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EX-32.2 - EXHIBIT 32.2 - FLOWSERVE CORPa09-30x2016exhibit322.htm
EX-32.1 - EXHIBIT 32.1 - FLOWSERVE CORPa09-30x2016exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - FLOWSERVE CORPa09-30x2016exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - FLOWSERVE CORPa09-30x2016exhibit311.htm
 
 
 

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

FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016
OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM           to          .
Commission File No. 1-13179
FLOWSERVE CORPORATION
(Exact name of registrant as specified in its charter)

New York
 
31-0267900
(State or other jurisdiction of incorporation or organization)
 
 (I.R.S. Employer Identification No.)
 
 
 
5215 N. O’Connor Blvd., Suite 2300, Irving, Texas
 
75039
(Address of principal executive offices)
 
 
 (Zip Code)

 
(972) 443-6500
 
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨ (do not check if a smaller reporting company)
Smaller reporting company ¨
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes þ No
As of October 19, 2016, there were 130,452,077 shares of the issuer’s common stock outstanding.


 
 
 



FLOWSERVE CORPORATION
FORM 10-Q
TABLE OF CONTENTS

 
Page
 
No.
 
 
 
 
 
 EX-31.1
 
 EX-31.2
 
 EX-32.1
 
 EX-32.2
 
 EX-101 INSTANCE DOCUMENT
 
 EX-101 SCHEMA DOCUMENT
 
 EX-101 CALCULATION LINKBASE DOCUMENT
 
 EX-101 LABELS LINKBASE DOCUMENT
 
 EX-101 PRESENTATION LINKBASE DOCUMENT
 
 EX-101 DEFINITION LINKBASE DOCUMENT
 
i



PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements.
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Amounts in thousands, except per share data)
Three Months Ended September 30,
 
2016
 
2015
Sales
$
943,334

 
$
1,096,476

Cost of sales
(677,891
)
 
(707,726
)
Gross profit
265,443

 
388,750

Selling, general and administrative expense
(271,643
)
 
(223,516
)
Net earnings from affiliates
3,394

 
2,615

Operating (loss) income
(2,806
)
 
167,849

Interest expense
(15,141
)
 
(16,283
)
Interest income
924

 
499

Other income (expense), net
1,899

 
(5,430
)
(Loss) earnings before income taxes
(15,124
)
 
146,635

Provision for income taxes
(4,996
)
 
(52,099
)
Net (loss) earnings, including noncontrolling interests
(20,120
)
 
94,536

Less: Net earnings attributable to noncontrolling interests
(808
)
 
(913
)
Net (loss) earnings attributable to Flowserve Corporation
$
(20,928
)
 
$
93,623

Net (loss) earnings per share attributable to Flowserve Corporation common shareholders:
 
 
 
Basic
$
(0.16
)
 
$
0.71

Diluted
(0.16
)
 
0.70

Cash dividends declared per share
$
0.19

 
$
0.18


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Three Months Ended September 30,
 
2016
 
2015
Net (loss) earnings, including noncontrolling interests
$
(20,120
)
 
$
94,536

Other comprehensive loss:
 
 
 
Foreign currency translation adjustments, net of taxes of $9,373 and $32,543 respectively
(15,735
)
 
(54,494
)
Pension and other postretirement effects, net of taxes of $(925) and $(1,615), respectively
3,719

 
3,688

Cash flow hedging activity, net of taxes of $(200) and $(663), respectively
560

 
1,538

Other comprehensive loss
(11,456
)
 
(49,268
)
Comprehensive (loss) income, including noncontrolling interests
(31,576
)
 
45,268

Comprehensive income attributable to noncontrolling interests
(807
)
 
(829
)
Comprehensive (loss) income attributable to Flowserve Corporation
$
(32,383
)
 
$
44,439


See accompanying notes to condensed consolidated financial statements.


1



FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Amounts in thousands, except per share data)
Nine Months Ended September 30,
 
2016
 
2015
Sales
$
2,916,814

 
$
3,273,342

Cost of sales
(2,018,646
)
 
(2,183,770
)
Gross profit
898,168

 
1,089,572

Selling, general and administrative expense
(737,083
)
 
(707,037
)
Net earnings from affiliates
8,522

 
6,268

Operating income
169,607

 
388,803

Interest expense
(44,982
)
 
(47,712
)
Interest income
2,243

 
1,504

Other income (expense), net
2,091

 
(30,258
)
Earnings before income taxes
128,959

 
312,337

Provision for income taxes
(47,809
)
 
(111,525
)
Net earnings, including noncontrolling interests
81,150

 
200,812

Less: Net earnings attributable to noncontrolling interests
(1,222
)
 
(4,515
)
Net earnings attributable to Flowserve Corporation
$
79,928

 
$
196,297

Net earnings per share attributable to Flowserve Corporation common shareholders:
 
 
 
Basic
$
0.61

 
$
1.47

Diluted
0.61

 
1.46

Cash dividends declared per share
$
0.57

 
$
0.54


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Amounts in thousands)
Nine Months Ended September 30,
 
2016
 
2015
Net earnings, including noncontrolling interests
$
81,150

 
$
200,812

Other comprehensive (loss) income:
 
 
 
Foreign currency translation adjustments, net of taxes of $6,315 and $87,943, respectively
(10,600
)
 
(147,262
)
Pension and other postretirement effects, net of taxes of $(3,545) and $(5,140), respectively
9,655

 
13,359

Cash flow hedging activity, net of taxes of $(620) and $(218), respectively
1,763

 
(181
)
Other comprehensive income (loss)
818

 
(134,084
)
Comprehensive income, including noncontrolling interests
81,968

 
66,728

Comprehensive income attributable to noncontrolling interests
(2,004
)
 
(5,909
)
Comprehensive income attributable to Flowserve Corporation
$
79,964

 
$
60,819


See accompanying notes to condensed consolidated financial statements.


2



FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands, except par value)
September 30,
 
December 31,
 
2016
 
2015
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
260,870

 
$
366,444

Accounts receivable, net of allowance for doubtful accounts of $49,665 and $43,936, respectively
896,755

 
988,391

Inventories, net
1,038,944

 
995,565

Prepaid expenses and other
186,311

 
125,410

Total current assets
2,382,880

 
2,475,810

Property, plant and equipment, net of accumulated depreciation of $906,726 and $855,214, respectively
750,128

 
758,427

Goodwill
1,229,817

 
1,223,986

Deferred taxes
76,095

 
69,327

Other intangible assets, net
219,280

 
228,777

Other assets, net
195,402

 
224,330

Total assets
$
4,853,602

 
$
4,980,657

 
 
 
 
LIABILITIES AND EQUITY
Current liabilities:
 
 
 
Accounts payable
$
394,600

 
$
491,378

Accrued liabilities
731,928

 
796,764

Debt due within one year
75,211

 
60,434

Total current liabilities
1,201,739

 
1,348,576

Long-term debt due after one year
1,535,678

 
1,560,562

Retirement obligations and other liabilities
402,645

 
387,786

Shareholders’ equity:
 
 
 
Common shares, $1.25 par value
220,991

 
220,991

Shares authorized – 305,000
 
 
 
Shares issued – 176,793
 
 
 
Capital in excess of par value
491,639

 
494,961

Retained earnings
3,591,867

 
3,587,120

Treasury shares, at cost – 46,977 and 47,703 shares, respectively
(2,078,439
)
 
(2,106,785
)
Deferred compensation obligation
8,369

 
10,233

Accumulated other comprehensive loss
(540,006
)
 
(540,043
)
Total Flowserve Corporation shareholders’ equity
1,694,421

 
1,666,477

Noncontrolling interests
19,119

 
17,256

Total equity
1,713,540

 
1,683,733

Total liabilities and equity
$
4,853,602

 
$
4,980,657


See accompanying notes to condensed consolidated financial statements.

