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Dresser Rand Group Inc. (NYSE:DRC)

Q1 FY08 Earnings Call

April 30, 2008, 08.30 AM ET

Executives

Blaise Derrico

Analysts

Jeffrey Spittel - Natexis Bleichroeder

Kevin Pollard - JPMorgan Chase & Co.

Ole Slorer - Morgan Stanley

J. David Anderson - UBS

Charles Minervino - Goldman Sachs

Joseph Gibney - Capital One Southcoast, Inc.

Geoff Kieburtz - Citigroup

Sunil Jagwani - Catapult

Director of Investor Relations

Vincent R. Volpe Jr. - President and CEO

Mark E. Baldwin - EVP and CFO

Operator

Good morning, ladies and gentlemen and welcome to Dresser-Rand's First Quarter 2008 Earnings Conference Call. My name is Dave 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 this conference call. [Operator Instructions].

As a reminder, this conference is being recorded for replay purposes. After Dresser-Rand's comments today, I will instruct to you on the procedures for asking your questions.

I would now to turn the conference over to Blaise Derrico, Director of Investor Relations.

Blaise Derrico - Director of Investor Relations

Thank you, David. Good morning, everyone. This call is open to the public, it's being web cast simultaneously at www.dresser-rand.com and will be archived for replay. A copy of the news release we issued yesterday is available on our website as are the slides that we'll 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 2. Statements made during this conference call that are not historical facts maybe 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 fine sensitive information that reflects management's best judgment only as of the date of the live call. Dresser-Rand does not undertake any ongoing obligation other than that imposed by law to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after this call. For 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.

Now I'll turn the call over to Vince R. Volpe Jr., President and CEO.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Thank you for joining us today and welcome to Dresser-Rand's earnings conference call. With me today are Mark Baldwin, Dresser-Rand's Chief Financial Officer and Blaise Derrico, our Director of Investor Relations. I will start with a review of recent highlights and Mark will follow me with a detailed discussion of our first quarter results.

Please turn to slide 3. We are pleased with our first quarter performance. Our operating results were slightly above the top end of our guidance range. Net income was about $27 million or $0.32 per share. Our first quarter net income included an after-tax curtailment amendment of $4.7 million or $0.06 per diluted share. This non-cash credit to income is connected to the recently ratified labor agreement at our Olean, New York operation.

Mark will cover our first quarter financial results in detail in a moment, but first a few recent highlights. Bookings were 35% higher than last year's first quarter. After-market bookings were excellent at a level of 24% higher than the corresponding period last year. Sales increased 16%, backlog grew 54% from March 31st, 2007 to a record level of approximately $2.1 billion. Operating income was $40 million before the curtailment amendment and operating cash flow was $55 million.

As I mentioned, we reached agreement with the members of the steel workers union representing workers of the Olean, New York facility. Finally, we announced that our Board of Directors has authorized a repurchase of up to $150 million of common stock, which is approximately 5% of the outstanding shares. Given the attractive stock price, significantly improved capital structure, free cash flow and continued confidence in our outlook, the authority to repurchase shares reflects the commitment to building shareholder value. It should be noted that we are maintaining our strategy to create value through accretive bolt-on acquisitions and that this repurchase program will be executed on an opportunistic basis.

Next slide please. Bookings for the last 12 months were slightly more than $2.3 billion or 23% higher than the same period a year ago and 72% higher than two years ago. Breaking it down into the two segments, new unit bookings of $1.4 billion are up 33% versus a year ago and the aftermarket bookings of $919 million are up about a 11%. As previously reported, aftermarket bookings slowed in the middle part of last year due to process changes at two national oil company clients. These issues appeared to be behind us.

In the first quarter of 2008, aftermarket bookings were up 24% compared to the corresponding period last year. The increase in aftermarket bookings was broad-based as most of the increase was from our worldwide client base. Approximately 38% of our bookings in the last 12 months were upstream, 11% midstream and 43% downstream. First quarter of 2008 new unit bookings of approximately $339 million comprised a number of large orders including several bookings for refinery work in Spain, Brazil, India and the United States.

In recent months, the narrowing of refinery crack spreads has heightened concerned about the outlook for refinery market. Frankly, we believe that on a worldwide basis, the refinery market will be very good for the foreseeable future. Inquiries continued to be strong and we have no reason to believe that the market is slowing.

In addition to the major expansion projects, there is still a lot of work within existing facilities to convert processes to handle heavy and sour crude. Two of the larger orders booked this past quarter are indeed from major refinery work.

First, we have been awarded a contract... slide 5 please, excuse me. First we have been awarded a contract for more than $40 million to supply six reciprocating compressors for Repsol's Cartagena Refinery in Spain for hydrogen make-up applications.

Turn to slide 6. The second major order for approximately $33 million is from Petrobras for working six of the refineries located in Brazil. We will supply 18 reciprocating compressors. These are clean fuels units being added to the refineries to comply with new legal requirements in Brazil regarding sulfur content in diesel and gasoline.

Turn to slide 7 please. Backlog at the end of March was at a record level of approximately $2.1 billion or 54% higher than a year earlier and 113% higher than two years ago. Breaking it down into the two segments, new unit backlog of $1.8 billion is up 61% versus a year ago and our aftermarket backlog is up about 24% to $342 million.

Turn to the next slide please. Before turning the call over to Mark, I would briefly comment on recently ratified labor agreement at the Olean, New York facility. This is obviously good news for the company, the employees and many other stakeholders. It certainly removes one of the more significant risks to our plan for the year. The approximately 500 workers of the Olean facility ratified the new contract by an overwhelming three to one majority. The three-year agreement will be effective on June 16, 2008.

