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NATCO Group, Inc. (NYSE:NTG)

Q2 2008 Earnings Call

August 5, 2008 10:00 am ET

Executives

Andy Smith - Vice President of Finance

John Clark - Chief Executive Officer and Chairman

Patrick McCarthy - President and Chief Operating Officer

Brad Farnsworth - Chief Financial Officer

Analyst

Neal Dingmann - Dahlman Rose & Co

Steve Ferazani - Sidoti & Co

Byron Pope - Tudor, Pickering & Holt

Welcome and thank you for joining our NATCO second quarter earnings conference call. (Operator Instructions) At this time for opening remarks and introductions I would like to turn the call over to Andy Smith.

Andy Smith

You should have a copy of our press release that we issued this morning. Please note that our earnings per share guidance in our original press release was incorrect, we issued a corrected press release this morning reaffirming our guidance of $2.55 to $2.65 earnings per-diluted share. If you do not have a copy of our press releases please consult our website where it’s posted at natcogroup.com for a copy.

Our first order of business today is the Safe Harbor disclaimer. Statements made in this call that are forward-looking in nature should be considered forward-looking statements within the meaning under securities laws and regulations and as such may involve risk and uncertainties as described in NATCO’s filings with the Securities and Exchange Commission.

On the call with me today are the Chairman of the Board and Chief Executive Officer John Clark; NATCO’s President and Chief Operating Officer Patrick McCarthy and Brad Farnsworth the Company’s CFO.

I will turn it over to John Clark.

John Clarke

On today’s call we will review our second quarter, provide an update on bookings and strategic initiatives and provide guidance for Q3 and again reconfirm full year guidance.

As discussed on our last call we expected that the second quarter would be a point of inflection when new and significant bookings would become more apparent, setting up not only a stronger finish during the second half of the year, but also building a backlog of work that will carry us strongly into 2009. These bookings on a year-to-date basis as of June 30 approximated $415 million, up $160 million over the same period in 2007.

Recall that a booking by definition is a firm order evidenced by a purchase order. This new record level of bookings gives us confidence that we are building towards strong earnings momentum and a revenue run rate of sufficient size to support our pending investment in infrastructure and additional resources. We will be well served by these commitments in the years ahead as we achieve operating leverage as we expect to come into our global expansion.

The second quarter as our earlier guidance suggested and our normalized result support also should represent a drop of revenue and earnings for the year. As we had discussed before that drop was created by the slower than originally anticipated rate of bookings during 2007 which is now reversed and is gaining momentum.

The winding down of our nearly completed project in Kazakhstan and a lower earnings contribution from SACROC which will also significantly improve and return to more historic levels of profitability as the operator adds compression for additional service towards year end and finally higher OpEx investment coming ahead of revenue.

I’m also pleased to report that the audit committee’s review of certain payments made in a foreign jurisdiction, as well as operations in several other jurisdictions in which we do business is nearing completion; however, during the quarter we incurred approximately $5.1 million of additional expenses reflected in G&A which brings a year-to-date total cost of the review to $7.1 million.

The quarter was strong for our North American branch business for standard and traditional equipment sales and service to both the US markets and Canadian oil sand’s market. Although, the cost of materials jumped dramatically, it put some downward pressure on standard and traditional margins. At the same time our Global Intergraded Engineered Solutions business or IES experienced a continuation of improvement and execution across its gas, oil and water technologies portfolio; again a very strong step up to put a significant backlog in hand and the bookings forecast to come.

Revenue for the second quarter was $160 million, up $20 million or about 14% over Q2 ‘07 and about $8 million higher sequentially when compared with Q1 ‘08. We benefited from a full quarter revenue contribution from Linco, which posted revenue of $13 million. Higher sales of standard and traditional equipment in North America all set in part by the lower revenue recognition from built-to-order projects or BTO projects and lower revenue from automation and controls.

Gross margin for the quarter was 27.5% compared with 28.8% for Q2 ‘07 and 30.5% last quarter. The primary explanation is timing and mix of sales as well as higher material cost of standard goods, particularly steel and the lag in reflecting those increased cost in market pricing.

