NATCO GROUP INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002,

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-15603

NATCO GROUP INC.
(Exact name of registrant as specified in its charter)

DELAWARE 22-2906892
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)

2950 NORTH LOOP WEST,
7TH FLOOR,
HOUSTON, TEXAS 77092
(Address of principal executive offices) (Zip Code)

713-683-9292
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:

As of August 1, 2002, $0.01 par value per share, 15,803,797 shares

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NATCO GROUP INC.

FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2002

TABLE OF CONTENTS

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PART I

ITEM 1. FINANCIAL STATEMENTS

NATCO GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

See accompanying notes to unaudited condensed
consolidated financial statements.

3

NATCO GROUP INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

See accompanying notes to unaudited condensed
consolidated financial statements.

4

NATCO GROUP INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

See accompanying notes to unaudited condensed
consolidated financial statements.

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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION

The accompanying condensed consolidated interim financial statements and
related disclosures are unaudited and have been prepared by NATCO Group Inc.,
("the Company") pursuant to generally accepted accounting principles for interim
financial statements and the rules and regulations of the Securities and
Exchange Commission. As permitted by these regulations, certain information and
footnote disclosures that would typically be required in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. However, the Company's management believes that these
statements reflect all the normal recurring adjustments necessary for a fair
presentation, in all material respects, of the results of operations for the
periods presented, so that these interim financial statements are not
misleading. These condensed consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Form 10-K filing for the year ended December 31, 2001.

To prepare financial statements in accordance with generally accepted
accounting principles, the Company's management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities at the date of the financial
statements, and reported amounts of revenues and expenses incurred during the
reporting period. Actual results could differ from those estimates. Furthermore,
certain reclassifications have been made to fiscal year 2001 amounts in order to
present these results on a comparable basis with amounts for fiscal year 2002.
These reclassifications had no impact on net income.

References to "NATCO" and "the Company" are used throughout this document
and relate collectively to NATCO Group Inc. and its consolidated subsidiaries.

(2) CAPITAL STOCK

On January 1, 2002, all outstanding shares of the Company's Class B Common
Stock, 334,719 shares, were converted to Class A Common Stock, on a share for
share basis, in accordance with the terms under which the Class B shares were
originally issued. As of June 30, 2002, Class A Common Stock was the Company's
only class of equity securities outstanding.

On February 1, 2001, NATCO issued 8,520 shares of Class B Common Stock to
the former shareholders of The Cynara Company ("Cynara"), in connection with the
achievement of certain performance criteria defined in the November 1998
purchase agreement. Goodwill was increased $85,000 as a result of this
transaction.

(3) EARNINGS PER SHARE

Basic earnings per share was computed by dividing net income by the weighted
average number of shares outstanding for the period. Diluted earnings per common
and common equivalent share was computed by dividing net income by the weighted
average number of common and common equivalent shares outstanding for the
period. For purposes of this calculation, outstanding employee stock options
were considered common stock equivalents. Included in diluted shares were common
stock equivalents related to employee stock options of 153,639 shares and
344,028 shares for the quarters ended June 30, 2002 and 2001, respectively, and
143,079 shares and 319,702 shares for the six-month periods ended June 30, 2002
and 2001, respectively. Anti-dilutive stock options were excluded from the
calculation of common stock equivalents. The impact of these anti-dilutive
shares would have been a reduction of 184,655 shares and 12,464 shares for the
quarters ended June 30, 2002 and 2001, respectively, and 218,212 shares and
11,662 shares for the six-month periods ended June 30, 2002 and 2001,
respectively.

(4) ACQUISITIONS

On March 19, 2001, the Company acquired all the outstanding share capital
of Axsia Group Limited ("Axsia"), a privately held company based in the United
Kingdom, for approximately $42.8 million, net of cash acquired. Axsia
specializes in the design and supply of water re-injection systems for oil and
gas fields, oily water treatment, oil separation, hydrogen production and other
process equipment systems. This acquisition was financed with borrowings under
NATCO's term loan facility, and was accounted for using the purchase method of
accounting. Results of operations for Axsia have been included in NATCO's
condensed consolidated financial statements since the date of acquisition. The
excess of the purchase price over the fair values of the net assets acquired was

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being amortized over a twenty-year period, prior to the adoption of Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" on January 1, 2002. See "Recent Accounting Pronouncements." Goodwill and
accumulated amortization related to the Axsia acquisition were $48.4 million and
$1.9 million, respectively, at June 30, 2002.

Assuming the Axsia acquisition occurred on January 1, 2001, the unaudited
pro forma results of the Company for the six-month period ended June 30, 2001,
would have been as follows:

These pro forma results assume debt service costs associated with the Axsia
acquisition, net of tax effect, calculated at the Company's effective tax rate
for the applicable period, and nondeductible goodwill amortization. Although
prepared on a basis consistent with NATCO's condensed consolidated financial
statements, these pro forma results do not purport to be indicative of the
actual results which would have been achieved had the acquisition been
consummated on January 1, 2001, and are not intended to be a projection of
future results.

Effective January 8, 2001, the Company entered into a Compromise Settlement
Agreement with the former owner of Total Engineering Services Team, Inc.,
("TEST"), which resulted in a cash payment of $1.5 million to NATCO on May 31,
2001, to settle certain contingencies related to NATCO's acquisition of TEST in
1997. The proceeds of this payment, net of related costs, were used to reduce
goodwill associated with the TEST acquisition.

(5) UNUSUAL CHARGES

In June 2001, the Company recorded an unusual charge of $1.6 million. The
charge consisted of $920,000 pursuant to an approved plan to close and merge an
existing NATCO office into the operations of Axsia, as well as other
streamlining actions associated with the acquisition. This charge included costs
for severance, office consolidation and other expenses. Also, the Company
withdrew a public debt offering and recorded an unusual charge of $680,000 for
costs incurred related to the proposed offering.

(6) INVENTORIES

Inventories consisted of the following amounts:

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(7) COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

Cost and estimated earnings on uncompleted contracts were as follows:

(8) LONG-TERM DEBT

The consolidated borrowings of the Company were as follows:

On March 16, 2001, the Company entered into a credit facility that consisted
of a $50.0 million term loan, a $35.0 million U.S. revolving facility, a $10.0
million Canadian revolving facility and a $5.0 million U.K. revolving facility.
The term loan matures on March 15, 2006, and each of the revolving facilities
matures on March 15, 2004. In October 2001, the Company amended this revolving
credit agreement to reduce the borrowing capacity in the U.S. from $35.0 million
to $30.0 million, and to increase the borrowing capacity in the U.K. from $5.0
million to $10.0 million. No other material modifications were made to the
agreement.

In July 2002, our lenders approved the amendment of various provisions of
the term loan and revolving credit facility agreement, effective April 1, 2002.
This amendment revised certain restrictive debt covenants, modified certain
defined terms, allowed for future capital investment in the Company's CO2
processing facility in West Texas, facilitates the issuance of up to $7.5
million of subordinated indebtedness, increased the aggregate amount of
operating lease expense allowed during a fiscal year and permitted an increase
in borrowings under the export sales credit facility, without further consent,
up to a maximum of $20.0 million. These modifications will result in higher
commitment fee percentages and interest rates if the Funded Debt to EBITDA
ratio, as defined, exceeds 3 to 1.

