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Dresser-Rand Group, Inc. (NYSE:DRC)

Q2 2011 Earnings Conference Call

Aug 5, 2011, 9:00 AM ET

Executives

Blaise Derrico - Director, IR

Vincent R. Volpe Jr. - President and CEO

Mark E. Baldwin - EVP and CFO

Analysts

Robin Shoemaker - Citi

Jeffrey Spittel - Madison Williams

Joe Gibney – Capital One

Roger Read - Morgan Keegan & Company, Inc.

David Anderson - JPMorgan

William Conroy - Pritchard Capital

Guy Davis - Simmons & Co.

Operator

Good morning, ladies and gentlemen, and welcome to the Dresser-Rand's Second Quarter 2011 Earnings Conference Call. My name is Jane, and I will be your coordinator for today'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 the conference call. (Operator instruction)

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

Jane, 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. A copy of the news release we issued last evening 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 2. The statements made during the 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 of the date of the live call.

Management statements may include Non-GAAP financial measures. For reconciliation of these measures refer to our earnings news release 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 the call over to Vince Volpe, our President and CEO.

Vince Volpe

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

Please turn to Slide 3. The second quarter has certainly presented with a series of challenges given the non-recurring and unusual costs associated with a variety of events which converge during the same reporting period. Let’s call it Murphy’s Law. Despite these issues which I will discuss in a moment our backlog has continued to build and we maintain the previous provided full year guidance for booking and operated income.

Group Guascor is now expected to be approximately neutral to earning in 2011 as despector of US sanctions regarding Pedevesa is creating a temporary delay in revenues in connection with several contracts Guascor has with an affinity in Pedevesa.

Please turn to slide 4. Let’s begin with an analysis of the major impacts which will reduce second quarter pre-tax income by approximately $27 million or $0.20 per share. Most of these items we disclosed previously so I don’t believe in principal that they come as a big surprise. First the flooding Wellsville were adversely impacted the second quarter operating income by approximately $10.8 million on a pre-tax basis or $0.08 a share. This previously stated the proponents of the loss production will be recovered by year and the net impact on operating income is expected to be close to the $2.5 million insurance deductible under the company’s insurance program which covers business interruption, clean up and other out of pocket expenses.

Second Non-recurring Guascor integration and transaction related expenses were approximately $7.9 million or $0.06 per share. Third, the continuing political instability in the Middle East and North African primarily Libya reduced pre-tax income by approximately $4 million or $0.03 per share compared with the corresponding period last year. Four, an operating loss of Guascor of $800,000 or $0.01 a share which included $7.5 million of incremental amortization and depreciation related to the acquisition accounting. And finally in connection with refinancing our senior subordinated notes during 2014, our premium and early redemption of debt and the acceleration of deferred financing fees amounted to approximately $3.2 million or $0.02 per share.

Considering the above items directly impacting our operating income, operating results before Guascor were consistent with the previously year’s actual results of $62.9 million and very much in the middle of guidance range provided during our first quarter of 2011 earning conference call. Furthermore, besides from the ongoing political instability in the Middle East and North Africa the other items listed above basically have a negligible effect on full year results. Accordingly we are reiterating our Pre-Guascor guidance for operating income to be in the range of $260 to $300 million.

Additionally recently imposed sanctions on n Petroleos de Venezuela or Pedevesa are creating a temporary delay in proceeding with several contracts Guascor with an affinity of a state owned oil company. However we have now determined that the sanctions are not applicable and the earnings are expected to be realized but on a delayed basis. As a result the previously expected approximately $0.05 a share of earnings secretion from Guascor is now expected to move out of the year.

Turn to the next slide please. Aftermarket bookings before Guascor of $275 million were as expected sequentially higher than those of first quarter 2011 and approximately 9% higher compared with the corresponding period last year. We continue to expect full year Aftermarket bookings before Guascor to be in the range of $1 to $1.2 billion.

As reported Aftermarket booking for the second quarter of $320 million were 27% higher than the corresponding period in 2010 including incremental Guascor bookings of $46 million. In the second quarter we had a nice supply technology warded connection with a rehabilitation project for Petrochemical plant located in Port Arthur, Texas that was shutdown for 10 years. It is a sign of what the refurbishment business may be starting to bring us. The client has contracted Dresser-Rand services to be the mechanical contractor in charge of overall project management and execution of the overall and upgrade of all the rotation equipment as the client brings facilities online. When complete, the plant will have a production capacity of 250,000 tons of Ammonium and somewhere of 50,000 tons of Methanol per year. The equipment in the scope include Syngas, refrigeration and recycled compressors and drivers, both steam turbines and mortar along with various pumps, turbines and gear boxes from 12 different manufactures.

Next slide please. New unit bookings before Guascor of $242 million were slightly down from first quarter 2011 principally due to the timing of the closing of 2 major projects. Although for the first 6 months of 2011 bookings stand at $501 million it is our view that runway will increase sequentially over the next 2 quarters such as the previously provided guidance range of $1.2 to $1.4 billion in bookings before Guascor is unchanged. These projects have long proposal cycles and we are confident we will achieve our previous guidance. Second quarter new unit bookings of $288 million included $41 million of Guascor bookings.

Please turn to slide 7. Second quarter new units bookings included significant number of orders for off stream applications. Off stream bookings represented nearly two thirds of the total. For larger upstream projects included equipment for FPSOs destined for offshore Brazil and West Africa. The Brazil FPSO included both compression and gas serving power generation services while West Africa FPSO which is a redeployment included steam turbine for power generation. We continue to do very well in the segment of the upstream market reflecting our strong value proposition in the more complex and challenging application.