Since the first of the year, a sharp rise in steel prices which have increased approximately 25% to 40% compressed margins in US branches to 22.8% which in-turn reduced standard and traditional segment margins to 25.1%. Standard cost sheets have now caught up with market rates and are being updated each month given the current volatility in steel prices. Importantly gross margins in IES were 34.5% reflecting solid execution and success and value pricing our proprietary technologies. This of course is where most of our future growth will come from.

Total segment profit was $17.2 million. After adding back the expenses related to the review we’re about 13% below both Q2 ‘07 and Q1 ‘08 for the reasons I cited above. On an as reported basis, segment profit as a percent of revenue was about 7.6% or about 11% excluding the cost of the review.

I will remind you that these costs are picked up in corporate G&A which is allocated to our segments by formula based on revenue assets and headcount through the S&T business segment or a significant portion of the expense even through their operations are predominantly focused in the US market place. Without this impact they would have reported about 9% EBITDA as a percent of revenue for the quarter while all other segments would have been well above our 10% or better go. Brad will detail these allocations later.

With respect to net income available to common we reported $6.2 million or $0.31 per share. Adding back the cost of the review would imply an EPS of $0.47 per share compared with $0.62 per share for Q2 ‘07 and $0.56 per share normalized for the same cost incurred in Q1 2008.

Total bookings for the second quarter were $238 million, almost double the bookings of Q2 ‘07 and up $63 million over Q1 ‘08. There were several notable bookings, but importantly there were also mini bookings across the board. I will note two projects that Patrick will discuss in greater detail along with a few others in a few moments.

The first is the new $25 million CO2 membrane order for offshore, Libya. While our focus has been on Southeast Asia, we have also been actively marketing our CO2 membrane technology to other parts of the world and this is evident that our long record of proven membrane performance and efficient operations in the Southeast Asia market and in West Texas is paying off and is transferable to other markets.

As plans for other CO2 rich fields are developed like Bouri offshore Brazil and our capabilities become even better known worldwide, our opportunities set expands dramatically. As a result we now have a record backlog of $273 million up almost $80 million since March 31. It is also important to note that in June NATCO was engaged by the leading national oil company in Southeast Asia, the complete of pre-engineering design worked to optimize a new offshore CO2 membrane system in advance of the full contract award to follow later in 2008.

The customers commitment to NATCO’s membrane technology will help ensure on-time delivery to meet its gas delivery requirements in 2010. NATCO’s technology was selected based on proven operations and performance on our existing CO2 membrane operations offshore in the joint development area or JDA and in the Gulf of Thailand. In addition the award of this contract follows our successful delivery of another large membrane system for the JDA which was awarded to NATCO in 2006, delivered in 2008 with a start-up expected in 2009.

While this is only a $6 million booking, it makes us the solid front runner for selection as the membrane system supplier which we now believe will be awarded late this quarter or early next. As we have discussed before the scope of these projects is large at about $50 million to $100 million a piece depending on final scoping requirements.

With that I will turn the program over to Patrick who will discuss the implications of bookings and update our joint ventures since strategic initiatives. We will address specific segment questions in the Q&A to the extent that you have.

Patrick McCarthy

As John has mentioned our second quarter bookings were excellent. We had approximately $100 million of oil product technology including separation and oil electro statistics as part of the $238 million quarterly bookings. The majority of the $100 million was booked for Canadian Oil Sand projects where we are the largest supplier of oil treating equipment to most all of the oil sands developers and in two South American countries, Brazil and Colombia.

During the first half of 2008, we booked $450 million of which 40% was for separation in oil electro statistics product technology. In addition, we had similar sales to the Middle East. Integrated Engineering Solutions Q2 pending backlog is $175 million, up 35% year-over-year. We are confident our global expansion strategy will continue to demonstrate growth opportunities.

The technologies we offer the global markets are based on many product patent, proprietary products and application know-how, providing process solution for Greenfield and Brownfield or de-bottlenecking projects. One of our key strategies is to build relationships with our end uses; the national oil companies, major integrated oil companies and independent producers who recognize the value of our technology through low CapEx, OpEx and higher recoveries.

