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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

Commission file number 1-13179

FLOWSERVE CORPORATION
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (972) 443-6500

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is an accelerated filer. Yes ý    No o

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2003 (the last business day of the registrant's most recently completed second fiscal quarter of 2003) was approximately $1,012,085,633.

The number of shares outstanding of the registrant's common stock as of April 21, 2004 was 54,248,133.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's 2004 Proxy Statement are incorporated by reference into Part III of this Form 10-K.

Except where otherwise indicated and unless the context otherwise requires, the terms "Flowserve," "Company," "we," "us," "our" and "our Company" refer collectively to Flowserve Corporation and its subsidiaries.

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

We believe that we are the world's leading manufacturer and aftermarket service provider of comprehensive flow control systems. We were incorporated in the State of New York on May 1, 1912. We develop and manufacture precision-engineered flow control equipment for critical service applications which require high reliability. The flow control system components we produce include pumps, valves and mechanical seals. Our products and services are used in several industries, including, but not limited to, the petroleum, chemical, power generation, water treatment and general industrial industries.

    We conduct our operations through three business segments:

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Flowserve Pump Division (FPD) for engineered pumps, industrial pumps and related services;

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Flow Solutions Division (FSD) for precision mechanical seals and related services; and

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Flow Control Division (FCD) for industrial valves, manual valves, control and nuclear valves, valve actuators and controls and related services.

    Each of our segments also provides aftermarket replacement parts. We are not required to carry unusually high amounts of inventory to meet customer delivery requirements or to assure needed deliveries from suppliers. We have been working to reduce our overall inventory levels to improve our operational effectiveness and to reduce working capital needs. We do not typically provide rights of product return for our customers and we do not offer extended payment terms under normal circumstances. In addition to the information on our business segments contained below, see Note 16 of the consolidated financial statements.

FLOWSERVE PUMP DIVISION

Through FPD, we design, manufacture, distribute and service engineered and industrial pumps and pump systems, replacement parts and related equipment principally to industrial markets. FPD's products and services are primarily used by companies that operate in the petroleum, chemical processing, power generating, water treatment and general industrial markets. Our pump systems and components are manufactured at 23 plants worldwide. We also manufacture a small portion of our pumps through several foreign joint ventures. We market our pump products through our worldwide sales force and our regional service and repair centers or on a commission basis through independent distributors and sales representatives.

FPD PRODUCTS

We manufacture more than 100 different pump models ranging from simple fractional horsepower industrial pumps to high horsepower (up to 10,000 horsepower) engineered pumps. Our pumps are manufactured in a wide range of metal alloys and with a variety of configurations, including pumps that utilize mechanical seals (sealed pumps) and pumps that do not utilize mechanical seals (magnetic-drive pumps).

FPD SERVICES

We provide engineered aftermarket services through our global network of 32 service centers in 17 countries. Our FPD service personnel provide a comprehensive set of equipment maintenance services for flow management control systems, including repair, advanced diagnostics, installation, commissioning, re-rate and retrofit programs, machining and full service solution offerings. A large portion of our FPD service work is performed on a quick response basis, and we offer 24-hour service in all of our major markets.

    The following is a summary list of our pump products and globally recognized brands:

FPD PRODUCT TYPES

Centrifugal Pumps:

•

Chemical Process ANSI and ISO

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Petroleum Process API 610

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Horizontal Between Bearing Single-stage

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Horizontal Between Bearing Multi-stage

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Vertical

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Submersible Motor

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Specialty

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Nuclear

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Positive Displacement Pumps:

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Reciprocating

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Gear

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Twin Screw

FPD BRAND NAMES

NEW FPD PRODUCT DEVELOPMENTS

Our investments in new product research and development have consistently led to producing more reliable and higher efficiency pumps. The majority of our new FPD products and enhancements are driven by our customers' need to achieve higher production rates at lower costs. As a result, we continually work with our customers to develop better pump solutions to improve the availability and efficiency of their pump systems; however, none of our newly developed pump products have required the investment of a material amount of our assets or was otherwise material.

FPD CUSTOMERS

FPD sells its products to more than 1,000 customers, including leading engineering and construction firms, original equipment manufacturers ("OEM"), distributors and end users. Our sales mix of original equipment products and aftermarket replacement parts diversifies our business and somewhat mitigates the impact of economic cycles in our business.

FPD COMPETITION

The pump industry is highly fragmented with more than 50 competitors; however, we primarily compete against a relatively limited number of large companies operating on a global scale. Competition is generally based on price, expertise, delivery times, breadth of product offerings, contractual terms, previous installation history and reputation for quality.

    The pump industry has undergone considerable consolidation in recent years, primarily caused by (1) the need to lower costs through reduction of excess capacity and (2) customers' preference to align with global full service suppliers in simplifying their supplier base. Despite the consolidation activity, the market remains highly competitive. We believe, based on independent industry sources, that we are, on a global basis, the third largest industrial pump supplier.

FPD BACKLOG

FPD's backlog of orders at December 31, 2003 was $570 million, compared with $495 million at December 31, 2002. We anticipate shipping approximately 90% or more of our current backlog by December 31, 2004.

FLOW SOLUTIONS DIVISION

Through FSD, we design, manufacture and distribute mechanical seals, sealing systems and parts, and provide related services principally to industrial markets. Flow control products require mechanical seals to be replaced throughout the products' useful lives. The replacement of mechanical seals is an integral part of our aftermarket services. Our mechanical seals are used on a variety of rotating equipment, including pumps, mixers, compressors, steam turbines and other specialty equipment, primarily in the petroleum, chemical processing, power generation and general industrial end-markets. We manufacture mechanical seals at three plants in the U.S. and at three plants outside the U.S. Through our global network of 61 seal quick response centers, we provide service, repair and diagnostic services for maintaining components of flow control systems.

    Our mechanical seal products are primarily marketed to end users through our direct sales force and on a commission basis to distributors and sales agents. A portion of our mechanical seal products is sold directly to OEMs for incorporation into rotating equipment requiring mechanical seals.

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FSD PRODUCTS

We design, manufacture and distribute approximately 180 different models of mechanical seals and sealing systems. We believe our ability to deliver or ship engineered new seal product orders within 72 hours from the customer's request, through design, engineering, manufacturing, testing and delivery, provides us with a leading competitive advantage. Mechanical seals are critical to the reliable operation of rotating equipment for prevention of leakage and emissions of hazardous substances and the reduction of shaft wear caused by non-mechanical seals. We also manufacture a gas-lubricated mechanical seal that is used in high-speed compressors for gas transmission and in the oil and gas production markets. We continually update our mechanical seals and sealing systems to integrate emerging technologies.

    The following list summarizes our seal products and services and globally recognized brands:

FSD SERVICES

We provide aftermarket services through our network of 64 seal quick response centers located throughout the world, including 24 such sites in North America. We also provide asset management services and condition monitoring for rotating equipment. Approximately 75% of our service work is performed on a quick response basis, and we offer 24-hour service in all of our major markets.

FSD PRODUCT TYPES

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Cartridge Seals

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Dry-Running Seals

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Metal Bellow Seals

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Elastomeric Seals

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Split Seals

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Gas Barrier Seals

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Couplings

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Service and Repair

•

Accessories and Support Systems

•

Monitoring and Diagnostics

FSD BRAND NAMES

•

BW Seals

•

Durametallic

•

Five Star Seal

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Flowserve

•

Flowstar

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GASPAC

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Pacific Wietz

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Pac-Seal

NEW FSD PRODUCT DEVELOPMENTS

FSD's investments in new product research and development focus on developing longer lasting and more efficient products. Approximately 30% of our original equipment mechanical seal sales for 2003 were sales of products developed within the past five years. In addition to numerous product upgrades, our recent mechanical seal and seal system innovations include: (1) a sterilizable mixer seal; (2) a high pressure compressor barrier seal; (3) a new web-based asset management tool; (4) an equipment data point monitoring package; and (5) engineered plastic critical-wear components for rotating equipment we are marketing jointly with a key supplier. We also market "Flowstar.Net," an interactive tool used to actively monitor and manage information relative to equipment performance. Flowstar.Net enhances our customers' ability to make informed decisions and respond quickly to plant production problems, extend the life of their production equipment and therefore lower maintenance expenses. None of these newly developed seal products required the investment of a material amount of our assets or was otherwise material.

FSD CUSTOMERS

Our mechanical seal products are sold directly to end users and to OEMs for incorporation into pumps, compressors, mixers or other rotating equipment requiring mechanical seals. Our mechanical seal sales are diversified among several industries, including petroleum, chemical, power generation and general industries.

    We have established alliances with over 200 customers. Our customer alliances typically involve a closer working relationship than other customer transactions. Under these alliances, customers typically agree to place all or a high percentage of their applicable business with us. In return, we typically commit to a higher level of service, technical support and prompt product availability than would normally be offered. These alliances provide significant benefits to us and our

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customers by creating a more efficient supply chain through the improvement of equipment reliability and a reduction of procurement and inventory costs. Our alliances help us provide products and services to our customers in a timely and cost-effective manner. They are also an effective platform for the rapid introduction of new products and services, such as condition data point monitoring, to the marketplace.

FSD COMPETITION

We compete against a number of manufacturers in the sale of mechanical seals. Our largest global mechanical seal competitor is John Crane, a unit of Smiths Group Plc. Based on independent industry sources, we believe that we are, on a global basis, the second largest industrial mechanical seals supplier.

FSD BACKLOG

FSD's backlog of orders at December 31, 2003 was $41 million, compared with $34 million at December 31, 2002. We anticipate shipping all of our current backlog by December 31, 2004.

FLOW CONTROL DIVISION

Through FCD, we design, manufacture and distribute manual valves, control valves, nuclear valves, actuators and related equipment and provide a variety of flow control-related services. Our valve products are an integral part of a flow control system and they are used to control the flow of liquids and gases. Substantially all of our valves are specialized and engineered to perform specific functions within a flow control system.

    Our products are primarily used by companies that operate in the chemical, power generation, petroleum, water and general industries. We manufacture valves and actuators through five major manufacturing plants in the U.S. and 17 major manufacturing plants outside of the U.S. We also manufacture a small portion of our valves through foreign joint ventures. Manual valve products and valve actuators are distributed through FCD's sales force and a network of distributors. Control valves are marketed through sales engineers and service and repair centers or on a commission basis through sales representatives in our principal markets.

FCD PRODUCTS

Our valve, actuator and automated valve accessory offerings represent one of the most comprehensive product portfolios in the flow control industry. Our valves are used in a wide variety of applications from general service to highly corrosive environments, as well as in environments experiencing extreme temperatures and/or pressures and applications requiring zero leakage. We sell valves to the chemical, power generation, petroleum, water and other industries. In addition to traditional valves, we also produce valves that incorporate "smart" valve technologies, which integrate high technology sensors, microprocessor controls and digital positioners into a high performance control valve, permitting real time system analysis, system warnings and remote services. We believe we were the first company to introduce "smart" valve technologies in response to demands for increased plant automation, more efficient process control and digital communications. We offer a growing line of digital products and will continue to incorporate digital technologies into our existing products to upgrade performance.

FCD SERVICES

We provide FCD aftermarket services through our network of 49 service centers located throughout the world. Our service personnel provide a comprehensive set of 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, including 24-hour service in all of our major markets. Services also include leak sealing, line stopping and hot tapping. Offering these types of services provides us access to our customers' installed base of flow control products.

The following is a summary list of our general valve products and globally recognized brands:

FCD PRODUCT TYPES

•

Actuator and Accessories

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Control Valves

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Ball Valves

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Lubricated Plug Valves

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•

Pneumatic Positioning

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Electro Pneumatic Positioning

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Digital Valves

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Digital Communications

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Manual Quarter-Turn Valves

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Valve Automation Systems

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Valve/Actuator Software

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Nuclear Valves

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Quarter-Turn Actuators

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Valve Repair Services

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Leak Sealing

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Hot tapping

FCD BRAND NAMES

NEW FCD PRODUCT DEVELOPMENTS

Our investments in new FCD product research and development focus on technological leadership and differentiating our product offerings. When appropriate, we invest in the redesign of existing products in an effort to improve their performance and continually meet customer needs. None of our newly developed products required the investment of a material amount of our assets or was otherwise material.

FCD CUSTOMERS

FCD's customer mix is diversified within several industries including chemical, water, petroleum, power and other industries. FCD's product mix includes original equipment and aftermarket parts.

FCD COMPETITION

Like the pump market, the valve market is highly fragmented and has undergone a significant amount of consolidation in recent years. Within the valve industry, we believe that the top 10 valve manufacturers, on a global basis, collectively maintain approximately 30% of the market. Based on independent industry sources, we believe that we are, on a global basis, the second largest industrial valve supplier.

