UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission File Number: 001-32586

 

 

 

 

DRESSER-RAND GROUP INC.

(Exact name of registrant as specified in its charter)

 

 

West8 Tower, Suite 1000
10205 Westheimer Rd.
Houston, Texas 77042
(Address Of Principal Executive Offices)

(713) 354-6100
(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

(Title of class)

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price of $26.10 per share at which the common equity was last sold, as of the last business day of the registrant’s most recently completed second fiscal quarter was $2,151,157,276

 

There were 82,529,890 shares of common stock outstanding on February 19, 2010.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Definitive Proxy Statement for its 2010 Annual Meeting of Stockholders (the “Proxy Statement”) are incorporated by reference into Part III.

 

 

TABLE OF CONTENTS

 

 

Overview

 

Dresser-Rand Group Inc. is a Delaware corporation formed in October 2004. Dresser-Rand Company, an affiliate of Dresser-Rand Group Inc., was initially formed on December 31, 1986, when Dresser Industries, Inc. and Ingersoll Rand entered into a partnership agreement for the formation of Dresser-Rand Company, a New York general partnership owned 50% by Dresser Industries, Inc. and 50% by Ingersoll Rand. On October 1, 1992, Dresser Industries, Inc. purchased a 1% equity interest from Dresser-Rand Company. In September 1999, Dresser Industries, Inc. merged with Halliburton Industries, and Dresser Industries, Inc.’s ownership interest in Dresser-Rand Company transferred to Halliburton Industries. On February 2, 2000, a wholly-owned subsidiary of Ingersoll Rand purchased Halliburton Industries’ 51% interest in Dresser-Rand Company. On August 25, 2004, Dresser-Rand Holdings, LLC, an affiliate of First Reserve Corporation (“First Reserve”), a private equity firm, entered into an equity purchase agreement with Ingersoll Rand to purchase all of the equity interests in the Dresser-Rand Entities for approximately $1.13 billion. The acquisition closed on October 29, 2004. On August 4, 2005, Dresser-Rand Group, Inc., completed its initial public offering of common stock at $21.00 per share. The common stock trades on the New York Stock Exchange under the symbol “DRC.” During 2006 and 2007, there were three secondary sales of the Company’s stock by D-R Interholding, LLC, an affiliate of First Reserve Corporation. D-R Interholding LLC subsequently sold its entire interest in Dresser-Rand Group Inc. In this Form 10-K, we refer to this acquisition as the “Acquisition” and the term “Transactions” means, collectively, the Acquisition and the related financings to fund the Acquisition.

 

Unless the context otherwise indicates, as used in this Form 10-K, (i) the terms “we,” “our,” “us,” the “Company”, the “Successor” and similar terms refer to Dresser-Rand Group Inc. and its consolidated subsidiaries, (ii) the term “Dresser-Rand Entities” refers to Dresser-Rand Company and its direct and indirect subsidiaries, Dresser-Rand Canada, Inc. and Dresser-Rand GmbH and (iii) the term “Ingersoll Rand” refers to Ingersoll Rand Company Limited, and its predecessors, which sold its interest in the Dresser-Rand Entities in the Acquisition.

 

We are among the largest global suppliers of custom-engineered rotating equipment solutions for long-life, critical applications in the oil, gas, chemical, petrochemical, process, power, military and other industries worldwide. Our segments are (1) new units and (2) aftermarket parts and services. Our products and services are widely used in applications that include gas gathering, gas recompression and export, gas lift and high pressure re-injection; CO₂ re-injection, enhanced oil recovery, main refrigeration compression and other duties for liquefied natural gas (LNG) plants; gas transmission and storage as well as gas processing; a variety of refinery services; ammonia and methanol synthesis gas; ethylene and other petrochemical services and chemical plant services. Our custom-engineered products are also used in other advanced applications to recover and/or increase energy efficiency. These include, among others, hot gas turbo-expanders for energy recovery in refineries; co- and tri-generation combined heat and power (CHP) packages for institutional and other clients; steam turbines to generate power in ships using steam raised by recovering exhaust heat from the main engines, and compressed air energy storage (CAES) applications for utility sized power generation projects that are environmentally friendly and provides unique grid management features. The typical CAES plant makes use of our classes of axial compressors, centrifugal compressors, gas expanders, controls and rotating equipment system integration capabilities. Other general industrial markets served include paper, steel, sugar, and distributed power generation. We operate globally with manufacturing facilities in the United States, France, United Kingdom, Germany, Norway, China and India.

 

We provide a wide array of products and services to our worldwide client base in over 140 countries from our global locations (65 sales offices, 37 service centers and 12 manufacturing locations) in 18 U.S. states and 29 countries. Our clients include Chevron, Royal Dutch Shell, ExxonMobil, BP, Statoil, Total, Petrobras, Pemex, PDVSA, Petronas, Saudi Aramco, ConocoPhillips, LUKOIL, Marathon Petroleum Company, Repsol, and Dow Chemical Company.

 

Our solutions-based service offering combines our industry-leading technology, extensive worldwide service center network and deep product expertise. This approach drives our growth as we offer integrated service solutions that help our clients lower their life cycle costs, minimize adverse environmental impact and maximize returns on their production and processing equipment. We believe our business model and alliance-based approach align us with our clients who increasingly choose service providers that can help optimize performance over the entire life cycle of their equipment. Our alliance program encompasses both the provision of new units and/or parts and services. We offer our clients a dedicated team, advanced business tools, a streamlined engineering and procurement process, and a life cycle approach to manufacturing, operating and maintaining their equipment, whether originally manufactured by us or by a third party. In many of our alliances, we are either the exclusive or preferred supplier of equipment and aftermarket parts and services to a client. Our alliances enable us to:

 

 

 

The markets in which we operate are large and fragmented. We estimate that in 2009, the worldwide aggregate annual value of new unit sales of the classes of equipment we manufacture was approximately $5 billion and the aftermarket parts and services needs of the installed base of such equipment (both in-house and outsourced) was approximately $9.5 billion.

 

The recent adverse economic conditions and the downturn in the oil and gas markets at the end of 2008 and into 2009 adversely affected new unit bookings, which will result in lower new unit sales in 2010. While the low level of new unit bookings in 2009 reflected the ongoing project delays that we have experienced throughout the first nine months of 2009, we believe we are experiencing a recovery in the new units market. Moreover, we continue to believe that in the long-term we are well positioned to benefit from a variety of trends that should continue to drive demand for our products and services, including:

 

 

Business Strategy

 

In 2009, approximately 89% of our revenues were generated from energy infrastructure and oilfield spending. Additionally, 55% of our total combined revenues were generated by our new units segment and 45% by our aftermarket parts and services segment. We intend to continue to focus on the upstream, midstream, and downstream segments of the oil and gas market. However, we are not focused exclusively on the oil and gas market; our presence in the emerging opportunities in the alternative energy and environmental services markets for our type of rotating equipment has continued to grow every year. Thus, we expect to capitalize on the expected long-term growth in equipment and services investment in these markets.

 

As we enter 2010, the market for new unit orders appears to be improving from the low level of bookings we experienced in 2009. While an accurate prediction of whether the economic environment will worsen or improve is difficult, we believe that we are experiencing a recovery in the new unit market. In the fourth quarter 2009, we have booked more than $369 million of new unit orders. This was slightly more than the $358 million of new unit orders booked in the first nine months of 2009. Additionally, our discussions with key clients continue to give us confidence that 2010 new unit bookings may begin to approach the 2008 level.

 

This is not the first downturn that we have experienced. We have been planning our footprint and manufacturing strategy over the past nine years knowing that our new units business is cyclical. We believe we have built a unique business model that will allow us to flex our manufacturing capacity as is necessary during cyclical upswings and downturns. Through our use of a “flexible manufacturing” strategy, we can accomplish the same amount of manufacturing in less space, where we use our suppliers to flex up or down as needed to meet our manufacturing requirements.

 

For example, nearly ten years ago, we took steps to lower our operating costs and breakeven point by completing a number of restructuring programs across the entire Company. During 2002 to 2004, we consolidated facilities and

reduced headcount by more than 20 percent. Since then, revenues more than doubled without adding significant manufacturing capacity. We accomplished this as a result of our business realignment toward the aftermarket parts and services segment, our lean manufacturing initiatives, and our decision to use the supply chain to flex manufacturing capacity to meet rising demand.

 

Our business model has yielded record results in 2009. We also expect our business model to minimize operating margin deterioration in 2010 despite lower revenues driven by lower 2009 new unit bookings. Approximately one-half of our revenues derive from our new units segment, which is tied to energy infrastructure investments. This segment is cyclical by nature. Our flexible manufacturing model, which fundamentally reflects our ability to flex our supply chain, helps us in times of slowing demand to keep our factories relatively full and fixed costs more fully absorbed, which has helped us maintain operating margins much better than in past industry downturns.

 

Another important aspect of our business model is that about half of our revenues derive from the aftermarket segment, which is much less cycle sensitive. Our equipment is mission critical to the operating assets of our end user clients. They run continuously and, therefore, require parts and servicing generally regardless of commodity prices. In 2009, this segment of our business represented approximately 76% of the Company’s operating income. By putting talented people and more efficient processes in place over the last nine years, we have grown this segment at about a 10% compounded annual rate.

 

Two other important characteristics of our business model are our strong value proposition and our low capital intensity. Our value proposition currently is centered around our clients’ total cost of owning and operating our supplied equipment. We believe we have built some of the most efficient and reliable equipment in the world. This class of equipment may run for 30 years or more. Over the life cycle of that equipment, the more efficient the equipment is, the less energy it consumes to operate and the less CO₂ and other emissions emanate from the equipment driving our machines. Hence, there is a quantifiable value proposition associated with what we build. With respect to our low capital intensity, we have demonstrated the ability to run our business on an ongoing basis with net working capital and capital expenditure requirements of approximately 5% and 1.5% to 2% of sales, respectively.

 

With respect to our long-term business strategy, our intent is as follows:

 

Increase Sales of Aftermarket Parts and Services to the Existing Installed Base.  The substantial portion of the aftermarket parts and services needs of the existing installed base of equipment that we currently do not, or only partially service, represents a significant opportunity for growth. We believe the market has a general preference for aftermarket original equipment manufacturers’ parts and services. We are implementing a proactive approach to aftermarket parts and services sales that capitalizes on our knowledge of the installed base of our own and our competitors’ equipment. Through the D-R Avenue project, we have assembled a significant amount of data on both Dresser-Rand’s and our competitors’ installed equipment base. We have developed predictive models that help us identify and be proactive in securing aftermarket parts and services opportunities. We are upgrading our service response by integrating the expertise of our factory-based product engineers with the client-oriented service personnel in the field through our Client Interface and Response System (CIRS). CIRS significantly enhances our ability to rapidly and accurately respond to any technical support or service request from our clients. We are expanding our service center network, which is the largest in the industry. Through our lean operating system, we have instilled a culture of operational and visual excellence. We believe our premium service level will result in continued growth of sales of aftermarket parts and services. We also expect positive contributions from recently added service centers coupled with the traction we are gaining from newly acquired businesses.

 

Expand Aftermarket Parts and Services Business to Non-Dresser-Rand Original Equipment Manufacturers’ Equipment.  We believe the aftermarket parts and services market for non-Dresser-Rand equipment represents a significant growth opportunity that we continue to pursue on a systematic basis. As a result of the knowledge and expertise derived from our long history and experience servicing the largest installed base in the industry, combined with our extensive investment in technology, we have a proven process of applying our technology and processes to improve the operating efficiency and performance of our competitors’ products. Additionally, with the largest global network of full-capability service centers and field service support for our class of equipment, we are often in a position to provide quick response to clients and to offer local service. We believe these, along with our world class field service safety performance, are important service differentiators for our clients. By using D-R Avenue, we intend to capitalize on our knowledge, our broad network of service centers, flexible technology and existing relationships with most major industry participants to grow our aftermarket parts and services solutions for non-Dresser-Rand equipment. We are able to identify technology upgrades that improve the performance of our clients’ assets and to proactively suggest upgrade and revamp projects that clients may not have considered.

Grow Alliances.  As a result of the need to improve efficiency in a competitive global economy, oil and gas companies are frequently consolidating their supplier relationships and seeking alliances with suppliers, shifting from purchasing units and services on an individual transactional basis to choosing long-term service providers that can help them optimize performance over the entire life cycle of their equipment. We continue to see a high level of interest among our clients in seeking alliances with us, and we have entered into agreements with more than 50 of our clients. We plan to leverage our market leadership, global presence, and comprehensive range of products and services to continue to take advantage of this trend by pursuing new client alliances as well as strengthening our existing alliances. We currently are the only alliance partner for rotating equipment with Marathon Petroleum Company. In addition, we are a preferred supplier to other alliance partners, including BP, Royal Dutch Shell, Statoil, ConocoPhillips, ExxonMobil, Chevron, Petrobras, Pemex, Valero, Praxair, Mustang Engineering, Fluor, PDVSA, and Repsol.

 

Expand our Performance-Based Long-Term Service Contracts.  We are growing our participation in the outsourced services market with our performance-based operations and maintenance solutions (known as our Availability+ program), which are designed to offer clients significant value (improved equipment performance, decreased life cycle cost and higher availability levels) versus the traditional services and products approach. These contracts generally represent multiyear, recurring revenue opportunities for us that typically include a performance-based element to the service provided. We offer these contracts for most of the markets that we serve.

 

Introduce New and Innovative Products and Technologies.  We believe we are an industry leader in introducing new, value-added technology. Product innovation has historically provided, and we believe will continue to provide, significant opportunities to increase revenues from both new units sales and upgrades to the installed base of equipment manufactured by us and other original equipment manufacturers. Many of our products utilize innovative technology that lowers operating costs and increases reliability and performance. Examples of such technology offerings include adapting the DATUM compressor platform for the revamping of other original equipment manufacturers’ equipment, a new design of dry-gas seals and bearings, a new generation of rotating separators and an integrated compression system (ICS). We have introduced a complete line of remote-monitoring and control instrumentation that offers significant performance benefits to clients and enhances our operations and maintenance services offering. Further discussion about innovative products and technologies can be found under New Product Development. We plan to continue developing innovative products, including new compressor platforms, which could further open up new markets to us.

 

Continue to Improve Profitability.  We continually seek to improve our financial and operating performance through cost reductions and productivity improvements. Process efficiencies, cycle time reductions and cost improvements are being driven by greater worldwide collaboration across Dresser-Rand locations. We have Process Innovation teams removing waste using advanced lean manufacturing methodologies such as value stream mapping. A large portion of our finished products comes from purchased materials and we are extending our process innovation and lean methodologies to remove waste from our supply chain. We are focused on continuing to improve our cost position in every area of our business, and we continue to believe there is substantial opportunity to further increase our productivity.

 

Selectively Pursue Acquisitions.  We intend to continue our disciplined pursuit of acquisition opportunities that fit our business strategy. We will focus on acquisitions within the energy sector that add new products or technologies to our portfolio, provide us with access to new markets or enhance our current product offering or service capabilities. Given our size and the large number of small companies in our industry and related industries, we believe many opportunities for strategic acquisitions remain.

 

Services and Products

 

We design, manufacture and market highly engineered rotating equipment and provide services primarily to the worldwide oil, gas, petrochemical and industrial process industries. Our segments are new units and aftermarket parts and services. The following charts show the proportion of our revenue generated by segment, destination and end market for the periods indicated:

 

 

Segment and destination revenues and related financial information for 2009, 2008, and 2007 can be found in Note 20, Segment Information, in the Notes to Consolidated Financial Statements in Item 15 of this Form 10-K.