3



FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine Months Ended September 30,
 
2016
 
2015
Cash flows – Operating activities:
 
 
 
Net earnings, including noncontrolling interests
$
81,150

 
$
200,812

Adjustments to reconcile net earnings to net cash used by operating activities:
 
 
 
Depreciation
74,875

 
73,652

Amortization of intangible and other assets
12,424

 
25,918

Loss on divestiture of business
7,664

 

Excess tax benefits from stock-based payment arrangements
(2,480
)
 
(6,822
)
Stock-based compensation
29,966

 
26,027

Latin America accounts receivable reserve and inventory write-downs
79,122

 

Foreign currency and other non-cash adjustments
940

 
54,635

Change in assets and liabilities, net of acquisition:
 
 
 
Accounts receivable, net
70,190

 
66,660

Inventories, net
(47,375
)
 
(119,530
)
Prepaid expenses and other
(59,799
)
 
(42,361
)
Other assets, net
(19,512
)
 
(17,890
)
Accounts payable
(97,838
)
 
(157,930
)
Accrued liabilities and income taxes payable
(90,304
)
 
(2,989
)
Retirement obligations and other
7,821

 
(6,402
)
       Net deferred taxes
11,349

 
37,261

Net cash flows provided by operating activities
58,193

 
131,041

Cash flows – Investing activities:
 
 
 
Capital expenditures
(64,475
)
 
(138,532
)
Payments for acquisition, net of cash acquired

 
(353,654
)
Proceeds from disposal of assets
632

 
4,103

Payment for divestiture of business
(5,064
)
 

Net cash flows used by investing activities
(68,907
)
 
(488,083
)
Cash flows – Financing activities:
 
 
 
Excess tax benefits from stock-based payment arrangements
2,480

 
6,822

Payments on long-term debt
(45,000
)
 
(30,000
)
Proceeds from issuance of senior notes

 
526,332

Payments of deferred loan cost

 
(5,108
)
Proceeds under other financing arrangements
24,701

 
8,157

Payments under other financing arrangements
(12,060
)
 
(15,524
)
Repurchases of common shares

 
(249,682
)
Payments of dividends
(72,960
)
 
(70,000
)
Other
1,325

 
192

Net cash flows (used) provided by financing activities
(101,514
)
 
171,189

Effect of exchange rate changes on cash
6,654

 
(26,655
)
Net change in cash and cash equivalents
(105,574
)
 
(212,508
)
Cash and cash equivalents at beginning of period
366,444

 
450,350

Cash and cash equivalents at end of period
$
260,870

 
$
237,842


See accompanying notes to condensed consolidated financial statements.

4



FLOWSERVE CORPORATION
(Unaudited)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.
Basis of Presentation and Accounting Policies
Basis of Presentation
The accompanying condensed consolidated balance sheet as of September 30, 2016, the related condensed consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2016 and 2015, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015, of Flowserve Corporation are unaudited. In management’s opinion, all adjustments comprising normal recurring adjustments necessary for fair statement of such condensed consolidated financial statements have been made. Where applicable, prior period information has been updated to conform to current year presentation.
The accompanying condensed consolidated financial statements and notes in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2016 ("Quarterly Report") are presented as permitted by Regulation S-X and do not contain certain information included in our annual financial statements and notes thereto. Accordingly, the accompanying condensed consolidated financial information should be read in conjunction with the audited consolidated financial statements presented in our Annual Report on Form 10-K for the year ended December 31, 2015 ("2015 Annual Report").
Venezuela – Our operations in Venezuela primarily consist of a service center that performs service and repair activities. Our Venezuelan subsidiary's sales for the three and nine months ended September 30, 2016 represented less than 0.5% of consolidated sales and its assets at September 30, 2016 represented less than 0.5% of total consolidated assets. Assets primarily consisted of United States ("U.S.") dollar-denominated monetary assets and bolivar-denominated non-monetary assets at September 30, 2016. In addition, certain of our operations in other countries sell equipment and parts that are typically denominated in U.S. dollars directly to Venezuelan customers.
We continue to experience delays in collecting payment on our accounts receivable from the national oil company in Venezuela, our primary Venezuelan customer.  Our total outstanding gross accounts receivable with this customer was approximately 7% of our gross accounts receivable at both September 30, 2016 and December 31, 2015, respectively, of which 100% and 64% has been classified as long-term within other assets, net on our condensed consolidated balance sheet at September 30, 2016 and December 30, 2015, respectively. These accounts receivable are primarily U.S. dollar-denominated and not disputed. However, while we have not historically had write-offs relating to this customer, the accounts receivable continue to be significantly in arrears. The increased deterioration of the social, political, economic and legal climate in 2016 has given rise to significant uncertainties about Venezuela's economic and political stability, and while we continue to conduct business on a prepayment basis with the Venezuelan customer, the volume of activity has diminished significantly throughout 2016 from prior year levels. In September, the Venezuelan customer offered current bondholders the ability to swap their current bonds for new bonds with a delayed maturity, price premium and higher coupon rate due to their current inability to service their debt obligations. As a result of the bond swap offer, S&P Global Ratings downgraded the customer's bonds to CC which potentially indicates that default is imminent with little prospect for recovery. Although we do not currently hold any related bonds, we interpret this action to be indicative of the customer's increasing inability to make future payments on our accounts receivable. Accordingly, due to these actions and the diminished activity of business and payments in 2016, we have estimated that as of September 30, 2016 our ability to fully collect the accounts receivable from our primary Venezuelan customer has become less than probable and we recorded a charge of $63.2 million to selling, general and administrative expense ("SG&A") to fully reserve for those potentially uncollectible accounts receivable and a charge to cost of sales ("COS") of $1.9 million to reserve for related net inventory exposures. We continue to pursue payments and on-going business with our Venezuelan customer.
At September 30, 2016 the DICOM exchange rate (formerly SIMADI) was 658.8 bolivars to the U.S. dollar, compared with the official exchange rate of 10.0 bolivars to the U.S. dollar. As of March 31, 2015, we determined, based on our specific facts and circumstances, that the SIMADI exchange rate was the most appropriate for the remeasurement of our Venezuelan subsidiary's bolivar-denominated net monetary assets in U.S. dollars. As a result of the remeasurement, in the first quarter of 2015 we recognized a loss of $20.6 million of which $18.5 million was reported in other income (expense), net and $2.1 million in cost of goods sold in our condensed consolidated statement of income and resulted in no tax benefit. As of September 30, 2016, we believe the DICOM exchange rate continues to be the most appropriate rate to remeasure the U.S. dollar value of the assets, liabilities and results of operations of our Venezuelan subsidiary.
Valuation of Goodwill, Indefinite-Lived Intangible Assets and Other Long-Lived Assets – As discussed in Note 1 to our consolidated financial statements included in our 2015 Annual Report, the value of our goodwill and indefinite-lived intangible assets is tested for impairment as of December 31 each year or whenever events or circumstances indicate such assets may be impaired.

