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Dresser-Rand Group 10-Q 2007 Table of Contents
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
For the Quarterly Period Ended March 31, 2007
For the Transition Period from to
Commission file number 001-32586
Dresser-Rand Group Inc.
(Exact name of registrant as specified in its charter)
(713) 467-2221
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large
accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). o Yes þ No
The number of shares of common stock, $.01 par value, outstanding as of April 1, 2007, was
85,828,165.
DRESSER-RAND GROUP INC.
TABLE OF CONTENTS
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DRESSER-RAND GROUP INC.
CONSOLIDATED STATEMENT OF INCOME
(Unaudited; dollars in millions except per share amounts and shares in thousands)
PART I. — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
See accompanying notes to unaudited consolidated financial statements.
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DRESSER-RAND GROUP INC.
CONSOLIDATED BALANCE SHEET
(Unaudited; dollars in millions, except per share amounts)
See accompanying notes to unaudited consolidated financial statements.
Page 4 of 31
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DRESSER-RAND GROUP INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited; dollars in millions)
See accompanying notes to unaudited consolidated financial statements.
Page 5 of 31
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
1. Basis of presentation
The accompanying consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial
information. Accordingly, they do not include all of the information and notes required by such
principles applicable to annual financial statements. These financial statements are unaudited
but, in the opinion of management, contain all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of our financial position and results of
operations. These financial statements should be read in conjunction with our Annual Report on
Form 10-K for the year ended December 31, 2006, and other filings with the Securities and Exchange
Commission. Operating results for the 2007 period presented are not necessarily indicative of the
results that may be expected for the year ending December 31, 2007.
2. Adoption of new accounting standard
Effective January 1, 2007, the company adopted FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. Interpretation No. 48
prescribes a financial statement recognition threshold and measurement attribute regarding tax
positions taken or expected to be taken in a tax return. A tax position (1) may be recognized in
financial statements only if it is more-likely-than-not that the position will be sustained upon
examination through any appeals and litigation processes based on the technical merits of the
position and, if recognized, (2) be measured at the largest amount of benefit that is greater than
50 percent likely of being realized upon ultimate settlement. The cumulative effect of the
adoption of Interpretation No. 48 was recorded during the three months ended March 31, 2007, as an
increase in the liability for unrecognized tax benefits and a reduction in retained earnings of
$0.1 as of January 1, 2007.
3. Curtailment gain
On January 23, 2006, a new labor agreement was ratified by the represented employees at our
Wellsville, New York, facility which became effective on February 1, 2006. That new agreement
reduced certain previously recorded retiree health benefits for the represented employees covered
by the agreement. As a result, we recorded a curtailment gain in the first quarter of 2006 of
$11.8 for the actuarial net present value of the estimated reduction in the future cash costs of
the retiree health care benefits.
4. Intangible assets and goodwill
The cost and related accumulated amortization of intangible assets were:
Amortization of intangible assets was $4.2 and $5.3 for the three months ended March 31, 2007 and
2006, respectively.
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
The changes in goodwill for the three months ended March 31, 2007 were:
5. Inventories
Inventories were as follows:
The progress payments represent payments from customers based on milestone completion schedules.
Any payments received in excess of the related inventory investment are classified as “Customer
Advance Payments” in the current liabilities section of the balance sheet.
6. Property, plant and equipment
Property, plant and equipment was comprised of the following:
7. Income taxes
Our estimated income tax provision for the three months ended March 31, 2007, results in an
effective rate that differs from the U.S. Federal statutory rate of 35% principally because of
certain expenses which are not tax deductions, state and
local taxes, lower tax rates in certain foreign tax jurisdictions, and the U.S. manufacturing tax
deduction. Our estimated income tax provision for the three months ended March 31, 2006 resulted
in an effective rate that differed from the U.S. Federal statutory rate of 35% principally because
of lower tax rates in certain foreign tax jurisdictions, a deduction
related to certain exports
from the United States and state and local taxes.
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
We began operations as a new entity on October 29, 2004, having been acquired by Dresser-Rand
Holdings LLC, an affiliate of First Reserve Corporation. The acquisition was an asset purchase in
the United States and a stock purchase outside the United States. The purchase price was
allocated among the entities acquired based on estimated fair values and deferred taxes were
recorded to reflect the difference between the purchase price allocated to foreign entities and
their underlying tax basis. We believe that we have provided adequate estimated liabilities for
taxes based on the allocation of the purchase price and understanding of the tax laws and
regulations in those countries. We operate in numerous countries and tax jurisdictions around the
world and no tax authority has audited any tax return of significance. Accordingly, we could be
exposed to additional income and other taxes.