Amounts borrowed under the term loan bear interest at a rate of 4.59% per
annum as of June 30, 2002. Amounts borrowed under the revolving portion of the
facility bear interest at a rate based upon the ratio of funded debt to EBITDA
(as defined in the credit facility) and ranging from, at the Company's election,
(1) a high of the London Inter-bank Borrowing Rate ("LIBOR") plus 3.00% to a low
of LIBOR plus 1.75% or, (2) a high of a base rate plus 1.50% to a low of a base
rate plus 0.25%.

NATCO will pay commitment fees of 0.30% to 0.625% per year depending upon
the ratio of funded debt to EBITDA, on the undrawn portion of the facility.

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The revolving credit facility is guaranteed by all of the Company's
domestic subsidiaries and is secured by a first priority lien on substantially
all inventory, accounts receivable and other material tangible and intangible
assets. NATCO has also pledged 65% of the voting stock of its active foreign
subsidiaries.

On February 6, 2002, the Company borrowed $1.5 million under a long-term
promissory note. This note accrues interest at the 90-day LIBOR plus 3.25% per
annum, and requires quarterly payments of principal of approximately $24,000 and
interest for five years beginning May 2002. This promissory note is
collateralized by a manufacturing facility in Magnolia, Texas, purchased during
2001.

The Company maintains a working capital facility for export sales that
provides for aggregate borrowings of $10.0 million, subject to borrowing base
limitations, under which borrowings of $4.4 million were outstanding at June 30,
2002. Letters of credit outstanding under the export sales credit facility as of
June 30, 2002 totaled $102,000. The export sales credit facility is secured by
specific project inventory and receivables, and is partially guaranteed by the
EXIM Bank. The export sales credit facility loans mature in July 2004.

As of June 30, 2002, the Company was in compliance with all restrictive debt
covenants. NATCO had letters of credit outstanding under the revolving credit
facilities totaling $17.5 million at June 30, 2002. These letters of credit
constitute contract performance and warranty collateral and expire at various
dates through August 2005.

The Company had unsecured letters of credit, guarantees and bonds totaling
$182,000 at June 30, 2002.

(9) INCOME TAXES

NATCO's effective income tax rate for the six months ended June 30, 2002 was
38.3%, which exceeded the amount that would have resulted from applying the U.S.
federal statutory tax rate due to the impact of state income taxes, foreign
income tax rate differentials and certain permanent book-to-tax differences.

(10) INDUSTRY SEGMENTS

The Company's operations are organized into three separate business
segments: North American operations, a segment which primarily provides
traditional, standard and small custom production equipment and components,
replacement parts, used equipment and components, equipment servicing and field
operating support including operations of the Company's domestic membrane
facility; engineered systems, a segment which primarily provides customized and
more complex technological equipment, large scale integrated oil and gas
production systems, and equipment and services provided by certain international
operations, including Axsia; and automation and control systems, a segment which
provides control panels and systems that monitor and control oil and gas
production, as well as installation and start-up and other field services
related to instrumentation and electrical systems.

The accounting policies of the reportable segments were consistent with the
policies used to prepare the Company's condensed consolidated financial
statements for the respective periods presented. Summarized financial
information concerning the Company's reportable segments is shown in the
following table.

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(11) COMMITMENTS AND CONTINGENCIES

The Porta-Test International, Inc., ("Porta-Test") purchase agreement,
executed in January 2000, contains a provision to calculate a payment to certain
former stockholders of Porta-Test Systems, Inc. for a three-year period ended
January 24, 2003, based upon sales of a limited number of specified products
designed by or utilizing technology that existed at the time of the acquisition.
Liability under this arrangement is contingent upon attaining certain
performance criteria, including gross margins and sales volumes for the
specified products. If applicable, payment is required annually. In January
2002, the Company accrued $219,000 under this arrangement for the year ended
January 24, 2002, resulting in an increase in goodwill. In April 2001, the
Company paid $226,000 in accordance with the purchase agreement. Any future
liabilities incurred under this arrangement will be recorded to goodwill.

(12) NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standard Board ("FASB") approved SFAS No. 142,
"Goodwill and Other Intangible Assets" in June 2001. This pronouncement requires
that intangible assets with indefinite lives, including goodwill, cease being
amortized and be evaluated on an impairment basis. Intangible assets with a
defined term, such as patents, would continue to be amortized over the useful
life of the asset.

The Company adopted SFAS No. 142 on January 1, 2002. Intangible assets
subject to amortization under the pronouncement as of June 30, 2002 and 2001 are
summarized in the following table:

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Amortization and interest expense of $208,000 and $184,000 were recognized
related to these assets for the quarters ended June 30, 2002 and 2001,
respectively, and $409,000 and $283,000 for the six-month periods ended June 30,
2002 and 2001, respectively. The estimated aggregate amortization and interest
expense for these assets for each of the following five fiscal years is:
2002--$790,000; 2003--$555,000; 2004--$270,000; 2005--$228,000; and
2006--$70,000. For segment reporting purposes, these intangible assets and the
related amortization expense were recorded under "Corporate and Eliminations,"
excluding the employment contracts which were allocated between the engineered
systems and North American operations business segments.

Goodwill was the Company's only intangible asset that required no periodic
amortization as of the date of the adoption of SFAS No. 142. Net goodwill at
June 30, 2002 was $80.4 million. The pro forma impact of applying SFAS No. 142
to operating results for the quarter and six-month period ended June 30, 2001,
would have been a reduction of amortization expense of $1.0 million and $1.6
million, respectively, resulting in net income of $1.6 million and $3.5 million,
respectively, and an increase in basic and diluted earnings per share of $.07
and $.10, respectively.

In accordance with SFAS No. 142, the Company tested impairment of goodwill.
Based upon the testing performed, management determined that goodwill was not
impaired as of June 30, 2002. Therefore, no impairment charge was recorded under
SFAS No. 142 as of June 30, 2002. Goodwill will be tested for impairment
annually on December 31.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This standard provides guidance on reporting and accounting for
obligations associated with the retirement of long-lived tangible assets and the
associated retirement costs. This standard is effective for financial statements
issued for fiscal years beginning after June 15, 2002. The Company has not yet
determined the impact that this pronouncement will have on its financial
condition or results of operations.

On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and standardizes the accounting model to be used for
asset dispositions and related implementation issues. This pronouncement did not
have a material impact on the Company's financial condition or results of
operations.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections."
This statement provides guidance for income statement classification of gains
and losses on extinguishment of debt and accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS No. 145 is effective for the Company in January 2003. The
Company has not determined the impact that this pronouncement will have on its
financial condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities," which addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that are currently accounted for
pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity." SFAS No. 146 is effective for the Company in January 2003. The
Company has not determined the impact that this pronouncement will have on its
financial condition or results of operations.