This new contemporary labor agreement is market-competitive and generally consistent with programs and policies covering other Dresser-Rand employees based in the United States. The new contract language allows for continuous operating improvements through more flexible and modern work rules. Wages will increase by 10.5% over the three-year life of the contract. We are also implementing improvements in insurance programs, pensions and vacations while lifetime retiree medical coverage has been eliminated for certain active and future employees. This new agreement is an important step and helps foster an environment conducive to investment at the Olean location.

In this regard, we're evaluating two potential investments in Olean. One is to construct additional test capability associated with our sub sea compressor separator technologies. The second is for new technology center to house about 500 engineers and technologists located at the Olean campus. The tech center will move engineers and scientists to one location improving communications and productivity. We expect to make the final decision on these in the near future. Should we go forward with these special projects, capital expenditures for 2008 will likely be in the range of 2% to 2.5% of sales, which is consistent with what I said at the time of our previous call. This is not necessarily the normal run rate for the business, which we continue to believe, is closer to a more modest 1.5% of sales.

I will now turn the call over to Mark.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Thank you, Vince and good morning, everyone. Please turn to slide 9. As Vince mentioned, we reported net income for the first quarter of $27 million or $0.32 per diluted common share. This includes a curtailment amendment of $4.7 million after-tax or $0.06 per share. The recently ratified labor agreement at the Olean operation resulted in the curtailment amendment, which represents a reduction in our balance sheet obligation for post employment benefits and the elimination of substantial future cash cost for retiree healthcare benefit.

We are showing on this slide the impact of several unusual items from both periods including this curtailment amendment. After adjusting for these unusual items, this slide shows adjusted net income was up approximately 33%. If you include the interest expense related to the litigation charge from the prior year, net income on an adjusted basis was up 28%.

Turn to slide 10, please. Sales for the first quarter of 2008 of $364 million were about 16% higher than the first quarter of 2007. In the quarter the weak dollar resulted in a modest translation benefit. This is not a precise measurement but the increase to our first quarter sales was approximately 2% to 3%.

New unit sales of $150 million were higher than the first quarter of 2007 by about $36 million. Sales of after-market parts and services increased approximately 7% from the corresponding period last year to $214 million.

You may recall that aftermarket bookings in the fourth quarter of 2007 were up 16% compared to the year earlier period suggesting that we should have realized somewhat higher sales in the first quarter. However, approximately 45% of the fourth quarter bookings came in December and given our average aftermarket cycle times of three to four months, some of these December bookings were shipped in the second quarter. Moreover, we are maintaining our full-year guidance that aftermarket revenues should increase on a percentage basis by 8% to 10% consistent with the growth we have experienced in the aftermarket over the past six years.

Turn to the next slide, please. Total operating income for the first quarter of 2008 was $47 million, which includes the previously mentioned curtailment amendment of $7.2 million before tax. Adjusting for the curtailment amendment, first quarter non-GAAP operating income was approximately $40 million. This compares to operating income of about $38 million for the first quarter of 2007, adjusted to exclude accelerated service unit expense and a litigation provision, which totaled about $5 million.

Operating income margin was 10.9% compared to 12% for the corresponding period in 2007 after adjusting for the items mentioned previously. In connection with the Olean Labor Agreement, we agreed to make a lump sum payment to those employees affected by the elimination of retiree healthcare i.e. those employees whom were not grand fathered under retiree healthcare benefit.

Under accounting principles generally accepted in the U.S., the expected lump sum payment that will be paid in the second quarter of 2008 will be considered a partial settlement that will require us to recognize approximately $2 million of net actuarial losses in the second quarter of 2008 income statement.

Next slide please. New unit operating margin improved nearly 50 basis points to 6.1% from the corresponding period last year of 5.6% after adjusting for the two unusual items last year. The unusual items included a charge for litigation and service unit expenses. The 50 basis point improvement is attributable to improved prices and higher volume. Aftermarket operating margin decreased 220 basis points to 23.4% from the corresponding period last year of 25.6%, adjusted for the two unusual items mentioned previously. The decrease in first quarter 2008 operating margin from the same period year ago is due to selling and administrative expenses allocated to the after-market segment growing nearly 14% compared to sales being up 7%.

We continue to invest in people and processes to support our strategy to grow aftermarket revenues. Selling expenses have expanded in line with the growth in bookings. We still believe aftermarket margins for the year will be roughly flat compared to 2007.

Turn to slide 14, please. At the end of the first quarter, liquidity was approximately $496 million and consisted of about $259 million of cash and $237 million of available borrowings under our bank credit arrangement.

Next slide, please. In terms of our first quarter cash flow, net cash provided by operating activities was about $55 million, this compares to $107 million in the first quarter of '07. The decrease of approximately $53 million was principally due to changes in working capital... principally due changes in working capital which provided $50 million less cash flow than the corresponding period a year ago. Working capital changes provided cash of approximately $35 million in the first quarter of 2008 compared to $86 million in the first quarter of 2007.

Breaking it down by major working capital component, first, accounts receivable provided cash of approximately $55 million in the first quarter of 2008 compared to $61 million in the first quarter of 2007.

Inventories, net of progress payments decreased about $4 million from the beginning of the year compared to an increase of $11 million in the first quarter of 2007. Customer advance payments were reduced approximately $14 million from the beginning of the year whereas customer advances provided cash of approximately $52 million in the first quarter of 2007.

Accounts payable used $10 million of cash in the first quarter of 2008 compared to a use of $16 million in the first quarter of 2007.

Next slide please. In terms of investing activities, we used approximately $6 million for capital expenditures in the first quarter of 2008 compared to $5 million in the first quarter of 2007. Our business model continues to generate very strong cash flow yields as we operate with near zero working capital and our capital expenditures are relatively modest.