As of January 1, 2007, the Company had $1.6 of unrecognized tax benefits that, if recognized,
would affect the estimated annual effective tax rate for 2007. These amounts are not expected to
increase or decrease significantly during 2007. The Company estimates that $0.6 will be added to
the total unrecognized tax benefits for 2007 transactions that would affect the estimated
effective tax rate for 2007 if recognized. The Company’s policy is to recognize accrued interest
on estimated future required tax payments on unrecognized tax benefits as interest expense and any
estimated tax penalties as operating expenses. Amounts accrued at January 1, 2007 are not
significant. Tax years that remain subject to examination by major tax jurisdiction follow:
Any material tax amounts due from examination of tax years prior to October 2004 are subject to
indemnification under an agreement with our former owner, Ingersoll Rand.
8. Pension plans
9. Postretirement benefits other than pensions
The components of net periodic postretirement benefits cost for such plans are as follows:
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
Effective February 1, 2007, prescription drug benefits were eliminated for all retired, Medicare
eligible participants in the Dresser-Rand Company Welfare Plan formerly covered under a collective
bargaining agreement at our Olean, New York facility. This change was treated as a negative plan
amendment with a pro rata reduction in expense during 2007 and credit to Other Comprehensive
Income at the date of amendment.
10. Commitments and contingencies (Pound sterling in millions)
Dresser-Rand (UK) Limited, one of our wholly-owned indirect subsidiaries, is involved in litigation
that was initiated on June 1, 2004, in the High Court of Justice, Queens Bench Division, Technology
and Construction Court in London, England, (the Court) with Maersk Oil UK Limited over alleged
defects in performance of certain compressor equipment sold by Dresser-Rand (UK) Limited. The
claimant sought damages of about £8.0 (approximately $15.7). Witness testimony concluded in
December 2006 and a decision was issued at the end of March 2007. In that decision, the Court
awarded Maersk approximately £1.8 ($3.5) or £0.2 ($0.3) in excess of amounts the Company previously
recorded as an accrued liability for this litigation. The additional $0.3 was
recorded as an expense during the three months ended March 31, 2007. In addition, the award exceeded
the amount previously offered by Maersk to settle the litigation and as a result, under U.K. laws,
Maersk is now entitled to and has requested reimbursement of certain costs of £2.3 ($4.5) and
interest, the maximum amount of which is calculated to be £0.9 ($1.8) at March 31, 2007. The
Company plans to dispute the amount of costs claimed by Maersk and the resolution process could
take several months, during which interest continues to accrue until the amounts are paid.
Nevertheless, the Company recorded accrued liabilities for an additional £0.5 ($1.0) recorded as
operating expenses and £0.5 ($1.0) recorded as interest expense during the three months ended March
31, 2007 as its estimate of the minimum amount that is probable that the Company will ultimately
pay in regards to this litigation. However, in addition to interest that continues to accrue, it is
reasonably possible that the trial costs and interest that the Company will ultimately be required
to pay upon resolution could be the total cost requested of £2.3 ($4.5) and maximum interest
calculated as of March 31, 2007 of £0.9 ($1.8) which would result in additional charges to expense
totaling £2.2 ($4.3).
We are involved in various litigation, claims and administrative proceedings, arising in the normal
course of business. Amounts recorded for identified contingent liabilities are estimates, which are
regularly reviewed and adjusted to reflect additional information when it becomes available.
Subject to the uncertainties inherent in estimating future costs for contingent liabilities,
management believes that any future adjustments to recorded amounts, with respect to these
currently known contingencies, would not have a material effect on the financial condition, results
of operations, liquidity or cash flows of the Company.
11. Warranty accruals
We maintain a product warranty liability that represents estimated future claims for equipment,
parts and services covered during a warranty period. A warranty liability is provided at the time
of revenue recognition based on historical experience and adjusted as required.
The following table represents the changes in the product warranty liability:
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
12. Segment information
We have two reportable segments based on the engineering and production processes, and the
products and services provided by each segment as follows:
Unallocable amounts represent expenses and assets that cannot be assigned directly to either
reportable segment because of their nature. Unallocable expenses include certain corporate
expenses, research and development expenses, and the curtailment gain. Assets that are directly
assigned to the two reportable segments are trade accounts receivable, net inventories, and
goodwill. Unallocable assets include cash, prepaid expenses, deferred taxes, property, plant and
equipment, and intangibles assets.
