Forward-Looking Information is Subject to Risk and Uncertainty” of this Annual Report.
Our bookings were $4,019.8 million during 2018. Because a booking represents a contract that can be, in certain circumstances, modified or canceled, and can include varying lengths between the time of booking and the time of revenue recognition, there is no guarantee that bookings will result in comparable revenues or otherwise be indicative of future results.
The outlook for the oil and gas industry is heavily dependent on the demand growth from both mature markets and developing geographies. In the short-term, we believe that stable oil prices will support oil and gas upstream and mid-stream investment and we further expect increased investment in later cycle downstream projects due to emerging market growth and certain regulatory requirements, such as IMO 2020. A recovery in the overall level of spending by oil and gas companies could continue to increase demand for our aftermarket products and services. We believe the medium and long-term

44


fundamentals for this industry remain attractive, and see a stabilized environment as the industry works through current excess supply. In addition, we believe projected depletion rates of existing fields and forecasted long-term demand growth will require additional investments. With our long-standing reputation in providing successful solutions for upstream, mid-stream and downstream applications, along with the advancements in our portfolio of offerings, we believe that we continue to be well-positioned to assist our customers in this improving environment.
We expect a continued competitive economic environment in 2019. We anticipate benefits from the continuation of our Flowserve 2.0 Transformation efforts, end-user strategies, the strength of our high margin aftermarket business, continued disciplined cost management, our diverse customer base, our broad product portfolio and our unified operating platform. Similar to prior years, we expect our results will be weighted towards the second half of the year.  While we believe that our primary markets continue to provide opportunities, we remain cautious in our outlook for 2019 given the continuing uncertainty of capital spending in many of our markets as well as economic and political risk associated with our international operations which could have a negative effect on global economic conditions.
On December 31, 2018, we had $1,364.8 million of fixed-rate Senior Notes outstanding and $104.8 million of variable-rate debt under our Term Loan Facility.  As of December 31, 2018, we had no variable to fixed interest rate derivative contracts. Due to the fact that a portion of our debt carries a variable rate of interest, our debt is subject to volatility in rates, which could impact interest expense. We expect our interest expense in 2019 will be relatively consistent with amounts incurred in 2018. Our results of operations may also be impacted by unfavorable foreign currency exchange rate movements. See “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” of this Annual Report.
We expect to generate sufficient cash from operations and have sufficient capacity under our Revolving Credit Facility to fund our working capital, capital expenditures, dividend payments, share repurchases, debt payments and pension plan contributions in 2019. The amount of cash generated or consumed by working capital is dependent on our level of revenues, customer cash advances, backlog, customer-driven delays and other factors. We will seek to improve our working capital utilization, with a particular focus on improving the management of accounts receivable and inventory. In 2019, our cash flows for investing activities will be focused on strategic initiatives, information technology infrastructure, general upgrades and cost reduction opportunities and we currently estimate capital expenditures to be between $90 million and $100 million, before consideration of any acquisition activity. We have $60.0 million in scheduled principal repayments in 2019 under our Term Loan Facility, and we expect to comply with the covenants under our Senior Credit Facility in 2019. See Note 11 to our consolidated financial statements included in Item 8 of this Annual Report for further discussion of our debt covenants.
We currently anticipate that our minimum contribution to our qualified U.S. pension plan will be approximately $20 million, excluding direct benefits paid, in 2019 in order to maintain fully-funded status as defined by applicable law. We currently anticipate that our contributions to our non-U.S. pension plans will be approximately $9 million in 2019, excluding direct benefits paid.