Another significant booking in the second quarter involves an export gas application for an offshore gas field located in South East Asia. We also booked liquefaction compressors for 2 small land based LNG facilities located in China. The market for these Liquefaction machines is quite active in China and it is expected to remain so for the foreseeable future.

As for the environment solutions market, we had another good quarter with bookings comprising more than 10% of total new unit bookings. The wards were primarily for steam turbine products going into a variety of mechanical drives, heat recovery and power generation applications.

I mentioned the new unit bookings before Guascor were down slightly from first quarter of 2011 principally done to the timing of the closing of 2 major projects. One of these projects was located off shore of Australia, the order was booked in first week of July and as well several orders booked in July which amount to more than $120 million in new units before adding Guascor bookings. Under this particular order we will supply expert gas compressors for a total order value of approximately $70 million.

As of the end of July 2011 new units backlog before Guascor scheduled for 2012 shipment stand at approximately $1 billion. There is a point of comparison, the new unit backlog at the end of July 2008 which were schedule for 2009 shipment was approximately $800 million. This is significant as 2009 represented the highest volume of new unit sales in the history of the company.

Please turn to slide 8. Before turning the call over to Mark for more details review of our second results, let me provide a little more color on the agreement we recently signed with Statoil. From where we sit this is a big deal and we believe will move us forward in our drive to having the most compelling value proposition for compression solutions in our industry.

As previously announced we’ve launched a joint research and development project based on the integrated compression system which we refer to as the ICS. The ICS is an advanced technology platform that is high efficiency DATUM centrifugal compressor technology driven by a high speed, close-coupled motor. The compressor rotor incorporates a proprietary, integrated gas for liquid separation unit avoiding the need for a large static inlet scrubber to protect the compressor. The compression system is complete with process gas coolers, process piping, valves and instrumentation, all packaged into a single lift module. The ICS provides a complete compression system for applications in upstream, midstream and downstream markets, featuring the industry's smallest footprint - with reduced weight - at the lowest total installed cost. The first ICS unit has been shipped to Petroleos for a top side application in September 2010, and is expected to start operation later this year.

Jointly with Statoil, we will focus on configuring the ICS package for high power applications in a nominal 8-12 MW range. The unit delivered to Petroleos was not only a 1 megawatt machine so we are now working jointly on a significantly more powerful machine that would be suitable for both top side and Sub sea applications. Once the equipment operating conditions and package requirements have been clearly defined, we will build a high power ICS prototype unit and test it in the unique liquid-gas hydrocarbon facility in Olean operation located in New York State.

Thereafter the unit will be submerged in water for qualification testing on a quota and quote sub-sea test bed to be constructed during the course of 2012 along side the existing facility in Olean.

We believe this joint industry development program will lead to an improved value proposition for the 'only-in-class' Integrated Compression System, and will help accelerate the broad market acceptance of the technology for both topside and sub sea applications. We are excited to be working jointly with Statoil, one of the premier producers in the industry, a long time client, and a recognized technology leader.

I will now turn the call over to Mark for a closer look at our second quarter financial results.

Mark E. Baldwin

Thanks you Vince and good morning everyone. Please turn to slide 9. Total revenues for the second quarter 2011 of $589 million increased to $159 million or 37% compared to $431 million for the second quarter of 2010 principally due to the higher volumes and the incremental revenues attributable to Guascor.

Guascor revenues for the period from closing on May 4th to the end of second quarter 2011 were approximately $75 million. These higher revenues were partially offset by lower volumes in the Middle East and North Africa principally Libya as a result of political instability in the region. Additionally the impact of the floods at the Wellsville facility pushed approximately $21 million of sales to future periods.

We begin at revenues for the second quarter of 2011 of $301 million increased to $134 million or 80% compared with the corresponding period last year principally due to higher volumes and incremental revenues attributable to Guascor of approximately $29 million partially offset by the impact of the flood in Wellsville.

Aftermarket parts and services revenues for the second quarter 2011 up $288 million increased $25 million or 9% compared with $263 million for the second quarter 2010. The increase was due to incremental revenues from Guascor of approximately $46 million which included $44 million of long term service agreement revenues associated with Guascor’s asset business. The increase in revenue for the quarter was partially offset by the impact of the flood in Wellsville which pushed approximately $7 million of sales into future periods and the political instability in the Middle East and North Africa.

Turn to slide 10 please. As you can see starting at the bottom of this slide net income for the second quarter was $10.7 million or $0.14 per common diluted share, this compared with a net income of $35 million fully $0.03 per diluted share for the second quarter 2010. The second quarter 2011 includes the impact of the floods at Wellsville facility. The acquisition of Guascor, the political instability in the Middle East and North Africa primarily Libya. And one time cost associated with our recent debt refinancing.

After tax earning for the second quarter 2011 relating to these events were reduced by approximately $0.20 per share.

Total operating income for the quarter 2011 was $30.9 million and this compares to the operating income of $62.9 million for the second quarter 2010. Operating income decreased for corresponding period last year due to a number of adverse impacts that Vince previously mentioned.

The Wellsville flood, Guascor operating loss, the Non-occurring integration and transaction expenses related to the Guascor acquisition and the political instability in the Middle East and North Africa reduced operating income by approximately $23.5 million compared to last year.

Operating income margin for the second quarter of 2011 was 6.4% compared to 14.6% for the corresponding period is 2010. The Wellsville flood and the Non-recurring Guascor integration and deal related expenses reduce second quarter operating margins by approximately 290 basis points. Operating margins were also adversely affected by lower new unit margins which are common on at the moment.

Cost of sales for the second quarter was $443 million compared to $288 million for the corresponding period in 2010. As a percentage of revenue cost of sales for the second quarter was 75.3% compared to 6.7% for the same period last year.

