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)

 

 

1200 West Sam Houston Parkway, No.

Houston, Texas 77043

(Address Of Principal Executive Offices)

 

(713) 467-2221

(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 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ     Accelerated filer  o     Non-accelerated filer  o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the 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 $23.48 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 $2,007,004,000.

 

There were 85,477,160 shares of common stock outstanding on February 15, 2007.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Definitive Proxy Statement for its 2007 Annual Meeting of Stockholders (the “Proxy Statement”) are incorporated by reference into Part III.

 

 

TABLE OF CONTENTS

 

 

Overview

 

Our predecessor company 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, our indirect parent and an affiliate of First Reserve Corporation (“First Reserve”), 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. 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 after giving effect to the consummation of the Transaction, (ii) the terms “Dresser-Rand Entities” and the “Predecessor” refer to the predecessors of the issuer (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, a Bermuda corporation, and its predecessors, which sold its interest in the Dresser-Rand Entities in the Acquisition.

 

We are among the largest global suppliers of rotating equipment solutions to the worldwide oil, gas, petrochemical and process industries. In 2006, approximately 93% of our combined revenues were generated from oil and gas infrastructure spending and 50% of our total combined revenues were generated by each of our aftermarket parts and services segment and our new units segment. Our services and products are used for a wide range of applications, including oil and gas production, high-pressure field injection and enhanced oil recovery, pipelines, refinery processes, natural gas processing, and petrochemical production. We believe we have the largest installed base in the world of the classes of equipment we manufacture, with approximately 40% of the total installed base of equipment in operation. Our installed base of equipment includes such well-recognized brand names as Dresser-Rand, Dresser-Clark, Ingersoll Rand, Worthington, Turbodyne, Terry, Coppus, Murray and Nadrowski. We provide a full range of aftermarket parts and services to this installed base through our global network of 26 service and support centers covering more than 140 countries. We operate globally with manufacturing facilities in the United States, France, Germany, Norway, and India. Our client base consists of most major independent oil and gas producers and distributors worldwide, national oil and gas companies, and chemical and industrial companies. Our clients include Royal Dutch Shell, ExxonMobil, BP, Statoil, Chevron, Petrobras, Pemex, PDVSA, ConocoPhillips, Lukoil, Marathon Oil Corporation and Dow Chemical Company.

 

We continue to evolve our business toward a solutions-based service offering that combines our industry-leading technology, proprietary worldwide service center network and deep product expertise. This approach drives our growth as we offer integrated service solutions that help our clients maximize returns on their production and processing equipment. We believe our business model and alliance-based approach align us with our clients who are shifting from purchasing isolated units and services on a transactional basis to choosing 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, and we offer our clients a dedicated team, 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 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 the worldwide aggregate annual value of new unit sales of the classes of equipment we manufacture and the aftermarket parts and services needs of the

installed base of such equipment (both in-house and outsourced) is approximately $14 billion. We believe that we are well positioned to benefit from a variety of long-term trends driving demand in our industry, including:

 

 

Recent Developments

 

During January of 2007, we reduced our term debt by $50 million. As a result, we expect to incur an additional non-cash charge relating to the write-off of unamortized debt issuance costs of approximately $0.9 million. Interest expense for 2007 is expected to be reduced by approximately $3.6 million based on rates prevailing at December 31, 2006.

 

Business Strategy

 

In 2006, approximately 93% of our revenues were generated from energy infrastructure and oilfield spending. Additionally, 50% of our total revenues were generated by our aftermarket parts and services business. We intend to continue to focus on the oilfield, natural gas and energy sectors and thus expect to capitalize on the expected long-term growth in equipment and services investment, especially related to natural gas, in these sectors. Specifically, we intend to:

 

Increase Sales of Aftermarket Parts and Services to Existing Installed Base.  The substantial portion of the aftermarkets 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 OEM 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 competitors’ installed equipment base and 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. 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 CIRS system. The CIRS system significantly enhances our ability to rapidly and accurately respond to any technical support or service request from our clients. We believe our premium service level will result in continued growth of sales of aftermarket parts and services.

 

Expand Aftermarket Parts and Services Business to Non-Dresser-Rand OEM Equipment.  We believe the aftermarket parts and services market for non-Dresser-Rand equipment represents a significant growth opportunity that we have only just begun 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, we are often in a position to provide quick response to clients and to offer local service. We believe these 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.

 

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 service providers that can help them optimize performance over the entire life cycle of their equipment. In the past few years, we have seen a high level of

interest among our clients in seeking alliances with us, and we have entered into agreements with more than 40 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 Oil Corporation and Royal Dutch Shell, plc. In addition, we are a preferred, non-exclusive supplier to other alliance partners, including BP, Statoil, ConocoPhillips, ExxonMobil, Chevron, Petrobras, Pemex, Kinder Morgan, Valero, Praxair, Targa, PDVSA, and Duke Energy.

 

Expand our Performance-Based Long-Term Service Contracts.  We are growing 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 product sales and upgrades to our, and other OEM’s, installed base of equipment. Many of our products utilize innovative technology that lowers operating costs, improves convenience and increases reliability and performance. Examples of recent new offerings include adapting the DATUM compressor platform for the revamping of other OEM equipment, a new design of dry-gas seals and bearings, a new generation of rotating separators and an integrated compression system (ICS). We recently 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. We plan to continue developing innovative products, including new compressor platforms for subsea and underground applications, which would 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. Since the fourth quarter of 2002, we adopted a number of restructuring programs across our entire company. An important element in these programs was process innovation that permitted us to streamline our operations. As a result of our business realignment toward our aftermarket parts and services segment, our lean manufacturing initiatives and our decision to begin charging customers a margin on third-party equipment they ask us to package with our own units, our operating income per employee (based on the average number of employees in each period) for the year ended December 31, 2006 improved substantially as compared to the year ended December 31, 2005. We are focused on continuing to improve our cost position in every area of our business, and we believe there is substantial opportunity to further increase our productivity in the future.

 

Selectively Pursue Acquisitions.  We intend to continue our disciplined pursuit of acquisition opportunities that fit our business strategy. We expect to make 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 market positions. Given our size and the large number of small companies in our industry and related industries, we believe we are well positioned to be an industry consolidator over time.

 

Services and Products

 

We design, manufacture and market highly engineered rotating equipment and services sold 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, geography and end market for the periods indicated:

 

Segment and geographic revenues and related financial information for 2006, 2005 and 2004 can be found in Note 23, Segment Information, in the Notes to Consolidated and Combined Financial Statements in Item 15 of this Form 10-K, which is incorporated herein by reference.

 

New Units

 

We are a leading manufacturer of highly-engineered turbo and reciprocating compression equipment and steam turbines and 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 industries worldwide. In 2006, in North America new unit turbomachinery bookings, we were the leader, and continued to rank in the top three in worldwide market share. Turbo products sales represented 53.3%, 50.8% and 48.7% of our total revenues for the fiscal years ended 2006, 2005 and 2004, 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. 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.

 

In 1995, we introduced the DATUM product line, which 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, modular and scalable construction, for flows to 500,000 cubic feet per minute (CFM), and discharge pressures to over 10,000 pounds per square inch gauge (psig). 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 less frames. The DATUM product line also offers improved rotor stability characteristics. DATUM compressors are available in 14 frame sizes. In addition to the DATUM centrifugal compressor line, we manufacture a line of axial flow compressors, legacy centrifugal compressors, 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 60 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 2006, in North America new unit reciprocating compressor sales, we were the clear leader, and continued to rank in the top three in worldwide market share. Reciprocating compressor sales represented 27.9%, 28.7% and 32.3% of our total revenues for the fiscal years ended 2006, 2005 and 2004, respectively. Reciprocating compressors use a traditional piston and cylinder design engine to increase pressure within a chamber. Typically, reciprocating compressors are used in lower volume/higher compression ratio applications. We offer 11 models of process reciprocating compressors, with power capacity ranging from 5 to 45,000 horsepower, and pressures ranging from vacuum to 60,000 psig. We offer seven models of separable compressors, with power ratings to 11,000 horsepower. Applications for our reciprocating compressors include upstream production (gas lift, Liquefied Natural Gas, export, gathering, processing, Liquefied Petroleum Gas, and Natural Gas Liquids), midstream transportation (gas transport, storage and fuel gas) and downstream processing (G-T-C, H₂ Production, refining, cool gas, methanol and ethylene, NH₃, Nitric Acid, and Urea).