(13) RELATED PARTY TRANSACTIONS

As previously agreed during 2001, the Company loaned an executive officer
and director of the Company $216,000 on April 15, 2002, under a full-recourse
note arrangement which accrues interest at 6% per annum and matures on July 31,
2003. The funds were used to pay tax burdens associated with stock options
exercised during 2001. At June 30, 2002, the outstanding balance under this note
arrangement, including accrued interest, was $219,000.

(14) SUBSEQUENT EVENTS

As of June 30, 2002, the Company had several outstanding notes receivable
from two employees who are executive officers and directors, with principal and
interest totaling $3.6 million. The maturity of these loans was July 31, 2003,
and interest accrued at rates ranging from 6% to 7.8% per annum. Effective July
1, 2002, the notes were amended to extend the maturity dates to July 31, 2004,
and to require interest to be calculated at an annual rate based on LIBOR plus
300 basis points, adjusted quarterly, applied to the notes balances as of June
30, 2002, including previously accrued interest.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

Management's Discussion and Analysis includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (each a
"Forward-Looking Statement"). The words "believe," "expect," "plan," "intend,"
"estimate," "project," "will," "could," "may" and similar expressions are
intended to identify Forward-Looking Statements. Forward-Looking Statements in
this document include, but are not limited to, discussions regarding indicated
trends in the level of oil and gas exploration and production and the effect of
such conditions on the Company's results of operations (see "--Industry and
Business Environment"), future uses of and requirements for financial resources
(see "--Liquidity and Capital Resources"), and anticipated backlog levels for
2002 (see "--Liquidity and Capital Resources"). The Company's expectations about
its business outlook, customer spending, oil and gas prices and the business
environment for the Company and the industry in general are only its
expectations regarding these matters. No assurance can be given that actual
results may not differ materially from those in the Forward-Looking Statements
herein for reasons including, but not limited to: market factors such as pricing
and demand for petroleum related products, the level of petroleum industry
exploration and production expenditures, the effects of competition, world
economic conditions, the level of drilling activity, the legislative environment
in the United States and other countries, policies of the Organization of
Petroleum Exporting Countries ("OPEC"), conflict in major petroleum producing or
consuming regions, the development of technology which could lower overall
finding and development costs, weather patterns and the overall condition of
capital and equity markets for countries in which the Company operates.

The following discussion should be read in conjunction with the financial
statements, related notes and other financial information appearing elsewhere in
this Form 10-Q. Readers are also urged to carefully review and consider the
various disclosures advising interested parties of the factors that affect the
Company, including without limitation, the disclosures made under the caption
"Risk Factors" and the other factors and risks discussed in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001, and in subsequent
reports filed with the Securities and Exchange Commission. The Company expressly
disclaims any obligation or undertaking to release publicly any updates or
revisions to any Forward-Looking Statement to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions
or circumstances on which any Forward-Looking Statement is based.

OVERVIEW

References to "NATCO" "the Company" "we" and "our" are used throughout this
document and relate collectively to NATCO Group Inc. and its consolidated
subsidiaries.

Our operations are organized into three separate business segments: North
American operations, a segment which primarily provides traditional, standard
and small custom production equipment and components, replacement parts, used
equipment and components, equipment servicing and field operating support
including operations of our domestic membrane facility; engineered systems, a
segment which primarily provides customized and more complex technological
equipment, large scale integrated oil and gas production systems, and equipment
and services provided by certain international operations, including Axsia; and
automation and control systems, a segment which provides control panels and
systems that monitor and control oil and gas production, as well as installation
and start-up and other field services related to instrumentation and electrical
systems.

CRITICAL ACCOUNTING POLICIES

The preparation of our consolidated financial statements requires management
to make certain estimates and assumptions that affect the results reported in
our consolidated financial statements and accompanying notes. These estimates
and assumptions are based on historical experience and on future expectations
that we believe to be reasonable under the circumstances. Note 2 to the
consolidated financial statements filed in our Annual Report on Form 10-K for
the year ended December 31, 2001, contains a summary of our significant
accounting policies. We believe the following accounting policy is the most
critical in the preparation of our condensed consolidated financial statements:

Revenue Recognition: Percentage-of-Completion Method. We recognize revenues
from significant contracts (greater than $250,000 and longer than four months in
duration) and all automation and controls contracts and orders on the
percentage-of-completion method of accounting. Earned revenue is based on the
percentage that costs incurred to date relate to total estimated costs of the
project, after giving effect to the most recent estimates of total cost. The
timing of costs incurred, and therefore recognition of revenue, could be
affected by various internal or external factors including, but not limited to:
changes in project scope (change orders), changes in productivity, scheduling,
the cost and availability of labor, the cost and availability of raw materials,
the weather,

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client delays in providing approvals at benchmark stages of the project and the
timing of deliveries from third-party providers of key components. The
cumulative impact of revisions in total cost estimate during the progress of
work is reflected in the period in which these changes become known. Earned
revenues reflect the original contract price adjusted for agreed claims and
change order revenues, if applicable. Losses expected to be incurred on the jobs
in progress, after consideration of estimated minimum recoveries from claims and
change orders, are charged to income as soon as such losses are known. Claims
for additional contract revenue are recognized if it is probable that the claim
will result in additional revenue and the amount can be reliably estimated. We
generally recognize revenue and earnings to which the percentage-of-completion
method applies over a period of two to six quarters. In the event a project is
terminated by our customer before completion, our customer is liable for costs
incurred under the contract. We believe that our operating results should be
evaluated over a term of several years to evaluate performance under long-term
contracts, after all change orders, scope changes and cost recoveries have been
negotiated and realized. We record revenues and profits on all other sales as
shipments are made or services are performed.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board ("FASB") approved Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" in June 2001. This pronouncement requires that intangible assets with
indefinite lives, including goodwill, cease being amortized and be evaluated on
an impairment basis. Intangible assets with a defined term, such as patents,
would continue to be amortized over the useful life of the asset. We adopted
SFAS No. 142 on January 1, 2002, and continued to amortize certain net assets
totaling $1.7 million at June 30, 2002, and recorded amortization and interest
expense related to those assets for the quarter and six-month period ended June
30, 2002 of $208,000 and $409,000, respectively. We ceased periodic amortization
of goodwill on the date of adoption. Net goodwill at June 30, 2002 was $80.4
million. The pro forma impact of applying SFAS No. 142 to operating results for
the quarter and six-month period ended June 30, 2001, would have been a
reduction of amortization expense of $1.0 million and $1.6 million,
respectively, resulting in net income of $1.6 million and $3.5 million,
respectively, and an increase in basic and diluted earnings per share of $.07
and $.10, respectively.

