NATCO Group Inc. Q1 2008 Earnings Call Transcript

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Q1 2008 Earnings Call

May 1, 2008 10:00 am ET


Andy Smith – Vice President Finance

John Clarke – Chairman, Chief Executive Officer

Patrick McCarthy – President, Chief Operating Officer

Brad Farnsworth – Chief Financial Officer


Collin Gerry – Raymond James

Neal Dingmann – Dahlman Rose

John Tasdemir – Tristone Capital

Steve Ferazani – Sidoti & Co.

Stephen Gengaro – Jefferies & Co.


Good day ladies and gentlemen. Thank you for joining our NATCO first quarter earnings conference call. (Operator instructions) At this time for opening remarks and introductions I would like to turn the call over to Mr. Andy Smith.

Andy Smith

Good morning, this is Andy Smith, Vice President Finance for NATCO. Thank you for joining our first quarter 2008 earnings conference call. You should have a copy of our press release that we issued last night. If not, please consult our website where it is posted at 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 risks and uncertainties as described in NATCO’s filings with the SEC.

On the call with me today are the Chairman of the Board and Chief Executive Officer John Clarke, NATCO’s President and Chief Operating Officer Patrick McCarthy and Brad Farnsworth, the company’s CFO. Let me turn it over to John Clarke.

John Clarke

Thanks Andy. Good morning everyone. On today’s call we will review our first quarter, provide an update on current activities by segment, continue our discussion with respect to key drivers for the rest of this year and next and address Q2 guidance and a revision to our full year guidance.

During the quarter we benefitted from a strong North American market for standard and traditional equipment sales and services, contributions from recent acquisitions and a continuation of good business from automation and controls. Each of these factors helped with the favorable year over year quarterly comparisons.

But lower bookings of built-to-order or BTO projects during 2007 as well as the anticipated wind down and demobilization of our field services project in Kazakhstan, work which has been scheduled for completion by midyear and a lower earnings contribution from our West Texas CO2 processing facility hurt sequential comparisons as did FX losses.

The good news is that bookings are regaining momentum. We are quite confident as we look at the number and size of attractive booking prospects for the balance of the year that we will again see a pickup in the pace of top line growth and reinvigorated growth in earnings.

If we look at IES bookings for 2007, using it as a pretty good proxy for BTO work, they average $44 million per quarter, below even the 2006 average by about 25%. For Q1 08, bookings for IES were $80 million, the highest since the second quarter of 2006. And for what we see for Q2 and Q3, booking prospects are also strong.

I think this illustrates the slide to the right that we have been talking about on past calls. Since these projects take anywhere from three to six quarters to run off, our revenue recognition in late 07 and the first half of 2008 has suffered. But when we look forward, the current and forecasted booking level should be favorable for revenue recognition and growth for the second half of this year and next.

So we strongly believe our storyline is intact and that nothing structurally has changed in the marketplace. We also indicated in the press release that we have incurred to date approximately $2.1 million of legal and professional expenses associated with the audit committee’s ongoing review of certain payments made in a foreign jurisdiction.

I refer you to the discussion in our 2007 10-K for an additional discussion of this topic. This is the first call in which we will use our redefined business segments as the basis of our discussion. We have filed an 8-K setting out our historical numbers recast for this new presentation.

They are defined as follows: Integrated Engineered Systems or IES, includes substantially all of our technology related sales activities, it’s essentially a combination of the BTO business of what was the Gas Technologies segment plus the old Oil and Water Technologies Segment’s BTO product line.

It also includes the SACROC facility in West Texas. The second segment is now our stand alone Standard and Traditional business which mostly represents our business in the Americas. And finally, our Automation and Controls Group which is unchanged from previous reporting.

Now let me make a few specific comments about the quarter which Patrick and Brad will elaborate on in a few minutes. Revenue for the first quarter was $152 million, up 19% over Q1 07 but down about $5 million sequentially when compared with Q4. Year over year, each of the segments enjoyed double digit increases in quarterly revenue.

The Standard and Traditional Segment captured two month’s revenue from the Linco acquisition which contributed about $11 million. S&T also posted another increase in revenue from its North American branch sales of equipment and aftermarket parts and service.

Sequentially, the decline in revenue is largely due to lower revenue recognition coming from BTO projects and a $4 million decrease in revenue coming from the automation and controls segment, offset in part by the Linco contribution and higher sales of Standard and Traditional equipment and services in North America.

Gross margin for the quarter was approximately 30.5%, a new record, which exceeded both last year’s first quarter and the fourth quarter by some 2%, a very strong showing reflecting the substantial improvement in execution and project management coming from successful implementation of our various lean initiatives and the new project delivery system or PDS which we’ve discussed before.