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
13. Stockholders’ equity
Changes in stockholders’ equity for three months ended March 31, 2007 were:
The components of total comprehensive income are as follows:
Effective February 1, 2007, prescription drug benefits were eliminated for all retired, Medicare
eligible participants in the Dresser-Rand Company Welfare Plan formerly covered under a collective
bargaining agreement at our Olean, New York facility. This change was treated as a plan amendment
with a prorata reduction in expense during 2007 and credit to Other Comprehensive Income at the
date of the amendment.
During the three months ended March 31, 2007, our Board of Directors granted options and stock
appreciation rights involving 748,310 shares of common stock and granted a total of 425,955 shares
of restricted stock or restricted stock units to employees under the Dresser-Rand Group Inc. 2005
Stock Incentive Plan. These stock compensation arrangements vest over three to five year periods.
14. Subsequent Events
On
April 5, 2007, the Company announced that it had acquired the Gimpel business from Tyco Flow
Control, a reporting unit of Tyco International for approximately $8.0. Gimpel products
include a line of trip, trip throttle, and non-return valves to protect steam turbines and related
equipment in industrial and marine applications and will be integrated into our steam new unit and
aftermarket parts and services businesses.
15. Supplemental guarantor financial information
In 2004, the Company issued senior subordinated notes. The following subsidiaries, all of which
are wholly owned, have guaranteed the notes on a full, unconditional and joint and several basis:
Dresser-Rand LLC, Dresser-Rand Power LLC, Dresser-Rand Company, Dresser-Rand Steam LLC and
Dresser-Rand Global Services, LLC.
The following condensed consolidated financial information of the Issuer (Dresser-Rand Group
Inc.), Subsidiary Guarantors and Subsidiary Non-Guarantors presents statements of operations for
the three months ended March 31, 2007
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
and 2006, balance sheets as of March 31, 2007 and December
31, 2006, and statements of cash flows for the three months ended March 31, 2007 and 2006.
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the three months ended March 31, 2007
CONDENSED CONSOLIDATING STATEMENT OF INCOME
For the three months ended March 31, 2006
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions)
CONDENSED CONSOLIDATING BALANCE SHEET
March 31, 2007
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (dollars in millions) CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2006
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DRESSER-RAND GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (dollars in millions) CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the three months ended March 31, 2007
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the three months ended March 31, 2006
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – (continued) (dollars in millions)
Overview
We are among the largest global suppliers of rotating equipment solutions to the worldwide oil,
gas, petrochemical and industrial process industries. Our segments are new units and aftermarket
parts and services. Our services and products are used for a range of applications, including oil
and gas production, refinery processes, natural gas processing, pipelines, petrochemical
production, high-pressure field injection and enhanced oil recovery. We also serve general
industrial markets including paper, steel, sugar, distributed power and government markets.
We operate globally with manufacturing facilities in the United States, France, Germany, Norway,
and India. We provide a wide array of products and services to our worldwide client base in over
140 countries from our 67 global locations in 11 U.S. states and 24 countries.
Results of Operations
Three months ended March 31, 2007 compared to the three months ended March 31, 2006
Overview. The energy markets continue to be driven by strong demand, inadequate production and
refining capacity, and geopolitical risks. The fundamentals
supporting higher prices currently appear to be
structural and likely to persist for several years.
All three
streams of the energy market are currently strong – upstream, midstream and downstream. In the
upstream market, the number of floating production facilities including floating, production,
offloading and storage vessels (FPSO) is currently expected to increase significantly over the next five
years. The liquefied natural gas (LNG) market is currently expected to double capacity in the next decade.
In the
midstream segment, nearly 40,000 miles of natural gas pipelines are
currently planned for
construction.
In recent years, the downstream refining market has been particularly strong in the U.S. because of
clean fuel initiatives. More recently, there has been a significant movement toward increasing
refining capacity worldwide. The forces propelling this movement are the mismatch of heavy sour
crude conversion and refinery utilization rates that are at their highest levels in 25 years.
The current industry view is that refinery capacity will increase by approximately 11 million barrels
per day by 2010.
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued) (dollars in millions) Total revenues. As discussed, the market for our products and services is currently very strong.