We have been successful selling value based R&D oil testing and developing new product technology through joint projects, utilizing our experienced staff of professionals within our process solutions group. We are working with leading oil companies to advance our technology portfolio including Petronas, Petrobrass, Shell and Statoil.

These are the recognized leaders in early adoption of new technology and commercial application. We together recognize the value of using separation and electro static technologies to increase oil production and de-bottleneck field locations with changing production profiles. Since its introduction in 2006, our patent to do frequency, oil electro statistics technology has demonstrated high performance from meeting more throughput using smaller sized vessels than competing technologies or by replacing internals within existing equipment.

We have eight installation in the US and Latin America. To date half have been retrofit to the existing production equipment and half is new equipment to service part of a new production system. One Canadian oil sands customers who purchased dual polarity electro static dehydration technology one year ago; whose equipment is in fabrication, has decided to change to do a frequency technology. This is a trend which we expect to continue.

Quarterly bookings included $25 million CO2 membrane plan for installation offshore Libya. The size and weight of our solution are advantages for the operators fixed platform requirement along with our separation efficiency for the reservoir conditions. The plan will be designed for 200 million standard cubic feet per day of gas flow rate having a 25% in the CO2 content and a 10% CO2 outlet specification.

At the boring backlog, an expectation of the next large CO2 award late third or early fourth quarter from Southeast Asia, we now look to expand our membrane technology reach into Brazil with their announcement of the 2P field which is a large oil and gas reserve. From reports and conversation s with Petrobrass, the reservoir has between 20% and 30% CO2 gas by volume and will ultimately require some 10 to 12 FPSOs and a technology to handle the CO2. We are working to expand Petrobrass’s appreciation of our CO2 membranes.

We talked on previous calls to the joint development project with Petrobrass which will evaluate our compact electrostatic separator technology through field test net share. With this relationship we are now in conversation to expand the scope to include additional NATCO technologies.

One example will be to test 2P CO2 gas conditions at our SACROC facility in West Texas. Because the 2P CO is a large reserved in deep waters its field development will take many years to reach expected production rates; therefore, it is a long term investment program for Petrobrass and NATCO. We look forward through our various technologies including oil, water, gas, de-sanding and others to parker and contribute value added processed solutions in association with Petrobrass.

With respect to project execution we have been building the infrastructure and adding resources in advance of what we now see and realize. In 2006, we introduced our Huston Execution Center to a Project Predictable Delivery System, PPD with the assistance of consultants from the oil and gas industry. As we have reported the investment became a team sponsored achievement and project margins improve significantly by mid year 2007.

The systems poor strength is designed focusing on project execution and delivery. The details involve bid preparation and proposal submittal, resource planning, supply chain management and strategic sourcing partners including engineered equipment suppliers and sub-contract engineering services. Our most recent advancement as part of our PPD system is a workload/resource planning component permitting the ability to integrate each execution centers resource capacity.

In addition to Houston the other location that makeup global execution includes Canada, London, Tokyo and Kula Lumpur. PPD was introduced into our London office at the beginning of 2008 and the implementation is progressing and will be fully engaged by the fourth quarter of this year. The training of PPD will begin in Carigali, in Tokyo later this year and Kula Lumpur having the smallest but growing staff side has been parallel with the Huston office.

The company’s performance over the previous four quarters has been consistent with excellent results on BTO projects. We have prepared through investment at our execution offices for the increased workload and look forward to continue the global expansion of integrated engineer solutions.

Referencing global expansion updates on our joint venture in Saudi Arabia and planned production vessel facility in Angola, the construction in Saudi is progressing towards a spring 2009 completion of the JV’s 100,000 square foot production vessel facility. NATCO has transferred a general manager from Carigali manufacturing into the kingdom having the position of general manager for the joint venture. He is presently recruiting senior staff and involved in the hiring and eventual training program for various crafts.