In accordance with SFAS No. 142, we tested impairment of goodwill. Based
upon the testing performed, we determined that goodwill was not impaired as of
June 30, 2002. Therefore, no impairment charge was recorded under SFAS No. 142
as of June 30, 2002. Goodwill will be tested for impairment annually on December
31.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This standard provides guidance on reporting and accounting for
obligations associated with the retirement of long-lived tangible assets and the
related retirement costs. This standard is effective for financial statements
issued for fiscal years beginning after June 15, 2002. We have not yet
determined the impact that this pronouncement will have on our financial
condition or results of operations.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections."
This statement provides guidance for income statement classification of gains
and losses on extinguishment of debt and accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS No. 145 is effective for us in January 2003. We have not yet
determined the impact that this pronouncement will have on our financial
condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities," which addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that are currently accounted for
pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity." SFAS No. 146 is effective for us in January 2003. We have not yet
determined the impact that this pronouncement will have on our financial
condition or results of operations.

ACQUISITIONS

On March 19, 2001, we acquired all the outstanding share capital of Axsia
Group Limited ("Axsia"), a privately held company based in the United Kingdom,
for approximately $42.8 million, net of cash acquired. Axsia specializes in the
design and supply of water re-injection systems for oil and gas fields, oily
water treatment, oil separation, hydrogen production and other process equipment
systems. This acquisition was financed with borrowings under our term loan
facility, and was accounted for using the purchase method of accounting. Results
of operations for Axsia have been included in our condensed consolidated
financial statements since the date of acquisition. The excess of the purchase
price over the fair values of the net assets acquired was being amortized over a
twenty-year period, prior to the adoption of SFAS No. 142. Goodwill and
accumulated amortization related to the Axsia acquisition were $48.4 million and
$1.9 million, respectively, at June 30, 2002.

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INDUSTRY AND BUSINESS ENVIRONMENT

We are a leading provider of equipment, systems and services used in the
production of crude oil and natural gas, primarily at the wellhead, to separate
oil and gas within a production stream and to remove contaminants. Our products
and services are used in onshore and offshore fields in most major oil and gas
producing regions of the world. Separation and decontamination of a production
stream is needed at almost every producing well in order to meet the
specifications of transporters and end users.

Our revenues and results of operations are closely tied to demand for oil
and gas products and spending by oil and gas companies for exploration and
development of oil and gas reserves. During periods of lower demand, revenues
for service providers such as NATCO generally decline, as existing projects are
completed and new projects are postponed. During periods of recovery, revenues
for service providers can lag behind the industry due to the timing of new
project awards.

Changes in commodity prices have impacted our business over the past several
years. The following table summarizes the price of domestic crude oil per barrel
and the wellhead price of natural gas per thousand cubic feet ("mcf") for the
years ended December 31, 2001 and 2000, as well as data related to the six-month
periods ended June 30, 2002 and 2001, derived from published reports by the U.S.
Department of Energy, and the rotary rig count, as published by Baker Hughes
Incorporated.

The spot price of West Texas intermediate crude oil per barrel as of August
2, 2002 was approximately $27 per barrel and has remained above $26 per barrel
since June 30, 2002. The rotary rig count for North America, as published by
Baker Hughes Incorporated, was 1,150 operating rigs, as of August 2, 2002.

The following discussion of our historical results of operations and
financial condition should be read in conjunction with our condensed
consolidated financial statements and notes thereto.

RESULTS OF OPERATIONS

In the first quarter of 2001, we changed the presentation of our reportable
segments by combining the traditional production equipment and services business
segment with the NATCO Canada business segment, to form the North American
operations business segment.

Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001

Revenues. Revenues of $74.4 million for the three months ended June 30, 2002
decreased $8.2 million, or 10%, from $82.6 million for the three months ended
June 30, 2001. The following table summarizes revenues by business segment for
the quarters ended June 30, 2002 and 2001, respectively.

14

North American operations revenues decreased $4.6 million, or 12%, for the
quarter ended June 30, 2002, as compared to the quarter ended June 30, 2001, due
to an overall market decline in the U.S. and Canada. North American rig counts
declined 32% from 1,597 operating rotary rigs as of June 29, 2001 to 1,090
operating rotary rigs as of June 28, 2002. As a result, we experienced lower
revenues for traditional equipment, finished goods and parts and services.
Third-party revenues for Canada declined modestly. Inter-company revenues for
this business segment were $430,000 for the quarter ended June 30, 2002, as
compared to $857,000 for the quarter ended June 30, 2001.

Revenues for the engineered systems business segment decreased $4.1 million,
or 12%, for the quarter ended June 30, 2002, as compared to the quarter ended
June 30, 2001. This decrease was primarily due to a decline in revenues
contributed by Axsia, acquired in March 2001, which provided $27.1 million of
revenues for the quarter ended June 30, 2001 as compared to $11.8 million for
the quarter ended June 30, 2002. Offsetting this decline was an increase in
other engineered systems projects, primarily in West Africa. Engineered systems
revenues of $30.3 million for the quarter ended June 30, 2002 included
approximately $401,000 of inter-company revenues, as compared to $30,000 of
inter-company revenues for the quarter ended June 30, 2001.

Revenues for the automation and control systems business segment increased
$839,000, or 7%, for the quarter ended June 30, 2002, as compared to the quarter
ended June 30, 2001. This increase in revenues was the result of an increase in
the number of jobs in progress in 2002 relative to 2001, and higher
inter-company sales, which increased from $849,000 for the quarter ended June
30, 2001 to $1.2 million for the quarter ended June 30, 2002.

The change in revenues for corporate and other represents the elimination of
inter-company revenues as discussed above.

Gross Profit. Gross profit for the quarter ended June 30, 2002 decreased
$2.6 million, or 13%, to $17.7 million, compared to $20.3 million for the
quarter ended June 30, 2001. As a percentage of revenue, gross margins declined
from 25% for the quarter ended June 30, 2001 to 24% for the quarter ended June
30, 2002. The following table summarizes gross profit by business segment for
the quarters then ended:

Gross profit for the North American operations business segment decreased
$500,000, or 5%, for the quarter ended June 30, 2002, as compared to the
respective period in 2001. This decrease in margin was due primarily to a 12%
decline in revenues. As a percentage of revenue, gross margins were 26% and 24%
for the quarters ended June 30, 2002 and 2001, respectively.

Gross profit for the engineered systems business segment for the quarter
ended June 30, 2002 decreased $2.1 million, or 24%, primarily due to a 12%
decline in revenues for the engineered systems business segment and unfavorable
under-absorption of engineering overhead expense. Gross margin as a percentage
of revenues for engineered systems was 21% and 25% for the quarters ended June
30, 2002 and 2001, respectively.

Gross profit for the automation and control systems business segment
decreased $47,000, or 2%, for the quarter ended June 30, 2002, as compared to
the quarter ended June 30, 2001. Gross margin as a percentage of revenue for the
quarters ended June 30, 2002 and 2001, was 19% and 21%, respectively.

Selling, General and Administrative Expense. Selling, general and
administrative expense of $13.0 million decreased $632,000, or 5%, for the
quarter ended June 30, 2002, as compared to the quarter ended June 30, 2001.
This decrease was largely related to cost savings realized from restructuring
certain of our existing operations during the quarter ended June 30, 2001, with
those of Axsia, acquired in March 2001, and a decline in selling and pre-order
engineering costs associated with the timing of new projects. Partially
offsetting this decrease in expense was the cost incurred during the quarter
ended June 30, 2002, associated with our Mexico office, opened in late 2001.