 

New Units

 

We are a leading manufacturer of highly-engineered turbo and reciprocating compression equipment and steam turbines. We also manufacture special-purpose gas turbines. Our new unit products are built to client specifications for long-life, critical applications. The following is a description of the new unit products that we currently offer.

 

Dresser-Rand Major Product Categories

 

 

Turbo Products.  We are a leading supplier of turbomachinery for the oil and gas industry worldwide. Turbo products sales represented 53.4%, 54.9%, and 60.9% of our total new unit revenues for the fiscal years ended 2009, 2008, and 2007, respectively. Centrifugal compressors utilize turbomachinery technology that employs a series of graduated impellers to increase pressure. Generally, these centrifugal compressors are used to re-inject natural gases into petroleum fields to increase field pressures for added petroleum recovery or to re-inject carbon dioxide (CO₂) to meet regulatory requirements. In addition, centrifugal compression is used to separate the composition of various gases in process applications to extract specific gases. These compressors are also used to provide the compression needed to increase pressures required to transport gases between gas sources through pipelines. Applications for our turbo products include gas lift and injection, gas gathering, storage and transmission, synthetic fuels, ethylene, fertilizer, refineries and chemical production and CAES application.

 

Our proprietary DATUM product line incorporates enhanced engineering features that provide significant operating and maintenance benefits for our clients. The DATUM is a comprehensive line of radial and axial split

centrifugal compressors, with modular and scalable construction, for flows to 500,000 cubic feet per minute (cfm) (236 m3/s), and discharge pressures to over 10,000 pounds per square inch gauge (psig) (690 barg). In some applications, a single DATUM compressor can compress greater flows per frame size than a comparable existing product offering, resulting in the capability to handle the same pressure ratio with fewer frames. The DATUM product line also offers improved rotor stability characteristics. DATUM compressors are available in 15 frame sizes. In addition to the DATUM centrifugal compressor line, we manufacture a line of axial flow compressors, legacy centrifugal compressors, warm-gas expanders, hot-gas expanders, gas and power turbines and control systems.

 

In addition, we offer a variety of gas turbines ranging in power capacity from approximately 1.5 to 50+ megawatts (MW), which support driver needs for various centrifugal compressor product lines, as well as for power generation applications.

 

Reciprocating Compressors.  We are a leading supplier of reciprocating compressors, offering products ranging from medium to high speed separable units driven by engines to large slow speed-motor driven process reciprocating compressors. In 2009, in new unit process reciprocating compressor sales, we were the clear leader in North America, and we continued to rank in the top three in worldwide market share. Reciprocating compressor product sales represented 21.0%, 25.7%, and 17.3% of our total new unit revenues for the fiscal years ended 2009, 2008, and 2007, respectively. Reciprocating compressors use a traditional piston and cylinder engine design to increase pressure within a chamber. Typically, reciprocating compressors are used in lower volume/higher compression ratio applications and are better able to handle changes in pressure and flow compared to centrifugal compressors. We offer 11 models of process reciprocating compressors, with power capacity up to 45,000 horsepower (33.6 MW), and pressures ranging from vacuum to 60,000 psig (4140 barg). We offer seven models of medium to high speed reciprocating compressors, with power ratings over 11,000 horsepower (8.2 MW). Applications for our reciprocating compressors include upstream production (gas lift, boil-off/residue gas, export, gathering, processing, Liquefied Petroleum Gas, and Natural Gas Liquids), midstream services (gas transport, storage, fuel gas and CO₂ injection) and downstream processing (G-T-L, H₂ production, refining, cool gas, methanol and ethylene, NH₃, nitric acid, and urea).We also offer control systems for our reciprocating compressors.

 

Steam Turbines.  We are a leading supplier of standard and engineered mechanical drive steam turbines and turbine generator sets. Steam turbine product sales represented 25.6%, 19.4%, and 21.9% of our total new unit revenues for the fiscal years ended 2009, 2008, and 2007, respectively. Steam turbines use steam from power plant or process applications and expand it through nozzles and fixed and rotating vanes, converting the steam energy into mechanical energy of rotation. We are one of the few remaining North American manufacturers of standard and engineered to order multi-stage steam turbines. Our steam turbine models have power capacity up to 75MW and are used primarily to drive pumps, fans, blowers, generators and compressors. Our steam turbines are used in a variety of industries, including oil and gas, refining, petrochemical, chemical, pulp and paper, metals, industrial power production and utilities, sugar and palm oil. We are the sole supplier to the United States Navy of steam turbines for aircraft carrier propulsion and other ship services.

 

New Product Development

 

We believe clients are increasingly choosing their suppliers based upon capability to custom engineer, manufacture and deliver reliable, high-performance products, with the lowest total cost of ownership, in the shortest cycle time, and to provide timely, locally based service and support. New product and technology development is a fundamental part of our value proposition and we believe that we are an industry leader in introducing new, value-added products and technologies. Our increasing investment in research and development also includes a continued commitment to attract and retain a staff of innovative technical experts who are recognized within the industry.

 

We have delivered numerous products and technologies that contribute to aftermarket parts and services growth, as well as design and process improvements that increase profitability. We continue to invest in the advancement of core technologies that include improving our DATUM compressor efficiency, as well as new technologies that will ensure our long term industry leadership. Our continuing investment in Ramgen Power Systems, LLC provides an opportunity to commercialize a breakthrough compression technology that applies proven supersonic aircraft technology to ground-based air and gas compressors.

 

We are also making incremental research and development investments that support our growth strategies for environmental solutions that include combined heat and power and ocean wave energy, as well as our proven energy storage solutions for alternative energy power generation via Compressed Air Energy Storage (SMARTCAES). This includes continued development and commercialization of technologies that were acquired as part of the former Peter Brotherhood Ltd and Enginuity companies for combined heat and power, wave energy, as well as efficiency improvements and emissions reductions for large reciprocating gas engines.

In 2009, we made substantial progress on our new Integrated Compression System (ICS). The ICS uses as a platform high-efficiency DATUM centrifugal compressor technology driven by a high-speed, close-coupled motor, including an integrated gas-liquid separation technology, packaged with process coolers in a single module. It provides a complete compression system that can be applied to upstream, midstream and downstream markets and is part of our technology roadmap to subsea compression.

 

In 2009, we shipped our first VECTRA 30G power turbines, replacing our older but highly successful DR-61, which when combined with the GE-LM2500 gas generator provide a high speed gas turbine solution that is available for new equipment and as a retrofit for legacy turbine packages. The advantage of our VECTRA product line is a modular aero-derivative design with high efficiency and quick change-out that increases operating availability and lowers operating costs.

 

Revamp/Upgrade Opportunities

 

In addition to supplying new rotating units, there are significant opportunities for us to supply engineered revamp and upgrade services to the installed base of rotating equipment.

 

Revamp services involve significant improvement to the aerodynamic performance of rotating machinery by incorporating newer technology to enhance equipment efficiency, durability or capacity. For example, steam turbine revamps involve modifying the original steam flow path components to match new operating specifications such as requirements for power, speed and steam condition.

 

Upgrade services are offered on all our lines of rotating equipment, either in conjunction with revamps or on a stand alone basis. Upgrades are offered to provide the latest applicable technology components for the equipment to improve durability, reliability, and/or availability. Typical upgrades include replacement of components such as governors, bearings, seals, pistons, electronic control devices and retrofitting of existing lubrication, sealing and control systems with newer technology.

 

Our proactive efforts to educate our clients on improved revamp technologies to our DATUM line provides significant growth potential with attractive margins. We have the support systems in place, including our technology platform and service facilities and our cost effective Corporate Product Configurator platform, to prepare accurate proposals that will allow us to take advantage of the growth potential in this market. In addition, we believe our alliance relationships will allow us to create new revamp opportunities.

 

Aftermarket Parts and Services

 

We continue to believe that the aftermarket parts and services segment provides us with long-term growth opportunities. Aftermarket parts and services are generally less cycle sensitive then the new units segment, although revenues and bookings tend to be higher in the second half of the year. With a typical operating life of 30 years or more, rotating equipment requires substantial aftermarket parts and services over its operating life. Parts and services activities realize higher margins than new unit sales. Additionally, the cumulative revenues from these aftermarket activities often exceed the initial purchase price of the unit, which in many cases is as low as five percent of the total life cycle cost of the unit to the client. Our aftermarket parts and services business offers a range of services designed to enable clients to maximize their return on assets by optimizing the performance of their mission-critical rotating equipment. We offer a broad range of aftermarket parts and services, including:

 

 

 

We believe we have the largest installed base of the classes of equipment we manufacture and the largest associated aftermarket parts and services business in the industry. Many of the units we manufacture are unique and highly engineered and require knowledge of their design and performance characteristics to service. We estimate that we currently provide approximately 55% of the supplier-provided aftermarket parts and services needs of our own manufactured equipment base and approximately 4% percent of the supplier provided aftermarket parts and services needs of the equipment base of other manufacturers. We focus on a global offering of technologically advanced aftermarket products and services, and as a result, our aftermarket activities tend to be concentrated on the provision of higher-value added parts and upgrades, and the delivery of sophisticated operating, repair and overhaul services. Smaller independent companies tend to focus on local markets and have a more basic aftermarket offering.

 

We believe equipment owners and operators generally prefer to purchase aftermarket parts and services from the original equipment manufacturer of a unit. A significant portion of our installed base is serviced in-house by our clients. However, we believe there is an increasing trend for clients to outsource this activity, driven by declining in-house expertise, cost efficiency and the superior service levels and operating performance offered by original equipment manufacturer service providers. We believe the steady demand for aftermarket parts and services from our installed base represents a stable source of recurring revenues and cash flow. Moreover, with our value-based solutions strategy, we have a demonstrated track record of growth in this segment as a result of our focus on expanding our service offerings into new areas, including servicing other original equipment manufacturers’ installed base of equipment, developing new technology upgrades and increasing our penetration of higher value-added services to our own installed base.

 

Because equipment in our industry typically has a multi-decade operating life, we believe aftermarket parts and services capability is a key element in both new unit purchasing decisions and sales of service contracts. Given the critical role played by the equipment we sell, clients place a great deal of importance on a supplier’s ability to provide rapid, comprehensive service, and we believe that the aftermarket parts and services business represents a significant long-term growth opportunity. We believe important factors for our clients include a broad product range, servicing capability, the ability to provide technology upgrades, local presence and rapid response time. We provide our solutions to our clients through a proprietary network of 37 service centers in 20 countries, employing over 1,500 service center and field service personnel, servicing our own and other original equipment manufacturers’ turbo and reciprocating compressors as well as steam and gas turbines. We believe our coverage area of service centers servicing both turbo and reciprocating compressors and steam turbines is approximately 50% larger than that of our next closest competitor.

 

Sales and Marketing

 

We market our services and products worldwide through our established sales presence in 23 countries. In addition, in certain countries in which we do business, we sell our products and services through sales representatives. Our sales force is comprised of over 500 direct sales/service personnel and a global network of approximately 130 independent representatives, all of whom sell our products and provide service and aftermarket support to our installed base locally in over 140 countries. We are able to deliver significant value to our clients through the use of our Corporate Product Configurator (CPC) platform, which permits us to interactively configure certain engineered solutions in real time at their location or ours in days rather than months. We believe this capability to be unique in the industry.

 

Manufacturing and Engineering Design

 

Our products and services are used primarily in supplying and servicing mission critical rotating equipment for the energy infrastructure worldwide, where increased environmental regulations test our innovative technologies and design capabilities. Our technologies support our clients’ competitiveness by improving process efficiencies and reducing emissions. We have taken aggressive steps to address the challenge of increasing environmental regulation, including a newly-created strategic business unit to focus on our growth in environmental markets. Not only do we impact the environment through the products and services offered, but also through the manufacture of our products.

Our Lean Manufacturing and Quality efforts are critical to reducing waste in production, transportation, inventory and material use. For instance, through the use of a “flexible manufacturing” strategy, we can accomplish the same amount of manufacturing in less space, where we use our suppliers to flex our capacity up or down as needed to meet our manufacturing requirements.

 

We are committed to providing our clients with the highest quality products and services, and are continuously striving for improved quality and efficiency of both our products and our processes. Our current worldwide Process Innovation team includes approximately 100 employees who work across the globe to improve quality, on-time delivery, cycle time, and profitability. The team uses a number of continuous improvement tools such as 6 Sigma, Lean Methodologies, Value Analysis/Value Engineering, and Total Quality Management. They teach employees how to apply value-creation and change management methodologies to their areas of responsibility, and to take ownership of process improvement. The Lean philosophy and Quality Improvement principles are continually being inspired and expanded throughout our Company in a structured fashion using a variety of training tools. Since mid 2008, over 8,100 courses and workshops have been completed, and over 2,100 employees have completed at least one on-line Lean course. From management to machine tool operators, our employees have an understanding of these Quality and Lean practices. To further improve efficiency and productivity, the entire organization is currently undergoing a transformation through a Global Singular Process (GSP) effort. Through data, processes, people, and technology, a common way of doing business is being defined.

 

Efficiency in our operations remains a priority as we focus on providing our clients with faster and improved configured solutions, shorter response times, improved cycle times, and consistent on-time delivery. Investments in 2009 have improved the efficiency of our operations. From 6-S workplace procedures in all Service Centers to energy audits in our largest manufacturing facilities, improvement initiatives are obvious day-to-day events. Cost improvements through waste reduction were also significant in 2009. Project FIT was launched to drive financially measurable reductions in indirect spending areas such as energy use, rent, consultants, etc. over a two-year period. In addition, consumption management of expense items such as travel and logistics, information technology, and other non-product commodities are expected to contribute to improved financial results.

 

We will further provide a competitive advantage to our clients through our current localization strategy as reflected in 2009 with new strategic arrangements in the Kingdom of Saudi Arabia and in South Korea.

 

Clients

 

Our global client base consists of most major independent oil and gas producers and distributors worldwide, national oil and gas companies, major energy companies, independent refiners, multinational engineering, procurement and construction companies, petrochemical companies, the United States government and other businesses operating in certain process industries. Our clients include Chevron, Royal Dutch Shell, ExxonMobil, BP, Statoil, Total, Petrobras, Pemex, PDVSA, Petronas, Saudi Aramco, ConocoPhillips, LUKOIL, Marathon Petroleum Company, Repsol, and Dow Chemical Company. In 2009, Chevron totaled 5.1% of total net revenues. In 2008, BP totaled 5.0% of total net revenues and in 2007, no one client exceeded 5.0% of total net revenues.

 

We believe our business model aligns us with our clients who are shifting from purchasing isolated units and services on an individual transactional basis to choosing service providers that can help optimize performance over the entire life cycle of their equipment. We are responding to this demand through an alliance-based approach. An alliance can encompass the provision of new units and/or parts and services, whereby we offer our clients a dedicated, experienced team, streamlined engineering and procurement processes, and a life cycle approach to operating and maintaining their equipment. Pursuant to the terms of an alliance agreement, we may become the client’s exclusive or preferred supplier of rotating equipment and aftermarket parts and services which gives us an advantage in obtaining new business from that client. Our client alliance agreements include frame agreements, preferred supplier agreements and blanket purchasing agreements. The alliance agreements are generally terminable upon 30 days notice without penalty, and therefore do not assure a long-term business relationship, but to date, we have not had an alliance client terminate our relationship.

