item 14 exhibits financial statement schedules reports form 8k index financial statements financial statement schedules exhibits see index exhibits list exhibits filed herewith index also includes identifies management contracts compensatory plans arrangements required filed exhibits form 10k item 60110 iii regulation sk b reports form 8k reports form 8k filed quarter ended december 31 1999 c index exhibits filed herewith management contracts compensatory plans arrangements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 29th day march 2000 natco group inc nathaniel gregory nathaniel gregory chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 29th 2000 index exhibits filed herewith management contracts compensatory plans arrangementsitem 14 exhibits financial statement schedules reports form 8k index financial statements financial statement schedules exhibits b reports form 8k company filed form 8k november 7 2000 announce board directors resolutions adopt stock repurchase plan provide full recourse loan executive officer facilitate exercise certain outstanding stock options c index exhibits included herewith management contracts compensatory plans arrangements signatures pursuant requirements section 13 15d securities exchange act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 29th day march 2001 natco group inc registrant nathaniel gregory nathaniel gregory chief executive officer chairman board directors pursuant requirements securities exchange act 1934 report signed following persons behalf registrant capacities indicated march 29th 2001 exhibit index included herewith management contracts compensatory plans arrangementsitem 14 exhibits financial statement schedules reports form 8k index financial statements financial statement schedules exhibits included herewith management contracts compensatory plans arrangements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 28th day march 2002 natco group inc registrant nathaniel gregory nathaniel gregory chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 28th 2002 exhibit index included herewith management contracts compensatory plans arrangementsitem 14 controls procedures controls procedures march 17 2003 various dates throughout 2002 2003 members management team including chief executive officer chief financial officer reviewed disclosure controls procedures defined securities exchange commission rule 13a14c securities exchange act 1934 evaluate continually improve effectiveness design operation controls based upon review management determined disclosure controls procedures operate important information collected timely manner provided management made known chief executive officer chief financial officer appropriate allow timely decisions regarding disclosure public filings addition significant changes made internal controls procedures subsequent december 31 2002 corrective actions anticipated noted significant deficiencies material weaknesses control structure pursuant section 906 sarbanesoxley act 2002 chief executive officer chief financial officer provided certain certifications sec certifications accompanied report filed sec set forth herein part iv item 15item 14 principal accounting fees services audit fees paid audit fees independent public accountants kpmg llp totaling 543547 433945 years ended december 31 2003 2002 respectively professional services rendered audit annual financial statements auditrelated fees paid auditrelated fees kpmg llp totaling 47521 23000 years ended december 31 2003 2002 respectively related primarily audit financial statements employee benefit plan tax fees paid tax fees kpmg llp totaling 72587 30523 years ended december 31 2003 2002 fees paid related primarily tax compliance consultation related tax issues us canada uk fees paid fees kpmg llp totaling 2750 years ended december 31 2003 2002 respectively related preparation information return associated employee benefit plan policy audit committee preapproval audit nonaudit services independent auditor audit committees policy preapprove audit nonaudit services provided independent public accountants auditors services may include audit services auditrelated services tax services preapproval generally provided one year detailed particular service category services generally subject specific budget audit committee delegated chairman authority preapprove engagements independent auditor accountants perform audit nonaudit services amounts 100000 per engagement subject subsequently reporting committee engagement approves independent public accountants auditors management required periodically report full audit committee regarding extent services provided independent public accountants auditors accordance preapproval fees services performed date none services provided independent public accountants auditors categories auditrelated tax fees described approved audit committee pursuant waiver preapproval provisions set forth rule 201c regulation sx part iv item 15item 14 principal accounting fees services information called item contained caption “audit committee report” 2005 annual meeting proxy statement filed within 120 days december 31 2004 incorporated document reference part iv item 15item 14 principal accountant fees services information called item contained caption “audit committee report” 2006 annual meeting proxy statement filed within 120 days december 31 2005 incorporated document reference index financial statements part iv item 15item 14 principal accountant fees services information called item contained caption “audit committee report” 2008 annual meeting proxy statement filed within 120 days december 31 2007 incorporated document reference index financial statements part iv item 15item 14 principal accountant fees services information called item contained caption “audit committee report” 2009 annual meeting proxy statement filed within 120 days december 31 2008 incorporated document reference index financial statements part iv item 15item 14 principal accountant fees services information called item contained caption “audit committee report” 2007 annual meeting proxy statement filed within 120 days december 31 2006 incorporated document reference index financial statements part iv item 15 item 7managements discussion analysis financial condition results operations following discussion companys historical results operations financial condition read conjunction companys consolidated financial statements notes thereto overview companys operations organized four separate business segments traditional production equipment services segment primarily provides standardized components replacement parts used components equipment servicing engineered systems segment primarily provides customized large scale integrated oil gas production systems canadian operations segment combines traditional production equipment services engineered systems instrumentation electrical control systems segment provides control panels systems monitor control oil gas production company recognizes revenues significant contracts greater 250000 longer four months duration instrumentation electrical contracts orders percentage completion method company records revenues profits sales shipments made earned revenue based percentage costs incurred date bear total estimated costs estimated total costs contract workinprocess indicate loss company recognizes entire loss immediately company generally recognizes revenue earnings percentage completion method applies period two six quarters customers typically retain interest uncompleted projects forwardlooking statements managements discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended forwardlooking statement words believes expects plans intends estimates projects could may similar expressions intended identify forwardlooking statements companys expectations business outlook customer spending oil gas prices business environment company industry general expectations regarding matters assurance given actual results may differ materially forwardlooking statements herein reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition world economic conditions level drilling activity legislative environment united states countries policies organization petroleum exporting countries opec conflict major petroleum producing consuming regions development technology could lower overall exploration development costs weather patterns overall condition capital equity markets countries company operates industry business environment company provides oilfield service equipment oil gas industry late 1998 throughout 1999 industry suffered downturn resulted significant decline overall drilling production expenditures oil gas operators due low hydrocarbon prices companys business closely linked market conditions customers production slows fewer purchases made companys products especially traditional production equipment services comprised approximately 32 35 companys revenues years ended december 31 1999 december 31 1998 respectively however trends toward higher oil prices indicated latter part 1999 first quarter 2000 example price west texas intermediate crude oil increased approximately 2600 per barrel march 2000 compared 1000 per barrel march 1999 furthermore march 22 2000 crude oil futures new york mercantile exchange trading 2800 per barrel april 2000 delivery although crude oil price increases indicators additional oil gas production may occur 2000 assurance overall production increase production trends continue throughout 2000 increase production would result increase revenues company results operations 1 1998 company changed fiscal year end march 31 december 31 comparison purposes unaudited statement operations data twelve months ended december 31 1997 1998 presented 2 represents results operations pth outstanding stock distributed company capricorn dividend june 30 1997 see note 17 notes consolidated financial statements twelve months ended december 31 1999 compared twelve months ended december 31 1998 revenues year ended december 31 1999 decreased 309 million 15 1699 million 2008 million year ended december 31 1998 revenues generated 1999 included 221 million revenue attributed cynara company acquired november 1998 excluding impact cynara 1999 companys revenues would declined 530 million 26 1999 compared 1998 overall decline revenue attributable significant reduction spending companys customers result sharp decrease energy prices began mid1998 continued early 1999 following table summarizes revenues business segment years ended december 31 1999 december 31 1998 increase revenues engineered systems year ended december 31 1999 144 million 32 relates primarily acquisition cynara twelve months operations included 1999 results versus one month operations 1998 revenues 600 million 456 million years ended december 31 1999 december 31 1998 respectively include affiliated revenues 17 million 15 million traditional equipment service revenues decreased 159 million 22 due overall decline oil gas industry fourth quarter 1998 throughout 1999 decline consistent reduction number drilling rigs operating united states operating rigs decreased 826 december 31 1998 625 december 31 1999 affiliated revenues business segment 12 million 07 million years ended december 31 1999 december 31 1998 respectively revenues instrumentation electrical systems decreased 47 million 10 1999 compared 1998 due completion significant project 1998 included revenues 418 million 466 million years ended december 31 1999 december 31 1998 affiliated revenues 23 million 11 million respectively decrease revenues natco canada year ended december 31 1999 compared year ended december 31 1998 237 million due primarily overall decline oil gas industry completion significant projects 1998 total revenues 198 million year ended december 31 1999 include 15 million revenue affiliates revenues 435 million year ended december 31 1998 include 25 million affiliate revenues change revenues corporate represents elimination revenues affiliates discussed gross profit gross profit year ended december 31 1999 increased 16 million 4 423 million compared 407 million year ended december 31 1998 percentage revenue gross margins improved 25 year ended december 31 1999 20 year ended december 31 1998 margin improvement attributable partially inclusion cynaras results 1999 well improved product mix due sharp decline revenue natco canada historically generated lower margins following table summarizes gross profit business segment years ended december 31 1999 december 31 1998 gross profit year ended december 31 1999 engineered systems increased 85 million 102 primarily due contribution 92 million cynara included 1999 results compared 04 million contributed cynara one month operations included 1998 results gross margin business segment represented 28 18 sales engineered systems years ended december 31 1999 december 31 1998 respectively decrease 41 million 23 gross profit traditional equipment services business segment year ended december 31 1999 compared respective period 1998 due 22 decline revenues percentage revenue gross margins 25 respectively years ended increase gross profit instrumentation electrical systems business segment year ended december 31 1999 compared year ended december 31 1998 result improved efficiency completed projects 1999 due completion high margin project venezuela second quarter 1999 gross margin percentage revenue years ended december 31 1999 december 31 1998 21 19 respectively gross profit year ended december 31 1999 natco canada decreased 29 million 48 31 million compared 60 million year ended december 31 1998 gross profit decreased due 55 decline revenue period percentage revenue gross margin 16 1999 compared 14 1998 selling general administrative expense selling general administrative expense increased 05 million 2 324 million year ended december 31 1999 compared 319 million reported year ended december 31 1998 overall expenses reduced united states canada due downturn industry expense reductions offset however due addition cynara provided 19 million year ended december 31 1999 addition 1999 company recorded nonrecurring costs 04 million primarily associated retirement officer 06 million related purchase company stock options previously granted chief executive officer company also 1999 company revised previous estimates related remaining costs associated closure natco uk ltd reversed related accruals depreciation amortization expense depreciation amortization expense year ended december 1999 increased 28 million 147 47 million compared 19 million year ended december 31 1998 increase due primarily addition cynara contributed 30 million depreciation amortization expense year ended december 31 1999 interest expense interest expense 33 million year ended december 31 1999 compared 29 million year ended december 31 1998 14 increase interest expense due primarily increase debt result acquisition cynara november 1998 partially offset debt repayments throughout 1999 interest cost postretirement benefit liability interest cost postretirement benefit liability remained constant yeartoyear basis revaluation gain postretirement benefit liability revaluation gain postretirement benefit liability increased 11 million loss 01 million year ended december 31 1998 gain 10 million 1999 primarily due decrease liability postretirement benefits liability decreased 1999 result increase discount rate 675 80 used calculate net present value liability addition company experienced favorable claim experience partially offset unfavorable increase medical trend rates year ended december 31 1999 provision benefit income taxes income tax expense increased 09 million 150 06 million year ended december 31 1998 compared 15 million year ended december 31 1999 increase due following 1 higher state income tax due greater percentage revenues 1999 compared 1998 contributed test whose manufacturing facilities located state louisiana 2 increase permanent booktotax differences due nondeductibility goodwill amortization related cynara acquisition made november 1998 3 onetime charge 03 million incurred deferred state rate adjustment resulted former holding company liquidated resulting assets transferred entity lower effective tax rate deferred tax assets income continuing operations income continuing operations decreased 26 million year ended december 31 1998 06 million year ended december 31 1999 pursuant discussion contributing factors include increase selling general administrative expense 05 million increase depreciation amortization expense 28 million increase net interest expense 03 million increase provision income taxes 09 million partially offset increase gross profit 16 million 11 million increase gain revaluation postretirement benefit liability net income net income year ended december 31 1999 decreased 06 million compared 26 million reported year ended december 31 1998 decrease due various factors discussed twelve months ended december 31 1998 compared twelve months ended december 31 1997 revenues year ended december 31 1998 increased 184 million 10 2008 million 1824 million year ended december 31 1997 increase principally attributable inclusion test full year 1998 compared six months 1997 increase also attributable inclusion cynara revenue five weeks 1998 excluding impact acquisitions revenues would declined 70 million 4 1998 1997 decline revenue 1998 compared 1997 attributable reduction spending companys customers result decrease energy prices began mid1998 continued early 1999 follow table summarizes revenues business segment years ended december 31 1998 december 31 1997 revenues engineered systems year ended december 31 1998 increased 89 million 24 compared year ended december 31 1997 inclusive revenues affiliates 15 million 07 million respective periods increase largely due completion projects 1998 awarded company 1997 traditional production equipment services revenue decreased 16 million 2 year ended december 31 1998 compared year ended december 31 1997 includes increase affiliated revenues 01 million 07 million 06 million respective periods results principally due strong order backlog carried 1998 revenues instrumentation electrical systems year ended december 31 1998 increased 247 million 113 466 million 219 million year ended december 31 1997 inclusive revenues affiliates 11 million 1998 revenues affiliates recorded 1997 increase principally attributable inclusion test full year 1998 compared six months 1997 natco canada revenues 1998 decreased 112 million 21 435 million 547 million 1997 change net increase affiliated revenues 04 million 25 million year ended december 31 1998 21 million year ended december 31 1997 decrease revenue attributable significant decline spending levels customers result low energy prices completion large project first six months 1998 change revenues corporate represents elimination revenues affiliates discussed gross profit gross profit year ended december 31 1998 increased 52 million 15 407 million 356 million year ended december 31 1997 percentage revenue gross margin improved 20 1998 versus 19 1997 margin improvement attributable improved performance engineered systems projects well improved product mix due decline revenue natco canada historically generated lower margins following table summarizes gross profit business segment years ended december 31 1998 december 31 1997 gross profit engineered systems increased 39 million 87 84 million twelve months ended december 31 1998 45 million twelve months ended december 31 1997 increase partially due inclusion cynara 1998 results additionally improved project management selectivity bid acceptance process contributed higher gross margins percentage revenue gross margins 18 1998 compared 12 1997 gross profit traditional production equipment services decreased 11 million 6 1998 compared 1997 decrease primarily due 2 reduction revenue time period percentage revenue gross margins 25 1998 compared 26 1997 increase gross profit 48 million 119 instrumentation electrical systems business segment twelve months ended december 31 1998 compared twelve months ended december 31 1997 principally attributable inclusion test full year 1998 compared six months 1997 percentage revenue gross margins remained constant 19 twelve months ended december 31 1998 twelve months ended december 31 1997 gross profit natco canada decreased 24 million 29 60 million 84 million decrease principally attributable 21 reduction revenues period time percentage revenue gross margins 14 1998 compared 15 1997 selling general administrative expense selling general administrative expense increased 37 million 13 319 million twelve months ended december 31 1998 compared 282 million twelve months ended december 31 1997 increase primarily due inclusion test full year 1998 compared six months 1997 well inclusion cynara five weeks 1998 addition nonrecurring expenses totaling 16 million recorded 1998 12 million related previous initial public offering effort early 1998 04 million related severance costs incurred addition insurance reserve reductions totaling 25 million recorded 1998 reflecting revisions previous estimates related workers compensation general liability claims 1997 company incurred nonrecurring compensation expense related conversion stock appreciation rights stock options totaling 12 million depreciation amortization expense depreciation amortization expense increased 08 million 73 19 million 11 million twelve months ended december 31 1997 increase principally due goodwill amortization related test acquisition depreciation cynara gas processing plants interest expense interest expense decreased 02 million 6 29 million 31 million twelve months ended december 31 1997 6 decrease interest expense due primarily conversion 13 subordinated notes common stock companys principal stockholders april 1 1998 interest cost postretirement benefit liability interest cost postretirement benefit liability remained constant yeartoyear basis revaluation loss postretirement benefit liability revaluation loss decreased 01 million 50 02 million twelve months ended december 31 1997 01 million twelve months ended december 31 1998 resulted slight changes actuarial assumptions provision benefit income taxes income tax expense decreased 03 million 33 09 million year ended december 31 1997 compared 06 million year ended december 31 1998 decrease primarily due lower contribution income continuing operations foreign affiliates 1998 compared 1997 tax rates income derived foreign affiliates typically higher domestic rates income continuing operations income continuing operations 1998 increased 15 million 136 26 million 11 million respective period 1997 increase due primarily 52 million increase gross profit largely due increase revenues 03 million decrease provision income taxes less 08 million increase depreciation amortization expense 37 million increase selling general administrative expense income discontinued operations income discontinued operations 08 million year ended december 31 1997 represented income pth capital stock distributed june 1997 companys sole stockholder income discontinued operations year ended december 31 1998 net income net income twelve months ended december 31 1998 increased 07 million 37 26 million 19 million twelve months ended december 31 1997 decrease due various factors discussed fiscal year ended march 31 1998 compared fiscal year ended march 31 1997 revenues fiscal year ended march 31 1998 increased 753 million 59 2020 million 1267 million fiscal year ended march 31 1997 increase 327 million attributable inclusion results test companys results last nine months fiscal year ended march 31 1998 addition company revenues 277 million bp exploration alaska inc alliance project compared revenues 45 million alliance fiscal year ended march 31 1997 follow table summarizes revenues business segment fiscal years ended march 31 1998 march 31 1997 revenues engineered systems fiscal 1998 decreased 94 million 22 342 million 436 million fiscal 1997 inclusive revenue affiliates 08 million year ended march 31 1998 09 million year ended march 31 1997 decrease revenues resulted primarily postponement major project increased selectivity bid process revenues traditional production equipment services fiscal 1998 increased 199 million 35 768 million 569 million fiscal 1997 inclusive revenue affiliates 06 million year ended march 31 1998 11 million year ended march 31 1997 increase revenues resulted primarily strong demand market products services revenues instrumentation electrical systems 332 million attributable inclusion test revenues nine months fiscal year ended march 31 1998 results include revenue affiliates 05 million year ended march 31 1998 revenues natco canada fiscal 1998 increased 277 million 87 597 million compared 320 million fiscal 1997 revenues affiliates included fiscal year 1998 results compared 39 million affiliate revenues included fiscal 1997 significant portion increase overall revenues natco canada due substantial project bp exploration alaska inc change revenues corporate represents elimination revenues affiliates discussed gross profit gross profit fiscal 1998 increased 143 million 55 402 million 259 million fiscal 1997 primarily due increases revenues discussed percentage revenues gross profits remained unchanged fiscal 1998 compared fiscal 1997 following table summarizes gross profit business segment fiscal years ended march 31 1998 march 31 1997 gross profit engineered systems fiscal 1998 decreased 08 million 13 52 million 60 million fiscal 1997 primarily due decrease revenue discussed percentage revenues gross profit increased 14 fiscal 1997 15 fiscal 1998 gross profit traditional production equipment services fiscal 1998 increased 51 million 35 196 million 145 million fiscal 1997 primarily due increases revenue discussed percentage revenues gross profit remained constant 25 fiscal years 1998 1999 gross profit instrumentation electrical systems 64 million fiscal 1998 attributable inclusion gross profit test nine months ended march 31 1998 gross profit natco canada fiscal 1998 increased 36 million 69 90 million 54 million fiscal 1997 primarily due increase revenue discussed percentage revenues gross profit decreased 17 fiscal 1997 15 fiscal 1998 primarily result lower margin bp exploration alaska inc project selling general administrative expense selling general administrative expense increased 52 million 22 285 million fiscal 1998 233 million fiscal 1997 increase 47 million attributable inclusion results test remainder primarily attributable increased expenses associated increase volume companys business addition insurance reserve reductions totaling 13 million recorded year ended march 31 1998 reflecting revisions previous estimates related workers compensation general liability claims year ended march 31 1997 nonrecurring compensation expense related conversion stock appreciation rights stock options totaling 12 million recorded depreciation amortization expense depreciation amortization expense increased 05 million 53 13 million fiscal 1998 09 million fiscal 1997 05 million increase fiscal 1998 04 million related depreciation amortization expense test interest expense interest expense increased 11 million 58 30 million fiscal 1998 19 million fiscal 1997 primarily result increased debt incurred connection acquisition test interest cost postretirement benefit liability interest cost postretirement benefit liability increased 01 million 10 million fiscal 1998 09 million fiscal 1997 due increased amortization resulting upward revaluation postretirement benefit liability based revised actuarial assumptions march 31 1997 revaluation loss postretirement benefit liability revaluation postretirement benefit liability decreased 13 million 87 15 million fiscal 1997 02 million fiscal 1998 resulted primarily decrease discount rate used actuarial calculations provision benefit income taxes income tax expense increased 18 million benefit 07 million fiscal year ended march 31 1997 expense 11 million fiscal year ended march 31 1998 change due primarily loss continuing operations fiscal year ended march 31 1997 associated expenditures closing natco uk office london addition effective tax rate fiscal 1998 18 reflects benefit net operating losses carried forward prior years income loss continuing operations income continuing operations increased 70 million 51 million fiscal 1998 loss 18 million fiscal 1997 primarily result increases gross profit inclusion operations test nine months ended march 31 1998 income discontinued operations income discontinued operations 08 million year ended march 31 1998 11 million year ended march 31 1997 represented income pth capital stock distributed june 1997 companys sole stockholder net income net income increased 19 million 46 59 million fiscal 1998 41 million fiscal 1997 primarily result factors discussed liquidity capital resources february 29 2000 company cash working capital 109 million 374 million respectively compared cash working capital 17 million 253 million december 31 1999 increase cash reflects funds received pursuant initial public offering companys class common stock less debt repayments made february 2000 discussed net cash provided used operating activities year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 154 million 15 million 31 million respectively increase net cash provided operating activities 1999 primarily due reduction order backlog consistent decrease trade accounts receivable related percentage completion projects 93 million december 31 1998 09 million december 31 1999 furthermore acquisition cynara november 1998 supplied additional working capital cash flow 1999 compared 1998 net cash used investing activities year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 26 million 171 million 247 million respectively companys primary use funds nine months ended december 31 1998 acquisition cynara required use 155 million cash companys primary use funds year ended march 31 1998 acquisition test required use 224 million cash net cash provided used financing activities year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 137 million 202 million 217 million respectively use cash financing activities 1999 due primarily repayment longterm debt cash provided financing activities nine months ended december 31 1998 year ended march 31 1998 relates issuances common stock borrowings longterm debt finance cynara test acquisitions respectively company maintains revolving credit term loan facilities well working capital facility export sales revolving credit facility provides 220 million borrowings united states 100 million borrowings canada subject borrowing base limitations december 31 1999 borrowings outstanding revolving credit facility addition company issued 25 million letters credit revolving facility december 31 1999 initial term loan 325 million reduced 312 million december 31 1999 borrowings revolving credit facility mature november 2001 term loan matures november 2003 revolving credit term facility secured substantially companys assets export sales credit facility provides aggregate borrowings 100 million subject borrowing base limitations borrowings outstanding december 31 1999 addition company issued letters credit totaling 73 million export facility export sales credit facility secured specific project inventory receivables partially guaranteed exim bank export sales credit facility loans mature july 2002 december 31 1999 weighted average interest rate companys borrowings credit facilities 898 january 24 2000 company invested 54 million cash purchase portatest inc financed cash hand borrowing revolving credit facility issuance oneyear promissory note approximately 07 million companys management believes acquisition allow company provide oil gas producers production facilities smaller efficient portatest inc included natco canada business segment first quarter 2000 purchase price allocation acquisition yet finalized february 2 2000 company received funds initial public offering class common stock totaling 377 million offering became effective january 27 2000 february 7 2000 company received proceeds 105 million underwriters initial public offering underwriter executed overallotment option companys class common stock february 8 2000 company purchased modular production equipment inc 25 million cash promissory note 03 million companys management believes water treatment technology expertise modular production equipment inc company offer customers advanced complete turnkey process solution acquisition included engineered systems business segment first quarter 2000 purchase price allocation acquisition yet finalized february 2000 proceeds companys initial public offering used pay revolving credit facility 259 million including 30 million borrowed finance purchase portatest inc outstanding debt balance february 29 2000 57 million company estimates cash generated operations 2000 sufficient meet cash operating requirements companys capital expenditures generally consist renovations expansions manufacturing plants technological improvements management information systems acquisitions improvements equipment used business historically capital expenditures ranged 10 million 20 million annually budgeted capital expenditures year ending december 31 2000 approximately 35 million capital expenditure budget includes project upgrade existing membrane manufacturing facility pittsburgh california companys sales backlog february 29 2000 february 28 1999 835 million 349 million respectively significant percentage february 29 2000 backlog represented contract one customer carigalitriton operating company sdn bhd ctoc contract awarded june 1999 projected generate total revenues approximately 730 million 1999 ctoc revenues 146 million represented 9 total revenues company revenues ctoc project fiscal 2000 expected constitute significant percentage total revenue backlog february 29 2000 excluding ctoc project reflects substantial decline backlog volumes prior year companys management anticipates backlog december 31 2000 excluding ctoc project substantially higher backlog february 29 2000 due bookings expected occur fiscal 2000 february 29 2000 borrowing base limitations reduced companys available borrowing capacity revolving credit agreement 191 million however companys management believes companys operating cash flow supported borrowing capacity adequate fund operations throughout 2000 company decide pursue one additional acquisition opportunities 2000 determination companys ability finance acquisitions critical element analysis opportunities inflation changes prices costs materials eg steel products rise fall value commodity markets generally increases raw materials labor costs passed customers recent accounting pronouncements statement financial accounting standards 133 accounting derivative instruments hedging activities issued financial accounting standards board june 1998 sfas 133 standardizes accounting derivative instruments including derivative instruments embedded contracts standard entities required carry derivative instruments statement financial position fair value accounting changes fair value ie gains losses derivative instrument depends whether designated qualifies part hedging relationship reason holding specified conditions met entities may elect designate derivative instrument hedge exposures changes fair values cash flows foreign currencies hedged exposure fair value exposure gain loss derivative instrument recognized earnings period change together offsetting loss gain hedged item attributable risk hedged exposure cash flow exposure effective portion gain loss derivative instrument reported initially component comprehensive income outside earnings subsequently reclassified earnings forecasted transaction affects earnings amounts excluded assessment hedge effectiveness well ineffective portion gain loss reported earnings immediately accounting foreign currency hedges similar accounting fair value cash flow hedges derivative instrument designated hedge gain loss recognized earnings period change company adopt sfas 133 fiscal year beginning january 1 2001 companys management determined impact sfas 133 companys financial statements believes determination meaningful closer date initial adoption item 7a quantitative qualitative disclosures market risk exchange rate sensitivity companys operations conducted around world number different countries accordingly future earnings exposed changes foreign currency exchange rates transactions denominated currencies companys functional currencies primary currencies company conducts business various jurisdictions majority foreign currency transactions denominated canadian dollar functional currency natco canada contracts denominated settled functional currency risks associated currency fluctuations minimized company currently hedge foreign currency translation risks believes foreign currency exchange risk significant operations interest rate sensitivity companys financial instruments subject changes interest rates include revolving credit term loan facility working capital facility export sales december 31 1999 company 312 million outstanding term loan portion revolving credit term loan facility term borrowings mature november 2003 bear interest floating rates december 31 1999 weighted average interest rate companys borrowings credit facility 898 borrowings outstanding revolving credit portion working capital facility december 31 1999 based past market movements reasonably possible nearterm market movements company believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material assuming companys current level borrowings 100 basis point increase interest rates borrowings would decrease companys current year net income cash flow operations less 01 million event adverse change interest rates company could take action mitigate exposure however due uncertainty actions could taken possible effects analysis assumes actions furthermore analysis consider effects possible change level overall economic activity could exist environment item 8item 7 managements discussion analysis financial condition results operations following discussion companys historical results operations financial condition read conjunction consolidated financial statements notes thereto overview offer products services either integrated systems individual components primarily three business lines traditional production equipment services provide standardized components replacement parts used components equipment servicing engineered systems provide customized large scale integrated oil gas production systems automation control systems provide control panels systems monitor control oil gas production financial reporting purposes however report canadian operations combine traditional production equipment services engineered systems segment therefore report four separate business segments traditional production equipment services engineered systems automation control systems canadian operations recognize revenues significant contracts greater 250000 longer four months duration automation control systems contracts orders percentage completion method earned revenue based percentage costs incurred date relative total estimated costs estimated total costs contract workinprocess indicate loss recognize entire loss immediately generally recognize revenues earnings percentage completion method applies period two six quarters record revenues sales shipments made january 2000 completed initial public offering common stock resulting issuance 5178807 shares common stock net proceeds 467 million july 2000 changed presentation certain assets acquired cynara company november 1998 related operating results segment reporting purposes majority assets reclassified traditional production equipment services business segment engineered systems business segment change retroactively reflected periods presented forwardlooking statements managements discussion analysis includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended forwardlooking statement words believe expect plan intend estimate project could may similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions regarding synergies opportunities resulting recent acquisitions see acquisitions indicated trends level oil gas exploration production effect conditions companys results operations see industry business environment future uses requirements financial resources see liquidity capital resources expectations business outlook customer spending oil gas prices business environment natco industry general expectations regarding matters assurance given actual results may differ materially forwardlooking statements herein reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition world economic conditions level drilling activity legislative environment united states countries policies organization petroleum exporting countries conflict major petroleum producing consuming regions development technology could lower overall finding development costs weather patterns overall condition capital equity markets countries natco operates following discussion read conjunction financial statements related notes financial information appearing elsewhere form 10k readers also urged carefully review consider various disclosures advising interested parties factors affect company including without limitation disclosures made caption business risks relating business factors risks discussed registration statement form s1a subsequent reports filed securities exchange commission expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based acquisitions november 1998 acquired outstanding common stock cynara company designer manufacturer specialized production equipment utilizing membrane technology separate bulk co2 natural gas streams approximately 155 million 500000 shares common stock right receive additional shares common stock based upon financial performance cynara assets ultimately issued 743981 additional shares december 31 2000 january 2000 acquired outstanding common stock portatest international inc manufacturer centrifugal devices used enhance effectiveness separation equipment approximately 70 million right receive additional payments based upon performance certain portatest assets february 2000 acquired outstanding common stock modular production equipment inc mpe designer manufacturer wastewater treatment separation systems specializing hydrocyclone technology approximately 27 million april 2000 acquired outstanding common stock engineered specialties inc esi provider proprietary technologies oily water treatment heavy metals removal production near wellhead approximately 71 million march 19 2001 acquired outstanding share capital axsia group limited privately held process design company based united kingdom approximately 458 million axsia specializes design supply water reinjection systems oil gas fields oily water treatment oil separation hydrogen production process equipment systems acquisition financed borrowings new credit facility accounted transactions using purchase method accounting industry business environment generally oil gas exploration production companies reduce exploration development activity periods weak oil prices demand increase activity periods strong oil prices demand extent revenues industry increase depends part upon success exploration efforts general revenue increases lag expansion exploration development capital budgets times recovery oil gas industry lag times several years offshore operations generally shorter onshore operations changing production profiles existing fields also increase demand products services industry existing fields reworked enhanced recovery methods employed due depletion additional complex equipment may required produce oil gas fields result changes mix oil gas produced field increase water co2 naturally occurring contaminants result enhanced recovery techniques addition many new oil gas fields produce lower quality contaminated hydrocarbon streams require complex production equipment examples include co2 rich formations west texas southeast asia heavy crude western canada orinoco delta venezuela throughout much 1999 oil gas industry suffering effects significant decline overall drilling production expenditures oil gas operators due low hydrocarbon prices since business closely linked market conditions customers lower drilling production expenditures result reduction revenues traditional production equipment services business segment affected significantly business line primarily provides replacement parts used oil gas production indicator capital spending oil gas industry commodity prices energy prices low 1998 1999 began rise steadily midyear production cuts opec oil producing countries reduced excess inventory levels energy prices remained high spring 2000 producers elected increase production bring energy prices sustainable levels following table summarizes average prices oil gas years ended december 31 2000 1999 1998 actual spot prices oil gas march 15 2001 1 based west texas intermediate spot prices dates indicated 2 based nymex henry hub prices dates indicated another indicator capital spending number operating drilling rigs average us international operating rig counts published weekly baker hughes increased 2000 compared 1999 following table summarizes average us canadian international operating rig counts years ended december 31 2000 1999 increase oil prices 1999 2000 positive effect overall sales 2000 compared 1999 recent price rig count improvements contributed improved overall industry conditions also cause customers continue increase exploration development efforts although energy price rig count increases indicators additional oil gas production may occur 2001 assurance overall production increase production trends continue 2001 increase production would result increase revenues company following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes thereto results operations 1 1998 changed fiscal year end march 31 december 31 comparative purposes presented unaudited statement operations data twelve months ended december 31 1998 2 2000 changed method accounting gains losses postretirement benefit obligation resulted cumulative change accounting principle year ended december 31 2000 compared year ended december 31 1999 revenues year ended december 31 2000 increased 546 million 32 2246 million 1699 million year ended december 31 1999 following table summarizes revenues business segment years ended december 31 2000 1999 respectively revenues traditional equipment services business segment year ended december 31 2000 increased 208 million 33 834 million 626 million year ended december 31 1999 increase due increase oilfield activity resulting overall increase oil gas prices 2000 experienced increased demand production process equipment well domestic parts service business partially offsetting increase decline service revenues 28 million related gas plant operation closed fourth quarter 1999 affiliated revenues business segment approximately 13 million 12 million years ended december 31 2000 1999 respectively revenues engineered systems business segment year ended december 31 2000 increased 153 million 29 678 million 525 million year ended december 31 1999 increase primarily due contribution one customer ctoc provided revenues 459 million year ended december 31 2000 compared 146 million year ended december 31 1999 acquisitions mpe esi february 2000 april 2000 respectively also contributed increase engineered systems revenue increase revenue partially offset decline domestic international engineered systems consistent decrease project awards customers throughout 1999 early 2000 result lower natural gas prices 1999 engineered systems revenues 678 million year ended december 31 2000 included affiliated revenues 286000 compared 17 million affiliated revenues year ended december 31 1999 revenues automation control systems business segment year ended december 31 2000 increased 918000 2 428 million 418 million year ended december 31 1999 despite completion several large projects 1999 revenues business segment increased due stable demand automation controls products increase affiliated revenues 23 million year ended december 31 1999 41 million year ended december 31 2000 revenues natco canada business segment year ended december 31 2000 increased 206 million 104 403 million 197 million year ended december 31 1999 increase partially due acquisition portatest contributed revenues 61 million year ended december 31 2000 increase affiliated revenues 26 million associated large projects including ctoc natco canada business segment results included two significant gas plant projects chevron canada several projects pemex completed 2000 overall industry market conditions canada improved consistent increase canadian rig count 2000 affiliated revenue year ended december 31 2000 41 million compared 15 million year ended december 31 1999 change revenues corporate eliminations represents elimination revenues affiliates discussed gross profit gross profit year ended december 31 2000 increased 195 million 46 618 million 423 million year ended december 31 1999 percentage revenue gross margins improved 27 year ended december 31 2000 compared 25 year ended december 31 1999 following table summarizes gross profit business segment years ended december 31 2000 1999 respectively gross profit traditional equipment services business segment year ended december 31 2000 increased 33 million 19 201 million 169 million year ended december 31 1999 increase margin primarily due 33 increase revenues segment improved margins export parts services percentage revenue gross margins segment 24 27 years ended december 31 2000 1999 respectively gross profit engineered systems business segment year ended december 31 2000 increased 109 million 81 244 million 135 million year ended december 31 1999 increase due primarily 29 increase revenues segment higher margin projects included sales mix 2000 compared 1999 percentage revenue gross margins segment 36 26 years ended december 31 2000 1999 respectively gross profit automation control systems business segment remained relatively constant year ended december 31 1999 year ended december 31 2000 revenues business segment increased 2 primarily due increase affiliated sales little impact gross margin percentage revenue gross margins segment 21 years ended december 31 2000 1999 gross profit natco canada business segment year ended december 31 2000 increased 54 million 174 85 million 31 million year ended december 31 1999 increase gross margin primarily due 104 increase revenues segment addition portatest acquired january 2000 provided margins 28 million year ended december 31 2000 percentage revenue gross margins segment 21 16 years ended december 31 2000 1999 respectively selling general administrative expense selling general administrative expense year ended december 31 2000 increased 70 million 22 395 million 325 million year ended december 31 1999 increase largely related execution business plan included additional costs associated acquisitions portatest mpe esi increased spending technology product development additional expenses related public company continued investment preorder engineering expenses depreciation amortization expense depreciation amortization expense year ended december 31 2000 increased 430000 9 51 million 47 million year ended december 31 1999 depreciation expense year ended december 31 2000 decreased 555000 15 31 million 37 million year ended december 31 1999 decrease primarily due extending service life certain operational assets decrease depreciation expense year ended december 31 2000 compared year ended december 31 1999 partially offset 1 depreciation addition capital assets last four quarters included renovations expansions existing manufacturing plants technological improvements management information systems purchase computer hardware software acquisitions improvements equipment used companys business 2 depreciation expense due inclusion results portatest mpe esi acquired fiscal 2000 amortization expense year ended december 31 2000 increased 913000 90 19 million 10 million year ended december 31 1999 increase primarily due amortization goodwill associated portatest mpe esi acquisitions also amortization expense increased due increase goodwill related acquisition cynara november 1998 pursuant cynara purchase agreement issued 325836 shares 418145 shares class b common stock september 1999 june 2000 respectively cynaras former shareholders based upon achievement certain performance criteria cost shares recorded goodwill interest expense interest expense year ended december 31 2000 decreased 17 million 52 16 million 33 million year ended december 31 1999 decrease due primarily reduction longterm debt term loan revolving credit facilities 312 million december 31 1999 150 million december 31 2000 retired 279 million longterm debt term loan facility february 2000 portion proceeds initial public offering unusual charges unusual charges year ended december 31 2000 15 million charge primarily compensation expense associated employment agreement executive officer terms agreement entitled officer sum equal outstanding note accrued interest totaling 12 million december 31 1999 upon sale class common stock initial public offering completed initial public offering january 27 2000 pursuant terms agreement recorded compensation expense amount note accrued interest including related payroll burdens totaling 13 million addition recorded relocation expenses totaling 208000 associated consolidation two facilities following acquisition portatest revaluation gain postretirement benefit liability december 2000 changed method accounting gains losses postretirement benefit obligation rather record gains losses income statement amortize gains losses exceed 10 accumulated postretirement benefit obligation expected remaining lives participants therefore record gain loss revaluation postretirement benefit liability year ended december 31 2000 year ended december 31 1999 revaluation gain postretirement benefit liability 10 million recorded due change actuarial discount rate used calculate net present value underlying liability provision income taxes income tax expense year ended december 31 2000 increased 38 million 245 53 million 15 million year ended december 31 1999 increase income tax expense primarily due increase income taxes 130 million year ended december 31 2000 compared 22 million year ended december 31 1999 increase income tax expense partially offset decrease effective tax rate 71 1999 41 2000 primarily due impact nondeductible goodwill expense cumulative effect change accounting principle gain 10000 net tax recorded year ended december 31 2000 related cumulative effect change method used account gains losses postretirement benefit obligation year ended december 31 1999 compared twelve months ended december 31 1998 revenues year ended december 31 1999 decreased 309 million 15 1699 million 2008 million twelve months ended december 31 1998 following table summarizes revenues business segment year ended december 31 1999 twelve months ended december 31 1998 1 1998 changed fiscal year end march 31 december 31 comparative purposes presented unaudited statement operations data twelve months ended december 31 1998 revenues traditional equipment services business segment year ended december 31 1999 decreased 91 million 13 626 million 717 million twelve months ended december 31 1998 decrease due overall decline oil gas industry fourth quarter 1998 throughout 1999 decline consistent reduction average number drilling rigs operating united states canada 1089 1998 854 1999 affiliated revenues business segment 12 million 700000 year ended december 31 1999 twelve months ended december 31 1998 respectively revenues engineered systems business segment year ended december 31 1999 increased 76 million 17 525 million 449 million twelve months ended december 31 1998 increase relates primarily acquisition cynara twelve months operations included 1999 results versus one month operations 1998 affiliated revenues business segment 17 million 15 million year ended december 31 1999 twelve months ended december 31 1998 respectively revenues automation control systems business segment year ended december 31 1999 decreased 47 million 10 418 million 466 million twelve months ended december 31 1998 decrease due completion significant project 1998 affiliated revenues business segment 23 million 11 million year ended december 31 1999 twelve months ended december 31 1998 respectively revenues natco canada business segment year ended december 31 1999 decreased 237 million 55 198 million 435 million twelve months ended december 31 1998 decrease due primarily overall decline oil gas industry completion significant projects 1998 affiliated revenues business segment 15 million 25 million year ended december 31 1999 twelve months ended december 31 1998 respectively change revenues corporate eliminations represents elimination revenues affiliates discussed gross profit gross profit year ended december 31 1999 increased 16 million 4 423 million 407 million twelve months ended december 31 1998 percentage revenue gross margins improved 25 year ended december 31 1999 20 twelve months ended december 31 1998 following table summarizes gross profit business segment year ended december 31 1999 twelve months ended december 31 1998 1 1998 changed fiscal year end march 31 december 31 comparative purposes presented unaudited statement operations data twelve months ended december 31 1998 gross profit traditional equipment services business segment year ended december 31 1999 decreased 10 million 6 169 million 179 million twelve months ended december 31 1998 decrease due 13 decline revenues percentage revenue gross margins business segment 27 25 year ended december 31 1999 twelve months ended december 31 1998 respectively gross profit engineered systems business segment year ended december 31 1999 increased 54 million 68 135 million 80 million twelve months ended december 31 1998 increase primarily due contribution 92 million cynara included results compared approximately 400000 contributed cynara one month operations included 1998 results percentage revenues gross margin business segment 26 18 year ended december 31 1999 twelve months ended december 31 1998 respectively gross profit automation control systems business segment remained relatively constant comparing year ended december 31 1999 twelve months ended december 31 1998 percentage revenue gross margins 21 19 periods respectively gross profit natco canada business segment year ended december 31 1999 decreased 29 million 48 31 million 60 million twelve months ended december 31 1998 gross profit decreased due 55 decline revenue period percentage revenue gross margins 16 14 year ended december 31 1999 twelve months ended december 31 1998 respectively selling general administrative expense selling general administrative expense year ended december 31 1999 increased 539000 2 324 million 319 million twelve months ended december 31 1998 overall expenses reduced united states canada due downturn industry expense reductions offset however due addition cynara provided 19 million selling general administrative expense year ended december 31 1999 addition 1999 recorded nonrecurring costs approximately 400000 primarily associated retirement officer approximately 600000 related purchase stock options previously granted chief executive officer also 1999 revised previous estimates related remaining costs associated closure natco uk ltd reversed related accruals depreciation amortization expense depreciation amortization expense year ended december 1999 increased 28 million 147 47 million 19 million twelve months ended december 31 1998 increase due primarily addition cynara contributed 30 million depreciation amortization expense year ended december 31 1999 interest expense interest expense year ended december 31 1999 increased 337000 12 33 million 29 million twelve months ended december 31 1998 increase interest expense due primarily increase debt result acquisition cynara november 1998 partially offset debt repayments throughout 1999 revaluation gain postretirement benefit liability revaluation gain postretirement benefit liability 10 million recorded year ended december 31 1999 due change actuarial assumptions gain recognized twelve months ended december 31 1998 provision income taxes income tax expense year ended december 31 1999 increased 942000 155 15 million 606000 twelve months ended december 31 1998 increase due following 1 higher state income tax greater percentage revenues 1999 compared 1998 contributed total engineering services testing inc test whose manufacturing facilities located state louisiana 2 increase permanent booktotax differences due nondeductibility goodwill amortization related cynara acquisition made november 1998 3 onetime charge approximately 300000 incurred deferred state rate adjustment resulted former holding company liquidated resulting assets transferred entity lower effective tax rate deferred tax assets liquidity capital resources february 28 2001 cash working capital 14 million 495 million december 31 2000 cash working capital 10 million 491 million compared 17 million 253 million december 31 1999 net cash provided used operating activities years ended december 31 2000 1999 nine months ended december 31 1998 63 million 154 million 15 million respectively decrease net cash provided operating activities 2000 primarily due increase trade accounts receivable inventories associated higher revenues new businesses acquired 2000 net cash used investing activities years ended december 31 2000 1999 nine months ended december 31 1998 236 million 26 million 171 million respectively primary use funds year ended december 31 2000 acquisitions portatest mpe esi required use 171 million capital expenditures required 81 million capital expenditures consisted primarily renovations expansions manufacturing plants technological improvements management information systems acquisitions improvements equipment used business including upgrade membrane manufacturing facility pittsburg california completed fourth quarter 2000 funds portatest acquisition january 2000 borrowed revolving credit facility funds repaid february 2000 proceeds initial public offering funds mpe acquisition february 2000 also provided initial public offering esi acquisition financed net borrowings 71 million revolving credit facilities primary use funds year ended december 31 1999 nine months ended december 31 1998 capital expenditures 36 million 1999 acquisition cynara 1998 required use 155 million cash net cash provided used financing activities years ended december 31 2000 1999 nine months ended december 31 1998 297 million 137 million 202 million respectively primary source funds financing activities year ended december 31 2000 initial public offering common stock provided net proceeds 467 million proceeds used primarily retire 279 million outstanding debt term loan arrangement repay 30 million borrowed revolving credit agreement purchase portatest repay 29 million debt assumed acquisitions portatest mpe use cash financing activities 1999 due primarily repayment longterm debt cash provided financing activities nine months ended december 31 1998 related issuances common stock borrowings longterm debt finance cynara test acquisitions respectively maintain revolving credit term loan facilities well working capital facility export sales revolving credit facility provides 220 million borrowings united states 100 million borrowings canada subject borrowing base limitations december 31 2000 borrowings outstanding revolving credit facility 150 million issued 21 million outstanding letters credit facility amended revolving credit agreement october 2000 extend maturity date november 2001 january 2003 material changes terms agreement borrowings outstanding term loan facility december 31 2000 revolving credit term loan facility secured substantially assets compliance debt covenants december 31 2000 december 31 2000 weighted average interest rate borrowings term loan revolving credit agreement 858 march 16 2001 entered new credit facility finance acquisition axsia credit facility consists 500 million term loan 350 million us revolving facility 100 million canadian revolving facility 50 million uk revolving facility term loan matures march 15 2006 revolving facilities matures march 15 2004 amounts borrowed term loan portion new facility currently bear interest rate 723 per annum amounts borrowed revolving portion new facility bear interest follows april 1 2002 rate equal election either 1 libor plus 225 2 base rate plus 075 april 1 2002 rate based upon ratio funded debt ebitda ranging election 1 high libor plus 250 low libor plus 175 2 high base rate plus 10 low base rate plus 025 pay commitment fees 050 per year april 1 2002 030 050 per year depending upon ratio funded debt ebitda april 1 2002 case undrawn portion facility new credit facility guaranteed domestic subsidiaries secured first priority lien inventory accounts receivable material tangible intangible assets also pledged 65 voting stock active foreign subsidiaries export sales credit facility provides aggregate borrowings 100 million subject borrowing base limitations borrowings outstanding december 31 2000 issued letters credit totaling 72 million export facility date export sales credit facility secured specific project inventory receivables partially guaranteed exportimport bank united states export sales credit facility loans mature july 2003 capital expenditures generally consist renovations expansions manufacturing plants technological improvements management information systems acquisitions improvements equipment use business year ended december 31 2000 capital expenditures 81 million believe operating cash flow supported borrowing capacity adequate fund operations throughout 2001 extent successful identifying additional acquisition opportunities 2001 ability finance acquisitions critical element analysis opportunities inflation changes prices costs materials eg steel products rise fall value commodity markets generally increases raw materials labor costs passed customers recent accounting pronouncements statement financial accounting standards sfas 133 accounting derivative instruments hedging activities issued financial accounting standards board fasb june 1998 sfas 133 standardizes accounting derivative instruments including derivative instruments embedded contracts standard entities required carry derivative instruments statement financial position fair value adopted sfas 133 january 1 2001 material effect financial condition results operation derivative arrangements financial instruments trading speculative purposes december 31 2000 quantitative qualitative disclosures market risk operations conducted around world number different countries accordingly future earnings exposed changes foreign currency exchange rates transactions denominated currencies functional currencies functional currencies primary currencies conduct business various jurisdictions majority foreign currency transactions denominated canadian dollar functional currency natco canada contracts denominated settled functional currency risks associated currency fluctuations minimized currently hedge foreign currency translation risks believe foreign currency exchange risk significant operations financial instruments subject changes interest rates including revolving credit term loan facility working capital facility export sales december 31 2000 borrowings outstanding term loan portion revolving credit term loan facility december 31 2000 outstanding borrowings revolving credit agreement totaled 150 million revolving credit agreement amended october 2000 extend maturity date borrowings november 2001 january 2003 borrowings revolving credit agreement bear interest floating rates december 31 2000 weighted average interest rate borrowings credit facility 858 borrowings outstanding working capital facility export sales december 31 2000 based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material assuming current level borrowings december 31 2000 100 basis point increase interest rates borrowings would decrease current net income cash flow operations less 100000 event adverse change interest rates could take action mitigate exposure due however uncertainty actions could taken possible effects calculation assumes actions furthermore calculation consider effects possible change level overall economic activity could exist environment item 8item 7 managements discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto overview offer products services either integrated systems individual components primarily three business lines traditional production equipment services provide standardized components replacement parts used components equipment servicing engineered systems provide customized large scale integrated oil gas production systems automation control systems provide control panels systems monitor control oil gas production report three separate business segments north american operations engineered systems automation control systems january 2000 completed initial public offering common stock resulting issuance 5178807 shares common stock net proceeds 467 million july 2000 changed presentation certain assets acquired cynara company november 1998 related operating results segment reporting purposes majority assets reclassified north american operations business segment engineered systems business segment change retroactively reflected periods presented forwardlooking statements managements discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended forwardlooking statement words believe expect plan intend estimate project could may similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions regarding synergies opportunities resulting recent acquisitions see acquisitions indicated trends level oil gas exploration production effect conditions companys results operations see industry business environment future uses requirements financial resources see liquidity capital resources anticipated backlog levels 2002 expectations business outlook customer spending oil gas prices business environment company industry general expectations regarding matters assurance given actual results may differ materially forwardlooking statements herein reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition world economic conditions level drilling activity legislative environment united states countries policies opec conflict major petroleum producing consuming regions development technology could lower overall finding development costs weather patterns overall condition capital equity markets countries operate following discussion read conjunction financial statements related notes financial information appearing elsewhere form 10k readers also urged carefully review consider various disclosures advising interested parties factors affect us including without limitation disclosures made caption risk factors risks discussed annual report form 10k subsequent reports filed securities exchange commission expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements contains summary significant accounting policies believe following accounting policy critical preparation consolidated financial statements revenue recognition percentageofcompletion method recognize revenues significant contracts greater 250000 longer four months duration automation controls contracts orders percentage completion method accounting earned revenue based percentage costs incurred date relate total estimated costs project giving effect recent estimates total cost timing costs incurred therefore revenues recognized could affected various internal external factors including changes project scope change orders changes productivity cost scarcity labor equipment governmental regulations political environment weather patterns timing client acceptances approval benchmark stages project cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues applicable losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects generally recognize revenue earnings percentage completion method applies period two six quarters believe operating results evaluated term several years evaluate performance longterm contracts change orders scope changes cost recoveries negotiated realized record revenues profits sales shipments made services performed acquisitions november 1998 acquired outstanding common stock cynara company cynara designer manufacturer specialized production equipment utilizing membrane technology separate bulk carbon dioxide natural gas streams approximately 155 million 500000 shares common stock right receive additional shares common stock based upon financial performance cynara assets ultimately issued 752501 additional shares january 2000 acquired outstanding common stock portatest international inc portatest manufacturer centrifugal devices used enhance effectiveness separation equipment approximately 70 million right receive additional payments based upon performance certain portatest assets see commitments contingencies february 2000 acquired outstanding common stock modular production equipment inc mpe designer manufacturer water treatment separation systems specializing hydrocyclone technology approximately 27 million april 2000 acquired outstanding common stock engineering specialties inc esi provider proprietary technologies oily water treatment heavy metals removal production near wellhead approximately 71 million march 19 2001 acquired outstanding share capital axsia privately held process design company based united kingdom approximately 428 million net cash acquired axsia specializes design supply water reinjection systems oil gas fields oily water treatment oil separation hydrocyclone technology hydrogen production process equipment systems acquisition financed borrowings term loan revolving credit facility accounted transactions using purchase method accounting industry business environment leading provider wellhead process equipment systems services used production oil gas revenues results operations closely tied demand oil gas products spending oil gas companies exploration development oil gas reserves companies generally invest exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices supply demand change commodity prices fluctuate producing cyclical trends industry periods slowdown revenues service providers natco generally decline existing projects completed new projects postponed periods recovery revenues service providers lag behind industry due timing new project awards past several years business impacted fluctuations oil gas industry united states canada 1998 throughout 1999 industry suffered effects significant decline expenditures due sharp decline hydrocarbon prices 2000 energy prices rose significantly industry began recovery 2001 energy prices declined part response higher prices 2000 part due general economic slowdown united states consequence volatility energy prices business affected several cycles spending oil gas companies past years following table summarizes price domestic crude oil per barrel wellhead price natural gas per thousand cubic feet mcf published us department energy number rotary drilling rigs operation published baker hughes incorporated recent five years december 31 2001 price oil 1549 per barrel price gas fallen 238 per mcf us rig count 887 generally expected spending exploration development efforts oil gas industry continue trend downward time 2002 longerterm perspective us department energy estimates worldwide demand petroleum products grow average annual rate 23 2020 demand natural gas increase average annual rate 32 2020 demand continues grow reserves united states decline producers service providers oil gas industry rely heavily global sources energy expansion new markets furthermore industry continues seek innovative technologically efficient means extract hydrocarbons existing fields due depletion reworking existing fields production profiles changing including mix oil gas produced field use enhanced recovery techniques many fields result higher levels contaminants water carbon dioxide result additional complex equipment may required produce oil gas fields addition many new oil gas fields produce lower quality contaminated hydrocarbon streams require complex production equipment trends increase demand products technology following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes thereto results operations year ended december 31 2001 compared year ended december 31 2000 revenues year ended december 31 2001 increased 620 million 28 2866 million 2246 million year ended december 31 2000 following table summarizes revenues business segment years ended december 31 2001 2000 respectively revenues north american operations business segment year ended december 31 2001 increased 258 million 21 1495 million 1237 million year ended december 31 2000 increase due increase oilfield activity fiscal 2000 mid2001 result favorable oil gas prices although oil gas prices began decline late 2001 demand remained high traditional equipment finished goods also experienced increased demand domestic export parts service business carbon dioxide field services business partially offsetting increases decline revenues 81 million provided canadian affiliate large projects completed fiscal 2000 several planned projects fiscal 2001 delayed intercompany revenues business segment approximately 52 million 54 million years ended december 31 2001 2000 respectively revenues engineered systems business segment year ended december 31 2001 increased 312 million 46 990 million 678 million year ended december 31 2000 increase primarily due acquisition axsia march 2001 contributed revenues 581 million year ended december 31 2001 increase partially offset decline revenues earned ctoc project contributed 459 million revenues year ended december 31 2000 compared 109 million year ended december 31 2001 excluding impact axsia acquisition ctoc project revenues business segment increased 81 million fiscal 2001 compared fiscal 2000 due primarily export projects including number projects south america engineered systems revenues 990 million year ended december 31 2001 included intercompany revenues 748000 compared 286000 intercompany revenues year ended december 31 2000 revenues automation control systems business segment year ended december 31 2001 increased 49 million 12 477 million 428 million year ended december 31 2000 increase due higher demand control equipment especially equipment provided deepwater projects increase field services performed customers intercompany revenues declined 41 million year ended december 31 2000 38 million year ended december 31 2001 change revenues corporate eliminations represents elimination intercompany revenues discussed gross profit gross profit year ended december 31 2001 increased 143 million 23 761 million 618 million year ended december 31 2000 percentage revenue gross margins declined 28 year ended december 31 2000 27 year ended december 31 2001 following table summarizes gross profit business segment years ended december 31 2001 2000 respectively gross profit north american operations business segment year ended december 31 2001 increased 69 million 24 355 million 286 million year ended december 31 2000 increase margin primarily due 21 increase revenues segment improved margins export parts services traditional finished goods percentage revenue gross margins segment 24 23 years ended december 31 2001 2000 respectively gross profit engineered systems business segment year ended december 31 2001 increased 69 million 28 312 million 244 million year ended december 31 2000 increase due primarily acquisition axsia march 2001 partially offset lower margin projects included sales mix 2001 compared 2000 excluding impact axsia ctoc project gross margin increased 15 million related primarily export projects percentage revenue gross margins segment 32 36 years ended december 31 2001 2000 respectively gross profit automation control systems business segment year ended december 31 2001 increased 550000 6 94 million 88 million year ended december 31 2000 margin improvement due increase demand electrical equipment resulted increase segment revenues 12 partially offset shift higher margin quote jobs time materials jobs fiscal 2001 compared fiscal 2000 percentage revenue gross margins segment 20 21 years ended december 31 2001 2000 respectively selling general administrative expense selling general administrative expense year ended december 31 2001 increased 120 million 30 515 million 394 million year ended december 31 2000 increase largely related execution business plan included additional costs associated acquisition axsia additional costs associated startup singapore mexico offices increased spending technology product development additional costs associated employee medical claims depreciation amortization expense depreciation amortization expense year ended december 31 2001 increased 30 million 59 81 million 51 million year ended december 31 2000 depreciation expense year ended december 31 2001 increased 991000 32 41 million 31 million year ended december 31 2000 increase primarily due inclusion depreciation expense assets acquired purchase axsia march 2001 depreciation assets placed service fiscal 2001 amortization expense year ended december 31 2001 increased 20 million 102 40 million 20 million year ended december 31 2000 increase primarily due amortization goodwill associated axsia acquisition march 2001 unusual charges unusual charges year ended december 31 2001 increased 72000 5 16 million 15 million year ended december 31 2000 charge fiscal 2001 included 920000 related certain restructuring costs streamline activities consolidate offices connection acquisition axsia march 2001 additional 680000 related decision withdraw private debt offering charge fiscal 2000 primarily compensation expense associated employment agreement executive officer terms agreement entitled officer sum equal outstanding note accrued interest totaling 12 million december 31 1999 upon sale companys class common stock initial public offering natco completed initial public offering january 27 2000 pursuant terms agreement recorded compensation expense amount note accrued interest including related payroll burdens totaling 13 million addition recorded relocation expenses totaling 208000 associated consolidation two facilities following acquisition portatest january 2000 interest expense interest expense year ended december 31 2001 increased 34 million 211 50 million 16 million year ended december 31 2000 increase due borrowings 500 million term loan arrangement finance purchase axsia additional borrowings revolving credit facilities fiscal 2001 compared fiscal 2000 increase commitment fees borrowing arrangements increase interest incurred letter credit arrangements due increase overall letters credit outstanding interest cost postretirement benefit liability interest cost postretirement benefit liability decreased 399000 31 13 million year ended december 31 2000 888000 year ended december 31 2001 decrease interest cost due amendment plan provides medical dental coverage retirees predecessor company amended plan retirees bear cost coverages thereby reducing projected liability related interest cost interest income interest income increased 479000 265 181000 year ended december 31 2000 660000 year ended december 31 2001 increase interest income primarily due interest earned federal income tax refund paid 2001 canadian taxing authorities expense net expense net 429000 year ended december 31 2001 relates primarily foreign currency transaction gains losses incurred primarily axsia certain costs exit derivative arrangements acquired purchase axsia march 2001 provision income taxes income tax expense year ended december 31 2001 decreased 15 million 27 39 million 53 million year ended december 31 2000 decline income tax expense primarily due decrease income taxes 93 million year ended december 31 2001 compared 130 million year ended december 31 2000 decrease income tax expense partially offset increase effective tax rate 41 42 years ended december 31 2000 2001 respectively primarily due impact nondeductible goodwill amortization expense year ended december 31 2000 compared year ended december 31 1999 revenues year ended december 31 2000 increased 546 million 32 2246 million 1699 million year ended december 31 1999 following table summarizes revenues business segment years ended december 31 2000 1999 respectively revenues north american operations segment year ended december 31 2000 increased 414 million 50 1237 million 823 million year ended december 31 1999 increase due increase oilfield activity resulting overall increase oil gas prices 2000 experienced increased demand production process equipment well domestic parts service business also canadian operations provided increased revenues due acquisition portatest january 2000 completion two significant gas plant projects chevron canada several projects pemex partially offsetting increases decline service revenues 28 million due early termination us carbon dioxide gasprocessing agreement customer fourth quarter 1999 intercompany revenues business segment approximately 54 million 27 million years ended december 31 2000 1999 respectively revenues engineered systems business segment year ended december 31 2000 increased 153 million 29 678 million 525 million year ended december 31 1999 increase primarily due contribution one customer ctoc provided revenues 459 million year ended december 31 2000 compared 146 million year ended december 31 1999 acquisitions mpe esi february 2000 april 2000 respectively also contributed increase engineered systems revenue increase revenue partially offset decline domestic international engineered systems consistent decrease project awards customers throughout 1999 early 2000 result lower natural gas prices 1999 engineered systems revenues 678 million year ended december 31 2000 included intercompany revenues 286000 compared 17 million intercompany revenues year ended december 31 1999 revenues automation control systems business segment year ended december 31 2000 increased 918000 2 428 million 418 million year ended december 31 1999 despite completion several large projects 1999 revenues business segment increased due stable demand automation controls products increase intercompany revenues 23 million year ended december 31 1999 41 million year ended december 31 2000 change revenues corporate eliminations represents elimination intercompany revenues discussed gross profit gross profit year ended december 31 2000 increased 195 million 46 618 million 423 million year ended december 31 1999 percentage revenue gross margins improved 28 year ended december 31 2000 compared 25 year ended december 31 1999 following table summarizes gross profit business segment years ended december 31 2000 1999 respectively gross profit north american operations business segment year ended december 31 2000 increased 87 million 43 286 million 200 million year ended december 31 1999 increase margin primarily due 50 increase revenues segment improved margins export parts services well contribution portatest acquired january 2000 percentage revenue gross margins segment 23 24 years ended december 31 2000 1999 respectively gross profit engineered systems business segment year ended december 31 2000 increased 109 million 81 244 million 135 million year ended december 31 1999 increase due primarily 29 increase revenues segment higher margin projects included sales mix 2000 compared 1999 percentage revenue gross margins segment 36 26 years ended december 31 2000 1999 respectively gross profit automation control systems business segment remained relatively constant year ended december 31 1999 year ended december 31 2000 revenues business segment increased 2 primarily due increase intercompany sales little impact gross margin percentage revenue gross margins segment 21 years ended december 31 2000 1999 selling general administrative expense selling general administrative expense year ended december 31 2000 increased 71 million 22 395 million 324 million year ended december 31 1999 increase largely related execution business plan included additional costs associated acquisitions portatest mpe esi increased spending technology product development additional expenses related public company continued investment preorder engineering expenses depreciation amortization expense depreciation amortization expense year ended december 31 2000 increased 430000 9 51 million 47 million year ended december 31 1999 depreciation expense year ended december 31 2000 decreased 555000 15 31 million 37 million year ended december 31 1999 decrease primarily due extending service life certain operational assets decrease depreciation expense year ended december 31 2000 compared year ended december 31 1999 partially offset 1 depreciation addition capital assets last four quarters included renovations expansions existing manufacturing plants drying plant pittsburg california facility technological improvements management information systems purchase computer hardware software acquisitions improvements equipment used companys business 2 depreciation expense due inclusion results portatest mpe esi acquired fiscal 2000 amortization expense year ended december 31 2000 increased 913000 90 19 million 10 million year ended december 31 1999 increase primarily due amortization goodwill associated portatest mpe esi acquisitions also amortization expense increased due increase goodwill related acquisition cynara november 1998 pursuant cynara purchase agreement issued 325836 shares 418145 shares class b common stock september 1999 june 2000 respectively cynaras former shareholders based upon achievement certain performance criteria cost shares charged goodwill interest expense interest expense year ended december 31 2000 decreased 17 million 52 16 million 33 million year ended december 31 1999 decrease due primarily reduction longterm debt term loan revolving credit facilities 312 million december 31 1999 150 million december 31 2000 retired 279 million longterm debt term loan facility february 2000 portion proceeds initial public offering unusual charges unusual charges year ended december 31 2000 15 million charge primarily compensation expense associated employment agreement executive officer terms agreement entitled officer sum equal outstanding note accrued interest totaling 12 million december 31 1999 upon sale class common stock initial public offering completed initial public offering january 27 2000 pursuant terms agreement recorded compensation expense amount note accrued interest including related payroll burdens totaling 13 million addition recorded relocation expenses totaling 208000 associated consolidation two facilities following acquisition portatest revaluation gain postretirement benefit liability december 2000 changed method accounting gains losses postretirement benefit obligation rather record gains losses immediately income statement amortize gains losses exceed 10 accumulated postretirement benefit obligation expected remaining lives participants therefore record gain loss revaluation postretirement benefit liability year ended december 31 2000 year ended december 31 1999 revaluation gain postretirement benefit liability 10 million recorded due change actuarial discount rate used calculate net present value underlying liability provision income taxes income tax expense year ended december 31 2000 increased 38 million 245 53 million 15 million year ended december 31 1999 increase income tax expense primarily due increase income taxes 130 million year ended december 31 2000 compared 22 million year ended december 31 1999 increase income tax expense partially offset decrease effective tax rate 71 1999 41 2000 primarily due impact nondeductible goodwill amortization expense cumulative effect change accounting principle gain 10000 net tax recorded year ended december 31 2000 related cumulative effect change method used account gains losses postretirement benefit obligation accordance apb opinion 20 accounting changes prior year financial statements restated change liquidity capital resources february 28 2002 cash working capital 40 million 382 million respectively december 31 2001 cash working capital 31 million 371 million respectively compared 10 million 491 million december 31 2000 respectively net cash provided used operating activities years ended december 31 2001 2000 1999 193 million 63 million 151 million respectively increase net cash provided operating activities fiscal 2001 primarily due collection receivables axsia increase advance payments customers partially offset increase inventories net cash used investing activities years ended december 31 2001 2000 1999 577 million 236 million 26 million respectively primary use funds year ended december 31 2001 acquisition axsia required use 483 million capital expenditures 100 million funds axsia acquisition borrowed 500 million term loan facility capital expenditures fiscal 2001 financed borrowings revolving credit facility cash generated current operations primary use funds year ended december 31 2000 acquisitions portatest mpe esi required use 171 million capital expenditures 81 million capital expenditures consisted primarily renovations expansions manufacturing plants technological improvements management information systems acquisitions improvements equipment including upgrade membrane manufacturing facility pittsburg california completed fourth quarter 2000 funds portatest acquisition january 2000 borrowed revolving credit facility funds repaid february 2000 proceeds initial public offering funds mpe acquisition february 2000 also provided initial public offering esi acquisition financed net borrowings 71 million revolving credit facilities primary use funds year ended december 31 1999 capital expenditures 36 million net cash provided used financing activities years ended december 31 2001 2000 1999 411 million 297 million 134 million respectively primary source funds financing activities year ended december 31 2001 borrowings 500 million term loan facility partially offset principal repayments 53 million term loan facility net repayments 747000 revolving credit facility payments postretirement benefit liability 18 million repayment shortterm notes 10 million primary source funds financing activities year ended december 31 2000 initial public offering common stock provided net proceeds 467 million proceeds used primarily retire 279 million outstanding debt term loan arrangement repay 30 million borrowed revolving credit agreement purchase portatest repay 29 million debt assumed acquisitions portatest mpe use cash financing activities 1999 due primarily repayment longterm debt maintain revolving credit term loan facilities well working capital facility export sales term loan provides 500 million borrowings revolving credit facilities provide 300 million borrowings united states 100 million borrowings canada 100 million borrowings united kingdom subject borrowing base limitations term loan matures march 15 2006 revolving facilities matures march 15 2004 december 31 2001 borrowings outstanding term loan facility 448 million borrowings 128 million outstanding revolving credit facility issued 190 million outstanding letters credit facility amounts borrowed term loan portion facility currently bear interest rate 425 per annum amounts borrowed revolving portion facility bear interest follows april 1 2002 rate equal election either 1 libor plus 225 2 base rate plus 075 april 1 2002 rate based upon ratio funded debt ebitda ranging election 1 high libor plus 250 low libor plus 175 2 high base rate plus 10 low base rate plus 025 pay commitment fees 050 per year april 1 2002 030 050 per year depending upon ratio funded debt ebitda april 1 2002 case undrawn portion facility revolving credit term loan facility guaranteed domestic subsidiaries secured first priority lien inventory accounts receivable material tangible intangible assets addition pledged 65 voting stock active foreign subsidiaries december 31 2001 compliance debt covenants weighted average interest rate borrowings term loan revolving credit agreement date 431 export sales credit facility provides aggregate borrowings 100 million subject borrowing base limitations 11 million outstanding december 31 2001 addition issued letters credit totaling 361000 export facility date export sales credit facility secured specific project inventory receivables partially guaranteed exportimport bank united states export sales credit facility loans mature july 2004 february 28 2002 borrowing base limitations reduced available borrowing capacity revolving credit facilities export sales credit agreement 168 million 22 million respectively commitments contingencies noncancelable future commitments debt operating lease arrangements next five years follows 2002109 million 2003103 million 2004235 million 200578 million 2006175 million portatest purchase agreement executed january 2000 contains provision calculate payment certain former stockholders portatest systems inc threeyear period ended january 24 2003 based upon sales limited number specified products designed utilizing technology existed time acquisition liability arrangement contingent upon attaining certain performance criteria including gross margins sales volumes specified products applicable payment required annually april 2001 paid 226000 arrangement related year ended january 24 2001 future liabilities incurred arrangement result increase goodwill special purpose entities unconsolidated affiliates partnerships believe operating cash flow supported available borrowing capacity adequate fund operations noncancelable future commitments debt operating lease arrangements throughout 2002 extent management successful identifying additional acquisition opportunities 2002 ability finance acquisitions debt andor equity critical element analysis opportunities related party transactions minority interest guarantee obligations related party debt obligations related parties responsibility reported balance sheet paid capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut chief executive officer reception telephone computer services normal office support relating space mr herbert winokur jr one directors chairman chief executive officer capricorn holdings inc directly indirectly controls approximately 31 outstanding common stock addition chief executive officer mr gregory nonsalaried member capricorn holdings llc general partner capricorn investors ii lp private investment partnership capricorn investors ii lp controls approximately 20 common stock fees paid capricorn management totaled 85000 75000 years ended december 31 2001 2000 1999 respectively commencing october 1 2001 fee increased 28750 quarterly due primarily upward adjustment capricorn managements underlying lease office space increase reviewed approved audit committee board directors december 31 1999 recorded receivable capricorn management 5000 related expenses paid behalf receivable existed december 31 2001 2000 terms employment agreement effect prior 1999 loaned chief executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 completed initial public offering class common stock paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay us approximately 665000 remaining loan balance including accrued interest 651000 december 31 2001 continues accrue interest 6 annually addition october 27 2000 board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options loan matures july 31 2003 provides interest stated thencurrent borrowing rate principal equal cost exercise options plus personal tax burdens result exercise december 31 2001 balance note principal accrued interest due officer loan arrangements 33 million inflation changes prices costs materials eg steel products rise fall value commodity markets generally increases raw materials labor costs passed customers recent accounting pronouncements june 2001 financial accounting standards board fasb approved statement financial accounting standards sfas 141 business combinations standard requires business combination initiated june 30 2001 accounted using purchase method accounting standard became effective july 1 2001 adopted standard july 1 2001 material effect financial condition results operations fasb approved sfas 142 goodwill intangible assets june 2001 pronouncement requires intangible assets indefinite lives including goodwill cease amortized evaluated impairment basis intangible assets defined term patents would continue amortized useful life asset pronouncement becomes effective january 1 2002 companies calendar year end net goodwill 799 million december 31 2001 goodwill amortization totaled 37 million year ended december 31 2001 yet determined impact pronouncement financial condition results operations permitted standard determine quantify exposure pronouncement fiscal 2002 completing required impairment testing june 2001 fasb issued sfas 143 accounting asset retirement obligations standard provides guidance reporting accounting obligations associated retirement longlived tangible assets associated retirement costs standard effective financial statements issued fiscal years beginning june 15 2002 yet determined impact pronouncement financial condition results operations october 2001 fasb issued sfas 144 accounting impairment disposal longlived assets statement replaces sfas 121 accounting impairment longlived assets longlived assets disposed standardizes accounting model used asset dispositions related implementation issues pronouncement becomes effective financial statements issued fiscal years beginning december 15 2001 yet determined impact pronouncement financial condition results operations quantitative qualitative disclosures market risk operations conducted around world number different countries accordingly earnings exposed changes foreign currency exchange rates majority foreign currency transactions relate operations canada uk natco canada contracts denominated canadian dollars costs incurred canadian dollars thereby mitigating risks associated currency fluctuations axsia ukbased operation acquired march 2001 many contracts denominated us dollars occasionally euros whereas costs may british pounds sterling consequently currency risk uk operations prior date acquisition axsia entered certain forward contract arrangements whereby sold us dollars future delivery specified strike price order hedge exposure currency fluctuations contracts denominated us dollars third fourth quarters 2001 paid approximately 249000 terminate forward contracts forward contracts derivative arrangements existed december 31 2001 currently intend enter new forward contracts derivative arrangements part currency risk management strategy financial instruments subject changes interest rates including revolving credit term loan facility working capital facility export sales december 31 2001 448 million outstanding term loan portion revolving credit term loan facility december 31 2001 outstanding borrowings revolving credit agreement totaled 128 million borrowings revolving credit agreement bear interest floating rates december 31 2001 weighted average interest rate borrowings revolving credit term loan facility 431 borrowings outstanding export sales credit facility 11 million december 31 2001 bore interest 475 based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material assuming current level borrowings december 31 2001 100 basis point increase interest rates borrowings would decrease current year net income cash flow operations less 350000 calculation assumes action part mitigate exposure furthermore calculation consider effects possible change level overall economic activity could exist environment item 8item 7 managements discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto overview offer products services either integrated systems individual components primarily three business lines traditional production equipment services provide standardized components replacement parts used components equipment servicing engineered systems provide customized large scale integrated oil gas water production processing systems automation control systems provide control panels systems monitor control oil gas production well repair testing inspection services existing systems report three separate business segments north american operations engineered systems automation control systems january 2000 completed initial public offering common stock resulting issuance 5178807 shares common stock net proceeds 467 million july 2000 changed presentation certain assets acquired cynara company november 1998 related operating results segment reporting purposes majority assets reclassified north american operations business segment engineered systems business segment change retroactively reflected periods presented forwardlooking statements managements discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended forwardlooking statement words believe expect plan intend estimate project could may similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions regarding synergies opportunities resulting acquisitions see acquisitions indicated trends level oil gas exploration production effect conditions results operations see industry business environment future uses requirements financial resources see liquidity capital resources anticipated backlog levels 2003 expectations business outlook customer spending oil gas prices business environment industry general us particular expectations regarding matters assurance given actual results may differ materially forwardlooking statements herein reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition world economic conditions level drilling activity legislative environment united states countries policies opec conflict major petroleum producing consuming regions development technology could lower overall finding development costs weather patterns overall condition capital markets countries operate following discussion read conjunction financial statements related notes financial information appearing elsewhere annual report form 10k readers also urged carefully review consider various disclosures advising interested parties factors affect us including without limitation disclosures made caption risk factors risks discussed annual report form 10k subsequent reports filed securities exchange commission expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies estimates preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements contains summary significant accounting policies believe following accounting policies critical preparation consolidated financial statements revenue recognition percentageofcompletion method recognize revenues significant contracts greater 250000 longer four months duration certain automation controls contracts orders percentage completion method accounting earned revenue based percentage costs incurred date relate total estimated costs project giving effect recent estimates total cost timing costs incurred therefore recognition revenue could affected various internal external factors including limited changes project scope change orders changes productivity scheduling cost availability labor cost availability raw materials weather client delays providing approvals benchmark stages project timing deliveries thirdparty providers key components cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues applicable losses expected incurred jobs progress consideration estimated probable minimum recoveries claims change orders charged income soon losses known claims additional contract revenue recognized probable claim result additional revenue amount reliably estimated generally recognize revenue earnings percentageofcompletion method applies period two six quarters event project terminated customer completion customer liable costs incurred contract believe operating results evaluated term several years evaluate performance longterm contracts change orders scope changes cost recoveries negotiated realized record revenues profits sales shipments made services performed impairment testing goodwill required statement financial accounting standards sfas 142 goodwill intangible assets evaluate goodwill annually impairment comparing fair value operating assets carrying value assets including related goodwill required sfas 142 identify separate reportable units purposes evaluation determining carrying value segregate assets liabilities extent possible clearly identifiable specific reportable unit intercompany receivablespayables excluded certain corporate assets liabilities clearly identifiable specific reportable unit allocated based ratio units net assets relative total net assets fair value compared carrying value reportable unit determine whether impairment occurred reportable unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting units assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 business combinations residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value would record impairment charge amount net goodwill 790 million december 31 2002 impairment charge recorded december 31 2002 acquisitions november 1998 acquired outstanding common stock cynara company cynara designer manufacturer specialized production equipment utilizing membrane technology separate bulk carbon dioxide natural gas streams approximately 155 million 500000 shares common stock right receive additional shares common stock based upon financial performance cynara assets ultimately issued 752501 additional shares class b common stock converted class common stock shareforshare basis prior december 31 2002 january 2000 acquired outstanding common stock portatest international inc portatest manufacturer centrifugal devices used enhance effectiveness separation equipment approximately 70 million right receive additional payments based upon performance certain portatest assets seecommitments contingencies february 2000 acquired outstanding common stock modular production equipment inc mpe designer manufacturer water treatment separation systems specializing hydrocyclone technology approximately 27 million april 2000 acquired outstanding common stock engineering specialties inc esi provider proprietary technologies oily water treatment heavy metals removal production near wellhead approximately 71 million march 2001 acquired outstanding share capital axsia privately held process design company based united kingdom approximately 428 million net cash acquired axsia specializes design supply equipment water reinjection systems oil gas fields oily water treatment oil separation hydrogen production oil gas processing equipment systems acquisition financed borrowings term loan revolving credit facility accounted transactions using purchase method accounting industry business environment leading provider wellhead process equipment systems services used production oil gas revenues results operations closely tied demand oil gas products spending oil gas companies exploration development oil gas reserves companies generally invest exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices supply demand change commodity prices fluctuate producing cyclical trends industry periods lower demand revenues service providers natco generally decline existing projects completed new projects postponed periods recovery revenues service providers lag behind industry due timing new project awards changes commodity prices impacted business past several years following table summarizes price domestic crude oil per barrel wellhead price natural gas per thousand cubic feet mcf published us department energy number rotary drilling rigs operation published baker hughes incorporated recent five years 1average wellhead price natural gas per mcf us period january 1 2002 november 30 2002 december 31 2002 spot price west texas intermediate crude oil 3117 per barrel price natural gas 475 per mcf us rig count 862 february 28 2003 spot price west texas intermediate crude oil 3698 per barrel price henry hub natural gas 800 per mcf per new york mercantile exchange us rig count 912 per baker hughes incorporated spot prices reflect overall volatility oil gas commodity prices current recent years although increased commodity prices generally correlate directly increase spending oil gas companies exploration development efforts rig counts remain lower expected based historical experience longerterm perspective us department energy estimates us demand petroleum products grow average annual rate 17 2025 us demand natural gas increase average annual rate 18 2025 demand grows reserves united states decline producers service providers oil gas industry may continue rely heavily global sources energy expansion new markets industry continues seek innovative technologically efficient means extract hydrocarbons existing fields production profiles change result additional complex equipment may required produce oil gas fields especially since many new oil gas fields produce lower quality contaminated hydrocarbon streams requiring complex production equipment general trends increase demand products services following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes thereto results operations year ended december 31 2002 compared year ended december 31 2001 revenues year ended december 31 2002 increased 30 million 1 2895 million 2866 million year ended december 31 2001 following table summarizes revenues business segment years ended december 31 2002 2001 respectively revenues north american operations business segment year ended december 31 2002 decreased 78 million 5 1374 million 1451 million year ended december 31 2001 decrease directly related decline oilfield activity throughout 2002 average north american rotary rig count declined 1497 year ended december 31 2001 1093 year ended december 31 2002 although revenues traditional equipment finished goods declined results latin american operations co2 gasprocessing operations field services improved 2002 relative 2001 revenues canadian operations decreased canadian rotary rig counts continued decline average 341 year ended december 31 2001 average 263 year ended december 31 2002 intersegment revenues business segment approximately 917000 781000 years ended december 31 2002 2001 respectively revenues engineered systems business segment year ended december 31 2002 increased 80 million 8 1070 million 990 million year ended december 31 2001 increase primarily due several large projects primarily west africa provided revenues approximately 310 million 2002 offset decline revenues ukbased operations decline revenues earned southeast asia substantial completion ctoc project late 2001 engineered systems revenues 1070 million year ended december 31 2002 included intersegment revenues 18 million compared 748000 intersegment revenues year ended december 31 2001 revenues automation control systems business segment year ended december 31 2002 increased 44 million 9 521 million 477 million year ended december 31 2001 increase due higher demand control equipment field services partially associated repair projects gulf mexico following several tropical weather systems 2002 intersegment revenues increased 38 million year ended december 31 2001 43 million year ended december 31 2002 change revenues corporate intersegment eliminations represents elimination intersegment revenues discussed gross profit gross profit year ended december 31 2002 decreased 59 million 8 702 million 761 million year ended december 31 2001 percentage revenue gross margins declined 27 year ended december 31 2001 24 year ended december 31 2002 following table summarizes gross profit business segment years ended december 31 2002 2001 respectively gross profit north american operations business segment year ended december 31 2002 increased 21 million 6 376 million 355 million year ended december 31 2001 increase margin primarily due contribution latin american operations co2 gasprocessing operations field services reflecting increased throughput expansion sacroc facility percentage revenue gross margins segment 27 24 years ended december 31 2002 2001 respectively gross profit engineered systems business segment year ended december 31 2002 decreased 80 million 26 232 million 312 million year ended december 31 2001 despite 8 increase revenues decline due completion several highmargin projects 2001 southeast asia within ukbased operations partially offset new projects 2002 awarded traditional margins percentage revenue gross margins segment 22 32 years ended december 31 2002 2001 respectively gross profit automation control systems business segment years ended december 31 2002 2001 remained constant despite 9 increase revenues period primarily due increase labor costs attributable higher medical benefit costs unfavorable mix labor materials 2002 compared 2001 percentage revenue gross margins segment 18 20 years ended december 31 2002 2001 respectively selling general administrative expense selling general administrative expense year ended december 31 2002 increased 25 million 5 539 million 515 million year ended december 31 2001 increase largely related following factors one year