UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.  )

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FLOWSERVE CORPORATION

(Name of Registrant as Specified In Its Charter)

 

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

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5215 N. O’Connor Blvd., Suite 2300

Irving, Texas 75039

April 13, 2007

 

NOTICE OF 2007 ANNUAL MEETING
OF SHAREHOLDERS

 

The 2007 Annual Meeting of Shareholders of Flowserve Corporation (the “Company”) will be held on May 17, 2007 at 11:00 a.m., local time, at the Flowserve Corporation Learning Center, 4343 West Royal Lane, Irving, Texas 75063. If you were a shareholder of record of the Company’s common stock at the close of business on March 30, 2007, you are entitled to notice of and to vote at the annual meeting.

 

At this meeting the Company will ask you to:

 

 

Approval of these performance-based incentive plans will enable the Company to effectively continue its annual cash and equity long-term incentive programs for management, but with previously unavailable federal tax benefits.

 

No new shares of common stock will be authorized if the Long-Term Incentive Plan is approved. This plan will use shares previously authorized by shareholders who approved the Company’s 2004 Stock Compensation Plan.

 

The enclosed proxy statement contains other important information which you should read and consider before you vote.

 

Your vote is important. Whether or not you plan to attend the meeting in person, the Company requests your vote. Please vote by completing and mailing the proxy card in the enclosed envelope or using the telephone or Internet. Thank you in advance for voting.

 

By Order of the Board of Directors,

 

Tara D. Mackey
Vice President, Assistant Secretary and Compliance Counsel

 

TABLE OF CONTENTS

 

FLOWSERVE CORPORATION
5215 N. O’Connor Blvd., Suite 2300 Irving, Texas 75039

 

2007 ANNUAL MEETING OF SHAREHOLDERS PROXY STATEMENT

 

 

We are providing these proxy materials in connection with the solicitation by the Board of Directors (the “Board”) of Flowserve Corporation, a New York corporation (the “Company”), of proxies to be voted at the 2007 annual meeting of shareholders, which is being held on May 17, 2007 and at any adjournment or postponement. This proxy statement and form of proxy are first being mailed to shareholders on or about April 20, 2007.

 

This proxy statement and the enclosed proxy card contain information about the election of directors that you may vote on at the annual meeting. It also contains information about the proposed shareholder approval of the Company’s Annual Incentive Plan and Long-Term Incentive Plan, which is more fully described beginning on page 59.

 

Who May Vote and Number of Votes

 

If you are a shareholder of record at the close of business on March 30, 2007, you may vote on the matters discussed herein. You have one vote for each share you own.

 

How to Vote

 

Voting by Proxy Holders for Shares Registered in the Name of a Brokerage Firm or Bank.  If your shares are held by a broker, bank or other nominee (i.e., in “street name”), you will receive instructions from your nominee, which you must follow in order to have your shares voted.

 

Voting by Proxy Holder for Shares Registered Directly in the Name of Shareholder.  If you hold your shares in your own name as a holder of record, you must instruct the proxy holders named in the enclosed proxy card how to vote your shares by using the toll-free telephone number or the Internet website set forth below or by signing, dating and mailing the enclosed proxy card to National City Bank in the enclosed envelope. Each of these voting methods is described below:

 

Vote by Telephone.  If you hold your shares in your name as a holder of record, you may vote by telephone by calling toll-free to 1-888-693-8683 from the United States and Canada and following the series of voice instructions that will direct you how to vote your shares. Have your proxy card available when you place your telephone call. Telephone voting is available 24 hours a day, 7 days a week until 6:00 a.m., Eastern Time, on May 17, 2007. IF YOU VOTE BY TELEPHONE, YOU DO NOT NEED TO RETURN YOUR PROXY CARD.

 

Vote by Internet.  You have the option to vote via the Internet at the following address: www.cesvote.com by following the on-screen instructions that will direct you how to vote your shares. Internet voting is available 24 hours a day, 7 days a week until 6:00 a.m., Eastern Time, on May 17, 2007. Have your proxy card available when you access the Internet website. IF YOU VOTE BY INTERNET, YOU DO NOT NEED TO RETURN YOUR PROXY CARD.

 

Vote by Mail.  If you would like to vote by mail, mark the enclosed proxy card, sign and date it and return it to National City Bank in the enclosed envelope.

 

Vote in Person.  If you are a registered shareholder and attend the annual meeting, you may deliver your completed proxy card in person. “street name” shareholders who wish to vote at the meeting will need to obtain a proxy from the broker, bank or other nominee that holds their shares.

 

Changing Your Vote

 

You may revoke your proxy at any time before it has been exercised by:

 

 

Quorum for the Meeting

 

A majority of the outstanding shares, present or represented by proxy, constitutes a quorum. A quorum is necessary to conduct business at the annual meeting. You are part of the quorum if you have voted by proxy. Shares that the holder abstains from voting on a particular proposal count at the meeting for purposes of determining a quorum.

 

“Broker non-votes” are counted as present and entitled to vote for purposes of determining a quorum. A “broker non-vote” occurs when a broker holding shares in “street name” for a beneficial owner is represented in person or by proxy at the meeting but does not vote on a particular proposal because the broker does not have discretionary voting power for that particular proposal and has not received instructions from the beneficial owner.

 

Counting of Votes

 

Only “votes cast” count in the voting results and withheld votes are not considered “votes cast.” Directors are elected by a plurality of votes cast. Under the rules of the New York Stock Exchange (“NYSE”), brokers may, at their discretion with respect to certain routine matters, vote shares they hold in “street name” on behalf of beneficial owners who have not returned voting instructions to the brokers. Routine matters include the election of directors. “Broker non-votes” on a particular proposal will not constitute votes cast with respect to such proposal.

 

At the close of business on March 30, 2007, the record date for the annual meeting, the Company had 57,046,483 shares of common stock issued and outstanding (excluding treasury shares) which may be voted.

 

Cost of Proxy Solicitation

 

The Company pays the cost of soliciting proxies. Brokerage firms and other custodians, nominees and fiduciaries are reimbursed by the Company for the reasonable out-of-pocket expenses that they incur to send proxy materials to shareholders and solicit their votes.

 

Shareholder Proposals

 

The Company’s 2008 annual meeting of shareholders is tentatively scheduled to be held on May 15, 2008. If the meeting is held on that date, advance notice of any nominations for directors sought to be presented at that meeting must be given by March 26, 2008. Notice of all other proposals sought to be presented at the Company’s 2008 annual meeting must be given by March 6, 2008. If proper notice is not timely given, the proxy statement with respect to the 2008 annual meeting may grant discretionary authority to the proxies named therein to vote on such proposals.

 

In order to be considered for inclusion in the proxy material for that meeting, shareholder proposals must comply with the requirements of Rule 14a-8 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and must be received by the Assistant Corporate Secretary no later than December 22, 2007. All shareholder proposals (including director nominations) submitted to the Assistant Corporate Secretary must be in accordance with the Company’s By-

Laws and delivered to the Company’s address noted below:

 

Flowserve Corporation
5215 N. O’Connor Blvd., Suite 2300
Irving, Texas 75039
Attention: Assistant Corporate Secretary

 

See the discussion on page 11 of this proxy statement titled “Shareholder Nominations for Director” for information regarding nominating a person to serve on the Board.

 

Voting by Participants in the Flowserve Corporation Retirement Savings Plan

 

If you are a participant in the Flowserve Corporation Retirement Savings Plan, the proxy card serves as a voting instruction to the trustee for the plan. The proxy card indicates the number of shares of common stock credited to your account under the plan as of the record date for voting at the meeting.

 

 

Vote Tabulations

 

Votes are counted by National City Bank, the Company’s independent transfer agent and registrar. National City Bank is the inspector of elections for the annual meeting.

 

The Board has nominated for re-election Christopher A. Bartlett and William C. Rusnack, two members of the class of directors whose terms of offices are expiring. The Board also nominated Rick J. Mills for election to the Board for the same term. Each individual is nominated to serve for a new term that will end at the 2010 annual meeting of shareholders.

 

The individuals named as proxies on the enclosed proxy card will vote your proxy for the election of these nominees unless you withhold authority to vote for any one or more of them. If any director is unable to stand for re-election, the Board may reduce the number of directors or choose a substitute.

 

Hugh K. Coble and George T. Haymaker, Jr., current members of our Board whose terms expire at the upcoming annual meeting, having reached the ages of 72 and 69, respectively, are not standing for re-election at the annual meeting. Instead, they will retire from the Board upon expiration of their terms, pursuant to Board policy. We thank Messrs. Coble and Haymaker for their years of exemplary service on the Board.

 

Recommendation

 

THE BOARD RECOMMENDS THAT YOU VOTE FOR THE ELECTION OF EACH OF THE NOMINEES LISTED ON THE FOLLOWING PAGE.

 

Christopher A. Bartlett, age 63, has served as a director since 2002 and serves as Chairman of the Organization and Compensation Committee and as a member of the Corporate Governance and Nominating Committee. He also served as director of the Company from 1988 to 1993. Dr. Bartlett is an Emeritus Professor of Business Administration at Harvard University. Prior to his academic career, he was a general manager of Baxter Travenol’s French subsidiary and a consultant at McKinsey & Co. Currently, Dr. Bartlett serves as a Chief Executive Officer advisor and management consultant on international strategic and organizational issues to several major corporations.

 

William C. Rusnack, age 62, has served as a director since 1997 and serves as a member of the Audit Committee. He is currently a private investor and independent corporate director. Mr. Rusnack was President, Chief Executive Officer, Chief Operating Officer and director of Premcor Inc. at various times from 1998 to 2002. Before joining Premcor, Mr. Rusnack served for 31 years with Atlantic Richfield Company, (“ARCO”), an integrated petroleum company, most recently as Senior Vice President of ARCO from 1990 to 1998 and President of ARCO Products Company from 1993 to 1998. He is also a director and member of the Audit and Executive Committees, as well as Chairman of the Compensation Committee of Sempra Energy, an energy services company and a director and member of the Executive Committee, as well as Chairman of the Audit Committee of Peabody Energy, a coal mining company.

 

Rick J. Mills, age 59, is currently a Vice President of Cummins Inc., a manufacturer of large diesel engines and President of the Components Group at Cummins Inc. He was Vice President and President — Filtration Business from 2000 to 2005 and held other key management positions from 1970 to 2000. Mr. Mills is also a director and member of the Audit Committee and Nominating and Governance Committee of Rohm and Haas, a global company producing specialty polymers and biologically active compounds.

 

Roger L. Fix, age 53, was elected as director in April 2006 and serves as a member of the Organization and Compensation Committee. Mr. Fix is the Chief Executive Officer of Standex International Corporation (“Standex”), a publicly traded diversified manufacturing and marketing company. He has been its Chief Executive Officer since 2003, President since 2001 and director since 2001. He was its Chief Operating Officer from 2001 to 2002. He is also a member of Standex’s Executive Committee since 2003. Before joining Standex, he was employed by Outboard Marine Corporation, a marine manufacturing company, as Chief Executive Officer and President from 2000 to 2001 and Chief Operating Officer and President during 2000. He served as its director from 2000 to 2001. He served as Chief Executive of John Crane Inc., a global manufacturer of mechanical seals for pump and compressor applications in the process industry, from 1998 to 2000 and as its President — North America from 1996 to 1998. He was President of Xomox Corporation, a manufacturer of process control valves and actuators, from 1993 to 1996. He was also employed by Reda Pump Company, a manufacturer of electrical submersible pumping systems for oil production, from 1981 to 1993, most recently as Vice President and General Manager/Eastern Division. He was also employed by Fisher Controls Company, a manufacturer of process control valves and pneumatic and electronic instrumentation, from 1976 to 1981.