5



We did not record an impairment of goodwill in 2015, 2014 or 2013; however the estimated fair value of our Engineered Product Operations ("EPO") reduced significantly in 2015 due to broad-based capital spending declines and heightened pricing pressure experienced in the oil and gas markets which are anticipated to continue in the near to mid-term.  EPO is a component of our Engineered Product Division ("EPD") reporting segment and is primarily focused on long lead time, custom and other highly-engineered pumps and pump systems. As of December 31, 2015 EPO had approximately $157 million of goodwill and its estimated fair value exceeded its carrying value by approximately 70%.  In addition, at December 31, 2015 our Industrial Product Division ("IPD") reporting unit, which is primarily focused on pre-configured industrial pumps and pumps systems, had approximately $301 million of goodwill and its estimated fair value exceeded its carrying value by approximately 70%. Key assumptions used in determining the estimated fair value of EPO and IPD included the annual operating plan and forecasted operating results, successful execution of our current realignment programs and identified strategic initiatives, a constant cost of capital, a short-term stabilization and mid to long-term improvement of the macro-economic conditions of the oil and gas market, and a relatively stable world gross domestic product. 
We have experienced a deterioration from plan in the operating results of EPO and IPD which we believe was both operationally and market driven. Although we have concluded that there are no current indicators of impairment on the goodwill associated with EPO and IPD as of September 30, 2016, conditions are uncertain and can quickly change in the markets in which we operate which could result in sustained or further deterioration and could impact the recoverability of certain of our long-lived assets, including goodwill. We will continue to closely monitor their performance and related market conditions and conduct our annual test for impairment as of December 31, 2016.
Accounting Policies
Significant accounting policies, for which no significant changes have occurred in the nine months ended September 30, 2016, are detailed in Note 1 to our consolidated financial statements included in our 2015 Annual Report.
Accounting Developments
Pronouncements Implemented
In June 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-12 "Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." This ASU was issued to address share-based payment awards with a performance target affecting vesting that could be achieved after the employee’s requisite service period. Our adoption of ASU No. 2014-12 effective January 1, 2016 did not have an impact on our consolidated financial condition and results of operations.
In November 2014, the FASB issued ASU No. 2014-16, "Derivatives and Hedging (Topic 815): "Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity." This ASU was issued to clarify and reinforce the practice of evaluating all relevant terms and features when reviewing the nature of a host contract. Our adoption of ASU No. 2014-16 effective January 1, 2016 did not have an impact on our consolidated financial condition and results of operations.
In January 2015, the FASB issued ASU 2015-01, "Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items." In connection with the FASB's efforts to simplify accounting standards, the FASB released new guidance on simplifying Income Statement presentation by eliminating the concept of extraordinary items from accounting principles generally accepted in the U.S. (“U.S. GAAP”). Our adoption of ASU No. 2015-01 effective January 1, 2016 did not have an impact on our consolidated financial condition and results of operations.
In February 2015, the FASB issued ASU No. 2015-02, "Consolidation (Topic 810) - Amendments to the Consolidation Analysis,” which provides guidance on the analysis process companies must perform in order to determine whether a legal entity should be consolidated. Our adoption of ASU No. 2015-02 effective January 1, 2016 did not have an impact on our consolidated financial condition and results of operations.
In April 2015, the FASB issued ASU No. 2015-03, "Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The ASU was issued in connection with the FASB's efforts to simplify accounting standards for the presentation of debt issuance costs. The ASU requires companies to present debt issuance costs in the same manner that debt discounts are currently reported, as a direct deduction from the carrying value of that debt liability. The applicability of this requirement does not impact the recognition and measurement guidance for debt issuance costs. In August 2015, the FASB issued ASU 2015-15, "Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements—Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (SEC Update)." In this ASU the SEC staff announced that it would "not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of

6



the line-of-credit arrangement." We adopted the provisions of ASU 2015-03 and ASU 2015-15 as of January 1, 2016. Prior period amounts have been reclassified to conform to the current period presentation. As of December 31, 2015, $10.3 million of debt issuance costs were reclassified in our consolidated balance sheet from other assets, net to long-term debt. Our adoption of ASU No. 2015-03 and ASU No. 2015-15 did not have an impact on our consolidated results of operations.
In May 2015, the FASB issued ASU No. 2015-07, "Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (a consensus of the Emerging Issues Task Force)." The ASU removes the requirement to categorize all investments for which fair value is measured using the net asset value per share practical expedient within the fair value hierarchy. Our adoption of ASU No. 2015-07 effective January 1, 2016 did not have an impact on our consolidated financial condition and results of operations.
In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes to simplify the presentation of deferred income taxes. The ASU requires that deferred tax liabilities and assets be classified as noncurrent on the balance sheet. We adopted ASU No. 2015-17 effective January 1, 2016 and as a result, prior period amounts have been reclassified to conform to the current period presentation. As of December 31, 2015, $156.0 million of deferred tax assets and $11.4 million of deferred tax liabilities were reclassified from current to noncurrent on our balance sheet. Our adoption of ASU No. 2015-17 effective January 1, 2016 did not have an impact on our consolidated results of operations.
Pronouncements Not Yet Implemented
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" which supersedes the revenue recognition requirements in "Revenue Recognition (Topic 605)." The standard is principle-based and provides a five-step model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. There are also expanded disclosure requirements in this ASU. In August 2015, the FASB issued ASU No. 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date." As a result, public entities will apply the new standard for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Early adoption as of the original public entity effective date is permitted. In March 2016, the FASB issued ASU No. 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations". This update is simply a clarification of the implementation guidance on principle versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Identifying Performance Obligations and Licensing", which amends certain aspects of ASU No. 2014-09. In May 2016, the FASB issued ASU No. 2016-11, "Rescission of SEC Guidance Because of ASU No. 2014-09 and ASU No. 2014-16;" this ASU rescinds specific SEC guidance on accounting for shipping and handling fees and costs and consideration given by a vendor to a customer. Additionally, in May 2016, the FASB issued ASU No. 2016-12, "Revenue from Contracts with Customers (Topic 606), Narrow-Scope Improvements and Practical Expedients." This ASU amends and clarifies the ASU No. 2014-09 guidance on assessing collectibility, presenting sales taxes, measuring non-cash consideration, and certain transition matters. We are currently evaluating the impact of ASU No. 2014-09 and all related ASU's on our consolidated financial condition and results of operations. Although we are continuing to evaluate, upon initial qualitative evaluation, we believe some anticipated key changes upon adoption will be potentially increased “over-time” revenue recognition and potential changes to the balance sheet related to accounts receivable, contract assets and contract liabilities.
In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern." This ASU requires management to evaluate whether there are conditions or events that raise substantial doubt about the ability of a company to continue as a going concern for one year from the date the financial statements are issued or within one year after the date that the financial statements are available to be issued when applicable. Further, the ASU provides management guidance regarding its responsibility to disclose the ability of a company to continue as a going concern in the notes to the financial statements. This ASU is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The adoption of ASU No. 2014-15 is not expected to have an impact on our consolidated financial condition and results of operations.
In July 2015, the FASB issued ASU No. 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory." The ASU updates represent changes to simplify the subsequent measurement of inventory. Previous to the issuance of this ASU, ASC 330 required that an entity measure inventory at the lower of cost or market. The amendments of ASU 2015-11 update narrows that “market” requirement to “net realizable value,” which is defined by the ASU as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. Application of this ASU is to be made prospectively, earlier application is permitted as of the beginning of an interim or annual reporting period. The adoption of ASU No. 2015-11 is not expected to have a material impact on our consolidated financial condition and results of operations.
In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." The ASU requires entities to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with changes in fair value recognized in net

7



income. The ASU also requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The requirement to disclose the method(s) and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet has been eliminated by this ASU. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently evaluating the impact of ASU No. 2016-01 on our consolidated financial condition and results of operations.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”.  The ASU requires that organizations that lease assets recognize assets and liabilities on the balance sheet for the rights and obligations created by those leases.  The ASU will affect the presentation of lease related expenses on the income statement and statement of cash flows and will increase the required disclosures related to leases.  This ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted.  We are currently evaluating the impact of ASU No. 2016-02 on our consolidated financial condition and results of operations.  Although we are continuing to evaluate, upon initial qualitative evaluation, we believe a key change upon adoption will be the balance sheet recognition of leased assets and liabilities. Based on our qualitative evaluation to date, we believe that any changes in income statement recognition will not be material.
In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting." The ASU affects the accounting for employee share-based payment transactions as it relates to accounting for income taxes, accounting for forfeitures, and statutory tax withholding requirements. This ASU is effective for annual periods beginning after December 15, 2016,including interim periods within those fiscal years with early adoption permitted. We are currently evaluating the impact of ASU No. 2016-09 on our consolidated financial condition and results of operations.
In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. The amendments in this ASU replace the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. We are currently evaluating the impact of ASU No. 2016-13 on our consolidated financial condition and results of operations.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments - A consensus of the FASB Emerging Issues Task Force.” The update was issued with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230 and other topics. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently evaluating the impact of ASU No. 2016-15 on our consolidated financial condition and results of operations.