Total segment profit increased to approximately $20.2 million, after adding back the expenses related to the ongoing review or about 30% higher than last year’s quarter. This was also in line with our original Q1 guidance. Sequentially, this was just short of Q4’s record level of segment profit, helped by better BTO execution and Linco which just about offset lower earnings from SACROC and Automation and Controls.

On an as reported basis, segment profit as a percent of revenue was about 12% or approximately 13% excluding the cost of the review. I will point out that the cost of the review is picked up in corporate G&A which is allocated to our segments by a formula based on revenue, assets and headcount.

So the Standard and Traditional business segment bore a significant portion of the expenses, even though their operations are predominately focused on the US marketplace. Without this impact, they would have approached 9% EBITDA as s percentage of revenue for the quarter. All other segments were well above our 10% or better goal.

We continue to focus on managing all of our expenses. But as we have discussed before, we haven’t heard and are incurring a number of added costs this year in building out the needed infrastructure and resources to allow us to scale up as the next wave of opportunities approaches later this year and next.

Our historic op ex run rate has been about 11-12%. For the quarter, it is running at about 17% with a number of onetime type cost. If we normalize op ex today, it would be about $25 million per quarter or the cost structure necessary to support $1 billion business which we are building.

With respect to net income to common, we reported $9.6 million or $0.50 per share. Adding back the costs of the ongoing review would imply an EPS of $0.56, compared with $0.45 per share for Q1 07 and $0.66 for Q4 07. We also experienced FX losses of about $1.1 million for the quarter worth about $0.04 per share. This is about twice the FX loss in Q1 07 and almost $1 million more than the fourth quarter.

Total bookings for the first quarter were $176 million, up $43 million over Q1 07 and $40 million higher than the fourth quarter with a large booking in Saudi and a couple of important wins in the downstream market that we discussed on our last call. I will also note that we received a relatively large $6 million membrane replacement order that will ship later this year, so it is a booking only in the quarter while a sale and resulting profit will be recognized in the fourth quarter.

Normally these orders are filled from inventory and shipped and the revenue recognized in the period. But in this case, the customer does not want to take possession until the end of the year. It does represent a nice earnings contribution to come later in the year. As a result, we bring forward a backlog of work totaling about $195 million, up $25 million since year end. Patrick.

Patrick McCarthy

Thank you John. Good morning everyone. Starting with the IES business segment, the results were revenue of $55 million, segment profit of $8.3 million, bookings of $80 million and ending backlog of $121 million. With the integration of Oil and Water BTO and Gas Technology including our Global Marketing Group, we have brought together all of our project execution personnel around the globe with our process solutions, new product development and research development.

The first quarter demonstrates a performance linked to our investment in the project delivery system that we put in place in the fall of 2006 to formalize work processes starting with screening and scoring incoming bid requests through all the major steps to execute projects within their budget and complete the work on time as per the project schedule.

For the last three quarters, project margins have shown a consistent improvement as well as on time delivery of the work. The $80 million segment bookings include $40 million as we have previously mentioned for the Manifa oil treaters in Saudi Arabia that will dehydrate up to 900,000 barrels of oil per day.

This award depicts so well the value of product technology as we continue to grow our company. Starting with our leading electrostatic patented and proprietary technologies to dehydrate and desalt oil in field production and in refinery processes in conjunction with our strategy to establish local presence with leading indigenous global oilfield service enterprises, such as Al-Rushaid Group, we were successful in securing the Manifa award.

Transcending our manufacturing core competencies with the Al-Rushaid Group in Saudi Arabia, we are progressing with a new vessel shop construction in Jubail. Also of note this quarter, we shipped the completed order of oil dehydrators for the [Kerase] project in the Kingdom.

When [Kerase] is fully commissioned and operational, the eight dehydrators, each 14 foot in diameter by 148 feet in length will process 1.28 million barrels of oil per day. To shed more light on the advancements we continue to develop at the R&D facility in Tulsa which will be relocated to Houston next year in a new spacious and demonstrative configuration, allow me to speak to some technological opportunities.

Starting with what we have named a compact electrostatic separator several years ago, we elected to analyze small, that is six to 12 inch OD pressurized vessels and measure how much water cut could we achieve in a continuous oil flow condition.

Without stating the parameters of what we have successfully accomplished, we are pleased to announce the signing of a new joint development project in the first quarter with the world’s leading deep water production company to help advance this technology which will have application for both surface and sub-sea service.

The JDP includes building a 7,000 barrel per day system to measure different API oils and various inlet water percents on the top side at an existing production platform in the first half of 2009. As we have demonstrated the compact electrostatic separator to customers who test oils at our lab, they are keenly interested in its potential and we expect to have other NOCs and IOCs participate in the JDP.

In addition to our electrostatic technology as part of the compact equipment system, we are also de-gassing the test flow using our whirly scrub V cyclonic device resulting in three phase separation in compact equipment sizes. The acquisition of Concept in December of 2007 extends our cyclonic separation knowledge and product expertise to accommodate three phase compact separation systems.