The overall increase in cost is a percentage of revenues resulted from a shift in mix within the new units segment as well as the shift in mix from a higher margin Aftermarket parts and services segment to our lower margin new unit segment. Additionally the flooding in Wellsville had an unfavorable impact on the absorption of fixed costs. Cost of sales as a percentage of revenues increased by approximately 100 basis points as a result of acquisition of Guascor.

Selling and Administrative expenses increased 34% to $99.6 million principally attributable to the acquisition of Guascor. In addition Selling and Administration expenses include approximately $7.9 million of Non-recurring transactions and integration costs. Excluding the impact of the acquisition of Guascor Selling and Administrative expenses for the second quarter of 2011 increased principally as a result of cost inflation. As a percentage of revenue Selling and Administrative expenses decreased to 16.9% from 17.2%.

Research and development expenses for the second quarter increased to $7.6 million principally as a result of the acquisition of Guascor.

Effective tax rate for the second quarter of 2011 of 38.5% was higher than expected full year rate of 33%. This was due to the treatment of certain foreign sourced income and will not significantly affect the full year effective tax rate of approximately 33%.

Next slide please. New unit operating income was $22 million for the second quarter 2011 compared to $28.7 million of the second quarter of 2010. This segments operating margin was 7.3% compared with 17.1% for the second quarter 2010. New unit operating margin decreased principally as a result of a large project with unusually low margin that shipped in the quarter. The adverse impact of the Wellsville flood and the step up amortization related to the acquisition of Guascor. New units operating margins excluding Guascor were 7.7% of sales primarily due to the large low margin projects that shipped in the quarter and the adverse impact of the Wellsville flood.

Nevertheless we are reiterating that on a full year basis new units operating margin for Guascor are expected to come in at double digits consistent with previous guidance.

Next slide please. Aftermarket operating income for the second quarter 2011 hopefully $6.1 million compares with $58.3 million for the second quarter 2010. This segment’s operating margin of approximately 16% compares with 22.1% for the second quarter of 2010. aftermarket operating margin before Guascor, they were below average at 19.4%. this is principally due to the outer pocket costs delay in shipments associated with the Wellsville flood which are expected to be substantially recovered in the second half of the year and therefore are not expected to affect the previously provided guidance for Aftermarket operating margins before Guascor to be in the range of 22% to 24% for the full year.

Next slide please. Turning to cash flow, net cash used in operating activities for the 6 months ending June 30,2011 was $13.8 million compared to net cash provided by operative activities of $102 million for the 6 months ended June 30, 2010 as a result of a low income and a higher level of working capital. In addition we made $25.7 million of (inaudible) contribution in the 6 months ended June 2011 in accordance with our funding policy which was significantly higher than our pending contribution for the 6 months ended June 30, 2010 of approximately $2 million.

Turn to slide 14 please. This slide shows that the changes in the net working capital resulted in the use of cash of approximately $73 million which is $36 million higher than the approximately $37 million use of cash from changes in working capital shown on the prior slide. The principal difference in our changing capital associated with acquisitions and currency translations.

On the cash flow statement working capital acquired in acquisition is included in the investing activities in accordance with generally acceptable accounting principles and the effect of changes is shown separately.

In the end of last year, accounts receivables and inventories increased as a result of higher activities in our factories. Increases in these working capital accounts were offset by increases in accounts payables and customer advances and progress payments also resulting from higher activities in our factories. The increase of activities in our factories is attributed to the higher levels of bookings in 2010 as a result of the continuing recovery in our market.

Next slide please. investing activities used approximately $293 million of cash in the first 6 months of 2011 compared with $79 million in the corresponding period in 2010. cash used in investing activities includes the acquisition of Guascor which we closed on May 4th 2011. We paid approximately $205 million in cash or $262 million net of the cash acquired and delivered approximately 5 million shares of Dresser Rand closing.

Cash used in investing activities for the 6 months ended June 30, 2010 includes approximately $45 million related to acquisitions of certain assets of leading edge turbo technology and turbo machines field service as well as the $24 million earn out payment associated with the 2008 acquisition of Peter Brotherhood.

Cash used in investing activities for the 6 months ended June 30, 2011 also includes capital expenditures of $23 million which is higher than approximately $10 million of capital expenditures in the first 6 months of 2010. The increase is largely due to the acquisition of Guascor and is principally related to the installation of engines in energy plants.

For 2011, we anticipate capital expenditures to be approximately 3 to 4% of sales which is which slightly higher than our previous guidance principally due to the acquisition of Guascor.

Net cash used in financing activities in $1.4 million for the 6 months ended June 30, 2011 compared to a net cash use in financing activities of $24.5 million for the 6 months ended June 30, 2010. Net cash used in financing activities for the 6 months ended June 30, 2011 includes the cash effect of the previously disclosed accelerated stock buy back programs in debt refinancing activities as well as incremental borrowings associated with the acquisition of Guascor.

Turn to slide 16 please. at the end of the second quarter our liquidity totaled approximately $531 million and consisted of approximately $127 million of unrestricted cash and $404 million of available borrowings under our bank credit agreements as $176 million was used for outstanding letters of credit and $20 million was outstanding on our revolver.

At the end of the second quarter we also had approximately $121 million of letter of credit and bank guarantees drawn under un-commitment bank lines.

Next slide please. At the end of the second quarter our balance sheet reflected the additional leverage we’ve taken on in connection with the Guascor acquisition and related accelerated stock buy back programs. At the end 0f the quarter our net debt to capital ratio was approximately 42%.

As our history has shown we have a business model that allows us to generate strong cash flows which will allow us to deal with as appropriate. For more information about our results for the second quarter please refer to our 10-Q which we filed last night with the SEC.