8



2.
Acquisition
SIHI Group B.V.
Effective January 7, 2015, we acquired for inclusion in IPD, 100% of SIHI Group B.V. ("SIHI"), a global provider of engineered vacuum and fluid pumps and related services, primarily servicing the chemical market, as well as the pharmaceutical, food & beverage and other process industries, in a stock purchase for €286.7 million ($341.5 million based on exchange rates in effect at the time the acquisition closed and net of cash acquired) in cash. The acquisition was funded using approximately $110 million in available cash and approximately $255 million in initial borrowings from our Revolving Credit Facility, which was subsequently paid down with a portion of the net proceeds from our 2022 EUR Senior Notes. SIHI, based in The Netherlands, has operations primarily in Europe and, to a lesser extent, the Americas and Asia.
The purchase price was allocated to the assets acquired and liabilities assumed based on estimates of fair values at the date of acquisition and is summarized below:
 
(Amounts in millions)
Accounts receivable
$
59.3

Inventories
74.0

Prepaid expenses and other
17.7

Total current assets
151.0

Intangible assets


Trademarks
20.9

Existing customer relationships
45.3

Backlog
8.5

Engineering drawings and other
3.9

Total intangible assets
78.6

Property, plant and equipment
94.5

Long-term deferred tax asset
11.7

Investments in affiliates
7.3

Total assets
343.1

Current liabilities
(88.0
)
Noncurrent liabilities
(114.7
)
Net assets
140.4

Goodwill
201.1

Purchase price, net of cash acquired of $23.4 million
$
341.5

The excess of the acquisition date fair value of the total purchase price over the estimated fair value of the net assets was recorded as goodwill. Goodwill of $201.1 million represents the value expected to be obtained from strengthening Flowserve’s portfolio of products and services through the addition of SIHI's engineered vacuum and fluid pumps, as well as the associated aftermarket services and parts. The goodwill related to this acquisition is recorded in the IPD segment and is not expected to be deductible for tax purposes. The trademarks are primarily indefinite-lived intangibles. As of date of acquisition existing customer relationships, engineering drawings and backlog had expected weighted average useful lives of 10 years, 10 years and less than one year, respectively. In total, amortizable intangible assets have a weighted average useful live of approximately 9 years.
3.
Stock-Based Compensation Plans
We maintain the Flowserve Corporation Equity and Incentive Compensation Plan (the "2010 Plan"), which is a shareholder-approved plan authorizing the issuance of up to 8,700,000 shares of our common stock in the form of restricted shares, restricted share units and performance-based units (collectively referred to as "Restricted Shares"), incentive stock options, non-statutory stock options, stock appreciation rights and bonus stock. Of the 8,700,000 shares of common stock authorized under the 2010 Plan, 3,209,140 were available for issuance as of September 30, 2016. The long-term incentive program was amended to allow Restricted Shares granted after January 1, 2016 to employees who retire and have achieved at least 55 years of age and 10 years of service to continue to vest over the original vesting period. No stock options have been granted since 2006.
 Restricted Shares – Awards of Restricted Shares are valued at the closing market price of our common stock on the date of grant. The unearned compensation is amortized to compensation expense over the vesting period of the restricted shares. We had unearned compensation of $26.9 million and $30.2 million at September 30, 2016 and December 31, 2015, respectively, which

9



is expected to be recognized over a weighted-average period of approximately two years. These amounts will be recognized into net earnings in prospective periods as the awards vest. The total fair value of Restricted Shares vested during the three months ended September 30, 2016 and 2015 was $0.6 million and $1.3 million, respectively. The total fair value of Restricted Shares vested during the nine months ended September 30, 2016 and 2015 was $38.7 million and $40.7 million, respectively.
We recorded stock-based compensation expense of $3.9 million ($6.0 million pre-tax) and $5.7 million ($8.6 million pre-tax) for the three months ended September 30, 2016 and 2015, respectively. We recorded stock-based compensation expense of $19.6 million ($30.0 million pre-tax) and $17.2 million ($26.0 million pre-tax) for the nine months ended September 30, 2016 and 2015, respectively.
The following table summarizes information regarding Restricted Shares:
 
Nine Months Ended September 30, 2016
 
Shares
 
Weighted Average
Grant-Date Fair
Value
Number of unvested shares:
 
 
 
Outstanding - January 1, 2016
1,540,843

 
$
58.14

Granted
862,631

 
38.37

Vested
(707,422
)
 
54.76

Canceled
(171,652
)
 
51.54

Outstanding - September 30, 2016
1,524,400

 
$
49.26


Unvested Restricted Shares outstanding as of September 30, 2016, includes approximately 850,000 units with performance-based vesting provisions. Performance-based units are issuable in common stock and vest upon the achievement of pre-defined performance targets, primarily based on our average annual return on net assets over a three-year period as compared with the same measure for a defined peer group for the same period. Most units were granted in three annual grants since January 1, 2014 and have a vesting percentage between 0% and 200% depending on the achievement of the specific performance targets. Compensation expense is recognized ratably over a cliff-vesting period of 36 months, based on the fair market value of our common stock on the date of grant, as adjusted for anticipated forfeitures. During the performance period, earned and unearned compensation expense is adjusted based on changes in the expected achievement of the performance targets. Vesting provisions range from 0 to approximately 1,623,000 shares based on performance targets. As of September 30, 2016, we estimate vesting of approximately 858,000 shares based on expected achievement of performance targets.
4.
Derivative Instruments and Hedges
Our risk management and foreign currency derivatives and hedging policy specifies the conditions under which we may enter into derivative contracts. See Notes 1 and 6 to our consolidated financial statements included in our 2015 Annual Report and Note 6 of this Quarterly Report for additional information on our derivatives. We enter into foreign exchange forward contracts to hedge our cash flow risks associated with transactions denominated in currencies other than the local currency of the operation engaging in the transaction. All designated foreign exchange hedging instruments are highly effective as of September 30, 2016.
Foreign exchange contracts designated as hedging instruments had a notional value of $4.8 million and $21.0 million at September 30, 2016 and December 31, 2015, respectively. Foreign exchange contracts with third parties not designated as hedging instruments had a notional value of $422.4 million and $376.3 million at September 30, 2016 and December 31, 2015, respectively. At September 30, 2016, the length of foreign exchange contracts currently in place ranged from three day to 24 months.
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 foreign exchange contracts agreements and expect all counterparties to meet their obligations. We have not experienced credit losses from our counterparties.