 

Competition

 

We encounter competition in all areas of our business. We compete against products manufactured by competitors worldwide. The principal methods of competition in these markets relate to product performance, client service, product lead times, global reach, brand reputation, breadth of product line, quality of aftermarket service and support and price. We believe the significant capital required to construct new manufacturing facilities, the production volumes required to maintain low unit costs, the need to secure a broad range of reliable raw material and intermediate

material supplies, the significant technical knowledge required to develop high-performance products, applications and processes and the need to develop close, integrated relationships with clients are barriers to entry for potential new market entrants. Some of our existing competitors have greater financial and other resources than we do.

 

Over the last 25 years, the turbo compressor industry has consolidated from more than 15 to 7 of our larger competitors, the reciprocating compressor industry has consolidated from more than 12 to 6 of our larger competitors and the steam turbine industry has consolidated from more than 18 to 5 of our larger competitors. Our larger competitors in the new unit segment of the turbo compressor industry include GE Oil & Gas/Nuovo Pignone, Siemens, Solar Turbines, Inc., Rolls-Royce Group plc, Elliott Company, Mitsubishi Heavy Industries and MAN Turbo; in the reciprocating compressor industry include GE Oil and Gas/Nuovo Pignone, Burckhardt Compression, Neuman & Esser Group, Ariel Corp., Thomassen and Mitsui & Co., Ltd.; and in the steam turbine industry include Elliott Company, Siemens, GE Oil & Gas/Nuovo Pignone, Mitsubishi Heavy Industries and Shin Nippon Machinery Co. Ltd.

 

In our aftermarket parts and services segment, we compete with our major competitors as discussed above, small independent local providers and our clients’ in-house service providers. However, we believe there is an increasing trend for clients to outsource services, driven by declining in-house expertise, cost efficiency and the superior service levels and operating performance offered by original equipment manufacturers’ knowledgeable service providers.

 

Research and Development

 

Our research and development expenses were $20.3 million, $12.7 million, and $12.8 million for the years ended December 31, 2009, 2008, and 2007, respectively. Certain development expenses are associated with specific orders and are not shown as research and development expenses on our consolidated statement of income, but instead are included in cost of sales. We believe current expenditures are adequate to sustain ongoing research and development activities. We make a substantial investment in research and development each year in order to maintain our product and services leadership positions. We have developed many of the technology and product breakthroughs in our markets, and manufacture some of the most advanced products available in each of our product lines. We believe we have significant opportunities for growth by developing new services and products that offer our clients greater performance and significant cost savings. We are also actively involved in research and development programs designed to improve existing products and manufacturing methods.

 

Employees

 

As of December 31, 2009, we had approximately 6,100 employees worldwide. Of our employees, approximately 64% are located in the United States. Approximately 37% of our employees in the United States are covered by collective bargaining agreements.

 

Painted Post, N.Y.

 

In November of 2007, Local 313 of IUE-CWA, the union that represents certain employees at the Company’s Painted Post facility (the “IUE”) made an offer to have its striking members return to work under the terms of the previously expired union agreement. The Company rejected that offer and a lockout of the represented employees commenced. Approximately one week later, after reaching an impasse in negotiations, the Company exercised it’s right to implement the terms of its last contract offer, ended the lockout, and the employees represented by the IUE agreed to return to work under the implemented terms. Subsequently, the IUE filed several unfair labor practice (“ULP”) charges against the Company with Region 3 of the National Labor Relations Board (“NLRB”), asserting multiple allegations arising from the protracted labor dispute, its termination, contract negotiations and related matters.

 

Region 3 of the NLRB decided to proceed to complaint on only one-third of the ULP allegations asserted by the IUE, while the remaining claims were dismissed. Notably, the NLRB found that many of the critical aspects of the Company’s negotiations with the IUE were handled appropriately, including the NLRB’s findings that the Union’s strike was not an unfair labor practice strike and the Company’s declaration of impasse and its unilateral implementation of its last offer were lawful. The Company, therefore, continued to operate under a more contemporary and competitive implemented contract offer while contract negotiations with the IUE continued in 2008 and 2009. In November 2009, a collective bargaining agreement between the union and the Company was ratified, which agreement, expires in March 2013. As a result, the Company was not required to make available the retiree medical benefits which the Company eliminated in its implemented last contract offer. The Company recognized a non-cash curtailment amendment gain of $18.6 in other comprehensive income on December 31, 2007, that is being amortized over 36 months beginning January 2008, as a result of the elimination of those benefits.

The claims that proceeded to complaint before the NLRB included the Company’s handling of the one week lockout, the negotiation of the recall process used to return employees to the facility after reaching impasse and lifting the lockout, and the termination of two employees who engaged in misconduct on the picket line during the strike. The trial of this matter took place before a NLRB Administrative Law Judge (the “ALJ”) in Elmira and Painted Post, N.Y. during the summer of 2009. On January 29, 2010, the ALJ issued a decision in an administrative hearing which found in favor of the union on some issues and upheld the Company’s position on others. The Company continues to believe it complied with the law with respect to these allegations. While management believes it should ultimately prevail with respect to these ULP allegations, several levels of appeal may be necessary. The Company anticipates that any impact arising from the ULPs will not have a material adverse effect on the Company’s financial condition. The litigation process, including appeals if elected by either party, could reasonably take 3 to 5 years and potentially even longer to resolve with finality.

 

Wellsville, N.Y.

 

The Company and Moore Lodge No. 1580, affiliated with District Lodge No. 65 of the International Association of Machinists and Aerospace Workers, AFL-CIO, the union that represents certain employees at the Company’s Wellsville facility (the “Machinists”), entered into a collective bargaining agreement in August 2009. The agreement, expires in August 2012.

 

Other Labor Relations Matters

 

A collective bargaining agreement will expire at our Burlington, IA facility in June 2010. In addition, we have an agreement with the United Brotherhood of Carpenters and Joiners of America whereby we hire skilled trade workers on a contract-by-contract basis in many parts of the United States. Our contract with the United Brotherhood of Carpenters and Joiners of America can be terminated by either party with 90 days prior written notice. Additionally, approximately 47% of our employees outside of the United States belong to industry or national labor unions. Our operations in the following other locations have individuals under collective bargaining agreements and/or are unionized: Olean, NY; Le Havre, France; Peterborough, UK; Naroda, India; Oberhausen and Bielefeld, Germany; and Kongsberg, Norway. Although we believe that our relations with our represented employees are good, we cannot assure you that we will be successful in negotiating new collective bargaining agreements, that such negotiations will not result in significant increases in cost of labor or that a breakdown in such negotiations will not result in the disruption of our operations.

 

Environmental and Government Regulation

 

Manufacturers, such as our Company, are subject to extensive environmental laws and regulations concerning, among other things, emissions to the air, discharges to land, surface water and subsurface water, the generation, handling, storage, transportation, treatment and disposal of waste and other materials, and the remediation of environmental pollution relating to such companies’ (past and present) properties and operations. Costs and expenses under such environmental laws incidental to ongoing operations are generally included within operating budgets. Potential costs and expenses may also be incurred in connection with the repair or upgrade of facilities to meet existing or new requirements under environmental laws. In many instances, the ultimate costs under environmental laws and the time period during which such costs are likely to be incurred are difficult to predict. We do not believe that our liabilities in connection with compliance issues will have a material adverse effect on us.

 

Various federal, state and local laws and regulations impose liability on current or previous real property owners, lessees or operators for the cost of investigating, cleaning up or removing contamination caused by hazardous or toxic substances at the property. In addition, such laws impose liability for such costs on persons who disposed of, or arranged for the disposal of, hazardous substances at third-party sites. Such liability may be imposed without regard to the legality of the original actions and without regard to whether we knew of, or were responsible for, the presence of such hazardous or toxic substances, and such liability may be joint and several with other parties. If the liability is joint and several, we could be responsible for payment of the full amount of the liability, whether or not any other responsible party is also liable.

 

We have sent wastes from our operations to various third-party waste disposal sites. From time to time we receive notices from representatives of governmental agencies and private parties contending that we are potentially liable for a portion of the investigation and remediation costs and damages at such third-party sites. We do not believe that our liabilities in connection with such third-party sites, either individually or in the aggregate, will have a material adverse effect on us.

The equity purchase agreement entered into in connection with the Acquisition provides that, with the exception of non-Superfund off-site liabilities and non-asbestos environmental tort cases, which had a three-year time limit for a claim to be filed, Ingersoll Rand will remain responsible without time limit for certain specified known environmental liabilities that existed as of the October 29, 2004, closing date. Each of these liabilities has been placed on the Environmental Remediation and Compliance Schedule to the equity purchase agreement (the “Final Schedule”). We are responsible for all environmental liabilities that were not identified prior to the closing date and placed on the Final Schedule, although we may have claims against others.

 

Pursuant to the equity purchase agreement, Ingersoll Rand is responsible for all response actions associated with the contamination matters placed on the Final Schedule and must perform such response actions diligently. However, to the extent contamination at leased properties was caused by a third party and to the extent contamination at owned properties resulted from the migration of releases caused by a third party, Ingersoll Rand is only required to conduct response actions after being ordered to do so by a governmental authority.

 

Intellectual Property

 

We rely on a combination of patent, trademark, copyright and trade secret laws, employee and third-party nondisclosure/confidentiality agreements and license agreements to protect our intellectual property. We sell most of our products and provide services under a number of registered trade names, service names, brand names and registered trademarks, which we believe are widely recognized in the industry.

 

In addition, many of our products and technologies are protected by patents. Except for our Company’s name and principal mark “Dresser-Rand,” no single patent, trademark or trade name is material to our business as a whole. We anticipate we will apply for additional patents in the future as we develop new products and processes. Any issued patents that cover our proprietary technology may not provide us with substantial protection or be commercially beneficial to us. The issuance of a patent is not conclusive as to its validity or its enforceability. If we are unable to protect our patented technologies or confidential information, our competitors could commercialize our technologies. Competitors may also be able to design around our patents. In addition, we may also face claims that our products, services, or operations infringe patents or misappropriate other intellectual property rights of others.

 

With respect to proprietary know-how, we rely on trade secret protection and confidentiality agreements. Monitoring the unauthorized use of our proprietary technology is difficult and the steps we have taken may not prevent unauthorized use of such technology. The disclosure or misappropriation of our trade secrets and other proprietary information could harm our ability to protect our rights and our competitive position.

 

Our Company’s name and principal trademark is a combination of the names of our founder companies, Dresser Industries, Inc. and Ingersoll Rand. We have acquired rights to use the “Rand” portion of our principal mark from Ingersoll Rand, and the rights to use the “Dresser” portion of our name from Dresser, Inc., the successor of Dresser Industries, Inc. If we lose the right to use either the “Dresser” or “Rand” portion of our name, our ability to build our brand identity could be negatively affected.

 

Additional Information

 

We file annual, quarterly and current reports, amendments to these reports, proxy statements and other information with the United States Securities and Exchange Commission (“SEC”). Our SEC filings may be accessed and read free of charge through our website at www.dresser-rand.com or through the SEC’s website at www.sec.gov.  These SEC filings are available on our website as soon as reasonably practicable after we file them electronically with the SEC. The information contained on, or that may be accessed through, our website is not part of this Form 10-K. All documents we file are also available at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

 

We have adopted a Code of Conduct that applies to all employees, executive officers and directors. The Code of Conduct is posted on our website, www.dresser-rand.com, and is available in print upon written request by any stockholder at no cost. The request should be submitted to Dresser-Rand Group Inc., c/o General Counsel, West8 Tower, Suite 1000, 10205 Westheimer Rd. Houston, TX, 77042. Any amendment to the Code of Conduct or any waiver of any provision of the Code of Conduct granted to our principal executive officer, principal financial officer, principal accounting officer or controller or person performing similar functions will be disclosed on our website at www.dresser-rand.com or in a report on Form 8-K within four business days of such event. Any waiver of any provision of the Code of Conduct granted to an executive officer or director may only be made by the Board or a Committee of the Board authorized to do so.

 

Economic recessions could adversely affect our business.

 

Prolonged periods of little or no economic growth could decrease demand for oil and gas, which in turn, could result in lower prices for oil and gas. Such decreased demand and lower prices can result in lower demand for our new equipment and, therefore, could adversely affect our results of operations and cash flows. The decline in growth rates in the United States and worldwide in late 2008 and into 2009 significantly reduced demand for our products and services. New units and aftermarket bookings in 2009 declined 49.1% and 14.6%, respectively, from 2008 levels.

 

Volatility and disruption of the credit markets may negatively impact us.

 

We intend to finance our operations and initiatives with existing cash, cash from operations, and borrowings under our credit facility, if necessary. Adverse national and international economic conditions may affect our ability to fully draw upon our credit facility and we may not be able to obtain financing at competitive pricing and terms. Further, while we believe our current liquidity is adequate for our current plans, deterioration in the credit markets or prolonged tightening of credit availability could adversely affect the ability of our clients to pay us or the ability of our suppliers to meet our needs or do so competitively, which could affect our results of operations, liquidity and cash flows.

 

Our operating results and cash flows could be harmed because of industry downturns.

 

Conditions in the oil and gas industry, which affect approximately 89% of our revenue, are subject to factors beyond our control. The businesses of most of our clients, particularly oil, gas and petrochemical companies, are, to varying degrees, cyclical and historically have experienced periodic downturns. Profitability in those industries is highly sensitive to supply and demand cycles and volatile commodity prices, and our clients in those industries historically have tended to delay large capital projects, including expensive maintenance and upgrades, during industry downturns. These industry downturns have been characterized by diminished product demand, excess manufacturing capacity and subsequent accelerated erosion of average selling prices. Demand for our new units and, to a lesser extent, aftermarket parts and services is driven by a combination of long-term and cyclical trends, including increased outsourcing of services, maturing oil and gas fields, the aging of the installed base of equipment throughout the industry, gas market growth and the construction of new energy infrastructure, and regulatory factors. In addition, the growth of new unit sales is generally linked to the growth of oil and gas consumption in markets in which we operate. Moreover, new unit bookings can be highly variable due to volatile market conditions, subjectivity clients exercise in placing orders, and timing of large orders.

 

Prices of oil and gas have been very volatile over the past two years with significant increases until achieving historic highs in July 2008 and a significant decline since that time. These price declines reduced demand for our new units, and to a lesser extent for our aftermarket parts and services, from the levels experienced during 2008 and our new unit bookings in 2009 declined 49.1% compared with 2008. Prolonged periods of reduced client investment in new units could have a material adverse impact on our financial condition, results of operations and cash flows. Any significant downturn in our clients’ markets or in general economic conditions could result in a reduction in demand for our services and products and could harm our business. Such downturns, including the perception that they might continue, could have a significant negative impact on the market price of our common stock and our senior subordinated notes.

 

We may not be successful in implementing our business strategy to increase our aftermarket parts and services revenue.