Please turn to slide 17. We ended the first quarter with a net debt-to-capital ratio of approximately 9% and net debt to our last 12-month adjusted EBITDA was a very comfortable 0.4 times. Given our attractive stock price, significantly improved capital structure, free cash flow and continued confidence in our outlook, our Board maintained its authority to repurchase up to $115 million of our common stock.

Earlier this month, S&P upgraded our credit rating one notch to BB from BB-. This upgrade takes into consideration the potential impact of the share repurchase program on our capital structure. S&P is also aware that we intend to continue our bolt-on acquisition strategy. For more information about our results for the first quarter, please refer to our 10-Q, which we filed last evening with the SEC.

As a reminder, our Annual Meeting of Stockholders will be held Tuesday, May 13th. Whether or not you expect to attending for senior voting as soon as possible will be greatly appreciated and we will ensure that your shares are represented at the annual meeting.

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

Vincent R. Volpe Jr. - President and Chief Executive Officer

Thank you, Mark. Turn to slide number 18 please. As for our business outlook, demand for products and services continue to be strong. Backlog is extended well into next year with approximately $720 million or 34% of our March 31, 2008 backlog scheduled to ship in 2009 and beyond. Our expectations for the 2008 operating income are unchanged. We continue to believe that our 2008 operating income will be in the range of $285 million to $315 million. As for the second quarter, we currently expect operating income to be in the range of 20% to 22% of the total year. Before we open the line to questions, I will mention one recent highlight of which we are particularly proud.

Turn to slide number 19. Earlier this month, Dresser-Rand received the prestigious 2008 North American Compressed Gas Solutions Company of the Year Award from Frost and Sullivan, an international consulting firm with more than 45 years experience. What makes this honor especially important is that Frost and Sullivan came to its conclusions independently, based on its own research. We did not enter to a competition or submit an entry seeking this award. Frost and Sullivan analysts use predetermined criteria and conducted interviews with market participants, clients and suppliers. These criteria included technological innovation that drives outstanding client value, improvements in client satisfaction and loyalty levels, one-stop solutions and responsiveness to clients' needs. We believe further validation of Dresser-Rand's value proposition is evidenced by the fact that the company has received more alliances than any other company in our industry. Our value proposition is why we are leading supplier of high-speed rotating equipment for the worldwide energy market and we are committed to maintaining that position.

At this point, we will open the line for questions. Operator, please begin the Q&A session. Thank you.

Question and Answer

Operator

And our first question comes from Jeff Spittel with Natexis Bleichroeder.

Jeffrey Spittel - Natexis Bleichroeder

Good morning, gentlemen.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Good morning, Jeff.

Jeffrey Spittel - Natexis Bleichroeder

Vince, I was wondering if you could talk broadly about the outlook for some of the larger upstream projects, what you see going on in either the FPSO market or just generally offshore.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, yes, I think the word is strong, Jeff. There is a terrific amount of activity. You can see that a significant amount of our bookings are coming that space. And I think that we'll see a similar mix going forward to what we sort of seen in the looking in the rearview mirror.

Jeffrey Spittel - Natexis Bleichroeder

Okay. And then switching to the aftermarket business, can you talk a little bit about, I know S&A [ph] was an impact in the quarter, can you talk about product mix and how that impacted margins in the quarter and I guess, what the moving parts are we should be looking for the rest of the year?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, I think to jump to the end of it, we believe that our margins should be fairly consistent on a full-year basis for that segment, Jeff, to what they were last year, okay. And so obviously that's not the case when you make the adjustment for some of the one-time expenses we had last year, not the case in the first quarter. But again we have a view for the full year that says, they should be above flat, and that's really our objective, right. In our business with these two segments, the first thing we're trying to do is, in the aftermarket we will try to grow volume. We like our margins where they are. Then I've said before, trying to press too much further in terms of pricing on those margins may not achieved the desired outcome offsetting them. So we want to grow volume and maintain margins in there and on the unit side of course we want to increase margins as we go forward. So I think we'd be pretty happy if we can hit last year's margins levels. We believe that we can. A little out of sink in Q1 but not to be unexpected because we've got... we add costs, particularly in the selling area that follow more... you can kind of track it more by the bookings than by the sales. You have to add the people first, then the bookings grow and then the sales flow through sort of three or four months later. So I wouldn't... I wouldn't put a too much of red flag on that, Jeff. I think we're in pretty good shape to maintain the same margin levels we had on a full year basis last year. And it's not a product mix issue, it's really and S&A issue and it's mostly selling.

Jeffrey Spittel - Natexis Bleichroeder

Okay, great. It's sound good. Thanks, Vince. I'll turn it over.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Kevin Pollard with JPMorgan.

Kevin Pollard - JPMorgan Chase & Co.

Thanks. Good mornings.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Kevin?

Kevin Pollard - JPMorgan Chase & Co.

Yes, I wanted to... first of all, I wonder if you could give us a view on what you think the new unit booking rate can continue based on the bidding that you're seeing out there? Will it be unreasonable to expect a kind of a space in that $300 million to $315 million per quarter that we have kind of seen in the last three quarters or so over the balance of this year?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

I think so, Kevin. I mean, I'm glad that you brought it up, because there is something that I like everyone to focus on and that is, when we do the comparisons next quarter we need to remember that in the second quarter of 2007 we booked $154 million job on one project, it was for BP Skarv, it was a floater. And so if you kind of take that out as an exceptional item, that's going to get you right smack into the area that you just quoted. So let's not be disappointed next year if we kind of come in that $300 million to $350 million region versus what we did last year, which was $453 million. Well, yes you can expect strong continued bookings, similar run rate to what we've seen on a trend basis and let's not give the wrong message when we see a significant year-over-year drop. It's really off in one project.

