The following discussion and analysis is provided to increase the understanding of, and should be read in conjunction with, the accompanying consolidated financial statements and notes. See "Item 1A. Risk Factors" and the section titled "Forward-Looking Information is Subject to Risk and Uncertainty" included in this Annual Report on Form 10-K for the year endedDecember 31, 2019 ("Annual Report") for a discussion of the risks, uncertainties and assumptions associated with these statements. Unless otherwise noted, all amounts discussed herein are consolidated. EXECUTIVE OVERVIEW Our Company We believe that we are a world-leading manufacturer and aftermarket service provider of comprehensive flow control systems. We develop and manufacture precision-engineered flow control equipment integral to the movement, control and protection of the flow of materials in our customers' critical processes. Our product portfolio of pumps, valves, seals, automation and aftermarket services supports global infrastructure industries, including oil and gas, chemical, power generation and water management, as well as general industrial markets where our products and services add value. Through our manufacturing platform and global network of Quick Response Centers ("QRCs"), we offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. We employ approximately 17,000 employees in more than 50 countries as ofDecember 31, 2019 . Our business model is significantly influenced by the capital spending of global infrastructure industries for the placement of new products into service and maintenance spending for aftermarket services for existing operations. The worldwide installed base of our products is an important source of aftermarket revenue, where products are expected to ensure the maximum operating time of many key industrial processes. Over the past several years, we have significantly invested in our aftermarket strategy to provide local support to drive customer investments in our offerings and use of our services to replace or repair installed products. The aftermarket portion of our business also helps provide business stability during various economic periods. The aftermarket business, which is primarily served by our network of 171 QRCs located around the globe, provides a variety of service offerings for our customers including spare parts, service solutions, product life cycle solutions and other value-added services. It is generally a higher margin business compared to our original equipment business and a key component of our profitable growth strategy. Our operations are conducted through two business segments that are referenced throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"): • FPD for custom, highly-engineered pumps, pre-configured industrial pumps,
pump systems, mechanical seals, auxiliary systems and replacement parts
and related services; and
• FCD for engineered and industrial valves, control valves, actuators and
controls and related services.
Our business segments share a focus on industrial flow control technology and have a high number of common customers. These segments also have complementary product offerings and technologies that are often combined in applications that provide us a net competitive advantage. Our segments also benefit from our global footprint, our economies of scale in reducing administrative and overhead costs to serve customers more cost effectively and shared leadership for operational support functions, such as research and development, marketing and supply chain. The reputation of our product portfolio is built on more than 50 well-respected brand names such as Worthington, IDP,Valtek , Limitorque, Durco, Argus, Edward, Valbart and Durametallic, which we believe to be one of the most comprehensive in the industry. Our products and services are sold either directly or through designated channels to more than 10,000 companies, including some of the world's leading engineering, procurement and construction ("EPC") firms, original equipment manufacturers, distributors and end users. We continue to leverage our QRC network to be positioned as near to customers as possible for service and support in order to capture valuable aftermarket business. Along with ensuring that we have the local capability to sell, install and service our equipment in remote regions, we continuously improve our global operations. We also continue to expand our global supply chain capability to meet global customer demands and ensure the quality and timely delivery of our products. We are focusing on our ongoing low-cost sourcing, including greater use of third-party suppliers and increasing our lower-cost, emerging market capabilities. Additionally, we continue to devote resources to improving the supply chain processes across our business segments to find areas of synergy and cost reduction and to improve our supply chain management capability 26 -------------------------------------------------------------------------------- to ensure it can meet global customer demands. We also remain focused on improving on-time delivery and quality, while managing warranty costs as a percentage of sales across our global operations, through the assistance of a focused Continuous Improvement Process ("CIP") initiative. The goal of the CIP initiative, which includes lean manufacturing, six sigma business management strategy and value engineering, is to maximize service fulfillment to customers through on-time delivery, reduced cycle time and quality at the highest internal productivity. Over the past year we have experienced continued stabilization in business and improved conditions in certain of our key markets. With continued stability in oil prices at improved levels through the middle of 2018 and 2019, our large-project business is showing continued signs of recovery and we anticipate that customers will continue to invest in maintenance and short cycle equipment during 2020. In the second quarter of 2018, we launched and committed resources to ourFlowserve 2.0 Transformation, a program designed to transform our business model to drive operational excellence, reduce complexity, accelerate growth, expand margins, increase capital efficiency and improve organizational health. For further information regarding ourFlowserve 2.0 Transformation, see "Our Results of Operations" below and Note 20 to our consolidated financial statements included in Item 8 of this Annual Report. Our Markets The following discussion should be read in conjunction with the "Outlook for 2020" section included below in this MD&A. Our products and services are used in several distinct industries: oil and gas, chemical, power generation, water management, and several other industries, such as mining, steel and paper, that are collectively referred to as "general industries." Demand for most of our products depends on the level of new capital investment as well as planned and unplanned maintenance expenditures by our customers. The level of new capital investment depends, in turn, on capital infrastructure projects driven by the need for products that rely on oil and gas, chemicals, power generation and water resource management, as well as general economic conditions. These drivers are generally related to the phase of the business cycle in their respective industries and the expectations of future market behavior. The levels of maintenance expenditures are additionally driven by the reliability of equipment, planned and unplanned downtime for maintenance and the required capacity utilization of the process. Sales to EPC firms and original equipment manufacturers are typically for large project orders and critical applications, as are certain sales to distributors. Project orders are typically procured for customers either directly from us or indirectly through contractors for new construction projects or facility enhancement projects. The quick turnaround business, which we also refer to as "short-cycle," is defined as orders that are received from the customer (booked) and shipped generally within six months of receipt. These orders are typically for more standardized, general purpose products, parts or services. Each of our two business segments generate certain levels of this type of business. In the sale of aftermarket products and services, we benefit from a large installed base of our original equipment, which requires periodic maintenance, repair and replacement parts. We use our manufacturing platform and global network of QRCs to offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. In geographic regions where we are positioned to provide quick response, we believe customers have traditionally relied on us, rather than our competitors, for aftermarket products due to our highly engineered and customized products. However, the aftermarket for standard products is competitive, as the existence of common standards allows for easier replacement of the installed products. As proximity of service centers, timeliness of delivery and quality are important considerations for all aftermarket products and services, we continue to selectively expand our global QRC capabilities to improve our ability to capture this important aftermarket business. Oil and Gas The oil and gas industry, which represented approximately 41% and 38% of our bookings in 2019 and 2018, respectively, experienced an increase in capital spending in 2019 compared to the previous year. The increase was primarily due to increased project activity and short cycle investment. Aftermarket opportunities in this industry remained stable throughout 2019 following increased spending in 2018 due to catch up of deferred spending on our customers' repair and maintenance budgets from previous years. 27 -------------------------------------------------------------------------------- The outlook for the oil and gas industry is heavily dependent on the demand growth from both mature markets and developing geographies as well as changes in the regulatory environment. In the short-term, we believe that stable oil prices will support oil and gas upstream and mid-stream investment and we further expect continued investment in later cycle downstream oil and gas and petrochemical projects due to emerging market growth and certain regulatory requirements, such as IMO 2020. We also believe stable oil prices support increased demand for our aftermarket products and services. We believe the medium and long-term fundamentals for this industry remain attractive and see a stabilized environment as the industry works through current excess supply. In addition, we believe projected depletion rates of existing fields and forecasted long-term demand growth will require additional investments. With our long-standing reputation in providing successful solutions for upstream, mid-stream and downstream applications, along with the advancements in our portfolio of offerings, we believe that we continue to be well-positioned to assist our customers in this improving environment. Chemical The chemical industry represented approximately 22% of our bookings in both 2019 and 2018. The chemical industry is comprised of chemical-based and pharmaceutical products. Capital spending in 2019 increased primarily due to global economic growth and forecasted demand for chemical-based products. The aftermarket opportunities remained stable throughout 2019 following increased spending in 2018 due to catch up of deferred spending of our customers' repair and maintenance budgets from previous years. The outlook for the chemical industry remains heavily dependent on global economic conditions. As global economies and unemployment conditions improve, a rise in consumer spending should follow. An increase in spending would drive greater demand for chemical-based products supporting improved levels of capital investment. We believe the chemical industry in the near-term will continue to invest inNorth America andMiddle East capacity additions, maintenance and upgrades for optimization of existing assets and that developing regions will selectively invest in capital infrastructure to meet current and future indigenous demand. We believe our global presence and our localized aftermarket capabilities are well-positioned to serve the potential growth opportunities in this industry. Power Generation The power generation industry represented approximately 11% of our bookings in both 2019 and 2018. In 2019, the power generation industry continued to experience softness in thermal power generation capital spending in the mature and key developing markets.China continued to curtail the construction of new coal-fired power generation over the last year, while inIndia and southeastAsia capital investment remained in place driven by increased demand forecasts. Natural gas-fired combined cycle ("NGCC") plants increased their share of the energy mix, driven by market prices for gas remaining low and stable (partially due to the increasing global availability of liquefied natural gas ("LNG")), low capital expenditures, and the ability of NGCC to stabilize unpredictable renewable sources. With the potential of unconventional sources of gas, the global power generation industry is forecasting an increased use of this form of fuel for power generation plants. Despite fewer new nuclear plants being constructed, nuclear power remains an important contributor to the global energy mix. We continue to support our significant installed base in the global nuclear fleet by providing aftermarket and life extension products and services. Due to our extensive history, we believe we are well positioned to take advantage of this ongoing source of aftermarket and new construction opportunities. Political efforts to limit the emissions of carbon dioxide may have some adverse effect on thermal power investment plans depending on the potential requirements imposed and the timing of compliance by country. However, many proposed methods of capturing and limiting carbon dioxide emissions offer business opportunities for our products and services. At the same time, we continue to take advantage of new investments in concentrated solar power generating capacity, where our pumps, valves, and seals are uniquely positioned for both molten salt applications as well as the traditional steam cycle. We believe the long-term fundamentals for the power generation industry remain solid based on projected increases in demand for electricity driven by global population growth, growth of urbanization in developing markets and the increased use of electricity driven transportation. We also believe that our long-standing reputation in the power generation industry, our portfolio of offerings for the various generating methods, our advancements in serving the renewable energy market and carbon capture methodologies, as well as our global service and support structure, position us well for the future opportunities in this important industry. 28 -------------------------------------------------------------------------------- Water Management The water management industry represented approximately 4% our bookings in both 2019 and 2018. Water management industry activity levels increased in 2019 as worldwide demand for fresh water, water treatment and re-use, desalination and flood control continued to create requirements for new facilities or for upgrades of existing systems, many of which require products that we offer, particularly pumps. Capital and aftermarket spending are on the rise in developed and emerging markets with governments and private industry providing funding for critical projects. The proportion of people living in regions that find it difficult to meet water requirements is expected to double by 2025. We believe that the persistent demand for fresh water during all economic cycles supports continued investments, especially inNorth America and developing regions.General Industries General industries represented, in the aggregate, approximately 22% and 25% of our bookings in 2019 and 2018, respectively. General industries comprise a variety of different businesses, including mining and ore processing, pulp and paper, food and beverage and other smaller applications, none of which individually represented more than 5% of total bookings in 2019 and 2018. General industries also include sales to distributors, whose end customers operate in the industries we primarily serve. Sales to distributors in 2019 were negatively impacted by decreased upstream oil and gas activity inNorth America . The outlook for this group of industries is heavily dependent upon the condition of global economies and consumer confidence levels. The long-term fundamentals of many of these industries remain sound, as many of the products produced by these industries are common staples of industrialized and urbanized economies. We believe that our specialty product offerings designed for these industries and our aftermarket service capabilities will provide continued business opportunities.