 

Diane C. Harris, age 64, has served as a director since 1993 and serves as a member of the Finance Committee. She is President of Hypotenuse Enterprises, Inc., a mergers and acquisitions service and corporate development outsourcing company. Ms. Harris was Vice President of Corporate Development of Bausch & Lomb Incorporated, an optics and health care products company, from 1981 to 1996, when she left to form Hypotenuse Enterprises, Inc. as its President. She was a director of the Association for Corporate Growth from 1993 to 1998 and its elected President from 1997 to 1998. Ms. Harris is also a director of the Monroe Fund, an investment company.

 

Lewis M. Kling, age 62, has served as President, Chief Executive Officer and as a director since 2005. He served as Chief Operating Officer from 2004 to 2005. Before joining the Company, he served as Group President and Corporate Vice President of SPX Corporation from 1999 to 2004 and as a member of the Board of Directors of Inrange Technologies Corporation from 2000 to 2003. Mr. Kling also served as President of Dielectric Communications, a division of General Signal Corporation, which was purchased by SPX Corporation, from 1997 to 1999. He is also a director of Eastman Chemical Company, a manufacturer of chemicals, fibers and plastics.

 

James O. Rollans, age 64, has served as a director since 1997. He serves as the Chairman of the Audit Committee and as a member of the Corporate Governance and Nominating Committee. He is an independent Corporate Director and Corporate Financial Advisor. Mr. Rollans was President and Chief Executive Officer of Fluor Signature Services, a subsidiary of Fluor Corporation, a major engineering, procurement and construction firm, from 1999 to 2001. He served as Senior Vice President of Fluor Corporation from 1992 to 1999, as its Chief Financial Officer from 1998 to 1999 and from 1992 to 1994, as its Chief Administrative Officer from 1994 to 1998 and as its Vice President of Corporate Communications from 1982 to 1992. Mr. Rollans is also a director of Encore Credit Corporation, a mortgage finance company and a director of Advanced Medical Optics, Inc., a developer and manufacturer of ophthalmic surgical and contact lens care products.

 

Michael F. Johnston, age 59, has served as a director since 1997. He serves as Chairman of the Finance Committee and as a member of the Corporate Governance and Nominating Committee. Mr. Johnston is the Chief Executive Officer and Chairman of the Board of Visteon Corporation (“Visteon”), an automotive components supplier and has served as Visteon’s President, Chief Executive Officer and Chief Operating Officer at various times since 2000. Before joining Visteon, Mr. Johnston was employed by Johnson Controls, Inc., a company serving the automotive and building services industry, as President of North America/Asia Pacific, Automotive Systems Group, from 1999 to 2000, President of Americas Automotive Group from 1997 to 1999 and in other senior management positions since 1991. He is also a director of Visteon and a director of Whirlpool Corporation, an appliance manufacturer.

 

Charles M. Rampacek, age 63, has served as a director since 1998. He serves as the Chairman of the Corporate Governance and Nominating Committee and as a member of the Audit Committee. Mr. Rampacek is currently a business and management consultant in the energy industry. Mr. Rampacek served as the Chairman of the Board, President and Chief Executive Officer of Probex Corporation (“Probex”), an energy technology company providing proprietary oil recovery services, from 2000 to 2003. From 1996 to 2000, Mr. Rampacek served as President and Chief Executive Officer of Lyondell-Citgo Refining, L.P., a manufacturer of petroleum products. From 1982 to 1995, he held various executive positions with Tenneco Inc. and its energy related subsidiaries, including President of Tenneco Gas Transportation Company, Executive Vice President of Tenneco Gas Operations and Senior Vice President of Refining. In 2005, two complaints seeking recovery of certain alleged losses were filed against former officers and directors of Probex, including Mr. Rampacek, as a result of the bankruptcy of Probex in 2003. These complaints were defended under Probex’s director and officer insurance by AIG and settlement was reached and paid by AIG with bankruptcy court approval in the first half of 2006. An additional complaint was filed in 2005 against noteholders of certain Probex debt, of which Mr. Rampacek was one. A settlement of $2,000 was reached and similarly approved in the first half of 2006. Mr. Rampacek is also a member of the Board of Directors of Enterprise Products GP, LLC and serves on its Audit, Conflicts and Governance Committee.

 

Kevin E. Sheehan, age 61, has served as a director since 1990. He serves as non-executive Chairman of the Board of Directors and also serves as a member of the Finance Committee. He also serves as an alternate director of all other committees for any committee member not in attendance at a committee meeting. He served as the Company’s Interim Chairman, President and Chief Executive Officer from April 2005 to August 2005. He is a partner in Cambridge Ventures, a venture capital firm focused on investments in early stage growth companies. He is on the Board of two private companies, neither connected to Cambridge Ventures, Contour Hardening and CIK Enterprises, where he also serves as Board Chairman. Prior to joining Cambridge Ventures, he was Managing Director of CID Capital for 12 years. He is also a director of Tecumseh Corporation, a manufacturer of compressors, gasoline engines and power train components. Before joining CID Capital in 1994, Mr. Sheehan was employed by Cummins Engine Company, a manufacturer of diesel engines and related components, for 22 years. He served at Cummins Engine Company as Vice President, Components Group, from 1986 to 1993, Vice President, Worldwide Parts and Service from 1983 to 1986 and Vice President, Computer Systems and Telecommunications from 1980 to 1983.

 

Hugh K. Coble, age 72, has served as a director since 1994 and serves as a member of the Organization and Compensation Committee. He is Vice Chairman, Emeritus, of Fluor Corporation, a major engineering, procurement and construction firm. Mr. Coble was a director of Fluor Corporation from 1984 and Vice Chairman from 1994 until his retirement in 1997. He joined Fluor Corporation in 1966 and was Group President of Fluor Daniel, Inc., a subsidiary of Fluor Corporation, from 1986 to 1994.

 

George T. Haymaker, Jr., age 69, has served as a director since 1997. He serves as a member of the Organization and Compensation Committee. Mr. Haymaker has been non-executive Chairman of the Board of Safelite Auto Glass, a provider of automobile replacement glass, since 2000. Mr. Haymaker was non-executive Chairman of the Board of Kaiser Aluminum Corporation, a company that is now principally a producer of semi-fabricated aluminum products, from 2001 to 2006, Chairman of the Board from 1994 until 2001 (non-executive Chairman after January 2000) and its Chief Executive Officer from 1994 to 1999. Before joining Kaiser Aluminum in 1993 as its President and Chief Operating Officer, Mr. Haymaker worked with a private partner in the acquisition and redirection of several metal fabricating companies. He was Executive Vice President of Alumax, Inc. from 1984 to 1986 and was Vice President, International Operations for Alcoa, Inc. from 1982 to 1984. Mr. Haymaker is also a director of CII Carbon, L.L.C., a supplier of calcined coke for aluminum smelters, a director of Mid-America Holdings, Ltd., an aluminum extruder, a director of 360 Networks Corporation, a provider of telecommunication services, a lead director and member of the Audit Committee of the Board of Hayes Lemmerz International, Inc., a global supplier of automotive and commercial wheels, brakes and other auto suspension components and a director and Chairman of the Compensation Committee of the Board of SCP Pool Corp., a distributor of swimming pool and related products.

 

The Board held 5 regular meetings and 8 special meetings in 2006. Executive sessions of non-management directors are normally held at each regular Board meeting. Any non-management director may request additional executive sessions to be scheduled. Shareholders may communicate with the Company’s non-management directors by following the instructions set forth in “Shareholder Communications with the Board” below.

 

Board members customarily have attended the Company’s annual meetings of shareholders. Each Board member attended the Company’s 2005 and 2006 annual meetings of shareholders. In 2006, each director attended over 75% of the meetings of the Board held during the period for which he or she has been a director and the meetings of the Board committees on which he or she served.

 

Kevin E. Sheehan, as non-executive Chairman of the Board, presides over meetings of the Board, including executive sessions of the Board where only non-employee directors are present. He approves the agendas for Board meetings in advance. He also serves as a member of the Finance Committee and as an alternate member of all other Board committees. Mr. Sheehan generally attends all committee meetings, where possible.

 

The Board maintains an Audit Committee, a Finance Committee, a Corporate Governance and Nominating Committee and an Organization and Compensation Committee. Only independent directors are eligible to serve on Board committees.

 

Each committee is governed by a written charter. The charters of the Audit Committee, Finance Committee, Corporate Governance and Nominating Committee and Organization and Compensation Committee are available on the Company’s website at www.flowserve.com under the “Investor Relations — Governance” caption. These documents are also available in print to any shareholder who submits a written request to Zac Nagle, Vice President, Investor Relations, Flowserve Corporation, 5215 N. O’Connor Blvd., Suite 2300, Irving, Texas 75039.

 

The Audit Committee is composed of three directors, Charles M. Rampacek, James O. Rollans (Chairman) and William C. Rusnack. The Board has determined that Mr. Rollans, former Chief Financial Officer of Fluor Corporation, is a qualified audit committee financial expert under the Securities and Exchange Commission (the “SEC”) rules and has accounting or related financial management expertise for purposes of the NYSE listing requirements. The Board also determined that all members of the Audit Committee are financially literate, within the meaning of the NYSE corporate governance listing standards and meet the independence standards set forth in the SEC rules and the NYSE corporate governance listing standards.

 

The Audit Committee directly engages the Company’s independent auditors, preapproves the scope of the annual external audit and preapproves all audit and non-audit services to be provided by the independent auditor. The Audit Committee further approves and directly reviews the results of the internal audit plan. The Audit Committee also meets with management and the independent auditors to review the quality and accuracy of the annual and quarterly financial statements and considers the reports and recommendations of independent internal and external auditors pertaining to audit results, accounting practices, policies and procedures and overall internal controls.

 

The Audit Committee meets regularly with the external and internal auditors in executive session to discuss their reports on a confidential basis. In addition, the Audit Committee prepares and issues

the Report of the Audit Committee located on page 57 of this proxy statement. The Audit Committee met 12 times in 2006.

 

The current members of the Finance Committee are Diane C. Harris, Michael F. Johnston (Chairman) and Kevin E. Sheehan. The Board determined that all members of the Finance Committee meet the independence standards set forth in the NYSE corporate governance listing standards.

 

The Finance Committee advises the Board on all corporate financing and related treasury matters regarding capital structure and major corporate transactions. The Finance Committee monitors corporate risk management programs. The Finance Committee approves major capital expenditures made by the Company. The Finance Committee also advises the Board on the Company’s pension fund performance. The Finance Committee met 6 times in 2006.

 

The Corporate Governance and Nominating Committee (“Corporate Governance Committee”) is composed of four directors, Christopher A. Bartlett, Michael F. Johnston, Charles M. Rampacek (Chairman) and James O. Rollans. The Board determined that all members of the Corporate Governance Committee meet the independence standards set forth in the SEC rules and the NYSE corporate governance listing standards.

 

The Corporate Governance Committee is responsible for making recommendations to the Board for the positions of Chairman of the Board, President and Chief Executive Officer and candidates for director. The Corporate Governance Committee utilizes a variety of methods for identifying and evaluating nominee director candidates. The Corporate Governance Committee assesses the appropriateness of the Board’s size and whether any vacancies on the Board are expected due to retirement or other factors. In the event that vacancies are anticipated, or otherwise arise, the Corporate Governance Committee considers various potential candidates for director who may come to the attention of the Corporate Governance Committee through current Board members, professional search firms, shareholders or other persons. The Corporate Governance Committee generally retains a national executive recruiting firm to research, screen and contact potential candidates regarding their interest in serving on the Board, although the Corporate Governance Committee may also use less formal recruiting methods.