Total revenues were $314.4 for the three months ended March 31, 2007, compared to $291.6 for the
three months ended March 31, 2006. This is a $22.8 or 7.8% increase. The highly engineered nature
of our worldwide products and services does not lend itself to measuring the impact of price,
volume and mix on changes in our total revenues from quarter to quarter. Nevertheless, based on
factors such as measures of labor hours and purchases from suppliers, volume was up during 2007.
Also, we have implemented price increases in excess of our cost increases across most of our
products and services during 2007.
Cost of sales. Cost of sales was $222.8 for the three months ended March 31, 2007, compared to
$224.6 for the three months ended March 31, 2006. As a percentage of revenues, cost of sales
decreased to 70.9% in 2007 from 77.0% in 2006 principally due to the change in revenue mix. Lower
margin New Units was 36.4% of total revenues in 2007 versus 47.7% in 2006. Cost of sales for 2007
also includes $2.6 to recognize the remaining fair value of service units granted certain members
of management in connection with the acquisition of the Company by Dresser-Rand Holdings, LLC
(Holdings) in 2004. Holdings granted a total of 2,692,500 service units and five tranches of exit
units totaling 6,282,500 exit units in Holdings to certain members of the Company’s management,
which permitted them to share in appreciation in the value of the Company’s shares. The service
units were granted without any remuneration. The service units were to vest over a period of five
years and had 10 year contractual terms. The fair value of each service unit was estimated on the
date of grant using the Black-Scholes option valuation model and that total fair value was being
amortized over the five year vesting period. During the three months ended March 31, 2007,
Holdings sold its remaining ownership in the Company and made the final distribution to the holders
of service units and exit units. Accordingly, since all amounts due the members of management
under the service unit arrangements have been distributed to them by Holdings and no future service
is required by the members of management holding service units to obtain value from the service
units, the remaining previously unrecognized fair value of the service units as of March 31, 2007,
of $3.4 was recognized as cost of sales ($2.6) and selling and administrative expenses ($0.8)
consistent with the Company’s past allocation of these costs. Cost of sales for the three months
ended March 31, 2007 also includes a provision for loss on
litigation of $1.3. See Note 10 in the
accompanying Notes to Unaudited Consolidated Financial Statements.
Gross profit. Gross profit was $91.6, or 29.1% of revenues, for the three months ended March 31,
2007, compared to $67.0, or 23.0% of revenues, for the three months ended March 31, 2006. These
increases were attributable to the factors mentioned above.
Selling and administrative expenses. Selling and administrative expenses were $55.5 for the
quarter ended March 31, 2007, compared to $46.5 for the quarter ended March 31, 2006. The $9.0 or
19.4% increase was attributed to higher expenses (1) to support the increased bookings and
revenues; (2) to continue establishing corporate functions for the stand-alone company; and (3) for
compliance with the Sarbanes-Oxley Act of 2002. Selling and administrative expenses as a percentage
of revenues were 17.6% for the three months ended March 31, 2007 compared to 15.9% for the quarter
ended March 31, 2006.
Research and development expenses. Total research and development expenses for the quarter ended
March 31, 2007 were $3.1 compared to $2.1 for the quarter ended March 31, 2006. The $1.0 increase
was from additional engineering staff hired to support the planned increase in research and
development projects.
Operating income. Operating income was $33.0 for the three months ended March 31, 2007, compared
to $30.2 for the three months ended March 31, 2006. The $2.8 increase was attributed primarily to
increased revenues partially offset by higher selling and administrative expense. As a percentage
of revenues, operating income for 2007 was 10.5% compared to 10.4% for 2006.
Interest expense, net. Interest expense, net was $10.9 for the three months ended March 31, 2007,
compared to $13.6 for the three months ended March 31, 2006. Interest expense, net for 2007
included $1.0 of accrued interest recorded in connection with litigation, see Note 10 in the
accompanying Notes to Unaudited Consolidated Financial Statements, and $1.8 in amortization of
deferred financing costs, of which $0.9 was accelerated amortization due to a early payments of
$50.0 on long-term debt in the period. Amortization of deferred financing costs for 2006 was $2.0,
including $1.1 from accelerated amortization related to early debt repayments.