Compact separation systems are obviously value-add on offshore production platforms requiring a small footprint and will permit the industry to perform more processing tasks on the sea floor as we continue to advance proven separation and electrostatic technology.

Concept is working in association with other Norwegian contractors as part of the Statoil Ormen Lange sub-sea compression pilot program scheduled to start operating this year. Our products are used in the high pressure gas scrubbers upstream of compression.

One other oil product technology enhancement we have been testing in our Tulsa lab is to increase production flow rates of oil, gas and water through the porta-test revolution cyclonic separation product. We have mentioned on previous calls the success we have enjoyed with Pemex in debottlenecking their changing production profiles using revolutions of different sizes to more efficiently separate two and three phase flows through existing production equipment.

Since 2001 we have designed and manufactured porta-test revolutions to retrofit 52 separators offshore Mexico in the Cantrell field. Initially the product was installed to perform oil and water separation but in the last two years we have installed several to accommodate three phase flow.

We have revised the revolution tube design and have tested in the lab a full scale model that has demonstrated faster separation characteristics. We expect to field test the new design later this year. In the first quarter working with our customer, we started up an oil treater on the North Slope that we’ve retrofitted using our patented dual frequency electrostatic technology to dehydrate heavy oil.

We mention this startup because the technology fit is an example where our products continue to enhance customer’s existing infrastructure. In fact, this location is now operating at its lowest level of BS&W at the outlet of the oil treater in the operator’s 25 year history.

Our JVs with Modec for the FPSO market and Scomi in Malaysia are approaching their two year anniversaries this July. NATCO Japan has grown its bookings 50% in the last 18 months since Modec became a 20% owner in this entity. NATCO owns 60% in Daiichi Trading and Tokyo owns 20%.

In Malaysia the CO2 membrane joint development program with Petronas is in its second year. We have agreed to install 130 inch diameter membrane on the [C pot] platform for production testing as part of our CO2 membrane separation plant. We recently completed the fabrication of the [C pock] membrane modules and shipped them to meet our product delivery schedule.

The platform is scheduled to flow CO2 gas through our membranes in 2009. The Carigali Hess operating company in April started flowing gas through the phase two membrane plant we supplied in 2007 what many of you will remember as [C top] two. The startup and commissioning test proved successful with the outlet conditions of the CO2 gas meeting all of the customer’s specifications.

When both phase one and two are operational, our CO2 membranes will see an inlet flow rate of 1.5 billion standard cubic feet of gas per day. This is the world’s largest offshore CO2 separation plant measured by volume.

The SACROC CO2 membrane facility had an excellent operational performance in the quarter, meeting outlet gas specifications and run time availability even though volumes handled were somewhat lower than peak throughput of last year. The 30 inch membrane continues its stellar separation and mechanical performance.

Now turning to the Standard and Traditional Segment, results were revenue of $70.9 million, segment profit of $5.4 million, bookings of $68.7 and ending backlog of $65.5 million. Standard and Traditional includes all North America branch locations, US and Canadian manufacturing and aftermarket part sales and service, both in the US and other areas of the world.

We are encouraged with the first quarter results with respect to overall activity and execution. In the quarter, US onshore rig count moved up ever so slightly and the longer than normal winter in the Rockies did impact some equipment sales. However, the US branches equipment sales increased 10% versus first quarter 2007 and parts and service sales increased year over year by 25%.

A 25% increase in parts and service sales is an impressive quarter any time, but it is especially impressive considering weather conditions caused issues with transporting equipment and service technicians to field locations in our highest growth region.

As you recall, we started lean initiatives in our manufacturing facilities in the fall of 2006 and as we continued to measure equipment sales quarter through our shops and the amount of subcontracted work for these periods, equipment sales are increasing using fewer subcontracted suppliers.

Productivity gains in our manufacturing processes is a direct result of lean initiatives as we continue to support and manage this ongoing program. In Canada the traditional gas drilling market remains in a depressed state. Our strength is the oil sands which continues to attract more capital investment and where we have demonstrated a strong booking history directly linked to our electrostatic oil technology and products, such as the porta-test revolutions used to efficiently separate water from oil in this region.

The quarterly execution results were excellent for all projects. We expect more oil treating equipment orders in 2008 from oil sands operators. We successfully started up two 12 foot diameter by 80 foot long dual polarity electrostatic oil treaters in the quarter at an oil sands location. We were selected by a major oil sands operator who we now supply electrostatic oil technology products for inclusion in a water cleanup mining operation pilot program.

Our product that will be part of a larger system is called Mosley mushroom cyclones. This is proven product technology usually sold into the minerals mining industry. The product enhances separation of solids and liquids. If the pilot is successful through its operation in the second half of 2008 we have an opportunity to grow more product sales to existing oil sands customers.