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

Vince Volpe

Thank you Mark and turn to slide 18 please. I will now turn to our outlook for 2011 which for the first time includes the expected impact of Guascor on our third quarter and full year results. Going forward we will report results including Guascor but do not intend on breaking them out as they will form an integral part of our ongoing business. Our full year guidance is consistent with our previous guidance but not reflecting inclusion of Guascor’s expected results.

For 2011 we expect new unit bookings of $1.4 to $1.6 billion, Aftermarket booking of $1.1 to $1.3 billion, operating income of $275 to $315 million although we currently have a bias towards the lower half of the range based on the ongoing impact of the political unrest in the Middle East and North Africa primarily Libya.

New units segment in the range of low double digits and Aftermarket segment margins in the range of 22% to 24%. Again with a bias towards the lower end of these ranges resulting principally from the step up amortization required by the acquisition accounting for Guascor.

Unallocated is $110 to $115 million, interest expense to be in the range of $60 to $64 million which includes $8.5 million of accelerated amortization of differed financing fees as a result of our replacing previously existing senior secured credit facility and executing the cash tender offer to purchase previously existing outstanding settlement subordinated notes and finally in our effective tax rate to be approximately 33 percent with diluted out shares, diluted shares outstanding expectedly approximately 80 million.

For the third quarter we expect our operating income to be in the range of 20% to 24% of the total year.

Thank you for your attention. At this point we will open the lines for question. Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Robin Schumacher from City.

Robin Shoemaker – Citi

Good morning Vince. Wanted to ask you in the 3 months now that you’ve own Guascor if your thinking has evolve. I did want to ask specifically about Guascor’s customers who we know are a lot of municipalities, who purchase waste energy, Indian’s per waste energy projects. Is any concern about the financial health of any of Guascor’s principal customers or?

Vince Volpe

Well first of all Robin we’ve just, to display discretion we’d ask you to hold then for 2 months approximately so when we are talking about second quarter Guascor results we are really talking about May and June. I know you understand but I just want to clarify that.

As far as your concern around Guascor’s user clients, I think most of these first of all are credit backed with bonds and things like that so broadly speaking when they enter into an order we don’t have a concern about the orders being able to be executed. The have a high percentage of jobs that don’t have any issues at all with them. Unfortunately what is the low percentage is a couple of very large projects that are affecting us right now and what we are talking about really is Venezuela. So let me focus on that, the reason from going for approximately $0.05 accretion to around zero on an EPS basis is really because of a couple of contracts that we’ve got with Pedevesa that Pedevesa put on hold and it’s not because Pedevesa didn’t have the money or didn’t want to execute it was really to react to a concern they had when the US sanctions came out against Pedevesa and the question that they were asking themselves was now that Dresser-Rand owns Guascor, are Dresser-Rand/Guascor going to be able to execute these contracts and so before they get started on them they put them on hold and wanted to get this clarified. We’ve now gone and done diligence on our side, both our internal general counsel as well as sought outside advice and we are absolutely clear that there is no impact these US sanctions on this business.

Pedevesa are going through and performing the same basic analysis and I’m quite confident they’re going to come up with the same answer and we’re in conversations with them right now on that. So that is an example of, that is the big deal in this sort of the short term analysis here with Guascor and that’s driven by US sanctions. It’s not driven by Pedevesa’s ability to pay. In fact, on a separate order that we booked several months ago for Pedevesa, we just got a down payment of $16 million. So they’re in business and yes Pedevesa is driving this project. It’s Pedevesa Industrial which is not the oil company, right? It’s the industrial section of that looking after Para Todos [ph] which is a program in Venezuela that provide electricity to people that need it. So no, I think after owning the business for two months, our view has not changed in terms of what we expect, what the capabilities are. Remember we did diligence for well over a year. So the two months that we now own them really shouldn’t bring us much in the way of surprises. So it’s all very much on track and I said the one issue here, the bump in the road is really driven by US sanctions and it’s a delay that we are quite confident is temporary and will probably just move these earnings out into next year.

Robin Shoemaker - Citi

Okay and then just as a follow up, the after market, you showed a couple of nice orders there and it seems like possibly aftermarket is turning. I did want to ask also about Guascor where you I think have indicated that Guascor’s aftermarket effort could be significantly strengthened and how would you assess that opportunity?

Vincent Volpe

Well I think conceptually the first thing you said is right. Let me start with your first statement before I get to Guascor and that is we are very pleased with the 275 million that we booked, not only because it was sequentially higher in previous quarter an well above last year, it was in line with what we expected and we look at the nature of the bookings and we are seeing signs of life. This refurbishment project that we talked about is a good example of an industry that previously was basically dead in the United States, chemical and petrochemical and this basically fertilizer plant that’s now being brought back online and we’ve got an applied technology order to work on 19 different manufacturers or OEMs class of equipment. So we’re excited about that and we’re highly confident that we’re going to be well in that range that we provided in terms of aftermarket bookings and on our way back up the growth curve.

So pretty excited about what, we’re starting to see signs of life in the aftermarket. I think it’s real now and it’s here. Guascor’s aftermarket, we have the same view we had before Robin and that is that over time we believe that the traditional aftermarket which normally is comprised of only 10% to 15% of their total bookings, we think we can grow that significantly because we’ve got, and this is really around the engine business, okay? We’ve got service centers where we’re going to be marketing worldwide. We’re going to be marketing the engine and the compressors together and we believe we can go and work on other people’s equipment. We’ve got the expertise. So I’m confident we can over time as I have been, drive that up to the kinds of percentages perhaps that we have on our own aftermarket which we’re more like 50-50.