Other income (expense), net. Other income, net was $2.3 for the three months ended March 31, 2007,
compared to income, net of $1.9 for the three months ended March 31, 2006. The 2007 results
included a $2.3 gain recorded on the sale of a minority investment in a small electricity
generating facility. Currency (losses) during 2007 amounted to $(0.1) compared to currency gains
for 2006 of $1.5.
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued) (dollars in millions) Provision for income taxes. Provision for income taxes was $9.0 for the three months ended March
31, 2007 and $6.2 for the three months ended March 31, 2006. Our estimated income tax provision
for the three months ended March 31, 2007, results in an effective rate that differs from the U.S.
Federal statutory rate of 35% principally because of certain expenses which are not tax
deductions, state and local taxes, lower tax rates in certain foreign tax jurisdictions and the
United States manufacturing tax deduction. Our estimated income tax provision for the three months
ended March 31, 2006 results in an effective rate that differs from the U.S. Federal statutory
rate of 35% principally because of lower tax rates in certain foreign tax jurisdictions, a
deduction related to certain exports from the U.S. and state and local taxes. The 2007 estimated
effective tax rate is slightly higher than in 2006 because a higher percentage of estimated income
before income taxes was derived from U.S. operations.
Bookings and backlog. Bookings for the three months ended March 31, 2007 increased to $425.6 from
$365.3 for the three months ended March 31, 2006. The increase was in the New Units segment.
Backlog was $1,380.6 at March 31, 2007, compared to $993.8 at March 31, 2006. These increases
reflect the strength of the markets that we serve.
Segment Information
We have two reportable segments based on the engineering and production processes, and the products
and services provided by each segment as follows:
1) New Units are highly engineered solutions to new customer requests. The segment includes
engineering, manufacturing, sales and administrative support.
2) Aftermarket Parts and Services consist of aftermarket support solutions for the existing
population of installed equipment. The segment includes engineering, manufacturing, sales and
administrative support.
Unallocable amounts represent expenses that cannot be assigned directly to either reportable
segment because of their nature. Unallocable expenses included corporate expenses, research and
development expenses, and the curtailment gain.
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued) (dollars in millions) Segment
Analysis-three months ended March 31, 2007, compared to three months
ended March 31, 2006.
New Units
Revenues. New Units revenues were $114.3 for the three months ended March 31, 2007, compared to
$139.1 for the three months ended March 31, 2006. The $24.8 or 17.8% decrease was attributable to
two very large orders in 2006 sales for which there were no similar sized orders in 2007. Cycle
times from order entry to completion for products in this segment typically range from six months
or less to 15 months depending on the engineering and manufacturing complexity of the configuration
and the lead time for critical components.
Gross profit. Gross profit was $16.7 for the three months ended March 31, 2007, compared to $11.2
for the three months ended March 31, 2006. Gross profit, as a percentage of segment revenues, was
14.6% for 2007 compared to 8.1% for 2006. These increases were primarily attributable to favorable
pricing and costs in 2007 compared to 2006, and lower allocations of manufacturing overhead due to
the change in the revenue mix. New Units were 36.4% of total revenues
in 2007 compared to 47.7% in
2006.
Operating income. Operating income was $4.6 for the three months ended March 31, 2007, compared to
a (loss) of $(1.3) for the three months ended March 31, 2006. As a percentage of segment revenues,
operating income was 4.0% for 2007 compared to (0.9)% for 2006. Both increases are due to the
factors cited above.
Bookings and Backlog. New Units bookings for the three months ended March 31, 2007 was $235.0
compared to $165.5 for the three months ended March 31, 2006. Backlog was $1,104.4 at March 31,
2007 compared to $749.8 at March 31, 2006. These increases are primarily due to continued strength
in the energy markets we serve.
Aftermarket Parts and Services
Revenues. Aftermarket parts and services revenues were $200.1 for the three months ended March 31,
2007, compared to
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued) (dollars in millions) $152.5 for the three months ended March 31, 2006. First quarter 2007 sales were
strong across all geographic regions. The $47.6 or 31.2% increase is attributable to higher
backlog at the beginning of the quarter of $285.6 compared to $196.6 at the beginning of 2006.
Elapsed time from order entry to completion in this segment typically ranges from 1 day to 12
months depending on the nature of the product or service.
Gross profit. Gross profit was $74.9 for the three months ended March 31, 2007, compared to $55.8
for the three months ended March 31, 2006. Gross profit as a percentage of segment revenues was
37.4% for 2007 compared to 36.6% for 2006. These increases were attributed to increased revenues
and improved margins due to price increase realizations, offset by higher allocations of
manufacturing overhead due to the change in the revenue mix. Aftermarket Parts and Services was
63.6% of total revenues in 2007 compared to 52.3% in 2006.