 

We estimate that we currently provide approximately 55% of the supplier-provided aftermarket parts and services needs of our own manufactured equipment base and approximately 4% of the aftermarket parts and services needs of the equipment base of other manufacturers. The successful implementation of our strategy depends on our ability to provide aftermarket parts and services to both our own and our competitors’ installed base of equipment, to develop and maintain our alliance relationships and to maintain competitive costs. Our ability to successfully implement our aftermarket business strategy also depends to a large extent on the success of our competitors in servicing the aftermarket parts and services needs of our clients, the willingness of our clients to outsource their service needs to us, the willingness of our competitors’ clients to outsource their service needs to us and general economic conditions. In addition, our ability to implement our localization initiatives, make strategic acquisitions and to enter into new alliance

agreements with national oil companies in developing countries will impact the success of our business strategy. We cannot assure you that we will succeed in implementing our strategy.

 

We face intense competition that may cause us to lose market share and harm our financial performance.

 

We encounter competition in all areas of our business. The principal methods of competition in our markets include product performance, client service, product lead times, global reach, brand reputation, breadth of product line, quality of aftermarket service and support and price. Our clients increasingly demand more technologically advanced and integrated products, and we must continue to develop our expertise and technical capabilities in order to manufacture and market these products successfully. To remain competitive, we will need to invest continuously in research and development, manufacturing, marketing, client service and support and our distribution networks. If we fail to develop and introduce new technologies or make product improvements that are accepted in the marketplace, our business could be adversely affected. In our aftermarket parts and services segment, we compete with our major competitors, small independent local providers and our clients’ in-house service providers. Other original equipment manufacturers typically have an advantage in competing for services and upgrades to their own equipment. Failure to penetrate this market will adversely affect our ability to grow our business. In addition, our competitors are increasingly emulating our alliance strategy. Our alliance relationships are terminable without penalty by either party, and our failure to maintain or enter into new alliance relationships will adversely affect our ability to grow our business.

 

We may not be able to integrate our acquisitions successfully, or achieve the expected benefits from, any future acquisitions, which could adversely affect our results.

 

We have at times used acquisitions as a means of expanding our business to enhance returns and expect that we will continue to do so. If we do not successfully integrate our acquisitions, we may not realize expected operating improvements and synergies. Future acquisitions may require us to incur additional debt and contingent liabilities, which may materially and adversely affect our business, operating results and financial condition. The acquisition and integration of companies involve a number of risks, including:

 

 

We may not be able to maintain the levels of operating efficiency that acquired companies achieved separately. Successful integration of acquired operations will depend upon our ability to manage those operations and to eliminate redundant and excess costs. We may not be able to achieve the cost reductions and other benefits that we would hope to achieve from acquisitions, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Economic, political and other risks associated with worldwide sales and operations could adversely affect our business.

 

Since we manufacture and sell our products and services worldwide, our business is subject to risks associated with doing business globally. For the year ended December 31, 2009, 38% of our net revenue was derived from North America, 19% from Europe, 16% from the Middle East and Africa, 17% from Asia Pacific and 10% from Latin America. Accordingly, our future results could be harmed by a variety of factors, including:

 

 

 

Our worldwide operations are affected by global economic and political conditions. Changes in economic or political conditions in any of the countries in which we operate could result in exchange rate movements, new currency or exchange controls or other restrictions being imposed on our operations or expropriation.

 

Some of the markets in which we operate are politically unstable and are subject to occasional civil and communal unrest. Riots, strikes, the outbreak of war or terrorist attacks in locations where we have operations or commercial interests, could also adversely affect our business.

 

From time to time, certain of our foreign subsidiaries operate in countries that are or have previously been subject to sanctions and embargoes imposed by the U.S. government and the United Nations. Those foreign subsidiaries sell compressors, turbines and related parts, accessories and services to clients including enterprises controlled by government agencies of these countries in the oil, gas, petrochemical and power generation industries. The Company’s foreign subsidiaries’ aggregate 2009 sales into countries that were subject to pending sanctions and embargoes was approximately 3% of the Company’s total sales. Although not material in magnitude, certain investors may view even our limited business in these restricted countries adversely. This could have an adverse impact on the price of our common stock and our senior subordinated notes. These sanctions and embargoes do not generally prohibit those subsidiaries from transacting business in such countries; however, they can prohibit us and our domestic subsidiaries, as well as employees of our foreign subsidiaries who are U.S. citizens, from participating in, approving or otherwise facilitating any aspect of the business activities in those countries. These constraints on our ability to have U.S. persons, including our senior management, provide managerial oversight and supervision may negatively affect the financial or operating performance of such business activities.

 

In addition, some of these countries are currently identified by the State Department as terrorist-sponsoring states, namely Iran, Sudan and Syria. Because certain of our foreign subsidiaries have transacted business in these countries in our last fiscal year, including sales to enterprises controlled by agencies of the governments of such countries, our reputation may suffer due to our association with these countries, which may have a material adverse effect on the price of our common stock and our senior subordinated notes. Further, certain U.S. states have enacted legislation regarding investments by pension funds and other retirement systems in companies that have business activities or contacts with countries that have been identified as terrorist-sponsoring states and similar legislation may be pending in other states. As a result, pension funds and other retirement systems may be subject to reporting requirements with respect to investments in companies such as ours or may be subject to limits or prohibitions with respect to those investments that may have a material adverse effect on the price of our common stock and our senior subordinated notes.

 

We operate in some countries in which the risk of bribery is recognized. We have clear policies addressing the Company’s prohibition against illegal payments and have a comprehensive training and certification of compliance program. However, a risk remains despite our efforts. In such circumstances, we could also face fines, sanctions and other penalties from authorities in the relevant jurisdictions, including prohibition of our participating in or curtailment of business operations in those jurisdictions.

Fluctuations in the value of the U.S. dollar and other currencies and the volatility of exchange rates may adversely affect our financial condition and results of operations.

 

Fluctuations in the value of the U.S. dollar may adversely affect our results of operations. Because our consolidated financial results are reported in U.S. dollars, if we generate sales or earnings in other currencies the translation of those results into U.S. dollars can result in a significant increase or decrease in the amount of those sales or earnings. In addition, our debt service requirements are primarily in U.S. dollars, even though a significant percentage of our cash flow is generated in euros or other foreign currencies. Significant changes in the value of the euro relative to the U.S. dollar could have a material adverse effect on our financial condition and our ability to meet interest and principal payments on U.S. dollar-denominated debt, including our senior subordinated notes and the U.S. dollar-denominated borrowings under our restated senior secured credit facility. Significant fluctuations between currencies may also adversely affect our clients and suppliers.

 

In addition, fluctuations in currencies relative to currencies in which our earnings are generated may make it more difficult to perform period-to-period comparisons of our reported results of operations. For example, the economic and political situation in Venezuela is subject to change. We are exposed to risks of currency devaluation in Venezuela primarily as a result of our bolívar receivable balances and bolívar cash balances. On occasion, the Venezuelan government has devalued the bolivar, including a recent devaluation on January 8, 2010. As a result of this most recent devaluation, the Company recorded a foreign exchange loss in our Consolidated Income Statement of approximately $13.6 million and a reduction in our aftermarket backlog of approximately $1.1 million in January 2010. It is not possible to estimate the impact on U.S. dollar backlog resulting from Venezuelan clients’ inability to fund previously booked projects as a result of the devaluation.

 

Additionally, the Venezuelan government has exchange controls and currency transfer restrictions that limit our ability to convert bolívars into U.S. dollars and transfer funds out of Venezuela, and we cannot assure you that our Venezuelan subsidiary will be able to convert bolivars to U.S. dollars to satisfy intercompany obligations. Specifically, included in our cash balance of $223.2 million reported at December 31, 2009, was $22.4 million denominated in Venezuelan bolívars. The balance is primarily a result of favorable operating cash flows in Venezuela. Due to the government restrictions on transfers of cash out of the country and control of exchange rates, we can not immediately convert the cash at the official exchange rate at December 31, 2009. We have various applications to convert bolivars in order to transfer approximately $17.1 million of such amount out of the country, but have experienced substantial delays in obtaining the necessary approvals, and in some cases, rejections of our applications. Consequently, approximately $3.1 million of our cash in Venezuela has been translated to U.S. dollars at December 31, 2009, at an effective exchange rate that was approximately 65% less favorable than the official rate (“Parallel Rate”), which resulted in a foreign exchange loss in our Consolidated Income Statement of approximately $5.6 million for the year ended December 31, 2009. Separately, we may from time to time convert additional cash in Venezuela, but without going through the application process, would only currently be able to do so at the Parallel Rate. This would result in us having fewer U.S. dollars than currently reported as a component of cash and cash equivalents on our Consolidated Balance Sheet with the difference recorded as a foreign exchange loss in our Consolidated Income Statement.

 

In addition to currency translation risks, we incur currency transaction risk whenever we or one of our subsidiaries enters into either a purchase or a sales transaction using a currency other than the local currency of the transacting entity. Given the volatility of exchange rates, we cannot assure you that we will be able to effectively manage our currency transaction and/or translation risks. Volatility in currency exchange rates may have a material adverse effect on our financial condition or results of operations. We have purchased and may continue to purchase foreign currency hedging instruments protecting or offsetting positions in certain currencies to reduce the risk of adverse currency fluctuations on transactions, but we have not historically hedged translation risk. We have in the past experienced and expect to continue to experience economic loss and a negative impact on earnings as a result of foreign currency exchange rate fluctuations.

 

If we lose our senior management or key personnel, our business may be materially and adversely affected.

 

The success of our business is largely dependent on our senior managers, as well as on our ability to attract and retain other qualified key personnel. In addition, there is significant demand in our industry for qualified engineers, mechanics and other skilled workers. Certain members of our management received a significant amount of the net proceeds from the initial public offering and secondary offerings of our common stock, and have the financial ability to retire. We cannot assure you that we will be able to retain all of our current senior management personnel and to attract and retain other necessary personnel, including qualified mechanics, engineers and other skilled workers, necessary for the development of our business. The loss of the services of senior management and other key personnel or the

failure to attract additional personnel as required could have a material adverse effect on our business, financial condition and results of operations.

 

Environmental compliance costs and liabilities and responses to concerns regarding climate change could affect our financial condition, results of operations and cash flows adversely.

 

Our operations and properties are subject to stringent U.S. and foreign, federal, state and local laws and regulations relating to environmental protection, including laws and regulations governing the investigation and clean up of contaminated properties as well as air emissions, water discharges, waste management and disposal and workplace health and safety. Such laws and regulations affect a significant percentage of our operations, are continually changing, are generally different in every jurisdiction and can impose substantial fines and sanctions for violations. Further, they may require substantial clean-up costs for our properties (many of which are sites of long-standing manufacturing operations) and the installation of costly pollution control equipment or operational changes to limit pollution emissions and/or decrease the likelihood of accidental hazardous substance releases. We must conform our operations and properties to these laws and adapt to regulatory requirements in all jurisdictions as these requirements change.

 

We routinely deal with natural gas, oil and other petroleum products. As a result of our manufacturing and services operations, we generate, manage and dispose of, or recycle, hazardous wastes and substances such as solvents, thinner, waste paint, waste oil, wash-down wastes and sandblast material. Hydrocarbons or other hazardous substances or wastes may have been disposed or released on, under or from properties owned, leased or operated by us or on, under or from other locations where such substances or wastes have been taken for disposal. These properties may be subject to investigatory, clean-up and monitoring requirements under U.S. and foreign, federal, state and local environmental laws and regulations. Such liability may be imposed without regard to the legality of the original actions and without regard to whether we knew of, or were responsible for, the presence of such hazardous or toxic substances, and such liability may be joint and several with other parties. If the liability is joint and several, we could be responsible for payment of the full amount of the liability, whether or not any other responsible party also is liable.

 

We have experienced, and expect to continue to experience, both operating and capital costs to comply with environmental laws and regulations, including the clean-up and investigation of some of our properties as well as offsite disposal locations. In addition, although we believe our operations are in compliance with environmental laws and regulations and that we are indemnified by Ingersoll Rand for certain contamination and compliance costs (subject to certain exceptions and limitations), new laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination, the imposition of new clean-up requirements, new claims for property damage or personal injury arising from environmental matters, or the refusal and/or inability of Ingersoll Rand to meet its indemnification obligations could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, financial condition and results of operations.

 

We also expect that scientific examination of and political attention to issues surrounding the existence and extent of climate change will continue. A variety of regulatory developments, both domestic and international, have been introduced that are focused on restricting or managing the emission of carbon dioxide, methane and other greenhouse gases. These developments and further legislation that we expect may be enacted or the development or changes within international accords could adversely affect our operations and the demand for or suitability of our products and services.

 

Failure to maintain a safety performance that is acceptable to our clients could result in the loss of future business.

 

Our U.S. clients are heavily regulated by the Occupational Safety & Health Administration concerning workplace safety and health. Our clients have very high expectations regarding safety and health issues and require us to maintain safety performance records for our worldwide operations, field services, repair centers, sales and manufacturing plants. Our clients often insist that our safety performance equal or exceed their safety performance requirements. We estimate that over 90% of our clients have safety performance criteria for their suppliers in order to be qualified for their “approved suppliers” list. If we fail to meet a client’s safety performance requirements, we may be removed from that client’s approved suppliers database and precluded from bidding on future business opportunities with that client.

 

In response to our clients’ requirements regarding safety performance, we maintain a database to measure our monthly and annual safety performance and track our incident rates. Our incident rates help us identify and track accident trends, determine root causes, formulate corrective actions, and implement preventive initiatives. We cannot assure you that we will be successful in maintaining or exceeding our clients’ requirements in this regard or that we will not lose the opportunity to bid on certain contracts.

Our business could suffer if we are unsuccessful in negotiating new collective bargaining agreements.

 

As of December 31, 2009, we had approximately 6,100 employees worldwide. Of our employees, approximately 64% are located in the United States. Approximately 37% of our employees in the United States are covered by collective bargaining agreements including operations in Olean, Painted Post and Wellsville, NY., and in Burlington, IA. A collective bargaining agreement will expire at our Burlington, IA facility in June 2010. In addition, we have an agreement with the United Brotherhood of Carpenters and Joiners of America whereby we hire skilled trade workers on a contract-by-contract basis in many parts of the United States. Our contract with the United Brotherhood of Carpenters and Joiners of America can be terminated by either party with 90 days’ prior written notice. Furthermore, approximately 47% of our employees outside of the United States belong to industry or national labor unions. Our operations in the following international locations are unionized with agreements negotiated annually: Le Havre, France; Peterborough, UK; Oberhausen and Bielefeld, Germany; Kongsberg, Norway; and Naroda, India. Although we believe that our relations with our represented employees are good, we cannot assure you that we will be successful in negotiating new collective bargaining agreements, that such negotiations will not result in significant increases in the cost of labor or that a breakdown in such negotiations will not result in the disruption of our operations.

 

We may be faced with product claims or adverse consequences of regulations as a result of the hazardous applications in which our products are used.

 

Because some of our products are used in systems that handle volatile, toxic or hazardous substances, a failure or alleged failure of certain of our products have resulted in, and in the future could result in, claims against our Company for product liability, including property damage, personal injury damage, wrongful death, pollution and other environmental damage, and consequential damages. These risks may expose our clients to liability. If our clients suffer damages as a result of the occurrence of such events, they may reduce their business with us. Further, we may be subject to potentially material liabilities relating to claims alleging personal injury as a result of hazardous substances incorporated into our products. Furthermore, a claim could be made for the adverse consequences of environmental contamination under various regulations. Such claims could have an adverse affect on our business, operations and cash flow.

 

Third parties may infringe our intellectual property or we may infringe the intellectual property of third parties, and we may expend significant resources enforcing or defending our rights or suffer competitive injury.