We have talked on previous calls about target zero which is our company’s HS&E program. Target zero is a continuous comprehensive program addressing many topics, a few to mention are: training of employees, management participation, proactive measurement of daily activities for all field and shop workers to perform job safety analysis prior to any task.

We are proud of our company’s overall acceptance and behavior around the principles of target zero and the improvement in results over the last several years. One location to recognize for their enthusiasm and exceptional performance is our Canadian operations. The manufacturing facility in Calgary will be receiving the gas processes association of Canada safety award for 2007, having no recordable incidents after completing 587 work days which is 1.1 million man hours of work.

Also our Canadian branches will receive a safety award from the same organization for having achieved 1,839 days without a recordable incident. We are extremely enthusiastic as we look forward through 2008 and in 2009 with recent industry buzz regarding potential oil and gas recovery from the Bakken oil shale and the gas shales of Barnett, Fayetteville, Haynesville and Marsalis.

Our branches are strategically located to enhance our equipment and parts and service sales as these reservoirs add more rigs and grow production. Our product technology including Linco’s oil measurement systems and concept cyclonic separation internals for high pressured gas production provides solutions to assist our customers in all mentioned producing regions.

Lastly, turning to the automation and controls segment, the results were revenue of $28.2 million, segment profit $4.4 million, bookings of $28 million and an ending backlog of $8.6 million.

The Gulf of Mexico field service activity and headcount was flat year over year in the first quarter. Packaged automation delivered the Shell Perdido chemical injection skid to be installed on a Gulf of Mexico deep water platform, achieving an on time delivery and the international work in Angola and Kazakhstan performed at exceptional levels.

Field services in the Gulf of Mexico has remained at pre-Katrina level since early 2007, but we do expect that a slight increase in the second quarter this year and continuing into the third. Packaged automation received a first quarter booking for a chemical injection system in a US refinery, extending our reach into the downstream sector.

Also another packaged automation award, a hydraulic power unit came to us from one of the leading turret FPSO buoy manufacturers. The HPU will control the locking system between the FPSO and the turret. The Angola term contract for construction services that is retrofitting and upgrading production equipment controls and safety systems continues at high levels of employment for US ex-pats, third country nationals and Angolans that we trained to develop skills for instrumentation and electrical service work.

Our field service time and material contract in Kazakhstan, we saw headcount peak through the fourth quarter of 2007 and first quarter 2008 resulting in an excellent performance. As we proceed through the second quarter, we are demobilizing headcount as we come to the completion of our scope. Thank you. Brad.

Brad Farnsworth

Thanks Patrick. 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 $28.2 million which includes $2.1 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 as follows.

Integrated engineered solutions, $800,000, standard and traditional $1 million and automation and controls $300,000. As we mentioned on earlier calls, we’re 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 is largely support costs for the higher business activity level, additional engineering, project management and procurement support, higher support level for international field services growth, general cost increases related to wages, employee benefits and other services, higher compensation costs associated with the company’s long term incentive programs and expenses related to our enterprise resource planning system initiative and M&A activities.

Other net for the quarter was $1.1 million and this amount largely represents net foreign exchange losses realized and unrealized due to our foreign subsidiaries contracting in currencies other than their functional currency and this cost us $0.04 per share during the quarter.

The dollar continued to weaken during the quarter, particularly against the Yen and that was a major factor in this result. Interest income for the quarter was $384,000. Our cash on hand at March 31 was fully invested in highly liquid instruments carrying a weighted average interest rate of 2.9%.

Invested balances have declined from $60.9 million at December 31 primarily due to using $23 million of cash to acquired Linco as of January 31. In addition the interest rate on invested balances declined during the quarter from an average of 4.5% at December 31 to 2.9%.

As you can see, our balance sheet is very strong and gives 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 about $166 million. 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 of approximately 35.5% for the full year.

For the quarter, the reported fully diluted EPS of $0.50 per share was based on 19.9 million diluted shares. Please note that during the quarter the remaining convertible preferred stock was converted to common and those shares are included in the diluted EPS determination.

Due to the level of income in the first quarter of 2007, the convertible preferred stock was also included in the diluted EPS calculation on an as converted basis. Capital expenditures for the quarter were approximately $6.9 million. These are broken down as follows, maintenance $1.6 million, growth and productivity enhancement $5.3 million. Cap ex for 2008 is expected to be in the $17-$19 million range with maintenance type projects representing about $6 million of that amount.

As of quarter end, our net working capital position was $102.7 million as compared to $110.3 million as of December 31. This lower level of working capital is largely due to the decrease in cash of $20.8 million related to funding the Linco acquisition, increases in inventory and prepaid expenses totaling $7.2 million and a $5.7 million reduction in advanced billings and payments from customers. We continue to look for ways of increasing the velocity of working capital.

And now I’ll turn it over to John Clarke for the wrap up.