Also in Saudi, our country manager who we hired in January 2008 has held several product technology symposiums in the second quarter with Saudi ramp field. The introduction of our technology portfolio to customers in the kingdom is creating more de-bottleneck opportunities within Brownfields for us.

The proposed joint venture vessel agreement to build and operate a production equipment shop in Angola made progress in the second quarter, advancing it’s status for company board approval from SONAMET and NATCO. Over the next several years Sunnyvale and its western partners are planning to sanction deepwater oil and gas development along with onshore facilities including refineries and gas plants.

Production vessels will be required for all projects and we envision all of NATCO’s product technologies as part of the process solutions. So, in summary we have an attractive mix of bookings in hand, high value prospects ahead of us and the capability to execute making the next several years even more exciting.

Looking to the standard and traditional business units they are comprised of business in the America, US branches, Linco Canadian operations and Mexico. We mentioned earlier about our oil sands bookings achievements in Canada during Q2. The other entities of standard and traditional had strong bookings resulting in an ending backlog of $113 million. Compared to Q2, 2007 the ending backlog has increased 100%. Linco represents 20% of this gain, but the US branches and Canada also had significant increase and ending backlog.

The market fundamentals remain strong for our branch business in the US. Although the overall US onshore rig utilization is only growing at a 4% year-over-year well completion data demonstrates a more robust increase. All other growth in well completions is in oil development drilling. At the end of May 2008 the industry has grown oil development wells drilled by 33% compared to May of 2007.

Long before the Bakken Oil Shale became a national headline we have been providing oil traders into that region. We are experiencing more customer activity in and around wells in North Dakota and other similar areas because of increases in oil well completions. Gas well completions are flat year over year, our equipment and aftermarket sales are up approximately 10% over Q2 2007.

We are encouraged with our lending backlog, a continuation of strong drilling activity resulting in a growing well completion market and overall customer demand allowing additional growth in the second half of 2008 and into 2009.

Automation and controls revenue year-over-year experienced a slight decrease as expected because the large reimbursable project in Kazakhstan is coming to completion. Our staffing levels have been steadily decreasing since the beginning of Q2. We will complete our scope for late Q3 this year. In Q2 we experienced a 10% increase in Gulf of Mexico head count and expect this level of activity to continue through the end of 2008.

We are encouraged about the ongoing work in Angola having to do with the INE after market construction tasks for Chevron. We look forward to market opportunities in conjunction with this ongoing term contract which represents a growing presence in the country, all in association with the proposed Angola and JB Vessel Fabrication facility we spoke to earlier. We continue to grow all of our business segments in an enthusiastic and energized market place.

Brad Farnsworth

John and Patrick have covered much of the segment financial results as well as market conditions. I’ll address some income statement items and also highlight several balance sheet items.

Total operating expense for the quarter was $31.4 million which includes $5 million of expenses related to the ongoing review of certain payments made in a foreign jurisdiction. As noted in the press release this amount is recorded in SG&A and allocated to our business segments has follows; Integrated Engineered Solutions $1.8 million, Standard and Traditional $2.5 million and Automation and Control $700,000.

As we’ve mentioned on earlier calls, we are deploying additional resources into certain areas of the company to facilitate and support our continued growth. Reasons for the absolute increase in operating expense between years are largely; support costs for the higher business activity level, additional engineering project management and procurement support, higher support level for international growth initiatives, general cost increases related to wages, employee benefits and other services, higher compensation cost associated with the company’s long term incentive programs, expenses related to our enterprise resource planning system initiative and MNA activities.

Depreciation and amortization expense for the quarter was $2.8 million. This amount increased over the prior year by approximately $1.3 million due to the ramp up of capital investment over the past year to support future growth. Interest income for the quarter was $225,000. Our cash on hand was $42 million at June 30 with $40.4 million of this amount invested in highly liquid instruments carrying a weighted average interest rate of 2.3%.

Invested balances have declined from $60.9 million at December 31 primarily due to using $24 million of cash to acquire Linco as of January 31. The interest rate on invested balances declined during the quarter from an average of 2.9% at March 31 to 2.3%.

