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Dresser-Rand Group Inc. (NYSE:DRC)

Q4 2008 Earnings Call Transcript

February 24, 2009 8:30 am ET

Executives

Blaise Derrico – Director, IR

Vince Volpe – President and CEO

Mark Baldwin – EVP and CFO

Analysts

Roger Read – Natexis Bleichroeder

Joe Gibney – CapitalOne

Mark Brown – Pritchard Capital

Richard Ong – Eagle Capital Management

Glenn Primack – Broadview

Thad Vayda – Stifel Nicolaus

Operator

Good morning, ladies and gentlemen, and welcome to Dresser-Rand’s fourth quarter and year-end 2008 earnings conference call. My name is Jamie, and I will be your coordinator for this day’s call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference call. (Operator instructions) As a reminder, this conference call is being recorded for replay purposes. After Dresser-Rand’s comments today, I will instruct you on the procedures for asking your questions. I will now turn the conference over to Blaise Derrico, Director of Investor Relations. Please proceed, sir.

Blaise Derrico

Jaime, thank you, and good morning all. This call is open to the public. It’s being webcast simultaneously at www.dresser-rand.com and will be temporarily archived for replay. The copy of the news release we issued yesterday is available on our Web site, as are the slides we will use today during our presentation. We will let you know when to advance the slide as we deliver our prepared remarks. Please turn to slide number two.

Statements made during this conference call that are not historical facts may be forward-looking statements. Forward-looking statements involve risk and uncertainties that may cause actual results or events to differ materially from those expressed or implied in such statements. In addition, this conference call contains time sensitive information that reflects management’s best judgment only as – only as of the date of the live call.

Dresser-Rand does not undertake any ongoing obligation other than that imposed by law to publicly update or revise any forward-looking statements to reflect future events, information, or circumstances that arise after this call. Further information concerning issues that could materially affect forward-looking statements, including our financial performance, can be found in Dresser-Rand’s periodic filings with the SEC.

I’ll now turn the call over to Vince Volpe, our President and CEO.

Vince Volpe

Thank you for joining us today, and welcome to Dresser-Rand’s earnings call. With me are Mark Baldwin, Dresser-Rand’s Chief Financial Officer; and, Blaise Derrico, our Director of Investor Relations.

Today, I will start with a few opening comments, and Mark will follow me with a detailed discussion of our fourth quarter results. Please turn to slide three.

2008 was an outstanding year for Dresser-Rand with new records created in many important categories, including bookings, sales and net income. Additionally, we did a good job with our safety program. Our total recorded injury rate approve – improved to 0.9, which is among the best in all manufacturing companies while our goal continues to be zero injuries.

A few other items deserve mentioning. In 2008, we made three acquisitions, Arrow, Enginuity, and Peter Brotherhood. We achieved a new contemporary labor agreement on our largest manufacturing facility based in Olean, New York, which will allow us to improve our competitor position in the global markets in which we serve.

We began construction of a new ultra high horsepower test stand in Le Havre France, and we broke ground on a new technology center in Olean, New York. We also booked the world’s first floating LNG order. And we began testing the integrated compression system or ICS, which is the platform for a sub-sea compression program. All in all, we’re very pleased with both the year’s financial results as well as the strategic progress we have made as a company.

As always, the credit belongs to our dedicated employees and to the confidence that our clients have had in us. I’ve talked over the years about the journey we were on to make Dresser-Rand the kind of company that our competitors respect; our clients value; our suppliers want to do business with; and, most importantly, our employees want to be part of. We set out on this journey more than eight years ago. And by following a consistent strategy in getting the right people in the right places, we have made continuous and steady progress.

Please turn to slide four. Over the past five years, we have more than doubled the size of the company in terms of sales, and our operating income is up more than four times.

Please turn to slide five. Total bookings for 2008 were a record $2.5 billion or 15% higher than 2007. They were also 37% higher than two years ago. Approximately 36% of our 2008 bookings were from upstream applications, 17% for midstream, 40% downstream, and approximately 7% for applications in general industry and the US Navy.

Please turn to slide six. New unit bookings total $1.4 billion or an increase of 8%, compared with 2007. And they were 43% higher compared to 2006.

Please turn to slide seven. In the fourth quarter, we booked a total of $416 million of new unit orders, including a $108 million order to supply eight DATUM compressors for Gazprom’s Portovaya station. The Portovaya compressor station is the head station of the Nord Stream pipeline and will have an installed compression capacity of 354 megawatts, which is unparalleled in Russia. The advanced technology of the DATUM compressors for this application provides Gazprom with the best solution in terms of total number of installed units, operational flexibility, and operating cost.

Next slide please. We also booked a $100 million order from Petrobras to supply power generation packages and services for the P-55 semi-submersible production platform. The platform will be installed in the Campos Basin, and will have a production capacity of 180,000 barrels per day of oil. The P-55 award includes a $78 million supply contract for four gas turbine driven power generation units using our advanced modular VECTRA 40G power turbines, and a services contract of up to $22 million. This award adds to our growing presence in Petrobras’ offshore installations with both power generation and compression solutions. And it’s further evidence of how the value of our technology continues to support our role as a leader in the build out of the growing floating production market.

Next slide please. Our aftermarket bookings were exceptionally soaring in 2008, and we’re up 25%, compared to 2007. We offer services to the vast install base of equipment that enable our clients to get the most from their assets by giving them service that optimizes the performance of their rotating equipment. Many of the units that we service are mission critical, highly engineered, and require expert knowledge of their design and performance characteristics. We continue to make progress, expanding our aftermarket parts and services also to non-Dresser-Rand equipment. In 2008, applied technology bookings were more than $100 million, which is approximately double the level two years ago.

Next slide please. We’ve established a track record of growth in the aftermarket segment with a value-based solutions strategy, focused on extending our service offerings into new areas, including servicing non-OEM equipment, developing new technologies for upgrades, and increasing our penetration of high value added services into our own install base. This equipment operates under conditions not usually affected by commodity prices or the ups and downs of the energy industry cycle. This means that our aftermarket business has historically been somewhat insulated from changes in worldwide economic conditions, representing therefore, what we expect will continue to be a reliable source of recurring revenue and cash flow. As we think about 2009 and beyond, this will be a critical element of our business model as we believe it brings us inherent stability and cash flow regardless of the level of the new infrastructure activity.

Turn to slide 11 please. Our backlog at the end of December was $2.3 billion or about 21% higher than the year – earlier period, and 78% higher than two years ago. The new unit backlog of $1.8 billion was up 19% versus a year ago, and the aftermarket backlog of $421 million was up about 33%. Our strong backlog gives us very good momentum going into 2009 as nearly $1.4 billion of new unit backlog is scheduled for delivery this year.

I’ll have more to say about our outlook in a moment. But first, I’ll turn the call over to Mark to review our fourth quarter financial results.

Mark Baldwin

Thank you, Vince, and good morning, everyone. Please turn to slide 12. Sales for the fourth quarter 2008 of $746 million were 43% higher than the fourth quarter of 2007. New unit sales of $447 million were higher than the fourth quarter of 2007 by $174 million or approximately 64%. Aftermarket sales of $299 million were approximately 21% higher than the corresponding period last year.

Turn to the next slide please. Our net income for the fourth quarter was $77 million or $0.94 per diluted common share. This compares with approximately $53 million or $0.61 per diluted share for the fourth quarter of 2007, adjusted for the estimated impact of the Painted Post work stoppage.

Turn to slide 14 please. Operating income for the fourth quarter 2008 was $132 million. This compares with $92 million for the fourth quarter of 2007, adjusted for the impact of the work stoppage at Painted Post, and represents an improvement of approximately 43%, principally due to higher sales.

Turn to slide 15 please. Our operating margin for the fourth quarter of 2008 was 17.7%. This compares with approximately 17.6% for the corresponding period in 2007, adjusted for the impact of the work stoppage.

Next slide please. Our new unit operating margin increased 500 basis points from last year’s fourth quarter to 13.2%. The increase was principally attributable to higher sales and the fact that our margin in 2007 was adversely impacted by the work stoppage at the Painted Post facility, which we estimate reduced 2007 margin by approximate 200 basis points to 220 basis points.

Next slide please. Our aftermarket operating margin of 30.8% was essentially flat with the fourth quarter of 2007, adjusted for the impact of the work stoppage at the Painted Post facility, which we estimate reduced 2007 margin by approximately 240 basis points to 260 basis points.

Turn to slide 18 please. Turning to cash flow. Net cash provided by operating activities for 2008 was $235 million. This compares with $216 million in 2007. The increase of approximately $19 million was principally from improved operating earnings, partially offset by a higher investment in working capital.

Turn to slide 19 please. As you can see on this slide, net working capital at the end of the year increased $31 million to a still, very modest, $33 million or 1.5% of 2008 sales. However, as we’ve mentioned previously, while we believe we can maintain a relatively modest level of networking capital going forward, a drop off in new unit bookings will likely reduce the level of customer advance payments, which could drive net working capital up. Our objective is to keep net working capital at no more than approximately 5% of sales through the cycle.

Next slide please. While we had a very strong level of cash flow in 2008, we ended the year with $59 million less cash, compared with what we had at the start of the year as we used approximately $285 million of cash for investments in assets, businesses in the purchase of our own common stock. In terms of investing activities, we used approximately $136 million of cash in 2008, compared with $26 million in 2007. This increase was due to higher capital expenditures and the acquisition of three businesses.

Capital expenditures of approximately $40 million included spending in two strategic projects. One investment was for the construction of additional test capability associated with our newly developed compressor-separator technologies. The second is for a technology center to house our 500 engineers and technologists.

The acquisition of three businesses, Peter Brotherhood Limited, Arrow Industries, and Enginuity, used cash of approximately $90 million. In connection with the Peter Brotherhood acquisition, we anticipate making an additional payment this year on an earn-out for the fiscal year ended November 30th 2008. The earn-out is up to a maximum of 16 million pounds, which would be achieved if the EBITDA for the fiscal year ended November 30, 2008 is at least 6 million pounds. We’re still in the process of finalizing the calculation, but expect to make the payment in the second quarter this year.

For 2009, we anticipate capital expenditures will be approximately 1.5% to 2% of sales. We also expect to make a sizeable contribution to our pension plans in 2009 totaling approximately $40 million. This is a significant increase from prior years’ funding requirements resulting from the reduction in the value of the assets in our pension funds this past year, and for the US plan, to comply with the pension protection act of 2006. As to financing activities, we used $115 million of cash for the re-purchase of approximate 4 million shares of our common stocks.

Turn to slide 21 please. At the end of the fourth quarter, our liquidity totaled approximately $376 million, and consisted of $147 million of cash and $229 million of available borrowings under our bank credit arrangements as $271 million was used for outstanding letters of credit.

Next slide please. We ended the year with a very strong balance sheet as our net debt to capital ratio was approximately 20%, and net debt to last months’ adjusted earnings before interest tax depreciation and amortization was less than one times.

For more information about our results please refer to our Form 10-K, which we filed last night with the SEC. With that, I’ll now turn the call back to Vince for some closing comments and to moderate our Q&A session.

Vince Volpe

Thank you, Mark. Please turn to slide number 23. I'll wrap up our prepared remarks with a few comments about our business outlook. As we enter the New Year, the market for new unit orders has changed as end-users for tactical reasons feel less urgency to place orders. Therefore, we currently believe that the new unit bookings will be in the range of approximately $700 million to $1.1 billion for 2009.

Our belief that this delay is temporary is further supported by the fact that new unit inquiries for both the first and fourth quarters of 2008 were at all time record highs. This is not the first slowdown we have faced, and we've been planning our footprint and manufacturing strategy over the past eight years to be ready when this occurred. Now, as we exercise these plans, I believe the strength of our business model will shine.

Turn to slide number 24 please. As an example of the flexibility we've designed into our operations, in the year 2001, our sales were $ 877 million. We had about 6,100 employees. And we earned $21 million in operating income. At the time, our company was clearly vertically integrated.

Over the years, we've worked hard in reducing internal breakeven point through process innovation, productivity improvements, and labor material and engineering, and through an active outsourcing and sub-contracting model. As you can see on this slide, the results are clear. Over the past eight years, we have increased sales by two and a half times, operating income by 15 times, and only added 7% to the workforce with approximately the same manufacturing footprint.

Now, as the new unit bookings levels will likely recede in 2009, our strategy of outsourcing will serve us well. And as a result, we believe we will be able to adjust the new unit demand without the need for large restructuring type activity being anticipated. This flexibility, along with an expected steady aftermarket, gives us comfort that the company will continue to perform well even in the face of delayed bookings and the new infrastructure build out. As none of us were able to actually predict when the economy will pick back up, we like many other companies, will need to be cautious, conservative, and smart about how we manage hiring and spending.

Fortunately, we have a deep backlog of work, and we expect to be able to rely on the historically dependable aftermarket. I also believe we have the leadership capabilities around the company to properly manage us through the times ahead. Specifically, we are identifying opportunities where we can reduce costs, such as taking costs out of the supply chain as commodity prices decline and reducing the amount of workplace with subcontractors.

Turn to the next slide please. As to our outlook for 2009, we continue to maintain our previous guidance. New unit revenues should increase on a percentage basis by 3% to 7%, and operating margins should remain in low double digits. Aftermarket revenues should increase on a percentage basis by 3% to 7%, and operating margin should be in the range of 26% to 28%.

Our operating income should be in the range of $320 million to $360 million. Interest expense net is expected to be approximately $30 million to $32 million. We are now estimating our effective tax rate for 2009 to be approximately 35%, and diluted shares outstanding are expected to be approximately $82 million. For the first quarter 2009, we expect our operating income to be in the range 11% to 13% of the total year.

Next slide please. Thank you for your attention. At this point, we'll open the line for questions. Operator, please begin the Q&A session. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll pause for a moment to assemble our roster. We'll take our first question from Roger Read from Natexis Bleichroeder.

Roger Read – Natexis Bleichroeder

Hi. Good morning, gentlemen.

Vince Volpe

Good morning, Rog [ph].

Roger Read – Natexis Bleichroeder

Good quarter guys. Unfortunately, we're all having the focus on the future and not talk too much about the past. I guess, the aftermarket is the one that – where you have – in general has less visibility and understand historically very dependable business. But with relatively lower refining utilization or even absolutely lower refining utilization, and the chemical industry, which if I remember correctly, creates a certain level of activity for you along the Gulf Coast also seeing some slowdowns. How does that affect the general repair and maintenance business or the sales of spare parts into those businesses?

Vincent Volpe

Well, I think – the good news, Roger, is – first of all, thanks for the comment on the quarter. I hope the performance wasn't wasted. At least we generated plenty of cash, and that’s helpful.

I think the short story on the question really is, overall, we think that the aftermarket is going to hold up fairly well, okay? When you've got 95,000 plus units out there running worldwide, you can absorb slowdowns in one area if other areas pick up. And interestingly enough, that is what we're seeing. So the geography you picked on, I think you're pretty accurate. We're seeing a slowdown in this part – traditionally, in this part of the country and in the downstream applications. On the other hand, places like Europe, Middle East, and Asia – that we’re making up for that.

And so, there are different philosophies about – particularly in downstream, when your crash spreads are down, there are different philosophies about what to do. Some people just want to cut back and spend nothing. Other people realize that it might not be a bad idea to actually accelerate turnarounds. And so worldwide, we're seeing a little bit of both of that. So I think – in the quantum, I think that we feel like the aftermarket’s going to hold up fairly well. And this is not the first quarter call, okay? But the first month and a half of the year here, we don’t have any reason to believe otherwise. So it looks like its going to be okay so far, Rog. I mean it’s early days this year, but that’s all I can give you right now in terms of reading the tea leaves.

Roger Read – Natexis Bleichroeder

We all know where the visibility is in the business and where the visibility isn’t. So just trying to get note of that. Changing gears a little bit, the P-55 award that you had this year, obviously, Petrobras has a lot of potential developments across the next several years. Is that something that’s tied much more to the gas side and more to the oil side, combination of the two? In other words, as they go through their pre-salt area, can you – do you think you’re well positioned for future P-55 type awards?

Mark Baldwin

It’s impossible to know how fast they’re going to go. And I don’t have the Petrobras CapEx projections right here handy with me, but I think it was about flat year-over-year. So this not a company in – it was either flat or up. I can’t remember know which. But it’s not one of these companies where we’re expecting a significant drop off in CapEx, like for instance, what we’re expecting from Petrobras Asia [ph]. So I think Petrobras, globally, looks like they're going to keep spending. And Roger, we are a very, very large supplier of theirs. We’re probably getting one out of two of what they give, okay, in our space or something like that. It's a pretty high share. And it’s been bright, short term here, it's going to be oil related.

Roger Read – Natexis Bleichroeder

Okay. And then just the last question, Petrobras, a lot of guys have had issues out there with Petrobras not being exactly the best payer recently. Can you give us any idea of what your exposure, if any there, on the accounts receivables side is and – yes. I guess, that will really be the question.

Vincent Volpe

Well, broadly speaking, were not in the same place other people are. I'm going to defer to our CFO here, Mark, to give you a little bit more information.

Mark Baldwin

Yes. Roger, in our 10-K, you'll be able to see that we did disclose what our exposure was. I'm trying to find it. I think it was about $19 million. And we have been receiving payments from them during the first six weeks of this year. So our experience has been good with them so far this year.

Roger Read – Natexis Bleichroeder

Okay.

Vincent Volpe

Roger, if our stuff stop working, they stop making oil.

Roger Read – Natexis Bleichroeder

I understand that, but I don’t know that that necessarily is the rational approach always in Venezuela.

Vincent Volpe

Well if they don’t pay us, we won't ship them stuff.

Roger Read – Natexis Bleichroeder

Well, they’re learning that elsewhere. All right. Thanks, guys.

Vince Volpe

Thanks, Roger.

Operator

We’ll take our next question from Joe Gibney with CapitalOne.

Joe Gibney – CapitalOne

Thanks. Good morning, everybody.

Vince Volpe

Good morning, Joe.

Joe Gibney – CapitalOne

I just want to circle around on the applied technology side, it’s pretty encouraging. I haven’t seen double-digit here in a couple of years. Curious on your outlook, you think you can sustain that kind of pace as we work our way through this year?

Vincent Volpe

Joe, were thinking about being able to take another big whack at it. I don’t know that we’ve – I don’t know that we have completely settled on the number yet internally, to be honest with you. But it wouldn’t surprise me to see another 20% plus growth here in applied technology. We're really gaining traction. I mean, we’ve only given you two years data [ph] there. If you were to go back four years, it was miniscule, right? It was $20 million or something four years ago.

Joe Gibney – CapitalOne

Sure. Okay. It's very encouraging. I appreciate it. To follow up a little bit on the acquisitions side, Mark, from your comments there, it sounds like Peter Brotherhood integrating quite well. Curious there, the outlook, anything else on the landscape? Are you guys still planning on being active on the acquisition side? And are the integration of Arrow and Enginuity also going well?

Vince Volpe

Well I think the integration of Arrow and Enginuity are going very well. As far as other acquisitions are concerned, we have a list. And we keep going down the list. And so, if we get motivated sellers and the right price, we're going to proceed. We do have a fair amount here now to swallow, so to speak, Joe. And I want to make sure that before we keep going attacking things on that we've got our house well in order, and that we've done a good job integrating. But all of the integration programs are on or ahead of schedule. Mark, do you want to add anything?

Mark Baldwin

No. We do these updates after the fact looking at what we had thought we were going to do with the acquisitions three, six, nine months later, and we're on track with the integration of those three.

Joe Gibney – CapitalOne

Okay. Great. That’s helpful. Vince, if you could just talk a little bit about – you’ve talked about the flexibility of your manufacturing mapping prepared certainly for downturn. Just how much of your business do you outsource and how quickly can you ratchet [ph] it down, just a little color there would be appreciated? Thanks.

Vincent Volpe

Well, Joe, of course it varies from one – from one facility to the other, right? So I'm going to give you the virtual – as if this was a virtual factory to give you a broad sense of it, but we – this past year, we did about 30% of our direct labor hours outside, okay? And in 2009, we'll probably do a little more than that. Now, I'm glad you asked the question because there's a bigger issue around this.

When we took the company public, I went merrily around the world telling people that we're going to benefit from the infrastructure build out just like many other people in oil services are benefiting from it. And we have very much benefited on the upside. And our growth has been commensurate with what's going on in the space in terms of the other folks out here. But what I also said was, “You're not going to see the strength of this business plan until there's a slow down because that’s where there will be differentiation.”

And this is exactly what I'm talking about, Joe, eight years ago we had a management change. We decided we were going to put this business model upside down. We were going to focus on aftermarket. Since year the 2000, we have grown 10% a year, compounded annual growth. And this past year, we had a great year. That was one piece.

The second piece was we said we were going to sell value and we were going to sell it at a premium because we have the best technology in the world. And you've seen what's happened to the margins on new units, going from 2001 negative numbers, well negative numbers, to 11% this year.

The other thing we said was, we needed to make sure that we understood that in the new unit business, it's always going to be a cyclical business. The cycles may be long, they may be protracted. But sooner or later things pop up just like the economy here and the price of oil to turn down. And so what we did in 2000, Joe, was we looked at, backwards, the lowest 10 years of activity that we've ever had. And we said, “That’s what we're going to size this organization for internally so that if and when it ever goes bad down there, we're at least going to be able to break even on units, okay? And then make sure that all the aftermarket flows to the bottom line.”

And so, that settles one part of the – one part of the analysis. The other part of the analysis said was fine. But if we downsized to that point, how are we going to be able to take more orders when in fact the business comes back up? And so we worked hard and we built a process innovation function. We brought people in that brought us skills sets we didn’t have. We focused on process innovation. We focused on productivity and labor, engineering, materials supply. And so, what we got ourselves in the motto is being able to grow along with the market, which is why we’ve gone from a near 2,000 – 3.9 million square feet under roof, to the year 2008 4 million square feet under roof. 6,100 people, we’re now 6,400 people at the end of last year. So very little increase in terms of internal capacity because we’ve used process innovation, operational excellence initiatives, and our supply chain to flex up.

So what that means, Joe, I assume this is where you took – the question was supposed to go was, as this infrastructure builds slows down on the new unit side, the first thing we’re going to do is do less work outside and still keep ourselves pretty darn well absorbed internally. Such that, if the business ever goes back down to $877 million in total, which I think is unlikely because our aftermarket business is already a billion dollar business, but if it ever does go down to low levels, we have a great deal of flexibility to pull stuff back in from the outside and still keep our facilities absorbed. And as you know, absorption is a critical component on the P&L. And so if you don't have good internal absorption, your margins go down in a hurry.

I think we're very, very – we're very well poised and prepared for a bit of a slowdown in the infrastructure build out, which is what we’re expecting. And frankly, Joe, we've already made plans. If we do book in that order of magnitude, we're starting already to think about what that would look like for 2010. So I think the business model has got a great opportunity to shine in comparative terms in this environment, in which we’re in – into which we’re heading right now.

Joe Gibney – Capital One

Sure. I appreciate all the color. Thanks, great quarter.

Vincent Volpe

Thank you very much.

Operator

We’ll take our next question from Mark Brown with Pritchard Capital.

Mark Brown – Pritchard Capital

Hi. I just wanted to check when you – the way you – you think about your value chain, upstream, midstream, downstream, which of those areas do you see the most pressure going forward or the most opportunity?

Vincent Volpe

Well, I think the – I think the upstream, we’ll probably see – we’ll continue to see fairly strong activity in that – in that segment, Mark. And I think downstream, probably we’ll see – we’ll see more pressure. That being said, it’s still quite possible that we'll have a significant year-end downstream bookings. But I think, we’ve kind of, in the past, been sort of equal between midstream and upstream – or rather upstream and downstream. And I think that with downstream being a little bit more, I think upstream maybe a little bit more this year, but plus or minus five percentage points. But I don’t think you’re going to see – see the thing go to 80, 20 either.

Mark Brown – Pritchard Capital

Just switching to your – with Painted Post behind you, are there any concerns about the Wellsville, New York collective bargaining agreement coming up in August? What's the status of the union agreement in Le Havre?

Vincent Volpe

Well, okay, do you mean in Le Havre or Wellsville, or both?

Mark Brown – Pritchard Capital

Both.

Vincent Volpe

Okay. We did the heavy lifting with the three major facilities – our four major facilities in the United States, including Burlington, several years ago. We started with Wellsville. And we brought that up to being what we consider a contemporary contract in terms of the language and so forth.

We then followed with Painted Post. Painted Post, we're not (inaudible) the folks there – with leadership there, I want to be specific. Because the folks are terrific there. The leadership there didn't – could not align himself around what we needed to do from a competitive standpoint. After 16 weeks, they decided that they would come back to work. We locked them out for a week. A week later, we were able to declare impasse. And now, we have all of our work rules there, and we have probably the most highly motivated work force in the company today in Painted Post. I cannot tell you how proud I am of what’s going on there.

And then shortly after that, we got into discussions with our – with the steel workers over in Olean whom I would categorize the relationship between labor and management as very good. And we were able to negotiate five or six months early there. So that's done.

So now, the situation where we’re in now is, all three of the factories, and of course Burlington, Iowa, along the lines of what we did in Wellsville, we were able to negotiate that several years ago. So all the factories have been through, if you will, this gut-wrenching process of you don't get to have retiring, medical for you and your family for the rest of your lives completely paid for by the company.

And so we're past all of that now. And we now have contemporary contracts. And so, what that means is we need to always negotiate in good faith. There is always the risk of work interruption and/or strikes. But I would say that the probability going forward is significantly less than what it was over the last several years principally because the big stuff that’s been done.

So we do have our negotiation up this year in Wellsville. There is an opportunity for a strike. I don't believe we're going to have one, but that's only one man's opinion. The negotiations are still in front of us, they need to take place in good faith. And so we’ll rely on labor and management to do the right thing, but I'm hopeful we won't have a strike. That being said, I can tell you that the strike contingency plan is already underway.

Okay. So if we do go there, we will be ready, and we'll be more – even more efficient than we were in Painted Post if we're confronted with that. And that’s our fiduciary responsibility. So I'm not sending you any kind of a message there by saying we're planning for a strike. We have an obligation to do that and we're doing it.

As far as Le Havre is concerned, we negotiate every year with them. And so it's a different dynamic. Again, I don't see anything there of significance, at least from the company's standpoint, where we're saying we need to make a huge change. I mean fundamentally, the – the work rules basically stay in place. There's little things maybe that get tweaked one year to the next. Fundamentally, it's a discussion around pay, and the company's in good health. We ought to be able to pay commensurate with what the general industry is paying in the area.

Things are slowing down there for everyone, and we'll probably be in – we might be in the same place. I mean I don't think we're going to – we’re not going to overpay our employees, but we’re not going to be the ones to take money away while everybody else is kind of giving them things, so. Again, there, I think, in Le Havre, we ought to have a – we'll have our typical yearly conversation, protracted because that's the way it is there. But I'm very hopeful, nonetheless, that things will turn out fine. And again, we always have backup plans if they don't, but nothing really big on the horizon that I would say it raises to the level of the concern we had around at Painted Post a couple of years ago.

Mark Brown – Pritchard Capital

Well thank you very much.

Vince Volpe

Okay.

Operator

We'll take our next question from Richard Ong with Eagle Capital Management.

Richard Ong – Eagle Capital Management

Good morning. Thank you. I have a couple – a few questions. When you mentioned the new unit backlog, about $1.4 billion should be shipping in 2009. That would be a 16% increase over 2008, yet your new unit expectations of revenues for '09 was up 3% to 7%, – help beside that issue?

Vincent Volpe

Well, a lot of that is Euro based, Richard. And I think we can give you a better explanation – or more detail separately, if necessary. But fundamentally, you got a lot of – everyone – the whole European continent goes from average of $101.47 to the Euro, to average $1.28 to the Euro, which is what our plan is baked in at.

And so, what you’re really looking at in '09 are deflated numbers in dollars because of the exchange rate. And it’s not insignificant. I don't have it off the top of my head, but it's probably 40% of our revenue or some pretty big number. Mark, does that sound about right, coming out of Europe?

Mark Baldwin

Probably a little less than that. Overall, our international sales are about half.

Vincent Volpe

Okay.

Mark Baldwin

Non-US dollar denominator, about half.

Vincent Volpe

That's a part of it for sure, Richard. And that, by the way, translates to the bottom line. Look, we hit $3.30. What, we hit $3.37 this year? We hit $3.37. We're guiding you from $3.20 to $3.40. And say, “Well –”, sorry $3.20 to $3.60. And that's no great shakes. But if you adjust for the exchange rate that $3.37 looks like – something like $3.10 to $3.15. And so, you're really talking about fully 10% growth on the bottom line just normalized for – normalized for the exchange rate. So I think that's a pretty big piece of the pie.

Richard Ong – Eagle Capital Management

Thanks. Another question is on the new unit, you said overall increase are at all time highs, could you kind of give us a sense of what the kinds of increase are or why you're seeing sudden interest – increase in inquiries during an economic slowdown?

Vincent Volpe

Well, I think what's behind it – first of all it's kind of – it's slightly more of the upstream than the downstream, but not a huge swing. It looks like the upstream may – may be a little bit more active than downstream in terms of bookings, but plus or minus five points if you will.

But this slowdown is really a slowdown, okay? I mean, I was in – I've been – I've talked to a variety of different customers. And what I've gotten from them is some very large companies, including national oil companies, that are saying "We’re proceeding with our programs. We're just going to slow down from a –", well I use the word tactical, okay. That's code for if I slow down a little bit, I can get better prices, better than my – I could get my cost structure to come into line because there's clearly deflation out there as it relates to steel and some of the core commodities. And so they're hoping and expecting that that would flow through to them.

And I can tell you all of our major clients are having the conversation with us. And our position is, I'll tell you right now, if the – if material costs come down, we'll give you the benefit of that, but not to the detriment of our margins. And so, that's a conversation that is very much going on right now. And so, I think that our end users believe that these projects are all valid projects. They either need oil to be a little bit higher or the costs to be lower, or some combination of those two, and the project makes sense and they go forward.

Remember, three or four years ago, maybe four years ago now, when oil was on its way up through $40. That was a great price. And people couldn't get the projects lined up fast enough. They were constrained by people, not by project economics. So I think that people may feel like the equilibrium point around the – or at least the price point on the cost side of the equation should come down to the point where these projects make some sense.

So I think our customers are looking for a combination of relief on costs, a little bit of potential of improvement on the commodity price side, and these projects move forward. And so, in order to do that, they got to be ready with us, okay, because we're long lead equipment. They need to inquire us. They need to continue to ask us, "What's happening with the pricing? Is it going up? Is it going down? What would you offer me? What things can we do to improve the costs? Are there things in our specs that we can change or modify?"

So as I said, record level high number of inquiries in Q4. And interestingly enough, we also did – very similar to what we had in Q1. So it looks like it's strong, Richard, in terms of an activity level. And I think we're into a delay. How long it will last? No idea, no idea whatsoever.

One of the things that is working also for – for the steel and their (inaudible) in terms of the cost side of the steel industry is that when general industry is down and there are less skyscrapers being built and less bridges so far being built, and so forth, a lot of the steel –and less automobiles, a lot of the uses of steel are there. And so that puts further pressure on the supply chain even if our market remains relatively buoyant compared to the others.

So that's kind of a long answer. I hope it gives you the flavor you're looking for.

Richard Ong – Eagle Capital Management

That's helpful, thanks. And if I may, one last question, any issues around bad debt, or the inability, or lack of ability to pay for some of your customers via there – maybe Russian companies or anywhere else around the world?

Vincent Volpe

Well, we have a – we have a very strict contract in process, and we have clients that are on credit and others that are not. And you could probably guess which ones are on which list, okay? And so, for those that are on the – they don't get credit terms extended to them, we insist on irrevocable letters of credit. We also insist on progress payment terms that keep us cash flow neutral or positive. And so, we don't – even if they were – and if they stop paying we have the right by contract to stop working.

So when you put those three pieces together, what it really means is, as long as they pay us we're fine and/or we can draw down on the LC. If for some reason all that dries up, we have the right to stop, and we will not find ourselves in the situation where what we have in inventory is greater than what we've collected. So that's the way we fundamentally protect ourselves.

Richard Ong – Eagle Capital Management

Okay. Great. Thank you.

Operator

(Operator instructions) We’ll take our next question from Glenn Primack with Broadview.

Glenn Primack – Broadview

Morning, Vince.

Vince Volpe

Hey, Glenn.

Glenn Primack – Broadview

I was wondering if you could elaborate a little bit on the Norton, Ohio case project, and Dresser’s role on that. Is that a project that you think moves forward? I’ve been on a few green conference calls, and it seems that this system still makes a lot more sense than building the transmission line railroad across America. Any comments on where you’re at in terms of the case project?

Vince Volpe

Yes, Glenn. We don’t normally – we don’t normally comment on a specific project. I don’t think there’s any secret that we’ve been involved and working on the one that you’ve alluded to. I think that – let me say this to you, case is in general, and these comments probably apply to Norton also. But case in general, we think makes sense. We think it still makes sense, particularly when combined with wind energy that has that renewable aspect to it. And the insecurity of depending strictly on wind goes away when you couple it with compressed air energy storage. And I won’t go through the thermodynamics of it now because I know you understand them already.

And Norton, by the way, does actually have a wind component too, as do others. So we think it’s a good market segment. I think had we not been confronted with the slowdown in the economy that we’ve seen here over the last x months, that we may have had a project already secured. And frankly, a year ago I was saying, “I think in a matter of months, not years, we ought to have one.” But hell, I’ve been wrong before, Glenn, you remember what I said before about LNG.

So this is another one where things happen and it slows down programs. But what I’ll – what I can tell you is the economics around case are very good. The new administration’s focus on searching for renewable sources of energy does nothing but augment the attractiveness of these types programs, and it goes for CO2 sequestration also.

Being able to clean up a coal fired plant, electro-city plants is huge. And it goes for nuclear also. We have tons of equipment we can put into – a lot of equipment that we put into the nuclear plants. And, oh by the way, all the old nuclear facilities require refurbishing, may it be about their turbines in them. So I think from an administration standpoint, case, CCS, nuclear business, these are all pretty attractive segments for us that move beyond petroleum, to steal somebody else’s two words.

So sit tight as relates the case, something I believe will happen in our lifetime, whether or not it’s this year, hard to know. But we’re still – we’re still actively promoting and working with the developers on the projects that are out there. And there are – there are sort of 15 or 20 projects that have been identified in one stage or another that at some point in time, maybe years from now in some cases, we feel we ought to be working on. So I know you’re focused on that one opportunity, but there’s more to it than that.

Glenn Primack – Broadview

Well, there’s a bunch all over the place, it seems like Colorado, Texas. And the economics, as I go through these little worksheets online, seem to make a lot more sense than – than building out transmission lines all over the country.

Vince Volpe

I agree with you, I agree with you Glenn. And I think that that – I do think that that’s going to be – I think that that’s going to be something we’re going to see more of in the future.

Glenn Primack – Broadview

One last one, you added some people to the organization during just the beginning of the year?

Vince Volpe

Yes.

Glenn Primack – Broadview

And it seems like there’s – maybe more emphasis on Middle East, North Africa where you don’t have as much share as you do in other countries. You just talked – you talked about those – the added depth of management and what you’ve done here. Is this more of a–?

Vince Volpe

We got a program – we’re just a couple – little early here to talk about it in detail. But we’ve got a program in the Middle East, one thing we have done is open a service center in Abu Dhabi. We have put, what I would consider, one of the most excellent managers the company's had who actually had to retire early. We brought him back. His name is Sammy Antoun. We've asked him to run our Middle East and Northern Africa. We setup a complete region now. So were bringing high level executive focus to that area of the world. And so I think what you'll see is more activity from us there. We think it's an important part of the world. We think the time is right, right now. We do believe that localization, being able to do more locally, is important.

Abu Dhabi is a good step forward. We have some other plans, and we're just – we don’t want to get too far ahead of ourselves, but I'd say stay tuned on some of that stuff. But we really believe that that’s an area of the world that will give us a greater yield, not just in selling new kits, but I think there's a large installed population there. And I don’t think we've gotten as much out of that – those assets as we do, for instance, from the assets that we have in the United States. So, on a per machine basis, we're getting a better yield out of the equipment that we have in the US and equipment that we have in the Middle East.

And so we need to improve our processes. It starts with people. That’s why we brought Sammy back on. And like I said, we’re just delighted to have him. And we have added the repair center and service center in Abu Dhabi, and there's more to come in the Middle East, so stay tuned.

Glenn Primack – Broadview

Is it your equipment in your install base in Iraq? I mean the oil refineries over there.

Vincent Volpe

Yes, we have a lot of equipment in Iraq.

Glenn Primack – Broadview

Okay. And no commentary on the GE downstream manager that’s now with Dresser? I think that was the –

Vincent Volpe

Oh, yes. I'd be happy to talk about it. This is another – this is a – this lady’s name is Nicoletta Giadrossi, and she has taken responsibility from Walt Nye who retired here a couple of months ago. And she's had – she's spent the better part of her last 20 years, a better part of it was with GE. And she spent a great deal of time in running their downstream business in oil and gas, so certainly understands our business, our markets. And we're delighted to have her looking after the European served area, which covers all of Europe North and – sort of Northern Africa and the Middle East region also as part of what she does. And she also has responsibility for Europe, Scandinavia, the rest of Africa, and the UK.

So she's been onboard with us since the beginning of the year, and we're delighted to have her. As I said, lots of experience in this business, good understanding of the products, terrific understanding of the clients. And so, she very much hit the ground running, and I think as long as I'm completing the story let me go ahead and give you the other two new additions because we're really – we’re just delighted to have them onboard.

The other fellow’s name is Luciano Mozzato. He came to us from United Technologies. Luciano has held a variety of roles and had P&L responsibilities upwards of $0.5 billion, different businesses that he's run. His last business was Otis Elevator. And you may say, “Well, what do elevators have to do with – have to do with parts and service in new units?” And the answer is, “There's quite a bit in common.” And one of the reasons we hired Luciano is because he brings some excellent new programs and new thinking to this space from an outstanding company, United Technologies. And so, we’ve been able to grow our business 10% a year. We want to make sure that we stay in that trajectory. And we think that by infusing some new thoughts and some new ideas from well proven outstanding company like UTC, it's going to be for us. So Luciano's been with us, again, since the beginning of the year. Great to have him.

And then the last addition was Jerry Walker. Jerry actually joined back in October. Jerry came from Honeywell, another outstanding company. He's had lots of experience in our space, in our business, so he knows the clients very well. He understands engineers’ order products. And Jerry is responsible for our North American operations. So that’s a little bit more than half of our total revenue coming out of the North American facilities Jerry has a responsibility for. And as I said, he's been with us since October, and Jerry replaced Jean-Francois Chevrier.

Jean-Francois' assignment, if you will, in North America was done at the end of the year. And I've asked Jean-Francois to stay on, which he has graciously accepted to do because we believe that now is the time for us to invest in new infrastructure build out where it makes sense. This localization program. And I talked a little bit about Middle East, but in fact, there are other parts in the world where we think we can really significantly increase market penetration, both on new units and particularly in services by being closer to our clients. And we think that our systems and processes are getting to the point where we can start to do that more efficiently than we could say five or ten years ago.

So Jerry's role is fundamentally to focus on those opportunities; make sure we get the proper marketing study or work done; develop a business plan; get it approved, including through the board; and then, make sure that we do everything necessary to handle on sort of a turnkey basis on operation up and ready to run to whomever the general manager is that’s going to take responsibility for that.

And of course, Jean-Francois has been with us for the better part of 20 years. He understands the upfront part of our business. He is likely the most qualified operations person that we have in the company at this level today, and so we think we really got a unique skill set there in JF. And that's why we've asked him to stay. So Glenn, I kind of does – I just went around the – went around the horn for you and talked about all the new additions. I think we've got a marvelous mix now of new folks coming in and still lots of experience on the leadership team. And so, I think that's a good mix and it will bode well for us going forward as we continue to press the strategy in some of these extended directions.

Glenn Primack – Broadview

Great, thanks.

Operator

We'll take our next question from Thad Vayda with Stifel Nicolaus.

Thad Vayda – Stifel Nicolaus

Morning. One quick one on your supply chain and/or vendors. Have you guys have to take any extraordinary steps to sort of ensure the integrity, supply of raw materials, or critical components, I mean first speaking of perhaps accelerating payment terms or providing back sub-financing or anything like that? Thank you.

Vincent Volpe

As of right now, I do not believe that we've had to, Thad. But what I can tell you is we do have a program, it's called Open Ratings, and its systems that are well understood that our supply chain management group manages. And so we believe that we have pretty good visibility into our key suppliers. And I won't go through the machinations of how it works, but it's a – it is a predictive tool. So if things start to happen in the supply base, and these are key suppliers, of course, we’re talking about, we're monitoring them. And we are able, in some cases to predict, in fact, in one case about two years ago, we were able to predict. A company was in bad shape. We went to call them, and sure enough they were about two weeks away from filing for protection under Chapter 11.

So we've got tools in place. We are very focused on that potential risk. We do not represent sort of 30%, 40%, or 50% of any of our suppliers' workload. And our strategy on all key suppliers is a two-plus-one strategy, two main suppliers and one good backup. So I think we're fairly well protected. But that is a good question, and it’s one that's on our minds.

Thad Vayda – Stifel Nicolaus

Thank you for your help.

Vincent Volpe

Okay.

Operator

That does conclude today's question-and-answer session. At this time, Mr. Derrico, I will turn the conference back over to you for any additional or closing remarks.

Blaise Derrico

I want to thank everybody for joining the call today. If you have further questions you can call me. My number is on the news release we issued last evening. And thanks for joining and have a great day.

Operator

That does conclude today’s conference. We thank you for your participation. You may disconnect at this time.

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Source: Dresser-Rand Group Inc. Q4 2008 Earnings Call Transcript
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