operating expenses axsia 2002 compared nine months fiscal 2001 additional costs associated startup singapore office march 2001 costs associated startup mexico marketing office opened late 2001 additional costs associated employee medical claims depreciation amortization expense depreciation amortization expense year ended december 31 2002 decreased 32 million 39 50 million 81 million year ended december 31 2001 depreciation expense year ended december 31 2002 increased 764000 19 49 million 41 million year ended december 31 2001 increase primarily due inclusion depreciation expense assets acquired purchase axsia march 2001 depreciation assets placed service late 2001 2002 including significant upgrade drying plant facility pittsburg california expansion gasprocessing plant sacroc field amortization expense year ended december 31 2002 decreased 39 million 98 92000 40 million year ended december 31 2001 decrease amortization expense attributable change accounting method prescribed sfas 142 goodwill intangible assets pronouncement adopted january 1 2002 requires goodwill longer amortized prescribed period rather intangible assets assigned useful life evaluated annually impairment see recent accounting pronouncements therefore goodwill amortization recorded year ended december 31 2002 compared 37 million year ended december 31 2001 addition results year ended december 31 2001 include amortization expense associated certain employment contracts fully amortized december 31 2001 closure charges year ended december 31 2002 548000 related closure manufacturing engineering facility edmonton alberta canada costs include involuntary termination certain employees relocation equipment certain personnel modification related operating lease arrangements december 31 2002 remaining accrued liability related restructuring 304000 expect incur additional relocation shop moving costs expensed incurred second quarter 2003 year ended december 31 2001 incurred charge totaling 920000 related certain restructuring costs streamline activities consolidate offices connection acquisition axsia march 2001 additional 680000 related decision withdraw private debt offering interest expense interest expense year ended december 31 2002 decreased 414000 8 45 million 49 million year ended december 31 2001 decrease due decline outstanding debt 586 million december 31 2001 524 million december 31 2002 weighted average interest rate outstanding borrowings remained constant respective periods interest cost postretirement benefit liability interest cost postretirement benefit liability decreased 417000 47 888000 year ended december 31 2001 471000 year ended december 31 2002 decrease interest cost due amendment plan provides medical dental coverage retirees predecessor company amended plan retirees bear cost coverages thereby reducing projected liability related interest cost interest income interest income decreased 412000 62 660000 year ended december 31 2001 248000 year ended december 31 2002 change interest income primarily due interest earned federal income tax refund paid 2001 canadian taxing authorities expense net expense net 400000 year ended december 31 2002 declined 29000 7 compared year ended december 31 2001 change relates primarily foreign currency transaction gains losses incurred operations united kingdom canada provision income taxes income tax expense year ended december 31 2002 decreased 22 million 56 17 million 39 million year ended december 31 2001 decline income tax expense primarily due decrease income taxes 56 million year ended december 31 2002 compared 93 million year ended december 31 2001 decrease effective tax rate 421 year ended december 31 2001 305 year ended december 31 2002 due primarily longer recognizing nondeductible goodwill amortization expense per sfas 142 adopted january 1 2002 year ended december 31 2001 compared year ended december 31 2000 revenues year ended december 31 2001 increased 620 million 28 2866 million 2246 million year ended december 31 2000 following table summarizes revenues business segment years ended december 31 2001 2000 respectively revenues north american operations business segment year ended december 31 2001 increased 255 million 21 1451 million 1197 million year ended december 31 2000 increase due increase oilfield activity fiscal 2000 mid2001 result favorable oil gas prices although oil gas prices began decline late 2001 demand remained high traditional equipment finished goods also experienced increased demand domestic export parts service business co2 gasprocessing field services business partially offsetting increases decline revenues 81 million provided canadian affiliate large projects completed fiscal 2000 several planned projects fiscal 2001 delayed intersegment revenues business segment approximately 781000 13 million years ended december 31 2001 2000 respectively revenues engineered systems business segment year ended december 31 2001 increased 312 million 46 990 million 678 million year ended december 31 2000 increase primarily due acquisition axsia march 2001 contributed revenues 581 million year ended december 31 2001 increase partially offset decline revenues earned ctoc project contributed 459 million revenues year ended december 31 2000 compared 109 million year ended december 31 2001 excluding impact axsia acquisition ctoc project revenues business segment increased 81 million fiscal 2001 compared fiscal 2000 due primarily export projects including number projects south america engineered systems revenues 990 million year ended december 31 2001 included intersegment revenues 748000 compared 268000 intersegment revenues year ended december 31 2000 revenues automation control systems business segment year ended december 31 2001 increased 49 million 12 477 million 428 million year ended december 31 2000 increase due higher demand control equipment especially equipment provided deepwater projects increase field services performed customers intersegment revenues declined 41 million year ended december 31 2000 38 million year ended december 31 2001 change revenues corporate intersegment eliminations represents elimination intersegment revenues discussed gross profit gross profit year ended december 31 2001 increased 143 million 23 761 million 618 million year ended december 31 2000 percentage revenue gross margins declined 28 year ended december 31 2000 27 year ended december 31 2001 following table summarizes gross profit business segment years ended december 31 2001 2000 respectively gross profit north american operations business segment year ended december 31 2001 increased 69 million 24 355 million 286 million year ended december 31 2000 increase margin primarily due 21 increase revenues segment improved margins export parts services traditional finished goods percentage revenue gross margins segment consistent 24 years ended december 31 2001 2000 gross profit engineered systems business segment year ended december 31 2001 increased 69 million 28 312 million 244 million year ended december 31 2000 increase due primarily acquisition axsia march 2001 partially offset lower margin projects included sales mix 2001 compared 2000 excluding impact axsia ctoc project gross margin increased 15 million related primarily export projects percentage revenue gross margins segment 32 36 years ended december 31 2001 2000 respectively gross profit automation control systems business segment year ended december 31 2001 increased 550000 6 94 million 88 million year ended december 31 2000 margin improvement due increase demand electrical equipment resulted increase segment revenues 12 partially offset shift higher margin quote jobs time materials jobs fiscal 2001 compared fiscal 2000 percentage revenue gross margins segment 20 21 years ended december 31 2001 2000 respectively selling general administrative expense selling general administrative expense year ended december 31 2001 increased 120 million 30 515 million 394 million year ended december 31 2000 increase largely related execution business plan included additional costs associated acquisition axsia additional costs associated startup singapore mexico offices increased spending technology product development additional costs associated employee medical claims depreciation amortization expense depreciation amortization expense year ended december 31 2001 increased 30 million 59 81 million 51 million year ended december 31 2000 depreciation expense year ended december 31 2001 increased 991000 32 41 million 31 million year ended december 31 2000 increase primarily due inclusion depreciation expense assets acquired purchase axsia march 2001 depreciation assets placed service fiscal 2001 amortization expense year ended december 31 2001 increased 20 million 102 40 million 20 million year ended december 31 2000 increase primarily due amortization goodwill associated axsia acquisition march 2001 closure charges year ended december 31 2001 increased 72000 5 16 million 15 million year ended december 31 2000 charge fiscal 2001 included 920000 related certain restructuring costs streamline activities consolidate offices connection acquisition axsia march 2001 additional 680000 related decision withdraw private debt offering charge fiscal 2000 primarily compensation expense associated employment agreement executive officer terms agreement entitled officer sum equal outstanding note accrued interest totaling 12 million december 31 1999 upon sale companys class common stock initial public offering natco completed initial public offering january 27 2000 pursuant terms agreement recorded compensation expense amount note accrued interest including related payroll burdens totaling 13 million addition recorded relocation expenses totaling 208000 associated consolidation two facilities following acquisition portatest january 2000 interest expense interest expense year ended december 31 2001 increased 34 million 211 50 million 16 million year ended december 31 2000 increase due borrowings 500 million term loan arrangement finance purchase axsia additional borrowings revolving credit facilities fiscal 2001 compared fiscal 2000 increase commitment fees borrowing arrangements increase interest incurred letter credit arrangements due increase overall letters credit outstanding interest cost postretirement benefit liability interest cost postretirement benefit liability decreased 399000 31 13 million year ended december 31 2000 888000 year ended december 31 2001 decrease interest cost due amendment plan provides medical dental coverage retirees predecessor company amended plan retirees bear cost coverages thereby reducing projected liability related interest cost interest income interest income increased 479000 265 181000 year ended december 31 2000 660000 year ended december 31 2001 increase interest income primarily due interest earned federal income tax refund paid 2001 canadian taxing authorities expense net expense net 429000 year ended december 31 2001 relates primarily foreign currency transaction gains losses incurred primarily axsia certain costs exit derivative arrangements acquired purchase axsia march 2001 provision income taxes income tax expense year ended december 31 2001 decreased 15 million 27 39 million 53 million year ended december 31 2000 decline income tax expense primarily due decrease income taxes 93 million year ended december 31 2001 compared 130 million year ended december 31 2000 decrease income tax expense partially offset increase effective tax rate 411 421 years ended december 31 2000 2001 respectively primarily due impact nondeductible goodwill amortization expense liquidity capital resources february 28 2003 cash working capital 26 million 471 million respectively december 31 2002 cash working capital 17 million 346 million respectively compared 31 million 371 million december 31 2001 respectively net cash provided used operating activities years ended december 31 2002 2001 2000 97 million 193 million 63 million respectively decrease net cash provided operating activities fiscal 2002 primarily due lower net income well increase accounts receivable decrease customer advance payments partially offset decline inventory levels net cash used investing activities years ended december 31 2002 2001 2000 56 million 577 million 236 million respectively primary use funds year ended december 31 2002 capital expenditures 53 million included expansion gasprocessing facility sacroc field primary use funds year ended december 31 2001 acquisition axsia required use 483 million capital expenditures 100 million included purchase shop facility magnolia texas expansion improvement facilities new iberia louisiana improvements sacroc gasprocessing plant west texas funds axsia acquisition borrowed 500 million term loan facility capital expenditures fiscal 2001 financed borrowings revolving credit facility cash generated current operations primary use funds year ended december 31 2000 acquisitions portatest mpe esi required use 171 million capital expenditures 81 million capital expenditures consisted primarily renovations expansions manufacturing plants technological improvements management information systems acquisitions improvements equipment including upgrade membrane manufacturing facility pittsburg california funds portatest acquisition january 2000 borrowed revolving credit facility funds repaid february 2000 proceeds initial public offering funds mpe acquisition february 2000 also provided initial public offering esi acquisition financed net borrowings 71 million revolving credit facilities net cash provided used financing activities years ended december 31 2002 2001 2000 54 million 411 million 297 million respectively primary use funds financing activities year ended december 31 2002 repayment longterm debt 71 million benefit payments postretirement benefit plan 19 million partially offset longterm borrowings 15 million 19 million increase bank overdrafts primary source funds financing activities year ended december 31 2001 borrowings 500 million term loan facility partially offset principal repayments 53 million term loan facility net repayments 747000 revolving credit facility payments postretirement benefit liability 18 million repayment shortterm notes 10 million primary source funds financing activities year ended december 31 2000 initial public offering common stock provided net proceeds 467 million proceeds used primarily retire 279 million outstanding debt term loan arrangement repay 30 million borrowed revolving credit agreement purchase portatest repay 29 million debt assumed acquisitions portatest mpe maintain revolving credit term loan facilities well working capital facility export sales term loan provides 500 million borrowings revolving credit facilities provide 300 million borrowings united states 100 million borrowings canada 100 million borrowings united kingdom subject borrowing base limitations term loan matures march 15 2006 revolving facilities matures march 15 2004 december 31 2002 borrowings outstanding term loan facility 378 million borrowings 90 million outstanding revolving credit facility issued 174 million outstanding letters credit facility amounts borrowed term loan portion facility currently bear interest rate 421 per annum amounts borrowed revolving portion facility bear interest rate based upon ratio funded debt ebitda defined credit facility ebitda ranging election 1 high libor plus 250 low libor plus 175 2 high base rate plus 10 low base rate plus 025 pay commitment fees 030 050 per year depending upon ratio funded debt ebitda undrawn portion facility july 2002 lenders approved amendment various provisions term loan revolving credit facility agreement effective april 1 2002 amendment allowed future capital investment co2 gasprocessing facility sacroc west texas revised certain debt covenants modified certain defined terms increased aggregate amount operating lease expense allowed fiscal year permitted increase borrowings export sales credit facility without consent maximum 200 million modifications result higher commitment fee percentages interest rates funded debt ebitda ratio exceeds 3 1 revolving credit term loan facility guaranteed domestic subsidiaries secured first priority lien inventory accounts receivable material tangible intangible assets addition pledged 65 voting stock active foreign subsidiaries revolving credit term loan facility contains restrictive covenants among things limit amount funded debt ebitda imposes minimum fixed charge coverage ratio minimum asset coverage ratio minimum net worth requirement december 31 2002 compliance debt covenants weighted average interest rate borrowings term loan revolving credit agreement date 426 export sales credit facility provides aggregate borrowings 100 million subject borrowing base limitations 43 million outstanding december 31 2002 addition issued letters credit totaling 720000 export facility date export sales credit facility secured specific project inventory receivables partially guaranteed exportimport bank united states export sales credit facility loans mature july 2004 borrowed 15 million longterm promissory note arrangement february 6 2002 note accrues interest 90day libor plus 325 per annum requires quarterly payments principal approximately 24000 interest five years beginning may 2002 promissory note collateralized manufacturing facility magnolia texas purchased fourth quarter 2001 unsecured letters credit totaling 432000 december 31 2002 january 31 2003 borrowing base limitations reduced available borrowing capacity revolving credit facilities 243 million borrowing capacity available export sales credit facility commitments contingencies following table summarizes known contractual obligations december 31 2002 1 capital lease arrangements significant firm purchase commitments december 31 2002 2 operating lease obligations periods exceed five years primarily include costs associated usage waterways united kingdom lease terms extend 125 years property sold sublet new tenant lease arrangements would fully transferable 3 longterm liabilities represent postretirement benefit obligation december 31 2002 benefit payments associated obligation estimated based upon actual experience year ended december 31 2002 changes actuarial assumptions medical trend rates subsequent years could cause liability postretirement benefit plan change portatest purchase agreement executed january 2000 contains provision calculate payment certain former stockholders portatest systems inc threeyear period ended january 23 2003 based upon sales limited number specified products designed utilizing technology existed time acquisition liability arrangement contingent upon attaining certain performance criteria including gross margins sales volumes specified products applicable payment required annually april 2001 paid 226000 arrangement related year ended january 23 2001 august 2002 company paid 197000 arrangement related year ended january 23 2002 resulting increase goodwill liability accrued arrangement years ended january 23 2003 2002 special purpose entities unconsolidated affiliates partnerships march 13 2003 executed agreement issue 15000 shares series b convertible preferred stock along warrants purchase 248800 shares common stock lime rock partners ii lp private investment fund aggregate purchase price 150 million aggregate purchase price approximately 99000 allocated warrants amortize discount three years proceeds issuance used reduce outstanding revolving debt balances general corporate purposes transaction expected close prior end march 2003 share series b convertible preferred stock face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year share series b convertible preferred stock convertible option holder thereof number shares common stock equal face value share divided conversion price 7805 ii cash payment equal amount dividends share accrued since prior semiannual dividend payment date warrants issued lime rock exercise price 1000 per share common stock expire third anniversary issuance force exercise warrants stock price trades 1350 per share 30 consecutive days estimate accounting issuance preferred shares lower earnings 005 per diluted share 2003 relative earnings might otherwise although assurances given believe operating cash flow supported borrowing capacity additional financing obtained capital investment adequate fund operations least next twelve months decide pursue acquisition opportunities determination ability finance acquisitions critical element analysis opportunity although compliance existing restrictive loan covenants december 31 2002 expect continue compliance assurance remain compliance future periods therefore may required request amendments waivers covenants future believe amendments waivers obtained necessary reasonable terms related party transactions minority interest guarantee obligations related party debt obligations related parties responsibility reported balance sheet pay capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut chief executive officer reception telephone computer services normal office support relating space mr herbert winokur jr one directors chairman chief executive officer capricorn holdings inc managing partner capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controls approximately 31 outstanding common stock addition chief executive officer mr gregory nonsalaried member capricorn holdings llc capricorn investors ii lp controls approximately 20 common stock fees paid capricorn management totaled 115000 85000 75000 years ended december 31 2002 2001 2000 respectively commencing october 1 2001 fee increased 28750 quarterly due primarily upward adjustment capricorn managements underlying lease office space increase reviewed approved audit committee board directors terms employment agreement effect prior 1999 loaned chief executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 completed initial public offering class common stock also pursuant terms employment agreement paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay us approximately 665000 addition october 27 2000 board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options amount loan equal cost exercise options plus personal tax burdens resulted exercise maturity loans july 31 2003 interest accrued rates ranging 6 78 per annum june 30 2002 outstanding notes receivable totaled 34 million including principal accrued interest effective july 1 2002 notes reviewed board amended extend maturity dates july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied notes balances june 30 2002 including previously accrued interest december 31 2002 balance notes principal accrued interest due officer loan arrangements 35 million loans executive officer made full recourse basis prior periods facilitate direct ownership common stock currently subject compliance provisions sarbanesoxley act 2002 previously agreed 2001 loaned employee executive officer director 216000 april 15 2002 fullrecourse note arrangement accrues interest 6 per annum matures july 31 2003 funds used pay exercise cost personal tax burdens associated stock options exercised 2001 effective july 1 2002 note amended extend maturity date july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied note balance june 30 2002 including previously accrued interest december 31 2002 balance note principal interest due officer loan arrangement approximately 223000 loan executive officer made full recourse basis prior periods facilitate direct ownership common stock currently subject compliance provisions sarbanesoxley act 2002 1997 loaned 15 million rate 10 per annum one directors also affiliate capricorn holdings inc march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn investors lp distributed holding common stock partners 1998 acquired option cost 200000 purchase 173050 shares common stock director price 881 per share option note could repaid shares common stock cost acquire option recorded treasury stock accompanying consolidated balance sheet note arrangement director recorded 19 million current asset december 31 1999 partially settled february 2000 exercised option purchase 173050 shares common stock director cost 15 million remaining balance note repaid june 2000 december 1999 assumed postretirement pension liability former affiliate ws tyler incorporated tyler february 2000 received 600000 tyler settlement agreement entered tyler capricorn investors lp us whereby assumed responsibility retired employee health life insurance obligations tyler see note 15 pension postretirement benefits inflation changes prices costs materials eg steel products rise fall value commodity markets generally increases raw materials labor costs passed customers however current economic political unrest venezuela increased inflation affected operations country since revenues earned venezuela 2002 represented less 1 total revenues exposure increase inflation significant recent accounting pronouncements june 2001 financial accounting standards board fasb approved sfas 141 business combinations standard requires business combination initiated june 30 2001 accounted using purchase method accounting standard became effective july 1 2001 adopted standard july 1 2001 material effect financial condition results operations fasb approved sfas 142 goodwill intangible assets june 2001 pronouncement requires intangible assets indefinite lives including goodwill cease amortized evaluated impairment annual basis intangible assets defined term patents would continue amortized useful life asset adopted sfas 142 january 1 2002 continued amortize certain net assets totaling 16 million december 31 2002 recorded amortization interest expense related assets 840000 year ended december 31 2002 ceased periodic amortization goodwill date adoption net goodwill december 31 2002 790 million pro forma impact applying sfas 142 operating results years ended december 31 2001 2000 would reduction amortization expense 37 million 16 million respectively resulting net income 90 million 93 million respectively pro forma increase basic diluted earnings per share would 23 respectively 2001 11 10 respectively 2000 accordance sfas 142 tested goodwill impairment december 31 2002 based upon testing performed determined goodwill impaired december 31 2002 therefore impairment charge recorded sfas 142 december 31 2002 goodwill tested impairment annually december 31 june 2001 fasb issued sfas 143 accounting asset retirement obligations standard requires us record fair value asset retirement obligation liability period incur legal obligation associated retirement tangible longlived assets result acquisition construction development andor normal use assets addition standard requires us record corresponding asset depreciated life asset gave rise liability subsequent initial measurement asset retirement obligation required adjust liability end period reflect changes estimated retirement cost passage time required adopt pronouncement january 1 2003 provisions pronouncement require us record certain retirement obligations first quarter 2003 currently determining impact pronouncement financial condition results operations october 2001 fasb issued sfas 144 accounting impairment disposal longlived assets statement replaces sfas 121 accounting impairment longlived assets longlived assets disposed standardizes accounting model used asset dispositions related implementation issues pronouncement became effective financial statements issued fiscal years beginning december 15 2001 adopted pronouncement january 1 2002 resulting immaterial impact financial condition results operations april 2002 fasb issued sfas 145 rescission fasb statements 4 44 64 amendment fasb statement 13 technical corrections statement amends existing guidance reporting gains losses extinguishment debt prohibiting classification gain loss extraordinary sfas 145 also amends sfas 13 require saleleaseback accounting certain lease modifications economic effects similar saleleaseback arrangements provisions statement related rescission statement 4 applied fiscal year beginning may 14 2002 early adoption encouraged provisions statement related statement 13 effective transactions occurring may 15 2002 early adoption encouraged sfas 145 adopted respects revision statement 13 may 15 2002 adopted january 1 2003 respect amendment sfas 4 however adoption sfas 145 expected material effect financial condition results operations june 2002 fasb issued sfas 146 accounting exit disposal activities addresses financial accounting reporting costs associated exit disposal activities including restructuring activities currently accounted pursuant guidance set forth eitf issue 943 liability recognition certain employee termination benefits costs exit activity sfas 146 effective exit disposal activities initiated december 31 2002 early adoption encouraged provisions pronouncement applied exit disposal activities january 1 2003 however expect pronouncement material effect financial condition results operations november 2002 fasb issued interpretation 45 guarantors accounting disclosure requirements guarantees including indirect guarantees indebtedness others interpretation fasb statements 5 57 107 rescission fasb interpretation 34 interpretation elaborates disclosures made guarantor interim annual financial statements obligations guarantees issued interpretation also clarifies guarantor required recognize inception guarantee liability fair value obligation taken initial recognition measurement provisions interpretation applicable guarantees issued modified december 31 2002 expect interpretation material impact financial condition results operations december 2002 fasb issued sfas 148 accounting stockbased compensationtransition disclosure amendment fasb statement 123 statement amends fasb statement 123 accounting stockbased compensation provide alternative methods transition volunteerbasis fair value method accounting stockbased employee compensation additionally statement amends disclosure requirements sfas 123 require prominent disclosures annual interim financial statements certain disclosure modifications required fiscal years ending december 15 2002 transition sfas 123 elected yet elected transition sfas 123 december 31 2002 item 7aitem 7 managements discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto overview offer products services either integrated systems individual components primarily three business lines traditional production equipment services provide standardized components replacement parts used components equipment servicing engineered systems provide customized large scale integrated oil gas water production processing systems automation control systems provide control panels systems monitor control oil gas production well repair testing inspection services existing systems report three separate business segments north american operations engineered systems automation control systems forwardlooking statements annual report form 10k including managements discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended forwardlooking statement words believe expect plan intend estimate project could may similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions accounting policies estimates indicated trends level oil gas exploration production effect conditions results operations see industry business environment future uses requirements financial resources see liquidity capital resources anticipated backlog levels 2004 expectations business outlook customer spending oil gas prices business environment industry general us particular expectations regarding matters actual results may differ materially forwardlooking statements herein reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition world economic conditions level drilling activity legislative environment united states countries policies opec conflict major petroleum producing consuming regions acts terrorism development technology could lower overall finding development costs weather patterns overall condition capital markets countries operate following discussion read conjunction financial statements related notes financial information appearing elsewhere annual report form 10k readers also urged carefully review consider various disclosures advising interested parties factors affect us including without limitation disclosures made caption risk factors risks discussed annual report form 10k subsequent reports filed securities exchange commission expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies estimates preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements contains summary significant accounting policies believe following accounting policies critical preparation consolidated financial statements revenue recognition percentageofcompletion method recognize revenues significant contracts greater 250000 longer four months duration certain automation controls contracts orders percentage completion method accounting earned revenue based percentage costs incurred date relate total estimated costs project giving effect recent estimates total cost timing costs incurred therefore recognition revenue could affected various internal external factors including limited changes project scope change orders changes productivity scheduling cost availability labor cost availability raw materials weather client delays providing approvals benchmark stages project timing deliveries thirdparty providers key components cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues applicable losses expected incurred jobs progress consideration estimated probable minimum recoveries claims change orders charged income soon losses known claims additional contract revenue recognized probable claim result additional revenue amount reliably estimated generally recognize revenue earnings percentageofcompletion method applies period two six quarters event project terminated customer completion customer liable costs incurred contract believe operating results evaluated term several years evaluate performance longterm contracts change orders scope changes cost recoveries negotiated realized record revenues profits sales shipments made services performed impairment testing goodwill required statement financial accounting standards sfas 142 goodwill intangible assets evaluate goodwill annually impairment comparing fair value operating assets carrying value assets including related goodwill required sfas 142 identify separate reportable units purposes evaluation determining carrying value segregate assets liabilities extent possible clearly identifiable specific reportable unit certain corporate assets liabilities clearly identifiable specific reportable unit allocated accordance standard fair value determined discounting projected future cash flows cost capital rate calculated fair value compared carrying value reportable unit determine whether impairment occurred reportable unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting units assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 business combinations residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value would record impairment charge amount net goodwill 801 million december 31 2003 tested goodwill impairment required sfas 142 december 31 2003 record impairment charge result testing deferred income tax assets valuation allowance account income taxes accordance sfas 109 accounting income taxes sfas 109 requires us provide valuation allowance net deferred income tax assets believe utilized future operations recent fiscal years canadian subsidiary recorded net losses consolidated partially due certain restructuring efforts undertaken late 2002 early 2003 impact certain foreign currency transactions result losses recorded 349000 valuation allowance december 31 2003 fully reserve net deferred tax asset subsidiary 258000 valuation allowance related realizability certain net operating losses related axsia another 152000 related foreign operations based upon level historical taxable income projected future taxable income periods deferred tax assets deductible believe likely realize benefits deductible differences net existing valuation allowances december 31 2003 however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections acquisitions november 1998 acquired outstanding common stock cynara company cynara designer manufacturer specialized production equipment utilizing membrane technology separate bulk carbon dioxide natural gas streams approximately 155 million 500000 shares outstanding class b common stock right receive additional shares common stock based upon financial performance cynara assets ultimately issued 752501 additional shares class b common stock former cynara stockholders provision class b common stock automatically converted common stock shareforshare basis january 1 2002 march 2001 acquired outstanding share capital axsia holdings limited privately held process design company based united kingdom approximately 428 million net cash acquired axsia specializes design supply equipment water reinjection systems oil gas fields oily water treatment oil separation hydrogen production oil gas processing equipment systems acquisition financed borrowings 2001 term loan revolving credit facility accounted transactions using purchase method accounting industry business environment leading provider wellhead process equipment systems services used production oil gas revenues results operations closely tied demand oil gas products spending oil gas companies exploration development oil gas reserves companies generally invest exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices supply demand change commodity prices fluctuate producing cyclical trends industry periods lower demand revenues service providers natco generally decline existing projects completed new projects postponed periods recovery revenues service providers lag behind industry due timing new project awards changes commodity prices impacted business past several years following table summarizes price domestic crude oil per barrel wellhead price natural gas per thousand cubic feet mcf published us department energy number rotary drilling rigs operation published baker hughes incorporated recent five years december 31 2003 spot price west texas intermediate crude oil 3251 per barrel price natural gas 596 per mcf us rig count 1114 february 27 2004 spot price west texas intermediate crude oil 3608 per barrel price henry hub natural gas 527 per mcf per new york mercantile exchange us rig count 1134 per baker hughes incorporated spot prices reflect overall volatility oil gas commodity prices current recent years historically viewed operating rig counts benchmark spending oil gas industry exploration development efforts traditional equipment sales services business generally correlates changes rig activity tends lag behind north american rig count trend longerterm perspective us department energy estimates us demand consumption petroleum natural gas products increase 2025 higher consumption rates expected worldwide driven demand refined products use natural gas power plants generate electricity demand grows reserves united states decline producers service providers oil gas industry may continue rely heavily global sources energy expansion new markets industry continues seek innovative technologically efficient means extract hydrocarbons existing fields production profiles change result additional complex equipment may required produce oil gas fields especially since many new oil gas fields produce lower quality contaminated hydrocarbon streams requiring complex production equipment general trends increase demand products services engineered systems business impacted largely awarding completion larger complex oil gas projects primarily international offshore locations projects typically longer bidding evaluation awarding construction period traditional equipment services business subject customers longterm view oil gas supply demand outlook related region well expected commodity prices political governmental situations recent periods experienced absence delays lack large international projects favorable economic terms impacted engineered systems business results well current level project bookings segment fourth quarter 2002 throughout 2003 streamlined certain operations decrease excess capacity responsive current market trends including closure consolidation manufacturing facilities edmonton alberta canada covington louisiana furthermore reallocated certain internal resources consolidated certain engineered systems operations uk closed engineered systems business development office singapore december 2003 placed service expansion gasprocessing facilities sacroc expansion increase operating capacity facility 180 mmcf per day 367 mmcf per day operating agreement facility provides daily processing minimums project operation contribute significantly earnings cash flows 2004 compared 2003 therefore expect larger percentage revenues margins 2004 compared 2003 attributable co2 gasprocessing business component north american operations segment following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes thereto results operations year ended december 31 2003 compared year ended december 31 2002 revenues year ended december 31 2003 decreased 81 million 3 2815 million 2895 million year ended december 31 2002 overall decline revenues primarily attributable slower expected recovery oil gas industry following downturn 2001 cyclical nature industry following table summarizes revenues business segment years ended december 31 2003 2002 respectively revenues north american operations segment year ended december 31 2003 decreased 47 million 3 1327 million 1374 million year ended december 31 2002 decrease related primarily decline number traditional equipment projects progress 2003 compared 2002 decline revenues contributed operations mexico membrane replacement sales respective periods declines partially offset higher parts service sales well increase revenues derived co2 gasprocessing business increase parts service sales directly attributable increase oilfield activity 2003 compared 2002 average us rotary rig count increased 830 year ended december 31 2002 1030 year ended december 31 2003 revenues canadian operations increased 2003 due several large projects completed year canadian rotary rig counts increased average 263 year ended december 31 2002 372 year ended december 31 2003 intersegment revenues business segment approximately 14 million 917000 years ended december 31 2003 2002 respectively revenues engineered systems segment year ended december 31 2003 decreased 88 million 8 983 million 1070 million year ended december 31 2002 decrease primarily due decline number large international production system jobs 2003 relative 2002 partially due project delays increased competition engineered systems revenues 983 million year ended december 31 2003 included intersegment revenues 784000 compared 18 million intersegment revenues year ended december 31 2002 revenues automation control systems segment year ended december 31 2003 increased 45 million 9 567 million 521 million year ended december 31 2002 increase primarily related general increase number jobs progress 2003 compared 2002 completion several larger projects 2003 intersegment revenues decreased 43 million year ended december 31 2002 40 million year ended december 31 2003 change revenues corporate intersegment eliminations represents elimination intersegment revenues discussed gross profit gross profit year ended december 31 2003 decreased 42 million 6 660 million 702 million year ended december 31 2002 percentage revenue gross margins declined 24 year ended december 31 2002 23 year ended december 31 2003 largely due decline margins associated north american operations business overall decline sales respective periods following table summarizes gross profit business segment years ended december 31 2003 2002 respectively gross profit north american operations segment year ended december 31 2003 decreased 38 million 10 338 million 376 million year ended december 31 2002 decrease gross profit primarily due 3 decline sales segment respective period including decline favorable margin sales related latin american operations membrane replacement sales several higher margin membrane sales completed 2002 percentage revenue gross margins segment 25 27 years ended december 31 2003 2002 respectively gross profit engineered systems segment year ended december 31 2003 decreased 688000 3 225 million 232 million year ended december 31 2002 decline gross profit primarily related 8 decline sales partially offset improved overall performance percentage revenue gross margins segment 23 22 years ended december 31 2003 2002 respectively gross profit automation control systems segment years ended december 31 2003 2002 increased 314000 3 97 million 94 million increase primarily due 9 increase sales segment respective period partially offset unfavorable mix projects 2003 increased competition jobs gulf mexico percentage revenue gross margins segment 17 18 years ended december 31 2003 2002 respectively selling general administrative expense selling general administrative expense year ended december 31 2003 decreased 25 million 5 515 million 539 million year ended december 31 2002 decrease largely due decline variable compensation based operating results impact restructuring activities canada fourth quarter 2002 restructuring efforts us uk last six months 2003 expense decreases partially offset higher employee medical costs workers compensation insurance claim costs higher professional fees corporate insurance policies overall headcount declined 1700 employees december 31 2002 1664 employees december 31 2003 depreciation amortization expense depreciation amortization expense year ended december 31 2003 increased 111000 2 51 million 50 million year ended december 31 2002 increase depreciation expense relates sacroc gas processing facility expansions amortization expense approximately 100000 years ended december 31 2003 2002 related primarily patents intangible assets closure charges year ended december 31 2003 21 million related certain restructuring activities third quarter 2003 including closure manufacturing facility covington louisiana consolidation operations uk postemployment benefits terminated employees locations corporate office addition costs incurred related closure singapore marketing office fourth quarter 2003 including certain lease termination costs postemployment benefits terminated employees year ended december 31 2002 incurred costs 548000 related closure manufacturing engineering facility edmonton alberta canada costs included involuntary termination certain employees relocation equipment certain personnel modification related operating lease arrangements december 31 2002 remaining accrued liability related canadian restructuring effort 304000 incurred additional relocation shop moving costs totaling 230000 2003 interest expense interest expense year ended december 31 2003 decreased 442000 10 41 million 45 million year ended december 31 2002 decrease due decline outstanding debt 524 million december 31 2002 436 million december 31 2003 weighted average interest rate outstanding borrowings approximately 4 years ended december 31 2003 2002 interest cost postretirement benefit liability interest cost postretirement benefit liability increased 366000 78 471000 year ended december 31 2002 837000 year ended december 31 2003 increase interest cost due decrease discount rate used actuarially determine present value postretirement obligation arrangement consistent general decline interest rates recent years expense net expense net 12 million year ended december 31 2003 increased 811000 203 compared year ended december 31 2002 change related primarily net foreign currency losses incurred operations united kingdom canada due significant devaluation us dollar relative foreign currencies year ended december 31 2003 provision income taxes income tax expense year ended december 31 2003 decreased 462000 27 12 million 17 million year ended december 31 2002 decline income tax expense primarily due decrease income taxes 56 million year ended december 31 2002 compared 14 million year ended december 31 2003 increase effective tax rate 305 year ended december 31 2002 902 year ended december 31 2003 due primarily decline pretax income permanent tax differences represented greater portion total taxable income valuation allowance recorded december 31 2003 reserve certain deferred tax assets related canadian operations preferred stock dividends recorded preferred stock dividends totaling 12 million year ended december 31 2003 related series b convertible preferred stock issued private investment fund march 2003 year ended december 31 2002 compared year ended december 31 2001 revenues year ended december 31 2002 increased 30 million 1 2895 million 2866 million year ended december 31 2001 following table summarizes revenues business segment years ended december 31 2002 2001 respectively revenues north american operations segment year ended december 31 2002 decreased 78 million 5 1374 million 1451 million year ended december 31 2001 decrease directly related decline oilfield activity throughout 2002 average north american rotary rig count declined 1497 year ended december 31 2001 1093 year ended december 31 2002 although revenues traditional equipment finished goods declined results latin american operations co2 gasprocessing operations field services improved 2002 relative 2001 revenues canadian operations decreased canadian rotary rig counts continued decline average 341 year ended december 31 2001 average 263 year ended december 31 2002 intersegment revenues business segment approximately 917000 781000 years ended december 31 2002 2001 respectively revenues engineered systems segment year ended december 31 2002 increased 80 million 8 1070 million 990 million year ended december 31 2001 increase primarily due several large projects primarily west africa provided revenues approximately 310 million 2002 offset decline revenues ukbased operations decline revenues earned southeast asia substantial completion ctoc project late 2001 engineered systems revenues 1070 million year ended december 31 2002 included intersegment revenues 18 million compared 748000 intersegment revenues year ended december 31 2001 revenues automation control systems segment year ended december 31 2002 increased 44 million 9 521 million 477 million year ended december 31 2001 increase due higher demand control equipment field services partially associated repair projects gulf mexico following several tropical weather systems 2002 intersegment revenues increased 38 million year ended december 31 2001 43 million year ended december 31 2002 change revenues corporate intersegment eliminations represents elimination intersegment revenues discussed gross profit gross profit year ended december 31 2002 decreased 59 million 8 702 million 761 million year ended december 31 2001 percentage revenue gross margins declined 27 year ended december 31 2001 24 year ended december 31 2002 following table summarizes gross profit business segment years ended december 31 2002 2001 respectively gross profit north american operations segment year ended december 31 2002 increased 21 million 6 376 million 355 million year ended december 31 2001 increase margin primarily due contribution latin american operations co2 gasprocessing operations field services reflecting increased throughput expansion sacroc facility percentage revenue gross margins segment 27 24 years ended december 31 2002 2001 respectively gross profit engineered systems segment year ended december 31 2002 decreased 80 million 26 232 million 312 million year ended december 31 2001 despite 8 increase revenues decline due completion several highmargin projects 2001 southeast asia within ukbased operations partially offset new projects 2002 awarded traditional margins percentage revenue gross margins segment 22 32 years ended december 31 2002 2001 respectively gross profit automation control systems segment years ended december 31 2002 2001 remained constant despite 9 increase revenues period primarily due increase labor costs attributable higher medical benefit costs unfavorable mix labor materials 2002 compared 2001 percentage revenue gross margins segment 18 20 years ended december 31 2002 2001 respectively selling general administrative expense selling general administrative expense year ended december 31 2002 increased 25 million 5 539 million 515 million year ended december 31 2001 increase largely related following factors one year operating expenses axsia 2002 compared nine months fiscal 2001 additional costs associated startup singapore office march 2001 costs associated startup mexico marketing office opened late 2001 additional costs associated employee medical claims depreciation amortization expense depreciation amortization expense year ended december 31 2002 decreased 32 million 39 50 million 81 million year ended december 31 2001 depreciation expense year ended december 31 2002 increased 764000 19 49 million 41 million year ended december 31 2001 increase primarily due inclusion depreciation expense assets acquired purchase axsia march 2001 depreciation assets placed service late 2001 2002 including significant upgrade drying plant facility pittsburg california expansion gasprocessing plant sacroc field amortization expense year ended december 31 2002 decreased 39 million 98 92000 40 million year ended december 31 2001 decrease amortization expense attributable change accounting method prescribed sfas 142 goodwill intangible assets pronouncement adopted january 1 2002 requires goodwill longer amortized prescribed period rather intangible assets assigned useful life evaluated annually impairment see recent accounting pronouncements therefore goodwill amortization recorded year ended december 31 2002 compared 37 million year ended december 31 2001 addition results year ended december 31 2001 include amortization expense associated certain employment contracts fully amortized december 31 2001 closure charges year ended december 31 2002 548000 related closure manufacturing engineering facility edmonton alberta canada costs include involuntary termination certain employees relocation equipment certain personnel modification related operating lease arrangements december 31 2002 remaining accrued liability related restructuring 304000 expect incur additional relocation shop moving costs expensed incurred second quarter 2003 year ended december 31 2001 incurred charge totaling 920000 related certain restructuring costs streamline activities consolidate offices connection acquisition axsia march 2001 additional 680000 related decision withdraw private debt offering interest expense interest expense year ended december 31 2002 decreased 414000 8 45 million 49 million year ended december 31 2001 decrease due decline outstanding debt 586 million december 31 2001 524 million december 31 2002 weighted average interest rate outstanding borrowings remained constant respective periods interest cost postretirement benefit liability interest cost postretirement benefit liability decreased 417000 47 888000 year ended december 31 2001 471000 year ended december 31 2002 decrease interest cost due amendment plan provides medical dental coverage retirees predecessor company amended plan retirees bear cost coverages thereby reducing projected liability related interest cost interest income interest income decreased 412000 62 660000 year ended december 31 2001 248000 year ended december 31 2002 change interest income primarily due interest earned federal income tax refund paid 2001 canadian taxing authorities expense net expense net 400000 year ended december 31 2002 declined 29000 7 compared year ended december 31 2001 change relates primarily foreign currency gains losses incurred operations united kingdom canada provision income taxes income tax expense year ended december 31 2002 decreased 22 million 56 17 million 39 million year ended december 31 2001 decline income tax expense primarily due decrease income taxes 56 million year ended december 31 2002 compared 93 million year ended december 31 2001 decrease effective tax rate 421 year ended december 31 2001 305 year ended december 31 2002 due primarily longer recognizing nondeductible goodwill amortization expense per sfas 142 adopted january 1 2002 liquidity capital resources january 31 2004 cash working capital 20 million 346 million respectively december 31 2003 cash working capital 18 million 346 million respectively compared 17 million 363 million december 31 2002 respectively decline working capital primarily due change current maturities longterm debt related term loan revolving credit facility revolving credit facility portion loan mature march 31 2004 effective march 15 2004 replaced facility new term loan revolving credit facility matures march 15 2007 described detail net cash provided operating activities years ended december 31 2003 2002 2001 126 million 105 million 199 million respectively increase net cash provided operating activities fiscal 2003 primarily due decline accounts receivable due increased collection efforts increase customer advance payments partially offset lower net income decline accrued liabilities timing accounts receivable billings collections receipt advance payments depends upon agreed project benchmarks jobs accounted percentage completion method accounting tends fluctuate reporting periods net cash used investing activities years ended december 31 2003 2002 2001 108 million 56 million 577 million respectively primary use funds year ended december 31 2003 capital expenditures 115 million majority related expansion sacroc gasprocessing facility placed service december 2003 cost partially offset proceeds sale building uk primary use funds year ended december 31 2002 capital expenditures 53 million largely related expansion sacroc primary use funds year ended december 31 2001 acquisition axsia required use 483 million capital expenditures 100 million included purchase manufacturing facility magnolia texas expansion improvement facilities new iberia louisiana improvements sacroc plant funds axsia acquisition borrowed 500 million term loan facility capital expenditures fiscal 2001 financed borrowings revolving credit facility cash generated current operations net cash provided used financing activities years ended december 31 2003 2002 2001 18 million 62 million 405 million respectively primary use funds financing activities year ended december 31 2003 repayment longterm debt revolving credit debt 71 million 21 million respectively well 16 million net benefit costs postretirement benefit plan 40 million bank overdraft reductions uses cash financing activities largely offset gross proceeds 150 million less issuance costs fair value allocable related stock warrants net 141 million issuance series b convertible preferred stock less dividends paid shares 12 million primary use funds year ended december 31 2002 repayment longterm debt 71 million benefit payments postretirement benefit plan 19 million partially offset longterm borrowings 15 million 19 million increase bank overdrafts proceeds issuance series b convertible preferred stock used working capital needs fund expansion sacroc facility primary source funds financing activities year ended december 31 2001 borrowings 500 million term loan facility partially offset principal repayments 53 million term loan facility net repayments 747000 revolving credit facilities payments postretirement benefit liability 18 million repayment shortterm notes 10 million maintain revolving credit term loan facilities well working capital facility export sales prior term loan effect 2003 provided initial 500 million borrowings revolving credit facilities provide 300 million borrowings united states 100 million borrowings canada 100 million borrowings united kingdom subject borrowing base limitations term loan mature march 31 2006 revolving facilities mature march 31 2004 facilities entered 2001 refer facilities 2001 facilities march 15 2004 replaced 2001 term loan revolving credit facilities term loan revolving credit arrangement provides term loan 450 million us revolving facility borrowing capacity 200 million canadian revolving facility borrowing capacity 50 million uk revolving credit facility borrowing capacity 100 million borrowing capacities revolving credit facilities subject borrowing base limitations 2004 term loan revolving facilities provide interest rate based upon ratio funded debt ebitda defined credit facility ebitda ranging election 1 high libor plus 275 low libor plus 200 2 high base rate plus 175 low base rate plus 100 natco pay commitment fees related facility based upon ratio funded debt ebitda undrawn portion facility 2004 term loan revolving facilities require quarterly payments 16 million beginning june 2004 mature march 15 2007 intend borrow funds 2004 term loan revolving credit facilities retire debt outstanding 2001 term loan revolving credit facilities march 15 2004 december 31 2003 borrowings outstanding term loan facility 308 million borrowings 109 million outstanding revolving credit facilities issued 198 million outstanding letters credit facilities amounts borrowed term loan portion 2001 facility bore interest rate 391 per annum amounts borrowed revolving portion 2001 facility bore interest rate based upon ratio funded debt ebitda defined credit facility ebitda ranged election 1 high libor plus 250 low libor plus 175 2 high base rate plus 10 low base rate plus 025 2001 facilities required pay commitment fees 030 0625 per year depending upon ratio funded debt ebitda undrawn portion facility december 31 2003 commitment fees calculated rate 0625 july 2002 lenders approved amendment various provisions 2001 term loan revolving credit facility agreement effective april 1 2002 amendment revised certain restrictive debt covenants modified certain defined terms allowed future capital investment sacroc co2 processing facility west texas facilitates issuance 75 million subordinated debt increased aggregate amount operating lease expense allowed fiscal year permitted increase borrowings export sales credit facility without consent maximum 200 million modifications resulted higher commitment fee percentages interest rates original agreements based funded debt ebitda ratio defined underlying agreement amended july 2003 lenders approved amendment 2001 term loan revolving credit facilities effective april 1 2003 amendment modified several restrictive covenant terms including fixed charge coverage ratio funded debt ebitda ratio defined agreement 2001 term loan revolving credit facilities agreement certain debt covenants became restrictive fourth quarter 2003 december 2003 company obtained waiver certain debt covenants including related net worth funded debt ebitda fixed charge coverage ratio march 31 2004 subject meeting minimum ebitda threshold company met threshold requirement december 31 2003 compliance covenant requirements amended date weighted average interest rate borrowings 2001 term loan revolving credit agreement december 31 2003 416 operating subsidiaries guarantee 2004 term loan revolving credit facilities secured first lien first priority security interest pledge substantially assets borrowers including accounts receivable inventory equipment intangibles equity interests us subsidiaries 66 13 equity interest active nonus subsidiaries assets active us subsidiaries secure us canadian uk facilities assets canadian subsidiary also secure canadian facility assets uk subsidiaries also secure uk facility us facility guaranteed us subsidiaries canadian uk facilities guaranteed us subsidiaries canadian subsidiary uk subsidiaries applicable 2004 term loan revolving credit facilities contain restrictive covenants similar contained 2001 facilities including among others limit amount funded debt ebitda defined 2004 facilities impose minimum fixed charge coverage ratio minimum asset coverage ratio minimum net worth requirement facilities also restrict payment dividends us respect series b preferred shares export sales credit facility provides aggregate borrowings 100 million subject borrowing base limitations 700000 outstanding december 31 2003 addition issued letters credit totaling 69000 export facility date fees related letters credit december 31 2003 approximately 1 outstanding balance export sales credit facility secured specific project inventory receivables partially guaranteed exportimport bank united states export sales credit facility loans mature july 2004 borrowed 15 million longterm promissory note arrangement finance purchase manufacturing facility magnolia texas fourth quarter 2001 note accrues interest 90day libor plus 325 per annum requires quarterly payments principal approximately 24000 interest five years beginning may 2002 promissory note collateralized manufacturing facility magnolia texas unsecured letters credit bonds totaling 584000 performance guarantees totaling 79 million december 31 2003 commitments contingencies following table summarizes known contractual obligations december 31 2003 1 capital lease arrangements december 31 2003 2 purchase obligations pursuant material equipment purchase orders placed 2003 delivery billing scheduled 2004 approximately 58 million balance related one purchase order significant purchase commitments extended beyond one year 3 longterm liabilities represent postretirement benefit obligation december 31 2003 benefit payments associated obligation estimated based upon actual experience year ended december 31 2003 changes actuarial assumptions medical trend rates subsequent years could cause liability postretirement benefit plan change special purpose entities unconsolidated affiliates partnerships march 25 2003 issued 15000 shares series b convertible preferred stock series b preferred shares warrants purchase 248800 shares common stock lime rock partners ii lp private investment fund aggregate sale price 150 million approximately 99000 aggregate sale price allocated warrants proceeds issuance securities net related estimated issuance costs approximately 800000 used reduce outstanding revolving debt balances general corporate purposes series b preferred shares face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment paid july 1 2003 series b preferred shares convertible option holder number shares common stock equal face value series b preferred share divided conversion price 7805 aggregate 1921845 shares december 31 2003 ii cash payment equal amount dividends shares accrued since prior semiannual dividend payment date december 31 2003 accrued dividends payable related series b preferred shares 2003 paid dividends 12 million holders series b preferred shares event change control defined certificate designations preferred shares holder series b preferred shares right convert series b preferred shares common stock cause us redeem cash series b preferred shares aggregate redemption price equal sum 1000 adjusted stock splits stock dividends etc multiplied number shares redeemed plus ii amount less zero equal product 500 adjusted stock splits stock dividends etc multiplied aggregate amount dividends paid cash since issuance date plus gain related stock warrants holder series b preferred shares converts upon change control occurring march 25 2006 holder would also entitled receive cash amount equal dividends would accrued march 25 2006 less sum aggregate amount dividends paid cash date conversion aggregate amount dividends accrued prior periods yet paid right redeem series b preferred shares cash march 25 2008 redemption price per share equal face value series b preferred shares plus amount dividends accrued paid since recent semiannual dividend payment date adopted sfas 150 accounting certain instruments characteristics liabilities equity july 1 2003 sfas 150 series b preferred shares would classified permanent equity however due cash redemption features upon change control described series b preferred shares qualify permanent equity treatment accordance emerging issues task force topic d98 classification measurement redeemable securities specifically requires permanent equity treatment precluded security redemption features solely within control issuer therefore accounted series b preferred shares temporary equity accompanying balance sheet assigned value right redeem series b preferred shares march 25 2008 series b preferred shares converted contingent redemption features redemption amount greater carrying value would recorded reduction income available common shareholders event becomes probable fail pay dividends two consecutive periods redemption price due respect series b preferred shares period 60 days following payment date default terms shares default period 1 dividend rate series b preferred shares would increase 1025 2 holders series b preferred shares would right elect appoint second director board directors 3 would restricted paying dividends redeeming acquiring common outstanding stock limited exceptions fail set aside make payments cash redemption price due respect series b preferred shares holders elect right redeem shares may terminated warrants issued lime rock partners ii lp exercise price 1000 per share common stock expire march 25 2006 force exercise warrants common stock trades 1350 per share 30 consecutive days warrants contain provision whereby holder could require us make netcash settlement warrants case change control warrants deemed derivative instruments therefore warrants recorded fair value issuance date fair value agreed counterparty agreement calculated applying pricing model included subjective assumptions stock volatility expected term warrants would outstanding dividend rate zero overall liquidity factor resulting liability originally recorded 99000 increased 154000 december 31 2003 result change fair value warrants similarly changes fair value future periods recorded net income period change january 31 2004 available borrowing capacity 2001 term loan revolving credit agreement export sales credit agreement 198 million 981000 respectively although assurances given believe operating cash flow supported borrowing capacity adequate fund operations next twelve months decide pursue acquisition opportunities determination ability finance acquisitions critical element analysis opportunities related party transactions minority interest guarantee obligations related party majorityowned subsidiaries debt obligations related parties responsibility excluded balance sheet pay capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut chief executive officer reception telephone computer services normal office support relating space mr herbert winokur jr one directors chairman chief executive officer capricorn holdings inc managing director capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controls approximately 31 outstanding common stock addition chief executive officer mr gregory nonsalaried member capricorn holdings llc capricorn investors ii lp controls approximately 19 common stock fees paid capricorn management totaled 115000 85000 years ended december 31 2003 2002 2001 respectively commencing october 1 2001 fee increased 28750 quarterly due primarily upward adjustment capricorn managements underlying lease office space increase reviewed approved audit committee board directors arrangement terminable either party 90 days notice terms employment agreement effect prior 1999 loaned chief executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 completed initial public offering class common stock also pursuant terms employment agreement paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay us approximately 665000 addition october 27 2000 board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options amount loan equal cost exercise options plus personal tax burdens resulted exercise maturity loans july 31 2003 interest accrued rates ranging 6 78 per annum june 30 2002 outstanding notes receivable totaled 34 million including principal accrued interest effective july 1 2002 notes reviewed board amended extend maturity dates july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied notes balances june 30 2002 including previously accrued interest december 31 2003 balance notes principal accrued interest due officer loan arrangements 36 million loans executive officer made full recourse basis prior periods facilitate direct ownership common stock currently subject compliance provisions sarbanesoxley act 2002 previously agreed 2001 loaned employee executive officer director 216000 april 15 2002 fullrecourse note arrangement accrues interest 6 per annum mature july 31 2003 funds used pay exercise cost personal tax burdens associated stock options exercised 2001 effective july 1 2002 note amended extend maturity date july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied note balance june 30 2002 including previously accrued interest december 31 2003 balance note principal interest due officer loan arrangement approximately 233000 loan executive officer made full recourse basis prior periods facilitate direct ownership common stock currently subject compliance provisions sarbanesoxley act 2002 inflation changes prices costs materials eg steel products rise fall value commodity markets generally increases raw materials labor costs passed customers late 2003 cost steel increased significantly cost increase sustained may impact future operations increase cost produce goods services recent accounting pronouncements june 2001 fasb issued sfas 143 accounting asset retirement obligations standard provides guidance reporting accounting obligations associated retirement longlived tangible assets related retirement costs standard effective financial statements issued fiscal years beginning june 15 2002 january 1 2003 adopted pronouncement recorded loss 34000 net tax effect cumulative effect change accounting principle addition recorded asset retirement obligation liability asset cost 96000 associated obligation remove certain leasehold improvements upon termination lease arrangements including concrete pads equipment depreciate asset cost remaining useful life related assets october 2001 fasb issued sfas 144 accounting impairment disposal longlived assets statement replaces sfas 121 accounting impairment longlived assets longlived assets disposed standardizes accounting model used asset dispositions related implementation issues pronouncement became effective financial statements issued fiscal years beginning december 15 2001 adopted pronouncement january 1 2002 resulting immaterial impact financial condition results operations april 2002 fasb issued sfas 145 rescission fasb statements 4 44 64 amendment fasb statement 13 technical corrections statement provides guidance income statement classification gains losses extinguishment debt accounting certain lease modification economic effects similar saleleaseback transactions sfas 145 became effective adopted january 1 2003 material effect financial condition results operations june 2002 fasb issued sfas 146 accounting exit disposal activities addresses significant issues regarding recognition measurement reporting costs associated exit disposal activities including restructuring activities previously accounted pursuant guidance set forth eitf issue 943 liability recognition certain employee termination benefits costs exit activity sfas 146 became effective january 1 2003 adoption sfas 146 material impact financial condition results operations november 2002 fasb issued interpretation 45 guarantors accounting disclosure requirements guarantees including indirect guarantees indebtedness others interpretation fasb statements 5 57 107 rescission fasb interpretation 34 interpretation elaborates disclosures made guarantor interim annual financial statements obligations guarantees issued interpretation also clarifies guarantor required recognize inception guarantee liability fair value obligation taken initial recognition measurement provisions interpretation applicable guarantees issued modified december 31 2002 application interpretation material impact financial condition results operations december 2002 fasb issued sfas 148 accounting stockbased compensationtransition disclosure amendment fasb statement 123 statement amends fasb statement 123 accounting stockbased compensation provide alternative methods transition volunteerbasis fair value method accounting stockbased employee compensation additionally statement amends disclosure requirements sfas 123 require prominent disclosures annual interim financial statements certain disclosure modifications required fiscal years ending december 15 2002 transition sfas 123 elected yet elected transition sfas 123 april 2003 fasb issued sfas 149 amendment statement 133 derivative instruments hedging activities statement provides additional guidance account derivative instruments including certain derivative instruments embedded contracts well hedging activities sfas 133 pronouncement becomes effective new contract arrangements hedging transactions entered june 30 2003 exceptions certain sfas 133 implementation issues begun prior june 15 2003 adopted pronouncement july 1 2003 material impact financial condition results operations may 2003 fasb issued sfas 150 accounting certain financial instruments characteristics liabilities equity statement provides guidance classify measure certain financial instruments characteristics liabilities equity generally requires treatment instruments liabilities including certain obligations issuer must settle issuing equity securities pronouncement effective financial instruments entered modified may 31 2003 otherwise became effective july 1 2003 required cumulative effect change accounting principle treatment upon adoption adopted pronouncement july 1 2003 material impact financial condition results operations december 2003 fasb issued amendment sfas 132 employers disclosures pensions postretirement benefits amendment effective december 31 2003 requires additional annual disclosures pension postretirement plan assets liabilities well investment policies strategies plan assets basis expected rate return assets total accumulated benefit obligation addition amendment requires interim disclosures components net periodic benefit cost tabular format contributions paid expected paid current fiscal year effective december 31 2004 required disclose benefits expected paid next five years pension postretirement plan aggregate amount expected paid succeeding five year period arrangements adopted amendment sfas 132 december 31 2003 required disclosures included annual report form 10k see note 15 pension postretirement benefits accompanying notes consolidated financial statements item 7ananitem 7 management’s discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto overview restructured organization effective january 1 2005 order improve execution customer focus business segments oil water technologies gas technologies automation controls oil water technologies group largest segment consists two product lines first standard traditional product line consisting oil gas separation dehydration equipment sales related services extensive north american branch distribution network second product line includes builttoorder process systems focused primarily oil water production processing systems designed built meet customer specifications gas technologies group includes co2 membrane business assets operating relationship related gas processing facilities west texas h2s removal technologies including shell paques™ gasrelated technologies focus removing contaminants gas stream automation controls group focuses sales new control panels systems monitor control oil gas production well field service activities including repair maintenance testing inspection services existing systems financial reporting purposes beginning 2005 allocate corporate expenses segments rather segregating costs standalone basis furthermore certain reclassifications made fiscal 2004 fiscal 2003 amounts order present results comparable basis amounts fiscal 2005 forwardlooking statements annual report form 10k including management’s discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended “forwardlooking statement” words “believe” “expect” “plan” “intend” “designed to” “estimate” “project” “will” “could” “may” similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions accounting policies estimates indicated trends level oil gas exploration production effect conditions results operations see “industry business environment” future uses requirements financial resources see “liquidity capital resources” implementation potential savings related various initiatives see “item 1 businessrecent developments” impact bookings future revenues anticipated backlog levels expectations business outlook customer spending oil gas prices business environment industry general us particular expectations regarding matters actual results may differ materially forwardlooking statements herein reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition world economic conditions level drilling activity legislative environment united states countries policies opec conflict major petroleum producing consuming regions acts terrorism development technology could lower overall finding development costs weather patterns overall condition capital markets countries operate following discussion read conjunction financial statements related notes financial information appearing elsewhere annual report form 10k readers also urged index financial statements carefully review consider various factors including without limitation disclosures made item 1a risk factors risks discussed annual report form 10k subsequent reports filed securities exchange commission may affect us outcomes related forwardlooking statements expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies estimates preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements contains summary significant accounting policies believe following accounting policies critical preparation consolidated financial statements revenue recognition percentageofcompletion method recognize revenues related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued 250000 less contract durations four months less recognize revenues using percentage completion method contracts greater 250000 contract durations excess four months represent customized engineered orders products qualify treatment accordance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 addition use percentage completion method automation controls segment equipment fabrication sales projects qualify treatment accordance requirements sop 811 automation controls segment sells customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration segment produce standard units maintain inventory products sale due nature segment’s equipment fabrication sales operations potential wide variations results operations could occur applying shipped methodology smaller contracts customized fabricated goods segment recognizes revenues regardless contract value duration applying percentage completion method 2005 approximately 56 total company revenues recorded shipped performed basis approximately 44 recorded using percentage completion method respect contract revenues recorded utilizing percentage completion method earned revenue based percentage costs incurred date relate total estimated costs project giving effect recent estimates total cost total estimated contract cost critical accounting estimate materially affect revenue net income requires us make judgments matters uncertain total costs expected incurred therefore recognition revenue could affected various internal external factors including limited changes project scope change orders changes productivity scheduling cost availability labor cost availability raw materials weather client delays providing approvals benchmark stages project timing deliveries thirdparty providers key components cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues applicable losses expected incurred jobs progress consideration estimated probable minimum recoveries claims change orders charged income soon losses known claims additional contract revenue recognized probable claim result additional revenue amount reliably estimated index financial statements generally recognize revenue earnings percentageofcompletion method applies period two six quarters event project terminated customer completion customer liable costs incurred contract believe operating results evaluated term one three years evaluate performance longterm contracts change orders scope changes cost recoveries negotiated realized estimates subjective nature possible could used different estimates total contract costs calculation revenue recognized using percentage completion method december 31 2005 company 1112 million revenues attributable open percentage completion projects aggregate gross margin 212 used different estimate total contract costs contract progress december 31 2005 1 increase decrease estimated margin earned contract would increased decreased total revenue pretax income year ended december 31 2005 approximately 14 million december 31 2005 company three contracts loss position estimated aggregate loss 31000 impairment testing goodwill required statement financial accounting standards “sfas” 142 “goodwill intangible assets” evaluate goodwill annually impairment comparing fair value operating assets carrying value assets including related goodwill required sfas 142 identified separate reporting units purposes evaluation used segments reporting units tested segments year end 2005 determining carrying value segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated permitted standard fair value determined discounting projected future cash flows cost capital rate calculated determining projected future cash flows segment make assumptions regarding following key indicators future market sales growth rates domestic international cost inflation margin expectations working capital expenditure levels tax levels fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value would record impairment charge amount net goodwill 809 million december 31 2005 tested goodwill impairment required sfas 142 december 31 2005 record impairment charge result testing estimated fair values discounted cash flow three segments oil water technologies gas technologies automation controls reduced 54 75 55 respectively would required perform second step goodwill impairment prescribed sfas 142 deferred income tax assets valuation allowance account income taxes accordance sfas 109 “accounting income taxes” sfas 109 requires us provide valuation allowance deferred income tax assets believe may utilized future operations gross deferred tax assets requiring tax allowances 111 million december 31 2005 gross deferred tax assets requiring valuation allowance 17 million december 31 2005 265000 valuation allowance related realizability certain us tax attributes related uk subsidiary group valuation allowance 12 million related uk operations another 172000 related foreign operations year end 2004 deferred tax assets requiring valuation allowance 29 million included valuation allowance 25 million related uk operations valuation allowance related uk operations due severance restructuring accrual approximately 1 million continuing losses contracts year resulted cumulative pretax losses prior three years 2005 valuation allowance related uk operations reduced 12 million predominately result improved business allowed utilization loss carryforwards index financial statements balance deferred tax assets largely relates us postretirement obligations accrued liabilities reserves deducted tax purposes carryforward foreign tax credits based upon level historical taxable income projected future taxable income periods deferred tax assets deductible us canadian tax jurisdictions believe likely realize benefits deductible differences carryforwards net existing valuation allowances december 31 2005 us canadian tax jurisdictions however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections us canadian tax jurisdictions foreign tax jurisdictions currently considering projections future taxable income determine realizability deductible differences carryforwards industry business environment one leading providers wellhead process equipment systems services used production oil gas revenue results operations closely tied demand oil gas products spending oil gas companies exploration development oil gas reserves companies generally invest exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices supply demand change commodity prices fluctuate producing cyclical trends industry periods lower demand revenue service providers natco generally decline existing projects completed new projects postponed pricing decreases due competitive pressures periods recovery revenue process equipment providers lag behind industry due timing new project awards changes commodity prices impacted business past several years following table summarizes price domestic crude oil per barrel wellhead price natural gas per thousand cubic feet “mcf” published us department energy number rotary drilling rigs operation published baker hughes incorporated recent five years historically viewed operating rig counts benchmark spending us oil gas industry exploration development efforts standard traditional equipment sales parts services business generally correlates changes rig activity tends lag behind north american rig count trend longerterm perspective us department energy projects us demand consumption petroleum natural gas products increase 2025 higher consumption rates expected worldwide driven demand refined products use natural gas power plants generate electricity demand grows reserves united states decline producers service providers oil gas industry may continue rely heavily global sources energy expansion new markets industry continues seek innovative technologically efficient means extract hydrocarbons existing fields production profiles change result additional complex equipment may required produce oil gas fields also many new oil gas fields produce lower quality contaminated hydrocarbon streams requiring complex production equipment general trends increase demand products services index financial statements results operations revenue year ended december 31 2005 increased 790 million 25 4005 million 3215 million year ended december 31 2004 2005 continued strong rig activity north america escalating activity builttoorder projects domestically internationally contributed demand within oil water technologies segment resulting record revenue profits segment gas technologies segment increased throughput west texas co2 processing facilities higher levels membrane replacement sales 2005 contributed favorably results offset reduction builttoorder projects due timing awards associated revenue results automation controls segment improved due increased activity levels gulf mexico spite impact hurricanes kartrina rita continued growth west africa operations builttoorder business impacted timing awards related large complex oil gas projects primarily international offshore locations projects typically longer bidding evaluation construction period standard traditional equipment sales cycle business heavily influenced oil gas supply demand outlook expected commodity prices well political governmental risks total bookings company 4939 million year ended december 31 2005 compared 3351 million year ended december 31 2004 reflecting significant increase award activity across business lines 2005 increased activity positively impacted results 2005 contribute favorably 2006 revenues gross profit year ended december 31 2005 increased 221 million 30 968 million 747 million year ended december 31 2004 percentage revenue gross profit 24 23 years ended december 31 2005 2004 respectively strengthening gross profit margin largely due improvements builttoorder job execution 2005 selling general administrative expense 604 million year ended december 31 2005 increased 62 million 11 compared year ended december 31 2004 approximately 38 million increase due higher performancebased compensation expense related increased earnings year increase stock price additional 33 million increase due higher support expenses related increased business activity especially sales service activities related standard traditional equipment sales north american startup new operation west africa higher corporate costs partially offset gain sale excess manufacturing facilities 11 million closure severance expenses 27 million year ended december 31 2005 included 12 million retirement company’s president announced september 2005 severance costs approximately 15 million related restructuring closure severance expenses 41 million year ended december 31 2004 included 25 million separation company’s former ceo 16 million restructuring severance uk operations items index financial statements following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes financial statements year ended december 31 2005 compared year ended december 31 2004 revenue year ended december 31 2005 increased 790 million 25 4005 million 3215 million year ended december 31 2004 increase revenues primarily attributable oil water technologies automation controls segments following table summarizes revenues business segment years ended december 31 2005 2004 oil water technologies segment revenue increased 678 million 29 year ended december 31 2005 compared year ended december 31 2004 primarily due increased demand products resulting increased exploration development activity oil gas industry average number operating rotary rigs us increased 1190 year ended december 31 2004 1380 year ended december 31 2005 canadian rig counts increasing average 369 458 increase activity contributed improved sales standard traditional equipment amount index financial statements 364 million additional 310 million revenue increase due successful awarding activity builttoorder projects domestically internationally intersegment revenues business segment 634000 year ended december 31 2005 compared 202000 year ended december 31 2004 revenue 387 million year ended december 31 2005 gas technologies segment decreased 26 million 6 compared 413 million year ended december 31 2004 decrease primarily due reduction builttoorder projects 74 million due timing awards associated revenue largely offset increase replacement membrane sales increased throughput co2 processing facility west texas totaling 48 million intersegment revenue business segment year ended december 31 2005 680000 intersegment revenue year ended december 31 2004 revenue automation controls segment increased 138 million 28 year ended december 31 2005 compared year ended december 31 2004 revenue 2005 improved due increased activity levels gulf mexico continued growth west africa operations partially offset 12 million revenue loss related effect hurricanes katrina rita intersegment revenue business segment 40 million year ended december 31 2005 compared 37 million year ended december 31 2004 change revenue eliminations represents elimination intersegment revenue discussed gross profit gross profit year ended december 31 2005 increased 221 million 30 968 million 747 million year ended december 31 2004 percentage revenue gross profit 24 23 years ended december 31 2005 2004 respectively following table summarizes gross profit segment years ended december 31 2005 2004 gross profit oil water technologies segment increased 152 million 34 year ended december 31 2005 compared year ended december 31 2004 primarily due 29 increase revenues respective periods gross profit percentage revenue increased 19 2004 20 2005 strengthening gross profit margin largely due improvements builttoorder job execution 2005 gross profit gas technologies segment year ended december 31 2005 increased 20 million 9 compared year ended december 31 2004 margins west texas co2 processing facilities membrane replacement sales increased 40 million partially offset 20 million decrease margins builttoorder projects due lower level revenue compared 2004 gross margin percentage revenue gas technologies 62 54 year ended december 31 2005 2004 respectively gross profit automation controls segment increased 49 million 61 year ended december 31 2005 compared year ended december 31 2004 margins year 2005 improved due index financial statements continued growth west africa operations increased activity levels gulf mexico gross margin percentage revenue year ended december 31 2005 2004 20 16 respectively selling general administrative expense selling general administrative expense 604 million year ended december 31 2005 increased 62 million 11 compared year ended december 31 2004 approximately 38 million increase due higher performancebased compensation expense related increased income results impact certain incentive awards increase stock value additional 33 million increase due higher support expenses related increased business activity especially sales service activities related standard traditional equipment sales north america startup new operations west africa higher corporate costs partially offset gain sale excess manufacturing facilities 11 million depreciation amortization expense depreciation amortization expense 52 million year ended december 31 2005 decreased 150000 3 compared results year ended december 31 2004 closure severance closure severance expenses 27 million year ended december 31 2005 included 12 million retirement company’s president announced september 2005 severance costs approximately 15 million related restructuring uk us operations closure severance expenses 41 million year ended december 31 2004 included 25 million separation company’s former ceo 16 million uk restructuring program severance initiatives interest expense interest expense 38 million year ended december 31 2005 decreased 31000 1 compared year ended december 31 2004 due reductions outstanding borrowings partially offset increase base interest rates writeoff unamortized loan costs recorded writeoff unamortized loan costs 667000 march 2004 related retirement 2001 term loan revolving credit facilities interest cost postretirement benefit liability interest cost postretirement liability 767000 year ended december 31 2005 decreased 63000 8 compared year ended december 31 2004 primarily due changes discount rates net expense 19 million year ended december 31 2005 related primarily 18 million expense related change valuation settlement outstanding warrants purchase common stock 56000 related net realized unrealized foreign currency exchange transaction losses net expense 22 million year ended december 31 2004 related primarily net realized unrealized foreign currency exchange transaction losses provision income taxes income tax expense year ended december 31 2005 79 million compared 30 million year ended december 31 2004 change tax expense primarily attributable increase pretax income 221 million year ended december 31 2005 pretax income 37 million year ended december 31 2004 decrease effective tax rate 832 year ended december 31 2004 357 year ended december 31 2005 due primarily partial reversal valuation allowance recorded 2004 related uk operating loss carryforwards 2005 net valuation allowance reduced 12 million remaining valuation allowance 17 million december 31 2005 preferred stock dividends recorded preferred stock dividends totaling 15 million years ended december 31 2005 2004 related series b convertible preferred stock “series b preferred shares” issued private investment fund march 2003 index financial statements year ended december 31 2004 compared year ended december 31 2003 revenue year ended december 31 2004 increased 400 million 14 3215 million 2815 million year ended december 31 2003 increase revenue primarily attributable oil water technologies gas technologies segments following table summarizes revenue business segment years ended december 31 2004 2003 revenue oil water technologies segment year ended december 31 2004 increased 155 million 7 2350 million 2195 million year ended december 31 2003 increase related primarily increased oilfield activity much increase occurring us canadian traditional equipment service onshore activities average us rotary rig count increased 1030 year ended december 31 2003 1190 year ended december 31 2004 canadian rotary rig counts remained stable averages 372 year ended december 31 2003 369 year ended december 31 2004 per baker hughes incorporated overall increases north america rig counts indicator increased exploration production activity resulted higher sales traditional equipment services well parts service amount 234 million addition revenue canadian operations favorably impacted large equipment order russian oil company amount 130 million increases partially offset decline number large international builttoorder jobs 2004 relative 2003 due project delays increased competition amount 209 million intersegment revenue business segment 202000 year ended december 31 2004 compared 11 million year ended december 31 2003 revenue gas technologies segment year ended december 31 2004 increased 310 million 298 413 million 104 million year ended december 31 2003 revenue increased year largely due benefit full year operations related expansion west texas co2 processing facility 79 million large builttoorder gas projects increased 189 million sales membranes service increased 41 million year intersegment revenue business segment 680000 year ended december 31 2004 revenue automation controls segment year ended december 31 2004 decreased 70 million 12 497 million 567 million year ended december 31 2003 decrease primarily related lower activity levels years gulf mexico particularly first half 2004 runoff several large projects 2003 partially offsetting gulf mexico activity decline large panel equipment project kazakhstan 74 million intersegment revenue decreased 37 million year ended december 31 2004 40 million year ended december 31 2003 change revenue eliminations represents elimination intersegment revenue discussed index financial statements gross profit gross profit year ended december 31 2004 increased 87 million 13 747 million 660 million year ended december 31 2003 percentage revenue gross profit 23 years ended december 31 2004 2003 following table summarizes gross profit business segment years ended december 31 2004 2003 gross profit oil water technologies segment year ended december 31 2004 decreased 46 million 9 446 million 492 million year ended december 31 2003 decline gross profit due primarily job execution problems us uk 102 million partially offset increase sales traditional equipment parts service 60 million percentage revenue gross margins segment 19 22 years ended december 31 2004 2003 respectively gross profit gas technologies segment year ended december 31 2004 increased 150 million 210 221 million 71 million year ended december 31 2003 significant increases margin contribution realized west texas co2 processing operations membrane replacement activity builttoorder projects percentage revenue gross margins segment 54 69 years ended december 31 2004 2003 respectively gross profit automation controls segment years ended december 31 2004 2003 decreased 17 million 18 80 million 97 million decrease primarily due 12 decrease sales segment respective period along higher percentage revenues 2004 related equipment sales typically lower margin contribution service parts sales percentage revenue gross margins segment 16 17 years ended december 31 2004 2003 respectively selling general administrative expense selling general administrative expense year ended december 31 2004 increased 28 million 5 542 million 515 million year ended december 31 2003 increase expense 2004 relates higher expenses outside services primarily associated company’s sarbanesoxley act section 404 implementation efforts 14 million increase incentive compensation based upon operating results 22 million expenses associated writedown international receivable 07 million increases partially offset cost savings programs started late 2003 continuing throughout 2004 depreciation amortization expense depreciation amortization expense year ended december 31 2004 increased 307000 6 54 million 51 million year ended december 31 2003 increase depreciation expense primarily due capital expenditures 2004 well co2 processing facility expansion west texas 2003 amortization expense related patents intangible assets approximately 59000 100000 years ended december 31 2004 2003 respectively closure severance closure severance expenses 41 million year ended december 31 2004 included 25 million separation company’s former chief executive officer 16 million uk operations restructuring severance items closure severance charges year ended december 31 2003 21 million related certain restructuring activities index financial statements third quarter 2003 including closure manufacturing facility covington louisiana consolidation certain operations uk postemployment benefits terminated employees locations corporate office addition costs incurred related closure singapore marketing office fourth quarter 2003 including certain lease termination costs postemployment benefits terminated employees also incurred relocation shop moving costs totaling 304000 2003 related 2002 closure manufacturing engineering facility edmonton alberta canada interest expense interest expense year ended december 31 2004 decreased 239000 6 38 million 41 million year ended december 31 2003 decrease interest expense primarily attributable new revolving credit term loan facilities entered march 2004 lower margin percentage revolver balances outstanding reduced deferred financing amortization expense new credit facilities lower bank fees lower average outstanding debt balances 2004 decreases partially offset general increase interest rates 2004 writeoff unamortized loan costs recorded writeoff unamortized loan costs 667000 march 2004 related retirement 2001 term loan revolving credit facilities interest cost postretirement benefit liability interest cost postretirement benefit liability remained relatively unchanged 2004 2003 increases plan’s actuarial assumptions primarily higher medical costs change discount rate used determine obligation postretirement benefit arrangement offset increased sharing plan’s costs participants projected favorable impact changes medicare laws enacted us congress december 2003 net expense 22 million year ended december 31 2004 increased 942000 78 compared year ended december 31 2003 increase related primarily net foreign currency losses incurred operations uk canada due devaluation us dollar relative foreign currencies year ended december 31 2004 provision income taxes income tax expense year ended december 31 2004 increased 18 million 145 30 million 12 million year ended december 31 2003 increase income tax expense primarily due increase income taxes 14 million year ended december 31 2003 compared 37 million year ended december 31 2004 decrease effective tax rate 902 year ended december 31 2003 832 year ended december 31 2004 due primarily increase composition pretax income partially offset increase net valuation allowances 21 million recorded 2004 net valuation allowance december 31 2004 29 million preferred stock dividends recorded preferred stock dividends totaling 15 million 12 million years ended december 31 2004 2003 respectively related series b preferred shares issued private investment fund march 2003 index financial statements liquidity capital resources financial condition liquidity january 31 2006 cash working capital 137 million 373 million respectively december 31 2005 cash working capital 92 million 399 million respectively compared 22 million 401 million december 31 2004 respectively increase working capital year primarily due changes trade receivables accrued expenses largely increased business activity increases accounts receivable partially offset higher trade accounts payable accrued expenses customer advances reduction debt 181 million due increase cash operations resulting higher activity levels believe cash operations borrowing capacity adequate current financing working capital needs intend consider feasible make strategic acquisitions companies assets product lines complement existing businesses cannot assure able successfully identify suitable acquisition opportunities complete particular acquisition able finance transaction cash flow net cash provided operating activities years ended december 31 2005 2004 2003 188 million 901000 110 million respectively increase net cash provided operating activities 2005 compared 2004 largely due significant increase net income year adjusted noncash items decrease net cash provided operating activities 2004 compared 2003 primarily due increase working capital largely trade accounts receivable inventory trade receivables fluctuate depending business levels invoice terms timing collections large projects particularly achieving contractual milestones permit invoicing interim payments index financial statements net cash used investing activities years ended december 31 2005 2004 2003 12 million 34 million 108 million respectively primary use funds year ended december 31 2005 capital expenditures 35 million largely offset proceeds sales excess manufacturing facilities 24 million primary use funds year ended december 31 2004 capital expenditures 36 million largely maintenance capital primary use funds year ended december 31 2003 capital expenditures 115 million majority related expansion west texas co2 processing facilities placed service december 2003 cost partially offset proceeds sale building uk net cash provided used financing activities years ended december 31 2005 2004 2003 106 million use 33 million source 153000 use respectively primary use cash 2005 repayment debt revolving lines credit longterm debt totaling 179 million sources cash 2005 proceeds issuance common stock related stock option exercises 67 million increase bank overdrafts 22 million primary sources funds financing activities year ended december 31 2004 20 million cash received issuance common stock related stock options exercised increase outstanding debt bank overdrafts 18 million 19 million respectively partially offset dividends paid series b preferred shares 15 million deferred financing fees 10 million primary use funds financing activities year ended december 31 2003 repayment longterm debt revolving credit debt 71 million 21 million respectively 40 million bank overdraft reductions uses cash financing activities 2003 largely offset gross proceeds 150 million less issuance costs fair value allocable related stock warrants net 141 million issuance series b preferred shares less dividends paid shares 12 million 2003 debt facilities maintain revolving credit term loan facilities well working capital facility export sales prior revolving credit term loan effect 2003 first quarter 2004 provided initial 500 million borrowings revolving credit facilities provided 300 million borrowings united states 100 million borrowings canada 100 million borrowings united kingdom subject borrowing base limitations term loan mature march 31 2006 revolving facilities mature march 31 2004 facilities entered 2001 refer facilities 2001 term loan revolving credit facilities march 15 2004 replaced 2001 term loan revolving credit facilities term loan revolving credit arrangement provides term loan 450 million revolving credit facility providing aggregate additional borrowings 350 million consisting us revolving facility borrowing capacity 200 million canadian revolving facility borrowing capacity 50 million uk revolving credit facility borrowing capacity 100 million borrowing capacities 2004 revolving credit facilities subject borrowing base limitations 2004 term loan revolving credit facilities require quarterly payments 16 million beginning june 2004 mature march 15 2007 borrowed funds 2004 term loan revolving credit facilities retire debt outstanding 2001 term loan revolving credit facilities march 15 2004 2005 prepaid 64 million 2004 term loan revolving credit facilities additionally prepaid 11 million representing remaining balance longterm promissory note manufacturing facility magnolia texas recorded charge 667000 march 2004 expense unamortized loan costs related 2001 term loan revolving credit facilities incurred additional 995000 deferred loan costs related 2004 term loan revolving credit facilities amortized interest expense maturity index financial statements facilities march 2007 also incurred approximately 115000 deferred loan cost primarily first quarter 2005 associated amendment 2004 term loan revolving credit facilities additional cost amortized term amendment ended june 2005 2004 term loan revolving credit facilities agreement provides interest rate based upon ratio funded debt ebitda defined credit facility “ebitda” ranging election 1 high london interbank offered rate “libor” plus 275 low libor plus 200 2 high base rate plus 175 low base rate plus 100 pay commitment fees related agreement undrawn portion facility 0375 december 31 2005 depending upon ratio funded debt ebitda borrowings 274 million outstanding term loan portion 2004 credit facility december 31 2005 bore interest 625 644 borrowings outstanding revolving credit portion 2004 term loan revolving credit facilities december 31 2005 letters credit outstanding 2004 revolving credit facilities 145 million december 31 2005 availability 2004 revolving credit facilities reduced amount outstanding letters credit loans fees related letters credit december 31 2005 approximately 200 outstanding balance letters credit support contract performance warranties expire various dates february 2008 operating subsidiaries guarantee 2004 term loan revolving credit facilities agreement secured first lien first priority security interest pledge substantially assets borrowers certain subsidiaries including accounts receivable inventory equipment intangibles equity interests us subsidiaries 66 13 equity interest active nonus subsidiaries interests certain contracts assets active us subsidiaries secure us canadian uk revolving facilities assets canadian subsidiary also secure canadian facility assets uk subsidiaries also secure uk facility us facility guaranteed us subsidiaries canadian uk facilities guaranteed us subsidiaries canadian subsidiary uk subsidiaries applicable 2004 term loan revolving credit facilities agreement contains restrictive covenants including among others limit amount funded debt ebitda impose minimum fixed charge coverage ratio minimum net worth requirement compliance restrictive debt covenants loan agreements december 31 2005 march 2005 company’s lenders approved amendment various provisions 2004 term loan revolving facilities effective january 1 2005 amendment revised certain restrictive debt covenants two quarter period modified certain defined terms changes submission financial statements lenders closely reflect sec requirements furnishing financial information july 23 2004 company two subsidiaries entered international revolving credit facilities wells fargo hsbc trade bank na providing letters credit loans 10 million subject borrowing base limitations working capital facility export sales secured specific project inventory receivables well certain inventory accounts receivable equipment partially guaranteed us exportimport bank loans facility mature march 31 2007 bear interest either 1 base rate defined agreement less 025 2 libor plus 200 company’s election facility replaced similar export sales credit facility terminated july 23 2004 letters credit outstanding facility december 31 2005 57 million facility fees related letters credit approximately 100 outstanding balance period january 1 2005 december 31 2005 addition unsecured letters credit bonds totaling 277000 december 31 2005 december 31 2005 available borrowing capacity 2004 term loan revolving credit agreement export sales credit agreement 176 million 43 million respectively although index financial statements assurances given believe operating cash flow supported borrowing capacity adequate fund operations least next twelve months decide pursue acquisition opportunities determination ability finance acquisitions critical element analysis opportunities preferred shares march 25 2003 issued 15000 shares series b convertible preferred stock “series b preferred shares” warrants purchase 248800 shares common stock lime rock partners ii lp private investment fund aggregate price 150 million approximately 99000 aggregate purchase price allocated warrants proceeds issuance securities net related issuance costs 679000 used reduce outstanding revolving debt balances general corporate purposes series b preferred shares face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment payable july 1 2003 series b preferred shares convertible option holder 1 number shares common stock equal face value series b preferred share divided conversion price 7805 aggregate 1921845 shares december 31 2005 2 cash payment equal amount dividends share accrued since prior semiannual dividend payment date june 15 2005 december 15 2005 paid dividends 750000 respectively series b preferred shares related