 

Steam Turbines.  We are a leading supplier of standard and engineered mechanical drive steam turbines and turbine generator sets. Steam turbines represented 18.8%, 20.5% and 19.0% of our total revenues for the fiscal years ended 2006, 2005 and 2004, 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 multi-stage steam turbines. Our mechanical drive steam turbine models have power capacity ranging from 2 to 75,000 horsepower and are used primarily to drive pumps, fans, blowers and compressors. Our models that have power capacity up to 100,000 kilowatts are used to drive electrical generators. Our steam turbines are used in a variety of industries, including oil and gas, refining, petrochemical, chemical, pulp and paper, electrical power production and utilities, sugar and palm oil. We also build equipment for universities, municipalities and hospitals. We are the sole supplier to the United States Navy of steam turbines for aircraft carrier propulsion.

 

New Product Development

 

New product development is an important part of our business. We believe we are an industry leader in introducing new, value-added technology. Our investment in research and development has resulted in numerous technology upgrades focused on aftermarket parts and services growth. Our recent new product development includes adapting the DATUM compressor platform for revamping of other OEM equipment, a new design of dry-gas seals and bearings, an in-line rotary separator (IRIS) and a new Integrated Compression System (ICS). ICS uses as a platform high-efficiency DATUM centrifugal compressor technology driven by a high-speed, close-coupled motor, with an integrated gas-liquid separation unit, packaged with process coolers in a single module. It provides a complete compression system that can be applied to all markets — upstream, midstream and downstream. We believe that the ICS is uniquely suited for developing sub-sea applications because the compressor, motor, separation system and gas coolers are contained in the same process module. We have recently introduced a complete suite package of remote monitoring and control instrumentation that offers significant performance benefits to clients and enhances our operations and maintenance services offering. We plan to continue developing innovative products.

 

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. Our client alliance sales have increased substantially as a result of our ability to meet these client requirements. For example, the proportion of our combined core centrifugal and process reciprocating new unit revenues from client alliances has increased from approximately $17 million in 2000 to approximately $218 million in 2006.

 

Aftermarket Parts and Services

 

The aftermarket parts and services segment provides us with long-term growth opportunities and a steady stream of recurring revenues and cash flow. With a typical operating life of 30 years or more, rotating equipment requires substantial aftermarket parts and services needs over its operating life. Parts and services activities tend to 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 50% of the supplier-provided aftermarket parts and services needs of our own manufactured equipment base and approximately two percent of the 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 clients generally show a preference for purchasing aftermarket parts and services from the OEM 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 OEM service providers. The steady demand from our installed base for aftermarket parts and services 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 OEMs’ 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 operational 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, customers 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 26 service and support centers in 15 countries, employing approximately 1,400 service center and field service personnel, servicing our own and other OEMs’ turbo and reciprocating compressors as well as steam and gas turbines. 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.

 

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 of 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 horsepower, 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 has proven to offer significant growth potential with attractive margins. We have the support systems in place, including our technology platform and service facilities and our cost effective Configurator platform, for preparing accurate proposals, 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.

 

Sales and Marketing

 

We market our services and products worldwide through our established sales presence in over 20 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 350 direct sales/service personnel and a global network of approximately 100 independent representatives, as well as 26 service and support centers in 15 countries who sell our products and provide service and aftermarket support to our installed base locally in over 140 countries.

 

Manufacturing and Engineering Design

 

Our manufacturing processes generally consist of fabrication, machining, component assembly and testing. Many of our products are designed, manufactured and produced to order and are often built to clients’ specifications for long-life, mission-critical applications. To improve quality and productivity, we are implementing a variety of manufacturing strategies including focus factories, low cost manufacturing, and integrated supply chain management. With the introduction of the Configurator, we have reduced cycle times of engineering designs by approximately one-third, which we believe to be one of the lowest cycle times in the industry. In addition, we have been successful in outsourcing the fabrication of subassemblies and components of our products, such as lube oil consoles and gas seal panels, whenever costs are significantly lower and quality is comparable to our own manufacturing. Our manufacturing operations are conducted in ten locations around the world. We have major manufacturing plants outside the United States in France, Norway, India and Germany.

 

We strive to manufacture the highest quality products and are committed to improve the quality and efficiency of our products and processes. For example, we have established a full-time worldwide process innovation team of 100 employees who work across our various departments, including engineering, finance, purchasing and others, and who are focused on providing our clients with faster and improved configured solutions, short service response times, improved cycle times and on-time-delivery. The team uses a combination of operational performance and continuous improvement tools from Lean Enterprise, 6 Sigma, Value Engineering/Value Analysis, Total Quality Management, plus other value-creation and change management methodologies. Our aggressive focus on product quality is essential due to the strict performance requirements for our final products. All of our plants are certified in compliance with ISO 9001, with several also holding ISO 14001.

 

We manufacture many of the components included in our products. The principal raw materials required for the manufacture of our products are purchased from numerous suppliers, and we believe that available sources of supply will generally be sufficient for our needs for the foreseeable future.

 

Clients

 

Our 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 Royal Dutch Shell, ExxonMobil, BP, Statoil, Chevron, Petrobras, Pemex, PDVSA, Conoco Phillips, Lukoil, Marathon Oil Company and Dow Chemical Company. In 2006, Daewoo Ship Building & Marine Engineering Co., Ltd. totaled 5.9%, PDVSA totaled 5.2% and Chevron totaled 5.0% of total net revenues. In 2005, no client exceeded 5.0%. In 2004, PDVSA totaled 6.5%.

 

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 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. We have so far entered more than 40 alliances, and currently are the only alliance partner for like rotating equipment with exclusive alliances with Marathon Oil Corporation, and Royal Dutch Shell, plc. We also have preferred, non-exclusive supplier alliances with BP, Statoil, ConocoPhillips, ExxonMobil, Chevron, Petrobras, Pemex, Kinder Morgan, Valero, Praxair, Targa, PDVSA, and Duke Energy.

 

Competition

 

We encounter competition in all areas of our business, principally in the new units segment. We compete against products manufactured by both U.S. and non-U.S. companies. 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 serve as disincentives for new market entrants. Some of our existing competitors, however, have greater financial and other resources than we do.

 

Over the last 20 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 7 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 General Electric/Nuovo Pignone, Siemens, Solar Turbines, Inc., Rolls-Royce Group plc, Elliott Company, Mitsubishi Heavy Industries and MAN Turbo; in the reciprocating compressor industry, include General Electric/Nuovo Pignone, Burckhardt Compression, Neuman & Esser, Peter Brotherhood Ltd., Ariel Corp., Thomassen and Mitsui; and in the steam turbine industry include Elliott Company, Siemens, General Electric/Nuovo Pignone, Mitsubishi Heavy Industries and Shin Nippon.

 

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 OEM knowledgeable service providers.

 

Research and Development

 

Our research and development expenses were $10.4 million, $7.1 million, $2.8 million and $5.7 million for the years ended December 31, 2006, 2005 for the period from October 30, 2004 through December 31, 2004 and for the period January 1, 2004 through October 29, 2004, respectively. We believe current expenditures are adequate to sustain ongoing research and development activities. It is our policy to 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, 2006, we had 5,612 employees worldwide. Of our employees, approximately 65% are located in the United States. Approximately 35% of our employees in the United States are covered by collective bargaining agreements. A material collective bargaining agreement will expire at our Painted Post, N.Y. facility in August 2007 and at our Olean, N.Y. facility in June 2008. 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. Our contract with the United Brotherhood of Carpenters and Joiners of America can be terminated by either party with 90 days prior written notice. Our operations in the following countries are unionized: Le Havre, France; Oberhausen and Bielefeld, Germany; Kongsberg, Norway; and Naroda, India. Additionally, overseas, approximately 35% of our employees belong to industry or national labor unions. We believe that our relations with our employees are good.

 

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 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 have 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 exist as of the 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 will be responsible for all liabilities that were not identified prior to the closing date and placed on the Final Schedule. To determine which matters will be included on the Final Schedule, we conducted Phase I and Phase II assessments at 30 of the Dresser-Rand Entities’ facilities.