Operating income. Operating income was $48.2 for the three months ended March 31, 2007, compared
to $34.4 for the three months ended March 31, 2006. As a percentage of segment revenues, operating
income was 24.1% for 2007 compared to 22.6% for 2006. The increases are due to the factors cited
above.
Bookings and Backlog. Aftermarket parts and services bookings for the three months ended March 31,
2007 were $190.6 compared to $199.8 for the three months ended March 31, 2006. Aftermarket bookings
have been adversely impacted by temporary changes in the procurement process approval cycle by a
few major clients. Demand is still strong and we currently expect bookings to rebound during the
balance of the year. Backlog was $276.2 as of March 31, 2007 compared to $244.0 at March 31, 2006.
Liquidity and Capital Resources
Net cash provided by operating activities for the three months ended March 31, 2007, was $107.4
compared to $12.5 for the same period in 2006. The increase of $94.9 in net cash provided by
operating activities was principally from changes in accounts receivable, inventories and customer
advance payments, together with improved operating performance. Net cash flow from accounts
receivable was $60.6 in the first three months of 2007 compared to the $49.0 for the first three
months of 2006, as sales in the first quarter of each year were lower than sales of the immediately
preceding quarter. Inventories, net increased $10.9 and customer advance payments increased $51.7
during the first three months of 2007 as a result of our increased backlog and our increased
efforts to collect customer payments in line with or ahead of the costs of inventory
work-in-process. Inventories increased $36.4 and customer advances decreased $7.5 during the first
three months of 2006. Net income improved to $15.4 for the three
months ended March 31, 2007
from $12.3 in the same period for 2006. Depreciation and amortization declined to $11.9 for the
three months ended March 31, 2007 from $13.1 for the three months ended March 31, 2006 because
certain intangible assets are now fully amortized. Non-cash, stock-based
compensation increased to $4.5 for the three months ended March 31, 2007, from $0.4 for the three
months ended March 31, 2006, principally from recognizing as expense the remaining unrecognized
fair value of service units granted by our former owner, Dresser-Rand Holdings, LLC, to certain members
of management as previously discussed.
Net cash used in investing activities was $4.7 for the three months ended March 31, 2007, compared
to net cash used of $3.2 in the same period for 2006 for capital expenditures.
Net cash used in financing activities was $50.0 for both the three months ended March 31, 2007 and
March 31, 2006, related to accelerated payments on long-term debt from available cash flow.
As of March 31, 2007, we had a cash balance
of $200.1 and the ability to borrow $152.0 under our
$350.0 senior secured revolving credit facility, as $198.0 was used for outstanding letters of
credit, bank guarantees, etc. Although there can be no assurances, based on our current and
anticipated levels of operations and conditions in our markets and industry, we believe that our
cash flow from operations, available cash and available borrowings under the senior secured
revolving credit facility will be adequate to meet our working capital, capital expenditures, debt
service and other funding requirements for the next twelve months and our long-term future
contractual obligations.
Recently adopted accounting standard
Effective January 1, 2007, the company adopted FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. Interpretation No. 48
prescribes a financial statement recognition threshold
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued) (dollars in millions) and measurement attribute regarding tax
positions taken or expected to be taken in a tax return. A tax position (1) may be recognized in
financial statements only if it is more-likely-than-not that the position will be sustained upon
examination through any appeals and litigation processes based on the technical merits of the
position and, if recognized, (2) be measured at the largest amount of benefit that is greater than
50 percent likely of being realized upon ultimate settlement. The cumulative effect of the
adoption of Interpretation No. 48 was recorded during the three months ended March 31, 2007, as an
increase in the liability for unrecognized tax benefits and a reduction in retained earnings of
$0.1 as of January 1, 2007.
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DRESSER-RAND GROUP INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — (continued) (dollars in millions) SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Risk Factors
This Form
10-Q includes "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These
forward-looking statements include statements concerning our plans,
objectives, goals, strategies, future events, future revenue or
performance, capital expenditures, financing needs, plans or
intentions relating to acquisitions, business trends and other
information that is not historical information. When used in this Form
10-Q, the words "anticipates," "believes," "expects," "intends" and
similar expressions identify such forward-looking statements.