Our effective tax rate for the quarter is 35.3%. This rate reflects our combined Federal and State statutory rates and at this point we are projecting a tax rate at that level for the full year 2008. For the quarter, the reported fully diluted EPS of $0.31 was based on 19.8 million diluted shares. Due to the level of income in the second quarter of 2007 the convertible preferred stock was also include in the diluted EPS calculation on an as converted basis.

As of quarter end our net working capital position was $104.2 million as compared to $110.3 million as of December 31, 2007. This lower level of working capital is due to a decrease in cash of $21 million largely related to funding the Linco acquisition; increases in accounts receivable, inventory and prepaid expenses totaling $8.2 million; decreases in accounts payable, accrued expenses and taxes of $10.4 million and an increase in advance billings and payments from customers of $3.7 million.

Capital expenditures for the quarter were approximately $7.7 million. These are broken down has follows; maintenance $1.9 million, growth and productivity enhancement $5.8 million. Capital expenditures for 2008 are expected to be on the $18 million to $20 million range with maintenance type projects representing about $6 million of that amount.

As you can see our balance sheet is very strong and continues to give us a great deal of financial flexibility to take advantage of future growth opportunities that may require capital outlays. Our available liquidity at quarter end was $165.3 million.

I’ll turn it back over to John for the wrap up.

John Clarke

Let me wrap up with a couple of comments on where we are heading. First of all the quarter’s financial results were a bit lackluster, it was the expected, but also as expected the set up for the balance of the year and particularly for 2009 and beyond is becoming increasingly clear. The work has always been out there and close at hand, but now it’s finally being booked. We’ve been working hard to prepare our organization for this day and we are ready with respect to resource planning, project execution and risk management.

In North America our customers CapEx budgets for 2008, 2009 are expanding based on attractive commodity prices and the potential resource adds coming from unconventional shale and other plays. This is driving rig counts higher and the ultimate number of completions higher.

Our scale in control manufacturing allows us to flex our resources within our branch system to follow with the capital spending.

In the US activity levels remain high and we are even seeing signs of return of activity to shale or gas drilling in Canada for later this year. At the same time we remain the number one supplier of all treating equipment, the Canadian oil sands market which continues to grow; in the global markets our alliance in joint ventures are producing results.

The business we do with Modac in the FPSO market has called sales of top site equipment by NATCO Japan to double to them alone. At June 30 NATCO Japan had booked approximately $30 million of work. Modac’s competitive position in markets like offshore Angola along with our technology and proposed Angolan vessel shop joint venture and growing local presence led us in an enhanced competitive position with customers like DB, Total, Chevron and of course the National Oil Company.

In addition we will be a strong competitor in the offshore Brazilian FPSO market where activities on 2P are heating up and where scope requirements will include the means of handling high concentrations of CO2 in the associated gas stream. Our relationship with Petronas has given us a significant competitive advantage in our partnership to advance membrane technology in the region. We know that they are satisfied with our technology, our performance history and service and our ability to deliver a high percentage of local content.

In Saudi Arabia construction of the shop is well underway. Recruiting of personnel is accelerating. Permitting and necessary certification is proceeding and first manufacturer equipment will start early next year.

In South America, Brazil and Columbia and in Mexico we are making good progress on electrostatics and other oil and water technology applications and finally in the downstream we are having success in competing in ground field de-bottlenecking in new builds using best in class electrostatic technology.

So the prospects are good especially has we look for 2009. In fact as we look to year end 2008 we would expect total bookings for the year to exceed $800 million reporting an ending backlog at 12.31 or great than $300 million. In the mean time we hope to conclude the audit committee’s internal review, take remedial action, reach a conclusion with the government and get on with growing the global companies with best in class reputation for quality service and compliance. While the amounts in question were immaterial, we have learned a lot and will continue to enhance our components culture.

Now with respect to guidance; looking at 2008 full year guidance we are reaffirming revenue between $630 million, segment profit of $88 million and $92 million. Obviously from where we are at June year-to-date we have some work to do but we are confident we will hit within the ranges and as Andy pointed out, we have corrected EPS shown in error in today’s press release to recollect a reaffirmation of previous guidance of $2.55 to $2.65 per share and obviously we apologize for the confusion.