periods january 1 2005 june 30 2005 july 1 2005 december 31 2005 respectively event change control defined certificate designations series b preferred shares holder series b preferred shares right convert series b preferred shares common stock cause company redeem cash series b preferred shares aggregate redemption price equal greater 1 sum 1000 adjusted stock splits stock dividends etc multiplied number shares redeemed plus b amount less zero equal product 500 adjusted stock splits stock dividends etc multiplied aggregate number series b preferred shares redeemed less sum aggregate amount dividends paid cash since issuance date plus gain related stock warrants 2 aggregate face value series b preferred shares plus aggregate amount dividends accrued shares since last dividend payment date holder series b preferred shares converts upon change control occurring march 25 2006 holder would also entitled receive cash amount equal dividends would accrued march 25 2006 less sum aggregate amount dividends paid cash date conversion aggregate amount dividends accrued prior periods yet paid right call redemption series b preferred shares cash march 25 2008 redemption price per share equal face value series b preferred shares plus amount dividends accrued paid since recent semiannual dividend payment date due cash redemption features upon change control described series b preferred shares qualify permanent equity treatment accordance emerging issues task force topic d98 “classification measurement redeemable securities” specifically requires permanent equity treatment precluded security redemption features solely within control issuer therefore accounted series b preferred shares temporary equity accompanying balance sheet assigned value right redeem series b preferred shares march 25 2008 series b preferred shares redeemed contingent redemption features redemption amount greater carrying value would recorded reduction income allocable common shareholders event becomes probable index financial statements fail pay dividends two consecutive periods redemption price due respect series b preferred shares period 60 days following payment date would default terms shares default period 1 dividend rate series b preferred shares would increase 1025 2 holders series b preferred shares would right elect appoint second director board directors 3 would restricted paying dividends redeeming acquiring common outstanding stock limited exceptions fail set aside make payments cash redemption price due respect series b preferred shares holders elect right redeem shares may terminated warrants issued lime rock partners ii lp exercise price 1000 per share common stock expire march 25 2006 resulting liability originally recorded 99000 recorded 196000 december 31 2004 reflecting change fair value warrants company adjusted liability fair value date issuance date exercise recorded expense 18 million year ended december 31 2005 compared expense 41000 year ended december 31 2004 august 26 2005 lime rock exercised full warrants purchase company common stock pursuant cashless exercise provision contained warrant instrument resulted cash payment company final number shares common stock issued lime rock calculated based average closing price company’s shares new york stock exchange ten tradingday period ending day prior exercise average price 17933 resulting issuance 110061 shares common stock exchange warrants significant treasury share acquisitions approved board directors july 28 2004 purchased aggregate 498670 shares natco group inc common stock two executive officers price 7859 per share represented 15trading day average closing price company’s common stock reported new york stock exchange period ended july 23 2004 officers used proceeds funds repay full outstanding loans company scheduled mature july 31 2004 july 28 2004 natco group inc entered separation agreement nathaniel gregory pursuant mr gregory stepped natco’s chairman board directors date resigned chief executive officer director september 7 2004 john u clarke independent director served board directors since february 2000 replaced mr gregory chairman board july 28 2004 recognized expense approximately 25 million related separation agreement mr gregory 2004 mr clarke served interim chief executive officer september 7 2004 election chief executive officer company december 7 2004 bookings backlog company’s bookings years ended december 31 2005 2004 2003 index financial statements company’s backlog december 31 2005 2004 bookings 4939 million compared 3351 million 2553 million years ended december 31 2005 2004 2003 respectively bookings increased 1321 million oil water technologies segment 44 million gas technologies segment 224 million automation controls segment year ended december 31 2005 year ended december 31 2005 total bookings included 297 million projects delivery iraq company bookings related work iraq year ended december 31 2004 equipment related bookings expected delivered first six months 2006 dates company significant concentrations bookings countries outside north america sales backlog december 31 2005 1710 million compared 776 million december 31 2004 backlog increased 771 million oil water technologies segment 84 million gas technologies segment 79 million automation controls segment year december 31 2005 2004 total backlog included 121 million 02 million respectively projects iraq commitments contingencies following table summarizes contractual obligations december 31 2005 1 purchase obligations pursuant material equipment purchase orders placed 2005 delivery billing scheduled 2006 2 longterm liabilities represent primarily postretirement benefit obligation december 31 2005 benefit payments associated obligation estimated based upon actual experience year ended december 31 2005 changes actuarial assumptions medical trend rates subsequent years could cause liability postretirement benefit plan change addition certain commitments contingencies related series b preferred shares issued private investment firm march 2003 see “item 7 management’s discussion analysis financial condition results operationsliquidity capital resources” january 31 2006 available borrowing capacity 2004 term loan revolving credit agreement export sales credit agreement 167 million 29 million respectively index financial statements offbalance sheet arrangements special purpose entities unconsolidated affiliates partnerships related party transactions minority interest guarantee obligations related party majorityowned subsidiaries debt obligations related parties responsibility excluded balance sheet august 26 2005 following market close lime rock partners ii lp exercised full warrants purchase shares natco group inc’s common stock pursuant common stock purchase warrant dated march 25 2003 board directors office unanimously approved terms conditions common stock purchase warrant exercise price warrant 1000 warrant agreement provided cashless exercise lime rock elected exercise warrants pursuant cashless exercise provision common stock purchase warrant company received cash payment upon exercise final number shares common stock issued lime rock calculated based average closing price company’s shares new york stock exchange ten tradingday period ending day prior exercise average price 17933 resulting issuance 110061 shares common stock exchange warrants ownership series b preferred shares lime rock owns excess 5 outstanding common stock converted basis mr bates director member governance nominating compensation committee appointed lime rock serves managing director lime rock management lp manages lime rock partners ii lp consequently mr bates may deemed indirect material interest warrant conversion transaction arrangement terminated december 31 2004 paid capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut former chief executive officer reception telephone computer services normal office support relating space fees paid capricorn management reviewed approved audit committee board directors totaled 115000 years ended december 31 2004 2003 2002 respectively mr herbert winokur jr one directors chairman chief executive officer capricorn holdings inc managing director capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controls approximately 12 outstanding common stock december 31 2005 addition former chief executive officer nonsalaried member capricorn holdings llc capricorn investors ii lp formerly controlled approximately 19 common stock distributed limited partners fourth quarter 2005 approved board directors july 28 2004 purchased aggregate 498670 shares natco group inc common stock two executive officers price 7859 per share represented 15trading day average closing price company’s common stock reported new york stock exchange period ended july 23 2004 officers used proceeds funds repay full outstanding loans company scheduled mature july 31 2004 inflation changes prices costs materials example steel products rise fall value commodity markets prices paid us raw materials may affected among things energy steel commodity prices tariffs duties imported materials foreign currency exchange rates generally increases raw materials labor costs passed customers experienced higher steel prices greater difficulty securing necessary steel supplies 2004 preceding several years attempt index financial statements mitigate financial impact higher raw materials costs operations assigning appropriate bid validity dates contract proposals applying surcharges adjusting prices products sell always successful anticipating price increases passing increases customers true early part 2004 able pass increasing steel prices customers result incurred unfavorable manufacturing cost variation substantially eliminated 2005 higher prices lower availability steel raw materials use business may adversely impact profitability future periods recent accounting pronouncements november 2004 fasb issued sfas 151 “inventory costs amendment arb 43 chapter 4” sfas 151 amends accounting research bulletin 43 chapter 4 clarify abnormal amounts idle facility expense freight handling costs wasted materials spoilage recognized current period charges addition sfas 151 requires allocation fixed production overhead inventory based normal capacity production facilities sfas 151 becomes effective inventory costs incurred fiscal years beginning june 15 2005 company adopted pronouncement june 15 2005 material impact consolidated results operations financial position cash flows year ended december 31 2005 december 2004 fasb issued sfas 123 revised 2004 “sharebased payment” “sfas 123r” amendment requires expensing stock options sharebased payments supercedes sfas 123 sfas 123r eliminates ability account sharebased compensation transactions using intrinsic value method accounting principles board apb opinion 25 accounting stock issued employees generally would require instead transactions accounted using fairvaluebased method sfas 123r effective first interim annual reporting period begins june 15 2005 however april 14 2005 securities exchange commission announced effective date sfas 123r would changed first annual reporting period begins june 15 2005 adoption sfas 123r expected significant effect consolidated results operations financial position cash flows illustration impact net income earnings per share presented “stock based compensation” section note 2 assuming applied fair value recognition provisions sfas 123r using blackscholes methodology december 2004 fasb issued sfas 153 “exchanges nonmonetary assets” amends apb opinion 29 guidance apb 29 “accounting nonmonetary transactions” based principle exchanges nonmonetary assets measured based fair value assets exchanged amendment made sfas 153 eliminates exception exchanges similar productive assets replaces broader exception exchanges nonmonetary assets commercial substance statement became effective june 15 2005 company adopted standard effective date material impact consolidated results operations financial position cash flows year ended december 31 2005 december 2004 fasb issued fasb staff position 1091 “fsp 1091” application fasb statement 109 “accounting income taxes” “sfas 109” tax deduction qualified production activities provided american jobs creation act 2004 provides guidance recently enacted american jobs creation act 2004 “jobs creation act” jobs creation act provides tax deduction income qualified domestic production activities fsp 1091 provides treatment deduction special deduction described sfas 109 deduction effect existing deferred tax assets liabilities year ended december 31 2005 impact deduction reported period deduction claimed us tax return december 2004 fasb issued fasb staff position 1092 “fsp 1092” accounting disclosure guidance foreign repatriation provision within american jobs creation act 2004 index financial statements provides guidance sfas 109 respect recording potential impact repatriation provisions jobs creation act company’s income tax expense deferred tax liability fsp 1092 states company allowed time beyond financial reporting period enactment evaluate effect jobs creation act plan reinvestment repatriation foreign earnings purposes applying sfas 109 company analyzed potential benefit electing repatriate earnings provisions jobs creation act determined benefit company would minimal due reduction foreign tax credits associated repatriation earnings therefore company elected repatriate earnings jobs creation act march 2005 fasb issued fasb interpretation “fin” 47 “accounting conditional asset retirement obligations” fin 47 clarifies term conditional asset retirement obligation used sfas 143 “accounting asset retirement obligations” refers legal obligation perform asset retirement activity timing method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing method settlement uncertainty timing method settlement conditional asset retirement obligation factored measurement liability sufficient information exists fin 47 also clarifies entity would sufficient information reasonably estimate fair value asset retirement obligation interpretation effective later end fiscal years ending december 15 2005 adoption standard material effect company’s consolidated results operations financial position cash flows year ended december 31 2005 may 2005 fasb issued sfas 154 “accounting changes error correctionsa replacement apb opinion 20 fasb statement 3” new standard changes requirements accounting reporting change accounting principle among changes sfas 154 requires voluntary change accounting principle applied retrospectively prior period financial statements presented new accounting principle unless impracticable sfas 154 also provides 1 change method depreciating amortizing longlived nonfinancial asset accounted change estimate prospectively effected change accounting principle 2 correction errors previously issued financial statements termed “restatement” new standard effective accounting changes corrections errors made fiscal years beginning december 15 2005 company adopt standard effective date currently evaluating impact company’s consolidated results operations financial position cash flows june 2005 fasb issued fasb staff position 1431 “fsp 1431” accounting electronic equipment waste obligations provides guidance sfas 143 respect european operations adopted european union fsp 1431 requires commercial user incur costs associated retirement historical electrical equipment waste fsp 1431 became effective later june 8 2005 date adoption law applicable eumember country adoption fsp 1431 uk operations material effect company’s consolidated results operations financial position cash flows year ended december 31 2005 september 2005 fasb’s emerging issues task force eitf issued eitf 0413 “accounting purchases sales inventory counterparty” pronouncement provides additional accounting guidance situations involving inventory exchanges parties contained apb opinion 29 “accounting nonmonetary transactions” sfas 153 “exchanges nonmonetary assets” standard effective new arrangements entered reporting periods beginning march 15 2006 inventory transactions completed december 15 2006 arrangements entered prior march 15 2006 company process evaluating impact standard consolidated results operations financial position cash flows adopt effective date index financial statements september 2005 sec staff revised eitf d98 “classification measurement redeemable securities” primarily provide guidance 1 earnings per share treatment redeemable common stock 2 application eitf d98 sharebased payment arrangements employees guidance earnings per share treatment redeemable common stock eitf d98 sharebased payment arrangements employees effective first fiscal period beginning september 15 2005 company adopt eitf d98 effective date applied concurrent adoption sfas 123r sharebased payment item 7aitem 7 management’s discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto overview years ended december 31 2007 2006 2005 business segments oil water technologies gas technologies automation controls oil water technologies group largest segment consisted two product lines first product line standard traditional product line extensive north america branch distribution network consisting oil gas separation dehydration equipment sales related services second product line included builttoorder systems focused primarily oil water production processing systems designed built meet customer specifications gas technologies group included co2 membrane business assets operating relationship related gas processing facilities west texas h2s removal technologies including shell paques™ automation controls group focused sales new control panels systems monitor control oil gas production well field service activities including repair maintenance testing inspection services existing systems allocated corporate expenses segments rather segregating costs standalone basis forwardlooking statements annual report form 10k including management’s discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended “forwardlooking statement” words “believe” “expect” “plan” “intend” “designed to” “estimate” “project” “will” “could” “may” similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions accounting policies estimates indicated trends level oil gas exploration production effect conditions results operations see “industry business environment” growth plans 2007 beyond future uses requirements financial resources see “liquidity capital resources” impact bookings future revenues anticipated backlog levels expectations business outlook customer spending potential acquisitions joint venture operations oil gas prices business environment industry general expectations regarding matters actual results may differ materially forwardlooking statements contained report reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition availability skilled labor force world economic conditions level drilling activity legislative environment united states countries energy policies opec conflict involving united states major petroleum producing consuming regions acts war terrorism technological advances could lower overall finding development costs oil gas weather patterns overall condition capital markets countries operate additional factor could cause forwardlooking statements incorrect actual events actual results differ anticipated outcome pending audit committee review regarding certain payments one countries business may present issues foreign corrupt practices act including government enforcement action could arise matters review matters review may resulted higher dollar amount payments country may greater financial business impact currently anticipate following discussion read conjunction financial statements related notes financial information appearing elsewhere annual report form 10k readers also urged carefully review consider various factors including without limitation disclosures made item 1a risk factors index financial statements factors risks discussed annual report form 10k subsequent reports filed securities exchange commission may affect us outcomes related forwardlooking statements expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies estimates preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements included item 8 report contains summary significant accounting policies believe following accounting policies estimates critical preparation consolidated financial statements revenue recognition general recognize revenues related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued less equal 250000 contract durations four months less addition compliance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 recognize revenues using percentage completion method contracts greater 250000 contract durations excess four months represent 1 customized engineered orders products qualify treatment 2 automation controls segment equipment fabrication sales projects qualify treatment automation controls segment also applies percentage completion method recognize revenues regardless contract value duration associated customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration factors support using percentage completion method include 1 segment produce standard units maintain inventory similar products sale 2 nature segment’s equipment fabrication sales operations 3 potential wide variations results operations could occur applying “as shipped” methodology relates smaller contracts customized fabricated goods earned revenue based percentage incurred costs date relate total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues instances customers billed advance services performed products manufactured company recognizes associated liability deferred revenue 2007 approximately 551 total company revenues recorded “as shipped” “as performed” basis approximately 449 recorded using percentage completion method respect contract revenues recorded utilizing percentage completion method earned revenue based percentage costs incurred date relate total estimated costs project giving effect recent estimates total cost total estimated contract cost critical accounting estimate materially affect revenue net income requires us make judgments matters uncertain total costs expected incurred therefore recognition revenue could affected various internal external factors including limited changes project scope change orders changes index financial statements productivity scheduling cost availability labor cost availability raw materials weather client delays providing approvals benchmark stages project timing deliveries thirdparty providers key components cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues applicable losses expected incurred jobs progress consideration estimated probable minimum recoveries claims change orders charged income soon losses known claims additional contract revenue recognized probable claim result additional revenue amount reliably estimated generally recognize revenue earnings percentage completion method applies period two six quarters event project terminated customer completion customer liable costs incurred contract believe operating results evaluated term one three years consider performance longterm contracts change orders scope changes cost recoveries negotiated realized estimates subjective nature possible could used different estimates total contract costs calculation revenue recognized using percentage completion method december 31 2007 company 2089 million revenue attributable open percentage completion projects aggregate gross margin 268 used different estimate total contract costs contract progress december 31 2007 1 increase decrease estimated margin earned contract would increased decreased total revenue pretax income year ended december 31 2007 approximately 29 million december 31 2007 company three contracts loss position estimated aggregate loss 30 million 26 million provided previous periods reported periodic revenue net tax assessed government authority imposed concurrent subsequent revenueproducing transaction us customers goodwill required statement financial accounting standards “sfas” 142 “goodwill intangible assets” evaluate goodwill annually impairment comparing fair value operating assets carrying value assets including related goodwill required sfas 142 identified separate reporting units purposes evaluation used segments reporting units tested segments december 31 2007 determining carrying value segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated permitted standard fair value determined discounting projected future cash flows using weighted average cost capital calculated determining projected future cash flows segment make assumptions regarding following key indicators future market sales growth rates domestic international cost inflation margin expectations working capital expenditure levels tax levels fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value would record impairment charge amount tested goodwill impairment required sfas 142 december 31 2007 result testing record impairment charge since impairment indicated estimated fair value discounted projected future cash flows three segments oil water technologies gas technologies automation controls lowered 61 76 72 respectively would required perform second step goodwill impairment prescribed sfas 142 index financial statements sharebased compensation effective january 1 2006 company adopted sfas 123r “sharebased payment” using modified prospective application transition method sharebased compensation cost measured grant date based calculated fair value award recognized operating expense straightline basis requisite service period management required make subjective assumptions volatility company’s common stock expected term outstanding stock options riskfree interest rate expected dividend payments contractual life options order calculate fair value award see note 16 sharebased compensation consolidated financial statements included item 8 report warranty sell products product warranty customers entitled free repair specified warranty period following purchase usually twelve months date shipment company records liability estimated warranty claims liability percentage revenue determined based historical review warranty claims industry business environment revenue results operations closely tied demand oil gas products spending oil gas companies exploration development oil gas reserves companies generally invest exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices supply demand change commodity prices fluctuate producing cyclical trends industry periods lower demand revenue service providers generally decline existing projects completed new projects postponed pricing decreases due competitive pressures periods recovery revenue process equipment providers lag behind industry due timing new project awards changes commodity prices impacted business past several years following table summarizes price domestic crude oil per barrel wellhead price natural gas per thousand cubic feet “mcf” published us department energy number rotary drilling rigs operation published baker hughes incorporated past five years 1 iran sudan rig counts discontinued baker hughes publication beginning january 2006 comparative purposes 2005 2004 2003 rig count numbers presented exclude iran sudan historically viewed operating rig counts benchmark spending us oil gas industry exploration development efforts standard traditional equipment sales parts services business generally relates changes rig activity longerterm perspective us department energy projects worldwide petroleum natural gas consumption projected increase average annual growth rate 14 2003 2030 higher consumption rates expected emerging economies particularly asia including china india 43 total increase world oil use projected worldwide demand grows producers oil gas industry increasingly rely nontraditional sources energy supply expansion new markets result additional complex equipment may required equipment service suppliers produce oil gas fields especially since many new oil gas fields produce lower quality contaminated hydrocarbon streams requiring complex production equipment general trends increase demand products services index financial statements results operations following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes financial statements 1 includes intersegment elimination amounts revenue cost goods sold services 58 million 105 million 46 million years ended december 31 2007 2006 2005 respectively index financial statements year ended december 31 2007 compared year ended december 31 2006 consolidated revenue gross profit revenue 5701 million year ended december 31 2007 increased 511 million 10 5190 million year ended december 31 2006 increase revenue primarily attributable stronger demand builttoorder projects gas technologies segment increased international field service activities automation controls segment gross profit gross profit year ended december 31 2007 increased 265 million 19 1635 million compared 1370 million year ended december 31 2006 increase approximately 132 million due increase revenue gas technologies automation controls segments remaining 133 million mainly due favorable mix higher margin sales gas technologies segment along improved execution builttoorder projects domestic standard traditional product lines within oil water technologies segment oil water technologies index financial statements oil water technologies segment revenue decreased 77 million 2 year ended december 31 2007 compared year ended december 31 2006 decrease attributed 159 million lower builttoorder project business activity mostly related international projects primarily due timing delays project awards partially offset approximately 82 million increased sales standard traditional equipment services business us export parts service business intersegment revenue business segment 14 million year ended december 31 2007 compared 60 million year ended december 31 2006 gross profit oil water technologies segment increased 94 million 11 year ended december 31 2007 compared year ended december 31 2006 increase primarily due improved execution builttoorder project business domestic standard traditional product lines including favorable product mix higher margin export business increase partially offset decrease sales international builttoorder project business approximately 10 million inventory adjustments resulting raw materials parts shrinkage revaluation slowmoving items certain us manufacturing branch locations additionally 17 million loss provision recorded prior year related cost overruns one builttoorder projects delivered 2007 percentage revenue gross margin 25 22 years ended december 31 2007 2006 respectively gas technologies gas technologies segment revenue 935 million year ended december 31 2007 increased 308 million 49 compared 627 million year ended december 31 2006 increase due higher builttoorder project activity 270 million increased throughput gas processing facilities west texas 38 million intersegment revenue business segment years ended december 31 2007 2006 gross profit gas technologies segment year ended december 31 2007 increased 110 million 34 compared year ended december 31 2006 primarily due higher sales co2 membrane builttoorder projects higher throughput company’s co2 gas processing facilities west texas gross profit percentage gas technologies 46 52 years ended december 31 2007 2006 respectively decrease gross profit percentage attributable revenue mix higher concentration lower margin builttoorder projects year compared prior year automation controls index financial statements revenue automation controls segment 1139 million increased 233 million 26 year ended december 31 2007 compared 906 million year ended december 31 2006 increase primarily due increased international field service activity 341 million partially offset reduction field service activity gulf mexico packaged automation product sales approximately 108 million intersegment revenue business segment 44 million year ended december 31 2007 compared 45 million year ended december 31 2006 gross profit automation controls segment increased 61 million 30 year ended december 31 2007 compared year ended december 31 2006 gross profit percentage change year increase gross profit attributed higher sales volume consolidated statement operations line items selling general administrative expense selling general administrative expense 856 million year ended december 31 2007 increased 141 million 20 compared 715 million year ended december 31 2006 increase consisted primarily 92 million higher selling preorder engineering services support activities related increased business volume additionally increases corporate general administration approximately 47 million mainly attributed higher compensation costs associated increased headcount employee retention programs sharebased incentive compensation resulted increased business activity depreciation amortization expense depreciation amortization expense 61 million year ended december 31 2007 increased 646000 12 compared 55 million year ended december 31 2006 increase primarily attributable depreciation operating equipment building improvements made 2007 closure severance closure severance income 229000 year ended december 31 2007 comprised largely gain associated settlement uk office lease obligation 250000 partial offsetting valuation adjustment charge 21000 closure severance expense 25 million year ended december 31 2006 included 23 million uk office closure cost approximately 200000 related severance costs interest expense interest expense 355000 year ended december 31 2007 related amortization deferred financing costs commitment fees paid unused portion company’s lines credit amount decreased 18 million 83 compared 21 million year ended december 31 2006 due primarily pay debt 2006 debt throughout 2007 interest income interest income 22 million year ended december 31 2007 increased 17 million 532000 year ended december 31 2006 due primarily increase invested cash throughout year result higher earnings cash flow net expense approximately 22 million year ended december 31 2007 consisting essentially net realized unrealized foreign exchange transaction losses net year ended december 31 2006 net 15 million gain included 25 million gain related sale partial interest japan joint venture offset 160000 writeoff part unamortized deferred financing costs associated termination 2006 prior term loan revolving credit facilities net realized unrealized foreign exchange transaction losses 734000 income unconsolidated investment gain 117000 related income unconsolidated investment year ending december 31 2007 minority interest minority interest expense 295000 337000 years ended december 31 2007 2006 respectively consisting minority interest earnings joint venture partners related consolidated joint ventures index financial statements income tax provision income tax expense year ended december 31 2007 252 million compared 194 million year ended december 31 2006 increase tax expense primarily attributable increase pretax income 715 million year ended december 31 2007 pretax income 571 million year ended december 31 2006 increase effective tax rate 3394 year ended december 31 2006 3525 year ended december 31 2007 primarily attributable valuation allowance reversal recorded 2006 preferred stock dividends recorded preferred stock dividends totaling 13 million 15 million years ended december 31 2007 2006 related series b preferred shares decrease relates reduction dividend requirement due certain preferred shareholders converting portion series b preferred shares common stock 2007 year ended december 31 2006 compared year ended december 31 2005 consolidated revenue gross profit revenue 5190 million year ended december 31 2006 increased 1186 million 30 4005 million year ended december 31 2005 result increased business activity three operating segments gross profit gross profit year ended december 31 2006 increased 399 million 41 1370 million compared 971 million year ended december 31 2005 result increased sales improved pricing overall job execution improvements percentage revenue gross margin 26 24 years ended december 31 2006 december 31 2005 respectively index financial statements oil water technologies intersegment revenue business segment 60 million year ended december 31 2006 compared 634000 year ended december 31 2005 oil water technologies segment revenue increased 734 million 24 year ended december 31 2006 compared year ended december 31 2005 approximately 412 million increase due higher international domestic business project awarding activities builttoorder product line approximately 322 million increase due higher demand standard traditional equipment services resulting increased exploration development activity oil gas industry gross profit oil water technologies segment increased 243 million 41 year ended december 31 2006 compared year ended december 31 2005 continued strength sales increased prices standard traditional equipment services accounted 159 million increase builttoorder projects domestically internationally contributed 84 million increase net projected cost overruns builttoorder project scheduled completion delivery first part 2006 higher profitability margins result pricing increases especially north american activities continued improvements overall job execution percentage revenue gross margin 22 20 year ended december 31 2006 2005 respectively gas technologies intersegment revenue business segment year ended december 31 2006 2005 gas technologies segment revenue 627 million year ended december 31 2006 increased 240 million 62 compared 387 million year ended december 31 2005 increase primarily due higher builttoorder project activity levels 233 million higher co2 processing revenue 12 million partially offset decrease membrane sales approximately 454000 gross profit gas technologies segment year ended december 31 2006 increased 80 million 33 compared year ended december 31 2005 primarily result increase sales index financial statements gross profit percentage revenue gas technologies operation 52 63 year ended december 31 2006 2005 respectively decrease gross margin attributable revenue mix due higher concentration lower margin builttoorder projects lower membrane sales 2006 period automation controls intersegment revenue business segment 45 million year ended december 31 2006 compared 40 million year ended december 31 2005 revenue automation controls segment 906 million increased 271 million 43 year ended december 31 2006 compared 635 million year ended december 31 2005 increase primarily due continued strength gulf mexico field services work increase packaged automation product sales increase international field service work primarily west africa kazakhstan prior year impacted approximately 12 million revenue loss segment’s gulf mexico operations due facility work interruptions related effect hurricanes katrina rita gross profit automation controls segment increased 76 million 59 year ended december 31 2006 compared year ended december 31 2005 primarily due increased revenue volume price increases product mix gross margin percentage revenue 23 20 year ended december 31 2006 2005 respectively increase gross margin primarily result increased pricing field services work gulf mexico higher packaged automation product sales along improved job execution consolidated statement operations line items selling general administrative expense selling general administrative expense 715 million year ended december 31 2006 increased 111 million 18 compared 604 million year ended december 31 2005 approximately 67 million increase due higher general administrative compensation costs associated increased headcount employee retention programs sharebased incentive compensation higher support costs related increased business activity approximately 600000 associated office consolidation uk 10 million related higher preorder engineering costs associated increased bid activities 10 million attributable gain sale assets prior year included 111 million increase 17 million noncash compensation cost correction error recorded fiscal year 2005 related stock options issued 1998 options originally exercise price set anticipation initial public offering subsequently canceled reissued lower price march 1999 later became public company january 2000 compensation expense determined using variable accounting per fasb interpretation “fin” 44 “accounting certain transactions involving stock compensation” issued subsequent index financial statements time options repriced retroactive effect management discovered error quarter ended september 30 2006 deemed immaterial 2005 2006 periods respect quarterly trends earnings periods company corrected accounting quarter ended september 30 2006 properly recognize compensation expense applying variable accounting awards required fin 44 depreciation amortization expense depreciation amortization expense 55 million year ended december 31 2006 increased 268000 5 compared 52 million year ended december 31 2005 increase attributable primarily depreciation additions 2006 operating equipment amortization intangible assets associated investment company fabricates pilotless burner ignition system controlling gasfired heaters used connection oil gas wellhead equipment closure severance closure severance expenses 25 million year ended december 31 2006 included 23 million uk office closure cost approximately 200000 related severance costs closure severance expenses 27 million year ended december 31 2005 included 12 million planned retirement company’s president announced september 2005 severance costs approximately 15 million related restructuring uk us canada operations interest expense interest expense 21 million year ended december 31 2006 decreased 17 million 45 compared 38 million year ended december 31 2005 due primarily debt reductions year net periodic cost postretirement benefit liability net periodic cost postretirement benefit liability zero year ended december 31 2006 decrease 767000 compared year ended december 31 2005 due changes made late 2005 reduced benefits increased participant contributions resulted reduction plan participants interest income interest income 532000 year ended december 31 2006 increased 446000 86000 year ended december 31 2005 due primarily increase shortterm highly liquid investments second half 2006 net 15 million gain included 25 million gain related sale partial interest japan joint venture offset 160000 writeoff part unamortized loan costs associated termination third quarter 2006 2004 term loan revolving credit facilities net realized unrealized foreign exchange transaction losses 734000 net expense 19 million year ended december 31 2005 related primarily 18 million expense related change valuation settlement outstanding warrants purchase common stock 56000 related net realized unrealized foreign currency exchange transaction losses minority interest minority interest expense 337000 related japanese subsidiary income tax provision income tax expense year ended december 31 2006 194 million compared 80 million year ended december 31 2005 change tax expense primarily attributable increase pretax income 571 million year ended december 31 2006 pretax income 224 million year ended december 31 2005 decrease effective tax rate 357 year ended december 31 2005 339 year ended december 31 2006 primarily attributable nondeductible marktomarket expense 18 million warrants exercised 2005 incurred 2006 december 31 2006 uk operations longer cumulative pretax loss prior threeyear period projected earnings uk operations therefore determined related valuation allowance longer needed thus reduced zero consequently company’s valuation allowance decreased 17 million 103000 year 2006 index financial statements preferred stock dividends recorded preferred stock dividends totaling 15 million years ended december 31 2006 2005 related series b preferred shares bookings backlog company’s bookings years ended december 31 2007 2006 2005 company’s backlog december 31 2007 2006 bookings 5335 million compared 5553 million 4939 million years ended december 31 2007 2006 2005 respectively bookings decreased 15 million 484 million oil water technologies segment gas technologies segment respectively increased 281 million automation controls segment year ended december 31 2007 compared year ended december 31 2006 sales backlog december 31 2007 1706 million compared 2073 million december 31 2006 backlog decreased 40 million oil water technologies segment decreased 333 million gas technologies segment increased 662000 automation controls segment year inflation changes prices inflation us inflation according us financial trend forecaster® approximately 43 35 40 years ended december 31 2005 2006 2007 respectively effects us inflation significant impact consolidated results operations financial condition past three years index financial statements changes prices costs materials products rise fall value commodity markets costs goods sold primarily affected among things labor energy steel commodity prices tariffs duties imported materials foreign currency exchange rates observed following price changes per metric ton 2240 pounds past three years carbon steel prices increased 18 2005 1 years 2006 2007 stainless steel prices increased threeyear periods 2005 2006 2007 365 113 205 respectively addition prices raw materials used produce skids platforms increased 20 154 164 2005 2006 2007 respectively engineering labor hourly rates associated employees subcontractors also increased average follows across transportation modes average prices freight 2006 2007 changed follows increases 08 tanker specialized freight 20 consolidated shipments 02 truckload 56 domestic air courier 117 inland water freight decrease 07 deepsea freight generally increases raw materials labor costs transportation costs passed customers part bids certain fixed price contracts may able pass cost increases impact gross margin jobs affected liquidity capital resources cash equivalents company’s cash equivalents 636 million december 31 2007 included highly liquid shortterm investments totaling 609 million accrue interest weighted average rate 451 working capital adjusted december 31 2007 1103 million working capital compared 784 million december 31 2006 increase 319 million 41 increase function higher business activities primarily due increases cash equivalents 283 million 229 million trade receivables 40 million inventory 30 million deferred income tax assets income tax receivables partially offset increase current liabilities increase current liabilities mainly due increases 154 million trade accounts payable 81 million accrued expenses 12 million income taxes liabilities index financial statements cash flow net cash provided operating activities years ended december 31 2007 2006 2005 496 million 521 million 188 million respectively net cash provided operating activities 2007 496 million 25 million lower 2006 primarily due higher investment working capital support increased business activities increase net cash provided operating activities 2006 compared 2005 primarily due significant increase net income year adjusted noncash items trade receivables fluctuate depending business levels invoice terms timing collections larger projects achieving contractual milestones permit invoicing interim payments net cash used investing activities years ended december 31 2007 2006 2005 304 million 39 million 12 million respectively primary use funds year ended december 31 2007 consisted 1 capital expenditures 153 million 96 million represented expenditures improve productivity expand facilities 57 million represented maintenance capital expenditures 2 net cash payment 151 million associated acquisition consept norwegian company known natco norway primary use funds year ended december 31 2006 capital expenditures 35 million largely offset proceeds sales excess manufacturing facilities 24 million primary use funds year ended december 31 2005 capital expenditures 36 million largely maintenance capital net cash provided used financing activities years ended december 31 2007 2006 2005 76 million 228 million 106 million respectively primary source cash 2007 associated 33 million proceeds stock issuances related stock options 39 million excess tax benefit sharebased compensation 20 million change bank overdrafts primary use cash 13 million dividend payments remaining preferred stockholders partial conversion series b preferred shares primary use cash 2006 15 million dividend payments preferred stockholders repayment debt revolving lines credit term debt totaling 179 million offset 67 million proceeds issuance common stock related stock option exercises increase 22 million bank overdrafts net total cash flow operating investing financing activities 283 million 260 million 70 million years ended december 31 2007 2006 2005 respectively december 31 2007 638 million cash hand 754 million total borrowing availability additionally pursuant terms new revolving credit facilities right increase borrowing capacity us portion facility additional 500 million addition normal operating cash requirements anticipated principal future cash requirements fund capital expenditures preferred stock dividends employee benefit obligations strategic acquisitions feasible companies assets product lines complement existing businesses believe cash operations borrowing capacity described adequate current longterm financing needs working capital needs cannot assure able successfully identify suitable acquisition opportunities complete particular acquisition able finance transaction index financial statements january 31 2008 available liquidity including cash hand borrowing availability revolving facilities approximately 1102 million additionally pursuant terms new revolving credit facilities right increase borrowing capacity us portion facility 50 million offbalance sheet arrangements offbalance sheet arrangements december 31 2007 contractual obligations following table summarizes company’s contractual obligations december 31 2007 1 represents open materialequipment services purchase orders placed 2007 delivery billing scheduled 2008 beyond 2 represents total us canada postretirement benefit obligation december 31 2007 changes actuarial assumptions medical trend rates subsequent years effect applying sfas 158 “employer’s accounting defined benefit pension postretirement plans” could cause actuarially determined liability postretirement benefit plan fluctuate shortterm longterm portion us postretirement benefit obligation recorded “accrued expenses” “postretirement benefits longterm liabilities” accounts respectively 3 represents longterm unrecognized tax benefits associated fin 48 “accounting uncertainty income taxes” included consolidated balance sheet liability account “postretirement benefits longterm liabilities” capital resources revolving credit facilities july 2006 company terminated prior term loan revolving credit facilities entered new revolving credit facilities agreement maturity june 30 2011 total initial borrowing capacity 850 million additionally pursuant terms revolving credit facilities right increase borrowing capacity 50 million company pays commitment fees undrawn portion facilities depending upon ratio funded debt earnings income taxes depreciation amortization ebitda calculated 025 december 31 2007 availability credit facilities reduced amount outstanding letters credit borrowings outstanding facilities december 31 2007 2006 company letters credit outstanding 189 million revolving credit facilities total available borrowing capacity 661 million december 31 2007 letters credit support contract performance warranties expire various dates december 8 2011 fees related letters credit approximately 10 outstanding balance december 31 2007 export sales facility june 2007 company entered export sales credit facility total borrowing capacity 100 million facility expire june 15 2010 partially guaranteed us exportimport bank subject certain borrowing base limitations interest borrowings facility either 1 lender’s prime rate less 050 2 london interbank offered rate plus 135 index financial statements company’s election company pays annual fee 75000 facility december 31 2007 company total available borrowing capacity 92 million outstanding letters credit 756000 facility december 31 2007 company unsecured letters credit bonds totaling 875000 related foreign subsidiaries compliance restrictive debt covenants outstanding credit facilities december 31 2007 although assurances given believe operating cash flow supported borrowing capacity adequate fund operations least next twelve months decide pursue acquisition opportunities determination ability finance acquisitions key element analysis opportunities recent accounting pronouncements february 2006 financial accounting standard board fasb issued sfas 155 “accounting certain hybrid financial instrumentsan amendment fasb statements 133 140” effective fiscal years beginning september 15 2006 statement issued clarify application fasb statement 133 beneficial interests securitized financial assets improve consistency accounting similar financial instruments regardless form instruments adoption standard january 1 2007 effective date impact company’s consolidated results operations financial position cash flows march 2006 fasb issued sfas 156 “accounting servicing financial assetsan amendment fasb statement 140” effective fiscal years beginning september 15 2006 statement issued simplify accounting servicing rights reduce volatility results using different measurement attributes adoption standard january 1 2007 impact company’s consolidated results operations financial position cash flows march 2006 eitf issued eitf 0603 “how taxes collected customers remitted governmental authorities presented income statement gross versus net presentation eitf 0603 requires presentation taxes assessed governmental authority directly imposed revenueproducing transaction seller customer either gross included revenue costs net excluded revenue basis accounting policy decision disclosed pursuant accounting principle board opinion 22 addition taxes reported gross basis company disclose aggregate basis amounts taxes interim annual financial statements period income statement presented amount significant issue applied financial reports interim annual reporting periods beginning december 15 2006 company currently reports revenue net basis adoption eitf 0603 january 1 2007 effect company’s consolidated results operations financial position cash flows june 2006 fasb issued fin 48 “accounting uncertainty income taxes” interpretation clarifies accounting uncertainty income taxes recognized enterprise’s financial statements accordance fasb statement 109 accounting income taxes fin 48 prescribes recognition threshold measurement attribute financial statement recognition measurement tax position taken expected taken tax return well provides guidance derecognition classification interest penalties accounting interim periods disclosure transition interpretation effective fiscal years beginning december 15 2006 adoption fin 48 january 1 2007 material effect company’s consolidated results operations financial position cash flows index financial statements september 2006 fasb issued staff position “fsp” aug air1 “accounting planned major maintenance activities” prohibits use accrueinadvance method accounting planned major maintenance activities annual interim financial reporting periods fsp aug air1 effective fiscal year beginning december 15 2006 december 31 2006 company accrual approximately 500000 related membranes’ maintenance replacements adoption fsp augair1 effective date january 1 2007 material effect company’s consolidated results operations financial position cash flows september 2006 fasb issued sfas 157 “fair value measurements” became effective january 1 2008 sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value measurements company adopted standard january 1 2008 material impact company’s consolidated results operations financial position cash flows september 2006 fasb issued sfas 158 “employers’ accounting defined benefit pension postretirement plans” sfas 158 establishes twostage requirement public company 1 recognize funded status pension postretirement benefit plan balance sheet disclose related information 2 measure plan’s assets benefit obligations company’s fiscal year end date company adopted sfas 158 december 31 2006 material impact company’s consolidated results operations financial position cash flows resulting adoption standard september 2006 sec released staff accounting bulletin 108 “sab 108” “considering effects prior year misstatements quantifying misstatements current year financial statements” provides interpretive guidance us securities exchange commission’s views regarding process quantifying materiality financial statements sab 108 effective fiscal years ending november 15 2006 early application first interim period ending november 15 2006 company adopted effective date december 31 2006 impact provision company’s consolidated results operations financial position cash flows february 2007 fasb issued sfas 159 “the fair value option financial assets financial liabilities including amendment fasb statement 115” permits entities choose measure eligible items fair value specified election dates elects adopt standard business entity shall report unrealized gains losses items fair value elected earnings subsequent reporting date effective date january 1 2008 company elected adopt sfas 159 december 2007 fasb issued sfas 141revised 2007 “business combinations” replaces sfas 141 “business combinations” effective fiscal years beginning december 15 2008 early adoption permitted sfas 141r changed method applying acquisition method accounting number significant aspects acquisition costs generally expensed incurred noncontrolling interests valued fair value acquisition date inprocess research development recorded fair value indefinitelived intangible asset acquisition date changes deferred tax asset valuation allowances income tax uncertainties acquisition date generally affect income tax expense sfas 141r effective prospective basis business combinations acquisition date beginning first annual period subsequent december 15 2008 exception accounting valuation allowances deferred taxes acquired tax contingencies sfas 141r amends sfas 109 “accounting income taxes” adjustments made valuation allowances deferred taxes acquired tax contingencies associated acquisitions closed prior effective date sfas 141r would also apply provisions sfas 141r company process evaluating impact sfas 141r company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 index financial statements december 2007 fasb issued sfas 160 “noncontrolling interests consolidated financial statementsan amendment arb 51” sfas 160 effective fiscal years interim periods within fiscal years beginning december 15 2008 early adoption prohibited sfas 160 requires recognition noncontrolling interest minority interest equity consolidated financial statements separate parent’s equity amount net income attributable noncontrolling interest included consolidated net income face income statement sfas 160 also amends certain arb 51’s consolidation procedures consistency requirements sfas 141r sfas 160 also includes expanded disclosure requirements regarding interests parent noncontrolling interest company process evaluating impact sfas 160 company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 february 2008 fasb issued fsp 1571 “application fasb statement 157 fasb statement 13 accounting pronouncements address fair value measurements purposes lease classification measurement statement 13” fsp 1571 amends sfas 157 “fair value measurements” exclude sfas 13 “accounting leases” accounting pronouncements address fair value measurements purposes lease classification measurement sfas 13 however exception apply assets acquired liabilities assumed business combination required measured fair value sfas 141r “business combinations” regardless whether assets liabilities related leases fsp 1571 effective upon initial adoption sfas 157 company adopted sfas 157 “fair value measurements” january 1 2008 impact company’s consolidated results operations financial position cash flows upon adoption fsp 1571 february 2008 fasb issued fsp 1572 “effective date fasb statement 157” fsp defers effective date sfas 157 “fair value measurements” nonfinancial assets nonfinancial liabilities except items recognized disclosed fair value financial statements recurring basis least annually fiscal years beginning november 15 2008 interim periods within fiscal years items within scope fsp 1572 effective upon issuance date february 12 2008 company adopted fsp 1572 february 12 2008 impact company’s consolidated results operations financial position cash flows upon adoption item 7aitem 7 management’s discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto overview effective january 1 2008 realigned financial segment reporting periods prior 2008 restated reflect basis segmentation presented • integrated engineered solutions segment includes global builttoorder project business related activities featuring oil water gas technologies well company’s west texas co2 processing facility • standard traditional segment includes sales related activities associated sale standard traditional oil gas wellhead processing equipment well aftermarket parts sales associated services primarily americas • automation controls segment includes fabrication sales control panels packaged automation systems well field services associated repair maintenance inspection testing onshore offshore control systems forwardlooking statements annual report form 10k including management’s discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended “forwardlooking statement” words “believe” “expect” “plan” “intend” “designed to” “estimate” “project” “will” “could” “may” similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions accounting policies estimates impacts current market conditions global economic crisis indicated trends level oil gas exploration production effect conditions results operations see “industry business environment” future uses requirements financial resources see “liquidity capital resources “year ended december 31 2008 compared year ended december 31 2007” impact bookings future revenues anticipated backlog levels see “bookings backlog” expectations business outlook customer spending potential acquisitions joint venture operations oil gas prices business environment industry general expectations regarding matters actual results may differ materially forwardlooking statements contained report reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition availability skilled labor force world economic conditions level drilling activity legislative environment united states countries energy policies opec conflict involving united states major petroleum producing consuming regions acts war terrorism technological advances could lower overall finding development costs oil gas weather patterns overall condition capital markets countries operate additional factor could cause forwardlooking statements incorrect actual events actual results differ anticipated outcome pending audit committee review regarding certain payments kazakhstan may present issues foreign corrupt practices act “fcpa” including government enforcement action could arise matters review matters review may resulted higher dollar amount payments country may greater financial business impact currently anticipate index financial statements following discussion read conjunction financial statements related notes financial information appearing elsewhere annual report form 10k readers also urged carefully review consider various factors including without limitation disclosures made item 1a risk factors risks discussed annual report form 10k subsequent reports filed securities exchange commission may affect us outcomes related forwardlooking statements expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements included item 8 report contains summary significant accounting policies believe following accounting policies critical preparation consolidated financial statements revenue recognition general recognize revenue related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued less equal 250000 contract durations four months less additionally compliance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 recognize revenue using percentage completion method 1 contracts greater 250000 contract durations excess four months represent customized engineered orders products qualify treatment 2 automation controls segment equipment fabrication sales projects qualify treatment automation controls segment also applies percentage completion method recognize revenue regardless contract value duration associated customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration factors support using percentage completion method include 1 segment produce standard units maintain inventory similar products sale 2 nature segment’s equipment fabrication sales operations 3 potential wide variations results operations could occur applying “as shipped” methodology relates smaller contracts customized fabricated goods earned revenue reflects original contract price adjusted agreed claims approved change orders change order claim unapproved revenue recognized respect recorded contract revenue utilizing percentage completion method earned revenue based percentage incurred costs date relate total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work may include losses expected incurred charged period changes losses become known generally recognize revenue earnings percentage completion method period two six quarters event project terminated customer completion customer liable costs incurred contract instances customers billed advance services performed products manufactured company recognizes associated liability deferred revenue 2008 554 total company revenue recorded asshipped performed basis 446 recorded using percentage completion method estimates subjective nature possible could used different estimates total contract costs calculation revenue recognized using percentage completion method december 31 2008 company 1838 million revenue attributable open index financial statements percentage completion projects aggregate gross profit percentage 287 used different estimate total contract costs contract progress december 31 2008 1 increase decrease estimated margin earned contract would increased decreased total revenue pretax income year ended december 31 2008 approximately 26 million december 31 2008 company four contracts loss position estimated aggregate loss 191000 reported periodic revenue net tax assessed government authority imposed concurrent subsequent revenueproducing transaction us customers goodwill evaluation required statement financial accounting standards “sfas” 142 “goodwill intangible assets” evaluate goodwill annually impairment comparing fair value operating assets carrying value assets including related goodwill required sfas 142 identified separate reporting units purposes evaluation used segments reporting units tested segments december 31 2008 determining carrying value segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated permitted standard fair value determined discounting projected future cash flows using weighted average cost capital calculated determining projected future cash flows segment make assumptions regarding following key indicators future market sales growth rates domestic international cost inflation margin expectations working capital expenditure levels tax levels fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value would record impairment charge amount tested goodwill impairment required sfas 142 december 31 2008 result testing record impairment charge since impairment indicated estimated fair value discounted projected future cash flows three segments integrated engineered solutions standard traditional equipment automation controls lowered 45 10 6 respectively would required perform second step goodwill impairment prescribed sfas 142 see note 7 goodwill intangible assets consolidated financial statements sharebased compensation company uses modified prospective application transition method account sharebased compensation consistent sfas 123r “share based payment” method sharebased compensation cost measured grant date based calculated fair value award recognized operating expense straightline basis requisite service period management required make subjective assumptions volatility company’s common stock expected term outstanding stock options riskfree interest rate expected dividend payments contractual life options order calculate fair value award see note 16 sharebased compensation consolidated financial statements warranty sell products product warranty customers entitled free repair specified warranty period following purchase warranty terms vary typically twelve months date shipment company records liability estimated warranty claims liability percentage revenue based historical review warranty claims see note 8 warranty costs consolidated financial statements industry business environment operate nearly every major oil gas producing region world majority revenue derived equipment sales provision related services integrated national independent oil index financial statements gas companies worldwide companies execute projects behalf markets serve highly competitive many substantial competitors business segment revenue results operations closely tied demand oil gas products spending oil gas companies exploration development refining processing oil gas reserves companies also generally invest upstream exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices companies generally invest less downstream development processing margins refined products decrease due market consumer economics supply demand fluctuations supply demand change commodity prices fluctuate produces cyclical trends industry extended periods lower demand revenue process equipment service providers generally decline existing projects completed new projects postponed pricing decreases due competitive pressures periods recovery revenue process equipment providers lag behind industry due timing new project awards extended periods increased oil gas demand growth revenue process equipment service providers usually increases important indicators current future spending levels oil gas companies oil natural gas prices global economy regional political stability important oil gas markets changes commodity prices steel also impact business following table summarizes average price domestic crude oil brent crude oil per barrel average wellhead price natural gas per thousand cubic feet “mcf” published us department energy number rotary drilling rigs operation published baker hughes incorporated past five years 1 iran sudan rig counts discontinued baker hughes publication beginning january 2006 comparative purposes 2005 2004 rig count numbers presented exclude iran sudan historically viewed operating rig counts one indicator activity oil gas industry exploration development revenue standard traditional segment generally correlates changes rig activity revenue integrated engineered solutions automation controls segments depends oil natural gas prices impact customers’ cash flows lower revenue generated sale oil natural gas usually translates lower exploration production capital project budgets current slowdown economic growth recent financial market crisis contributed sharp decline record crude oil prices july approximately 145 per barrel approximately 3754 per barrel february 10 2009 along decrease average wellhead price natural gas 807 per mcf 2008 515 per mcf january 2009 additionally significant decline us rig counts high september 2008 2031 1300 february 20 2009 current prices categories exploration heavy oil canadian oil sands economic develop addition limited access capital caused recent contraction credit markets lingering pricing inflation prior periods likely constrain growth industry supply capacity decline oil gas prices impacted business 2008 expected continue 2009 2010 according “shortterm energy outlook” published energy information administration “eia” us government’s department energy february 10 2009 eia expects worldwide petroleum demand contract approximately 1 2009 decrease demand north index financial statements america pacific partially offset increase demand china middle east latin america forecasts indicated possibility even severe decline demand 2009 eia projects mild rebound petroleum demand 2010 record backlog december 31 2008 keep revenue strong first half 2009 bookings prospects 2009 remain uncertain may impact latter half year well 2010 performance result management implemented certain cost control measures 2009 recognizing need continue commitments establishing global presence developing technologies retaining skilled workforce meet future demands results operations following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes financial statements 1 includes intersegment elimination amounts revenue cost goods sold services 63 million 61 million 121 million years ended december 31 2008 2007 2006 respectively index financial statements year ended december 31 2008 compared year ended december 31 2007 consolidated revenue gross profit segment profit 1 company allocates corporate expenses operating segments based headcount total assets revenue 2 segment profit nongaap financial measure reconciled net income see note 19 industry segments geographic information consolidated financial statements company believes segment profit one primary drivers results provides meaningful presentation measuring liquidity performance company revenue 6574 million year ended december 31 2008 increased 873 million 15 5701 million year ended december 31 2007 increase primarily due continued strength sales standard traditional segment across north america 1116 million included 634 million revenue acquisitions made 2008 480 million revenue equipment services base business increases partially offset lower revenue 204 million field service fabrication revenues automation controls segment primarily due 176 million decrease revenue resulting completion kazakhstan work 37 million decrease revenue integrated engineered solutions segment primarily related booking delays gross profit gross profit 1887 million year ended december 31 2008 increased 252 million 15 1635 million year ended december 31 2007 increase primarily due 300 million higher contribution standard traditional equipment parts services across north america included gross profit 165 million acquisitions made 2008 well 30 million contribution improved project execution integrated engineered solutions segment increase partially offset 78 million lower contribution field service fabrication operations automation controls segment primarily due lower sales described gross profit percentage flat compared 2007 different product mix led sales high value technologies global markets segment profit segment profit 638 million year ended december 31 2008 decreased 140 million 18 778 million year ended december 31 2007 decrease primarily due increases operating expenses 392 million consisting 157 million related higher corporate general administrative support expenses resulting increased headcount support expansion business including international legal compliance 103 million related 2008 legal compliance review costs review associated legal compliance costs complete future expenses related efforts resolve matters government also contributing increase operating expenses 79 million related higher distribution service costs primarily associated acquisitions linco index financial statements connor 37 million higher selling preorder engineering expense associated historically high bidding activity increase sales personnel country managers 29 million related higher minority interest expense result increased activities joint ventures integrated engineered solutions revenue 2164 million year ended december 31 2008 decreased 37 million 2 2201 million year ended december 31 2007 decrease due 167 million lower revenue us builttoorder activity primarily due significant bookings delays occurred latter half 2007 extended first half 2008 resulting lower revenue runoff lower revenue co2 gas processing facilities west texas due lower throughput caused displaced compression decreases partially offset higher international builttoorder projects 154 million primarily due increased activity japan intersegment revenue 534000 year ended december 31 2008 compared 582000 year ended december 31 2007 gross profit gross profit 780 million year ended december 31 2008 increased 30 million 4 750 million year ended december 31 2007 increase primarily due 59 million higher contribution international builttoorder project business due improved execution fixed price contracts higher relative contribution membrane replenishment sales increases partially offset lower contribution co2 gas processing facilities west texas discussed segment profit segment profit 321 million year ended december 31 2008 decreased 118 million 27 439 million year ended december 31 2007 decrease primarily due increase operating expenses 148 million 49 million related higher corporate general administrative support expenses resulting increased headcount support expansion business including international legal compliance 43 million related 2008 legal compliance review costs 38 million related higher selling preorder engineering expense associated higher bidding activity approximately 18 million related higher minority interest expense resulting increased business activity joint venture japan index financial statements standard traditional revenue 3538 million year ended december 31 2008 increased 1116 million 46 2422 million year ended december 31 2007 increase primarily due additional revenue 634 million acquisitions made 2008 388 million increase due strong demand equipment services across us year 110 million increase sales heavy oil equipment canadian oil sands market due strong bookings earlier year future canadian oil sands opportunities become uncertain recent decline global crude oil prices may unfavorable impact existing backlog timing future bookings pertains market increases partially offset 18 million lower parts service sales primarily latin america due slower bookings experienced first half year intersegment revenue 14 million year ended december 31 2008 compared 12 million year ended december 31 2007 gross profit gross profit 920 million year ended december 31 2008 increased 300 million 48 620 million year ended december 31 2007 increase primarily due 165 million incremental margin contribution acquisitions made 2008 remaining increase gross profit primarily resulted 105 million contribution related higher product sales services us 30 million higher contribution increased sales heavy oil equipment canadian oil sands market segment profit segment profit 277 million year ended december 31 2008 increased 101 million 57 176 million year ended december 31 2007 increase primarily due increase gross profit contribution 300 million offset increase 199 million operating expenses 93 million related acquisitions linco connor remaining increase operating expenses primarily due 55 million higher corporate general administrative support expenses resulting increased headcount support expansion business including international legal compliance 46 million related 2008 legal compliance review costs automation controls index financial statements revenue 935 million year ended december 31 2008 decreased 204 million 18 1139 million year ended december 31 2007 decrease primarily due 176 million reduction international field service activities related conclusion field service work kazakhstan company commenced winding operations coupled 48 million decrease due lower sales control panels activities fabrication business decreases partially offset 20 million increase international field service activities primarily west africa subsequent hurricane season throughout fourth quarter demand increased gulf mexico service technicians expect workforce normal baseline gulf mexico middle 2009 intersegment revenue 44 million year ended december 31 2008 compared 43 million year ended december 31 2007 gross profit gross profit 188 million decreased 78 million 29 year ended december 31 2008 265 million year ended december 31 2007 decrease primarily due 41 million reduction contribution kazakhstan company commenced winding operations well 30 million lower contribution fabrication activities combined approximately 11 million cost overruns two large customized projects completed year decreases partially offset approximately 387000 contribution higher sales west african international field service activities segment profit segment profit 39 million year ended december 31 2008 decreased 123 million 76 162 million year ended december 31 2007 decrease primarily due 78 million decrease gross profit contribution well increase 45 million operating expenses increase operating expenses primarily due 43 million increase corporate general administrative support expenses including 19 million related domestic foreign expansion costs 14 million related 2008 legal compliance review costs 467000 related closure kazakhstan operations approximately 485000 related various support expenses including long term compensation programs consolidated statement operations line items selling general administrative expense selling general administrative expense 1229 million year ended december 31 2008 increase 373 million 44 compared 856 million year ended december 31 2007 increase due 188 million higher selling preorder engineering distribution support activities related increased business activity primarily standard traditional segment 188 million increase 68 million related 2008 acquisitions standard traditional segment corporate general administrative costs also increased approximately 185 million including 22 million related 2008 acquisitions standard traditional segment remaining increase 163 million attributable 60 million higher compensation costs primarily related noncash compensation expense stock option restricted stock grants combined increased headcount costs associated employee retention programs additionally company incurred 103 million 2008 legal compliance review costs amount 43 million allocated integrated engineered solutions 46 million standard traditional 14 million automation controls segments respectively depreciation amortization expense depreciation amortization expense 111 million 61 million years ended december 31 2008 2007 respectively 50 million increase primarily due amortization intangible assets associated acquisitions connor september 2008 linco january 2008 consept december 2007 well depreciation operating equipment office leasehold improvements made 2007 2008 interest expense interest expense 741000 year ended december 31 2008 included interest paid borrowings credit facility 2008 471000 amortization deferred index financial statements financing costs commitment fees paid unused portion company’s lines credit 270000 interest expense 355000 year ended december 31 2007 included amortization deferred financing costs commitment fees paid unused portion company’s lines credit interest income interest income 959000 22 million years ended december 31 2008 2007 respectively decrease 12 million prior year period resulted decrease invested cash result cash used linco connor acquisitions along reduction investment yields due lower short term interest rates net income 11 million year ended december 31 2008 consisting primarily 20 million net unrealized foreign exchange transaction gains 566000 net periodic benefit postretirement benefit liability income partially offset net realized foreign exchange transaction losses 16 million net expense approximately 20 million year ended december 31 2007 consisting primarily net realized unrealized foreign exchange transaction losses income tax provision income tax expense year ended december 31 2008 189 million compared 252 million year ended december 31 2007 decrease tax expense primarily attributable decrease pretax income 540 million including minority interest year ended december 31 2008 pretax income 715 million including minority interest year ended december 31 2007 effective tax rate year ended december 31 2008 350 compared 353 year ended december 31 2007 preferred stock dividends recorded preferred stock dividends totaling 248000 13 million years ended december 31 2008 2007 respectively decrease due conversion remaining series b redeemable convertible preferred stock common shares march 25 2008 year ended december 31 2007 compared year ended december 31 2006 consolidated revenue gross profit segment profit 1 company allocates corporate expenses operating segments based headcount total assets revenue 2 segment profit nongaap financial measure reconciled net income see note 19 consolidated financial statements company believes segment profit one primary drivers results provides meaningful presentation measuring liquidity performance company revenue 5701 million year ended december 31 2007 increased 511 million 10 5190 million year ended december 31 2006 increase primarily due 233 index financial statements million related increased international field service activities automation controls segment 140 million associated stronger demand builttoorder projects integrated engineered solutions segment 78 million primarily related higher demand us equipment services standard traditional segment gross profit gross profit 1635 million year ended december 31 2007 increased 265 million 19 1370 million year ended december 31 2006 increase 158 million due improved execution builttoorder projects favorable mix higher margin sales within integrated engineered solutions segment 61 million due higher sales volumes automation controls segment 47 million due higher revenue improved pricing domestic standard traditional product lines segment profit segment profit 778 million year ended december 31 2007 increased 127 million 19 651 million year ended december 31 2006 increase primarily due higher gross profit 265 million partially offset higher operating expenses 139 million increase operating expenses primarily due 77 million increase corporate general administrative support expenses 40 million higher distribution services 23 million higher selling preorder engineering expense associated higher bidding activity integrated engineered solutions revenue 2201 million year ended december 31 2007 increased 140 million 7 2061 million year ended december 31 2006 increase primarily attributed 95 million higher builttoorder project sales principally associated co2 membrane hydrogen sulfide gas removal technologies increased throughput gas processing facilities west texas intersegment revenue 582000 year ended december 31 2007 compared 62000 year ended december 31 2006 gross profit gross profit 750 million year ended december 31 2007 increased 158 million 27 592 million year ended december 31 2006 increase primarily due 125 million higher contribution builttoorder project activity resulting improved project execution well increased contribution related gas processing facilities west texas segment profit segment profit 439 year ended december 31 2007 increased 104 million 31 335 million year ended december 31 2006 increase primarily due higher gross profit 158 million partially offset higher operating expenses 54 million increase operating expenses consisted higher selling preorder engineering corporate general administrative costs primarily support higher us uk builttoorder project activity index financial statements standard traditional revenue 2422 million year ended december 31 2007 increased 78 million 3 2344 million year ended december 31 2006 increase primarily due 220 million higher demand us equipment services resulting increase drilling well completion activity predominantly rocky mountain region increase partially offset 56 million lower revenue canadian business unit due decrease conventional gas activity 79 million lower revenue mexico business unit due lower bookings standard separators equipment resulting production declines region 2007 compared 2006 intersegment revenue 12 million year ended december 31 2007 compared 76 million year ended december 31 2006 gross profit gross profit 620 million year ended december 31 2007 increased 47 million 8 574 million year ended december 31 2006 primarily due higher revenue improved pricing domestic standard traditional product lines segment profit segment profit 176 million year ended december 31 2007 decreased 21 million 10 197 million year ended december 31 2006 decrease primarily related 67 million increase operating expenses exceeds 47 million increase gross profit increase operating expenses primarily consisted 43 million related us branch organization 14 million related corporate expenses primarily international domestic expansion approximately 900000 related canadian branch automation controls revenue 1139 million year ended december 31 2007 increased 233 million 26 906 million year ended december 31 2006 increase primarily due increased index financial statements international field service activity 341 million kazakhstan operations provided 320 million partially offset reduction field service activity gulf mexico packaged automation product sales approximately 108 million intersegment revenue 44 million year ended december 31 2007 compared 45 million year ended december 31 2006 gross profit gross profit 265 million year ended december 31 2007 increased 61 million 30 204 million year ended december 31 2006 due higher level international field services gross profit percentage change year increase gross profit attributed higher sales volume international field service work segment profit segment profit 162 million year ended december 31 2007 increased 43 million 36 119 million year ended december 31 2006 increase primarily due higher gross profit contribution 61 million offset slightly higher operating expenses 18 million corporate general administrative support expenses primarily related international domestic expansion consolidated statement operations line items selling general administrative expense selling general administrative expense 856 million year ended december 31 2007 increased 141 million 20 compared 715 million year ended december 31 2006 increase consisted primarily 92 million higher selling preorder engineering services support activities related increased business volume additionally increases corporate general administration approximately 47 million mainly attributed higher compensation costs associated increased headcount employee retention programs sharebased incentive compensation resulted increased business activity 2007 depreciation amortization expense depreciation amortization expense 61 million year ended december 31 2007 increased 646000 12 compared 55 million year ended december 31 2006 increase primarily attributable depreciation operating equipment building improvements made 2007 interest expense interest expense 355000 year ended december 31 2007 related amortization deferred financing costs commitment fees paid unused portion company’s lines credit amount decreased 18 million 83 compared 21 million year ended december 31 2006 due primarily company paying debt 2006 debt throughout 2007 interest income interest income 22 million year ended december 31 2007 increased 17 million 532000 year ended december 31 2006 due primarily increase invested cash throughout year result higher earnings cash flow net expense approximately 20 million year ended december 31 2007 primarily consisting net realized unrealized foreign exchange transaction losses net year ended december 31 2006 net expense 977000 included charge 25 million closure severance expense 734000 net realized unrealized foreign exchange transaction losses 160000 writeoff part unamortized deferred financing costs associated termination prior term loan revolving credit facilities 2006 partially offset approximately 25 million gain related sale partial interest japan joint venture income tax provision income tax expense year ended december 31 2007 252 million compared 194 million year ended december 31 2006 increase tax expense primarily attributable increase pretax income 715 million including minority interest year ended index financial statements december 31 2007 pretax income 571 million including minority interest year ended december 31 2006 increase effective tax rate 3394 year ended december 31 2006 3525 year ended december 31 2007 primarily attributable valuation allowance reversal recorded 2006 preferred stock dividends recorded preferred stock dividends totaling 13 million 15 million years ended december 31 2007 2006 related series b preferred shares decrease relates reduction dividend requirement due certain preferred shareholders converting portion series b preferred shares common stock 2007 bookings backlog company’s bookings years ended december 31 2008 2007 2006 increase bookings integrated engineered solutions year ended december 31 2008 compared year ended december 31 2007 driven partial awards large project co2 membrane business significant global awards oil treatment dehydration upstream market desalting downstream refining market increased bookings japan standard traditional segment recorded increased bookings year ended december 31 2008 compared year ended december 31 2007 due resurgence activity canadian oil market successful efforts various domestic oil shale areas higher activity rocky mountain gas zone west texas oil market bookings also favorable result linco connor businesses acquired 2008 decrease bookings automation controls segment year ended december 31 2008 compared year ended december 31 2007 reflection decreased field service activities kazakhstan company commenced winding operations lower activities gulf mexico field service manufacturing business decrease bookings integrated engineered solutions year ended december 31 2007 compared year ended december 31 2006 due delay large project awards anticipated late 2007 awarded early mid 2008 standard traditional segment increase bookings year ended december 31 2007 compared year ended december 31 2006 due increase drilling well completion activity levels 2007 increase bookings automation controls segment year ended december 31 2007 compared year ended december 31 2006 reflection expansion international field service activities primarily kazakhstan index financial statements company’s backlog december 31 2008 2007 inflation changes prices inflation according us financial trend forecaster® based consumer price index us inflation approximately 009 43 25 years ended december 31 2008 2007 2006 respectively effects us inflation significant impact consolidated results operations financial condition past three years changes prices costs materials products rise fall value commodity markets costs goods sold primarily affected among things labor energy steel commodity prices tariffs duties imported materials foreign currency exchange rates observed following average price changes per metric ton 2240 pounds listed commodities past three years carbon steel prices increased 46 2008 1 2007 2006 addition prices raw materials used produce skids platforms increased 31 16 15 2008 2007 2006 respectively engineering labor hourly rates associated employees subcontractors also increased average follows across transportation modes average prices freight 2007 2008 changed follows increases 10 tanker specialized freight 6 consolidated shipments 7 truckload 21 domestic air courier 21 inland water freight 22 deepsea freight generally increases raw materials labor costs transportation costs passed customers part bids certain fixed price contracts may able pass cost increases impact gross margin jobs affected index financial statements liquidity capital resources cash equivalents working capital working capital excluding cash equivalents increased 681 million december 31 2008 467 million december 31 2007 213 million increase working capital primarily attributable relative increase business activities prior year including working capital increase 156 million related linco connor acquisitions increase working capital consisted increases trade accounts receivable 526 million inventory 117 decrease accrued expenses 91 million combination various net asset increases 24 million increases offset increases billings uncompleted contracts excess costs estimated earnings 203 million accounts payable 199 million well decrease costs estimated earnings excess billings uncompleted contracts 143 million 526 million change accounts receivable approximately 346 million resulted increased billings excess costs estimated earnings several large builttoorder projects end year 101 million related linco connor acquisitions approximately 46 due higher revenue generated year compared previous year 32 million resulted approximately 2 days increase average collection period billed receivables year 117 million increase inventory primarily related 81 million resulting 2008 acquisitions 36 increase stores parts workinprocess inventory north american operations net valuation reserves decrease accrued liabilities 91 million primarily attributable decrease project cost accruals jobs progress december 31 2008 203 million increase billings uncompleted contracts excess costs estimated earnings result several projects early stages 2008 require advance payments customers part contractual terms contract increase 199 million accounts payable principally result overall increase business activity 50 million related linco connor acquisitions 143 million decrease costs estimated earnings excess billings uncompleted contracts mainly due completion several large engineered equipment projects 2007 early 2008 cash flow net cash provided operating activities decreased 90 million 2008 compared 2007 decrease net cash provided operating activities primarily result lower net income 112 million changes working capital items excluding cash equivalents 2008 compared 2007 resulting net change cash used working capital 109 million net foreign exchange translation decreases partially offset 131 million increase items primarily consisting 40 million increase deferred tax expense 37 million higher sharebased compensation expense 49 million higher depreciation expense 500000 increase items net cash provided operating activities decreased 24 million 2007 compared 2006 decrease net cash provided index financial statements operating activities primarily result changes working capital items excluding cash equivalents 2007 compared 2006 resulting net change cash used working capital 108 million net foreign exchange translation main reason change use working capital 2007 increase costs excess billings uncompleted contracts associated progression several large projects near completion stage conversely customer advance payments generally received project’s early stages substantial source cash 2006 offsetting change use cash working capital increase net income 86 million 2007 2006 remaining 200000 changes cash provided operating activities 2007 compared 2006 result several individually immaterial offsetting items management believes substantially remaining unbilled costs excess billings billed subsequent periods collectible 312 million unbilled costs excess billings december 31 2008 63 million subsequently billed january 2009 net cash used investing activities years ended december 31 2008 2007 2006 939 million 304 million 39 million respectively primary uses funds 2008 related net cash payments 624 million associated acquisitions 2008 316 million capital expenditures 227 million used growth initiatives productivity improvements 89 million used maintenance capital expenditures replaced enhanced useful lives fixed assets primary use funds year ended december 31 2007 consisted 1 capital expenditures 153 million 96 million represented expenditures improve productivity expand facilities 57 million represented maintenance capital expenditures 2 net cash payment 151 million associated acquisition consept norwegian company known natco norway primary use funds year ended december 31 2006 maintenance capital expenditures 66 million offset 30 million proceeds sale partial interest japanese subsidiary quarter ended september 30 2006 net cash provided used financing activities years ended december 31 2008 2007 2006 120 million 76 million 228 million respectively primary source cash 2008 130 million borrowings revolving credit facilities export sales credit facility 28 million change banks overdrafts 15 million proceeds stock issuances related stock option exercises partially offset treasury shares acquired 57 million 46 million related repurchases shares share repurchase program 11 million related tax payments shares surrendered upon lapse restrictions restricted stock primary source cash 2007 associated 33 million proceeds stock issuances related stock option exercises 39 million excess tax benefit sharebased compensation 20 million change bank overdrafts primary use cash payment 13 million dividends remaining preferred stockholders partial conversion series b preferred shares primary use cash 2006 payment 15 million preferred stockholder dividends repayment debt prior revolving lines credit term debt 274 million offset 42 million excess tax benefit sharebased compensation 35 million proceeds issuance stock options net total decrease increase cash flow operating investing financing activities 459 million 283 million 260 million years ended december 31 2008 2007 2006 respectively december 31 2008 177 million cash hand 1105 million total borrowing availability terms amended revolving credit facilities right increase borrowing capacity us portion facility additional 224 million addition normal operating cash requirements anticipated principal future cash requirements fund capital expenditures employee benefit obligations strategic acquisitions feasible companies assets product lines complement existing businesses index financial statements believe cash operations borrowing capacity described adequate current longterm financing working capital needs cannot assure able successfully identify suitable acquisition opportunities complete particular acquisition able finance transaction january 31 2009 available liquidity including cash hand borrowing availability revolving facilities approximately 1237 million offbalance sheet arrangements offbalance sheet arrangements december 31 2008 contractual obligations following table summarizes company’s contractual obligations december 31 2008 1 represents open materialequipment services purchase orders placed 2008 delivery billing scheduled 2009 beyond 2 represents total us canada postretirement benefit obligation december 31 2008 changes actuarial assumptions medical trend rates subsequent years effect applying sfas 158 “employer’s accounting defined benefit pension postretirement plans” could cause actuarially determined liability postretirement benefit plan fluctuate shortterm longterm portion us postretirement benefit obligation recorded “accrued expenses” “postretirement benefits longterm liabilities” accounts respectively 3 represents longterm unrecognized tax benefits associated fin 48 “accounting uncertainty income taxes” included consolidated balance sheet liability account “postretirement benefits longterm liabilities” capital resources discussion company’s existing credit facilities revolving credit facility july 2006 company terminated prior term loan revolving credit facility entered new revolving credit facility agreement maturity june 30 2011 total borrowing capacity 850 million december 23 2008 company certain subsidiaries entered amendment facility resulting increased borrowing capacity 527 million total 1377 million additionally company ability issue letters credit guarantees bonds 1000 million company paid amendment fee 426000 includes upfront fee 050 plus arrangement fee agent amended company pays commitment fees undrawn portion facility ranging 40 60 based upon ratio funded debt ebitda calculated 40 december 31 2008 interest borrowings facility ranges london interbank offered rate libor lender’s prime rate plus 250 350 depending debt ebitda ratio index financial statements availability credit facility reduced amount borrowing outstanding letters credit year company drew 278 million repaid 198 million outstanding borrowings facility december 31 2008 80 million borrowings 234 million letters credit outstanding facility total available borrowing capacity december 31 2008 1063 million fees related letters credit approximately 250 outstanding balance december 31 2008 export sales facility june 2007 company entered export sales credit facility total borrowing capacity 100 million facility expire june 15 2010 partially guaranteed us exportimport bank subject certain borrowing base limitations interest borrowings facility either 1 lender’s prime rate less 050 2 libor plus 135 company’s election company pays annual fee 75000 facility year company drew 219 million repaid 169 million facility december 31 2008 company 50 million borrowings 771000 letters credit outstanding facility total available borrowing capacity december 31 2008 42 million fees related letters credit approximately 10 outstanding balance december 31 2008 letters credit support various contract performance warranties expire various dates april 1 2014 december 31 2008 company unsecured letters credit bonds totaling approximately 24 million related international subsidiaries compliance restrictive debt covenants outstanding credit facilities december 31 2008 recent accounting pronouncements september 2006 financial accounting standards board fasb issued statement financial accounting standards sfas 157 “fair value measurements” “sfas 157” became effective financial statements issued fiscal years beginning november 15 2007 sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value instruments company adopted sfas 157 january 1 2008 material impact company’s consolidated results operations financial position cash flows february 2007 fasb issued sfas 159 “the fair value option financial assets financial liabilities including amendment fasb statement 115” “sfas 159” permits entities choose measure eligible items fair value specified election dates elects adopt standard business entity shall report unrealized gains losses items fair value elected earnings subsequent reporting date company adopted sfas 159 january 1 2008 elected measure eligible items fair value defined pronouncement december 2007 fasb issued sfas 141revised 2007 “business combinations” “sfas 141r” replaces sfas 141 “business combinations” effective fiscal years beginning december 15 2008 early adoption permitted sfas 141r changed method applying acquisition method accounting number significant aspects acquisition costs generally expensed incurred noncontrolling interests valued fair value acquisition date inprocess research development recorded fair value indefinitelived intangible asset acquisition date changes deferred tax asset valuation allowances income tax uncertainties acquisition date generally affect income tax expense sfas 141r effective prospective basis business combinations acquisition date beginning first annual period subsequent december 15 2008 exception accounting valuation allowances deferred taxes acquired tax contingencies sfas 141r amends sfas 109 “accounting income taxes” adjustments made valuation allowances deferred taxes acquired tax contingencies associated index financial statements acquisitions closed prior effective date sfas 141r would also apply provisions sfas 141r company adopted sfas 141r january 1 2009 however pronouncement applied prospectively business combinations acquisitions occur guidance becomes effective impact company depend nature terms size business combinations completed effective date december 2007 fasb issued sfas 160 “noncontrolling interests consolidated financial statementsan amendment arb 51” sfas 160” sfas 160 effective fiscal years interim periods within fiscal years beginning december 15 2008 early adoption prohibited sfas 160 requires recognition noncontrolling interest minority interest equity consolidated financial statements separate parent’s equity amount net income attributable noncontrolling interest included consolidated net income face income statement sfas 160 also amends certain arb 51’s consolidation procedures consistency requirements sfas 141r sfas 160 also includes expanded disclosure requirements regarding interests parent noncontrolling interest company adopted sfas 160 january 1 2009 beginning 2009 interim reporting periods present noncontrolling interest minority interest separate component shareholders’ equity well comply reporting disclosure requirements current comparative periods february 2008 fasb issued fasb staff position “fsp” 1571 “application fasb statement 157 fasb statement 13 accounting pronouncements address fair value measurements purposes lease classification measurement statement 13” “fsp 1571” fsp 1571 amends sfas 157 exclude fasb statement 13 “sfas 13” “accounting leases” accounting pronouncements address fair value measurements purposes lease classification measurement sfas 13 however exception apply assets acquired liabilities assumed business combination required measured fair value sfas 141r regardless whether assets liabilities related leases fsp 1571 effective upon initial adoption sfas 157 company adopted sfas 157 january 1 2008 impact company’s consolidated results operations financial position cash flows february 2008 fasb issued fsp 1572 “effective date fasb statement 157” “fsp 1572” fsp defers effective date sfas 157 “fair value measurements” nonfinancial assets nonfinancial liabilities except items recognized disclosed fair value financial statements recurring basis least annually fiscal years beginning november 15 2008 interim periods within fiscal years items within scope fsp 1572 effective upon issuance date february 12 2008 company adopted fsp 1572 february 12 2008 impact company’s consolidated results operations financial position cash flows march 2008 fasb issued sfas 161 “disclosures derivative instruments hedging activities amendment fasb statement 133” sfas 161” statement amends expands disclosure requirements sfas 133 “accounting derivative instruments hedging activities” sfas 161 effective fiscal years interim periods beginning november 15 2008 early adoption encouraged company adopted sfas 161 january 1 2009 pronouncement provides disclosure requirements adoption standard material impact company’s consolidated results operations financial position cash flows april 2008 fasb issued fsp fas 1423 “determination useful life intangible assets” “fsp fas 1423” shall effective financial statements issued fiscal years beginning december 15 2008 interim periods within fiscal years early adoption prohibited fsp amends paragraph 11d sfas 142 “goodwill intangible assets” “sfas 142” entity use assumptions renewal extension arrangement adjusted index financial statements entityspecific factors paragraph 11 sfas 142 even likely substantial cost material modifications fsp intends improve consistency useful life recognized intangible asset sfas 142 period expected cash flows used measure fair value asset sfas 141r us generally accepted accounting principles company adopted fsp fas 1423 january 1 2009 expect adoption material impact company’s consolidated results operations financial position cash flows however could impact future transactions entered company may 2008 fasb issued sfas 162 “the hierarchy generally accepted accounting principles” “sfas 162” pronouncement identifies sources accounting principles framework selecting principles used preparation financial statements business entities presented conformity generally accepted accounting principles gaap united states gaap hierarchy sfas 162 effective 60 days following sec’s approval public company accounting oversight board amendments au section 411 “the meaning present fairly conformity generally accepted accounting principles” sfas 162 expected result change current practice company adopt sfas 162 effective date november 2008 fasb ratified consensus reached eitf 0806 “equity method investment accounting considerations” “eitf 0806” eitf 0806 issued address questions regarding application equity method subsequent issuance fas 141r eitf 0806 concluded equity method investments continue recognized using cost accumulation model thus continuing include transaction costs carrying amount equity method investment addition eitf 0806 clarifies impairment assessment applied equity method investment whole rather individual assets underlying investment eitf 0806 effective fiscal years beginning december 15 2008 company process evaluating impact eitf 0806 company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 december 2008 fasb issued fsp fas 1404 fin 46r8 “disclosures public entities enterprises transfers financial assets interests variable interest entities” “fsp fas 1404” “fin 46r8” pronouncement increases disclosure requirements public companies effective fiscal years interim periods within fiscal years beginning december 15 2008 earlier application encouraged fsp amends fasb statement 140 “accounting transfers servicing financial assets extinguishments liabilities” require public entities provide additional disclosures transfers financial assets also amends fasb interpretation 46 revised december 2003 consolidation variable interest entities require public enterprises including sponsors variable interest variable interest entity provide additional disclosures involvement variable interest entities company process evaluating impact fsp 1404 fin 46r8 company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 item 7aitem 7 management’s discussion analysis financial condition results operations following discussion historical results operations financial condition read conjunction consolidated financial statements notes thereto index financial statements overview business segments oil water technologies gas technologies automation controls oil water technologies group largest segment consists two product lines first standard traditional product line consisting oil gas separation dehydration equipment sales related services extensive north american branch distribution network second product line includes builttoorder process systems focused primarily oil water production processing systems designed built meet customer specifications gas technologies group includes co2 membrane business assets operating relationship related gas processing facilities west texas h2s removal technologies including shell paques™ automation controls group focuses sales new control panels systems monitor control oil gas production well field service activities including repair maintenance testing inspection services existing systems allocate corporate expenses segments rather segregating costs standalone basis certain reclassifications made fiscal 2004 amounts order present results comparable basis amounts fiscal 2005 2006 forwardlooking statements annual report form 10k including management’s discussion analysis financial condition results operations includes forwardlooking statements within meaning section 27a securities act 1933 amended section 21e securities exchange act 1934 amended “forwardlooking statement” words “believe” “expect” “plan” “intend” “designed to” “estimate” “project” “will” “could” “may” similar expressions intended identify forwardlooking statements forwardlooking statements document include limited discussions accounting policies estimates indicated trends level oil gas exploration production effect conditions results operations see “industry business environment” growth plans 2007 beyond future uses requirements financial resources see “liquidity capital resources” impact bookings future revenues anticipated backlog levels expectations business outlook customer spending potential acquisitions oil gas prices business environment industry general expectations regarding matters actual results may differ materially forwardlooking statements contained report reasons including limited market factors pricing demand petroleum related products level petroleum industry exploration production expenditures effects competition availability skilled labor force world economic conditions level drilling activity legislative environment united states countries energy policies opec conflict involving united states major petroleum producing consuming regions acts war terrorism technological advances could lower overall finding development costs weather patterns overall condition capital markets countries operate following discussion read conjunction financial statements related notes financial information appearing elsewhere annual report form 10k readers also urged carefully review consider various factors including without limitation disclosures made item 1a risk factors risks discussed annual report form 10k subsequent reports filed