FCD BACKLOG

FCD's backlog of orders at December 31, 2003 was $216 million, compared with $211 million at December 31, 2002. FCD anticipates shipping approximately 90% of the current backlog by December 31, 2004.

GENERAL BUSINESS

COMPETITION

The markets for our products are highly competitive, with competition occurring on the basis of price, technical expertise, delivery, contractual terms, previous installation history and reputation for quality. Delivery speed and the proximity of service centers are important considerations for our aftermarket products and services. Customers have traditionally relied on us, rather than our competitors, for aftermarket products relating to our highly engineered and customized products. However, aftermarket competition for standard products has increased. Price competition tends to be more significant for OEMs than aftermarket services and generally has been increasing. In the aftermarket portion of our service business, we compete against large and well-established national or global competitors and, in some markets, against smaller regional and local companies, as well as the in-house maintenance departments of our end user customers. In the sale of aftermarket products and services, we benefit from our large installed base of pumps and valves, which require maintenance, repair and replacement parts. In the petroleum industry, the competitors for aftermarket services tend to be the customers' own in-house capabilities. In other industries, except the nuclear power industry, the competitors for aftermarket services tend to be local independent repair shops. Low cost replicators of spare parts are competitors for spare parts for all industries except for the nuclear power industry. We possess certain competitive advantages in the nuclear power industry due to our "N Stamp," a

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prerequisite to serve customers in that industry, and our considerable base of proprietary knowledge.

    Generally, our customers are attempting to reduce the number of vendors from which they purchase, thereby reducing the size and diversity of their inventory. Although vendor reduction programs could adversely affect our business, we have been successful in entering into global alliance arrangements with a number of customers to leverage competitive advantages.

NEW PRODUCT DEVELOPMENT

Our development efforts focus on developing new products and improving versions of existing products. We conduct research and development at various manufacturing sites primarily to develop new products and to improve our existing product lines. We spent approximately $25.3 million, $24.4 million and $23.4 million during 2003, 2002 and 2001, respectively, on Company-sponsored research and development initiatives.

    Our research and development group consists of engineers involved in new product development and improvement of existing products. Additionally, we sponsor consortium programs for research with various universities and jointly conduct limited development work with certain vendors, licensees and customers. We believe current expenditures are adequate to sustain our ongoing research and development activities.

CUSTOMERS

We sell to a wide variety of customers in the petroleum, chemical, power generation, water treatment and general industries. No individual customer accounted for more than 10% of our consolidated 2003 revenues.

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 agents to supplement our direct sales force in countries where business practices or customs make it appropriate, or wherever it is uneconomical to have a direct sales staff. We generate a majority of our sales leads through existing relationships with vendors, customers and prospects or through referrals.

RISKS OF INTERNATIONAL BUSINESS

Sales to foreign destinations, including U.S. export sales, comprised approximately 60% of our sales in 2003. Our activities are subject to the customary risks of operating in an international environment, such as military conflicts, unstable political situations, local laws, the potential imposition of trade restrictions or tariff increases and the relationship of the U.S. dollar to other currencies. The impact of these conditions is mitigated somewhat by the strength and diversity of our product lines and geographic coverage. To minimize the impact of foreign exchange rate movements on our operating results, we regularly enter into forward exchange contracts to hedge specific foreign currency denominated transactions, as more fully described in Note 8 of our consolidated financial statements.

    For detailed information on revenues to different geographic areas and long-lived assets based on the facilities' location, see Note 16 of the consolidated financial statements included in this Form 10-K filing.

INTELLECTUAL PROPERTY; TRADEMARKS AND PATENTS

We own a number of trademarks and patents relating to the name and design of our products. We consider our trademarks and patents to be an important aspect 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 important and valuable. Accordingly, we attempt to proactively protect such proprietary information. We generally own the rights to the products which we manufacture and sell and are unencumbered by any license or franchise to operate. Our trademarks typically extend indefinitely, whereas our existing patents will expire 20 years from the dates they were filed, which occurred at various times in the past. We do not believe that the expiration of patents will have a material adverse impact on our operations.

RAW MATERIALS

The principal raw materials used in manufacturing our products are readily available and include bar stock and structural steel, castings, fasteners, gaskets, motors, silicon and carbon faces and fluoropolymer components. While substantially all

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raw materials are purchased from outside sources, we have been able to obtain an adequate supply and anticipate no shortages of such materials. We continue to expand worldwide sourcing to capitalize on low cost sources of purchased goods.

    We are a vertically integrated manufacturer of certain pump and valve products. Certain corrosion-resistant castings for our pumps and quarter-turn valves are manufactured at our foundries. Other metal castings are also manufactured at our foundries or they are purchased from outside sources.

    We also produce most of our highly engineered corrosion resistant plastic parts for certain pump and valve product lines. These include rotomolding as well as injection and compression molding of a variety of fluoropolymer and other plastic materials. We do not anticipate difficulty in obtaining such raw materials in the future.

    Suppliers of raw materials for nuclear markets must be qualified by the American Society of Mechanical Engineers and, accordingly, are limited in number. However, to date we have experienced no significant difficulty in obtaining such materials.

EMPLOYEES AND LABOR RELATIONS

We have approximately 13,000 employees of whom approximately one-half work in the U.S. Some of our hourly employees at our pump manufacturing plants located in Vernon, California, Phillipsburg, New Jersey and Springboro, Ohio, our Pump Service Center in Cleveland, Ohio, our valve manufacturing plant in Lynchburg, Virginia, and our foundry 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, Austria, Belgium, Brazil, Canada, France, Germany, Italy, Mexico, the Netherlands, Spain and the United Kingdom. We believe employee relations throughout our operations are generally satisfactory, including those represented by unions.

ENVIRONMENTAL REGULATIONS AND PROCEEDINGS

We are subject to environmental laws and regulations in all jurisdictions in which we have operating facilities. We periodically make capital expenditures to abate and control pollution and to satisfy environmental requirements. At present, we have no plans for any material capital expenditures for environmental control facilities. However, we have experienced and continue to experience operating costs relating to environmental matters, although certain costs have been offset by successful waste minimization programs. Based on information currently available, we believe that future environmental compliance expenditures will not have a material adverse effect on our financial position. We have established reserves which we believe to be adequate to cover potential environmental liabilities.

EXPORTS

Licenses are required from U.S. government agencies to export certain products. In particular, products with nuclear applications are restricted, as are certain other pump, valve and mechanical seal products.

    Our export sales from the U.S. to foreign unaffiliated customers were $208 million in 2003, $192 million in 2002 and $167 million in 2001.

AVAILABILITY OF FORMS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION

Our shareholders may obtain, without charge, copies of the following documents as filed with the Securities and Exchange Commission:

•

annual reports on Form 10-K,

•

quarterly reports on Form 10-Q,

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current reports on Form 8-K,

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changes in beneficial ownership reports for insiders,

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proxy statements, and

•

any amendments thereto,

as soon as reasonably practical after such material is filed with or furnished to the Securities and Exchange Commission.

    Copies may also be obtained by accessing our website at www.flowserve.com or by providing a written request for such copies or additional information regarding our operating or financial performance to Michael E. Conley, Director, Investor Relations, Flowserve Corporation, 5215 North O'Connor Blvd., Suite 2300, Irving, Texas 75039.

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    We have adopted self-governance guidelines for our Board of Directors. We also have charters for the following committees of the Board: Audit/Finance Committee, Compensation Committee and the Corporate Governance and Nominating Committee. Copies of the Self-Governance Guidelines, as well as the charter for each of the foregoing Board committees, also may be obtained as shown above.

ITEM 2. PROPERTIES

Our corporate headquarters is a leased facility in Irving, Texas, which we began occupying on January 1, 2004. The facility encompasses approximately 100,000 square feet. We currently utilize 98% of this space and believe it is suitable and adequate for our future needs. The lease term is for 10 years and we have the option to renew the lease for two additional five-year periods. Prior to January 1, 2004 and during the period covered by this report, we leased a 59,500 square foot facility as our corporate headquarters. The lease for this facility expired on December 31, 2003.

    Information on our principal manufacturing facilities operating at December 31, 2003 is as follows:

    Most principal manufacturing facilities are owned. Most leased facilities are covered by long-term lease agreements. We maintain a substantial network of U.S. and foreign service centers and sales offices, most of which are leased. We believe we will be able to extend leases on our service centers and sales offices where desired, as they expire. See Note 10 to the consolidated financial statements included in this 10-K filing for additional information regarding our obligations under leasing arrangements.

    During 2003, we utilized approximately 65% to 70% of our manufacturing capacity, although usage rate among the facilities varied. We could, in general, increase our capacity through the purchase of new or additional manufacturing equipment without obtaining additional facilities.

ITEM 3. LEGAL PROCEEDINGS

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

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

    In June 2002, we were sued by Ruhrpumpen, Inc. who alleged antitrust violations, conspiracy, fraud and breach of contract claims arising out of our December 2000 sale to Ruhrpumpen of a plant in Tulsa, Oklahoma and a license for eight defined pump lines. The sale agreement had a purchase price of

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approximately $5.4 million plus other material terms, including Ruhrpumpen's assumption of certain liabilities. Ruhrpumpen subsequently amended its complaint to add Mr. Ronald F. Shuff, our Vice President, Secretary and General Counsel, and two other employees as individual defendants. The sale to Ruhrpumpen was the result of a divestiture agreement we reached with the U.S. Department of Justice ("DOJ") in July 2000 in connection with our acquisition of IDP. Our agreement with the DOJ gives it the authority to make inquiries about and otherwise monitor our divestiture. On or about May 13, 2003, we received a letter from the DOJ making inquiry into some of the issues raised by Ruhrpumpen in its lawsuit and seeking information about the divestiture and Ruhrpumpen's lawsuit. The DOJ continues to monitor the lawsuit and the divestiture. During March 2004, the case was tried in the U.S. District Court for the Northern District of Texas. At trial, Ruhrpumpen sought the recovery of over $100 million in actual and exemplary damages. We vigorously contested Ruhrpumpen's allegations and purported damages. At the close of the trial, Ruhrpumpen voluntarily dismissed its claims against Mr. Shuff and the other two employees. We are currently awaiting a ruling from the court as to the remaining claims against the Company.

    During the quarter ended September 30, 2003, related lawsuits were filed in federal court, in the Northern District of Texas, alleging that we violated federal securities laws during a period beginning on October 23, 2001 and ending September 27, 2002. The cases were consolidated and a lead plaintiff was appointed by the court. A consolidated amended complaint was filed on February 5, 2004. The consolidated amended complaint, like the earlier individual complaints, also names as individual defendants Mr. C. Scott Greer, Chairman, President and Chief Executive Officer, and Ms. Renée J. Hornbaker, Vice President and Chief Financial Officer, and seeks unspecified compensatory damages and recovery of costs. On March 11, 2004, the court granted the lead plaintiff leave to file a further amended complaint within 15 days of our filing of the finalized restatement of our financial results. We strongly believe that the lawsuit is without any merit and plan to vigorously defend the case.

    On February 4, 2004, we received an informal inquiry from the SEC requesting the voluntary production of documents and information related to our February 3, 2004 announcement that we would restate our financial results for the nine months ended September 30, 2003 and the full years 2002, 2001 and 2000. In a separate informal inquiry, the SEC requested, and we supplied, documents and other information relating to whether our Form 8-K, filed November 21, 2002, adequately fulfilled obligations that may have arisen under Regulation FD. We intend to continue to cooperate with the SEC in these inquiries.

    We are also a defendant in several other lawsuits, including product liability claims, that are insured, subject to the applicable deductibles, arising in the ordinary course of business. We believe that we have adequately accrued estimated losses for such lawsuits.

    Although none of the aforementioned potential liabilities can be quantified with absolute certainty, we have established reserves covering these exposures, which we believe are reasonable based on past experience and available facts. While additional exposures beyond these reserves could exist, none gives rise to any additional liability that can now be reasonably estimated, and we believe any such costs will not have a material adverse impact on our results of operations or financial position. We will continue to evaluate these potential contingent loss exposures and, if they develop, recognize expense as soon as such losses become probable and can be reasonably estimated.

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

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY

Our executive officers and certain other corporate officers, all positions and offices held by each person named, their ages and their business experience are presented on the following pages. The information provided on the following page is presented as of the period covered by this 10-K filing. Executive officers serve at the discretion of the Board of Directors.

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(1)

Ms. Giddings served as Vice President and Corporate Controller during the period covered by this report; however, Ms. Giddings resigned on March 12, 2004.

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(2)

Mr. MacDowell served as Vice President and Chief Information Officer during the period covered by this report; however, Mr. MacDowell resigned on March 5, 2004.