 

All identified candidates, including shareholder-proposed nominees, as applicable, are evaluated by the Corporate Governance Committee using generally the same methods and criteria, although those methods and criteria may vary from time to time depending on the Corporate Governance Committee’s assessment of the Company’s needs and situation.

 

The Company’s director nomination process for nominating shareholders and our policy regarding the consideration of such nominations is discussed under “Shareholder Nominations for Director” below.

 

The Board’s Corporate Governance Guidelines contain Board membership criteria. Generally, the Board believes that its members should have the highest professional and personal ethics and a diversity of backgrounds. All existing and prospective new members should have a broad strategic view, possess a global business perspective and demonstrate relevant and successful career experience. Their service on other boards of public companies should be limited to a number that permits them, given their individual circumstances, to responsibly perform all director duties. Each director must represent the interests of all shareholders.

 

The Corporate Governance Committee is also responsible for preparing materials for the annual Chief Executive Officer’s performance review

conducted by the Board. Further, the Corporate Governance Committee reviews and recommends, as deemed appropriate, changes to corporate governance matters consistent with SEC rules and the NYSE corporate governance listing standards. The Corporate Governance Committee met 6 times in 2006.

 

The Organization and Compensation Committee (“Compensation Committee”) is composed of four directors, Christopher A. Bartlett (Chairman), Hugh K. Coble, Roger L. Fix and George T. Haymaker, Jr. The Board determined that all members of the Compensation Committee meet the independence standards set forth in the SEC rules and the NYSE corporate governance listing standards.

 

The Compensation Committee is responsible for establishing executive compensation for officers, including the Chief Executive Officer and key management personnel. Decisions regarding compensation are made by the Compensation Committee in a manner that is intended to be internally equitable, externally competitive and an incentive for effective performance in the best interests of shareholders. The Compensation Committee administers the Company’s stock option plans, restricted stock plans and incentive compensation plans for key employees, including considering the recommendations of the Chief Executive Officer in granting awards to other Named Executives under those plans. The Compensation Committee may, under certain circumstances, delegate routine or ministerial activities under these plans to management. The Compensation Committee also reviews the recommendations of the Chief Executive Officer and the Vice President-Human Resources regarding adjustment to the Company’s executive compensation programs. The Compensation Committee has retained and regularly meets with its directly retained independent executive compensation consultant, Lyons, Benenson & Co., who assists the Compensation Committee in evaluating how well the Company’s compensation programs adhere to the philosophies and principles stated below under “Compensation Discussion and Analysis.” The Compensation Committee is also responsible for reviewing the management succession plan and for recommending changes in director compensation to the Board. The Compensation Committee periodically reviews the organizational design, management development plans and managerial capabilities of the Company. The Compensation Committee also prepares and issues the Report of the Compensation Committee as presented on page 32 of this proxy statement. The Compensation Committee met 8 times in 2006.

 

The Corporate Governance Guidelines contain a formal set of qualification standards with respect to the determination of director independence, which either meet or exceed the independence requirements of the NYSE. Under the Corporate Governance Guidelines, only those directors who have no material relationship with the Company (except as a director) are deemed independent. The Corporate Governance Guidelines specify the criteria by which the independence of our directors will be determined, including strict guidelines for directors and their immediate families with respect to past employment or affiliation with the Company or its independent registered public accounting firm. See “Corporate Governance Guidelines” below for more information on these guidelines.

 

The Board has determined that, other than Lewis M. Kling, each member of the Board, including all persons nominated for election or re-election meet the independence standards set forth in the applicable SEC rules and the NYSE corporate governance listing standards. Mr. Kling is not considered independent, as he serves as President and Chief Executive Officer of the Company.

 

In addition to the corporate governance duties noted for each above, the Board monitors and

updates, as deemed appropriate, internal guidelines designed to promote effective oversight of the Company’s material business affairs. The guidelines set parameters for the director recruiting process and the composition of Board committees. They also determine the formal process for Board review and evaluation of the Chief Executive Officer, individual directors and Board performance. The guidelines also establish targets for director stock ownership.

 

These guidelines require a director to offer his or her resignation when such director’s principal occupation changes during a term of office. Under such circumstances, the Corporate Governance Committee will review whether it is appropriate for the director to continue serving on the Board. Finally, these guidelines establish maximum term and age limits for directors, which may be waived by the Board if deemed appropriate.

 

The Board’s Corporate Governance Guidelines, as well as the Company’s Code of Ethics and Code of Business Conduct, are available on the Company’s website at www.flowserve.com under the “Investor Relations — Governance” caption. These documents are also available in print to any shareholder who submits a written request to Zac Nagle, Vice President, Investor Relations, Flowserve Corporation, 5215 N. O’Connor Blvd., Suite 2300, Irving, Texas 75039.

 

In accordance with the Company’s By-Laws, if you are a shareholder entitled to vote at an annual meeting, you may nominate one or more persons for election as a director of the Company at that meeting. You may do this by sending a written notice to the Assistant Corporate Secretary, Flowserve Corporation, 5215 N. O’Connor Blvd., Suite 2300, Irving, Texas 75039. The Company must receive your notice not less than 50 days before the annual meeting date (provided, however, that in the event that less than 60 days’ notice or prior public disclosure of the date of the meeting is given or made to shareholders, the notice by the shareholder in order to be considered timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting is mailed or such public disclosure of the date of the annual meeting is made). The shareholder’s notice must set forth:

 

     (a) as to each shareholder-proposed nominee (i) the name, age, business address and residence address of such person, (ii) the principal occupation of such person, (iii) the class and number of any shares of the Company or any subsidiary of the Company which are beneficially owned by such person and (iv) any other information relating to such person that is required to be disclosed in solicitations for proxies for election of directors pursuant to the rules and regulations promulgated under the Exchange Act; and

 

     (b) as to the shareholder giving the notice (i) the name and record address of such shareholder and (ii) the class and number of Company shares beneficially owned by such shareholder.

 

After submission, in accordance with the Company’s policy on considering director nominations by shareholders, the notice will be referred to the Corporate Governance Committee for further consideration. The Corporate Governance Committee may require any shareholder-proposed nominee to furnish such other information as may reasonably be required to determine the eligibility of such proposed nominee or to assist in evaluating the proposed nominee. The Corporate Governance Committee may require the submission of a fully completed and signed Questionnaire for Directors and Executive Officers on the Company’s standard form and a written consent by the shareholder-proposed nominee to serve as a director if so elected. Shareholder nominations that comply with these procedures and that meet the criteria outlined above will receive the same consideration that the Corporate Governance Committee’s other proposed nominees receive.

 

Shareholders and other interested parties may communicate with the Board by writing to Kevin E. Sheehan, Chairman of the Board, c/o Flowserve’s Assistant Corporate Secretary, Flowserve Corporation, 5215 N. O’Connor Blvd., Suite 2300, Irving, Texas 75039. All such communications are delivered to Mr. Sheehan.

 

During 2006, the members of the Compensation Committee were Christopher A. Bartlett, Hugh H. Coble, Roger L. Fix, (who joined the Board and this committee in April 2006,) and George T. Haymaker, Jr. None of the members of the Compensation Committee was at any time during 2006 an officer or employee of the Company. None of our executive officers serve as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our Board or Compensation Committee.

 

The following information presents names, ages, positions and background summaries of the Company’s executive officers and certain other corporate officers.

 

Andrew J. Beall, age 50, has served as Senior Vice President since December 2006 and President of Flow Solutions Division since 2003. He served as Vice President from 2003 to December 2006. From 1994 to 2003, Mr. Beall served in a number of key United States and international management positions with the Company including as Vice President of Flowserve Pump Division, Flow Solutions Division and Flow Control Division in Latin America from 1999 to 2003.

 

Deborah K. Bethune, age 48, has served as Vice President, Tax since 2004. Prior to that, she served with Electronic Data Systems Corporation for 17 years, where she held several tax management positions, most recently as the Director of International Taxes for the Americas and Asia Pacific regions.

 

Mark A. Blinn, age 45, has served as Senior Vice President since December 2006 and Chief Financial Officer since 2004. He served as Vice President from 2004 to December 2006. Prior to that, he served as Chief Financial Officer of FedEx Kinko’s Office and Print Services, Inc. from 2003 to 2004 and as Vice President and Treasurer of Kinko’s, Inc. from 2002 to 2003. Mr. Blinn also served as Vice President and Chief Accounting Officer of Centex Corporation from 2000 to 2002 and as Managing Director of Corporate Finance since 1999.

 

Mark D. Dailey, age 48, has served as Senior Vice President, Human Resources since November 2006 and Chief Compliance Officer since May 2005. He served as Vice President, Supply Chain and Continuous Improvement, from 1999 until 2005. Mr. Dailey was Vice President, Supply Chain and held other supply chain management positions from 1992 to 1999 for the North American Power Tools Division of The Black and Decker Corporation.

 

Paul W. Fehlman, age 43, has served as Vice President and Corporate Treasurer since 2005. He served as Director of Financial Services and Assistant Treasurer from 2000 to 2005.

 

Thomas E. Ferguson, age 50, has served as Senior Vice President since December 2006 and as President of Flowserve Pump Division since 2003. He served as Vice President from 2003 to December 2006. He was President of Flow Solutions Division from 2000 to 2002, Vice President and General Manager of Flow Solutions Division North America from 1999 to 2000 and Vice President of Marketing and Technology for Flow Solutions Division from 1997 to 1999.

 

Richard J. Guiltinan, Jr., age 53, has served as Vice President, Controller and Chief Accounting Officer since 2004. Prior to that, he served as a consultant to Chevron on three multinational restructuring and merger integration projects in 2003 and 2002. From 1985 to 2001, Mr. Guiltinan served in accounting, financial management and operating positions at Caltex Corporation, a joint venture of Chevron and Texaco, including as Chief Financial Officer from 2000 to 2001. He is also a director of North American Technologies Group, Inc., (“NATK”) a company that manufactures and markets composite railroad crossties to the railroad industry. He serves as Chairman of the Audit Committee of NATK.

 

Linda P. Jojo, age 41, has served as Senior Vice President and Chief Information Officer since December 2006. She served as Vice President from June 2004 to December 2006. Prior to that, she served as Chief Information Officer of GE Silicones Division of General Electric Corporation from 2000 to 2004 and held other management positions at General Electric Corporation from 1991 to 2000.

 

Lewis M. Kling, age 62, has served as President, Chief Executive Officer and as a director since 2005. He served as Chief Operating Officer from 2004 to 2005. Before joining the Company, he served as Group President and Corporate Vice President of SPX Corporation from 1999 to 2004

and as a member of the Board of Directors of Inrange Technologies Corporation from 2000 to 2003. Mr. Kling also served as President of Dielectric Communications, a division of General Signal Corporation, which was purchased by SPX Corporation, from 1997 to 1999. Mr. Kling is also a director of Eastman Chemical Company, a manufacturer of chemicals, fibers and plastics.

 

Thomas L. Pajonas, age 51, has served as Senior Vice President since December 2006 and President of Flow Control Division since 2004. He served as Vice President from 2004 to December 2006. Prior to joining the Company, he served as Managing Director of Alstom Transport from 2003 to 2004 and Senior Vice President from 1999 to 2003 of the Worldwide Power Boiler Business of Alstom, Inc. From 1996 to 1999 he served in various capacities as Senior Vice President and General Manager International Operations and subsequently Senior Vice President and General Manager Standard Boilers Worldwide of Asea Brown Boveri.

 

Jerry L. Rockstroh, age 51, has served as Senior Vice President of Supply Chain and Continuous Improvement Process since December 2006. He served as Vice President of Supply Chain and Continuous Improvement Process since late 2005 to December 2006 and as Vice President of Supply Chain during 2005. From September 1983 to February 2005, he served in various executive level positions within different business units of AlliedSignal/Honeywell, including as World Wide Vice President of Operations and Integrated Supply Chain.