securities exchange commission may affect us outcomes related forwardlooking statements expressly disclaim obligation undertaking release publicly updates revisions forwardlooking statement reflect change expectations regard thereto change events conditions circumstances forwardlooking statement based critical accounting policies estimates preparation consolidated financial statements requires us make certain estimates assumptions affect results reported consolidated financial statements accompanying notes index financial statements estimates assumptions based historical experience future expectations believe reasonable circumstances note 2 consolidated financial statements contains summary significant accounting policies believe following accounting policies estimates critical preparation consolidated financial statements revenue recognition percentageofcompletion method recognize revenues related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued 250000 less contract durations four months less recognize revenues using percentage completion method contracts greater 250000 contract durations excess four months represent customized engineered orders products qualify treatment accordance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 addition use percentage completion method automation controls segment equipment fabrication sales projects qualify treatment accordance requirements sop 811 automation controls segment sells customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration segment produce standard units maintain inventory products sale due nature segment’s equipment fabrication sales operations potential wide variations results operations could occur applying shipped methodology smaller contracts customized fabricated goods segment recognizes revenues regardless contract value duration applying percentage completion method 2006 approximately 533 total company revenues recorded ‘as shipped’ ‘as performed’ basis approximately 467 recorded using percentage completion method respect contract revenues recorded utilizing percentage completion method earned revenue based percentage costs incurred date relate total estimated costs project giving effect recent estimates total cost total estimated contract cost critical accounting estimate materially affect revenue net income requires us make judgments matters uncertain total costs expected incurred therefore recognition revenue could affected various internal external factors including limited changes project scope change orders changes productivity scheduling cost availability labor cost availability raw materials weather client delays providing approvals benchmark stages project timing deliveries thirdparty providers key components cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues applicable losses expected incurred jobs progress consideration estimated probable minimum recoveries claims change orders charged income soon losses known claims additional contract revenue recognized probable claim result additional revenue amount reliably estimated generally recognize revenue earnings percentageofcompletion method applies period two six quarters event project terminated customer completion customer liable costs incurred contract believe operating results evaluated term one three years consider performance longterm contracts change orders scope changes cost recoveries negotiated realized estimates subjective nature possible could used different estimates total contract costs calculation revenue recognized using percentage completion method december 31 2006 company 1052 million revenues attributable open percentage completion projects aggregate gross margin 203 used different estimate total contract costs contract progress december 31 2006 1 increase decrease estimated margin earned contract would increased decreased total revenue pretax income year ended index financial statements december 31 2006 approximately 13 million december 31 2006 company two contracts loss position estimated aggregate loss 18 million reported revenue net tax assessed government authority imposed concurrent subsequent revenueproducing transaction us customers goodwill evaluation required statement financial accounting standards “sfas” 142 “goodwill intangible assets” evaluate goodwill annually impairment comparing fair value operating assets carrying value assets including related goodwill required sfas 142 identified separate reporting units purposes evaluation used segments reporting units tested segments december 31 2006 determining carrying value segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated permitted standard fair value determined discounting projected future cash flows using weighted average cost capital calculated determining projected future cash flows segment make assumptions regarding following key indicators future market sales growth rates domestic international cost inflation margin expectations working capital expenditure levels tax levels fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value would record impairment charge amount net goodwill 809 million december 31 2006 tested goodwill impairment required sfas 142 december 31 2006 record impairment charge result testing estimated fair values discounted cash flow three segments oil water technologies gas technologies automation controls reduced 65 85 72 respectively would required perform second step goodwill impairment prescribed sfas 142 deferred income tax assets valuation allowance based upon level historical taxable income projected future taxable income periods deferred tax assets deductible applicable tax jurisdictions believe likely realize benefits deductible differences carryforwards net existing valuation allowances december 31 2006 however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections applicable tax jurisdictions certain foreign tax jurisdictions able rely projections future taxable income determine realizability deductible differences carryforwards december 31 2005 deferred tax assets uk operations completely offset valuation allowance result cumulative pretax losses uk operations prior threeyear period december 31 2006 uk operations longer cumulative pretax loss prior threeyear period projecting earnings valuation allowance related uk operations reduced zero valuation allowance 103000 still recorded offset net operating losses foreign jurisdictions able rely projections future taxable income sharebased compensation effective january 1 2006 company adopted sfas 123r “sharebased payment” using modified prospective application transition method sharebased compensation cost measured grant date based calculated fair value award recognized operating expense straightline basis requisite service period index financial statements management required make subjective assumptions volatility company’s common stock expected term outstanding stock options riskfree interest rate expected dividend payments contractual life options order calculate fair value award see note 15 sharebased compensation industry business environment revenue results operations closely tied demand oil gas products spending oil gas companies exploration development oil gas reserves companies generally invest exploration development efforts periods favorable oil gas commodity prices invest less periods unfavorable oil gas prices supply demand change commodity prices fluctuate producing cyclical trends industry periods lower demand revenue service providers natco generally decline existing projects completed new projects postponed pricing decreases due competitive pressures periods recovery revenue process equipment providers lag behind industry due timing new project awards changes commodity prices impacted business past several years following table summarizes price domestic crude oil per barrel wellhead price natural gas per thousand cubic feet “mcf” published us department energy number rotary drilling rigs operation published baker hughes incorporated recent five years 1 iran sudan rig counts discontinued baker hughes publication beginning january 2006 comparative purposes 2005 2004 2003 2002 rig count numbers presented exclude iran sudan historically viewed operating rig counts benchmark spending us oil gas industry exploration development efforts standard traditional equipment sales parts services business generally relates changes rig activity longerterm perspective us department energy projects worldwide petroleum natural gas consumption projected increase average annual growth rate 14 2003 2030 higher consumption rates expected emerging economies particularly asia including china india 43 total increase world oil use projected worldwide demand grows producers oil gas industry increasingly rely nontraditional sources energy supply expansion new markets result additional complex equipment may required equipment service suppliers produce oil gas fields especially since many new oil gas fields produce lower quality contaminated hydrocarbon streams requiring complex production equipment general trends increase demand products services index financial statements results operations following discussion historical results operations financial condition read conjunction audited consolidated financial statements notes financial statements 1 includes intersegment elimination amounts revenue cost goods sold services 105 million 46 million 39 million years ended december 31 2006 2005 2004 respectively year ended december 31 2006 compared year ended december 31 2005 consolidated revenue gross profit revenue 5190 million year ended december 31 2006 increased 1186 million 30 4005 million year ended december 31 2005 result increased business activity three operating segments gross profit gross profit year ended december 31 2006 increased 406 million 42 1374 million compared 968 million year ended december 31 2005 result increased sales improved pricing overall job execution improvements percentage revenue gross margin 26 24 years ended december 31 2006 december 31 2005 respectively index financial statements oil water technologies intersegment revenue business segment 60 million year ended december 31 2006 compared 634000 year ended december 31 2005 oil water technologies segment revenue increased 734 million 24 year ended december 31 2006 compared year ended december 31 2005 approximately 412 million increase due higher international domestic business project awarding activities builttoorder product line approximately 322 million increase due higher demand standard traditional equipment services resulting increased exploration development activity oil gas industry gross profit oil water technologies segment increased 243 million 41 year ended december 31 2006 compared year ended december 31 2005 continued strength sales increased prices standard traditional equipment services accounted 159 million increase builttoorder projects domestically internationally contributed 84 million increase net projected cost overruns builttoorder project scheduled completion delivery first part 2007 higher profitability margins result pricing increases especially north american activities continued improvements overall job execution percentage revenue gross margin 22 20 year ended december 31 2006 2005 respectively gas technologies intersegment revenue business segment year ended december 31 2006 2005 gas technologies segment revenue 627 million year ended december 31 2006 increased 240 million 62 compared 387 million year ended december 31 2005 increase primarily due higher builttoorder project activity levels 233 million higher co2 processing revenue 12 million partially offset decrease membrane sales approximately 454000 gross profit gas technologies segment year ended december 31 2006 increased 88 million 36 compared year ended december 31 2005 primarily result increase sales index financial statements gross margin percentage revenue gas technologies operation 52 62 year ended december 31 2006 2005 respectively decrease gross margin attributable revenue mix due higher concentration lower margin builttoorder projects lower membrane sales 2006 period automation controls intersegment revenue business segment 45 million year ended december 31 2006 compared 40 million year ended december 31 2005 revenue automation controls segment 906 million increased 271 million 43 year ended december 31 2006 compared 635 million year ended december 31 2005 increase primarily due continued strength gulf mexico field services work increase packaged automation product sales increase international field service work primarily west africa kazakhstan prior year impacted approximately 12 million revenue loss segment’s gulf mexico operations due facility work interruptions related effect hurricanes katrina rita gross profit automation controls segment increased 76 million 59 year ended december 31 2006 compared year ended december 31 2005 primarily due increased revenue volume price increases product mix gross margin percentage revenue 23 20 year ended december 31 2006 2005 respectively increase gross margin primarily result increased pricing field services work gulf mexico higher packaged automation product sales along improved job execution consolidated statement operations line items selling general administrative expense selling general administrative expense 715 million year ended december 31 2006 increased 111 million 18 compared 604 million year ended december 31 2005 approximately 67 million increase due higher general administrative compensation costs associated increased headcount employee retention programs sharebased incentive compensation higher support costs related increased business activity approximately 600000 associated office consolidation uk 10 million related higher preorder engineering costs associated increased bid activities 10 million attributable gain sale assets prior year included 111 million increase 17 million noncash compensation cost correction error recorded fiscal year 2005 related stock options issued 1998 options originally exercise price set anticipation initial public offering subsequently canceled reissued lower price march 1999 later became public company january 2000 compensation expense determined using variable accounting per fasb interpretation “fin” 44 “accounting certain transactions involving stock compensation” issued subsequent time options repriced retroactive effect management discovered error index financial statements quarter ended september 30 2006 deemed immaterial 2005 2006 periods respect quarterly trends earnings periods company corrected accounting quarter ended september 30 2006 properly recognize compensation expense applying variable accounting awards required fin 44 depreciation amortization expense depreciation amortization expense 55 million year ended december 31 2006 increased 268000 5 compared 52 million year ended december 31 2005 increase attributable primarily depreciation additions 2006 operating equipment amortization intangible assets associated investment company fabricates pilotless burner ignition system controlling gasfired heaters used connection oil gas wellhead equipment closure severance closure severance expenses 25 million year ended december 31 2006 included 23 million uk office closure cost approximately 200000 related severance costs closure severance expenses 27 million year ended december 31 2005 included 12 million planned retirement company’s president announced september 2005 severance costs approximately 15 million related restructuring uk us canada operations interest expense interest expense 21 million year ended december 31 2006 decreased 17 million 45 compared 38 million year ended december 31 2005 due primarily debt reductions year net periodic cost postretirement benefit liability net periodic cost postretirement benefit liability zero year ended december 31 2006 decrease 767000 compared year ended december 31 2005 due changes made late 2005 reduced benefits increased participant contributions resulted reduction plan participants interest income interest income 532000 year ended december 31 2006 increased 446000 86000 year ended december 31 2005 due primarily increase shortterm highly liquid investments second half 2006 net 15 million gain included 25 million gain related sale partial interest japan joint venture offset 160000 writeoff part unamortized loan costs associated termination third quarter 2006 2004 term loan revolving credit facilities net realized unrealized foreign exchange transaction losses 734000 net expense 19 million year ended december 31 2005 related primarily 18 million expense related change valuation settlement outstanding warrants purchase common stock 56000 related net realized unrealized foreign currency exchange transaction losses minority interest minority interest expense 337000 related japanese subsidiary provision income taxes income tax expense year ended december 31 2006 195 million compared 79 million year ended december 31 2005 change tax expense primarily attributable increase pretax income 575 million year ended december 31 2006 pretax income 221 million year ended december 31 2005 decrease effective tax rate 357 year ended december 31 2005 339 year ended december 31 2006 primarily attributable nondeductible marktomarket expense 18 million warrants exercised 2005 incurred 2006 december 31 2006 uk operations longer cumulative pretax loss prior threeyear period projecting earnings uk operations determined related valuation allowance longer needed reduced zero consequently company’s valuation allowance decreased 17 million 103000 year 2006 index financial statements preferred stock dividends recorded preferred stock dividends totaling 15 million years ended december 31 2006 2005 related series b convertible preferred stock “series b preferred shares” year ended december 31 2005 compared year ended december 31 2004 consolidated revenue gross profit revenue year ended december 31 2005 increased 790 million 25 4005 million 3215 million year ended december 31 2004 increase revenues primarily attributable oil water technologies automation controls segments gross profit gross profit year ended december 31 2005 increased 221 million 30 968 million 747 million year ended december 31 2004 percentage revenue gross profit 24 23 years ended december 31 2005 2004 respectively oil water technologies intersegment revenue business segment 634000 year ended december 31 2005 compared 202000 year ended december 31 2004 oil water technologies segment revenue increased 678 million 29 year ended december 31 2005 compared year ended december 31 2004 primarily due increased demand products resulting increased exploration development activity oil gas industry increase activity contributed improved sales standard traditional equipment amount 364 million additional 310 million revenue increase due successful awarding activity builttoorder projects domestically internationally gross profit oil water technologies segment increased 152 million 34 year ended december 31 2005 compared year ended december 31 2004 primarily due 29 increase revenues respective periods gross profit percentage revenue increased 19 2004 20 2005 strengthening gross profit margin largely due improvements builttoorder job execution 2005 index financial statements gas technologies intersegment revenue business segment year ended december 31 2005 2004 revenue 387 million year ended december 31 2005 gas technologies segment decreased 26 million 6 compared 413 million year ended december 31 2004 decrease primarily due reduction builttoorder projects 74 million due timing awards associated revenue largely offset increase replacement membrane sales increased throughput co2 processing facility west texas totaling 48 million gross profit gas technologies segment year ended december 31 2005 increased 20 million 9 compared year ended december 31 2004 margins west texas co2 processing facilities membrane replacement sales increased 40 million partially offset 20 million decrease margins builttoorder projects due lower level revenue compared 2004 gross margin percentage revenue gas technologies 62 54 year ended december 31 2005 2004 respectively automation controls intersegment revenue business segment 40 million year ended december 31 2005 compared 37 million year ended december 31 2004 revenue automation controls segment increased 138 million 28 year ended december 31 2005 compared year ended december 31 2004 revenue 2005 improved due increased activity levels gulf mexico continued growth west africa operations partially offset 12 million revenue loss related effect hurricanes katrina rita gross profit year ended december 31 2005 increased 49 million 61 128 million percentage revenue gross profit 20 16 years ended december 31 2005 2004 respectively index financial statements consolidated statement operations line items selling general administrative expense selling general administrative expense 604 million year ended december 31 2005 increased 62 million 11 compared year ended december 31 2004 approximately 38 million increase due higher performancebased compensation expense related increased income results impact certain incentive awards increase stock value additional 33 million increase due higher support expenses related increased business activity especially sales service activities related standard traditional equipment sales north america startup new operations west africa higher corporate costs partially offset gain sale excess manufacturing facilities 10 million depreciation amortization expense depreciation amortization expense 52 million year ended december 31 2005 decreased 150000 3 compared results year ended december 31 2004 closure severance closure severance expenses 27 million year ended december 31 2005 included 12 million retirement company’s president announced september 2005 severance costs approximately 15 million related restructuring uk us operations closure severance expenses 41 million year ended december 31 2004 included 25 million separation company’s former ceo 16 million uk restructuring program severance initiatives interest expense interest expense 38 million year ended december 31 2005 decreased 31000 1 compared year ended december 31 2004 due reductions outstanding borrowings partially offset increase base interest rates writeoff unamortized loan costs recorded writeoff unamortized loan costs 667000 march 2004 related retirement 2001 term loan revolving credit facilities net periodic cost postretirement benefit liability net periodic cost postretirement liability 767000 year ended december 31 2005 decreased 63000 8 compared year ended december 31 2004 primarily due changes discount rates interest income interest income 86000 year ended december 31 2005 compared 123000 year ended december 31 2004 due primarily reduction shortterm investments year 2005 net expense 19 million year ended december 31 2005 related primarily 18 million expense related change valuation settlement outstanding warrants purchase common stock 56000 related net realized unrealized foreign currency exchange transaction losses net expense 22 million year ended december 31 2004 related primarily net foreign currency losses incurred operations uk canada 2004 provision income taxes income tax expense year ended december 31 2005 79 million compared 30 million year ended december 31 2004 change tax expense primarily attributable increase pretax income 221 million year ended december 31 2005 pretax income 37 million year ended december 31 2004 decrease effective tax rate 832 year ended december 31 2004 357 year ended december 31 2005 due primarily partial reversal valuation allowance recorded 2004 related uk operating loss carryforwards 2005 net valuation allowance reduced 12 million remaining valuation allowance 17 million december 31 2005 index financial statements preferred stock dividends recorded preferred stock dividends totaling 15 million years ended december 31 2005 2004 related series b convertible preferred stock “series b preferred shares” bookings backlog company’s bookings years ended december 31 2006 2005 2004 company’s backlog december 31 2006 2005 bookings 5553 million compared 4939 million 3351 million years ended december 31 2006 2005 2004 respectively bookings decreased 147 million oil water technologies segment increased 614 million gas technologies segment 146 million automation controls segment year ended december 31 2006 compared year ended december 31 2005 december 31 2006 company significant concentrations bookings countries outside north america sales backlog december 31 2006 2073 million compared 1710 million december 31 2005 backlog decreased 55 million oil water technologies segment increased 458 million gas technologies segment decreased 40 million automation controls segment year inflation changes prices costs materials example steel products rise fall value commodity markets prices paid us raw materials may affected among things energy steel commodity prices tariffs duties imported materials foreign currency exchange rates generally increases raw materials labor costs passed customers experienced higher steel prices greater difficulty securing necessary steel supplies 2004 preceding several years attempt mitigate financial impact higher raw materials costs operations assigning appropriate bid validity dates contract proposals applying surcharges adjusting prices products sell always successful anticipating price increases passing increases customers incurred unfavorable manufacturing cost variation 2004 substantially eliminated 2005 index financial statements 2006 experienced higher prices lower availability steel stainless steel significantly higher prices highgrade exotic metal alloys containing chromium nickel raw materials used business doubling drycargo shipping costs higher contract engineering hourly labor rates liquidity capital resources cash equivalents company cash equivalents 352 million december 31 2006 included highly liquid shortterm investments totaling 280 million accrue interest weighted average rate 476 working capital december 31 2006 775 million working capital compared 491 million december 31 2005 increase 284 million 58 increase due primarily increase 260 million cash equivalents 44 million trade receivables 53 million inventory primarily work progress attributable increased business activity 21 million deferred income tax assets 15 million prepaid expense current assets offset net increase 108 million current liabilities net increase primarily related 251 million increase accrued expenses customer advances partially offset elimination current portion longterm debt 64 million 82 million decrease trade accounts payable cash flow net cash provided operating activities years ended december 31 2006 2005 2004 521 million 188 million 901000 respectively increase net cash provided operating activities 2006 compared 2005 largely due significant increase net income years ended december 31 2006 versus 2005 adjusted noncash items offset increase working capital consisting primarily trade receivables inventories result increased business activity increase net cash provided operating activities 2005 compared 2004 primarily due significant increase net income year adjusted noncash items trade receivables fluctuate depending business levels invoice terms timing collections larger projects achieving contractual milestones permit invoicing interim payments net cash used investing activities years ended december 31 2006 2005 2004 39 million 12 million 34 million respectively primary use funds year ended december 31 2006 66 million capital expenditures offset 30 million proceeds sales partial interest japanese subsidiary quarter ended september 30 2006 primary use funds year ended december 31 2005 capital expenditures 35 million largely offset proceeds sales excess manufacturing facilities 24 million primary use funds year ended december 31 2004 capital expenditures 36 million largely maintenance capital index financial statements net cash used financing activities years ended december 31 2006 2005 228 million 106 million respectively net cash provided financing activities 33 million year ended december 31 2004 primary use cash 2006 15 million dividend payments preferred stockholders 750000 treasury share purchase prepayment 274 million longterm debt offset 35 million proceeds issuance stock options 42 million excess tax benefit sharebased compensation respectively primary use cash 2005 15 million dividend payments preferred stockholders repayment debt revolving lines credit longterm debt totaling 179 million offset 67 million proceeds issuance common stock related stock option exercises increase 22 million bank overdrafts primary sources funds financing activities year ended december 31 2004 20 million cash received issuance common stock related stock options exercised increase outstanding debt bank overdrafts 18 million 19 million respectively partially offset dividends paid series b preferred shares 15 million deferred financing fees 10 million net total cash flow operating investing financing activities 260 million 70 million 443000 years ended december 31 2006 2005 2004 respectively december 31 2006 352 million cash hand 783 million total borrowing availability additionally pursuant terms 2006 revolving credit facilities right increase borrowing capacity us portion facility additional 500 million addition normal operating cash requirements anticipated principal future cash requirements fund capital expenditures preferred stock dividends employee benefit obligations strategic acquisitions feasible companies assets product lines complement existing businesses believe cash operations borrowing capacity described adequate current longterm financing needs working capital needs cannot assure able successfully identify suitable acquisition opportunities complete particular acquisition able finance transaction january 31 2007 available liquidity including cash hand borrowing availability revolving facilities approximately 1151 million additionally pursuant terms 2006 revolving credit facilities right increase borrowing capacity us portion facility additional 500 million offbalance sheet arrangements offbalance sheet arrangements december 31 2006 contractual obligations following table summarizes company’s known contractual obligations december 31 2006 1 represents open materialequipment services purchase orders placed 2006 delivery billing scheduled 2007 beyond index financial statements 2 represents total us postretirement benefit obligation december 31 2006 benefit payments associated obligation actuarially estimated based upon past actual experience changes actuarial assumptions medical trend rates subsequent years effect applying sfas 158 “employer’s accounting defined benefit pension postretirement plans” could cause liability postretirement benefit plan fluctuate shortterm longterm portion us postretirement benefit obligation recorded “accrued expenses other” “postretirement benefits longterm liabilities” accounts respectively 3 represents total uk office closure obligation balance sheet shortterm portion obligation included “accrued expenses other” longterm portion included “postretirement longterm liabilities” accounts payments due period represent estimated payments future years debt revolving credit facilities july 12 2006 company terminated 2004 term loan revolving credit facilities entered new agreement 2006 revolving credit facilities 2006 revolving credit facilities provide total borrowing capacity 850 million maturity date june 30 2011 borrowing capacities 2006 revolving credit facilities agreement subject monthly borrowing base limitations addition base commitments new facilities permit company require increase aggregate borrowing capacity 500 million certain requirements met incurred 454000 deferred financing fees related 2006 revolving credit facilities agreement amortized 2006 revolving credit facilities agreement’s fiveyear term 2006 revolving credit facilities agreement provides interest rate based upon ratio funded debt ebitda defined credit facility “ebitda” ranging company’s election 1 low london interbank offered rate “libor” plus 100 high libor plus 200 2 low base rate defined credit facility “base rate” plus 000 high base rate plus 100 company obligated pay commitment fees related agreement undrawn portion facility depending upon ratio funded debt ebitda calculated 025 undrawn portion facility december 31 2006 borrowings outstanding 2006 revolving credit facilities december 31 2006 company letters credit outstanding 109 million december 31 2006 availability 2006 revolving credit facilities reduced amount outstanding letters credit loans fees related letters credit approximately 10 outstanding balance december 31 2006 letters credit support contract performance warranties expire various dates december 2009 2006 revolving credit facilities agreement secured first lien first priority security interest pledge substantially assets borrowers certain subsidiaries including accounts receivable inventory equipment intangibles equity interests us subsidiaries 66 13 equity interest active nonus subsidiaries interests certain contracts assets company active us subsidiaries secure us canadian uk revolving facilities assets company’s canadian subsidiary also secure canadian facility assets company’s uk subsidiaries also secure uk facility us facility guaranteed us subsidiary company canadian uk facilities guaranteed natco group inc us subsidiaries canadian subsidiary uk subsidiaries applicable 2006 revolving credit facilities agreement contains restrictive covenants including among others limit amount funded debt ebitda impose minimum fixed charge coverage ratio impose index financial statements minimum tangible net worth requirement compliance restrictive debt covenants december 31 2006 pursuant 2006 revolving credit facilities company permitted make distributions property cash stockholders dividends required series b preferred stock certain dividends exceed aggregate 30 million per year certain conditions related funded debt ebitda borrowing capacity met 15 million per year aggregate conditions met subject certain restrictions company also ability buy back 250 million value common stock borrowings 274 million outstanding term loan portion 2004 term loan revolving credit facility december 31 2005 bore interest average rate 626 borrowings outstanding revolving credit portion facilities december 31 2005 december 31 2005 company 145 million letters credit outstanding 2004 term loan revolving credit facilities related fees approximately 200 outstanding balance letters credit support contract performance warranties expire various dates february 2008 year ended december 31 2006 decreased debt 2004 term loan revolving credit facility 2006 revolving credit facilities 274 million 274 million december 31 2005 zero december 31 2006 export sales facility july 23 2004 company two subsidiaries entered international revolving credit agreement wells fargo hsbc trade bank na providing loans 100 million subject borrowing base limitations working capital facility export sales secured specific project inventory receivables well certain inventory accounts receivable equipment partially guaranteed us exportimport bank loans facility mature june 23 2007 bear interest either 1 base rate defined agreement less 025 2 libor plus 200 company’s election loans outstanding december 31 2006 letters credit outstanding facility december 31 2006 58 million facility fees related letters credit approximately 100 outstanding balance december 31 2006 company unsecured letters credit bonds totaling 584000 available borrowing capacity december 31 2006 revolving credit facilities export sales credit agreement 741 million 42 million respectively although assurances given believe operating cash flow supported borrowing capacity adequate fund operations least next twelve months decide pursue acquisition opportunities determination ability finance acquisitions key element analysis opportunities new accounting pronouncements march 2005 fasb issued fasb interpretation “fin” 47 “accounting conditional asset retirement obligations” fin 47 clarifies term “conditional asset retirement obligation” used sfas 143 “accounting asset retirement obligations” refers legal obligation perform asset retirement activity timing method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing method settlement uncertainty timing method settlement conditional asset retirement obligation factored measurement liability sufficient information exists fin 47 also clarifies entity would sufficient information reasonably estimate fair value asset retirement obligation interpretation effective later end fiscal years ending december 15 2005 adoption interpretation fiscal 2006 material effect company’s consolidated results operations financial position cash flows index financial statements may 2005 fasb issued sfas 154 “accounting changes error correctionsa replacement apb opinion 20 fasb statement 3” standard changes requirements accounting reporting change accounting principle among changes sfas 154 requires voluntary change accounting principle applied retrospectively prior period financial statements presented new accounting principle unless impracticable sfas 154 also provides 1 change method depreciating amortizing longlived nonfinancial asset accounted change estimate prospectively effected change accounting principle 2 correction errors previously issued financial statements termed “restatement” new standard effective accounting changes corrections errors made fiscal years beginning december 15 2005 company adopted standard january 1 2006 effective date impact company’s consolidated results operations financial positions cash flow september 2005 fasb’s emerging issues task force “eitf” issued eitf 0413 “accounting purchases sales inventory counterparty” pronouncement provides additional accounting guidance situations involving inventory exchanges parties contained apb opinion 29 “accounting nonmonetary transactions” sfas 153 “exchanges nonmonetary assets” standard effective new arrangements entered reporting periods beginning march 15 2006 inventory transactions completed december 15 2006 arrangements entered prior march 15 2006 company adopted standard january 1 2006 adoption standard material effect company’s consolidated results operations financial position cash flows september 2005 sec staff revised eitf d98 “classification measurement redeemable securities” primarily provide guidance 1 earnings per share treatment redeemable common stock 2 application eitf d98 sharebased payment arrangements employees guidance earnings per share treatment redeemable common stock eitf d98 sharebased payment arrangements employees effective first fiscal period beginning september 15 2005 company adopted eitf d98 effective date january 1 2006 relates earnings per share treatment redeemable common stock applied application sharebased payment arrangements employees concurrently adoption sfas 123r adoption standard material effect company’s consolidated results operations financial position cash flows february 2006 fasb issued sfas 155 “accounting certain hybrid financial instrumentsan amendment fasb statements 133 140” effective fiscal years beginning september 15 2006 statement issued clarify application fasb statement 133 beneficial interests securitized financial assets improve consistency accounting similar financial instruments regardless form instruments adoption standard january 1 2007 effective date impact company’s consolidated results operations financial position cash flows march 2006 fasb issued sfas 156 “accounting servicing financial assetsan amendment fasb statement 140” effective fiscal years beginning september 15 2006 statement issued simplify accounting servicing rights reduce volatility results using different measurement attributes adoption standard january 1 2007 impact company’s consolidated results operations financial position cash flows march 2006 eitf issued eitf 0501 “accounting conversion instrument became convertible upon issuer’s exercise call option” issue requires issuance equity securities settle debt instrument became convertible issuer’s exercise call option accounted conversion debt instrument contains substantive conversion feature issuance date absent substantive conversion feature accounted debt extinguishment eitf 0501 effective periods beginning june 28 2006 company adopted standard july 1 2006 adoption standard material effect company’s consolidated results operations financial position cash flows index financial statements march 2006 eitf issued eitf 0603 “how taxes collected customers remitted governmental authorities presented income statement gross versus net presentation eitf 0603 requires presentation taxes assessed governmental authority directly imposed revenueproducing transaction seller customer either gross included revenue costs net excluded revenue basis accounting policy decision disclosed pursuant apb opinion 22 addition taxes reported gross basis company disclose aggregate basis amounts taxes interim annual financial statements period income statement presented amount significant issue applies financial reports interim annual reporting periods beginning december 15 2006 company currently reports revenue net basis company adopted eitf 0603 january 1 2007 expect application eitf 0603 effect company’s consolidated results operations financial position cash flows june 2006 fasb issued fin 48 “accounting uncertainty income taxes” interpretation clarifies accounting uncertainty income taxes recognized enterprise’s financial statements accordance fasb statement 109 accounting income taxes fin 48 prescribes recognition threshold measurement attribute financial statement recognition measurement tax position taken expected taken tax return well provides guidance derecognition classification interest penalties accounting interim periods disclosure transition interpretation effective fiscal years beginning december 15 2006 company adopted fin 48 january 1 2007 believe application interpretation material effect consolidated results operations financial position cash flows september 2006 fasb issued staff position “fsp” aug air1 “accounting planned major maintenance activities” prohibits use accrueinadvance method accounting planned major maintenance activities annual interim financial reporting periods fsp aug air1 effective fiscal year beginning december 15 2006 december 31 2006 company accrual approximately 500000 related membranes’ maintenance replacements company adopted fsp augair1 effective date january 1 2007 september 2006 fasb issued sfas 157 “fair value measurements” become effective january 1 2008 sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value measurements company process evaluating impact standard consolidated results operations financial positions cash flows adopt january 1 2008 applicable september 2006 fasb issued sfas 158 “employers’ accounting defined benefit pension postretirement plans” statement requires public company recognize funded status pension postretirement benefit plan balance sheet disclose related information financial statements’ footnotes end fiscal year ending december 15 2006 company currently measures plans’ assets benefit obligations company’s fiscal year end date company adopted sfas 158 december 31 2006 material impact company’s consolidated results operations financial position cash flows resulting adoption standard september 2006 sec released staff accounting bulletin 108 “sab 108” “considering effects prior year misstatements quantifying misstatements current year financial statements” provides interpretive guidance us securities exchange commission’s views regarding process quantifying materiality financial statements sab 108 effective fiscal years ending november 15 2006 early application first interim period ending november 15 2006 impact provision company’s consolidated results operations financial position cash flows year ended december 31 2006 company adopted effective date december 31 2006 index financial statements february 2007 fasb issued sfas 159 “the fair value option financial assets financial liabilities including amendment fasb statement 115” permits entities choose measure eligible items fair value specified election dates sfas 159 effective january 1 2008 early adoption permitted business entity shall report unrealized gains losses items fair value elected earnings subsequent reporting date company currently assessing impact sfas 159 consolidated financial position results operations february 2007 fasb issued fsp fas 1581 “conforming amendments illustrations fasb statements 87 88 106 related staff implementation guides” staff position provides 1 updated illustrations contained appendix b statement 87 appendix b statement 87 appendix c statement 106 amended statement 158 2 updated questions answers previous fasb special reports related statement 87 88 106 fsp fas 1581 effective date statement 158 december 31 2006 impact company’s consolidated results operations financial position cash flows resulting adoption fsp fas 1581 item 7a nannannanitem 7a quantitative qualitative disclosures market risk operations conducted around world number different countries accordingly earnings exposed changes foreign currency exchange rates majority foreign currency transactions relate operations canada uk natco canada contracts denominated canadian dollars costs incurred canadian dollars thereby mitigating risks associated currency fluctuations axsia ukbased operation acquired march 2001 many contracts denominated us dollars occasionally euros whereas costs may british pounds sterling consequently currency risk uk operations prior date acquisition axsia entered certain forward contract arrangements whereby sold us dollars future delivery specified strike price order hedge exposure currency fluctuations contracts denominated us dollars third fourth quarters 2001 paid approximately 249000 terminate forward contracts forward contracts derivative arrangements existed december 31 2002 currently intend enter new forward contracts derivative arrangements part currency risk management strategy financial instruments subject changes interest rates including revolving credit term loan facility working capital facility export sales longterm facility secured magnolia manufacturing plant december 31 2002 378 million outstanding term loan portion revolving credit term loan facility december 31 2002 outstanding borrowings revolving credit agreement totaled 90 million borrowings revolving credit agreement bear interest floating rates december 31 2002 weighted average interest rate borrowings revolving credit term loan facility 426 borrowings outstanding export sales credit facility 43 million december 31 2002 bore interest 425 borrowing longterm arrangement secured magnolia manufacturing facility totaled 14 million december 31 2002 accrued interest 465 based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material assuming current level borrowings december 31 2002 100 basis point increase interest rates borrowings would decrease current year net income cash flow operations approximately 364000 calculation assumes action part mitigate exposure furthermore calculation consider effects possible change level overall economic activity could exist environment item 8item 7a quantitative qualitative disclosures market risk operations conducted around world number different countries accordingly earnings exposed changes foreign currency exchange rates majority foreign currency transactions relate operations canada uk canada contracts denominated canadian dollars costs incurred canadian dollars mitigates risks associated currency fluctuations uk many sales contracts material purchases denominated currency british pounds sterling primarily us dollars euros whereas engineering overhead costs principally denominated british pounds sterling attempt minimize exposure foreign currency exchange rate risk requiring settlement functional currencies possible however enter forward contracts currencyrelated derivative hedge arrangements currently intend enter contracts arrangements part currency risk management strategy warrants issued holders series b preferred shares provide netcash settlement event change control defined warrants consequently use derivative accounting record warrant transaction liability representing fair value derivative arrangement recorded 99000 march 31 2003 adjusted 154000 december 31 2003 reflect projected change fair value warrants period resulting 55000 revaluation loss period inception december 31 2003 fair value agreed counterparty agreement based pricing model included subjective assumptions concerning volatility common stock expected term warrants would outstanding expected dividend rate zero overall liquidity factor reporting date liability adjusted current fair value changes fair value reported earnings period change may exposed certain income fluctuations based upon changes fair market value liability due changes price common stock well factors financial instruments subject changes interest rates including revolving credit term loan facilities working capital facility export sales longterm facility secured magnolia manufacturing plant december 31 2003 borrowings 308 million outstanding term loan portion 2001 revolving credit term loan facilities interest rate 391 borrowings bear interest floating rates outstanding 2001 revolving credit agreement december 31 2003 totaled 109 million december 31 2003 weighted average interest rate borrowings 2001 revolving credit facilities 488 borrowings 700000 outstanding working capital facility export sales december 31 2003 accrue interest 400 borrowings longterm arrangement secured magnolia manufacturing facility totaled 13 million accrued interest 440 based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material assuming current level borrowings december 31 2003 100 basis point increase interest rates variable interest rate facilities would decrease net income cash flow operations 275000 436000 respectively event adverse change interest rates could take action mitigate exposure however due uncertainty actions could taken possible effects calculation assumes actions furthermore calculation consider effects possible change level overall economic activity could exist environment item 8nanitem 7a quantitative qualitative disclosures market risk operations conducted around world number different countries accordingly earnings cash flow exposed changes foreign currency exchange rates majority foreign currency transactions relate operations canada uk canada contracts denominated canadian dollars costs incurred canadian dollars mitigates risks associated currency fluctuations uk many sales contracts material purchases denominated currency british pounds sterling primarily us dollars euros whereas engineering overhead costs principally denominated british pounds sterling attempt minimize exposure foreign currency exchange rate risk requiring settlement functional currencies possible currently enter forward contracts currencyrelated derivative hedge arrangements financial instruments subject changes interest rates including revolving credit term loan facilities working capital facility export sales december 31 2005 borrowings 274 million outstanding term loan portion 2004 revolving credit interest rates 625 644 december 31 2005 weighted average interest rate borrowings 2004 revolving credit facilities 626 borrowings outstanding revolving credit facilities working capital facility export sales december 31 2005 based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material assuming current level borrowings december 31 2005 100 basis point increase interest rates variable interest rate facilities would decrease net income cash flow operations 274000 event adverse change interest rates could take action mitigate exposure however due uncertainty actions could taken possible effects calculation assumes actions furthermore calculation consider effects possible change level overall economic activity could exist environment item 8item 7a quantitative qualitative disclosures market risk exchange rate operations conducted around world number different countries accordingly earnings cash flow exposed changes foreign currency exchange rates majority foreign currency transactions related operations canada uk japan canada sales contracts related costs incurred denominated canadian dollars mitigates risks associated currency fluctuations uk many sales contracts material purchases denominated currency british pounds sterling primarily us dollars euros whereas engineering overhead costs principally denominated british pounds sterling japan contracts denominated us dollars costs incurred japanese yen future may additional foreign currency transactions related operations scandinavia kingdom saudi arabia result recent acquisitions joint ventures attempt minimize exposure foreign currency exchange rate risk requiring settlement functional currencies possible currently enter forward contracts currencyrelated derivative hedge arrangements may consider market conditions warrant index financial statements interest rate financial instruments subject changes interest rates including revolving credit facilities working capital facility export sales december 31 2007 borrowings outstanding revolving credit facilities working capital facility export sales based past market movements anticipated nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material item 8item 7a quantitative qualitative disclosures market risk exchange rate operations conducted around world number different countries accordingly earnings cash flow exposed changes foreign currency exchange rates majority foreign currency transactions relate operations canada uk norway japan canada contracts denominated canadian dollars costs incurred canadian dollars mitigates risks associated currency fluctuations uk many sales contracts material purchases denominated currency british pounds sterling primarily us dollars euros whereas engineering overhead costs principally denominated british pounds sterling norway contracts index financial statements denominated norwegian kroner costs incurred norwegian kroner japan contracts costs incurred denominated currency japanese yen primarily us dollars attempt minimize exposure foreign currency exchange rate risk requiring settlement functional currencies possible currently enter forward contracts currencyrelated derivative hedge arrangements interest rate financial instruments subject changes interest rates including revolving credit facilities export sales credit facility shortterm investments invest excess cash shortterm highly liquid investments investment objective preserve principal maintain liquidity december 31 2008 130 million outstanding credit facilities based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material item 8item 7a quantitative qualitative disclosures market risk operations conducted around world number different countries accordingly earnings cash flow exposed changes foreign currency exchange rates majority foreign currency transactions relate operations canada uk japan canada contracts denominated canadian dollars costs incurred canadian dollars mitigates risks associated currency fluctuations uk many sales contracts material purchases denominated currency british pounds sterling primarily us dollars euros whereas engineering overhead costs principally denominated british pounds sterling japan contracts denominated us dollars costs incurred japanese yen attempt minimize exposure foreign currency exchange rate risk requiring settlement functional currencies possible currently enter forward contracts currencyrelated derivative hedge arrangements financial instruments subject changes interest rates including revolving credit term loan facilities working capital facility export sales december 31 2005 borrowings 274 million outstanding term loan portion 2004 term loan revolving credit facilities interest rates 625 644 july 2006 replaced 2004 term loan revolving credit facilities 2006 revolving credit facilities december 31 2006 borrowings outstanding 2006 revolving credit facilities working capital facility export sales based past market movements possible nearterm market movements believe potential nearterm losses future earnings fair values cash flows changes interest rates likely material item 8 item 8 financial statements supplementary data following consolidated financial statements company year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 applicable along independent auditors report independent auditors report board directors natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 1999 december 31 1998 related consolidated statements operations stockholders equity comprehensive income cash flows year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 consolidated financial statements responsibility companys management responsibility express opinion consolidated financial statements based audits conducted audits accordance generally accepted auditing standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 1999 december 31 1998 results operations cash flows year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 conformity generally accepted accounting principles kpmg llp houston texas march 1 2000 natco group inc subsidiaries consolidated balance sheets dollars thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements operations dollars thousands except per share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements stockholders equity comprehensive income dollars thousands see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements cash flows dollars thousands see accompanying notes consolidated financial statements natco group inc subsidiaries notes consolidated financial statements dollars thousands 1 organization natco group inc company formed june 1988 capricorn investors lp capricorn led group investors invested sufficient funds company enable company acquire several businesses combustion engineering inc ce june 21 1989 company acquired ce outstanding common stock w tyler incorporated tyler national tank company natco net assets certain foreign affiliates company accompanying consolidated financial statements related disclosures include results operations company majorityowned subsidiaries year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 1992 company contributed common stock investment tyler 5500 cash process technology holdings inc pth exchange issued outstanding common stock pth 1992 1993 pth company sold certain shares pth common stock third parties 1997 company completed taxfree spinoff pth stockholder results operations pth shown discontinued operations consolidated statements operations june 30 1997 natco acquired total engineering services team inc test november 20 1998 natco acquired cynara company cynara 2 summary significant accounting policies fiscal year change effective april 1 1998 company changed fiscal year end march 31 december 31 principles consolidation consolidated financial statements include accounts company majorityowned subsidiaries significant intercompany accounts transactions eliminated consolidation concentration credit risk concentrations credit risk respect trade receivables limited due large number customers comprising companys customer base geographic dispersion single customer represented 10 revenues year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 company one customer represented 14 revenues year cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents restricted cash december 31 1998 cash amount 883 pledged collateral outstanding letters credit related performance warranty guarantees classified restricted cash balance sheet restricted cash exists december 31 1999 inventories stated lower cost market cost determined using last first lifo method natco domestic inventories average cost test inventories first fifo method inventories property plant equipment property plant equipment stated cost less allowance depreciation plant equipment calculated using straightline method estimated useful lives maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included income carrying values property plant equipment location reviewed annually often indications assets may impaired goodwill amortized straightline basis periods 20 40 years company assesses recoverability intangible asset determining whether amortization remaining life recovered undiscounted future operating cash flows based recent analysis company believes material impairment goodwill exists december 31 1999 amortization expense year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 739 167 128 respectively accumulated amortization december 31 1999 december 31 1998 1133 394 respectively assets net assets consist prepaid pension assets deposits longterm nature deferred financing costs covenants compete deferred financing costs covenants compete capitalized amortized term related agreements amortization expense year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 570 244 262 respectively environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred revenue recognition revenues significant contracts natco contracts greater 250 longer four months duration test contracts orders recognized percentage completion method earned revenue based percentage incurred costs date bear total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects revenues related costs recognized products shipped services rendered customer stockbased compensation statement financial accounting standards sfas 123 accounting stockbased compensation permits entities recognize expense vesting period fair value stockbased awards date grant alternatively sfas 123 also allows entities continue apply provisions accounting principles board apb opinion 25 provide pro forma net income pro forma earnings per share disclosures employee stock option grants made 1995 future years fairvaluebased method defined sfas 123 applied company elected continue apply provision apb opinion 25 provide pro forma disclosure provisions sfas 123 research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years research development expenses totaled 1898 1001 738 year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 respectively warranty costs estimated future warranty obligations related products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims december 31 1999 december 31 1998 company 1798 2528 respectively outstanding letters credit related warranties income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment translation foreign currencies financial statement amounts related foreign operations translated united states dollar equivalents exchange rates follows 1 balance sheet accounts yearend exchange rates 2 statement operations accounts weighted average exchange rates period gains losses resulting translations deferred included accumulated comprehensive loss separate component stockholders equity gains losses foreign currency transactions reflected consolidated statements operations use estimates management company made number estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity generally accepted accounting principles actual results could differ estimates earnings per common share february 1997 financial accounting standards board fasb issued sfas 128 earnings per share replaced primary fully diluted earnings per share basic diluted earnings per share company adopted provisions sfas 128 fourth quarter 1997 previously reported earnings per share data restated sfas 128 basic earnings per share calculation excludes dilutive effect common stock equivalents determining basic earnings per share diluted earnings per common equivalent share computed dividing net income weighted average number common equivalent shares outstanding purposes calculation outstanding employee stock options considered common stock equivalents conformity securities exchange commission requirements common stock options warrants potentially dilutive instruments issued nominal consideration periods covered income statements presented reflected earnings per share calculations periods presented following table presents earnings per common share amounts computed using sfas 128 3 capital stock common stock june 25 1997 board directors company approved increase number authorized common shares 3000 20000000 date directors declared 7503 one common stock split effected distribution 7502 additional shares share common stock held stockholders record date march 6 1998 companys charter amended increase number authorized shares capital shares 20000000 55000000 5000000 shares preferred stock par value 001 50000000 shares common stock date board directors declared common stock split effected exchange four shares every three shares common stock outstanding share data restated reflect effects transaction november 18 1998 companys charter amended divide common stock two classes class common stock 45000000 shares class b common stock 5000000 shares two classes common stock relative rights preferences except holders class b common stock right voting separately class elect one member companys board directors vote amendment companys charter would authorize additional class b common stock would adversely affect right elect director class b shares may converted holder class shares time automatically convert class shares january 1 2002 4 acquisitions june 30 1997 natco completed acquisition test weatherford enterra inc 22475 cash funds used acquisition test provided 10640 additional equity 2360 loan capricorn investors ii lp capricorn ii proceeds new senior credit facility acquisition accounted purchase results test included consolidated financial statements since date acquisition purchase agreement allowed purchase price adjustments included guarantee collectibility test accounts receivable acquired purchase price date company subsequently received cash 1387 1690 related purchase price adjustments reimbursement uncollected accounts receivable test respectively end purchase price adjustment period goodwill amounted 6237 amortized fortyyear period november 20 1998 company completed acquisition cynara group private investors 5250 cash assumption 10118 cynara bank debt issuance 500000 shares natco class b common stock valued 5250 addition company may required issue additional 1400000 shares cynaras former shareholders based performance criteria defined purchase agreement company placed 450000 shares escrow related provision company issued 325836 escrowed shares december 31 1999 could required issue additional 950000 shares march 31 2000 december 31 2000 additional shares issued corresponding increase made cost excess fair value net assets acquired funds used acquisition cynara provided 5300 additional equity proceeds new senior credit facility provided syndicate major international banks acquisition accounted purchase results cynara included consolidated financial statements since date acquisition goodwill december 31 1999 december 31 1998 13480 11622 respectively accumulated amortization 577 30 respective periods 5 inventories consisted following amounts december 31 1999 december 31 1998 inventories valued using lifo method included amounted 14639 16060 respectively year ended december 31 1999 liquidations lifo layers resulted reduction cost sales 21 reduction lifo layers nine months ended december 31 1998 year ended march 31 1998 6 cost estimated earnings uncompleted contracts cost estimated earnings uncompleted contracts follows 7 property plant equipment net components property plant equipment follows depreciation expense 3666 1291 1168 respectively year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 company leases certain pieces machinery equipment customers generally periods one month one year cost leased machinery equipment 2958 2685 related accumulated depreciation 2161 1935 december 31 1999 december 31 1998 respectively lease rental income 450 536 648 year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 respectively included revenues 8 assets net assets consisted following deferred financing costs amortized life related debt instruments three five years accumulated amortization amounted 294 129 december 31 1999 december 31 1998 respectively 9 accrued expenses accrued expense consisted following nine months ended december 31 1998 year ended march 31 1998 company revised previous estimate accrued insurance reserves resulting reduction insurance expense 1207 1326 respectively 10 shortterm debt december 31 1999 december 31 1998 natco working capital facility export sales 100 million 50 million respectively loans bear interest prime 850 775 respectively december 31 1999 december 31 1998 borrowings based value inventory accounts receivable bank facility secured specific project inventory receivables 90 guarantee exim bank second lien assets pledged natco revolving credit bank loan working capital facilities loans annual programs facility place december 31 1999 matures july 23 2002 borrowings outstanding facility december 31 1999 outstanding balance december 31 1998 1585 company letters credit outstanding facility totaling 7360 523 december 31 1999 december 31 1998 respectively 11 longterm debt consolidated borrowings company follows aggregate annual future maturities longterm debt next five years ended december 31 follows 2000 4643 2001 4643 2002 4643 2003 17251 2004 0 natco november 20 1998 revolving credit term loan facility put place syndicate major international banks credit facility provides 32000 revolving credit line 22000 available us 10000 available canada finance eligible accounts receivable inventories 32500 term loan indebtedness credit facility bears interest floating rate based companys option upon base rate canadian prime rate respect base rate loans plus margin percentage ii london interbank offered rate one two three six months plus margin percentage margin percentage base rate canadian prime rate loans varies 100 000 depending companys debt capitalization ratio margin percentage eurodollar loans varies 250 100 depending companys debt capitalization ratio term borrowings mature november 30 2003 revolving borrowings mature november 30 2001 agreements contain affirmative covenants including financial requirements related minimum net worth debt capitalization ratio fixed charge coverage ratio well restrictions natco making distributions property cash company excess agreed sum without prior lender approval requires commitment fees accordance standard banking practices loan collateralized substantially assets company subsidiaries well guarantee company december 31 1999 company compliance restrictive covenants natco letters credit outstanding revolving credit facilities totaling 2553 december 31 1999 letters credit constitute contract performance warranty collateral expire various dates september 2002 industrial revenue bond secured plant real property equipment natco also guaranteed natco interest ranged 79 85 payable semiannually august 4 1999 company sold facility leased longterm agreement 950 net book value facility time sale approximately 385 proceeds sale used retire industrial development revenue bond related facility amounted 715 remaining amount applied companys outstanding revolver balances dividend restrictions respect new credit facilities natco agreed make distributions property cash company stockholders excess 1500 1998 2000 1999 2200 year thereafter plus 50 excess cash flow beginning 2001 companys previous canadian loan facility contained various restrictive covenants included limited restrictions aggregate capital expenditures andor dividends paid one fiscal year exceed 50 net cash flow defined sum tax net profit plus depreciationamortization deferred taxes less payments made long term debt fiscal year ended march 31 1998 natco canada restricted making payments excess 1699 parent company december 11 1991 company issued promissory notes capricorn evidence borrowings 5000 notes subordinated senior debt company thereafter interest payments deferred added principal amount notes period prior june 1997 maturity dates notes extended 2000 4600 thereof assumed consent capricorn pth connection distribution company capital stock pth capricorn conjunction refinancing domestic debt facility remaining notes plus accrued unpaid interest held capricorn exchanged 5100 principal amount companys 13 subordinated promissory note due 2000 cap note june 1997 company completed refinancing domestic debt facility part finance acquisition test time capricorn ii invested aggregate 13000 company received exchange 2113334 shares common stock 2400 principal amount companys 13 subordinated promissory note due 2000 cap ii note terms except principal amount identical cap note 13 subordinated notes convertible 1479258 shares company common stock effective april 1 1998 cap ii notes converted common stock company 12 income taxes income tax expense benefit consisted following components temporary differences related following items give rise deferred tax assets liabilities follows december 31 1999 december 31 1998 company record valuation allowance related deferred tax assets opinion management future operations likely generate sufficient taxable income realize deferred tax assets december 31 1999 company net operating loss carryforwards federal income tax purposes 1930 available offset future federal income tax 2019 income tax expense differs amount computed applying us federal income tax rate 34 income continuing operations income taxes result following provision made us income taxes would payable undistributed earnings foreign subsidiaries distributed company form dividends since managements intention reinvest earnings permanently related foreign operations december 31 1999 december 31 1998 amounts significant federal income tax returns fiscal years beginning 1997 open review internal revenue service 13 stockholders equity ceo stock options connection engagement nathaniel gregory chief executive officer company granted options purchase natco common stock subsequently converted options purchase common stock company december 31 1998 march 31 1998 options related aggregate 905104 shares company common stock outstanding options december 31 1999 totaled aggregate 880104 shares stock appreciation rights 1994 natco adopted national tank company stock appreciation rights plan national tank plan national tank plan provided grants officers key employees natco rights appreciation value stated number shares natco common stock value determined committee natco board directors maximum number rights issuable national tank plan 500000 rights vested three year period march 31 1997 390005 rights outstanding 290080 vested compensation expense adjusted connection plan nine months ended december 31 1998 year ended march 31 1998 reflect expense 23 86 respectively rights plan converted stock options discussed individual stock options july 1 1997 board directors company approved exchange rights outstanding discussed previously national tank plan individual options purchase common stock company exercise price options equal fair market value common stock accordingly compensation expense recorded individual stock options granted july 1 1997 vested ratably period three years accordance terms original stock appreciation rights new options issued july 1 1997 vested ratably four year period maximum term options 75 years company reserved aggregate 390005 shares common stock issuance upon exercise individual stock options stock options plans january 1998 february 1998 company adopted directors compensation plan employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares company common stock options vest periods four years maximum term options ten years december 31 1999 december 31 1998 march 31 1998 options relating aggregate 455085 464672 260006 shares outstanding plans following table summarizes transactions companys stock option plans year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 pro forma information regarding net income earnings per share required sfas 123 determined company accounted employee stock options minimum value method statement assumptions risk free rate 55 expected life options 10 years options issued year ended december 31 1999 nine months ended december 31 1998 options issued prior march 31 1998 risk free rate return used 7 expected life used 75 years purposes pro forma disclosures estimated fair value options amortized expense options vesting period companys pro forma net earnings per share year ended december 31 1999 nine months ending december 31 1998 year ended march 31 1998 follows statement provides pro forma amounts options granted beginning 1995 pro forma expense likely increase future years new option grants become subject pricing model preferred stock purchase rights may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 companys common stock announces commencement tender offer consummation would result ownership person group 15 common stock person group acquire 15 companys common stock right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board directors may redeem rights price 001 per right time acquisition person group 15 less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed 14 pension postretirement benefits company adopted sfas 132 revised disclosures pension postretirement benefit plans disclosures regarding pension benefits represent plan certain union employees foreign subsidiary disclosures regarding postretirement benefits represent health care life insurance benefits employees retired time company acquired ce december 1999 company entered agreement tyler capricorn company assumed responsibility retired employee health life insurance obligations tyler liability accrued respect obligations determined independent actuarial firm 1063 consideration agreement tyler paid company 400 cash assigned portion federal income tax refund due tyler amount 600 capricorn guaranteed payment latter amount see note 23 subsequent events discussion following table sets forth plans benefit obligation fair value plan assets funded status december 31 1999 december 31 1998 deferred compensation plan test adopted deferred compensation plan test plan effective july 1 1995 provide incentives rewards certain individuals awards payable five equal annual installments plus earnings allocated participants account company elected make additional awards plan year beginning january 1 1998 december 31 1999 december 31 1998 total amounts owed test plan 303 578 respectively balance presently accrues interest prime rate plus 1 defined contribution plans company subsidiaries defined contribution pension plans covering substantially nonunion hourly salaried employees completed three months service employee contributions 3 covered employees compensation matched 100 company additional 2 covered employees compensation matched 50 addition company may make discretionary contributions profit sharing contributions company contributions plan totaled 1638 1912 912 year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 respectively 15 operating leases company subsidiaries lease various facilities equipment noncancelable operating lease agreements leases expire various dates 2003 future minimum lease payments required operating leases remaining noncancelable lease terms excess one year december 31 1999 follows 2000 2640 2001 1514 2002 671 2003 225 2004 85 total expense operating leases year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 3169 2298 2563 respectively discussion lease rental income see property plant equipment net note 7 16 related parties company agreed 1989 pay 350 per year plus specified outofpocket expenses capricorn management reimburse capricorn management costs expenses incurred employees performing specified management responsibilities services included periods common ownership services pth whose capital stock company distributed capricorn june 30 1997 another affiliate sold effective july 1 1997 parties amended contract limit services provided capricorn management advisory information research services administrative services reduce cost reimbursement 75 per year services provided include office space parking connecticut companys chief executive officer reception telephone computer services normal office support relating space fees paid capricorn management totaled 75 56 163 year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 respectively employees capricorn management participated various natco employee benefit plans company time received billings vendors services provided capricorn management personnel acting benefit company capricorn management reimburses company foregoing expenses december 31 1999 december 31 1998 capricorn management owed company 5 16 respectively expenses year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 pth paid 84 49 95 respectively company tax consulting analysis services effective december 31 1994 capricorn entered option agreement former officer 25 stockholder company see option enabled stockholder exchange common stock specified interest note company exercised may 10 1995 18 subordinated note 1330 see note 11 also fiscal year 1997 capricorn purchased 1079 note holder fiscal year ended march 31 1998 capricorn purchased remaining portion note 1997 company loaned amount 1525 rate 10 per annum director company also affiliate capricorn march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn distributed holding company common stock partners 1998 company acquired option cost 200 purchase 173050 shares company common stock director price 881 per share companys option note may repaid shares common stock company cost acquire option recorded treasury stock accompanying consolidated balance sheet refer discussion subsequent events note 23 executive officer company employment agreement pursuant entitled bonus upon occurrence sale public offering company bonus equal one onehalf percent 15 value securities owned stockholders company prior sale offering including common stock valued price per share received either sale public offering debt held stockholders july 1999 company amended agreement eliminate bonus instead company agreed lend officer 1205 purchase 136832 shares common stock loan accrues interest 6 annually officer receive bonus equal outstanding principal interest note upon sale public offering company refer discussion subsequent events note 23 december 1999 company assumed postretirement pension liability former affiliate tyler refer discussion pensions postretirement benefits note 14 17 discontinued operations pth manufactures vibrating screens rock crushing equipment conveyor components screening media operations united states canada scotland june 30 1997 company completed taxfree spinoff pth distributing 14250 shares pth stock owned capricorn holder common stock capricorn sole stockholder company time distribution accordingly transaction recorded historical cost basis spinoff distribution reduced stockholders equity 4558 represents net assets pth date spinoff including assumption 4576 debt owed company capricorn forgiveness 2347 intercompany balances historical results discontinued operations include allocation companys nonspecific interest expense based ratio net assets pth divided sum net assets company plus companys debt interest expense directly incurred natco excluded ratio interest expense company attributable operations pth included profit loss discontinued operations year ending march 31 1998 including disposal date june 30 1997 285 time spinoff company pth entered tax sharing agreement provisions determining responsibility tax liabilities pth years pth included companys consolidated tax returns income taxes allocated pth based pretax income calculated separate company basis pursuant requirements sfas 109 accounting income taxes income tax allocated pth year ended march 31 1998 395 summarized financial data discontinued operations follows financial statements related notes reclassified present financial information businesses discontinued operations results operations businesses classified discontinued operations consolidated statements income shown net related income tax expense 18 commitments contingencies june 1997 company connection financing effected provide funds acquisition test corporate purposes distributed outstanding stock pth owned company sole stockholder capricorn connection distribution company received opinion counsel effect distribution would taxfree company capricorn taxfree treatment distribution depends part upon underlying facts circumstances time distribution assurance internal revenue service agree interpretation company counsel facts circumstances internal revenue service challenge taxfree treatment distribution challenge ultimately prevail company would treated recognizing gain respect distribution amount equal excess fair market value pth stock time distribution tax basis company treatment could material adverse effect companys results operations financial condition 19 litigation company party various routine legal proceedings primarily involve commercial claims products liability claims asbestos related personal injury claims workers compensation claims cannot predict outcome lawsuits legal proceedings claims certainty nevertheless believe outcome proceedings even determined adversely would material adverse effect business financial condition 20 industry segments geographic information company adopted provisions sfas 131 disclosures segments enterprise related information companys eight business units separate management teams infrastructures offer different products services business units aggregated four reportable segments described since longterm financial performance reportable segments affected similar economic conditions engineered systems segment consists five business units us engineered systems cynara natco japan natco venezuela natco london provide design engineering manufacturing startup services engineered process systems principal markets segment include major oil gas producing regions world including north america latin america europe africa far east customers include major multinational independent national stateowned companies traditional production equipment services us sales service sole business unit reported segment unit designs engineers manufactures provides startup services production equipment generally less complex units provided engineered systems segment also provides replacement parts field shop servicing equipment used equipment refurbishing principal market segment us onshore offshore market also serves international market customers include major multinational independent national stateowned companies instrumentation electrical systems test sole business unit reported segment unit designs manufactures installs services instrumentation electrical control systems principal markets segment include major oil gas producing regions world including north america latin america europe kazakhstan africa far east customers include major multinational independent national stateowned companies natco canada segment consists subsidiary canada natco canada provides design engineering manufacturing startup services engineered process systems also provides replacement parts field shop servicing equipment used equipment refurbishing natco canada also done selective manufacturing engineered systems segment past principal markets segment oil gas producing regions canada customers include major multinational independent companies accounting policies reportable segments described note 2 company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense gains losses revaluations postretirement benefit liability interest cost postretirement benefit liability accounting changes nonrecurring items summarized financial information concerning companys reportable segments shown following table year ended nine months ended companys geographic data continuing operations year ended december 31 1999 nine months ended december 31 1998 year ended march 31 1998 follows corporate expenses consist corporate overhead research development expenses revenue one customer canada year ended march 31 1998 amounted 19923 contract awarded natco canada principally result sales efforts made natco corporate personnel located united states 21 quarterly data following tables summarize unaudited quarterly information years ended december 31 1999 1998 22 office closure prior 1997 company began winding operations natco uk ltd activities include transferring net assets employees companys parts service business new us subsidiary natco london inc resolving pending severance office closure leasehold issues included march 31 1998 statement operations charge 282 recognized estimated cost exit activities principally consists lease termination costs professional fees associated winding operation year ended december 31 1999 company completed closure reached favorable settlements related various amounts owed customers vendors related number contracts entered 1993 1995 accrual costs associated various claims made fiscal years 1995 1998 based best available information time result favorable settlements company revised previous estimates reversed 314 accruals 23 subsequent events january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders proceeds company less underwriting fees 37700 funds used retire debt 22857 revolving credit facility complete acquisition portatest international inc february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock proceeds 10463 net fees proceeds used pending acquisition modular production equipment inc working capital needs september october 1999 company executed nonbinding letters intent acquire portatest international inc engineering specialties inc modular production equipment inc company closed portatest international inc transaction january 24 2000 approximately 5400 cash net cash acquired issuance oneyear promissory note approximately 700 february 8 2000 company closed modular production equipment inc transaction approximately 2500 cash net cash acquired issuance oneyear promissory note approximately 300 purchase price allocations yet finalized acquisitions companys initial public offering became effective january 2000 bonus arrangement officer company executed partial settlement 1242 note receivable accrued interest recorded december 31 1999 arrangement february 2000 company recorded compensation expense 1248 officer used proceeds bonus payment net tax repay 665 debt outstanding february 29 2000 balance receivable accrued interest officer 583 see note 16 related parties note arrangement director recorded 1890 current asset december 31 1999 partially settled february 2000 company exercised option purchase 173050 shares common stock director cost 1525 remaining balance note february 29 2000 365 see note 16 related parties february 2000 company received 613 tyler settlement agreement entered tyler capricorn company whereby company assumed responsibility retired employee health life insurance obligations tyler see note 14 pension postretirement benefits item 9item 8 financial statements supplementary data follow consolidated financial statements company years ended december 31 2000 1999 nine months ended december 31 1998 applicable along independent auditors report independent auditors report board directors natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 2000 1999 related consolidated statements operations stockholders equity comprehensive income cash flows years ended december 31 2000 1999 nine months ended december 31 1998 consolidated financial statements responsibility companys management responsibility express opinion consolidated financial statements based audits conducted audits accordance auditing standards generally accepted united states america standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2000 1999 results operations cash flows years ended december 31 2000 1999 nine months ended december 31 1998 conformity accounting principles generally accepted united states america discussed note 15 consolidated financial statements company changed method accounting postretirement benefits january 2000 kpmg llp houston texas february 15 2001 natco group inc subsidiaries consolidated balance sheets thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements stockholders equity comprehensive income thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements cash flows thousands see accompanying notes consolidated financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization natco group inc natco formed june 1988 capricorn investors lp led group investors provided capital company acquire several businesses combustion engineering inc ce june 21 1989 company acquired ce outstanding common stock ws tyler incorporated tyler national tank company well net assets certain foreign affiliates accompanying consolidated financial statements related disclosures include results operations company majorityowned subsidiaries years ended december 31 2000 1999 nine months ended december 31 1998 1992 natco contributed common stock investment tyler 55 million cash process technology holdings inc pth exchange issued outstanding common stock pth 1992 1993 pth natco sold certain shares pth common stock third parties 1997 company completed taxfree spin pth stockholder june 30 1997 natco acquired total engineering services team inc test november 20 1998 natco acquired cynara company cynara company acquired portatest international inc portatest january 24 2000 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock february 8 2000 april 4 2000 natco acquired modular production equipment inc mpe engineering specialties inc esi respectively references natco company used throughout document relate collectively natco group inc consolidated subsidiaries 2 summary significant accounting policies fiscal year change effective april 1 1998 company changed fiscal year end march 31 december 31 principles consolidation consolidated financial statements include accounts company majorityowned subsidiaries significant intercompany accounts transactions eliminated consolidation concentration credit risk concentrations credit risk respect trade receivables limited due large number customers comprising companys customer base geographic dispersion however year ended december 31 2000 one customer carigalitriton operating company sdn bhd ctoc general contractor samsung provided revenues 459 million approximately 20 total revenues customer provided 10 revenues year ended december 31 2000 customer provided 10 revenues year ended december 31 1999 nine months ended december 31 1998 see note 22 industry segments geographic information cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents restricted cash december 31 1998 cash amount 883000 pledged collateral outstanding letters credit related performance warranty guarantees classified restricted cash balance sheet restricted cash existed december 31 2000 december 31 1999 inventories stated lower cost market cost determined using last first lifo method natco domestic inventories average cost test inventories first fifo method inventories property plant equipment property plant equipment stated cost less allowance depreciation plant equipment calculated using straightline method assets estimated useful lives maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included income carrying values property plant equipment location reviewed annually often indications assets may impaired goodwill amortized straightline basis periods 20 40 years company assesses recoverability intangible asset determining whether amortization remaining life recovered undiscounted future operating cash flows based recent analysis companys management believes material impairment goodwill exists december 31 2000 amortization expense years ended december 31 2000 1999 nine months ended december 31 1998 20 million 739000 167000 respectively accumulated amortization december 31 2000 december 31 1999 28 million 11 million respectively assets net assets consist prepaid pension assets longterm deposits deferred financing costs covenants compete deferred financing costs covenants compete amortized term related agreements amortization expense years ended december 31 2000 1999 nine months ended december 31 1998 554000 570000 244000 respectively environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred revenue recognition revenues significant contracts natco contracts greater 250000 longer four months duration test contracts orders recognized percentage completion method earned revenue based percentage incurred costs date bear total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects revenues related costs recognized products shipped services rendered customer stockbased compensation statement financial accounting standards sfas 123 accounting stockbased compensation permits entities recognize expense vesting period fair value stockbased awards date grant alternatively sfas 123 allows entities continue apply provisions accounting principles board apb opinion 25 provide pro forma net income earnings per share disclosures employee stock option grants made 1995 future years fairvaluebased method defined sfas 123 applied company elected continue apply provision apb opinion 25 provide pro forma disclosure provisions sfas 123 research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years research development expenses totaled 18 million 19 million 10 million years ended december 31 2000 1999 nine months ended december 31 1998 respectively warranty costs estimated future warranty obligations related products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims december 31 2000 december 31 1999 company 931000 18 million respectively outstanding letters credit related warranties income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment translation foreign currencies financial statement amounts related foreign operations translated united states dollar equivalents exchange rates follows 1 balance sheet accounts yearend exchange rates 2 statement operations accounts weighted average exchange rate period gains losses resulting translations deferred included accumulated comprehensive loss separate component stockholders equity gains losses foreign currency transactions reflected consolidated statements operations use estimates companys management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity generally accepted accounting principles actual results could differ estimates earnings per common share basic earnings per share excludes dilutive effect common stock equivalents diluted earnings per common equivalent share computed dividing net income weighted average number common equivalent shares outstanding purposes calculation outstanding employee stock options considered common stock equivalents conformity securities exchange commission requirements common stock options warrants potentially dilutive instruments issued nominal consideration periods covered income statements presented reflected earnings per share calculations periods presented antidilutive stock options excluded calculation common stock equivalents impact antidilutive shares would reduction 36000 shares year ended december 31 2000 antidilutive stock options year ended december 31 1999 nine months ended december 31 1998 following table presents earnings per common share amounts computed using sfas 128 3 capital stock november 18 1998 companys charter amended divide common stock two classes class common stock 45000000 shares class b common stock 5000000 shares two classes common stock relative rights preferences except holders class b common stock right voting separately class elect one member companys board directors class b shares may converted holder class shares time automatically convert class shares january 1 2002 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders proceeds company less underwriting fees 377 million funds used retire debt 279 million term loan facility repay borrowings 30 million revolving credit facility used acquire portatest retire 22 million portatest debt acquired pay offering costs 15 million fund working capital needs february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock proceeds 105 million net underwriters fees proceeds overallotment used complete acquisition mpe including repayment 685000 debt acquired working capital needs 1997 company provided loan 15 million interest rate 10 per annum director company also affiliate capricorn holdings inc capricorn march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn distributed holdings natcos common stock partners 1998 company acquired option cost approximately 200000 purchase 173050 shares natcos common stock director price 881 per share companys option note provided obligation could repaid shares natcos common stock cost acquire option recorded treasury stock accompanying consolidated balance sheets february 2000 company exercised option acquire 173050 shares natcos class common stock director 15 million reduced note due director amount shares recorded treasury stock cost accompanying consolidated balance sheet balance note due director repaid june 2000 september 1999 june 2000 325836 class b shares 418145 class b shares respectively issued former shareholders cynara company cynara connection achievement certain performance criteria defined november 1998 purchase agreement goodwill increased 34 million 1999 41 million 2000 result transactions october 2000 companys board directors approved stock repurchase plan 750000 shares companys class common stock could acquired november 2000 company reacquired 34000 shares class common stock repurchase plan 242000 average cost 7 per share cost reacquire shares recorded treasury stock december 31 2000 4 acquisitions november 20 1998 company completed acquisition cynara group private investors 53 million cash assumption 101 million cynara bank debt issuance 500000 shares natco class b common stock valued 53 million purchase agreement also stipulated natco may required issue additional 1400000 shares class b common stock cynaras former shareholders based certain performance criteria defined purchase agreement company issued 325836 class b shares 418145 class b shares september 1999 june 2000 respectively per agreement resulted increase goodwill see note 3 capital stock funds used acquisition cynara provided 53 million equity proceeds borrowings senior credit facility provided syndicate major international banks acquisition accounted purchase results cynara included consolidated financial statements since date acquisition goodwill december 31 2000 1999 176 million 135 million respectively accumulated amortization 14 million 577000 respective periods company acquired outstanding common stock portatest january 24 2000 approximately 63 million cash net cash acquired included payment specific accrued liabilities former company purchase certain proprietary intellectual property associated us company issuance oneyear promissory note 10 million denominated canadian dollars payment contingent upon certain operating criteria met see note 19 commitments contingencies acquisition accounted using purchase method accounting results operations portatest included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period goodwill accumulated amortization related portatest acquisition 57 million 277000 respectively december 31 2000 company acquired outstanding common stock mpe february 8 2000 approximately 24 million cash net cash acquired issuance oneyear promissory note 338000 accrues interest 10 per annum acquisition accounted using purchase method accounting results operations mpe included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period goodwill accumulated amortization related mpe acquisition 34 million 169000 respectively december 31 2000 company acquired outstanding common stock esi april 4 2000 approximately 71 million net cash equivalents acquired subject adjustment acquisition financed borrowings 71 million existing revolving credit facility borrowings 26 million existing export sales facility accounted using purchase method accounting results operations esi included natcos consolidated financial statements since date acquisition final purchase price adjustment determined december 31 2000 excess purchase price fair values net assets acquired amortized twentyyear period goodwill accumulated amortization related esi acquisition 60 million 212000 respectively december 31 2000 5 unusual charges pursuant employment agreement executive officer entitled bonus upon occurrence sale public offering company bonus equaled one onehalf percent 15 value securities owned stockholders company prior sale offering including common stock valued price per share received either sale public offering debt held stockholders july 1999 company amended employment agreement eliminate bonus agreed loan officer 12 million purchase 136832 shares common stock per agreement officer would receive bonus equal outstanding principal interest note upon sale public offering company february 2000 company completed initial public offering class common stock natco recorded expense 13 million settlement obligation agreement officer used proceeds net tax repay company approximately 665000 outstanding balance note december 31 2000 616000 loan accrues interest 6 annually first quarter 2000 natco incurred relocation charges approximately 208000 associated consolidation existing company facility acquired connection acquisition portatest 6 inventories consisted following amounts december 31 2000 december 31 1999 inventories valued using lifo method included amounted 223 million 146 million respectively year ended december 31 1999 liquidations lifo layers resulted reduction cost sales 21000 reductions lifo layers year ended december 31 2000 nine months ended december 31 1998 7 cost estimated earnings uncompleted contracts cost estimated earnings uncompleted contracts follows 8 property plant equipment net components property plant equipment follows depreciation expense 31 million 37 million 13 million respectively years ended december 31 2000 1999 nine months ended december 31 1998 company leases certain machinery equipment customers generally periods one month one year cost leased machinery equipment 51 million 30 million related accumulated depreciation 34 million 22 million december 31 2000 1999 respectively lease rental income 581000 450000 536000 years ended december 31 2000 1999 nine months ended december 31 1998 respectively included revenues 9 assets net assets consisted following deferred financing costs amortized life related debt instruments three five years accumulated amortization 552000 294000 december 31 2000 1999 respectively 10 accrued expenses accrued expense consisted following nine months ended december 31 1998 company revised previous estimate accrued insurance reserves resulting reduction insurance expense 12 million 11 shortterm debt conjunction purchase portatest january 2000 company issued oneyear promissory note 1 million denominated canadian dollars accrues interest 15 per annum note payable along accrued interest january 24 2001 february 2000 company issued oneyear promissory note face value 338000 interest payable per annum 10 conjunction acquisition mpe note payable along accrued interest february 8 2001 12 longterm debt consolidated borrowings company follows next five years ended december 31 aggregate future maturities longterm debt 150 million due 2003 annual future maturities due 2001 2002 2004 2005 november 20 1998 revolving credit term loan facility put place syndicate major international banks credit facility provides 320 million revolving credit line 220 million available us 100 million available canada finance eligible accounts receivable inventories 325 million term loan indebtedness credit facility bears interest floating rate based companys option upon base rate canadian prime rate respect base rate loans plus margin percentage ii london interbank offered rate one two three six months plus margin percentage margin percentage base rate canadian prime rate loans varies 100 000 depending companys debt capitalization ratio margin percentage eurodollar loans varies 250 100 depending companys debt capitalization ratio term borrowings mature november 30 2003 october 2000 company amended revolving credit term loan facility extend maturity date revolving credit facility january 1 2003 agreements contain affirmative covenants including financial requirements related minimum net worth debt capitalization ratio fixed charge coverage ratio well restrictions natco making distributions property cash company excess agreed sum without prior lender approval requires commitment fees accordance standard banking practices loan collateralized substantially assets company subsidiaries well guarantee company december 31 2000 company compliance restrictive covenants natco letters credit outstanding revolving credit facility totaling 21 million december 31 2000 letters credit constitute contract performance warranty collateral expire various dates september 2002 company maintains working capital facility export sales provides aggregate borrowings 100 million subject borrowing base limitations borrowings outstanding december 31 2000 company issued letters credit facility totaled 72 million december 31 2000 export sales credit facility secured specific project inventory receivables partially guaranteed exim bank export sales credit facility loans mature july 2003 first quarter 2000 natco retired outstanding debt term loan facility utilizing proceeds initial public offering companys class common stock addition company borrowed 30 million revolving credit facility finance acquisition portatest repaid february 2000 company borrowed 71 million revolving credit facility 26 million facility export sales april 2000 finance purchase esi august 2000 company retired outstanding borrowings export sales facility net borrowings revolving credit facility year ended december 31 2000 116 million dividend restrictions respect credit facilities natco agreed make distributions property cash company stockholders excess 20 million 1999 22 million year thereafter plus 50 excess cash flow beginning 2001 13 income taxes income tax expense benefit consisted following components temporary differences related following items give rise deferred tax assets liabilities follows december 31 2000 1999 company record valuation allowance related deferred tax assets opinion management future operations likely generate sufficient taxable income realize deferred tax assets december 31 2000 company net operating loss carryforwards federal income tax purposes 15 million available offset future federal income tax 2020 income tax expense differs amount computed applying us federal income tax rate 34 income continuing operations income taxes result following provision made us income taxes would payable undistributed earnings foreign subsidiaries distributed company form dividends since managements intention reinvest earnings permanently related foreign operations december 31 2000 1999 1998 amounts significant federal income tax returns fiscal years beginning 1998 open review internal revenue service 14 stockholders equity ceo stock options connection employment nathaniel gregory chief executive officer company granted options purchase national tank company common stock subsequently converted options purchase common stock company december 31 2000 1999 options related aggregate 264363 shares 880104 shares respectively companys common stock appreciation rights 1994 natco adopted national tank company stock appreciation rights plan national tank plan national tank plan provided grants officers key employees natco rights appreciation value stated number shares natco common stock value determined committee natco board directors maximum number rights issuable national tank plan 500000 rights vested threeyear period compensation expense adjusted connection plan nine months ended december 31 1998 reflect expense 23000 individual stock options july 1 1997 board directors company approved exchange rights outstanding national tank plan discussed previously individual options purchase common stock company furthermore additional stock options granted time exercise price options determined fair market value common stock date issue accordingly compensation expense recorded associated grants individual stock options granted july 1 1997 vested ratably period three four years maximum term options 75 years december 31 2000 aggregate 764204 stock options remained outstanding plan stock option plans january 1998 february 1998 company adopted directors compensation plan employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares company common stock options vest periods four years maximum term options ten years december 31 2000 1999 1998 options relating aggregate 743953 shares 455085 shares 464672 shares respectively outstanding plans 2000 employee stock option plan november 2000 board directors company approved authorized issuance 300000 shares companys common stock 2000 employee stock option plan options granted plan december 31 2000 following table summarizes transactions companys stock option plans years ended december 31 2000 1999 nine months ended december 31 1998 pro forma information regarding net income earnings per share required sfas 123 determined applying blackscholes single option reduced term valuation method valuation model requires management make highly subjective assumptions volatility natcos common stock expected term outstanding stock options companys riskfree interest rate expected dividend payments contractual life options volatility stock prices evaluated based upon historical data new york stock exchange date initial public offering january 28 2000 february 28 2001 volatility calculated 59 year ended december 31 2000 steppeddown 10 per year next five years reflect expected stabilization following table summarizes assumptions used determine pro forma compensation expense sfas 123 december 31 2000 riskfree rates determined based upon us treasury obligations option date outstanding similar term company intend pay dividends common stock term options outstanding december 31 2000 year ended december 31 1999 nine months ended december 31 1998 company accounted employee stock options minimum value method permitted sfas 123 assumptions risk free rate 55 expected life options 10 years options issued march 31 1998 options issued prior march 31 1998 risk free rate return used 7 expected life used 75 years purposes pro forma disclosures estimated fair value options amortized expense options vesting period companys pro forma net earnings per share years ended december 31 2000 1999 nine months ended december 31 1998 follows sfas 123 requires pro forma amounts options granted beginning 1995 pro forma expense likely increase future years new option grants become subject pricing model preferred stock purchase rights may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natcos common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 companys common stock announces commencement tender offer consummation would result ownership person group 15 companys common stock person group acquire 15 companys common stock right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board directors may redeem rights price 001 per right time acquisition person group 15 less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed 15 change accounting principle effective january 1 2000 natco recorded cumulative effect change accounting principle related gains losses postretirement benefit obligation prior years gains losses resulted experience assumption changes recorded charge current income period change order reduce volatility earnings associated gains losses permitted sfas 106 employers accounting postretirement benefits pensions natco revised method accounting gains losses amortize net gain loss exceeds 10 companys adjusted postretirement benefit obligation remaining life expectancy plan participants gain 10000 net tax recorded consolidated statement income year ended december 31 2000 result change accounting principle pro forma impact earnings change year ended december 31 1999 nine months ended december 31 1998 reduction 598000 increase 31000 respectively see note 16 pension postretirement benefits 16 pension postretirement benefits company adopted sfas 132 revised disclosures pension postretirement benefit plans disclosures regarding pension benefits represent plan certain union employees foreign subsidiary disclosures regarding postretirement benefits represent health care life insurance benefits employees retired time company acquired ce december 1999 company entered agreement tyler capricorn company assumed responsibility retired employee health life insurance obligations tyler liability accrued respect obligations determined independent actuarial firm 11 million consideration agreement tyler paid company 475000 cash assigned portion federal income tax refund due tyler amount approximately 600000 tyler remitted 600000 january 2000 settlement arrangement december 2000 natco changed method used record gains losses postretirement benefit obligation resulted gain 10000 net tax year ended december 31 2000 unrecognized loss 15 million see note 15 change accounting principle following table sets forth