Kevin Pollard - JPMorgan Chase & Co.

Right. That's how I will use the last three quarters and for the last four as a starting point. If I can sort of take this one step further into what it means, you've got a pretty clear view on what your '08 revenues is going to look like since it's already all in backlog. But you've got... you've always thinking only one quarter into the year with nearly $700 million of backlog for '09 and beyond I guess, and if you can maintain that $300 million to $350 million a quarter order rate, it seems pretty likely that your '09 revenue would be up at least in the kind of $1.4 billion range versus $1.1 million. Is that logical extension of we've talked about given your backlog and expectations for new units?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

I would say that that's not unreasonable, it's still little bit too early for us to get too granular with that.

Kevin Pollard - JPMorgan Chase & Co.

All right, I was not trying to pin down a specific forecast, I'm just trying to get a magnitude of growth rate that can be seen going into '09?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Yes, we're going to see a nice profit, there is no doubt about it. We don't see an expansion right now in our cycle times, okay. So if you keep doing the math and you use 14 months to 16 months and roll foreword, you are going to get a number like that.

Kevin Pollard - JPMorgan Chase & Co.

Right. Okay.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Or you take the backlog that we've just given you, I think you're doing math correctly.

Kevin Pollard - JPMorgan Chase & Co.

Yes. Okay. And then if I could switch over to aftermarket, just to clarify you said you are optimistic that you can maintain margins flat with last year. They obviously had a negative impact a couple of quarters of the Painted Post strike, when you say margins consistent with '07 are you sort of including those strike cost or sort of what's the number with and without the strike?

Vincent R. Volpe Jr. - President and Chief Executive Officer

I'm giving you... yes, look we've been... we want to be very, very clear here which is why Mark made all of the adjustments for you on a segment basis, okay. And so, what we're saying is we believe that margins this year will be fairly consistent, now you get a little bit of mix change, so plus or minus of percentage, okay. But fairly consistent with what we would call the clean margins last year. So to be... a tad more pedantic, last year our aftermarket for the full year margins were 25.1%. We then made the adjustments for you all and said, had we not had the strike impact and some of the other unusual events, we would have been around 27% and that's where we are we are expecting in that 27% range this year.

Kevin Pollard - JPMorgan Chase & Co.

Great. That's what I wanted to clarify. And then one last, just sort of general question. You only booked a $150 million or so of new unit revenue this quarter. So obviously, you kind of a lot going out the door in the last three quarters to get your $1.1 billion. Is there anything you can do to sort of help us with the progression of that will be fairly evenly spread over the last three quarters or are there any quarters where you would expect to be unusually high?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well the fourth quarter is usually up a little bit just because... and then I think with what we've got right now laid out in the backlog, I think you ought to be thinking about between sort of 75% and 100% increase in Q2 and Q3 over what we did in Q1, so just less than double Q1 is going to go in Q2.

Kevin Pollard - JPMorgan Chase & Co.

Okay.

Vincent R. Volpe Jr. - President and Chief Executive Officer

All right. And probably about the same in Q3, just use that 75% to 100% increase and then the remainder you get in Q4.

Kevin Pollard - JPMorgan Chase & Co.

Okay. Thanks that's real helpful, and I appreciate.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Okay.

Operator

Our next question comes from Ole Slorer with Morgan Stanley.

Ole Slorer - Morgan Stanley

Thank you. And thanks for a nice start to the year, Vince.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes, it's a nice way to start, Ole.

Ole Slorer - Morgan Stanley

Yes. So all the disruptions from the labor negotiations that you've been doing, I mean they now appear to be behind us there is nothing in this quarter or going forward as you think it could be a correct ball [ph]?

Vincent R. Volpe Jr. - President and Chief Executive Officer

That is correct. From an operational standpoint, it is clear sailing and we are just delighted with that. Now recall that Mark did tell you that there will be a $2 million charge to the P&L in Q2 based on payments that we're making for... in layman's terms, look we stopped but we ended retiree medical for certain employees and we made a payment in kind to do that. And that is going out, and this is going out in the second quarter. And so we will take a, I guess I'd call it an actuarial hit of $2 million. So when you think about Q2, we've given you a number of between 20% and 22% of our full-year operating income. That's the guidance that we provided. That number does not include the $2 million hit. So you would have to deduct that $2 million from the number. We will, just as we have been very sort of transparent this quarter, we will do it again and we will show you what that number is but it is going to be somewhere around $2 million. But that has nothing to do with the operating part of the business. From an operations standpoint everybody is working, productivity is up. Painted Post where we still don't have a contract you'd never know it because I have never seen the work force more engaged into my 27 years here. So we are very pleased with where we are now.

Ole Slorer - Morgan Stanley

Okay, sounds good. And on the... just to get a clarification on the backlog, the breakdown between or just sort of the new order breakdown between 38%, 11%, and 41%. That was for the total backlog or was it for the new unit only?

Vincent R. Volpe Jr. - President and Chief Executive Officer

We're going to have to just look that up briefly, I don't think that there is a significant shift, Ole. I don't think there is a significant difference I should say. But let me just, let me just take a look here.

Ole Slorer - Morgan Stanley

Do you see a similar order intake both in aftermarket and in the new units?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes.

Ole Slorer - Morgan Stanley

Okay. That's interesting, [inaudible] your aftermarket business a little more refining related, but you are saying it's upstream related?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

What we are looking for here is, excuse me for a second, is this split on units of percentage split of aftermarket. Excuse me, what always looking for is refining, upstream, midstream, and downstream just on units.