 

Our success depends in part on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. If we fail to successfully enforce our intellectual property rights, our competitive position could suffer, which could harm our operating results. We may be required to spend significant resources to monitor and police our intellectual property rights. Similarly, if we were to infringe on the intellectual property rights of others, our competitive position could suffer. Furthermore, we cannot assure you that any pending patent application or trademark application held by us will result in an issued patent or registered trademark, or that any issued or registered patents or trademarks will not be challenged, invalidated, circumvented or rendered unenforceable. Also, others may develop technologies that are similar or superior to our technology, duplicate or reverse engineer our technology or design around the patents owned or licensed by us.

 

Litigation may be necessary to enforce our intellectual property rights and protect our proprietary information, or to defend against claims by third parties that our products infringe their intellectual property rights. Any litigation or claims brought by or against us, whether with or without merit, or whether successful or not, could result in substantial costs and diversion of our resources, which could have a material adverse effect on our business, financial condition or results of operations. Any intellectual property litigation or claims against us could result in the loss or compromise of our intellectual property and proprietary rights, subject us to significant liabilities, require us to seek licenses on unfavorable terms, prevent us from manufacturing or selling products and require us to redesign or, in the case of trademark claims, rename our products, any of which could have a material and adverse effect on our business, financial condition and results of operations.

 

Our business may be adversely affected if we encounter difficulties as we implement an Oracle based information management system.

 

We are in the process of implementing an Oracle based information management system across our worldwide operations. We have implemented the system in part at our LeHavre, Burlington and Bielefeld facilities and our domestic field service operations and have started implementation in the rest of our North American manufacturing facilities and repair centers. Although the transition to date has proceeded without any material adverse effects, a

disruption in the implementation or the related procedures or controls could adversely affect both our internal and disclosure controls and harm our business, including our ability to forecast or make sales, manage our supply chain and coordinate production. Moreover, such a disruption could result in unanticipated costs or expenditures and a diversion of management’s attention and resources.

 

Our brand name may be subject to confusion.

 

Our Company’s name and principal mark is a combination of the names of our founder companies, Dresser Industries, Inc. and Ingersoll Rand. We have acquired rights to use the “Rand” portion of our principal mark from Ingersoll Rand, and the rights to use the “Dresser” portion of our name from Dresser, Inc., the successor of Dresser Industries, Inc. If we lose the right to use either the “Dresser” or “Rand” portion of our name, our ability to build our brand identity could be negatively affected.

 

We require a significant amount of cash to operate our business and to service our indebtedness. Our ability to generate cash and access capital on reasonable terms and conditions depends on many factors beyond our control.

 

Our ability to make payments on and to refinance our debt, and to fund planned capital expenditures and research and development efforts, will depend on our ability to generate cash and to access capital. Our ability to generate cash is subject to economic, financial, competitive, legislative, regulatory and other factors that may be beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our restated senior secured credit facility or otherwise in an amount sufficient to enable us to pay our debt, or to fund our other liquidity needs. We may need to refinance all or a portion of our debt on or before maturity. We might be unable to access the full amount of borrowings available under our restated senior secured credit facility, which depends in part on the financial condition of the financial institutions participating in our credit facility. We might be unable to refinance any of our debt, including our restated senior secured credit facility or our senior subordinated notes, on commercially reasonable terms.

 

The covenants in our restated senior secured credit facility and the indenture governing our senior subordinated notes impose restrictions that may limit our operating and financial flexibility.

 

Our restated senior secured credit facility and the indenture governing our senior subordinated notes contain a number of significant restrictions and covenants that limit our ability to:

 

 

The restated senior secured credit facility also requires us to comply with specified financial ratios and tests, including but not limited to, a maximum consolidated net leverage ratio and a minimum consolidated interest coverage ratio. The indenture governing our senior subordinated notes also contains restrictions on dividends or other payments to us by our restricted subsidiaries.

 

These covenants could have a material adverse affect on our ability to finance our future operations or capital needs. Furthermore, they may restrict our ability to expand, pursue our business strategies and otherwise conduct our business. Our ability to comply with these covenants may be affected by circumstances and events beyond our control, such as economic conditions and changes in regulations, and we cannot be sure that we will be able to comply. A breach of these covenants could result in a default under the indenture governing our senior subordinated notes and/or the restated senior secured credit facility. If there were an event of default under the indenture governing our senior

subordinated notes and/or the restated senior secured credit facility, the affected creditors could cause all amounts borrowed under these instruments to be due and payable immediately. Additionally, if we fail to repay indebtedness under our restated senior secured credit facility when it becomes due, the lenders under the restated senior secured credit facility could proceed against the assets and capital stock which we have pledged to them as security. Our assets and cash flow might not be sufficient to repay our outstanding debt in the event of a default.

 

Our pension expenses and funding requirements are affected by factors outside our control, including the performance of plan assets, interest rates, actuarial data and experience and changes in laws and regulations.

 

Our future funding obligations for our U.S. defined benefit pension plans qualified with the Internal Revenue Service depend upon the level of benefits provided by the plans, the future performance of assets set aside in trusts for these plans, the level of interest rates used to determine funding levels, actuarial experience and changes in government laws and regulations. If the market value of securities held by the plan trusts declines, our pension expense would increase and, as a result, could adversely affect our financial results. Decreases in interest rates that are not offset by contributions and asset returns could also increase our obligation under such plans. Such factors and the statutory funding requirements of various countries in which we sponsor pension plans may legally require us to make contributions to our pension plans in the future, and those contributions could be material. In addition, if local authorities increase the minimum funding requirements for our pension plans, we could be required to contribute more funds, which would negatively affect our cash flow.

 

We have reported material weaknesses in our internal controls over financial reporting in prior years.

 

We reported material weaknesses in internal control over financial reporting in our Annual Report on Form 10-K for the year ended December 31, 2006. Those material weaknesses were remediated as of December 31, 2007. A description of the material weaknesses is included in Item 9A. Controls and Procedures, in our Annual Report on Form 10-K for the year ended December 31, 2006.

 

While the remedial measures we have taken were effective in sustaining the remediation of all previously identified material weaknesses in our internal control over financial reporting, deficiencies might arise in the future that could, among other things, cause us to fail to timely file our periodic reports with the SEC and require us to incur additional costs and divert management resources. Errors in our financial statements could require a restatement or prevent us from timely filing our periodic reports with the SEC. Additionally, should we subsequently encounter weaknesses in our internal control over financial reporting, investors could lose confidence in our reported financial information, which could have a negative effect on the price of our securities.

 

The market price of our common stock may be volatile.

 

Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions, could reduce the market price of our publicly traded securities in spite of our operating performance. In addition, our operating results could be below the expectations of securities analysts and investors, and in response, the market price of our securities could decrease significantly. Among other factors that could affect the price of our securities are:

 

 

In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and a diversion of management attention and resources, which could significantly harm our profitability and reputation.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law may discourage a takeover attempt.

 

Provisions contained in our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law could make it more difficult for a third party to acquire us. Provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our amended and restated certificate of incorporation authorizes our board of directors to determine the rights, preferences, privileges and restrictions of unissued series of preferred stock, without any vote or action by our stockholders. Thus, our board of directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our common stock. These rights may have the effect of delaying or deterring a change of control of our Company. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock.

 

 

None

 

 

Our corporate headquarters is located in Houston, Texas. The following table describes the material facilities owned or leased by us and our subsidiaries as of December 31, 2009.

 

 

 

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. We are indemnified by our former owner, Ingersoll Rand Company Limited, for certain of these matters as part of Ingersoll Rand’s sale of the Company. While adverse decisions in certain of these litigation matters, claims and administrative proceedings could have a material effect on a particular period’s results of operations, subject to the uncertainties inherent in estimating future costs for contingent liabilities and the benefit of the indemnity from Ingersoll Rand, management believes that any future accruals, with respect to these currently known contingencies, would not have a material effect on the financial condition, liquidity or cash flows of the Company.

 

Of the litigation pending, two separate tort claims have been brought against the Company and others in 2008, with one brought in the Court of Queens Bench Alberta, Judicial District of Calgary, Canada by Talisman Energy Inc. and others and one brought in the Prakhanong Provincial court, Thailand by Kaona Power Supply Co. Ltd., alleging, among other matters, defects and negligence in connection with the manufacture, testing, installation and commissioning of certain new units and claiming damages in the aggregate of approximately $30.0 plus pre-judgment interest and costs, although the evidence currently does not support damage claims in excess of $16.0. While damages are a possibility, the Company shall vigorously defend these lawsuits, including by asserting its contractual limitation of

liability and agreement to exclude consequential damages. Moreover, the Company is asserting rights it believes it has to insurance coverage with respect to these two claims.

 

In November of 2007, Local 313 of IUE-CWA, the union that represents certain employees at the Company’s Painted Post facility (the “IUE”) made an offer to have its striking members return to work under the terms of the previously expired union agreement. The Company rejected that offer and a lockout of the represented employees commenced. Approximately one week later, after reaching an impasse in negotiations, the Company exercised it’s right to implement the terms of its last contract offer, ended the lockout, and the employees represented by the IUE agreed to return to work under the implemented terms. Subsequently, the IUE filed several unfair labor practice (“ULP”) charges against the Company with Region 3 of the National Labor Relations Board (“NLRB”), asserting multiple allegations arising from the protracted labor dispute, its termination, contract negotiations and related matters.

 

Region 3 of the NLRB decided to proceed to complaint on only one-third of the ULP allegations asserted by the IUE, while the remaining claims were dismissed. Notably, the NLRB found that many of the critical aspects of the Company’s negotiations with the IUE were handled appropriately, including, the NLRB’s findings that the Union’s strike was not an unfair labor practice strike and the Company’s declaration of impasse and its unilateral implementation of its last offer were lawful.

 

The claims that proceeded to complaint before the NLRB included the Company’s handling of the one week lockout, the negotiation of the recall process used to return employees to the facility after reaching impasse and lifting the lockout, and the termination of two employees who engaged in misconduct on the picket line during the strike. The trial of this matter took place before a NLRB Administrative Law Judge (the “ALJ”) in Elmira and Painted Post, N.Y. during the summer of 2009. On January 29, 2010, the ALJ issued a decision in an administrative hearing which found in favor of the union on some issues and upheld the Company’s position on others. The Company continues to believe it complied with the law with respect to these allegations. While management believes it should ultimately prevail with respect to these ULP allegations, several levels of appeal may be necessary. The Company anticipates that any impact arising from the ULPs will not have a material adverse effect on the Company’s financial condition. The litigation process, including appeals if elected by either party, could reasonably take 3 to 5 years and potentially even longer to resolve with finality.

 

During the three months ended September 30, 2009, the Company received notification from the current plan trustees of one of its subsidiaries’ pension plans in the United Kingdom that sex equalization under the plan may have been achieved later than originally expected. The third-party trustee at the time action was taken believes that it had taken the appropriate steps to properly amend the plan as originally expected. The Company has accrued $4.9 to address contingent exposure regarding this dispute related to a period in the 1990’s over potential unequal treatment of men and women under the pension plan and is exploring its rights against others.

 

 

No matters were submitted to a vote of security holders during the three months ended December 31, 2009.

 

 

The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock reported in the New York Stock Exchange consolidated tape under the symbol “DRC”.

 

 

As of February 22, 2010, there were 15 holders of record of our common stock. By including persons holding shares in broker accounts under street names, however, we estimate our stockholder base to be approximately 31,883 as of February 22, 2010.

 

We do not currently have plans to pay any cash dividends on our common stock, and instead intend to retain earnings, if any, for future operations and acquisitions. At December 31, 2009, the amount available to us to pay cash dividends under the more restrictive covenants of our restated senior secured credit facility and our indenture governing the senior subordinated notes is limited to 5% of the proceeds from any public offering of stock since October 29, 2004. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions, business outlook and other factors that our board of directors may deem relevant.

 

Issuer Purchases of Equity Securities

 

The following table contains information about repurchases of our common stock during the three months ended December 31, 2009:

 

 

 

 

Performance Graph

 

The following is a line graph comparing the Company’s cumulative, total stockholder return with a general market index (the S&P 500) and the PHLX Oil Service Sector Index (OSX) of 15 companies in the oil service sector. The selected indices are accessible to our stockholders in newspapers, the internet and other readily available sources. This graph assumes a $100 investment in each of Dresser-Rand Group Inc., the S&P 500 and the PHLX Oil Service Sector Index at the close of trading on August 5, 2005, the date of our initial public offering, and also assumes the reinvestment of all dividends.

 

Comparison of Cumulative Total Return

 

 

 

This Performance Graph shall not be deemed to be incorporated by reference into our SEC filing and should not constitute soliciting material or otherwise be considered filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

 

The following selected financial information as of and for the periods indicated has been derived from our audited consolidated or combined financial statements. You should read the following information together with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the notes thereto included in Item 15 of this Form 10-K.

 

 

 

 

 

 

“Safe Harbor” Statement Under Private Securities Litigation Reform Act of 1995

 

This Form 10-K 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-K, the words “anticipates,” “believes,” “estimates,” “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:

 

 

Our actual results, performance or achievements could differ materially from those expressed in, or implied by, the forward-looking statements. We can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them does, what the impact would be on our results of operations and financial condition. We undertake no obligation to update or revise forward-looking statements which may be made to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events. Further discussion of these and other risk considerations is provided in Item 1A, Risk Factors, in this Form 10-K.

 

Overview

 

We are among the largest global suppliers of custom-engineered rotating equipment solutions for long-life critical applications in the worldwide oil, gas, petrochemical and industrial process industries. Our services and products are used for a wide 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, and distributed power and government markets. In addition, see Item 1, Business, in this Form 10-K for a description of the markets we serve.

 

We operate globally with manufacturing facilities in the United States, France, United Kingdom, Germany, Norway, China and India. We provide a wide array of products and services to our worldwide client base in over 140 countries from our global locations (65 sales offices, 37 service centers and 12 major manufacturing locations) in 18

U.S. states and 29 countries. For the year ended December 31, 2009, our revenue by geographic region consisted of North America 38%, Europe 19%, Asia Pacific 17%, Middle East and Africa 16% and Latin America 10%. Our total combined revenues by geographic region for the year ended December 31, 2008, consisted of North America 41%, Europe 25%, Asia Pacific 12%, Middle East and Africa 11% and Latin America 11%.

 

Corporate History

 

Dresser-Rand has been serving the energy markets since 1840. For nearly 170 years, the Company has been able to build on the legacy of innovation and technology from 18 companies that include many of the most respected names in the industry — Dresser-Clark, Ingersoll Rand, Worthington, Turbodyne, Terry, Nadrowski, Coppus, Murray, Gimpel, Peter Brotherhood, Arrow Industries, Enginuity and Compression Renewal Services. During that time, we have amassed the largest installed base of equipment in our class that would be very difficult for competitors to replicate.