(3)

Mr. Shedlarski served as Vice President and President of Flow Control Division during the period covered by this report; however, Mr. Shedlarski announced his retirement on April 2, 2004 with effect on May 1, 2004.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock (FLS) is traded on the New York Stock Exchange. On April 2, 2004, our records showed approximately 4,431 shareholders of record. Based on these records plus requests from brokers and nominees listed as shareholders of record, we estimate there are approximately 1,600 beneficial owners of our common stock. We did not pay a dividend on our shares of common stock in 2002 or 2003 and have no current plans to begin paying dividends in the near future.

PRICE RANGE OF
FLOWSERVE COMMON STOCK
(INTRADAY HIGH/LOW SALES PRICES)

During 2003, 2002 and 2001, we issued 16,775, 31,100 and 27,700 shares of restricted common stock, respectively, pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933. Shares were issued for the benefit of our directors and certain officers and employees subject to restrictions on transfer.

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ITEM 6. SELECTED FINANCIAL DATA

FIVE-YEAR SELECTED FINANCIAL DATA

(a)

Financial results in 2003 include integration expense of $19,768 and restructuring expense of $2,879, resulting in a reduction in after tax net earnings of $14,820.

(b)

Financial results in 2002 include IFC results from the date of acquisition. Financial results in 2002 include integration expense of $16,179, restructuring expense of $4,347, a loss on debt repayment and extinguishment of $11,237 and a $5,240 purchase accounting adjustment associated with the required write-up and subsequent sale of acquired inventory, resulting in a reduction in after tax net earnings of $23,689.

(c)

Financial results in 2001 include integration expense of $63,043, a reduction of Flowserve restructuring expense of $1,208 and a $24,974 loss on debt repayment and extinguishment, resulting in a reduction in after tax net earnings of $57,550.

(d)

Financial results in 2000 include Invatec and IDP from the date of the respective acquisitions. Financial results in 2000 include integration expense of $35,211, restructuring expense of $19,364 and a $3,229 loss on debt repayment and extinguishment, resulting in a reduction in after tax net earnings of $37,752.

(e)

Financial results in 1999 include integration expense of $14,207 relating to the Company's Flowserver program, restructuring expense of $15,860, other nonrecurring items for inventory and fixed asset impairment of $5,067 (included in costs of sales), and executive separation contracts and certain costs related to fourth-quarter 1999 facility closures of $5,799 (included in selling and administrative expense), resulting in a reduction in net earnings of $27,322.

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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.

CORPORATE PROFILE

Flowserve Corporation ("Flowserve" or the "Company") is a global industrial company focused on flow control products and services. Flowserve was formed in 1997 by the merger of two publicly traded companies, Durco International Inc., (Durco), which became the successor company, and BW/IP, Inc. (BW/IP). We are incorporated in the State of New York and are headquartered in Irving, Texas, a suburb of Dallas. We have operations in 56 countries and about 13,000 employees around the globe.

    We are one of the world's leading providers of fluid motion and control products and services. We produce engineered and industrial pumps, seals and valves and provide a range of related flow management services. Fluid motion and control products generally are used by our customers to regulate the movement of liquids or gases through processing systems in their facilities. The industries we serve include oil and gas, chemical, power generation and water. We also serve companies in the mining, pulp & paper, food and beverage, steel, heating, ventilation and air conditioning (HVAC) and other industries.

    We conduct our business through three business segments that represent our major product areas. Our Flowserve Pump Division (FPD) produces, sells and services engineered and industrial pumps, as either complete units or parts. This business has 23 manufacturing facilities, of which 9 are located in North America and 11 in Europe. The remaining facilities are located in South America and Asia. FPD also has 32 service operations, which are either free standing or co-located in a manufacturing facility. In 2003, FPD had revenues of $1.2 billion, of which approximately 43% were from oil & gas, 19% power, 11% water, 8% chemical and 19% general industry. We are one of the world's leading suppliers of pumps to the oil & gas, chemical and power industries. Based on independent industry sources, we believe that we are, on a global basis, the third largest industrial pump supplier. We believe our ability to offer the broadest range of pumps for the petroleum, power and chemical markets, our strong customer relationships and our more than 100 years of experience in pumping equipment are our major sources of competitive advantage. This broad range of pump products is the result of the Durco and BW/IP merger and our 2000 acquisition of Ingersoll Dresser Pump Co (IDP). In addition, FPD's reputation for providing quality engineering solutions for the most challenging customer application is a core strength.

    Our Flow Solutions Division (FSD) produces, sells and services precision mechanical seals. FSD has six manufacturing operations, four of which are located in North America and two are in Europe. The remaining operations are located in South America or Asia. FSD operates 47 service locations, called quick response centers (QRCs). These QRCs generally are standalone facilities, with 22 located in North America, 11 in Europe with the remainder principally located in South America and Asia Pacific. FSD had 2003 revenues of $359.5 million, of which approximately 32% were from oil and gas, 30% chemical and 38% general industry. Our unmatched ability to turn around engineered seal products within 72 hours from the customer's request, through design, engineering, manufacturing, testing and delivery, is our major source of competitive advantage. Based on independent industry sources, we believe that we are the second largest mechanical seal supplier on a global basis.

    The Flow Control Division (FCD) produces, sells and services industrial valves, manual valves, control valves, nuclear valves, valve actuators and valve automation controls. FCD has 22 manufacturing operations, of which five are located in the U.S. and 12 in Europe. The remaining operations are located in South America and Asia. We have 49 valve service centers that are generally free standing and principally based in the U.S. FCD had 2003 revenues of $888.1 million, of which approximately 32% were from chemical, 20% power, 15% oil and gas, 3% water and 30% general industry. As a result of our 2002 acquisition of the Flow Control Division of Invensys plc ("IFC"), we are one of the world's

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leading suppliers of valves and related products and services to the chemical industry. Based on independent industry sources, we believe that we are the second largest industrial valve supplier on a global basis. We believe that our comprehensive portfolio of valve products and services is a key source of our competitive advantage. Further, our focus on service and severe corrosion and erosion applications is a key competency.

OVERVIEW

Our Markets

We are dependent on the profitability and liquidity of our customers. Customer profitability is important because this usually means good demand for their products, which can lead them to expand their capacity through capital investments and enhance the efficiency of their operations through maintenance expenditures. Their liquidity is important as they also need access to cash resources, either through cash reserves or financing, to be able to invest in capital equipment such as pumps, valves and mechanical seals.

    The oil and gas market represented about 31% of our business in 2003. A high price in oil, above $22 to $24 per barrel, generally spurs additional investment in upstream petroleum projects. Typically, this is because the price of oil is driven by supply and demand. This was the case for 2003, as we saw an increase in bookings for oil projects, particularly in Asia, Africa and Latin America. Despite the high price, in the Middle East there were more limited expenditures for our products to this market, generally due to the Iraq war and post-war unrest throughout the region. However, high oil prices often reduce the demand for our products and services from refiners who seek to take advantage of favorable refining margins by operating at high levels of capacity utilization and deferring maintenance until absolutely necessary. Clean fuels regulations, particularly in the U.S., have been a source of some project business from refiners. However, the profitability of such projects is typically much lower than for maintenance related items.

    Despite high natural gas prices in 2003, there was little additional investment or maintenance activity by our gas customers, many of which have experienced liquidity constraints as a result of financial difficulties related to their former energy trading activities. As the results of these companies improve or they are otherwise recapitalized, we could see incremental business as the demand for natural gas remains high. Today, a number of companies are discussing potential investments in liquefied natural gas. We would expect to benefit from a portion of this business. For oil and gas, our outlook for 2004 is that our bookings could grow about 1.5% based on forecasts provided by European Industrial Forecasting (EIF).

    While high oil and gas prices are generally good for our oil and gas customers, they are generally adverse for chemical companies, since oil and natural gas are used to manufacture many of their products. In 2003, the price of natural gas in the U.S. increased almost 70% from 2002. This significantly reduced the profitability of our chemical customers, who faced high feedstock costs and weak demand due to the soft economy. In response, they reduced their spending on capital investments and operated their facilities at lower levels, thus reducing the demand for our higher margin parts, replacement products and services. If the economy improves, and demand for chemical-based products increases, we expect to see some improvement in the demand for our products to the chemical industry. Further, this industry's improved profitability could spur new investment in other parts of the world such as Asia, and we would expect to benefit from those investments as well. In 2003, the chemical industry represented about 18% of our business. Based on forecasts provided by EIF, our bookings for this market could grow about 2.4% in 2004.

    Increased natural gas prices also diminished the profitability of many power generators that in recent years made significant investments in power plants that generate electricity from natural gas. While they have been able to recover a portion of their higher costs through rate increases, their liquidity is still challenged due to over investment in these power facilities. However, a number of nuclear power generators are planning significant maintenance activities. We have seen an increase in our orders for this area and expect it to be a positive contributor to 2004 orders and sales. In addition, there are several coal-fired power plants planned for the U.S. and we are actively pursuing those opportunities. The revenue opportunity for our products at a

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coal-fired plant typically can be three times that of a natural gas power plant. The power industry was approximately 17% of our business in 2003. Based on EIF forecasts, our orders for this market could increase by 3.0% in 2004.

    Worldwide demand for fresh water and water treatment continues to create demand for new facilities or upgrades of existing systems requiring our products, especially pumps. We believe that we are a global leader in the desalination market, which is an important source of fresh water in the Mediterranean area and the Middle East. This is a significant market for our pumps and valve actuation products. In 2003, the water market represented about 7% of our business. Based on EIF forecasts, we estimate demand for our products for the water market could increase by 2.9% in 2004.

    General industry represents a variety of different businesses, including mining, pulp & paper, food and beverage, steel and HVAC, none of which represents 5% of total sales. General industry comprised about 27% of our business in 2003. Some of these businesses, such as mining, pulp and paper and steel, appear to have experienced cyclical troughs in 2003. Other industries such as food and beverage were relatively stable. HVAC was somewhat weaker due to a decline in the commercial real estate market. In 2004, some of these businesses that are tied to the economic recovery such as mining, pulp and paper and steel are expected to improve. Overall, based on EIF forecasts, our bookings related to general industry could increase by 2.5% in 2004.

    Our customers include engineering contractors, original equipment manufacturers (OEMs), end users and distributors. Sales to engineering contractors and OEMs are typically for project orders. Project orders generally have lead times greater than three months. Project orders provide product to our customers either directly or indirectly for their new construction projects or facility enhancement projects. However, some distributor sales may also be for projects and some OEM sales may be not be for projects.

    The quick turnaround business, which we also refer to as the book and ship business, is defined as orders that are received from the customer (booked) and shipped within an approximate three-month period. They are typically for more standard products, parts or services. Each of our three segments generates this type of business.

    Our reporting of trends by product type, customer type and business type are based upon analytical review of individual operational results and our knowledge of their respective businesses as we do not track revenues by any of these categories.

Our Capital Structure

We could be viewed as a leveraged company as we have a non-investment grade rating. As a result, our ability to borrow additional funds and make investment decisions is limited by the terms of our credit agreement with our banks. In that agreement, we must maintain certain minimum or maximum financial ratios specified in our covenants to be in compliance with the terms of the agreement. If we fail to meet such ratios, we could seek a waiver and/or amendment to these covenants, which would likely require a fee to our lenders. We may also have to pay a higher rate of interest on our borrowings and, under particularly adverse circumstances, we could be forced to divest a portion of our business or be required to issue equity. At this time, if we were to fail to meet such ratios, we believe our most likely action would be to seek, and likely obtain, a waiver and/or amendment, as we have been consistently paying down more debt than required and our net debt-to-capital ratio has declined for three consecutive years. In the second quarter of 2003, we successfully obtained an amendment to our covenants to provide us with relief and more flexibility in certain areas.

    Our sources of operating cash include the sale of our products and services and the reduction of our working capital, particularly accounts receivable and inventories. We have goals to continue to improve our working capital utilization through improved processes. Our 2004 goal for days sales receivables outstanding (DSO) is 60 days, compared with an actual DSO of 68 days at the end of 2003. Based on 2003 sales, achieving this goal could provide approximately $100 million in cash. Our objective for 2004 inventory turns is to improve by approximately one full turn per year, from 4.2 turns actual at year end 2003. In the last year, our inventory turns were flat with 2002. Based on 2003 data, an

17

improvement of one turn would yield about $130 million in cash.

    We continue to manage our investment in property, plant and equipment. In 2003, our capital expenditures were $28.8 million, or 46.3% of depreciation. Major investments in our facilities are not considered to be necessary as we have excess capacity. In addition, as we have consolidated facilities through acquisition integration over the last several years, we have upgraded the equipment in the remaining facilities with better equipment from the closing facilities. In 2004, we anticipate capital expenditures, excluding any acquisition activity, to approximate $35 million, which is slightly higher than in 2003.