OUR RESULTS OF OPERATIONS
Throughout this discussion of our results of operations, we discuss the impact of fluctuations in foreign currency exchange rates. We have calculated currency effects on operations by translating current year results on a monthly basis at prior year exchange rates for the same periods. In the second quarter of 2018, we launched and committed resources to ourFlowserve 2.0 Transformation, a program designed to transform our business model to drive operational excellence, reduce complexity, accelerate growth, improve organizational health and better leverage our existing global platform, which is further discussed in Note 20 to our consolidated financial statements included in Item 8 of this Annual Report. For the year endedDecember 31, 2019 and 2018, we incurredFlowserve 2.0 Transformation related expenses of$28.0 million and$41.2 million , respectively. TheFlowserve 2.0 Transformation expenses incurred primarily consist of professional services, project management and related travel costs recorded in SG&A. 29 -------------------------------------------------------------------------------- In 2015, we initiated Realignment Programs that consist of both restructuring and non-restructuring charges that are further discussed in Note 20 to our consolidated financial statements included in Item 8 of this Annual Report. As ofDecember 31, 2019 , the Realignment Programs are substantially complete and we have incurred charges of$351.7 million to date. The total charges for Realignment Programs andFlowserve 2.0 Transformation by segment are detailed below for the years endedDecember 31, 2019 and 2018:
Subtotal-Reportable Eliminations and
(Amounts in thousands) FPD FCD Segments All Other Consolidated Total Total Realignment and Transformation Program Charges COS$ 12,587 $ 4,395 $ 16,982 $ 255 $ 17,237 SG&A(1) (14,506 ) 774 (13,732 ) 32,467 18,735 Income tax expense(2) (4,000 ) - (4,000 ) - (4,000 ) Total$ (5,919 ) $ 5,169 $ (750 ) $ 32,722 $ 31,972
_________________________
(1) Includes gains from the sales of non-strategic manufacturing facilities that are included in our Realignment Programs. (2) Income tax expense (benefit) includes exit taxes. December 31, 2018 Subtotal-Reportable Eliminations and (Amounts in thousands) FPD FCD Segments All Other Consolidated Total Total Realignment and Transformation Program Charges COS$ 39,477 $ 3,221 $ 42,698 $ - $ 42,698 SG&A 5,910 (294 ) 5,616 46,786 52,402 Income tax expense(1) (1,000 ) - (1,000 ) - (1,000 ) Total$ 44,387 $ 2,927 $ 47,314 $ 46,786 $ 94,100
_________________________
(1) Income tax expense (benefit) includes exit taxes. Bookings and Backlog
2019 2018 2017 (Amounts in millions) Bookings$ 4,238.3 $ 4,019.8 $ 3,803.9
Backlog (at period end) 2,157.0 1,891.6 2,033.4
We define a booking as the receipt of a customer order that contractually engages us to perform activities on behalf of our customer in regard to the manufacture, delivery, and/or support of products or the delivery of service. Bookings recorded and subsequently canceled within the same fiscal period are excluded from reported bookings. Bookings of$4.2 billion in 2019 increased by$218.5 million , or 5.4%, as compared with 2018. The increase included negative currency effects of approximately$108 million . The increase was primarily driven by customer original equipment bookings. The increase was driven by higher bookings in the oil and gas, power generation, chemical and water management industries, partially offset by decreased bookings in the general industries. Bookings in 2018 included approximately$31 million related to the two FPD locations and associated product lines that were divested in the third quarter of 2018.
Bookings of
30 -------------------------------------------------------------------------------- Backlog represents the aggregate value of booked but uncompleted customer orders and is influenced primarily by bookings, sales, cancellations and currency effects. Backlog of$2.2 billion atDecember 31, 2019 increased by$265.4 million , or 14.0%, as compared withDecember 31, 2018 . Currency effects provided an increase of less than$1 million (currency effects on backlog are calculated using the change in period end exchange rates). Backlog related to aftermarket orders was approximately 33% and 36% of the backlog atDecember 31, 2019 and 2018, respectively. We expect to recognize revenue on approximately 88% ofDecember 31, 2019 backlog during 2020. Backlog includes our unsatisfied (or partially unsatisfied) performance obligations related to contracts having an original expected duration in excess of one year of approximately$709 million as discussed in Note 2 to our consolidated financial statements included in Item 8 of this Annual Report. Backlog of$1.9 billion atDecember 31, 2018 decreased by$141.8 million , or 7.0%, as compared withDecember 31, 2017 . Currency effects provided a decrease of approximately$83 million . Backlog related to aftermarket orders was approximately 36% and 31% of the backlog atDecember 31, 2018 and 2017, respectively. We expected to recognize revenue on approximately 89% ofDecember 31, 2018 backlog during 2019. Sales
2019 2018 2017
(Amounts in millions)
Sales
Sales in 2019 increased by$112.2 million , or 2.9%, as compared with 2018. The increase included negative currency effects of approximately$94 million . The increase was more heavily-weighted to aftermarket sales, with increased sales intoNorth America ,Europe andAsia Pacific , partially offset by decreased sales intoLatin America ,Africa and theMiddle East . Sales in 2018 included approximately$30 million related to the two FPD locations and associated product lines that were divested in the third quarter of 2018.