 

Ronald F. Shuff, age 54, has served as Senior Vice President since December 2006, Secretary since 1989 and General Counsel since 1988. He served as Vice President from 1990 to December 2006.

 

 

In the paragraphs that follow, we will give an overview and analysis of our executive compensation program and policies, the material compensation decisions we have made under our program and policies and the material factors that we considered in making those decisions. Following this section you will find a series of tables containing specific information about the compensation earned or paid in 2006 to the following individuals, whom we collectively refer to as our “Named Executive Officers”:

 

 

The discussion below is intended to help you understand the detailed information provided in those tables and put that information into context within our overall compensation program.

 

Our key compensation objectives are to attract and retain key leaders, reward current performance, drive future performance and align the long-term interests of the Company’s executives with those of its shareholders. We have several different compensation elements to achieve these objectives, including base salary, annual incentives and long-term incentives (including a long-term cash incentive plan, stock options, restricted stock awards and performance shares and units). Each

element of the executive compensation program is consistent with our employee compensation program for all of our employees generally. In addition, we believe our executive compensation program creates an environment of goals, expectations and rewards for all of our employees.

 

Our executive compensation program is administered by the Compensation Committee of our Board. Consistent with the listing requirements of the NYSE, the Compensation Committee is composed entirely of independent, non-employee members of the Board. In addition, the Chairman of the Board of Directors generally attends the meetings of the Compensation Committee.

 

As reflected in its charter, the Compensation Committee has overall responsibility for setting the compensation for the Chief Executive Officer (“CEO”) of the Company and for approving the compensation of its other executive officers, including the Chief Financial Officer (“CFO”) and its three most highly-compensated executive officers other than the CEO and CFO (Named Executive Officers). The Compensation Committee also oversees the alignment of organizational design and management development in support of achieving our operational objectives and strategic plans; and monitoring the policies, practices and processes designed to develop our core organizational capabilities and managerial competencies.

 

To assist the Compensation Committee with its responsibilities, it has directly retained the services of Lyons, Benenson & Co., an independent outside compensation consulting firm. Additional information regarding the Compensation Committee and its processes and procedures is described in “Meetings and Committees of the Board — Organization and Compensation Committee.”

 

The Compensation Committee is responsible for establishing the principles that underlie the Company’s executive compensation program and that guide the design and administration of specific plans, agreements and arrangements for its executives, including the Named Executive Officers. Our Compensation principles are intended to motivate our executives to improve our financial position and to be personally accountable for the performance of the business units, divisions, or functions for which they are responsible. These principles are also used to retain the services of valuable executives and to motivate them to make and implement decisions about the Company’s business that will enhance the value of shareholders’ investments. The Company’s executive compensation principles, which are established and refined from time to time by the Compensation Committee, are described below:

 

Compensation Should Reinforce Our Business Objectives and Values.  Our overarching business objective is to profitably grow our position as a product and integrated solutions provider in the flow control industry. Six strategies for achieving this objective are communicated to all our employees. These strategies include: organic growth, globalization, process excellence, portfolio management, organizational capability and technology/innovation. The Compensation Committee considers these strategies when identifying the appropriate incentive measures and assigning of individual goals and objectives to the Named Executive Officers and are referred to herein as our six strategies.

 

Compensation Should be Performance-Related.  The Compensation Committee believes that a significant portion of our executives’ total compensation should be tied not only to how well they perform, but also to how well their divisions and the Company perform in accordance with applicable financial and non-financial objectives. Thus, the Compensation Committee uses a variety of performance-based compensation vehicles in our executive compensation program that are

designed to incorporate performance criteria that promote our annual operating plan and long-term business strategy.

 

The Compensation Committee believes that there should be a strong link between executive pay and our performance. Accordingly, the Compensation Committee feels that in years when our performance exceeds objectives established for the relevant performance period, executive officers should be paid more than the established target award (which is typically set at the competitive median of general industry companies similar in size). When performance does not meet key objectives, incentive award payments should be less than the target level.

 

The Compensation Committee also emphasizes and measures the Company’s performance relative to the organizations in the Company’s peer group as a means to evaluate and compare how well we deliver results that enhance the value of shareholders’ investments. During the past three years, the organizations comprising this peer group consisted of: America Standard Cos. Inc., CIRCOR International Inc., Crane Co., Danaher Co., Dover Corp., Emerson Electric Co., Graco Inc., IDEX Corp, ITT Industrial Inc., Illinois Tool Works Inc., Robbins & Myers Inc., Roper Industries Inc., Tyco International Ltd., Watts Water Technology Inc., United Technology Corp. and Weir Group PLC. The Compensation Committee chose this peer group from Companies in the Industrial Goods — Durable sector. They had multinational operations, operated in the oil and gas industry, produced flow control products and/or had overlapping customer bases.

 

Incentive Compensation Should Represent the Majority of Total Compensation.  The Compensation Committee believes that the proportion of an executive’s total compensation that varies with individual, division, function and/or corporate performance should increase as the scope and level of the individual’s business responsibilities increase. Accordingly, for 2006, approximately 80% of the total target-direct compensation (the sum of base salary, target annual incentive opportunity and target long-term incentive compensation) of the CEO at the time of award was tied to our stock price or our performance. Generally, for 2006, the amount of the total target direct compensation at risk for the CFO and the other Named Executive Officers ranged from approximately 60% to 70%.

 

Compensation Levels are Reviewed for Competitiveness.  To further the principles described above, at least once each year, the Compensation Committee reviews compensation survey data compiled and prepared by management and its consultant, as reviewed by the Compensation Committee’s consultant, to evaluate how and whether our executive compensation program is competitive. The Compensation Committee uses this survey data to benchmark our executive base salary, annual bonus opportunities, total cash compensation, long-term incentive compensation and total direct compensation. The Compensation Committee uses the survey data to evaluate how for each executive position, the Compensation Committee’s compensation actions are appropriate, reasonable and consistent with the Company’s philosophy, considering the various labor markets in which the Company competes for executives. The survey data, which is gathered from the Towers Perrin Executive Compensation Database, consists of general industry data representing companies similar in size to the Company and available data from our peer group, as identified above. The Compensation Committee does not limit its analysis to survey data relating to the organizations in our peer group due to the limited scope of available compensation data and the fact that our competitors for qualified executives are not necessarily limited to companies in our industry sectors. Similarly, for some executive positions, we may require skills and/or experience from a more varied set of backgrounds than apparently contained in the peer group.

 

Incentive Compensation Should be Balanced Between Short- and Long-Term Performance.  In selecting the specific elements of our executive compensation program, the Compensation Committee seeks to structure a balance between achieving strong short-term or annual results and furthering our long-term viability and success. Therefore, to reinforce the importance of balancing these perspectives, the executives participate in both short and long-term incentive programs. As an executive attains higher levels of responsibility in our organization, an increasing amount of that individual’s compensation is contingent upon our attaining target performance levels.

 

Our Executives’ Interests Should be Fully Aligned with the Shareholders’ Interests.  The Compensation Committee believes that it is in our shareholders best interests for our Company’s executives to have a financial interest in our long-term results. Consequently, we have established required stock ownership levels for our executives with associated penalties that apply when our executives do not adhere to their stockholders retention requirements. In 2006, executives obtained stock through stock option grants, restricted stock awards and a non-qualified deferred compensation plan that encourages our executives to invest, on a voluntary basis their salary and cash incentive awards, in shares of the Company’s common stock.

 

To implement the principles described above, the Compensation Committee has adopted several policies that govern the design and structure of the Company’s executive compensation program. The Compensation Committee established these policies to work to ensure that the specific elements of this program influence executive behavior to manage our business in a manner that enhances the value of our shareholders’ investments.

 

Executive Compensation Program is Reviewed Annually for Competitiveness.  Our executive compensation program is comprised of base salary, annual incentive opportunities, long-term incentive compensation, perquisites and other personal benefits and company-sponsored retirement plans. Each year, the Compensation Committee reviews our overall executive compensation program, with the input of its directly retained consultant, in light of evolving market practices in the general industry, external regulatory requirements, the competitive market for executives and our executive compensation philosophy. The Compensation Committee also periodically reviews the potential expense associated with the Company’s change-in-control program for executives. If necessary, the Compensation Committee makes changes in our compensation program to better achieve competitive market positioning.

 

The target total direct compensation (base salary, target annual incentive opportunity and target long-term incentive compensation) of our executives, including the Named Executive Officers, is generally set at the competitive median for executives with similar responsibilities at multi-national industrial companies similar in size to our Company. The Compensation Committee believes that median performance merits median pay. The Compensation Committee thus establishes objectives for both absolute and relative Company performance, as well as division or function value drivers (that is, objectives that drive business growth and profitability), so that performance and pay can be objectively determined at the end of the performance period. Actual total direct compensation, which may be above, below, or at the competitive median, is determined by performance against these pre-established measures and objectives.

 

Current Versus Long-Term Compensation.  The Compensation Committee believes that executive compensation should be linked to enhancing the value of the Company’s shareholders’ investments. Thus, consistent with the principles described above, the Compensation Committee structures the compensation of the Named Executive Officers to emphasize the long-term success of the Company. In 2006, our executive compensation program included long-term incentives, through the grant of equity-based awards, such as stock

options, restricted stock and performance share units, which are tied to the long-term performance of the Company’s common stock.

 

The Compensation Committee also recognizes, however, that while stock prices may reflect corporate performance over the long term, other factors, such as general economic conditions, industry business cycles and varying attitudes among investors toward the stock market in general and specific industries and/or companies in particular, may significantly affect stock prices at any point in time. Accordingly, the annual cash components of the executive compensation program, consisting of base salary and annual incentive opportunities, emphasize current or short-term corporate performance and the realization of defined business objectives, which are independent of fluctuations in the stock price.

 

The proportion of annual compensation (that is, base salary and annual incentive opportunity) to long-term pay (that is, long-term incentive compensation) at target has been approximately two to three for the CEO and one to one for all other Named Executive Officers over the past several years. The Compensation Committee believes that this ratio is appropriate, as it provides each Named Executive Officer a competitive amount of cash compensation each year (with the opportunity to increase that amount if he or she exceeds his or her annual incentive objectives) complemented by a significant opportunity to earn a substantial amount of additional compensation if our Company and the executive are successful in achieving the Company’s long-term objectives. Accordingly, this approach meets our objective of aligning the executives’ compensation with the Company’s short- and long-term performance.

 

Cash Versus Non-Cash Compensation.  Consistent with the principles described above, the Compensation Committee believes that the Named Executive Officers’ interests are more closely aligned with the interests of the Company’s shareholders when portions of total direct compensation are provided in the form of equity or equity-based incentives. Accordingly, as discussed below, a majority of the Company’s 2006 long-term incentive program was structured with equity and equity-based compensation: stock options and restricted stock awards. Under the long-term incentive program, the proportion of cash compensation to non-cash compensation has been approximately one to two over the past several years.

 

Fixed Versus At-Risk Compensation.  The Compensation Committee believes that the ratio of a Named Executive Officer’s compensation that is at-risk rather than fixed should increase as the scope and level of the executive’s business responsibilities increase. Accordingly, the Compensation Committee targets a ratio of fixed to at-risk compensation of one to four for the CEO and one to two for all other Named Executive Officers.

 

Fixed pay is comprised of base salary, while at-risk pay is comprised of the annual incentive awards and long-term incentive awards. The calculation of annual incentive award payments and cash long-term incentive payments for executives is determined based on the Company’s and applicable division’s actual performance measured against objective performance criteria that are approved by the Compensation Committee in advance. Time-vested stock options and time-vested restricted stock awards are also granted to the Named Executive Officers, effectively tying a significant amount of an executive’s compensation to the Company’s long-term stock price performance.