    We have a U.S. defined benefit pension plan that is expected to require contributions in excess of related expense for the foreseeable future. In 2003, contributions were $27 million, compared with expense of $12 million. Higher contributions are necessary due to reduced investment returns from the plan in 2000 through 2002 and a relatively high level of lump sum payouts from the plan as we have continued to reduce our workforce. Contributions to our U.S. pension plan in 2004 are likely to range between $12 million and $17 million. We plan to continue to fund our pension plan to a level that is at least 80% of our current benefit obligation as defined by U.S. pension rules and regulations.

Our Strategies

Organic Growth.    We have a number of initiatives directed at growing our business at a faster pace than that of our end markets. Of these, our end user initiative is the most significant. It is based on a highly successful model used by our mechanical seals business for many years. The foundations of this initiative are local customer support, rapid response and customer alliances. These customer alliances are designed to create a win-win opportunity for us and our customers. These alliances focus on decreased down-time for our customers' facilities and a high and relatively consistent market share for us. Our seal business has increased its market share during the last several years through this focus. We are expanding this approach to our pump business. This is being done through common end user customer sales force management. In our valve business, this initiative is being pursued through total portfolio management. To facilitate this approach, our valve sales force is now organized by industry rather than brands or products.

Process Excellence.    We also have a number of initiatives focused on process excellence. They include supply chain, our continuous improvement process (CIP) and our Flowserve Management System (FMS). In the area of supply chain, we have focused on leveraging our purchases and increasing supply from lower cost areas. CIP combines Lean Manufacturing and Theory of Constraints with Six Sigma tools and change management. To date, about 80% of our associates have been trained in these techniques. FMS is a management system developed to align each employee's goals with our strategies. This system began in late 2001 and was initially implemented at the division, or in some cases the operating unit level. In 2003, we expanded FMS training and tools to more associates. We believe that tighter alignment between individual goals and corporate strategies should increase the effectiveness of our initiatives in the future. For 2003, we estimate cost reductions from these process improvement initiatives were about $38 million, or 2% of our costs. In 2004, we have a goal of about $46 million in cost reductions related to these initiatives.

Globalization.    We believe that our future success will be dependent on the global diversity of our business. An important globalization initiative is to expand our presence in faster growing markets such as Asia, Latin America and Africa. We are adding resources in these regions to better serve our customers there. In the area of supply chain management, we have focused on increasing our supply from lower cost areas such as India, China, Mexico, Latin America and Eastern Europe. In addition, we have projects to increase outsourcing to centers of excellence in such places as India for engineering and back office functions and improve local service to our customers.

    Another strategy is the expansion of our presence in under-represented markets such as Asia, Latin America, Africa, India, China, Mexico and Eastern Europe. We are adding resources in these regions to better serve our customers there.

Acquisition Growth.    Since 1997, we have expanded through a number of acquisitions. The industry in

18

which we participate continues to be very fragmented. While we believe that we are the third largest pump company, our share of the pump industry is only about 4.0%. As the second largest valve and second largest mechanical seal businesses, our estimated market shares are 4.0% and 14.0%, respectively. These estimated market shares are based upon the total addressable market for pumps, valves and seals, which is broader than the markets currently served by our products and applications. We expect to continue to grow through acquisitions. In 2004, we expect to limit our acquisitions to smaller companies ($50 million or less in revenues) within the flow control industry that are considered to be "bolt-ons," and thus require little operational integration. We make acquisitions to broaden our product range to current customers, expand our reach in faster growing markets, add capabilities that enable us to serve current customers more efficiently or effectively, and reduce our manufacturing footprint through consolidation of facilities. We may also consider the divestiture of certain smaller parts of our business that have more limited growth potential or are not considered to be a core competency.

Organizational Capability.    To continue to grow, we acknowledge the need to continuously build and enhance our human resources. A number of initiatives are focused in this area, including performance management, diversity, career planning and training and development. We designed these programs to expand our capabilities to meet the challenges of a solutions-oriented business in a highly competitive, global environment. Our approach to compensation and benefits is to be market competitive, underpinned by higher rewards for higher performers.

OUR RESULTS OF OPERATIONS

In general, 2003 and 2002 consolidated results and the Flow Control Division results were higher than the corresponding period in the previous year due to the impact of the acquisition of IFC, which took place on May 2, 2002. The results for IFC subsequent to that date are included in the results for our Flow Control Division. The IFC acquisition is discussed in further detail in the Liquidity and Capital Resources section of this Management's Discussion and Analysis. Pro forma results for 2002 and 2001 referenced throughout this Management's Discussion and Analysis assume that the acquisition of IFC occurred on January 1, 2001 and include estimated purchase accounting and financing impacts.

    All pro forma information is provided solely to enhance understanding of the operating results, not to purport what our results of operations would have been had such transactions or events occurred on the dates specified or to project our results of operations for any future period. Pro forma information should not be considered an alternative to operating results calculated in accordance with generally accepted accounting principles.

Sales

    Sales increased 6.8% in 2003 which reflects the impact of about $141 million of a full year's inclusion of IFC sales compared with eight months in the prior year and favorable currency translation benefits of about $154 million resulting from the strengthening of international currencies, particularly the Euro against the U.S. dollar. Pro forma sales in 2003 were flat but would have been down absent the currency translation benefit of about 7%. Partially offsetting these positives were lower sales of quick turnaround business into the chemical and general industrial sectors attributable to the U.S. recession and to a lesser extent the European recession in the latter half of the year. Sales into these sectors have declined for each of the past three years. The quick turnaround business is generally booked and shipped within an approximate three-month period. We believe that the weakness in this business is due to customer deferrals of plant maintenance and a lower level of capacity utilization due to partial or complete plant closures. Chemical and industrial pumps, valves and mechanical seals and related services are most dependent on this quick turnaround business. Sales into the power and water markets also declined in 2003. Additionally, replacement parts and services into the Middle East and Venezuela decreased in 2003 due to post-war unrest and political unrest, respectively.

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    Sales increased 17.4% in 2002 which reflects the impact of the IFC acquisition. Pro forma sales including IFC were down 1.4% in 2002. In 2002, currency translation impacts were negligible as benefits associated with the strengthening of the Euro were offset by devaluation of Latin American currencies. The decline in 2002 pro forma sales reflects weaker sales into the power market as well as lower sales of quick turnaround products and services into the chemical and general industrial sectors. However, sales of mechanical seals increased $22.7 million in 2002 compared with 2001.

    Sales to international customers, including export sales from the U.S., were approximately 61% of sales in 2003 compared with 56% of sales in 2002 and 48% in 2001. Sales into Europe, the Middle East and Africa in 2003 increased to 40% from 34% in the prior year predominantly due to favorable currency translation and increased project business. IFC's proportionately higher mix of international operations contributed to the 2002 increase. Absent currency translation impacts, we believe that our sales to international customers will continue to increase as a percentage of total sales as our highest revenue growth opportunities are in Asia, Latin America and Africa.

Bookings And Backlog

    Bookings, or incoming orders for which there are customer purchase commitments, increased 11.0% in 2003. The improvement reflects the impact of the IFC acquisition of about $155 million and an approximate $161 million benefit from currency translation. Pro forma bookings in 2003 increased 4.2%. In addition to the currency translation impact, the improvement in 2003 reflects an increase in upstream petroleum projects, particularly within Asia, West Africa and the CIS. However, bookings in 2003 were unfavorably impacted by reduced demand for products and services to chemical, power and general industrial customers. Additionally, bookings in 2003 into the Middle East and Venezuela were lower due to the political and economic turmoil in those regions.

    Bookings in 2002 increased 10.6%, reflecting the impact of the IFC acquisition. Pro forma bookings in 2002 declined by 7.2%. The decline reflected reduced demand for products and services to chemical, power and general industrial customers.

    Backlog in 2003 of $818.2 million increased 11.5% compared with an increase of 10.7% in 2002. Backlog represents the accumulation of uncompleted customer orders. By the end of 2004, we expect to ship over 90% of this backlog. The 2003 backlog increase resulted from currency translation benefits of about 9% as well as increased bookings during 2003 as previously discussed. The increase in backlog in 2002 reflects the IFC acquisition. On a pro forma basis, including IFC, backlog decreased by 5.9% in 2002 due to lower pro forma bookings despite favorable currency translation.

Gross Profit And Gross Profit Margin

    Gross profit in 2003 increased 6.6% which reflects the full year impact of the IFC acquisition of approximately $43 million, $3.2 million of lower incentive compensation and currency translation benefits of about $47 million. Partially offsetting these benefits were the impacts of unfavorable product mix and an estimated $12.6 million increase associated with lower overhead absorption due to estimated lower unit volume.

    Pro forma gross profit in 2003 decreased 1.1% and pro forma gross profit margin declined 30 basis points. Despite the benefit from currency translation, the decline in gross profit and gross margin reflects the negative impact of a less profitable product mix as well as $12.6 million of increased operating variances associated with lower overhead absorption due to lower unit volumes. Customer market factors discussed above contributed to the reduced demand for our

20

products which yielded lower unit volumes. The profitability of the product mix has eroded in each of the past three years due to higher volumes of less profitable project business, and in 2003, increased warranty expense of about $7.2 million associated with more warranty claims. Additionally, the product mix contained lower volumes of higher margin parts and quick turnaround business, including lower volumes of historically more profitable chemical and industrial pumps, industrial valves and service related activities. The quick turnaround business is generally related to more standard products, parts and services. The volumes of this business decreased due to reduced profitability of customers in chemical, general industrial, gas pipeline, power and refining industries. These customers are operating under lower volume conditions or unfavorable price positions due to the economy, unfavorable cost positions due to higher raw material costs or currency, or a combination of the factors above. In 2003, these impacts were partially offset by IFC cost savings synergies of an estimated $9.8 million.

    Material price inflation was relatively flat throughout the three-year period. However, in the latter part of 2003, costs for certain raw materials, particularly metal alloys and nickel, began to increase. These cost increases for raw materials represent approximately 1 to 1¹/2 percent of our total material expenditures. We believe we can offset much of these cost increases through price increases on our products and other material cost reduction initiatives. However, there can be no assurances that these and other potential material price increases will not impact gross profit in the future.

    Gross profit in 2002 increased 12.3%, reflecting the impact of the IFC acquisition despite an estimated 1.7% unfavorable currency impact. Pro forma gross profit declined 6.8% from the prior year. Pro forma gross profit margin declined 180 basis points during 2002 which reflects the less profitable product mix and lower overhead absorption. Additionally, gross profit and related margin were impacted in 2002 by a negative $5.2 million purchase accounting adjustment associated with the required write-up and subsequent sale of inventory resulting from the acquisition of IFC. However, this was partially offset by the benefit of implementing SFAS No. 141 and No. 142, which improved gross profit by $1.4 million in 2002.

Selling, General And Administrative (SG&A) Expense

    In 2003, SG&A expense increased 13.1%, which reflects a full year effect of the IFC acquisition of about $31 million and negative currency translation impacts of approximately $29 million and approximately $30 million of increased legal, professional, consulting and associated expenses, partially offset by improved earnings in unconsolidated affiliates, lower incentive compensation of $3.6 million and the impact of general cost savings initiatives. Pro forma SG&A expense in 2003 increased 5.2%. Absent currency translation, pro forma SG&A expense decreased 2.0% during 2003. The reduction in pro forma SG&A expense reflects improved earnings in unconsolidated affiliates, lower incentive compensation expense of $3.6 million in 2003 and an estimated $5.2 million of synergy benefits associated with the IFC integration program and the impact of general cost savings initiatives, offset in part by increased legal, professional, consulting and associated expenses of approximately $30 million.

    SG&A expense in 2002 increased 16.1% due to the IFC acquisition. However, 2002 pro forma SG&A expense declined by about 0.8%. The reduction in pro forma SG&A expense in 2002 reflects an $18.3 million benefit associated with discontinuing the amortization of goodwill in conjunction with the implementation of SFAS No. 141 and No. 142, offset by higher commissions associated with higher sales levels and increased maintenance expenses.

Integration And Restructuring Expense

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    The integration and restructuring expenses in 2003 and 2002 relate to the integration of IFC into the Flow Control Division. We have largely completed our restructuring and integration programs related to IFC, except for final severance payments and payments for other exit activities primarily related to European integration activities. Integration expense of $63.0 million and restructuring expense of $1.2 million reversed in 2001 relate to the integration of IDP into the Flowserve Pump Division. The IDP integration program was more expansive than the IFC program, resulting in higher costs. See page 26 of this Management's Discussion and Analysis for further discussion on integration and restructuring expenses.

Operating Income

    Operating income decreased 11.0% in 2003. Pro forma operating income decreased 17.9% in 2003. Despite currency translation benefits of an estimated $19 million, the decline in 2003 operating income reflects the impact of weak market conditions which resulted in lower demand and sales for chemical, power and general industrial market products and services, our more profitable businesses. In addition, an increase in unfavorable absorption variances of about $12.6 million, higher warranties of about $7.2 million, approximately $30 million of higher legal, professional, consulting and associated expenses and increased integration and restructuring expenses of $2.2 million negatively impacted operating income. These impacts were partially offset by estimated incremental synergy benefits of $15 million associated with the IFC integration program. Synergy savings associated with the IFC integration at December 31, 2003 are estimated to be at least $20 million annually.