plans benefit obligation fair value plan assets funded status december 31 2000 1999 deferred compensation plan test adopted deferred compensation plan test plan effective july 1 1995 provide incentives rewards certain individuals awards payable five equal annual installments plus earnings allocated participants account company elected make additional awards plan year beginning january 1 1998 december 31 2000 december 31 1999 total amounts owed test plan 244000 303000 respectively balance presently accrues interest prime rate plus 1 defined contribution plans company subsidiaries defined contribution pension plans covering substantially nonunion hourly salaried employees completed three months service employee contributions 3 covered employees compensation matched 100 company additional 2 covered employees compensation matched 50 addition company may make discretionary contributions profit sharing contributions company contributions plan totaled 14 million 16 million 19 million years ended december 31 2000 1999 nine months ended december 31 1998 respectively 17 operating leases company subsidiaries lease various facilities equipment noncancelable operating lease agreements leases expire various dates 2005 future minimum lease payments required operating leases remaining noncancelable lease terms excess one year december 31 2000 follows 2001 29 million 2002 21 million 2003 444000 2004 138000 2005 52000 total expense operating leases years ended december 31 2000 1999 nine months ended december 31 1998 44 million 35 million 23 million respectively discussion lease rental income see note 8 property plant equipment net 18 related parties company paid management fee capricorn management advisory information research administrative services included office space parking connecticut companys chief executive officer reception telephone computer services normal office support relating space fees paid capricorn management totaled 75000 56000 years ended december 31 2000 1999 nine months ended december 31 1998 respectively employees capricorn management participated various natco employee benefit plans company time received billings vendors services provided capricorn management personnel acting benefit company capricorn management reimburses company foregoing expenses december 31 1999 capricorn management owed company 5000 expenses receivable capricorn management existed december 31 2000 year ended december 31 1999 nine months ended december 31 1998 pth paid 84000 49000 respectively company tax consulting analysis services receivable pth existed december 31 2000 tax consulting arrangement terminated january 2000 1997 company loaned 15 million rate 10 per annum director company also affiliate capricorn march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn distributed holding natco common stock partners 1998 natco acquired option cost 200000 purchase 173050 shares common stock director price 881 per share natcos option note could repaid shares companys common stock cost acquire option recorded treasury stock accompanying consolidated balance sheet note arrangement director recorded 19 million current asset december 31 1999 partially settled february 2000 company exercised option purchase 173050 shares common stock director cost 15 million remaining balance note repaid june 2000 pursuant employment agreement company lent executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 company completed initial public offering class common stock natco paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay company approximately 665000 remaining loan balance accrues interest 6 annually addition october 27 2000 companys board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options loan matures july 31 2003 provides interest stated companys current borrowing rate principal equal cost exercise options plus personal tax burdens result exercise december 31 2000 balance receivable accrued interest due officer loan arrangements 19 million see note 5 unusual charges december 1999 company assumed postretirement pension liability former affiliate tyler february 2000 company received 600000 tyler settlement agreement entered tyler capricorn company whereby company assumed responsibility retired employee health life insurance obligations tyler see note 16 pension postretirement benefits 19 commitments contingencies june 1997 company connection financing effected provide funds acquisition test corporate purposes distributed outstanding stock pth owned company sole stockholder capricorn connection distribution company received opinion counsel effect distribution would taxfree company capricorn taxfree treatment distribution depends part upon underlying facts circumstances time distribution assurance internal revenue service agree interpretation company counsel facts circumstances internal revenue service challenge taxfree treatment distribution challenge ultimately prevail company would treated recognizing gain respect distribution amount equal excess fair market value pth stock time distribution tax basis company treatment could material adverse effect companys results operations financial condition portatest purchase agreement executed january 2000 contains provision calculate payment certain former stockholders portatest based upon sales limited number specified products designed utilizing technology existed time acquisition liability arrangement contingent upon attaining certain performance criteria including gross margins sales volumes specified products potential payment calculated year anniversary date acquisition extending threeyear period ended january 24 2003 december 31 2000 company accrued approximately 253000 related obligation arrangement corresponding increase goodwill future liabilities incurred arrangement also result increase goodwill 20 change accounting estimate april 2000 company extended service life certain assets based upon operational factors effect net income basic diluted earnings per share cumulative effect change accounting principle increase 305000 02 respectively year ended december 31 2000 21 litigation company party various routine legal proceedings primarily involve commercial claims products liability claims asbestos related personal injury claims workers compensation claims cannot predict outcome lawsuits legal proceedings claims certainty nevertheless believe outcome proceedings even determined adversely would material adverse effect business financial condition 22 industry segments geographic information company adopted provisions sfas 131 disclosures segments enterprise related information companys eight business units separate management teams infrastructures offer different products services business units aggregated four reportable segments described since longterm financial performance reportable segments affected similar economic conditions traditional production equipment services us sales service sole business unit reported segment unit designs engineers manufactures provides startup services production equipment generally less complex provided engineered systems segment also provides replacement parts field shop servicing equipment used equipment refurbishing principal market segment us onshore offshore market also serves international market customers include major multinational independent national stateowned companies engineered systems segment consists five business units us engineered systems ntc technical services natco japan natco venezuela natco london provide design engineering manufacturing startup services engineered process systems principal markets segment include major oil gas producing regions world including north america latin america europe africa far east customers include major multinational independent national stateowned companies automation control systems test sole business unit reported segment unit designs manufactures installs services instrumentation electrical control systems principal markets segment include major oil gas producing regions world including north america latin america europe kazakhstan africa far east customers include major multinational independent national stateowned companies segment formerly named instrumentation electrical systems natco canada segment consists subsidiary canada natco canada provides design engineering manufacturing startup services engineered process systems also provides replacement parts field shop servicing equipment used equipment refurbishing natco canada also done selective manufacturing engineered systems segment past principal markets segment oil gas producing regions canada customers include major multinational independent companies accounting policies reportable segments described note 2 company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense accounting changes nonrecurring items summarized financial information concerning companys reportable segments shown following table july 2000 company changed presentation certain assets acquired cynara company cynara november 1998 related operating results segment reporting purposes majority assets reclassified traditional production equipment services business segment engineered systems business segment change retroactively reflected periods presented year ended nine months ended companys geographic data continuing operations years ended december 31 2000 1999 nine months ended december 31 1998 follows corporate expenses consist corporate overhead research development expenses 23 quarterly data following tables summarize unaudited quarterly information years ended december 31 2000 1999 24 office closure prior 1997 company began winding operations natco uk ltd activities include transferring net assets employees companys parts service business new us subsidiary natco london inc resolving pending severance office closure leasehold issues 1999 company reached favorable settlements related various amounts owed customers vendors related number contracts entered 1993 1995 accrual costs associated various claims made fiscal years 1995 1998 based best available information time result favorable settlements company revised previous estimates reversed 314000 accruals 25 subsequent events march 16 2001 company entered new credit facility group banks led chase manhattan bank credit facility consists 500 million term loan 350 million us revolving facility 100 million canadian revolving facility 50 million uk revolving facility term loan matures march 15 2006 revolving facilities matures march 15 2004 march 19 2001 natco acquired outstanding capital stock axsia group limited privately held process design company based united kingdom approximately 458 million cash acquisition funded borrowings new revolving credit facilities recorded using purchase method accounting item 9item 8 financial statements supplementary data follow consolidated financial statements years ended december 31 2001 2000 1999 applicable along independent auditors report independent auditors report board directors natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 2001 2000 related consolidated statements operations stockholders equity comprehensive income cash flows three years ended december 31 2001 consolidated financial statements responsibility companys management responsibility express opinion consolidated financial statements based audits conducted audits accordance auditing standards generally accepted united states america standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2001 2000 results operations cash flows years ended december 31 2001 2000 1999 conformity accounting principles generally accepted united states america discussed note 15 consolidated financial statements company changed method accounting postretirement benefits january 2000 kpmg llp houston texas february 18 2002 natco group inc subsidiaries consolidated balance sheets dollars thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements operations dollars thousands except per share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements stockholders equity comprehensive income dollars thousands see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements cash flows dollars thousands see accompanying notes consolidated financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization natco group inc natco formed june 1988 capricorn investors lp led group investors provided capital company acquire several businesses combustion engineering inc ce june 21 1989 company acquired ce outstanding common stock ws tyler incorporated tyler national tank company well net assets certain foreign affiliates 1992 natco contributed common stock investment tyler 55 million cash process technology holdings inc pth exchange issued outstanding common stock pth 1992 1993 pth natco sold certain shares pth common stock third parties 1997 company completed taxfree spin pth stockholder june 30 1997 natco acquired total engineering services team inc test november 18 1998 natco acquired cynara company cynara company acquired portatest international inc portatest january 24 2000 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock february 8 2000 april 4 2000 natco acquired modular production equipment inc mpe engineering specialties inc esi respectively march 19 2001 natco acquired axsia group limited axsia privately held process design company based united kingdom accompanying consolidated financial statements related disclosures include results operations company majorityowned subsidiaries years ended december 31 2001 2000 1999 furthermore certain reclassifications made fiscal 2000 fiscal 1999 amounts order present results comparable basis amounts fiscal 2001 references natco company used throughout document relate collectively natco group inc consolidated subsidiaries 2 summary significant accounting policies principles consolidation consolidated financial statements include accounts company majorityowned subsidiaries significant intercompany accounts transactions eliminated consolidation concentration credit risk concentrations credit risk respect trade receivables limited due large number customers comprising companys customer base geographic dispersion years ended december 31 2001 1999 customer provided 10 revenues however fiscal 2000 carigalitriton operating company sdn bhd ctoc general contractor samsung provided revenues 459 million approximately 20 total revenues pursuant large project awarded july 1999 customer provided 10 revenues year ended december 31 2000 see note 21 industry segments geographic information cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents restricted cash december 31 1998 cash amount 883000 pledged collateral outstanding letters credit related performance warranty guarantees classified restricted cash balance sheet restricted cash existed december 31 2001 2000 1999 inventories stated lower cost market cost determined using last first lifo method natco domestic inventories average cost test inventories first fifo method inventories property plant equipment property plant equipment stated cost less allowance depreciation plant equipment calculated using straightline method assets estimated useful lives maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included income carrying values property plant equipment location reviewed annually often indications assets may impaired goodwill amortized straightline basis periods 20 40 years company assesses recoverability intangible asset determining whether amortization remaining life recovered undiscounted future operating cash flows based recent analysis companys management believes material impairment goodwill exists december 31 2001 amortization expense years ended december 31 2001 2000 1999 37 million 20 million 739000 respectively accumulated amortization december 31 2001 2000 64 million 28 million respectively assets net assets consist prepaid pension assets longterm deposits deferred financing costs covenants compete deferred financing costs covenants compete amortized term related agreements amortization expense years ended december 31 2001 2000 1999 932000 554000 570000 respectively environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred revenue recognition revenues significant contracts natco contracts greater 250000 longer four months duration test contracts orders recognized percentage completion method earned revenue based percentage incurred costs date bear total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects revenues related costs recognized products shipped services rendered customer stockbased compensation statement financial accounting standards sfas 123 accounting stockbased compensation permits entities recognize expense vesting period fair value stockbased awards date grant alternatively sfas 123 allows entities continue apply provisions accounting principles board apb opinion 25 provide pro forma net income earnings per share disclosures employee stock option grants made 1995 future years fairvaluebased method defined sfas 123 applied company elected continue apply provision apb opinion 25 provide pro forma disclosure provisions sfas 123 research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years research development expenses totaled 21 million 18 million 19 million years ended december 31 2001 2000 1999 respectively warranty costs estimated future warranty obligations related products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims december 31 2001 2000 company 54 million 931000 respectively outstanding letters credit related warranties income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment derivative arrangements assets liabilities associated underlying derivative arrangements qualify hedge value accounting recorded fair market value balance sheet date changes fair value charged income current period accordance sfas 133 accounting derivative instruments hedging activities company recorded charge 249000 exit certain derivative arrangements acquired purchase axsia march 2001 company derivative financial instruments december 31 2001 2000 1999 translation foreign currencies financial statement amounts related foreign operations translated united states dollar equivalents exchange rates follows 1 balance sheet accounts yearend exchange rates 2 statement operations accounts weighted average exchange rate period gains losses resulting translations deferred included accumulated comprehensive loss separate component stockholders equity gains losses foreign currency transactions reflected consolidated statements operations use estimates companys management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity generally accepted accounting principles actual results could differ estimates earnings per common share basic earnings per share excludes dilutive effect common stock equivalents diluted earnings per common equivalent share computed dividing net income weighted average number common equivalent shares outstanding purposes calculation outstanding employee stock options considered common stock equivalents conformity securities exchange commission requirements common stock options warrants potentially dilutive instruments issued nominal consideration periods covered income statements presented reflected earnings per share calculations periods presented antidilutive stock options excluded calculation common stock equivalents impact antidilutive shares would reduction 145000 shares 36000 shares years ended december 31 2001 2000 respectively antidilutive stock options year ended december 31 1999 following table presents earnings per common share amounts computed using sfas 128 3 capital stock november 18 1998 companys charter amended divide common stock two classes class common stock 45000000 shares class b common stock 5000000 shares two classes common stock relative rights preferences except holders class b common stock right voting separately class elect one member companys board directors class b shares may converted holder class shares time automatically convert class shares january 1 2002 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders proceeds company less underwriting fees 377 million funds used retire debt 279 million term loan facility repay borrowings 30 million revolving credit facility used acquire portatest retire 22 million portatest debt acquired pay offering costs 15 million fund working capital needs february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock proceeds 105 million net underwriters fees proceeds overallotment used complete acquisition mpe including repayment 685000 debt acquired working capital needs 1997 company provided loan 15 million interest rate 10 per annum director company also affiliate capricorn holdings inc march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn holdings inc distributed holdings natcos common stock partners 1998 company acquired option cost approximately 200000 purchase 173050 shares natcos common stock director price 881 per share companys option note provided obligation could repaid shares natcos common stock cost acquire option recorded treasury stock accompanying consolidated balance sheets february 2000 company exercised option acquire 173050 shares natcos class common stock director 15 million reduced note due director amount shares recorded treasury stock cost accompanying consolidated balance sheet balance note due director repaid june 2000 february 2001 june 2000 september 1999 company issued 8520 class b shares 418145 class b shares 325836 class b shares respectively former shareholders cynara connection achievement certain performance criteria defined november 1998 purchase agreement goodwill increased 85000 2001 41 million 2000 34 million 1999 result transactions october 2000 companys board directors approved stock repurchase plan 750000 shares companys class common stock could acquired fiscal 2001 company reacquired approximately 118000 shares class common stock repurchase agreement 867000 average cost 7 per share 2000 company reacquired 34000 shares class common stock repurchase plan 243000 average cost 7 per share cost reacquire shares recorded treasury stock december 31 2001 2000 respectively 4 acquisitions november 1998 company completed acquisition cynara group private investors 53 million cash assumption 101 million cynara bank debt issuance 500000 shares natco class b common stock valued 53 million purchase agreement also stipulated natco may required issue additional 1400000 shares class b common stock cynaras former shareholders based certain performance criteria defined purchase agreement company issued 325836 class b shares 418145 class b shares 8520 class b shares september 1999 june 2000 february 2001 respectively per agreement resulted increase goodwill see note 3 capital stock funds used acquisition cynara provided 53 million equity proceeds borrowings senior credit facility provided syndicate major international banks acquisition accounted purchase results cynara included consolidated financial statements since date acquisition goodwill december 31 2001 2000 176 million accumulated amortization 23 million 14 million respective periods company acquired outstanding common stock portatest january 24 2000 approximately 63 million cash net cash acquired included payment specific accrued liabilities former company purchase certain proprietary intellectual property associated us company issuance oneyear promissory note 10 million denominated canadian dollars payment contingent upon certain operating criteria met see note 18 commitments contingencies acquisition accounted using purchase method accounting results operations portatest included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period goodwill accumulated amortization related portatest acquisition 53 million 528000 respectively december 31 2001 company acquired outstanding common stock mpe february 8 2000 approximately 24 million cash net cash acquired issuance oneyear promissory note 338000 accrued interest 10 per annum acquisition accounted using purchase method accounting results operations mpe included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period goodwill accumulated amortization related mpe acquisition 34 million 338000 respectively december 31 2001 company acquired outstanding common stock esi april 4 2000 approximately 71 million net cash equivalents acquired subject adjustment acquisition financed borrowings 71 million existing revolving credit facility borrowings 26 million existing export sales facility accounted using purchase method accounting results operations esi included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period goodwill accumulated amortization related esi acquisition 60 million 510000 respectively december 31 2001 march 19 2001 company acquired outstanding share capital axsia approximately 428 million net cash acquired axsia specializes design supply water reinjection systems oil gas fields oily water treatment oil separation hydrocyclone technology hydrogen production process equipment systems acquisition financed borrowings natcos term loan facility accounted using purchase method accounting results operations axsia included natcos consolidated financial statements since date acquisition purchase price 450 million allocated follows 22 million cash acquired 384 million current assets excluding cash 20 million longterm assets excluding goodwill 460 million current liabilities excess purchase price fair value net assets acquired amortized twentyyear period goodwill accumulated amortization expense related axsia acquisition 484 million 19 million respectively december 31 2001 although axsia purchase price allocation yet finalized natcos management believe final purchase price allocation differ materially december 31 2001 assuming axsia acquisition occurred january 1 respective year unaudited pro forma results company twelve months ended december 31 2001 2000 respectively would follows pro forma results assume debt service costs associated axsia acquisition net tax effect calculated companys effective tax rate applicable period nondeductible goodwill amortization although prepared basis consistent natcos consolidated financial statements pro forma results purport indicative actual results would achieved acquisition consummated january 1 respective year intended projection future results effective january 8 2001 company entered compromise settlement agreement former owner test resulted cash payment 15 million natco may 31 2001 settle certain contingencies related natcos acquisition test 1997 proceeds payment net related costs used reduce goodwill associated test acquisition 5 unusual charges june 2001 company recorded unusual charge 16 million charge consisted 920000 pursuant approved plan close merge existing natco office operations axsia well streamlining actions associated acquisition charge included costs severance office consolidation expenses also company withdrew public debt offering recorded unusual charge 680000 costs incurred related proposed offering pursuant employment agreement executive officer entitled bonus upon occurrence sale public offering company bonus equaled one onehalf percent 15 value securities owned stockholders company prior sale offering including common stock valued price per share received either sale public offering debt held stockholders july 1999 company amended employment agreement eliminate bonus agreed loan officer 12 million purchase 136832 shares common stock per agreement officer would receive bonus equal outstanding principal interest note upon sale public offering company february 2000 company completed initial public offering class common stock natco recorded expense 13 million settlement obligation agreement officer used proceeds net tax repay company approximately 665000 outstanding balance note december 31 2001 651000 loan accrues interest 6 annually first quarter 2000 natco incurred relocation charges approximately 208000 associated consolidation existing company facility acquired connection acquisition portatest 6 inventories consisted following amounts december 31 2001 2000 inventories valued using lifo method included amounted 295 million 223 million respectively year ended december 31 1999 liquidations lifo layers resulted reduction cost sales 21000 reductions lifo layers years ended december 31 2001 2000 7 cost estimated earnings uncompleted contracts cost estimated earnings uncompleted contracts follows 8 property plant equipment net components property plant equipment follows depreciation expense 41 million 31 million 37 million respectively years ended december 31 2001 2000 1999 company leases certain machinery equipment customers generally periods one month one year cost leased machinery equipment 53 million 51 million related accumulated depreciation 35 million 34 million december 31 2001 2000 respectively lease rental income 12 million 581000 450000 years ended december 31 2001 2000 1999 respectively included revenues 9 assets net assets consisted following deferred financing costs amortized life related debt instruments three five years accumulated amortization 12 million 552000 december 31 2001 2000 respectively 10 accrued expenses accrued expense consisted following 11 shortterm debt conjunction purchase portatest january 2000 company issued oneyear promissory note 1 million denominated canadian dollars accrued interest 15 per annum january 24 2001 note repaid along accrued interest february 2000 company issued oneyear promissory note face value 338000 interest payable per annum 10 conjunction acquisition mpe february 2001 company paid 206000 principal interest 12 longterm debt consolidated borrowings company follows aggregate future maturities longterm debt next five years ended december 31 summarize follows 200270 million 200370 million 2004208 million 200570 million 2006168 million march 16 2001 company entered new credit facility consisted 500 million term loan 350 million us revolving facility 100 million canadian revolving facility 50 million uk revolving facility term loan matures march 15 2006 revolving facilities matures march 15 2004 october 2001 company amended revolving credit agreement reduce borrowing capacity us 350 million 300 million increase borrowing capacity uk 50 million 100 million material modifications made agreement amounts borrowed term loan bear interest rate 425 per annum december 31 2001 amounts borrowed revolving portion facility bear interest follows april 1 2002 rate equal companys election either 1 london interbank offered rate libor plus 225 2 base rate plus 075 april 1 2002 rate based upon ratio funded debt ebitda defined credit facility ranging companys election 1 high libor plus 250 low libor plus 175 2 high base rate plus 10 low base rate plus 025 natco pay commitment fees 050 per year april 1 2002 030 050 per year following 2002 depending upon ratio funded debt ebitda april 1 2002 case undrawn portion facility revolving credit facility guaranteed companys domestic subsidiaries secured first priority lien inventory accounts receivable material tangible intangible assets natco also pledged 65 voting stock active foreign subsidiaries borrowings 500 million term loan facility used primarily acquisition axsia remaining borrowings along additional borrowings revolving credit facility used repay 165 million outstanding predecessor revolving credit term loan facility december 31 2001 company compliance restrictive debt covenants natco letters credit outstanding revolving credit facilities totaling 190 million december 31 2001 letters credit constitute contract performance warranty collateral expire various dates october 2004 company maintains working capital facility export sales provides aggregate borrowings 100 million subject borrowing base limitations borrowings 11 million outstanding december 31 2001 letters credit outstanding export sales credit facility december 31 2001 totaled 361000 export sales credit facility loans secured specific project inventory receivables partially guaranteed exim bank mature july 2004 company unsecured letters credit totaling 944000 december 31 2001 november 20 1998 revolving credit term loan facility put place syndicate major international banks credit facility provides 320 million revolving credit line 220 million available us 100 million available canada finance eligible accounts receivable inventories 325 million term loan indebtedness credit facility bears interest floating rate based companys option upon base rate canadian prime rate respect base rate loans plus margin percentage ii london interbank offered rate one two three six months plus margin percentage margin percentage base rate canadian prime rate loans varies 100 000 depending companys debt capitalization ratio margin percentage eurodollar loans varies 250 100 depending companys debt capitalization ratio term borrowings mature november 30 2003 october 2000 company amended revolving credit term loan facility extend maturity date revolving credit facility january 1 2003 agreements contain affirmative covenants including financial requirements related minimum net worth debt capitalization ratio fixed charge coverage ratio well restrictions natco making distributions property cash company excess agreed sum without prior lender approval requires commitment fees accordance standard banking practices loan collateralized substantially assets company subsidiaries well guarantee company december 31 2000 company compliance restrictive covenants first quarter 2000 natco retired outstanding debt term loan facility utilizing proceeds initial public offering companys class common stock addition company borrowed 30 million revolving credit facility finance acquisition portatest repaid february 2000 company borrowed 71 million revolving credit facility 26 million facility export sales april 2000 finance purchase esi august 2000 company retired outstanding borrowings export sales facility net borrowings revolving credit facility year ended december 31 2000 116 million dividend restrictions respect credit facilities natco agreed make distributions property cash company stockholders excess 50 net income less excess cash flow beginning 2001 dividends declared paid years ended december 31 2001 2000 1999 13 income taxes income tax expense benefit consisted following components temporary differences related following items give rise deferred tax assets liabilities follows december 31 2001 company recorded valuation allowance 13 million related certain deferred tax assets acquired purchase axsia march 2001 valuation allowance recorded related companys deferred tax assets fiscal 2000 opinion management future operations likely generate sufficient taxable income realize deferred tax assets december 31 2001 company net operating loss carryforwards federal income tax purposes 31 million available offset future federal income tax 2021 income tax expense differs amount computed applying us federal income tax rate 34 income continuing operations income taxes result following provision made us income taxes would payable undistributed earnings foreign subsidiaries distributed company form dividends since managements intention reinvest earnings permanently related foreign operations federal income tax returns fiscal years beginning 1998 open review internal revenue service 14 stockholders equity ceo stock options connection engagement chief executive officer company granted options purchase national tank company common stock subsequently converted options purchase common stock company december 31 2001 2000 options related aggregate 346113 shares 264363 shares respectively companys common stock appreciation rights 1994 natco adopted national tank company stock appreciation rights plan national tank plan national tank plan provided grants officers key employees natco rights appreciation value stated number shares natco common stock value determined committee natco board directors maximum number rights issuable national tank plan 500000 rights vested threeyear period individual stock options july 1 1997 board directors company approved exchange rights outstanding national tank plan discussed previously individual options purchase common stock company compensation expense recognized extent projected fair market value stock exchange date exceeded exercise price options furthermore additional stock options granted plan exercise price equal fair market value shares date grant accordingly compensation expense recorded additional grants individual stock options granted july 1 1997 vested ratably period three four years maximum term options 10 years december 31 2001 2000 aggregate 527701 764204 stock options respectively remained outstanding plan stock option plans january 1998 february 1998 company adopted directors compensation plan employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares company common stock options vest periods four years maximum term options ten years december 31 2001 2000 1999 options relating aggregate 743920 shares 743953 shares 455085 shares respectively outstanding plans natco group inc 2001 stock incentive plan november 2000 board directors company approved authorized issuance 300000 shares companys common stock 2000 employee stock option plan may 24 2001 companys stockholders approved natco group inc 2001 stock incentive plan superceded replaced 2000 plan entirety increased number shares options awards may granted plan maximum 1000000 shares december 31 2001 options relating aggregate 795826 shares outstanding plan options outstanding plan december 31 2000 following table summarizes transactions companys stock option plans years ended december 31 2001 2000 1999 pro forma information regarding net income earnings per share required sfas 123 determined applying blackscholes single optionreduced term valuation method valuation model requires management make highly subjective assumptions volatility natcos common stock expected term outstanding stock options companys riskfree interest rate expected dividend payments contractual life options volatility stock prices evaluated based upon historical data new york stock exchange date initial public offering january 28 2000 february 1 2002 volatility calculated 52 december 31 2001 steppeddown 10 per year next four years reflect expected stabilization following table summarizes assumptions used determine pro forma compensation expense sfas 123 december 31 2001 riskfree rates determined based upon us treasury obligations option date outstanding similar term company intend pay dividends common stock term options outstanding december 31 2001 year ended december 31 1999 company accounted employee stock options minimum value method permitted sfas 123 assumptions risk free rate 55 expected life options 10 years options issued march 31 1998 options issued prior march 31 1998 risk free rate return used 7 expected life used 75 years purposes pro forma disclosures estimated fair value options amortized expense options vesting period companys pro forma net earnings per share years ended december 31 2001 2000 1999 follows sfas 123 requires pro forma amounts options granted beginning 1995 pro forma expense likely increase future years new option grants become subject pricing model preferred stock purchase rights may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natcos common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 companys common stock announces commencement tender offer consummation would result ownership person group 15 companys common stock person group acquire 15 companys common stock right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board directors may redeem rights price 001 per right time acquisition person group 15 less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed 15 change accounting principle effective january 1 2000 natco recorded cumulative effect change accounting principle related gains losses postretirement benefit obligation prior december 31 2000 gains losses resulted experience assumption changes recorded charge current income period change sfas 106 employers accounting postretirement benefits pensions natco revised method accounting gains losses amortize net gain loss exceeds 10 companys adjusted postretirement benefit obligation remaining life expectancy plan participants newly adopted accounting principle preferable circumstances deferral unrealized gains losses common practice results less volatility net periodic postretirement benefit cost gain 10000 net tax recorded consolidated statement income december 31 2000 result change accounting principle pro forma impact earnings change year ended december 31 1999 reduction 598000 see note 16 pension postretirement benefits 16 pension postretirement benefits company adopted sfas 132 revised disclosures pension postretirement benefit plans disclosures regarding pension benefits represent plan certain union employees foreign subsidiary disclosures regarding postretirement benefits represent health care life insurance benefits employees retired company acquired ce december 1999 company entered agreement tyler capricorn investors lp company assumed responsibility retired employee health life insurance obligations tyler liability accrued respect obligations determined independent actuarial firm 11 million consideration agreement tyler paid company 475000 cash assigned portion federal income tax refund due tyler amount approximately 600000 tyler remitted 600000 january 2000 settlement arrangement december 2000 natco changed method used record gains losses postretirement benefit obligation resulted gain 10000 net tax year ended december 31 2000 unrecognized loss 15 million see note 15 change accounting principle may 1 2001 company amended postretirement benefit plan provided medical dental coverage retirees predecessor company amended plan retirees bear additional costs coverage significant plan changes include higher deductibles prescription coverage drug card program elimination dental benefits july 1 2001 company obtained thirdparty valuation liability plan arrangement amended based upon valuation effect amendment 64 million reduction companys postretirement benefit liability december 31 2001 cumulative unrecognized loss 36 million existed related postretirement benefit plan accordance sfas 106 employers accounting postretirement benefits pensions benefit associated plan amendment amortized income prior service cost adjustment remaining life expectancy plan participants additionally cumulative unrecognized loss amortized expense remaining life expectancy plan participants november 2001 company agreed maintain benefits preamendment levels specified class retirees exchange expense reimbursement former sponsor postretirement benefit plan agreement requires reimbursement 79000 per year four succeeding years pursuant arrangement company received 79000 reimbursement postretirement benefit expenses 2001 recorded receivable present value future benefits 291000 august 2001 participants canadian pension plan voted terminate contributions plan receive actuarially determined cash distributions december 31 2001 company formally announced termination pension plan continued fund plan based upon plan provisions following table sets forth plans benefit obligation fair value plan assets funded status december 31 2001 2000 defined contribution plans company subsidiaries defined contribution pension plans covering substantially nonunion hourly salaried employees completed three months service employee contributions 3 covered employees compensation matched 100 company additional 2 covered employees compensation matched 50 addition company may make discretionary contributions profit sharing contributions company contributions plan totaled 18 million 14 million 16 million years ended december 31 2001 2000 1999 respectively 17 operating leases company subsidiaries lease various facilities equipment noncancelable operating lease agreements leases expire various dates september 2006 excluding lease arrangement facility axsia requires lease commitments facility sublet another party future minimum lease payments required operating leases remaining noncancelable lease terms excess one year december 31 2001 follows 200239 million 200333 million 200427 million 2005811000 2006674000 total expense operating leases years ended december 31 2001 2000 1999 53 million 44 million 35 million respectively discussion lease rental income see note 7 property plant equipment net 18 related parties company paid capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut companys chief executive officer reception telephone computer services normal office support relating space mr herbert winokur jr one companys directors chairman chief executive officer capricorn holdings inc directly indirectly controls approximately 31 companys common stock addition companys chief executive officer mr gregory nonsalaried member capricorn holdings llc general partner capricorn investors ii lp private investment partnership capricorn investors ii lp controls approximately 20 companys common stock fees paid capricorn management totaled 85000 75000 years ended december 31 2001 2000 1999 respectively commencing october 1 2001 fee increased 28750 per quarter due primarily upward adjustments capricorn managements underlying lease office space increase reviewed approved audit committee companys board directors december 31 1999 company recorded receivable capricorn management 5000 related expenses paid behalf receivable existed december 31 2001 2000 year ended december 31 1999 pth paid 84000 company tax consulting analysis services receivable pth existed december 31 2001 2000 tax consulting arrangement terminated january 2000 1997 company loaned 15 million rate 10 per annum director company also affiliate capricorn holdings inc march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn investors lp distributed holding natco common stock partners 1998 natco acquired option cost 200000 purchase 173050 shares common stock director price 881 per share natcos option note could repaid shares companys common stock cost acquire option recorded treasury stock accompanying consolidated balance sheet note arrangement director recorded 19 million current asset december 31 1999 partially settled february 2000 company exercised option purchase 173050 shares common stock director cost 15 million remaining balance note repaid june 2000 terms employment agreement effect prior 1999 company loaned chief executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 company completed initial public offering class common stock natco paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay company approximately 665000 remaining loan balance accrued interest 651000 december 31 2001 continues accrue interest 6 annually addition october 27 2000 companys board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options loan matures july 31 2003 provides interest stated companys thencurrent borrowing rate principal equal cost exercise options plus personal tax burdens result exercise december 31 2001 balance note principal accrued interest due officer loan arrangements 33 million see note 5 unusual charges december 1999 company assumed postretirement pension liability former affiliate tyler february 2000 company received 600000 tyler settlement agreement entered tyler capricorn investors lp company whereby company assumed responsibility retired employee health life insurance obligations tyler see note 16 pension postretirement benefits 19 commitments contingencies portatest purchase agreement executed january 2000 contains provision calculate payment certain former stockholders portatest systems inc threeyear period ended january 24 2003 based upon sales limited number specified products designed utilizing technology existed time acquisition liability arrangement contingent upon attaining certain performance criteria including gross margins sales volumes specified products applicable payment required annually april 2001 company paid 226000 arrangement related year ended january 24 2001 future liabilities incurred arrangement result increase goodwill 20 change accounting estimate april 2000 company extended service life carbon dioxide gasprocessing plant based upon extension agreement operate facility effect net income basic diluted earnings per share cumulative effect change accounting principle increase 305000 02 respectively year ended december 31 2000 21 litigation company party various routine legal proceedings primarily involve commercial claims products liability claims workers compensation claims cannot predict outcome lawsuits legal proceedings claims certainty nevertheless believe outcome proceedings even determined adversely would material adverse effect business financial condition 22 industry segments geographic information company adopted provisions sfas 131 disclosures segments enterprise related information companys business units separate management teams infrastructures offer different products services business units aggregated three reportable segments described since longterm financial performance reportable segments affected similar economic conditions first quarter 2001 company changed presentation reportable segments combining traditional production equipment services business segment natco canada business segment form north american operations business segment change retroactively reflected periods presented north american operations segment consists us sales service business unit companys canadian subsidiary us sales service business unit designs engineers manufactures provides startup services production equipment generally less complex units provided engineered systems provides replacement parts field shop servicing equipment used equipment refurbishing natco canada provides design engineering manufacturing startup services production equipment well replacement parts field shop servicing equipment used equipment refurbishing natco canada also provides selective manufacturing services engineered systems segment principal market us sales service business unit us onshore offshore market international market customers include major multinational independent national stateowned companies principal markets natco canada oil gas producing regions canada customers include major multinational independent companies engineered systems segment consists five business units us engineered systems ntc technical services natco japan natco venezuela axsia provide design engineering manufacturing startup services engineered process systems principal markets segment include major oil gas producing regions world including north america south america europe middle east africa far east customers include major multinational independent national stateowned companies automation control systems test sole business unit reported segment unit designs manufactures installs services instrumentation electrical control systems principal markets segment include major oil gas producing regions world including north america south america europe kazakhstan africa far east customers include major multinational independent national stateowned companies segment formerly named instrumentation electrical systems accounting policies reportable segments described note 2 company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense accounting changes nonrecurring items summarized financial information concerning companys reportable segments shown following table july 2000 company changed presentation certain assets acquired cynara november 1998 related operating results segment reporting purposes majority assets reclassified traditional production equipment services business segment engineered systems business segment change retroactively reflected periods presented summarized financial information concerning companys reportable segments shown following table companys geographic data continuing operations years ended december 31 2001 2000 1999 follows equipment large international projects generally manufactured us therefore revenues results operations related projects presented derived united states purposes geographic presentation corporate expenses consist corporate overhead research development expenses 23 quarterly data following tables summarize unaudited quarterly information years ended december 31 2001 2000 1999 24 office closure prior 1997 company began winding operations natco uk ltd activities include transferring net assets employees companys parts service business new us subsidiary natco london inc resolving pending severance office closure leasehold issues 1999 company reached favorable settlements related various amounts owed customers vendors related number contracts entered 1993 1995 accrual costs associated various claims made fiscal years 1995 1998 based best available information time result favorable settlements company revised previous estimates reversed 314000 accruals year ended december 31 1999 25 new accounting pronouncements june 2001 financial accounting standards board fasb approved sfas 141 business combinations standard requires business combination initiated june 30 2001 accounted using purchase method accounting standard became effective july 1 2001 company expect pronouncement material effect financial condition results operations fasb approved sfas 142 goodwill intangible assets june 2001 pronouncement requires intangible assets indefinite lives including goodwill cease amortized evaluated impairment basis intangible assets defined term patents would continue amortized useful life asset pronouncement becomes effective january 1 2002 companies calendar year end company net goodwill 809 million september 30 2001 goodwill amortization totaled 26 million nine months ended september 30 2001 company yet determined impact pronouncement financial condition results operations permitted standard company determine quantify exposure pronouncement fiscal 2002 completing required impairment testing june 2001 fasb issued sfas 143 accounting asset retirement obligations standard provides guidance reporting accounting obligations associated retirement longlived tangible assets associated retirement costs standard effective financial statements issued fiscal years beginning june 15 2002 company yet determined impact pronouncement financial condition results operations october 2001 fasb issued sfas 144 accounting impairment disposal longlived assets statement replaces sfas 121 accounting impairment longlived assets longlived assets disposed standardizes accounting model used asset dispositions related implementation issues pronouncement becomes effective financial statements issued fiscal years beginning december 15 2001 company yet determined impact pronouncement financial condition results operations 26 subsequent events january 1 2002 outstanding shares companys class b common stock 334719 shares converted class common stock share basis accordance terms class b shares issued february 2002 company borrowed 15 million wells fargo bank na promissory note arrangement requires quarterly principal interest payments fiveyear term beginning may 2002 interest accruing variable rate libor 325 obligation collateralized magnolia manufacturing facility purchased 2001 item 9item 8 financial statements supplementary data follow consolidated financial statements years ended december 31 2002 2001 2000 applicable along independent auditors report independent auditors report board directors natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 2002 2001 related consolidated statements operations stockholders equity comprehensive income cash flows three years ended december 31 2002 consolidated financial statements responsibility companys management responsibility express opinion consolidated financial statements based audits conducted audits accordance auditing standards generally accepted united states america standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2002 2001 results operations cash flows three years ended december 31 2002 conformity accounting principles generally accepted united states america discussed note 2 consolidated financial statements effective january 1 2002 company adopted provisions statement financial accounting standards sfas 142 goodwill intangible assets required discussed note 14 consolidated financial statements company changed method accounting postretirement benefits january 2000 kpmg llp houston texas february 19 2003 natco group inc subsidiaries consolidated balance sheets thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements stockholders equity comprehensive income thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements cash flows thousands see accompanying notes consolidated financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization natco group inc formed june 1988 capricorn investors lp led group investors provided capital company acquire several businesses combustion engineering inc ce june 1989 company acquired ce outstanding common stock national tank company certain businesses subsequently divested distributed shareholders june 30 1997 natco acquired total engineering services team inc test november 18 1998 natco acquired cynara company cynara company acquired portatest international inc portatest january 24 2000 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock february 8 2000 april 4 2000 natco acquired modular production equipment inc mpe engineering specialties inc esi respectively march 19 2001 natco acquired axsia group limited axsia privately held process design company based united kingdom accompanying consolidated financial statements related disclosures include results operations company whollyowned subsidiaries years ended december 31 2002 2001 2000 furthermore certain reclassifications made fiscal 2001 fiscal 2000 amounts order present results comparable basis amounts fiscal 2002 references natco company used throughout document relate collectively natco group inc consolidated subsidiaries 2 summary significant accounting policies principles consolidation consolidated financial statements include accounts company whollyowned subsidiaries significant intercompany accounts transactions eliminated consolidation concentration credit risk concentrations credit risk respect trade receivables limited due large number customers comprising companys customer base geographic dispersion year ended december 31 2002 one customer exxonmobil corporation affiliates general contractor hyundai heavy industries co provided 10 companys consolidated revenues customer provided 10 consolidated revenues year ended december 31 2001 fiscal 2000 carigalitriton operating company sdn bhd ctoc general contractor samsung provided revenues 459 million approximately 20 total revenues pursuant large project awarded july 1999 customer provided 10 revenues year ended december 31 2000 see note 21 industry segments geographic information cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents inventories stated lower cost market cost determined using last first lifo method natco domestic inventories average cost test inventories first fifo method inventories property plant equipment property plant equipment stated cost less allowance depreciation plant equipment calculated using straightline method assets estimated useful lives maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included income carrying values property plant equipment location reviewed annually often indications assets may impaired goodwill prior adoption january 1 2002 statement financial accounting standards sfas 142 goodwill intangible assets goodwill amortized straightline basis periods 20 40 years accordance sfas 142 company ceased amortization goodwill began evaluate goodwill impairment basis based testing companys management believes impairment goodwill exists december 31 2002 see note 23 goodwill impairment testing amortization expense years ended december 31 2001 2000 37 million 16 million respectively accumulated amortization december 31 2002 2001 64 million assets net assets include prepaid pension assets patents longterm deposits deferred financing costs covenants compete deferred financing costs covenants compete amortized term related agreements amortization interest expense 840000 932000 554000 years ended december 31 2002 2001 2000 respectively environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred revenue recognition revenues significant contracts natco contracts greater 250000 longer four months duration certain test contracts orders recognized percentage completion method earned revenue based percentage incurred costs date bear total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects revenues related costs recognized products shipped services rendered customer stockbased compensation sfas 123 accounting stockbased compensation permits entities recognize expense vesting period fair value stockbased awards date grant alternatively sfas 123 allows entities continue apply provisions accounting principles board apb opinion 25 provide pro forma net income earnings per share disclosures employee stock option grants made 1995 future years fairvaluebased method defined sfas 123 applied december 2002 sfas 148 accounting stockbased compensation transition disclosure amendment fasb statement 123 issued provides alternative methods transition fair value method accounting stock based compensation volunteer basis requires additional disclosures annual interim periods company elected continue apply provision apb opinion 25 provide pro forma disclosure provisions sfas 123 companys pro forma net earnings per share years ended december 31 2002 2001 2000 per sfas 123 follows research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years research development expenses totaled 20 million 21 million 18 million years ended december 31 2002 2001 2000 respectively warranty costs estimated future warranty obligations related products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims december 31 2002 2001 company 60 million 54 million respectively outstanding letters credit related warranties income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment derivative arrangements assets liabilities associated underlying derivative arrangements qualify hedge value accounting recorded fair market value balance sheet date changes fair value charged income current period accordance sfas 133 accounting derivative instruments hedging activities company recorded charge 249000 exit certain derivative arrangements acquired purchase axsia march 2001 company derivative financial instruments december 31 2002 2001 2000 translation foreign currencies financial statement amounts related foreign operations translated united states dollar equivalents exchange rates follows 1 balance sheet accounts yearend exchange rates 2 statement operations accounts weighted average exchange rate period gains losses resulting translations deferred included accumulated comprehensive loss separate component stockholders equity gains losses foreign currency transactions reflected consolidated statements operations use estimates companys management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity generally accepted accounting principles actual results could differ estimates earnings per common share basic earnings per share excludes dilutive effect common stock equivalents diluted earnings per common potential common share computed dividing net income weighted average number common potential common shares outstanding purposes calculation outstanding employee stock options considered potential common shares conformity securities exchange commission requirements common stock options warrants potentially dilutive instruments reflected earnings per share calculations periods presented antidilutive stock options excluded calculation potential common shares impact antidilutive shares would reduction 314000 shares 145000 shares 36000 shares years ended december 31 2002 2001 2000 respectively following table presents earnings per common share amounts computed using sfas 128 3 capital stock 1997 company provided loan 15 million interest rate 10 per annum director company also affiliate capricorn holdings inc march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn holdings inc distributed holdings natcos common stock partners 1998 company acquired option cost approximately 200000 purchase 173050 shares natcos common stock director price 881 per share companys option note provided obligation could repaid shares natcos common stock cost acquire option recorded treasury stock accompanying consolidated balance sheets february 2000 company exercised option acquire 173050 shares natcos class common stock director 15 million reduced note due director amount shares recorded treasury stock cost accompanying consolidated balance sheet balance note due director repaid june 2000 november 18 1998 companys charter amended divide common stock two classes class common stock 45000000 shares class b common stock 5000000 shares two classes common stock relative rights preferences except holders class b common stock right voting separately class elect one member companys board directors class b shares may converted holder class shares time automatically converted class shares january 1 2002 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares issued company 3446193 shares issued selling stockholders proceeds company less underwriting fees 377 million funds used retire debt 279 million term loan facility repay borrowings 30 million revolving credit facility used acquire portatest retire 22 million portatest debt acquired pay offering costs 15 million fund working capital needs february 3 2000 underwriter exercised overallotment option resulted issuance 1125000 additional shares class common stock proceeds 105 million net underwriters fees proceeds overallotment used complete acquisition mpe including repayment 685000 debt acquired working capital needs october 2000 companys board directors approved stock repurchase plan 750000 shares companys class common stock could acquired fiscal 2001 company reacquired approximately 118000 shares class common stock repurchase agreement 867000 average cost 732 per share 2000 company reacquired 34000 shares class common stock repurchase plan 243000 average cost 716 per share cost reacquire shares recorded treasury stock december 31 2002 2001 respectively february 2001 june 2000 company issued 8520 class b shares 418145 class b shares respectively former shareholders cynara connection achievement certain performance criteria defined november 1998 purchase agreement goodwill increased 85000 2001 41 million 2000 result transactions 4 acquisitions november 1998 company completed acquisition cynara group private investors 53 million cash assumption 101 million cynara bank debt issuance 500000 shares natco class b common stock valued 53 million purchase agreement also stipulated natco may required issue additional 1400000 shares class b common stock cynaras former shareholders based certain performance criteria defined purchase agreement company issued 418145 class b shares 8520 class b shares june 2000 february 2001 respectively per agreement resulted increase goodwill see note 3 capital stock funds used acquisition cynara provided 53 million equity proceeds borrowings senior credit facility provided syndicate major international banks acquisition accounted purchase results cynara included consolidated financial statements since date acquisition accordance sfas 142 goodwill intangible assets company ceased amortizing goodwill associated cynara acquisition january 1 2002 goodwill accumulated amortization 176 million 23 million respectively december 31 2002 company acquired outstanding common stock portatest january 24 2000 approximately 63 million cash net cash acquired included payment specific accrued liabilities former company purchase certain proprietary intellectual property associated us company issuance oneyear promissory note 10 million denominated canadian dollars payment contingent upon certain operating criteria met see note 18 commitments contingencies acquisition accounted using purchase method accounting results operations portatest included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period prior adoption sfas 142 goodwill intangible assets january 1 2002 goodwill accumulated amortization related portatest acquisition 54 million 532000 respectively december 31 2002 company acquired outstanding common stock mpe february 8 2000 approximately 24 million cash net cash acquired issuance oneyear promissory note 338000 accrued interest 10 per annum acquisition accounted using purchase method accounting results operations mpe included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period prior adoption sfas 142 goodwill intangible assets january 1 2002 goodwill accumulated amortization related mpe acquisition 34 million 338000 respectively december 31 2002 company acquired outstanding common stock esi april 4 2000 approximately 71 million net cash equivalents acquired subject adjustment acquisition financed borrowings 71 million existing revolving credit facility borrowings 26 million existing export sales facility accounted using purchase method accounting results operations esi included natcos consolidated financial statements since date acquisition excess purchase price fair values net assets acquired amortized twentyyear period prior adoption sfas 142 goodwill intangible assets january 1 2002 goodwill accumulated amortization related esi acquisition 60 million 510000 respectively december 31 2002 march 19 2001 company acquired outstanding share capital axsia approximately 428 million net cash acquired axsia specializes design supply water reinjection systems oil gas fields oily water treatment oil separation hydrocyclone technology hydrogen production process equipment systems acquisition financed borrowings natcos term loan facility accounted using purchase method accounting results operations axsia included natcos consolidated financial statements since date acquisition purchase price 450 million allocated follows 22 million cash acquired 384 million current assets excluding cash 20 million longterm assets excluding goodwill 460 million current liabilities excess purchase price fair value net assets acquired amortized twentyyear period prior adoption sfas 142 goodwill intangible assets january 1 2002 goodwill accumulated amortization expense related axsia acquisition 474 million 19 million respectively december 31 2002 assuming axsia acquisition occurred january 1 respective year unaudited pro forma results company twelve months ended december 31 2001 2000 respectively would follows pro forma results assume debt service costs associated axsia acquisition net tax effect calculated companys effective tax rate applicable period nondeductible goodwill amortization although prepared basis consistent natcos consolidated financial statements pro forma results purport indicative actual results would achieved acquisition consummated january 1 respective year intended projection future results effective january 8 2001 company entered compromise settlement agreement former owner test resulted cash payment 15 million natco may 31 2001 settle certain contingencies related natcos acquisition test 1997 proceeds payment net related costs used reduce goodwill associated test acquisition 5 closure november 4 2002 companys management committed plan close manufacturing engineering facility edmonton alberta canada plan includes involuntary termination 27 employees including plant workers administrative staff relocation equipment certain personnel facilities costs related modifying certain operating lease arrangements company began implementing plan november 2002 incurred approximately 548000 costs plan including severance related costs 123000 asset impairment charges 121000 costs totaling 304000 primarily related lease obligations december 31 2002 companys remaining accrued liability related restructuring 304000 additional relocation shop moving costs expensed incurred expected second quarter 2003 june 2001 company recorded charge 16 million consisted 920000 pursuant approved plan close merge existing natco office operations axsia well streamlining actions associated acquisition charge included costs severance office consolidation expenses also company withdrew public debt offering recorded charge 680000 costs incurred related proposed offering pursuant employment agreement executive officer entitled bonus upon occurrence sale public offering company bonus equaled one onehalf percent 15 value securities owned stockholders company prior sale offering including common stock valued price per share received either sale public offering debt held stockholders july 1999 company amended employment agreement eliminate bonus agreed loan officer 12 million purchase 136832 shares common stock per agreement officer would receive bonus equal outstanding principal interest note upon sale public offering company february 2000 company completed initial public offering class common stock natco recorded expense 13 million settlement obligation agreement officer used proceeds net tax repay company approximately 665000 see note 17 related parties first quarter 2000 natco incurred relocation charges approximately 208000 associated consolidation existing company facility acquired connection acquisition portatest 6 inventories consisted following amounts december 31 2002 2001 inventories valued using lifo method included amounted 263 million 295 million respectively reductions lifo layers resulted 59000 decrease net income year ended december 31 2002 reductions lifo layers years ended december 31 2001 2000 7 cost estimated earnings uncompleted contracts cost estimated earnings uncompleted contracts follows 8 property plant equipment net components property plant equipment follows depreciation expense 49 million 41 million 31 million respectively years ended december 31 2002 2001 2000 company leases certain machinery equipment customers generally periods one month one year cost leased machinery equipment 50 million 53 million related accumulated depreciation 33 million 35 million december 31 2002 2001 respectively lease rental income 13 million 12 million 581000 years ended december 31 2002 2001 2000 respectively included revenues 9 accrued expenses accrued expense consisted following 10 shortterm debt conjunction purchase portatest january 2000 company issued oneyear promissory note 1 million denominated canadian dollars accrued interest 15 per annum january 24 2001 note repaid along accrued interest february 2000 company issued oneyear promissory note face value 338000 interest payable per annum 10 conjunction acquisition mpe february 2001 company paid 206000 principal interest 11 longterm debt consolidated borrowings company follows aggregate future maturities longterm debt next five years ended december 31 follows 200371 million 2004203 million 200571 million 2006168 million 200710 million march 16 2001 company entered credit facility consisted 500 million term loan 350 million us revolving facility 100 million canadian revolving facility 50 million uk revolving facility term loan matures march 15 2006 revolving facilities matures march 15 2004 october 2001 company amended revolving credit agreement reduce borrowing capacity us 350 million 300 million increase borrowing capacity uk 50 million 100 million material modifications made agreement time amounts borrowed term loan bear interest rate 421 per annum december 31 2002 amounts borrowed revolving portion facility bear interest follows april 1 2002 rate equal companys election either 1 london interbank offered rate libor plus 225 2 base rate plus 075 april 1 2002 rate based upon ratio funded debt ebitda defined credit facility ebitda ranging companys election 1 high libor plus 250 low libor plus 175 2 high base rate plus 10 low base rate plus 025 natco paid commitment fees 050 per year april 1 2002 pay 030 050 per year following 2002 depending upon ratio funded debt ebitda april 1 2002 case undrawn portion facility july 2002 lenders approved amendment various provisions term loan revolving credit facility agreement effective april 1 2002 amendment allowed future capital investment co2 gasprocessing facility sacroc west texas revised certain debt covenants modified certain defined terms increased aggregate amount operating lease expense allowed fiscal year permitted increase borrowings export sales credit facility without consent maximum 200 million modifications result higher commitment fee percentages interest rates funded debt ebitda ratio exceeds 3 1 revolving credit term loan facility guaranteed companys domestic subsidiaries secured first priority lien inventory accounts receivable material tangible intangible assets addition company pledged 65 voting stock active foreign subsidiaries revolving credit term loan facility contains restrictive covenants among things limit amount funded debt ebitda imposes minimum fixed charge coverage ratio minimum asset coverage ratio minimum net worth requirement december 31 2002 company compliance restrictive debt covenants natco letters credit outstanding revolving credit facilities totaling 174 million december 31 2002 letters credit constitute contract performance warranty collateral expire various dates september 2005 borrowings 500 million term loan facility used primarily acquisition axsia remaining borrowings along additional borrowings revolving credit facility used repay 165 million outstanding predecessor revolving credit term loan facility company maintains working capital facility export sales provides aggregate borrowings 100 million subject borrowing base limitations borrowings 43 million outstanding december 31 2002 letters credit outstanding export sales credit facility december 31 2002 totaled 720000 export sales credit facility loans secured specific project inventory receivables partially guaranteed exim bank mature july 2004 company unsecured letters credit totaling 432000 december 31 2002 company borrowed 15 million longterm promissory note arrangement february 6 2002 note accrues interest 90day libor plus 325 per annum requires quarterly payments principal approximately 24000 interest five years beginning may 2002 promissory note collateralized manufacturing facility magnolia texas company purchased fourth quarter 2001 dividend restrictions respect credit facilities natco agreed make distributions property cash company stockholders excess 50 net income less excess cash flow beginning 2001 dividends declared paid years ended december 31 2002 2001 2000 12 income taxes income tax expense benefit consisted following components temporary differences related following items give rise deferred tax assets liabilities follows december 31 2002 2001 company recorded valuation allowance 258000 13 million related certain deferred tax assets acquired purchase axsia march 2001 company net operating loss carryforwards federal income tax purposes 76 million december 31 2002 available offset future federal income tax 2022 income tax expense differs amount computed applying us federal income tax rate 34 income continuing operations income taxes result following cumulative undistributed earnings foreign subsidiaries totaled 104 million december 31 2002 company considers earnings foreign subsidiaries indefinitely reinvested accordingly provision us foreign state income taxes made earnings upon distribution foreign subsidiary earnings form dividends otherwise distributed earnings would reportable us income tax purposes subject adjustment foreign tax credits federal income tax returns fiscal years beginning 1999 open review internal revenue service 13 stockholders equity ceo stock options connection engagement chief executive officer company granted options purchase common shares national tank company subsequently converted options purchase common stock company december 31 2002 2001 stock options granted chief executive officer stock option plans related 346113 shares companys common stock appreciation rights 1994 natco adopted national tank company stock appreciation rights plan national tank plan national tank plan provided grants officers key employees natco rights appreciation value stated number shares natco common stock value determined committee natco board directors maximum number rights issuable national tank plan 500000 rights vested threeyear period individual stock options july 1 1997 board directors company approved exchange rights outstanding national tank plan discussed previously individual options purchase common stock company compensation expense recognized extent projected fair market value stock exchange date exceeded exercise price options furthermore additional stock options granted plan exercise price equal fair market value shares date grant accordingly compensation expense recorded additional grants individual stock options granted july 1 1997 vested ratably period three four years maximum term options 10 years december 31 2002 2001 2000 options relating aggregate 527701 shares 527701 shares 764204 shares respectively remained outstanding plan stock option plans january 1998 february 1998 company adopted directors compensation plan employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares companys common stock options vest periods four years maximum term options ten years december 31 2002 2001 2000 options relating aggregate 731587 shares 743920 shares 743953 shares respectively outstanding plans natco group inc 2001 stock incentive plan november 2000 board directors company approved authorized issuance 300000 shares companys common stock 2000 employee stock option plan may 24 2001 companys stockholders approved natco group inc 2001 stock incentive plan superceded replaced 2000 plan entirety increased number shares options awards may granted plan maximum 1000000 shares december 31 2002 2001 options relating aggregate 807326 shares 795826 shares respectively outstanding plan options outstanding plan december 31 2000 transactions pursuant companys stock option plans years ended december 31 2002 2001 2000 include pro forma information regarding net income earnings per share required sfas 123 determined applying blackscholes single option reduced term valuation method valuation model requires management make highly subjective assumptions volatility natcos common stock expected term outstanding stock options companys riskfree interest rate expected dividend payments contractual life options volatility stock prices evaluated based upon historical data new york stock exchange date initial public offering january 28 2000 february 1 2003 volatility calculated 52 december 31 2002 steppeddown 10 per year next three years reflect expected stabilization following table summarizes assumptions used determine pro forma compensation expense sfas 123 december 31 2002 riskfree rates determined based upon us treasury obligations option date outstanding similar term company intend pay dividends common stock term options outstanding december 31 2002 purposes pro forma disclosures estimated fair value options amortized expense options vesting period companys pro forma net earnings per share years ended december 31 2002 2001 2000 see note 2 summary significant accounting policies preferred stock purchase rights may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natcos common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 companys common stock announces commencement tender offer consummation would result ownership person group 15 companys common stock person group acquire 15 companys common stock right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board directors may redeem rights price 001 per right time acquisition person group 15 less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed 14 change accounting principle effective january 1 2000 natco recorded cumulative effect change accounting principle related gains losses postretirement benefit obligation prior december 31 2000 gains losses resulted experience assumption changes recorded charge current income period change sfas 106 employers accounting postretirement benefits pensions natco revised method accounting gains losses amortize net gain loss exceeds 10 companys adjusted postretirement benefit obligation remaining life expectancy plan participants newly adopted accounting principle preferable circumstances deferral unrealized gains losses common practice results less volatility net periodic postretirement benefit cost gain 10000 net tax recorded consolidated statement income december 31 2000 result change accounting principle see note 15 pension postretirement benefits 15 pension postretirement benefits company adopted sfas 132 revised disclosures pension postretirement benefit plans disclosures regarding pension benefits represent plan certain union employees foreign subsidiary disclosures regarding postretirement benefits represent health care life insurance benefits employees retired company acquired ce december 1999 company entered agreement ws tyler incorporated tyler capricorn investors lp company assumed responsibility retired employee health life insurance obligations tyler liability accrued respect obligations determined independent actuarial firm 11 million consideration agreement tyler paid company 475000 cash assigned portion federal income tax refund due tyler amount approximately 600000 tyler remitted 600000 january 2000 settlement arrangement december 2000 natco changed method used record gains losses postretirement benefit obligation resulted gain 10000 net tax year ended december 31 2000 unrecognized loss 15 million see note 14 change accounting principle may 1 2001 company amended postretirement benefit plan provided medical dental coverage retirees predecessor company amended plan retirees bear additional costs coverage significant plan changes include higher deductibles prescription coverage drug card program elimination dental benefits july 1 2001 company obtained thirdparty valuation liability plan arrangement amended based upon valuation effect amendment 64 million reduction companys postretirement benefit liability december 31 2001 cumulative unrecognized loss 36 million existed related postretirement benefit plan accordance sfas 106 employers accounting postretirement benefits pensions benefit associated plan amendment amortized income prior service cost adjustment remaining life expectancy plan participants additionally cumulative unrecognized loss amortized expense remaining life expectancy plan participants november 2001 company agreed maintain benefits preamendment levels specified class retirees exchange expense reimbursement former sponsor postretirement benefit plan agreement requires reimbursement 79000 per year four succeeding years pursuant arrangement company received 79000 year reimbursement postretirement benefit expenses 2002 2001 recorded receivable present value future benefits 217000 august 2001 participants canadian pension plan voted terminate contributions plan receive actuarially determined cash distributions december 31 2002 company formally terminated pension plan benefit payments distributed except amounts due certain retirees yet replied notification pending distributions company intends purchase annuity contract approximately 234000 fund remaining liability plan arrangement following table sets forth plans benefit obligation fair value plan assets funded status december 31 2002 2001 defined contribution plans company subsidiaries defined contribution pension plans covering substantially nonunion hourly salaried employees completed three months service employee contributions 3 covered employees compensation matched 100 company additional 2 covered employees compensation matched 50 addition company may make discretionary contributions profit sharing contributions company contributions plan totaled 14 million 18 million 14 million years ended december 31 2002 2001 2000 respectively 16 operating leases company subsidiaries lease various facilities equipment noncancelable operating lease agreements leases expire various dates september 2006 excluding lease arrangement facility axsia requires lease commitments facility sublet another party future minimum lease payments required operating leases remaining noncancelable lease terms excess one year december 31 2002 follows 200340 million 200430 million 200512 million 200610 2007915000 total expense operating leases years ended december 31 2002 2001 2000 58 million 53 million 44 million respectively discussion lease rental income see note 8 property plant equipment net 17 related parties company pays capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut companys chief executive officer reception telephone computer services normal office support relating space mr herbert winokur jr one companys directors chairman chief executive officer capricorn holdings inc managing partner capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controls approximately 31 companys outstanding common stock addition companys chief executive officer mr gregory nonsalaried member capricorn holdings llc capricorn investors ii lp controls approximately 20 companys common stock fees paid capricorn management totaled 115000 85000 75000 years ended december 31 2002 2001 2000 respectively commencing october 1 2001 fee increased 28750 per quarter due primarily upward adjustments capricorn managements underlying lease office space increase reviewed approved audit committee companys board directors terms employment agreement effect prior 1999 company loaned chief executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 company completed initial public offering class common stock also pursuant terms employment agreement company paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay company approximately 665000 addition october 27 2000 companys board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options amount loan equal cost exercise options plus personal tax burdens resulted exercise maturity loans july 31 2003 interest accrued rates ranging 6 78 per annum june 30 2002 outstanding notes receivable totaled 34 million including principal accrued interest effective july 1 2002 notes reviewed companys board amended extend maturity dates july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied notes balances june 30 2002 including previously accrued interest december 31 2002 balance notes principal accrued interest due officer loan arrangements 35 million loans executive officer made full recourse basis prior periods facilitate direct ownership companys common stock currently subject compliance provisions sarbanesoxley act 2002 previously agreed 2001 company loaned employee executive officer director 216000 april 15 2002 fullrecourse note arrangement accrues interest 6 per annum matures july 31 2003 funds used pay exercise cost personal tax burdens associated stock options exercised 2001 effective july 1 2002 note amended extend maturity date july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied note balance june 30 2002 including previously accrued interest december 31 2002 balance note principal interest due officer loan arrangement approximately 223000 loan executive officer made full recourse basis time prior periods facilitate direct ownership companys common stock currently subject compliance provisions sarbanesoxley act 2002 1997 company loaned 15 million rate 10 per annum director company also affiliate capricorn holdings inc march 1998 related promissory note amended change interest rate 11 per annum principal due date capricorn investors lp distributed holding natco common stock partners 1998 natco acquired option cost 200000 purchase 173050 shares common stock director price 881 per share natcos option note could repaid shares companys common stock cost acquire option recorded treasury stock accompanying consolidated balance sheet note arrangement director recorded 19 million current asset december 31 1999 partially settled february 2000 company exercised option purchase 173050 shares common stock director cost 15 million remaining balance note repaid june 2000 december 1999 company assumed postretirement pension liability former affiliate tyler february 2000 company received 600000 tyler settlement agreement entered tyler capricorn investors lp company whereby company assumed responsibility retired employee health life insurance obligations tyler see note 15 pension postretirement benefits 18 commitments contingencies portatest purchase agreement executed january 2000 contains provision calculate payment certain former stockholders portatest systems inc threeyear period ended january 23 2003 based upon sales limited number specified products designed utilizing technology existed time acquisition liability arrangement contingent upon attaining certain performance criteria including gross margins sales volumes specified products applicable payment required annually april 2001 company paid 226000 arrangement related year ended january 23 2001 august 2002 company paid 197000 arrangement related year ended january 23 2002 resulting increase goodwill liability accrued pursuant arrangement december 31 2002 19 change accounting estimate april 2000 company extended service life carbon dioxide gasprocessing plant based upon extension agreement operate facility effect net income basic diluted earnings per share cumulative effect change accounting principle increase 305000 02 respectively year ended december 31 2000 20 litigation company party various routine legal proceedings primarily involve commercial claims products liability claims workers compensation claims company cannot predict outcome lawsuits legal proceedings claims certainty nevertheless companys management believes outcome proceedings even determined adversely would material adverse effect business financial condition 21 industry segments geographic information company adopted provisions sfas 131 disclosures segments enterprise related information companys business units separate management teams infrastructures offer different products services business units aggregated three reportable segments described since longterm financial performance reportable segments affected similar economic conditions north american operations segment consists us sales service business unit companys canadian venezuelan subsidiaries latin american operations co2 gasprocessing operations us sales service business unit designs engineers manufactures provides startup services production equipment generally less complex units provided engineered systems provides replacement parts field shop servicing equipment used equipment refurbishing natco canada provides design engineering manufacturing startup services production equipment well replacement parts field shop servicing equipment used equipment refurbishing natco canada also provides selective manufacturing services engineered systems segment natco venezuela latin american operations generally provide replacement parts service customers south america mexico respectively co2 gasprocessing operations include ongoing service two gasprocessing plants united states principal market us sales service business unit us onshore offshore market international market customers include major multinational independent national stateowned companies principal markets natco canada oil gas producing regions canada customers include major multinational independent companies engineered systems segment consists four business units us engineered systems ntc technical services natco japan axsia provide design engineering manufacturing startup services engineered process systems principal markets segment include major oil gas producing regions world including north america south america europe middle east africa far east customers include major multinational independent national stateowned companies automation control systems test sole business unit reported segment unit designs manufactures installs services instrumentation electrical control systems principal markets segment include major oil gas producing regions world including north america south america europe kazakhstan africa far east customers include major multinational independent national stateowned companies segment formerly named instrumentation electrical systems accounting policies reportable segments described note 2 company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense accounting changes nonrecurring items summarized financial information concerning companys reportable segments shown following table summarized financial information concerning companys reportable segments shown following table companys geographic data continuing operations years ended december 31 2002 2001 2000 follows equipment large international projects generally manufactured us therefore revenues results operations related projects presented derived united states purposes geographic presentation corporate expenses consist corporate overhead research development expenses 22 quarterly data following tables summarize unaudited quarterly information years ended december 31 2002 2001 2000 23 goodwill impairment testing financial accounting standards board fasb approved sfas 142 goodwill intangible assets june 2001 pronouncement requires intangible assets indefinite lives including goodwill cease amortized evaluated impairment annual basis intangible assets defined term patents would continue amortized useful life asset company adopted sfas 142 january 1 2002 intangible assets subject amortization pronouncement december 31 2002 2001 summarized following table amortization interest expense 840000 932000 554000 recognized related assets years ended december 31 2002 2001 2000 respectively estimated aggregate amortization interest expense assets following five fiscal years 2003625000 2004383000 2005341000 2006152000 200727000 segment reporting purposes intangible assets related amortization expense recorded corporate eliminations goodwill companys intangible asset required periodic amortization date adoption sfas 142 net goodwill december 31 2002 790 million pro forma impact applying sfas 142 operating results years ended december 31 2001 2000 would reduction amortization expense 37 million 16 million respectively resulting net income 90 million 93 million respectively pro forma increase basic diluted earnings per share would 23 respectively 2001 11 10 respectively 2000 accordance sfas 142 company tested impairment goodwill comparing fair value operating assets carrying value assets including related goodwill required pronouncement company identified separate reportable units purposes evaluation determining carrying value company segregated assets liabilities extent possible clearly identifiable specific reporting unit intercompany receivablespayables excluded certain corporate assets liabilities clearly identifiable specific reporting unit allocated based ratio reporting units net assets relative total net assets resulting fair value compared carrying value reportable unit determine whether impairment occurred reportable unit level impairment indicated accordance pronouncement additional tests required since impairment goodwill indicated based upon testing performed impairment charge recorded sfas 142 december 31 2002 goodwill tested impairment annually december 31 24 new accounting pronouncements june 2001 financial accounting standards board fasb approved sfas 141 business combinations standard requires business combination initiated june 30 2001 accounted using purchase method accounting standard became effective july 1 2001 material effect companys financial condition results operations fasb approved sfas 142 goodwill intangible assets june 2001 pronouncement requires intangible assets indefinite lives including goodwill cease amortized evaluated impairment basis see discussion results impairment testing note 23 goodwill impairment testing june 2001 fasb issued sfas 143 accounting asset retirement obligations standard requires company record fair value asset retirement obligation liability period legal obligation associated retirement tangible longlived assets result acquisition construction development andor normal use assets incurred addition standard requires company record corresponding asset depreciated life asset gave rise liability subsequent initial measurement asset retirement obligation company required adjust liability end period reflect changes estimated retirement cost passage time company adopt pronouncement january 1 2003 require certain liabilities recorded first quarter 2003 company currently determining effect pronouncement financial condition results operations october 2001 fasb issued sfas 144 accounting impairment disposal longlived assets statement replaces sfas 121 accounting impairment longlived assets longlived assets disposed standardizes accounting model used asset dispositions related implementation issues pronouncement became effective financial statements issued fiscal years beginning december 15 2001 company adopted pronouncement january 1 2002 resulting material effect financial condition results operations april 2002 fasb issued sfas 145 rescission fasb statements 4 44 64 amendment fasb statement 13 technical corrections statement amends existing guidance reporting gains losses extinguishment debt prohibiting classification gain loss extraordinary sfas 145 also amends sfas 13 require saleleaseback accounting certain lease modifications economic effects similar saleleaseback arrangements provisions statement related rescission statement 4 applied fiscal year beginning may 14 2002 early adoption encouraged provisions statement related statement 13 effective transactions occurring may 15 2002 early adoption encouraged sfas 145 adopted respects revision statement 13 may 15 2002 adopted january 1 2003 respect amendment sfas 4 however adoption sfas 145 expected material effect companys financial condition results operations june 2002 fasb issued sfas 146 accounting exit disposal activities addresses financial accounting reporting costs associated exit disposal activities including restructuring activities currently accounted pursuant guidance set forth eitf issue 943 liability recognition certain employee termination benefits costs exit activity sfas 146 effective exit disposal activities initiated december 31 2002 early adoption encouraged provisions pronouncement applied exit disposal activities january 1 2003 however company expect pronouncement material effect financial condition results operations november 2002 fasb issued interpretation 45 guarantors accounting disclosure requirements guarantees including indirect guarantees indebtedness others interpretation fasb statements 5 57 107 rescission fasb interpretation 34 interpretation elaborates disclosures made guarantor interim annual financial statements obligations guarantees issued interpretation also clarifies guarantor required recognize inception guarantee liability fair value obligation taken initial recognition measurement provisions interpretation applicable guarantees issued modified december 31 2002 company expect interpretation material effect financial condition results operations december 2002 fasb issued sfas 148 accounting stockbased compensationtransition disclosure amendment fasb statement 123 statement amends fasb statement 123 accounting stockbased compensation provide alternative methods transition volunteerbasis fair value method accounting stockbased employee compensation additionally statement amends disclosure requirements sfas 123 require prominent disclosures annual interim financial statements certain disclosure modifications required fiscal years ending december 15 2002 transition sfas 123 elected company elected transition sfas 123 december 31 2002 see note 13 stockholders equity 25 subsequent events march 13 2003 company executed agreement issue 15000 shares series b convertible preferred stock along warrants purchase 248800 shares companys common stock lime rock partners ii lp private investment fund aggregate purchase price 150 million aggregate purchase price approximately 99000 allocated warrant company amortize discount three years proceeds issuance used reduce companys outstanding revolving debt balances general corporate purposes transaction expected close prior end march 2003 share series b convertible preferred stock face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year share series b convertible preferred stock convertible option holder thereof number shares common stock equal face value share divided conversion price 7805 ii cash payment equal amount dividends share accrued since prior semiannual dividend payment date warrants issued lime rock exercise price 1000 per share common stock expire third anniversary issuance company force exercise warrants companys stock price trades 1350 per share 30 consecutive days item 9item 8 financial statements supplementary data follow consolidated financial statements years ended december 31 2003 2002 2001 applicable along independent auditors report independent auditors report board directors natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 2003 2002 related consolidated statements operations stockholders equity comprehensive income cash flows years threeyear period ended december 31 2003 consolidated financial statements responsibility companys management responsibility express opinion consolidated financial statements based audits conducted audits accordance auditing standards generally accepted united states america standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2003 2002 results operations cash flows years threeyear period ended december 31 2003 conformity accounting principles generally accepted united states america discussed note 13 consolidated financial statements effective january 1 2003 company changed method accounting asset retirement obligations discussed note 2 consolidated financial statements effective january 1 2002 company changed method accounting goodwill intangible assets kpmg llp houston texas february 23 2004 except note 10 march 15 2004 natco group inc subsidiaries consolidated balance sheets thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements stockholders equity comprehensive income thousands except share data see accompanying notes consolidated financial statements natco group inc subsidiaries consolidated statements cash flows thousands see accompanying notes consolidated financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization natco group inc formerly known cummings point industries inc formed june 1988 capricorn investors lp led group investors provided capital company acquire several businesses combustion engineering inc ce june 1989 company acquired ce outstanding common stock national tank company certain businesses subsequently divested distributed shareholders june 30 1997 natco acquired total engineering services team inc test november 18 1998 natco acquired cynara company cynara company acquired portatest international inc portatest january 24 2000 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares newly issued company 3446193 existing shares sold selling stockholders february 3 2000 underwriter exercised overallotment option resulted issuance company 1125000 additional shares class common stock february 8 2000 april 4 2000 natco acquired modular production equipment inc mpe engineering specialties inc esi respectively march 19 2001 natco acquired axsia group limited axsia privately held process design company based united kingdom accompanying consolidated financial statements related disclosures include results operations company whollyowned subsidiaries years ended december 31 2003 2002 2001 furthermore certain reclassifications made fiscal 2002 fiscal 2001 amounts order present results comparable basis amounts fiscal 2003 references natco company used throughout document relate collectively natco group inc consolidated subsidiaries 2 summary significant accounting policies principles consolidation consolidated financial statements include accounts company whollyowned subsidiaries significant intercompany accounts transactions eliminated consolidation concentration credit risk concentrations credit risk respect trade receivables limited due large number customers comprising companys customer base geographic dispersion year ended december 31 2003 customer provided 10 companys consolidated revenues year ended december 31 2002 one customer exxonmobil corporation affiliates general contractor hyundai heavy industries co provided 10 companys consolidated revenues customer provided 10 consolidated revenues year ended december 31 2001 see note 19 industry segments geographic information cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents trade accounts receivable trade accounts receivable recorded invoiced amount allowance doubtful accounts provided estimate probable losses resulting bad debt company reviews allowance doubtful accounts month individually investigates past due balances 90 days order assess collectibility receivable trade accounts receivable balances charged allowance doubtful accounts collectibility determined remote inventories stated lower cost market cost determined using last first lifo method natco domestic inventories average cost test inventories first fifo method inventories property plant equipment property plant equipment stated cost less allowance depreciation plant equipment calculated using straightline method assets estimated useful lives maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included income carrying values property plant equipment location reviewed annually often indications assets may impaired goodwill prior adoption january 1 2002 statement financial accounting standards sfas 142 goodwill intangible assets goodwill amortized straightline basis periods 20 40 years accordance sfas 142 company ceased amortization goodwill began evaluate goodwill impairment basis required sfas 142 company identifies separate reportable units purposes evaluating goodwill impairment determining carrying value company segregates assets liabilities extent possible clearly identifiable specific reportable unit certain corporate assets liabilities clearly identifiable specific reportable unit allocated accordance standard fair value determined discounting projected future cash flows companys cost capital rate calculated fair value compared carrying value reportable unit determine whether impairment occurred reportable unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting units assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 business combinations residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value company would record impairment charge amount net goodwill 801 million december 31 2003 tested impairment required sfas 142 based testing companys management believes impairment goodwill exists december 31 2003 see note 21 goodwill impairment testing amortization expense year ended december 31 2001 37 million assets net assets include deferred financing fees patents longterm deposits prepaid pension assets deferred financing costs covenants compete amortized term related agreements amortization interest expense 847000 840000 932000 years ended december 31 2003 2002 2001 respectively environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred revenue recognition revenues significant contracts natco contracts greater 250000 longer four months duration certain test contracts orders recognized percentage completion method earned revenue based percentage incurred costs date bear total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects revenues related costs recognized products shipped services rendered stockbased compensation sfas 123 accounting stockbased compensation permits entities recognize expense vesting period fair value stockbased awards date grant alternatively sfas 123 allows entities continue apply provisions accounting principles board apb opinion 25 provide pro forma net income earnings per share disclosures employee stock option grants made 1995 future years fairvaluebased method defined sfas 123 applied december 2002 sfas 148 accounting stockbased compensationtransition disclosure amendment fasb statement 123 issued provides alternative methods transition fair value method accounting stockbased compensation volunteer basis requires additional disclosures annual interim periods company elected continue apply provision apb opinion 25 provide pro forma disclosure requirements sfas 123 companys pro forma net income earnings per share data years ended december 31 2003 2002 2001 per sfas 123 follows research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years research development expenses totaled 19 million 20 million 21 million years ended december 31 2003 2002 2001 respectively warranty costs estimated future warranty obligations related products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims december 31 2003 2002 company 69 million 60 million respectively outstanding letters credit related warranties income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment derivative arrangements assets liabilities associated underlying derivative arrangements qualify hedge value accounting recorded fair market value balance sheet date changes fair value charged income current period accordance sfas 133 accounting derivative instruments hedging activities company recorded charge 249000 exit certain derivative arrangements acquired purchase axsia march 2001 december 31 2003 company issued 248800 warrants purchase shares natco common stock associated issuance series b preferred stock warrants recorded fair market value 154000 december 31 2003 changes fair market value derivative arrangements recorded net income period change translation foreign currencies financial statement amounts related foreign operations functional currencies us dollar translated us dollar equivalents exchange rates follows 1 balance sheet accounts yearend exchange rates 2 statement operations accounts weighted average exchange rate period gains losses resulting translations deferred included accumulated comprehensive loss separate component stockholders equity gains losses foreign currency transactions reflected consolidated statements operations use estimates companys management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity generally accepted accounting principles actual results could differ estimates earnings per common share basic earnings per share excludes dilutive effect common stock equivalents diluted earnings per common potential common share computed dividing net income loss available common stockholders weighted average number common potential common shares outstanding net income loss available common stockholders december 31 2003 represented net income cumulative effect change accounting principle less preferred stock dividends accrued paid weighted average number common potential common shares outstanding derived applying ifconverted method determine incremental shares associated convertible preferred stock warrants restricted stock outstanding company recorded loss available common stockholders year ended december 31 2003 therefore common stock equivalents related employee stock options convertible preferred stock warrants restricted stock deemed antidilutive excluded calculation weighted average shares years ended december 31 2002 2001 potentially dilutive employee stock options included earnings per share calculations applicable antidilutive stock options excluded calculation potential common shares years presented impact antidilutive shares would reduction 495000 shares 314000 shares 145000 shares years ended december 31 2003 2002 2001 respectively following table presents earnings per common share amounts computed using sfas 128 3 capital stock redeemable convertible preferred stock equity november 18 1998 companys charter amended divide common stock two classes class common stock 45000000 shares class b common stock 5000000 shares two classes common stock relative rights preferences except holders class b common stock right voting separately class elect one member companys board directors class b shares may converted holder class shares time february 2001 company issued 8520 class b shares former shareholders cynara connection achievement certain performance criteria defined november 1998 purchase agreement goodwill increased 85000 2001 result transaction total shares issued former cynara stockholders earnout arrangement 752501 shares january 1 2002 outstanding shares companys class b common stock 334719 shares converted automatically class common stock share basis accordance terms class b common stock originally issued resulting single class redesignated common stock october 2000 companys board directors approved stock repurchase plan 750000 shares companys class common stock could acquired fiscal 2001 company reacquired approximately 118000 shares class common stock repurchase agreement 867000 average cost 732 per share cost reacquire shares recorded treasury stock december 31 2003 2002 respectively march 25 2003 company issued 15000 shares series b convertible preferred stock series b preferred shares warrants purchase 248800 shares natcos common stock lime rock partners ii lp private investment fund aggregate sale price 150 million approximately 99000 aggregate sale price allocated warrants proceeds issuance securities net related estimated issuance costs