Depreciation and Amortization Expense. Depreciation and amortization expense
of $1.2 million for the quarter ended June 30, 2002, decreased $990,000, or 45%,
compared to $2.2 million for the quarter ended June 30, 2001. Depreciation
expense of $1.2

15

million for the quarter ended June 30, 2002, increased $116,000, or 11%, as
compared to the respective period for 2001. This increase was primarily due to
the addition of capital assets purchased and constructed during fiscal 2001.
Amortization expense for the quarter ended June 30, 2002 was $28,000, as
compared to $1.1 million for the quarter ended June 30, 2001. This decline in
amortization expense was attributable to a change in accounting method
prescribed by SFAS No. 142, "Goodwill and Other Intangible Assets." This
pronouncement, adopted on January 1, 2002, requires that goodwill no longer be
amortized over a prescribed period but rather intangible assets not assigned a
useful life be evaluated annually for impairment. See "Recent Accounting
Pronouncements." Therefore, no goodwill amortization was recorded for the
quarter ended June 30, 2002, compared to $1.0 million for the quarter ended June
30, 2001. The results for the second quarter of 2001 also include amortization
expense associated with certain employment contracts that were fully amortized
as of December 31, 2001.

Unusual Charges. Unusual charges for the quarter ended June 30, 2001 were
$1.6 million, of which approximately $920,000 related to certain restructuring
costs to streamline activities and consolidate offices in connection with our
acquisition of Axsia in March 2001, and an additional $680,000 related to our
withdrawn private placement of debt.

Interest Expense. Interest expense was $1.2 million for the quarter ended
June 30, 2002, as compared to $1.6 million for the respective period in 2001.
This decrease of $431,000, or 27%, was due primarily to a decline in the
weighted average interest rate on outstanding debt from approximately 7% at June
30, 2001 to approximately 5% at June 30, 2002.

Interest Cost on Postretirement Benefit Liability. Interest cost on
postretirement benefit liability, related to a plan that provides medical and
dental coverage to retirees of a predecessor company, decreased $199,000, or
62%, from $322,000 for the quarter ended June 30, 2001 to $123,000 for the
quarter ended June 30, 2002. This decrease in interest cost was due to a June
2001 amendment of this plan whereby retirees bear more cost for coverage,
reducing our projected liability and the related interest cost.

Provision for Income Taxes. Income tax expense of $706,000 for the quarter
ended June 30, 2002, increased $160,000 from $546,000 for the quarter ended June
30, 2001. The primary reason for this increase in tax expense was an increase in
income before income taxes, which was $1.8 million for the quarter ended June
30, 2002, as compared to $1.1 million for the respective period in 2001. The
effective tax rate declined from 51.2% for the second quarter of 2001 to 38.4%
for the second quarter of 2002, due to the impact of eliminating non-deductible
goodwill amortization as per SFAS No. 142, "Goodwill and Other Intangible
Assets." See "Recent Accounting Pronouncements."

Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001

Revenues. Revenues of $148.0 million for the six months ended June 30, 2002
increased $2.5 million, or 2%, from $145.5 million for the six months ended June
30, 2001. The following table summarizes revenues by business segment for the
six-month periods ended June 30, 2002 and 2001, respectively.

North American operations revenues increased slightly for the six months
ended June 30, 2002, as compared to the six months ended June 30, 2001, due
largely to strong sales of traditional equipment, parts and services in the
first quarter of 2002. Revenues for Canada declined for the six months ended
June 30, 2002, as compared to the respective period in 2001, due to overall poor
market conditions. Inter-company revenues for this business segment were $1.5
million for the six months ended June 30, 2002, as compared to $2.3 million for
the six months ended June 30, 2001.

Revenues for the engineered systems business segment increased $3.0 million,
or 6%, for the six months ended June 30, 2002, as compared to the six months
ended June 30, 2001. This increase was primarily due to increased project
activity as a result of bookings of new projects received in 2001 and early
2002, partially offset by project completions in North Africa and Southeast
Asia. Engineered systems revenues of $55.4 million for the six months ended June
30, 2002 included approximately $713,000 of inter-company revenues, as compared
to $38,000 of inter-company revenues for the six months ended June 30, 2001.

16

Revenues for the automation and control systems business segment remained
relatively constant for the six months ended June 30, 2002, when compared to the
six months ended June 30, 2001, despite an overall decline in drilling activity
and increased competition in the Gulf of Mexico, a primary market for the
services of this business segment. Inter-company revenues of approximately $2.5
million and $1.9 million were included in the results for the six-month periods
ended June 30, 2002 and 2001, respectively.

The change in revenues for corporate and other represents the elimination of
inter-company revenues as discussed above.

Gross Profit. Gross profit for the six months ended June 30, 2002 decreased
$373,000, or 1%, to $35.9 million, compared to $36.3 million for the six months
ended June 30, 2001. As a percentage of revenue, gross margins declined from 25%
for the six months ended June 30, 2001, to 24% for the six months ended June 30,
2002. The following table summarizes gross profit by business segment for the
periods then ended:

Gross profit for the North American operations business segment increased
$1.3 million, or 8%, for the six months ended June 30, 2002, as compared to the
respective period in 2001. This increase in margin was due to slightly improved
margins for our parts and services, as well as favorable margins earned in our
Latin America operations. As a percentage of revenue, gross margins were 26% and
24% for the six-month periods ended June 30, 2002 and 2001, respectively.

Gross profit for the engineered systems business segment for the six months
ended June 30, 2002 decreased $1.4 million, or 10%, compared to the six months
ended June 30, 2001. This decrease was due primarily to a reduction in overall
margin earned on the CTOC project in the respective period, as CTOC was
virtually completed at the beginning of 2002. Gross margin for engineered
systems represented 22% and 26% of the segment's revenues for the six-month
periods ended June 30, 2002 and 2001, respectively.

Gross profit for the automation and control systems business segment
decreased $287,000, or 6%, for the six months ended June 30, 2002, as compared
to the six months ended June 30, 2001. This decline was attributable to the
absence of a large-scale instrumentation and electrical project in 2002 compared
to 2001. Gross margin as a percentage of revenue for the six-month periods ended
June 30, 2002 and 2001, was 19% and 20%, respectively.

Selling, General and Administrative Expense. Selling, general and
administrative expense of $26.6 million increased $1.9 million, or 8%, for the
six months ended June 30, 2002, as compared to the six months ended June 30,
2001. This increase was largely related to the following factors: (1) six months
of operating expenses at Axsia during 2002 compared to less than four months
operating expenses from the acquisition date through June 30, 2001, (2) start-up
costs related to the Singapore office opened in March 2001 to increase marketing
efforts in Southeast Asia, and (3) start-up costs related to the Mexico office
opened in late-2001.