That is going to take time. That’s not something we’re going to see in one or two quarters but as I think I’ve indicated on previous calls and in previous public disclosures, we’ve got an integration team working on the ground fulltime. They could be intact for as long as three years and part of what they’re doing is focusing on this very specific topic. So I think the view is unchanged. We’re still quite bullish and it’s going to take time. There is one clarification I’d like to make though around the aftermarket as long as you’ve brought it up and it’s something that I’m probably as guilty as anyone else of having kind of misled you guys.

When I talk about the aftermarket being 10% to 15% of their total, I’m talking about the traditional parts and service business the kind that compares to Dresser-Rand does, but there’s a whole another piece of their business which we are classifying as aftermarket because it is, but it’s not been our traditional business. It’s the energy asset management side of the business and that’s like a third or sometimes, roughly a third of their total invoicings. This is where they have these assets that they’re operating long term and they’re generating monthly revenues for five and ten year periods. We really like that business. That is an aftermarket business. We think that pulls some parts and other things, but that is quote kind of a non-traditional aftermarket.

So when you look at the total Guascor aftermarket or the total DR aftermarket that comes from Guascor, there’s only two pieces of it. One is the energy asset management business which is about a third of their total invoicings and then the rest is this traditional parts and service and repairs that corresponds to what we which really represents only 10% to 15% of the total if you look at the rest of it. So that’s a little bit of a clarification about how to think about the aftermarket, but really no change in terms of our view of the ability to grow and it will take time.

Robin Shoemaker - Citi

Good. Okay, thank you Vince.

Operator

Thank you. Our next question is from Jeff Spittel from Madison Williams.

Jeffrey Spittel - Madison Williams

Thanks. Good morning guys. Vince, if I could want to start off maybe walking through the roadmap for new units margins in the second half of the year. With reiterated guidance make sure I understand I guess what the qualitative drivers are, understand we have not a repeat of the low margin shipment that you had. You don’t have wells all the deal with. I would imagine kind of similar throughput given the top line guidance and is it fair to say maybe a better overall margin profile? What’s rolling out of the backlog in the second half?

Vincent Volpe

Yes, Jeff let me try and dissect a little bit of that for you. First of all the contract that moved the needle so to speak on the second quarter was a large contract basically in at zero warnings and the reality is the contract, even though it’s a bad contract, it’s actually not a zero warnings contract. We’re going to see five, it’s basically a 5% earnings contract and the 5% is going to be all margin that comes out in the third quarter.

Mark could explain the accounting to you if you’d like separately, but basically we’ve only been allowed to recognize 95% of the revenue against 100% of the cost because we still have some outstanding documentation that’s tied to the last 5%. Now the units shipped in so we recognize 95% of the revenue. So it shows up as a zero earnings contract in this quarter.

So right off the bat you’ve got 5% of that thing which is like 100% margin that’s going to move into Q3. So that helps, just arithmetically it helps you think through the timing issue of why Q2 really looked that low. It still would have been kind of high single digits, but it would have been higher than it was and also, now what you’ve got going on beyond that in the back end of the year is you don’t have another one of those jobs. So you’re back to normal variable margins and then you get the benefit of higher volume in those periods.

So with a high volume against basically our period costs are divided by four. Each quarter is about equally spread across the year. So you’re going to get that operating leverage in the second half of the year which is just going to arithmetically help your margins and of course we know what our backlog Jeff is, schedule the shift between now and the end of the year. We’re highly confident that we get most of it, if not all of it and so we’re looking at significantly higher quarters, margins particularly in Q4.

Q4 we’re going to be in that $450 million range in terms of unit shipments and so that’s going to drag the margins. That’s going to be pull the margins up significantly. So yeah, we’re in pretty good shape as it relates to meeting what we said for the full year which is the low double digit number. Now I do want to caution everyone that there is a little bit of strain being put on that. We still think we’re in that train, but the strain is we’ve got Guascor in there now and we’ve got to step up the purchase accounting to increase the amortization which is pretty high for the rest of this year which is going to drag those, maybe put I don’t know, Mark what, 60, 80 basis points of pressure?

That’s really temporary through this year. Next year window a much more normal amortization spread and so this isn’t really an issue next year. So we’re still on track to hit double digits and it’s because we don’t have another one of these ‘bad contracts’ in Q3 and Q4 and we’ve got the impact of much higher volumes. Does that kind of get done for you Jeff?

Jeffrey Spittel - Madison Williams

No, that’s great color. Thanks, appreciate it and then switching over I guess on the heels of what you said about the applied technology order and maybe some movement in the North American petrochemical complex, are you seeing any indications from customers related all the sub stream shell activity that they’re looking to change their configuration there and if so does that lead any business potential for you guys?

Vincent Volpe

I do think that there is an opportunity for more business there. I want to caution you on that. So Jeff, from Dresser-Rand standpoint, these are high speed separable compressors today and Guascor engines tomorrow so to speak and we’ve still got to introduce the engine into that space. That will take a little bit of time but traditionally, this singularly isn’t going to move the needle because they’re just much smaller, right? An engine may sell for $0.5 million and a compressor maybe the same, compared to an order for $70 million for an FPSO in the upstream space.

So I do think it will help. Every little bit helps, but I don’t think you’re going to say oh wow, all of a sudden there’s this huge change in the bookings profile because of Shell gas at DR. So I want to try to give you a balanced view on that. Yeah, it’s positive but I don’t think it’s a needle mover for us.

Jeffrey Spittel - Madison Williams

Fair answer. Okay, thanks very much Vince. I’ll turn it back.

Operator

Thank you. Our next question is from Joe Gibney from Capital One.