 

The equity purchase agreement provided that the Final Schedule would include all noncompliance and contamination matters identified in the Phase I and Phase II assessments that the parties agree should be included thereon. A contamination matter was to be included on the Final Schedule if it met one of several standards, the most important of which is that if such contamination matter were known by the applicable governmental authority, that authority would be expected to require a response action (which is broadly defined to include not only cleanup, but investigation and monitoring). For purposes of inclusion on the Final Schedule, contamination matters are broadly defined to include each known point of contamination plus all additional contamination associated with, or identified during an investigation of, such known point of contamination. Pursuant to the equity purchase agreement, Ingersoll Rand is responsible for all response actions associated with the contamination matters 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.

 

During 2006, the parties reached agreement with respect to the inclusion on the Final Schedule of all of the outstanding matters identified in the Phase I and Phase II assessments. We do not believe that the final resolution of these outstanding matters is material to us.

 

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 under a number of registered trade 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, 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 patent or 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 proprietary disclosure or misappropriation of our trade secrets could harm our ability to protect our rights and our competitive position.

 

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, and an affiliate of First Reserve. 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 through our website at www.dresser-rand.com or through the SEC’s website at www.sec.gov. 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 submitted the certification of our CEO required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual, relating to our compliance with the NYSE’s corporate governance listing standards, to the NYSE on September 26, 2006 with no qualifications.

ITEM 1A.  RISK FACTORS

 

Risks Related to Our Business

 

We have identified material weaknesses in our internal controls.

 

Our management has concluded that our disclosure controls and procedures and internal control over financial reporting were not effective as of December 31, 2006 as a result of several material weaknesses in our internal control over financial reporting. As a result, this Form 10-K includes an adverse opinion from PricewaterhouseCoopers LLP, our independent registered public accounting firm, on our internal control over financial reporting. A description of the material weaknesses is included in Item 9A, “Controls and Procedures,” in this Form 10-K.

 

The material weaknesses could result in a misstatement of substantially all accounts and disclosures, which would result in a material misstatement of annual or interim financial statements that would not be prevented or detected. Errors in our financial statements could require a restatement or prevent us from timely filing our periodic reports with the SEC. Additionally, inferior internal control over financial reporting could cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our securities.

 

While we have taken and continue to take actions to remediate the material weaknesses, we cannot be certain that any remedial measures we have taken or plan to take will be effective in remedying all identified deficiencies in our internal control over financial reporting or result in the design, implementation and maintenance of adequate controls over our financial processes and reporting in the future. Our inability to remediate the material weaknesses or any additional material weaknesses that may be identified in the future 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. Additionally, the effectiveness of our or any system of disclosure controls and procedures is subject to inherent limitations, and therefore we cannot be certain that our internal control over financial reporting or our disclosure controls and procedures will prevent or detect future errors or fraud in connection with our financial statements.

 

Our operating results and cash flows could be harmed during economic or industry downturns.

 

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 product 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 gas 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. Therefore, 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, or the perception that they may occur, could have a significant negative impact on the market price of our senior subordinated notes and our common stock.

 

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 50% of the supplier-provided aftermarket parts and services needs of our own manufactured equipment base and approximately two percent of the aftermarket parts and services needs of the equipment base of other manufacturers. Our future success depends, in part, on our ability to provide aftermarket parts and services to both our own and our competitors’ equipment base and our ability to develop and maintain our alliance relationships. Our ability to implement our business strategy successfully depends on a number of factors, including 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. 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, principally in the new unit segment. 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. In addition, our significant financial leverage and the restrictive covenants to which we are subject may harm our ability to compete effectively. 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 OEMs 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 complete, or achieve the expected benefits from, any future acquisitions, which could adversely affect our growth.

 

We have at times used acquisitions as a means of expanding our business and expect that we will continue to do so. If we do not successfully integrate acquisitions, we may not realize operating advantages 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 savings 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 international 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 internationally. For the year ended December 31, 2006, 36% of our net revenue was derived from North America, 24% from Europe, 14% from Latin America, 14% from Asia Pacific and 12% from the Middle East and Africa. Accordingly, our future results could be harmed by a variety of factors, including:

 

 

Our international 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. In addition, the financial condition of foreign clients may not be as strong as that of our current domestic clients.

 

Some of the international markets in which we operate are politically unstable and are subject to occasional civil and communal unrest, such as Venezuela and Western Africa. For example, in Nigeria we terminated a contract due to civil unrest. Riots, strikes, the outbreak of war or terrorist attacks in foreign locations, such as in the Middle East, 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, including Iraq, Iran, Libya, Sudan and Syria. Those foreign subsidiaries sell compressors, turbines and related parts and accessories to customers including enterprises controlled by government agencies of these countries in the oil, gas, petrochemical and power production industries. Although these sanctions and embargoes do not prohibit those subsidiaries from selling products and providing services in such countries, they do prohibit the issuer and its 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, including those named in the preceding paragraph, are or previously have been identified by the State Department as terrorist-sponsoring states. Because certain of our foreign subsidiaries have contact with and transact business in such countries, 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 senior subordinated notes and our common stock. 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 prices of our senior subordinated notes and our common stock.

 

Fluctuations in the value of the U.S. dollar may adversely affect our results of operations. Because our combined 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 the senior subordinated notes and the U.S. dollar-denominated borrowings under the senior secured credit facility.

 

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 purposes of accounting, the assets and liabilities of our foreign operations, where the local currency is the functional currency, are translated using period-end exchange rates, and the revenues and expenses of our foreign operations are translated using average exchange rates during each period.

 

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. 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, our business may be materially 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 personnel. Six of the top members of our senior management team have been with us for over 20 years, including our Chief Executive Officer and president who has been with us for 26 years. In addition, there is significant demand in our industry for qualified engineers and mechanics. Further, several members of our management received a significant amount of the net proceeds from the initial public offering and secondary offerings of our common stock by D-R Interholding, LLC and may receive additional amounts from any future secondary offerings. We cannot assure you that we will be able to retain all of our current senior management personnel and to

attract and retain other personnel, including qualified mechanics and engineers, 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 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 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 fabrication and aftermarket parts and services operations, we generate, manage and dispose of or recycle hazardous wastes and substances such as solvents, thinner, waste paint, waste oil, washdown 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 (will be) 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.

 

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, or OSHA, 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 plant units. 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 supplier’s 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. In the past, we have been removed from one client’s approved supplier database for failure to meet the client’s safety performance requirements. 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 clients’ contracts.

 

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

 

As of December 31, 2006, we had 5,612 employees worldwide. Of our employees, approximately 65% are located in the United States. Approximately 35% of our employees in the United States are covered by collective bargaining agreements. A material collective bargaining agreement will expire at our Painted Post, N.Y. facility in August 2007 and at our Olean, N.Y. facility in June 2008. 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. Our contract with the United Brotherhood of Carpenters and Joiners of America can be terminated by either party with 90 days’ prior written notice. Our operations in the following locations are unionized: Le Havre, France; Oberhausen and Bielefeld, Germany; Kongsberg, Norway; and Naroda, India. Additionally, approximately 35% of our employees outside of the United States belong to industry or national labor unions. Although we believe that our relations with our 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.

 

First Reserve’s interests may not be aligned with yours; it may be able to exercise significant influence over our director nomination process.

 

First Reserve is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. First Reserve may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us.

 

In addition, in connection with the Acquisition, we entered into a stockholders agreement with First Reserve and certain management stockholders, which was amended and restated in connection with our initial public offering. The stockholders agreement provides that for so long as First Reserve holds at least 5% of the outstanding shares of our common stock, it may designate all of the nominees for election to our board of directors other than any independent directors. All stockholders that are a party to the stockholders agreement are obligated to vote their shares in favor of such nominees. Independent directors will be designated for nomination by our board of directors, however such independent nominees must be reasonably acceptable to First Reserve for so long as it holds at least 5% of the outstanding shares of our common stock.

 

Our Predecessor financial information may not be comparable to future periods.

 

The Predecessor financial information included in this Form 10-K does not reflect our results of operations, financial position and cash flows that would have occurred if we had been a separate, independent entity during the periods presented and may not be comparable to future periods. The Predecessor financial information included in this Form 10-K does not reflect the many significant changes that have occurred in our capital structure, funding and operations as a result of the transactions or the additional costs we incur in operating as an independent stand alone company. For example, funds required for working capital and other cash needs historically were obtained from Ingersoll Rand on an interest-free, intercompany basis without any debt service requirement. Furthermore, we were a limited partnership in the United States until October 29, 2004 and generally did not pay income taxes, but have since become subject to income taxes.