45


CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table presents a summary of our contractual obligations at December 31, 2018:
 
Payments Due By Period
 
Within 1 Year
 
1-3 Years
 
3-5 Years
 
Beyond 5
Years
 
Total
 
(Amounts in millions)
Term Loan Facility and Senior Notes:
$
60.0

 
$
44.8

 
$
1,364.8

 
$

 
$
1,469.6

Fixed interest payments(1)
36.6

 
73.3

 
36.4

 

 
146.3

Variable interest payments(2)
3.5

 
0.9

 

 

 
4.4

Other debt and capital lease obligations
8.2

 
5.3

 

 

 
13.5

Operating leases
68.4

 
88.3

 
50.0

 
66.5

 
273.2

Purchase obligations:(3)
 
 
 
 
 
 
 
 
 

Inventory
411.1

 
3.4

 

 
0.2

 
414.7

Non-inventory
39.2

 
0.1

 
0.3

 

 
39.6

Pension and postretirement benefits(4)
59.5

 
123.3

 
122.7

 
295.9

 
601.4

Total
$
686.5

 
$
339.4

 
$
1,574.2

 
$
362.6

 
$
2,962.7

_______________________________________
(1)
Fixed interest payments represent interest payments on the Senior Notes and Term Loan Facility as defined in Note 11 to our consolidated financial statements included in Item 8 of this Annual Report.
(2)
Variable interest payments under our Term Loan Facility were estimated using a base rate of three-month LIBOR as of December 31, 2018.
(3)
Purchase obligations are presented at the face value of the purchase order, excluding the effects of early termination provisions. Actual payments could be less than amounts presented herein.
(4)
Retirement and postretirement benefits represent estimated benefit payments for our U.S. and non-U.S. defined benefit plans and our postretirement medical plans, as more fully described below and in Note 12 to our consolidated financial statements included in Item 8 of this Annual Report.
As of December 31, 2018, the gross liability for uncertain tax positions was $41.2 million. We do not expect a material payment related to these obligations to be made within the next twelve months. We are unable to provide a reasonably reliable estimate of the timing of future payments relating to the uncertain tax positions.
The following table presents a summary of our commercial commitments at December 31, 2018:
 
Commitment Expiration By Period
 
Within 1 Year
 
1-3 Years
 
3-5 Years
 
Beyond 5
Years
 
Total
 
(Amounts in millions)
Letters of credit
$
315.5

 
$
136.8

 
$
13.2

 
$
26.4

 
$
491.9

Surety bonds
94.6

 
1.0

 
8.9

 

 
104.5

Total
$
410.1

 
$
137.8

 
$
22.1

 
$
26.4

 
$
596.4


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

PENSION AND POSTRETIREMENT BENEFITS OBLIGATIONS
Plan Descriptions

We and certain of our subsidiaries have defined benefit pension plans and defined contribution plans for full-time and part-time employees. Approximately 65% of total defined benefit pension plan assets and approximately 53% of defined benefit pension obligations are related to the U.S. qualified plan as of December 31, 2018. Unless specified otherwise, the references in this section are to all of our U.S. and non-U.S. plans. None of our common stock is directly held by these plans.

46


Our U.S. defined benefit plan assets consist of a balanced portfolio of equity and fixed income securities. Our non-U.S. defined benefit plan assets include a significant concentration of United Kingdom ("U.K.") fixed income securities, as discussed in Note 12 to our consolidated financial statements included in Item 8 of this Annual Report. We monitor investment allocations and manage plan assets to maintain acceptable levels of risk. At December 31, 2018, the estimated fair market value of U.S. and non-U.S. plan assets for our defined benefit pension plans decreased to $658.0 million from $713.5 million at December 31, 2017. Assets were allocated as follows:
 
 
U.S. Plan
Asset category
 
2018
 
2017
Cash and Cash Equivalents
 
1
%
 
1
%
Global Equity
 
30
%
 
36
%
Global Real Assets
 
13
%
 
12
%
Equity securities
 
43
%
 
48
%
Diversified Credit
 
13
%
 
12
%
Liability-Driven Investment
 
43
%
 
39
%
Fixed income
 
56
%
 
51
%

 
 