 

On December 31, 1986, Dresser Industries, Inc. and Ingersoll Rand (collectively, the partners) entered into a partnership agreement for the formation of Dresser-Rand Company, a New York general partnership owned 50% by Dresser Industries, Inc. and 50% by Ingersoll Rand. The partners contributed substantially all of the operating assets and certain related liabilities, which comprised their worldwide reciprocating compressor, steam turbine and turbo-machinery businesses. The net assets contributed by the partners were recorded by Dresser-Rand Company at amounts approximating their historical values. Dresser-Rand Company commenced operations on January 1, 1987. On October 1, 1992, Dresser Industries, Inc. acquired a 1% equity interest from Dresser-Rand Company to increase its ownership to 51% of Dresser-Rand Company. In September 1999, Dresser Industries, Inc. merged with Halliburton Industries. Accordingly, Dresser Industries, Inc.’s ownership interest in Dresser-Rand Company transferred to Halliburton Industries on that date. On February 2, 2000, a wholly-owned subsidiary of Ingersoll Rand purchased Halliburton Industries’ 51% interest in Dresser-Rand Company for a net purchase price of approximately $543.

 

On August 25, 2004, Dresser-Rand Holdings, LLC, an affiliate of First Reserve, entered into an equity purchase agreement with Ingersoll Rand (the “Acquisition”) to purchase all of the equity interests in the Dresser-Rand Entities for $1,130. The Acquisition closed on October 29, 2004. In October 2004, Dresser-Rand Group Inc. a Delaware corporation was formed.

 

On August 4, 2005, Dresser-Rand Group Inc. completed its initial public offering of common stock at $21.00 per share. The common stock trades on the New York Stock Exchange under the symbol “DRC.” During 2006 and 2007, there were three secondary sales of the Company’s stock by D-R Interholding, LLC, an affiliate of First Reserve Corporation. D-R Interholding LLC subsequently sold its entire interest in Dresser-Rand Group Inc.

 

Basis of Presentation

 

The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of Dresser-Rand Group Inc. and its consolidated subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Unless the context otherwise indicates, the terms “we”, “our”, “us”, the “Company” and similar terms, refer to Dresser-Rand Group Inc. and its consolidated subsidiaries.

 

Effects of Currency Fluctuations

 

We conduct operations in over 140 countries. Therefore, our results of operations are subject to both currency transaction risk and currency translation risk. We incur currency transaction risk whenever we or our subsidiaries enter into a large purchase or a large sales transaction using a currency other than the functional currency of the transacting entity. With respect to currency translation risk, our financial condition and results of operations are measured and recorded in the relevant functional currency and then translated into U.S. dollars for inclusion in our consolidated financial statements. Exchange rates between these currencies and U.S. dollars in recent years have fluctuated significantly and may continue to do so in the future. The most significant component of our revenues and costs are denominated in U.S. dollars. Euro-related revenues and costs are also significant. Historically, we have engaged in hedging strategies from time to time to reduce the effect of currency fluctuations on specific transactions. However, we have not sought to hedge currency translation risk. We expect to continue to engage in hedging strategies going forward, but have not attempted to qualify for hedge accounting treatment during 2009, 2008 or 2007. Significant declines in the value of the euro relative to the U.S. dollar could have a material adverse effect on our financial condition and results of operations.

 

Included in our cash balance of $223.2 reported at December 31, 2009, was $22.4 million denominated in Venezuelan bolivars. The balance is primarily a result of favorable operating cash flows in Venezuela. Due to

government restrictions on transfers of cash out of the country and control of exchange rates, we can not immediately convert the cash at the official exchange rate at December 31, 2009. We have various applications to convert bolivars in order to transfer approximately $17.1 million of such amount out of the country, but have experienced substantial delays in obtaining the necessary approvals, and in some cases rejections of our applications. Consequently, approximately $3.1 million of our cash in Venezuela has been translated to U.S. dollars at December 31, 2009, at an effective exchange rate that is approximately 65% less favorable than the official rate (“Parallel Rate”) which resulted in a foreign exchange loss in our Consolidated Income Statement of approximately $5.6 million for the year ended December 31, 2009. Separately, we may from time to time convert additional cash from Venezuela, but without going through the application process, would only currently be able to do so at the Parallel Rate. This would result in us having fewer U.S. dollars than currently reported as a component of cash and cash equivalents on our Consolidated Balance Sheet with the difference recorded as a foreign exchange loss in our Consolidated Income Statement.

 

On occasion, the Venezuelan government has also devalued the bolivar, including a recent devaluation on January 8, 2010. As a result of this most recent devaluation, the Company recorded a foreign exchange loss in our Consolidated Income Statement of approximately $13.6 million and a reduction in our aftermarket backlog of approximately $1.1 million in January 2010. It is not possible to estimate the impact on U.S. dollar backlog resulting from Venezuelan clients’ inability to fund previously booked projects as a result of the devaluation.

 

Revenues

 

Our revenues are primarily generated through the sale of new units and aftermarket parts and services. Revenues are recognized as described in Note 2, Summary of Significant Accounting Policies, in our Notes to Consolidated Financial Statements.

 

Cost of Sales

 

Cost of sales includes raw materials, facility related employee and overhead costs, freight and warehousing, and product engineering.

 

Selling and Administrative Expenses

 

Selling expenses consist of costs associated with marketing and sales. Administrative expenses are primarily management, accounting, corporate expenses and legal costs.

 

Research and Development Expenses

 

Research and development expenses include payroll, employee benefits, and other labor related costs, facilities, workstations and software costs associated with product development. These costs are expensed as incurred. Expenses for major projects are carefully evaluated to manage return on investment requirements. We expect that our research and development spending will be at least in line with 2009 levels.

 

Other (Expense) Income

 

Other (expense) income includes those items that are non-operating in nature. Examples of items reported as other (expense) income are equity in earnings of certain 50% or less owned affiliates, casualty losses, certain government grants and the impact of currency exchange fluctuations.

 

Depreciation and Amortization

 

Property, plant and equipment is reported at cost less accumulated depreciation, which is generally provided using the straight-line method over the estimated useful lives of the assets. Expenditures for improvements that extend the life of the asset are generally capitalized. Intangible assets primarily consist of amounts allocated to customer relationships, software and technology, trade names and other intangibles. All of the intangible assets are generally amortized using the straight-line method over their estimated useful lives.

 

Bookings and Backlog

 

New Units

 

Bookings represent firm orders placed for specific scope of supply during the period, whether or not filled. The elapsed time from booking to completion of performance is typically six to fifteen months (longer for less frequent major projects). The backlog of unfilled orders includes amounts based on signed contracts as well as agreed letters of

authorization which management has determined are likely to be performed. Although backlog represents business that is considered firm, cancellations or scope adjustments may occur. In certain cases, cancellation of a contract provides us with the opportunity to bill for certain incurred costs and penalties. Backlog is adjusted to reflect currency exchange rates as of the date the backlog is reported. Bookings are adjusted to reflect cancellations and revised scope.

 

Aftermarket Parts and Services

 

Bookings represent firm orders placed for specific scope of supply during the period, whether or not filled. Backlog primarily consists of unfilled parts orders and open repair and field service orders. The elapsed time from order entry to completion can be one day to 12 months depending on the complexity of the order. Backlog is adjusted to reflect currency exchange rates as of the date the backlog is reported. Bookings are adjusted to reflect cancellations and revised scope.

 

Letters of Credit, Bank Guarantees and Surety Bonds

 

In the ordinary course of our business, we make use of letters of credit, bank guarantees and surety bonds. We use both performance bonds, ensuring the performance of our obligations under various contracts to which we are a party, and advance payment bonds, which ensure that clients that place purchase orders with us and make advance payments under such contracts are reimbursed to the extent we fail to deliver under the contract. Under the revolving portion of our amended and restated senior secured credit facility, we are entitled to have up to $500 of letters of credit outstanding at any time, subject to certain conditions.

 

Results of Operations

 

Year ended December 31, 2009, compared to the year ended December 31, 2008

 

 

Total revenues.  The adverse economic conditions and the downturn in the oil and gas markets in late 2008 and 2009 adversely affected new unit bookings which is expected to result in lower new unit sales in 2010. This downturn, however, did not have a negative impact on 2009 sales because of significant backlog in the beginning of 2009 and long lead times in our new unit segment. In addition, our aftermarket parts and services segment is less cycle sensitive than the new units segment. Total revenues were $2,289.6 for the year ended December 31, 2009, compared to $2,194.7 for the year ended December 31, 2008. This is a $94.9, or 4.3% increase. The highly engineered nature of our worldwide products and services does not easily lend itself to measuring the impact of price, volume and mix on changes in our total revenues from year to year. Nevertheless, based on factors such as measures of labor hours and purchases from suppliers, revenues increased as a result of normal price increases and higher volume in 2009. The segments remained relatively consistent as a percentage of revenues when compared to 2008.

 

Cost of sales.  Cost of sales was $1,632.1 for the year ended December 31, 2009, compared to $1,576.1 for the year ended December 31, 2008. As a percentage of revenues, cost of sales decreased to 71.3% for 2009 compared to 71.8% for

2008. The decrease in cost of sales as a percentage of revenue was primarily due to productivity improvements partly mitigated by an unfavorable mix and a non-recurring accrual related to a potential pension adjustment in the United Kingdom of $4.9.

 

Gross profit.  Gross profit was $657.5, or 28.7% of revenues for the year ended December 31, 2009, compared to $618.6, or 28.2% of revenues for the year ended December 31, 2008. We experienced increased margins due to the factors discussed above.

 

Selling and administrative expenses.  Selling and administrative expenses were $287.3 for the year ended December 31, 2009, compared to $273.8 for the year ended December 31, 2008. Selling and administrative expenses were 12.5% as a percentage of revenues for both years ended December 31, 2009, and 2008 respectively.

 

Research and development expenses.  Total research and development expenses for the year ended December 31, 2009 were $20.3, compared to $12.7 for the year ended December 31, 2008. Research and development expenses increased significantly in 2009 as a result of executing our strategy to introduce new and innovative products and technologies. The formation of a Technology and Business Development organization in January 2009 further accelerated investment on key new product development initiatives for Integrated Compression Systems (ICS), Liquid Natural Gas (LNG) and gas turbines, as well as, expanding the annual portfolio of projects focused on product enhancements. We expect our research and development spending to be at least in line with 2009 levels.

 

Curtailment amendment/partial settlement.  In connection with a collective bargaining agreement ratified by our represented employees at our Olean, NY, facility on March 31, 2008, certain changes were made to retiree medical benefits for employees covered by the agreement. Employees who did not meet certain age and service criteria on April 1, 2008, were paid a lump sum totaling $6.4 in May 2008 calculated based on years of service in lieu of receiving future retiree medical benefits, resulting in a curtailment amendment. The retiree medical benefits for those employees who met certain age and service criteria were amended to provide certain additional benefits. The net effect of these amendments of $3.6 was recognized during the three months ended March 31, 2008, as a credit to other comprehensive income, which is being amortized into the statement of income over the three-year term of the agreement. The above changes were in addition to the elimination of prescription drug benefits effective February 1, 2007, for Medicare-eligible participants for the represented employees at our Olean, NY, facility. That amendment was recognized during the three months ended March 31, 2007, in other comprehensive income and resulted in negative prior service cost. The Company recognized a $7.2 curtailment amendment in the statement of income for the three months ended March 31, 2008, representing the unamortized balance of the 2007 plan amendment at that date, because no future service is required to be entitled to benefits. Also, under accounting principles generally accepted in the United States of America, the payment of the $6.4 lump sum in May 2008 was considered a partial settlement that required the Company to recognize approximately $1.8 of net actuarial losses in the statement of income for the three months ended June 30, 2008, that were previously included in accumulated other comprehensive income. The net amounts related to changes in retiree medical benefits for these represented employees of $5.4 was recognized in the statement of income for the year ended December 31, 2008. As a result of this and other prior amendments, cost of sales in 2008 includes a credit related to our pension and post-retirement benefits of $6.8 compared to expense of $8.2 in 2009. Additionally, we did not recognize deferred actuarial losses of $82.3 in 2008 and $2.3 in 2009 in our statement of income. These deferred actuarial losses have been recorded in accumulated other comprehensive income (loss).

 

Operating income.  Operating income was $348.6 for the year ended December 31, 2009, compared to $337.5 for the year ended December 31, 2008. The $11.1 increase was attributed to higher gross profit partially offset by increased research and development expenses and higher selling and administrative expenses. As a percentage of revenues, operating income remained relatively consistent at 15.2% for 2009 compared to 15.3% for 2008.

 

Interest expense, net.  Interest expense, net was $31.8 for the year ended December 31, 2009, compared to $29.4 for the year ended December 31, 2008, including $3.2 of amortization of deferred financing costs for 2009 and $3.1 for 2008. We experienced lower interest income in the year ended December 31, 2009 resulting from lower interest bearing cash balances and lower interest rates.

 

Other expense, net.  Other expense, net was $4.9 for the year ended December 31, 2009, compared to $6.8 for the year ended December 31, 2008. Net currency losses were $3.8 in 2009 and $6.5 in 2008. Due to government restrictions on transfers of cash out of Venezuela and control of exchange rates, we can not immediately convert a portion of the cash at the official exchange rate at December 31, 2009. We have various applications to convert bolivars in order to transfer approximately $17.1 of such amount out of the country, but have experienced substantial delays in obtaining the necessary approvals, and in some cases rejections of our applications. Consequently, approximately $3.1 of our cash in Venezuela has been translated to U.S. dollars at the Parallel Rate, which resulted in a foreign exchange loss in our Consolidated Income Statement of approximately $5.6 for the year ended December 31, 2009.

On occasion, the Venezuelan government has devalued the bolivar, including a recent devaluation on January 8, 2010. As a result of this most recent devaluation, the Company recorded a foreign exchange loss in our Consolidated Income Statement of approximately $13.6 million.

 

Provision for income taxes.  Provision for income taxes was $101.1 for the year ended December 31, 2009, and $103.6 for the year ended December 31, 2008. The effective tax rate for 2009 was 32.4% compared to 34.4% for 2008. Our estimated income tax provision for the year ended December 31, 2009 and 2008, results in an effective rate that differs from the U.S. Federal statutory rate of 35% principally because of different tax rates in foreign tax jurisdictions and certain deductions and credits allowable for income tax purposes partially offset by state and local income taxes and valuation allowances on net operating loss carryforwards that more likely than not will not be realized. We will adjust valuation allowances in the future when it becomes more likely than not that the benefits of deferred tax assets will be realized. During the three months ended September 30, 2009, we executed a corporate restructuring to facilitate our global cash management. In connection with the restructuring, we experienced a tax benefit in certain foreign tax jurisdictions which reduced our effective tax rate by approximately 2.0 percentage points for the year ended December 31, 2009. We anticipate that the reorganization will result in an ongoing reduction in our tax rate of approximately 1.5%. The previously discussed devaluation of the bolivar in January 2010 will not result in a tax benefit and is expected to increase our effective tax rate by approximately 1.9% for the year ended December 31, 2010.

 

Bookings and backlog.  Bookings for the year ended December 31, 2009, decreased to $1,661.5 from $2,523.3 for the year ended December 31, 2008. The backlog decreased to $1,711.7 at December 31, 2009, from $2,251.5 at December 31, 2008. The recent adverse economic conditions and the downturn in the oil and gas markets in 2009 adversely affected new unit bookings which will result in lower new unit sales in 2010. These new unit bookings in 2009 reflected the ongoing project delays that we experienced throughout the first nine months of 2009. At December 31, 2009, approximately 73% of the $1,711.7 backlog was scheduled to ship in 2010.

 

The devaluation of the Venezuelan bolivar that occurred on January 8, 2010, is expected to reduce our aftermarket backlog by approximately $1.1 in the three months ended March 31, 2010. It is not possible to estimate the impact on U.S. dollar backlog resulting from Venezuelan clients’ inability to fund previously booked projects as a result of the devaluation.