approximately 800000 used reduce companys outstanding revolving debt balances general corporate purposes series b preferred shares face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment payable july 1 2003 series b preferred shares convertible option holder number shares common stock equal face value series b preferred share divided conversion price 7805 aggregate 1921845 shares december 31 2003 ii cash payment equal amount dividends shares accrued since prior semiannual dividend payment date 2003 company paid dividends 12 million holders series b preferred shares event change control defined certificate designations preferred shares holder series b preferred shares right convert series b preferred shares common stock cause company redeem cash series b preferred shares aggregate redemption price equal sum 1000 adjusted stock splits stock dividends etc multiplied number shares redeemed plus ii amount less zero equal product aggregate amount dividends paid cash since issuance date plus gain related stock warrants holder series b preferred shares converts upon change control occurring march 25 2006 holder would also entitled receive cash amount equal dividends would accrued march 25 2006 less sum aggregate amount dividends paid cash date conversion aggregate amount dividends accrued prior periods yet paid company right redeem series b preferred shares cash march 25 2008 redemption price per share equal face value series b preferred shares plus amount dividends accrued paid since recent semiannual dividend payment date company adopted sfas 150 accounting certain instruments characteristics liabilities equity july 1 2003 sfas 150 series b preferred shares would classified permanent equity however due cash redemption features upon change control described series b preferred shares qualify permanent equity treatment accordance emerging issues task force topic d98 classification measurement redeemable securities specifically requires permanent equity treatment precluded security redemption features solely within control issuer therefore company accounted series b preferred shares temporary equity accompanying balance sheet assigned value right redeem series b preferred shares march 25 2008 series b preferred shares converted contingent redemption features redemption amount greater carrying value would recorded reduction income available common shareholders event becomes probable company fails pay dividends two consecutive periods redemption price due respect series b preferred shares period 60 days following payment date company default terms shares default period 1 dividend rate series b preferred shares would increase 1025 2 holders series b preferred shares would right elect appoint second director board directors 3 company would restricted paying dividends redeeming acquiring common outstanding stock limited exceptions company fails set aside make payments cash redemption price due respect series b preferred shares holders elect companys right redeem shares may terminated warrants issued lime rock partners ii lp exercise price 1000 per share common stock expire march 25 2006 company force exercise warrants natos common stock trades 1350 per shares 30 consecutive days warrants contain provision whereby holder could require company make netcash settlement warrants case change control warrants deemed derivative instruments therefore warrants recorded fair value issuance date fair value agreed counterparty agreement calculated applying pricing model included subjective assumptions stock volatility expected term warrants would outstanding dividend rate zero overall liquidity factor company recorded resulting liability 99000 issuance date liability increased 154000 december 31 2003 result change fair value warrants similarly changes fair value future periods recorded net income period change december 31 2003 company recorded adjustment beginning retained earnings 400000 represented elimination reserve indemnify former affiliate tax ramifications may result taxfree spinoff former subsidiary 1997 reserve associated indemnification recorded 1999 december 31 2003 statute limitations expired review appropriate taxing authorities reserve deemed unnecessary since original transaction result gain loss reversal reserve recorded adjustment retained earnings rather component net income year ended december 31 2003 4 acquisitions march 19 2001 company acquired outstanding share capital axsia approximately 428 million net cash acquired axsia specializes design supply water reinjection systems oil gas fields oily water treatment oil separation hydrocyclone technology hydrogen production process equipment systems acquisition financed borrowings natcos term loan facility accounted using purchase method accounting results operations axsia included natcos consolidated financial statements since date acquisition purchase price 450 million allocated follows 22 million cash acquired 384 million current assets excluding cash 20 million longterm assets excluding goodwill 460 million current liabilities excess purchase price fair value net assets acquired amortized twentyyear period prior adoption sfas 142 goodwill intangible assets january 1 2002 goodwill accumulated amortization expense related axsia acquisition 474 million 19 million respectively december 31 2003 assuming axsia acquisition occurred january 1 respective year unaudited pro forma results company twelve months ended december 31 2001 would follows pro forma results assume debt service costs associated axsia acquisition net tax effect calculated companys effective tax rate applicable period nondeductible goodwill amortization although prepared basis consistent natcos consolidated financial statements pro forma results purport indicative actual results would achieved acquisition consummated january 1 respective year intended projection future results effective january 8 2001 company entered compromise settlement agreement former owner test resulted cash payment 15 million natco may 31 2001 settle certain contingencies related natcos acquisition test 1997 proceeds payment net related costs used reduce goodwill associated test acquisition 5 closure september 2003 companys management approved restructuring plan included involuntary termination certain administrative operating personnel connection closure manufacturing facility covington louisiana companys corporate headquarters companys research development facility tulsa oklahoma consolidation operations uk result restructuring plan company recorded expense 12 million approximately 756000 related postemployment costs terminated employees provided companys severance policy accounted accordance sfas 112 employers accounting postemployment benefits amendment fasb statements 5 43 427000 related consultants fees equipment moving costs employee relocations company accrual 95000 related restructuring plan december 31 2003 expect incur additional costs related restructuring 2004 december 2003 companys management approved additional restructuring costs including plan close engineered systems location singapore recorded closure expense 692000 515000 related severance 35000 related termination lease arrangement 142000 related relocation employee company accrual 560000 related restructuring plan december 31 2003 expect incur additional costs related office closure 2004 december 31 2002 company recorded liability totaling 304000 related certain restructuring costs incurred connection closure manufacturing facility edmonton alberta canada december 31 2003 liability totaled 88000 following table summarizes changes restructuring liability cost type portion accrual related lease termination twelve months ended december 31 2003 reduced approximately 239000 113000 related amounts paid 126000 related change companys assessment liability lease arrangement facility 2003 company recorded closure expense associated canadian restructuring plan 230000 related equipment moving costs employee relocations including severance costs 129000 identified restructuring costs plan measurement date june 2001 company recorded charge 16 million consisted 920000 pursuant approved plan close merge existing natco office operations axsia well streamlining actions associated acquisition charge included costs severance office consolidation expenses company also withdrew public debt offering 2001 recorded charge 680000 costs incurred related proposed offering 6 inventories consisted following amounts december 31 2003 2002 inventories valued using lifo method included amounted 286 million 263 million respectively reductions lifo layers resulted 59000 decrease net income year ended december 31 2002 reductions lifo layers years ended december 31 2003 2001 7 cost estimated earnings uncompleted contracts cost estimated earnings uncompleted contracts follows 8 property plant equipment net components property plant equipment follows pursuant september 2003 restructuring plan company closed manufacturing facility covington louisiana fourth quarter 2003 transferred equipment inventory branch manufacturing locations december 31 2003 manufacturing facility net book value 714000 classified held sale companys management expects sell facility within one year facility included north american operations business segment december 31 2003 2002 depreciation expense 50 million 49 million 41 million respectively years ended december 31 2003 2002 2001 company leases certain machinery equipment customers shortterm operating lease arrangements generally periods one month one year company recorded depreciation expense related leased assets 433000 380000 354000 years ended december 31 2003 2002 2001 respectively operating lease arrangements shortterm periods one month one year often result sale equipment within one year assets lease company records depreciation expense based upon assets estimated useful life net book value leased assets recorded 14 million 17 million december 31 2003 2002 respectively included accompanying balance sheet caption current assets since company intends sell assets within one year place assets used inventory upon return lessee lease rental income 15 million 13 million 12 million included revenues north american operations business segment years ended december 31 2003 2002 2001 respectively 9 accrued expenses accrued expense consisted following 10 longterm debt consolidated borrowings company follows aggregate future maturities longterm debt next five years ended december 31 follows 200456 million 200565 million 200665 million 2007250 million debt maturing prior 2008 march 16 2001 company entered credit facility consisted 500 million term loan 350 million us revolving facility 100 million canadian revolving facility 50 million uk revolving facility term loan matures march 31 2006 revolving facilities matures march 31 2004 revolving credit term loan facilities contain restrictive covenants among things limit amount funded debt ebitda imposes minimum fixed charge coverage ratio minimum asset coverage ratio minimum net worth requirement october 2001 company amended revolving credit agreement reduce borrowing capacity us 350 million 300 million increase borrowing capacity uk 50 million 100 million material modifications made agreement time borrowings 500 million term loan facility used primarily acquisition axsia remaining borrowings along additional borrowings revolving credit facility used repay 165 million outstanding predecessor revolving credit term loan facility july 2002 companys lenders approved amendment various provisions term loan revolving credit facility agreement effective april 1 2002 amendment revised certain restrictive debt covenants modified certain defined terms allowed future capital investment companys sacroc co2 processing facility west texas facilitates issuance 75 million subordinated indebtedness increased aggregate amount operating lease expense allowed fiscal year permitted increase borrowings export sales credit facility without consent maximum 200 million modifications resulted higher commitment fee percentages interest rates original loan agreement based funded debt ebitda ratio defined underlying agreement amended july 2003 companys lenders approved amendment existing term loan revolving credit facility effective april 1 2003 amendment modified several restrictive covenant terms including fixed charge coverage ratio funded debt ebitda ratio defined agreement companys term loan revolving credit facility agreement certain debt covenants became restrictive fourth quarter 2003 company required obtain waiver covenants related net worth funded debt ebitda ratio fixed charge coverage ratio march 31 2004 subject company meeting minimum ebitda threshold subsequently achieved order remain compliance governing agreement amended december 2003 company obtained waiver certain debt covenants including related net worth funded debt ebitda fixed charge coverage ratio march 31 2004 subject meeting minimum ebitda threshold company met threshold requirement december 31 2003 compliance covenant requirements amended date amounts borrowed term loan bear interest rate 391 per annum december 31 2003 amounts borrowed revolving portion facility bear interest follows april 1 2002 rate equal companys election either 1 london interbank offered rate libor plus 225 2 base rate plus 075 april 1 2002 rate based upon ratio funded debt ebitda defined credit facility ebitda ranging companys election 1 high libor plus 300 low libor plus 175 2 high base rate plus 150 low base rate plus 025 natco paid commitment fees 050 per year april 1 2002 required pay commitment fees 030 0625 per year following 2002 depending upon ratio funded debt ebitda undrawn portion facility december 31 2003 companys commitment fees calculated rate 0625 march 15 2004 company replaced 2001 term loan revolving credit facilities term loan revolving credit arrangement called 2004 term loan revolving facilities provides term loan 450 million us revolving facility borrowing capacity 200 million canadian revolving facility borrowing capacity 50 million uk revolving credit facility borrowing capacity 100 million borrowing capacities 2004 revolving credit facilities subject borrowing base limitations 2004 term loan revolving facilities provide interest rate based upon ratio funded debt ebitda defined credit facility ebitda ranging companys election 1 high libor plus 275 low libor plus 200 2 high base rate plus 175 low base rate plus 100 natco pay commitment fees related facility based upon ratio funded debt ebitda undrawn portion facility 2004 term loan revolving facilities require quarterly payments 16 million beginning june 2004 mature march 15 2007 company intends borrow funds 2004 term loan revolving credit facilities retire debt outstanding 2001 term loan revolving credit facilities march 15 2004 result classified current installments five year repayments bank debt december 31 2003 based repayment terms 2004 term loan revolving facilities 2004 term loan revolving credit facilities guaranteed company operating subsidiaries secured first lien first priority security interest pledge substantially assets borrowers including accounts receivable inventory equipment intangibles equity interests us subsidiaries 66 13 equity interest active nonus subsidiaries assets company active us subsidiaries secure us canadian uk facilities assets companys canadian subsidiary also secure canadian facility assets companys uk subsidiaries also secure uk facility us facility guaranteed us subsidiary company canadian uk facilities guaranteed natco group inc us subsidiaries canadian subsidiary uk subsidiaries applicable 2004 term loan revolving credit facilities contain restrictive covenants similar contained 2001 facilities including among others limit amount funded debt ebitda defined 2004 facilities impose minimum fixed charge coverage ratio minimum asset coverage ratio minimum net worth requirement company maintains working capital facility export sales provides aggregate borrowings 100 million subject borrowing base limitations borrowings 700000 outstanding december 31 2003 letters credit outstanding export sales credit facility december 31 2003 totaled 69000 fees related letters credit december 31 2003 approximately 1 outstanding balance export sales credit facility secured specific project inventory receivables partially guaranteed exim bank loans facility mature july 2004 require renewal annually natco letters credit outstanding revolving credit facilities totaling 198 million december 31 2003 fees related letters credit december 31 2003 ranged approximately 1 325 outstanding balance letters credit support contract performance warranties expire various dates april 2007 company unsecured letters credit bonds totaling 584000 guarantees totaling 79 million december 31 2003 february 6 2002 company borrowed 15 million longterm promissory note finance purchase manufacturing facility magnolia texas note accrues interest 90day libor plus 325 per annum requires quarterly payments principal approximately 24000 interest five years beginning may 2002 final balloon payment due february 2007 promissory note collateralized manufacturing facility magnolia texas acquired fourth quarter 2001 respect 2004 term loan revolving credit facilities natco agreed make distributions property cash company stockholders except dividends required series b preferred stock provisions dividends declared paid common stockholders years ended december 31 2003 2002 2001 dividends totaling 12 million declared paid holders companys series b preferred stock year ended december 31 2003 11 income taxes income tax expense benefit cumulative effect change accounting principle consisted following components temporary differences related following items give rise deferred tax assets liabilities follows december 31 2003 2002 company recorded valuation allowance 759000 258000 respectively included valuation allowance 258000 related certain deferred tax assets acquired purchase axsia march 2001 additional valuation allowance 2003 349000 related certain deferred tax assets canada 152000 related foreign affiliates company net operating loss carryforwards federal income tax purposes 36 million federal income tax purposes december 31 2003 available offset future federal income tax 2023 net foreign tax credit research development tax credit carryforwards begin expire december 2005 december 2019 respectively based upon historical taxable income projected future taxable income periods companys deferred tax assets deductible management believes likely company realize benefits deductible differences net existing valuation allowances december 31 2003 however amount deferred tax asset considered realizable could change future taxable income differs companys projections income tax expense differs amount computed applying us federal income tax rate 34 income continuing operations income taxes per following reconciliation cumulative undistributed earnings foreign subsidiaries totaled 60 million december 31 2003 company considers earnings foreign subsidiaries indefinitely reinvested accordingly provision us foreign state income taxes made earnings upon distribution foreign subsidiary earnings form dividends otherwise distributed earnings would reportable us income tax purposes subject adjustment foreign tax credits federal income tax returns fiscal years beginning 2000 open review appropriate taxing authorities 12 stockholders equity july 1 1997 board directors company approved exchange certain stock appreciation rights outstanding subsidiarys plan individual options purchase common stock company compensation expense recognized extent projected fair market value stock exchange date exceeded exercise price options furthermore additional stock options granted plan exercise price equal fair market value shares date grant accordingly compensation expense recorded additional grants individual stock options granted july 1 1997 vested ratably period three four years maximum term options 10 years december 31 2003 2002 2001 options relating aggregate 477700 shares 527701 shares 527701 shares respectively remained outstanding plan january 1998 february 1998 company adopted directors compensation plan 1998 employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares companys common stock options vest periods four years maximum term options ten years december 31 2003 2002 2001 options relating aggregate 628217 shares 731587 shares 743920 shares respectively outstanding plans november 2000 board directors company approved authorized issuance 300000 shares companys common stock 2000 employee stock option plan may 24 2001 companys stockholders approved natco group inc 2001 stock incentive plan superceded replaced 2000 plan entirety increased number shares options awards may granted plan maximum 1000000 shares december 31 2003 2002 2001 options relating aggregate 879422 shares 807326 shares 795826 shares respectively outstanding plan pursuant natco group inc directors compensation plan amended natco group inc 2001 stock incentive plan company granted 2500 restricted shares five nonemployee directors june 2003 restricted shares vest 100 june 3 2006 forfeitable service discontinues prior date death disability retirement company recognize expense 85000 related grants ratably vesting period addition company granted nonemployee directors options purchase 2500 shares companys common stock fair market value date grant options vest 100 following one year service anniversary date issuance transactions pursuant companys stock option plans years ended december 31 2003 2002 2001 include pro forma information regarding net income earnings per share required sfas 123 determined applying blackscholes single optionreduced term valuation method valuation model requires management make highly subjective assumptions volatility natcos common stock expected term outstanding stock options companys riskfree interest rate expected dividend payments contractual life options volatility stock prices evaluated based upon historical data new york stock exchange date initial public offering january 28 2000 december 31 2003 volatility calculated 49 december 31 2003 steppeddown 10 per year next year reflect expected stabilization following table summarizes assumptions used determine pro forma compensation expense sfas 123 december 31 2003 riskfree rates determined based upon us treasury obligations option date outstanding similar term company intend pay dividends common stock term options outstanding december 31 2003 purposes pro forma disclosures estimated fair value options amortized expense options vesting period companys pro forma net earnings per share years ended december 31 2003 2002 2001 see note 2 summary significant accounting policies december 31 2003 pursuant equity compensation plans approved companys security holders 1985339 shares common stock could issued upon exercise employee stock options average price 821 per share 12500 shares restricted stock average price 680 additional 238195 shares remain available issuance companys stock option plans december 31 2003 series b convertible preferred shares converted common stock december 31 2003 additional 1921845 shares common stock would issued along 248800 shares related stock warrants issuance series b convertible preferred shares related stock warrants approved security holders preferred stock purchase rights may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natcos common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 companys common stock 20 case lime rock partners ii lp announces commencement tender offer consummation would result ownership person group 15 companys common stock person group acquire 15 companys common stock 20 case lime rock partners ii lp right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board directors may redeem rights price 001 per right time acquisition person group 15 20 case lime rock partners ii lp less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed 13 change accounting principle effective january 1 2003 company recorded cumulative effect change accounting principle related adoption sfas 143 accounting asset retirement obligations standard required company record fair value asset retirement obligation liability period legal obligation associated retirement tangible longlived assets result acquisition construction development andor normal use assets incurred addition standard requires company record corresponding asset depreciated life asset gave rise liability subsequent initial measurement asset retirement obligation company required adjust related liability reporting date reflect changes estimated retirement cost passage time loss 34000 net tax recorded january 1 2003 result change accounting principle related asset retirement obligation asset cost 96000 associated obligation remove certain leasehold improvements upon termination lease arrangements including concrete pads equipment asset cost depreciated remaining useful life related assets significant change asset liability year ended december 31 2003 14 pension postretirement benefits company adopted sfas 132 employers accounting pensions postretirement benefits revised disclosures pension postretirement benefit plans disclosures regarding pension benefits represent plan certain union employees foreign subsidiary disclosures regarding postretirement benefits represent health care life insurance benefits employees retired company acquired ce may 1 2001 company amended postretirement benefit plan provided medical dental coverage retirees predecessor company amended plan retirees bear additional costs coverage significant plan changes include higher deductibles prescription coverage drug card program elimination dental benefits july 1 2001 company obtained thirdparty valuation liability plan arrangement amended based upon valuation effect amendment 64 million reduction companys postretirement benefit liability december 31 2001 cumulative unrecognized loss 36 million existed related postretirement benefit plan accordance sfas 106 employers accounting postretirement benefits pensions benefit associated plan amendment amortized income prior service cost adjustment remaining life expectancy plan participants additionally cumulative unrecognized loss amortized expense remaining life expectancy plan participants november 2001 company agreed maintain benefits preamendment levels specified class retirees exchange expense reimbursement former sponsor postretirement benefit plan agreement requires reimbursement 79000 per year four succeeding years pursuant arrangement company received 157000 79000 reimbursement postretirement benefit expenses years ended december 31 2003 2002 respectively recorded receivable remaining benefit december 31 2003 august 2001 participants canadian pension plan voted terminate contributions plan receive actuarially determined cash distributions december 31 2002 company formally terminated pension plan benefit payments distributed except amounts due certain retirees yet replied notification pending distributions february 2003 company paid 245000 purchase annuity contract canada life assurance company assumed liability future pension payments natco canada boilermaker union employees pension plan effective april 1 2003 components net periodic benefit cost pension plan calculated period january 1 2003 march 31 2003 benefit obligation fair value net assets existed arrangement december 31 2003 december 8 2003 president united states signed law medicare prescription drug improvement modernization act 2003 acts impact reflected amounts disclosed companys financial statements accompany notes company currently reviewing effects act plans expect complete review 2004 addition company waiting guidance united states department health human services employer subsidy provision administered financial accounting standards board impact act recognized companys financial statements following table sets forth plans benefit obligation fair value plan assets funded status december 31 2003 2002 december 2003 company adopted amendment sfas 132 required various disclosures concerning companys postretirement benefit plans pensions december 31 2003 2002 including plans measurement date employers estimated contributions next fiscal year percentage fair value plan assets measurement date data concerning specific assets contribute longterm rate return used investment policies strategies plan asset category basis upon longterm rate return plan assets determined company measured plan assets liabilities december 31 2003 2002 employer contributions expected companys pension plan year ended december 31 2004 since plan terminated assets distributed december 31 2003 company expects provide contributions approximately 18 million related postretirement benefit plan year ended december 31 2004 company held assets related pension postretirement plans december 31 2003 therefore company neither calculated longterm rate return applicable plan assets devised investment strategies manage plan assets defined contribution plans company subsidiaries defined contribution pension plans covering substantially nonunion hourly salaried employees completed three months service employee contributions 3 covered employees compensation matched 100 company additional 2 covered employees compensation matched 50 addition company may make discretionary contributions profit sharing contributions company contributions plan totaled 15 million 14 million 18 million years ended december 31 2003 2002 2001 respectively 15 operating leases company subsidiaries lease various facilities equipment noncancelable operating lease agreements leases expire various dates march 2018 excluding lease arrangement facility axsia requires lease commitments facility sublet another party future minimum lease payments required operating leases remaining noncancelable lease terms excess one year december 31 2003 follows 200437 million 200516 million 200614 million 200711 2008828000 total expense operating leases years ended december 31 2003 2002 2001 54 million 58 million 53 million respectively discussion lease rental income see note 8 property plant equipment net 16 related parties company pays capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut companys chief executive officer reception telephone computer services normal office support relating space mr herbert winokur jr one companys directors chairman chief executive officer capricorn holdings inc managing director capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controls approximately 31 companys outstanding common stock addition companys chief executive officer mr gregory nonsalaried member capricorn holdings llc capricorn investors ii lp controls approximately 19 companys common stock fees paid capricorn management totaled 115000 85000 years ended december 31 2003 2002 2001 respectively commencing october 1 2001 fee increased 28750 per quarter due primarily upward adjustments capricorn managements underlying lease office space increase reviewed approved audit committee companys board directors arrangement terminable either party 90 days notice terms employment agreement effect prior 1999 company loaned chief executive officer 12 million july 1999 purchase 136832 shares common stock february 2000 company completed initial public offering class common stock also pursuant terms employment agreement company paid executive officer bonus equal principal interest accrued note arrangement recorded compensation expense 13 million officer used proceeds settlement net tax repay company approximately 665000 addition october 27 2000 companys board directors agreed provide full recourse loan executive officer facilitate exercise certain outstanding stock options amount loan equal cost exercise options plus personal tax burdens resulted exercise maturity loans july 31 2003 interest accrued rates ranging 6 78 per annum june 30 2002 outstanding notes receivable totaled 34 million including principal accrued interest effective july 1 2002 notes reviewed companys board amended extend maturity dates july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied notes balances june 30 2002 including previously accrued interest december 31 2003 balance notes principal accrued interest due officer loan arrangements 36 million loans executive officer made full recourse basis prior periods facilitate direct ownership companys common stock currently subject compliance provisions sarbanesoxley act 2002 previously agreed 2001 company loaned employee executive officer director 216000 april 15 2002 fullrecourse note arrangement accrues interest 6 per annum matures july 31 2003 funds used pay exercise cost personal tax burdens associated stock options exercised 2001 effective july 1 2002 note amended extend maturity date july 31 2004 require interest calculated annual rate based libor plus 300 basis points adjusted quarterly applied note balance june 30 2002 including previously accrued interest december 31 2003 balance note principal interest due officer loan arrangement approximately 233000 loan executive officer made full recourse basis time prior periods facilitate direct ownership companys common stock currently subject compliance provisions sarbanesoxley act 2002 17 commitments contingencies portatest purchase agreement executed january 2000 contains provision calculate payment certain former stockholders portatest systems inc threeyear period ended january 23 2003 based upon sales limited number specified products designed utilizing technology existed time acquisition liability arrangement contingent upon attaining certain performance criteria including gross margins sales volumes specified products applicable payment required annually april 2001 company paid 226000 arrangement related twelvemonth period ended january 23 2001 august 2002 company paid 197000 arrangement related twelvemonth period ended january 23 2002 resulting increase goodwill performance criteria met company record additional liability arrangement twelvemonth period ended january 23 2003 18 litigation magnum transcontinental corp arbitration related matter matters stem agreement among natco group magnum transcontinental corporation us procurement arm petroserv sa zephyr offshore inc petroserv subsidiary manufacture install processing plant petroserv rig petroservs agency agreement natco certain projects brazil natco claims magnum owes 418990 plant manufacturing agreement additional work performed excess days agreed contract natco submitted matter binding american arbitration association arbitration october 29 2003 arbitrator selected arbitration scheduled houston texas august 2004 arbitration magnum counterclaimed 4685000 alleging breach contract natco recorded accrual related matter december 31 2003 natco disputes amounts claimed magnum intends vigorously pursue claims defending counterclaim natco filed request arbitration petroserv submitted mediation request representation agreement natco claiming unpaid agency fees several contracts including magnum contract resolution resulted mediation held january 23 2004 natco believes fees owed petroserv agency agreement offset natcos claims magnum natco disputes owes fees magnum work obtained brazil representation agreement terminated early 2003 presently known action petroserv take regard company subsidiaries defendants otherwise involved number legal proceedings ordinary course business company insures risk proceedings extent deemed prudent management natco offer assurance type value insurance meet liabilities may arise pending future legal proceedings related business activities company cannot predict outcome legal proceedings certainty opinion management ultimate liability respect pending lawsuits expected significant material adverse effect companys consolidated financial position results operations cash flows 19 industry segments geographic information company adopted provisions sfas 131 disclosures segments enterprise related information companys business units separate management teams infrastructures offer different products services business units aggregated three reportable segments described since longterm financial performance reportable segments affected similar economic conditions north american operations segment consists us sales service business unit companys canadian venezuelan subsidiaries latin american operations co2 gasprocessing operations us sales service business unit designs engineers manufactures provides startup services production equipment generally less complex units provided engineered systems provides replacement parts field shop servicing equipment used equipment refurbishing natco canada provides design engineering manufacturing startup services production equipment well replacement parts field shop servicing equipment used equipment refurbishing natco canada also provides manufacturing services engineered systems segment latin american operations generally provide replacement parts service customers latin america co2 gasprocessing operations include ongoing service two gasprocessing plants united states principal market us sales service business unit us onshore offshore market international market customers include major multinational independent national stateowned companies principal markets natco canada oil gas producing regions canada customers include major multinational independent companies engineered systems segment consists three business units us engineered systems natco japan axsia provide design engineering manufacturing startup services engineered process systems principal markets segment include major oil gas producing regions world including north america south america europe middle east africa far east customers include major multinational independent national stateowned companies automation control systems test sole business unit reported segment unit designs manufactures installs services instrumentation electrical control systems principal markets segment include major oil gas producing regions world including north america south america europe kazakhstan africa far east customers include major multinational independent national stateowned companies segment formerly named instrumentation electrical systems accounting policies reportable segments described note 2 company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense closure net accounting changes september 2003 company changed presentation reportable segments reclassifying certain research development costs bonus expenses among business segments corporate segment addition net excluded determination segment profit loss changes made result change managements internal reporting better state total costs profits segment retroactively reflected periods presented consistent recent restructuring late 2003 closely align companys segment presentation internal reporting presentation used companys management company changed presentation reportable segments december 2003 reclassifying certain manufacturing plants related assets totaling 56 million engineered systems segment north american operations segment result reclassification capital expenditures depreciation amortization expense increased north american operations segment 77000 751000 respectively corresponding decreases engineered systems segment similar reclassifications made 2002 125 million 303000 945000 related total assets capital expenditures depreciation amortization expense respectively 2001 128 million 21 million 569000 respectively presentation assets associated impact capital expenditures depreciation amortization expense retroactively reflected periods presented summarized financial information concerning companys reportable segments shown following table following table reconciles total segment profit net income cumulative effect change accounting principle impact change measurement method used determine segment profit loss years ended december 31 2003 2002 2001 follows companys geographic data continuing operations years ended december 31 2003 2002 2001 follows equipment large international projects generally manufactured united states therefore revenues results operations related projects presented derived united states purposes geographic presentation 20 quarterly data following tables summarize unaudited quarterly information years ended december 31 2003 2002 2001 21 goodwill impairment testing fasb approved sfas 142 goodwill intangible assets june 2001 pronouncement requires intangible assets indefinite lives including goodwill cease amortized evaluated impairment annual basis intangible assets defined term patents would continue amortized useful life asset company adopted sfas 142 january 1 2002 intangible assets subject amortization pronouncement december 31 2003 2002 summarized following table amortization interest expense 847000 840000 932000 recognized related assets years ended december 31 2003 2002 2001 respectively estimated aggregate amortization interest expense assets following five fiscal years 2004462000 2005414000 2006129000 200745000 200828000 segment reporting purposes intangible assets related amortization expense recorded corporate eliminations goodwill companys intangible asset required periodic amortization date adoption sfas 142 net goodwill december 31 2003 2002 801 million 790 million respectively pro forma impact applying sfas 142 operating results year ended december 31 2001 would reduction amortization expense 37 million resulting net income 90 million pro forma increase basic diluted earnings per share 2001 would 23 respectively accordance sfas 142 company tested impairment goodwill comparing fair value operating units carrying value assets including related goodwill required pronouncement company identified separate reporting units purposes evaluation determining carrying value company segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated accordance standard fair value determined discounting projected future cash flows companys weighted average cost capital rate resulting fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level impairment indicated accordance pronouncement additional tests required net goodwill 224 million 542 million 44 million 159000 december 31 2003 north american operations segment engineered systems segment automation control systems segment corporate segment respectively 202 million 542 million 44 million 159000 respectively december 31 2002 change value goodwill december 31 2003 2002 due entirely impact exchange rate changes since impairment goodwill indicated based upon testing performed impairment charge recorded sfas 142 december 31 2003 2002 goodwill tested impairment december 31 annual basis 22 new accounting pronouncements june 2001 fasb issued sfas 143 accounting asset retirement obligations standard provides guidance reporting accounting obligations associated retirement longlived tangible assets related retirement costs standard effective financial statements issued fiscal years beginning june 15 2002 january 1 2003 adopted pronouncement recorded loss 34000 net tax effect cumulative effect change accounting principle addition recorded asset retirement obligation liability asset cost 96000 associated obligation remove certain leasehold improvements upon termination lease arrangements including concrete pads equipment depreciate asset cost remaining useful life related assets october 2001 fasb issued sfas 144 accounting impairment disposal longlived assets statement replaces sfas 121 accounting impairment longlived assets longlived assets disposed standardizes accounting model used asset dispositions related implementation issues pronouncement became effective financial statements issued fiscal years beginning december 15 2001 company adopted pronouncement january 1 2002 resulting material effect financial condition results operations april 2002 fasb issued sfas 145 rescission fasb statements 4 44 64 amendment fasb statement 13 technical corrections statement amends existing guidance reporting gains losses extinguishment debt prohibiting classification gain loss extraordinary sfas 145 also amends sfas 13 require saleleaseback accounting certain lease modifications economic effects similar saleleaseback arrangements provisions statement related rescission statement 4 applied fiscal year beginning may 14 2002 early adoption encouraged provisions statement related statement 13 effective transactions occurring may 15 2002 early adoption encouraged sfas 145 adopted january 1 2003 material effect companys financial condition results operations june 2002 fasb issued sfas 146 accounting exit disposal activities addresses financial accounting reporting costs associated exit disposal activities including restructuring activities currently accounted pursuant guidance set forth eitf issue 943 liability recognition certain employee termination benefits costs exit activity sfas 146 effective exit disposal activities initiated december 31 2002 early adoption encouraged provisions pronouncement applied exit disposal activities january 1 2003 material effect companys financial condition results operations november 2002 fasb issued interpretation 45 guarantors accounting disclosure requirements guarantees including indirect guarantees indebtedness others interpretation fasb statements 5 57 107 rescission fasb interpretation 34 interpretation elaborates disclosures made guarantor interim annual financial statements obligations guarantees issued interpretation also clarifies guarantor required recognize inception guarantee liability fair value obligation taken initial recognition measurement provisions interpretation applicable guarantees issued modified december 31 2002 company adopted interpretation january 1 2003 material effect companys financial condition results operations december 2002 fasb issued sfas 148 accounting stockbased compensationtransition disclosure amendment fasb statement 123 statement amends fasb statement 123 accounting stockbased compensation provide alternative methods transition volunteerbasis fair value method accounting stockbased employee compensation additionally statement amends disclosure requirements sfas 123 require prominent disclosures annual interim financial statements certain disclosure modifications required fiscal years ending december 15 2002 transition sfas 123 elected company elected transition sfas 123 december 31 2002 see note 12 stockholders equity april 2003 fasb issued sfas 149 amendment statement 133 derivative instruments hedging activities statement provides additional guidance account derivative instruments including certain derivative instruments embedded contracts well hedging activities sfas 133 pronouncement becomes effective new contract arrangements hedging transactions entered june 30 2003 exceptions certain sfas 133 implementation issues begun prior june 15 2003 adopted pronouncement july 1 2003 material impact financial condition results operations may 2003 fasb issued sfas 150 accounting certain financial instruments characteristics liabilities equity statement provides guidance classify measure certain financial instruments characteristics liabilities equity generally requires treatment instruments liabilities including certain obligations issuer must settle issuing equity securities pronouncement effective financial instruments entered modified may 31 2003 otherwise became effective july 1 2003 required cumulative effect change accounting principle treatment upon adoption adopted pronouncement july 1 2003 material impact financial condition results operations december 2003 fasb issued amendment sfas 132 employers disclosures pensions postretirement benefits amendment effective december 31 2003 requires additional annual disclosures pension postretirement plan assets liabilities well investment policies strategies plan assets basis expected rate return assets total accumulated benefit obligation addition amendment requires interim disclosures components net periodic benefit cost tabular format contributions paid expected paid current fiscal year effective december 31 2004 required disclose benefits expected paid next five years pension postretirement plan aggregate amount expected paid succeeding five year period arrangements adopted amendment sfas 132 december 31 2003 required disclosures included annual report form 10k see note 14 pension postretirement benefits item 9nanitem 8 financial statements supplementary data consolidated financial statements years ended december 31 2005 2004 2003 applicable along reports independent registered public accounting firm set forth index financial statements management’s report internal control financial reporting management company responsible establishing maintaining effective internal control financial reporting defined rules 13a15f securities exchange act 1934 internal control financial reporting designed provide reasonable assurance company’s management board directors regarding preparation fair presentation published financial statements external purposes accordance generally accepted accounting principles internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements therefore even systems determined effective provide reasonable assurance respect financial statement preparation presentation also projections evaluations effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate assessed effectiveness company’s internal control financial reporting december 31 2005 making assessment used criteria set forth committee sponsoring organizations treadway commission coso internal controlintegrated framework based assessment believe december 31 2005 company’s internal control financial reporting effective based criteria management’s assessment effectiveness internal control financial reporting december 31 2005 audited kpmg llp independent registered public accounting firm audit opinion assessment internal control financial reporting appears page 45 report john u clarke chairman chief executive officer march 15 2006 richard w fitzgerald senior vice president chief financial officer march 15 2006 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 2005 2004 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2005 connection audits consolidated financial statements also audited financial statement scheduled ii consolidated financial statements financial statement schedule responsibility company’s management responsibility express opinion consolidated financial statements financial statement schedule based audits conducted audits accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2005 2004 results operations cash flows years threeyear period ended december 31 2005 conformity us generally accepted accounting principles also opinion related financial statement schedule considered relation basic consolidated financial statements taken whole presents fairly material respects information set forth therein discussed note 20 consolidated financial statements effective january 1 2003 company changed method accounting asset retirement obligations also audited accordance standards public company accounting oversight board united states effectiveness natco group inc’s internal control financial reporting december 31 2005 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso report dated march 15 2006 expressed unqualified opinion management’s assessment effective operation internal control financial reporting kpmg llp houston texas march 15 2006 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited management’s assessment included accompanying management’s report internal control financial reporting natco group inc maintained effective internal control financial reporting december 31 2005 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso natco group inc’s management responsible maintaining effective internal control financial reporting assessment effectiveness internal control financial reporting responsibility express opinion management’s assessment opinion effectiveness company’s internal control financial reporting based audit conducted audit accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether effective internal control financial reporting maintained material respects audit included obtaining understanding internal control financial reporting evaluating management’s assessment testing evaluating design operating effectiveness internal control performing procedures considered necessary circumstances believe audit provides reasonable basis opinion company’s internal control financial reporting process designed provide reasonable assurance regarding reliability financial reporting preparation financial statements external purposes accordance generally accepted accounting principles company’s internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements also projections evaluation effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate opinion management’s assessment natco group inc maintained effective internal control financial reporting december 31 2005 fairly stated material respects based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso also opinion natco group inc maintained material respects effective internal control financial reporting december 31 2005 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso also audited accordance standards public company accounting oversight board united states consolidated balance sheets natco group inc subsidiaries december 31 2005 2004 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2005 report dated march 15 2006 expressed unqualified opinion consolidated financial statements kpmg llp houston texas march 15 2006 index financial statements natco group inc subsidiaries consolidated balance sheets thousands except share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements stockholders’ equity comprehensive income loss thousands except share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements cash flows thousands see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization natco group inc formerly known cummings point industries inc formed june 1988 capricorn investors lp led group investors provided capital company acquire several businesses combustion engineering inc “ce” june 1989 company acquired ce outstanding common stock national tank company certain businesses subsequently divested distributed shareholders june 30 1997 natco acquired total engineering services team inc “test” november 18 1998 natco acquired cynara company acquired portatest international inc based canada january 24 2000 january 27 2000 company completed initial public offering 7500000 shares class common stock price 1000 per share 4053807 shares newly issued company 3446193 existing shares sold selling stockholders february 3 2000 underwriter exercised overallotment option resulted issuance company 1125000 additional shares class common stock february 8 2000 april 4 2000 natco acquired modular production equipment inc engineering specialties inc respectively march 19 2001 natco acquired axsia group limited privately held process design company based uk accompanying consolidated financial statements related disclosures include results operations company majorityowned domestic international subsidiaries years ended december 31 2005 2004 2003 furthermore certain reclassifications made fiscal 2004 fiscal 2003 amounts order present results comparable basis amounts fiscal 2005 references “natco” “the company” used throughout document relate collectively natco group inc consolidated subsidiaries 2 summary significant accounting policies principles consolidation consolidated financial statements include accounts company majorityowned domestic international subsidiaries intercompany balances transactions eliminated consolidation use estimates company’s management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity generally accepted accounting principles actual results could differ estimates limited concentration credit risk concentrations credit risk respect trade receivables limited due large number customers comprising company’s customer base geographic dispersion years ended december 31 2005 2004 2003 customer provided 10 company’s consolidated revenues see note 20 industry segments geographic information cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued trade accounts receivable trade accounts receivable recorded invoiced amount allowance doubtful accounts provided estimate probable losses resulting bad debt company reviews allowance doubtful accounts month individually investigates past due balances 90 days order assess collectibility receivable trade accounts receivable balances charged allowance doubtful accounts collectibility determined remote inventories stated lower cost market cost determined using last first “lifo” method us inventories except automation controls segment uses average cost first “fifo” method inventories property plant equipment property plant equipment stated cost less allowance depreciation plant equipment calculated using straightline method assets’ estimated useful lives maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included income leases company’s operating leases include various facilities equipments company records operating expenses determined lease agreements discussion operating lease see note 12 commitments contingencies impairment longlived assets company reviews longlived assets impairment whenever events changes circumstances indicate carrying amount asset may recoverable impairment assets held used determined comparison carrying amount asset undiscounted future net cash flows expected generated asset assets considered impaired impairment recognized measured amount carrying amount assets exceeds fair value assets goodwill accordance sfas 142 “goodwill intangible assets” company evaluates goodwill impairment basis required sfas 142 company identifies separate reporting units purposes evaluating goodwill impairment determining carrying value company segregates assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated accordance standard fair value determined discounting projected future cash flows company’s cost capital rate calculated fair value compared carrying value reporting unit determine whether impairment occurred reportable unit level event impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value company would record impairment charge amount net goodwill 809 million december 31 2005 tested impairment required sfas 142 based testing company’s management believes impairment goodwill exists december 31 2005 see note 6 goodwill intangible assets net assets include deferred financing fees patents longterm deposits deferred financing costs amortized term related agreement amortization interest expense 527000 11 million 847000 years ended december 31 2005 2004 2003 respectively index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred revenue recognition recognize revenues related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued 250000 less contract durations four months less recognize revenues using percentage completion method contracts greater 250000 contract durations excess four months represent customized engineered orders products qualify treatment accordance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 addition use percentage completion method automation controls segment equipment fabrication sales projects qualify treatment accordance requirements sop 811 automation controls segment sells customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration segment produce standard units maintain inventory products sale due nature segment’s equipment fabrication sales operations potential wide variations results operations could occur applying shipped methodology smaller contracts customized fabricated goods segment recognizes revenues regardless contract value duration applying percentage completion method earned revenue based percentage incurred costs date relate total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects stockbased compensation sfas 123 “accounting stockbased compensation” permits entities recognize expense vesting period fair value stockbased awards date grant alternatively sfas 123 allows entities continue apply provisions accounting principles board “apb” opinion 25 provide pro forma net income earnings per share disclosures employee stock option grants made 1995 future years fairvaluebased method defined sfas 123 applied december 2002 sfas 148 “accounting stockbased compensationtransition disclosure amendment fasb statement 123” issued provides alternative methods transition fair value method accounting stockbased compensation volunteer basis requires additional disclosures annual interim periods company elected continue apply provision apb opinion 25 provide pro forma disclosure requirements sfas 123 company accounts stockbased compensation using intrinsic value method prescribed accounting principles board opinion 25 “accounting stock issued employees” accordingly compensation expense recognized company’s stock option plans extent quoted market price stock measurement date equal less amount employee required pay stock december 2002 financial accounting standards board “fasb” issued sfas index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 148 “accounting stockbased compensationtransition disclosure” statement requires pro forma disclosures reflect difference stockbased employee compensation cost included net income total cost measured fair value based method per sfas 123 “accounting stockbased compensation” would recognized income statement fair value based method applied awards following table illustrates effect net income loss earnings loss per share company applied fair value recognition provisions sfas 123 years ended december 31 2005 2004 2003 pro forma information regarding net income earnings per share required sfas 123 determined applying blackscholes single optionreduced term valuation method valuation model requires management make highly subjective assumptions volatility natco’s common stock expected term outstanding stock options company’s riskfree interest rate expected dividend payments contractual life options volatility stock prices evaluated based upon historical data new york stock exchange date initial public offering january 28 2000 december 31 2005 volatility calculated 47 december 31 2005 following table summarizes assumptions used determine pro forma compensation expense sfas 123 december 31 2005 riskfree rates determined based upon us treasury obligations option date outstanding similar term company intend pay dividends common stock term options outstanding december 31 2005 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued company also maintains restricted stock program wherein fair market value stock date issuance amortized ratably charged income average period restrictions lapse restricted shares vest based performance company records estimate compensation expense expensed one three years related restricted shares compensation expense recognized statement operations adjusted changes estimate number restricted shares vest well changes company’s stock price related expense net tax associated restricted stock plans reflected net income loss reported 16 million 13000 years ended december 31 2005 2004 respectively related expense net tax year ended december 31 2003 december 2004 fasb issued sfas 123 revised 2004 “sharebased payment” “sfas 123r” amendment requires expensing stock options sharebased payments supercedes sfas 123 allowed companies choose expensing stock options showing proforma disclosure sec rule provides sfas 123r effective registrants beginning first fiscal year beginning june 15 2005 adopt provisions sfas 123r january 1 2006 using modified prospective application accordingly recognize compensation expense newly granted awards modified repurchased cancelled january 1 2006 compensation cost unvested portion awards outstanding january 1 2006 recognized ratably remaining vesting period based fair value date grant calculated pro forma disclosure sfas 123 company estimates effect net income earnings per share periods following adoption sfas 123r consistent company’s pro forma disclosure sfas 123 except estimated forfeitures considered calculation compensation expense sfas 123r additionally actual effect net income earnings per share vary depending upon number options granted subsequent periods compared prior years research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years warranty costs estimated future warranty obligations related products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued derivative arrangements assets liabilities associated underlying derivative arrangements qualify hedge value accounting recorded fair market value balance sheet date changes fair value charged income current period accordance sfas 133 “accounting derivative instruments hedging activities” comprehensive income comprehensive income includes changes equity period except resulted investments distributions company’s stockholders company’s stockholders’ transactions comprehensive income reflected company’s consolidated statements stockholders’ equity comprehensive income includes net income comprehensive income generally accepted accounting principles sfas 130 “reporting comprehensive income” translation foreign currencies financial statement amounts related foreign operations functional currencies us dollar translated us dollar equivalents exchange rates follows 1 balance sheet accounts yearend exchange rates 2 statement operations accounts weighted average exchange rate period gains losses resulting translations deferred included accumulated comprehensive gain loss separate component stockholders’ equity gains losses foreign currency transactions reflected line net company’s consolidated statements operations earnings loss per share basic earnings loss per share excludes dilutive effect common stock equivalents diluted earnings loss per common potential common share computed dividing net income loss allocable common stockholders weighted average number common potential common shares outstanding net income allocable common stockholders december 31 2005 represented net income less preferred stock dividends accrued paid weighted average number common potential common shares outstanding derived applying ifconverted method determine incremental shares associated convertible preferred stock warrants restricted stock outstanding discussion earnings loss per common share see note 16 earnings loss per share 3 inventories consisted following amounts company’s inventory december 31 2005 2004 valuation method shown reductions lifo layers years ended december 31 2005 2004 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 4 cost estimated earnings uncompleted contracts cost estimated earnings uncompleted contracts follows 5 property plant equipment net components property plant equipment follows pursuant september 2003 restructuring plan company closed manufacturing facility covington louisiana fourth quarter 2003 transferred equipment inventory branch manufacturing locations december 31 2004 manufacturing facility book value 714000 classified held sale september 2005 facility sold 14 million resulting gain 640000 net closing costs depreciation expense 52 million 53 million 50 million respectively years ended december 31 2005 2004 2003 company leases certain machinery equipment customers shortterm operating lease arrangements generally periods one month one year company recorded depreciation expense related leased assets 405000 401000 433000 years ended december 31 2005 2004 2003 respectively operating lease arrangements terms one month three years often result sale equipment within one year assets lease company records depreciation expense based upon assets’ estimated useful life net book value leased assets recorded 732000 13 million december 31 2005 2004 respectively index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued included accompanying balance sheet caption “other current assets” since company intends sell assets within one year place assets used inventory upon return lessee lease rental income 07 million 10 million 15 million included revenues oil water technologies segment years ended december 31 2005 2004 2003 respectively 6 goodwill intangible assets sfas 142 “goodwill intangible assets” requires intangible assets indefinite lives including goodwill evaluated impairment annual basis frequently triggering event intangible assets defined term patents amortized useful life asset intangible assets subject amortization december 31 2005 2004 summarized following table amortization interest expense 527000 11 million 847000 recognized related assets years ended december 31 2005 2004 2003 respectively estimated aggregate amortization interest expense assets next five fiscal years 2006417000 2007127000 200847000 200945000 201034000 net goodwill 809 million december 31 2005 comprised 474 million 291 million 44 million oil water technologies reporting unit gas technologies reporting unit automation controls reporting unit respectively net goodwill 807 million december 31 2004 comprised 473 million 290 million 44 million oil water technologies reporting unit gas technologies reporting unit automation controls reporting unit respectively change value goodwill december 31 2005 2004 due entirely impact foreign currency exchange rate changes accordance sfas 142 goodwill reallocated based upon fair value method change business segments effective january 1 2005 reclassifications made prior year comparable information discussion segments see note 18 industry segments geographic information accordance sfas 142 company tested impairment goodwill comparing fair value operating units carrying value assets including related goodwill required pronouncement company identified separate reporting units purposes evaluation determining carrying value company segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated accordance standard fair value determined discounting projected future cash flows company’s weighted average cost capital rate resulting fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level impairment indicated accordance pronouncement additional tests required since impairment goodwill indicated based upon testing performed impairment charge recorded december 31 2005 2004 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 7 accrued expenses warranty costs accrued expenses warranty costs consisted following tabular reconciliation changes company’s aggregate product warranty liability years ended december 31 2004 2005 set forth thousands december 31 2005 2004 company 58 million 22 million respectively outstanding letters credit related warranties 83 million 37 million respectively outstanding letters credit related combination performance warranties 8 closure severance december 15 2005 board directors approved restructuring company’s uk operations consolidating gloucester england office camberley england location december 2005 company recorded severance contract expense 700000 december 31 2005 company liability remaining 631000 also company expects incur additional costs first nine months 2006 related rationalization office lease expenses associated vacating gloucester site consolidating facilities camberley england location currently total amount anticipated costs estimated approximately 27 million items accounted either operating expense closure severance charge first nine months 2006 third quarter 2005 severance costs approximately 799000 recorded related redundancy certain personnel company’s uk operations december 31 2005 company remaining liability related matter index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued effective september 17 2005 company patrick mccarthy entered second amendment mr mccarthy’s employment agreement amended terms second amendment mr mccarthy continue serve president june 30 2006 unless sooner terminated company mr mccarthy march 1 2006 pursuant earlier amendment employment agreement entered september 2004 following departure company’s chief executive officer mr mccarthy remain employed capacity president company period nine months following appointment permanent chief executive officer mr mccarthy mr mccarthy would right elect terminate employment time 10day period following ninemonth anniversary receive severance benefits equal two times base salary pro rata bonus year date termination continuation health care benefits period 18 months following termination immediate vesting termination date options granted prior 2005 lapse restrictions restricted stock granted prior 2005 termination date mr mccarthy granted option restricted stock awards june 2005 subject forfeiture event mr mccarthy exercised election 10day period commenced september 7 2005 terminated september 17 2005 second amendment mr mccarthy agreed remain president company additional period terminate later june 30 2006 consideration 1 receiving amounts would otherwise entitled exercised election described 247000 amount due respect base salary paid mr mccarthy october 3 2005 remaining 388470 payable company’s election either lump sum biweekly payments 11month period commencing case date seven months date mr mccarthy separates service 2 continuation salary benefits date termination salary subject increase board makes adjustments generally salary levels senior management team 3 guaranteed bonus 2005 less target bonus 60 base salary payable accordance operation 2005 bonus plan 4 pro rata share target bonus 2006 payable accordance operation applicable plan effect 5 right onethird options granted june 2005 lapse restrictions onethird restricted stock granted june 2005 case mr mccarthy voluntarily terminate employment prior june 30 2006 6 continuation health care coverage 18 months commencing month following last day employment event change control period continued employment mr mccarthy entitled greater benefits described employment agreement change control agreement offset amounts entitlements described paid time terms employment agreement including limited mr mccarthy’s agreement compete company period one year following termination employment remain full force effect company recorded charge 12 million third quarter 2005 related mr mccarthy’s amended employment agreement addition previously accrued expense 155000 related 2005 bonus company may incur additional charges respect lapse restrictions remaining twothirds restricted stock awarded mr mccarthy 2005 estimate charges accrued expensed estimated remaining term employment agreement amended december 2004 company recorded severance expense 13 million related restructuring plan included involuntary termination certain administrative operating personnel uk canada company recorded facility closure costs 69000 made cumulative payments 10 million index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued first three quarters 2005 related plan company also recorded gain 388000 sale facility uk first quarter 2005 additionally company took valuation adjustment charge approximately 249000 year ended 2005 related restructuring plan reversed approximately 216000 previously accrued amounts december 31 2005 company liability approximately 599000 related restructuring plan september 2004 company recorded severance expense 210000 related staff reductions us canada december 31 2005 company remaining liability related matter june 2004 company recorded paid severance expense 111000 primarily associated staff reductions automation controls segment oil water technologies segment december 31 2005 company remaining liability related matter july 28 2004 company entered separation agreement mr nathaniel gregory company’s ceo pursuant mr gregory stepped chairman board directors date agreed resign company september 7 2004 company recorded expense approximately 25 million related 1 severance payments 2 continuation mr gregory’s welfare benefits period 36 months following separation 3 extending exercise dates mr gregory’s outstanding options 18 months following separation date company recorded approximately 62000 stock based employee compensation expense 4 payment certain attorneys’ fees connection separation agreement 5 reimbursement certain moving expenses company paid 24 million amount december 31 2005 december 31 2005 company liability 30000 related separation agreement company also agreed 1 accelerate vesting mr gregory’s outstanding options 2 reimburse certain living commuting expense separation date consistent past practice 3 continue providing director officer indemnification insurance period time 4 pay bonuses earned separation date pursuant company’s bonus plan 5 continue reimburse expenses mr gregory’s office space connecticut december 31 2004 cost items expensed period incurred agreement mr gregory agreed provide advisory services period one year following separation date requested board release company certain potential claims parties also agreed certain procedures repayment mr gregory’s outstanding loans company paid full july 28 2004 december 2003 company’s management approved additional restructuring costs including plan close oil water technologies segment location singapore recorded closure expense 692000 515000 related severance 35000 related termination lease arrangement 142000 related employee relocation company remaining liability related restructuring plan december 31 2005 september 2003 company recorded expenses 722000 associated managementapproved restructuring plan included involuntary termination certain administrative operating personnel connection closure manufacturing facility covington louisiana company’s corporate headquarters company’s research development facility tulsa oklahoma related consolidation operations uk total expense recognized restructuring plan 640000 related postemployment benefits accounted accordance sfas 112 “employers’ accounting postemployment benefits amendment fasb statements 5 43” 82000 related consultant’s fees equipment moving costs employee relocations accounted index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued accordance sfas 146 “accounting costs associated exit disposal activities” year ended december 31 2004 company incurred additional 51000 expense related restructuring plan offset accrual reversals result changes assessment liability plan totaling 77000 resulting increase net income 26000 year ended december 31 2004 company remaining liability related restructuring plan december 31 2005 following summary closure severance expense roll forward company’s accrued closure severance costs december 31 2005 2004 2003 follows thousands 1 reassessment leasehold termination costs 126000 foreign exchange impact 47000 2 foreign exchange impact 68000 3 foreign exchange impact 58000 estimated payment liability 15 million 2006 706000 2007 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 9 income taxes components income loss continuing operations income taxes change accounting principle follows income tax expense benefit cumulative effect change accounting principle consisted following components tax benefits 19 million 403000 associated exercise employee stock options lapse restrictions restricted stock allocated equity recorded additional paid capital year ended december 31 2005 2004 respectively additionally income tax expense benefit 290000 696000 11 million allocated accumulated comprehensive income loss december 31 2005 2004 2003 respectively index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued deferred income taxes reflect net effects temporary differences carrying amounts assets liabilities financial reporting purposes amounts used income tax purposes well operating loss tax credit carryforwards tax effects temporary differences carryforwards follows december 31 2005 265000 valuation allowance related realizability certain us tax attributes related uk subsidiary group valuation allowance 12 million related uk operations another 172000 related foreign operations december 31 2004 258000 valuation allowance related realizability certain us tax attributes related uk subsidiary group valuation allowance 25 million related uk operations another 176000 related foreign operations 2005 valuation allowance related uk operations reduced 25 million 12 million predominately result utilization uk loss carryforwards year end 2004 valuation allowance 25 million related uk operations recorded due severance restructuring accrual approximately 1 million continuing losses contracts year resulted cumulative pretax losses prior three years additionally valuation allowance 349000 recorded 2003 related company’s canadian subsidiary reversed 2004 result improved results company net operating loss carryforwards fully offset valuation allowances related foreign subsidiaries 529000 december 31 2005 company also net operating loss carryforward us income tax purposes 16 million december 31 2005 available offset future federal income tax 2022 net us foreign tax credit carryforwards 16 million begin expire december 2010 company net operating loss carryforward uk 10 million 53 million december 31 2005 2004 net operating loss may carried forward indefinitely current uk law index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued based upon level historical taxable income projected future taxable income periods deferred tax assets deductible us canadian tax jurisdictions believe likely realize benefits deductible differences carryforwards net existing valuation allowances december 31 2005 us canadian tax jurisdictions however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections us canadian tax jurisdictions foreign tax jurisdictions relying projections future taxable income determine realizability deductible differences carryforwards income tax expense differs amount computed applying us federal income tax rate 35 income continuing operations income taxes set forth following reconciliation cumulative undistributed earnings foreign subsidiaries totaled 67 million december 31 2005 company considers earnings foreign subsidiaries indefinitely reinvested accordingly provision us foreign state income taxes made earnings upon distribution foreign subsidiary earnings form dividends otherwise distributed earnings would reportable us income tax purposes subject adjustment foreign tax credits calculating tax effect distributing earnings practicable time federal income tax returns fiscal years beginning 2002 open review appropriate taxing authorities index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 10 longterm debt consolidated borrowings company follows aggregate future maturities longterm debt next five years ended december 31 follows 64 million maturing 2006 210 million maturing 2007 debt maturing prior 2008 2004 term loan revolving credit loans march 15 2004 company entered new term loan revolving facilities agreement referred 2004 term loan revolving credit facilities provides term loan 450 million us revolving facility borrowing capacity 200 million canadian revolving facility borrowing capacity 50 million uk revolving facility borrowing capacity 100 million borrowing capacities 2004 revolving credit facilities agreement subject borrowing base limitations company recorded charge 667000 march 2004 expense unamortized loan costs related previous term loan revolving credit facilities referred 2001 term loan revolving credit facilities incurred additional 995000 deferred loan costs related 2004 term loan revolving credit facilities amortized interest expense term 2004 facilities march 2007 company also incurred approximately 115000 deferred loan cost primarily first quarter 2005 associated amendment 2004 term loan revolving credit facilities additional cost amortized term amendment ended june 2005 2004 term loan revolving credit facilities agreement provides interest rate based upon ratio funded debt ebitda defined credit facility “ebitda” ranging company’s election 1 high london interbank offered rate “libor” plus 275 low libor plus 200 2 high base rate plus 175 low base rate plus 100 company pay commitment fees related agreement undrawn portion facility depending upon ratio funded debt ebitda calculated 0375 december 31 2005 borrowings 274 million outstanding term loan portion 2004 term loan revolving credit facility december 31 2005 bore interest average rate 626 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued borrowings outstanding revolving credit portion facilities december 31 2005 company prepaid 64 million 2004 term loan revolving credit facilities company letters credit outstanding 2004 term loan revolving credit facilities 145 million date fees related letters credit approximately 200 outstanding balance december 31 2005 letters credit support contract performance warranties expire various dates february 2008 2004 term loan revolving credit facilities agreement secured first lien first priority security interest pledge substantially assets borrowers certain subsidiaries including accounts receivable inventory equipment intangibles equity interests us subsidiaries 66 13 equity interest active nonus subsidiaries interests certain contracts assets company active us subsidiaries secure us canadian uk revolving facilities assets company’s canadian subsidiary also secure canadian facility assets company’s uk subsidiaries also secure uk facility us facility guaranteed us subsidiary company canadian uk facilities guaranteed natco group inc us subsidiaries canadian subsidiary uk subsidiaries applicable 2004 term loan revolving facilities agreement contains restrictive covenants including among others limit amount funded debt ebitda impose minimum fixed charge coverage ratio impose minimum net worth requirement march 2005 company’s lenders approved amendment various provisions 2004 term loan revolving facilities effective january 1 2005 amendment revised certain restrictive debt covenants modified certain defined terms changed submission financial statements lenders closely reflect current sec requirements furnishing financial information december 31 2005 company compliance restrictive debt covenants loan agreements respect 2004 term loan revolving credit facilities natco agreed make distributions property cash company stockholders except dividends required series b preferred stock provisions dividends totaling 15 million declared paid holders company’s series b preferred stock year ended december 31 2005 promissory note february 6 2002 company borrowed 15 million longterm promissory note finance purchase manufacturing facility magnolia texas note accrued interest 90day libor plus 325 required quarterly payments principal approximately 24000 interest five years beginning may 2002 final balloon payment due february 2007 promissory note collateralized manufacturing facility magnolia texas note paid full third quarter 2005 revolving credit bank loans export sales facility july 23 2004 company two subsidiaries entered international revolving credit agreement wells fargo hsbc trade bank na providing loans 10 million subject borrowing base limitations working capital facility export sales secured specific project inventory receivables well certain inventory accounts receivable equipment partially guaranteed us exportimport bank loans facility mature march 31 2007 bear interest either 1 base rate defined agreement less 025 2 libor plus 200 company’s election facility replaced similar export sales credit facility terminated july 23 2004 letters credit outstanding facility december 31 2005 57 million facility fees related letters credit approximately 100 outstanding balance period september 30 2005 december 31 2005 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued company previously maintained working capital facility export sales provided aggregate borrowings 100 million subject borrowing base limitations expired july 23 2004 replaced export credit facility described export sales credit facility secured specific project inventory receivables partially guaranteed us exportimport bank company also unsecured letters credit bonds totaling 277000 guarantees totaling 364 million december 31 2005 11 postretirement benefits company maintains postretirement benefit plan provides health care life insurance benefits retired employees predecessor company plan accounted accordance sfas 106 “employer’s accounting postretirement benefits pensions” company recorded liability actuarially determined accumulated postretirement benefit obligation associated plan company adopted sfas 132 “employer’s accounting pensions postretirement benefits” revised disclosures pension postretirement benefit plans disclosures regarding postretirement benefits represent health care life insurance benefits employees retired company acquired combustion engineering december 31 2005 company amended postretirement benefit plan included elimination prescription drug coverage postage 65 participants along increases retiree premiums elimination dental coverage one groups retirees predecessor company amended plan retirees bear additional costs coverage december 31 2005 company obtained thirdparty valuation liability plan arrangement amended based upon valuation effect amendment 57 million reduction company’s accumulated postretirement benefit obligation december 31 2005 prior service cost benefit 139 million partially offset cumulative unrecognized loss 117 million related postretirement benefit plan accordance sfas 106 “employers’ accounting postretirement benefits pensions” benefit associated plan amendment amortized income prior service cost adjustment remaining life expectancy plan participants additionally cumulative unrecognized loss amortized remaining life expectancy plan participants november 2001 company agreed maintain benefits preamendment levels specified class retirees exchange expense reimbursement former sponsor postretirement benefit plan agreement required reimbursement 79000 per year four succeeding years pursuant arrangement company received 79000 0 157000 reimbursement postretirement benefit expenses years ended december 31 2005 2004 2003 respectively december 31 2003 president united states signed law medicare prescription drug improvement modernization act 2003 may 2004 financial accounting standards board issued sfas 1062 “accounting disclosure requirements related medicare prescription drug improvement modernization act 2003” pronouncement requires company determine whether benefit provided plan “actuarially equivalent” medicare prescription drugbenefit benefit provided actuarially equivalent federal subsidy deemed significant event company required account federal subsidy attributable past services actuarial gain sfas 106 reduce accumulated postretirement benefit obligation portion federal subsidy attributable current future service company required reduce net periodic postretirement benefit cost employee provides service company’s actuary made assessment 2004 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued benefits provided postretirement benefit plan actuarially equivalent based assessment net periodic cost reduced approximately 157000 173000 years ended december 31 2005 2004 respectively sfas 1062 longer apply company prospectively due company’s decision end 2005 eliminate postage 65 prescription drug coverage program company believes result reduction fas 106 net periodic cost beginning 2006 following table sets forth plan’s benefit obligation fair value plan assets funded status december 31 2005 2004 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued company sets discount rate assumption calculate current actuarial present value expected future cash flows referencing moody’s aa rate plus 25 basis points rounded nearest quarter percentagepoint change discount rate 600 2004 575 2005 resulted increase approximately 145000 accumulated postretirement benefit obligation onepercentage point change assumed health care cost trends would following effects december 31 2005 2004 december 2003 company adopted amendment sfas 132 required various disclosures concerning company’s postretirement benefit plans including plan’s measurement date employer’s estimated contributions next fiscal year percentage fair value plan assets measurement date data concerning specific assets contribute longterm rate return used investment policies strategies plan asset category basis upon longterm rate return plan assets determined postretirement benefit plan company expects provide contributions approximately 700000 years ended december 31 2006 2010 company held assets related postretirement plans december 31 2005 therefore company neither calculated longterm rate return applicable plan assets devised investment strategies manage plan assets defined contribution plans company subsidiaries different defined contribution plans different eligibility terms contribution schemes defined contribution plans consist following us plan covering eligible employees completed three months service employee contributions 3 covered employee’s compensation matched 100 employing entity additional 2 covered employee’s compensation matched 50 plan employer may make additional discretionary contributions profit sharing contributions uk plan available employees date commencement contributions made employee employing entity 5 pensionable pay additional contributions made employing entity based employees age employees contribute 15 annual salary pensionable pay defined employee’s annual salary less government lower earnings individuals become liable pay uk national insurance contributions according uk law canada plan covering approximately 64 salaried employees employee contributions 4 covered employee’s compensation matched 100 employing entity employing entity may make additional discretionary contributions profit sharing contributions plan index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued contributions employing entities plans consolidated basis totaled 24 million 21 million 23 million years ended december 31 2005 2004 2003 respectively 12 commitments contingencies operating leases company subsidiaries lease various facilities equipment noncancelable operating lease agreements leases expire various dates march 2015 excluding lease arrangement facility axsia requires lease commitments facility sublet another party future minimum lease payments required operating leases remaining noncancelable lease terms excess one year december 31 2005 follows 200641 million 200725 million 200817 million 200914 million 201011 million total expense operating leases years ended december 31 2005 2004 2003 46 million 50 million 54 million respectively discussion lease rental income see note 5 property plant equipment net 13 litigation magnum transcontinental corp arbitration petroserv sa v national tank company 165th jud dist ct harris co tx cause 200418769 matters stemmed agreement among natco group magnum transcontinental corporation us procurement arm petroserv sa zephyr offshore inc petroserv subsidiary manufacture install processing plant petroserv rig petroserv’s agency agreement natco certain projects brazil natco claimed magnum owed 418990 plant manufacturing agreement additional work performed excess days agreed contract natco submitted matter binding american arbitration association arbitration october 29 2003 arbitration magnum originally counterclaimed 4685000 alleging breach contract magnum amended answer counterclaim arbitration july 16 2004 reducing total amount claimed 1304000 arbitration hearing held october 2004 magnum reduced counter claim 570000 february 11 2005 arbitrator awarded natco full amount claim plus interest granted magnum total 58000 counterclaim neither party appealed arbitrator’s determination within period provided magnum paid natco approximately 410000 march 24 2005 natco filed request arbitration petroserv submitted mediation request representation agreement natco claiming unpaid agency fees several contracts including magnum contract resolution resulted mediation held january 23 2004 natco believed fees owed petroserv agency agreement offset natco’s claims magnum natco disputed owed fees magnum work obtained brazil representation agreement terminated early 2003 petroserv served collections suit state court may 2004 seeking 731323 plus attorneys’ fees interest court costs representing amounts allegedly due representation agreement several contracts including magnum transcontinental contract natco filed counterclaim action claiming breach agency agreement fiduciary obligations petroserv owed natco second unsuccessful mediation held case august 2004 march 11 2005 natco petroserv agreed settle lawsuit natco paying approximately 420000 petroserv commissions earned accrued interest legally recoverable attorneys’ fees natco applied funds received magnum arbitration discussed settlement payment jose corona individually personal representative estate noe corona sr et al v natco group inc jaime liendo 381st judicial district court starr county texas cause dc04175 lawsuit filed 2004 arose 2003 automobile accident involving employee one subsidiaries index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued noe corona sr died injuries sustained accident original filing specify damages mediation conducted march 30 2005 success plaintiffs amended filing april 15 2005 plead damages 30 million related mental anguish grief bereavement loss society companionship damage familial relationship loss care counseling guidance allegedly suffered six surviving adult children well funeral medical expenses pain suffering noe corona second mediation held may 24 2005 parties agreed settle plead potential claims arising accident settlement confidential funded insurance natco paying 100000 deductible natco subsidiaries defendants otherwise involved number legal proceedings ordinary course business insure risk proceedings extent deemed prudent management offer assurance type value insurance meet liabilities may arise pending future legal proceedings related business activities cannot predict outcome legal proceedings certainty opinion management ultimate liability respect pending lawsuits expected material adverse effect consolidated financial position results operations cash flows 14 stockholders’ equity july 1 1997 board directors company approved exchange certain stock appreciation rights outstanding subsidiary’s plan individual options purchase common stock company compensation expense recognized extent projected fair market value stock exchange date exceeded exercise price options furthermore additional stock options granted plan exercise price equal fair market value shares date grant accordingly compensation expense recorded additional grants individual stock options granted july 1 1997 vested ratably period three four years maximum term options 10 years july 1 1999 board directors company approved award options former chief executive officer pursuant terms employment agreement amended options granted exercise price equal fair market value shares date grant accordingly compensation expense recorded grant individual stock options granted july 1 1999 vested ratably four years maximum term options 10 years pursuant separation agreement entered former ceo july 28 2004 period exercise options following termination extended 18 months company recorded approximately 62000 stockbased compensation expense related term extension year ended december 31 2004 december 31 2005 options remained outstanding individual arrangements december 31 2004 2003 options relating aggregate 50000 shares 477700 shares respectively remained outstanding individual arrangements january 1998 february 1998 company adopted directors compensation plan 1998 employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares company’s common stock options vest periods four years maximum term options ten years december 31 2005 2004 2003 options relating aggregate 454426 shares 738334 shares 628217 shares respectively outstanding plans november 2000 board directors company approved authorized issuance 300000 shares company’s common stock 2000 employee stock option plan may 24 2001 company’s stockholders approved natco group inc 2001 stock incentive plan superceded replaced 2000 plan entirety increased number shares options awards may index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued granted plan maximum 1000000 shares december 31 2005 2004 2003 options relating aggregate 467129 shares 898563 shares 879422 shares respectively outstanding plan addition december 31 2005 2004 2003 73964 81825 12500 shares restricted stock respectively outstanding plan april 2004 board directors company approved authorized issuance 600000 shares company’s common stock natco group inc 2004 stock incentive plan june 15 2004 company’s stockholders approved plan december 31 2005 2004 options relating aggregate 145234 42000 shares 244504 63186 shares respectively restricted stock outstanding plan september december 2004 board directors granted 84071 shares restricted stock senior management certain employees restrictions shares lapse upon company achieving 100 earnings per share subject adjustment extraordinary items determined sole discretion governance nominating compensation committee trailing twelve months basis three consecutive quarters shares subject forfeiture performance goal met within three years date grant june september december 2004 board directors granted aggregate 48440 shares restricted stock current ceo served interim ceo september december 2004 nonemployee directors restrictions shares lapse respect grant service interim ceo equal installments first second third anniversaries date grant long recipient either continuing service interim permanent ceo completed service interim ceo earlier upon earliest recipient’s death disability retirement board following completion service interim ceo b board’s election chairman recipient c occurrence corporate change defined 2004 stock incentive plan restrictions shares lapse respect grants nonemployee directors time included current ceo following one year service director date grant earlier upon recipient’s termination board due death disability retirement board attainment age 68 upon occurrence corporate change january 2005 board directors granted total 100000 shares restricted stock ceo restrictions 43000 shares lapsed july 2005 restrictions remaining 57000 shares lapse third anniversary date grant long recipient continues service ceo earlier upon recipient’s death disability occurrence corporate change defined 2004 stock incentive plan april june 2005 board directors granted aggregate 32500 shares restricted stock nonemployee directors restrictions shares lapse following one year service director date grant earlier upon recipient’s termination board due death disability retirement board attainment age 68 upon occurrence corporate change june 2005 board directors granted aggregate 31439 shares restricted stock senior management restrictions shares lapse upon company achieving 110 earnings per share subject adjustment extraordinary items determined sole discretion governance nominating compensation committee trailing twelve months basis three consecutive quarters shares subject forfeiture performance goal met within three years date grant december 2005 board directors granted aggregate 18000 shares restricted stock certain key employees restrictions shares lapse second anniversary date grant long recipient continues service employee earlier upon recipient’s death disability occurrence corporate change index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued transactions pursuant company’s stock incentive plans years ended december 31 2005 2004 2003 include purposes pro forma disclosures estimated fair value options amortized expense options’ vesting period company’s pro forma net earnings per share years ended december 31 2005 2004 2003 see note 2 summary significant accounting policies december 31 2005 pursuant equity compensation plans approved company’s security holders 1066789 shares common stock could issued upon exercise employee stock options average price 917 per share 318468 shares restricted stock issued average price 979 additional 270501 shares remain available issuance company’s stock option plans december 31 2005 2004 company issued 584901 321532 shares common stock treasury stock options exercised addition company issued 155307 net 8482 forfeitures 120011 shares common stock treasury stock restricted stock awards 2005 2004 110061 shares related exercises warrants third quarter 2005 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued series preferred stock may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natco’s common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 company’s common stock 20 case lime rock partners ii lp announces commencement tender offer consummation would result ownership person group 15 company’s common stock person group acquire 15 company’s common stock 20 case lime rock partners ii lp right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board directors may redeem rights price 001 per right time acquisition person group 15 20 case lime rock partners ii lp less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed series b preferred stock march 25 2003 company issued 15000 shares series b convertible preferred stock “series b preferred shares” warrants purchase 248800 shares natco’s common stock lime rock partners ii lp private investment fund aggregate price 150 million approximately 99000 aggregate price allocated warrants proceeds issuance securities net related issuance costs 679000 used reduce company’s outstanding revolving debt balances general corporate purposes discussion warrants see note 15 warrants series b preferred shares face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment payable july 1 2003 series b preferred shares convertible option holder 1 number shares common stock equal face value series b preferred share divided conversion price 7805 aggregate 1921845 shares december 31 2005 2 cash payment equal amount dividends shares accrued since prior semiannual dividend payment date 2005 company paid dividends 15 million holders series b preferred shares december 31 2005 accrued dividends payable related series b preferred shares event change control defined certificate designations series b preferred shares holder series b preferred shares right convert series b preferred shares common stock cause company redeem cash series b preferred shares aggregate redemption price equal greater 1 sum 1000 adjusted stock splits stock dividends etc multiplied number shares redeemed plus b amount less zero equal index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued product 500 adjusted stock splits stock dividends etc multiplied aggregate number series b preferred shares redeemed less sum aggregate amount dividends paid cash since issuance date plus gain related stock warrants 2 aggregate face value series b preferred shares plus aggregate amount dividends accrued shares since last dividend payment date holder series b preferred shares converts upon change control occurring march 25 2006 holder also would entitled receive cash amount equal dividends would accrued march 25 2006 less sum aggregate amount dividends paid cash date conversion aggregate amount dividends accrued prior periods yet paid company right call redemption series b preferred shares cash march 25 2008 redemption price per share equal face value series b preferred shares plus amount dividends accrued paid since recent semiannual dividend payment date due cash redemption features upon change control described series b preferred shares qualify permanent equity treatment accordance emerging issues task force topic d98 “classification measurement redeemable securities” specifically requires permanent equity treatment precluded security redemption features solely within control issuer therefore company accounted series b preferred shares temporary equity accompanying balance sheet assigned value right redeem series b preferred shares march 25 2008 series b preferred shares redeemed contingent redemption features redemption amount greater carrying value would recorded reduction income available common stockholders event becomes probable company fail pay dividends two consecutive periods redemption price due respect series b preferred shares period 60 days following payment date company would default terms shares default period 1 dividend rate series b preferred shares would increase 1025 2 holders series b preferred shares would right elect appoint second director board directors 3 company would restricted paying dividends redeeming acquiring common outstanding stock limited exceptions company fail set aside make payments cash redemption price due respect series b preferred shares holders elect company’s right redeem shares may terminated december 31 2003 company recorded adjustment beginning retained earnings 400000 represented elimination reserve indemnify former affiliate tax ramifications may result taxfree spinoff former subsidiary 1997 reserve associated indemnification recorded 1999 december 31 2003 statute limitations expired review appropriate taxing authorities reserve deemed unnecessary since original transaction result gain loss reversal reserve recorded adjustment retained earnings rather component net income year ended december 31 2003 significant treasury share acquisitions approved company’s board directors july 28 2004 company purchased aggregate 498670 shares natco group inc common stock two executive officers price 7859 per share represented 15trading day average closing price company’s common stock index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued reported new york stock exchange period ended july 23 2004 officers used proceeds funds repay full outstanding loans company scheduled mature july 31 2004 cost acquire shares recorded treasury stock december 31 2004 15 warrants march 25 2003 company issued 15000 shares series b convertible preferred stock warrants purchase 248800 shares natco’s common stock lime rock partners ii lp warrants exercise price 1000 per share common stock expire march 25 2006 company ability force exercise warrants natco’s common stock traded 1350 per share 30 consecutive trading days point holder could elect 1 exercise warrants full 2 exercise net amount shares issuable deduction exercise price current market price shares date preceding exercise date 3 exercise warrants resulting termination warrants contained provision whereby holder could require company make netcash settlement warrants case change control warrants deemed derivative instruments therefore warrants recorded fair value issuance date fair value agreed counterparty agreement calculated applying pricing model included subjective assumptions stock volatility expected term warrants would outstanding dividend rate zero overall liquidity factor company recorded resulting liability 99000 issuance date august 26 2005 lime rock exercised warrants pursuant cashless exercise provision contained warrant instrument resulting cash payment company number shares common stock issued lime rock calculated based average closing price company’s shares new york stock exchange ten tradingday period ending day prior exercise average price 17933 resulting issuance 110061 shares common stock exchange warrants december 31 2004 company liability related warrants 196000 company adjusted liability fair value date issuance date exercise recorded expense 18 million year ended december 31 2005 compared expense 41000 year ended december 31 2004 16 earnings loss per share company computed basic earnings per share dividing net income loss allocable common stockholders weighted average number shares outstanding period net income allocable common stockholders december 31 2005 represented net income less preferred stock dividends accrued company determined diluted earnings per common potential common share december 31 2005 net income allocable common stockholders divided weighted average number shares outstanding period applying “ifconverted” method determine incremental shares associated convertible preferred stock warrants restricted stock outstanding shares considered common potential common shares purposes calculating earnings per share december 31 2005 accordance sfas 128 “earnings per share” outstanding employee stock options considered potential common shares purposes calculation december 31 2005 company excluded 19 million shares issuable upon conversion series b preferred shares inclusion shares antidilutive level income 2005 year ended december 31 2005 antidilutive options shares inthemoney company recorded loss allocable common stockholders years ended december 31 2004 2003 therefore common stock equivalents related employee nonemployee stock index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued options series b preferred shares warrants restricted stock deemed antidilutive excluded calculation weighted average shares impact antidilutive shares would reduction 270000 shares 765000 shares years ended december 31 2004 2003 respectively december 31 2004 2003 company excluded 19 million shares issuable upon conversion series b preferred shares following table presents earnings per common share amounts computed using sfas 128 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 17 related parties minority interest guarantee obligations related party majorityowned subsidiaries debt obligations related parties responsibility excluded balance sheet august 26 2005 following market close lime rock partners ii lp exercised full warrants purchase shares natco group inc’s common stock pursuant common stock purchase warrant dated march 25 2003 board directors office unanimously approved terms conditions common stock purchase warrant exercise price warrant 1000 warrant agreement provided cashless exercise lime rock elected exercise warrants pursuant cashless exercise provision common stock purchase warrant company received cash payment upon exercise final number shares common stock issued lime rock calculated based average closing price company’s shares new york stock exchange ten tradingday period ending day prior exercise average price 17933 resulting issuance 110061 shares common stock exchange warrants ownership series b preferred shares lime rock owns excess 5 outstanding common stock converted basis mr bates director member governance nominating compensation committee appointed lime rock serves managing director lime rock management lp manages lime rock partners ii lp consequently mr bates may deemed indirect material interest warrant conversion transaction arrangement terminated december 31 2004 paid capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut former chief executive officer reception telephone computer services normal office support relating space fees paid capricorn management reviewed approved audit committee board directors totaled 115000 years ended december 31 2004 2003 2002 respectively mr herbert winokur jr one directors chairman chief executive officer capricorn holdings inc managing director capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controls approximately 12 outstanding common stock december 31 2005 addition former chief executive officer nonsalaried member capricorn holdings llc capricorn investors ii lp formerly controlled approximately 19 common stock distributed limited partners fourth quarter 2005 approved company’s board directors july 28 2004 company purchased aggregate 498670 shares natco group inc common stock two executive officers price 7859 per share represented 15trading day average closing price company’s common stock reported new york stock exchange period ended july 23 2004 officers used proceeds funds repay full outstanding loans company scheduled mature july 31 2004 18 industry segments geographic information company adopted provisions sfas 131 “disclosures segments enterprise related information” company’s business units separate management teams infrastructures offer different products services 2005 business units aggregated three reporting segments described since longterm financial performance reportable segments affected similar economic conditions index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued natco restructured organization effective january 1 2005 order improve execution customer focus new reporting units oil water technologies gas technologies automation controls • oil water technologies group includes standard traditional oil gas separation dehydration equipment sales related services builttoorder systems focused primarily oil water production processing • gas technologies group includes co2 membrane business assets operating relationship related gas processing facilities west texas h2s removal technologies including shell paques™ builttoorder gasrelated technologies focus removing contaminants gas stream • automation controls group focuses sales new control panels systems monitor control oil gas production well field service activities including repair maintenance testing inspection services existing systems natco allocates corporate expenses operating segments allocation based headcount total assets revenues bookings corporate assets allocated segments based total assets segment accounting policies reporting segments consistent policies used prepare company’s consolidated financial statements respective periods presented company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense closure severance writeoff unamortized loan costs net accounting changes