Non-U.S. Plans
Asset category
 
2018
 
2017
Cash and Cash Equivalents
 
7
%
 
3
%
North American Companies
 
3
%
 
3
%
Global Equity
 
2
%
 
3
%
Equity securities
 
5
%
 
6
%
U.K. Government Gilt Index
 
43
%
 
41
%
U.K. Corporate Bond Index
 
%
 
1
%
Global Fixed Income Bond
 
2
%
 
2
%
Liability-Driven Investment
 
9
%
 
9
%
Fixed income
 
54
%
 
53
%
Multi-asset
 
19
%
 
22
%
Buy-in Contract
 
10
%
 
10
%
Other
 
5
%
 
6
%
Other Types
 
34
%
 
38
%
The projected benefit obligation ("Benefit Obligation") for our defined benefit pension plans was $809.2 million and $875.3 million as of December 31, 2018 and 2017, respectively. Benefits under our defined benefit pension plans are based primarily on participants’ compensation and years of credited service.
The estimated prior service cost and the estimated actuarial net loss for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2019 is approximately $0.4 million and $6.4 million, respectively. We amortize any estimated net gains or losses over the remaining expected service period or over the remaining expected lifetime for plans with only inactive participants.
We sponsor defined benefit postretirement medical plans covering certain current retirees and a limited number of future retirees in the U.S. These plans provide for medical and dental benefits and are administered through insurance companies. We fund the plans as benefits are paid, such that the plans hold no assets in any period presented. Accordingly, we have no investment strategy or targeted allocations for plan assets. The benefits under the plans are not available to new employees or most existing employees.
The Benefit Obligation for our defined benefit postretirement medical plans was $18.8 million and $23.9 million as of December 31, 2018 and 2017, respectively. The estimated actuarial net gain for the defined benefit postretirement medical plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2019 is $0.2 million. The estimated prior service cost that is expected to be amortized from accumulated other comprehensive loss into pension expense in 2019 is $0.1 million. We amortize any estimated net gain or loss over the remaining average life expectancy of approximately 11 years.

47


Accrual Accounting and Significant Assumptions
We account for pension benefits using the accrual method, recognizing pension expense before the payment of benefits to retirees. The accrual method of accounting for pension benefits requires actuarial assumptions concerning future events that will determine the amount and timing of the benefit payments.
Our key assumptions used in calculating our cost of pension benefits are the discount rate, the rate of compensation increase and the expected long-term rate of return on plan assets. We, in consultation with our actuaries, evaluate the key actuarial assumptions and other assumptions used in calculating the cost of pension and postretirement benefits, such as discount rates, expected return on plan assets for funded plans, mortality rates, retirement rates and assumed rate of compensation increases, and determine such assumptions as of December 31 of each year to calculate liability information as of that date and pension and postretirement expense for the following year. See discussion of our accounting for and assumptions related to pension and postretirement benefits in the “Our Critical Accounting Estimates” section of this MD&A.
In 2018, net pension expense for our defined benefit pension plans included in operating income was $28.2 million compared with $35.2 million in 2017 and $37.5 million in 2016.
The following are assumptions related to our defined benefit pension plans as of December 31, 2018:
 
U.S. Plan
 
Non-U.S. Plans
Weighted average assumptions used to determine Benefit Obligation:
 

 
 

Discount rate
4.34
%
 
2.42
%
Rate of increase in compensation levels
3.50

 
3.28

Weighted average assumptions used to determine 2018 net pension expense:
 
 
 
Long-term rate of return on assets
6.00
%
 
3.62
%
Discount rate
3.63

 
2.25

Rate of increase in compensation levels
4.01

 
3.25

The following provides a sensitivity analysis of alternative assumptions on the U.S. qualified and aggregate non-U.S. pension plans and U.S. postretirement plans.
Effect of Discount Rate Changes and Constancy of Other Assumptions:
 
0.5% Increase
 
0.5% Decrease
 
(Amounts in millions)
U.S. defined benefit pension plan:
 

 
 

Effect on net pension expense
$
(1.4
)
 
$
1.4

Effect on Benefit Obligation
(16.2
)
 