Sales in 2018 increased by
Sales to international customers, including export sales from theU.S. , were approximately 63% of total sales in both 2019 and 2018 and 64% for 2017. Sales intoEurope , theMiddle East andAfrica ("EMA") were approximately 32% of total sales in both 2019 and 2018 and 36% in 2017. Sales intoAsia Pacific were approximately 21% of total sales for 2019, 20% for 2018 and 19% for 2017. Sales intoLatin America were approximately 6% of total sales in 2019, 2018 and 2017. Gross Profit and Gross Profit Margin 2019 2018 2017 (Amounts in millions, except percentages) Gross profit$ 1,295.4 $ 1,187.8 $ 1,089.0 Gross profit margin 32.8 % 31.0 % 29.7 % Gross profit in 2019 increased by$107.6 million , or 9.1%, as compared with 2018. Gross profit margin in 2019 of 32.8% increased from 31.0% in 2018. The increase in gross profit margin was primarily attributed to the favorable impact of revenue recognized on higher margin projects, lower realignment charges associated with our Realignment Programs, improvements in operational efficiency and a$7.7 million charge related to the write-down of inventory in the second quarter of 2018 that did not recur. Aftermarket sales represent approximately 50% of total sales in both 2019 and 2018. Gross profit in 2018 increased by$98.8 million , or 9.1%, as compared with 2017. Gross profit margin in 2018 of 31.0% increased from 29.7% in 2017. The increase in gross profit margin was primarily attributable to a$16.9 million charge for costs related to a contract to supply oil and gas platform equipment to an end user inLatin America in 2017 that did not recur, revenue recognized on higher margin projects, a mix shift to higher margin aftermarket sales, favorable impact of increased sales on our absorption of fixed manufacturing costs and increased savings related to our Realignment Programs, partially offset by a$7.7 million charge for cost incurred related to the write-down of inventory associated with the divestiture of two FPD locations and related product lines in the second quarter of 2018. Aftermarket sales increased to approximately 50% of total sales, as compared with approximately 48% of total sales in 2017. 31 --------------------------------------------------------------------------------
SG&A 2019 2018 2017 (Amounts in millions, except percentages) SG&A$ 899.8 $ 943.7 $ 901.7 SG&A as a percentage of sales 22.8 % 24.6 %
24.6 %
SG&A in 2019 decreased by$43.9 million , or 4.7%, as compared with 2018. Currency effects yielded a decrease of approximately$18 million . In 2019, SG&A as a percentage of sales decreased 180 basis points as compared with the same period in 2018 primarily due to lower charges related to ourFlowserve 2.0 Transformation and Realignment Programs, decreased broad-based annual incentive compensation expense, gains from the sales of non-strategic manufacturing facilities during the year, favorable impacts resulting from the 2018 divestiture of two FPD locations and a$9.7 million impairment charge related to long-lived assets in the second quarter of 2018 that did not recur. SG&A in 2018 increased by$42.0 million , or 4.7%, as compared with 2017. Currency effects yielded an increase of approximately$7 million . In 2018, SG&A as a percentage of sales remained relatively unchanged as compared with 2017. SG&A was favorably impacted by increased sales leverage, a$26.0 million impairment charge related to our manufacturing facility inBrazil in 2017 that did not recur, lower stock-based compensation expense, lower bad debt expense and lower charges and increased savings related to our Realignment Programs. These favorable cost impacts were substantially offset by charges related to theFlowserve 2.0 Transformation program, implementation costs associated with our adoption of the New Revenue Standard, increased accrued broad-based annual incentive compensation expense and an impairment charge of$9.7 million related to the long-lived assets associated with the divestiture of two FPD locations and related product lines in the second quarter of 2018. (Loss) Gain on Sale of Businesses 2019 2018 2017 (Amounts in millions)
(Loss) gain on sale of businesses $ -
The loss on sale of businesses in 2018 of$7.7 million resulted from the divestiture of two FPD locations and related product lines. The gain on sale of businesses in 2017 was the result of the$141.3 million gain from the sales of the Gestra and Vogt businesses. See Note 3 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on these sales. Net Earnings from Affiliates 2019 2018 2017 (Amounts in millions)
Net earnings from affiliates
Net earnings from affiliates represents our net income from investments in six joint ventures (one located in each ofChile ,China ,India ,Saudi Arabia ,South Korea and theUnited Arab Emirates ) that are accounted for using the equity method of accounting. Net earnings from affiliates in 2019 decreased by$0.6 million , or 5.4%, as compared to the prior year, primarily as a result of decreased earnings of our FPD joint venture inIndia . Net earnings from affiliates in 2018 decreased by$1.5 million , or 11.9%, as compared to the prior year, primarily as a result of decreased earnings of our FPD joint venture inSouth Korea . Operating Income 2019 2018 2017 (Amounts in millions, except percentages) Operating income$ 406.0 $ 247.5 $ 341.1 Operating income as a percentage of sales 10.3 % 6.5 % 9.3 % 32
-------------------------------------------------------------------------------- Operating income in 2019 increased by$158.5 million , or 64.0%, as compared with 2018. The increase included negative currency effects of approximately$12 million . The increase was primarily a result of the$107.6 million increase in gross profit, the$43.9 million decrease in SG&A and the loss of$7.7 million from the divestiture of two FPD locations and related product lines in the third quarter of 2018 that did not recur. Operating income in 2018 decreased by$93.6 million , or 27.4%, as compared with 2017. The decrease included currency benefits of approximately$2 million . The decrease was primarily a result of the$141.3 million gain from the sales of the Gestra and Vogt businesses in 2017 that did not recur, the$42.0 million increase in SG&A and the loss of$7.7 million from the divestiture of two FPD locations and related product lines, partially offset by the$98.8 million increase in gross profit discussed above.
Interest Expense and Interest Income
2019 2018 2017 (Amounts in millions)
Interest expense
Interest expense in 2019 decreased by$3.2 million as compared with 2018. The decrease was primarily attributable to lower borrowings in 2019 and currency impacts on interest expense associated with our outstanding Euro-denominated senior notes, as compared to the same period in 2018. Interest income in 2019 increased by$1.9 million as compared to 2018 . The increase in interest income was primarily attributable to higher average cash balances compared with same period in 2018. Interest expense in 2018 decreased by$1.5 million as compared with 2017. The decrease was primarily attributable to lower borrowings in 2018, as compared to the same period in 2017. Interest income in 2018 increased by$3.1 million as compared with 2017. The increase in interest income was primarily attributable to higher average cash balances compared with 2017. Other Income (Expense), net 2019 2018 2017 (Amounts in millions)
Other income (expense), net
Other expense, net decreased$2.0 million as compared to 2018, due to a$7.6 million decrease in losses from transactions in currencies other than our sites' functional currencies, partially offset by a$3.3 million increase in losses from foreign exchange contracts. The net change was primarily due to the foreign currency exchange rate movements in the Euro, Indian rupee,Singapore dollar and Mexican peso in relation to theU.S. dollar during the year endedDecember 31, 2019 , as compared with the same period in 2018. Other expense, net decreased$2.2 million in 2018, due to a$6.4 million decrease in net periodic benefit costs for pensions and post retirement obligations, partially offset by a$5.3 million increase in losses from foreign exchange contracts. The net change was primarily due to the foreign currency exchange rate movements in the Euro, Indian rupee, Mexican peso and Argentinian peso in relation to theU.S. dollar during the year endedDecember 31, 2018 , as compared with the same period in 2017. Tax Expense and Tax Rate 2019 2018 2017 (Amounts in millions, except percentages) Provision for income taxes$ 80.1 $ 51.2 $ 258.7 Effective tax rate 23.4 % 29.1 % 98.4 % 33
-------------------------------------------------------------------------------- OnDecember 22, 2017 , theU.S. enacted the 2017 the Tax Cuts and Jobs Act of 2017 ("Tax Reform Act"), which significantly changedU.S. tax law. The Tax Reform Act, among other things, lowered the Company'sU.S. statutory federal income tax rate from 35% to 21% effectiveJanuary 1, 2018 , while imposing a deemed repatriation tax on deferred foreign income and implementing a modified territorial tax system. The Tax Reform Act also provides for a one-time transition tax on certain foreign earnings and the acceleration of depreciation for certain assets placed into service afterSeptember 27, 2017 as well as prospective changes which began in 2018, including repeal of the domestic manufacturing deduction, capitalization of research and development expenditures, additional limitations on executive compensation and limitations on the deductibility of interest. Our effective tax rate of 23.4% for the year endedDecember 31, 2019 decreased from 29.1% in 2018 primarily due to the net impact of foreign operations. The 2019 tax rate differed from the federal statutory rate of 21% primarily due to state tax and foreign audit assessments, partially offset by the net impact of foreign operations. The 2018 tax rate differed from the federal statutory rate of 21% primarily due to the net impact of foreign operations, including losses in certain foreign jurisdictions for which no tax benefit was provided. The 2017 tax rate differed from the federal statutory rate of 35% primarily due to the impacts pursuant to enactment of the Tax Reform Act, the net impact of foreign operations, the establishment of a valuation allowance against our deferred tax assets in various foreign jurisdictions, primarilyGermany andMexico , and taxes related to the sale of the Gestra and Vogt businesses. Our effective tax rate is based upon current earnings and estimates of future taxable earnings for each domestic and international location. Changes in any of these and other factors, including our ability to utilize foreign tax credits and net operating losses or results from tax audits, could impact the tax rate in future periods. As ofDecember 31, 2019 , we have foreign tax credits of$29.1 million , expiring in 2026, 2028 and 2029 tax years, against which we recorded a valuation allowance of$29.1 million . Additionally, we have recorded other net deferred tax assets of$55.0 million , which relate to net operating losses, tax credits and other deductible temporary differences that are available to reduce taxable income in future periods, most of which do not have a definite expiration. Should we not be able to utilize all or a portion of these credits and losses, our effective tax rate would increase. Net Earnings and Earnings Per Share 2019 2018 2017 (Amounts in millions, except per share amounts) Net earnings attributable to Flowserve Corporation $ 253.7$ 119.7 $ 2.7 Net earnings per share - diluted $ 1.93$ 0.91 $ 0.02 Average diluted shares 131.7 131.3 131.4 Net earnings in 2019 increased by$134.0 million to$253.7 million , or to$1.93 per diluted share, as compared with 2018. The increase was primarily attributable to an increase in operating income of$158.5 million , a$2.0 million decrease in other expense, net and a$5.1 million decrease in interest expense, net, partially offset by a$28.9 million increase in tax expense. Net earnings in 2018 increased by$117.0 million to$119.7 million , or to$0.91 per diluted share, as compared with 2017. The increase was primarily attributable to a$207.5 million decrease in tax expense, a$2.2 million decrease in other expense net, and a$1.5 million decrease in interest expense, partially offset by a decrease in operating income of$93.6 million . Other Comprehensive Income (Loss) 2019 2018 2017 (Amounts in millions)