These numbers are supported by Q3 guidance of revenue between $160 million and $170 million and a segment profit of $20 million to $23 million. With that we will be happy to take your questions; operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Neil Dingmann - Dahlman Rose.

Neal Dingmann - Dahlman Rose & Co

John did I hear you correct; you put a time line out for some a couple of these big awards.

John Clarke

I didn’t think I did that Neil.

Neal Dingmann - Dahlman Rose & Co

I thought between you and Pat you mention about the timing about the later part of the quarter, actually the next quarter; is that not the case?

John Clarke

Well what I said was in Southeast Asia where we have been working diligently to land the next CO2 job; we have a precursor order for the design engineering work that we believe will lead to an order before the end of the year.

Neal Dingmann – Dahlman Rose

Okay and then questions on the built-to-order margins; when I look sort of region-to-region, is that going to very considerably? Like when Pat mentioned a number of different areas, obviously you’ll are expanding quite well. I’m just wondering like if I look at Southeast Asia versus Saudi versus Brazil, how different are margins in those regions?

John Clarke

Well I think the best way to think about it is first of all around execution and then secondly around the technology that is embedded in the solution that we are selling and as you see our deployment of electrostatic CO2 membrane in these high value technologies which really are going to most of the markets you mentioned, I don’t think you will see a lot of variance by regional markets, but you’ll continue to see a push towards higher margins as these higher value technologies get deployed.

Neal Dingmann – Dahlman Rose

Okay and then just a follow up on the first question a bit again. On the bookings that you mentioned, the 800 for year end and 300, does that include the one that you had just mentioned or is that just what you’re sort of seeing and able to touch right now?

John Clarke

Well, it’s what we would expect to see and touch by the end of the year.

Neal Dingmann – Dahlman Rose

Okay, and then on the steel cost that you had in the US, is there anyway on steel costs or some other standard equipment costs to I guess built some of that inner walk, any of those or hedge any of those costs in or not really just whatever the market happens to be, that just happens to be the case?

John Clarke

Well, we have actually looked and spent some time studying whether we could actually hedge meaningfully to take the steel cost risk out of our business and it’s not a very liquid market and it’s not a very practical solution at least as the market stands today.

Now what we do, do around the build-to-order project is to make sure that we have back-to-back price estimates coming from our suppliers that are embedded in our proposals and then our proposals have relatively short bid validity dates to help us protect ourselves. Also in those bigger discreet projects we can sometimes build in escalation provisions that also protect us.

The challenge gets to be in our standard product line where if you think about it we are pricing a the catalog type of cost and if steel prices for instance become very volatile, its hard to keep the standard cost sheets up with a very volatile market. We are doing that more aggressively now, so that we are staying on top of changing prices, but every once in a while we get caught in a up graph that’s hard to get in front of, particularly in a competitive market place.

Neal Dingmann – Dahlman Rose

Sure and that last question John; what are you seeing in sort of the acquisition market. Obviously you still have a fair amount of cash; just wondering if you’ve seen anything, has that market gotten any better or is it still pretty expensive?

John Clarke

Well, I would say that it’s gotten better but it is still very competitive. We continue to have a pretty long list of targets that we have run after. Obviously, from lack of a press release we had yet to finish in the winter circle again since Linco and Concept, but we continue to look at it. I think as a general comment, there is still a lot of activity and I think strategic guys like NATCO continue to be competitive in looking at these assets that are out there particularly in North America and around world.

Operator

Your next question comes from Steve Ferazani - Sidoti & Company.

Steve Ferazani – Sidoti & Co

I just want to run through the guidance a little bit; it looks like top line you’re not necessarily going to see a huge jump in the second half, which means to hit that earnings number you’re going to need really significant gross margin improvement; given material cost and I’m guessing some wage pressures, is it a product mix; how do you do that kind of margin?