10



The fair value of foreign exchange contracts not designated as hedging instruments are summarized below:
 
September 30,
 
December 31,
(Amounts in thousands)
2016
 
2015
Current derivative assets
$
1,812

 
$
2,364

Noncurrent derivative assets
67

 

Current derivative liabilities
1,313

 
3,196

Noncurrent derivative liabilities
77

 
441


The fair value of foreign exchange contracts designated as hedging instruments are summarized below:
 
September 30,
 
December 31,
(Amounts in thousands)
2016
 
2015
Current derivative assets
$

 
$
26

Current derivative liabilities
29

 
1,448

Current and noncurrent derivative assets are reported in our condensed consolidated balance sheets in prepaid expenses and other and other assets, net, respectively. Current and noncurrent derivative liabilities are reported in our condensed consolidated balance sheets in accrued liabilities and retirement obligations and other liabilities, respectively.
The impact of net changes in the fair values of foreign exchange contracts are summarized below:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in thousands)
2016
 
2015
 
2016
 
2015
(Loss) gain recognized in income
$
(774
)
 
$
4,391

 
$
5,587

 
$
31,372

Gains and losses recognized in our condensed consolidated statements of income for foreign exchange contracts are classified as other expense, net.
In March 2015, we designated €255.7 million of our €500.0 million Euro senior notes discussed in Note 5 as a net investment hedge of our investments in certain of our international subsidiaries that use the Euro as their functional currency. We used the spot method to measure the effectiveness of our net investment hedge. Under this method, for each reporting period, the change in the carrying value of the Euro senior notes due to remeasurement of the effective portion is reported in accumulated other comprehensive loss on our condensed consolidated balance sheet and the remaining change in the carrying value of the ineffective portion, if any, is recognized in other income (expense), net in our condensed statement of income. We evaluate the effectiveness of our net investment hedge on a prospective basis at the beginning of each quarter. We did not record any ineffectiveness for the nine months ended September 30, 2016.
5.
Debt
Debt, including capital lease obligations, consisted of:
 
September 30,
 
  December 31,  
(Amounts in thousands, except percentages)
2016
 
2015(1)
1.25% EUR Senior Notes due March 17, 2022, net of unamortized discount and debt issuance costs of $6,431 and $7,034
$
555,469

 
$
535,966

4.00% USD Senior Notes due November 15, 2023, net of unamortized discount and debt issuance costs of $3,065 and $3,339
296,935

 
296,661

3.50% USD Senior Notes due September 15, 2022, net of unamortized discount and debt issuance costs of $4,000 and $4,445
496,000

 
495,555

Term Loan Facility, interest rate of 2.09% at September 30, 2016 and 1.86% at December 31, 2015, net of debt issuance costs of $845 and $1,181
239,155

 
283,819

Capital lease obligations and other borrowings
23,330

 
8,995

Debt and capital lease obligations
1,610,889

 
1,620,996

Less amounts due within one year
75,211

 
60,434

Total debt due after one year
$
1,535,678

 
$
1,560,562

_______________________________________
(1) Prior period information has been updated to conform to presentation requirements as prescribed by ASU No. 2015-03, "Interest - Imputation of Interest (Subtopic 835-30).

Senior Credit Facility
As discussed in Note 10 to our consolidated financial statements included in our 2015 Annual Report, our credit agreement provides for an initial $400.0 million term loan (“Term Loan Facility”) and a $1.0 billion revolving credit facility (“Revolving Credit Facility” and, together with the Term Loan Facility, the “Senior Credit Facility”) with a maturity date of October 14, 2020. As of September 30, 2016 and December 31, 2015, we had no amounts outstanding under the Revolving Credit Facility. We had outstanding letters of credit of $98.3 million and $105.2 million at September 30, 2016 and December 31, 2015, respectively, which together with financial covenant limitations based on the terms of our Senior Credit Facility, contributed to the reduction of our borrowing capacity to $608.8 million and $894.8 million, respectively. Our compliance with applicable financial covenants under the Senior Credit Facility is tested quarterly, and we complied with all applicable covenants as of September 30, 2016.
We may prepay loans under our Senior Credit Facility in whole or in part, without premium or penalty, at any time. A commitment fee, which is payable quarterly on the daily unused portions of the Senior Credit Facility, was 0.150% (per annum) during the period ended September 30, 2016. During the nine months ended September 30, 2016, we made scheduled repayments of $45.0 million under our Term Loan Facility. We have scheduled repayments of $15.0 million due in each of the next four quarters on our Term Loan Facility.
6.
Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models may be applied. Assets and liabilities recorded at fair value in our condensed consolidated balance sheets are categorized by hierarchical levels based upon the level of judgment associated with the inputs used to measure their fair values. Recurring fair value measurements are limited to investments in derivative instruments. The fair value measurements of our derivative instruments are determined using models that maximize the use of the observable market inputs including interest rate curves and both forward and spot prices for currencies, and are classified as Level II under the fair value hierarchy. The fair values of our derivatives are included in Note 4.
Our financial instruments are presented at fair value in our condensed consolidated balance sheets, with the exception of our long-term debt. The estimated fair value of our long-term debt, excluding the Senior Notes, approximates the carrying value and is classified as Level II under the fair value hierarchy. The carrying value of our debt is included in Note 5. The estimated fair value of our Senior Notes at September 30, 2016 was $1,409.8 million compared to the carrying value of $1,348.4 million. The estimated fair value of the Senior Notes is based on Level I quoted market rates. The carrying amounts of our other financial instruments (e.g., cash and cash equivalents, accounts receivable, net, accounts payable and short-term debt) approximated fair value due to their short-term nature at September 30, 2016 and December 31, 2015.
7.
Inventories
Inventories, net consisted of the following:
 
September 30,
 
  December 31,  
(Amounts in thousands)
2016
 
2015
Raw materials
$
383,623

 
$
390,998

Work in process
739,493

 
739,227

Finished goods
227,084

 
235,083

Less: Progress billings
(233,358
)
 
(285,582
)
Less: Excess and obsolete reserve
(77,898
)
 
(84,161
)
Inventories, net
$
1,038,944

 
$
995,565


In the three months ended September 30, 2016, we recorded a $14.1 million adjustment which was primarily related to our EPD reporting segment to write down inventory in Brazil of which approximately $8 million related to prior periods (approximately $4 million in 2015). The out of period amounts are not material to the consolidated financial results or our reporting segment results in the current quarter or prior periods.

11



8.
Earnings Per Share
The following is a reconciliation of net (loss) earnings of Flowserve Corporation and weighted average shares for calculating net earnings per common share. Earnings per weighted average common share outstanding was calculated as follows:
 
Three Months Ended September 30,
(Amounts in thousands, except per share data)
2016
 
2015
Net (loss) earnings of Flowserve Corporation
$
(20,928
)
 
$
93,623

Dividends on restricted shares not expected to vest

 
3

(Loss) earnings attributable to common and participating shareholders
$
(20,928
)
 
$
93,626

Weighted average shares:
 
 
 
Common stock
130,299

 
132,036

Participating securities

 
514

Denominator for basic earnings per common share
130,299

 
132,550

Effect of potentially dilutive securities

 
610

Denominator for diluted earnings per common share
130,299

 
133,160

(Loss) earnings per common share:
 
 
 
Basic
$
(0.16
)
 
$
0.71

Diluted
(0.16
)
 
0.70

 
Nine Months Ended September 30,
(Amounts in thousands, except per share data)
2016
 
2015
Net earnings of Flowserve Corporation
$
79,928

 
$
196,297

Dividends on restricted shares not expected to vest
5

 
9

Earnings attributable to common and participating shareholders
$
79,933

 
$
196,306

Weighted average shares:
 
 
 
Common stock
130,087

 
133,389

Participating securities
298

 
513

Denominator for basic earnings per common share
130,385

 
133,902

Effect of potentially dilutive securities
522

 
747

Denominator for diluted earnings per common share
130,907

 
134,649

Earnings per common share:
 
 
 
Basic
$
0.61

 
$
1.47

Diluted
0.61

 
1.46

Diluted earnings per share above is based upon the weighted average number of shares as determined for basic earnings per share plus shares potentially issuable in conjunction with stock options and Restricted Shares. As a result of the net loss for the three months ended September 30, 2016, we excluded 803,251 of unvested Restricted Shares from the calculation of diluted EPS due to their anti-dilutive effect.
9.
Legal Matters and Contingencies
Asbestos-Related Claims
We are a defendant in a substantial number of lawsuits that seek to recover damages for personal injury allegedly caused by exposure to asbestos-containing products manufactured and/or distributed by our heritage companies in the past. While the overall number of asbestos-related claims has generally declined in recent years, there can be no assurance that this trend will continue, or that the average cost per claim will not further increase. Asbestos-containing materials incorporated into any such products were encapsulated and used as internal components of process equipment, and we do not believe that any significant emission of asbestos fibers occurred during the use of this equipment.
Our practice is to vigorously contest and resolve these claims, and we have been successful in resolving a majority of claims with little or no payment. Historically, a high percentage of resolved claims have been covered by applicable insurance or indemnities from other companies, and we believe that a substantial majority of existing claims should continue to be covered by