Depreciation and Amortization Expense. Depreciation and amortization expense
of $2.4 million for the six months ended June 30, 2002, decreased $1.4 million,
or 38%, compared to $3.8 million for the six months ended June 30, 2001.
Depreciation expense of $2.3 million for the six months ended June 30, 2002,
increased $278,000, or 14%, as compared to the respective period for 2001. This
increase was primarily due to the acquisition of Axsia in March 2001 and the
addition of capital assets purchased and constructed during fiscal 2001.
Amortization expense for the six months ended June 30, 2002 was $53,000, as
compared to $1.8 million for the six months ended June 30, 2001. This decline in
amortization expense was attributable to a change in accounting method
prescribed by SFAS No. 142, "Goodwill and Other Intangible Assets." This
pronouncement, adopted on January 1, 2002, requires that goodwill no longer be
amortized over a prescribed period but rather intangible assets not assigned a
useful life be evaluated annually for impairment. See "Recent Accounting
Pronouncements." Therefore, no goodwill amortization was recorded for the six
months ended June 30, 2002, compared to $1.6 million for the six months ended
June 30, 2001. The results for the six months ended June 30, 2001 also include
amortization expense associated with certain employment contracts that were
fully amortized as of December 31, 2001.

Unusual Charges. Unusual charges for the six months ended June 30, 2001 were
$1.6 million, of which approximately $920,000 related to certain restructuring
costs to streamline activities and consolidate offices in connection with our
acquisition of Axsia in March 2001, and an additional $680,000 related to our
withdrawn private placement of debt.

17

Interest Expense. Interest expense was $2.2 million for the six months ended
June 30, 2002, as compared to $2.3 million for the respective period in 2001.
This decrease of $120,000, or 5%, was due primarily to a decline in the weighted
average interest rate on outstanding debt balanced from approximately 7% as of
June 30, 2001 to approximately 5% as of June 30, 2002.

Interest Cost on Postretirement Benefit Liability. Interest cost on
postretirement benefit liability, related to a plan that provides medical and
dental coverage to retirees of a predecessor company, decreased $399,000, or
62%, from $644,000 for the six months ended June 30, 2001 to $245,000 for the
six months ended June 30, 2002. This decrease in interest cost was due to a June
2001 amendment of this plan whereby retirees bear more cost for coverage,
reducing our projected liability and the related interest cost.

Provision for Income Taxes. Income tax expense of $1.8 million for the six
months ended June 30, 2002, increased $292,000 from $1.5 million for the six
months ended June 30, 2001. The primary reason for this increase in tax expense
was an increase in income before income taxes, which was $4.7 million for the
six months ended June 30, 2002, as compared to $3.4 million for the respective
period in 2001. The effective tax rate declined from 44.4% for the six months
ended June 30, 2001 to 38.3% for the six months ended June 30, 2002, due to the
impact of eliminating non-deductible goodwill amortization as per SFAS No. 142,
"Goodwill and Other Intangible Assets." See "Recent Accounting Pronouncements."

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2002, we had cash and working capital of $2.9 million and
$42.6 million, respectively, as compared to cash and working capital of $3.1
million and $37.1 million, respectively, at December 31, 2001.

Net cash used by operating activities for the six months ended June 30, 2002
was $367,000, compared to net cash provided by operating activities of $1.4
million for the six months ended June 30, 2001. Factors that contributed to the
increase in cash used by operating activities during 2002 included an increase
in trade accounts receivable and a decline in customer advance payments.

Net cash used in investing activities for the six months ended June 30, 2002
was $3.3 million, of which $2.9 million was used for capital expenditures.
During the six months ended June 30, 2001, $50.8 million was used for investing
activities primarily related to the acquisition of Axsia, which required $48.2
million, and capital expenditures of $3.1 million.

Net cash provided by financing activities for the six months ended June 30,
2002 and 2001, was $2.9 million and $52.7 million, respectively. The primary
source of funds for financing activities for the six months ended June 30, 2002
was net borrowings of $3.9 million under long-term revolving credit facilities
and borrowings of $1.5 million under a new long-term debt arrangement, offset by
repayments of $3.5 million under the term loan facility. The primary source of
funds for financing activities during the six months ended June 30, 2001 was
borrowings of $50.0 million under the term loan facility and net borrowings of
$4.1 million under long-term revolving credit facilities, offset by repayments
of $1.8 million under the term loan facility and repayments of $1.0 million
under short-term note arrangements.

We borrowed $1.5 million under a long-term promissory note arrangement on
February 6, 2002. This note accrues interest at the 90-day London Interbank
Offered Rate ("LIBOR") plus 3.25% per annum, and requires quarterly payments of
principal and interest for five years beginning May 2002. This promissory note
is collateralized by our manufacturing facility in Magnolia, Texas, purchased in
the fourth quarter of 2001.

On March 16, 2001, we entered into a credit facility that consisted of a
$50.0 million term loan, a $35.0 million U.S. revolving facility, a $10.0
million Canadian revolving facility and a $5.0 million U.K. revolving facility.
The term loan matures on March 15, 2006, and each of the revolving facilities
matures on March 15, 2004. In October 2001, we amended this revolving credit
agreement to reduce the borrowing capacity in the U.S. from $35.0 million to
$30.0 million, and to increase our borrowing capacity in the U.K. from $5.0
million to $10.0 million. No other material modifications were made to the
agreement.

In July 2002, our lenders approved the amendment of various provisions of
the term loan and revolving credit facility agreement, effective April 1, 2002.
This amendment revised certain restrictive debt covenants, modified certain
defined terms, allowed for future capital investment in our CO2 processing
facility in West Texas, facilitates the issuance of $7.5 million of subordinated
debt, increased the aggregate amount of operating lease expense allowed during a
fiscal year and permitted an increase in borrowings under the export sales
credit facility, without further consent, up to a maximum of $20.0 million.
These modifications will result in higher commitment fee percentages and
interest rates if the Funded Debt to EBITDA ratio, as defined, exceeds 3 to 1.

18

Amounts borrowed under the term loan facility bear interest at 4.59% per
annum as of June 30, 2002. Amounts borrowed under the revolving facilities bear
interest at a rate based upon the ratio of funded debt to EBITDA (as defined in
the credit facility) and ranging from, at our election, (1) a high of LIBOR plus
3.00% to a low of LIBOR plus 1.75% or, (2) a high of a base rate plus 1.50% to a
low of a base rate plus 0.25%.

As of June 30, 2002, the weighted average interest rate of our borrowings
under the revolving credit facilities was 4.94%.

We will pay commitment fees of 0.30% to 0.625% per year, depending upon the
ratio of funded debt to EBITDA, on the undrawn portion of the facility.

The revolving credit facility is guaranteed by all of our domestic
subsidiaries and is secured by a first priority lien on substantially all
inventory, accounts receivable and other material tangible and intangible
assets. We have also pledged 65% of the voting stock of our active foreign
subsidiaries.

On March 19, 2001, we borrowed the entire $50.0 million available under the
term loan portion of the facility and used $45.0 million to purchase all the
outstanding share capital of Axsia. The remaining borrowings of $5.0 million,
along with additional borrowings under the revolving credit facility, were used
to repay $16.5 outstanding under a predecessor revolving credit and term loan
facility. As of June 30, 2002, we had borrowings of $41.3 million outstanding
under the term loan facility.