17.5

Non-U.S. defined benefit pension plans:
 
 
 
Effect on net pension expense
(1.0
)
 
0.9

Effect on Benefit Obligation
(26.7
)
 
30.2

U.S. Postretirement medical plans:
 
 
 
Effect on postretirement medical expense
(0.1
)
 
0.1

Effect on Benefit Obligation
(0.5
)
 
0.6

Effect of Changes in the Expected Return on Assets and Constancy of Other Assumptions:
 
0.5% Increase
 
0.5% Decrease
 
(Amounts in millions)
U.S. defined benefit pension plan:
 

 
 

Effect on net pension expense
$
(2.1
)
 
$
2.1

Non-U.S. defined benefit pension plans:
 

 
 

Effect on net pension expense
(1.2
)
 
1.2

As discussed below, accounting principles generally accepted in the U.S. (“U.S. GAAP”) provide that differences between expected and actual returns are recognized over the average future service of employees or over the remaining expected lifetime for plans with only inactive participants.

48


At December 31, 2018, as compared with December 31, 2017, we increased our discount rate for the U.S. plan from 3.63% to 4.34% based on an analysis of publicly-traded investment grade U.S. corporate bonds, which had higher yields due to current market conditions. The average discount rate for the non-U.S. plans increased from 2.25% to 2.42% based on analysis of bonds and other publicly-traded instruments, by country, which had higher yields due to market conditions. The average assumed rate of compensation decreased from 4.01% to 3.50% for the U.S. plan and increased to 3.28% from 3.25% for our non-U.S. plans. To determine the 2018 pension expense, the expected rate of return on U.S. plan assets remained constant at 6.00% and we decreased our average rate of return on non-U.S. plan assets from 3.88% to 3.62%, primarily based on our target allocations and expected long-term asset returns. As the expected rate of return on plan assets is long-term in nature, short-term market changes do not significantly impact the rate. For all U.S. plans, we adopted the RP-2006 mortality tables and the MP-2018 improvement scale published in October 2018. We applied the RP-2006 tables based on the constituency of our plan population for union and non-union participants. We adjusted the improvement scale to utilize 75% of the ultimate improvement rate, consistent with assumptions adopted by the Social Security Administration trustees, based on long-term historical experience. Currently, we believe this approach provides the best estimate of our future obligation. Most plan participants elect to receive plan benefits as a lump sum at the end of service, rather than an annuity. As such, the updated mortality tables had an immaterial effect on our pension obligation.
We expect that the net pension expense for our defined benefit pension plans included in earnings before income taxes will be approximately $0.6 million higher in 2019 than the $28.2 million in 2018, primarily due to a decrease in the amortization of actuarial gains and losses and no anticipated special events. We have used discount rates of 4.34%, 2.42% and 4.20% at December 31, 2018, in calculating our estimated 2019 net pension expense for U.S. pension plans, non-U.S. pension plans and postretirement medical plans, respectively.
The assumed ranges for the annual rates of increase in health care costs were 7.0% for 2018, 7.0% for 2017 and 7.5% for 2016, with a gradual decrease to 5.0% for 2029 and future years. If actual costs are higher than those assumed, this will likely put modest upward pressure on our expense for retiree health care.
Plan Funding
Our funding policy for defined benefit plans is to contribute at least the amounts required under applicable laws and local customs. We contributed $48.1 million, $44.9 million and $46.8 million to our defined benefit plans in 2018, 2017 and 2016, respectively. After consideration of our intent to remain fully-funded based on standards set by law, we currently anticipate that our contribution to our U.S. pension plan in 2019 will be approximately $20 million, excluding direct benefits paid. We expect to contribute approximately $9 million to our non-U.S. pension plans in 2019, excluding direct benefits paid.
For further discussion of our pension and postretirement benefits, see Note 12 to our consolidated financial statements included in Item 8 of this Annual Report.