Other comprehensive income (loss)
Other comprehensive loss in 2019 decreased by$58.0 million as compared with 2018. The decreased loss was primarily due to foreign currency translation adjustments resulting primarily from exchange rate movements of the Euro, British pound, Chinese yuan and Indian rupee versus theU.S. dollar atDecember 31, 2019 as compared with 2018. Other comprehensive loss in 2018 increased by$187.6 million to$67.8 million from income of$119.8 million in 2017. The loss was primarily due to foreign currency translation adjustments resulting primarily from exchange rate movements 34 -------------------------------------------------------------------------------- of the Euro, Argentinian peso, Indian rupee and British pound versus theU.S. dollar atDecember 31, 2018 as compared with 2017. Business Segments We conduct our operations through two business segments based on type of product and how we manage the business. We evaluate segment performance and allocate resources based on each segment's operating income. See Note 18 to our consolidated financial statements included in Item 8 of this Annual Report for further discussion of our segments. The key operating results for our two business segments, FPD and FCD, are discussed below. Flowserve Pump Division Segment Results Our largest business segment is FPD, through which we design, manufacture, pre-test, distribute and service specialty and highly-engineered custom and pre-configured pumps and pump systems, mechanical seals and auxiliary systems (collectively referred to as "original equipment"). FPD includes longer lead time, highly-engineered pump products and mechanical seals that are generally manufactured within shorter lead times. FPD also manufactures replacement parts and related equipment and provides aftermarket services. FPD primarily operates in the oil and gas, petrochemical, chemical, power generation, water management and general industries. FPD operates in 49 countries with 39 manufacturing facilities worldwide, 13 of which are located inEurope , 12 inNorth America , eight inAsia Pacific and six inLatin America , and we have 144 QRCs, including those co-located in manufacturing facilities and/or shared with FCD. FPD 2019 2018 2017 (Amounts in millions, except percentages) Bookings$ 3,007.9 $ 2,753.5 $ 2,587.4 Sales 2,706.3 2,623.3 2,478.7 Gross profit 899.3 775.7 692.1 Gross profit margin 33.2 % 29.6 % 27.9 % SG&A 566.3 578.9 593.0 Loss on sale of business - (7.7 ) - Segment operating income 343.5 201.0 112.3
Segment operating income as a percentage of sales 12.7 %
7.7 % 4.5 % Backlog (at period end) 1,560.9
1,286.2 1,421.8
Bookings in 2019 increased by$254.4 million , or 9.2%, as compared with 2018. The increase included negative currency effects of approximately$79 million . Bookings in 2018 included approximately$31 million related to the two FPD locations and associated product lines that were divested in the third quarter of 2018. The increase in customer bookings was primarily driven by the oil and gas, chemical and power generation industries, partially offset by decreased bookings in the general industries. Increased customer bookings of$100.4 million intoNorth America ,$78.1 million into theMiddle East ,$72.1 million intoAsia Pacific ,$18.6 million inLatin America and$11.5 million intoAfrica , were partially offset by decreased customer bookings of$49.9 million intoEurope . The increase was primarily driven by customer original equipment bookings. Of the$3.0 billion of bookings in 2019, approximately 44% were from oil and gas, 22% from general industries, 19% from chemical, 10% from power generation and 5% from water management. Bookings in 2018 increased by$166.1 million , or 6.4%, as compared with 2017 and included an order for approximately$80 million to provide pumps and related equipment for theHengli Integrated Refining Complex Project inChina , and was partially offset by approximately$23 million in reduced bookings due to the divestiture of two FPD locations and related product lines in the third quarter of 2018. The increase included currency benefits of approximately$19 million . The increase in customer bookings was primarily driven by the oil and gas, general and chemical industries. Customer bookings increased$91.4 million intoEurope ,$61.7 million into theMiddle East ,$43.6 million intoNorth America and$3.4 million intoLatin America and were partially offset by decreased customer bookings of$18.7 million intoAfrica and$5.1 million intoAsia Pacific . The increase was primarily in aftermarket bookings. Of the$2.8 billion of bookings in 2018, approximately 41% were from oil and gas, 25% from general industries, 18% from chemical, 11% from power generation and 5% from water management. 35 -------------------------------------------------------------------------------- Sales in 2019 increased$83.0 million , or 3.2%, as compared with 2018. The increase included negative currency effects of approximately$66 million . Sales in 2018 included approximately$30 million related to the two FPD locations and associated product lines that were divested in the third quarter of 2018. The increase was primarily driven by aftermarket sales, resulting from increased customer sales of$45.3 million intoNorth America ,$28.6 million intoEurope ,$16.8 million into theMiddle East and$8.8 million intoAfrica , partially offset by decreased sales of$17.8 million intoLatin America and$4.0 million intoAsia Pacific . Sales in 2018 increased$144.6 million , or 5.8%, as compared with 2017. The increase included currency benefits of approximately$23 million and was partially offset by approximately$19 million in reduced sales due to the divestiture of two FPD locations and related product lines in the third quarter of 2018. The increase was more heavily-weighted towards aftermarket sales, resulting from increased customer sales of$69.9 million intoNorth America ,$58.4 million intoAsia Pacific ,$55.8 million intoAfrica and$50.9 million intoLatin America , partially offset by decreased sales of$82.4 million into theMiddle East and$2.6 million intoEurope . Gross profit in 2019 increased by$123.6 million , or 15.9%, as compared with 2018. Gross profit margin in 2019 of 33.2% increased from 29.6% in 2018. The increase in gross profit margin was primarily attributable to revenue recognized on higher margin projects, lower realignment charges associated with our Realignment Programs, sales mix shift to higher margin aftermarket sales, improvements in operational efficiency and a$7.7 million charge related to the write-down of inventory in the second quarter of 2018 that did not recur. Gross profit in 2018 increased by$83.6 million , or 12.1%, as compared with 2017. Gross profit margin in 2018 of 29.6% increased from 27.9% in 2017. The increase in gross profit margin was primarily attributable to the favorable impact of increased sales on our absorption of fixed manufacturing costs, a$16.9 million charge for costs related to a contract to supply oil and gas platform equipment to an end user inLatin America in 2017 that did not recur, lower charges and increased savings related to our Realignment Programs and revenue recognized on higher margin projects, partially offset by a$7.7 million charge for cost incurred related to the write-down of inventory associated with the divestiture of two FPD locations and related product lines. SG&A in 2019 decreased by$12.6 million , or 2.2%, as compared with 2018. Currency effects provided a decrease of approximately$13 million . The decrease in SG&A, including currency, was due to favorable impacts on SG&A due to gains from the sales of non-strategic manufacturing facilities during the year, the 2018 divestiture of two FPD locations and a$9.7 million impairment charge related to the long-lived assets in the second quarter of 2018 that did not recur, substantially offset by an increase in selling-related expenses and collections of previously reserved bad debts in 2018 that did not recur. SG&A in 2018 decreased by$14.1 million , or 2.4%, as compared with 2017. Currency effects provided an increase of approximately$5 million . The decrease in SG&A was primarily attributable to a$26.0 million impairment charge related to our manufacturing facility inBrazil in 2017 that did not recur, lower bad debt expense and decreased charges related to our Realignment Programs, partially offset by higher selling and administrative related expenses and an impairment charge on long-lived assets related to the divestiture of two FPD locations and related product lines of$9.7 million . The loss on sale of businesses in 2018 of$7.7 million resulted from the divestiture of two FPD locations and related product lines. Refer to Note 3 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on this divestiture. Operating income in 2019 increased by$142.5 million , or 70.9%, as compared with 2018. The increase included negative currency effects of approximately$10 million . The increase was due to the$123.6 million increase in gross profit, the$12.6 million decrease in SG&A and the$7.7 million loss from the divestiture of two FPD locations and related product lines in the third quarter of 2018 that did not recur. Operating income in 2018 increased by$88.7 million , or 79.0%, as compared with 2017. The increase included negative currency effects of approximately$1 million . The increase was due to the$83.6 million increase in gross profit and the$14.1 million decrease in SG&A, partially offset by the$7.7 million loss from the divestiture of two FPD locations and related product lines in the third quarter of 2018 that did not recur. Backlog of$1.6 billion atDecember 31, 2019 increased by$274.7 million , or 21.4%, as compared withDecember 31, 2018 . Currency effects provided an increase of approximately$5 million . Backlog of$1.3 billion atDecember 31, 2018 decreased by$135.6 million , or 9.5%, as compared withDecember 31, 2017 . Currency effects provided a decrease of approximately$66 million . 36 -------------------------------------------------------------------------------- Flow Control Division Segment Results FCD designs, manufactures, distributes and services a broad portfolio of engineered and industrial valve and automation solutions, including isolation and control valves, actuation, controls and related equipment. FCD leverages its experience and application know-how by offering a complete menu of engineering and project management services to complement its expansive product portfolio. FCD has a total of 49 manufacturing facilities and QRCs in 22 countries around the world, with five of its 21 manufacturing operations located in theU.S. , 10 located inEurope , five located inAsia Pacific and one located inLatin America . We believe that FCD is the second largest industrial valve supplier in the world. FCD 2019 2018 2017 (Amounts in millions, except percentages) Bookings$ 1,240.9 $ 1,274.3 $ 1,225.7 Sales 1,244.0 1,215.8 1,188.1 Gross profit 411.6 416.9 396.7 Gross profit margin 33.1 % 34.3 % 33.4 % SG&A 213.6 215.0 213.6 Gain on sale of businesses - - 141.3 Segment operating income 198.0 201.2 323.7