    Operating income of $179.7 million in 2002 improved 37.8%, reflecting the IFC acquisition, lower integration and restructuring expenses of $41.3 million and a benefit of $19.7 million associated with cessation of amortization of goodwill and trademarks associated with SFAS 142. Absent the benefit of SFAS 142, the decrease in operating income reflects weaker business conditions resulting in lower volumes and the resulting overhead underabsorption.

Interest Expense And Loss On Repayment Of Debt

    Interest income increased during 2003 and 2002 due to higher average cash balances.

    Interest expense decreased 11.7% in 2003, compared with a decrease of 20.2% in 2002. The reduction in interest expense reflects lower prevailing interest rates and reduced debt levels associated with optional and scheduled debt paydowns since the acquisition of IFC as well as lower borrowing spreads associated with the renegotiation of our revolving credit facility in April 2002. At December 31, 2003 approximately 51% of our debt was at fixed rates, including the effects of $215 million of notional interest rate swaps.

    The reduction of interest expense in 2002 also resulted from lower debt levels associated with the repayment of one-third of the then outstanding Senior Subordinated Notes in the fourth quarter of 2001 using proceeds from a sale of our common shares.

    During 2003, we incurred losses of $1.3 million on debt repayments and extinguishment related to the accelerated write-off of unamortized prepaid financing fees resulting from $163.1 million of optional debt repayments throughout the year. In 2002, we incurred $11.2 million of such losses resulting from the debt amendments required pursuant to the IFC acquisition during the second quarter and from optional debt repayments during the third and fourth quarters. In 2001, we incurred such losses as a result of the early extinguishment of $133 million of 12.25% Senior Subordinated

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Notes, using proceeds from the sale of our common shares. Prior to our adoption of SFAS No. 145 on January 1, 2003, these losses were reported as extraordinary items in the statement of operations; however, the 2002 and 2001 amounts have been reclassified to conform to the 2003 presentation, as required under the new standard. We expect to incur additional non-cash losses as we continue to prepay debt. We currently anticipate that 2004 interest expense could be at the 2003 level or less due to continued expected debt prepayments.

Tax Expense And Tax Rate

    The reduction in the 2003 effective rate is primarily due to U.S. tax refunds received during the year which had not been previously recognized as a benefit. In 2002, the significant effective tax rate drivers include a benefit related to the extraterritorial income exclusion and the elimination of goodwill amortization resulting from our implementation of SFAS No. 142. The relatively low earnings levels in 2001 compared with 2002 and 2003 magnified the impact of unfavorable permanent differences resulting in the 5.3% effective tax rate for 2001. Our effective tax rate is based upon current earnings, estimates of future taxable earnings for each domestic and international location and the estimated impact of tax planning strategies. Changes in any of these and other factors, in particular our ability to utilize foreign tax credits, could impact the tax rate in future periods. We have foreign tax credits of $1.5 million, all fully reserved, which expire in 2004 through 2007. Additionally, foreign tax credits of $11.6 million expiring in 2005 and $9.4 million expiring in 2006 have been partially reserved. Should we be able to realize these credits, we would reverse the related valuation allowance which would have a favorable impact on our effective tax rate. Should we not be able to utilize all or a portion of these credits, we would lose the benefit which would have a negative impact on our effective tax rate.

    We expect our effective tax rate to be between 35% and 37% in 2004, although it is dependent upon the mix of earnings between our domestic and international locations, our tax planning strategies and our ability to utilize foreign tax credits.

Net Earnings And Earnings Per Share

    Net earnings increased 16.3% in 2003 due to lower levels of interest expense, loss on debt repayments and integration and restructuring expense, offset in part by the impact of lower sales volume and resultant lower gross margin as well as higher SG&A. Earnings per share in 2003 were negatively impacted by a 5.9% higher average diluted share count.

    Net earnings in 2002 increased $56.0 million which reflects the IFC acquisition, benefit of SFAS No. 141 and No. 142 and reduced interest, integration and restructuring expenses. The implementation of SFAS No. 141 and No. 142 resulted in an increase to net earnings of $14.3 million, or $0.27 per share, to earnings in 2002. Earnings per share in 2002 were negatively impacted by a 32.8% higher average diluted share count.

    The 2003 increase in average diluted shares reflects the full year weighted average impact from the equity offering completed in April 2002 to finance the IFC acquisition. The increase in 2002 reflects the full year impact of our equity offering completed in November 2001, the proceeds of which were used to retire debt.

Other Comprehensive Income

    Other comprehensive income improved in 2003, which reflects the strengthening of the Euro, improved pension plan asset returns and more beneficial hedging results. In 2002, the

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improvement reflected increased net earnings and a favorable foreign currency translation adjustment resulting from the strengthening of the Euro, partially offset by declines in the value of pension plan assets.

BUSINESS SEGMENTS

We evaluate segment performance based on operating income excluding special items. We believe that special items, while indicative of efforts to integrate IFC and IDP into our business, do not reflect ongoing business results. Earnings before special items are not a recognized measure under generally accepted accounting principles ("GAAP") and should not be viewed as an alternative to GAAP measures of performance.

The key operating results for our three business segments, Flowserve Pump Division (FPD), Flow Solutions Division (FSD) and Flow Control Division (FCD) are discussed below:

(1)

Operating income in 2001 is before special items. There were no special items in 2002 or 2003.

    Bookings of pumps, pump parts and services for the Flowserve Pump Division (FPD) in 2003 increased 7.4%. The improvement in bookings reflects favorable currency translation of about 7% and an increase in upstream petroleum projects, particularly within Asia, West Africa and the CIS. In addition, nuclear power bookings improved in 2003. These benefits were offset by lower bookings in the U.S. of quick turnaround business for the chemical and general industrial sectors, which declined each year over the three year period. Additionally, parts bookings, particularly into the Middle East and Venezuela, were down in 2003. The 7.9% decline in bookings in 2002 reflects lower bookings of quick turnaround business for the chemical, general industrial and power sectors of the business as mentioned above.

    Sales declined by 1.4% during 2003. Currency translation favorably impacted sales by about 7% in 2003. In addition, project sales into the oil and gas markets increased. However, these benefits were more than offset by a lower level of backlog at the beginning of 2003 which was down 10.2% lower than the prior year, as well as lower bookings of quick turnaround and after market business as discussed above. Sales in 2002 were 2.9% above the prior year due to higher shipments of engineered pump projects, particularly in the petroleum and water markets, which were in backlog at the beginning of 2002. Sales in 2002 were also adversely impacted by weak market conditions in the power, chemical and general industrial sectors of the business.

    FPD segment operating income decreased by 25.3% in 2003, compared with a 3.1% decrease in 2002. The 2003 decline in operating income reflects lower sales of 8.5% (absent estimated favorable currency effects of 7.1%), a lower mix of historically more profitable chemical and general industrial product sales and services, lower after market shipments into the Middle East and Venezuela, unfavorable overhead absorption of about $14.2 million due primarily to lower unit volumes and higher warranty costs of about $5.1 million. Segment operating income in 2002 benefited by $14.0 million from the implementation of SFAS No. 141 and No. 142, but declined due to the aforementioned weak market conditions, which impacted results in each of the past three years. In addition, unfavorable overhead absorption impacted results in 2002 by about $3.5 million due to lower production volumes and reductions in finished goods inventory in the facilities that manufacture pumps

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for the chemical, power and general industrial sectors.

    Bookings of seals for the Flow Solutions Division (FSD) increased 5.1% in 2003, which reflects a currency translation benefit of approximately 4%. Bookings in 2002 increased 4.6%. The bookings improvement in both years reflects the division's emphasis on end user business and its success in establishing longer-term customer alliance programs, including fixed fee alliances, despite weakened market conditions. Fixed fee alliances are contractual agreements with customers wherein the customer pays us a fixed amount each period (usually monthly) for the term of the agreement. In return for this fixed cost, the customer is entitled to new seals, repairs, upgraded equipment, replacements and maintenance services as defined within the scope of each agreement. We believe that this emphasis combined with heightened levels of service, reliability and innovation have contributed to an increase in market share in 2003 and 2002. We are currently implementing this end user strategy in our other divisions.

    Sales for FSD increased by 2.7% in 2003 compared with a 6.9% increase in 2002. The improvement in 2003 reflects currency translation benefits of approximately 4%, offset by the impact of lower demand caused by weaker market conditions particularly within the chemical industry and U.S. refineries. Despite weaker business conditions, FSD sales improved in 2002, reflecting the benefits of the aforementioned customer focus, end user strategy and estimated favorable currency effects of 4.3%.

    FSD segment operating income in 2003 increased 14.3%. The improvement reflects currency translation benefits of 5%, the 2.7% increase in sales and the absence of $4.0 million of performance incentive expense due to our weak consolidated performance compared with plan in 2003. Segment operating income improved 26.0% in 2002. The improvement in 2002 reflected the benefit of the sales increase of 6.9% and the impact of continuous improvement process projects in both years. Additionally, increases in plant efficiencies resulted from bringing previously outsourced production in-house, generally at only variable cost. Operating income in 2002 also benefited by $1.2 million from the implementation of SFAS No. 141 and No. 142.

    Bookings of valves and related products and services for the Flow Control Division (FCD) increased by 19.1% in 2003 due to the full year impact of the IFC acquisition of $155 million and

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an estimated 7% currency translation benefit. Pro forma bookings for 2003 were about flat. The decline in bookings absent currency benefits reflects weakness in the chemical, power and general industrial markets in 2003. Approximately 80% of FCD bookings are in these markets, which declined in both 2003 and 2002. Additionally, 2003 was adversely impacted by the absence of an unusually large nuclear power order from 2002 of approximately $28 million. Bookings increased 61.6% in 2002 due predominantly to the IFC acquisition. Pro forma bookings in 2002 declined 10.5% reflecting market weakness.

    Sales increased 22.4% in 2003 compared with an increase of 61.0% in 2002, primarily due to full year impact of IFC of about $141 million. Sales in 2003 were about flat with pro forma 2002, which was down 9.5% from pro forma 2001. Currency translation provided an estimated 7% benefit for 2003. Sales in both years were adversely affected by reduced customer demand for valve products and services in the power, chemical and general industrial sectors of the business.

    FCD segment operating income in 2003 increased 52.1%. The improvement reflects the IFC acquisition as well as currency translation benefits of about 9%. Pro forma segment operating income increased 20.6%. In addition to currency translation, the improvement reflects estimated incremental synergy benefits of $15 million in 2003. Synergy savings associated with the integration are estimated to be at least $20 million annually. We have largely completed the integration of IFC. See Restructuring and Acquisition Related Charges of this Management's Discussion and Analysis for a detailed discussion on the IFC integration program. These benefits were offset by the impact of lower unit volumes and an unfavorable mix of product sales.

    Segment operating income in 2002 increased 16.4%, but pro forma segment operating income declined 47.6%. Operating income in 2002, before special items, benefited by $4.4 million from the implementation of SFAS No. 141 and No. 142. The decline in operating results in 2002 on a pro forma basis reflected the 9.5% decline in sales due to weak conditions in the chemical, power and general industrial markets, as well as lower production throughput due to lower sales volume combined with a reduction of finished goods inventories, which resulted in unfavorable manufacturing absorption variances.

Segment Operating Income

We evaluate segment performance based on segment operating income, which is operating income excluding special items. Segment operating income provides the most meaningful measure of operating performance since it eliminates expenses associated with strategic corporate decisions not directly associated with ongoing segment performance and since such expenses are closely related to our plans to purchase and integrate our acquisitions. Special items during 2003 and 2002 are all associated with the acquisition of IFC into the Flow Control Division. Special items during 2001 are related to the August 2000 acquisition of IDP into the Flowserve Pump Division. The following summarizes special items excluded from the calculation of segment operating income during the three year period ended December 31, 2003.

RESTRUCTURING AND ACQUISITION RELATED CHARGES

Restructuring Costs—IFC

In conjunction with the IFC acquisition during 2002, we initiated a restructuring program designed to reduce costs and eliminate excess capacity by closing 18 valve facilities, including 10 service facilities, and reducing sales and related support personnel. Our actions, some of which were approved and committed to in 2002 with the remaining actions approved and committed to in 2003, are expected to result in a gross reduction of approximately 889 positions and a net reduction of approximately 662 positions. Net position eliminations represent the gross positions eliminated from the closed facilities offset by

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positions added at the receiving facilities, which are required to produce the products transferred into the receiving facilities.