12



insurance or indemnities. Accordingly, we have recorded a liability for our estimate of the most likely settlement of asserted claims and a related receivable from insurers or other companies for our estimated recovery, to the extent we believe that the amounts of recovery are probable and not otherwise in dispute. While unfavorable rulings, judgments or settlement terms regarding these claims could have a material adverse impact on our business, financial condition, results of operations and cash flows, we currently believe the likelihood is remote.
Additionally, we have claims pending against certain insurers that, if resolved more favorably than reflected in the recorded receivables, would result in discrete gains in the applicable quarter. We are currently unable to estimate the impact, if any, of unasserted asbestos-related claims, although future claims would also be subject to then existing indemnities and insurance coverage.
United Nations Oil-for-Food Program
In mid-2006, the French authorities began an investigation of over 170 French companies, of which one of our French subsidiaries was included, concerning suspected inappropriate activities conducted in connection with the United Nations Oil for Food Program. As previously disclosed, the French investigation of our French subsidiary was formally opened in the first quarter of 2010, and our French subsidiary filed a formal response with the French court. In July 2012, the French court ruled against our procedural motions to challenge the constitutionality of the charges and quash the indictment. Hearings occurred on April 1-2, 2015, and the Company presented its defense and closing arguments. On June 18, 2015, the French court issued its ruling dismissing the case against the Company and the other defendants. However, on July 1, 2015, the French prosecutor lodged an appeal. We currently do not expect to incur additional case resolution costs of a material amount in this matter. However, if the French authorities ultimately take enforcement action against our French subsidiary regarding its investigation, we may be subject to monetary and non-monetary penalties, which we currently do not believe will have a material adverse financial impact on our company.
Other
We are currently involved as a potentially responsible party at five former public waste disposal sites in various stages of evaluation or remediation. The projected cost of remediation at these sites, as well as our alleged "fair share" allocation, will remain uncertain 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. Many of the other parties identified are financially strong and solvent companies that appear able to pay their share of the remediation costs. Based on our information about the waste disposal practices at these sites and the environmental regulatory process in general, we believe that it is likely that ultimate remediation liability costs for each site will be apportioned among all liable parties, including site owners and waste transporters, according to the volumes and/or toxicity of the wastes shown to have been disposed of at the sites. We believe that our financial exposure for existing disposal sites will not be materially in excess of accrued reserves.
As previously disclosed in our 2015 Annual Report, we terminated an employee of an overseas subsidiary after uncovering actions that violated our Code of Business Conduct and may have violated the Foreign Corrupt Practices Act.  We completed our internal investigation into the matter, self-reported the potential violation to the United States Department of Justice (the “DOJ”) and the SEC, and continue to cooperate with the DOJ and SEC.  We previously received a subpoena from the SEC requesting additional information and documentation related to the matter and have completed our response to the subpoena.  We currently believe that this matter will not have a material adverse financial impact on the Company, but there can be no assurance that the Company will not be subjected to monetary penalties and additional costs. 
We are also a defendant in a number of other lawsuits, including product liability claims, that are insured, subject to the applicable deductibles, arising in the ordinary course of business, and we are also involved in other uninsured routine litigation incidental to our business. We currently believe none of such litigation, either individually or in the aggregate, is material to our business, operations or overall financial condition. However, litigation is inherently unpredictable, and resolutions or dispositions of claims or lawsuits by settlement or otherwise could have an adverse impact on our financial position, results of operations or cash flows for the reporting period in which any such resolution or disposition occurs.
Although none of the aforementioned potential liabilities can be quantified with absolute certainty except as otherwise indicated above, we have established reserves covering exposures relating to contingencies, to the extent believed to be reasonably estimable and probable based on past experience and available facts. While additional exposures beyond these reserves could exist, they currently cannot be estimated. We will continue to evaluate and update the reserves as necessary and appropriate.

13



10.
Retirement and Postretirement Benefits
Components of the net periodic cost for retirement and postretirement benefits for the three months ended September 30, 2016 and 2015 were as follows:
 
U.S.
Defined Benefit Plans
 
Non-U.S.
Defined Benefit Plans
 
Postretirement
Medical Benefits
(Amounts in millions) 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Service cost
$
5.6

 
$
6.0

 
$
1.8

 
$
2.1

 
$

 
$

Interest cost
4.8

 
4.3

 
2.9

 
3.1

 
0.3

 
0.3

Expected return on plan assets
(6.0
)
 
(6.0
)
 
(2.7
)
 
(3.0
)
 

 

Amortization of prior service cost
0.2

 
0.1

 

 

 

 

Amortization of unrecognized net loss (gain)
1.2

 
2.3

 
1.3

 
1.3

 
(0.1
)
 
(0.1
)
Net periodic cost recognized
$
5.8

 
$
6.7

 
$
3.3

 
$
3.5

 
$
0.2

 
$
0.2


Components of the net periodic cost for retirement and postretirement benefits for the nine months months ended September 30, 2016 and 2015 were as follows:
 
U.S.
Defined Benefit Plans
 
Non-U.S.
Defined Benefit Plans
 
Postretirement
Medical Benefits
(Amounts in millions) 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Service cost
$
16.9

 
$
18.1

 
$
5.3

 
$
6.3

 
$

 
$

Interest cost
14.3

 
12.8

 
8.8

 
9.3

 
0.9

 
0.9

Expected return on plan assets
(18.0
)
 
(18.1
)
 
(8.0
)
 
(9.0
)
 

 

Amortization of prior service cost
0.4

 
0.3

 

 

 
0.1

 
0.1

Amortization of unrecognized net loss (gain)
3.7

 
6.9

 
3.7

 
3.9

 
(0.3
)
 
(0.4
)
Net periodic cost recognized
$
17.3

 
$
20.0

 
$
9.8

 
$
10.5

 
$
0.7

 
$
0.6

11.
Shareholders’ Equity
Dividends – On February 15, 2016, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.18 per share to $0.19 per share payable beginning on April 8, 2016. On February 16, 2015, our Board of Directors authorized an increase in the payment of quarterly dividends on our common stock from $0.16 per share to $0.18 per share payable beginning on April 10, 2015. Generally, our dividend date-of-record is in the last month of the quarter, and the dividend is paid the following month. Any subsequent dividends will be reviewed by our Board of Directors and declared in its discretion dependent on its assessment of our financial situation and business outlook at the applicable time.
Share Repurchase Program – On November 13, 2014, our Board of Directors approved a $500.0 million share repurchase authorization. Our share repurchase program does not have an expiration date, and we reserve the right to limit or terminate the repurchase program at anytime without notice.
We had no repurchases of shares of our outstanding common stock for the three months ended September 30, 2016 compared to 2,378,700 shares repurchased for $110.0 million, during the three months ended September 30, 2015. We had no repurchases of shares of our outstanding common stock for the nine months ended September 30, 2016 compared to 4,833,146 shares repurchased for $249.7 million, during the nine months ended September 30, 2015. As of September 30, 2016 we had $160.7 million of remaining capacity under our current share repurchase program.
12.
Income Taxes
For the three months ended September 30, 2016, we incurred a pre-tax loss of $15.1 million and provided for income taxes of $5.0 million resulting in an effective tax rate of negative 33.0%. For the nine months ended September 30, 2016, we earned $129.0 million before taxes and provided for income taxes of $47.8 million, resulting in an effective tax rate of 37.1%. The effective tax rate varied from the U.S. federal statutory rate for the three and nine months ended September 30, 2016 primarily due to the net impact of foreign operations, tax impacts from our Realignment Programs and losses in certain foreign jurisdictions for which no tax benefit was provided.