accounting policies segments described note 2 summary significant accounting policies company evaluates performance operating segments based income net interest expense income taxes depreciation amortization expense closure severance net accounting changes certain segment amounts previously reported years ended december 31 2004 2003 reclassified conform presentation segment amounts reported years ended december 31 2005 index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued summarized financial information concerning company’s segments shown following table following table reconciles total segment profit net income cumulative effect change accounting principle index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued following table provides information revenues product line within oil water technologies segment years ended december 31 2005 2004 2003 company’s geographic data continuing operations years ended december 31 2005 2004 2003 follows revenues results operations presented based origination bookings purposes geographic presentation necessarily reflect destination equipment ultimately delivered index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued 19 quarterly data unaudited following tables summarize quarterly information years ended december 31 2005 2004 2003 20 change accounting principle effective january 1 2003 company recorded cumulative effect change accounting principle related adoption sfas 143 “accounting asset retirement obligations” standard required company record fair value asset retirement obligation liability period legal obligation associated retirement tangible longlived assets result acquisition construction development andor normal use assets incurred addition standard requires company record corresponding asset depreciated life asset gave rise liability subsequent initial measurement asset retirement obligation company required adjust related liability reporting date reflect changes estimated retirement cost passage time loss 34000 net tax recorded january 1 2003 result change accounting principle related asset retirement obligation asset cost 96000 associated obligation remove certain leasehold improvements upon termination lease arrangements including concrete pads equipment asset cost depreciated remaining useful life related assets significant change asset liability years ended december 31 2005 2004 21 recent accounting pronouncements november 2004 fasb issued sfas 151 “inventory costs amendment arb 43 chapter 4” sfas 151 amends accounting research bulletin 43 chapter 4 clarify abnormal index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued amounts idle facility expense freight handling costs wasted materials spoilage recognized current period charges addition sfas 151 requires allocation fixed production overhead inventory based normal capacity production facilities sfas 151 becomes effective inventory costs incurred fiscal years beginning june 15 2005 company adopted pronouncement june 15 2005 material impact consolidated results operations financial position cash flows year ended december 31 2005 december 2004 fasb issued sfas 123 revised 2004 “sharebased payment” “sfas 123r” amendment requires expensing stock options sharebased payments supercedes sfas 123 sfas 123r eliminates ability account sharebased compensation transactions using intrinsic value method accounting principles board apb opinion 25 accounting stock issued employees generally would require instead transactions accounted using fairvaluebased method sfas 123r effective first interim annual reporting period begins june 15 2005 however april 14 2005 securities exchange commission announced effective date sfas 123r would changed first annual reporting period begins june 15 2005 adoption sfas 123r expected significant effect consolidated results operations financial position cash flows illustration impact company’s net income earnings per share presented “stock based compensation” section note 2 assuming company applied fair value recognition provisions sfas 123r using blackscholes methodology december 2004 fasb issued sfas 153 “exchanges nonmonetary assets” amends apb opinion 29 guidance apb 29 “accounting nonmonetary transactions” based principle exchanges nonmonetary assets measured based fair value assets exchanged amendment made sfas 153 eliminates exception exchanges similar productive assets replaces broader exception exchanges nonmonetary assets commercial substance statement became effective june 15 2005 company adopted standard effective date material impact consolidated results operations financial position cash flows year ended december 31 2005 december 2004 fasb issued fasb staff position 1091 “fsp 1091” application fasb statement 109 “accounting income taxes” “sfas 109” tax deduction qualified production activities provided american jobs creation act 2004 provides guidance recently enacted american jobs creation act 2004 “jobs creation act” jobs creation act provides tax deduction income qualified domestic production activities fsp 1091 provides treatment deduction special deduction described sfas 109 deduction effect company’s existing deferred tax assets liabilities year ended december 31 2005 impact deduction reported period deduction claimed us tax return december 2004 fasb issued fasb staff position 1092 “fsp 1092” accounting disclosure guidance foreign repatriation provision within american jobs creation act 2004 provides guidance sfas 109 respect recording potential impact repatriation provisions jobs creation act company’s income tax expense deferred tax liability fsp 1092 states company allowed time beyond financial reporting period enactment evaluate effect jobs creation act plan reinvestment repatriation foreign earnings purposes applying sfas 109 company analyzed potential benefit electing repatriate earnings provisions jobs creation act determined benefit company would minimal due reduction foreign tax credits associated repatriation earnings therefore company elected repatriate earnings jobs creation act index financial statements natco group inc subsidiaries notes consolidated financial statementscontinued march 2005 fasb issued fasb interpretation “fin” 47 “accounting conditional asset retirement obligations” fin 47 clarifies term conditional asset retirement obligation used sfas 143 “accounting asset retirement obligations” refers legal obligation perform asset retirement activity timing method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing method settlement uncertainty timing method settlement conditional asset retirement obligation factored measurement liability sufficient information exists fin 47 also clarifies entity would sufficient information reasonably estimate fair value asset retirement obligation interpretation effective later end fiscal years ending december 15 2005 adoption standard material effect company’s consolidated results operations financial position cash flows may 2005 fasb issued sfas 154 “accounting changes error correctionsa replacement apb opinion 20 fasb statement 3” new standard changes requirements accounting reporting change accounting principle among changes sfas 154 requires voluntary change accounting principle applied retrospectively prior period financial statements presented new accounting principle unless impracticable sfas 154 also provides 1 change method depreciating amortizing longlived nonfinancial asset accounted change estimate prospectively effected change accounting principle 2 correction errors previously issued financial statements termed “restatement” new standard effective accounting changes corrections errors made fiscal years beginning december 15 2005 company adopt standard effective date currently evaluating impact company’s consolidated results operations financial position cash flows june 2005 fasb issued fasb staff position 1431 “fsp 1431” accounting electronic equipment waste obligations provides guidance sfas 143 respect european operations adopted european union fsp 1431 requires commercial user incur costs associated retirement historical electrical equipment waste fsp 1431 became effective later june 8 2005 date adoption law applicable eumember country adoption fsp 1431 company’s uk operations material effect consolidated results operations financial position cash flows year ended december 31 2005 september 2005 fasb’s emerging issues task force eitf issued eitf 0413 “accounting purchases sales inventory counterparty” pronouncement provides additional accounting guidance situations involving inventory exchanges parties contained apb opinion 29 “accounting nonmonetary transactions” sfas 153 “exchanges nonmonetary assets” standard effective new arrangements entered reporting periods beginning march 15 2006 inventory transactions completed december 15 2006 arrangements entered prior march 15 2006 company process evaluating impact standard consolidated results operations financial position cash flows adopt effective date september 2005 sec staff revised eitf d98 “classification measurement redeemable securities” primarily provide guidance 1 earnings per share treatment redeemable common stock 2 application eitf d98 sharebased payment arrangements employees guidance earnings per share treatment redeemable common stock eitf d98 sharebased payment arrangements employees effective first fiscal period beginning september 15 2005 company adopt eitf d98 effective date applied concurrent adoption sfas 123r sharebased payment index financial statements item 9item 8 financial statements supplementary data consolidated financial statements years ended december 31 2007 2006 2005 applicable along reports management independent registered public accounting firm set forth management’s report internal control financial reporting management company responsible establishing maintaining effective internal control financial reporting defined rules 13a15f securities exchange act 1934 internal control financial reporting designed provide reasonable assurance company’s management board directors regarding preparation fair presentation published financial statements external purposes accordance generally accepted accounting principles internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements also projections evaluations effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate assessed effectiveness company’s internal control financial reporting december 31 2007 making assessment used criteria set forth committee sponsoring organizations treadway commission coso internal controlintegrated framework based assessment believe december 31 2007 company’s internal control financial reporting effective based criteria effect material weakness material weakness deficiency combination deficiencies internal control financial reporting reasonable possibility material misstatement company’s annual interim financial statements prevented detected timely basis following material weakness identified included management’s assessment company maintain effective foreign corrupt practices act fcpa compliance program company’s policies procedures sufficient give reasonable assurance matters involving potential violations fcpa appropriately identified reported evaluated result material weakness payments made accordance company’s policies procedures index financial statements independent registered public accounting firm issued audit report internal control financial reporting report appears beginning page 52 annual report john u clarke chairman chief executive officer march 17 2008 bradley p farnsworth senior vice president chief financial officer march 17 2008 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries company december 31 2007 2006 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2007 connection audits consolidated financial statements also audited financial statement schedule ii valuation qualifying accounts consolidated financial statements financial statement schedules responsibility company’s management responsibility express opinion consolidated financial statements financial statement schedule based audits conducted audits accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2007 2006 results operations cash flows years threeyear period ended december 31 2007 conformity us generally accepted accounting principles also opinion related financial statement schedule considered relation basic consolidated financial statements taken whole presents fairly material respects information set forth therein discussed notes 2 3 9 consolidated financial statements company changed accounting sharebased payment transactions postretirement benefits 2006 planned major maintenance activities 2007 income tax uncertainties 2007 respectively also audited accordance standards public company accounting oversight board united states company’s internal control financial reporting december 31 2007 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso report dated march 17 2008 expressed adverse opinion effectiveness company’s internal control financial reporting kpmg llp houston texas march 17 2008 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited natco group inc subsidiaries company internal control financial reporting december 31 2007 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso company’s management responsible maintaining effective internal control financial reporting assessment effectiveness internal control financial reporting included accompanying management’s report internal control financial reporting page 49 responsibility express opinion company’s internal control financial reporting based audit conducted audit accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether effective internal control financial reporting maintained material respects audit included obtaining understanding internal control financial reporting assessing risk material weakness exists testing evaluating design operating effectiveness internal control based assessed risk audit also included performing procedures considered necessary circumstances believe audit provides reasonable basis opinion company’s internal control financial reporting process designed provide reasonable assurance regarding reliability financial reporting preparation financial statements external purposes accordance generally accepted accounting principles company’s internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements also projections evaluation effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate material weakness deficiency combination deficiencies internal control financial reporting reasonable possibility material misstatement company’s annual interim financial statements prevented detected timely basis following material weakness identified included management’s assessment company’s policies procedures sufficient identify report evaluate potential violations foreign corrupt practices act also audited accordance standards public company accounting oversight board united states consolidated balance sheets december 31 2007 2006 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2007 natco group inc subsidiaries material weakness considered determining nature timing extent audit tests applied audit 2007 consolidated financial statements report affect report dated march 17 2008 expressed unqualified opinion consolidated financial statements index financial statements opinion effect aforementioned material weakness achievement objectives control criteria natco group inc maintained effective internal control financial reporting december 31 2007 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission kpmg llp houston texas march 17 2008 index financial statements natco group inc subsidiaries consolidated balance sheets thousands except share data accompanying notes integral part consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data accompanying notes integral part consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements stockholders’ equity comprehensive income thousands except share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements cash flows thousands accompanying notes integral part consolidated financial statements index financial statements n atco group inc subsidiaries notes consolidated financial statements 1 organization basis presentation natco group inc one leading providers process equipment systems services used production oil gas company designed manufactured marketed production equipment provided related services 80 years company’s production equipment used onshore offshore major oil gas producing regions world references “natco” “the company” used throughout document relate collectively natco group inc consolidated subsidiaries consolidated financial statements include accounts company majorityowned controlled subsidiaries material intercompany balances transactions eliminated consolidation account investments 20 50 exercise significant influence operation financial policies using equity method preparation financial statements requires company’s management make estimates assumptions affect amounts reported consolidated financial statements accompanying notes actual results could differ estimates certain prior period amounts reclassified conform current period presentation 2 summary significant accounting policies use estimates company’s management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenue expenses recognized period prepare financial statements conformity us generally accepted accounting principles actual results could differ estimates company’s significant estimates affected critical accounting policies revenue recognition warranty goodwill impairment sharebased compensation cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents concentration credit risk financial instruments potentially subject company concentration credit risk defined statement financial accounting standards “sfas” 105 “disclosure information financial instruments offbalance sheet risk financial instruments concentrations credit risk” consist primarily trade receivables company grants credit customers performing initial periodic credit evaluation customers’ financial condition typically require collateral receivables per management’s evaluation concentration credit risk related trade receivables limited due large diversified number customers comprising company’s customer base years ended december 31 2007 2006 2005 customer provided 10 company’s consolidated revenues trade accounts receivable allowance doubtful accounts trade accounts receivable recorded invoiced amount portfolio receivables comprised primarily accounts major national international corporate entities stable payment experience company provides allowance uncollectible accounts necessary specifically identified case basis review allowance doubtful accounts monthly basis evaluating past due balances based contractual terms order assess collectability receivable trade accounts receivable balances charged allowance doubtful accounts collectability determined remote inventories stated lower cost market net reserves us operations excluding automation controls pilotless burner joint venture inventory cost determined using index financial statements lastin firstout “lifo” method automation controls segment uses “the weightedaverage” cost method international subsidiaries pilotless burner joint venture consolidated company us use firstin firstout “fifo” method quarterly basis company reviews slowmoving inventory items usage determine potential obsolescence reserves established based either case basis management’s assessments future demands market conditions prepaid expense current assets prepaid expense current assets include prepayments insurance utilities rent etc amortized prorata basis periods benefited property plant equipment property plant equipment capitalized original cost stated original cost less allowance depreciation depreciable basis depreciated estimated useful life asset using straightline method maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting gain loss recorded consolidated statement operations see note 6 property plant equipment longlived assets company reviews longlived assets held used impairment annually frequently circumstances indicate impairment condition may exist carrying value longlived assets exceeds fair value required sfas 144 “accounting impairment disposal longlived assets” impairment longlived assets recognized carrying value longlived assets exceeds fair value recoverable carrying value exceeds sum undiscounted cash flows expected result use eventual disposition longlived asset impairment loss measured amount carrying value longlived asset exceeds fair value recorded consolidated statement operations allowed restored later periods longlived assets evaluated impairment december 31 2007 based evaluation company’s management believes impairment longlived assets existed december 31 2007 goodwill reviewed possible impairment annual basis fourth quarter fiscal year frequently circumstances indicate impairment may exist required sfas 142 “goodwill intangible assets” company identifies separate reporting units determines net carrying value well fair value fair value calculated using discounted projected future cash flows company’s weighted average cost capital based set management assumptions made time evaluation conducted fair value reporting unit compared net carrying value including goodwill determine whether impairment occurred reporting unit level carrying value reporting unit exceeds fair value impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value company would record impairment loss reduction goodwill charge period’s operating results december 31 2007 goodwill tested impairment required sfas 142 based testing company’s management believes impairment goodwill existed december 31 2007 see note 7 goodwill intangible assets leases company operating leases covering various facilities pieces equipment records operating expenses based sfas 13 “accounting leases” discussion company’s operating leases see note 13 commitments contingencies intangible assets intangible assets include deferred financing costs patents customer lists deferred financing costs amortized term related debt agreements patents customer lists index financial statements intangible assets amortized straightline basis asset’s estimated useful life ranging four half 17 years contingencies accounted accordance sfas 5 “accounting contingencies” information available prior issuance financial statements indicate probable asset impaired liability incurred date financial statements amount loss reasonably estimated company records estimate loss contingency accounting contingencies environmental legal income tax matters requires management use judgment revenue recognition general recognize revenues related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued less equal 250000 contract durations four months less addition compliance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 recognize revenues using percentage completion method contracts greater 250000 contract durations excess four months represent 1 customized engineered orders products qualify treatment 2 automation controls segment equipment fabrication sales projects qualify treatment automation controls segment also applies percentage completion method recognize revenues regardless contract value duration associated customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration factors support using percentage completion method include 1 segment produce standard units maintain inventory similar products sale 2 nature segment’s equipment fabrication sales operations 3 potential wide variations results operations could occur applying “as shipped” methodology relates smaller contracts customized fabricated goods earned revenue based percentage incurred costs date relate total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected period changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known report revenue net tax assessed governmental authority directly imposed revenue producing transaction instances customers billed advance services performed products manufactured company recognizes associated liability deferred revenue sharebased compensation effective january 1 2006 company adopted statement financial accounting standards 123r “sharebased payment” using modified prospective application transition method sharebased compensation cost measured grant date based estimated fair value award recognized operating expense straightline basis requisite service period addition sharebased compensation cost recognized includes compensation cost unvested sharebased awards january 1 2006 according sfas 123r tax benefit tax deduction excess recognized compensation costs excess tax benefits reported financing cash flow rather operating cash flow prior january 1 2006 company accounted sharebased compensation accordance accounting principles board opinion “apb” 25 “accounting stock issued employees” using intrinsic value method reported entire tax benefit related exercise stock options operating cash flow see note 16 sharebased compensation index financial statements earnings per share eps according sfas 128 “earnings per share” basic eps computed dividing net income loss available common stockholders weighted average number common shares outstanding period diluted eps computed dividing net income loss sum weighted average number common shares outstanding period incremental shares associated 1 stock options awards determined using “treasury method” 2 convertible preferred stock determined applying “ifconverted” method net income available common stockholders represents net income less convertible preferred stock dividends accrued since january 1 2006 calculation weighted average number total assumed proceeds accordance sfas 123r sfas 128 see note 17 earnings per share research development research development cost charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives five ten years product warranty cost product warranty cost estimated percentage revenue based historical claims data absence historical claims experience management’s estimates estimated future warranty obligations related manufactured products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims case basis income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment financial instruments company’s financial instruments consist primarily cash equivalents trade receivables trade payables debt instruments carrying values financial instruments approximate respective values either shortterm nature carry variable interest rates approximate market rates comprehensive income comprehensive income defined sfas 130 “reporting comprehensive income” includes changes equity period except resulted investments distributions company’s stockholders company includes unrealized gains losses related foreign currency translation adjustments comprehensive income foreign currencytranslation adjustment transaction gains losses financial statements foreign subsidiaries functional currencies us dollar translated us dollar equivalents period end exchange rates balance sheet accounts weighted average exchange rate period statement operations accounts currency translation adjustment gain loss resulting translations deferred included currency translation adjustment comprehensive income loss separate component stockholders’ equity certain transactions remain open settled periodend date therefore remeasured using periodend exchange rate resulting gain loss foreign currency transactions included net company’s consolidated statements operations index financial statements investment entities company entered joint ventures certain international companies accounted equity method investments originally recorded cost adjusted recognize company’s proportionate share net income loss dividend distributions joint ventures company records proportionate share joint ventures’ income loss period joint ventures generate income loss minority interest company consolidates entities controlling financial interest recognize portion income losses related ownership minority interest partners consolidated joint ventures expense income classify expense income “minority interest” consolidated statements operations postretirement benefits sfas 158 “employers’ accounting defined benefit pension postretirement plans” requires recognize prospective basis funded status postretirement benefit consolidated balance sheet recognize component accumulated comprehensive income loss net tax gain loss prior service cost credit arise period recognized components net periodic benefit cost company adopted sfas 158 december 31 2006 see note 11 postretirement benefits 3 change accounting principle january 1 2007 company changed method accounting planned major maintenance activities accrueinadvance method permitted direct expense method required fsp aug air1 previously company accrued cost upcoming periodic replacements maintenance membranes used gas processing facilities owned us advance performing related replacements maintenance based historical membrane replacements andor maintenance costs expected paid future classified current liability direct expense method costs actually incurred expensed period incurred company recorded change accounting principle accordance fsp aug air1 requires retrospective application new accounting principle practicable prior accounting periods principle always used accounting principle retrospectively applied period january 1 2002 period thereafter effective january 1 2007 company began recording actual cost related replacements andor maintenance membranes incurred cumulative effect retrospective application accounting principle january 1 2006 464000 decrease total liabilities 296000 increase retained earnings net 168000 related tax expense index financial statements following tables present effect retrospective application change accounting principle company’s consolidated financial statements periods presented natco group inc subsidiaries consolidated balance sheet natco group inc subsidiaries consolidated statements operations index financial statements natco group inc subsidiaries consolidated statement cash flows index financial statements 4 inventories consisted following amounts inventory reserves consisted following amounts 1 increase lifo reserve 2007 related primarily increase inventory increase price raw materials labor overhead reductions lifo layers years ended december 31 2007 2006 index financial statements company’s net inventories december 31 2007 2006 valuation method 5 costs estimated earnings uncompleted contracts 6 property plant equipment components property plant equipment depreciation expense 59 million 53 million 52 million respectively years ended december 31 2007 2006 2005 company leases certain machinery equipment customers shortterm operating lease arrangements generally periods exceed one year certain options extend three years operating lease arrangements often result sale equipment within one year company recorded depreciation expense related leased assets 292000 341000 405000 years ended december 31 2007 2006 2005 respectively asset lease company records depreciation expense based upon asset’s estimated useful life net book value leased assets index financial statements 732000 466000 december 31 2007 2006 respectively included accompanying consolidated balance sheet caption “other current assets” company intends sell assets within one year place assets used equipment inventory upon return lessee lease income 12 million 900000 700000 included revenue oil water technologies segment years ended december 31 2007 2006 2005 respectively 2006 company signed operating lease corporate headquarters building houston texas lease term started november 15 2007 company incurred certain capitalizable cost render building ready intended use leasehold improvements amortized term lease 7 goodwill intangible assets goodwill net goodwill segment years ended december 31 2007 2006 increase goodwill year ended december 31 2007 primarily due acquisition natco norway december 2007 entire goodwill amount 174 million allocated gas technologies segment changes carrying amount goodwill follows impairment goodwill indicated based testing performed management impairment charge recorded december 31 2007 2006 intangible assets intangible amortizable assets subject amortization december 31 2007 2006 index financial statements patents customer lists intangible assets year ended december 31 2007 increased primarily due acquisition natco norway december 2007 aggregate amount acquired intangible assets 115 million consisting 59 million patents customer lists 56 million company amortizes acquired intangible assets definite lives exceed 15 years intangible assets amortized using following useful lives deferred financing costsfive years patentsup 17 years consisting variety licenses trademarks four half 115 years amortization interest expense related intangible assets 319000 377000 527000 years ended december 31 2007 2006 2005 respectively estimated aggregate amortization interest expense intangible assets following five fiscal years 200811 million 200911 million 201010 million 2011919000 2012840000 acquired intangible assets allocated gas technologies segment 8 accrued expense accrued expense consisted tabular reconciliation changes company’s aggregate product warranty liability years ended december 31 2007 2006 set forth thousands index financial statements 9 income taxes components income taxes income tax expense consisted index financial statements deferred income taxes reflect net effects temporary differences carrying amounts assets liabilities financial reporting purposes amounts used income tax purposes well operating loss tax credit carryforwards tax effects temporary differences carryforwards based upon level historical taxable income projected future taxable income periods deferred tax assets deductible applicable tax jurisdictions believe likely realize benefits deductible differences carryforwards december 31 2007 however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections applicable tax jurisdictions deferred tax assets 103000 full valuation allowance december 31 2006 written year without income tax effects company tax benefit us net operating loss “nol” carryforwards 349000 available offset future taxable income 2021 us nol carryforwards subject annual limitations section 382 internal revenue code company tax benefit uk nol carryforwards 259000 nol carryforward may carried forward indefinitely current uk law company also tax benefit foreign nol carryforwards 25000 company foreign tax credit carryforwards 30 million available offset future us tax liabilities unutilized foreign tax credit carryforwards expire tax periods 2012 2018 index financial statements income tax expense differs amount computed applying us federal income tax rate 35 income continuing operations income taxes set forth following reconciliation cumulative undistributed earnings foreign subsidiaries totaled 160 million december 31 2007 company considers earnings foreign subsidiaries indefinitely reinvested accordingly provision us foreign state income taxes made earnings upon distribution foreign subsidiary earnings form dividends otherwise distributed earnings would reportable us income tax purposes subject adjustment foreign tax credits calculating tax effect distributing earnings practicable time effective january 1 2007 company adopted provisions fin 48 “accounting uncertainty income taxes” interpretation clarifies accounting uncertainty income taxes recognized enterprise’s financial statements accordance fasb statement 109 “accounting income taxes” fin 48 prescribes recognition threshold measurement attribute financial statement recognition measurement tax position taken expected taken tax return well provides guidance derecognition classification interest penalties accounting interim periods disclosure transition company determined cumulative effect financial statements related adopting fin 48 january 1 2007 company provided liability 824000 unrecognized tax benefits related various federal income tax matters interest penalties may incurred part liability would recognized component interest expense respectively december 31 2007 interest penalty expenses recognized company’s us federal tax returns currently open audit internal revenue service relate years ending december 31 2004 2006 reconciliation changes company’s unrecognized tax benefits associated fin 48 included consolidated balance sheet liability account “postretirement benefits longterm liabilities” year ended december 31 2007 set forth thousands recognized entire amount liability would affect effective tax rate december 31 2007 believed current tax positions resulted unrecognized tax benefits significantly increase decrease within next year index financial statements 10 longterm debt revolving credit facilities july 2006 company terminated prior term loan revolving credit facilities entered new revolving credit facilities agreement maturity june 30 2011 total borrowing capacity 850 million additionally pursuant terms revolving credit facilities right increase borrowing capacity 50 million company pays commitment fees undrawn portion facilities depending upon ratio funded debt ebitda calculated 025 december 31 2007 availability credit facilities reduced amount outstanding letters credit borrowings outstanding facilities december 31 2007 2006 company letters credit outstanding 189 million revolving credit facilities total available borrowing capacity 661 million december 31 2007 letters credit support contract performance warranties expire various dates december 8 2011 fees related letters credit approximately 10 outstanding balance december 31 2007 export sales facility june 2007 company entered export sales credit facility total borrowing capacity 100 million facility expire june 15 2010 partially guaranteed us exportimport bank subject certain borrowing base limitations interest borrowings facility either 1 lender’s prime rate less 050 2 london interbank offered rate plus 135 company’s election company pays annual fee 75000 facility december 31 2007 company total available borrowing capacity 92 million outstanding letters credit 756000 facility december 31 2007 company unsecured letters credit bonds totaling 875000 related foreign subsidiaries compliance restrictive debt covenants outstanding credit facilities december 31 2007 11 postretirement benefits health care life insurance postretirement benefits plans company maintains postretirement benefit plans providing health care life insurance benefits retired employees canadian subsidiary predecessor company plans accounted accordance sfas 106 “employer’s accounting postretirement benefits pensions” company uses december 31 measurement date postretirement benefit plans recorded liability actuarially determined accumulated postretirement benefit obligation apbo associated plans may 2004 december 31 2005 company accounted prescription drug benefit retiree medical plans accordance sfas 1062 “accounting disclosure requirements related medicare prescription drug improvement modernization act 2003” december 31 2005 company amended postretirement benefit plans eliminate prescription drug coverage postage 65 participants along increases retiree premiums elimination dental coverage one groups retirees predecessor company amended plans retirees bear additional costs coverage result sfas 1062 longer applied company starting january 1 2006 sfas 106 net periodic cost reduced since date effective december 31 2006 company adopted sfas 158 “employer’s accounting defined benefit pension postretirement plans” requires funded status obligations associated health care life insurance postretirement benefit plans recognized balance sheet december 31 2006 actuarially determined accumulated postretirement benefit obligation “apbo” 71 million whereas projected accrued benefit cost associated postretirement benefit plans already recorded company’s balance sheet sfas 106 94 million therefore company adjusted liability december 31 2006 reducing postretirement benefit 23 million increasing accumulated comprehensive income aoci deferred tax assets accounts 15 million 840000 respectively index financial statements consolidated statement stockholders’ equity comprehensive income year ended december 31 2006 inadvertently included adjustment initially apply sfas 158 net tax 15 million comprehensive income resulted comprehensive income total comprehensive income balances overstated 15 million total stockholders’ equity balance affected company view matter material consolidated financial statements comprehensive income total comprehensive income year ended december 31 2006 adjusted reflect appropriate presentation account balances december 31 2006 company made changes plans 2007 company’s contribution respect retiree medical life insurance plans shall frozen effective january 1 2008 level 2007 expenses incurred claims paid retirees covered dependents bear future costs escalations excess claims paid applicable company recorded plan amendments resulting net actuarially determined reduction apbo 19 million december 31 2007 company increased aoci deferred tax asset accounts 12 million approximately 700000 respectively net periodic cost postretirement benefit liability 1 adjustment made 2007 represents liability associated canadian employees changes benefit obligations recognized oci 1 adjustment made december 31 2007 resulting changes made plans described according sfas 158 amounts included aoci expected recognized components net periodic cost postretirement benefit liability fiscal year 2008 index financial statements assumptions used calculation company’s postretirement benefit plans us plan canadian plan following tables set forth year 2007 2006 reconciliations beginning ending balances postretirement benefit obligation fair value plan assets amounts recognized consolidated balance sheets aoci related postretirement benefits company used december 31 measurement date postretirement benefits plans 1 adjustment made 2007 representing liability associated canadian employees index financial statements effect onepercent change health care cost components apbo company’s postretirement benefit plans unfunded benefits paid company’s cash flow operations incurred company made payments 646000 company’s postretirement health care life insurance benefit plans year ended december 31 2007 based actuarially determined calculation expects pay approximately 666000 plans 2008 actual future expected benefit payments related postretirement benefit plans follow defined contribution plans company subsidiaries different defined contribution plans different eligibility terms contribution schemes defined contribution plans consist following us plan covering eligible employees completed one month service employee contributions 3 covered employee’s compensation matched 100 company index financial statements additional 2 covered employee’s compensation matched 50 plan company may make additional discretionary contributions profit sharing contributions company made additional discretionary 1 match four quarters 2007 eligible employees us plan canadian plan covering eligible employees within three months date employment contribution scheme us plan company made additional discretionary 1 match four quarters 2007 eligible employees canada plan uk plan available permanent employees uk subsidiaries date employment contributions made employee 5 pensionable pay company 6 pensionable pay additional discretionary contributions made company certain employees contribute 100 annual salary pensionable pay defined employee’s basic salary contributions company plans consolidated basis totaled 36 million 24 million 24 million years ended december 31 2007 2006 2005 respectively 12 comprehensive income comprehensive income includes changes stockholders’ equity period except resulting investments owners distributions owners comprehensive income included following actuarially determined postretirement benefit amortized aoci associated adoption fas 158 aoci consisted following index financial statements 13 commitments contingencies operating leases company subsidiaries lease certain facilities equipment noncancelable operating lease agreements leases expire various dates january 2018 future minimum lease payments required operating leases original remaining noncancelable terms excess one year december 31 2007 follows 200843 million 2009 33 million 201030 million 201129 million 201224 million total expense operating leases years ended december 31 2007 2006 2005 67 million 52 million 46 million respectively discussion lease income see note 6 property plant equipment commitments contingencies 1 company’s commitments contingencies consist primarily outstanding letters credits used guarantee performance contracts customers commercial bids insurance advanced payments since commitments associated letters credits financial guarantees typically expire unused amounts shown necessarily reflect actual future cash funding requirements fcpa review february 28 2008 audit committee board directors company assistance outside counsel initiated review certain payments made foreign jurisdiction company operates may present issues fcpa based results internal review company determined payments made one persons identified government employees order obtain certain work permits licenses satisfy certain “penalties” assessed authorities internal review sufficiently complete reasonably determine nature extent matters covered investigation time determined reasonable amount assurance total payments issue approximately 161000 payments made various times 2006 2007 company presently believes payments immaterial amount expects matter effect company’s previously reported financial results including fiscal year ended december 31 2007 reported matter securities exchange commission “sec” us department justice “doj” intend keep apprised progress review connection march 11 2008 sec informed us opened preliminary inquiry matter company cooperating inquiry audit committee working towards completing internal review issues may arise audit committee completes work addition doj sec governmental authorities could seek criminal civil sanctions including monetary fines penalties company andor certain employees well additional changes business practices compliance programs event review governmental investigation identifies violations law extent payments determined illegal foreign jurisdiction possible index financial statements could civil criminal penalties assessed jurisdiction amounts accrued company’s financial statements respect matters although expect matter material adverse effect business financial condition results operations give assurance effect 14 litigation company material litigation pending december 31 2007 2006 natco subsidiaries defendants otherwise involved internal investigation related sec inquiry discussed note 13 commitments contingencies well number legal proceedings ordinary course business insure risk proceedings extent deemed prudent management offer assurance type value insurance meet liabilities may arise pending future legal proceedings related business activities although cannot predict outcome legal proceedings certainty opinion management ultimate liability respect pending lawsuits expected material adverse effect business financial condition results operations 15 capital stock incentive plans company’s authorized capital stock comprised common stock series junior participating preferred stock series b redeemable convertible preferred stock common stock series b preferred stock currently outstanding description transactions affecting outstanding common stock material terms authorized preferred stock follows stock incentive plans january february 1998 company adopted directors compensation plan 1998 employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares company’s common stock november 2000 board approved authorized issuance 300000 shares common stock 2000 employee stock option plan may 2001 company’s stockholders approved 2001 stock incentive plan replaced 2000 plan entirety increased number shares options awards may granted plan maximum 1000000 shares stockholders approved plan may 2001 april 2004 board approved authorized issuance 600000 shares company’s common stock 2004 stock incentive plan company’s stockholders approved plan june 2004 march 2006 board approved authorized issuance 950000 shares company’s common stock 2006 longterm incentive compensation plan stockholders approved plan may 2006 december 31 2007 2006 2005 aggregate 717990 969130 270501 shares common stock respectively reserved issuance company’s longterm incentive compensation plans summary stock option activity company’s stock incentive plans years ended december 31 2005 2006 2007 included note 16 sharebased compensation summary restricted stock activity company’s stock incentive plans years ended december 31 2005 2006 2007 follows september december 2004 board directors granted 84071 shares performancebased restricted stock senior management certain employees restrictions shares remained outstanding grant lapsed november 2006 upon company’s achieving performance requirement applicable shares june september december 2004 board directors granted aggregate 48440 shares restricted stock current chief executive officer ceo served interim ceo september december 2004 nonemployee directors restrictions index financial statements grant service interim ceo lapsed equal installments december 2005 2006 2007 respectively restrictions respect grants nonemployee directors lapsed june 2005 january 2005 board directors granted total 100000 shares restricted stock ceo restrictions 43000 shares lapsed july 2005 restrictions remaining 57000 shares lapsed january 2008 april june 2005 board directors granted aggregate 32500 shares restricted stock nonemployee directors restrictions shares lapsed april june 2006 respectively june 2005 board directors granted aggregate 31439 shares performancebased restricted stock senior management restrictions shares remained outstanding grant lapsed november 2006 upon company achieving performance requirement december 2005 board directors granted aggregate 18000 shares restricted stock certain key employees restrictions shares lapsed december 2007 following two years service recipient january april 2006 board directors granted aggregate 16500 shares restricted stock certain key employees restrictions shares lapse third anniversary date grant long recipient continues service employee earlier upon recipient’s death disability occurrence corporate change june october 2006 board directors granted aggregate 48581 shares restricted stock senior management restrictions shares lapse third anniversary date grant subject certain performancebased criteria recipient’s continuous employment company date grant date restrictions lapse earlier provided applicable incentive plan award agreement result change control june 2006 board directors granted aggregate 15000 shares restricted stock nonemployee directors restrictions shares lapsed may 2007 respect retiring director june 2007 following one year continuous service remaining directors january december 2007 board directors granted aggregate 99030 shares restricted stock certain key employees restrictions shares lapse third anniversary date grant subject recipient’s continuous employment company date grant date restrictions lapse earlier provided applicable incentive plan award agreement result change control june 2007 board directors granted aggregate 12500 shares restricted stock nonemployee directors restrictions shares lapse following one year service director date grant treasury shares 2005 2006 2007 company acquired additional treasury shares result 1 forfeiture restricted shares termination employment prior lapse restrictions 2 surrender shares payment withholding taxes due shares following lapse restrictions company issued treasury shares exercise stock options restricted stock awards company’s stock incentive plans company 2550 zero 1168 shares held treasury december 31 2005 2006 2007 respectively common stock purchase rights series preferred stock may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natco’s common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 company’s common stock announces commencement tender offer consummation index financial statements would result ownership person group 15 company’s common stock person group acquire 15 company’s common stock right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board may redeem rights price 001 per right time acquisition person group 15 less 50 common stock board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed series b redeemable convertible preferred stock march 25 2003 company issued 15000 shares series b convertible preferred stock “series b preferred shares” private investment fund series b preferred shares face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment payable july 1 2003 series b preferred shares convertible option holder 1 number shares common stock equal face value series b preferred share divided conversion price 7805 2 cash payment equal amount dividends shares accrued since prior semiannual dividend payment date july august 2007 certain holders converted total 5085 shares company’s series b preferred shares total 651502 shares company’s common stock according conversion features described part conversion holders also received pro rata dividend payment dividend payable converted shares conversion date cash lieu conversion fractional shares years ended 2006 2005 company paid dividends 15 million holders series b preferred shares year ended december 31 2007 company paid dividends approximately 13 million holders series b preferred shares accrued dividends payable related series b preferred shares december 31 2007 date total 9915 shares series b preferred shares outstanding convertible aggregate 1270339 shares common stock company may redeem series b preferred shares cash march 25 2008 redemption price per share equal face value series b preferred shares plus amount dividends accrued paid since recent semiannual dividend payment date due certain cash redemption features upon change control series b preferred shares qualify permanent equity treatment accordance eitf topic d98 “classification measurement redeemable securities” specifically requires permanent equity treatment precluded security redemption features solely within control issuer therefore company accounted series b preferred shares temporary equity accompanying balance sheet assigned value right redeem series b preferred shares march 25 2008 series b preferred shares redeemed contingent redemption features redemption amount greater carrying value would recorded reduction income available common stockholders event becomes probable 16 sharebased compensation prior adoption sfas 123r sharebased compensation cost included amounts related restricted stock effective january 1 2006 company adopted sfas 123r “sharebased payment” december 31 2007 company 717990 shares available future awards longterm incentive compensation plans 1168 shares treasury stock company may elect issue new shares treasury shares longterm incentive compensation plans forfeitures estimated annual rates index financial statements 472 144 respectively stock options granted restricted stock awarded twelvemonth period ended december 31 2007 based company’s historical cancellation forfeiture experience components total sharebased compensation expense related company’s sharebased options awards recognized years ended december 31 2007 stock options company measures fair value sharebased options utilizing blackscholesmerton single optionreduced term valuation method requires management make various subjective assumptions june 2007 company reviewed evaluated applicable assumptions used determination fair value stock options resulted changes assumptions applied company’s annual 2007 stock options granted revised assumptions prospectively applied future grants stock options expected term previously used “simplified” method estimating expected term arrive expected term six years method replaced june 2007 method estimate based “historical exercise behavior” analyzed stock option exercise activities january 1 1995 practically feasible date regarding records maintained system valuation date calculated expected term based total options exercised unvested options cancelled options exercisable resulting expected term determined four half years company’s management believes revised expected term better represents stock options exercise behavior volatility determined based daily price stock expected term four half years risk free interest rate risk free interest rate based zerocoupon treasury bond rate remaining term equal expected term used average published zerocoupon treasury bond rates remaining terms four five years changes assumptions generally following effect fair value stock options related sharebased compensation expense assumptions change effect fair value expected term years increase volatility increase risk free interest rate increase dividend increase decrease index financial statements assumptions used determine fair value stock options follows summary stock option activity related information set forth december 31 2007 38 million unrecognized compensation cost including estimates forfeitures related unvested stock options cost expected recognized weighted average period 14 years restricted stock 2007 board directors authorized issuance aggregate 111530 shares restricted stock natco’s 2001 2004 2006 longterm incentive compensation plans shares 1 aggregate 6000 issued new employees restrictions lapse following three years employment 2 aggregate 12500 issued nonemployee directors restrictions lapse june 2008 3 aggregate 93030 issued officers key employees restrictions lapse june 2010 restrictions shares may lapse sooner death disability recipient retirement board age 68 case directors occurrence corporate change defined plan shares subject forfeiture recipient terminates service prior time restrictions lapse index financial statements summary restricted stock activity related information set forth december 31 2007 47 million total unrecognized compensation cost including estimated forfeitures related unvested restricted stock cost expected recognized weighted average period 19 years pro forma information sfas 123 periods prior fiscal 2006 prior january 1 2006 effective date sfas 123r company accounted sharebased compensation employees intrinsic value method accordance apb 25 “accounting stock issued employees” provided pro forma disclosure required sfas 123 following table illustrates pro forma effects net income earnings per common shares recognizing estimated compensation expense fair value method required sfas 123 fiscal year 2005 thousands except share data index financial statements 17 earnings per share according sfas 128 “earnings per share” basic eps computed dividing net income loss available common stockholders weighted average number common shares outstanding period diluted eps computed dividing net income loss sum weighted average number common shares outstanding period incremental shares associated 1 stock options awards determined using “treasury method” 2 convertible preferred stock determined applying “ifconverted” method net income available common stockholders represents net income less convertible preferred stock dividends accrued january 1 2006 company adopted sfas 123r computed incremental shares according sfas 123r requirements total assumed proceeds used “treasury method” include 1 assumed proceeds exercise stock optionslapse restrictions restricted stock 2 excess tax benefit resulted assumed tax deduction upon exercise stock optionslapse restrictions restricted stock deferred tax benefit would recognized financial statements based fair value 3 period average unrecognized compensation expense related future services according sfas 123r stock options restricted stock could antidilutive even shares inthemoney antidilutive common shares related stock options restricted stock included calculation impact would increase approximately 53692 shares 23569 shares respectively year ended december 31 2007 99407 shares 5133 shares related stock options restricted stock respectively year ended december 31 2006 year ended december 31 2005 antidilutive shares related stock options restricted stock december 31 2007 2006 company included 13 million 19 million shares respectively issuable upon conversion series b redeemable convertible preferred shares calculation dilutive weighted average shares inclusion shares dilutive level income four quarters yeartodate 2007 2006 index financial statements following table presents earnings per common share amounts computed using sfas 128 index financial statements 18 related parties years ended december 31 2007 2006 guarantee obligations related party majorityowned subsidiaries debt obligations related parties responsibility excluded balance sheet hold minority interest two entities future may asked guarantee certain obligations consistent interest entities joint several basis parties entities 19 industry segments geographic information company adopted provisions sfas 131 “disclosures segments enterprise related information” company’s business units separate management teams infrastructures offer different products services business units aggregated three reporting segments described since longterm financial performance reportable segments affected similar economic conditions natco’s reporting segments january 1 2005 december 31 2007 oil water technologies gas technologies automation controls • oil water technologies group includes standard traditional oil gas separation dehydration equipment sales related services builttoorder systems focused primarily oil water production processing • gas technologies group includes co2 membrane business assets operating relationship related gas processing facilities west texas h2s removal technologies including shell paques™ • automation controls group focuses sales manufacture new control panels systems monitor control oil gas production well field service activities including repair maintenance testing inspection services existing systems natco allocates corporate expenses operating segments allocation based headcount total assets revenues bookings corporate assets allocated segments based total assets segment accounting policies segments consistent policies used prepare company’s consolidated financial statements respective periods presented described note 2 summary significant accounting policies company evaluates performance operating segments based income net interest expense depreciation amortization expense closure severance net periodic cost postretirement benefit liability net income taxes index financial statements summarized financial information concerning company’s segments shown following table reconciles total segment profit net income index financial statements following table provides information revenues product line within oil water technologies segment years ended december 31 2007 2006 2005 geographic data company’s continuing operations years ended december 31 2007 2006 2005 follows revenue results operations presented based origination bookings purposes geographic presentation necessarily reflect destination equipment ultimately delivered 20 quarterly data unaudited following tables summarize quarterly information years ended december 31 2007 2006 index financial statements 21 recent accounting pronouncements february 2006 financial accounting standard board fasb issued sfas 155 “accounting certain hybrid financial instrumentsan amendment fasb statements 133 140” effective fiscal years beginning september 15 2006 statement issued clarify application fasb statement 133 beneficial interests securitized financial assets improve consistency accounting similar financial instruments regardless form instruments adoption standard january 1 2007 effective date impact company’s consolidated results operations financial position cash flows march 2006 fasb issued sfas 156 “accounting servicing financial assetsan amendment fasb statement 140” effective fiscal years beginning september 15 2006 statement issued simplify accounting servicing rights reduce volatility results using different measurement attributes adoption standard january 1 2007 impact company’s consolidated results operations financial position cash flows march 2006 eitf issued eitf 0603 “how taxes collected customers remitted governmental authorities presented income statement gross versus net presentation eitf 0603 requires presentation taxes assessed governmental authority directly imposed revenueproducing transaction seller customer either gross included revenue costs net excluded revenue basis accounting policy decision disclosed pursuant accounting principle board opinion 22 addition taxes reported gross basis company disclose aggregate basis amounts taxes interim annual financial statements period income statement presented amount significant issue applied financial reports interim annual reporting periods beginning december 15 2006 company currently reports revenue net basis adoption eitf 0603 january 1 2007 effect company’s consolidated results operations financial position cash flows june 2006 fasb issued fin 48 “accounting uncertainty income taxes” interpretation clarifies accounting uncertainty income taxes recognized enterprise’s financial statements accordance fasb statement 109 accounting income taxes fin 48 prescribes recognition threshold measurement attribute financial statement recognition measurement tax position taken expected taken tax return well provides guidance derecognition classification interest penalties accounting interim periods disclosure transition interpretation effective fiscal years beginning december 15 2006 adoption fin 48 january 1 2007 material effect company’s consolidated results operations financial position cash flows september 2006 fasb issued staff position “fsp” aug air1 “accounting planned major maintenance activities” prohibits use accrueinadvance method accounting planned major maintenance activities annual interim financial reporting periods fsp aug air1 effective fiscal year beginning december 15 2006 december 31 2006 company accrual approximately 500000 related membranes’ maintenance replacements adoption fsp augair1 effective date january 1 2007 material effect company’s consolidated results operations financial position cash flows september 2006 fasb issued sfas 157 “fair value measurements” became effective january 1 2008 sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value measurements company adopted standard january 1 2008 material impact company’s consolidated results operations financial position cash flows index financial statements september 2006 fasb issued sfas 158 “employers’ accounting defined benefit pension postretirement plans” sfas 158 establishes twostage requirement public company 1 recognize funded status pension postretirement benefit plan balance sheet disclose related information 2 measure plan’s assets benefit obligations company’s fiscal year end date company adopted sfas 158 december 31 2006 material impact company’s consolidated results operations financial position cash flows resulting adoption standard september 2006 sec released staff accounting bulletin 108 “sab 108” “considering effects prior year misstatements quantifying misstatements current year financial statements” provides interpretive guidance us securities exchange commission’s views regarding process quantifying materiality financial statements sab 108 effective fiscal years ending november 15 2006 early application first interim period ending november 15 2006 company adopted effective date december 31 2006 impact provision company’s consolidated results operations financial position cash flows february 2007 fasb issued sfas 159 “the fair value option financial assets financial liabilities including amendment fasb statement 115” permits entities choose measure eligible items fair value specified election dates elects adopt standard business entity shall report unrealized gains losses items fair value elected earnings subsequent reporting date effective date january 1 2008 company elected adopt sfas 159 december 2007 fasb issued sfas 141 revised 2007 “business combinations” replaces sfas 141 “business combinations” effective fiscal years beginning december 15 2008 early adoption permitted sfas 141r changed method applying acquisition method accounting number significant aspects acquisition costs generally expensed incurred noncontrolling interests valued fair value acquisition date inprocess research development recorded fair value indefinitelived intangible asset acquisition date changes deferred tax asset valuation allowances income tax uncertainties acquisition date generally affect income tax expense sfas 141r effective prospective basis business combinations acquisition date beginning first annual period subsequent december 15 2008 exception accounting valuation allowances deferred taxes acquired tax contingencies sfas 141r amends sfas 109 “accounting income taxes” adjustments made valuation allowances deferred taxes acquired tax contingencies associated acquisitions closed prior effective date sfas 141r would also apply provisions sfas 141r company process evaluating impact sfas 141r company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 december 2007 fasb issued sfas 160 “noncontrolling interests consolidated financial statementsan amendment arb 51” sfas 160 effective fiscal years interim periods within fiscal years beginning december 15 2008 early adoption prohibited sfas 160 requires recognition noncontrolling interest minority interest equity consolidated financial statements separate parent’s equity amount net income attributable noncontrolling interest included consolidated net income face income statement sfas 160 also amends certain arb 51’s consolidation procedures consistency requirements sfas 141r sfas 160 also includes expanded disclosure requirements regarding interests parent noncontrolling interest company process evaluating impact sfas 160 company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 february 2008 fasb issued fsp 1571 “application fasb statement 157 fasb statement 13 accounting pronouncements address fair value measurements purposes index financial statements lease classification measurement statement 13” fsp 1571 amends sfas 157 “fair value measurements” exclude sfas 13 “accounting leases” accounting pronouncements address fair value measurements purposes lease classification measurement sfas 13 however exception apply assets acquired liabilities assumed business combination required measured fair value sfas 141r “business combinations” regardless whether assets liabilities related leases fsp 1571 effective upon initial adoption sfas 157 company adopted sfas 157 “fair value measurements” january 1 2008 impact company’s consolidated results operations financial position cash flows upon adoption fsp 1571 february 2008 fasb issued fsp 1572 “effective date fasb statement 157” fsp defers effective date sfas 157 “fair value measurements” nonfinancial assets nonfinancial liabilities except items recognized disclosed fair value financial statements recurring basis least annually fiscal years beginning november 15 2008 interim periods within fiscal years items within scope fsp 1572 effective upon issuance date february 12 2008 company adopted fsp 1572 february 12 2008 impact company’s consolidated results operations financial position cash flows upon adoption 22 subsequent events january 2008 company acquired lincoelectromatic inc us company designs manufactures distributes services extensive line equipment used measure oil natural gas custody transfer approximately 23 million cash subject certain adjustments march 4 2008 company sent notice redemption holders series b preferred shares calling redemption outstanding series b preferred shares effective close business march 25 2008 aggregate redemption price 9915000 plus payment related dividend since last dividend payment date amounting approximately 275000 march 13 2008 holders series b preferred shares sent notice conversion company requesting shares converted aggregate 1270340 shares common stock immediately prior redemption time requesting payment related dividend discussed conversion series b preferred shares prior redemption time permitted certificate designations pursuant shares issued march 17 2008 holders series b preferred shares tendered share certificates company requirement conversion notice effective holders series b preferred shares tender share certificates prior redemption time company intends redeem shares indicated redemption notice item 9item 8 financial statements supplementary data consolidated financial statements years ended december 31 2008 2007 2006 applicable along reports management independent registered public accounting firm set forth index financial statements management’s report internal control financial reporting management company responsible establishing maintaining effective internal control financial reporting defined rules 13a15f securities exchange act 1934 internal control financial reporting designed provide reasonable assurance company’s management board directors regarding preparation fair presentation published financial statements external purposes accordance generally accepted accounting principles internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements therefore even systems determined effective provide reasonable assurance respect financial statement preparation presentation also projections evaluations effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate assessed effectiveness company’s internal control financial reporting december 31 2008 making assessment used criteria set forth committee sponsoring organizations treadway commission coso internal controlintegrated framework based assessment believe december 31 2008 company’s internal control financial reporting effective based criteria management’s assessment effectiveness internal control financial reporting december 31 2008 audited kpmg llp independent registered public accounting firm audit opinion assessment internal control financial reporting appears page 47 report john u clarke chairman chief executive officer march 2 2009 bradley p farnsworth senior vice president chief financial officer march 2 2009 index financial statements report independent registered public accounting firm board directors shareholders natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries company december 31 2008 2007 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2008 connection audits consolidated financial statements also audited financial statement schedule iivaluation qualifying accounts consolidated financial statements financial statement schedule responsibility company’s management responsibility express opinion consolidated financial statements financial statement schedule based audits conducted audits accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2008 2007 results operations cash flows years threeyear period ended december 31 2008 conformity us generally accepted accounting principles also opinion related financial statement schedule considered relation basic consolidated financial statements taken whole presents fairly material respects information set forth therein discussed notes 3 9 consolidated financial statements company changed accounting planned major maintenance activities 2007 income tax uncertainties 2007 respectively also audited accordance standards public company accounting oversight board united states company’s internal control financial reporting december 31 2008 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso report dated february 26 2009 expressed unqualified opinion effectiveness company’s internal control financial reporting kpmg llp houston texas february 26 2009 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited natco group inc subsidiaries company internal control financial reporting december 31 2008 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso company’s management responsible maintaining effective internal control financial reporting assessment effectiveness internal control financial reporting included accompanying management’s report internal control financial reporting page 45 responsibility express opinion company’s internal control financial reporting based audit conducted audit accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether effective internal control financial reporting maintained material respects audit included obtaining understanding internal control financial reporting assessing risk material weakness exists testing evaluating design operating effectiveness internal control based assessed risk audit also included performing procedures considered necessary circumstances believe audit provides reasonable basis opinion company’s internal control financial reporting process designed provide reasonable assurance regarding reliability financial reporting preparation financial statements external purposes accordance generally accepted accounting principles company’s internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements also projections evaluation effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate opinion natco group inc maintained material respects effective internal control financial reporting december 31 2008 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission also audited accordance standards public company accounting oversight board united states consolidated balance sheets natco group inc subsidiaries december 31 2008 2007 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2008 report dated february 26 2009 expressed unqualified opinion consolidated financial statements kpmg llp houston texas february 26 2009 index financial statements natco group inc subsidiaries consolidated balance sheets thousands except share par value data accompanying notes integral part consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data accompanying notes integral part consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements stockholders’ equity comprehensive income thousands except share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements cash flows thousands accompanying notes integral part consolidated financial statements index financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization basis presentation natco group inc one leading providers process equipment systems services used production oil gas company designed manufactured marketed production equipment provided related services 80 years company’s production equipment used onshore offshore major oil gas producing regions world references “natco” “the company” used throughout document relate collectively natco group inc consolidated subsidiaries consolidated financial statements include accounts company majorityowned controlled subsidiaries material intercompany balances transactions eliminated consolidation account investments 20 50 exercise significant influence operation financial policies using equity method preparation financial statements requires company’s management make estimates assumptions affect amounts reported consolidated financial statements accompanying notes actual results could differ estimates certain prior period amounts reclassified conform current period presentation 2 summary significant accounting policies use estimates company’s management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenue expenses recognized period prepare financial statements conformity us generally accepted accounting principles actual results could differ estimates company’s significant estimates affected critical accounting policies revenue recognition warranty goodwill impairment sharebased compensation cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents concentration credit risk financial instruments potentially subject company concentration credit risk defined statement financial accounting standards “sfas” 105 “disclosure information financial instruments offbalance sheet risk financial instruments concentrations credit risk” consist primarily trade receivables company grants credit customers performing initial periodic credit evaluation customers’ financial condition typically require collateral receivables per management’s evaluation concentration credit risk related trade receivables limited due large diversified number customers comprising company’s customer base years ended december 31 2008 2007 2006 customer provided 10 company’s consolidated revenues trade accounts receivable allowance doubtful accounts trade accounts receivable recorded invoiced amount portfolio receivables comprised primarily accounts major national international corporate entities stable payment experience company provides allowance uncollectible accounts necessary specifically identified case basis review allowance doubtful accounts monthly basis evaluating past due balances based contractual terms order assess collectability receivable trade accounts receivable balances charged allowance doubtful accounts collectability determined remote inventories stated lower cost market net reserves us operations excluding automation controls linco connor pilotless burner joint venture inventory cost index financial statements determined using lastin firstout “lifo” method automation controls segment uses “the weightedaverage” cost method international subsidiaries linco connor pilotless burner joint venture consolidated company us use firstin firstout “fifo” method quarterly basis company reviews slowmoving inventory items usage determine potential obsolescence reserves established based either case basis management’s assessments future demands market conditions prepaid expense current assets prepaid expense current assets primarily include prepayments insurance utilities rent amortized prorata basis periods benefited property plant equipment property plant equipment capitalized original cost stated original cost less allowance depreciation depreciable basis depreciated estimated useful life asset using straightline method maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting gain loss recorded consolidated statement operations see note 6 property plant equipment longlived assets company reviews longlived assets held used impairment annually frequently circumstances indicate impairment condition may exist carrying value longlived assets exceeds fair value required sfas 144 “accounting impairment disposal longlived assets” impairment longlived assets recognized carrying value longlived assets exceeds fair value recoverable carrying value exceeds sum undiscounted cash flows expected result use eventual disposition longlived asset impairment loss measured amount carrying value longlived asset exceeds fair value recorded consolidated statement operations allowed restored later periods longlived assets evaluated impairment december 31 2008 based evaluation company’s management believes impairment longlived assets existed december 31 2008 goodwill reviewed possible impairment annual basis frequently circumstances indicate impairment may exist required sfas 142 “goodwill intangible assets” “sfas 142” company identifies separate reporting units determines net carrying value well fair value fair value calculated using discounted projected future cash flows company’s weighted average cost capital based set management assumptions made time evaluation conducted fair value reporting unit compared net carrying value including goodwill determine whether impairment occurred reporting unit level carrying value reporting unit exceeds fair value impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value company would record impairment loss reduction goodwill charge period’s operating results goodwill tested impairment december 31 2008 based testing company’s management believes impairment goodwill existed december 31 2008 see note 7 goodwill intangible assets leases company operating leases covering various facilities pieces equipment records operating expenses based sfas 13 “accounting leases” discussion company’s operating leases see note 13 commitments contingencies index financial statements intangible assets intangible assets include deferred financing costs patents customer lists intangibles deferred financing costs amortized term related debt agreements patents customer lists intangible assets amortized straightline basis asset’s estimated useful life ranging 2 20 years see note 7 goodwill intangible assets contingencies accounted accordance sfas 5 “accounting contingencies” information available prior issuance financial statements indicate probable asset impaired liability incurred date financial statements amount loss reasonably estimated company records estimate loss contingency accounting contingencies environmental legal income tax matters requires management use judgment see note 13 commitments contingencies revenue recognition general recognize revenue related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued less equal 250000 contract durations four months less additionally compliance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 recognize revenue using percentage completion method 1 contracts greater 250000 contract durations excess four months represent customized engineered orders products qualify treatment 2 automation controls segment equipment fabrication sales projects qualify treatment automation controls segment also applies percentage completion method recognize revenue regardless contract value duration associated customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration factors support using percentage completion method include 1 segment produce standard units maintain inventory similar products sale 2 nature segment’s equipment fabrication sales operations 3 potential wide variations results operations could occur applying “as shipped” methodology relates smaller contracts customized fabricated goods earned revenue reflects original contract price adjusted agreed claims approved change orders change order claim unapproved revenue recognized respect recorded contract revenue utilizing percentage completion method earned revenue based percentage incurred costs date relate total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work may include losses expected incurred charged period changes losses become known generally recognize revenue earnings percentage completion method period two six quarters event project terminated customer completion customer liable costs incurred contract instances customers billed advance services performed products manufactured company recognizes associated liability deferred revenue sharebased compensation effective january 1 2006 company adopted sfas 123r “sharebased payment” “sfas 123r” using modified prospective application transition method sharebased compensation cost measured grant date based estimated fair value award recognized operating expense straightline basis requisite service period addition sharebased compensation cost recognized includes compensation cost unvested sharebased awards january 1 2006 according sfas 123r tax benefit tax deduction excess recognized compensation costs excess tax benefits reported financing cash flow rather operating cash flow index financial statements prior january 1 2006 company accounted sharebased compensation accordance accounting principles board opinion “apb” 25 “accounting stock issued employees” using intrinsic value method reported entire tax benefit related exercise stock options operating cash flow see note 16 sharebased compensation earnings per share “eps” according sfas 128 “earnings per share” “sfas 128” basic eps computed dividing net income loss available common stockholders weighted average number common shares outstanding period diluted eps computed dividing net income loss sum weighted average number common shares outstanding period incremental shares associated 1 stock options awards determined using “treasury method” 2 convertible preferred stock determined applying “ifconverted” method net income available common stockholders represents net income less convertible preferred stock dividends accrued since january 1 2006 calculation weighted average number total assumed proceeds accordance sfas 123r sfas 128 see note 17 earnings per share research development research development cost charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives five ten years product warranty cost product warranty cost estimated percentage revenue based historical claims data absence historical claims experience management’s estimates estimated future warranty obligations related manufactured products charged cost goods sold period related revenue recognized additionally company provides customers letters credit covering potential warranty claims case basis income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment financial instruments company’s financial instruments consist primarily cash equivalents trade receivables trade payables debt instruments carrying values financial instruments approximate respective values either shortterm nature carry variable interest rates approximate market rates comprehensive income comprehensive income defined sfas 130 “reporting comprehensive income” includes changes equity period except resulted investments distributions company’s stockholders company includes unrealized gains losses related foreign currency translation adjustments comprehensive income foreign currencytranslation adjustment transaction gains losses operations conducted around world number different countries financial statements foreign subsidiaries typically measured using local currency functional currency entity operates index financial statements management reviews determines functional currency foreign subsidiaries considering primary economic environment entity operates well evaluating factors set forth sfas 52 “foreign currency translation” may certain circumstances determine currency local currency entity functional currency financial statements foreign subsidiaries functional currencies us dollar translated us dollar equivalents period end exchange rates balance sheet accounts weighted average exchange rate period statement operations accounts currency translation adjustment gain loss resulting translations deferred included currency translation adjustment “accumulated comprehensive income loss” separate component stockholders’ equity consolidated balance sheet certain transactions remain open settled periodend date therefore remeasured using periodend exchange rate resulting gain loss foreign currency transactions included “other net” company’s consolidated statements operations accordingly earnings cash flow exposed changes foreign currency exchange rates investment entities company entered joint ventures certain international companies accounted equity method investments originally recorded cost adjusted recognize company’s proportionate share net income loss dividend distributions joint ventures company records proportionate share joint ventures’ income loss period joint ventures generate income loss minority interest company consolidates entities controlling financial interest recognize portion income losses related ownership minority interest partners consolidated joint ventures expense income classify expense income “minority interest” consolidated statements operations postretirement benefits sfas 158 “employers’ accounting defined benefit pension postretirement plans” requires recognize prospective basis funded status postretirement benefit consolidated balance sheet recognize component accumulated comprehensive income loss net tax gain loss prior service cost credit arise period recognized components net periodic benefit cost company adopted sfas 158 december 31 2006 see note 11 postretirement benefits 3 change accounting principle january 1 2007 company changed method accounting planned major maintenance activities accrueinadvance method permitted direct expense method required fsp aug air1 previously company accrued cost upcoming periodic replacements maintenance membranes used gas processing facilities owned us advance performing related replacements maintenance based historical membrane replacements andor maintenance costs expected paid future classified current liability direct expense method costs actually incurred expensed period incurred company recorded change accounting principle accordance fsp aug air1 requires retrospective application new accounting principle practicable prior accounting periods principle always used accounting principle retrospectively applied period january 1 2002 period thereafter effective january 1 2007 company began recording actual cost related replacements andor maintenance membranes incurred cumulative effect retrospective application accounting principle january 1 2006 464000 decrease total liabilities 296000 increase retained earnings net 168000 related tax expense index financial statements following tables present effect retrospective application change accounting principle company’s consolidated financial statements periods presented natco group inc subsidiaries consolidated statements operations natco group inc subsidiaries consolidated statement cash flows index financial statements 4 inventories consisted following amounts inventory reserves consisted following amounts 1 increase lifo reserve 2008 related primarily increase level inventory increase price raw materials labor overhead reductions lifo layers years ended december 31 2008 2007 company’s net inventories december 31 2008 2007 valuation method index financial statements 5 costs estimated earnings billings uncompleted contracts costs estimated earnings date excess progress billings contracts progress represent cumulative revenue recognized less cumulative billings customer billed revenue collected reported trade accounts receivable unbilled revenue reported costs estimated earnings excess billings uncompleted contracts company’s consolidated balance sheets timing bill customers generally based advance billing terms contingent upon completion certain phases work stipulated contract progress billings trade accounts receivable december 31 2008 2007 typically collected within one year cost revenue includes direct contract costs material labor indirect costs attributable contract activity 6 property plant equipment components property plant equipment depreciation expense 79 million 59 million 53 million respectively years ended december 31 2008 2007 2006 company leases certain machinery equipment customers shortterm operating lease arrangements generally periods exceed one year certain options extend three years operating lease arrangements often result sale equipment within one year company recorded depreciation expense related leased assets 208000 292000 341000 years ended december 31 2008 2007 2006 respectively asset lease company records depreciation expense based upon asset’s estimated useful life net book value leased assets 945000 732000 december 31 2008 2007 respectively leased equipment term one year less reclassified current assets december 31 2008 451000 494000 index financial statements included accompanying consolidated balance sheet caption “prepaid expenses current assets” “property plant equipment net” respectively december 31 2007 732000 included accompanying consolidated balance sheet caption “prepaid expenses current assets” lease income 15 million 12 million 900000 included revenue standard traditional segment years ended december 31 2008 2007 2006 respectively 7 goodwill intangible assets goodwill net goodwill segment december 31 2008 december 31 2007 follows changes carrying amount goodwill follows thousands goodwill evaluated least annually determine fair value recorded goodwill decreased carrying value purposes impairment testing goodwill evaluated reporting unit level company’s reporting units impairment testing determined operating segments connection annual goodwill impairment assessment performed december 31 2008 company performed impairment test integrated engineered solutions standard traditional automation controls reporting units provisions sfas 142 management utilized discounted cash flow analysis “dcfa” estimate fair values company’s reporting units develop estimates future cash flows used analysis management considered adverse market conditions affecting company’s common stock price beginning fourth quarter 2008 continuing 2009 including significant decrease number operating rigs decline oil natural gas commodity prices completing first step analysis management used threeyear projection discounted cash flows plus terminal value estimate fair value reporting units developing fair value estimates certain key assumptions included discount rate 1500 reporting units future outlook towards growth virtually flat management believes results dcfa using assumptions described represents fair value reasonable market capitalization existed december 31 2008 company’s stock price trading book value december 31 2008 management attributes low stock price industrywide companyspecific factors event company’s stock price continues trading levels relation book value company would expect continue performing quarterly evaluations carrying value goodwill future earnings cash flows company’s reporting units decline andor discount rates increase impairment charge goodwill intangible assets may required net carrying value reporting unit exceeds estimated fair value impairment could material index financial statements based results first step impairment test management concluded impairment indicated reporting units validating conclusion management considered results longlived asset impairment tests performed sensitivity analyses key assumptions used deriving respective fair values reporting units impairment goodwill indicated based testing performed management impairment charge recorded december 31 2008 2007 intangible assets intangible amortizable assets subject amortization december 31 2008 2007 management performed impairment review intangible assets december 31 2008 accordance sfas 144 impairment indicated based testing performed management impairment charge recorded december 31 2008 2007 company amortizes acquired intangible assets definite lives exceed 20 years intangible assets amortized using following useful lives deferred financing costs5 years patentsup 17 years consisting variety licenses trademarks 45 15 years amortization interest expense related intangible assets 32 million 319000 377000 years ended december 31 2008 2007 2006 respectively estimated aggregate amortization interest expense intangible assets following five fiscal years 200928 million 201027 million 201124 million 201222 million 201321 million index financial statements 8 accrued expense accrued expense consisted 1 following table presents changes company’s aggregate product warranty liability years ended december 31 2008 2007 2006 increase warranty reserve 33 million december 31 2007 47 million december 312008 primarily due increases revenue raw material costs 2008 well adjustments related actual claims cost percentage historical average revenue decrease warranty reserve 39 million december 31 2006 33 million december 31 2007 primarily due known claim approximately 919000 existed provided december 31 2006 large builttoorder project required significant rework subsequently paid 2007 well overall decrease actual claims cost percentage historical average revenue 2 project cost consists accrued vendor subcontract costs related projects progress decrease project cost 320 million year ended december 31 2007 186 million year ended december 31 2008 primarily due several large us international builttoorder projects near completion december 31 2007 completed delivered 2008 typically negotiated terms vendors subcontractors aligned terms customers order maintain favorable cash flow larger builttoorder projects index financial statements 9 income taxes components income taxes income tax expense consisted amount income tax attributable gains losses comprehensive income excluded net income totaled 22 million 228000 563000 years ended december 31 2008 2007 2006 index financial statements deferred income taxes reflect net effects temporary differences carrying amounts assets liabilities financial reporting purposes amounts used income tax purposes well operating loss tax credit carryforwards tax effects temporary differences carryforwards based upon level historical taxable income projected future taxable income periods deferred tax assets deductible applicable tax jurisdictions believe likely realize benefits deductible differences carryforwards december 31 2008 however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections applicable tax jurisdictions company tax benefit us net operating loss “nol” carryforwards 313000 available offset future taxable income 2021 us nol carryforwards subject annual limitations section 382 internal revenue code company also tax benefit 583000 related nol carryforwards generated foreign jurisdictions nol carryforwards may carried forward indefinitely foreign jurisdiction law company foreign tax credit carryforwards 653000 available offset future us tax liabilities unutilized foreign tax credit carryforwards expire tax periods 2012 2018 index financial statements income tax expense differs amount computed applying us federal income tax rate 35 income continuing operations income taxes set forth following reconciliation cumulative undistributed earnings foreign subsidiaries totaled 217 million december 31 2008 company considers earnings foreign subsidiaries indefinitely reinvested accordingly provision us foreign state income taxes made earnings upon distribution foreign subsidiary earnings form dividends otherwise distributed earnings would reportable us income tax purposes subject adjustment foreign tax credits calculating tax effect distributing earnings practicable time effective january 1 2007 company adopted provisions fin 48 “accounting uncertainty income taxes” “fin 48” interpretation clarifies accounting uncertainty income taxes recognized enterprise’s financial statements accordance fasb statement 109 “accounting income taxes” fin 48 prescribes recognition threshold measurement attribute financial statement recognition measurement tax position taken expected taken tax return well provides guidance derecognition classification interest penalties accounting interim periods disclosure transition company determined cumulative effect financial statements related adopting fin 48 january 1 2007 company provided liability 824000 unrecognized tax benefits related various federal income tax matters interest penalties may incurred part liability would recognized component interest expense respectively december 31 2008 interest penalty expenses recognized company’s us federal tax returns currently open audit internal revenue service relate years ending december 31 2004 2007 reconciliation changes company’s unrecognized tax benefits associated fin 48 included consolidated balance sheet liability account “postretirement benefits longterm liabilities” years ended december 31 2008 2007 set forth thousands recognized entire amount liability would affect effective tax rate december 31 2008 believed current tax positions resulted unrecognized tax benefits significantly increase decrease within next year index financial statements 10 longterm debt december 31 2008 company available capacity credit agreements 1105 million discussion company’s existing credit facilities revolving credit facility july 2006 company terminated prior term loan revolving credit facility entered new revolving credit facility agreement maturity june 30 2011 total borrowing capacity 850 million december 23 2008 company certain subsidiaries entered amendment facility resulting increased borrowing capacity 527 million total 1377 million additionally company ability issue letters credit guarantees bonds 1000 million company paid amendment fee 426000 includes upfront fee 050 plus arrangement fee agent amended company pays commitment fees undrawn portion facility ranging 40 60 based upon ratio funded debt ebitda calculated 40 december 31 2008 interest borrowings facility ranges london interbank offered rate libor lender’s prime rate plus 250 350 depending debt ebitda ratio availability credit facility reduced amount borrowing outstanding letters credit year company drew 278 million repaid 198 million outstanding borrowings facility december 31 2008 80 million borrowings 234 million letters credit outstanding facility total available borrowing capacity december 31 2008 1063 million fees related letters credit approximately 250 outstanding balance december 31 2008 export sales facility june 2007 company entered export sales credit facility total borrowing capacity 100 million facility expire june 15 2010 partially guaranteed us exportimport bank subject certain borrowing base limitations interest borrowings facility either 1 lender’s prime rate less 050 2 libor plus 135 company’s election company pays annual fee 75000 facility year company drew 219 million repaid 169 million facility december 31 2008 company 50 million borrowings 771000 letters credit outstanding facility total available borrowing capacity december 31 2008 42 million fees related letters credit approximately 10 outstanding balance december 31 2008 letters credit support various contract performance warranties expire various dates april 1 2014 december 31 2008 company unsecured letters credit bonds totaling approximately 24 million related international subsidiaries compliance restrictive debt covenants outstanding credit facilities december 31 2008 11 postretirement benefits health care life insurance postretirement benefits plans company maintains postretirement benefit plans providing health care life insurance benefits retired employees canadian subsidiary predecessor company plans accounted accordance sfas 106 “employer’s accounting postretirement benefits pensions” company uses december 31 measurement date postretirement benefit plans recorded liability actuarially determined accumulated postretirement benefit obligation “apbo” associated plans effective december 31 2006 company adopted sfas 158 “employer’s accounting defined benefit pension postretirement plans” requires funded status obligations index financial statements associated health care life insurance postretirement benefit plans recognized balance sheet december 31 2006 actuarially determined apbo 71 million whereas projected accrued benefit cost associated postretirement benefit plans already recorded company’s balance sheet sfas 106 94 million therefore company adjusted liability december 31 2006 reducing postretirement benefit 23 million increasing accumulated comprehensive income “aoci” deferred tax assets accounts 15 million 840000 respectively company made changes plans 2007 company’s contribution retiree medical life insurance plans frozen effective january 1 2008 level 2007 expenses incurred claims paid retirees covered dependents bear future costs escalations excess claims paid applicable company recorded plan amendments resulting net actuarially determined reduction apbo 19 million december 31 2007 net periodic benefit cost postretirement benefit liability 1 adjustment made 2007 represents liability associated canadian employees changes benefit obligations recognized comprehensive income “oci” 1 adjustment made december 31 2007 resulting changes made plans described according sfas 158 amounts included aoci expected recognized components net periodic cost postretirement benefit liability fiscal year 2009 index financial statements assumptions used calculation company’s postretirement benefit plans us plan company’s contribution retiree medical life insurance plans frozen effective january 1 2008 level 2007 expenses incurred claims paid therefore applicable canadian plan following tables set forth year 2008 2007 reconciliations beginning ending balances postretirement benefit obligation fair value plan assets amounts recognized consolidated balance sheets aoci related postretirement benefits company used december 31 measurement date postretirement benefits plans 1 adjustment made 2007 represents liability associated canadian employees index financial statements effect onepercent change health care cost components apbo company’s postretirement benefit plans unfunded benefits paid company’s cash flow operations incurred company made payments 614000 company’s postretirement health care life insurance benefit plans year ended december 31 2008 based actuarially determined calculation expects pay approximately 449000 plans 2009 actual future expected benefit payments related postretirement benefit plans follow defined contribution plans company subsidiaries different defined contribution plans different eligibility terms contribution schemes defined contribution plans consist following us plan covering eligible employees completed one month service employee contributions 3 covered employee’s compensation matched 100 company index financial statements additional 2 covered employee’s compensation matched 50 plan company may make additional discretionary contributions profit sharing contributions company made additional discretionary 1 match four quarters 2008 eligible employees us plan canadian plan covering eligible employees within three months date employment contribution scheme us plan company made additional discretionary 1 match four quarters 2008 eligible employees canada plan uk plan available permanent employees uk subsidiaries date employment contributions made employee 5 pensionable pay company 6 pensionable pay additional discretionary contributions made company certain employees contribute 100 annual salary pensionable pay defined employee’s basic salary contributions company plans consolidated basis totaled 42 million 36 million 24 million years ended december 31 2008 2007 2006 respectively 12 comprehensive income comprehensive income includes changes stockholders’ equity period except resulting investments owners distributions owners comprehensive income included following actuarially determined postretirement benefit amortized aoci associated adoption fas 158 index financial statements aoci consisted following 13 commitments contingencies operating leases company subsidiaries lease certain facilities equipment noncancelable operating lease agreements leases expire various dates january 2018 future minimum lease payments required operating leases original remaining noncancelable terms excess one year december 31 2008 follows 200963 million 2010 53 million 201143 million 201237 million 201335 million total expense operating leases years ended december 31 2008 2007 2006 85 million 67 million 52 million respectively discussion lease income see note 6 property plant equipment commitments contingencies 1 company’s commitments contingencies consist primarily outstanding letters credits used guarantee performance contracts customers commercial bids insurance advanced payments since commitments associated letters credits financial guarantees typically expire unused amounts shown necessarily reflect actual future cash funding requirements february 28 2008 audit committee board directors company assistance outside counsel initiated review certain payments made kazakhstan may present compliance issues foreign corrupt practices act “fcpa” based results internal review company determined payments made one persons identified government employees order obtain certain work permits licenses satisfy certain “penalties” assessed authorities audit committee also reviewed operations several jurisdictions company business internal review complete time respect kazakhstan operations determined reasonable amount assurance total payments issue less 220000 respect jurisdictions referenced payments issue similarly immaterial amount total company presently believes aggregate payments referenced immaterial amount expects matter effect company’s previously reported financial results index financial statements reported matter sec us department justice “doj” kept apprised status review sec conducting investigation matter company cooperating inquiry part resolution matter doj sec governmental authorities could seek criminal civil sanctions including monetary fines penalties company andor certain employees well additional changes business practices compliance programs event review governmental investigation identifies violations law extent payments determined illegal foreign jurisdiction possible could civil criminal penalties assessed jurisdiction 2008 company took number important steps enhance internal controls compliance company added staffing restructured organization increased training awareness improved communications throughout organization company taken remedial actions assure record keeping compliant laws regulations jurisdictions operate fiscal year ended december 31 2008 incurred 103 million legal accounting professional services related fcpa matter another unrelated compliance matter although expect matters material adverse effect business financial condition give assurance effect however fees incurred related contingencies impact cash flows liquidity 2008 may continue future 14 litigation natco subsidiaries defendants otherwise involved internal review related sec inquiry discussed note 13 contingencies well number legal proceedings ordinary course business insure risk certain liabilities extent deemed prudent management offer assurance type value insurance meet liabilities may arise pending future legal proceedings related business activities extent matters arise time covered insurance company may incur legal costs settlement payments judgments excess accruals may adversely impact business financial condition results operations liquidity although cannot predict outcome legal proceedings certainty opinion management ultimate liability respect pending lawsuits expected material adverse effect business financial condition results operations cash flow 15 capital stock incentive plans company’s authorized capital stock comprised common stock series junior participating preferred stock series b redeemable convertible preferred stock common stock currently outstanding description transactions affecting outstanding common stock material terms authorized preferred stock follows stock incentive plans january february 1998 company adopted directors compensation plan 1998 employee stock incentive plan plans authorized issuance options purchase aggregate 760000 shares company’s common stock plans expired february 2008 shares may granted shares outstanding expiration date may still exercised holders 10 years following date grant november 2000 board approved authorized issuance 300000 shares common stock 2000 employee stock option plan may 2001 company’s stockholders approved 2001 stock incentive plan replaced 2000 plan entirety increased number shares options awards may granted plan maximum 1000000 shares stockholders approved plan may 2001 april 2004 board approved authorized index financial statements issuance 600000 shares company’s common stock 2004 stock incentive plan company’s stockholders approved plan june 2004 march 2006 board approved authorized issuance 950000 shares company’s common stock 2006 longterm incentive compensation plan stockholders approved plan may 2006 december 31 2008 2007 2006 aggregate 270791 717990 969130 shares common stock respectively reserved issuance company’s longterm incentive compensation plans summary stock option activity company’s stock incentive plans years ended december 31 2006 2007 2008 included note 16 sharebased compensation summary restricted stock activity company’s stock incentive plans years ended december 31 2006 2007 2008 follows january april 2006 board directors granted aggregate 16500 shares restricted stock certain key employees restrictions shares lapse third anniversary date grant long recipient continues service employee earlier upon recipient’s death disability occurrence corporate change june october 2006 board directors granted aggregate 48581 shares restricted stock senior management restrictions shares lapse third anniversary date grant subject certain performancebased criteria recipient’s continuous employment company date grant date restrictions lapse earlier provided applicable incentive plan award agreement result change control june 2006 board directors granted aggregate 15000 shares restricted stock nonemployee directors restrictions shares lapsed may 2007 respect retiring director june 2007 following one year continuous service remaining directors january december 2007 board directors granted aggregate 99030 shares restricted stock certain key employees restrictions shares lapse third anniversary date grant subject recipient’s continuous employment company date grant date restrictions lapse earlier provided applicable incentive plan award agreement result change control june 2007 board directors granted aggregate 12500 shares restricted stock nonemployee directors restrictions shares lapse following one year service