As of June 30, 2002, we were in compliance with all restrictive debt
covenants. We had letters of credit outstanding under the revolving credit
facilities totaling $17.5 million at June 30, 2002. These letters of credit
constitute contract performance and warranty collateral and expire at various
dates through August 2005.

We maintain a working capital facility for export sales that provides for
aggregate borrowings of $10.0 million, subject to borrowing base limitations,
under which borrowings of $4.4 million were outstanding as of June 30, 2002.
Letters of credit outstanding under this facility at June 30, 2002 totaled
$102,000. The export sales credit facility is secured by specific project
inventory and receivables, and is partially guaranteed by the EXIM Bank. The
export sales credit facility loans mature in July 2004.

We had unsecured letters of credit, guarantees and bonds outstanding at June
30, 2002 of $182,000.

Our sales backlog at June 30, 2002 was $103.7 million compared to $101.3
million at June 30, 2001. Backlog remained relatively constant as normal run-off
was replenished by new bookings in late 2001 and 2002.

At June 30, 2002, borrowing base limitations and outstanding letters of
credit reduced our available borrowing capacity under the term loan and
revolving credit agreement and export sales credit agreement to $11.0 million
and $96,000, respectively. We are actively considering a capital investment at
our CO2 processing plant in West Texas which would require additional cash
outlays beginning in the second half of 2002, and are reviewing financing
alternatives to fund this investment. Although no assurances can be given, we
believe that our operating cash flow, supported by our borrowing capacity and
additional financing obtained for capital investment, will be adequate to fund
operations throughout 2002. Should we decide to pursue additional acquisition
opportunities during the remainder of 2002, the determination of our ability to
finance these acquisitions will be a critical element of the analysis of the
opportunities.

RELATED PARTY TRANSACTIONS

As previously agreed during 2001, we loaned an executive officer and
director $216,000 on April 15, 2002, under a full-recourse note arrangement
which accrues interest at 6% per annum and matures on July 31, 2003. The funds
were used to pay tax burdens associated with stock options exercised during
2001. At June 30, 2002, the outstanding balance under this note arrangement,
including accrued interest, was $219,000.

As of June 30, 2002, we had several outstanding notes receivable from two
employees who are executive officers and directors, with principal and interest
totaling $3.6 million. The maturity of these loans was July 31, 2003, and
interest accrued at rates ranging from 6% to 7.8% per annum. Effective July 1,
2002, the notes were amended to extend the maturity dates to July 31, 2004, and
to require interest to be calculated at an annual rate based on LIBOR plus 300
basis points, adjusted quarterly, applied to the notes balances as of June 30,
2002, including previously accrued interest.

19

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our operations are conducted around the world in a number of different
countries. Accordingly, future earnings are exposed to changes in foreign
currency exchange rates. The majority of our foreign currency transactions
relate to operations in Canada and the U.K. In Canada, most contracts are
denominated in Canadian dollars, and most of the costs incurred are in Canadian
dollars, thereby mitigating risks associated with currency fluctuations. In the
U.K., many of our sales contracts and material purchases are denominated in a
currency other than British pounds sterling, primarily U.S. dollars and euros,
whereas our engineering and overhead costs are principally denominated in
British pounds sterling. Consequently, we have currency risk in our U.K.
operations. No forward contracts or other derivative arrangements existed at
June 30, 2002, and we do not currently intend to enter into new forward
contracts or other derivative arrangements as part of our currency risk
management strategy.

Our financial instruments are subject to change in interest rates, including
our revolving credit and term loan facility and our working capital facility for
export sales. At June 30, 2002, we had borrowings of $41.3 million outstanding
under the term loan portion of the revolving credit and term loan facility, at
an interest rate of 4.59%. Borrowings, which bear interest at floating rates,
outstanding under the revolving credit agreement at June 30, 2002, totaled $13.6
million. As of June 30, 2002, the weighted average interest rate of our
borrowings under revolving credit facilities was 4.94%. Borrowings under the
working capital facility for export sales at June 30, 2002 totaled $4.4 million
and accrued interest at 4.75%.

Based on past market movements and possible near-term market movements, we
do not believe that potential near-term losses in future earnings, fair values
or cash flows from changes in interest rates are likely to be material. Assuming
our current level of borrowings, a 100 basis point increase in interest rates
under our variable interest rate facilities would decrease our current quarter
net income and cash flow from operations by approximately $100,000. In the event
of an adverse change in interest rates, we could take action to mitigate our
exposure. However, due to the uncertainty of actions that could be taken and the
possible effects, this calculation assumes no such actions. Furthermore, this
calculation does not consider the effects of a possible change in the level of
overall economic activity that could exist in such an environment.

20

PART II

ITEM 1. LEGAL PROCEEDINGS

We are a party to various routine legal proceedings that are incidental to
our business activities. We insure against the risk of these proceedings to the
extent deemed prudent, but we offer no assurance that the type or value of this
insurance will meet the liabilities that may arise from any pending or future
legal proceedings related to our business activities. We do not, however,
believe the pending legal proceedings, individually or taken together, will have
a material adverse effect on our results of operations or financial condition.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Annual Meeting of Stockholders of NATCO Group Inc. was held on May 23,
2002 in Houston, Texas. At the Annual Meeting, the holders of 14,870,104 shares
out of 15,803,797 shares entitled to vote as of the record date, were
represented in person or by proxy, constituting a quorum. Proposals which were
submitted to a vote of security holders included the following and were adopted
by the margins indicated:

(1) Election of two (2) Class I members of the Board of Directors, each to
hold office for a three-year term expiring at the annual meeting of
stockholders in 2005.

Messrs. Keith K. Allan, Howard I. Bull and George K. Hickox, Jr., will
continue to serve as directors of the Company, each with a term expiring at the
annual meeting of stockholders in 2003. Messrs. Nathaniel A. Gregory and Herbert
S. Winokur, Jr. will continue to serve as directors of the Company, each with a
term expiring at the annual meeting of stockholders in 2004.

(2) Ratification of KPMG LLP as the Company's independent public
accountants for the fiscal year beginning January 1, 2002.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) See Index of Exhibits for a list of those exhibits filed herewith,
which index includes and identifies management contracts or
compensatory plans or arrangements required to be filed as exhibits to
this Form 10-Q by Item 601(10)(iii) of Regulation S-K.

(b) Reports on Form 8-K. We filed a report on Form 8-K on April 29, 2002,
to announce earnings for the first quarter of 2002.

(c) Index of Exhibits

21

EXHIBIT NO. DESCRIPTION

2.1 -- Amended and Restated Agreement and Plan of Merger
dated November 17, 1998 but effective March 26, 1998
among the Company, NATCO Acquisition Company,
National Tank Company and The Cynara Company
(incorporated by reference to Exhibit 2.1 of the
Company's Registration Statement No. 333-48851 on
Form S-1).