Joe Gibney – Capital One

Thanks. Good morning. Mark, just a question for you. I think you referenced the potential deal average pretty rapidly here. Certainly your business model is supportive of that. Just trying to understand, just help us a little bit with expectations for how aggressive maybe you can be or want be, understanding how to balance that with potential acquisitions, other opportunities that are down the road, but just how aggressive do you think you want to be on some of the debt pay down coming out of the Grupo deal?

Mark Baldwin

I think you used the right term. We’ve got to balance that with acquisition opportunities. I think large acquisition opportunities, we’re probably going to delay if you will, but what we call both-ons as we have in the past will likely continue and as a result, we’ll balance that with the pay down. As you can see from the history of that chart that we showed, we have the ability to rapid de-lever and I think we’re comfortable in the kind of the two to three range, two times to three times debt to EBITDA range.

It may float up a little more than that periodically if we’ve got a good acquisition opportunity like Guascor, but I think that two to three range is where we feel comfortable Joe.

Jeffrey Spittel - Madison Williams

Okay, that’s helpful and then just on the sub sea test bed construction working its way through in 2012 so we’re not getting a lot closer to and the reality of sub sea construction here and this is a large megawatt machine you’re working on here at 8 to 12. Just curious, what are your thoughts on timeframe for sort of a marketed prime? Is 2013 a reality for a marketed product here on the ICS in this high middle?

Vincent Volpe

I think it is Jeff and I’ve been, I’ve always said it’s kind of a long way out and always cautioned you guys. When we think about the ICS, think about it as a topside unit because that’s where it’s going first and then ultimately sub sea. I actually and I still broadly feel that way, but I actually think that with this program that we’ve got with Stat Oil, building the unit, getting it on the test stand and it will be testing, probably it will be early 13 will be the test program per se, but we’ve got a lot of customers around this.

There will be people in to look at it. We’ve got the Petrobas unit, even though it’s only a megawatt, it’s a Datum compressor that can be scaled up to 100 megawatts if we need to or 80 megawatts. Pick another number, but much bigger machine. So I’m not concerned about scaling from one megawatt to 10 megawatts and I think most customers get that. It’s a bigger separator so they want to see that and then we want to see that, we want to show we can marinize the machine.

So I think that we’ve done a lot of approving already on Petrobras. We’re going to do more with this and I think clients will kind of move right along with this and I think once we get well into the testing program and you start getting like a thousand hours on this thing or $500 on the test stand and it runs the way we expect it to, I wouldn’t be surprised to see people seriously considering putting this into a sub sea application and I wouldn’t be surprised that by the end of 2013, if we don’t have any orders by then that at least we’ve got serious inquiries that we’re working on for sub sea at that space.

I believe with the rest of the infrastructure being as well developed as it is now for sub sea that once we make this and we demonstrate it works, you build it and they’ll buy it and so I actually think that we can move this market right along and this is absolutely the device to put down there. There’s pump people out there they’re not playing, they’ve got a compressor. That’s not really the case. There’s people with wet gas machines that will put them on the bottom of the ocean, but you can’t compare any of that to a compressor that is fundamentally going to stay dry sitting on the bottom of the ocean and it’s only going to be the only that will do that.

So by physical aspect, it has got to be the most robust machine out there. So I’m very enthusiastic and as I said I think latter half of 2013. If we don’t get all the way to the point of g orders we’ve at least got some very serious inquiries to move in that direction because everybody is going to be watching very closely. Now obviously we’ve got to execute over the next year and do what we said we can do in terms of building the unit to making sure it works on tests. So we have our job to do also, but assuming we get that done I think it can happen for us.

Jeffrey Spittel - Madison Williams

Alright, thank you. Appreciate it gentlemen. I’ll turn it back.

Operator

Thank you. Our next question is from Roger Read from Morgan Keegan.

Roger Read - Morgan Keegan & Company, Inc.

Hey, good morning. I guess kind of the quick questions I had, understand from the discussion margins and the new units business back half of this year, projects obviously. You picked up here in early July. I was wondering Vince if you could give us an idea, clearly some low margin stuff running through in the first half of this year. Where do you see pricing in margins sort of these new projects compared to six months ago, 12 months ago and then maybe even if you could take a six month forward kind of jaunt here?

Vince Volpe

Well, yeah I think over that period I can give you some guidance. I think prices are basically flat. Margins will be flat. As the costs move up the pricing is going to move up, but I don’t see a lot of margin expansion right now on the variable line Roger. As I’ve said before I think the margin expansion that we’ll get in the out years and I’m not providing guidance yet on 2012 so don’t start making changes here on me, but just it’s going to calculate to margin expansion as you get more volume and I think that again, so to go back through it, pricing, I think margins have been pretty stable for the last year more than now.

The costs have been low and the prices have been low. The costs are starting to come up, well at least they have started. We’ll have to see what this new set of macroeconomics does for the cost base and the supply chain, but they have been starting to come up still in other things. We’ve been able to keep up with that to maintain our margins on jobs on a variable basis and as you put more volume through an existing flexible manufacturing structure you don’t have to add the same, you don’t have to add capacity costs at the same rate.

You get operating leverage. So I think the margins should expand over time on an operating basis just because of the operating leverage, but on a variable basis I think they’re going to be pretty stable and I’m comfortable saying that over the next six months because the jobs that we’re booked over the next six months, we’ve already priced them today. If this takes that long from the time you price a thing until it turns into an order.

Roger Read - Morgan Keegan & Company, Inc.

Right. So it sounds like the direction is definitely in the right or it’s headed in the right direction maybe I should say?

Vince Volpe

Yeah, well it’s not headed in the wrong direction Roger, let me put it to you that way. Let me just make another comment also and it’s coming back to what Joe was asking Mark a question on the balance sheet. We’ve booked $0.5 billion the first of in new units first half of the year. We’re sticking with our range of 1.2 to 1.4 billion pre Guascor. Let’s not put them in the discussion yet. So that means that we’ve got a lot more bookings second half of the year.