John Clarke

Thanks Brad. In closing, let me make a few comments on where we are today and where we are going. As you can gather from our comments today, we are fully confident about the market opportunities ahead of us and we are equally committed to executing our long term growth strategies and building the needed organization and infrastructure necessary to execute our plans and safeguard our assets.

These efforts are critical. They come at a cost near term but represent an investment which we’ll be rewarded for many years to come. Our opportunities are significant, our technologies are valuable and our developing relationships in world markets are producing desired results.

Patrick has done a good job of addressing the importance of our technologies and the solutions that we can offer customers. As we look to the balance of the year, we remain confident that the North American market will continue to strengthen, based largely on increased spending on non-conventional gas plays.

We also see early signs of potential improvement in the offshore and perhaps even in the shallow gas market in Canada. In global markets where project awards are getting larger and more complex, our capabilities to deliver on time and on budget will help differentiate us from our competitors.

We are aggressively pursuing a number of projects in the $50-$100 million range based on superior technologies, project management capabilities and timely delivery. But as we have seen, the timing of final awards on these larger projects which are often only small portions of development plans involving facilities that can easily exceed $1 billion is quite difficult to predict even though we have a great deal of visibility into our customer’s project pipeline.

So it really is a question of when and not if. If we take a quick review of our key markets around the world, we can make the point. In Southeast Asia, we continue to diligently work with our JV partner and our technology partner to secure the next offshore Malaysia CO2 project. We have fortified our relationship with Petronas through our joint membrane develop program as Patrick mentioned and in the meantime we are making another on time on budget delivery of the [C pod] project in which Petronas is a partner.

In the Middle East, our $40 million win related to Manifa in Saudi was one based on technology, competitive pricing and the commitment demonstrated by our investment in a new facility to manufacture equipment in Saudi which is under construction and should be ready for first production early next year.

Obviously this is an enormous market for us. In Mexico as Patrick explained, we continue to work with Pemex to help bring a technology solution to their challenge of reversing or slowing the sharp decline in production coming from the reservoirs and handling higher water cuts.

This is a common theme worldwide where our technologies are recognized as best in class. In West Africa, our efforts to partner in a local manufacturing facility in Angola will position us well for securing jobs on FPSOs and is quite complimentary to our Modec relationship.

Finally, in Canada, the oil sands play continues to accelerate with increasing levels of spending on the production processing side of the equation. We maintain the largest market share in this market and continue to sell systems on a repeat basis to satisfied customers, particularly those using SAGD recovery techniques.

Each of these projects are in the tens of millions of dollars range and should represent the first of many regional projects given commodity prices, global demand, the scarcity and quality of resources in these markets and elsewhere around the world.

We have also added key personnel across the globe to direct to build our business. We have added country managers in Saudi, the UAE and Angola and a number of new business development personnel, including dedicated resources to attack the downstream refinery market where we have had early success.

We have also added technical staff and administrative staff as well. Talent comes at a cost but will pay off handsomely in the future. As I mentioned on calls like this before, we have grown significantly and rather rapidly and have attempted to build infrastructure, organizational capabilities and our risk management system which will allow us to scale and grow globally on a systematic basis.

At the same time, we are building a corporate culture based on safety, integrity, customer satisfaction and flawless execution. These are important priorities for our Board, our management team and for you our shareholders. Accordingly, we remain confident in our prospects for 2008 and beyond while at the same time we are working to manage and efficient cost structure to support our growth.

For the second quarter 2008, we expect revenue of $155 to $165 million and segment profit of $17 to $20 million exclusive of the costs associated with the audit committee’s ongoing review. The quarter’s performance will be influenced by the timing effects of our 2007 bookings experience and the resulting impact on revenue recognition and the effects of our demobilization in Kazakhstan.

For the full year, we are modestly reducing our guidance for similar reasons, the timing of bookings and revenue recognition, revenue to replace Kazakhstan and higher operating expenses related to both infrastructure build out and staffing adds. We now expect revenue between $610 and $630 million, segment profit of $88-$92 million exclusive of the cost of the review, supporting EPS of $2.55 to $2.65.

So I know that was a bit long but with that we’ll take your questions. Thank you, operator.

Question-and-Answer Session


(Operator instructions) Your first question comes from Collin Gerry – Raymond James.

Collin Gerry – Raymond James

A lot of information there, I do want to dive into the guidance a little bit more. You mentioned a really bullish outlook, so definitely not structural. It seems like a lot of the difference in the new guidance seems to be on the cost side but also as you said the revenue recognition, the timings of bookings also Kazakhstan falling off a little bit.

So hopefully I’ve nailed the three main points there but I guess my question is what changed between last quarter and this quarter to affect the guidance and have we baked in a degree of any kind of future delays on the revenue recognition side as we move forward through 2008?