OUR CRITICAL ACCOUNTING ESTIMATES
The process of preparing financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions to determine reported amounts of certain assets, liabilities, revenues and expenses and the disclosure of related contingent assets and liabilities. These estimates and assumptions are based upon information available at the time of the estimates or assumptions, including our historical experience, where relevant. The most significant estimates made by management include: timing and amount of revenue recognition; deferred taxes, tax valuation allowances and tax reserves; reserves for contingent loss; pension and postretirement benefits; and valuation of goodwill, indefinite-lived intangible assets and other long-lived assets. The significant estimates are reviewed at least annually if not quarterly by management. Because of the uncertainty of factors surrounding the estimates, assumptions and judgments used in the preparation of our financial statements, actual results may differ from the estimates, and the difference may be material.
Our critical accounting policies are those policies that are both most important to our financial condition and results of operations and require the most difficult, subjective or complex judgments on the part of management in their application, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that the following represent our critical accounting policies. For a summary of all of our significant accounting policies, see Note 1 to our consolidated financial statements included in Item 8 of this Annual Report. Management and our external auditors have discussed our critical accounting estimates and policies with the Audit Committee of our Board of Directors.

49


Revenue Recognition
Effective January 1, 2018, we adopted ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" and all related ASUs ("New Revenue Standard"), using the modified retrospective method for transition. For a discussion related to our adoption of the New Revenue Standard requirements refer to Note 1 included in Item 8 of this Annual Report.
We recognize revenue either over time or at a point in time, depending on the specific facts and circumstances for each contract, including the terms and conditions of the contract as agreed with the customer and the nature of the products or services to be provided.
Our primary method for recognizing revenue over time is the percentage of completion (“POC”) method, whereby progress towards completion is measured by applying an input measure based on costs incurred to date relative to total estimated costs at completion. If control of the products and/or services does not transfer over time, then control transfers at a point in time. We determine the point in time that control transfers to a customer based on the evaluation of specific indicators, such as title transfer, risk of loss transfer, customer acceptance and physical possession. For a discussion related to revenue recognition refer to Note 2 included in Item 8 of this Annual Report.
Deferred Taxes, Tax Valuation Allowances and Tax Reserves
We recognize valuation allowances to reduce the carrying value of deferred tax assets to amounts that we expect are more likely than not to be realized. Our valuation allowances primarily relate to the deferred tax assets established for certain tax credit carryforwards and net operating loss carryforwards for non-U.S. subsidiaries, and we evaluate the realizability of our deferred tax assets by assessing the related valuation allowance and by adjusting the amount of these allowances, if necessary. We assess such factors as our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets in determining the sufficiency of our valuation allowances. Failure to achieve forecasted taxable income in the applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in our effective tax rate on future earnings. Implementation of different tax structures in certain jurisdictions could, if successful, result in future reductions of certain valuation allowances.
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Significant judgment is required in determining income tax provisions and evaluating tax positions. We establish reserves for open tax years for uncertain tax positions that may be subject to challenge by various tax authorities. The consolidated tax provision and related accruals include the impact of such reasonably estimable losses and related interest and penalties as deemed appropriate. Tax benefits recognized in the financial statements from uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.
While we believe we have adequately provided for any reasonably foreseeable outcome related to these matters, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities. To the extent that the expected tax outcome of these matters changes, such changes in estimate will impact the income tax provision in the period in which such determination is made.
Reserves for Contingent Loss
Liabilities are recorded for various contingencies arising in the normal course of business when it is both probable that a loss has been incurred and such loss is reasonably estimable. Assessments of reserves are based on information obtained from our independent and in-house experts, including recent legal decisions and loss experience in similar situations. The recorded legal reserves are susceptible to changes due to new developments regarding the facts and circumstances of each matter, changes in political environments, legal venue and other factors. Recorded environmental reserves could change based on further analysis of our properties, technological innovation and regulatory environment changes.
Estimates of liabilities for unsettled asbestos-related claims are based on known claims and on our experience during the preceding two years for claims filed, settled and dismissed, with adjustments for events deemed unusual and unlikely to recur. A substantial majority of our asbestos-related claims are covered by insurance or indemnities. Estimated indemnities and receivables from insurance carriers for unsettled claims and receivables for settlements and legal fees paid by us for asbestos-related claims are estimated using our historical experience with insurance recovery rates and estimates of future recoveries, which include estimates of coverage and financial viability of our insurance carriers. We have claims pending against certain insurers that, if resolved more favorably than estimated future recoveries, would result in discrete gains in the applicable quarter. We are currently unable to estimate the impact, if any, of unasserted asbestos-related claims, although future claims would also be subject to existing indemnities and insurance coverage. Changes in claims filed, settled and