14



For the three months ended September 30, 2015, we earned $146.6 million before taxes and provided for income taxes of $52.1 million resulting in an effective tax rate of 35.5%. For the nine months ended September 30, 2015, we earned $312.3 million before taxes and provided for income taxes of $111.5 million resulting in an effective tax rate of 35.7%. The effective tax rate varied from the U.S. federal statutory rate for the three months ended September 30, 2015 primarily due to the net impact of foreign operations and the establishment of a valuation allowance against our deferred tax assets in Brazil in the amount of $10.0 million. The effective tax rate varied from the U.S. federal statutory rate for the nine months ended September 30, 2015 primarily due to tax impacts of the realignment programs, the Venezuelan exchange rate remeasurement loss and the establishment of a valuation allowance of $10.0 million against our deferred tax assets in Brazil, partially offset by the net impact of foreign operations.
As of September 30, 2016, the amount of unrecognized tax benefits increased by $3.8 million from December 31, 2015. With limited exception, we are no longer subject to U.S. federal income tax audits for years through 2014, state and local income tax audits for years through 2009 or non-U.S. income tax audits for years through 2009. We are currently under examination for various years in Austria, France, Germany, India, Italy, Singapore, Spain, the U.S. and Venezuela.
It is reasonably possible that within the next 12 months the effective tax rate will be impacted by the resolution of some or all of the matters audited by various taxing authorities. It is also reasonably possible that we will have the statute of limitations close in various taxing jurisdictions within the next 12 months. As such, we estimate we could record a reduction in our tax expense of approximately $10 million within the next 12 months.
13.
Segment Information
The following is a summary of the financial information of the reportable segments reconciled to the amounts reported in the condensed consolidated financial statements:
Three Months Ended September 30, 2016
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Sales to external customers
$
448,749

 
$
196,172

 
$
298,413

 
$
943,334

 
$

 
$
943,334

Intersegment sales
7,098

 
7,126

 
937

 
15,161

 
(15,161
)
 

Segment operating (loss) income
(25,160
)
 
(15,668
)
 
52,840

 
12,012

 
(14,818
)
 
(2,806
)
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2015
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Sales to external customers
$
502,208

 
$
227,502

 
$
366,766

 
$
1,096,476

 
$

 
$
1,096,476

Intersegment sales
12,298

 
14,137

 
1,168

 
27,603

 
(27,603
)
 

Segment operating income
78,342

 
24,985

 
77,063

 
180,390

 
(12,541
)
 
167,849

Nine Months Ended September 30, 2016
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Sales to external customers
$
1,415,695

 
$
591,008

 
$
910,111

 
$
2,916,814

 
$

 
$
2,916,814

Intersegment sales
25,763

 
24,772

 
5,410

 
55,945

 
(55,945
)
 

Segment operating income (loss)
98,477

 
(6,185
)
 
140,140

 
232,432

 
(62,825
)
 
169,607

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Sales to external customers
$
1,533,955

 
$
690,873

 
$
1,048,514

 
$
3,273,342

 
$

 
$
3,273,342

Intersegment sales
35,479

 
34,948

 
2,945

 
73,372

 
(73,372
)
 

Segment operating income
233,264

 
18,716

 
186,266

 
438,246

 
(49,443
)
 
388,803


15



14. Accumulated Other Comprehensive Loss
The following table presents the changes in accumulated other comprehensive loss ("AOCL"), net of tax for the three months ended September 30, 2016 and 2015:
 
2016
 
2015
(Amounts in thousands)
Foreign currency translation items(1)
 
Pension and other post-retirement effects
 
Cash flow hedging activity
 
Total(1)
 
Foreign currency translation items(1)
 
Pension and other post-retirement effects
 
Cash flow hedging activity
 
Total(1)
Balance - July 1
$
(408,287
)
 
$
(114,525
)
 
$
(2,255
)
 
$
(525,067
)
 
$
(331,301
)
 
$
(125,727
)
 
$
(6,929
)
 
$
(463,957
)
Other comprehensive (loss) income before reclassifications
(15,735
)
 
1,952

 
39

 
(13,744
)
 
(54,494
)
 
1,245

 
(35
)
 
(53,284
)
Amounts reclassified from AOCL

 
1,767

 
521

 
2,288

 

 
2,443

 
1,573

 
4,016

Net current-period other comprehensive (loss) income
(15,735
)
 
3,719

 
560

 
(11,456
)
 
(54,494
)
 
3,688

 
1,538

 
(49,268
)
Balance - September 30
$
(424,022
)
 
$
(110,806
)
 
$
(1,695
)
 
$
(536,523
)
 
$
(385,795
)
 
$
(122,039
)
 
$
(5,391
)
 
$
(513,225
)
_______________________________________
(1) Includes foreign currency translation adjustments attributable to noncontrolling interests of $3.5 million and $1.4 million at July 1, 2016 and 2015 and $3.5 million and $2.7 million at September 30, 2016 and 2015, respectively. Includes net investment hedge loss of $2.2 million and $0.7 million, net of deferred taxes, for the three months ended September 30, 2016 and 2015, respectively. Amounts in parentheses indicate debits.

The following table presents the reclassifications out of AOCL:
 
 
Three Months Ended September 30,
(Amounts in thousands)
Affected line item in the statement of income
2016(1)
 
2015(1)
Cash flow hedging activity
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
Sales
$
(717
)
 
$
(1,990
)
 
Tax benefit
196

 
417

 
 Net of tax
$
(521
)
 
$
(1,573
)
 
 
 
 
 
Pension and other postretirement effects
 
 
 
 
Amortization of actuarial losses(2)
 
$
(2,395
)
 
$
(3,465
)
  Prior service costs(2)
 
(153
)
 
(177
)


Tax benefit
781

 
1,199



Net of tax
$
(1,767
)
 
$
(2,443
)
_______________________________________
(1) Amounts in parentheses indicate decreases to income. None of the reclass amounts have a noncontrolling interest component.
(2) These accumulated other comprehensive loss components are included in the computation of net periodic pension cost. See Note 10 for additional details.




16



The following table presents the changes in AOCL, net of tax for the nine months ended September 30, 2016 and 2015:

 
2016
 
2015
(Amounts in thousands)
Foreign currency translation items(1)
 
Pension and other post-retirement effects
 
Cash flow hedging activity
 
Total(1)
 
Foreign currency translation items(1)
 
Pension and other post-retirement effects
 
Cash flow hedging activity
 
Total(1)
Balance - January 1
$
(413,422
)
 
$
(120,461
)
 
$
(3,458
)
 
$
(537,341
)
 
$
(238,533
)
 
$
(135,398
)
 
$
(5,210
)
 
$
(379,141
)
Other comprehensive (loss) income before reclassifications
(10,600
)
 
4,330

 
633

 
(5,637
)
 
(147,262
)
 
6,031

 
(6,739
)
 
(147,970
)
Amounts reclassified from AOCL

 
5,325

 
1,130

 
6,455

 

 
7,328

 
6,558

 
13,886

Net current-period other comprehensive (loss) income
(10,600
)
 
9,655

 
1,763

 
818

 
(147,262
)
 
13,359

 
(181
)
 
(134,084
)
Balance - September 30
$
(424,022
)
 
$
(110,806
)
 
$
(1,695
)
 
$
(536,523
)
 
$
(385,795
)
 
$
(122,039
)
 
$
(5,391
)
 
$
(513,225
)
________________________________
(1) Includes foreign currency translation adjustments attributable to noncontrolling interests of $2.7 million and $1.3 million at January 1, 2016 and 2015 and $3.5 million and $2.7 million at September 30, 2016 and 2015, respectively. Includes net investment hedge losses of $6.1 million and $9.3 million, net of deferred taxes, for the nine months ended September 30, 2016 and 2015, respectively. Amounts in parentheses indicate debits.