John Clarke

I think you have nailed the three points that we would focus in on. And I think in terms of what has changed, as we’ve talked about before, for the full year in order to hit our numbers you pretty well have to have your bookings in hand by about this call, around the May timeframe.

We did not get quite where we wanted to be so that really is one of the factors that is causing an adjustment in the guidance for the balance of the year. On the Kazakhstan front, we’ve always known and we’ve talked about the fact that this work would be coming to an end.

We have not yet found a replacement, a go get, to replace that revenue that we would not have for the balance of the year. That was one of our go gets in our plan and we’re optimistic that we will refill that hole. But it’s not at hand right now. And on the cost front, it’s been a bit of a moving target in terms of when we are able to add the resource that we need and when we spend money for say infrastructure build outs.

So that number has been a bit of a moving target. But again I think we’re getting to the point where it’s kind of settling in to a number that we can manage to and then that will support the business that we see going forward.

Collin Gerry – Raymond James

Switching gears a little bit on the $2.1 million charge related to the investigation, you mentioned that there’s a little bit more detail in the 8-K, I haven’t had a chance to read it. But, any kind of timing guidance as far as future quarters or how long you expect this to kind of run out and is this kind of a good cost range on a quarterly basis as we go forward?

John Clarke

First of all let me point out that I referred or should have referred to the 10-K in my comments. And then secondly I would say that as we discussed before, any of my comments are necessarily limited on what I can say about the review itself. I would only say that the review is ongoing. It will be thorough to satisfy not only the audit committee but also the regulators. So we really don’t have a timeline nor do we have a budget. It’s something that’s just going to run its course.

Collin Gerry – Raymond James

A housekeeping item on the FX impact, is that something that we can expect to kind of bounce around going forward or are there any kind of structural changes you made to how that runs through the income statement that maybe mutes that effect going forward?

Brad Farnsworth

As I mentioned previously, the weakness of the dollar during the quarter especially as our business has picked up in Japan. The dollar weakness against the Yen contributed quite a bit to that. It’s difficult to say, obviously, which way currency movements are going to run. But we are looking at putting some things in place, possibly doing some hedging to dampen the effect of that going forward.


Your next question comes from Neal Dingmann – Dahlman Rose.

Neal Dingmann – Dahlman Rose

It sounds pretty interesting on this new JV deep water venture, was wondering if you have a little bit of color on that, was just wondering on the magnitude, how large that could be an the timing behind it.

Patrick McCarthy

The pilot program, again we are looking at a first half 2009 to have it installed to start up the test. If successful, we are extremely optimistic of helping ourselves at the outset on onshore and platform production of oil and water cuts. The obvious long range goal here is to get to [marinization] of a sub-sea processing component and that is in the future. We’ll take a step at a time and that first step will be the production test on a platform deck.

Neal Dingmann – Dahlman Rose

You had mentioned about the prospects around the Marsalis and some of these newer shale plays, I mean obviously Haynesville has been thrown out there. Was wondering as far as capacity wise, as far as new facilities, do you have some of these things or as these things progress, do you have the capacity out there to start to service all these areas and would you consider, would you need other facilities in the Appalachian or are you set facility wise?

Patrick McCarthy

Today absolutely we’re ready for the growth in the sectors. We are evaluating should we add additional branch locations and we will be adding business development and service technicians into the region, in all these regions as quickly as we can find the help.

But we’re enthusiastic and as we have talked to the customer base, a lot of the customers are trying to get rigs to come into these areas. But no we’re confident we can be right there for them on their requirements of supply.

John Clarke

A great case in point, I mean one of the advantages of having our 38 branch locations is we are able to in effect flex our resources to where those cap ex dollars are going. And a couple three years ago when the Barnett was heating up and we were servicing it from really three locations coming from west Texas, south Texas and even east Texas and Arkansas. We realized that was going to be a hotbed.

We established a new branch in Godly and moved resources into it and we’re right on top of all the action there. We’ve got similar plans looking at each of these plays that you’ve mentioned and Patrick mentioned. It’s always a challenge getting the resources but we at least have a leg up because we’ve got a substantial cadre of guys right now ready to go.

Neal Dingmann – Dahlman Rose

Can you explain a little bit, you had mentioned as far as and I think was this behind the bookings earlier in your comments about the three to six quarters of run off so that the second half looks or you see at least better visibility in the second half. Was that because of some things that you had started or explain that a little bit on that side?

John Clarke

The point I was trying to make is if you look at, you know we’re paying the piper today if you will for rather squishy bookings in 2007, averaging as I pointed out around $44 million. We’re starting with Q1 bookings of $80 million and I am implying that we believe that the bookings momentum for the balance of this year will continue to be at a much more robust level than what we experienced in similar quarters last year.

So as those new bookings come on and we start to progress that work, then we will see more revenue recognized as we pursue our percent complete of those projects. So that’s why I say as we look at second half of this year and what we will bring into 09, it should be a pretty good start.