50


dismissed and differences between actual and estimated settlement costs and insurance or indemnity recoveries could impact future expense.
Pension and Postretirement Benefits
We provide pension and postretirement benefits to certain of our employees, including former employees, and their beneficiaries. The assets, liabilities and expenses we recognize and disclosures we make about plan actuarial and financial information are dependent on the assumptions and estimates used in calculating such amounts. The assumptions include factors such as discount rates, health care cost trend rates, inflation, expected rates of return on plan assets, retirement rates, mortality rates, turnover, rates of compensation increases and other factors.
The assumptions utilized to compute expense and benefit obligations are shown in Note 12 to our consolidated financial statements included in Item 8 of this Annual Report. These assumptions are assessed annually in consultation with independent actuaries and investment advisors as of December 31 and adjustments are made as needed. We evaluate prevailing market conditions and local laws and requirements in countries where plans are maintained, including appropriate rates of return, interest rates and medical inflation (health care cost trend) rates. We ensure that our significant assumptions are within the reasonable range relative to market data. The methodology to set our significant assumptions includes:
Discount rates are estimated using high quality debt securities based on corporate or government bond yields with a duration matching the expected benefit payments. For the U.S. the discount rate is obtained from an analysis of publicly-traded investment-grade corporate bonds to establish a weighted average discount rate. For plans in the U.K. and the Eurozone we use the discount rate obtained from an analysis of AA-graded corporate bonds used to generate a yield curve. For other countries or regions without a corporate AA bond market, government bond rates are used. Our discount rate assumptions are impacted by changes in general economic and market conditions that affect interest rates on long-term high-quality debt securities, as well as the duration of our plans’ liabilities.
The expected rates of return on plan assets are derived from reviews of asset allocation strategies, expected long-term performance of asset classes, risks and other factors adjusted for our specific investment strategy. These rates are impacted by changes in general market conditions, but because they are long-term in nature, short-term market changes do not significantly impact the rates. Changes to our target asset allocation also impact these rates.
The expected rates of compensation increase reflect estimates of the change in future compensation levels due to general price levels, seniority, age and other factors.
Depending on the assumptions used, the pension and postretirement expense could vary within a range of outcomes and have a material effect on reported earnings. In addition, the assumptions can materially affect benefit obligations and future cash funding. Actual results in any given year may differ from those estimated because of economic and other factors.
We evaluate the funded status of each retirement plan using current assumptions and determine the appropriate funding level considering applicable regulatory requirements, tax deductibility, reporting considerations, cash flow requirements and other factors. We discuss our funding assumptions with the Finance Committee of our Board of Directors.
Valuation of Goodwill, Indefinite-Lived Intangible Assets and Other Long-Lived Assets
The initial recording of goodwill and intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets. We test the value of goodwill and indefinite-lived intangible assets for impairment as of December 31 each year or whenever events or circumstances indicate such assets may be impaired.
The test for goodwill impairment involves significant judgment in estimating projections of fair value generated through future performance of each of the reporting units. The identification of our reporting units began at the operating segment level and considered whether components one level below the operating segment levels should be identified as reporting units for purpose of testing goodwill for impairment based on certain conditions. These conditions included, among other factors, (i) the extent to which a component represents a business and (ii) the aggregation of economically similar components within the operating segments and resulted in four reporting units. Other factors that were considered in determining whether the aggregation of components was appropriate included the similarity of the nature of the products and services, the nature of the production processes, the methods of distribution and the types of industries served.
An impairment loss for goodwill is recognized if the implied fair value of goodwill is less than the carrying value. We estimate the fair value of our reporting units based on an income approach, whereby we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. A discounted cash flow analysis requires us to make various judgmental assumptions about future sales, operating margins, growth rates and discount rates, which are based on our budgets,