Segment operating income as a percentage of sales 15.9 %
16.5 % 27.2 % Backlog (at period end) 600.1 608.4 617.4 Bookings in 2019 decreased$33.4 million , or 2.6%, as compared with 2018. The decrease included negative currency effects of approximately$29 million . The decrease in customer bookings in the general and chemical industries were partially offset by increases in the power generation, oil and gas and water management industries. Decreased customer bookings of$27.3 million intoNorth America ,$8.2 million intoAsia Pacific and$2.6 million intoEurope were partially offset by increased bookings of$24.1 million into theMiddle East . The decrease was more heavily weighted towards customer aftermarket bookings. Of the$1.2 billion of bookings in 2019, approximately 34% were from oil and gas, 29% from chemical, 24% from general industries and 13% from power generation. Bookings in 2018 increased$48.6 million , or 4.0%, as compared with 2017. The increase included currency benefits of approximately$11 million . The increase in customer bookings in the general, oil and gas and chemical industries were partially offset by decreases in the power generation and water management industries. Increased customer bookings of$78.7 million intoNorth America and$17.4 million intoAsia Pacific were partially offset by decreased bookings of$27.7 million intoEurope and$18.0 million into theMiddle East . The increase was driven by both customer original equipment and aftermarket bookings. Of the$1.3 billion of bookings in 2018, approximately 33% were from oil and gas, 29% from chemical, 27% from general industries and 11% from power generation. Sales in 2019 increased by$28.2 million , or 2.3%, as compared with 2018. The increase included negative currency effects of approximately$28 million and was driven by increased customer original equipment sales. Sales increased$40.2 million intoAsia Pacific ,$17.6 million intoEurope ,$6.5 million intoLatin America and$3.5 million intoNorth America and were partially offset by decreased customer sales of$23.5 million into theMiddle East and$15.9 million intoAfrica . Sales in 2018 increased by$27.7 million , or 2.3%, as compared with 2017. The increase included currency benefits of approximately$8 million and was driven by increased customer original equipment sales. Sales increased$62.4 million intoNorth America ,$40.1 million intoAsia Pacific and$7.9 million intoAfrica and were partially offset by a decrease in customer sales of$46.0 million intoEurope ,$25.1 million into theMiddle East and$10.8 million intoLatin America . Gross profit in 2019 decreased by$5.3 million , or 1.3%, as compared with 2018. Gross profit margin in 2019 of 33.1% decreased from 34.3% in 2018. The decrease in gross profit margin was primarily attributed to a mix shift to more original equipment sales and revenue recognized on lower margin original equipment orders as compared to the same period in 2018. Gross profit in 2018 increased by$20.2 million , or 5.1%, as compared with 2017. Gross profit margin in 2018 of 34.3% increased from 33.4% in 2017. The increase in gross profit margin was primarily attributable to the positive impact of increased sales on our absorption of fixed manufacturing costs and decreased charges and increased savings achieved related to our Realignment Programs compared to the same period in 2017. 37 -------------------------------------------------------------------------------- SG&A in 2019 decreased by$1.4 million , or 0.7% as compared with 2018. Currency effects provided a decrease of approximately$4 million . The decrease in SG&A was primarily due to currency effects as compared to 2018. SG&A in 2018 increased by$1.4 million , or 0.7%, as compared with 2017. Currency effects provided an increase of approximately$2 million . The increase in SG&A was primarily due to higher selling and administrative related expenses, partially offset by lower charges and increased savings related to our Realignment Programs compared to 2017. The gain on sale of businesses in 2017 was the result of the$141.3 million gain from the sales of the Gestra and Vogt businesses. See Note 3 to our consolidated financial statements included in Item 8 of this Annual Report for additional information on these sales. Operating income in 2019 decreased by$3.2 million , or 1.6%, as compared with 2018. The decrease included negative currency effects of approximately$3 million . The decrease was primarily due to the$5.3 million decrease in gross profit, partially offset by the decrease in SG&A of$1.4 million . Operating income in 2018 decreased by$122.5 million , or 37.8%, as compared with 2017. The decrease included negative currency effects of approximately$1 million . The decrease was due to the$141.3 million gain from the sales of the Gestra and Vogt businesses in 2017, which was partially offset by the$20.2 million increase in gross profit Backlog of$600.1 million atDecember 31, 2019 decreased by$8.3 million , or 1.4%, as compared withDecember 31, 2018 . Currency effects provided a decrease of approximately$5 million . Backlog of$608.4 million atDecember 31, 2018 decreased by$9.0 million , or 1.5%, as compared withDecember 31, 2017 . Currency effects provided a decrease of approximately$17 million . LIQUIDITY AND CAPITAL RESOURCES Cash Flow Analysis 2019 2018 2017 (Amounts in millions)
Net cash flows provided (used) by operating activities
$ 311.1 Net cash flows provided (used) by investing activities (23.8 ) (81.5 ) 176.6 Net cash flows provided (used) by financing activities (229.7 ) (173.3 ) (185.4 ) Existing cash, cash generated by operations and borrowings available under our senior credit facility are our primary sources of short-term liquidity. We monitor the depository institutions that hold our cash and cash equivalents on a regular basis, and we believe that we have placed our deposits with creditworthy financial institutions. Our sources of operating cash generally include the sale of our products and services and the conversion of our working capital, particularly accounts receivable and inventories. Our total cash balance atDecember 31, 2019 was$671.0 million , compared with$619.7 million atDecember 31, 2018 and$703.4 million atDecember 31, 2017 . Our cash provided by operating activities was$312.7 million ,$190.8 million and$311.1 million in 2019, 2018 and 2017, respectively, which provided cash to support short-term working capital needs. Cash flow used by working capital increased in 2019 due primarily to cash used by higher contract assets of$45.9 million and higher inventory of$31.1 million , partially offset by higher accounts payable of$22.9 million , higher accrued liabilities and income taxes payable of$4.2 million , higher contract liabilities of$14.4 million and lower accounts receivable of$2.9 million . Cash flow used by working capital increased in 2018 due primarily to cash used by higher inventory of$29.3 million , higher accounts receivables of$25.4 million , higher contract assets of$23.7 million and lower accrued liabilities and income taxes payable of$18.2 million , partially offset by cash provided by higher contract liabilities of$33.7 million . During 2019, we contributed$37.3 million to our defined benefit pension plans as compared to$48.1 million in 2018. Decreases in accounts receivable provided$2.9 million of cash flow in 2019, as compared with cash flow used of$25.4 million in 2018 and cash flow provided of$60.2 million in 2017, respectively. For the fourth quarter of 2019 our days' sales outstanding ("DSO") was 67 days as compared to 72 days for 2018 and 75 days for 2017. We have not experienced a significant increase in customer payment defaults in 2019. 38 -------------------------------------------------------------------------------- Increases in inventory used$31.1 million of cash flow in 2019 as compared with$29.3 million in 2018 and cash provided of$48.6 million in 2017. The use of cash from inventory in 2019 was primarily due to an increase in raw materials and work in process and in 2018 the cash used was due to decreased progress billings. Inventory turns were 4.3 times atDecember 31, 2019 , as compared with 4.2 times for 2018 and 3.3 times for 2017. Our calculation of inventory turns does not reflect the impact of advanced cash received from our customers. Increases in contract assets used$45.9 million of cash flow and increases in contact liabilities provided$14.4 million of cash flow in 2019. Increases in contract assets used$23.7 million of cash flow and increases in contact liabilities provided$33.7 million of cash flow in 2018. Increases in accounts payable provided$22.9 million of cash flow in 2019 compared with cash used of$4.8 million in 2018 and cash provided of$12.4 million in 2017. Increases in accrued liabilities and income taxes payable provided$4.2 million of cash flow in 2019 compared with cash used of$18.2 million and$3.4 million in 2018 and 2017, respectively. Cash used by investing activities were$23.8 million in 2019, as compared to$81.5 million in 2018 and cash provided of$176.6 million in 2017. The decrease of cash used in 2019 was primarily due to a decrease in capital expenditures and proceeds from the disposal of assets during the year which provided$42.3 million , primarily from the sale of non-strategic manufacturing facilities that are included in our Realignment Programs. Capital expenditures were$66.2 million ,$84.0 million and$61.6 million in 2019, 2018 and 2017, respectively. In 2020, we currently estimate capital expenditures to be between$90 million and$100 million before consideration of any acquisition activity. Cash used by financing activities were$229.7 million in 2019 compared to$173.3 million and$185.4 million in 2018 and 2017, respectively. Cash outflows during 2019 resulted primarily from the$105.0 million in payments on long-term debt,$99.6 million of dividend payments and the repurchase of$15.0 million of our common stock. Cash outflows during 2018 resulted primarily