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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-Q



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(Mark One)



|þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2006

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



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NATCO Group Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 22-2906892                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer 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  þ    No ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                      |  |                       
|------------------------ |  | -------------------- |  | ----------------------
|Large accelerated filer ̈ |  | Accelerated filer  þ |  | Non-accelerated filer ̈

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

As of October 31, 2006, the issuer had outstanding 17,323,147 shares of common stock, par value $0.01 per share.



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##### Table of Contents

NATCO GROUP INC.

FORM 10-Q

For the Quarter Ended September 30, 2006

TABLE OF CONTENTS



|           |  |                                                                                                         |  |         
|---------- |  | ------------------------------------------------------------------------------------------------------- |  | --------
|           |  |                                                                                                         |  | Page No.
|PART I     |  | FINANCIAL INFORMATION                                                                                   |  |         
|           |  |                                                                                                        
|Item 1.    |  | Financial Statements                                                                                    |  |         
|           |  |                                                                                                        
|           |  | Consolidated Balance SheetsSeptember 30, 2006 (unaudited) and December 31,2005                         |  | 3       
|           |  |                                                                                                        
|           |  | Unaudited Consolidated Statements of OperationsThree and Nine Months Ended September 30, 2006 and 2005 |  | 4       
|           |  |                                                                                                        
|           |  | Unaudited Consolidated Statements of Cash FlowsNine Months Ended September 30, 2006 and 2005           |  | 5       
|           |  |                                                                                                        
|           |  | Notes to Unaudited Consolidated Financial Statements                                                    |  | 6       
|           |  |                                                                                                        
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                   |  | 25      
|           |  |                                                                                                        
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                              |  | 43      
|           |  |                                                                                                        
|Item 4.    |  | Controls and Procedures                                                                                 |  | 43      
|           |  |                                                                                                        
|PART II    |  | OTHER INFORMATION                                                                                       |  |         
|           |  |                                                                                                        
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                             |  | 45      
|           |  |                                                                                                        
|Item 6.    |  | Exhibits                                                                                                |  | 45      
|           | 
|Signatures |  | 46                                                                                                     



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##### Table of Contents

PART IFINANCIAL INFORMATION

Item 1.Financial Statements

NATCO GROUP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and par value data)



|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ----------------- | - | ------- | -
|                                                                                                                                                                                                                  |  | September 30, 2006 |         | December 31, 2005 |  
|                                                                                                                                                                                                                  |  | (unaudited)        |         |                   |  
|ASSETS                                                                                                                                                                                                            |  |                    |         |                   |   |         |  
|Current assets:                                                                                                                                                                                                   |  |                    |         |                   |   |         |  
|Cash and cash equivalents                                                                                                                                                                                         |  | $                  | 20,934  |                   | $ | 9,198   |  
|Trade accounts receivable, less allowance for doubtful accounts of $1,862 and $1,123 as of September 30, 2006 and December 31, 2005,
respectively                                                                 |  |                    | 123,695 |                   |   | 111,770 |  
|Inventories                                                                                                                                                                                                       |  |                    | 48,434  |                   |   | 37,194  |  
|Deferred income tax assets, net                                                                                                                                                                                   |  |                    | 4,309   |                   |   | 3,465   |  
|Prepaid expenses and other current assets                                                                                                                                                                         |  |                    | 3,614   |                   |   | 3,612   |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|Total current assets                                                                                                                                                                                              |  |                    | 200,986 |                   |   | 165,239 |  
|Property, plant and equipment, net                                                                                                                                                                                |  |                    | 32,852  |                   |   | 33,263  |  
|Goodwill, net                                                                                                                                                                                                     |  |                    | 81,199  |                   |   | 80,891  |  
|Deferred income tax assets, net                                                                                                                                                                                   |  |                    | 2,917   |                   |   | 3,329   |  
|Other assets, net                                                                                                                                                                                                 |  |                    | 1,474   |                   |   | 1,021   |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|Total assets                                                                                                                                                                                                      |  | $                  | 319,428 |                   | $ | 283,743 |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY                                                                                                                                      |  |                    |         |                   |   |         |  
|Current liabilities:                                                                                                                                                                                              |  |                    |         |                   |   |         |  
|Trade accounts payable and other                                                                                                                                                                                  |  | $                  | 36,107  |                   | $ | 48,720  |  
|Accrued expenses and other                                                                                                                                                                                        |  |                    | 47,489  |                   |   | 41,781  |  
|Customer advanced billings and payments                                                                                                                                                                           |  |                    | 42,825  |                   |   | 18,272  |  
|Current portion of long-term debt                                                                                                                                                                                 |  |                    |        |                   |   | 6,429   |  
|Income taxes payable                                                                                                                                                                                              |  |                    | 3,181   |                   |   | 890     |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|Total current liabilities                                                                                                                                                                                         |  |                    | 129,602 |                   |   | 116,092 |  
|Long-term debt, excluding current installments                                                                                                                                                                    |  |                    | 4,500   |                   |   | 20,964  |  
|Long-term deferred tax liabilities                                                                                                                                                                                |  |                    | 1,087   |                   |   | 483     |  
|Postretirement benefits and other long-term liabilities                                                                                                                                                           |  |                    | 10,504  |                   |   | 9,814   |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|Total liabilities                                                                                                                                                                                                 |  |                    | 145,693 |                   |   | 147,353 |  
|Commitments and contingencies                                                                                                                                                                                     |  |                    |        |                   |   |        |  
|Minority interest                                                                                                                                                                                                 |  |                    | 380     |                   |   |        |  
|Series B redeemable convertible preferred stock (aggregate redemption value of $15,000), $.01 par value. 15,000 shares authorized, issued and
outstanding (net of issuance costs)                                 |  |                    | 14,222  |                   |   | 14,222  |  
|Stockholders equity:                                                                                                                                                                                             |  |                    |         |                   |   |         |  
|Preferred stock, $.01 par value. Authorized 5,000,000 shares (of which 500,000 are designated as Series A and 15,000 are designated as Series
B); no shares issued and outstanding (except Series B shares above) |  |                    |        |                   |   |        |  
|Series A preferred stock, $.01 par value. Authorized 500,000 shares; no shares issued and outstanding                                                                                                             |  |                    |        |                   |   |        |  
|Common stock, $.01 par value. Authorized 50,000,000 shares; issued and outstanding 17,313,147 and 16,914,052 shares as of September 30,
2006 and December 31, 2005, respectively                                  |  |                    | 173     |                   |   | 169     |  
|Additional paid-in-capital                                                                                                                                                                                        |  |                    | 111,640 |                   |   | 101,671 |  
|Retained earnings                                                                                                                                                                                                 |  |                    | 45,579  |                   |   | 19,914  |  
|Treasury stock, no shares and 2,550 shares at cost as of September 30, 2006 and December 31, 2005, respectively                                                                                                   |  |                    |        |                   |   | (22     | )
|Accumulated other comprehensive income                                                                                                                                                                            |  |                    | 1,741   |                   |   | 436     |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|Total stockholders equity                                                                                                                                                                                        |  |                    | 159,133 |                   |   | 122,168 |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  
|Total liabilities, redeemable convertible preferred stock and stockholders equity                                                                                                                                |  | $                  | 319,428 |                   | $ | 283,743 |  
|                                                                                                                                                                                                                  |  |                    |         |                   |   |         |  