 

We did not have a recent operating history as a stand-alone company prior to the Acquisition.

 

Although we have a substantial operating history, prior to the Acquisition we were not operating as a stand-alone company. As a result of the Acquisition, we no longer have access to the borrowing capacity, cash flow, assets and services of Ingersoll Rand and its other affiliates as we did while under Ingersoll Rand’s control. We are a significantly smaller company than Ingersoll Rand, with significantly fewer resources and less diversified operations. Consequently, our results of operations are more susceptible than those of Ingersoll Rand to competitive and market factors specific to our business.

 

We may be faced with unexpected product claims or 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 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 and consequential damages. 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.

 

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, 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 operation. 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 adverse effect on our business, financial condition and results of operations.

 

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., and an affiliate of First Reserve. 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.

 

The common stock and certain debt securities of Ingersoll Rand and certain debt securities of Dresser, Inc. are publicly traded in the United States. Acts or omissions by these unaffiliated companies may adversely affect the value of the “Dresser” and “Rand” brand names or the trading price of our senior subordinated notes and our common stock. In addition, press and other third-party announcements or rumors relating to any of these unaffiliated companies may adversely affect the trading price of our senior subordinated notes and our common stock and the demand for our services and products, even though the events announced or rumored may not relate to us, which in turn could adversely affect our results of operations and financial condition.

 

Natural gas operations entail inherent risks that may result in substantial liability to us.

 

We supply products to the natural gas industry, which is subject to inherent risks, including equipment defects, malfunctions and failures and natural disasters resulting in uncontrollable flows of gas or well fluids, fires and explosions. These risks may expose our clients to liability for personal injury, wrongful death, property damage, pollution and other environmental damage. We also may become involved in litigation related to such matters. If our clients suffer damages as a result of the occurrence of such events, they may reduce their orders from us. Our business, consolidated financial condition, results of operations and cash flows could be materially adversely affected as a result of such risks.

 

Risks Related to Our Leverage

 

Our substantial indebtedness could adversely affect our financial condition and prevent us from fulfilling our debt service obligations.

 

Our financial performance could be affected by our substantial indebtedness. As of December 31, 2006, our total indebtedness was approximately $505.6 million. In addition, we had $202.9 million of letters of credit outstanding and additional borrowings available under the revolving portion of our senior secured credit facility of $147.1 million. We may also incur additional indebtedness in the future.

 

Our high level of indebtedness could have important consequences, including, but not limited to:

 

 

Our net cash flow generated from operating activities was $164.1 million and $212.4 million for the year ended December 31, 2006 and 2005, respectively, and $57.7 million and $17.4 million for the period January 1, 2004 through October 29, 2004 and the period October 30, 2004 through December 31, 2004, respectively. Our high level of indebtedness requires that we use a substantial portion of our cash flow from operating activities to pay principal of our indebtedness, which will reduce the availability of cash to fund working capital requirements, capital expenditures, research and development or other general corporate or business activities, including future acquisitions.

 

In addition, a portion of our indebtedness bears interest at variable rates. If market interest rates increase, debt service on our variable-rate debt will rise, which would adversely affect our cash flow.

 

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to sell assets, seek additional capital or seek to restructure or refinance our indebtedness, including our senior subordinated notes. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

 

We require a significant amount of cash to service our indebtedness. Our ability to generate cash 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. 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 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 refinance any of our debt, including our senior secured credit facility or our senior subordinated notes, on commercially reasonable terms.

 

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

 

Our 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 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 but does not prohibit payment of dividends by our restricted subsidiaries to us on a pro rata basis or prohibit loans and advances to us so long as no default or event of default has occurred and is continuing or would occur as a consequence of such payments.

 

These covenants could materially and adversely affect 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 prevailing 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 senior secured credit facility. If there were an event of default under the indenture governing our senior subordinated notes and/or the 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 senior secured credit facility when it becomes due, the lenders under the 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.

 

Other Risks Relating to Us

 

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 common stock 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 common stock could decrease significantly. Among other factors that could affect our stock price 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 are located in Houston, Texas. The following table describes the material facilities owned or leased by us and our subsidiaries as of February 15, 2007.

 

ITEM 3.  LEGAL PROCEEDINGS

 

Dresser-Rand (UK) Limited, one of our wholly-owned indirect subsidiaries, is involved in litigation that was initiated on June 1, 2004, and is currently pending in the High Court of Justice, Queens Bench Division, Technology and Construction Court in London, England, with Maersk Oil UK Limited over alleged defects in performance of certain compressor equipment sold by Dresser-Rand (UK) Limited. The claimant is seeking damages of about 8 million pounds sterling (approximately $15.7 million). Witness testimony concluded in July 2006, closing arguments concluded in December 2006 and a decision is expected in the first quarter of 2007. In prior years, we had offered to settle and recorded a litigation liability for 0.9 million pounds sterling (approximately $1.8 million). Based on a report received from an expert damages witness hired by the Company and our review of the expert testimony at the trial, we increased our accrual for the estimated loss for this litigation by 0.7 million pounds sterling during 2006 (approximately $1.3 million) bringing the total accrual to 1.6 million pounds sterling (approximately $3.1 million). While we believe that we have made adequate provision for the ultimate loss in this litigation and intend to continue our vigorous defense of this suit, it is reasonably possible that the loss could be up to the 3.1 million pounds sterling (approximately $6.1 million) limit of liability stated in the agreement with the customer, not including interest or costs, or 1.5 million pounds sterling (approximately $3.0 million) in excess of amounts recognized as of December 31, 2006.

 

We are involved in various litigation, claims and administrative proceedings, arising in the normal course of business. Amounts recorded for identified contingent liabilities are estimates, which are regularly reviewed and adjusted to reflect additional information when it becomes available. Subject to the uncertainties inherent in estimating future costs for contingent liabilities, management believes that any future adjustments to recorded amounts, with respect to these currently known contingencies, would not have a material effect on the financial condition, results of operations, liquidity or cash flows of the Company.

 

No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2006.

 

Trading in our common stock commenced on the New York Stock Exchange on August 5, 2005, under the symbol “DRC”.

 

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.

 

 

As of February 15, 2007, there were 23 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 10,900 as of February 15, 2007.

 

We do not currently intend to pay any cash dividends on our common stock, and instead intend to retain earnings, if any, for future operations and debt reduction. At December 31, 2006, the amounts available to us to pay cash dividends under the more restrictive covenants of our senior secured credit facility and the indenture governing the senior subordinated notes is limited to 5% of the proceeds of any future issuance of common stock. 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.

 

We did not repurchase any of our common stock in the fourth quarter of 2006, except as it relates to stock compensation plans.

Performance Graph

 

The following chart shows how $100 invested in our common stock on August 5, 2005 would have grown through the period ending December 29, 2006, as measured by total stockholder return on the common stock compared with $100 invested in the S&P 500 Index and $100 invested in a custom composite index. The custom composite index includes Cameron International, Dril-Quip, Inc., FMC Technologies, Inc., Hydril Company, and National-Oilwell Varco Inc.

 

 

 

This Performance Graph shall not be deemed to be incorporated by reference into our SEC filings and should not constitute soliciting material or otherwise be considered filed under the Securities Act of 1933, as amended, or the Securities 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated and combined financial statements and the notes thereto included elsewhere in 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,” “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 impact they will have 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.

 

Overview

 

We are among the largest global suppliers of rotating equipment solutions to 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, distributed power and government markets. In addition, see Item 1, Business in this Form 10-K for a description of the strong economic conditions of the markets we serve.

 

We operate globally with manufacturing facilities in the United States, France, Germany, Norway and India. We provide a wide array of products and services to our worldwide client base in over 140 countries from our 67 global locations in 11 U.S. states and 24 countries. Our total combined revenues by geographic region for the year ended December 31, 2006, consisted of North America 36%, Europe 24%, Latin America 14%, Asia Pacific 14% and the Middle East and Africa 12%. For the year ended December 31, 2005, our revenue by geographic region consisted of North America 42%, Europe 19%, Middle East and Africa 15%, Latin America 13%, and Asia Pacific 11%.