    We believe we have achieved at least $20 million of annual run rate savings as a result of our integration program. Run rate savings reflect the quantification of cost saving synergies achieved at December 31, 2003 on an annualized basis. The synergy savings reflect the benefit of lower payroll and benefit costs resulting from the net position eliminations, partially offset by increased outsourcing costs, and elimination of fixed costs at the closed facilities including depreciation, utilities, lease expense, insurance, taxes and other fixed costs.

    We established a restructuring program reserve of $11.0 million upon acquisition of IFC, and increased the reserve by a total of $9.6 million in the latter half of 2002. We recognized additional accruals of $4.5 million in 2003 for this program, primarily related to the closure of certain valve service facilities and the related reductions in workforce. Cash expenditures against the accrual were $4.2 million in 2002 and $11.6 million in 2003. The remaining accrual of $9.3 million reflects payments to be made in 2004 and beyond for severance obligations due to terminated personnel in Europe of $5.7 million as well as lease and other contract termination and other exit costs of $3.6 million.

    Cumulative costs of $7.2 million associated with the closure of Flowserve facilities through December 31, 2003, have been recognized as restructuring expense in operating results, whereas cumulative costs associated with the closure of IFC facilities of $17.9 million, including related deferred taxes of $6.2 million, became part of the purchase price allocation of the transaction. The effect of these closure costs increased the amount of goodwill otherwise recognizable as a result of the IFC acquisition.

    The following illustrates activity related to the IFC restructuring reserve:

Integration Costs—IFC

During 2003 and 2002, we also incurred acquisition-related integration expense in conjunction with IFC, which is summarized below:

    The acquisition-related activities resulted in integration costs as categorized above and further defined as follows. Personnel and related costs include payroll, benefits, consulting fees, and retention and integration performance bonuses paid to our employees and contractors for the development, management and execution of the integration plan. Transfer of product lines includes costs associated with the transfer of product lines as well as realignment required in the receiving facilities. Asset impairments reflect the loss on disposal of property, plant and equipment at the facilities closed and disposal of inventory for discontinued product lines when the facilities were

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combined. The other category includes costs associated with information technology integration, legal entity consolidations, legal entity name changes, signage, new product literature and other. None of these items individually amounted to greater than $0.5 million.

Remaining Restructuring and Integration Costs—IFC

We have largely completed our restructuring and integration programs related to IFC, except for payments for certain European activities. We expect to incur no additional restructuring and integration costs in connection with this program. Payments from the restructuring accrual will continue into 2004 and 2005 due to the timing of severance obligations in Europe.

Restructuring Costs—IDP

In August 2000, in conjunction with the IDP acquisition, we initiated an integration program designed to reduce costs and eliminate excess capacity by closing or significantly downsizing eight pump manufacturing facilities and eight service and repair facilities; closing IDP's former headquarters; and reducing redundant sales, administrative and related support personnel. These actions, approved and committed to in 2000, resulted in the gross reduction of 1,500 positions and a net reduction of 1,100 positions. Net positions reflect the gross positions eliminated from the closed facilities offset by positions added at the receiving facilities required to produce the products transferred into the receiving facilities. As a result of these activities, we generated approximately $90 million of annual synergy savings. The savings reflect the benefit of lower payroll and benefit costs resulting from the net position eliminations, partially offset by increased outsourcing costs, and elimination of fixed costs at the closed facilities including depreciation, utilities, lease expense, insurance, taxes and other fixed costs. We completed our IDP-related integration and restructuring activities during 2001, and substantially completed the expenditures thereunder as of December 31, 2002.

    We recognized $65 million in restructuring costs, comprised of $42 million related to the IDP operations acquired and $23 million related to Flowserve operations. The $42 million related to IDP operations, reduced by deferred tax effects of $16 million, resulted in recognition of $26 million of incremental goodwill. The $23 million related to Flowserve operations was recognized as restructuring expense in the consolidated statement of operations in 2000 and 2001.

    The following illustrates activity related to the IDP restructuring reserve:

    The majority of the funding of the restructuring activities was completed in 2002. Revisions to the accrual were recorded in 2000 and 2001 to reflect actual results and changes in estimates including an incremental accrual in 2000 required based upon updated actuarial information for postretirement and pension expense relating to finalization of union negotiations for closed facilities. Of the final adjustment of $2.9 million in 2001, $1.2 million related to Flowserve facilities and was reflected as negative restructuring expense and the remaining $1.7 million related to IDP facilities and was recorded as a reduction to goodwill. Non-cash reductions reflect reclassification from the restructuring accrual to post-retirement benefits and pension liabilities in 2000 and to other accrued liabilities in 2001 and 2002. Severance costs include costs associated with involuntary termination benefits, including enhancements to certain severed employees of long-term retirement benefits of $16.4 million, and

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costs related to exiting facilities that would provide no future benefit. Other exit costs of $12.6 million included $5.1 million of payroll and consulting costs to execute the closure program, $2.5 million of facility clean-up costs including environmental, $2.1 million relocation costs for IDP personnel, $1.7 million of costs to physically dispose of patterns and equipment, and $1.2 million of other costs including lease termination and legal costs.

Integration Costs—IDP

During 2001, we also incurred integration expense as follows:

    The acquisition-related activities resulted in integration costs as categorized above and further defined as follows. Personnel and related costs include payroll, benefits, consulting fees, severances, and retention and integration performance bonuses paid to our employees and contractors for the development, management and execution of the integration plan. Transfer of product lines includes costs associated with the transfer of product lines as well as realignment required in the receiving facilities. Asset impairments reflect the loss on disposal of property, plant and equipment at the facilities closed and disposal of inventory for product lines discontinued when the facilities were combined. The other category includes costs associated with information technology, legal entity consolidations, legal entity name changes, signage, new product literature and other. None of these items individually amounted to greater than $0.5 million.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow Analysis

Cash generated by operations and borrowings available under our existing revolving credit facility are our primary sources of short-term liquidity. Our cash balance at December 31, 2003 was $53.5 million, an increase of $4.3 million from 2002, which increased $27.7 million from 2001.

    The decrease in cash flows provided by operating activities in 2003 primarily relates to pension contributions, income taxes and outflows related to the IFC integration. In 2003, contributions to U.S. pension plans were $27.0 million, compared with $4.6 million in 2002 and $0.4 million in 2001. In 2002, we also benefited from receipt of a $23.2 million U.S. income tax refund compared with $4.9 million received in 2003. Cash outflows related to the IFC integration were $27.2 million in 2003 compared with $19.3 million in 2002.

    The increase in operating cash flows of $296.8 million in 2002 from 2001 primarily relates to a $58.4 million reduction in outflows for integration and restructuring, $56.0 million of higher net earnings, receipt of a tax refund of $23.2 million, $37.3 million of lower interest and improvements in working capital.

    Working capital reductions provided operating cash flow of $88.9 million in 2003, and $91.5 million in 2002, but used $102.9 million of cash flow in 2001. The reduction in working capital for 2003 reflects our continued emphasis on improving accounts receivable collections and reducing inventory. Accounts receivable reductions in 2003 generated $30.8 million of cash flow compared with $76.7 million in 2002 and $15.8 million in 2001. The improvement in

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accounts receivable primarily reflects improved collections and lower sales volume. In addition, incremental factoring of certain non-U.S. receivables contributed $10.5 million in 2003 and $31.7 million in 2002. Days' sales outstanding improved to 68 days from 71 days at December 31, 2002 and 76 days at December 31, 2001. Inventory reductions contributed $14.8 million of cash flow for 2003 compared with $29.5 million in the prior year. The majority of the inventory reduction was in finished goods, offset in part by an increase in project-related work in process inventory required to support shipments of products in backlog. In 2001, inventory was a $44.6 million use of cash due to an increase in support of backlog for future shipments and increased finished goods safety stock to meet customer deliveries during the IDP integration and during a systems conversion at a valve plant. As a result of the inventory reduction, inventory turns were 4.2 times at December 31, 2003 and 2002 compared with 4.3 times at December 31, 2001.

    Cash outflows from operating activities for 2001 were high due to payments associated with the IDP integration program, including restructuring and integration payments of $79.5 million and interest payments of $125.2 million. At December 31, 2001, we had drawn $70.0 million of revolving credit primarily to fund integration activities and increases in working capital.

    Cash outflows for investing activities were $26.6 million in 2003, compared with $557.2 million in 2002 and $28.2 million in 2001. The decrease in 2003 results from the absence of acquisitions, partially offset by a lower level of receipts from disposals. The increase in 2002 results primarily from the purchase of IFC, partially offset by lower capital expenditures.

    Cash outflows for financing activities were $165.8 million in 2003, compared with inflows of $328.1 million in 2002 and $59.5 million in 2001. The change in 2003 results from the absence of equity offerings in 2003 compared with 2002 and 2001. The increase in 2002 results from the issuance of equity and increased borrowings associated with the purchase of IFC.

    We believe cash flows from operating activities combined with availability under our existing revolving credit agreement 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 economic, political and other risks associated with sales of our products, operational factors, competition, fluctuations in foreign exchange rates and fluctuations in interest rates, among other factors.

    During 2002 and 2001, we also generated $16.9 million and $8.0 million, respectively, of cash flow related to the exercise of employee stock options, which are reflected in financing activities of the consolidated statement of cash flows. Amounts in 2003 were not significant.

Payments for Acquisitions

On May 2, 2002, we completed our acquisition of IFC for a contractual purchase price of $535 million, subject to adjustment pursuant to the terms of the purchase and sale agreement. A reduction of $2.2 million was agreed to and settled during the fourth quarter of 2003, which yielded a final contractual purchase price of $532.8 million. The reduction related to the finalization of balances at the date of acquisition for cash, related party activity and tax payments. In addition, we incurred $6.1 million of costs associated with consummation of the acquisition including investment banking, legal, actuarial and accounting fees. The total purchase price including such costs was $538.9 million. By acquiring IFC, one of the world's foremost manufacturers of valves, actuators and associated flow control products, we believe that we are the world's second largest manufacturer of valves. We financed the acquisition and associated transaction costs by issuing 9.2 million shares of common stock in April 2002 for net proceeds of approximately $276 million and through new borrowings under our senior secured credit facilities.

    The purchase price has been allocated to assets acquired and liabilities assumed based on estimated fair value at the date of the acquisition. We completed the purchase price allocation of IFC during 2003 and expect no further revisions. These final allocations included $45 million for amortized intangibles, $25 million of indefinite lived intangible assets and $309 million recorded as goodwill.

    The operating results of IFC have been included in the consolidated statements of

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operations from May 2, 2002, the date of acquisition.

    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.

Capital Expenditures

    Capital expenditures were funded primarily by operating cash flows and bank borrowings. For each of the three years, capital expenditures were invested in new and replacement machinery and equipment, information technology and acquisition integration activities including structures and equipment required at receiving facilities. In each year, capital expenditures were less than depreciation expense due to excess capacity and the upgrading of equipment through integration processes. We expect this trend of low capital expenditures to continue for the next 3 to 5 years. Capital expenditures of approximately $35 million are expected in 2004.

Financing

Debt, including capital lease obligations, consisted of:

    Maturities of debt, including capital lease obligations, for the next five years and beyond are:

Senior Credit Facility

As of December 31, 2003 and 2002, our senior credit facility is composed of a revolving credit facility and Tranche A and Tranche C term loans. Tranche A consists of a U.S. dollar denominated tranche and a Euro denominated tranche, the latter of which is a term note due in 2006. During

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2003, we made scheduled debt payments of $0.9 million and optional debt prepayments of $163.1 million, including $39 million during the fourth quarter. In 2002, we also made $33.8 million of mandatory and $170 million of optional prepayments on the term loans. We have scheduled Tranche A principal payments of $8.0 million in the first quarter of 2004 and $19.5 million in each of the remaining quarters of 2004. However, as a result of the optional prepayments made in 2002 and 2003, we have no scheduled payments on Tranche C due until March 31, 2005, when $0.7 million is due.

    The following summarizes our repayment of obligations under the senior credit facility and, in 2001, the senior subordinated notes:

    The senior credit facility is collateralized by substantially all of our U.S. assets and a pledge of 65% of the stock of certain foreign subsidiaries.

    The Tranche A and Tranche C loans, which were amended and restated in connection with the IFC acquisition, have final maturities of June 2006 and June 2009, respectively. The senior credit facility was amended during June 2003 to, among other things, delay the step-downs in the maximum leverage ratio and the step-ups in the minimum interest coverage ratio. The term loans bear floating interest rates based on LIBOR plus a borrowing spread, or the prime rate plus a borrowing spread, at our option. The borrowing spread for the senior credit facility can increase or decrease based on the leverage ratio as defined in the facility and on our public debt ratings.