director date grant january 2008 board directors granted 45000 30000 shares performancebased restricted stock chief executive officer chief operating officer respectively restricted stock awards provide restrictions lapse march 1 2011 subject targeted earnings achievement continuous employment company date grant date restrictions lapse january december 2008 board directors granted aggregate 194070 shares restricted stock certain key employees restrictions shares lapse third anniversary date grant subject recipient’s continuous employment company date grant date restrictions lapse earlier provided applicable incentive plan award agreement result change control june 2008 board directors granted aggregate 12500 shares restricted stock nonemployee directors restrictions shares lapse following one year service director date grant treasury shares 2008 2007 2006 company acquired additional treasury shares result 1 forfeiture restricted shares termination employment prior lapse restrictions 2 surrender shares payment withholding taxes due shares following lapse restrictions 3 part company’s share repurchase program commenced november 2008 company issued treasury shares exercise stock options restricted stock awards company’s stock incentive plans company 321274 1168 zero shares held treasury december 31 2008 2007 2006 respectively index financial statements common stock purchase rights series preferred stock may 14 2008 company entered amended restated rights agreement mellon investor services llc rights agent “amended restated rights agreement” extend expiration date stockholder rights plan evidenced agreement make certain changes terms provisions plan company’s original rights agreement scheduled expire close business may 15 2008 stockholder rights plan originally adopted may 5 1998 company’s board declared dividend one preferred share purchase right “right” outstanding share common stock held record may 15 1998 also approved issuance rights respect shares common stock issued date prior rights becoming exercisable result entering amended restated rights agreement share common stock continue one right associated right entitle holder purchase company onehundredth share series junior participating preferred stock price 35000 cash subject adjustment occurrence specified events rights exercisable evidenced certificates company’s common stock transferable apart common stock rights currently attached certificates representing outstanding shares common stock separate right certificates distributed rights separate common stock distribution date occur upon earlier close business ten business days following public announcement person group “acquiring person” acquired beneficial ownership includes common stock subject derivative transaction security 15 company’s outstanding common stock b ten business days following commencement announcement intention commence tender offer exchange offer completed would result person group becoming acquiring person certain inadvertent acquisitions result person becoming acquiring person promptly divests sufficient common stock applicable terminates otherwise disposes sufficient derivative transactions securities rights exercisable distribution date right exercised holder thereof rights stockholder company soon practicable following distribution date separate certificates evidencing rights mailed holders record company’s common stock mailing separate certificates alone evidence rights person group become acquiring person “flipin event” right outstanding would become right buy number shares common stock would market value equal two times purchase price right rights beneficially owned acquiring person would however become null void company enough authorized common stock right becomes exercisable number one onehundredths share series junior participating preferred stock would market value equal two times purchase price right following occurrence distribution date company acquired merger business combination transaction 50 company’s assets earning power sold transferred “flipover event” amended restated rights agreement requires documents relating business combination transaction provide business combination transaction holder right would right receive upon exercise current purchase price number shares common stock acquiring company market value equal two times purchase price right index financial statements number shares fractions series junior participating preferred stock securities property issuable upon exercise rights purchase price payable subject customary adjustments time prevent dilution number outstanding rights number shares fractions series junior participating preferred stock issuable upon exercise right also subject adjustment following events occurs prior distribution date stock dividend company’s common stock payable common stock b subdivision consolidation combination company’s common stock time acquisition person group beneficial ownership 15 less 50 company’s outstanding common stock board may option issue common stock series junior participating preferred stock mandatory redemption part rights owned acquiring person would become null void time prior person becoming acquiring person board may redeem less outstanding rights price 01 per right redemption rights may made effective time basis conditions board may establish immediately board’s decision redeem rights right exercise rights terminate right holders rights receive redemption price rights expire may 15 2018 unless earlier extended redeemed exchanged board may amend terms rights without consent holders rights includes amendments extend final expiration date rights distribution date occurred extend period rights may redeemed first public announcement person group become beneficial owner 15 company’s outstanding common stock amendment may adversely affect interests holders rights series b redeemable convertible preferred stock march 25 2003 company issued 15000 shares series b convertible preferred stock “series b preferred shares” private investment fund series b preferred shares face value 1000 paid cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment payable july 1 2003 series b preferred shares convertible option holder 1 number shares common stock equal face value series b preferred share divided conversion price 7805 2 cash payment equal amount dividends shares accrued since prior semiannual dividend payment date july august 2007 certain holders converted total 5085 shares company’s series b preferred shares total 651502 shares company’s common stock according conversion features described part conversion holders also received pro rata dividend payment dividend payable converted shares conversion date cash lieu conversion fractional shares remaining 9915 shares series b preferred shares converted 13 million shares company’s common stock march 25 2008 years ended december 31 2008 2007 2006 company paid dividends approximately 248000 13 million 15 million holders series b preferred shares respectively 16 sharebased compensation prior adoption sfas 123r sharebased compensation cost included amounts related restricted stock effective january 1 2006 company adopted sfas 123r “sharebased payment” index financial statements december 31 2008 company 270791 shares available future awards longterm incentive compensation plans 321274 shares treasury stock company may elect issue new shares treasury shares longterm incentive compensation plans forfeitures estimated annual rates 110 144 respectively stock options granted restricted stock awarded twelvemonth period ended december 31 2008 based company’s historical cancellation forfeiture experience components total sharebased compensation expense related company’s sharebased options awards recognized years ended december 31 2008 stock options company measures fair value sharebased options utilizing blackscholesmerton single optionreduced term valuation method requires management make various assumptions changes assumptions third quarter 2008 company reviewed evaluated applicable assumptions used determination fair value stock options evaluation resulted changes assumptions applied company’s annual 2008 stock options granted third fourth quarters 2008 expected term estimate expected term based “historical exercise behavior” analyzed stock option exercise activities january 1 1994 practically feasible date regarding records maintained system valuation date calculated expected term based total options exercised unvested options cancelled options exercisable resulting expected term determined four years company’s management believes revised expected term better represents stock options exercise behavior volatility determined based daily price observations expected term four years risk free interest rate risk free interest rate determined using average published zerocoupon treasury bond rates remaining terms three five years ending valuation date assumptions used determine fair value stock options granted follows index financial statements summary stock option activity related information set forth 1 represents vested shares less estimated forfeiture rate december 31 2008 49 million unrecognized compensation cost including estimates forfeitures related unvested stock options cost expected recognized weighted average period 11 years restricted stock 2008 board directors authorized issuance aggregate 281570 shares restricted stock natco’s 2001 2004 2006 longterm incentive compensation plans shares 1 aggregate 36400 issued new employees restrictions lapse following three years employment 2 aggregate 12500 issued nonemployee directors restrictions lapse one year 3 aggregate 232670 issued officers key employees restrictions lapse july 2011 restrictions shares may lapse sooner death disability recipient retirement board age 68 case directors occurrence corporate change defined plan shares subject forfeiture recipient terminates service prior time restrictions lapse summary restricted stock activity related information set forth index financial statements december 31 2008 127 million total unrecognized compensation cost including estimated forfeitures related unvested restricted stock cost expected recognized weighted average period 21 years 17 earnings per share according sfas 128 “earnings per share” basic eps computed dividing net income loss available common stockholders weighted average number common shares outstanding period diluted eps computed dividing net income loss sum weighted average number common shares outstanding period incremental shares associated 1 stock options awards determined using “treasury method” 2 convertible preferred stock determined applying “ifconverted” method net income available common stockholders represents net income less convertible preferred stock dividends accrued january 1 2006 company adopted sfas 123r computed incremental shares according sfas 123r requirements total assumed proceeds used “treasury method” include 1 assumed proceeds exercise stock optionslapse restrictions restricted stock 2 excess tax benefit resulted assumed tax deduction upon exercise stock optionslapse restrictions restricted stock deferred tax benefit would recognized financial statements based fair value 3 period average unrecognized compensation expense related future services according sfas 123r stock options restricted stock could antidilutive even shares inthemoney antidilutive common shares related stock options restricted stock included calculation impact would increase 65533 shares 340 shares respectively year ended december 31 2008 53692 shares 23569 shares related stock options restricted stock respectively year ended december 31 2007 year ended december 31 2006 would 99407 shares 5133 shares related stock options restricted stock december 31 2008 2007 2006 company included 295000 shares 16 million shares 19 million shares respectively issuable upon conversion series b redeemable convertible shares “preferred shares” calculation dilutive weighted average shares inclusion shares dilutive level income four quarters yeartodate 2008 2007 2006 index financial statements following table presents earnings per common share amounts computed using sfas 128 index financial statements 18 related parties years ended december 31 2008 2007 guarantee obligations related party majorityowned subsidiaries debt obligations related parties responsibility excluded balance sheet hold minority interest two entities future may asked guarantee certain obligations consistent interest entities joint several basis parties entities 19 industry segments geographic information company adopted provisions sfas 131 “disclosures segments enterprise related information” company’s business units separate management teams infrastructures offer different products services business units aggregated three reporting segments described since longterm financial performance reportable segments affected similar economic conditions effective january 1 2008 realigned financial segment reporting periods prior 2008 restated reflect basis segmentation presented • integrated engineered solutions segment includes global builttoorder project business related activities featuring oil water gas technologies well company’s west texas co2 processing facility • standard traditional segment includes sales related activities associated sale standard traditional oil gas wellhead processing equipment well aftermarket parts sales associated services primarily americas • automation controls segment includes fabrication sales control panels packaged automation systems well field services associated repair maintenance inspection testing onshore offshore control systems natco allocates corporate expenses reporting segments based headcount total assets revenue corporate assets allocated segments based total assets segment accounting policies segments consistent policies used prepare company’s consolidated financial statements respective periods presented described note 2 summary significant accounting policies company evaluates performance reporting segments based income depreciation amortization expense interest expense interest income net income tax provision index financial statements summarized financial information concerning company’s reportable segments shown following table following table reconciles total segment profit net income index financial statements geographic data company’s continuing operations years ended december 31 2008 2007 2006 follows revenue results operations presented based origination bookings purposes geographic presentation necessarily reflect destination equipment ultimately delivered 20 quarterly data unaudited following tables summarize quarterly information years ended december 31 2008 2007 21 recent accounting pronouncements september 2006 financial accounting standards board fasb issued statement financial accounting standards sfas 157 “fair value measurements” “sfas 157” became effective financial statements issued fiscal years beginning november 15 2007 sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value instruments company adopted sfas 157 january 1 2008 material impact company’s consolidated results operations financial position cash flows february 2007 fasb issued sfas 159 “the fair value option financial assets financial liabilities including amendment fasb statement 115” “sfas 159” permits entities choose measure eligible items fair value specified election dates elects adopt standard business entity shall report unrealized gains losses items fair value elected earnings subsequent reporting date company adopted sfas 159 january 1 2008 elected measure eligible items fair value defined pronouncement index financial statements december 2007 fasb issued sfas 141revised 2007 “business combinations” “sfas 141r” replaces sfas 141 “business combinations” effective fiscal years beginning december 15 2008 early adoption permitted sfas 141r changed method applying acquisition method accounting number significant aspects acquisition costs generally expensed incurred noncontrolling interests valued fair value acquisition date inprocess research development recorded fair value indefinitelived intangible asset acquisition date changes deferred tax asset valuation allowances income tax uncertainties acquisition date generally affect income tax expense sfas 141r effective prospective basis business combinations acquisition date beginning first annual period subsequent december 15 2008 exception accounting valuation allowances deferred taxes acquired tax contingencies sfas 141r amends sfas 109 “accounting income taxes” adjustments made valuation allowances deferred taxes acquired tax contingencies associated acquisitions closed prior effective date sfas 141r would also apply provisions sfas 141r company adopted sfas 141r january 1 2009 however pronouncement applied prospectively business combinations acquisitions occur guidance becomes effective impact company depend nature terms size business combinations completed effective date december 2007 fasb issued sfas 160 “noncontrolling interests consolidated financial statementsan amendment arb 51” sfas 160” sfas 160 effective fiscal years interim periods within fiscal years beginning december 15 2008 early adoption prohibited sfas 160 requires recognition noncontrolling interest minority interest equity consolidated financial statements separate parent’s equity amount net income attributable noncontrolling interest included consolidated net income face income statement sfas 160 also amends certain arb 51’s consolidation procedures consistency requirements sfas 141r sfas 160 also includes expanded disclosure requirements regarding interests parent noncontrolling interest company adopted sfas 160 january 1 2009 beginning 2009 interim reporting periods present noncontrolling interest minority interest separate component shareholders’ equity well comply reporting disclosure requirements current comparative periods february 2008 fasb issued fasb staff position “fsp” 1571 “application fasb statement 157 fasb statement 13 accounting pronouncements address fair value measurements purposes lease classification measurement statement 13” “fsp 1571” fsp 1571 amends sfas 157 exclude fasb statement 13 “sfas 13” “accounting leases” accounting pronouncements address fair value measurements purposes lease classification measurement sfas 13 however exception apply assets acquired liabilities assumed business combination required measured fair value sfas 141r regardless whether assets liabilities related leases fsp 1571 effective upon initial adoption sfas 157 company adopted sfas 157 january 1 2008 impact company’s consolidated results operations financial position cash flows february 2008 fasb issued fsp 1572 “effective date fasb statement 157” “fsp 1572” fsp defers effective date sfas 157 “fair value measurements” nonfinancial assets nonfinancial liabilities except items recognized disclosed fair value financial statements recurring basis least annually fiscal years beginning november 15 2008 interim periods within fiscal years items within scope fsp 1572 effective upon issuance date february 12 2008 company adopted fsp 1572 february 12 2008 impact company’s consolidated results operations financial position cash flows march 2008 fasb issued sfas 161 “disclosures derivative instruments hedging activities amendment fasb statement 133” sfas 161” statement amends expands index financial statements disclosure requirements sfas 133 “accounting derivative instruments hedging activities” sfas 161 effective fiscal years interim periods beginning november 15 2008 early adoption encouraged company adopted sfas 161 january 1 2009 pronouncement provides disclosure requirements adoption standard material impact company’s consolidated results operations financial position cash flows april 2008 fasb issued fsp fas 1423 “determination useful life intangible assets” “fsp fas 1423” shall effective financial statements issued fiscal years beginning december 15 2008 interim periods within fiscal years early adoption prohibited fsp amends paragraph 11d sfas 142 “goodwill intangible assets” “sfas 142” entity use assumptions renewal extension arrangement adjusted entityspecific factors paragraph 11 sfas 142 even likely substantial cost material modifications fsp intends improve consistency useful life recognized intangible asset sfas 142 period expected cash flows used measure fair value asset sfas 141r us generally accepted accounting principles company adopted fsp fas 1423 january 1 2009 expect adoption material impact company’s consolidated results operations financial position cash flows however could impact future transactions entered company may 2008 fasb issued sfas 162 “the hierarchy generally accepted accounting principles” “sfas 162” pronouncement identifies sources accounting principles framework selecting principles used preparation financial statements business entities presented conformity generally accepted accounting principles gaap united states gaap hierarchy sfas 162 effective 60 days following sec’s approval public company accounting oversight board amendments au section 411 “the meaning present fairly conformity generally accepted accounting principles” sfas 162 expected result change current practice company adopt sfas 162 effective date november 2008 fasb ratified consensus reached eitf 0806 “equity method investment accounting considerations” “eitf 0806” eitf 0806 issued address questions regarding application equity method subsequent issuance fas 141r eitf 0806 concluded equity method investments continue recognized using cost accumulation model thus continuing include transaction costs carrying amount equity method investment addition eitf 0806 clarifies impairment assessment applied equity method investment whole rather individual assets underlying investment eitf 0806 effective fiscal years beginning december 15 2008 company process evaluating impact eitf 0806 company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 december 2008 fasb issued fsp fas 1404 fin 46r8 “disclosures public entities enterprises transfers financial assets interests variable interest entities” “fsp fas 1404” “fin 46r8” pronouncement increases disclosure requirements public companies effective fiscal years interim periods within fiscal years beginning december 15 2008 earlier application encouraged fsp amends fasb statement 140 “accounting transfers servicing financial assets extinguishments liabilities” require public entities provide additional disclosures transfers financial assets also amends fasb interpretation 46 revised december 2003 consolidation variable interest entities require public enterprises including sponsors variable interest variable interest entity provide additional disclosures involvement variable interest entities company process evaluating impact fsp 1404 fin 46r8 company’s consolidated results operations financial position cash flows adopt effective date january 1 2009 index financial statements 22 acquisitions january 2008 company acquired lincoelectromatic inc usbased company total cost approximately 237 million including 300000 acquisition related costs net approximately 700000 cash acquired linco designs manufactures distributes services extensive line equipment used measure oil natural gas custody transfer included standard traditional reporting segment results linco included consolidated financial results since february 2008 september 2008 company acquired connor sales company inc based williston north dakota total cost approximately 349 million cash net approximately 800000 cash acquired 15 million certain adjustments connor provides oil field equipment services customers williston basin bakken oil shale north dakota included standard traditional reporting segment results connor included consolidated financial results since september 2008 approximately 307 million assigned goodwill related acquisitions expected deductible consolidated us income tax returns preliminary purchase price allocation resulted identifying amortizable intangible assets initial weighted average lives acquisitions follows supplemental pro forma data unaudited following unaudited pro forma condensed combined financial statements gives effect acquisition linco connor accounted business combination using purchase method accounting transactions occurred beginning 2007 respectively unaudited pro forma combined financial statements intended represent indicative results operations future periods results actually would realized linco connor natco combined company specified period item 9item 8 financial statements supplementary data consolidated financial statements years ended december 31 2006 2005 2004 applicable along reports management independent registered public accounting firm set forth index financial statements management’s report internal control financial reporting management company responsible establishing maintaining effective internal control financial reporting defined rules 13a15f securities exchange act 1934 internal control financial reporting designed provide reasonable assurance company’s management board directors regarding preparation fair presentation published financial statements external purposes accordance generally accepted accounting principles internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements therefore even systems determined effective provide reasonable assurance respect financial statement preparation presentation also projections evaluations effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate assessed effectiveness company’s internal control financial reporting december 31 2006 making assessment used criteria set forth committee sponsoring organizations treadway commission coso internal controlintegrated framework based assessment believe december 31 2006 company’s internal control financial reporting effective based criteria management’s assessment effectiveness internal control financial reporting december 31 2006 audited kpmg llp independent registered public accounting firm audit opinion assessment internal control financial reporting appears page 45 report john u clarke chairman chief executive officer march 14 2007 bradley p farnsworth senior vice president chief financial officer march 14 2007 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited accompanying consolidated balance sheets natco group inc subsidiaries december 31 2006 2005 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2006 connection audits consolidated financial statements also audited financial statement schedule ii consolidated financial statements financial statement schedule responsibility company’s management responsibility express opinion consolidated financial statements financial statement schedule based audits conducted audits accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether financial statements free material misstatement audit includes examining test basis evidence supporting amounts disclosures financial statements audit also includes assessing accounting principles used significant estimates made management well evaluating overall financial statement presentation believe audits provide reasonable basis opinion consolidated financial statements referred present fairly material respects financial position natco group inc subsidiaries december 31 2006 2005 results operations cash flows years threeyear period ended december 31 2006 conformity us generally accepted accounting principles also opinion related financial statement schedule considered relation basic consolidated financial statements taken whole presents fairly material respects information set forth therein discussed note 2 consolidated financial statements effective january 1 2006 company changed method accounting sharebased payments also discussed note 2 consolidated financial statements effective december 31 2006 company changed accounting postretirement benefit plans also audited accordance standards public company accounting oversight board united states effectiveness natco group inc’s internal control financial reporting december 31 2006 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso report dated march 14 2007 expressed unqualified opinion management’s assessment effective operation internal control financial reporting kpmg llp houston texas march 14 2007 index financial statements report independent registered public accounting firm board directors stockholders natco group inc audited management’s assessment included accompanying management’s report internal control financial reporting natco group inc maintained effective internal control financial reporting december 31 2006 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso natco group inc’s management responsible maintaining effective internal control financial reporting assessment effectiveness internal control financial reporting responsibility express opinion management’s assessment opinion effectiveness company’s internal control financial reporting based audit conducted audit accordance standards public company accounting oversight board united states standards require plan perform audit obtain reasonable assurance whether effective internal control financial reporting maintained material respects audit included obtaining understanding internal control financial reporting evaluating management’s assessment testing evaluating design operating effectiveness internal control performing procedures considered necessary circumstances believe audit provides reasonable basis opinion company’s internal control financial reporting process designed provide reasonable assurance regarding reliability financial reporting preparation financial statements external purposes accordance generally accepted accounting principles company’s internal control financial reporting includes policies procedures 1 pertain maintenance records reasonable detail accurately fairly reflect transactions dispositions assets company 2 provide reasonable assurance transactions recorded necessary permit preparation financial statements accordance generally accepted accounting principles receipts expenditures company made accordance authorizations management directors company 3 provide reasonable assurance regarding prevention timely detection unauthorized acquisition use disposition company’s assets could material effect financial statements inherent limitations internal control financial reporting may prevent detect misstatements also projections evaluation effectiveness future periods subject risk controls may become inadequate changes conditions degree compliance policies procedures may deteriorate opinion management’s assessment natco group inc maintained effective internal control financial reporting december 31 2006 fairly stated material respects based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso also opinion natco group inc maintained material respects effective internal control financial reporting december 31 2006 based criteria established internal controlintegrated framework issued committee sponsoring organizations treadway commission coso also audited accordance standards public company accounting oversight board united states consolidated balance sheets natco group inc subsidiaries december 31 2006 2005 related consolidated statements operations stockholders’ equity comprehensive income cash flows years threeyear period ended december 31 2006 report dated march 14 2007 expressed unqualified opinion consolidated financial statements kpmg llp houston texas march 14 2007 index financial statements natco group inc subsidiaries consolidated balance sheets thousands except share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements operations thousands except per share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements stockholders’ equity comprehensive income thousands except share data see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries consolidated statements cash flows thousands index financial statements natco group inc subsidiaries consolidated statements cash flows thousands see accompanying notes consolidated financial statements index financial statements natco group inc subsidiaries notes consolidated financial statements 1 organization natco group inc leading provider wellhead process equipment systems services used production oil gas company designed manufactured marketed production equipment services 80 years company’s production equipment used onshore offshore major oil gas producing regions world references “natco” “the company” used throughout document relate collectively natco group inc consolidated subsidiaries 2 summary significant accounting policies principles consolidation basis presentation consolidated financial statements include accounts company majorityowned controlled subsidiaries material intercompany balances transactions eliminated consolidation investments exercise significant influence accounted using equity method references fiscal year apply company’s fiscal year ends december 31 certain reclassifications made fiscal 2005 fiscal 2004 amounts order present results comparable basis amounts fiscal 2006 use estimates company’s management made estimates assumptions relating reported amounts assets liabilities disclosure contingent assets liabilities amounts revenues expenses recognized period prepare financial statements conformity us generally accepted accounting principles actual results could differ estimates company’s significant estimates affected critical accounting policies revenue recognition income tax valuation allowance goodwill impairment sharebased compensation cash equivalents company considers highly liquid investment instruments original maturities three months less cash equivalents concentration credit risk financial instruments potentially subject company concentration credit risk defined statement financial accounting standards “sfas” 105 “disclosure information financial instruments offbalance sheet risk financial instruments concentrations credit risk” consist primarily trade receivables company grants credits customers performing initial periodic credit evaluation customers’ financial condition typically require collateral receivables per management’s evaluation concentration credit risk related trade receivables limited due large diversified number customers comprising company’s customer base years ended december 31 2006 2005 2004 customer provided 10 company’s consolidated revenues trade accounts receivable allowance doubtful accounts trade accounts receivable recorded invoiced amount portfolio receivables comprised primarily accounts major national international corporate entities stable payment experience company provides allowance uncollectible accounts necessary specifically identified case basis review allowance doubtful accounts every month individually investigate past due balances 90 days based contractual terms order assess collectibility receivable trade accounts receivable balances charged allowance doubtful accounts collectibility determined remote inventories stated lower cost market net reserves excess obsolete inventory us operations excluding automation controls inventory cost determined using index financial statements lastin firstout “lifo” method automation controls segment uses “the weightedaverage” cost international subsidiaries immaterial consolidated company us use firstin firstout “fifo” method quarterly basis company conducts process review obsolescence based investigation slowmoving inventory usage reserves established based either case basis management’s assessments future demands market conditions prepaid expense current assets prepaid expense current assets include prepayments insurance utilities rent etc amortized prorata basis periods benefited property plant equipment property plant equipment capitalized original cost stated original cost less allowance depreciation depreciable basis depreciated estimated useful life asset using straightline method maintenance repair costs expensed incurred renewals betterments capitalized upon sale retirement properties accounts relieved cost related accumulated depreciation resulting profit loss included current period income see note 5 property plant equipment impairment longlived assets company reviews longlived assets held used impairment annually frequently circumstances indicate impairment condition may exist carrying value longlived assets exceeds fair value required sfas 144 “accounting impairment disposal longlived assets” impairment longlived assets recognized carrying value longlived assets exceeds fair value recoverable carrying value exceeds sum undiscounted cash flows expected result use eventual disposition longlived asset impairment loss measured amount carrying value longlived asset exceeds fair value recorded income continuing operations income taxes statement operations allowed restored later periods longlived assets evaluated impairment december 31 2006 based evaluation company’s management believes impairment longlived assets existed december 31 2006 goodwill reviewed possible impairment annual basis fourth quarter fiscal year frequently circumstances indicate impairment may exist required sfas 142 “goodwill intangible assets” company identifies separate reporting units determines net carrying value well fair value fair value calculated using discounted projected future cash flows company’s weighted average cost capital based set management’ assumptions time evaluation conducted fair value reporting unit compared net carrying value including goodwill determine whether impairment occurred reporting unit level carrying value reporting unit exceeds fair value impairment indicated additional test performed whereby implied fair value goodwill determined allocation fair value reporting unit’s assets liabilities whether recognized unrecognized manner similar purchase price allocation accordance sfas 141 “business combinations” residual fair value purchase price allocation would assumed relate goodwill carrying value goodwill exceeded residual fair value company would record impairment loss reduction carrying value related assets charge period’s operating results december 31 2006 goodwill tested impairment required sfas 142 based testing company’s management believes impairment goodwill existed december 31 2006 see note 6 goodwill intangible assets leases company’s operating leases include various facilities equipments company records operating expenses determined lease agreements discussion operating leases see note 12 commitments contingencies index financial statements assets net longterm assets include deferred financing fees patents longterm deposits deferred financing costs amortized term related debt agreements patents miscellaneous intangible assets amortized straightline basis asset’s estimated useful life ranging four half 17 years environmental remediation costs company accrues environmental remediation costs based estimates known environmental remediation exposure accruals recorded cost remediation probable estimable even significant uncertainties exist ultimate cost remediation ongoing environmental compliance costs including maintenance monitoring costs expensed incurred contingencies accounted accordance sfas 5 “accounting contingencies” information available prior issuance financial statements indicate probable asset impaired liability incurred date financial statements amount loss reasonably estimated company records estimate loss contingency accounting contingencies environmental legal income tax matters requires management use judgment revenue recognition recognize revenues related costs products shipped services rendered 1 time materials service contracts 2 manufactured goods produced standard manufacturing operations sold ordinary course business regular marketing channels 3 certain customized manufactured goods smaller jobs less customization making similar standard manufactured goods contracts valued 250000 less contract durations four months less recognize revenues using percentage completion method contracts greater 250000 contract durations excess four months represent customized engineered orders products qualify treatment accordance requirements aicpa statement position 811 “accounting performance certain productiontype contracts” sop 811 addition use percentage completion method automation controls segment equipment fabrication sales projects qualify treatment accordance requirements sop 811 automation controls segment sells customized products fabricated order pursuant large number smaller contracts durations two three months occasional large systems projects longer duration segment produce standard units maintain inventory products sale due nature segment’s equipment fabrication sales operations potential wide variations results operations could occur applying shipped methodology smaller contracts customized fabricated goods segment recognizes revenues regardless contract value duration applying percentage completion method earned revenue based percentage incurred costs date relate total estimated costs giving effect recent estimates total cost cumulative impact revisions total cost estimates progress work reflected year changes become known earned revenue reflects original contract price adjusted agreed claims change order revenues losses expected incurred jobs progress consideration estimated minimum recoveries claims change orders charged income soon losses known customers typically retain interest uncompleted projects report revenue net tax assessed governmental authority directly imposed revenue producing transaction instances customers billed advance services performed products manufactured company recognizes associated liability deferred revenue sharebased compensation effective january 1 2006 company adopted statement financial accounting standards 123r “sharebased payment” using modified prospective application transition method sharebased compensation cost measured grant date based estimated fair value award recognized operating expense straightline basis requisite service period addition sharebased compensation cost recognized includes compensation cost unvested sharebased awards january 1 2006 index financial statements prior january 1 2006 company accounted sharebased compensation accordance accounting principles board opinion “apb” 25 “accounting stock issued employees” using intrinsic value method reported entire tax benefit related exercise stock options operating cash flow sfas 123r requires us report tax benefit tax deduction excess recognized compensation costs excess tax benefits financing cash flow rather operating cash flow see note 15 sharebased compensation earnings per common share basic diluted earnings per share computed accordance sfas 128 “earnings per share” basic earnings per share excludes dilutive effect common stock equivalents computed dividing net income loss allocable common stock holders weighted average number common shares outstanding period diluted earnings per common potential common share computed dividing net income loss allocable common stockholders weighted average number common potential common shares outstanding period net income allocable common stockholders december 31 2006 represented net income less preferred stock dividends accrued paid weighted average number common potential common shares outstanding derived applying ifconverted method determine incremental shares associated convertible preferred stock restricted stock options outstanding effective january 1 2006 calculation weighted average number total assumed proceeds computed accordance sfas 123r see note 17 earnings per share research development research development costs charged operations year incurred cost equipment used research development activities alternative uses capitalized equipment treated expense period equipment depreciated estimated lives 5 10 years product warranty costs product warranty cost estimated percentage revenue based historical claims data absence historical claims experience management’s estimates estimated future warranty obligations related manufactured products charged cost goods sold period related revenue recognized additionally company provides foreign customers letters credit covering potential warranty claims case basis income taxes deferred tax assets liabilities recognized future tax consequences attributable differences financial statement carrying amounts existing assets liabilities respective tax bases deferred tax assets liabilities measured using enacted tax rates expected apply taxable income years temporary differences expected recovered settled effect deferred tax assets liabilities change tax rates recognized income period includes enactment date assessing realizability deferred tax assets management considers whether likely portion deferred tax assets realized ultimate realization deferred tax assets dependent upon future generation taxable income periods temporary differences become deductible management considered scheduled reversal deferred tax liabilities projected future taxable income tax planning strategies making assessment financial instruments company’s financial instruments consist primarily cash equivalents trade receivables payables debt instruments carrying values financial instruments approximate respective values either shortterm nature carry variable interest rates approximate market rates comprehensive income comprehensive income defined sfas 130 “reporting comprehensive income” includes changes equity period except resulted investments distributions company’s stockholders company includes unrealized gains losses related foreign index financial statements currency translation adjustments adjustment initially apply sfas 158 “employers’ accounting defined benefit pension postretirement plans” december 31 2006 foreign currency 1 translation adjustment financial statements foreign subsidiaries functional currencies us dollar translated us dollar equivalents period end exchange rates balance sheet accounts weighted average exchange rate period statement operations accounts currency translation adjustment gains losses resulting translations deferred included currency translation adjustment comprehensive income loss separate component stockholders’ equity 2 transaction gains losses certain transactions remain open settled periodend date therefore remeasured using periodend exchange rate resulting gains losses foreign currency transactions included “other net” company’s consolidated statements operations investment entities company joint venture scomi group bhd malaysia accounted equity method joint venture investment originally recorded cost adjusted recognize company’s proportionate share net income loss dividend distributions joint venture company records proportionate share joint venture’s income loss period joint venture activities considered immaterial december 31 2006 minority interest company consolidates two entities controlling financial interest recognize portion earnings losses related ownership minority interest partners consolidated joint ventures expense income classify expense income “minority interest” consolidated statements operations postretirement benefits sfas 158 “employers’ accounting defined benefit pension postretirement plans” requires recognize prospective basis funded status postretirement benefit consolidated balance sheet recognize component accumulated comprehensive income loss net tax gains losses prior service costs credits arise period recognized components net periodic benefit cost company adopted sfas 158 december 31 2006 see note 11 postretirement benefits 3 inventories consisted following amounts inventory reserves consisted following amounts index financial statements 1 increase lifo reserve 2006 related primarily increase inventory inflation raw materials labor overhead reductions lifo layers years ended december 31 2006 2005 company’s net inventories december 31 2006 2005 valuation method 4 costs estimated earnings uncompleted contracts 5 property plant equipment components property plant equipment follows depreciation expense 53 million 52 million 53 million respectively years ended december 31 2006 2005 2004 company leases certain machinery equipment customers index financial statements shortterm operating lease arrangements generally periods one month one year company recorded depreciation expense related leased assets 341000 405000 401000 years ended december 31 2006 2005 2004 respectively operating lease arrangements often result sale equipment within one year asset lease company records depreciation expense based upon asset’s estimated useful life net book value leased assets recorded 466000 732000 december 31 2006 2005 respectively included accompanying balance sheet caption “other current assets” since company intends sell assets within one year place assets used inventory upon return lessee lease income 900000 700000 10 million included revenues oil water technologies automation controls segments years ended december 31 2006 2005 2004 respectively 6 goodwill intangible assets accordance sfas 142 “sfas 142” “goodwill intangible assets” company evaluates intangible assets indefinite lives including goodwill impairment basis intangible assets defined term patents amortized useful life asset goodwill net goodwill 809 million december 31 2006 2005 comprised 474 million 291 million 44 million oil water technologies reporting unit gas technologies reporting unit automation controls reporting unit accordance sfas 142 company tested impairment goodwill comparing fair value operating units carrying value assets including related goodwill required standard company identified separate reporting units purposes evaluation determining carrying value company segregated assets liabilities extent possible clearly identifiable specific reporting unit certain corporate assets liabilities clearly identifiable specific reporting unit allocated accordance standard fair value determined discounting projected future cash flows company’s weighted average cost capital resulting fair value compared carrying value reporting unit determine whether impairment occurred reporting unit level per sfas 142 impairment indicated additional tests required since impairment goodwill indicated based upon testing performed impairment charge recorded december 31 2006 2005 goodwill reallocated based upon fair value method change business segments effective january 1 2005 reclassifications made fiscal year 2004 comparable information description company’s segments see note 19 industry segments geographic information intangible assets intangible assets subject amortization december 31 2006 2005 follows index financial statements increase intangible assets year ended december 31 2006 primarily due investment intangible assets first quarter 2006 result company’s purchase 50 ownership interest joint venture fabricates pilotless ignition system controlling gasfired heaters used connection oil gas wellhead equipment third quarter 2006 company recorded expense 160000 writeoff majority remaining deferred financing fees associated 2004 term loan revolving credit facilities refinanced july 2006 discussed note 10 longterm debt amortization interest expense 377000 527000 11 million recognized related assets years ended december 31 2006 2005 2004 respectively estimated aggregate amortization interest expense intangible assets next five fiscal years 282000 segment reporting purposes intangible assets net related accumulated amortization expense allocated applicable segment 7 accrued expenses accrued expenses consisted following tabular reconciliation changes company’s aggregate product warranty liability years ended december 31 2006 2005 set forth thousands 8 closure severance december 15 2005 board directors approved final phase restructuring company’s uk operations consolidating gloucester england office camberley england location company finalized rationalization office lease expenses associated vacating gloucester facility accrued 23 million estimated costs 2006 related operating costs incurred associated office consolidation twelve months ending december 31 2006 amounted 354000 noncash accelerated leasehold improvement amortization 573000 relocation costs december 31 2006 total estimated liability related office consolidation 21 million including foreign currency translation adjustment 125000 index financial statements pursuant amendment effective employment agreement company entered september 2005 mr patrick mccarthy agreed continue president company exchange certain benefits payments included among things payment certain severance benefits guaranteed bonus 2005 acceleration vesting certain options lapse restrictions portion restricted stock awards continuation certain health benefits following termination company recorded charge 12 million third quarter 2005 related amendment addition previously accrued expense 155000 related 2005 bonus june 26 2006 company mr mccarthy entered amended restated employment agreement “employment agreement” became effective july 1 2006 terms employment agreement reviewed approved company’s board directors mr mccarthy named company’s president chief operating officer serve july 1 2008 company incur additional charges respect effectiveness employment agreement remains liable severance obligation former arrangement paid upon mr mccarthy’s termination december 31 2006 company aggregate liability 938000 related matter july december 2004 company recorded severance expense 25 million 13 million respectively related termination two executives certain administrative operating personnel us uk canada december 31 2006 company aggregate liability 590000 related matters following summary closure severance expense roll forward company’s current noncurrent closure severance liability december 31 2006 2005 2004 follows thousands index financial statements estimated payment schedule cash portion remaining liabilities december 31 2006 1122000 2007 473000 2008 801000 2009 166000 2010 121000 2011 467000 2012 beyond december 31 2006 approximately 500000 noncash portion remaining liabilities 9 income taxes components income taxes follows income tax expense consisted following components deferred income taxes reflect net effects temporary differences carrying amounts assets liabilities financial reporting purposes amounts used income tax purposes well operating loss tax credit carryforwards tax effects temporary differences carryforwards follows index financial statements based upon level historical taxable income projected future taxable income periods deferred tax assets deductible applicable tax jurisdictions believe likely realize benefits deductible differences carryforwards net existing valuation allowances december 31 2006 however amount deferred tax asset considered realizable thus amount valuation allowances could change future taxable income differs projections applicable tax jurisdictions certain foreign tax jurisdictions able rely projections future taxable income determine realizability deductible differences carryforwards december 31 2005 deferred tax assets uk operations completely offset valuation allowance 12 million result cumulative pretax losses uk operations prior threeyear period december 31 2006 uk operations longer cumulative pretax loss prior threeyear period projected earnings uk operations determined related valuation allowance longer needed deferred tax assets 524000 full valuation allowance december 31 2005 written year without income tax effects valuation allowance 103000 still recorded offset net operating losses foreign jurisdictions able rely projections future taxable income company tax benefit us net operating loss “nol” carryforwards 509000 available offset future taxable income 2022 us nol carryforwards subject annual limitations section 382 internal revenue code company tax benefit uk nol carryforwards 392000 nol carryforward may carried forward indefinitely current uk law company also tax benefit foreign nol carryforwards 103000 valuation allowance recorded deferred tax benefit company able rely projections future taxable income foreign jurisdictions company foreign tax credit carryforwards 12 million available offset future us tax liabilities foreign tax credit carryforwards begin expire 2011 income tax expense differs amount computed applying us federal income tax rate 35 income continuing operations income taxes set forth following reconciliation index financial statements cumulative undistributed earnings foreign subsidiaries totaled 126 million december 31 2006 company considers earnings foreign subsidiaries indefinitely reinvested accordingly provision us foreign state income taxes made earnings upon distribution foreign subsidiary earnings form dividends otherwise distributed earnings would reportable us income tax purposes subject adjustment foreign tax credits calculating tax effect distributing earnings practicable time us federal income tax returns taxable years beginning 2003 open review appropriate taxing authority 10 longterm debt consolidated borrowings company follows revolving credit facilities july 2006 company terminated prior term loan revolving credit facilities entered new 2006 revolving credit facilities agreement maturity june 30 2011 total borrowing capacity 850 million new facilities permit company require increase aggregate borrowing capacity 500 million certain requirements met incurred 454000 deferred financing fees related new agreement amortized agreement’s fiveyear term 2006 revolving credit facilities agreement provides interest rate based upon ratio funded debt ebitda defined credit facility “ebitda” ranging company’s election 1 low london interbank offered rate “libor” plus 100 high libor plus 200 2 low base rate defined credit facility “base rate” plus 000 high base rate plus 100 company pays commitment fees undrawn portion facility depending upon ratio funded debt ebitda calculated 025 december 31 2006 borrowings outstanding 2006 revolving credit facilities december 31 2006 company letters credit outstanding 109 million december 31 2006 available borrowing capacity 741 million availability credit facilities reduced amount outstanding letters credit borrowings letters credit support contract performance warranties expire various dates december 2009 fees related letters credit approximately 10 outstanding balance december 31 2006 borrowings 2006 revolving credit facilities secured first lien first priority security interest pledge substantially assets borrowers certain subsidiaries including accounts receivable inventory equipment intangibles equity interests us subsidiaries 66 13 equity interest index financial statements active nonus subsidiaries interests certain contracts facilities agreement contains restrictive covenants including among others limit amount funded debt ebitda impose minimum fixed charge coverage ratio impose minimum tangible net worth requirement compliance restrictive debt covenants december 31 2006 pursuant agreement company may make distributions property cash stockholders dividends required series b preferred stock certain dividends exceed aggregate 30 million per year certain conditions related funded debt ebitda borrowing capacity met 15 million per year conditions met subject certain restrictions company also ability buy back 250 million value common stock borrowings 274 million outstanding term loan portion company’s prior term loan revolving credit facilities december 31 2005 bore interest average rate 626 borrowings revolving credit portion facilities date december 31 2005 company 145 million letters credit outstanding prior facilities related fees approximately 200 outstanding balance letters credit supported contract performance warranties expire various times prior february 2008 letters credit outstanding prior facility time entered 2006 revolving credit facilities agreement continued letters credit issued new agreement export sales facility july 23 2004 company two subsidiaries entered international revolving credit agreement wells fargo hsbc trade bank na providing loans 100 million subject borrowing base limitations working capital facility export sales secured specific project inventory receivables well certain inventory accounts receivable equipment partially guaranteed us exportimport bank loans facility mature march 31 2007 bear interest either 1 base rate defined agreement less 025 2 libor plus 200 company’s election december 31 2006 loans outstanding facility company outstanding letters credit 58 million resulting available borrowing capacity 42 million facility fees related letters credit approximately 100 outstanding balance date december 31 2006 company unsecured letters credit bonds totaling 584000 11 postretirement benefits health care life insurance postretirement benefits plans overview company maintains postretirement benefit plan provides health care life insurance benefits retired employees predecessor company plan accounted accordance sfas 106 “employer’s accounting postretirement benefits pensions” company recorded liability actuarially determined accumulated postretirement benefit obligation associated plan may 2004 december 31 2005 company accounted prescription drug benefit retiree medical plans accordance sfas 1062 “accounting disclosure requirements related medicare prescription drug improvement modernization act 2003” december 31 2005 company amended postretirement benefit plans eliminate prescription drug coverage postage 65 participants along increases retiree premiums elimination dental coverage one groups retirees predecessor company amended plans retirees bear additional costs coverage result sfas 1062 longer applied company starting january 1 2006 sfas 106 net index financial statements periodic cost reduced since date due plan amendments made december 2005 retiree premiums increased certain plan benefits reduced december 31 2005 company amended postretirement benefit plan included elimination prescription drug coverage postage 65 participants along increases retiree premiums elimination dental coverage one groups retirees predecessor company amended plan retirees bear additional costs coverage accordance sfas 106 “employers’ accounting postretirement benefits pensions” benefit associated plan amendment cumulative unrecognized loss amortized income prior service cost adjustment remaining life expectancy plan participants adoption sfas 158 september 2006 fasb issued sfas 158 “employer’s accounting defined benefit pension postretirement plans” statement amends sfas 106 sfas 132 “employers’ disclosures pensions postretirement benefitsan amendment fasb statements 87 88 106” requiring full balance sheet recognition difference plan assets benefit obligation funded status amount overfunded underfunded recognized sfas 158 measured difference fair value plan assets plan’s benefit obligation benefit obligation including actuarial gains losses prior service cost remaining transition amounts sfas 158 change components calculation net periodic benefit cost items previously deferred applying sfas 106 recognized components accumulated comprehensive income “aoci” net applicable taxes estimated net loss prior service cost eventually amortized aoci net periodic benefit cost future years sfas 158 also requires fiscalyear end measurement date plan assets benefit obligations company’s current measurement date company adopted sfas 158 december 31 2006 adoption sfas 158 material impact consolidated balance sheet statement stockholders’ equity natco group inc’s balance sheet liability recognized sfas 158 health care life insurance postretirement benefit obligation equal december 31 2006 accumulated postretirement benefit obligation “apbo” 71 million determined actuarial calculation amount projected accrued benefit cost already recorded company’s balance sheet sfas 106 94 million company adjusted liability december 31 2006 debiting postretirement benefit 23 million crediting aoci deferred tax assets accounts 15 million approximately 800000 respectively following tables summarize effect applying sfas 158 balance sheet december 31 2006 incremental effect applying sfas 158 individual line items balance sheet december 31 2006 1 classified current longterm portion postretirement benefit recorded accounts “accrued expense other” “postretirement benefit longterm liabilities” respectively index financial statements net periodic cost postretirement benefit liability included following components changes benefit obligations recognized aoci amounts included aoci expected recognized components net periodic cost postretirement benefit liability fiscal year 2007 assumptions used calculation company’s postretirement benefit plan following tables set forth year 2006 2005 reconciliations beginning ending balances postretirement benefit obligation fair value plan assets amounts recognized consolidated balance sheets aoci related postretirement benefits company used december 31 measurement date postretirement benefits plans index financial statements effect onepercent change health care cost components apbo company’s postretirement benefit plans unfunded benefits paid company’s cash flow operations incurred company expects contribute approximately 644000 plans 2007 index financial statements actual future expected benefit payments related postretirement benefit plans follow defined contribution plans company subsidiaries different defined contribution plans different eligibility terms contribution schemes defined contribution plans consist following us plan covering eligible employees completed three months service employee contributions 3 covered employee’s compensation matched 100 employing entity additional 2 covered employee’s compensation matched 50 plan employer may make additional discretionary contributions profit sharing contributions company made additional discretionary 1 match four quarters 2006 eligible employees us plan canada plan covering approximately 80 salaried employees contribution scheme us plan employing entity made additional discretionary 1 match four quarters 2006 eligible employees canada plan uk plan available permanent employees uk subsidiaries date employment contributions made employee 5 pensionable pay employing entity 6 pensionable pay additional discretionary contributions made employing entity employees based employees’ age senior management employees contribute 100 annual basic salary pensionable pay defined employee’s basic salary contributions employing entities plans consolidated basis totaled 24 million 24 million 21 million years ended december 31 2006 2005 2004 respectively 12 commitments contingencies operating leases company subsidiaries lease certain facilities equipment noncancelable operating lease agreements leases expire various dates march 2015 office uk operations subject longterm lease agreement vacated september 30 2006 pursuant uk office consolidation see note 8 closure severance company recorded charge estimated remaining liability obligation september 30 2006 according sfas 146 “costs associated exit disposal activities” future minimum lease payments required operating leases original remaining noncancelable terms excess one year december 31 2006 follows 200750 million 2008 index financial statements 39 million 200936 million 201034 million 201131 million total expense operating leases years ended december 31 2006 2005 2004 52 million 46 million 50 million respectively discussion lease income see note 5 property plant equipment commitments contingencies 1 company’s outstanding letters credits primarily used guarantee performance contracts customers since commitments associated letters credits financial guarantees may expire unused amounts shown necessarily reflect actual future cash funding requirements 13 litigation natco subsidiaries defendants otherwise involved number legal proceedings ordinary course business insure risk proceedings extent deemed prudent management offer assurance type value insurance meet liabilities may arise pending future legal proceedings related business activities although cannot predict outcome legal proceedings certainty opinion management ultimate liability respect pending lawsuits expected material adverse effect consolidated financial position results operations cash flows company material litigation pending december 31 2006 2005 company resolved following matters magnum transcontinental corp arbitration petroserv sa v national tank company 165th jud dist ct harris co tx cause 200418769 matters stemmed 1 agreement among natco group magnum transcontinental corporation us procurement arm petroserv sa zephyr offshore inc petroserv subsidiary manufacture install processing plant petroserv rig 2 petroserv’s agency agreement natco certain projects brazil natco claimed magnum owed 418990 plant manufacturing agreement additional work performed excess days agreed contract natco submitted matter binding american arbitration association arbitration october 29 2003 arbitration magnum originally counterclaimed 4685000 alleging breach contract reduced counterclaim approximately 730000 course arbitration february 2005 arbitrator awarded natco full amount claim plus interest granted magnum total 58000 counterclaim magnum paid natco approximately 410000 march 2005 natco filed request arbitration petroserv submitted mediation request agency agreement natco claiming unpaid agency fees several contracts including magnum contract resolution resulted mediation petroserv served collections suit state court may 2004 seeking 730000 plus attorneys’ fees interest court costs representing amounts allegedly due agency agreement natco filed counterclaim action claiming breach agency agreement fiduciary obligations petroserv owed natco second unsuccessful mediation held case august 2004 march 2005 natco petroserv settled matter natco paying approximately 420000 petroserv commissions earned accrued interest legally recoverable attorneys’ fees natco applied funds received magnum arbitration discussed settlement payment index financial statements jose corona individually personal representative estate noe corona sr et al v natco group inc jaime liendo 381st judicial district court starr county texas cause dc04175 lawsuit filed 2004 arose 2003 automobile accident involving employee one subsidiaries noe corona sr died injuries sustained accident mediation conducted march 30 2005 success plaintiffs amended original filing april 2005 plead damages 30 million related mental anguish grief bereavement loss society companionship damage familial relationship loss care counseling guidance allegedly suffered six surviving adult children well funeral medical expenses pain suffering mr corona second mediation held may 2005 parties agreed settle plead potential claims arising accident settlement confidential funded insurance natco paying 100000 deductible 14 capital stock incentive plans company’s outstanding capital stock comprised common stock series junior participating preferred stock series b convertible preferred stock description transactions affecting outstanding common stock material terms outstanding preferred stock follows stock incentive plans july 1999 board directors approved award 50000 options former chief executive officer pursuant terms employment agreement amended options granted exercise price equal fair market value shares date grant accordingly compensation expense recorded grant pursuant separation agreement entered former ceo july 2004 period exercise options following termination extended 18 months company recorded approximately 62000 stockbased compensation expense related term extension year ended december 31 2004 options exercised 2005 january february 1998 company adopted directors compensation plan 1998 employee stock incentive plan plans authorize issuance options purchase aggregate 760000 shares company’s common stock november 2000 board approved authorized issuance 300000 shares common stock 2000 employee stock option plan may 2001 company’s stockholders approved 2001 stock incentive plan replaced 2000 plan entirety increased number shares options awards may granted plan maximum 1000000 shares april 2004 board approved authorized issuance 600000 shares company’s common stock 2004 stock incentive plan company’s stockholders approved plan june 2004 march 2006 board approved authorized issuance 950000 shares company’s common stock 2006 longterm incentive compensation plan stockholders approved plan may 2006 december 31 2006 2005 2004 aggregate 969130 270501 595500 shares common stock respectively reserved issuance company’s longterm incentive compensation plans summary stock option activity company’s stock incentive plans years ended december 31 2006 2005 2004 included note 15 sharebased compensation summary restricted stock activity company’s stock incentive plans years ended december 31 2006 2005 2004 follows september december 2004 board directors granted 84071 shares performancebased restricted stock senior management certain employees restrictions shares remained outstanding grant lapsed november 2006 upon company’s achieving 100 earnings per share subject adjustment trailing twelve months basis three consecutive quarters june september december 2004 board directors granted aggregate 48440 shares restricted stock current ceo served interim ceo september december 2004 nonemployee directors index financial statements restrictions grant service interim ceo lapse equal installments first second third anniversaries date grant upon earliest recipient’s death disability retirement board b board’s election chairman recipient c occurrence corporate change defined 2004 stock incentive plan restrictions lapsed respect grants nonemployee directors june 2005 january 2005 board directors granted total 100000 shares restricted stock ceo restrictions 43000 shares lapsed july 2005 restrictions remaining 57000 shares lapse january 2008 long ceo continues service earlier upon death disability occurrence corporate change april june 2005 board directors granted aggregate 32500 shares restricted stock nonemployee directors restrictions shares lapsed following one year service director date grant june 2005 board directors granted aggregate 31439 shares performancebased restricted stock senior management restrictions shares remained outstanding grant lapsed november 2006 upon company achieving 110 earnings per share subject adjustment trailing twelve months basis three consecutive quarters december 2005 board directors granted aggregate 18000 shares restricted stock certain key employees restrictions shares lapse second anniversary date grant long recipient continues service employee earlier upon recipient’s death disability occurrence corporate change treasury shares company purchased aggregate 498670 shares common stock two executive officers price 7859 per share represented 15trading day average closing price company’s common stock reported new york stock exchange period ended july 23 2004 officers used proceeds funds repay full outstanding loans company scheduled mature july 31 2004 cost acquire shares recorded treasury stock december 31 2004 company aggregate 852819 treasury shares outstanding december 31 2004 2005 2006 company acquired additional treasury shares result surrender restricted shares 1 termination employment prior lapse restrictions 2 payment withholding taxes due shares following lapse restrictions 2005 2006 company issued treasury shares exercise options issue restricted stock company’s stock incentive plans company 2550 shares held treasury december 31 2005 december 31 2006 respectively common stock purchase rights series preferred stock may 1998 board directors company declared dividend one preferred share purchase right outstanding share common stock share common stock thereafter issued prior time rights become exercisable right entitle holder purchase one onehundredth one share series junior participating preferred stock price 7250 cash rights become exercisable evidenced certificates ownership natco’s common stock transferable apart common stock rights become exercisable following tenth day person group announces acquisition 15 company’s common stock announces commencement tender offer consummation would result ownership person group 15 company’s common stock person group acquire 15 company’s common stock right would become right buy number shares common stock would market value two times exercise price right rights beneficially owned acquiring person group would however become void time prior time rights become exercisable board may redeem rights price 001 per right time acquisition person group 15 less 50 common stock index financial statements board may redeem part rights issuing common stock exchange rate one share common stock two shares common stock right exercisable rights expire may 15 2008 unless previously extended redeemed series b convertible preferred stock march 25 2003 company issued 15000 shares series b convertible preferred stock “series b preferred shares” private investment fund series b preferred shares face value 1000 pays cumulative dividend 10 per annum face value payable semiannually june 15 december 15 year except initial dividend payment payable july 1 2003 series b preferred shares convertible option holder 1 number shares common stock equal face value series b preferred share divided conversion price 7805 aggregate 1921845 shares december 31 2006 2 cash payment equal amount dividends shares accrued since prior semiannual dividend payment date years ended december 31 2006 2005 2004 company paid dividends 15 million holders series b preferred shares december 31 2006 accrued dividends payable related series b preferred shares company may redeem series b preferred shares cash march 25 2008 redemption price per share equal face value series b preferred shares plus amount dividends accrued paid since recent semiannual dividend payment date due certain cash redemption features upon change control series b preferred shares qualify permanent equity treatment accordance eitf topic d98 “classification measurement redeemable securities” specifically requires permanent equity treatment precluded security redemption features solely within control issuer therefore company accounted series b preferred shares temporary equity accompanying balance sheet assigned value right redeem series b preferred shares march 25 2008 series b preferred shares redeemed contingent redemption features redemption amount greater carrying value would recorded reduction income available common stockholders event becomes probable 15 sharebased compensation sharebased compensation information sfas 123r effective january 1 2006 company adopted sfas 123r “sharebased payment” sfas 123r requires expensing stock options sharebased payments revision sfas 123 “accounting stockbased compensation” supersedes accounting principles board opinion “apb” 25 “accounting stock issued employees” company applied sfas 123r awards granted modified canceled repurchased effective date well unvested portion prior awards prior january 1 2006 company reported entire tax benefit related stock options exercised operating cash flow sfas 123r requires us report tax benefit tax deduction excess recognized compensation costs excess tax benefits financing cash flow rather operating cash flow selected longhaul method account tax effect sharebased payment awards company adopted sfas 123r using modified prospective application method accordingly prior periods revised comparative purposes overview certain employees nonemployee directors participate longterm incentive compensation plans provide among things grants options acquire shares company’s common stock awards restricted stock forms sharebased compensation stock options currently outstanding index financial statements plans performance requirements vest annually periods three four years maximum term ten years company issued service performancebased awards longterm incentive compensation plans determined fair value service awards amortized vesting period generally one three years provided award amortization cost related performancebased awards recorded unless considered probable criteria defined awards would met company may elect issue new shares common stock treasury shares longterm incentive compensation plans stock incentive plans currently effect approved shareholders outstanding common stock december 31 2006 company 969130 shares available future awards longterm incentive compensation plans treasury stock sfas 123r sharebased compensation cost measured grant date based estimated fair value award recognized expense employee’s requisite service period sharebased compensation expense recognized consolidated statement operations based awards ultimately expected vest sfas 123r requires forfeitures estimated date grant revised necessary subsequent periods actual forfeitures differ estimates forfeitures estimated annual rates 2833 30 respectively stock options granted restricted stock awarded twelve months ended december 31 2006 based company’s historical cancellation forfeiture experience total estimated sharebased compensation expense related company’s sharebased options awards recognized year ended december 31 2006 follows stock options company values sharebased options applying blackscholesmerton single optionreduced term valuation method previously used company’s pro forma information required sfas nos 123 148 valuation model requires management make subjective assumptions volatility company’s common stock expected term outstanding stock options riskfree interest rate expected dividend payments contractual life options following weighted average assumptions used determine fair value stock options granted twelve months ended december 31 2006 expected term expected term options estimated six years computed using “simplified method” permitted staff accounting bulletin 107 “sab 107” sfas 123r december 31 2007 assurance estimated fair value share option grant date correspond value ultimately realized option holder upon exercise expected volatility expected volatility evaluated based upon historical volatility company’s stock price nyse sixyear period date grant equivalent sixyear expected term stock options used simple average calculation method based daily price observations measured consistently throughout applicable historical period placed exclusive reliance historical volatility permitted sab 107 index financial statements riskfree interest rate riskfree interest rate determined date grant based upon observed interest rates associated us treasury zerocoupon issues remaining term equal sixyear expected option term dividend yield company anticipate paying dividends common stock foreseeable future summary stock option activity related information set forth prior adoption sfas 123r sharebased compensation cost included amounts related restricted stock 36 million unrecognized compensation cost net estimated forfeitures related unvested stock options december 31 2006 cost expected recognized weighted average period 19 years sharebased compensation expense includes 11 million noncash compensation expense net 650000 tax benefit 17 million pretax correction error recorded fiscal year 2005 related stock options issued 1998 price set anticipation initial public offering subsequently canceled reissued lower price march 1999 later became public company january 2000 compensation expense determined using variable accounting per fasb interpretation “fin” 44 “accounting certain transactions involving stock compensation” issued subsequent time options repriced retroactive effect management discovered error quarter ended september 30 2006 deemed immaterial 2005 2006 periods respect quarterly trends earnings periods company corrected accounting quarter ended september 30 2006 properly recognize compensation expense applying variable accounting awards required fin 44 effective january 1 2006 adoption sfas 123r variable accounting index financial statements longer applicable repriced stock options therefore impact related options 2006 future periods restricted stock 2006 board directors authorized issuance aggregate 80081 shares restricted stock 2001 2004 stock incentive plans shares 1 aggregate 16500 issued new employees restrictions lapse following three years employment 2 aggregate 15000 issued nonemployee directors restrictions lapse june 2007 3 aggregate 48581 issued officers key employees restrictions lapse august 2009 provided company achieved 225 earnings per share adjusted trailing twelve months basis three consecutive quarters prior date restrictions shares may lapse sooner death disability recipient retirement board age 68 case directors occurrence corporate change shares subject forfeiture recipient terminates service prior time restrictions lapse case performancebased stock performance criteria met prior august 2009 summary restricted stock activity related information set forth 22 million unrecognized compensation cost net estimated forfeiture related restricted stock yet vested december 31 2006 cost expected recognized weightedaverage period 18 years three months ended september 30 2006 company changed estimated forfeiture rate 833 30 result departure former chief financial officer cumulative effect change decreased compensation expense year ended december 31 2006 51000 index financial statements impact adopting sfas 123r year ended december 31 2006 impact adopting sfas 123r following effect company’s financial statements pro forma information sfas 123 periods prior fiscal 2006 prior january 1 2006 effective date sfas 123r company accounted sharebased compensation employees intrinsic value method accordance apb 25 “accounting stock issued employees” provided pro forma disclosure required sfas 123 pro forma net income earnings per share disclosures required employee stock option grants made 1995 subsequent years fair valuebased method defined sfas 123 always applied following table illustrates pro forma effects net income earnings per common shares recognizing estimated compensation expense fair value method required sfas 123 fiscal years 2005 2004 16 warrants march 25 2003 company issued 15000 series b preferred shares warrants purchase 248800 shares natco’s common stock thirdparty investor warrants exercise price 1000 per share common stock expire march 25 2006 company ability force exercise warrants natco’s common stock traded 1350 per share 30 consecutive trading days point holder could elect 1 exercise warrants full 2 exercise net amount shares issuable deduction exercise price current market price shares date index financial statements preceding exercise date 3 exercise warrants resulting termination warrants contained provision whereby holder could require company make netcash settlement warrants case change control warrants deemed derivative instruments therefore warrants recorded fair value issuance date fair value agreed counterparty agreement calculated applying pricing model included subjective assumptions stock volatility expected term warrants would outstanding dividend rate zero overall liquidity factor company recorded resulting liability 99000 issuance date august 26 2005 holder exercised warrants pursuant cashless exercise provision contained warrant instrument resulting cash payment company number shares common stock issued warrant holder calculated based average closing price company’s shares new york stock exchange ten tradingday period ending day prior exercise average price 17933 resulting issuance 110061 shares common stock exchange warrants december 31 2004 company liability related warrants 196000 company adjusted liability fair value date issuance date exercise recorded expense 18 million year ended december 31 2005 compared expense 41000 year ended december 31 2004 17 earnings per share accordance sfas 128 “earnings per share” company computed basic earnings per share dividing net income allocable common stockholders weighted average number shares outstanding period net income allocable common stockholders december 31 2006 represented net income less preferred stock dividends accrued company determined diluted earnings per common potential common share december 31 2006 net income allocable common stockholders divided weighted average number shares outstanding period applying “ifconverted” method determine incremental shares associated convertible preferred stock options restricted stock outstanding shares considered common potential common shares purposes calculating earnings per share december 31 2006 accordance sfas 128 january 1 2006 company adopted sfas 123r computed incremental shares according sfas 123r requirements total assumed proceeds used “treasury method” include 1 assumed proceeds exercise stock optionslapse restrictions restricted stock 2 excess tax benefit resulted assumed tax deduction upon exercise stock optionslapse restrictions restricted stock deferred tax benefit would recognized financial statements based fair value 3 period average unrecognized compensation expense related future services purposes weighted average shares calculation diluted earnings per share restricted stock performance criteria met excluded according sfas 123r stock options restricted stock could antidilutive even shares inthemoney antidilutive common shares related stock options restricted stock included year ended december 31 2006 impact would reduction approximately 99407 shares 5133 shares respectively year ended december 31 2005 antidilutive shares related stock options restricted stock shares inthemoney lapse restrictions certain shares restricted stock second third quarters 2006 various new grants stock options second quarter 2006 accounted changes weighted average number shares basic diluted common stock year ended december 31 2006 19 million shares issuable upon conversion series b preferred shares included calculation incremental shares inclusion shares dilutive level income four quarters yeartodate 2006 december 31 2005 company excluded shares yeartodate 2005 calculation incremental shares antidilutive index financial statements following table presents earnings per common share amounts computed using sfas 128 18 related parties years ended december 31 2006 2005 2004 guarantee obligations related party majorityowned subsidiaries debt obligations related parties responsibility excluded balance sheet hold minority interest two entities future may asked guarantee certain obligations consistent interest entities joint several basis parties entities index financial statements august 26 2005 following market close lime rock partners ii lp exercised full warrants purchase shares natco group inc’s common stock pursuant common stock purchase warrant dated march 25 2003 board directors office unanimously approved terms conditions common stock purchase warrant exercise price warrant 1000 warrant agreement provided cashless exercise lime rock elected exercise warrants pursuant cashless exercise provision common stock purchase warrant company received cash payment upon exercise number shares common stock issued lime rock calculated based average closing price company’s shares new york stock exchange ten tradingday period ending day prior exercise average price 17933 resulting issuance 110061 shares common stock exchange warrants ownership series b preferred shares lime rock owned excess 10 outstanding common stock converted basis mr thomas r bates jr director member governance nominating compensation committee time serving board appointment lime rock serving managing director lime rock management lp manages lime rock partners ii lp consequently mr bates may deemed indirect material interest warrant conversion transaction arrangement terminated december 31 2004 paid capricorn management gp affiliate company capricorn holdings inc administrative services included office space parking connecticut former chief executive officer reception telephone computer services normal office support relating space fees paid capricorn management reviewed approved audit committee board directors totaled 115000 year ended december 31 2004 mr herbert winokur jr one directors chairman chief executive officer capricorn holdings inc managing director capricorn holdings llc general partner capricorn investors ii lp private investment partnership directly indirectly controlled approximately 31 outstanding common stock december 31 2004 approved company’s board directors july 2004 company purchased aggregate 498670 shares common stock two executive officers price 7859 per share represented 15trading day average closing price common stock reported new york stock exchange period ended july 23 2004 officers used proceeds funds repay full outstanding loans company scheduled mature july 31 2004 19 industry segments geographic information company adopted provisions sfas 131 “disclosures segments enterprise related information” company’s business units separate management teams infrastructures offer different products services business units aggregated three reporting segments described since longterm financial performance reportable segments affected similar economic conditions natco’s reporting segments since january 1 2005 oil water technologies gas technologies automation controls • oil water technologies group includes standard traditional oil gas separation dehydration equipment sales related services builttoorder systems focused primarily oil water production processing • gas technologies group includes co2 membrane business assets operating relationship related gas processing facilities west texas h2s removal technologies including shell paques™ • automation controls group focuses sales manufacture new control panels systems monitor control oil gas production well field service activities including repair maintenance testing inspection services existing systems index financial statements natco allocates corporate expenses operating segments allocation based headcount total assets revenues bookings corporate assets allocated segments based total assets segment accounting policies segments consistent policies used prepare company’s consolidated financial statements respective periods presented described note 2 summary significant accounting policies company evaluates performance operating segments based income net interest expense depreciation amortization expense closure severance writeoff unamortized loan costs net periodic cost postretirement benefit liability net income taxes certain segment amounts previously reported years ended december 31 2004 reclassified conform presentation segment amounts reported years ended december 31 2005 2006 summarized financial information concerning company’s segments shown following table reconciles total segment profit net income index financial statements following table provides information revenues product line within oil water technologies segment years ended december 31 2006 2005 2004 geographic data company’s continuing operations years ended december 31 2006 2005 2004 follows revenues results operations presented based origination bookings purposes geographic presentation necessarily reflect destination equipment ultimately delivered 20 quarterly data unaudited following tables summarize quarterly information years ended december 31 2006 2005 21 recent accounting pronouncements march 2005 fasb issued fasb interpretation “fin” 47 “accounting conditional asset retirement obligations” fin 47 clarifies term “conditional asset retirement obligation” used index financial statements sfas 143 “accounting asset retirement obligations” refers legal obligation perform asset retirement activity timing method settlement conditional future event may within control entity obligation perform asset retirement activity unconditional even though uncertainty exists timing method settlement uncertainty timing method settlement conditional asset retirement obligation factored measurement liability sufficient information exists fin 47 also clarifies entity would sufficient information reasonably estimate fair value asset retirement obligation interpretation effective later end fiscal years ending december 15 2005 adoption interpretation fiscal 2006 material effect company’s consolidated results operations financial position cash flows may 2005 fasb issued sfas 154 “accounting changes error correctionsa replacement apb opinion 20 fasb statement 3” standard changes requirements accounting reporting change accounting principle among changes sfas 154 requires voluntary change accounting principle applied retrospectively prior period financial statements presented new accounting principle unless impracticable sfas 154 also provides 1 change method depreciating amortizing longlived nonfinancial asset accounted change estimate prospectively effected change accounting principle 2 correction errors previously issued financial statements termed “restatement” new standard effective accounting changes corrections errors made fiscal years beginning december 15 2005 company adopted standard january 1 2006 effective date impact company’s consolidated results operations financial positions cash flow september 2005 fasb’s emerging issues task force “eitf” issued eitf 0413 “accounting purchases sales inventory counterparty” pronouncement provides additional accounting guidance situations involving inventory exchanges parties contained apb opinion 29 “accounting nonmonetary transactions” sfas 153 “exchanges nonmonetary assets” standard effective new arrangements entered reporting periods beginning march 15 2006 inventory transactions completed december 15 2006 arrangements entered prior march 15 2006 company adopted standard january 1 2006 adoption standard material effect company’s consolidated results operations financial position cash flows september 2005 sec staff revised eitf d98 “classification measurement redeemable securities” primarily provide guidance 1 earnings per share treatment redeemable common stock 2 application eitf d98 sharebased payment arrangements employees guidance earnings per share treatment redeemable common stock eitf d98 sharebased payment arrangements employees effective first fiscal period beginning september 15 2005 company adopted eitf d98 effective date january 1 2006 relates earnings per share treatment redeemable common stock applied application sharebased payment arrangements employees concurrently adoption sfas 123r adoption standard material effect company’s consolidated results operations financial position cash flows february 2006 fasb issued sfas 155 “accounting certain hybrid financial instrumentsan amendment fasb statements 133 140” effective fiscal years beginning september 15 2006 statement issued clarify application fasb statement 133 beneficial interests securitized financial assets improve consistency accounting similar financial instruments regardless form instruments adoption standard january 1 2007 effective date impact company’s consolidated results operations financial position cash flows march 2006 fasb issued sfas 156 “accounting servicing financial assetsan amendment fasb statement 140” effective fiscal years beginning september 15 2006 index financial statements statement issued simplify accounting servicing rights reduce volatility results using different measurement attributes adoption standard january 1 2007 impact company’s consolidated results operations financial position cash flows march 2006 eitf issued eitf 0501 “accounting conversion instrument became convertible upon issuer’s exercise call option” issue requires issuance equity securities settle debt instrument became convertible issuer’s exercise call option accounted conversion debt instrument contains substantive conversion feature issuance date absent substantive conversion feature accounted debt extinguishment eitf 0501 effective periods beginning june 28 2006 company adopted standard july 1 2006 adoption standard material effect company’s consolidated results operations financial position cash flows march 2006 eitf issued eitf 0603 “how taxes collected customers remitted governmental authorities presented income statement gross versus net presentation eitf 0603 requires presentation taxes assessed governmental authority directly imposed revenueproducing transaction seller customer either gross included revenue costs net excluded revenue basis accounting policy decision disclosed pursuant apb opinion 22 addition taxes reported gross basis company disclose aggregate basis amounts taxes interim annual financial statements period income statement presented amount significant issue applies financial reports interim annual reporting periods beginning december 15 2006 company currently reports revenue net basis company adopted eitf 0603 january 1 2007 expect application eitf 0603 effect company’s consolidated results operations financial position cash flows june 2006 fasb issued fin 48 “accounting uncertainty income taxes” interpretation clarifies accounting uncertainty income taxes recognized enterprise’s financial statements accordance fasb statement 109 accounting income taxes fin 48 prescribes recognition threshold measurement attribute financial statement recognition measurement tax position taken expected taken tax return well provides guidance derecognition classification interest penalties accounting interim periods disclosure transition interpretation effective fiscal years beginning december 15 2006 company adopted fin 48 january 1 2007 believe application interpretation material effect consolidated results operations financial position cash flows september 2006 fasb issued staff position “fsp” aug air1 “accounting planned major maintenance activities” prohibits use accrueinadvance method accounting planned major maintenance activities annual interim financial reporting periods fsp aug air1 effective fiscal year beginning december 15 2006 december 31 2006 company accrual approximately 500000 related membranes’ maintenance replacements company adopted fsp augair1 effective date january 1 2007 september 2006 fasb issued sfas 157 “fair value measurements” become effective january 1 2008 sfas 157 defines fair value establishes framework measuring fair value generally accepted accounting principles expands disclosures fair value measurements company process evaluating impact standard consolidated results operations financial positions cash flows adopt january 1 2008 applicable september 2006 fasb issued sfas 158 “employers’ accounting defined benefit pension postretirement plans” statement requires public company recognize funded status pension postretirement benefit plan balance sheet disclose related information financial statements’ footnotes end fiscal year ending december 15 2006 company currently measures plans’ assets benefit obligations company’s fiscal year end date company index financial statements adopted sfas 158 december 31 2006 material impact company’s consolidated results operations financial position cash flows resulting adoption standard september 2006 sec released staff accounting bulletin 108 “sab 108” “considering effects prior year misstatements quantifying misstatements current year financial statements” provides interpretive guidance us securities exchange commission’s views regarding process quantifying materiality financial statements sab 108 effective fiscal years ending november 15 2006 early application first interim period ending november 15 2006 impact provision company’s consolidated results operations financial position cash flows year ended december 31 2006 company adopted effective date december 31 2006 february 2007 fasb issued sfas 159 “the fair value option financial assets financial liabilities including amendment fasb statement 115” permits entities choose measure eligible items fair value specified election dates sfas 159 effective january 1 2008 early adoption permitted business entity shall report unrealized gains losses items fair value elected earnings subsequent reporting date company currently assessing impact sfas 159 consolidated financial position results operations february 2007 fasb issued fsp fas 1581 “conforming amendments illustrations fasb statements 87 88 106 related staff implementation guides” staff position provides 1 updated illustrations contained appendix b statement 87 appendix b statement 87 appendix c statement 106 amended statement 158 2 updated questions answers previous fasb special reports related statement 87 88 106 fsp fas 1581 effective date statement 158 december 31 2006 impact company’s consolidated results operations financial position cash flows resulting adoption fsp fas 1581 item 9 nannannanitem 15 exhibits financial statement schedules reports form 8k index financial statements financial statement schedules exhibits included herewith management contracts compensatory plans arrangements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 21st day march 2003 natco group inc registrant nathaniel gregory nathaniel gregory chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 21st 2003 certifications nathaniel gregory certify 1 reviewed annual report form 10k natco group inc 2 based knowledge annual report contain untrue statement material fact omit state material fact necessary make statements made light circumstances statements made misleading respect period covered annual report 3 based knowledge financial statements financial information included annual report fairly present material respects financial condition results operations cash flows registrant periods presented annual report 4 registrants certifying officers responsible establishing maintaining disclosure controls procedures defined exchange act rules 13a14 15d14 registrant designed disclosure controls procedures ensure material information relating registrant including consolidated subsidiaries made known us others within entities particularly period annual report prepared b evaluated effectiveness registrants disclosure controls procedures date within 90 days prior filing date annual report evaluation date c presented annual report conclusions effectiveness disclosure controls procedures based evaluation date 5 registrants certifying officers disclosed based recent evaluation registrants auditors audit committee registrants board directors persons performing equivalent functions significant deficiencies design operation internal controls could adversely affect registrants ability record process summarize report financial data identified registrants auditors material weaknesses internal controls b fraud whether material involves management employees significant role registrants internal controls 6 registrants certifying officers indicated annual report whether significant changes internal controls factors could significantly affect internal controls subsequent date recent evaluation including corrective actions regard significant deficiencies material weaknesses date march 21 2003 nathaniel gregory nathaniel gregory chief executive officer certifications j michael mayer certify 1 reviewed annual report form 10k natco group inc 2 based knowledge annual report contain untrue statement material fact omit state material fact necessary make statements made light circumstances statements made misleading respect period covered annual report 3 based knowledge financial statements financial information included annual report fairly present material respects financial condition results operations cash flows registrant periods presented annual report 4 registrants certifying officers responsible establishing maintaining disclosure controls procedures defined exchange act rules 13a14 15d14 registrant designed disclosure controls procedures ensure material information relating registrant including consolidated subsidiaries made known us others within entities particularly period annual report prepared b evaluated effectiveness registrants disclosure controls procedures date within 90 days prior filing date annual report evaluation date c presented annual report conclusions effectiveness disclosure controls procedures based evaluation date 5 registrants certifying officers disclosed based recent evaluation registrants auditors audit committee registrants board directors persons performing equivalent functions significant deficiencies design operation internal controls could adversely affect registrants ability record process summarize report financial data identified registrants auditors material weaknesses internal controls b fraud whether material involves management employees significant role registrants internal controls 6 registrants certifying officers indicated annual report whether significant changes internal controls factors could significantly affect internal controls subsequent date recent evaluation including corrective actions regard significant deficiencies material weaknesses date march 21 2003 j michael mayer j michael mayer chief financial officer exhibit index included herewith management contracts compensatory plans arrangementsitem 15 exhibits financial statement schedules reports form 8k index financial statements financial statement schedules exhibits included annual report management contracts compensatory plans arrangements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 15th day march 2004 natco group inc registrant nathaniel gregory nathaniel gregory chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 15th 2004 exhibit index included annual report management contracts compensatory plans arrangementsitem 15 exhibits financial statement schedules reports form 8k 2 omittedto filed amendment 3 index exhibits management contracts compensatory plans arrangements included annual report filed amendment signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 16th day march 2005 natco group inc registrant john u clarke john u clarke chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 16 2005 signature title john u clarke john u clarke chairman board chief executive officer principal executive officer patrick mccarthy patrick mccarthy director president richard w fitzgerald richard w fitzgerald senior vice president chief financial officer principal financial officer ryan liles ryan liles vice president controller principal accounting officer keith k allan keith k allan director thomas r bates jr thomas r bates jr director julie h edwards julie h edwards director george k hickox jr george k hickox jr director herbert winokur jr herbert winokur jr director exhibit index management contracts compensatory plans arrangements included annual report filed amendmentitem 15 exhibits financial statement schedules page 1 financial statements management’s report internal control financial reporting report independent registered public accounting firm report independent registered public accounting firm consolidated balance sheets consolidated statements operations consolidated statements stockholders’ equity comprehensive income loss consolidated statements cash flows notes consolidated financial statements 2 financial statement schedules index financial statements natco group inc schedule iivaluation qualifying accounts thousands dollars table presents valuation qualifying accounts continuing operations 1 represents provision allowance uncollectible accounts receivable 2 represents foreign currency translation 3 represents amounts written reserve schedules omitted required information included financial statements notes thereto index financial statements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 15th day march 2006 natco group inc registrant john u clarke john u clarke chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 15 2006 signature title john u clarke john u clarke chairman board chief executive officer principal executive officer patrick mccarthy patrick mccarthy director president richard w fitzgerald richard w fitzgerald senior vice president chief financial officer principal financial officer james graves james graves vice president controller principal accounting officer keith k allan keith k allan director thomas r bates jr thomas r bates jr director julie h edwards julie h edwards director george k hickox jr george k hickox jr director thomas c knudson thomas c knudson director herbert winokur jr herbert winokur jr director index financial statements index financial statements index financial statements index financial statements index financial statements management contracts compensatory plans arrangements included annual reportitem 15 exhibits financial statement schedules page 1 financial statements management’s report internal control financial reporting report independent registered public accounting firm report independent registered public accounting firm consolidated balance sheets consolidated statements operations consolidated statements stockholders’ equity comprehensive income consolidated statements cash flows notes consolidated financial statements 2 financial statement schedules schedule ii valuation qualifying accounts schedules omitted required information included financial statements notes thereto schedule iivaluation qualifying accounts table presents valuation qualifying accounts continuing operations 1 represents net provision allowance uncollectible accounts receivable 2 represents foreign currency translation 3 represents amounts written reserve 3 exhibits index financial statements exhibit index financial statements index financial statements included annual report management contracts compensatory plans arrangements index financial statements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 17th day march 2008 natco group inc registrant john u clarke john u clarke chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 17 2008 signature title john u clarke john u clarke chairman board chief executive officer principal executive officer patrick mccarthy patrick mccarthy president chief operating officer bradley p farnsworth bradley p farnsworth senior vice president chief financial officer principal financial officer james graves james graves vice president controller principal accounting officer keith k allan keith k allan director thomas r bates jr thomas r bates jr director julie h edwards julie h edwards director george k hickox jr george k hickox jr director thomas c knudson thomas c knudson directoritem 15 exhibits financial statement schedules schedule ii valuation qualifying accounts schedules omitted required information included financial statements notes thereto schedule iivaluation qualifying accounts table presents valuation qualifying accounts continuing operations 1 represents net provision allowance uncollectible accounts receivable 2 represents foreign currency translation 3 represents amounts written reserve 3 exhibits index financial statements exhibit index financial statements index financial statements included annual report management contracts compensatory plans arrangements index financial statements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 2nd day march 2009 natco group inc registrant john u clarke john u clarke chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 2 2009 signature title john u clarke john u clarke chairman board chief executive officer principal executive officer patrick mccarthy patrick mccarthy president chief operating officer bradley p farnsworth bradley p farnsworth senior vice president chief financial officer principal financial officer james graves james graves vice president controller principal accounting officer keith k allan keith k allan director thomas r bates jr thomas r bates jr director julie h edwards julie h edwards director george k hickox jr george k hickox jr director thomas c knudson thomas c knudson directoritem 15 exhibits financial statement schedules index financial statements natco group inc schedule iivaluation qualifying accounts thousands dollars table presents valuation qualifying accounts continuing operations 1 represents provision allowance uncollectible accounts receivable 2 represents foreign currency translation 3 represents amounts written reserve schedules omitted required information included financial statements notes thereto index financial statements index financial statements index financial statements index financial statements management contracts compensatory plans arrangements included annual report index financial statements signatures pursuant requirements section 13 15d securities act 1934 registrant duly caused report signed behalf undersigned thereunto duly authorized city houston state texas 14th day march 2007 natco group inc registrant john u clarke john u clarke chief executive officer chairman board directors pursuant requirements securities act 1934 report signed following persons capacities indicated march 14 2007 signature title john u clarke john u clarke chairman board chief executive officer principal executive officer patrick mccarthy patrick mccarthy director president bradley p farnsworth bradley p farnsworth senior vice president chief financial officer principal financial officer james graves james graves vice president controller principal accounting officer keith k allan keith k allan director thomas r bates jr thomas r bates jr director julie h edwards julie h edwards director george k hickox jr george k hickox jr director thomas c knudson thomas c knudson director herbert winokur jr herbert winokur jr director index financial statements exhibit index financial statements index financial statements index financial statements management contracts compensatory plans arrangements included annual report