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business plans, economic projections, anticipated future cash flows and market participants. Assumptions are also made for varying perpetual growth rates for periods beyond the long-term business plan period.
We did not record an impairment of goodwill in 2018, 2017 or 2016; however, the estimated fair value of our EPO and IPD reporting units reduced significantly in 2016 and 2015 due to broad-based capital spending declines and heightened pricing pressure experienced in the oil and gas markets which are anticipated to continue in the near to mid-term.  The EPO reporting unit is a component of our EPD reporting segment and is primarily focused on long lead time, custom and other highly-engineered pump products and systems. As of December 31, 2018, our EPO reporting unit had approximately $158 million of goodwill and its estimated fair value exceeded its carrying value by approximately 60% as compared to approximately $159 million of goodwill and its estimated fair value exceeded its carrying value by approximately 82% as of December 31, 2017. In addition, our IPD reporting unit had approximately $311 million of goodwill and its fair value exceeded its carrying value by approximately 40% as of December 31, 2018 as compared to approximately $319 million of goodwill and its fair value exceeded its carrying value by approximately 66% as of December 31, 2017. Key assumptions used in determining the estimated fair value of our EPO and IPD reporting units included the annual operating plan and forecasted operating results, successful execution of our current Flowserve Transformation 2.0 program and identified strategic initiatives, a constant cost of capital, continued stabilization and mid to long-term improvement of the macro-economic conditions of the oil and gas market, and a relatively stable global gross domestic product. Although we have concluded that there is no impairment on the goodwill associated with our EPO and IPD reporting units as of December 31, 2018, we will continue to closely monitor their performance and related market conditions for future indicators of potential impairment and reassess accordingly. 
We considered our market capitalization in our evaluation of the fair value of our goodwill. Our market capitalization decreased slightly as compared with 2017 and did not indicate a potential impairment of our goodwill as of December 31, 2018.
Impairment losses for indefinite-lived intangible assets are recognized whenever the estimated fair value is less than the carrying value. Fair values are calculated for trademarks using a "relief from royalty" method, which estimates the fair value of a trademark by determining the present value of estimated royalty payments that are avoided as a result of owning the trademark. This method includes judgmental assumptions about sales growth and discount rates that have a significant impact on the fair value and are substantially consistent with the assumptions used to determine the fair value of our reporting units discussed above. We did not record a material impairment of our trademarks in 2018, 2017 or 2016.
The recoverable value of other long-lived assets, including property, plant and equipment and finite-lived intangible assets, is reviewed when indicators of potential impairments are present. The recoverable value is based upon an assessment of the estimated future cash flows related to those assets, utilizing assumptions similar to those for goodwill. Additional considerations related to our long-lived assets include expected maintenance and improvements, changes in expected uses and ongoing operating performance and utilization.
Due to uncertain market conditions and potential changes in strategy and product portfolio, it is possible that forecasts used to support asset carrying values may change in the future, which could result in non-cash charges that would adversely affect our financial condition and results of operations.

ACCOUNTING DEVELOPMENTS
We have presented the information about accounting pronouncements not yet implemented in Note 1 to our consolidated financial statements included in Item 8 of this Annual Report.