 

Corporate History

 

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 million. Dresser-Rand Company’s combined financial statements reflect Ingersoll Rand’s additional basis in Dresser-Rand Company. Dresser-Rand Company formerly operated as an operating business unit of Ingersoll Rand.

 

On August 25, 2004, Dresser-Rand Holdings, LLC, our indirect parent and an affiliate of First Reserve, entered into an equity purchase agreement with Ingersoll Rand to purchase all of the equity interests in the Dresser-Rand Entities for $1.13 billion. The acquisition closed on October 29, 2004. In connection with the acquisition, funds affiliated with First Reserve contributed $430 million in cash as equity to Dresser-Rand Holdings, LLC, which used this cash to fund a portion of the purchase price for the Dresser-Rand Entities. The remainder of the cash needed to finance the acquisition, including related fees and expenses, was provided by borrowings of $420 million in senior subordinated notes due 2014 and under a $695 million senior secured credit facility which consisted of a $395 million term loan portion and a $300 million revolving portion. During 2005, we increased the $300 million revolving portion of our senior secured credit facility to $350 million.

 

The preparation of the Predecessor financial statements was based on certain assumptions and estimates, including allocations of costs from Ingersoll Rand, which the Predecessor believed were reasonable. This financial

information may not, however, necessarily reflect the results of operations, financial positions and cash flows that would have occurred if our Predecessor had been a separate, stand-alone entity during the periods presented.

 

In connection with the transactions, we incurred substantial indebtedness, interest expense and repayment obligations. The interest expense relating to this debt reduces our net income. In addition, we accounted for the acquisition under the purchase method of accounting, which resulted in an increase in depreciation and amortization above historical levels. As a result of the transactions, we incurred a number of one-time fees and expenses of approximately $33.5 million. See “The Transactions.”

 

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 either a large purchase or sales transaction using a currency other than the local 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 local 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 majority 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 2006 and 2005. 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 our ability to meet interest and principal payments on U.S. dollar denominated debt, including the senior subordinated notes and borrowings under the senior secured credit facility.

 

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 and Combined 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 continue in line with historical levels.

 

Other Income (Expense)

 

Other income (expense) includes those items that are non-operating in nature. Examples of items reported as other income (expense) are insurance proceeds, equity in earnings in 50% or less owned affiliates, casualty losses, 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 amortized over their estimated useful lives.

 

Income Taxes

 

For the Predecessor periods presented, certain of the Dresser-Rand Entities were accounted for as a partnership and were not required to provide for income taxes, since all partnership income and losses were allocated to the partners for inclusion in their respective financial statements. In connection with the Transactions, the assets of the former partnership are now subject to corporate income taxes. For income tax purposes, the former partnership assets have been recorded at, and will be depreciated based upon their fair market value at the time of the Transaction instead of the historical amount. On October 29, 2004, our business became subject to income tax, which has impacted our results of operations for the years ended December 31, 2006 and 2005 and for the period from October 30, 2004 through December 31, 2004 and will affect our results in the future.

 

For the Predecessor periods presented and prior to the Transactions, certain of our operations were subject to U.S. or foreign income taxes. After the Transactions, all of our operations are subject to U.S. or foreign income taxes. In preparing our financial statements, we have determined the tax provision of those operations on a separate company basis.

 

Bookings and Backlog

 

New Units

 

Bookings represent orders placed during the period, whether or not filled. The elapsed time from booking to completion of performance may be up to 15 months (or 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 only 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 project cancellations, deferrals, currency fluctuations and revised project scope.

 

Aftermarket Parts and Services

 

Bookings represent orders placed during the period, whether or not filled. Backlog primarily consists of unfilled parts and revamp orders, with open repair and field service orders comprising a smaller part of the backlog. The cancellation of an order for parts can generally be made without penalty.

 

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 senior secured credit facility, we are entitled to have up to $350 million of letters of credit outstanding at any time, subject to certain conditions.

 

Basis of Presentation

 

The acquisition of the Dresser-Rand Entities was accounted for under the purchase method of accounting. As a result, the financial data presented for 2004 include a Predecessor period from January 1, 2004 through October 29, 2004 and a Successor period from October 30, 2004 through December 31, 2004. As a result of the Acquisition, the consolidated statement of operations for the Successor period includes interest and amortization expense resulting from the senior subordinated notes and senior secured credit facility, and depreciation of plant and equipment and amortization of intangible assets related to the acquisition. Further, as a result of purchase accounting, the fair values of our assets on the date of the Acquisition became their new cost basis. Results of operations for the Successor periods reflect the newly established cost basis of these assets. We allocated the Acquisition consideration to the tangible and intangible assets acquired and liabilities assumed by us based upon their respective fair values as of the date of the Acquisition, which resulted in a significant change in our annual depreciation and amortization expenses.

 

The accompanying financial information for the periods prior to the acquisition are labeled as “Predecessor” and the period subsequent to the acquisition are labeled as “Successor.”

 

Successor

 

Our consolidated financial statements for the years ended December 31, 2006 and 2005 and for the period from October 30, 2004 through December 31, 2004 include the accounts of Dresser-Rand Group Inc. and its wholly-owned subsidiaries. Included in these periods are fair value adjustments to assets and liabilities, including inventory, goodwill, other intangible assets and property, plant and equipment. Also included is the corresponding effect that these adjustments had to cost of sales, depreciation and amortization expenses.

 

Predecessor

 

The combined financial statements for the period from January 1, 2004 through October 29, 2004 include the accounts and activities of the Predecessor. Partially-owned companies have been accounted for under the equity method. Dresser-Rand’s financial statements reflect costs that have been allocated by Ingersoll Rand prior to the consummation of the acquisition. As a result of recording these amounts, our predecessor’s combined financial statements for these periods may not be indicative of the results that would be presented if we had operated as an independent, stand-alone entity.

 

Results of Operations

 

Year ended December 31, 2006 (Successor) compared to the year ended December 31, 2005 (Successor)

 

 

Total revenues.  The energy market is very robust as the worldwide demand for and price of oil and gas continues to be strong, which in turn has caused very strong market conditions for our products and services. Total revenues were $1,501.5 million for the year ended December 31, 2006 compared to $1,208.2 million for the year ended December 31, 2005. The $293.3 million, 24.3% increase shows the strength of the markets we serve. The highly engineered nature of our worldwide products and services does not lend itself to measuring the impact of price, volume and mix on changes in our total revenues from year to year. Nevertheless, based on factors such as measures of labor hours and purchases from suppliers, volume was up significantly during 2006. Also, we have implemented price increases in excess of our cost increases across most of our products and services during 2006.

 

Cost of sales.  Cost of sales was $1,097.8 million for the year ended December 31, 2006, compared to $921.0 million for the year ended December 31, 2005. As a percentage of revenues, cost of sales decreased to 73.1% for 2006 principally due to increased price realization in excess of cost increases net of productivity improvements and the operating leverage from higher volume on fixed manufacturing costs.

 

Gross profit.  Gross profit was $403.7 million, or 26.9% of revenues for the year ended December 31, 2006, compared to $287.2 million, or 23.8% of revenues for the year ended December 31, 2005. These increases were attributable to the factors mentioned above.

 

Selling and administrative expenses.  Selling and administrative expenses were $228.8 million for the year ended December 31, 2006, compared to $164.0 million for the year ended December 31, 2005. The $64.8 million, 39.5% increase was attributed to higher expense (1) for the stock-based compensation expense — exit units in 2006 of $23.6 million (see description below); (2) to support the increased bookings and revenues; (3) to continue establishing corporate functions for the stand-alone company; and (4) for compliance with the Sarbanes-Oxley Act of 2002; and (5) from acquisition of certain assets of Tuthill Energy Systems (TES). Selling and administrative expenses as a percentage of revenues were 15.2% (13.7% before the $23.6 million stock-based compensation expense — exit units) for the year ended December 31, 2006 compared to 13.6% for the year ended December 31, 2005.