Although we believe that such statements are based on reasonable
assumptions, these forward-looking statements are subject to numerous
factors, risks and uncertainties that could cause actual outcomes and
results to be materially different from those projected. These
factors, risks and uncertainties include, among others, the following:
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DRESSER-RAND GROUP INC.
OTHER INFORMATION – LEGAL PROCEEDINGS ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK (dollars and pound
sterling in millions)
Our results of operations are affected by fluctuations in the value of local currencies in which
we transact business. We record the effect of translating our non-U.S. subsidiaries’ financial
statements into U.S. dollars using exchange rates as they exist at the end of each month. The
effect on our results of operations of fluctuations in currency exchange rates depends on various
currency exchange rates and the magnitude of the transactions completed in currencies other than
the U.S. dollar. The net foreign currency loss was $0.1 for the three months ended March 31, 2007,
compared to a net currency gain $1.5 for the three months ended March 31, 2006.
We enter into financial instruments to mitigate the impact of changes in currency exchange rates
that may result from long-term customer contracts where we deem appropriate.
We have interest rate risk related to the term loan portion of senior secured credit facility as
the interest rate on the principal outstanding on the loans is variable. A 1% increase in the
interest rate would have the affect of increasing interest expense by $0.9 annually, based on the
outstanding principal balance at March 31, 2007.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design
and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of March 31,
2007. Disclosure controls and procedures are those controls and procedures designed to provide
reasonable assurance that the information required to be disclosed in our Exchange Act filings is
(1) recorded, processed, summarized and reported within the time periods specified in Securities
and Exchange Commission’s rules and forms, and (2) accumulated and communicated to management,
including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that,
as of March 31, 2007, our disclosure controls and procedures were not effective, at the reasonable
assurance level, due to the identification of the material weaknesses in internal control over
financial reporting described below.
In preparing our Exchange Act filings, including this Quarterly Report on Form 10-Q, we implemented
processes and procedures to provide reasonable assurance that the identified material weaknesses in
our internal control over financial reporting were mitigated with respect to the information that
we are required to disclose. Notwithstanding the material weakness described below, we believe our
consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present in
all material respects our financial position, results of operations and cash flows for the periods
presented in accordance with accounting principles generally accepted
in the United States of America (“GAAP”). As a result, we believe,
and our Chief Executive Officer and Chief Financial Officer have certified to their knowledge, that
this Quarterly Report on Form 10-Q does not contain any untrue statements of material fact or omit
to state any material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered in this
Quarterly Report.
Material Weaknesses in Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control
over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
Internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and
procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the Company; (b) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with GAAP, and that receipts and expenditures of the Company are being
made only in accordance with authorizations of management and directors of the Company; and (c)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the Company’s assets that could have a material effect on the interim or
annual consolidated financial statements. Because of its inherent limitations,
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DRESSER-RAND GROUP INC.
OTHER INFORMATION — LEGAL PROCEEDINGS internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, we conducted an evaluation of
the effectiveness of our internal control over financial reporting as of December 31, 2006 based on
the criteria established in Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
Based on the evaluation performed, we identified the following material weaknesses in our internal
control over financial reporting as of December 31, 2006. A material weakness is a control
deficiency, or combination of control deficiencies, that results in more than a remote likelihood
that a material misstatement of the annual or interim financial statements will not be prevented or
detected.
We did not maintain an effective control environment. A control environment sets the tone of an
organization, influences the control consciousness of its people, and is the foundation of all
other components of internal control over financial reporting. Specifically, (a) we did not
maintain a sufficient complement of personnel at some of our business divisions with an appropriate
level of accounting knowledge, experience and training in the selection, application and
implementation of GAAP commensurate with our financial reporting requirements, and (b) we did not
establish and maintain appropriate policies and procedures with respect to the primary components
of information technology general controls. This resulted in either not having appropriate controls
designed and in place or not achieving operating effectiveness over changes to programs, computer
operations and system security. Additionally, we lacked a sufficient complement of personnel with a
level of knowledge and experience to have an appropriate information technology organizational
structure. These control environment material weaknesses contributed to the material weaknesses
discussed below.