from$99.4 million of dividend payments and$60.0 million in payments on long-term debt. Cash outflows during 2017 resulted primarily from$99.2 million of dividend payments and$60.0 million in payments on long-term debt. In 2019 we repurchased 324,889 shares of our outstanding common stock for$15.0 million . As ofDecember 31, 2019 , we had$145.7 million of remaining capacity under our share repurchase plan previously approved by the Board of Directors. Our cash needs for the next 12 months are expected to be lower than those of 2019 due to our Realignment Programs being substantially completed and anticipated benefits from working capital reductions. We believe cash flows from operating activities, combined with availability under our senior credit facility and our existing cash balances, will be sufficient to enable us to meet our cash flow needs for the next 12 months. However, cash flows from operations could be adversely affected by a decrease in the rate of general global economic growth and an extended decrease in capital spending of our customers, as well as economic, political and other risks associated with sales of our products, operational factors, competition, regulatory actions, fluctuations in foreign currency exchange rates and fluctuations in interest rates, among other factors. We believe that cash flows from operating activities and our expectation of continuing availability to draw upon our credit agreements are also sufficient to meet our cash flow needs for periods beyond the next 12 months. Acquisitions and Dispositions We regularly evaluate acquisition opportunities of various sizes. The cost and terms of any financing to be raised in conjunction with any acquisition, including our ability to raise economical capital, is a critical consideration in any such evaluation. Note 3 to our consolidated financial statements included in Item 8 of this Annual Report contains a discussion of our disposition activity. Financing Our credit agreement provides for a$800.0 million unsecured senior credit facility with a maturity date ofJuly 16, 2024 ("Senior Credit Facility"). The Senior Credit Facility includes a$750.0 million sublimit for the issuance of letters of credit and a$30.0 million sublimit for swing line loans. We have the right to increase the amount of the Senior Credit Facility by an aggregate amount not to exceed$400.0 million , subject to certain conditions, including each Lender's approval providing any increase. The interest rates per annum applicable to the Senior Credit Facility (other than with respect to swing line loans) are LIBOR plus between 1.000% to 1.750%, depending on our debt rating by eitherMoody's Investors Service, Inc. orStandard & Poor's ("S&P") Ratings, or, at our option, the Base Rate (as defined in the Senior Credit Agreement) plus between 0.000% to 0.750% depending on our debt rating by eitherMoody's Investors Service, Inc. or S&P Global Ratings. AtDecember 31 , 39 -------------------------------------------------------------------------------- 2019 the interest rate on the Senior Credit Facility was LIBOR plus 1.375% in the case of LIBOR loans and the Base Rate plus 0.375% in the case of Base Rate loans. In addition, a commitment fee is payable quarterly in arrears on the daily unused portions of the Senior Credit Facility. The commitment fee will be between 0.090% and 0.300% of unused amounts under the Senior Credit Facility depending on our debt rating by eitherMoody's Investors Service, Inc. or S&P's Ratings. Certain financing arrangements contain provisions that may result in an event of default if there was a failure under other financing arrangements to meet payment terms. Such provisions are referred to as "cross default" provisions. A discussion of our debt and related covenants is included in Note 12 to our consolidated financial statements included in Item 8 of this Annual Report. We were in compliance with the covenants as ofDecember 31, 2019 . Liquidity Analysis Our cash balance increased by$51.3 million to$671.0 million as ofDecember 31, 2019 as compared withDecember 31, 2018 . The cash increase included$312.7 million in operating cash inflows and$42.3 million from the sale of non-strategic manufacturing facilities that are included in our Realignment Programs, partially offset by$105.0 million in payments on long-term debt,$99.6 million in dividend payments,$66.2 million in capital expenditures and the repurchase of$15.0 million of our common stock. AtDecember 31, 2019 and 2018, as a result of the values of the plan's assets and our contributions to the plan, ourU.S. pension plan was fully-funded as defined by applicable law. After consideration of our intent to maintain fully funded status, we contributed$20.0 million to ourU.S. pension plan in 2019, excluding direct benefits paid of$0.6 million . We continue to maintain an asset allocation consistent with our strategy to maximize total return, while reducing portfolio risks through asset class diversification. OUTLOOK FOR 2020 Our future results of operations and other forward-looking statements contained in this Annual Report, including this MD&A, involve a number of risks and uncertainties - in particular, the statements regarding our goals and strategies, new product introductions, plans to cultivate new businesses, future economic conditions, revenue, pricing, gross profit margin and costs, capital spending, expected cost savings from our transformation and realignment programs, global economic and political risk, depreciation and amortization, research and development expenses, potential impairment of assets, tax rate and pending tax and legal proceedings. Our future results of operations may also be affected by employee incentive compensation including our annual program and the amount, type and valuation of share-based awards granted, as well as the amount of awards forfeited due to employee turnover. In addition to the various important factors discussed above, a number of other factors could cause actual results to differ materially from our expectations. See the risks described in "Item 1A. Risk Factors" as well as the section titled "Forward-Looking Information is Subject to Risk and Uncertainty" of this Annual Report. Our bookings were$4,238.3 million during 2019. Because a booking represents a contract that can be, in certain circumstances, modified or canceled, and can include varying lengths between the time of booking and the time of revenue recognition, there is no guarantee that bookings will result in comparable revenues or otherwise be indicative of future results. We expect a continued competitive economic environment in 2020. We anticipate benefits from the continuation of ourFlowserve 2.0 Transformation efforts, end-user strategies, the strength of our high margin aftermarket business, continued disciplined cost management, our diverse customer base, our broad product portfolio and our unified operating platform. Similar to prior years, we expect our results will be weighted towards the second half of the year. While we believe that our primary markets continue to provide opportunities, we remain cautious in our outlook for 2020 given the continuing uncertainty of capital spending in many of our markets as well as economic and political risk associated with our international operations which could have a negative effect on global economic conditions. OnDecember 31, 2019 , we had$1,354.1 million of fixed-rate Senior Notes outstanding. We expect our interest expense in 2020 will be modestly lower compared with amounts incurred in 2019. Our results of operations may also be impacted by unfavorable foreign currency exchange rate movements. See "Item 7A. Quantitative and Qualitative Disclosures about Market Risk" of this Annual Report. We expect to generate sufficient cash from operations and have sufficient capacity under our Senior Credit Facility to fund our working capital, capital expenditures, dividend payments, share repurchases, debt payments and pension plan contributions in 2020. The amount of cash generated or consumed by working capital is dependent on our level of revenues, customer cash advances, backlog, customer-driven delays and other factors. We will seek to improve our working capital utilization, with a particular focus on improving the management of accounts receivable and inventory. In 2020, our cash flows for investing activities will be focused on strategic initiatives, information technology infrastructure, general upgrades 40 -------------------------------------------------------------------------------- and cost reduction opportunities and we currently estimate capital expenditures to be between$90 million and$100 million , before consideration of any acquisition activity. We currently anticipate that our minimum contribution to our qualifiedU.S. pension plan will be approximately$20 million , excluding direct benefits paid, in 2020 in order to maintain fully-funded status as defined by applicable law. We currently anticipate that our contributions to our non-U.S. pension plans will be approximately$2 million in 2020, excluding direct benefits paid. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following table presents a summary of our contractual obligations atDecember 31, 2019 : Payments Due By Period Beyond 5 Within 1 Year 1-3 Years 3-5 Years Years Total (Amounts in millions) Senior Notes $ -$ 1,055.9 $ 298.2 $ -$ 1,354.1 Fixed interest payments(1) 36.5 62.3 10.5 - 109.3 Other debt 11.3 11.8 - - 23.1 Leases: Operating 42.2 83.3 18.2 84.7 228.4 Finance 4.9 7.2 0.3 0.1 12.5 Purchase obligations:(2) Inventory 496.3 8.9 0.2 - 505.4 Non-inventory 48.0 0.2 0.3 - 48.5 Pension and postretirement benefits(3) 61.7 125.1 125.3 300.7 612.8 Total $ 700.9$ 1,354.7 $ 453.0 $ 385.5 $ 2,894.1
_______________________________________
(1) Fixed interest payments represent interest payments on the Senior Notes as
defined in Note 12 to our consolidated financial statements included in
Item 8 of this Annual Report.
(2) Purchase obligations are presented at the face value of the purchase order,
excluding the effects of early termination provisions. Actual payments could
be less than amounts presented herein.
(3) Retirement and postretirement benefits represent estimated benefit payments
for our
medical plans, as more fully described below and in Note 13 to our
consolidated financial statements included in Item 8 of this Annual Report.
As ofDecember 31, 2019 , the gross liability for uncertain tax positions was$40.6 million . We do not expect a material payment related to these obligations to be made within the next twelve months. We are unable to provide a reasonably reliable estimate of the timing of future payments relating to the uncertain tax positions. The following table presents a summary of our commercial commitments atDecember 31, 2019 : Commitment Expiration By Period Beyond 5 Within 1 Year 1-3 Years 3-5 Years Years Total (Amounts in millions) Letters of credit$ 343,407 $ 148,665 $ 14,050 $ 52,395 $ 558,517 Surety bonds 70,445 11,889 196 3,526 86,056 Total$ 413,852 $ 160,554 $ 14,246 $ 55,921 $ 644,573
We expect to satisfy these commitments through performance under our contracts.