 

Stock-based compensation expense — exit units.  On October 29, 2004, Dresser-Rand Holdings, LLC (Holdings), an affiliate of First Reserve Corporation, acquired the Company (the Acquisition). The financial statements of Holdings and First Reserve Corporation are not included in these consolidated financial statements. The amended and restated limited liability company agreement (Agreement) of Holdings permits the grant of the right to purchase common units to management members of the Company and the grant of service units and exit units (collectively referred to as “profit units”), consisting of one initial tranche of service units and five initial tranches of exit units to certain management members who own common units. On November 22, 2004, and in connection with the closing of the Acquisition of the Company by Holdings, several of the Company’s executives, including the Chief Executive Officer and four other of the most highly compensated executive officers at that time, purchased common units in Holdings for $4.33 per unit, the same amount paid for such common units by funds affiliated with First Reserve Corporation in connection with the Acquisition. Executives who purchased common units were also issued a total of 2,392,500 service units and five tranches of exit units totaling 5,582,500 exit units in Holdings, which permit them to share in appreciation in the value of the Company’s shares. In May 2005, three new executives purchased 303,735 common units in Holdings at a price of $4.33 per share and were granted 300,000 service units and 700,000 exit units. At that time the price per unit was below their fair value resulting in a “cheap stock” charge to expense in the second quarter of 2005 of $2.4 million. The Company accounts for the transactions between Holdings and the Company’s executives in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-based Payment, (Statement 123R), which requires the Company to record expense for services paid by a stockholder for the benefit of the Company.

 

The exit units were granted in a series of five tranches. Exit units are eligible for vesting upon the occurrence of certain exit events, as defined in the Agreement, including (i) funds affiliated with First Reserve Corporation receiving an amount of cash in respect of their ownership interest in Holdings that exceeds specified multiples of the equity those funds have invested in the Company, or (ii) there is both (a) a change in control, certain terminations of employment, death or disability, and (b) the fair value of the common units at the time of such an event is such that were the common units converted to cash, funds affiliated with First Reserve would receive an amount of cash that exceeds specified multiples of the equity those funds have invested in the Company. Vested exit units convert to common units of Holdings. When the exit units vest, the Company recognizes a non-cash, stock-based compensation expense and a credit to additional paid-in-capital for the fair value of the exit units determined at the grant date.

 

During 2006, Holdings sold shares of the Company common stock that it owned for net proceeds to Holdings of approximately $1 billion. As a result, all five tranches of exit units vested and the Company recorded a pre-tax, non-cash compensation expense equal to the total fair value at the grant date of the exit units of $23.6 million during 2006. As of December 31, 2006, Holdings owns 13.6% of the Company’s common stock. Any future sales of the Company’s common stock by Holdings will not result in any future expense for stock-based compensation expense — exit units for the Company.

 

Research and development expenses.  Total research and development expenses for the year ended December 31, 2006 were $10.4 million compared to $7.1 million for the year ended December 31, 2005. The $3.3 million increase was from an unusually low 2005 expense due to the increased volume of new business that caused reassignment of some research and development resources to customer order engineering tasks. Additional engineering staff was hired in 2006 to support the growth in the business.

 

Curtailment gain.  On January 23, 2006, a new labor agreement was ratified by the represented employees at our Wellsville, New York, facility which became effective on February 1, 2006. That new agreement reduced certain previously recorded retiree health benefits for the represented employees covered by the agreement. As a result, we recorded a curtailment gain in 2006 for the actuarial net present value of the estimated reduction in the future cash costs of the retiree health care benefits.

 

Operating income.  Operating income was $176.3 million for the year ended December 31, 2006, compared to $116.1 million for the year ended December 31, 2005. The $60.2 million increase was attributed primarily to increased revenues and the operating leverage effect of higher volume on fixed manufacturing costs, plus the $11.8 million curtailment gain cited above less higher selling and administrative expenses, which included the stock-based compensation — exit units of $23.6 million. As a percentage of revenues, operating income for 2006 was 11.7% (12.5% without the $11.8 million curtailment gain and $23.6 million exit units expense) compared to 9.6% for 2005.

 

Interest expense, net.  Interest expense, net was $47.9 million for the year ended December 31, 2006, compared to $57.0 million for the year ended December 31, 2005. Interest expense, net for 2006 included $5.7 million in amortization of deferred financing costs, of which $2.0 million was accelerated amortization due to a reduction of $100.0 million in long-term debt in the period. Amortization of deferred financing costs for 2005 was $9.5 million, including $5.4 million from higher amortization due to accelerated debt reduction.

 

Early redemption premium on debt.  We used a portion of the proceeds from our initial public offering in 2005 to prepay $50.0 million of our notes incurring a prepayment premium of $3.7 million.

 

Other income (expense), net.  Other income, net was $8.9 million for the year ended December 31, 2006, compared to (expense), net of $(2.8) million for the year ended December 31, 2005. The increase is primarily currency gains in 2006 from the weaker dollar verses the Euro during the year compared to currency losses in 2005 when the dollar was stronger.

 

Provision for income taxes.  Provision for income taxes was $58.5 million for the year ended December 31, 2006 and $15.5 million for the year ended December 31, 2005. Our income tax provision for the year ended December 31, 2006 results in an effective rate that differs from U.S. Federal statutory rate of 35% principally because of the non-cash $23.6 million stock-based compensation expense — exit units which is not deductible for tax purposes, state and local income taxes and a U.S. deduction related to certain export sales from the U.S. Also, during 2006, we provided a valuation allowance of $2.0 million for deferred tax assets principally for our subsidiary in Brazil because their accumulated losses and related net operating loss carryforward caused us to conclude that it was more likely than not, as defined by generally accepted accounting principles, that their deferred tax assets would not be realized. We will adjust valuation allowances in the future when it becomes more likely than not that the benefit of deferred tax assets will be realized. We have taken steps to improve our performance in Brazil including ceasing manufacturing of new units and changing local management. We are currently focusing our Brazilian operation on the more profitable aftermarket parts and services market.

 

Bookings and backlog.  Bookings for the year ended December 31, 2006 increased to $1,838.9 million from $1,446.2 million for the year ended December 31, 2005. Backlog was $1,267.4 million at December 31, 2006, compared to $884.7 million at December 31, 2005. These increases reflect the strength of the markets that we serve.

 

Segment information

 

We have two reportable segments based on the engineering and production processes, and the products and services provided by each segment as follows:

 

1) New Units are highly engineered solutions to new customer requests. The segment includes engineering, manufacturing, sales and administrative support.

 

2) Aftermarket Parts and Services consist of aftermarket support solutions for the existing population of installed equipment. The segment includes engineering, manufacturing, sales and administrative support.

 

Unallocable amounts represent expenses and assets that cannot be assigned directly to either reportable segment because of their nature. Unallocable expenses included corporate expenses (Successor) and research and development expenses.

 

 

New Units

 

Revenues.  New Units revenues were $749.6 million for the year ended December 31, 2006, compared to $576.6 million for the year ended December 31, 2005. The $173.0 million, 30.0% increase is primarily attributable to the continued strong demand from the markets we serve. We started the year with a backlog of $688.1 million at December 31, 2005, compared to $489.3 million at December 31, 2004. In addition, new orders booked were $1,002.3 million during 2006, compared to $771.9 million during 2005. Cycle times from order entry to completion for products in this segment typically range six to 15 months depending on the engineering and manufacturing complexity of the configuration and the lead time for critical components.

 

Gross profit.  Gross profit was $108.6 million for the year ended December 31, 2006, compared to $70.9 million for the year ended December 31, 2005. Gross profit, as a percentage of segment revenues, was 14.5% for 2006 compared to 12.3% for 2005. These increases were primarily attributable to the higher volume and prices and operating leverage benefit of higher volume on fixed manufacturing costs.

 

Operating income.  Operating income was $47.3 million for the year ended December 31, 2006, compared to $20.8 million for the year ended December 31, 2005. As a percentage of segment revenues, operating income was 6.3% for 2006 compared to 3.6% for 2005. Both increases are due to the factors cited above.

 

Bookings and Backlog.  New Units bookings for the year ended December 31, 2006 was $1,002.3 million compared to $771.9 million for the year ended December 31, 2005. Backlog was $981.8 million at December 31, 2006 compared to $688.1 million at December 31, 2005. These increases are primarily due to continued strength in the energy markets we serve.