Neal Dingmann – Dahlman Rose

I know it’s obviously very difficult to predict some of these NOC type contracts but your comment about you still believe that it’s a matter of if or just when not if, is there incremental data points or conversation that you’ve had recently to continue to give you pretty good confidence around that or is that just the continued sort of working with these areas?

John Clarke

Well our confidence is based on our daily interface with our customers and the fact that we can see visible progress of them advancing these projects. So it’s not that we’re just waiting to open an envelope one day. We are involved as these things progress and again we have a pretty good sense of where they are.

But as I’ve said there are a number of other factors that don’t involve us that drive the schedules of these very, very large complex projects. These are driven by the end user, the NOC or the engineering company that’s sort of sitting between us and our customer.


Your next question comes from John Tasdemir – Tristone Capital.

John Tasdemir – Tristone Capital

I guess a couple thoughts, one is first looking at the number, $0.50 and then you knock out the $2 million or the $0.06 [inaudible] 56, and then you have $1 million another $0.04 of FX loss. So you kind of missed the number by $0.06 which is really like $1.5 million pretax. I mean it sounds pretty trivial in the grand scheme of things when you’re talking about gearing your company for $1 billion in revenue.

But you know and I know I can’t really pin you down on this. But you know you’re talking you know you talked about all the work and we see it, you know we see all the things happening around the world but you know that timing is always a big question. And you know I guess my question really is, as we look into you know 2000, you know, later 2008, really into 2009 I mean is there, in your mind kind of year where things really start to click.

Is it 09, is it 10? Does it have to do with a lot of these new rigs coming on the market? Or is there, can you give me a sense of when you say $1 billion, I mean is that a five year plan or is this something that’s closer than that?

John Clarke

Well I think that in terms of building a $1 billion company that’s going to take some time. We’ve talked in sort of the three to five year timeframe as a combination of organic growth which I believe we are right now the cusp of the next kind of step function breakout based on the project work that we’ve identified, the Saudi JV and just the general needs in these markets.

And then don’t forget as well that we have a very significant untapped firepower in our balance sheet that we would also hope to deploy that should be able to not only accelerate our organic plans but also perhaps add to the growth towards that $1 billion plan that we have.

So as I sit here today, looking at 08, 09 and where we’ve been in 07 and beyond, we’ve essentially doubled already once, we want to double almost again and if you look at the break points, I think you’re sitting on the cusp of an 08, 09 breakout that I think the market will have greater confidence in once we start booking some of these big awards.

So we appreciate the healthy skepticism until we get these things across the finish line. But I can assure you we’re working every day to make it happen and we’re building and putting in place the systems and the people that are needed to be successful against that business.

And I think one of the things that I think is important to note in the quarter, if you look at our gross margin at 30.5% and some of the veterans who have followed us over the last four years or so will realize that that is a very, very significant improvement on where we started this exercise in that time period.

And it’s across the board, we’ve had improvement in all of our business lines and what that tells me is if we get the work, we’re going to execute it and we’re going to deliver against our commitments to our customers and $1.5 million pretax miss today is in fact going to be quite small relative to what the prize is down the road.

John Tasdemir – Tristone Capital

Since you brought it up, are there acquisition targets out there today? Are there guys that you’re looking at?

John Clarke

We’ve said before and we remain totally focused on two avenues of acquisition focus. And one is if you look at the onshore market and Linco is a great example of this of where can we add product line or service that will leverage our North American footprint through the 38 branches and all of the capabilities that we’ve got in the Americas.

We have continued to look at opportunities in that space, Linco being our first successful try. And there are many more out there that we continue to sort through. It’s obviously a very heady market in North America. Shops are full, so it’s not about buying capacity, it’s really about how can we leverage the capabilities that we’ve got.

And then if you look on the global market, we continue to focus on technology adds and again, Concept is a great example of our being able to bring to bear a great platform for them as a relatively new startup type company where we retain all of the key employees, the key IP and it plugs into our portfolio, opens the market to us in Norway, brings relationship like with Statoil.

And then we’re able to cross sell their technologies across the rest of NATCO. So those are the kinds of things that we continue to look for. We’re not looking for scale just for the sake of size. But we really are trying to leverage what we bring to the marketplace today and broaden our offering to our customers.


Your next question comes from Steve Ferazani – Sidoti & Co.

Steve Ferazani – Sidoti & Co.

I just want to run through your guidance a little bit, how much of that includes projects that either haven’t been booked or is the risk simply that they’ve been booked and you’re just not sure when you’ll recognize the revenue? And I guess I’m particularly asking about sort of the larger sized projects.

John Clarke

If you look at our guidance, we obviously will have a blend if you will of projects that are on the books and projects that we hope to win and would affect the 2008 numbers. We have not broken out what that mix is obviously because we don’t know with precision. But we are pretty confident of the bookings level that is standing behind the revised forecast.