    As part of our senior credit facility, we have a $300 million revolving credit facility that expires in June 2006. The revolving credit facility allows us to issue up to $200 million in letters of credit. As of December 31, 2003 and 2002, we had no amounts outstanding under the revolving credit facility. However, we had issued $42.7 million in letters of credit under the facility, which reduced our borrowing capacity of the facility to $257.3 million at December 31, 2003. This compares with a borrowing capacity of $248.2 million at December 31, 2002.

    We are required, under certain circumstances as defined in the credit facility, to use a percentage of excess cash generated from operations to reduce the outstanding principal of the term loans in the following year. Based upon the annual calculations performed at December 31, 2003, 2002 and 2001, no additional principal payments became due in 2004, 2003 or 2002 under this provision.

Senior Subordinated Notes

At December 31, 2003, we had $188.5 million and EUR 65 million (equivalent to $81.8 million) in face value of Senior Subordinated Notes outstanding.

    The Senior Subordinated Notes were originally issued in 2000 at a discount to yield 12.5%, but have a coupon rate of 12.25%. Approximately one-third of these Senior Subordinated Notes were repurchased at a premium in 2001 utilizing proceeds from an equity offering, in accordance with the provisions of the indenture.

    Beginning in August 2005, all remaining Senior Subordinated Notes outstanding become callable by us at 106.125% of face value, but otherwise are not due until 2010. Interest on the Senior Subordinated Notes notes is payable semi-annually in February and August.

Common Stock Offerings

During 2002, we financed the acquisition of IFC and associated transaction costs with a combination of bank financing and net proceeds of approximately $276 million received from the issuance of 9.2 million shares of common stock during April 2002.

    During 2001, we completed an offering of approximately 6.9 million shares of our common stock for net proceeds of approximately $154 million, which were used to:

•

prepay $101.5 million of the U.S. dollar denominated Senior Subordinated Notes;

•

prepay EUR 35 million ($31 million) of the Euro denominated Senior Subordinated Notes; and

•

pay associated prepayment premiums and other direct costs.

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    During 2001, we recorded an extraordinary item of $17.9 million, net of $7.1 million of tax, which represented the sum of the prepayment premiums, other direct costs, and the write-off of unamortized prepaid financing fees and discount for the portion of the Notes that was prepaid. Due to the adoption of SFAS No. 145 on January 1, 2003, this item, totalling $25.0 million on a pre-tax basis, has been reclassified as a component of earnings before income taxes.

Debt Covenants and Other Matters

The provisions of our senior credit facility require us to meet or exceed specified defined financial covenants, including a leverage ratio, an interest coverage ratio and a fixed charge coverage ratio. Further, the provisions of these and other debt agreements generally limit or restrict indebtedness, liens, sale and leaseback transactions, asset sales and payment of dividends, capital expenditures and other activities.

    Our senior credit facility requires us to submit audited financial statements to the lenders within 100 days of year end. As a consequence of delays stemming from the restatement of our financial information for the nine months ended September 30, 2003 and the full years 2002, 2001 and 2000, we were unable to provide the audited financial statements within the specified period of time. Accordingly, we obtained a waiver from our lenders regarding this covenant and, accordingly, present the scheduled maturities under the facility due in 2005 and beyond as non-current in the consolidated balance sheet.

    As of December 31, 2003, we complied with all financial covenants under our debt facilities, as illustrated below:

•

an actual leverage ratio of 3.73 compared with a permitted maximum of 4.0;

•

an actual interest coverage ratio of 3.01 compared with a permitted minimum of 2.75; and

•

an actual fixed charge ratio of 1.9 compared with a required minimum of 1.1.

    We have determined that at September 30, 2001, December 31, 2001 and March 31, 2002, we did not comply by 25 basis points or less with two financial covenants in our then applicable credit agreement, which is no longer in effect. We believe that we could have undertaken readily available actions to maintain compliance or obtained a waiver or amendment to the then existing credit agreement had we then known this situation. Except for these periods, we have complied with all covenants under our debt facilities. We believe that this matter has no impact on our existing debt agreements and that our outstanding debt is properly classified in our consolidated balance sheet.

    The maximum leverage ratio reduces to 3.75 at September 30, 2004 and the minimum interest coverage increased to 3.0 at March 31, 2004. We currently estimate that we will comply with the interest coverage covenant at March 31, 2004 by a small margin. Should our estimated earnings change, we may not comply with the interest coverage covenant and we may seek a waiver or an amendment to the senior credit facility in order to remain in compliance. We believe that such waiver or amendment, should it be needed, would be approved by the requisite number of lenders; however, there can be no assurance that such a waiver or amendment would be granted. We are not presently able to ascertain the cost and/or conditions associated with receipt of such waiver or amendment. Under particularly adverse circumstances, we could be forced to divest a portion of our business or issue equity.

    The following is a summary of net debt (defined as debt less cash) to capital at various dates since 2001:

    The net debt to capital ratio has decreased due to the impact of the common stock offerings, repayments of debt under the senior credit facility and increases in shareholders' equity resulting from continued earnings and favorable foreign currency translation.

    While the IFC acquisition increased the absolute level of indebtedness, we believe that our ability to service debt, as measured by our covenant ratios, debt ratings and net debt to capital ratios, has improved. This is because we issued shares of common stock to finance a portion of the IFC acquisition. Additionally, under

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our senior credit facility covenant ratios, we receive credit for 100% of the pro forma EBITDA of IFC for the four-quarter period prior to the acquisition, while incremental debt used to finance the acquisition was only about 50% of the purchase price. Our lenders use EBITDA as a surrogate for earnings and cash flows in our senior credit facility.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The following table presents a summary of our contractual obligations at December 31, 2003:

    The following table presents a summary of our commercial commitments at December 31, 2003:

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

PENSION AND POSTRETIREMENT BENEFITS OBLIGATIONS

We sponsor several defined benefit pension plans and postretirement health care plans. Our recorded liability for these plans was $274 million at December 31, 2003 and $277 million at December 31, 2002. Determination of the value of the pension and postretirement benefits liabilities is based on actuarial valuations. Inherent in these valuations are key assumptions, regarding discount rates, life expectancy, expected return on plan assets and assumed rates of increase in wages and in health care costs. Current market conditions, including changes in rates of returns, interest rates and medical inflation rates, are considered in selecting these assumptions. Changes in the related pension and postretirement benefit costs may occur in the future due to changes in the assumptions used and changes resulting from fluctuations in the number of plan participants.

    We expect to fund contributions to the plans from operating cash flows. Primarily as a result of stronger market performance of pension plan assets in 2003, we reduced our minimum pension liability by $7.7 million, whereas in 2002 and 2001 as a result of an increase in the number of plan participants and poor investment performance, we increased our minimum pension liability by $42.9 million and $16.2 million, net of tax effects, respectively. Additionally, we expect to contribute between $12 million and $17 million into our qualified U.S. pension plan during 2004, although we could contribute as much as $67 million.

    Because many of the non-U.S. plans are unfunded, as permitted by local law, the range of contributions is more difficult to pinpoint. Nonetheless, we expect to contribute approximately $8 million to these plans during 2004, based on prevailing exchange rates at December 31, 2003.

    We are still gathering consolidated information regarding our aggregate non-U.S. plans, for purposes of determining the impact of alternative actuarial assumptions to the amounts reported in the consolidated financial statements. However, the following provides a sensitivity analysis of alternative assumptions on the U.S. pension and postretirement plans, which represent our most significant obligations.

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Effect Of Discount Rate Changes And Constancy Of Other Assumptions

Effect Of Changes In The Expected Return On Assets And Constancy Of Other Assumptions

OUR CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's discussion and analysis is based on our consolidated financial statements and related footnotes contained within this 10-K filing. Our more critical accounting policies used in the preparation of the consolidated financial statements are discussed below.

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

    The process of preparing financial statements in conformity with accounting principles generally accepted in the U.S. requires the use of estimates and assumptions to determine 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 the best information available at the time of the estimates or assumptions, including our historical experience, where relevant. The estimates and assumptions could change materially as conditions change within and beyond our control. Accordingly, actual results could differ materially from those estimates. The most significant estimates made by management include revenue recognition, allowance for doubtful accounts, reserves for excess and obsolete inventories, deferred tax asset valuation, restructuring reserves, legal and environmental accruals, warranty accruals, pension and postretirement benefits obligations ("PBO") and valuation of goodwill, indefinite-lived intangible assets and other long-lived assets. The significant estimates are reviewed quarterly with our Audit/Finance Committee of the Board of Directors. The following is a discussion of the critical accounting policies and the related management estimates and assumptions necessary in determining the value of related assets or liabilities. For a detailed discussion on the application of our accounting policies, see Note 1 in the consolidated financial statements.

Revenue Recognition

Revenues for products and short-term contracts are recognized based on the shipping terms agreed to with the customer and fulfillment of all but inconsequential or perfunctory actions required, which is the point of title transfer, unless the customer order requires formal acceptance under which circumstances revenue is not recognized until formal acceptance has been received. Revenue on service contracts is recognized after the services have been rendered and accepted by the customer. All revenue for products, short-term projects and service contracts require, prior to recognition, the persuasive evidence of an

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arrangement, a fixed or determinable sales price and reasonable assurance of collectibility.

    Revenue for longer-term contracts (defined as contracts longer than nine-months in duration where reasonably reliable estimates of cost can be made, with contract values over $750,000 and progress billings from the customer) are recorded on the percentage of completion method calculated on a cost-to-cost basis. We utilized percentage of completion revenue recognition for approximately 5-10% of consolidated revenues. This method of revenue recognition requires us to prepare estimates of costs to complete contracts in progress. In making such estimates, we make judgments to evaluate contingencies such as potential variances in scheduled delivery and the cost of materials, labor costs and productivity, the impact of change orders, liability claims, contract disputes, or achievement of contractual performance standards. Changes in total estimated contract costs and losses, if any, are recognized in the period they are determined.

    In certain instances, we provide guaranteed completion dates and/or achievement of other performance criteria. Failure to meet schedule or performance guarantees or increases in contract costs can result in unrealized incentive fees or non-recoverable costs, which could exceed revenues realized from the project. In such instances, we might be required to record reserves to cover such excesses, which would adversely affect our results of operation and financial position.

Allowance For Doubtful Accounts

We establish an allowance for doubtful accounts based on estimates of the amount of uncollectible accounts receivable. The amount of the allowance is determined based upon the aging of the receivable, customer credit history, customer disputes, outstanding industry and market segment information, economic trends and conditions, credit reports and customer financial condition. We consider our historical collection history and specifically known uncollectible accounts in establishing our allowance. Customer credit issues, customer bankruptcies, general economic conditions or other matters largely beyond our control can affect the collectibility of our accounts receivable. If our customers' financial conditions worsened or if customer disputes increased beyond levels currently provided for, we might be required to incur additional write-offs, which would adversely impact our results of operation, cash flows and financial position.

    Our credit risk may be mitigated by our large number of customers across many different geographic regions. We currently have a credit insurance policy for our European subsidiaries, whereby we generally receive funds from the third party insurer, net of deductible, in instances where customers covered by this policy are unable to pay. We periodically evaluate the creditworthiness of the credit insurer.

Inventories

Inventories are stated at the lower of cost or market. We determine cost for U.S. inventories by the last-in, first-out (LIFO) method and for other inventories by the first-in, first-out (FIFO) method. We estimate the market value of our inventory based on an assessment of recent sales prices, and provide for excess and obsolete inventories determined by historical usage and estimated future demand and related pricing. In determining excess quantities, we consider recent sales activity, related margins and market positioning of our products. These estimates are generally not subject to significant volatility, due to the long life cycles of our product lines, except for product rationalizations generally associated with acquisition integration programs. However, factors beyond our control such as demand levels, technological advances and pricing competition could change from period to period. If such factors had an adverse effect on us, we might be required to reduce the value of our inventory, which would adversely affect our results of operations, cash flows and financial position.

Deferred Tax Asset Valuation

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 and capital loss carryforwards for U.S. and non-U.S. subsidiaries. We evaluate the realizability of our deferred tax assets by assessing its valuation

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allowance and by adjusting the amount of such allowance, 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.

Restructuring Reserves

Restructuring reserves may be established in conjunction with an acquisition in circumstances where we intend to reorganize the Company or the acquired business. Such reserves reflect many estimates including costs pertaining to employee separation, settlements of contractual obligations and other matters associated with exiting a facility. Under current accounting rules, restructuring costs related to facilities and employees of an acquired business generally become a component of goodwill, whereas restructuring costs associated with exiting an existing Flowserve facility are recorded as restructuring expense in the statement of operations. We assess the reserve requirements for each restructuring plan quarterly based on information gathered during due diligence regarding the restructured business assets and liabilities and our own prior experiences. Uncertainty exists in both the information gathered about the restructured business and the costs necessary to restructure and integrate the operations. If additional costs prove necessary, we may be required to recognize additional expense, which could adversely impact our results of operations and financial position.