We’re repeating that guidance which means we still believe in it and we all know that the new unit business is what drives positive cash flow. As that grows because we get down payments and advance payments or progress in advance payments. So those projects principally are cash flow positive or in the worst case neutral and after a strong cash flow. So if you see strong bookings coming, it’s actually going to help you de-lever more quickly in terms of the balance sheet and I just wanted to point that out for those of you out there that are kind of sitting there saying hmm, 42%. That’s the capital ratio, that’s not all that low and we agree it’s not but we’re also confident that we’ve got that cash flow machine that’s going to work for us and I want to just reiterate and tap under the back of Mark’s answer.

Roger Read - Morgan Keegan & Company, Inc.

Okay and then my only other question was, as you look at the aftermarket business, one of the things holding margins down as I’ve understood it has been sort of the customer mix that’s been going through. Have you seen at this point any changes in that that would say you should start to see margins go higher? I understand the volume part of it, but is there anything else that maybe could lead to and I’m not trying to get you to raise your numbers, but maybe put you to the higher end of your expectation range for 2011 versus the lower end.

Vince Volpe

Well I think as I said we’ve got the amortization step up on Guascor that is part of our numbers going forward. That actually wants to put pressure, downward pressure on the margins. We do think that on a variable margin basis, if you go back a few years, mean on parts, repairs field service, they’ve been unbelievably flat and it really has been volume that has depressed those margins. It is not the direct cost or the cost of good sold/price relationship.

They’ve been flat I guess with the exception over the last two years the repair margins have been down a bit. Otherwise 2010 to 2011, if we just kind of look at those numbers, very flat and so I don’t think we’re going to see a big shift in that Roger going forward in terms of customer mix or anything else. I think it’s volume again. Volume is a good thing and we think we’re in circular growth here, recessions not outstanding, but we haven’t heard anything based on the latest situation around US debt, European debt etc that’s slowing down many of the oil companies.

Roger Read - Morgan Keegan & Company, Inc.

I second that but it’s early days yet as they say.

Vince Volpe

Yeah, I know. I understand.

Roger Read - Morgan Keegan & Company, Inc.

Alright, thanks guys.

Operator

Thank you. Our next question is from David Anderson from JPMorgan.

David Anderson - JPMorgan

Good morning Vince. Quick question on the Guascor guidance property. It looks like you’re about 15 million there estimated there for the full year, I guess the rest of the year. What is the kind of risk of those numbers? You feel pretty confident that that’s going to come through?

Vince Volpe

I do. I think we have, a part of those numbers right off the bat are these recurring revenues that come from assets that we’re operating and collecting sort of monthly paychecks for. So that’s ’in the bag.’ The other portion of it is jobs that we have in backlog that we believe we’re going to ship and get paid for. So yeah, I think we’re pretty solid on that number, yes.

David Anderson - JPMorgan

Looking towards the next year, you’re talking about volume, volume has got to pick up from margins. We’ve seen this in the past so that’s not a big surprise, but you really need that refining maintenance cycle to kick in. Any progress there? I know things have been kind of delayed. Are you getting the sense things are starting to pick up?

Vince Volpe

Yes I am. Look, I believe that we’re going to be low on the range of the guidance that we provided and I believe that the second half of the year will be on a run rate basis higher than the first half of the year in bookings. I don’t want to get too granular but I’d say that Q3 ought to be on the same order of magnitude as Q2 and that we believe Q4 will be at least there and maybe even a tad higher and I think that we’re seeing the pickup in the US maintenance in the refining to be very specific.

David Anderson - JPMorgan

Also looking towards next year you mentioned a couple of FPSOs in there. It sounds like 2012 is going to be the timeframe we’re going to be seeing some of these start go through. Can you remind us again about what your revenue opportunities for FPSO and also kind of how many of these are you chasing that you think you could potentially win next year?

Vince Volpe

Well, I don’t have the number off the top of my head, how many we think we can potentially win next year David, but…

David Anderson - JPMorgan

But I mean is it double digits? Is it like 10, 20? I mean just give us a rough size there.

Vince Volpe

I would say that over the next 18 months, alright because these things you know how they move? A customer says they’re going to buy and then it gets delayed. So I’m going to give myself some little bit of wiggle room here. Over the next 18 months I would say we could see 10 plus FPSO orders either for compression or power generation or we really hit the ball out of the park both and so the revenue, I will let Blaise talk because I keep forgetting our formula David. You’ve got to go look at the published data because this thing is very enormously in size and quarter bookings opportunities. Blaise, what are…?

Blaise Derrico

Yeah, based on our experience David, for every million standard cubic feet of gas that’s handled by the FPSO, whether for re-injection or export gas, it’s a $200,000 equipment opportunity and that’s just for the compression piece and the power generation could be a like amount. So we’ve seen on the compression side orders range anywhere from say 20 million to as much as 75 million and as Vince mentioned if we hit the ball out of the park it could be double that number.

Operator

(Operator instructions). Our next question comes from William Conroy from Pritchard Capital.

William Conroy - Pritchard Capital

Thanks for taking my questions. Vince, maybe one for you and correct me if I’m wrong. I thought you mentioned that you had maybe a bias in the operating income guidance towards the lower end of the range. What is out there that could potentially kick you into the upper half?

Vince Volpe

William, there is a lot of moving parts, but basically it’s Libya. Libya is working with all bringers tons of ins and outs in the business and hopefully we don’t have another flood, whatever all those things are, but Libya is the thing that moves us away from kind of sitting right on the middle and so if we had, all of a sudden there was a turnaround and bingo. Libya has cost us like through half the year like $8 million or something compared to what we did last year.