 

Aftermarket Parts and Services

 

Revenues.  Aftermarket parts and services revenues were $751.9 million for the year ended December 31, 2006, compared to $631.6 million for the year ended December 31, 2005. The $120.3 million, 19.0% increase is attributable to the strong energy market which resulted in higher bookings during 2006, as well as higher backlog at the beginning of the year of $196.6 million at December 31, 2005, compared to $148.3 million at the beginning of 2005. Elapsed time from order entry to completion in this segment typically range from 1 day to 12 months depending on the nature of the product or service.

 

Gross profit.  Gross profit was $295.1 million for the year ended December 31, 2006, compared to $216.3 million for the year ended December 31, 2005. Gross profit as a percentage of segment revenues was 39.3% for 2006 compared to 34.3% for 2005. These increases were attributed to increased revenues and improved margins due to price increase realizations, as well as lower allocations of manufacturing overhead and sales and administration expenses due to the change in the revenue mix (Aftermarket parts and services was 50.1% of total revenues in 2006 compared to 52.3% in 2005.)

 

Operating income.  Operating income was $204.4 for the year ended December 31, 2006, compared to $141.4 million for the year ended December 31, 2005. As a percentage of segment revenues, operating income was 27.2% for 2006 compared to 22.4% for 2005. The increases are due to the factors cited above.

 

Bookings and Backlog.  Aftermarket parts and services bookings for the year ended December 31, 2006 were $836.6 million compared to $674.3 million for the year ended December 31, 2005. Backlog was $285.6 million as of December 31, 2006 compared to $196.6 million at December 31, 2005. The increases from the prior year reflect the strength of the energy markets we serve.

 

Year ended December 31, 2005 (Successor) compared to the Period from October 30, 2004 through December 31, 2004 (Successor) and for the Period from January 1, 2004 through October 29, 2004 (Predecessor)

 

There were significant differences in the basis of financial reporting between the Successor and Predecessor periods as a result of the Acquisition on October 29, 2004, and the resultant application of purchase accounting to the assets and liabilities acquired.

 

Total revenues.  The worldwide market demand for oil and gas products continued to increase in 2005, which in turn increased the demand for our products and services. Total revenues were $1,208.2 million for the year ended December 31, 2005 compared to $199.9 million for the period October 30 through December 31, 2004 and $715.5 million for the period January 1 through October 29, 2004. The increase compared to the combined periods of 2004 was primarily in the new units segment.

 

Cost of sales.  Cost of sales was $921.0 million, $149.6 million and $538.0 million, respectively, for the year ended December 31, 2005, the period from October 30 through December 31, 2004 and the period from January 1 through October 29, 2004. Cost of sales increased compared to the combined periods of 2004 principally attributed to the combination of higher 2005 revenues, revenue mix change (the higher cost new units segment was 47.6% of total revenues in 2005 versus 38.8% for the period from October 30 through December 31, 2004 and 37.4% for the period from January 1 through October 29, 2004), and purchase accounting (including increased depreciation and amortization). As a percentage of revenues, cost of sales increased slightly to 76.2% for 2005 from 74.8% for the period from October 30 through December 31, 2004 and from 75.2% for the period from January 1 through October 29, 2004. The increase was primarily due to the adverse revenues mix change and purchase accounting expense (in the year ended December 31,2005 and in the period from October 30 through December 31, 2004).

 

Gross profit.  Gross profit was 23.8% for the year ended December 31, 2005 compared to 25.2% and 24.8%, respectively, for the period from October 30 through December 31, 2004 and for the period from January 1 through October 29, 2004. The decrease is attributable to the factors mentioned above.

 

Selling and administrative expenses.  Selling and administrative expenses of $164.0 million for the year ended December 31, 2005 increased from $21.5 million and $122.7 million, respectively, for the period from October 30 through December 31, 2004 and for the period from January 1 through October 29, 2004. Establishing corporate functions for the stand alone company was the principal cause of an increase in headquarters expenses during 2005 compared to administrative expenses allocated to us from Ingersoll Rand during 2004. An additional $6.7 million of the increase was the result of the acquisition of TES. The remaining increase was due to the increased support costs associated with higher revenues. Selling and administrative expenses increased as a percentage of revenues to 13.6% for 2005 compared to 10.8% for the period from October 30 through December 31, 2004, but decreased compared to 17.1% for the period from January 1 through October 29, 2004.

 

Research and development expenses.  Total research and development expenses for the year ended December 31, 2005 were $7.1 million compared to $2.8 million and $5.7 million, respectively, for the period from October 30 through December 31, 2004 and for the period from January 1 through October 29, 2004. The decrease from the combined periods of 2004 was due to the increased booking rate that caused reassignment of some research and development resources to customer order engineering tasks.

 

Operating income.  Operating income was $116.1 million for the year ended December 31, 2005 compared to $26.0 million for the period from October 30 through December 31, 2004 and $49.1 million for the period from January 1 through October 29, 2004. The increase compared to the combined periods of 2004 was primarily from increased revenues and the operating leverage effect of higher revenues on fixed costs. As a percentage of revenues, operating income for the year ended December 31, 2005, was 9.6% compared to 13.0% and 6.9%, respectively, for the period from October 30 through December 31, 2004 and for the period January 1 through October 29, 2004.

 

Interest income (expense), net.  Net interest income (expense) was $(57.0) million for the year ended December 31, 2005, compared to $(9.7) million for the period from October 30 through December 31, 2004 and $3.1 million for the period January 1 through October 29, 2004. Interest expense is primarily on the outstanding principal of the senior secured credit facility and the senior subordinated notes issued in connection with the Acquisition. Interest expense for 2005 included $9.5 million in amortization of deferred financing fees, of which $5.5 million was accelerated amortization due to the payment of $211.0 million in long-term debt in the period. Deferred financing fees were $0.7 million for the period from October 30 through December 31, 2004.

 

Early redemption premium on debt.  We used a portion of the proceeds from our initial public offering to prepay $50 million of our notes incurring a premium payment of $3.7 million in 2005.

 

Other income (expense), net.  Other (expense) was $(2.8) million for the year ended December 31, 2005 compared to $(1.8) million for the period from October 30 through December 31, 2004 and income of $1.9 million for the period from January 1 through October 29, 2004. The increase in expense is primarily the result of greater currency losses in the year

ended December 31, 2005 compared to the period from October 30 through December 31, 2004 and currency gains for the period from January 1 through October 29, 2004.

 

Provision for income taxes.  Provision for income taxes for the year ended December 31, 2005 was $15.5 million and differs from the U.S. Federal statutory rate of 35% principally because of extraterritorial income exclusion in the U.S. related to export sales, stock compensation and the removal of the valuation allowance related to the deferred tax asset in the U.S. because it was considered to be more likely than not that the asset would be realized based on the weight of available evidence at the time. This compares to the provision for taxes of $7.3 million for the period from October 30 through December 31, 2004 and $11.9 million for the period from January 1 through October 29, 2004. The effective tax rate for the two periods in 2004 differs from the U.S. Federal statutory rate of 35% primarily because of foreign operations taxed at different rates, state and local income taxes, valuation allowances, extraterritorial income exclusion and non-taxable partnership income.

 

Bookings and backlog.  Bookings for the year ended December 31, 2005 of $1,446.2 million compared to $218.0 million for the period from October 30 through December 31, 2004 and $901.2 million for the period from January 1 through October 29, 2004. Backlog at December 31, 2005 of $884.7 million compared to $637.6 million at December 31, 2004. The increase in both metrics was due to increased worldwide demand in the new units segment.

 

Segment Information

 

 

New Units

 

Revenues.  New units revenues were $576.6 million for the year ended December 31, 2005 compared to $77.6 million for the period October 30 through December 31, 2004 and $267.7 million for the period January 1 through October 29, 2004. The increase compared to the combined periods of 2004 is primarily attributable to higher backlog at

the beginning of the year ($489.3 million at December 31, 2004 versus $287.7 million at December 31, 2003). The increased booking rate also contributed to higher revenues in 2005.

 

Gross profit.  Gross profit of $70.9 million compared to $9.8 million for the period from October 30 through December 31, 2004, and $32.3 million for the period from January 1 through October 29, 2004. Gross profit as a percentage of segment revenues was 12.3% compared to 12.6% for the period from October 30 through December 31, 2004 and 12.1% for the period from January 1 through October 29, 2004.