Ole Slorer - Morgan Stanley

Just on unit?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Right.

Ole Slorer - Morgan Stanley

There was a material difference between, the break down between your new unit and your aftermarket?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Ole, do you have other questions, we will pull that one up and I will go ahead and tell everybody what it was here in a minute but anything else?

Ole Slorer - Morgan Stanley

The second one will be related whether you see... I guess I understood you correctly, you'll see that current mix in your business between up and downstream and midstream stay about the same over the next couple of years despite some concerns in the market about some potential slowdown in refining investments? You don't see that as the way I read what you say?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Yes, I'm going to answer that in the second. Let me answer your first question, on just units, it's pretty darn close. And we had 38% in total on upstream; on units it was 40%. And then we had 43% on downstream, and on units it was actually 48%. So, that is sort of the opposite of what you are thinking in terms of the aftermarket being mostly downstream. We had very good strong aftermarket bookings in the downstream. Look, I mean, I've have said this before, I understand what the U.S. refiners are saying, I don't understand exactly why they're saying it though, because when we look at our overall enquiry level and our bookings, we continue to see strength not only in the given quarter, but when you look at your inquiries, that's future booking stream. Now, I think that what we are seeing for sure similar to what we reported this quarter is a lot of that work is moving offshore, offshore U.S. So, maybe there is a bit of a slowdown in the U.S. refining, but I can tell you that on a worldwide basis, there is a heck of a lot of activity.

Ole Slorer - Morgan Stanley

And then in terms of pricing trends, are there any material difference between the way prices are shaping up for those three different end user markets?

Vincent R. Volpe Jr. - President and Chief Executive Officer

No, they're pretty strong, Ole. Our competitors play... our big major competitors play in all three of those segments, or at least the upstream and the downstream, and so you get fairly consistent pricing pressure across the spectrum.

Ole Slorer - Morgan Stanley

And pricing trends, are they still favorable?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes. What we... and I'd mentioned this before also. What we're seeing in the beginning part of year on the unit strengths are a little bit flat because we've got some long cycle time backlog that we're actually flushing out right now versus what we saw, which was in shorter cycle time backlog last year. And that's just the way the math works. So, we do expect that we will cross into the low double-digit range on new unit earnings. Even though, when you look at the first quarter and I would say the second quarter is going to be similar, you're going to get... you're going to see fairly flat new unit margins on the revenue line or on the margin line rather for Q1 and Q2, and then you'll see a more pronounced pickup in the back end of the year. So, yes, globally when we look at it from a bookings standpoint, we continue to see that a couple of hundred, 200 basis point to 300 basis point pick up, that we've continually seen over the last couple of years. So, we're just continuing.

Ole Slorer - Morgan Stanley

And just finally on cash flow, I mean the net debt reduction was about $50 million greater than we've been looking for, and you announced the buyback, you've also been talking periodically about acquisitions, are you changing your view at all between the mix of buyback versus acquisitions and is that related to the way you value your... is it related to the way you'll see a stock relative to acquisitions? Or is it just a function of not seeing the amount of acquisition targets that you thought you would relative to your account?

Vincent R. Volpe Jr. - President and Chief Executive Officer

No, I don't think it's a... I think that our vision on the... I'm going to ask Mark to answer the second part of the question. But from an acquisition standpoint, we're looking at bolt-on acquisitions, we have said before that we've got a variety of them on the screen. I personally am not happy with the speed at which we've been able to execute these, but I can tell you we're not the ones slowing things down, you need the seller to move as fast as the buyer also. So, they're out there, we believe that we will make these bolt-on acquisitions, the list is long. Again, these are not huge acquisitions, but there is really no change from that side. I think the share repurchase came from a different phenomenon, I'm going to let Mark answer that, but from an acquisition side there is no change. We are going to bolt on and we think that will bring terrific value.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Yes, from a cash flow standpoint, not only have we had the cash flow in the first quarter, our outlook continues to be that way. As you know, we have a capital light business model, both net working capital and capital expenditures. So, as we look out ahead, not only do we have the cash now, but we see the cash flow in the future being strong and we look at our valuation relative to the market. I think most of you know that our stock has underperformed the OSX for the first three or four months of the year and we just believe that that is a good value right now and we are going to go into the market and on an opportunistic basis, buy back some shares.

Ole Slorer - Morgan Stanley

Mark, Vincent, thanks for that.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Okay.

Operator

Our next question comes from David Anderson with UBS.

J. David Anderson - UBS

Vincent earlier said 48% of the new units was on the downstream side. How does that break down in terms of international versus U.S. and how has that shifted?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, we are going to have to dig this... dig the number up for you on that one, but it has definitely shifted versus last year overseas. I mean you've got just those two projects that I talked about. One was for Cartagena, which is in Spain, and the other one is for Brazil, and so what we're seeing here is definitely a move offshore.

J. David Anderson - UBS

Would you expect to see that remain fairly consistent over the next several quarters or so?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, there is still more work to be done in the U.S., Dave. So, you're going to... I don't know that we are going to see a whole scale, it's all going offshore.

J. David Anderson - UBS

Okay.

Vincent R. Volpe Jr. - President and Chief Executive Officer

As I said, I am having a little trouble flanging up what we're seeing in terms of inquiries and what the refineries are pronouncing back in States, so...

J. David Anderson - UBS

Understood and then I guess just taking this a little bit different way. What percentage of that downstream is non-refining work, like say on the chemical side and processing and the like?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Very little work at this point. Most of it's refining.

J. David Anderson - UBS

Most of it's refining. Would you expect that side of the business to pick up over time?