The following table presents the reclassifications out of AOCL:
 
 
Nine Months Ended September 30,
(Amounts in thousands)
Affected line item in the statement of income
2016(1)
 
2015(1)
Foreign currency translation items
 
 
 
 
Cash flow hedging activity
 
 
 
 
   Foreign exchange contracts
Other expense, net
$

 
$
(3,327
)
 
Sales
(1,531
)
 
(5,694
)
 
Tax benefit
401

 
2,463

 
 Net of tax
$
(1,130
)
 
$
(6,558
)
 
 
 
 
 
Pension and other postretirement effects
 
 
 
 
Amortization of actuarial losses(2)
 
$
(7,184
)
 
$
(10,396
)
Prior service costs(2)
 
(458
)
 
(530
)
 
Tax benefit
2,317

 
3,598

 
Net of tax
$
(5,325
)
 
$
(7,328
)
_______________________________________
(1) Amounts in parentheses indicate decreases to income. None of the reclass amounts have a noncontrolling interest component.
(2) These accumulated other comprehensive loss components are included in the computation of net periodic pension cost. See Note 10 for additional details.

At September 30, 2016, we expect to recognize a loss of $0.6 million, net of deferred taxes, into earnings in the next twelve months related to designated foreign exchange contracts based on their fair values at September 30, 2016.

17



15. Realignment Programs
In the first quarter of 2015, we initiated a realignment program ("R1 Realignment Program") to reduce and optimize certain non-strategic QRCs and manufacturing facilities from the SIHI acquisition. In the second quarter of 2015, we initiated a second realignment program ("R2 Realignment Program") to better align costs and improve long-term efficiency, including further manufacturing optimization through the consolidation of facilities, a reduction in our workforce, the transfer of activities from high-cost regions to lower-cost facilities and the divestiture of certain non-strategic assets.
The R1 Realignment Program and the R2 Realignment Program (collectively the "Realignment Programs") consist of both restructuring and non-restructuring charges. Restructuring charges represent costs associated with the relocation or reorganization of certain business activities and facility closures and include related severance costs. Non-restructuring charges are primarily employee severance associated with workforce reductions to reduce redundancies. Expenses are primarily reported in COS or SG&A, as applicable, in our condensed consolidated statements of income. We anticipate a total investment in these programs of approximately $400 million, including projects still under final evaluation. We anticipate that the majority of any remaining charges will be incurred throughout 2016 and 2017.
Generally, the aforementioned charges will be paid in cash, except for asset write-downs, which are non-cash charges. The following is a summary of total charges, net of adjustments, related to the Realignment Programs:
 
Three Months Ended September 30, 2016
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Restructuring Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
5,711

 
$
15,599

 
$
796

 
$
22,106

 
$

 
$
22,106

     SG&A
393

 
3,928

 
20

 
4,341

 
(32
)
 
4,309

     Income tax expense
2,000

 
2,800

 
600

 
5,400

 

 
5,400

 
$
8,104

 
$
22,327

 
$
1,416

 
$
31,847

 
$
(32
)
 
$
31,815

Non-Restructuring Charges
 

 
 

 
 

 
 
 
 
 
 

     COS
$
2,707

 
$
445

 
$
(749
)
 
$
2,403

 
$
(6
)
 
$
2,397

     SG&A
1,010

 
(344
)
 
623

 
1,289

 
1,385

 
2,674

 
$
3,717

 
$
101

 
$
(126
)
 
$
3,692

 
$
1,379

 
$
5,071

Total Realignment Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
8,418

 
$
16,044

 
$
47

 
$
24,509

 
$
(6
)
 
$
24,503

     SG&A
1,403

 
3,584

 
643

 
5,630

 
1,353

 
$
6,983

     Income tax expense
2,000

 
2,800

 
600

 
5,400

 

 
$
5,400

Total
$
11,821

 
$
22,428

 
$
1,290

 
$
35,539

 
$
1,347

 
$
36,886


18



 
Three Months Ended September 30, 2015
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Restructuring Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
437

 
$
57

 
$
1,082

 
$
1,576

 
$

 
$
1,576

     SG&A
909

 
(434
)
 
(1,070
)
 
(595
)
 

 
(595
)
 
$
1,346

 
$
(377
)
 
$
12

 
$
981

 
$

 
$
981

Non-Restructuring Charges
 

 
 

 
 

 
 
 
 
 
 

     COS
$
(27
)
 
$
91

 
$
59

 
$
123

 
$

 
$
123

     SG&A
453

 
253

 
(128
)
 
578

 

 
578

 
$
426

 
$
344

 
$
(69
)
 
$
701

 
$

 
$
701

Total Realignment Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
410

 
$
148

 
$
1,141

 
$
1,699

 
$

 
$
1,699

     SG&A
1,362

 
(181
)
 
(1,198
)
 
(17
)
 

 
$
(17
)
Total
$
1,772

 
$
(33
)
 
$
(57
)
 
$
1,682

 
$

 
$
1,682

 
Nine Months Ended September 30, 2016
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Restructuring Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
10,566

 
$
17,709

 
$
3,083

 
$
31,358

 
$

 
$
31,358

     SG&A
9,211

 
5,717

 
356

 
15,284

 

 
15,284

     Income tax expense
2,000

 
2,800

 
600

 
5,400

 

 
5,400

 
$
21,777

 
$
26,226

 
$
4,039

 
$
52,042

 
$

 
$
52,042

Non-Restructuring Charges
 

 
 

 
 

 
 
 
 
 
 

     COS
$
3,844

 
$
4,729

 
$
2,970

 
$
11,543

 
$
8

 
$
11,551

     SG&A
1,989

 
56

 
2,212

 
4,257

 
2,644

 
6,901

 
$
5,833

 
$
4,785

 
$
5,182

 
$
15,800

 
$
2,652

 
$
18,452

Total Realignment Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
14,410

 
$
22,438

 
$
6,053

 
$
42,901

 
$
8

 
$
42,909

     SG&A
11,200

 
5,773

 
2,568

 
19,541

 
2,644

 
22,185

     Income tax expense
2,000

 
2,800

 
600

 
5,400

 

 
5,400

Total
$
27,610

 
$
31,011

 
$
9,221

 
$
67,842

 
$
2,652

 
$
70,494


19



 
Nine Months Ended September 30, 2015
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Restructuring Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
547

 
$
18,696

 
$
2,101

 
$
21,344

 
$

 
$
21,344

     SG&A
1,031

 
9,811

 
1,272

 
12,114

 

 
12,114

     Income tax expense

 
5,500

 

 
5,500

 

 
5,500

 
$
1,578

 
$
34,007

 
$
3,373

 
$
38,958

 
$

 
$
38,958

Non-Restructuring Charges
 

 
 

 
 

 
 
 
 
 
 

     COS
$
7,323

 
$
1,019

 
$
5,150

 
$
13,492

 
$

 
$
13,492

     SG&A
3,297

 
2,147

 
3,795

 
9,239

 

 
9,239

 
$
10,620

 
$
3,166

 
$
8,945

 
$
22,731

 
$

 
$
22,731

Total Realignment Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
7,870

 
$
19,715

 
$
7,251

 
$
34,836

 
$

 
$
34,836

     SG&A
4,328

 
11,958

 
5,067

 
21,353

 

 
21,353

     Income tax expense

 
5,500

 

 
5,500

 

 
5,500

Total
$
12,198

 
$
37,173

 
$
12,318

 
$
61,689

 
$

 
$
61,689


The following is a summary of total inception to date charges, net of adjustments, related to the Realignment Programs:
 
Inception to Date
 (Amounts in thousands)
Engineered Product Division
 
Industrial Product Division (1)
 
Flow Control Division
 
Subtotal–Reportable Segments
 
Eliminations and All Other
 
Consolidated Total
Restructuring Charges
 
 
 
 
 
 
 
 
 
 
 
     COS
$
20,529

 
$
38,155

 
$
12,384

 
$
71,068

 
$

 
$
71,068

     SG&A
16,686

 
14,976

 
7,967

 
<