 

Mix of Long-Term Incentives.  In 2006, our long-term incentive awards for the Named Executive Officers took the form of a mix of stock option grants, restricted stock awards and cash awards. Our target long-term incentive compensation award was then split equally between these three components. The Compensation Committee has determined that the long-term incentive mix was appropriate because it aligns the interests of the Named Executive Officers with those of shareholders, encourages equity ownership and promotes a balance between stock-based and financial-based achievements.

 

For 2006, the Compensation Committee approved the guidelines for determining the value of long-term incentive awards. The Compensation Committee may in the future make adjustments to this mix of award types or approve different award types, such as performance shares, as part of its overall long-term incentive program.

 

Changes in the Company’s Executive Compensation Program.  In 2006, the Compensation Committee made the following changes to the executive compensation program as a result of the Company’s growth and to maintain competitive market positioning based on absolute and relative performance:

 

 

Changes approved for 2007 include:

 

 

The Compensation Committee believes these changes will further strengthen the performance and retention objectives of our executive compensation program.

 

Review and Assessment of Compensation Under Termination Scenarios.  The Compensation Committee also reviews each Named Executive Officer’s total compensation under several scenarios including a change-in-control of the Company, termination of employment by management and resignation or retirement by the executive. Tally sheets setting forth all of the listed scenarios are prepared by our Company and reviewed by the Compensation Committee with input from its independent consultant. Based on the Compensation Committee’s review of the tally sheets, the Compensation Committee determined that the potential payments that would be provided to the Named Executive Officers are appropriate.

 

The primary elements of the Company’s executive compensation program in 2006 were:

 

 

At the beginning of each year, typically in February, the Compensation Committee reviews each Named Executive Officer’s total compensation. The Compensation Committee

members also meet regularly with the Named Executive Officers at various times during the year, which allows the Compensation Committee to form its own assessment of their performance. In addition, each year, the CEO presents to the Compensation Committee his evaluation of each other Named Executive Officer, which includes a review of each officer’s contributions and performance over the past year, strengths, weaknesses, development plans and succession potential. The CEO also presents compensation recommendations for the Compensation Committee’s consideration. Following this presentation and a review of the competitive market for pay, the Compensation Committee makes its own assessments and formulates compensation amounts for each Named Executive Officer with respect to each of the elements in the Company’s executive compensation program as described in more detail below. The Compensation Committee also solicits input from all non-employee members of the Board as to the CEO’s performance during the year. The Compensation Committee considers collective appraisal forms, completed by all Board members, setting forth the overall Board’s annual performance assessment of the CEO, which is used in considering the compensation for the CEO.

 

Base Salary.  As described above, at the beginning of each year, the Compensation Committee reviews and determines the base salaries of the Named Executive Officers. The Compensation Committee has established and maintains base salary ranges for the Company’s various executive positions within market ranges indicated by the compensation survey data compiled and prepared by management and independently reviewed by the Compensation Committee’s consultant. For each executive, the Compensation Committee takes into account the scope of his or her responsibilities and experience and the executive’s performance. The Compensation Committee balances these factors against competitive salary practices. In determining each Named Executive Officer’s base salary, the Compensation Committee also considers internal equity within the Company with respect to the other executives referencing external benchmarks provided by the Compensation Committee’s consultant. Because we are committed to a pay-for-performance philosophy, the Compensation Committee generally manages base salary levels to the market median of general industry companies similar in size.

 

Based on the factors discussed above, for 2006, Mr. Kling’s base salary was increased by 5% and the base salary increases for the Named Executive Officers ranged from 5% to 11%. The base salaries the Company paid to the Named Executive Officers during 2006 are shown in the 2006 Summary Compensation Table on page 33.

 

Annual Incentive Opportunity.  At the beginning of each year, the Compensation Committee establishes an annual incentive opportunity for each Named Executive Officer, under the Company’s Annual Incentive Plan. At that time, the Compensation Committee (i) sets the overall Company performance objectives for the year, (ii) sets divisional performance measures for the year and (iii) approves a target annual incentive opportunity for each Named Executive Officer.

 

In addition, we pay, where applicable, annual incentive awards in March for the prior year’s performance, based upon the Compensation Committee’s assessment of actual performance during the prior year as the pre-established Company performance objectives. For 2006, the performance measures for annual incentive awards were based on internally defined metrics based on operating income and cash flow. In addition, divisional operating margin sales growth and cash flow targets are applied to those Named Executive Officers with divisional management responsibility. The Compensation Committee selected these measures, with input from management, because these performance metrics support the six strategies that we believe drive sustainable and profitable Company growth (as discussed under “The Company’s Executive Compensation Principles” above). A more in-depth description of the Compensation Committee’s decisions with

respect to the annual incentive awards paid to each Named Executive Officer for 2006 follows.

 

Setting Company Performance Measures.  The Compensation Committee, working with the CEO and the Compensation Committee’s consultant, set the performance measures for the Company for 2006. The measures established for 2006 were as follows:

 

The metrics presented in the table above were evaluated using internal criteria which do not necessarily correlate with the Company’s reported results.

 

One hundred percent of the preliminary annual incentive award determination for each Named Executive Officer was based upon his or her performance against these objectives, as applicable based on the Named Executive Officer’s individual position.

 

Setting a Target Incentive Opportunity.  The Compensation Committee then established a target annual incentive opportunity for each such Named Executive Officer.

 

The Compensation Committee established a payout range around the target annual incentive allocation. The payout range determines the percentage of the target incentive to be paid, based on a percentage of goal achievement, with a minimum below which no payment will be made and an established upper limitation.

 

The payout range, as a percent of target award, that was established for 2006 for each such Named Executive Officer was 0% to 225%.

 

Measuring Performance.  After the end of 2006, the Compensation Committee reviewed the Company’s actual performance against each of the performance objectives established at the beginning of the year. The Compensation Committee noted that the Company’s performance was substantially improved over 2005 including a 13.6% increase in sales and a 20.5% increase in operating income. Strong operating cash flow facilitated funding of $101 million repayment of debt and other financing obligations, $36 million of optional “U.S.” pension contributions and the repurchase of 1.3 million shares ($63 million). Consistent with the goal of aligning awards with performance, the Compensation Committee adjusted the target annual incentive award amount for each Named Executive Officer in accordance with the actual achievement of Company and division performance measures. In determining the extent to which these performance objectives were met for 2006, the Compensation Committee exercised its judgment, within pre-established parameters set by the Compensation Committee, whether to reflect or exclude the impact of certain specified developments that may have occurred during the year, such as unanticipated changes in accounting principles or extraordinary, unusual, or

other unplanned events that have been reported in the Company’s public filings. Accordingly, in 2006 the Compensation Committee excluded the impact of unplanned realignment costs, acquisitions and recognition of certain stock option modification expense under Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, when determining the amount for annual incentive awards. Additionally, the change in accounting for the U.S. inventories from last-in, first-out method (LIFO) to the first-in, first-out method FIFO had no impact on annual incentive awards. The resulting preliminary annual incentive award for the Chief Executive Officer was 118% of his target award. The preliminary awards for the other Named Executive Officers ranged from 118% to 134% of their target awards. The preliminary awards would have ranged from 100% to 120% had the Compensation Committee included the unplanned realignment, acquisitions and stock modification expenses.

 

While one hundred percent of the preliminary annual incentive award determination was based on the Compensation Committee’s assessment of performance against our Company’s and divisions’ performance measures, the Compensation Committee may increase or decrease a Named Executive Officer’s award by up to 25% based on an assessment of individual contribution to our performance as well as his or her performance in relation to any extraordinary events or transactions. The Compensation Committee considers the CEO’s assessments and recommendations as to other Named Executive Officers when determining these adjustments. In 2006, the Compensation Committee increased the preliminary annual incentive award payouts for each of the Named Executive Officers from 10% to 15%, based on its assessment of each such executive’s performance against specific objectives that supported our six strategies (as discussed in “The Company’s Executive Compensation Principles”).

 

The annual incentive awards the Company paid to the Named Executive Officers for 2006 are reported in the 2006 Summary Compensation Table on page 33.

 

The Compensation Committee believes that the 2006 annual incentive awards are consistent with our Company’s strategy of rewarding its executives for the achievement of important, challenging business goals. In view of the Company’s results for the year, the Compensation Committee feels the annual incentive award calculations resulted in performance-related bonus annual payments to the Named Executive Officers, which the Compensation Committee deemed earned and reasonable.

 

Long-Term Incentives.  Our long-term incentive program rewards the Named Executive Officers for our Company performance over a period of more than one fiscal year. Since 2004 and prior to 2007, the long-term incentive program has consisted of three components: performance-based cash awards, time-vested stock options and time-vested restricted stock awards.

 

As previously discussed, the Compensation Committee believes that long-term incentive compensation is essential to retaining and motivating executives. The Compensation Committee further believes that, by providing our executives with long-term incentives, their decisions affecting the operation of our business will be aimed at enhancing the long-term value of shareholders’ investments.

 

Each February, the Compensation Committee determines the aggregate dollar value, if any, of the long-term incentive award for each Named Executive Officer, then makes annual grants of stock options and restricted stock and establishes target long-term cash incentive opportunities, accordingly. The equity awards are made after the end of the year when the Compensation Committee has had an opportunity to evaluate the Company’s operating results for the prior year and at the same time that the Company is making all of its compensation decisions for the current fiscal year. The Compensation Committee may increase or decrease a Named Executive Officer’s stock option and restricted stock awards based on an assessment of his or her individual contribution to the Company’s results after considering the recommendations of the CEO. Beginning with

2007 long-term incentive compensation, the Compensation Committee has determined that only the restricted stock component may be adjusted. The Compensation Committee also decided that any such adjustments must be based on individual performance relative to the Company’s six strategic initiatives and cannot increase the Company’s total target pool of shares by more than 10%.

 

In determining the aggregate dollar value of individual long-term incentive awards, as well as the amount of total awards to our executives as a group, the Compensation Committee considers two factors: the target dollar value of the long-term incentive package and the package’s potential dilutive effect.

 

In setting the target dollar value of the long-term incentive package for each Named Executive Officer, the Compensation Committee considers general industry survey data on total compensation packages and the value of long-term incentive awards at organizations within the Company’s peer group as previously identified. We generally provide long-term incentive awards at target level that approximate the 50th percentile of competitive practice, based on the Compensation Committee’s review of peer group and general industry data provided by the Compensation Committee’s consultant.

 

As part of its decision-making process, the Compensation Committee also considers the potential dilutive effect on the Company’s shareholders of awards of the general magnitude contemplated as a result of completing the first step described above. The Compensation Committee evaluates shareholder dilution based on the equity compensation “burn rates” (that is, the rate at which shares are used by our Company) of the companies in the Company’s peer group, guidelines used by certain institutional advisory services and the advice of the Compensation Committee’s consultant. Generally, the Company targets a maximum Company-wide “burn rate” of 1.0% of the Company’s outstanding common stock for the annual grant of long-term incentive awards for all Company employees

 

Based on these considerations, the Compensation Committee determined for 2006, a combination consisting of approximately one-third in value of stock options, one-third in value of restricted stock and one-third in value of cash-based long-term incentives would best serve the goals the Compensation Committee sought to achieve.

 

In addition, the Compensation Committee considered the total awards to be made to the Named Executive Officers in the context of the Company’s overall equity compensation program. Based on projections of equity awards to be made to employees during the balance of 2006, the Compensation Committee determined that it could make the proposed awards to the Named Executive Officers and the projected additional awards to employees and still remain comfortably within the Company’s guideline of a “burn rate” on the order of 1.0% of the Company’s outstanding common stock.