Vincent R. Volpe Jr. - President and Chief Executive Officer

I think that we are going to see a little bit more activities in petrochemicals, ethylene, and things like that. So, I think that we will see a pick up in the petrochemicals side of the equation not necessarily the detriment of refining, but I think it's another one of those market segments that we are not... there's not a lot in our numbers right now that is providing... that provides us with this continued bullish view that Dresser-Rand is a late cycle play, is going to be in a growth mode for a while here.

J. David Anderson - UBS

Okay, and then on the aftermarket side, I think you guys have talked about some... maybe some organic expansions in certain areas, if I'm not mistaken I think you highlighted like a West Africa or a Middle East as areas to build out on the aftermarket side. Is there a thought about that this year or is that a bit more longer term in nature?

Vincent R. Volpe Jr. - President and Chief Executive Officer

It might show up by the end of the year just in terms of where we are... we are opening some more service footprint in those areas of the world that you have just mentioned. So, we might see bookings pick up towards the end of the year. In terms of this year's revenue and earnings, Dave, I would say you probably won't see it.

J. David Anderson - UBS

Okay. Got you.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Probably a '09 number.

J. David Anderson - UBS

And just one last little housekeeping thing, in terms of your guidance. Is that... I'm going to assume that does not include that curtailment gain in there?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Sorry, are you talking about full-year guidance?

J. David Anderson - UBS

Yes.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes.

J. David Anderson - UBS

Thinking your operating income, I assume that does not include the curtailment gain.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes, we say we basically stay silent on it because when you talk about $285 million to $315 million and then you talk about a net curtailment gain of $5 million, it's almost too small to actually talk about, but I feel pretty good that we've got... we are going to be inside of that range, and if things go well then you could... if you added the $5 million to $300 million, which is the middle, you'd be at $305 million, so...

J. David Anderson - UBS

Got you. Okay, great. Thanks, guys.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes.

Operator

Our next question comes from Charles Minervino with Goldman Sachs.

Charles Minervino - Goldman Sachs

Hi, good morning.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Good morning, Charles.

Charles Minervino - Goldman Sachs

So, just a question, you often talk about the three-tiered approach to your aftermarket growth strategy. I'm just wondering if you can give us a little bit of an update on the aftermarket business, what kind of progress you're making on either capturing additional market share on your own products in the aftermarket or on competitor products?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes, normally we provide that input sort of every other quarter. So, I don't have the number specifically right in front of me, Chuck, on applied technology, which is really what you're talking about. But we're expecting for the year bookings to go beyond $100 million, and so we did about $80 million last year and I don't have any information at this point that says that we're not on track to do that. So, I would say that you're looking at a 25% increase year-over-year in working on our another people's stuff and it's about... it's a little more than... it will be a little more than 10% of our bookings.

Charles Minervino - Goldman Sachs

Okay. That's all I have. Thank you.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Okay. Okay, Chuck.

Operator

Our next question comes from Joe Gibney with Capital One Southcoast.

Joseph Gibney - Capital One Southcoast, Inc.

Good morning, everybody.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Good morning, Joe.

Joseph Gibney - Capital One Southcoast, Inc.

Just one, it's based a little bit on Painted Post, certainly understand from an operational perspective, it's no longer impactful, but any progression here towards... moving towards the signed agreement with Painted?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, we just had another meeting here a couple of days ago and there was no significant progress in terms of what the union were up to the... union leadership were up to the table. So, Joe, it's not obvious to me that any time in the near term we're going to have to sign contracts. That being said, I would consider... I would not consider that risk... of any significant risk at all for the simple fact that we've given people their salary increase even though we were not obligated to do that. The salary increase we had offered, people are very engaged, they are back to work, and so... and frankly the work rules that the union leadership was so concerned about don't really seem to be concerning anybody on the floor. So, we've got a very good environment. Our clients have seen it, they've continued to give us orders and so I would say operationally while there is still... there is still no contract, operationally that has no impact on the performance of the facility. And I don't know that we're going to have a contract any time in the near future. So it's... your guess is as good as mine, Joe, in terms of how long this whole thing lasts. And if we ever get a signed contract, there are other things that could happen up there, so....

Joseph Gibney - Capital One Southcoast, Inc.

All right, that's helpful. I appreciate the color on the downstream, I know you mentioned on a petrochemical side, very little obviously... right now built into the growth, obviously potential for a pick up there, but any additional color on the LNG front and your expectations within that subsegment of your business?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, I can tell you that we don't have... I mean we obviously didn't book anything this quarter or that would have been like the first thing that I disclosed. With all the time that has gone by here, but we're involved in a number of projects and sooner or later these projects have got to go forward. So, I would say that again it's all upside opportunity for us and it is a significant number.

Joseph Gibney - Capital One Southcoast, Inc.

Okay, and last one from me just wanted to touch base on the acquisition front, obviously you guys wanting to stay active here on the bolt-on side. Just curious if you could update us maybe a little bit about what are some of the parameters you're looking for, you mentioned this is a long list of potential candidates that are out there, but is it large installed base, is it technology driven, just give a little bit color maybe about some of the things you are looking at out there, would be appreciated.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Well, it's sort of what we consider the middle of our fairway and where we think there is a good sized list is, first of all technology that we understand. So, high-speed rotating equipment or contiguous products and services on those products inside of oilfield services play, so oil and gas related for the most part. Now, they may be in some other tangential markets, but we are looking for the lion's share of markets they serve to be the same ones we serve, so that we know the customers. And clearly companies that have significant installed base represent a good opportunity for us because with our existing infrastructure, we think in many cases we can extract more from the channel than what they may be getting on their own. And so that kind of makes them more valuable to us than to the existing owners. So, those are really the parameters that we are looking for. Obviously, we expect at least in a year or two that these would be accretive, if not sooner on a pro forma basis. And as I said, think about fairly small bolt-on type acquisitions rather than major elephants out there.