We did not maintain effective controls over reconciliations or journal entries. Specifically, (a)
our controls over the preparation, review and monitoring of account reconciliations were
ineffective to provide reasonable assurance that account balances were accurate and agreed to
appropriate supporting detail, calculations or other documentation, and (b) effective controls were
not designed and in place to provide reasonable assurance that journal entries, both recurring and
non-recurring, were prepared with acceptable support and sufficient documentation and that journal
entries were reviewed and approved to provide reasonable assurance of the validity, accuracy and
completeness of the entries recorded. These control deficiencies could result in a misstatement to
substantially all accounts and disclosures that would result in a material misstatement to the
annual or interim financial statements that would not be prevented or detected. However, they did
not result in audit adjustments to our 2006 consolidated financial statements.
We did not design or maintain effective controls over segregation of duties. Specifically, certain
key personnel had incompatible duties or had unrestricted and unmonitored access to critical
financial application programs and data that was beyond the requirements of their assigned
responsibilities that could allow the creation, review, and processing of financial data without
independent review and authorization. These control deficiencies could result in a misstatement to
substantially all accounts and disclosures that would result in a material misstatement to our
interim or annual consolidated financial statements that would not be prevented or detected.
However, they did not result in audit adjustments to our 2006 consolidated financial statements.
Changes in Internal Control Over Financial Reporting
During the first quarter of 2007, we continued (a) to hire additional experienced information
technology personnel, (b) to implement a new worldwide information technology system, (c) to hire
additional and reassign experienced accounting personnel and (d) to improve the documentation of
our worldwide accounting policies, processes and procedures. Except for the changes described in
this paragraph, there have been no changes in our internal control over financial reporting that
occurred during the quarter ended March 31, 2007 that have materially affected or are reasonably
likely to materially affect our internal control over financial reporting.
We plan to continue implementing changes as required to remediate the above reported material
weaknesses in internal control over financial reporting as of December 31, 2006.
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DRESSER-RAND GROUP INC.
OTHER INFORMATION — LEGAL PROCEEDINGS PART II. – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS (dollars and pound sterling in millions)
Dresser-Rand (UK) Limited, one of our wholly-owned indirect subsidiaries, is involved in litigation
that was initiated on June 1, 2004, in the High Court of Justice, Queens Bench Division, Technology
and Construction Court in London, England, (the Court) with Maersk Oil UK Limited over alleged
defects in performance of certain compressor equipment sold by Dresser-Rand (UK) Limited. The
claimant sought damages of about £8.0 (approximately $15.7). Witness testimony concluded in
December 2006 and a decision was issued at the end of March 2007. In that decision, the Court
awarded Maersk approximately £1.8 ($3.5) or £0.2 ($0.3) in excess of amounts the Company previously
recorded as an accrued liability for this litigation. The additional $0.3 was
recorded as an expense during the three months ended March 31, 2007. In addition, the award exceeded
the amount previously offered by Maersk to settle the litigation and as a result, under U.K. laws,
Maersk is now entitled to and has requested reimbursement of certain costs of £2.3 ($4.5) and
interest, the maximum amount of which is calculated to be £0.9 ($1.8) at March 31, 2007. The
Company plans to dispute the amount of costs claimed by Maersk and the resolution process could
take several months during, which interest continues to accrue until the amounts are paid.
Nevertheless, the Company recorded accrued liabilities for an additional £0.5 ($1.0) recorded as
operating expenses and £0.5 ($1.0) recorded as interest expense during the three months ended March
31, 2007 as its estimate of the minimum amount that is probable that the Company will ultimately
pay in regards to this litigation. However, in addition to interest that continues to accrue, it is
reasonably possible that the trial costs and interest that the Company will ultimately be required
to pay upon resolution could be the total cost requested of £2.3 ($4.5) and maximum interest
calculated as of March 31, 2007 of £0.9 ($1.8) which would result in additional charges to expense
totaling £2.2 ($4.3).
We are involved in various litigation, claims and administrative proceedings, arising in the
normal course of business. Amounts recorded for identified contingent liabilities are estimates,
which are regularly reviewed and adjusted to reflect additional information when it becomes
available. Subject to the uncertainties inherent in estimating future costs for contingent
liabilities, management believes that any future adjustments to recorded amounts, with respect to
these currently known contingencies, would not have a material effect
on the financial condition, results of operations, liquidity or cash
flows of the Company.
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DRESSER-RAND GROUP INC.
OTHER INFORMATION – EXHIBITS ITEM 6. EXHIBITS
The following exhibits are filed with this report:
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DRESSER-RAND GROUP INC.
OTHER INFORMATION – SIGNATURES SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
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