Andy Smith

A lot of that, it is exactly as you say product mix. Remember we had a large membrane ordered that’s shipping in the fourth quarter, which is high margin, as well as the shift to a little more IES in the second half of the year than the first. We expect SACROC to return to higher levels which again is also higher margin and then as we pass along some of the steel price increases in the US business we would expect to pickup margin points there as well.

Steve Ferazani – Sidoti & Co

Given the pickup and development wise do you think you can get some push through for the price increases with the standard and traditional or where does that stands?

John Clarke

Well I think we got a very robust market ahead of us in North America and so far we have been able to have some pretty good pricing strength in the market and I think its important to note that what bid us was on the cost side not the price side and while it’s still a very competitive market place, we are still the largest guy in the market place; we can run with these larger operators as they redirect their capitals at some of these hotter spots.

So I don’t see an environment or the balance of this year or next where the fundamentals change much and if you look over the last couple of years we have been able to commence some pretty good pricing in that North American market place and I think that if you look at that standard official business, particularly over the last 12 months and probably into the next 24, the mix of higher value sales coming out of Canadian oil sands will be a big add to us.

Steve Ferazani – Sidoti & Co

I know you can’t talk about the FCPA review, but at this point if you say it’s winding down, can you give an estimate of what kind of costs you could incur in the next quarter there?

John Clarke

We should be substantially complete with the legal and accounting reviews; there’ll be some small dollar amounts I’m sure trialing into this month and perhaps next, but they won’t be nearly of the magnitude that we’ve enjoyed in the last two quarters.

Operator

Your next question comes from Byron Pope - Tudor, Pickering and Holt.

Byron Pope – Tudor, Pickering & Holt

John, I just wanted to put a little more on the North America outlook and particularly in Q2; can you help us quantify the impact that Canada’s spring brake-up had on the top line and maybe margins and as we look through the back half of the year, it sounded like you’re seeing shallow gas activity come back; just your thoughts on Canada and for the back half of the year.

Patrick McCarthy

Byron, Patrick McCarthy. The Q2 Canadian results are pretty much reflective of the strong backlog in the oil sands bookings and our traditional gas market has been relatively soft over the last several quarters; expectation is in ’09. What we hear from operators is that they will be spending a few more dollars, but the Canadian sales for NATCO have really driven off the oil sands at this point.

Byron Pope – Tudor, Pickering & Holt

Okay, so sequentially not a huge impact from spring break-up?

Patrick McCarthy

Yes, exactly.

Byron Pope – Tudor, Pickering & Holt

Okay and then moving onto kind of the engineered assistance group, as I look to 2009 it seems as though the prospects you guys have lined up are fairly robust; any reason as we think about book-to-bill ratios, why that book-to-bill ratio wouldn’t be kind of north of one as we think about modeling 2009 to you guys?

Patrick McCarthy

Well, I think if you guide into the IES business stand alone you will probably see a comparison that looks like that, but you also have to remember that quite a bit of our revenue is not reflected in our backlog given that most of our standard and traditional sales essentially come out a inventory and are turned over quite quickly, so I think you have to scroll down into the IES segment to get that kind of analysis done.

Byron Pope – Tudor, Pickering & Holt

Okay, and then last question and just for automation and controls; I mean even if I strip out the FCPA related charged, it seems as though the detrimental margins there were fairly high going from Q1 to Q2 aside from kind of the Kazakhstan project winding down; any other kind of issues on the cost side that hurt us in the second quarter there?

Patrick McCarthy

No, the traditional market place, Gulf of Mexico and Angola are running consistently where we have been and we do see an up tick in the second half with head count in the Gulf of Mexico.

Andy Smith

In that business segment, the segment margins obviously are affected a lot by volumes and with the run off of that Kazakhstan project it really pushed down those margins. There is also some fixed production expenses that are included in gross margins and so again as you spread that over a smaller base with a little bit less profitability and some of our TNM work outside of Kazakhstan you see that kind of detrimental affect in margin.

Operator

We have no further questions.

John Clarke

Thank you all for joining us on our call today and we look forward to the balance of the year and if there are any questions that we can answer for you, obviously reach out for the team.

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