3.1 -- Restated Certificate of Incorporation of the Company,
as amended by Certificate of Amendment dated November
18, 1998 and Certificate of Amendment dated November
29, 1999 (incorporated by reference to Exhibit 3.1 of
the Company's Registration Statement No. 333-48851 on
Form S-1).

3.2 -- Certificate of Designations of Series A Junior
Participating Preferred Stock (incorporated by
reference to Exhibit 3.2 of the Company's
Registration Statement No. 333-48851 on Form S-1).

3.3 -- Amended and Restated Bylaws of the Company, as
amended (incorporated by reference to Exhibit 3.3 of
the Company's Quarterly Report on Form 10-Q for the
period ended March 31, 2000).

4.1 -- Specimen Common Stock certificate (incorporated by
reference to Exhibit 4.1 of the Company's
Registration Statement No. 333-48851 on Form S-1).

4.2 -- Rights Agreement dated as of May 15, 1998 by and
among the Company and ChaseMellon Shareholder
Services, L.L.C., as Rights Agent (incorporated by
reference to Exhibit 4.2 of the Company's
Registration Statement No. 333-48851 on Form S-1).

4.3 -- Registration Rights Agreement dated as of November
18, 1998 among the Company and Capricorn Investors,
L.P. and Capricorn Investors II, L.P. (incorporated
by reference to Exhibit 4.3 of the Company's
Registration Statement No. 333-48851 on Form S-1).

10.1** -- Directors Compensation Plan (incorporated by
reference to Exhibit 10.1 of the Company's
Registration Statement No. 333-48851 on Form S-1).

10.2** -- Form of Nonemployee Director's Option Agreement
(incorporated by reference to Exhibit 10.2 of the
Company's Registration Statement No. 333-48851 on
Form S-1).

10.3** -- Employee Stock Incentive Plan (incorporated by
reference to Exhibit 10.3 of the Company's
Registration Statement No. 333-48851 on Form S-1).

10.4** -- Form of Nonstatutory Stock Option Agreement
(incorporated by reference to Exhibit 10.24 to the
Company's Registration Statement No. 333-48851 on
Form S-1).

10.6 -- Service and Reimbursement Agreement dated as of July
1, 1997 between the Company and Capricorn Management,
G.P. (incorporated by reference to Exhibit 10.6 of
the Company's Registration Statement No. 333-48851 on
Form S-1).

10.7** -- Form of Indemnification Agreement between the Company
and its officers and directors (incorporated by
reference to Exhibit 10.0 of the Company's
Registration Statement No. 333-48851 on Form S-1).

10.9 -- Stockholders' Agreement by and among the Company,
Capricorn Investors, L.P. and Capricorn Investors II,
L.P. (incorporated by reference to Exhibit 10.11 of
the Company's Registration Statement No. 333-48851 on
Form S-1).

22

EXHIBIT NO. DESCRIPTION

10.10** -- Employment Agreement dated as of July 31, 1997
between the Company and Nathaniel A. Gregory, as
amended as of July 12, 1999 (incorporated by
reference to Exhibit 10.12 of the Company's
Registration Statement No. 333-48851 on Form S-1).

10.12** -- Change of Control Policy dated as of September 28,
1999 (incorporated by reference to Exhibit 10.20 of
the Company's Registration Statement No. 333-48851 on
Form S-1).

10.13** -- Severance Pay Summary Plan Description (incorporated
by reference to Exhibit 10.21 of the Company's
Registration Statement No. 333-48851 on Form S-1).

10.15 -- International Revolving Loan Agreement dated as of
June 30, 1997 between National Tank Company and Texas
Commerce Bank, National Association, as amended
(incorporated by reference to Exhibit 10.23 to the
Company's Registration Statement No. 333-48851 on
Form S-1).

10.16 -- Loan Agreement ($35,000,000 U.S. Revolving Loan
Facility, $10,000,000 Canadian Revolving Loan
Facility, $5,000,000 U.K. Revolving Loan Facility and
$50,000,000 Term Loan Facility) dated as of March 16,
2001 among NATCO Group Inc., NATCO Canada, Ltd.,
Axsia Group Limited, The Chase Manhattan Bank, Royal
Bank of Canada, Chase Manhattan International
Limited, Bank One, N.A. (Main Office Chicago,
Illinois), Wells Fargo Bank Texas, National
Association, JP Morgan, a Division of Chase
Securities, Inc., and the other lenders now or
hereafter Parties hereto (incorporated by reference
to Exhibit 10.16 of the Company's Annual Report on
Form 10-K for the period ended December 31, 2000).

10.17* -- First Amendment to Loan Agreement ($35,000,000 U.S.
Revolving Loan Facility, $10,000,000 Canadian
Revolving Loan Facility, $5,000,000 U.K. Revolving
Loan Facility and $50,000,000 Term Loan Facility)
dated as of March 16, 2001 among NATCO Group Inc.,
NATCO Canada, Ltd., Axsia Group Limited, The Chase
Manhattan Bank, Royal Bank of Canada, Chase Manhattan
International Limited, Bank One, N.A. (Main Office
Chicago, Illinois), Wells Fargo Bank Texas, National
Association, JP Morgan, a Division of Chase
Securities, Inc., and the other lenders now or
hereafter Parties hereto.

10.18* -- Second Amendment to Loan Agreement ($35,000,000 U.S.
Revolving Loan Facility, $10,000,000 Canadian
Revolving Loan Facility, $5,000,000 U.K. Revolving
Loan Facility and $50,000,000 Term Loan Facility)
dated as of March 16, 2001 among NATCO Group Inc.,
NATCO Canada, Ltd., Axsia Group Limited, The Chase
Manhattan Bank, Royal Bank of Canada, Chase Manhattan
International Limited, Bank One, N.A. (Main Office
Chicago, Illinois), Wells Fargo Bank Texas, National
Association, JP Morgan, a Division of Chase
Securities, Inc., and the other lenders now or
hereafter Parties hereto.

10.19* -- Second Amended Single Installment Note between
Nathaniel A. Gregory and NATCO Group Inc., effective
July 1, 2002.

10.20* -- Amended Single Installment Note between Nathaniel
Gregory and NATCO Group Inc., effective July 1, 2002.

10.21* -- Amended Single Installment Note between Nathaniel
Gregory and NATCO Group Inc., effective July 1, 2002.

10.22* -- Amended Single Installment Note between Nathaniel
Gregory and NATCO Group Inc., effective July 1, 2002.

10.23* -- Amended Single Installment Note between Patrick M.
McCarthy and NATCO Group Inc., effective July 1,
2002.
- ----------

* Filed herewith

** Management contracts or compensatory plans or arrangements.

23

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

NATCO Group Inc.
(Registrant)

By: /s/ J. MICHAEL MAYER
--------------------------------------
Name: J. Michael Mayer
Senior Vice President and
Chief Financial Officer

Date: August 14, 2002

By: /s/ RYAN S. LILES
--------------------------------------
Name: Ryan S. Liles
Vice President and Controller
(Principal Accounting Officer)

Date: August 14, 2002

24

EXHIBIT INDEX

- ----------

* Filed herewith

** Management contracts or compensatory plans or arrangements.

26