Joseph Gibney - Capital One Southcoast, Inc.

Sure. That's helpful. I appreciate. I'll turn it back. Good quarter.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Okay. Thanks, Joe.

Operator

[Operator Instructions]. Our next question comes from Geoff Kieburtz.

Geoff Kieburtz - Citigroup

Good morning.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Good morning, Geoff.

Geoff Kieburtz - Citigroup

Not to beat a dead horse, but I'd like to come back to this question of the upstream, downstream. Just the slide, simple question, it doesn't add to 100%, are we missing something? Adds to 92%?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Other.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Navy and other.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes. Other, which is principally the U.S. Navy and government, Geoff.

Geoff Kieburtz - Citigroup

Got you. Okay. I think from the earlier questions you resolved, the main point is that you don't see a meaningfully different growth trajectory or meaningfully different profitability drivers along these three market segments, is that correct?

Vincent R. Volpe Jr. - President and Chief Executive Officer

No... no and yes. What I said was... let me be a little bit clear. What I said was from a profitability statement, what you said is actually right, that's what I said. I said that whether it's upstream or downstream, we are getting about the same operating margins. Because the competition is participating in all of those. As far as the growth trajectory is concerned, I believe that we will see... I think that we've seen huge growth in refining over the last 12 months to 18 months, and what I'm saying there is, I believe we're going to see continued activity levels consistent on a yearly basis with what we saw in the past or fairly close to that. So, that is a different growth trajectory than what I believe we're going to see in perhaps the oil production side of the business where I think we'll continue to see... we might see actually a higher growth trajectory period-over-period in that space. But again these projects are lumpy, Geoff. And so from one quarter to the next don't expect any... I don't think you are going to see a trend based on next quarter's book.

Geoff Kieburtz - Citigroup

No, not. It's definitely a question more about sort of the multi-period outlook that you've got.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes.

Geoff Kieburtz - Citigroup

So, if I understand you, downstream has grown strongly... more strongly than upstream in the past, say, four to eight quarters, you expect it to continue at that pace, but upstream will accelerate its pace of growth?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Or at least stay on the same... stay on the same slope.

Geoff Kieburtz - Citigroup

Okay, okay. And when we look at the bookings, I think you said that the bookings, the backlog, and that revenue mix is not terribly different whether we're looking at new units or aftermarket?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes.

Geoff Kieburtz - Citigroup

Okay. Good. Small, mid... for Mark, is the net interest expense in the quarter, the $7.2 million that's in the slides, the $7 million that's in the press release.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Let me get that.

Geoff Kieburtz - Citigroup

Okay. Let me move on. On the new unit margins, just to clarify, your comment about low double digits, that's a run rate you expect to reach by the end of '08 or is that an average you expect to achieve?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

That's the average. That's what we expect on a full-year basis, Geoff.

Geoff Kieburtz - Citigroup

Okay. So, we got a rise in the second half of the year that's going to be fairly significant?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Correct.

Geoff Kieburtz - Citigroup

Okay. And what is behind that. What's the principal driver of that significant margin improvement?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes. If we... let's decouple bookings and sales for a sec, well the principal driver is price, okay?

Geoff Kieburtz - Citigroup

Okay.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Productivity about offsetting cost increases, okay?

Geoff Kieburtz - Citigroup

Okay. You've got higher price backlog, it's going to start to flow through the income statement?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Yes. It depends on when we book. And this is what... I think I explained previously. We book an order in period zero that has for a variety of reasons extended testing or whatever, it has say 18-month or 20-month cycle time to it, okay. The next quarter, we've priced a little bit higher, we booked an order that's only got 14-month backlog. We recognize revenue and earnings on sales and we sell when we deliver. So, what you can have arithmetically and what's going on in the first part of this year is orders that we booked earlier than things that we shipped recently that are now shipping.

Geoff Kieburtz - Citigroup

Right.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

And that's the arithmetic behind why you can see this in a given quarter and so we're seeing it in the first half of this year and the second half, we are seeing a more normal progression, which therefore gets us to low double digits on a full-year basis.

Geoff Kieburtz - Citigroup

And with that dynamic if you look into '09, you have some degree of visibility because of the backlog situation. Do you anticipate margins will build then from the run rate that you have at the end of the year or will they build from the average base that you achieved in '08?

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

No, I think that builds from the average because we cannot... we always have an opportunity to book something that's got full string testing, Geoff, and there's a 20-month cycle time and then have something show up. After that... that we book after that actually ships before that, because it's not a short cycle time. So, we're going to see lumps in the business, which is why we try and provide the guidance on a full-year basis on the margin percentages.

Geoff Kieburtz - Citigroup

Got you. Okay. And just last question, technical question, you mentioned somewhat briefly work you're doing on the subsea compression, it does appear to be another project with Statoil, Hidro, and Siemens. Can you give us any sense of what you know about that other project and where Dresser-Rand is in regard to the technology development?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes. The... well, the project itself, I think you're talking about the Asgard testing program?

Geoff Kieburtz - Citigroup

Correct.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Okay. So, that is a program to test wet gas compressor. So, a compressor that's going to have gas and liquid in that gas stream, and what they are trying to figure out with Siemens and MAN TURBO was also on that program by the way. They are trying to figure out how wet they can get those compressors before they see a big degradation in performance and a drop in reliability. And those two things have to happen, that's just physics. Question is, how long will the machines hold up, how long can they run and that's about a two-year test program that they are entering into, okay. What we have in terms of our technology is a compressor/separator in the same casing. So, what we're doing is, we are not going to get the compressor wet. We're figuring out how to keep it dry. Where we are in that program, which is different than what's going on Asgard is, we already have an order... a production order. So, we are... what we believe we have... what we believe as a better mousetrap fundamentally and intuitively and we are ahead of them in terms of the program, because we've already got a production order that we're going to be testing this summer, which is why by the way it's very likely that you'll see us go forward with a... with a liquid injection test facility that I talked about putting into Olean in my prepared remarks. So, I would say that we are ahead of the game, not behind the game and we're ahead of it with what I believe is leapfrog technology, which we've patented. So, we'll talk more about this as the year goes by, Geoff, for sure because it's very important and it is... what we're doing, the unit that we are building will be our top side on a platform, okay. So, it won't be the marinized version, but marinization is not new technology. The trick is what's going on inside the machine and that is what we'll be testing on a production unit for Petrobras this summer.

Geoff Kieburtz - Citigroup

So, just to be clear. Taking either one of these technologies isn't really... to the subsea environment isn't a significant technological challenge, it's really the issue of how you deal with the liquid and the gas stream?

Vincent R. Volpe Jr. - President and Chief Executive Officer

That's it. That is the Holy Grail.

Geoff Kieburtz - Citigroup

Okay. Great, thanks very much.

Vincent R. Volpe Jr. - President and Chief Executive Officer

I think Mark has an answer on your other question.

Mark E. Baldwin - Executive Vice President and Chief Financial Officer

Yes. The net interest expense is 7.0 for the quarter.

Geoff Kieburtz - Citigroup

Okay. Great, thank you.

Operator

Our next question comes from Sunil Jagwani with Catapult.

Sunil Jagwani – Catapult

First a simple question. Just trying to be a dead horse. But the comment about 66... I am sorry, 32% of the backlog being or at the years beyond 2008 implies that the remaining 66% is for the remaining 2008, not including the first quarter obviously. Is that correct?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Yes.

Sunil Jagwani - Catapult

Okay. And then more importantly, I know Ole asked the question regarding your exposure to the downstream market. Yesterday, Valero talked about reducing their CapEx for the second time in two consecutive quarters. Can you give us an idea of the exposure that you've had to bookings over the last 12 months to the U.S. refining industry, in particular?

Vincent R. Volpe Jr. - President and Chief Executive Officer

I'm not sure... tell me, why don't you rephrase your question, Sunil? Help me understand a little bit better exactly.

Sunil Jagwani - Catapult

Well, as I see it, the U.S. refiners will be borrowing money for the first time in several years just given the margin environment. And Valero has now cut CapEx twice in two quarters and a couple of others are flirting the similar announcements. And I'm just trying to understand how much sensitivity you might have in your projected and expected bookings in the future to that segment of the market?

Vincent R. Volpe Jr. - President and Chief Executive Officer

Right. Okay. Look, a significant part of our bookings are refining. So, if all the refinery bookings dry up, then that will have an impact on our new unit bookings. I guess what I continue to say here is that on a worldwide basis, I don't see them drying up. Now, from one quarter to the next... Motiva gave us an order for close to $100 million, Marathon gives us an order for $63 million for U.S.... in both cases U.S. refinery expansions, every single thing that they're putting in there is Dresser-Rand equipment, and so those are really outstanding and perhaps exceptional projects. But what I just disclosed here is two very significant projects, one for Petrobras for $33 million and one for Cartagena, which is in Spain, for about $40 million in bookings. And so that is indicative of what we're seeing going on out there. So, I think refining is going to be strong for us here going forward.

Sunil Jagwani - Catapult

And this may be a... perhaps a little bit too granular, but do you find that you serve... that your products go into projects, which are lower related to yield enhancement of the refinery as opposed to just actual throughput growth because the...

Vincent R. Volpe Jr. - President and Chief Executive Officer

I understand what's... that's a good question, both... they go into both. In other words, you don't have to expand a refinery, 100,000-barrel expansion or 200,000-barrel expansion, to sell new equipment or even revamp equipment, which is part of our new unit. Revamps are actually part of our new unit segment. People are debottlenecking, if people had changes in the feedstock, you go to either heavier or sour type crude, there is a lot of compression that needs to be either changed and reconfigured or even potentially added. And so that may be where the disconnect is, Sunil, in terms of people talking about slowing down expansion and me sitting here saying, but from my standpoint, refining is still going to be strong. Maybe what you... maybe you've asked the right question here that will help all of us understand that it doesn't have to be a full bore expansion for us to get an order. I mean even in the oil production business, okay, you don't need to build a new platform or have a new floater to need more compression. In existing infrastructure, this P-18 where we've found our first compressor separator, that's an existing platform, it's an old platform and the reservoir pressure is dropping. They need more... they need to reinject more gas at a higher pressure into that structure for them to continue to produce. And believe me they're in a hurry and they need new compression to do that. And that really is a proxy for what we believe we're going to see in the future as one of the growth segments of the business. No new platforms, but a lot more compression and it's going to have to be small and it's going to have to have a small footprint and it's either going to have to be squeezed in on the top side of the platform or will be put at the bottom of the ocean. So, I think that you really may be on to something to help explain why I see refining as strong and Bill Quesi [ph] doesn't.

Sunil Jagwani - Catapult

Okay. Well, thank you so much. I appreciate it.

Vincent R. Volpe Jr. - President and Chief Executive Officer

Okay.

Operator

And we have no further questions at this time.

Blaise Derrico - Director of Investor Relations

Okay. We'd like to thank everyone for joining the call. This is Blaise Derrico, you can contact me. My number is at the bottom of the new release we issued last night. Everybody have a great day. Thank you.

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Source: Dresser-Rand Group, Inc. Q1 2008 Earnings Call Transcript
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