It’s real work. We had crews in there that we had to pull out and the good news is we think that will come back. The sooner we get back to back to work there that could help move things from the lower half at least back up to the middle. If you look at where you guys are in YCU, I guess I’m talking about terms and first call. You are sitting about in the middle of the range right now and so what I’m telling you is we think we’re going to be in the lower half so can we get to the middle? I don’t know.

Can we get to the upper half? We need to see a turnaround in Libya. I also think that if we had an unexpectedly high third quarter bookings in aftermarket and there were parts and stuff in there, maybe we could. Not maybe, we could get some of that stuff out by the end of the year. So I think you should just write Luciano Pizarro [ph] a letter and tell him to get booking, okay?

Not to be glib about it but seriously the answer to the question is if we get above what I’ve sort of indicated and a couple of these bigger projects come to roost earlier rather than later in the aftermarket, we may be able to get that plus Libya get us into that part of the guidance range, but for now I’d sit tight in terms of where we are.

William Conroy - Pritchard Capital

Got it. Changing gears a little bit and following on a little bit to Jeff’s question much earlier, are you starting to see more inquiries for either restarts or projects really related to not gas as seed stock type plants? Whether that’s fertilizer or chemical or whatever?

Vince Volpe

We are seeing more work in the aftermarket. I think what we’re going, we’ve got some work we believe coming that would be in that petrochemical space. So first of all yes, there is and that was dead. Two years ago it was zero, right? So we’ve got some projects percolating now in that space. Again compared to the upstream business they’re not as big but they are out there. I think what we really think is maybe more positive is in the aftermarket side of the business where you turn the facilities back on, you’re refurbishing them, you’re upgrading them, you’re trying to make them more efficient, you’re trying to increase the production capability, be they ethylene complexes or fertilizer plants, whatever in that space, chemical facilities.

So I think the opportunity is actually more pronounced in the aftermarket than it is in the new space. But now that being said, I said it was dead a couple of years but I was actually talking about the US. Obviously there was some petrochemical work going on overseas. We do see some coming. I believe I saw the DOW and Saudi Aramco have announced they’re moving forward on (inaudible) now.

You’ve got to be careful when you, that ‘opportunity’ has got two pieces. One is refining and one is petrochemical and what they said is they’re going to all move forward on the petrochemical piece, but William that’s from the time they say something like that and the time that we get an order, it could be a year or more or two even. So it’s not something that I would expect is going to come across the trends in the next three months, but it’s positive.

William Conroy - Pritchard Capital

Understood Vince. I appreciate the perspective. Thank you.

Operator

Thank you. I’m showing no further questions at this time and would like to turn the call back over to Blaise Derrico for any closing remarks.

Blaise Derrico

Jane, thank you. I’d like to thank everyone for joining the call today. If you have further questions please call me. You can find my – Jane I think I see one more question.

Operator

Yes. We do have a question from Guy Davis from Simmons & Co.

Guy Davis - Simmons & Co.

Yeah, thank you guys for squeezing me in here at the end.

Vince Volpe

No problem Guy, how are you today?

Guy Davis - Simmons & Co.

Doing well, thanks. I just wanted to quickly go back to the operating income guidance and so I’m looking here seasonally, With the guidance that you’ve given, is it fair to expect that almost 50% of your op income is going to be in the fourth quarter this year and I was just hoping you could kind of walk through that just a little bit. I know you gave a little bit of color earlier, but I just want to make sure that that’s consistent with your expectation.

Vince Volpe

Yes it is Guy and what I would say to you is we never liked being in this situation. We like to see 25% per quarter, but the reason first of all that we’re in the situation is because we had very low bookings in 2009 and the big orders are sort of 12 to 16 months and so by the time that dearth of activity works its way through the system you end up with very low sales the first half basically of 2011. So that’s kind of the bad news is that it’s all back end loaded.

The good news is, 2010 bookings were significantly higher than 29. They were almost, well they went from 700 million to well over a billion and so as a result of that, the second half of 2011 and into 2012 you’ve got pretty strong backlog. So that’s why we’re in the position that we’re in. Now, how bad is this position in terms of can you get it done? Well, we’re looking at shipments north of 400 million in units in the fourth quarter of this year. If I look on my charts, for the last several years, I go back to 2008 that was the biggest quarter. I’m looking at it now and you don’t have the numbers there but it is literally the same, well it’s almost the same number within it but 3% or 4%, 5 %

It’s the same number that we shipped in 2008 we’re going to ship in 2011 in the fourth quarter. So we’ve been here before in terms of throughput and by the way remember we have a flexible manufacturing model that we have developed over time. So it’s theoretically more capacity now than we did in 2008. So anyway we’re not going into uncharted waters in terms of what we need to do in terms of getting all this work out.

From an aftermarket standpoint, it’s stuff that moves through. We had quarters that have been this big before or on the same order of magnitude. So again I don’t think that is getting any, again 2008 was really a good reference point, right around 300 million in the aftermarket is going to go and that’s about what went in 2008.

So we’ve been there. So sort of here is how we got to being in the situation we’re in and yes we think we can execute and we have history to demonstrate that we’ve done it before. So it’s going to be a challenging quarter for sure, but I’m confident that we can get it done.

Guy Davis - Simmons & Co.

Thanks for the color there.

Blaise Derrico

Okay Guy, thank you and again, this is Blaise Derrico. If you do have further questions please call me. My direct dial can be found on the earnings news release we issued last evening. Again thank you for joining the call. Have a great day.

Operator

Ladies and gentlemen this does conclude your conference. You may all disconnect and have a wonderful day.

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