 

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 and assets that cannot be assigned directly to either reportable segment because of their nature. Unallocable expenses include corporate expenses, research and development expenses, and curtailment amendment amortization.

Segment Analysis — year ended December 31, 2009, compared to year ended December 31, 2008

 

 

New Units

 

Revenues.  The adverse economic conditions and the downturn in the oil and gas markets in late 2008 and 2009 adversely affected new unit bookings which is expected to result in lower new unit sales in 2010. This downturn, however, did not have a negative impact on 2009 sales. Revenues for this segment were $1,258.8 for the year ended December 31, 2009, compared to $1,202.7 for the year ended December 31, 2008. The $56.1, or 4.7% increase was attributable principally to significant backlog in the beginning of 2009 and long lead times as well as the realization of prior period price increases and increased volume.

 

Gross profit.  Gross profit was $262.9 for the year ended December 31, 2009, compared to $217.2 for the year ended December 31, 2008. Gross profit, as a percentage of segment revenues, was 20.9% for 2009 compared to 18.1% for 2008. Gross profit as a percentage of revenues increased as a result of cost and productivity improvements, partly mitigated by unfavorable mix within the new unit segment and the allocation of a non-recurring accrual related to a potential pension adjustment in the United Kingdom of $2.8 for the year ended December 31, 2009.

 

Operating income.  Operating income was $169.0 for the year ended December 31, 2009, compared to $131.9 for the year ended December 31, 2008. As a percentage of segment revenues, operating income was 13.4% for 2009 compared to 11.0% for 2008. Both increases were due to the factors discussed above.

 

Bookings and Backlog.  New unit bookings for the year ended December 31, 2009, decreased to $727.2, compared to $1,429.3 for the year ended December 31, 2008. The adverse economic conditions and the downturn in the oil and gas markets in 2009 adversely affected new unit bookings which will result in lower new unit sales in 2010. These new unit bookings in 2009 reflected the ongoing project delays that we experienced throughout the first nine months of 2009. While it is difficult to accurately predict whether the environment will worsen or improve, we believe that the decline is the result of a temporary delay in the placement of orders rather than the cancellation of projects. Backlog was $1,370.8 at December 31, 2009, compared to $1,830.5 at December 31, 2008.

Aftermarket Parts and Services

 

Revenues.  Revenues for this segment were $1,030.8 for the year ended December 31, 2009, compared to $992.0 for the year ended December 31, 2008. The increase in revenues was primarily the result of the realization of prior period price increases and increased volume.

 

Gross profit.  Gross profit was $394.6 for the year ended December 31, 2009, compared to $401.4 for the year ended December 31, 2008. Gross profit, as a percentage of segment revenues was 38.3% for 2009 compared to 40.5% for 2008. Gross profit as a percentage of revenues decreased primarily due to a less favorable mix within the aftermarket segment and the allocation of a non-recurring accrual related to a potential pension adjustment in the United Kingdom of $2.1, partially offset by improved pricing and cost and productivity improvements.

 

Operating income.  Operating income was $264.7 for the year ended December 31, 2009, compared to $276.7 for the year ended December 31, 2008. As a percentage of segment revenues, operating income was 25.7% for 2009 compared to 27.9% for 2008. The changes in operating income and operating income as a percentage of segment revenues have resulted principally for the reasons discussed above.

 

Bookings and backlog.  Bookings for the year ended December 31, 2009, were $934.3, compared to $1,094.0 for the year ended December 31, 2008. The decline in bookings in the aftermarket segment for the year ended December 31, 2009, has principally resulted from a significant decline in order flow from one national oil company client, unfavorable foreign exchange and reduced maintenance spending by our clients worldwide. Backlog was $340.9 for the year ended December 31, 2009, compared to $421.0 for the year ended December 31, 2008.

 

The devaluation of the Venezuelan bolivar that occurred on January 2010 is expected to reduce our aftermarket backlog by approximately $1.1 in the three months ended March 31, 2010.

 

Year ended December 31, 2008 compared to the year ended December 31, 2007

 

 

Total revenues.  During the first half of 2008, the energy market was very robust as the worldwide demand for and price of oil and gas was strong, which in turn caused very strong market conditions for our products and services. The decline in the oil and gas prices over the latter half of 2008 did not have a negative impact on 2008 revenues because of significant backlog, continued bookings of legacy projects, and long lead times in our new unit segment. In addition, our aftermarket parts and services segment provides us with a steady stream of recurring revenues. Total revenues were $2,194.7 for the year ended December 31, 2008, compared to $1,665.0 for the year ended December 31, 2007. This is a $529.7, or 31.8% increase. The highly engineered nature of our worldwide products and services does not easily lend itself to measuring the impact of price, volume and mix on changes in our total revenues from year to year. Nevertheless, based on factors such as measures of labor hours and purchases from suppliers, volume increased significantly during 2008 as we continued to expand in global markets. The New Units segment increased as a percentage of revenues while the Aftermarket parts and services segment decreased.

Cost of sales.  Cost of sales was $1,576.1 for the year ended December 31, 2008, compared to $1,216.1 for the year ended December 31, 2007. As a percentage of revenues, cost of sales decreased to 71.8% for 2008 compared to 73.0% for 2007. The decrease in cost of sales as a percentage of revenue was primarily due to the effects of the work stoppage at our Painted Post facility in 2007 as discussed below.

 

Gross profit.  Gross profit was $618.6, or 28.2% of revenues for the year ended December 31, 2008, compared to $448.9, or 27.0% of revenues for the year ended December 31, 2007. We experienced increased margins due to a variety of factors including higher revenue and a more favorable mix. In addition, 2007 was negatively impacted because the represented employees at our Painted Post facility imposed a work stoppage on August 3, 2007, at the conclusion of the existing collective bargaining agreement as we were unsuccessful in reaching a new agreement. The work stoppage continued through November 29, 2007, when we declared impasse. At that time, we implemented our last contract offer and the employees agreed to return to work. We estimate the work stoppage and related preparation costs reduced our gross profit for the year ended December 31, 2007, by approximately $34. In November 2009, the members of IUE-CWA Local 313, representing the workers at our Painted Post facility ratified a new labor agreement after working for nearly two years without a contract. The contract is effective November 9, 2009, through March 1, 2013. This matter is more fully discussed in Item 3 of Part I of this Form 10-K.

 

Selling and administrative expenses.  Selling and administrative expenses were $273.8 for the year ended December 31, 2008, compared to $239.0 for the year ended December 31, 2007. Selling and administrative expenses were 12.5% as a percentage of revenues for the year ended December 31, 2008, compared to 14.4% for 2007. The dollar increase in selling and administrative expenses reflects additional costs to support higher sales activity in 2008.

 

Research and development expenses.  Total research and development expenses for the year ended December 31, 2008 were $12.7, compared to $12.8 for the year ended December 31, 2007. Research and development expenses have remained consistent with 2007 and our 2008 planned spending.

 

Curtailment amendment/partial settlement.  In connection with a new collective bargaining agreement ratified by our represented employees at our Olean, NY, facility on March 31, 2008, certain changes were made to retiree medical benefits for employees covered by the agreement. Employees who did not meet certain age and service criteria on April 1, 2008, were paid a lump sum totaling, for all eligible employees, $6.4 in May 2008 calculated based on years of service in lieu of receiving future retiree medical benefits, resulting in a curtailment amendment. The above changes were in addition to the elimination of prescription drug benefits effective February 1, 2007, for Medicare eligible participants for the represented employees at our Olean, NY, facility. That amendment was recognized during the three months ended March 31, 2007, in other comprehensive income and resulted in negative prior service cost. Accounting principles generally accepted in the United States of America require a portion of any prior service cost recognized in other comprehensive income to be recognized in the statement of income when a curtailment occurs. Accordingly, the Company recognized a $7.2 curtailment amendment in the statement of income for the three months ended March 31, 2008, representing the unamortized balance of the 2007 plan amendment at that date, because no future service is required to be entitled to benefits. Also, under accounting principles generally accepted in the United States of America, the payment of the $6.4 lump sum in May 2008 was considered a partial settlement that required the Company to recognize approximately $1.8 of net actuarial losses included in accumulated other comprehensive income in the statement of income for the three months ended June 30, 2008. The net gain related to changes in retiree medical benefits for these represented employees of $5.4 was recognized in the statement of income for the year ended December 31, 2008. As a result of this and other prior amendments, cost of sales in 2008 includes a credit related to our pension and post retirement benefits of $6.8 compared to expense of $6.8 in 2007. Additionally, we did not recognize deferred actuarial losses of $82.3 in 2008 or deferred actuarial gains of $39.3 in 2007 in our statement of income. In accordance with SFAS No. 158, these deferred actuarial gains and losses have been recorded in accumulated other comprehensive income (loss).

 

Operating income.  Operating income was $337.5 for the year ended December 31, 2008, compared to $197.1 for the year ended December 31, 2007. The $140.4 increase was attributed to higher gross profit partially offset by increased selling and administration expense and the curtailment amendment/partial settlement as discussed above. As a percentage of revenues, operating income was 15.3% for 2008 compared to 11.8% for 2007.

 

Interest expense, net.  Interest expense, net was $29.4 for the year ended December 31, 2008, compared to $36.8 for the year ended December 31, 2007. Interest expense, net for 2007 included $6.9 in amortization of deferred financing costs, of which $3.7 was non-recurring accelerated amortization due to an early payment of $137.2 in long-term debt in 2007 and amending and restating our senior secured credit facility. The early payment resulted in a net decrease in interest of $1.9 from 2007 to 2008. Non-recurring interest related to the Maersk litigation totaling $2.2 as described in Note 15 to the Notes to Consolidated Financial Statements is also included in the amounts for 2007.

Other (expense) income, net.  Other expense, net was $6.8 for the year ended December 31, 2008, compared to other income, net of $7.3 for the year ended December 31, 2007. Net currency losses were $6.5 in 2008 and net currency gains were $5.5 in 2007. The 2007 results also included a $2.3 gain recorded on the sale of a minority investment in a small electricity generating facility.

 

Provision for income taxes.  Provision for income taxes was $103.6 for the year ended December 31, 2008, and $60.9 for the year ended December 31, 2007. The effective tax rate for 2008 was 34.4% compared to 36.3% for 2007. The 2008 rate is slightly lower than the 35% U.S. statutory rate principally because of lower tax rates in certain foreign tax jurisdictions and United States manufacturing and export deductions, partially offset by state and local income taxes and valuation allowances on net operating loss carryforwards that, more likely than not, will not be realized. We will adjust valuation allowances in the future when it becomes more likely than not that the benefits of deferred tax assets will be realized.

 

Bookings and backlog.  Bookings for the year ended December 31, 2008, increased to $2,523.3 from $2,194.7 for the year ended December 31, 2007. The backlog increased to $2,251.5 at December 31, 2008, from $1,859.3 at December 31, 2007. These increases were principally in the New Units segment. This increase reflects the strength of the markets during most of 2008.

 

Segment Analysis — year ended December 31, 2008 compared to year ended December 31, 2007

 

 

New Units

 

Revenues.  Revenues for this segment were $1,202.7 for the year ended December 31, 2008, compared to $813.5 for the year ended December 31, 2007. The $389.2, or 47.8% increase was attributable principally to continuing strong energy markets during most of 2008.

 

Gross profit.  Gross profit was $217.2 for the year ended December 31, 2008, compared to $127.2 for the year ended December 31, 2007. Gross profit, as a percentage of segment revenues, was 18.1% for 2008 compared to 15.6% for 2007. These increases were primarily attributable to lower margins in 2007. In 2007, the represented employees at our Painted Post facility imposed a work stoppage on August 3, 2007, at the conclusion of the existing collective bargaining

agreement as we were unsuccessful in reaching a new agreement. The work stoppage continued through November 29, 2007. We estimate the work stoppage reduced this segment’s gross profit for the year ended December 31, 2007, by approximately $14 to $15. In November 2009, the members of IUE-CWA Local 313, representing the workers at our Painted Post facility ratified a new labor agreement after working for nearly two years without a contract. The contract is effective November 9, 2009, through March 1, 2013. This matter is more fully discussed in Item 3 of Part I of this Form 10-K.

 

Operating income.  Operating income was $131.9 for the year ended December 31, 2008, compared to $56.4 for the year ended December 31, 2007. As a percentage of segment revenues, operating income was 11.0% for 2008 compared to 6.9% for 2007. Both increases were due to the factors cited above.

 

Bookings and Backlog.  Bookings for the year ended December 31, 2008, increased to $1,429.3, compared to $1,321.5 for the year ended December 31, 2007. Backlog increased to $1,830.5 at December 31, 2008, from $1,543.0 at December 31, 2007. These increases were primarily due to continued strength in the energy markets during most of 2008.

 

Aftermarket Parts and Services

 

Revenues.  Revenues for this segment were $992.0 for the year ended December 31, 2008, compared to $851.5 for the year ended December 31, 2007. This segment was adversely impacted by changes in the procurement process approval cycle and a delay in the budget appropriations for certain of our national oil company clients during 2007. The increase in revenues in 2008 reflected an improvement in these circumstances.

 

Gross profit.  Gross profit was $401.4 for the year ended December 31, 2008, compared to $321.7 for the year ended December 31, 2007. Gross profit, as a percentage of segment revenues was 40.5% for 2008 compared to 37.8% for 2007. These changes were attributed to a variety of factors including higher revenues and a more favorable mix. In addition, 2007 was negatively impacted because the represented employees at our Painted Post facility imposed a work stoppage on August 3, 2007, at the conclusion of the existing collective bargaining agreement as we were unsuccessful in reaching a new agreement. The work stoppage continued through November 29, 2007. We estimate the work stoppage reduced this segment’s gross profit for the year ended December 31, 2007 by approximately $19 to $20. In November 2009, the members of IUE-CWA Local 313, representing the workers at our Painted Post ratified a new labor agreement after working for nearly two years without a contract. The contract is effective November 9, 2009, through March 1, 2013. This matter is more fully discussed in Item 3 of Part I of this Form 10-K.

 

Operating income.  Operating income was $276.7 for the year ended December 31, 2008, compared to $213.8 for the year ended December 31, 2007. As a percentage of segment revenues, operating income was 27.9% for 2008 compared to 25.1% for 2007. The increase in the dollar amount and increase in percent of sales were due to the factors cited above.

 

Bookings and Backlog.  Bookings for the year ended December 31, 2008, were $1,094.0, compared to $873.2 for the year ended December 31, 2007. Backlog increased to $421.0 at December 31, 2008 from $316.3 at December 31, 2007. Aftermarket parts and services were adversely impacted in 2007, by changes in the procurement process approval cycle and a delay in the budget appropriations for certain national oil company clients. Bookings in 2008 reflect an improvement in this situation.

 

Liquidity and Capital Resources

 

Net cash provided by operating activities in the year ended December 31, 2009, was $129.8 compared to $234.8 for the year ended December 31, 2008. Although net income improved to $210.8 for the year ended December 31, 2009, from $197.7 for the year ended December 31, 2008, cash flows were negatively impacted by an increased investment in working capital. Accounts receivable declined in 2009 as a result of improved collections. The decrease in accounts receivable, however, was more than offset by lower progress and customer advance payments and lower accounts payable and accruals, which have resulted from lower bookings. Additionally, we made $28.0 of additional pension plan contributions in 2009 when compared to 2008 in accordance with our funding policy.