PENSION AND POSTRETIREMENT BENEFITS OBLIGATIONS Plan Descriptions 41 -------------------------------------------------------------------------------- We and certain of our subsidiaries have defined benefit pension plans and defined contribution plans for full-time and part-time employees. Approximately 65% of total defined benefit pension plan assets and approximately 53% of defined benefit pension obligations are related to theU.S. qualified plan as ofDecember 31, 2019 . Unless specified otherwise, the references in this section are to all of ourU.S. and non-U.S. plans. None of our common stock is directly held by these plans. OurU.S. defined benefit plan assets consist of a balanced portfolio of equity and fixed income securities. Our non-U.S. defined benefit plan assets include a significant concentration ofUnited Kingdom ("U.K.") fixed income securities, as discussed in Note 13 to our consolidated financial statements included in Item 8 of this Annual Report. We monitor investment allocations and manage plan assets to maintain an acceptable level of risk. AtDecember 31, 2019 , the estimated fair market value ofU.S. and non-U.S. plan assets for our defined benefit pension plans increased to$745.1 million from$658.0 million atDecember 31, 2018 . Assets were allocated as follows: U.S. Plan Asset category 2019 2018 Cash and Cash Equivalents 1 % 1 % Global Equity 28 % 30 % Global Real Assets 12 % 13 % Equity securities 40 % 43 % Diversified Credit 12 % 13 % Liability-Driven Investment 47 % 43 % Fixed income 59 % 56 % Non-U.S. Plans Asset category 2019 2018 Cash and Cash Equivalents 2 % 7 % North American Companies 1 % 3 % Global Equity 1 % 2 % Equity securities 2 % 5 % U.K. Government Gilt Index 43 % 43 % Global Fixed Income Bond - % 2 % Liability-Driven Investment 7 % 9 % Fixed income 50 % 54 % Multi-asset 19 % 19 % Buy-in Contract 21 % 10 % Other 6 % 5 % Other types 46 % 34 % The projected benefit obligation ("Benefit Obligation") for our defined benefit pension plans was$897.1 million and$809.2 million as ofDecember 31, 2019 and 2018, respectively. Benefits under our defined benefit pension plans are based primarily on participants' compensation and years of credited service. The estimated prior service cost and the estimated actuarial net loss for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net pension expense in 2020 is approximately$0.5 million and$10.9 million , respectively. We amortize any estimated net gains or losses over the remaining expected service period or over the remaining expected lifetime for plans with only inactive participants. We sponsor defined benefit postretirement medical plans covering certain current retirees and a limited number of future retirees in theU.S. These plans provide for medical and dental benefits and are administered through insurance companies. We fund the plans as benefits are paid, such that the plans hold no assets in any period presented. Accordingly, we have no investment strategy or targeted allocations for plan assets. The benefits under the plans are not available to new employees or most existing employees. 42 -------------------------------------------------------------------------------- The Benefit Obligation for our defined benefit postretirement medical plans was$18.9 million and$18.8 million as ofDecember 31, 2019 and 2018, respectively. The estimated actuarial net gain and the estimated prior service cost for the defined benefit postretirement medical plans that are expected to be amortized from accumulated other comprehensive loss into net pension expense in 2020 are immaterial. We amortize any estimated net gain or loss over the remaining average life expectancy of approximately 11 years. Accrual Accounting and Significant Assumptions We account for pension benefits using the accrual method, recognizing pension expense before the payment of benefits to retirees. The accrual method of accounting for pension benefits requires actuarial assumptions concerning future events that will determine the amount and timing of the benefit payments. Our key assumptions used in calculating our cost of pension benefits are the discount rate, the rate of compensation increase and the expected long-term rate of return on plan assets. We, in consultation with our actuaries, evaluate the key actuarial assumptions and other assumptions used in calculating the cost of pension and postretirement benefits, such as discount rates, expected return on plan assets for funded plans, mortality rates, retirement rates and assumed rate of compensation increases, and determine such assumptions as ofDecember 31 of each year to calculate liability information as of that date and pension and postretirement expense for the following year. See discussion of our accounting for and assumptions related to pension and postretirement benefits in the "Our Critical Accounting Estimates" section of this MD&A. In 2019, the service cost component of the pension expense for our defined benefit pension plans included in operating income was$29.0 million compared with$29.4 million in 2018 and$29.5 million in 2017. The non-service cost portion of net pension expense (e.g., interest cost, actuarial gains and losses and expected return on plan assets) for our defined benefit pension plans included in other income (expense), net was$1.8 million , compared to a benefit of$1.2 million in 2018 and an expense of$5.7 million in 2017. The following are assumptions related to our defined benefit pension plans as ofDecember 31, 2019 : U.S. Plan Non-U.S. Plans Weighted average assumptions used to determine Benefit Obligation: Discount rate 3.41 % 1.61 % Rate of increase in compensation levels 3.50
3.12
Weighted average assumptions used to determine 2019 net pension expense: Long-term rate of return on assets
6.00 % 3.37 % Discount rate 4.34
2.42
Rate of increase in compensation levels 3.50
3.28
The following provides a sensitivity analysis of alternative assumptions on theU.S. qualified and aggregate non-U.S. pension plans andU.S. postretirement plans. Effect of Discount Rate Changes and Constancy of Other Assumptions: 0.5% Increase 0.5% Decrease (Amounts in millions)U.S. defined benefit pension plan: Effect on net pension expense$ (1.9 ) $ 2.0 Effect on Benefit Obligation (18.5 ) 20.1 Non-U.S. defined benefit pension plans: Effect on net pension expense (0.6 ) 0.8 Effect on Benefit Obligation (31.7 ) 36.0U.S. Postretirement medical plans: Effect on Benefit Obligation (0.5 ) 0.6 43
--------------------------------------------------------------------------------
Effect of Changes in the Expected Return on Assets and Constancy of Other Assumptions:
0.5% Increase 0.5% Decrease (Amounts in millions)U.S. defined benefit pension plan: Effect on net pension expense$ (2.1 ) $ 2.1 Non-U.S. defined benefit pension plans: Effect on net pension expense (1.1 ) 1.1 As discussed below, accounting principles generally accepted in theU.S. ("U.S. GAAP") provide that differences between expected and actual returns are recognized over the average future service of employees or over the remaining expected lifetime for plans with only inactive participants. AtDecember 31, 2019 , as compared withDecember 31, 2018 , we decreased our discount rate for theU.S. plan from 4.34% to 3.41% based on an analysis of publicly-traded investment gradeU.S. corporate bonds, which had lower yields due to current market conditions. The average discount rate for the non-U.S. plans decreased from 2.42% to 1.61% based on analysis of bonds and other publicly-traded instruments, by country, which had lower yields due to market conditions. The average assumed rate of compensation remained unchanged at 3.50% for theU.S. plan and decreased to 3.12% from 3.28% for our non-U.S. plans. To determine the 2019 pension expense, the expected rate of return onU.S. plan assets remained constant at 6.00% and we decreased our average rate of return on non-U.S. plan assets from 3.62% to 3.37%, primarily based on our target allocations and expected long-term asset returns. As the expected rate of return on plan assets is long-term in nature, short-term market fluctuations do not significantly impact the rate. For allU.S. plans, we adopted the Pri-2012 mortality tables and the MP-2019 improvement scale published inOctober 2019 . We applied the Pri-2012 tables based on the constituency of our plan population for union and non-union participants. We adjusted the improvement scale to utilize 75% of the ultimate improvement rate, consistent with assumptions adopted by theSocial Security Administration trustees, based on long-term historical experience. Currently, we believe this approach provides the best estimate of our future obligation. Most plan participants elect to receive plan benefits as a lump sum at the end of service, rather than an annuity. As such, the updated mortality tables had an immaterial effect on our pension obligation. We expect that the net pension expense for our defined benefit pension plans included in earnings before income taxes will be approximately$3.6 million higher in 2020 than the$30.8 million in 2019, primarily due to an increase in the amortization of actuarial losses and no anticipated special events. We have used discount rates of 3.41%, 1.61% and 3.27% atDecember 31, 2019 , in calculating our estimated 2020 net pension expense for theU.S. pension plans, non-U.S. pension plans and postretirement medical plans, respectively. The assumed ranges for the annual rates of increase in health care costs were 7.5% for 2019, 7.0% for 2018 and 7% for 2017, with a gradual decrease to 5.0% for 2029 and future years. If actual costs are higher than those assumed, this will likely put modest upward pressure on our expense for retiree health care. Plan Funding Our funding policy for defined benefit plans is to contribute at least the amounts required under applicable laws and local customs. We contributed$37.3 million ,$48.1 million and$44.9 million to our defined benefit plans in 2019, 2018 and 2017, respectively. After consideration of our intent to remain fully-funded based on standards set by law, we currently anticipate that our contribution to ourU.S. pension plan in 2020 will be approximately$20 million , excluding direct benefits paid. We expect to contribute approximately$2 million to our non-U.S. pension plans in 2020, excluding direct benefits paid. For further discussion of our pension and postretirement benefits, see Note 13 to our consolidated financial statements included in Item 8 of this Annual Report. OUR CRITICAL ACCOUNTING ESTIMATES The process of preparing financial statements in conformity withU.S. GAAP requires the use of estimates and assumptions to determine reported amounts of certain assets, liabilities, revenues and expenses and the disclosure of related contingent assets and liabilities. These estimates and assumptions are based upon information available at the time of the estimates or assumptions, including our historical experience, where relevant. The most significant estimates made by management include: timing and amount of revenue recognition; deferred taxes, tax valuation allowances and tax reserves; reserves for contingent loss; pension and postretirement benefits; and valuation of goodwill, indefinite-lived intangible assets and other long-lived assets. The significant estimates are reviewed at least annually if not quarterly by management. Because 44 -------------------------------------------------------------------------------- of the uncertainty of factors surrounding the estimates, assumptions and judgments used in the preparation of our financial statements, actual results may differ from the estimates, and the difference may be material. Our critical accounting policies are those policies that are both most important to our financial condition and results of operations and require the most difficult, subjective or complex judgments on the part of management in their application, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that the following represent our critical accounting policies. For a summary of all of our significant accounting policies, see Note 1 to our consolidated financial statements included in Item 8 of this Annual Report. Management and our external auditors have discussed our critical accounting estimates and policies with the Audit Committee of our Board of Directors. Revenue Recognition We recognize revenue when (or as) we satisfy a performance obligation by transferring control to a customer. Transfer of control is evaluated