Legal And Environmental Accruals

The costs relating to legal and environmental liabilities are estimated and liabilities recorded when it is both probable that a loss has been incurred and such loss is estimable. We have a formal process for assessing the facts and recording any required reserves on a case-by-case basis. Assessments of legal and environmental 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.

Warranty Accruals

Warranty obligations are based upon product failure rates, materials usage and service costs. We estimate warranty provisions based upon an analysis of all identified or expected claims and an estimate of the cost to resolve those claims. The estimates of expected claims are generally a factor of historical claims and known product issues. Changes in claim rates, differences between actual and expected warranty costs and facility rationalization activities could impact warranty obligation estimates, which might have adverse effects to our results of operations and financial position.

Pension And Postretirement Benefits Obligations

Determination of the value of our pension and postretirement benefits liabilities is based on actuarial valuations. Inherent in these valuations are key assumptions which are assessed annually in the fourth quarter and which include:

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discount rates;

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expected return on plan assets for funded plans;

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life expectancy of participants;

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assumed rate of wage increases; and

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assumed rate of health care cost increases.

    We evaluate, in conjunction with our professional advisors, prevailing market conditions in countries where plans are maintained, including appropriate rates of return, interest rates and medical inflation rates. Specifically for our U.S. plan, we assess such market factors as changes in the cash balance interest crediting rate, borrowing rates for investment grade corporate and industrial companies, assumptions used by Fortune 500 companies, our actual wage increases in recent years, expected rates of return for each targeted asset class held by the plans and return premiums generated by active investment

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management. For the non-U.S. plans, we perform similar analyses, but also factor in local laws and requirements. We also compare our significant assumptions with our peers and discuss our key assumptions, prior to their incorporation into actuarial calculations, with the Audit/Finance Committee of the Board of Directors. 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.

Valuation Of Goodwill, Indefinite-Lived Intangible Assets And Other Long-Lived Assets

Our business acquisitions typically generate goodwill and other intangible assets, which affect prospective amortization expense and possible impairment expense we might incur. We test the value of goodwill and indefinite-lived intangible assets for impairment annually in the fourth quarter or whenever events or circumstances indicate such assets may be impaired. The test involves significant judgment in estimating projections of fair value generated through future performance of each of the reporting units, which correlate to our operating segments. In calculating the fair value of the reporting units, we rely on a number of factors including operating results, business plans, economic projections, anticipated future cash flows and market data used in discounting those cash flows. Inherent uncertainties exist in determining and applying such factors. The net realizable value of other long-lived assets, including property, plant and equipment, is reviewed periodically, when indicators of potential impairments are present, based upon an assessment of the estimated future cash flows related to those assets, utilizing methodologies similar to that for goodwill and indefinite-lived assets. 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 results of operations and financial condition. If the fair values are less than our estimates, our assets could require a change, which would adversely impact our results of operations and financial position.

BUSINESS OUTLOOK FOR 2004

While we remain optimistic about our markets and our performance over the long-term, our outlook for 2004 remains cautious. The economic forecasts for many of our markets are expected to improve. However, the rate and amount of improvement, market share and the mix of our business can impact our revenues and bookings in 2004. For additional discussion on our markets, reference the Overview section on page 16 of this Management's Discussion and Analysis. As a result of these factors, our revenues are expected to increase slightly from 2003, absent currency fluctuations. Our operating income in 2004 should benefit from a number of operational improvement programs including procurement and continuous process improvement initiatives as well as other operational improvements in several of our facilities. However, partially offsetting the benefits will be higher wage and benefit costs due to inflation and higher accruals associated with performance incentive programs, which were negligible in 2003.

    Operating income could be impacted by changes in demand in our served markets. In particular, increased demand for chemical or general industrial products, generally our quick turnaround and historically more profitable products, could improve our product mix and result in improved profitability. Additionally, increased demand in the Middle East, most notably Iraq, could improve our profitability. In addition, accelerated implementation of our end user strategy could positively improve demand and resultant profitability. Conversely, declines in any of our markets could result in lower levels of profitability. If we are not able to adequately offset material cost increases either through other material cost savings or through price increases, our profitability will be adversely impacted.

    We do not expect to incur integration or restructuring expense in 2004, which amounted to $22.6 million pretax in 2003. At December 31, 2003, 49% of our debt was floating rate debt. We expect to evaluate opportunities to reduce the

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amount of floating interest rate debt in 2004 to reduce potential volatility in rates, which could negatively impact our effective interest rate. As a result, interest expense could be at the 2003 level despite additional planned debt reductions.

    We expect our effective tax rate to be between 35% and 37% in 2004, although it is dependent upon the mix of earnings between our domestic and international locations, our tax planning strategies and our ability to utilize foreign tax credits.

    If these factors occur as we have described, we expect that net earnings and earnings per share should improve in 2004.

    We expect to generate sufficient cash from operations to fund our business, capital expenditures, pension plan contribution obligations and pay down debt at a level greater than the mandatory requirement through improved earnings and working capital. We expect to improve working capital utilization as we reduce the days sales outstanding and increase inventory turns. However, the amount of cash generated from working capital could be dependent on the level of revenues and other factors. Working capital requirements will change as our revenue changes, despite expected improvement in its utilization. Capital expenditures in 2004 will be focused on new product development, information technology infrastructure and cost reduction opportunities and should be about $35 million before consideration of any acquisition activity. While current pension regulations allow us significant latitude in the amount of contributions, we currently anticipate that our contributions to our qualified U.S. defined pension plan will be between $12 million and $17 million. Our mandatory debt payments in 2004 are $66 million, however we anticipate reducing our debt by approximately $125 million. Based upon this outlook, we expect to comply with our bank covenants including step-downs in the required leverage ratio, which begin in the third quarter of 2004, and step-ups in interest coverage ratio which begin in the first quarter of 2004. Further information regarding our debt covenants is presented in the Financing section of Liquidity and Capital Resources in this Item 7.

ACCOUNTING DEVELOPMENTS

Pronouncements Implemented

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Generally, this pronouncement requires companies to recognize the fair value of liabilities for retiring their facilities at the point that legal obligations associated with their retirement are incurred, with an offsetting increase to the carrying value of the facility. The expense associated with the retirement becomes a component of a facility's depreciation, which is recognized over its useful life. We adopted SFAS No. 143 on January 1, 2003; however, the adoption did not have a significant effect on our consolidated financial position or results of operations due to limited abandonment and retirement obligations associated with our facilities.

    In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The most significant impact of SFAS No. 145 is to eliminate the requirement that gains and losses from debt extinguishment be classified as extraordinary items unless they are infrequent and unusual in nature. We adopted SFAS No. 145 on January 1, 2003 and have reclassified previously reported extraordinary items from 2002 and 2001, which relate to early extinguishment of debt, to become a component of earnings before income taxes.

    In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized initially at fair value when the liability is incurred. Under previous accounting rules, costs to exit or dispose of an activity were generally recognized at the date that the exit or disposal plan was committed to and communicated. We adopted SFAS No. 146 on January 1, 2003 to account for exit and disposal activities arising after that date. See Note 6 of the consolidated financial statements for a detailed discussion of our exit and disposal activities.

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    In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation," which became effective for us upon its issuance. SFAS No. 148 provides three transition options for companies that account for stock-based compensation, such as stock options, under the intrinsic-value method to convert to the fair value method. SFAS No. 148 also revised the prominence and character of the disclosures related to companies' stock-based compensation. In complying with the new reporting requirements of SFAS No. 148, we elected to continue using the intrinsic-value method to account for qualifying stock-based compensation, as permitted by SFAS No. 148. However, we have included the disclosures prescribed by SFAS No. 148 within the consolidated financial statements.

    During November 2002, the FASB issued FASB Interpretation No. (FIN) 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 generally requires a guarantor to recognize a liability for obligations arising from guarantees. FIN 45 also requires new disclosures for guarantees meeting certain criteria outlined in that pronouncement. The disclosure requirements of FIN 45 became effective for us at December 31, 2002 and were implemented as of that date. The recognition and measurement provisions of FIN 45 became effective on January 1, 2003 and have been implemented for guarantees issued after that date.

    In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies the accounting and reporting for derivative contracts, including hedges. The amendments and clarifications under SFAS No. 149 generally serve to codify the conclusions reached by the Derivatives Implementation Group, to incorporate other FASB projects on financial instruments, and to clarify other implementation issues. SFAS No. 149 became effective prospectively for our derivative contracts entered into or modified after June 30, 2003. The implementation of SFAS No. 149 had no material effect on our consolidated financial position or results of operations.

    In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 generally requires the recognition as liabilities in the balance sheet for obligations under financial instruments possessing both liability and equity characteristics, such as mandatorily redeemable instruments, obligations to repurchase equity shares by transferring assets and obligations to issue a variable number of shares. SFAS No. 150 became effective for us beginning July 1, 2003 at which time we had no instruments governed by the pronouncement to be incorporated into liabilities. Thus the implementation of SFAS No. 150 had no material effect on our consolidated financial position or results of operations.

    In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The revised pronouncement requires substantially more disclosures about pension and postretirement benefits, including information about plan assets, estimated prospective contribution levels, estimated prospective benefit payment levels and other items which the FASB believes will provide clarity to readers of the financial statements. Except for information regarding anticipated future benefit payments, for which the revision allows deferral, we have made the disclosures specified by SFAS No. 132, as revised.

Pronouncements Not Yet Implemented

In December 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities," which addresses the consolidation of variable interest entities ("VIEs") by business enterprises that are the primary beneficiaries. A VIE is an entity that does not have sufficient equity investment at risk to permit it to finance its activities without additional subordinated financial support, or whose equity investors lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the enterprise that has the majority of the risks or rewards associated with the VIE. We believe we have no interests in VIEs that will require disclosure or consolidation under FIN 46, and therefore expect its implementation to have no significant effect on our results of operations or financial position.

    During December 2003, the Medicare Prescription Drug, Improvement and Modernization Act Of 2003 (the "Act") was enacted in the U.S. The Act generally permits plan

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sponsors that provide retiree prescription drug benefits that are "actuarially equivalent" to the benefits of Medicare Part D to be eligible for a non-taxable federal subsidy. As permitted by FASB Staff Position No. (FSP) 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," we have elected to defer accounting for any effects of the Act until December 31, 2004. We are evaluating the impact of the Act, including the emergence of specific authoritative guidance regarding the accounting treatment afforded the provisions of the Act, which could require us to change information previously reported.

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS

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

    We enter into forward contracts to hedge our risks associated with transactions denominated in foreign currencies. Our risk management and derivatives policy specify the conditions under which we may enter into derivative contracts. As of December 31, 2003 and 2002, we had approximately $75.1 million and $48.6 million, respectively, of notional amount in outstanding contracts with third parties. As of December 31, 2003, the maximum length of any forward contract currently in place was 17 months. The fair value of outstanding forward contracts at December 31, 2003 and 2002 was an asset of $5.4 million and $3.3 million, respectively.

    Also as part of our risk management program, we enter into interest rate swap agreements to hedge our exposure to floating interest rates on certain portions of our debt. As of December 31, 2003 and 2002, we had $215.0 million and $125.0 million, respectively, of notional amount in outstanding interest rate swaps with third parties. As of December 31, 2003, the maximum length of any interest rate contract currently in place was approximately three years. At December 31, 2003 and 2002, the fair value of the interest rate swap agreements was a liability of $7.6 million and $9.8 million, respectively.

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

    Our earnings are impacted by changes in short-term interest rates as a result of borrowings under our credit facility, which bears interest based on floating rates. At December 31, 2003, after the effect of interest rate swaps, we had approximately $462.7 million of variable rate debt obligations outstanding with a weighted average interest rate of 3.9%. A hypothetical change of 100-basis points in the interest rate for these borrowings, assuming constant variable rate debt levels, would have changed interest expense by approximately $4.6 million for 2003.

    We employ a foreign currency hedging strategy to minimize potential losses in earnings or cash flows from unfavorable foreign currency exchange rate movements. These strategies also minimize potential gains from favorable exchange rate movements. Foreign currency exposures arise from transactions, including firm commitments and anticipated transactions, denominated in a currency other than an entity's functional currency and from foreign-denominated revenues and profits translated back into U.S. dollars. Based on a sensitivity analysis at December 31, 2003, a 10% adverse change in the foreign currency exchange rates could impact our results of operations by $6.1 million.

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    An analysis of the estimated impact by currency follows:

    We adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, on January 1, 2001. In accordance with the transition provisions of SFAS 133, we recorded a net $0.8 million cumulative-effect adjustment in other comprehensive income representing the fair value of hedging instruments as of January 1, 2001 after deferred tax of $0.5 million.

    Hedging related transactions, recorded to other comprehensive income (expense), net of deferred taxes, are summarized below: