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Dresser-Rand Group Inc. (NYSE:DRC)

Q1 2014 Results Earnings Conference Call

May 02, 2014, 9:00 AM ET

Executives

Blaise Derrico - VP, Investor Relations

Vincent Volpe - President & CEO

Jan Kees van Gaalen - EVP & CFO

Analysts

Ole Slorer - Morgan Stanley

James West - Barclays

George O'Leary - Tudor, Pickering, Holt

Robin Shoemaker - Citi

David Anderson - JPMorgan

Jon Donnel - Howard Weil

Jim Rollyson - Raymond James

Chase Jacobson - William Blair

Jeff Spittel - Clarkson Capital

Joe Gibney - CapitalOne

Jeffrey Campbell - Tuohy Brothers Investment Research

Glenn Primack - Peak Six

Operator

Good day, ladies and gentlemen, and welcome to the Dresser-Rand's First Quarter 2014 Earnings Conference Call. (Operator Instructions) As a reminder, today’s call is being recorded.

I would now like to introduce your host for the call, Mr. Blaise Derrico, Vice President, Investor Relations. Mr. Derrico, please go ahead.

Blaise Derrico - Vice President, Investor Relations

Thank you, Janine. 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. A copy of the news release we issued yesterday is available on our website, as are the slides we will use today during our presentation. We will let you know when to advance the slides as we deliver our prepared remarks.

Please turn to slide number two. The statements made during this conference call that are not historical facts may be forward-looking statements. Forward-looking statements involve risks 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 of the date of the live call.

Management statements may also include non-GAAP financial measures. For reconciliation of these measures, refer to our earnings news release or the conference slides available on our website.

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 the financial performance related to forward-looking statements can be found in Dresser-Rand's periodic filings with the SEC.

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

Vincent Volpe

Thank you, Blaise. Thank you for joining us today and welcome to Dresser-Rand’s earnings conference call. I’ll start with a few opening comments and Jan Kees van Gaalen, our Chief Financial Officer, will follow me with a detailed discussion of our first quarter results.

Please turn to slide three. Our first quarter operating income of $40.2 million was slightly above the top end of our guidance range. Net working capital improved approximately $33 million and approximately $59 million of cash was generated from operating activities, which represents an improvement of more than $100 million over the corresponding period last year.

As anticipated, new unit bookings for the first quarter were light, but should improve over the course of the year as major project awards are expected starting over the next few months. Aftermarket bookings were lower than last year’s level as a result of the impact of the draft Spanish regulation of approximately $26 million, the adverse translational effect of the stronger U.S. dollar of approximately $7 million, and reduced bookings for one Latin American National Oil Company, or NOC, client.

While the shortfall with this NOC client was considerable in the first quarter, approximately $28 million, we are working collaboratively and believe that, over time, we will be able to resume normal business activity. We continue to expect full-year bookings to increase 5% to 10% from the 2013 level.

With first quarter results generally in line with our expectations, we remain confident about the opportunities available for Dresser-Rand and our continued progress on operational excellence initiatives. And we expect to see improved operating margins as volumes increase over the balance of the year while controlling costs. As a result, we are reiterating our full-year operating income guidance of $377 million to $396 million.

Please turn to slide four. Aftermarket bookings of $350 million for the first quarter 2014 were 12% lower than the corresponding period in 2013. The decrease is principally attributable, as I mentioned, for reduced aftermarket bookings of $28 million versus last year for one NOC Latin American client, as well as the impact of the draft Spanish regulation, which reduced first quarter 2014 aftermarket bookings by approximately $26 million. Additionally, the stronger U.S. dollar had an adverse translational effect of approximately $7 million.

In total, these three items represented variance of approximately $61 million versus last year’s first quarter bookings. Beyond these items, we’re seeing good levels of business activity worldwide although we are monitoring closely several countries were business might suffer delays due to security and political reasons.

Please turn to slide five. In the new unit segment, first quarter bookings of $244 million were approximately 9% lower than the corresponding period in 2013, reflecting the lumpy nature of the new unit business. Our first quarter new unit bookings came from all segments of energy infrastructure and included flash and fuel gas trains for an LNG facility located on the eastern shore of the United States, DATUM compressors for refrigeration service at our natural gas-to-liquids export terminal in Texas, the terminal was used to export propane and ethane to petrochemical facilities outside of the United States, two gas turbine driver packages for a production platform off the coast of Brunei, a steam turbine generator set for a chemical plant in the United States, two compressor trains for net gas and recycle services in a refinery in Latin America, a power generation package for a refinery in Saudi Arabia, and a low-pressure propylene refrigeration unit for midstream application in the U.S.

Please turn to slide six. We also booked an order to supply compression equipment for a large gas plant in the Middle East. We’re particularly excited about this order because it features Synchrony magnetic bearing technology that represents our first commercial order for a major oil and gas company who is applying this technology.

We will supply two DATUM compressors for the plant’s sales of propane gas services. The compressors will be driven by high-speed motors, which will also run Synchrony mag bearings. This oil-free compression solution is expected to improve the equipment’s overall efficiency and reliability and should also allow for unmanned operation. This is the way of the future. These compression trains will help in the production and processing of 75 million cubic feet of non-associated gas and 4,500 barrels of condensate per day.

Please turn to slide seven. I’m also very pleased to report that this month, as we speak, we booked the very first order of our newly launched LNGo distributed liquefied natural gas product technology. This approximately $10 million order is for a North American facility to liquefy pipeline gas for LNG distribution and will be included in second quarter bookings.

We’re very excited about this technology for distributed LNG production, which allows for scalable plants comprised of portable skids starting as small as 6,000 gallons per day. We believe the market is leaning more and more towards scalable plants to build capacity over time versus the large initial investment and a long-cycle time required for plans with capacities of 100,000 gallons per day and more. A number of larger-size plants have been delayed, and in some cases, cancelled as a result of more challenging economics of installing a plant at such scale.

Scalable plants give operators greater flexibility to start and phase their growth commensurate with demand and quickly capitalize on regional pricing differentials. In addition, a smaller plant can be located close to the market, reducing both transportation risk and cost. We are continuing to see a steady stream of interest and we have several other proposals outstanding that we expect to book in the near future. We are enthusiastic about this technology and the market opportunity we see developing.

The other aspect I’ll mention regards to LNGo is that our entry into this exciting new market would not have materialized were it not for the acquisition of Guascor. I know that there have been a few puts and takes with this acquisition, but this is a major positive.

The market for distributed LNG is larger than what we have initially envisioned, especially as we are now sizing up opportunities beyond North America. This is the first example of a Dresser-Rand product offering bringing together our engine and compressor technologies for an energy infrastructure application.

We estimate that about half the added value for our LNGo facilities is tied to engines. Importantly, beyond the initial sale, there is also the value associated with a sizable aftermarket opportunity of providing parts, services and repairs to a growing installed base of this equipment.

I’ll now turn the call over to Jan Kees for a more detailed review of our first quarter results.

Jan Kees van Gaalen

Thank you, Vince, and good morning, everyone. Please turn to slide eight. Total bookings for the last 12 months were approximately $2.9 billion, 5% lower than the same period a year ago. New unit bookings of approximately $1.3 billion compares to approximately $1.5 billion for the corresponding period a year ago.

Aftermarket bookings for the last 12 months increased approximately 1% to approximately $1.6 billion. Approximately 25% of our total bookings in the last 12 months were upstream, 15% midstream, 31% downstream, and 27% environmental solutions.

Next slide please. Backlog at the end of March was approximately $2.7 billion. New unit backlog of $2.0 billion was approximately 7% lower than a year ago while our aftermarket backlog increased by about 7% to $703 million.

Please turn to slide 10. Revenues for the first quarter 2014 of $699 million, increased approximately $67 million or 9%, compared to $766 million for the first quarter 2013. The decrease in revenues was principally due to the variability and timing of large new unit orders. The impact of the draft Spanish regulation reduced aftermarket sales in Latin America and an adverse translation impact of foreign currency fluctuations resulting from a stronger U.S. dollar.

The lower new unit volumes reflected numerous project delays experienced in late 2012 and continuing until now, especially in the upstream segment of oil and gas. This contributed to the decrease in new unit revenues of approximately $52 million or 12% to $391 million for the first quarter 2014, compared to $443 million for the first quarter 2013.

Aftermarket parts and services revenues were $308 million for the first quarter 2014 compared to $323 million for the first quarter 2013, a decrease of $15 million or 5%. The decrease in revenues was principally due to the impact of the draft Spanish regulation, which lowered revenues by approximately $26 million.

Revenues also decreased as a result of adverse translation impact of foreign currency fluctuations of approximately $7 million due to a stronger U.S. dollar and also reduced shipments in Latin America.

Please turn to slide 11. Cost of sales was $552 million for the first quarter 2014, compared to $594 million for the corresponding period last year. As a percentage of revenues, cost of sales for the first quarter 2014 increased to 78.9% of sales, compared to 77.6% for the corresponding period last year.

The increase in cost of sales, as a percentage of revenues, was principally the result of reduced operating leverage on fixed costs due to lower volumes and the impact of the draft Spanish regulation, which contributed approximately 0.7 percentage points to the increase in cost of sales as a percentage of revenues.

Selling and administrative expenses were approximately $100 million for the first quarter 2014, compared to $95 million for the corresponding period last year. The increase was generally the result of cost inflation and higher third-party commissions driven by the mix of sales. As a percentage of revenues, selling and administrative expenses increased to 14.3% from 12.6%.

Research and development expenses were $7.4 million, compared to $10.3 million for the corresponding period last year. The decline is a result of timing of expenditures, as we expect our total 2014 restructuring and development expense to be consistent with 2013.

Total operating income for the first quarter 2014 was $40 million, a decrease of 39% compared with $66 million for the first quarter 2013. Our operating income was slightly above expectations and was at the high end of our guidance.

As a percentage of revenues, operating income for the first quarter 2014 was 5.8% and compares with 8.5% for the corresponding period in 2013. This decrease in income from operations, as a percentage of revenues, was principally the result of reduced operating leverage on fixed costs due to lower volumes, the impact of the draft Spanish regulation and the stronger U.S. dollar.

The first quarter of 2014 operating income and operating income, as a percentage of sales, decreased by approximately $11 million and 1.3 percentage points, respectively, as a result of the impact of the draft Spanish regulation when compared to the first quarter of 2013.

Interest expense, net, was $13 million for the three months ended March 31, 2014, compared to $14 million for the three months ended March 31, 2013. We experienced higher interest income for the first quarter of 2014 resulting from higher average interest-bearing cash balances.

Other income, net, was $3.3 million for the three months ended March 31, 2014, compared to the other expense, net, of $1 million for the three months ended March 31, 2013. Other expense/income, net, consists principally of net currency gains and losses on investments accounted for under the equity method of accounting.

Other expense/income, net, for the three months ended March 31, 2013 was also impacted by the devaluation of the Venezuelan bolivar on February 8, 2013. As a result of this devaluation, we recorded a non-deductible foreign exchange loss of approximately $3.1 million for the three months ended March 31, 2013.

In the first quarter 2014, the effective tax rate was 45.6%, compared with 31.5% for the first quarter 2013. The 2014 rate is higher than the first quarter 2013 as a result of certain legislative changes and the mix of earnings.

In the U.S., the R&D credit has not been extended and certain past through rules which impact the recognition of certain types of deemed income sub-part F have lapsed and have not been extended. The first quarter rate was also higher due to the disproportionate amount of losses in countries for which there will be no tax benefit and the most material of these in the first quarter losses relates to the Spanish cogeneration facilities and a valuation allowance had to be established.

The bottom line of all of this is that our reported net income for the first quarter 2014 was approximately $17 million or $0.22 per diluted share. This compares to net income of $0.43 per diluted share for the first quarter 2013. Incidentally, the first quarter 2014 net income and diluted earnings per share were reduced by approximately $10.8 million or $0.14 per share, respectively, as a result of the draft Spanish regulation described below when compared to the first quarter 2013.

Please turn to slide 12. New unit operating income was $16 million for the first quarter 2014, compared to $29 million for the corresponding period in 2013. As a percentage of new unit segment revenues, operating income was 4% for the first quarter 2014, compared to 6.5% for the first quarter last year. The decrease in operating margin was primarily due to reduced operating leverage on fixed costs as well as -- as a result of lower volumes.

Turn to slide 13, please. Aftermarket operating income was approximately $50 million for the first quarter of 2014, compared to $66 million for the corresponding period last year. As a percentage of segment revenues, operating income decreased to 16.2% from 20.5%. The decrease in the segment operating income was principally due to the impact of the draft Spanish regulation and the stronger U.S. dollar.

The first quarter 2014 operating income and operating income, as a percentage of sales, decreased by approximately $11 million and 2.1 percentage points, respectively, as a result of the impact of the Spanish regulation when compared to the first quarter of 2013.

Please turn to slide 14. The table on this slide shows the amount of revenues and implied margin for the extended scope contracts accounted for on the percentage of completed method for the first quarter 2014 and the full-year 2013. Let me make a couple of observations. First, gross margins for each of the two periods are in the range of 18% to 24% and they are relatively consistent with our traditional business.

Second, the revenues attributable to extended scope contracts, as a percentage of total revenues, are relatively small at approximately 5% and 7% of total revenues for the first quarter of 2014 and for the full-year of 2013, respectively. Finally, we do not choose the method of accounting for these type of contracts. It’s the nature of these extended scope contracts to drive the accounting methodology.

Turn to slide 15, please. Turning to cash flow, operating activities provided cash of approximately $59 million in the first quarter of 2014, compared to approximately $43 million of cash used by operating activity in the corresponding period last year, an improvement of more than $100 million.

The principal reason for operating activities having provided cash in the first quarter was the $33 million decrease in working capital. This compares to an increase in working capital of approximately $84 million in the corresponding period last year. In this year’s first quarter, we contributed approximately $6 million to our pension plans, which is consistent with the amount contributed in the first quarter of last year.

Please turn to slide 16. This slide shows the changes in the components of working capital. Accounts receivable decreased in the first quarter of 2014 as a result of the cyclically lower volume and timely cash collections from clients related to high fourth quarter 2013 sales, as well as a decrease in costs and estimated earnings on uncompleted contracts related to contracts being recognized on the percentage of completion accounting method.

Accounts payable and accruals decreased in the quarter principally as the result of the timing of payments. Lower customer advances are also attributable to our higher percentage of business with large National Oil Company customers.

We continue to believe that our net working capital will come down gradually over the course of 2014 and we believe it will approach the mid-teens as a percentage of full-year sales by the end of the year due to the following. One, we expect to complete all of the administrative steps required to invoice the pipeline job in Central Asia. Two, in connection with our new LNGo product line, over the course of this year, we continue to expect a conversion of this inventory into cash. Three, anticipated new bookings -- new unit bookings and the collection of progress payments associated with these orders. Four, reducing our exposure in Latin America. For the second quarter, we currently anticipate the net working capital continuing to gradually move lower.

Next slide, please. In the first quarter, net cash used in investing activities of $14 million, compares to $31 million for the corresponding period last year. Cash used in investing activities for the three months ended March 31, 2014 includes capital expenditures of $11 million, compared to $20 million in the corresponding period in 2013.

As to financing activities, during the quarter, we repaid approximately $56 million of debt as compared to the year ago period and we borrowed a little over $100 million under the revolver, primarily to fund the working capital.

Turn to slide number 18, please. At the end of the first quarter, our liquidity totaled approximately $732 million and consisted of approximately $179 million of unrestricted cash and $532 million of available borrowings under our bank credit arrangements as we had outstanding borrowings of $553 million and $84 million was used for outstanding letters of credit. At the end of the first quarter, we also had approximately $236 million of letters of credit and bank guarantees drawn under uncommitted bank lines.

Next slide, please. At the end of March, our net debt to capital ratio was approximately 41% and our net debt to our last 12 months EBITDA was approximately 2.8 times, compared to 42% and 2.8 times at the end of 2013. For more information about our results for the first quarter, please refer to our 10-Q, which we filed earlier today with the SEC. As a reminder, our Annual Meeting of stockholders will be held on Tuesday, May 6.

With that, I will turn the call back to Vince for closing comments and to moderate our Q&A session.

Vincent Volpe

Thank you. Please turn to slide number 20. Turning now to our outlook, we continue to expect new units and aftermarket parts and service segment bookings to increase between 5% and 10% over the 2013 level.

The key risks to our 2014 bookings outlook include ongoing delays in clients placing major new unit orders, and for the aftermarket, the ever-present geopolitical risk in certain regions of the world where we have an installed base of equipment. In this regard, we are continuing to monitor the political stability in certain countries, most notably Libya and Iraq at this time.

Turning to the P&L, we are reiterating our guidance for the full-year 2014. We expect 2014 revenues to be in the $2.9 billion to $3.1 billion range and operating income between $377 million and $396 million. For modeling purposes, we are showing on this slide other key financial metrics to arrive at net income and EPS numbers for 2014. We expect our full-year fully-diluted earnings per share for 2014 to be in the range of $2.60 to $2.80 based on fully-diluted share outstanding of approximately 77.5 million.

Please turn to slide number 21. I want to share with you some insights into our second quarter outlook. Let me start by pointing out that our business is a seasonal pattern that is continuing. For example, our first half operating income for the last nine years ranged between 22% and 48% of our full-year operating income with an average of 36%.

At present, we expect second quarter operating income to be between $60 million and $70 million, which when added to our first quarter operating income of approximately $40 million would represent between 26% and 29% of the current full-year analysts’ consensus operating income estimate of approximately $380 million. This would place the first half operating income, as a percentage of the full-year result well within the band of our historical performance although below the average.

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

(Operator Instructions) And our first question is from Ole Slorer of Morgan Stanley. Please go ahead.

Ole Slorer - Morgan Stanley

Thanks a lot. And congratulations with the LNGo sale there.

Vincent Volpe

Thank you, Ole. Good morning.

Ole Slorer - Morgan Stanley

Good morning. Could you talk a little bit to the kind of potential $10 million tickets are small in context of CapEx and infrastructure, relative to the kind of stuff you normally book, so this will be more of a volume story. So could you talk a little bit about the level of adoption, what kind of -- what could be a reasonable annual or quarterly sales volume of these systems if you look out, say a year or two, something that we will -- hold the feats right away?

Vincent Volpe

And that is a good way to look at it, Ole, because what’s really got to happen now is, this unit’s got to be installed, it’s got to run. I think the fact that we did a full -- sort of a full unit test in our Painted Post facility was very, very helpful. We have people that continue to come and visit and see what that looks like. But there is nothing like getting a unit out running in the field, and so I think that we expect this to be operating sometime in the third quarter or perhaps early fourth quarter, and then I think what we’ll see as we get successful operation under our belt, we will start to see the orders ramp up from there.

I think in the interim, we will probably book a few jobs anyway, but I think we will see as units could get out and start to run, people come visit existing installations, say gee I’ve got an installation just like this, let me go ahead and do this. So looking out a year, I would say that it’s not -- my view is that next year we ought to be at least at $100 million in sales.

Beyond that, I think the number will continue to increase, Ole, because we’re starting to see the overseas opportunities popping up, people that we weren’t even calling on are calling on us, just because they heard the publicity, seen what we’ve got on our website and so forth and perhaps listen to these calls. So, it will grow over time for sure. I think $100 million is a reasonable expectation for sales in 2015. And as we get smarter, as we go along, we’ll get smarter and we’ll update you on that, if it ends up being more, great, and if it’s less we’ll be disappointed and I think frankly surprised.

Ole Slorer - Morgan Stanley

And what are the end use markets? Is it predominantly for the ethyl fuel or are there other -- what's the range of customers that are discussing these systems?

Vincent Volpe

Well, that’s a -- the beauty of this system is that it’s quite flexible. You have to look at this as sort of building blocks and you can add and subtract modules. So that accesses a great deal of the market. So, you’ve got, for instance, these first units are going to be taking pipeline-quality gas, the gas will be liquefied and then transported to an off-site facility actually to be used in power generation applications.

You’ve also got shale gas where you’ve got gas in-situ that today is being flared. These systems will convert that gas to LNG, and as people are converting their actual drilling rigs and fracking equipment to LNG, there may be an in-situ use for the LNG or they may want to move it somewhere else, but that really is a play for shale which is around avoiding flare gas.

You‘ve got small wells that have got stranded gas that they have really nothing to do, they can’t afford putting a pipeline in and so forth, but you can put one of these units in and you can convert that to LNG and you can participate in peak shaving market applications, for either domestic use or power generation applications.

You’ve got mining, coal-bed methane is a great source of gas and we are looking at people considering converting their mining vehicles from diesel to LNG, what better way to run that fleet and to take the gas which you’ve got trapped in your own mine and convert it to LNG. So that’s just a few -- I think I hit on most of the biggies though.

And as you think about where there is gas in the world and where it’s being discovered and you look markets like China and frankly even Europe, there is opportunity well beyond North America, which is really what we were targeting when we started this. So, I think it’s going to get pretty big, Ole, it will be over time now.

The other thing we like about this is that we’re the first ones really, as far as I know, we’re the first one to actually do this. We’ve got plenty of added value of our own equipment with our engines that we purchased from Guascor as well as our reciprocating compressors and our controls, and so we’re able to get, what I would consider, reasonably good margins in terms of the overall margin to build the equipment and then, I think in many cases, this is going to be - we’re going to sell these to fleet operators.

And so you’re now going to be in a position where we are going to be doing -- we’re going to be focused on the aftermarket also and operating and maintaining these fleets. I don’t really have any intention to sell these to people that are going to work on them themselves. I’m looking at fleet operators that may be in other businesses so that I can provide or we can provide at Dresser-Rand, the preponderance of the aftermarket service and parts and repairs with our extensive services networks.

So all in all, it looks like a small opportunity on a per unit basis. I think there is plenty of units to be put out there and it’s a great -- it’s going to lead us through really nice pickup in our very profitable aftermarket. That’s a good story.

Operator

Our next questioner is James West with Barclays. Please proceed.

James West - Barclays

Question about your continued guidance for new unit awards this year, you maintain the 5% to 10% growth with some caveats in there about project delays. You have been doing this a long time, and I know you have a very good feel for kind of when projects are typically going to hit. And so I wanted to hopefully get some more color around that. Are we at the point now where some of these major projects are getting to letters of intent or in the negotiations where you feel comfortable making that statement or are we still just looking at kind of here is our pipeline?

Vincent Volpe

It’s the former, James. I think that we’ll see a pickup here sooner rather than later. I’ve heard some mixed views on what’s happening in the FPSO business, but we expect and that’s a big piece of what we book in our new unit business. We expect it could be upwards of up to 20 units built our contracted for this year. That’s the high end of the guess, but if it’s anywhere near that, that represents a big opportunity for us as you all know, and then I think -- I think things could start as early as Q2.

James West - Barclays

That's very helpful. And just one unrelated follow-up. On Latin America, you mentioned in your comments you're working with the NOC down there where you’ve seen orders slip, and then Jan Kees mentioned part of the working capital, help in working capital was reducing exposure to Latin America. Can you help me kind of mirror those two? Are you really deemphasizing Lat-Am, or am I missing something there?

Vincent Volpe

No, it’s one client. Let me sort of take you through this and help you a little bit with the math if I can. The orders -- we, over time, really this has been an outstanding client of ours for many years and over time we’ve seen their receivables build to a point where we said, listen, we need to work at reducing these together, let’s not add to this, and so in concert with them, in a very collaborative manner, we started to work at exactly that.

And so, what that means is you don’t take the orders. There is a big pipeline of orders that they sort of want to give us, but we’re not going to fill them and so we find a way collaboratively to reduce the receivables. And I can tell you that from the end of the year to the end of Q1, we took what about $25 million? So, $25 million came out, which of course helps working capital.

And we think that there is a plan that’s being put in place right now where we’re going to continue to work on those receivables. We will supply them with critical equipment, there is no doubt about that and as this plan develops over time, we will step up the amount that we actually ship to them because the need is very much still there.

So, I would say that the slippage in the bookings is on purpose, it’s self-inflicted. We and they are doing this together. I think when we get back to steady state, you’ll see the floodgates open back up. And so whether or not it’s all in time to get back to our traditional levels by the end of this year is a question mark, but it should improve and increase over time while at the same time we continue to work on our receivable balance and improve net working capital, so that’s how the two pieces fit together.

Operator

Your next question is from George O'Leary of Tudor, Pickering, Holt.

George O'Leary - Tudor, Pickering, Holt

You mentioned your optimism around major products hitting relatively soon at least over the next couple of quarters. Can you talk about what end markets those are in, where this is all FPSO oriented or is it a little bit more distributed around some of your other end markets?

Vincent Volpe

I think the change that we expect is principally in the upstream business and a significant part of that is FPSO, it’s not all FPSO as some of these are fixed platforms and other applications for oil production.

George O'Leary - Tudor, Pickering, Holt

That’s helpful. And then as you look at the next three quarters of this year, thinking about revenue and margin progression, is it the right way to think about it, that it looks like revenues are biased towards the back half of the year, and margins kind of dramatically increase in Q3 and Q4 to get --?

Vincent Volpe

That’s a very good way to look at it and that’s the way we see it also George.

George O'Leary - Tudor, Pickering, Holt

And then can you -- just looking forward with respect to the amount of petrochemical work that's coming down the pipe, is that still such a competitive market that you don't think the margins are attractive enough to really go after that work hard, or with the dearth of work that's coming, is there an opportunity that margins increase as demand increases, and that may be something you're interested in playing in?

Vincent Volpe

Well, of course we like to see -- we always like to see margins increase on these things. Our view of it is, I think over the mid-term that we won’t see significant price increases in that space. I don’t know what the long-term holds, but there is quite a bit of competition in that space, these are not normally as complex as technology demanding as you see in the deepwater applications for FPSOs for example.

That being said, we’ve got some very strong technology offerings in places where it is important like large, I’ll give you an example, large rod load reciprocating compressors for petrochemicals, we think we are -- we believe we have the best technology in the world and we know that we have very strong share in that space and that space does hold up pretty well under pricing pressure. So, there is -- so I would say that we don’t think we shouldn’t go after any of the petrochemical business, but we’re pretty selective about the applications we really push for.

Operator

Your next question comes from Robin Shoemaker of Citi. Please go ahead.

Robin Shoemaker - Citi

So can you just give us an update briefly on the Spanish draft regulation? Is this a done deal, or is there still some possibility that the government might reverse its decision on eliminating this subsidy?

Jan Kees van Gaalen

The independent report was prepared at the request of the Ministry of Industry. And the various generating parties have been providing input to that and the report is currently being reviewed by the Ministry. And I suspect that over the next two, three months, we will have discussions -- we have been having ongoing discussions, but we will have continuing discussions and we’ll see the results of that.

Vincent Volpe

Rob, and as you know, the guidance that we provided assumes that nothing good happens in this area for the year. So anything that would happen, positive would be an upside for us.

Robin Shoemaker - Citi

I was wondering also if you could update on this Pemex Littoral project where you have the working capital tied up. Is that likely to be completed and fully paid for, I understood it was somewhere around mid-year, but is it kind of a second or third quarter event most likely?

Vincent Volpe

We collected in the first quarter, so it shipped and it’s done Robin.

Robin Shoemaker - Citi

So, part of your working capital reduction this quarter or --?

Vincent Volpe

Yes, absolutely. One of the principal driver was that.

Jan Kees van Gaalen

And you saw that also in the POC table that I provided.

Robin Shoemaker - Citi

Just finally then on, you mentioned Libya and Iraq as situations that you're monitoring for obvious reasons, how much -- can you give us a ballpark of your business, I guess it's primarily aftermarket relates to these two countries?

Vincent Volpe

Libya is a pretty significant part of our aftermarket opportunity. A few years ago when we had about a year of really security issues and risks, I think the impact was about $16 million, that’s off the top of my head, we have to go back and look at the, on an operating income basis. So it’s not insignificant. I think that represents about a year’s, in that case about a year’s worth shortfall maybe a little bit less. So that’s the risk.

The Iraq side of the business is, it’s been pretty small, but I think what that is, the security issues there is more of a potentially impairing or impeding an opportunity. Okay? And so there is an opportunity to grow. We’ve got some pretty big orders we’re looking at in Iraq. But I think that at the end of the day, if they don’t go forward, I don’t think it really represents a risk to our business in terms of guidance we’ve given. We just like to see them go forward because every little bit helps when you’re trying to grow.

Operator

The next question is from David Anderson of JPMorgan. Please go ahead.

David Anderson - JPMorgan

So Vince, you're talking about seeing some bigger awards in the back part of the year. You talked about the FPSO side. Is that primarily where you see the orders coming from, and is this basically, of course, we were talking about a year ago we started seeing the delays. Are you basically expecting these delays to start moving ahead is that kind of the primary part because they also sound like you're not really expecting to see a lot on the petrochem side?

Vincent Volpe

Yes, it is, David. I think we’re looking at orders closing perhaps in the second quarter that were supposed to close in 2012. And so to give you a sense of how long this thing has been going on and at the end of 2012, I told you guys I thought it was going to be about six months, that was wrong. And so I do think we are now down to -- when you get to the part where you are negotiating the contract and/or getting ready to sign letters of intent, it’s not going to go south on you at that point.

They’ve been through in a couple of these they’ve through at least one and sometimes two, cost reduction efforts to get to where they are now. So, I think we see some of that stuff moving through. I think we are being pretty cautious, David, and when I talk about 5% to 10% increase over last year, last year was a lousy year, okay, in terms of new unit bookings, it was well below what we expected.

So, 5% to 10% isn’t -- it’s not earth-shattering, okay? I don’t mean to downplay this, but what I’m really saying is that we’re trying to be cautious here. We really think -- we think these are the numbers we can achieve and we think it’s based on what we see and what we principally see in terms of bigger stuff that moves the needle or the FPSO orders.

You know that we’ve got two major LNG orders that we are going to get during the feed process right now. Once they get to the investment decision, we’re assuming that they go forward. Those are needle-movers also. I don’t think either of those is going to happen this year, but there is a chance one of them may, that would be upside.

There is an opportunity to perhaps another CAES order could even be released by the end of the year. That also, to me, looks like upside. So I wouldn’t say that our -- actually our fortunes rise and fall just on the upstream business, but I think in terms of what we’re forecasting solidly when we talk about 5% to 10% increase will principally come from the upstream.

David Anderson - JPMorgan

When you talk about these delays that are coming through, help me understand what’s changed? So you saw them happen about a year ago. Has it just been a redesign? Has it been like specific cost reductions? Help us understand why these are going through now? What have they solved, I guess, economically from your standpoint?

Vincent Volpe

Well, I can think of one very, very large project. They said they took about 20% out of the penultimate estimate, if you will, that forced the thing to stop. They took about -- they say now that they are taking about 20% out of that by going to a more functional approach. I don’t know exactly what they did because the price of our equipment didn’t decrease David, and we didn’t reduce the specifications, this is critical.

So what we’re building is mission-critical. You don’t want to fiddle too much in an offshore application with the specs around a machine that is compressing high-pressure gas, okay? So, from our standpoint, we really haven’t seen the cost reduction as an issue. We don’t know exactly -- in other words, to be sure, they push like they always do for the best -- best pricing they can get from us.

But we haven’t seen things that have really fundamentally changed our cost or our cost structure, so they’ve been doing it with somebody else, whether it’s the vessel manufacturer, the engineering contractor, the service company that may be involved, I don’t really know. But yes, that’s what it is, it’s been cost reduction.

David Anderson - JPMorgan

And one last question if you don't mind. You said 27% of your bookings the last 12 months and new units were environmental. Can you help me understand kind of how that differs from the oil and gas side from, say a pricing or margin, or like a cycle time perspective? How should we think about that? Or should we not think of it as any different as the rest?

Vincent Volpe

Well, we have -- considering a piece of that is a case project. Those are really long-lead time projects, that’s a different looking animal and so the margins there are reasonable. I think where we’ve seen a bit of a downdraft in that space, frankly, is in our engine business and in our steam turbine business because of price of gas has been so cheap that some of these biogas and waste energy applications have slowed down.

I actually think that that’s going to increase over time, but that’s come down a little bit. And those margins, when those projects go forward, are pretty similar to what we get in the rest of the space.

Operator

Your next question is from Jon Donnel with Howard Weil. Please go ahead.

Jon Donnel - Howard Weil

Sorry to hop on these FPSO questions, but in terms -- I think we talked a little bit about it here on this last question, but with these new projects kind of getting to market here, and I think the folks on sort of standardization from the E&P guys, I know it's probably not going to be hitting your equipment so much, but do these delays that have happened give you more of an opportunity perhaps to have done some front-end engineering work, so that your overall cycle time on these new orders can slow down, or are we still looking at because it's so highly technical and highly engineered, that even as you set your order book, eventually that they're still going to be towards the higher end of that cycle time within the new units?

Vincent Volpe

No. Our cycle times have come down on the FPSO business. We have worked because it’s been an initiative of Dresser-Rand to work at reducing cycle time in our turbo compressor business and which principally what this is, and packaging businesses.

So the cycle times have come down and will continue to come down over time. There are things that we and there is a whole bunch of things you do, some of that to reduce the cycle time, John, one of that is, for instance, standardizing on your casing designs. And so, yes, we have worked on those types of things.

There is a bunch of other things we do also. We have to work with our suppliers, as an example, and if you can’t get the motor in less than nine or 10 months, you’re not going to be able to ship the whole train any faster than that. So things like that we’ve been working on. We have been working on standardization.

And I talk about motors because that is an area where we have worked with. We’re working with I think two suppliers now and I might be wrong about that, but I think it’s two, is that right, Jan Kees? Two suppliers where we have brought down significantly on a standardization initiative their cycle times and frankly their costs.

So this has given us an opportunity to continue to work with cycle time reduction. It’s very important in the scheme of things. It’s important from a cash flow standpoint for our customers if nothing else and we are going to continue to work on cycle time reductions. It’s a very, very important initiative internally in Dresser-Rand. Just a lot of good things happen when you do that.

Jon Donnel - Howard Weil

And then in terms of the impact to the aftermarket bookings from the Spanish regulation changes here, is that $26 million impact for the quarter, is that a typical quarterly run rate that we should be thinking about, or is that just do they tend to order that all in the first quarter every year? I mean I guess if that is a quarterly rate and it seems like there's actually some pretty substantial growth there for the remainder of the business there year-over-year?

Jan Kees van Gaalen

Well, John, that was a pretty standard run rate. In the last quarter of 2013, it came down a little, because we adjusted the prices, but effectively pretty standard run rate.

Vincent Volpe

But in total more than $100 million impact year-over-year John if you’re trying to think about the rest of the business and you’re talking about growth, your comment is right and you are thinking about it the right way. Now, obviously and that’s assuming that nothing good happens, right? It’s a little bit more than $100 million year-over-year comparison.

Operator

Your next questioner is Jim Rollyson with Raymond James. Please go ahead.

Jim Rollyson - Raymond James

Vince, to go back to this FPSO stuff a little bit, it sounds like some of the cost issues that have happened in developments have been ongoing and causing problems. You mentioned going back to 2012 for things that hopefully start to materialize this year. And yet publicly, it seems like the majors and some of the NOCs have only started talking about this more recently. As you look at the industry and ways to try and bring costs down, what do you see on the horizon to try and maybe standardize things to where you can get, I think your presentation has the 160 plus projects on the drawing board. Like what do you think that's out there that can finally get the flood gates to open, and some of these projects to start actually hitting?

Vincent Volpe

Well, I think the need to replace depleting reserves is a force that nobody can ignore long-term. So I think supply and demand right off the bat, Jim, To sort of take a step back, it’s going to drive these things forward whether majors like it or not, right? I mean that’s what’s going to happen.

I do think that there is a lot of creative people in the oil and gas business in terms of thinking about cost reductions. We believe that with the ICS that we talk about will become over time a pretty standard statement and we believe that there is -- there may be people out there that will actually design their vessels smaller as a result of being able to use the ICS. So we need to get through that project, it’s this year that we’re doing -- we’ve been doing the development work for the past several years.

We are in a program with Statoil. We are going to be testing I think in Q3 the subsea version and the top-side version of that mission which is about 10 or 11 megawatt machine, I believe, I don’t remember the exact size.

Jan Kees van Gaalen

10 megawatts.

Vincent Volpe

Okay. I got these smart guys on either side of me. And so, I think that’s an important step for the majors to see and I believe that we’ve got DATUM Is on the Pemex Littoral project, which is really, if you will, sort of the guts of the package and those things have been shipped and I don’t know when the commissioning is -- I think it’s at present when exactly the units will be started up, it should be in the fairly near future, so we will get some more runtime on those, and those are good size units, they are about the same rating.

Even larger, Blaise, with his facts, is explaining there are 17 megawatts. So they are little bit bigger than what we are testing in-house, and I think that is the type of thing that once you’ve demonstrated that it works as a product, you can go to the vessel manufacturers and designers, if you will, and say listen, if you design the vessel around something like this and I’m assuming that people that make turrets and do other things focus on same concepts, you’ll actually be able to make a smaller boat, and so that’s where you really save money on CapEx.

So that’s ahead of our approach, so to speak, but I think that there are people working on different parts of this. You’re listening to some of the other folks that talk about it when they are working on what they can do to make smaller vessels and that’s the answer and maybe look at more functionality and some of the specifications, rather than trying to gold plate everything. So, I think it’s supply and demand, Jim, and I also think that there are people, I know there are people that are working on standardization to help the economics also.

Jim Rollyson - Raymond James

And just last as a follow-up, you guys are off to a good start on the reduction in working capital, obviously in the first quarter and expectations that will continue to trend down. Given your outlook for operating income, et cetera, for this year any thoughts on how much more working capital could decrease as the year goes on?

Vincent Volpe

Well, I think Jan Kees indicated that somewhere nominally we ought to get down to around 15%. I think he said mid teens to give himself a little flexibility. That’s what we’re focused on, trying to get down to somewhere around 15% or call it mid-teens, but 15% is what we’re trying for.

Operator

Your next questioner is Chase Jacobson with William Blair. Please proceed.

Chase Jacobson - William Blair

I have a question on the aftermarket part of the business. Specifically in the services piece of aftermarket, that was down quite a bit this quarter. I know we have issues from the Spanish draft regulation and the pull back of the customer in Latin America. Is there anything else going on there that we need to know about? I assume this quarter is the bottom, given your guidance. But how should we view the trajectory of the margin improvement there throughout the year? Is it going to be a sharp uptick in the second quarter, or is it going to be more gradual going to the second half of the year?

Vincent Volpe

No, it should be gradual and again biased to the second half of the year. What drives that, Chase, as you know is that, you are building parts in the same factories you build the units in, and so as lot of volumes goes through there, particularly new unit volume, but as volume increases, you get better absorption in your facilities and you get more operating leverage because your period costs are divided, your capacity costs are divided by quarterly by four.

And so as you get more volume, your margins naturally will increase and you will also have - and the other reason of course you get better actual shock absorption per se In terms of your labor rate. So it’s gradual, I think you’ll see a, we expect an uptick in Q2 over Q1, but I wouldn’t look for anything earth-shattering until we get to the back end of the year and we continue to reiterate full-year guidance. And so we are looking at a piece of paper that gets us to where we said we think we can get and what we guided to.

Chase Jacobson - William Blair

Okay. Now that you have the working capital coming down and the free cash flow is pretty good in the quarter, can you just talk about your capital allocation priorities? I know debt is near the top of the list, but any other investments we should be expecting?

Jan Kees van Gaalen

We are going to use the capital we free up to bring down our indebtedness. And then, as we get to our historical target levels, then we look at how to get it back to the shareholder in the most distinct way.

Operator

The next questioner is Jeff Spittel with Clarkson Capital. Please proceed.

Jeff Spittel - Clarkson Capital

If we could follow-up on the LNG business, I appreciate that you built some inventory in advance of the growth, and as you start to commercialize this, it sounds like you will be converting a lot of that inventory to cash. As we think about it growing over time here, how quickly are those cycle times going to evolve, and when you get an order in the door how quickly can you turn it around?

Vincent Volpe

Well, this one, the first one letter of intent now delivery within -- perhaps by the end of the second quarter, and then a little bit of time for installation and commissioning. And so as I indicated, I think sometime hopefully in the third quarter, it will be actually running. So it’s pretty fast.

Jeff Spittel - Clarkson Capital

But a big picture question for you, Vince, given the uplift in crude production in North America, and some of the bottlenecks in the downstream complex, do you think that you could see something over the next few years similar to what we saw several years ago with some larger refining projects, whether there are expansions or reconfigurations that could help the business?

Vincent Volpe

Yes, I think the short answer is yes, we do.

Operator

The next questioner is Joe Gibney with CapitalOne. Please go ahead.

Joe Gibney - CapitalOne

I just had one quick housekeeping question. Can we get an update on, I apologize if this was in your prepared remarks but an update on new unit bookings scheduled to ship for 2014, and then perhaps a view into the sequential quarter in Q2?

Vincent Volpe

Yes. I don’t have the number in front of me or at my fingertips, Joe, so if you have a second question ask it.

Joe Gibney - CapitalOne

If need be I can circle up with Blaise after, that's fine.

Vincent Volpe

Perhaps, that’s better rather than me potentially misspeaking. What we’ll do though, Joe, is if you don’t have any other questions, we still have a couple of other folks who would like to ask questions and I will - Blaise will work furiously at finding an answer to your question and we’ll tell you. Stay on the phone for a couple of more minutes and we’ll get the answer for you.

Operator

Your next questioner is Jeffrey Campbell with Tuohy Brothers Investment Research. Please go ahead.

Jeffrey Campbell - Tuohy Brothers Investment Research

My first question was listening to a lot of the other services calls and equipment calls, in the fourth quarter 2014. We're hearing a lot about oil companies moving to high-technology solutions to reduce costs, is it fair to view the Synchrony magnetic bearing is exposed to this trend, and if so, how long do you think it has to perform the spec to gain momentum?

Vincent Volpe

Jeffrey, you picked up on what I was trying to transmit, so I appreciate that. I don’t think it’s going to be very fast. I think that it’s going to have to run reliably for -- we’ve got to build the units and then it’s probably going to need to run reliably for six months to a year. I think people are very interested in watching, because the concept here is an oil-free machine which also can be unmanned.

So oil, having the oil in-situ particularly in some of these more aggressive environments like where this one is going, creates a lot of maintenance issues and concerns. When it’s on a platform, it also creates environmental concerns and I think that’s one piece of the equation. The other piece of the question is with magnetic bearings, you can understand a lot more about what’s going on with the machine in terms of signals that can be transmitted to you because of the nature of the -- sort to speak the magnetic bearing itself understands how much it’s vibrating and is able to transmit different types of signals and diagnostics.

So I think with unmanned platforms have been talked about in the past, I think that they will come back, unmanned applications in different parts of the world, so it will catch on and we are very excited about the technology. We typically got terrific technology in the mag bearings. We’ve got very strong gas seal technology that’s our own and so we believe that with the advent now of high-speed motors that run at the same speed as the compressor which obviates the need for a speed increasing gear, which requires oil, you now have a motor, you have no gear, you have an oil-free coupling, you have gas seals, magnetic bearings, you haven ‘t got any oil.

In the motor drive application, you’ll have no oil. And so you’ve got no oil and you’ve got quote-unquote a smart machine as it relates to the diagnostics and the ability for us to write algorithms to make sure that we are doing preventive maintenance. We should be able to facilitate more and more unmanned operation of what is really critical equipment. So it’s out there, it’s in front, Jeffrey.

We’re not going to get five orders next year though. I think you are going to see this as people thinking and talking about it internally. The oil companies are pretty slow anyway and so I would say we might see something in ‘16, but I wouldn’t put this in my very quick grow bucket from a Dresser-Rand standpoint.

Jan Kees van Gaalen

Cautious is probably the best term.

Jeffrey Campbell - Tuohy Brothers Investment Research

And the other question I wanted to ask real quickly is first of all I wanted to congratulate you on LNGo, I know you've been working on that for a while, and I appreciate the Guascor contribution to the effort. Going forward what other contributions can Guascor provide to DRC?

Vincent Volpe

Well, I think, we just talked about that. We’ve got power generation applications in the United States where traditionally Guascor has not been strong, that’s picking up, we’re building through the distribution network there. We see applications where we may be able to combine engines potentially with steam turbines for cogeneration.

We’ve got obviously the oil and gas, in oil and gas, we’ve got high-speed separables and we are developing a 2 megawatt engine right now, which is really a terrific fit for that space. Right now, the engine sizes that we have we can sort of the low-end of the oil and gas applications and when I talk about high-speed separable, these are reciprocating compressions principally used for gas gathering and gas transmission applications and small lines and in small plants.

So what we’ve got right now serves the low-end of the market, but where the real need is, so to speak, in the hamburger is that that 2 megawatt range, we’ve got great compressor offering for that and we believe that when we come out with a 2 megawatt engine, that is going to have very, very good emissions characteristics and efficiency that we will be in a position to really serve a much greater part of that market and we anticipated that when we purchased Guascor.

So that’s something that we’ve been working on already for well over a year and we will continue to work on the development. So there is a few different areas where I think the synergies of two companies being together makes good sense as it relates particularly to the engine business.

Jeffrey Campbell - Tuohy Brothers Investment Research

Okay. Thanks very much. I appreciate it.

Vincent Volpe

Thank you. Before we go to the next question, operator, we do have an answer for Joe Gibney and Blaise why don’t you go ahead and answer it.

Blaise Derrico

The new unit backlog scheduled to ship, 1.1 billion and Joe, that’s consistent with that that we came into the year with 1.5 billion. We shipped about 400 million of units in the first quarter. So the scheduled backlog hasn’t changed.

Vincent Volpe

Okay. Thank you, Blaise. Operator, please take the next question.

Operator

And our next question is Glenn Primack of Peak Six. Please go ahead.

Glenn Primack - Peak Six

One, what are you going to have on display at the OTC? Two, would be on average how many years would your equipment be out in service before someone would have to order more like aftermarket parts and service? And three would be, just on the FPSO, on the range of content per boat, and then would those have the new DATUM, the new improved DATUM technology on them?

Vincent Volpe

Well, I think -- let’s start with the third question first. For this next round, you will see the traditional product offerings for the most part going on those vessels. As I said earlier, I think, Glenn, that we need to get through this development program with Statoil to generate more -- a little bit of more positive inertia around the unit move on to FPSOs. It’s coming there. As I said, we’ve put them on Pemex Littarol, so it is happening. But I don’t think you’ll see that in this next round in a big way.

Your second question was around, I think what it takes from the client, you ship to the time you get the next big parts and service order and also how long these things running generally 30, 40, 50, 60 years with that unit, reciprocating units that are more than 100 years old, they’ve been retrofit and so forth, but the actual frame and gear out there have been out there for a 100 years or more.

Normally, it’s about three years. So what happens is the client will buy start-up spares and perhaps capital spares and then depending on the application nominally three years -- about every three years, they need to do the routine maintenance and they will change parts and that’s when we’ll get the overhaul work and so forth.

Depending on the facility, very clean dry gas facilities, we’ve got a PDH plant in Thailand - excuse me in Taiwan that has been running - the machine hasn’t been open for something like 12 years, it’s been running or hasn’t been open for 12 years, so that’s an application where you don’t see much in terms of their is no corrosiveness, there is no process upsets to be worried about.

You get into a refinery, you need to stop every three years. If you don’t, you’re going to break something and so people will get a little greedy extending their overhauls and end up paying a lot of money. Similar in the upstream applications, the constituents are not clean, it’s what’s coming out of the drum for the most part. People try and take condensates and other liquids out, they don’t always achieve, some of that gets into the equipment, it can erode it. There is a variety of different things. So I would say -- but we think about it about every three years to be specific, Glenn.

Then on your first question, since I don’t know the answer, you’re going to have to come to our booth to at the OTC and see what we’ve got. It’s a surprise. I don’t actually know what we’re exhibiting, sorry about that.

Blaise

Okay, Janine. I don’t see any further questions. I want to thank everybody for joining the call. If you have questions, this is Blaise Derrico, my phone number is at the bottom of the news release, please call me. Everybody, have a great day and thanks for joining.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the meeting. And you may all disconnect. Everyone have a wonderful day.

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