based on the customer's ability to direct the use of and obtain substantially all of the benefits of a performance obligation. Revenue is recognized either over time or at a point in time, depending on the specific facts and circumstances for each contract, including the terms and conditions of the contract as agreed with the customer and the nature of the products or services to be provided. Our primary method for recognizing revenue over time is the percentage of completion ("POC") method, whereby progress towards completion is measured by applying an input measure based on costs incurred to date relative to total estimated costs at completion. If control of the products and/or services does not transfer over time, then control transfers at a point in time. We determine the point in time that control transfers to a customer based on the evaluation of specific indicators, such as title transfer, risk of loss transfer, customer acceptance and physical possession. For a discussion related to revenue recognition refer to Note 2 included in Item 8 of this Annual Report. Deferred Taxes, Tax Valuation Allowances and Tax Reserves We recognize valuation allowances to reduce the carrying value of deferred tax assets to amounts that we expect are more likely than not to be realized. Our valuation allowances primarily relate to the deferred tax assets established for certain tax credit carryforwards and net operating loss carryforwards for non-U.S. subsidiaries, and we evaluate the realizability of our deferred tax assets by assessing the related valuation allowance and by adjusting the amount of these allowances, if necessary. We assess such factors as our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets in determining the sufficiency of our valuation allowances. Failure to achieve forecasted taxable income in the applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in our effective tax rate on future earnings. Implementation of different tax structures in certain jurisdictions could, if successful, result in future reductions of certain valuation allowances. The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Significant judgment is required in determining income tax provisions and evaluating tax positions. We establish reserves for open tax years for uncertain tax positions that may be subject to challenge by various tax authorities. The consolidated tax provision and related accruals include the impact of such reasonably estimable losses and related interest and penalties as deemed appropriate. Tax benefits recognized in the financial statements from uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. While we believe we have adequately provided for any reasonably foreseeable outcome related to these matters, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities. To the extent that the expected tax outcome of these matters changes, such changes in estimate will impact the income tax provision in the period in which such determination is made. Reserves for Contingent Loss Liabilities are recorded for various contingencies arising in the normal course of business when it is both probable that a loss has been incurred and such loss is reasonably estimable. Assessments of reserves are based on information obtained from our independent and in-house experts, including recent legal decisions and loss experience in similar situations. The recorded legal reserves are susceptible to changes due to new developments regarding the facts and circumstances of each matter, changes in political environments, legal venue and other factors. Recorded environmental reserves could change based on further analysis of our properties, technological innovation and regulatory environment changes. 45 -------------------------------------------------------------------------------- Estimates of liabilities for unsettled asbestos-related claims are based on known claims and on our experience during the preceding two years for claims filed, settled and dismissed, with adjustments for events deemed unusual and unlikely to recur. A substantial majority of our asbestos-related claims are covered by insurance or indemnities. Estimated indemnities and receivables from insurance carriers for unsettled claims and receivables for settlements and legal fees paid by us for asbestos-related claims are estimated using our historical experience with insurance recovery rates and estimates of future recoveries, which include estimates of coverage and financial viability of our insurance carriers. We have claims pending against certain insurers that, if resolved more favorably than estimated future recoveries, would result in discrete gains in the applicable quarter. We are currently unable to estimate the impact, if any, of unasserted asbestos-related claims, although future claims would also be subject to existing indemnities and insurance coverage. Changes in claims filed, settled and dismissed and differences between actual and estimated settlement costs and insurance or indemnity recoveries could impact future expense. Pension and Postretirement Benefits We provide pension and postretirement benefits to certain of our employees, including former employees, and their beneficiaries. The assets, liabilities and expenses we recognize and disclosures we make about plan actuarial and financial information are dependent on the assumptions and estimates used in calculating such amounts. The assumptions include factors such as discount rates, health care cost trend rates, inflation, expected rates of return on plan assets, retirement rates, mortality rates, turnover, rates of compensation increases and other factors. The assumptions utilized to compute expense and benefit obligations are shown in Note 13 to our consolidated financial statements included in Item 8 of this Annual Report. These assumptions are assessed annually in consultation with independent actuaries and investment advisors as ofDecember 31 and adjustments are made as needed. We evaluate prevailing market conditions and local laws and requirements in countries where plans are maintained, including appropriate rates of return, interest rates and medical inflation (health care cost trend) rates. We ensure that our significant assumptions are within the reasonable range relative to market data. The methodology to set our significant assumptions includes: • Discount rates are estimated using high quality debt securities based on
corporate or government bond yields with a duration matching the expected
benefit payments. For the
analysis of publicly-traded investment-grade corporate bonds to establish
a weighted average discount rate. For plans in the
we use the discount rate obtained from an analysis of AA-graded corporate
bonds used to generate a yield curve. For other countries or regions
without a corporate AA bond market, government bond rates are used. Our
discount rate assumptions are impacted by changes in general economic and
market conditions that affect interest rates on long-term high-quality
debt securities, as well as the duration of our plans' liabilities.
• The expected rates of return on plan assets are derived from reviews of
asset allocation strategies, expected long-term performance of asset
classes, risks and other factors adjusted for our specific investment
strategy. These rates are impacted by changes in general market
conditions, but because they are long-term in nature, short-term market
changes do not significantly impact the rates. Changes to our target asset
allocation also impact these rates. • The expected rates of compensation increase reflect estimates of the change in future compensation levels due to general price levels, seniority, age and other factors. Depending on the assumptions used, the pension and postretirement expense could vary within a range of outcomes and have a material effect on reported earnings. In addition, the assumptions can materially affect benefit obligations and future cash funding. Actual results in any given year may differ from those estimated because of economic and other factors. We evaluate the funded status of each retirement plan using current assumptions and determine the appropriate funding level considering applicable regulatory requirements, tax deductibility, reporting considerations, cash flow requirements and other factors. We discuss our funding assumptions with theFinance Committee of our Board of Directors. Valuation ofGoodwill , Indefinite-Lived Intangible Assets and Other Long-Lived Assets The initial recording of goodwill and intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets. We test the value of goodwill and indefinite-lived intangible assets for impairment as ofDecember 31 each year or whenever events or circumstances indicate such assets may be impaired. The test for goodwill impairment involves significant judgment in estimating projections of fair value generated through future performance of each of the reporting units. The identification of our reporting units began at the operating segment level and considered whether components one level below the operating segment levels should be identified as reporting units for purpose of testing goodwill for impairment based on certain conditions. These conditions included, among other factors, 46 -------------------------------------------------------------------------------- (i) the extent to which a component represents a business and (ii) the aggregation of economically similar components within the operating segments and resulted in four reporting units. Other factors that were considered in determining whether the aggregation of components was appropriate included the similarity of the nature of the products and services, the nature of the production processes, the methods of distribution and the types of industries served. An impairment loss for goodwill is recognized if the implied fair value of goodwill is less than the carrying value. We estimate the fair value of our reporting units based on an income approach, whereby we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. A discounted cash flow analysis requires us to make various judgmental assumptions about future sales, operating margins, growth rates and discount rates, which are based on our budgets, business plans, economic projections, anticipated future cash flows and market participants. We did not record an impairment of goodwill in 2019, 2018 or 2017. We also considered our market capitalization in our evaluation of the fair value of our goodwill. Our market capitalization increased as compared with 2018 and did not indicate a potential impairment of our goodwill as ofDecember 31, 2019 . Impairment losses for indefinite-lived intangible assets are recognized whenever the estimated fair value is less than the carrying value. Fair values are calculated for trademarks using a "relief from royalty" method, which estimates the fair value of a trademark by determining the present value of estimated royalty payments that are avoided as a result of owning the trademark. This method includes judgmental assumptions about sales growth and discount rates that have a significant impact on the fair value and are substantially consistent with the assumptions used to determine the fair value of our reporting unit discussed above. We did not record a material impairment of our trademarks in 2019, 2018 or 2017. The recoverable value of other long-lived assets, including property, plant and equipment and finite-lived intangible assets, is reviewed when indicators of potential impairments are present. The recoverable value is based upon an assessment of the estimated future cash flows related to those assets, utilizing assumptions similar to those for goodwill. Additional considerations related to our long-lived assets include expected maintenance and improvements, changes in expected uses and ongoing operating performance and utilization. Due to uncertain market conditions and potential changes in strategy and product portfolio, it is possible that forecasts used to support asset carrying values may change in the future, which could result in non-cash charges that would adversely affect our financial condition and results of operations.
ACCOUNTING DEVELOPMENTS We have presented the information about accounting pronouncements not yet implemented in Note 1 to our consolidated financial statements included in Item 8 of this Annual Report.
47
--------------------------------------------------------------------------------
© Edgar Online, source