Steve Ferazani – Sidoti & Co.

Can I ask you this, are you including any revenue from the next offshore Malaysia project at this point or is that out for 08?

John Clarke

It would be very little. But that should not be surprising given the fact that it’s already May and if you think of the revenue [wreck] as sort of a bell shaped curve, you don’t get very much in the earliest quarters, it kind of recognizes the most in the middle part.

Steve Ferazani – Sidoti & Co.

What are you looking for SG&A moving forward, is that going to flatten out here or are we going to continue to see growth through this year?

John Clarke

It has grown obviously quarter to quarter for the last couple of quarters. I would like to see us target a 11-12% normalized op ex rate. We’ve got to get over some initial front end spending that’s kind of bloating the numbers up a bit in this quarter and recent quarters. But I think we can reasonably get to that as we get into the second half of the year here.

Steve Ferazani – Sidoti & Co.

In terms of headcount, do you see that continuing to grow or with some of these acquisitions, do you think there’s going to be some reductions due to more synergies?

John Clarke

One of the things about this market, headcount is very hard to come by in terms of new hires of the real skilled positions that we are focused on adding. And that’s why a bit of what you see in our numbers is a little lumpy because it depends on the success that we have in adding folks along the way.

The other thing that I would say about acquisitions and this too has been true in the case of Linco and Concept is the people are a very significant asset to add. And when we added both Concept and Linco, we essentially took them lock stock and barrel and we’re looking for adds into both organizations to further growth their businesses.

So what I would see in the way of future deals, based on the types of things we’re looking at, they’re not really consolidation plays where we’re going to buy something and whack a bunch of costs out. They’re really opportunities to bring top line reasonable costs and leverage of whatever the combined organization can bring to the marketplace.

Steve Ferazani – Sidoti & Co.

On the Saudi Arabian JV, you didn’t talk too much about that, what’s the progress on that, is the timeline still in place? Can you add a little color on that?

Patrick McCarthy

We’re proceeding with the construction of the vessel fabrication shop. And we expect completion first quarter of 2009. And as you talk to headcount, as we go into the second half of 2008, we’re bringing together the organization that will be responsible for that facility.

And we are outlining and having conversations as you would expect with all the operators in the upstream and downstream sectors of the economy in the Kingdom and look forward to having business flow through the facility second quarter of 09.

John Clarke

And you know that’s another great example of the kinds of things that add front end costs ahead of the revenue. And you know it’s a tough balancing act to manage your front end expenses in anticipation of first revenue.

Steve Ferazani – Sidoti & Co.

On the Saudi Arabian JV front, we saw a similar joint venture with one of the big international drillers, they ended up having to pull out, they sort of cited lack of control and didn’t have a lot in the decision making process. Can you address those issues?

John Clarke

I won’t address their issues but I’ll address the things that we’re doing. One, this is a 50/50 JV. The manufacturing facility will be managed by a NATCO veteran of 25 years that has moved or is in the process of moving from Canada to the Kingdom.

We will build and again this is one of the reasons that our partner picked NATCO, we will export all of our business practices and model of cost control, quality control, delivery mechanisms, training welders, fitters, the whole bit into a facility that should be best in class once it’s up and running.

The other thing I would point out in terms of cost management, obviously we’ve got to be conscious as partners managing the costs to be competitive on a global basis. But we will be building smaller units if you will than what the guy that you’re referring to was building in the form of rigs and other real big cap ex items.


Your last question comes from Stephen Gengaro – Jefferies & Co.

Stephen Gengaro – Jefferies & Co.

When I look at the allocation between gross profit and operating profit, was there any change in sort of what you allocated to the operating expense line? Was there any movement across as you sort of changed the way you report earnings, did you move anything from the cost of sales line to the op ex line?

John Clarke

No, nothing along those. There’s obviously re-bucketing around the business segments, but nothing geographic in that regard.

Stephen Gengaro – Jefferies & Co.

So there’s nothing that would artificially inflate the gross margin vis-à-vis history?

John Clarke


Stephen Gengaro – Jefferies & Co.

As we look ahead, obviously you talked about the second quarter guidance already, should we expect an upward trajectory in the second half of the year with sort of anything seasonal we should concern ourselves about or you think it should be a pretty steady improvement, obviously depending on the timing of orders.

John Clarke

I think your last caveat there is what conditions my answer. You know I’m quite hopeful that we are coming off of the low for the year with our second quarter guidance number. The timing of bookings going forward will obviously impact the balance of the year. We do have a membrane order waiting for us in Q4 that I mentioned on the call. So hopefully it’s onward and upward from here.


There are no further questions.

John Clarke

We’ll conclude at this time. Everyone on the phone call, we appreciate your interest and your questions and if you have any more then obviously follow up with management at your convenience. Thank you so much.

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