 

For the past two years, the Compensation Committee has established the practice of annually approving and granting equity awards to long-term incentive plan participants at the Compensation Committee’s February meeting. Accordingly, the Compensation Committee met on February 15, 2006 and approved the number and value of long-term incentive awards for the Named Executive Officers and stock options and restricted stock. The exercise price of the stock option awards is equal to the closing price of the common stock as reported by the NYSE on the date the grant is approved by the Compensation Committee. The equity awards were granted on the same day. This practice was continued through equity awards in February 2007.

 

The material terms and conditions of these equity awards are determined under the provisions of the equity compensation plans. These plans are contained in and were fixed pursuant to our existing exhibits to the Company’s Annual Report on Form 10-K, which can be found on the Company’s website at www.flowserve.com under the “Investors Relations — SEC Filings” caption. The 2006 stock options are effective as of the date that the Compensation Committee authorizes or

approves such awards and, as provided in the 2004 Stock Compensation Plan, have exercise prices equal to the closing market price of the Company’s common stock on the date of grant.

 

Cash Long-Term Incentive Opportunity.  Named Executive Officers participated in the Company’s Long-Term Cash Incentive Plan in 2006 in order to link their interests to the Company’s financial performance over an extended period. These awards have a three-year performance period and are paid based on achievement of pre-determined financial metrics. The Compensation Committee intends that these awards are to provide a strong incentive to our executives to achieve specific performance goals over the performance period that advance our business strategy, increase the value of shareholders’ investments and encourage executive retention, as these awards are subject to forfeiture if the executive’s employment terminates for any reason other than death, disability, or retirement before the end of the performance period. Each of the Named Executive Officer’s 2006 target opportunity is subject to a multiplier ranging from zero to 300%, depending on the Company’s performance relative to the pre-determined financial goals.

 

In 2006, the Compensation Committee approved cash long-term incentive opportunities that will be payable in March 2009 if the Company achieves, on an overall basis for the three-year performance period from 2006 through 2008, specified objectives based on internally defined metrics for the following three performance measures:

 

 

Because the Compensation Committee believes that disclosure of the specific targets for each of these performance measures would result in competitive harm to the Company, it has decided not to disclose these specific performance targets for these awards. However, the Compensation Committee believes that the specific performance targets for these awards are at least as challenging as the performance targets established for prior performance periods and represent a substantial improvement over current counterpart performances.

 

The target opportunities for the CEO, the CFO and the other Named Executive Officers during 2006 are shown in the 2006 Summary Compensation Table under Non-Equity Incentive Plan Compensation on page 33.

 

Stock Options.  Stock options comprised one-third of the long-term incentive opportunity for the Named Executive Officers in 2006. A stock option rewards an executive only if the market value of the Company’s common stock increases above the exercise price of the option and the individual remains employed with our Company for the period required for the option to vest. In addition, stock options link a portion of the executive’s compensation to the interests of the Company’s shareholders by providing an incentive to increase our stock price, thereby simultaneously enhancing the value of shareholders’ investments.

 

Target stock option grants for the Named Executive Officers represented approximately one-third of the executive’s total long-term incentive opportunity for 2006. Target grants were determined by dividing this portion of the executive’s long-term incentive opportunity by the stock option value. Management’s compensation consultant, based on the consulting firm’s established valuation methodology, determined the stock option value. The value was established in 2004 and was approved as the value used to determine the number of stock options granted annually for a three-year period (2004 through 2006) as a means of stabilizing target annual grants. All stock options are granted with an exercise price that is equal to 100% of fair market value of the Company’s stock on the date of grant.

 

The expense under SFAS No. 123(R) of the stock options earned by the Named Executive Officers during 2006 is shown in the Summary Compensation Table on page 33. Following the approval by the Company’s shareholders on August 24, 2006, the regular terms of certain

options granted to employees, and certain of our directors and executive officers (including one Named Executive Officer), which were scheduled to expire in 2005 and 2006, were extended as follows: (i) the regular term of options otherwise expiring in 2005 expired on October 29, 2006, and (ii) the regular term of options otherwise expiring in 2006 expires on the later of: (A) 75 days after the regular term of the option as originally granted expires, or (B) December 31, 2006.

 

For financial reporting purposes the approval of these amendments is considered a stock option modification subject to the recognition of a non-cash compensation charge in accordance with SFAS No. 123(R). For further discussion regarding the incremental accounting expense of the grants calculated as of the extension date in accordance with SFAS No. 123(R), see the 2006 Summary Compensation Table on page 33 and the 2006 Director Compensation Table on page 52.

 

Additional information on the awards granted in 2006, including the number of shares subject to each award and its full grant date fair value, is shown in the 2006 Grants of Plan-Based Awards Table on page 34.

 

Restricted Stock Awards.  Starting in 2004, the Compensation Committee began granting time-vested restricted stock awards to replace a portion of the annual cash long-term incentive opportunities and stock option awards on a basis intended to provide comparable value to the Company’s executives. The Compensation Committee believes that introducing the restricted stock component provides a better balance for executives between risk and potential reward, thus serving as a more effective incentive for our superior executive performers to remain with the Company and continue such performance.

 

Restricted stock awards are for shares of the Company’s common stock and will only be earned by a Named Executive Officer if the individual continues to be employed by the Company until at least the applicable vesting date of the awards.

 

During the restriction periods, the Named Executive Officers holding unvested restricted shares are entitled to vote the shares and to receive dividends on the shares, if and when declared by the Board, in each case on the same basis as the Company’s shareholders holding unrestricted shares.

 

Target restricted stock grants to the Named Executive Officers in 2006 represented approximately one-third of the executive’s total long-term incentive opportunity. Target grants were determined by dividing this portion of the executive’s long-term incentive opportunity by the restricted stock value. Management’s compensation consultant, based on the consulting firm’s established valuation methodology, recommended this restricted stock value, which was subsequently incorporated by the Compensation Committee into its award analysis. The Compensation Committee began using this per share value in 2004 as a fixed value for a three-year period (2004 through 2006) as a means of stabilizing target annual grants.

 

The expense under SFAS No. 123(R) of the restricted stock awards earned by the Named Executive Officers during 2006 are shown in the 2006 Summary Compensation Table on page 33. Additional information on the awards granted in 2006, including the number of shares subject to each award and its full grant date fair value, is shown in the 2006 Grants of Plan-Based Awards Table on page 34.

 

Stock Ownership Requirements.  The executive compensation program includes stock ownership requirements for the Company’s executives. The Compensation Committee believes that this ownership policy encourages the executives to act like owners by requiring them to acquire and maintain a meaningful stake in the Company and thereby promotes our objective of enhancing the value of shareholders’ investments.

 

In 2006, the Compensation Committee adopted amended stock ownership requirements for the executives, including the Named Executive Officers, as a result of a competitive analysis

conducted by the Committee’s compensation consultant that indicated that the Company’s stock ownership guidelines exceeded competitive levels. The stock ownership requirements are designed to satisfy an individual executive’s prudent needs for personal asset diversification, while maintaining management stock ownership at levels high enough to clearly confirm to our shareholders management’s commitment to share value appreciation. Under these requirements, our executives are expected, over time, to acquire and hold shares of the Company’s common stock equal in value to a multiple of their target annual equity grant (including target stock option grants and target restricted stock grants). The Company’s current stock ownership requirement for Named Executive Officers in 2006 was three times the executive’s target annual stock grant. Named Executive Officers are expected to achieve the level of required stock ownership within five years from the date the guidelines are applicable or from when the executive joins the Company.

 

The Compensation Committee reviews the requirements on a regular basis and monitors the executives’ progress toward meeting their target ownerships levels. Shares held directly by an executive count toward satisfying the requirements. The share equivalent of vested, unexercised stock options and shares held in our Company Non-Qualified Deferred Compensation Plan also count toward satisfying the requirements.

 

Defined Benefit Pension Plan.  The Named Executive Officers participate in our Company’s tax-qualified defined benefit pension plan on the same terms as the rest of the Company’s U.S. salaried employees. Because the Internal Revenue Code of 1986, as amended (the “Code”), limits the pension benefits (based on an annual compensation limit) that can be accrued under a tax-qualified defined benefit pension plan, our Company has established and maintains a partially funded, non-qualified defined benefit restoration pension plan for our executives, including the Named Executive Officers, to compensate these individuals for the reduction in their pension benefit resulting from this limitation. This executive retirement plan is purely a restoration plan to provide comparable level retirement benefits to those provided to other U.S. employees. Our Company has also established and maintains a second partially funded, supplemental defined benefit pension plan for its U.S. executives, including the Named Executive Officers, to maintain a total retirement benefit level that is competitive with general industry companies similar in size. These programs are designed to provide U.S. executives with income following retirement that was commensurate with their pay at the Company and to ensure that we are able to attract and retain executive talent by providing comprehensive retirement benefits.

 

We accrue pension plan benefits based on a percentage, as determined by the executive’s age and years of service, of the executive’s earnings, with earnings comprised of base salary and target annual incentive award. The actuarial present value of the accumulated pension benefits of the Named Executive Officers as of the end of 2006, as well as other information about the Company’s defined benefit pension plans, are shown in the 2006 Pension Benefits Table on page 40.

 

Change-in-Control Plan.  To ensure that the Named Executive Officers receive financial protection in the event of the loss of their positions following a transaction that involves a change in the ownership or control of the Company and to fulfill their expectations with respect to their long-term incentive compensation arrangements, the Company’s Executive Officer Change-in-Control Severance Plan provides certain specified severance benefits to the Named Executive Officers. These benefits are triggered if, within two years following a change-in-control of the Company (as defined in the plan), the employment of the Named Executive Officer is terminated involuntarily other than for cause, death or disability, or for reasons constituting a “constructive termination.” In addition, benefits are triggered when a Named Executive Officer is terminated prior to a change-in-control if such termination (i) occurs after the initiation of discussions leading to such change-in-control, but prior to the

change-in-control and (ii) can be demonstrated to have occurred at the request or initiation of parties to such change-in-control. These severance benefits include:

 

 

The Compensation Committee believes that it is in the best interests of the Company and its shareholders to offer such a plan to its executives, including the Named Executive Officers. The Company competes for executives in a highly competitive market in which companies routinely offer similar benefits to senior employees. The Compensation Committee views these amounts as reasonable and appropriate for the Named Executive Officers, who may not be in a position to obtain comparable employment. The Compensation Committee also believes that these benefits are important so that they should not be discouraged from supporting a change-in-control transaction, which the Board may deem in the best interest of shareholders, although the Board currently believes that the shareholders’ best future interests are best served by the Company remaining independent.

 

In the Compensation Committee’s view, the accelerated vesting of all outstanding equity awards in connection with a change-in-control of the Company is currently a customary and reasonable component of a comprehensive change-in-control benefits program plan, but the Compensation Committee will continue to review this matter. The Compensation Committee believes that the equity awards granted to our executives have been reasonable in amount and a substantial part of the value that would be received by them in the event of a change-in-control of the Company would have resulted from the likely future increase in the price of the Company’s common stock over the years. The Compensation Committee believes that this is an appropriate result and the current executive team’s performance would have been responsible for this anticipated share price increase, which likewise benefited the long-term shareholders’ increase.

 

Our defined benefit pension plan also confers competitive post-employment benefits on the executives. The additional years of credited service and additional age credit for purposes of determining an individual’s benefits under the plan compensate that individual for his or her early termination from the plan.

 

The potential tax gross-up payment, while potentially substantial, is only applicable in the event of a change-in-control of the Company and, in the Compensation Committee’s view, is an appropriate method for the Company to offset the

effects of a 20% excise tax levied by federal income tax laws on certain income paid to executives in such circumstances. The potential tax gross-up payment will change from time to time based on several factors, including the executive’s W-2 earnings, unvested equity value and our stock price.