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ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have market risk exposure arising from changes in interest rates and foreign currency exchange rate movements. We are exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, but we currently expect all counterparties will continue to meet their obligations given their current creditworthiness.
Interest Rate Risk
Our earnings are impacted by changes in short-term interest rates as a result of borrowings under our Senior Credit Facility, which bear interest based on floating rates. At December 31, 2018, we had $104.8 million of variable rate debt obligations outstanding under our Senior Credit Facility with a weighted average interest rate of 4.30%. A hypothetical change of 100 basis points in the interest rate for these borrowings, assuming constant variable rate debt levels, would have changed interest expense by $1.0 million for the year ended December 31, 2018. At December 31, 2017, we had $164.4 million of variable rate debt obligations outstanding under our Senior Credit Facility with a weighted average interest rate of 3.19%. A hypothetical change of 100 basis points in the interest rate for these borrowings, assuming constant variable rate debt levels, would have changed interest expense by $1.6 million for the year ended December 31, 2017.
Foreign Currency Exchange Rate Risk
A substantial portion of our operations are conducted by our subsidiaries outside of the U.S. in currencies other than the U.S. dollar. The primary currencies in which we operate, in addition to the U.S. dollar, are the Argentine peso, Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese yuan, Colombian peso, Euro, Indian rupee, Japanese yen, Mexican peso, Singapore dollar, Swedish krona, Russian ruble, Malaysian ringgit and Venezuelan bolivar. Almost all of our non-U.S. subsidiaries conduct their business primarily in their local currencies, which are also their functional currencies. Foreign currency exposures arise from translation of foreign-denominated assets and liabilities into U.S. dollars and from transactions, including firm commitments and anticipated transactions, denominated in a currency other than a non-U.S. subsidiary’s functional currency. In March 2015, we designated €255.7 million of our €500.0 million 2022 EUR Senior Notes as a net investment hedge of our investments in certain of our international subsidiaries that use the Euro as their functional currency. Generally, we view our investments in foreign subsidiaries from a long-term perspective and use capital structuring techniques to manage our investment in foreign subsidiaries as deemed necessary. We realized net (losses) gains associated with foreign currency translation of $(63.1) million, $98.8 million and $(72.0) million for the years ended December 31, 2018, 2017 and 2016, respectively, which are included in other comprehensive loss. The net loss in 2018 was primarily driven by the weakening of the Euro, Argentinian peso, Indian rupee and British pound versus the U.S. dollar at December 31, 2018 as compared with December 31, 2017.
We employ a foreign currency risk management strategy to minimize potential changes in cash flows from unfavorable foreign currency exchange rate movements. Where available, the use of forward exchange contracts allows us to mitigate transactional exposure to exchange rate fluctuations as the gains or losses incurred on the forward exchange contracts will offset, in whole or in part, losses or gains on the underlying foreign currency exposure. Our policy allows foreign currency coverage only for identifiable foreign currency exposures. As of December 31, 2018, we had a U.S. dollar equivalent of $280.9 million in aggregate notional amount outstanding in foreign exchange contracts with third parties, compared with $235.6 million at December 31, 2017. Transactional currency gains and losses arising from transactions outside of our sites’ functional currencies and changes in fair value of foreign exchange contracts are included in our consolidated results of operations. We recognized foreign currency net (losses) gains of $(18.7) million, $(14.0) million and $2.8 million for the years ended December 31, 2018, 2017 and 2016, respectively, which are included in other expense, net in the accompanying consolidated statements of income.
Based on a sensitivity analysis at December 31, 2018, a 10% change in the foreign currency exchange rates for the year ended December 31, 2018 would have impacted our net earnings by approximately $3 million. At December 31, 2017, a 10% change in the foreign currency exchange rates for the year ended December 31, 2017 would have impacted our net earnings by approximately $7 million. This calculation assumes that all currencies change in the same direction and proportion relative to the U.S. dollar and that there are no indirect effects, such as changes in non-U.S. dollar sales volumes or prices. This calculation does not take into account the impact of the foreign currency forward exchange contracts discussed above.


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ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Flowserve Corporation

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Flowserve Corporation and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes and schedule of valuation and qualifying accounts for each of the three year