 

Net cash used in investing activities was $62.6 for the year ended December 31, 2009, compared to $136.3 for 2008. Capital expenditures of $41.1 in 2009 were comparable to capital expenditures of $40.2 in 2008. In 2009, cash used in investing activities included $12.7 related to the acquisition of Compressor Renewal Services Ltd. (“CRS”). Cash used in investing activities for the year ended December 31, 2008 included $91.4 related to the acquisitions of Peter Brotherhood Ltd., Enginuity LLC, and Arrow Industries, Inc., which included $5.1 of acquisitions costs. Additionally, in 2008, the Company entered into an agreement by which it acquired a non-controlling interest in Ramgen Power Systems, LLC (“Ramgen”), a privately held development stage company that is developing compressor technology that applies proven supersonic aircraft technology to ground-based air and gas compressors. In addition to receiving a non-controlling interest, the Company received an option to acquire the business of Ramgen at a price of $25.0 and a

royalty commitment, exercisable at any time through October 28, 2012. Pursuant to the agreement, an initial investment of $5.0 was made in November 2008, and our final contractually obligated investment of $5.0 was made in May 2009. The Company made an additional optional investment in November 2009 of $5.0. The agreement allows the Company to make additional optional investments of $9.0 through October 2012.

 

On January 22, 2010, we paid contingent consideration of $24.1 to the former owners of Peter Brotherhood Ltd in accordance with the purchase agreement. The payment has been accrued in the Consolidated Balance Sheet at December 31, 2009.

 

Net cash provided by financing activities was $1.9 for the year ended December 31, 2009, compared to net cash used in financing activities of $148.6 for 2008. During 2008, we repurchased 4,110,754 shares of our common stock for approximately $150 as part of a Board authorized repurchase plan.

 

As of December 31, 2009, we had cash and cash equivalents of $223.2 and the ability to borrow $332.2 under our $500 restated senior secured revolving credit facility, as $167.8 was used for letters of credit. In addition to these letters of credit, a total of $85.8 of letters of credit and bank guarantees were outstanding at December 31, 2009, which were issued by banks offering uncommitted lines of credit. 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 restated senior secured revolving credit facility will be adequate to meet our working capital, capital expenditures, interest payments and other funding requirements for the next 12 months and our long-term future contractual obligations.

 

The Venezuelan government has exchange controls and currency transfer restrictions that limit our ability to convert bolivars into U.S. dollars and transfer funds out of Venezuela, and we cannot assure you that our Venezuelan subsidiary will be able to convert bolivars to U.S. dollars to satisfy intercompany obligations. Included in our cash balance of $223.2 reported at December 31, 2009, was $22.4 denominated in Venezuelan bolívars. The balance is primarily a result of favorable operating cash flows in Venezuela. Due to the government restrictions on transfers of cash out of the country and control of exchange rates, we can not immediately convert a portion of the cash at the official exchange rate at December 31, 2009. We have applied to convert bolivars in order to transfer approximately $17.1 of such amount out of the country, but have experienced substantial delays in obtaining the necessary approvals, and in some cases, rejections of our applications. Consequently, approximately $3.1 of our cash in Venezuela has been translated to U.S. dollars at the Parallel Rate at December 31, 2009, which resulted in a foreign exchange loss in our Consolidated Income Statement of approximately $5.6 for the year ended December 31, 2009. Separately, we may from time to time convert the additional cash from Venezuela, but without going through the application process, would only currently be able to do so at the Parallel Rate. This would result in us having fewer U.S. dollars than currently reported as a component of cash and cash equivalents on our Consolidated Balance Sheet with the difference recorded as a foreign exchange loss in our Consolidated Income Statement.

 

We provide a range of benefits to employees and retired former employees, including pensions, postretirement, postemployment and healthcare benefits. In the aggregate, our pension plans at December 31, 2009, were underfunded by approximately $95.6. In order to comply with minimum funding requirements, we contributed approximately $37.4 to our funded plans worldwide in 2009 and currently project that we will contribute approximately $6.0 to our funded plans worldwide in 2010.

The asset allocations of the Company’s pension plans by asset category are as follows:

 

 

 

 

 

 

 

The Company’s investment objectives in managing its defined benefit plan assets are to provide reasonable assurance that present and future benefit obligations to all participants and beneficiaries are met as they become due; to provide a total return that, over the long-term, maximizes the ratio of the plan assets to liabilities, while minimizing the present value of required Company contributions at the appropriate levels of risk; and to meet any statutory requirements, laws and local regulatory agencies’ requirements. Key investment decisions involving asset allocations, investment manager structure, investment managers, investment advisors and trustees or custodians are reviewed regularly. An asset liability modeling study is used as the basis for aggregated asset allocation decisions and updated approximately every five years or as required. The Company’s current global asset allocation strategy for its pension plans is 60% in equity securities and 40% in debt securities and cash excluding those assets in non-US plans required by regulation to be in insurance contracts or other similar assets. The Company sets upper limits and lower limits of plus or minus 5%. The rebalancing strategy is reviewed quarterly if cash flows are not sufficient to rebalance the plans and appropriate action is taken to bring the plans within the strategic allocation ranges.

Contractual Obligations (€ in millions)

 

On December 28, 2007, the Company closed a €23 transaction, including a committed line of credit, that is being used to fund construction of a test bench facility (the “Facility”) at the Port of LeHavre, France for full load, full power testing of compressors powered by gas turbines and electric motors.

 

The Company is leasing the facility and 14 acres of land underlying the Facility under a lease (the “Lease”) under which the Company agreed to bear certain rights, obligations, and expenses related to the Facility and land. The Port of Le Havre owns the land and allows access for construction of the Facility and occupancy under the terms of a 30-year ground lease.

 

The Company is required to pay rent to the lessor during the initial base term of the Lease after construction is completed in an amount equal to the total of interest payable by the lessor on the outstanding principal amount of the debt incurred to construct the facility. Interest is generally determined by reference to the EURIBOR rate, plus an applicable margin of between 125 and 250 basis points.

 

The initial base term of the Lease expires in February 2015. At maturity, the Lease may either be terminated or extended subject to the mutual agreement of the parties. The Company may purchase the Facility at any time for the amount of the lessor’s debt outstanding, including upon maturity of the Lease. If the Lease is terminated upon maturity, the Company has guaranteed that the lessor will receive at least 80% of the cost of the Facility upon the sale of the Facility.

 

The Lease contains representations, warranties and covenants typical of such leases. Events of default in the Lease include, but are not limited to, certain payment defaults, certain bankruptcy and liquidation proceedings and the failure to observe or perform any covenants or agreements contained in the Lease. Any event of default could trigger acceleration of the Company’s payment obligations under the terms of the Lease.

 

The following is a summary of our significant future contractual obligations, including amounts relating to the above mentioned operating lease, by year as of December 31, 2009:

 

 

Critical Accounting Policies

 

Note 2, Summary of Significant Accounting Policies, in the Notes to Consolidated and Combined Financial Statements included in this Form 10-K, includes a summary of significant accounting policies and methods used in the preparation of the consolidated financial statements. The following summarizes what we believe are the critical accounting policies and methods we use:

 

Revenue recognition — We recognize revenue when it is realized or realizable and earned. We consider revenue realized or realizable and earned when we have persuasive evidence of an arrangement, delivery of the product or service has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. Delivery does not occur until products have been shipped or services have been provided to the client, risk of loss has transferred to the client and client acceptance has been obtained, client acceptance provisions have lapsed, or we have objective evidence that the criteria specified in the client acceptance provisions have been satisfied. The amount of revenue related to any contingency is not recognized until the contingency is resolved.

 

We enter into multiple-element revenue arrangements or contracts, which may include any combination of designing, developing, manufacturing, modifying, erecting and commissioning complex products to customer specifications and providing services related to the performance of such products. These contracts normally take between six and fifteen months to complete. The criteria described below are applied to determine whether and/or

how to separate multiple element revenue arrangements into separate units of accounting and how to allocate the arrangement consideration among those separate units of accounting:

 

 

Our sales arrangements do not include a general right of return of the delivered unit(s). If the above criteria are not met, the arrangement is accounted for as one unit of accounting which results in revenue being recognized when the last undelivered unit is delivered. If these criteria are met, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value. If, however, there is objective and reliable evidence of fair value of the undelivered unit(s) but no such evidence for the delivered unit(s), the residual method is used to allocate the arrangement consideration. Under the residual method, the amount of consideration allocated to the delivered unit(s) equals the total arrangement consideration less the aggregate fair value of the undelivered unit(s).

 

We are required to estimate the future costs that will be incurred related to sales arrangements to determine whether any arrangement will result in a loss. These costs include material, labor and overhead. Factors influencing these future costs include the availability of materials and skilled laborers.

 

Inventories — We purchase materials for the manufacture of components for use in both our new units and aftermarket parts and services segments. The decision to purchase a set quantity of a particular item is influenced by several factors including: current and projected cost; future estimated availability; existing and projected contracts to produce certain items; and the estimated needs for our aftermarket parts and services business. We value our inventory at the lower of cost or market value. We estimate the net realizable value of our inventories and establish reserves to reduce the carrying amount of these inventories to the lower of cost or market (net realizable value) as necessary.

 

Income Taxes — Our effective tax rate is based on income before income taxes and the tax rates applicable to that income in the various jurisdictions in which we operate. An estimated effective tax rate for the year is applied to the Company’s quarterly operating results. In the event that there is a significant unusual or discrete item recognized, or expected to be recognized, in the Company’s quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as the unusual or discrete item. We consider the resolution of prior tax matters to be such items. Significant judgment is required in determining our effective tax rate and in evaluating tax positions. We establish tax accruals for uncertain tax positions in accordance with ASC 740-10 (formally Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109). ASC 740-10 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. We adjust these accruals in light of changing facts and circumstances.

 

Tax regulations may require items of income and expense to be included in the tax return in different periods than items are reflected in the consolidated financial statements. As a result, the effective tax rate reflected in the consolidated financial statements may be different than the tax rate reported in the income tax return. Some of these differences are permanent, such as expenses that are not deductible on the tax return, and some are temporary differences, such as depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as tax deductions or credits in the tax return in future years for which we have already recorded the tax benefit in the consolidated financial statements. We establish valuation allowances for our deferred tax assets when it is more likely than not that the amount of expected future taxable income will not support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the consolidated financial statements for which the related tax payment has been deferred or an expense which we have already taken a deduction on the income tax return, but has not yet been recognized as expense in the consolidated financial statements.

 

Employee benefit plans — We provide a range of benefits to employees and retired former employees, including pensions, postretirement, postemployment and healthcare benefits. Determining the cost associated with such benefits is dependent on various actuarial assumptions, including discount rates, expected return on plan assets, compensation increases, employee mortality and turnover rates, and healthcare cost trend rates. Independent actuaries perform the required calculations to determine expense in accordance with accounting principles generally accepted in the United States of America. Actual results may differ from the actuarial assumptions and are generally accumulated and amortized over future periods. We review our actuarial assumptions at each measurement date and make modifications to the assumptions based on then current rates and trends if appropriate to do so. The discount rate, the rate of compensation increase and the expected long-term rates of return on plan assets are determined as of the measurement

date. The discount rate reflects a rate at which pension benefits could be effectively settled. The discount rate is established and based primarily on the yields of high quality fixed-income investments available and expected to be available during the period to maturity of the pension and postretirement benefits. We also review the yields reported by Moody’s on AA corporate bonds as of the measurement date. The rate of compensation increase is dependent on expected future compensation levels. The expected long-term rates of return are projected to be the rates of return to be earned over the period until the benefits are paid. Accordingly, the long-term rates of return should reflect the rates of return on present investments, expected contributions to be received during the current year and on reinvestments over the period. The rates of return utilized reflect the expected rates of return during the periods for which the payment of benefits is deferred. The expected long-term rate of return on plan assets used is based on what is realistically achievable based on the types of assets held by the plans and the plan’s investment policy. We review each plan and its returns and asset allocations to determine the appropriate expected long-term rate of return on plan assets to be used. We believe that the assumptions utilized in recording our obligations under our plans are reasonable based on input from our actuaries, outside investment advisors, and information as to assumptions used by plan sponsors.

 

A 1% change in the medical cost trend rate assumed for postretirement benefits would have the following effects for the year ended December 31, 2009, and at December 31, 2009, respectively:

 

 

Commitments and contingencies — We are involved in various litigations, claims and administrative proceedings, including environmental matters, arising in the normal course of business. We have recorded reserves in the financial statements related to these matters which are developed based on consultation with legal counsel and internal and external consultants and engineers, depending on the nature of the reserve. We provide for environmental accruals when, in conjunction with our internal and external counsel, we determine that a liability is both probable and reasonably estimable. Factors that affect the recorded amount of any liability in the future include: our participation percentage due to a settlement by, or bankruptcy of, other potentially responsible parties; a change in the environmental laws requiring more stringent requirements; a change in the estimate of future costs that will be incurred to remediate the site; and changes in technology related to environmental remediation. We have property and casualty insurance to cover such liabilities, but there is no guarantee that the coverage will be sufficient.

 

We have accrued liabilities for product liability claims, workers’ compensation matters and product warranty issues. We have recorded liabilities in our financial statements related to these matters, which are developed using input derived from actuarial estimates and historical, anticipated experience data and the judgment of counsel depending on the nature of the accrued liability. We believe our estimated liabilities are reasonable. If the level of claims changes or if the cost to provide the benefits related to these claims should change, our estimate of the underlying liability may change.

 

Goodwill and other intangible assets — We have significant goodwill and other intangible assets on our balance sheet. The valuation and classification of these assets and the assignment of amortization lives involves significant judgments and the use of estimates. The testing of these intangible assets under established accounting guidelines for impairment also requires significant use of judgment and assumptions, particularly as it relates to the identification of reporting units and the determination of fair market value. These estimated fair market values are estimated using market earnings multiples and estimates of future cash flows of our businesses. Factors affecting these market multiples and future cash flows include: the continued market acceptance of the products and services offered by our businesses; the development of new products and services by our businesses and the underlying cost of development; the future cost structure of our businesses; and future technological changes. Our goodwill and other intangible assets are tested and reviewed for impairment on an annual basis or when there is a significant change in circumstances. We believe that our estimates and assumptions used are reasonable and comply with accounting principles generally accepted in the United States of America. Changes in business conditions could potentially require future adjustments to these valuations.

 

The preparation of all financial statements includes the use of estimates and assumptions that affect a number of amounts included in our financial statements. If actual amounts are ultimately different from previous estimates, the revisions are included in our results for the period in which the actual amounts become known or better estimates can be made.

New Accounting Standards

 

On January 1, 2009, the Company adopted ASC 810 (formerly Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51). ASC 810 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, sometimes called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. ASC 810 requires, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; consolidated net income to be reported on the consolidated statement of income at amounts inclusive of income attributable to the parent and noncontrolling interest; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. Non-controlling interests are not material to the Company’s consolidated financial statements.

 

On January 1, 2009, the Company adopted ASC 805 (formerly Statement No. 141(R), Business Combinations) which applies to business combinations entered into after December 31, 2008. ASC 805 replaces prior guidance on the subject and requires the acquirer of a business to recognize and measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at fair value. Additionally, it also requires transaction costs related to the business combination to be expensed as incurred. The adoption of ASC 805 did not have a material impact on the consolidated financial statements.