 

The Compensation Committee reviews the plan periodically to evaluate both its effectiveness and competitiveness and to determine the value of potential awards. This analysis and assessment of competitiveness is reviewed by the Compensation Committee’s independent consultant.

 

The amount of the estimated payments and benefits payable to the Named Executive Officers, assuming a change-in-control of the Company and a qualifying termination of employment as of the last day of 2006 and other information about the plan, is shown in the discussion of Potential Payments Upon Termination or Change-in-Control on page 42.

 

Perquisites and Other Benefits.  We maintain medical and dental insurance, accidental death insurance and disability insurance programs for all of its U.S. employees, as well as customary vacation, leave of absence and other similar policies. U.S. executives, including the Named Executive Officers, are eligible to participate in these programs on the same basis as the rest of the Company’s U.S. salaried employees.

 

In addition, the Named Executive Officers are also eligible to receive reimbursement for certain financial counseling, health and country club dues, automobile allowances and medical examination expenses and are eligible to participate in an executive life insurance plan and an executive disability plan. In addition, we own a minority interest in a corporate jet, via a time-share program. The corporate jet has been used primarily for business purposes. Other benefits available to the Named Executive Officers are as follows:

 

Non-Qualified Deferred Compensation Plan.  Executives, including the Named Executive Officers, may participate in our Non-Qualified Deferred Compensation Plan, which is available to all U.S. employees who meet the Internal Revenue Service definition of a “highly compensated employee.” The Non-Qualified Deferred Compensation Plan allows eligible participants to elect, at their discretion, to defer payment of a portion of their salary and all or a portion of their annual incentive award as part of their personal retirement or financial planning. We do not make any contributions to the plan.

 

Deferred amounts may be invested in a number of investment alternatives, including a fund that provides for the purchase of shares of our common stock. Each year, the amount of a participant’s deferred compensation account changes based on the appreciation and/or depreciation in the value of the investment alternatives selected by the participant and any additional contributions made to the Deferred Compensation Account. Generally, there are no vesting requirements on deferred amounts or earnings on deferred amounts.

 

In past years and on an ongoing basis, executives may have deferred significant amounts of their salary and annual incentive awards, which minimized the reduction in the federal income tax deduction available to our Company, because the compensation deferred was not subject to Section 162(m) of the Code limitation until the year paid.

 

In addition, as a result of the requirements applicable to non-qualified deferred compensation arrangements included in the American Jobs Creation Act of 2004 and regulations issued under Section 409A of the Code, during 2005 the Compensation Committee approved changes to the Non-Qualified Deferred Compensation Plan to ensure compliance with the new law and to minimize any adverse income tax consequences to plan participants.

 

A description of the Non-Qualified Compensation Plan and individual contributions to that plan for each Named Executive Officer during 2006 and total account balances, if applicable in either case,

as of the end of the fiscal year, are shown in the 2006 Non-Qualified Deferred Compensation Table on page 41. Only Mr. Ferguson elected to contribute to this plan in 2006.

 

Perquisites and Other Personal Benefits.  In addition to the perquisites and benefits discussed above, we provide our Named Executive Officers with an automobile allowance. The CEO receives a monthly allowance of $1,300 and the other Named Executive Officers receive a monthly allowance of $1,100. Neither the CEO, nor the other Named Executive Officers receive any additional cash compensation to reimburse them for any income tax liability that may arise and become due and payable as a result of their receipt of this item.

 

The CEO and the Named Executive Officers are also eligible for an annual financial planning fee reimbursement benefit of up to $8,000 and monthly club dues reimbursement benefit of up to $500. The Company also pays the cost of an annual physical for these executives.

 

The aggregate incremental cost to the Company of providing these personal benefits to the Named Executive Officers during 2006 are shown in the 2006 Summary Compensation Table on page 33.

 

Employment Agreements

 

Consistent with its compensation philosophy, in general, the Company does not enter into employment agreements with its executives. As a result, these individuals serve at the will of the Board. The only exceptions to this policy are the individual employment agreement with the CEO, Mr. Lewis M. Kling and the pending employment agreement with the CFO, Mark A. Blinn.

 

Employment Agreement with Lewis M. Kling.  The Company entered into an employment agreement with Mr. Kling in connection with his promotion to President and Chief Executive Officer of the Company on July 28, 2005. The agreement is for a minimum of three years with automatic renewal for one year periods. The employment agreement with Mr. Kling provides for a base salary, an annual target bonus, participation in the Company’s long-term incentive program, benefits and perquisites on the same level as other executives, retirement plan benefits and severance benefits in the event of his termination (as described in greater detail below). The employment agreement also incorporates non-compete and non-solicitation provisions, which are in effect for a period of one year following a termination of employment for any reason.

 

Pursuant to Mr. Kling’s employment agreement, in the event Mr. Kling is terminated by the Company without Cause or if he terminates employment for good reason, as defined in the agreement, Mr. Kling will be provided the following severance benefits: (i) a lump-sum payout equal to the sum of his annual base salary and the annual bonus that he earned in the year prior to the year of termination, (ii) a pro-rated annual bonus award, based on his target bonus award percentage, (iii) immediate vesting on all unvested stock-based awards, (iv) a target payout of all cash-based performance plan awards and (v) full vesting of his non-qualified pension benefit.

 

Pending Employment Agreement with Mark A. Blinn.  The Company provided special retention arrangements to Mr. Blinn on December 14, 2006. Pursuant to the pending employment agreement, Mr. Blinn received an award of stock options and restricted stock that vest three years from the date of grant, provided Mr. Blinn remains employed by the Company. In addition, if Mr. Blinn is not promoted to CEO upon the departure of Mr. Kling from the Company, or if another individual is appointed as Chief Operating Officer (“COO”) prior to Mr. Kling’s departure from the Company, Mr. Blinn: (i) will receive immediate vesting on all unvested stock options and restricted stock grants that were awarded and (ii) may elect to resign and receive severance benefits pursuant to the Officer Severance Plan (equal to two years of base salary continuation and a target annual incentive award).

 

Transitional Executive Security Plan

 

A search for a new CEO was conducted by a transition committee of the Board following the agreement between the Board and C. Scott Greer,

former President and CEO, not to renew Mr. Greer’s employment agreement with the Company upon expiration on June 30, 2005. The Board adopted a Transitional Executive Security Plan effective as of March 14, 2005 (the “TES Plan”), to promote continuity in management during this transition period. The Board concluded that the TES Plan was appropriate and desirable to promote management stability while the Company was experiencing increased bookings and stronger business conditions in many of its markets. The Board was optimistic about the Company’s business prospects and decided to adopt the TES Plan as a special incentive to retain and motivate the senior management staff during the CEO search period.

 

The TES Plan provided for two mutually exclusive benefits. First, the Company agreed to pay a cash lump sum equal to 12 months base pay to participants who remained employed by the Company through the first anniversary of the date as of which a new Chief Executive Officer commenced employment with the Company. Mr. Kling, the President and CEO of the Company, was appointed on August 1, 2005. Second, the Company agreed to pay a cash lump sum equal to 18 months base pay to any participant whose employment was terminated by the Company without cause (as defined in the TES Plan) before such date (unless such participant was entitled to benefits under a change-in-control severance plan maintained by the Company). In addition, for any participant who was eligible for such a severance payment under the TES Plan, the Company agreed to provide continued welfare benefits for 9 months (reduced by benefits from any subsequent employer) and agreed that all outstanding equity awards granted to the participant would immediately vest in full and generally remain exercisable (if applicable) for a period of 180 days following termination of employment. In either case, the payment of benefits was conditioned upon a customary release of claims by the participant.

 

The following executive officers of the Company participated in the TES Plan: Andrew J. Beall, Mark A. Blinn, Mark D. Dailey, Thomas E. Ferguson, John H. Jacko (who resigned in February 2007), Linda P. Jojo, Thomas L. Pajonas and Ronald F. Shuff. Certain other corporate officers also participated in the TES Plan. Mr. Kling’s participation in the TES Plan ended when he entered into his employment agreement on July 28, 2005 to become President and CEO and he received a $520,000 lump-sum payment in settlement of his plan participation rights. The TES Plan was terminated upon pay out on August 1, 2006.

 

In December, 2006, the Board of Directors and the Compensation Committee approved and the Company adopted a revised severance plan for Flowserve’s senior executive officers and other corporate officers (“Officer Severance Plan”). Under the Officer Severance Plan, Flowserve’s Officers are provided benefits for a termination of employment as a result of a reduction in force or if the executive is terminated without cause: (i) two years of the executive’s current base salary, paid on a bi-weekly basis in accordance with the Company’s regular salary payments and (ii) a lump sum payment, payable at the time annual incentive awards are paid to executives still employed by the Company, substantially equivalent to the annual incentive plan payment, at target, the officer would have otherwise received under the Company’s annual incentive plan if the officer had been employed at the end of the applicable performance period and was otherwise eligible for a payment under the annual incentive plan. In addition, in order to receive such payments, the executive must execute a release and covenant not to sue and must continue to comply with a one-year non-competition and non-solicitation agreement following his or her termination of employment.

 

The Officer Severance Plan replaced the Company’s practice of each executive negotiating his or her severance package upon a termination of employment. The Compensation Committee believes that the Officer Severance Plan is far superior to individual negotiations in the event of a termination of employment and adopted the Plan for that reason. The Compensation Committee

determined that the Company’s former practice of not maintaining this type of formal severance program was not competitive in the current executive labor market.

 

In addition, to protect the Company’s competitive position, each executive is required to sign an agreement with the Company that requires them to forfeit the proceeds from some or all of their long-term incentive awards if they engage in conduct that is detrimental to the Company. Detrimental conduct includes working for certain competitors, soliciting customers or employees after employment ends and disclosure of confidential information in a manner which may result in competitive harm to the Company.

 

Section 162(m) of the Code limits to $1 million per year the federal income tax deduction to public corporations for compensation paid for any fiscal year to the corporation’s CEO and the four other most highly-compensated executive officers as of the end of the fiscal year included in the 2006 Summary Compensation Table in our Company’s proxy statement, unless such compensation meets certain requirements. Approximately $3.1 million, base compensation, cash bonuses and stock awards paid to executive officers for 2006 were within the $1 million Section 162(m) threshold and should, therefore, be deductible by our Company for federal income tax purposes.

 

The cash-based Annual Incentive Plan has not been approved by shareholders and, therefore, does not currently comply with the rules under Section 162(m). The plan will be presented to shareholders for approval in our proxy statement for our 2007 Annual Meeting of Shareholders. If approved, we should be allowed to deduct performance-based compensation beginning in 2007. Further information about this proposal is set forth beginning on page 63.

 

Stock options under our existing plans are intended to comply with the rules under Section 162(m) for treatment as performance-based compensation. Therefore, we should be allowed to deduct compensation related to options granted under each of these plans.

 

The Compensation Committee also instructed that the stock-based long-term incentive program will be updated to comply with the rules under Section 162(m) and be presented to the shareholders for approval in our proxy statement for our 2007 Annual Meeting of Shareholders. If approved, we should be allowed to deduct performance-based compensation granted under the 2007 Long-Term Incentive Plan, including the new performance-based restricted share unit awards, beginning with the grants awarded in 2007.

 

The Compensation Committee has considered and will continue to consider tax deductibility in structuring compensation arrangements. However, the Compensation Committee retains discretion to establish executive compensation arrangements that it believes are consistent with its principles described earlier and in the best interests of our Company and its stockholders, even if those arrangements are not fully deductible under Section 162(m).

 

Accounting Implications of Executive Compensation

 

Effective January 1, 2006, we recognize compensation expense for all equity based awards pursuant to the principles set forth in SFAS No. 123(R) in our financial statements. The Compensation Committee considered the accounting implications of the awards in setting the long-term incentive mix and determined that the mix of time-vested stock options, time-vested restricted stock and a cash-based long-term incentive plan was appropriate for 2006.

 

CEO Compensation in 2006

 

While the compensation of the CEO was set in a manner consistent with the general compensation principles and policies discussed earlier, in the interests of providing shareholders with a better

understanding of his compensation for 2006, we are providing the following discussion.

 

In February 2006, the Compensation Committee identified specific criteria for evaluating the CEO’s performance during 2006. These criteria included stock performance, financial performance, strategic vision and leadership, including the development of human capital. In evaluating the CEO’s performance in 2006, the Compensation Committee Chairman gathered input from individual Board members during the Board’s special executive session. During this session, the Compensation Committee reviewed detailed compensation market data prepared by our Company’s compensation consultant. The Compensation Committee discussed and determined the following CEO compensation changes and awards in executive session with only Compensation Committee members and the Compensation Committee’s independent consultant present. The Compensation Committee also followed the principles and practices earlier discussed during the Board’s special executive session to conduct the CEO performance review.

 

Base Salary.  The CEO’s base salary was increased from $850,000 to $890,000 during 2006.

 

Annual Incentive Opportunity.  To recognize the CEO’s performance during 2006, the Compensation Committee approved an annual incentive award for him of $1,147,232. This amount was paid in cash. This award reflected the Company’s financial performance as measured by the performance metrics discussed above plus a 10% increase made by the Compensation Committee in recognition of Mr. Kling’s leadership in developing and implementing the Company’s six strategic initiatives earlier discussed.

 

Long-Term Incentives.  Following the principles and practices set forth earlier, the Company approved a grant of stock options covering 90,000 shares to the CEO during 2006 at the same time and at the same fair market value exercise price that awards were made to other executives and on a broad basis to other management employees. In addition, the CEO received a restricted stock award covering 55,000 shares, at the same time 2006 restricted stock grants were made to key managers including the Named Executive Officers, pursuant to the principles and processes discussed earlier.

 

The Compensation Committee reviews the CEO’s total compensation package on an annual basis and analyzes it in view of competitive data provided by the Compensation Committee’s consultant and the Company’s performance for the fiscal year. The Compensation Committee plans to continue to annually disclose its CEO and Named Executive Officers’ compensation adjustments and awards, plus the rationale for these actions, in future proxy statements.

 

The Organization and Compensation Committee of the Board of Directors of the Company (the “Compensation Committee”) is currently comprised of four independent directors, Christopher A. Bartlett, Hugh K. Coble, Roger L. Fix and George T. Haymaker, Jr.

 

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management. Based on this review and discussion, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Proxy Statement and incorporated by reference in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended December 31, 2006.

 

          Christopher A. Bartlett, Chairman
          Hugh K. Coble
          Roger L. Fix
          George T. Haymaker, Jr.

 

The following table sets forth compensation information for the year 2006 for the individual who served as CEO of the Company during 2006, the individual who served as CFO of the Company during 2006 and three other individuals who served as the most highly compensated executive officers of the Company during 2006 (Named Executive Officer).

 

 

 

The following table sets forth certain information with respect to 2006 plan-based awards granted to the Named Executive Officers for the year ended December 31, 2006.

 

 

 

 

Lewis M. Kling.  The Company entered into an employment agreement with Lewis M. Kling as of July 28, 2005, whereby Mr. Kling agreed to serve as President and CEO beginning on August 1, 2005 and ending on July 31, 2008, with automatic renewal for one-year periods (the “Employment Agreement”). Prior to his appointment as President and CEO, Mr. Kling served as the Company’s COO after joining the Company in July 2004. Pursuant to terms of the Employment Agreement, Mr. Kling receives an initial annual base salary of $850,000, subject to increase based on annual reviews. He is eligible to receive an annual bonus, based on the attainment of certain performance targets established by the Compensation Committee, ranging from 0% to 200% of his base salary. He is also eligible to participate in other benefit and incentive plans of the Company on terms no less favorable than those applicable to other senior executives. Additionally, he is entitled to the vesting of 20% of any non-qualified pension benefit that is not yet then vested, provided that he remains employed through July 31, 2008. Under the Employment Agreement, Mr. Kling’s participation in the Company’s Transitional Executive Security Plan (described on page 36), was terminated and no payments are due to him under that plan. In lieu of his participation in that plan, the Company made a special one-time lump-sum payment to Mr. Kling of $520,000 in August 2005.

 

Additionally, the Employment Agreement included a grant of an option to purchase 69,748 shares of the Company’s common stock at an exercise price of $33.86, the fair market value of the shares on the grant date, July 28, 2005. The options vest in three equal annual installments, with vesting to occur upon the first anniversary of the grant date. Mr. Kling was also granted 40,800 shares of restricted stock which vest on July 28, 2008.

 

The Employment Agreement provides that if the Company terminates Mr. Kling’s employment other than for cause, death or disability or Mr. Kling terminates his employment for good reason (as these terms are defined in the Employment Agreement) and Mr. Kling has executed and not revoked a release of claims against the Company: (i) the Company will pay to Mr. Kling within 30 days after his employment terminates a lump-sum cash amount equal to the sum of (A) (I) the sum of his annual base salary at the time of termination and (II) the annual bonus earned by him for the bonus year preceding the year in which his employment terminates and (B) a pro-rata portion of the target bonus based on the number of days of service during the bonus year occurring prior to termination of employment; (ii) all stock-based awards held by Mr. Kling that have not yet vested or otherwise become unrestricted shall immediately vest or become unrestricted in full; (iii) the target payment under all dollar-denominated, performance-based long-term incentive compensation programs shall be paid to Mr. Kling in a lump sum in cash within 30 days; and (iv) Mr. Kling shall become fully vested in any non-qualified pension benefit that is not yet vested. Also, Mr. Kling shall be entitled to purchase health benefit coverage for Mr. Kling and his current spouse substantially similar to that available under the Company’s U.S. health benefit programs at the cost to the Company of providing such coverage to its actively employed senior executives through, respectively, the period of Mr. Kling’s and his current spouse’s eligibility for coverage under Medicare. Following any such termination, Mr. Kling will also receive any Accrued Compensation (as described below).

 

If Mr. Kling’s employment is terminated for cause or Mr. Kling terminates his employment without good reason, the Employment Agreement will terminate without further obligations to Mr. Kling other than the Company’s indemnification obligation to Mr. Kling and the payment to Mr. Kling of the sum of (i) his annual base salary through the date his employment terminates, (ii) any payments that have become vested or that are otherwise due in accordance with the terms of any employee benefit, incentive or compensation plan and (iii) any reimbursable expenses incurred by Mr. Kling, in each case to the extent theretofore unpaid (collectively, “Accrued Compensation”).

 

If Mr. Kling’s employment is terminated by reason of his death or disability, the Employment Agreement will terminate without further obligations to Mr. Kling other than (i) the Company’s indemnification obligation to Mr. Kling, (ii) the payment of Accrued Compensation, (iii) all stock-based awards that have not yet vested or otherwise become unrestricted shall immediately become vested or otherwise unrestricted in full, (iv) the target payment under all dollar-denominated, performance-based long-term incentive compensation programs will be paid to Mr. Kling (or his estate or beneficiary, as applicable) and (v) Mr. Kling shall become fully vested in any non-qualified pension benefit that is not yet vested.

 

Mark A. Blinn.  The Compensation Committee approved special retention equity grants for Mr. Blinn, the Company’s Senior Vice President and CFO, consisting of 30,000 shares of restricted stock and options to purchase 30,000 shares of common stock with an exercise price of $52.25 per share, which was the fair market value on December 14, 2006, the date of grant. Both the restricted stock and the options will fully vest on December 14, 2009 if not earlier forfeited by a termination of Mr. Blinn’s employment with the Company, except to the limited extent noted hereafter.

 

In addition, the Compensation Committee reached a pending agreement in principle with Mr. Blinn, subject to the finalization of a mutually agreeable written contract, on the following related terms. If Mr. Blinn is not promoted to CEO upon the departure of Lewis M. Kling, the Company’s current President and CEO, or if another person is appointed COO prior to Mr. Kling’s departure, then (i) all of Mr. Blinn’s then unvested stock options and restricted stock grants from the Company will immediately vest and (ii) he may elect, within 30 days of receiving notification from the Company that he will not be so promoted, to resign and receive severance benefits as if he was terminated without cause under the Officer Severance Plan described below under “Potential Payments Upon Termination or Change-in-Control.” Upon such resignation, all unvested restricted stock and stock options granted to Mr. Blinn will automatically vest and any unvested performance shares or restricted stock units which are contingent upon specified levels of financial performance by the Company will expire. However, Mr. Blinn is obligated, if he elects to so resign, to continue to furnish up to an additional 120 days of transitional support to the Company, in his then current job function and at his then current salary, if requested by the Company.

 

A search for a new CEO was conducted by a transition committee of the Board following the agreement between the Board and C. Scott Greer, former President and CEO, not to renew Mr. Greer’s employment agreement with the Company upon expiration on June 30, 2005. The Board adopted a Transitional Executive Security Plan effective as of March 14, 2005 (the “TES Plan”), to promote continuity in management during this transition period. The Board concluded that the TES Plan was appropriate and desirable to promote management stability while the Company was experiencing increased bookings and stronger business conditions in many of its markets. The Board was optimistic about the Company’s business prospects and decided to adopt the TES Plan as a special incentive to retain and motivate the senior management staff during the CEO search period.

 

The TES Plan provided for two mutually exclusive benefits. First, the Company agreed to pay a cash lump sum equal to 12 months base pay to participants who remained employed by the Company through the first anniversary of the date as of which a new Chief Executive Officer commenced employment with the Company. Mr. Kling, the President and CEO of the Company, was appointed on August 1, 2005. Second, the Company agreed to pay a cash lump sum equal to 18 months base pay to any participant whose employment was terminated by the Company without cause (as defined in the TES Plan) before such date (unless such participant was entitled to benefits under a change-in-control severance plan maintained by the Company). In addition, for any

participant who was eligible for such a severance payment under the TES Plan, the Company agreed to provide continued welfare benefits for 9 months (reduced by benefits from any subsequent employer) and agreed that all outstanding equity awards granted to the participant would immediately vest in full and generally remain exercisable (if applicable) for a period of 180 days following termination of employment. In either case, the payment of benefits was conditioned upon a customary release of claims by the participant.

 

The following executive officers of the Company participated in the TES Plan in 2006 Andrew J. Beall, Mark A. Blinn, Mark D. Dailey, Thomas E. Ferguson, John H. Jacko (who resigned in February 2007), Linda P. Jojo, Thomas L. Pajonas and Ronald F. Shuff. Certain other corporate officers also participated in the TES Plan. Mr. Kling’s participation in the TES Plan ended when he entered into his employment agreement on July 28, 2005 to become President and CEO and he received a $520,000 lump-sum payment in settlement of his plan participation rights. The TES Plan was terminated upon pay out on August 1, 2006.

 

In 2006, the Named Executive Officers received compensation under the TES Plan as reported in the bonus column of the preceding 2006 Summary Compensation Table on page 33. No participant in the TES Plan received or will receive further payments under this plan.

 

The following table sets forth certain information with respect to outstanding equity awards at December 31, 2006 with respect to the Named Executive Officers.

 

 

 

 

The following table sets forth certain information with respect to stock option award exercises and restricted stock award vesting during the fiscal year ended December 31, 2006 with respect to the Named Executive Officers.

 

 

The following table sets forth certain information as of December 31, 2006 with respect to potential payments under our Pension Plans⁽²⁾, described below, for each Named Executive Officer.