 

Operating income.  Operating income (loss) was $20.8 million for the year ended December 31, 2005, compared to $3.6 million for the period October 30 through December 31, 2004, and $(0.5) million for the period January 1 through October 29, 2004. The increase compared to the combined periods of 2004 was due to the gross profit increase mentioned above less higher allocation of selling and administrative expense due to revenue mix. As a percentage of segment revenues, operating income at 3.5% decreased from 4.6% for the period from October 30 through December 31, 2004, but increased from the (0.2)% for the period from January 1 through October 29, 2004.

 

Bookings and backlog.  New unit bookings for the year ended December 31, 2005 of $771.9 million compared to $121.1 million for the period from October 30 through December 31, 2004 and $415.8 million for the period from January 1 through October 29, 2004. New unit backlog at December 31, 2005, of $688.1 million compared to $489.3 million at December 31, 2004.

 

Aftermarket Parts and Services

 

Revenues.  Aftermarket parts and services revenues were $631.6 million for the year ended December 31, 2005 compared to $122.3 million for the period October 30 through December 31, 2004 and $447.8 million for the period from January 1 through October 29, 2004. The increase compared to the combined periods of 2004 is primarily attributable to the higher new order-booking rate. The higher backlog at the beginning of the year ($148.3 million at December 31, 2004 versus $132.2 million at December 31, 2003) also contributed to higher revenues in 2005.

 

Gross profit.  Gross profit was $216.3 million for the year ended December 31, 2005, compared to $40.5 million for the period from October 30 through December 31, 2004 and $145.2 million for the period January 1 through October 29, 2004. Gross profit as a percentage of segment revenues was 34.3% compared to 33.1% for the period October 30 through December 31, 2004 and 32.4% for the period January 1 through October 29, 2004. The increase was attributed to lower allocations due to revenue mix (aftermarket parts and services segment was 52.0% of total revenues in 2005 versus 62.0% in 2004).

 

Operating income.  Operating income was $141.4 million for the year ended December 31, 2005 compared to $30.6 million for the period October 30 through December 31, 2004, and $85.0 million for the period January 1 through October 29, 2004. The increase compared to the combined periods of 2004 was due to the gross profit increase mentioned above less lower allocation of selling and administrative expense due to revenue mix. As a percentage of segment revenues, operating income at 22.4% compares to 25.0% for the period October 30 through December 31, 2004, and 19.0% for the period January 1 through October 29, 2004.

 

Bookings and backlog.  Aftermarket parts and services bookings for the year ended December 31, 2005, were $674.3 million compared to $96.9 million for the period from October 30 through December 31, 2004 and $485.4 million for the period from January 1 through October 29, 2004. Aftermarket parts and services backlog at December 31, 2005, was $196.6 million compared to $148.3 million at December 31, 2004.

 

Liquidity and Capital Resources

 

Historically, our primary source of cash has been from operations. Prior to the closing of the Transactions, our Predecessor participated in Ingersoll Rand’s centralized treasury management system whereby, in certain countries, our Predecessor’s cash receipts were remitted to Ingersoll Rand and Ingersoll Rand funded our Predecessor’s cash disbursements. Our Predecessor’s primary cash disbursements were for capital expenditures and working capital. Following the consummation of the Transactions, we initially relied upon a transition services agreement with Ingersoll Rand to provide these services until we could establish our own cash management system. As of April 2, 2005, we were no longer reliant upon Ingersoll Rand for any cash management services.

 

Net cash provided by operating activities for the year ended December 31, 2006 was $164.1 million compared to $212.4 million for the year ended December 31, 2005. This decline in net cash provided by operating activities for 2006 principally resulted from an increase in working capital and other in 2006 compared to a decrease in 2005, partially offset by higher net income and other net non-cash expenses in 2006 compared to 2005. Net income improved to $78.8 million in 2006 from $37.1 million in 2005. Depreciation and amortization was $50.4 million for the year ended

December 31, 2006 compared to $61.4 million for the year ended December 31, 2005. This decline is attributable to the Order backlog and Non-compete agreement intangible assets acquired in the Acquisition now being fully amortized. Non-cash stock-based compensation increased to $26.0 million for the year ended December 31, 2006 from $4.1 million for the year ended December 31, 2005 principally because of the exit unit expense of $23.6 million previously described. The non-cash curtailment gain during the year ended December 31, 2006 has also been previously described. Non-cash deferred tax provision was $14.2 million for the year ended December 31, 2006 compared to $(2.2) million for the year ended December 31, 2005 because higher income before income taxes will allow the Company to use certain previously recognized net operating loss carryforwards in the 2006 U.S. federal income tax return. Accounts receivable increased $28.3 million because of higher fourth quarter 2006 sales compared to the fourth quarter of 2005. Inventories-net increased $35.2 million during 2006 principally from higher raw materials and supplies to support the higher backlog at December 31, 2006. Work-in-process and finished goods inventory less progress payments and customer advance payments remained relatively constant at December 31, 2006 compared to December 31, 2005.

 

Cash used in investing activities was $19.5 million for the year ended December 31, 2006 compared to $59.5 million for the year ended December 31, 2005. Capital expenditures increased to $19.7 million for the year ended December 31, 2006 from $15.5 million for the year ended December 31, 2005. As previously reported, we acquired certain assets of TES and two smaller operations for $55.0 million and sold our investment in a partially owned entity for $10 million during the year ended December 31, 2005.

 

Net cash used in financing activities was $100.1 million for the year ended December 31, 2006 compared to $160.1 million for the year ended December 31, 2005. During 2006, we repaid $100 million in advance of required maturities of borrowings under our senior secured credit facility. As previously reported, in 2005, we completed our initial public offering of 31,050,000 shares of our common stock for net proceeds of approximately $608.9 million. We used approximately $55.0 million of the net proceeds to redeem $50.0 million face value amount of our senior subordinated notes due 2014, including the payment of $3.7 million applicable redemption premium and $1.3 million accrued interest to the redemption date. Our Board of Directors approved the payment of a dividend, of the remaining net proceeds, excluding certain costs, of approximately $557.7 million ($10.26 per share) to our stockholders existing immediately prior to the offering, consisting of affiliates of First Reserve and certain members of senior management of the Company. In addition, we paid $211.2 million in long-term debt and $1.6 million in short-term debt during 2005.

 

As of December 31, 2006, we had a cash balance of $146.8 million and the ability to borrow $147.1 million under our $350 million senior secured revolving credit facility, as $202.9 million was used for letters of credit. Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures and research and development efforts will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We are currently not aware of any significant restrictions on the ability of the Company’s subsidiaries to distribute cash to the Company. From time to time based on market conditions, we may repurchase a portion of the senior subordinated notes at market prices which may result in purchase prices in excess of par. Although we cannot assure you that we will continue to generate comparable levels of cash from operations, based on our current and anticipated levels of operations and conditions in our markets and industry, we believe that our cash flow from operations, available cash and available borrowings under the senior secured credit facility will be adequate to meet our working capital, capital expenditures, debt service and other funding requirements for the next twelve months and our long-term future contractual obligations.

 

Net cash provided by operating activities for year ended December 31, 2005, was $212.4 million, compared to $17.4 million for the period from October 30 through December 31, 2004 (Successor) and $57.7 million for the period January 1 through October 29, 2004 (Predecessor). The improved net cash provided by operating activities for 2005 was mainly from profitable operations, higher depreciation and amortization due to purchase accounting being applied to the Acquisition, a reduction in inventories and an increase in customer advance payments. Depreciation and amortization was $61.4 million for the year ended December 31, 2005, compared to $16.3 million for the period from October 30 through December 31, 2004 and $22.7 million for the period from January 1 through October 29, 2004. Inventories-net declined $28.7 million and customer advance payments increased $49.9 million from December 31, 2004, a result of our increased efforts to collect customer payments in line with or ahead of the costs of inventory work- in-process. The change over the periods in other assets and liabilities is primarily attributable to accrued interest on new debt and other accruals and prepayments related to being a stand-alone company compared to being a division of Ingersoll Rand.

 

Net cash flow used by investing activities for the year ended December 31, 2005 was $59.5 million. Capital expenditures for the year ended December 31, 2005 were $15.5 million. We sold our investment in a partially owned entity in the first quarter of 2005 for $10 million. For the period from October 30, 2004 through December 31, 2004, and