See accompanying notes to unaudited consolidated financial statements.



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##### Table of Contents

NATCO GROUP INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)



|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|-------------------------------------------------- |  | -------------------------------- | ------- | - | ------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                   |  | Three Months Ended September 30, |         |   | Nine Months Ended September 30, |  
|                                                   |  | 2006                             |         |   | 2005                            |   |         | 2006 |  |   | 2005    |  
|Revenue:                                           |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Products                                           |  | $                                | 104,248 |   |                                 | $ | 83,368  |      |  | $ | 309,261 |   |  | $ | 231,016 |  
|Services                                           |  |                                  | 27,930  |   |                                 |   | 19,032  |      |  |   | 69,390  |   |  |   | 54,688  |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total                                              |  | $                                | 132,178 |   |                                 | $ | 102,400 |      |  | $ | 378,651 |   |  | $ | 285,704 |  
|Cost of goods sold and services:                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Products                                           |  | $                                | 82,219  |   |                                 | $ | 66,593  |      |  | $ | 241,913 |   |  | $ | 186,493 |  
|Services                                           |  |                                  | 13,745  |   |                                 |   | 10,958  |      |  |   | 34,130  |   |  |   | 30,679  |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total                                              |  | $                                | 95,964  |   |                                 | $ | 77,551  |      |  | $ | 276,043 |   |  | $ | 217,172 |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Gross profit                                       |  | $                                | 36,214  |   |                                 | $ | 24,849  |      |  | $ | 102,608 |   |  | $ | 68,532  |  
|Selling, general and administrative expense        |  |                                  | 19,964  |   |                                 |   | 14,645  |      |  |   | 53,688  |   |  |   | 43,647  |  
|Depreciation and amortization expense              |  |                                  | 1,299   |   |                                 |   | 1,276   |      |  |   | 4,163   |   |  |   | 3,931   |  
|Closure, severance and other                       |  |                                  | 2,325   |   |                                 |   | 2,076   |      |  |   | 2,570   |   |  |   | 2,166   |  
|Interest expense                                   |  |                                  | 491     |   |                                 |   | 942     |      |  |   | 1,922   |   |  |   | 3,033   |  
|Interest cost on postretirement benefit liability  |  |                                  | (100    | ) |                                 |   | 210     |      |  |   |        |   |  |   | 630     |  
|Interest income                                    |  |                                  | (96     | ) |                                 |   | (5      | )    |  |   | (215    | ) |  |   | (70     | )
|Minority interest                                  |  |                                  | 400     |   |                                 |   |        |      |  |   | 380     |   |  |   |        |  
|Other, net                                         |  |                                  | (2,213  | ) |                                 |   | 1,630   |      |  |   | (2,084  | ) |  |   | 2,024   |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Income before income tax expense                   |  | $                                | 14,144  |   |                                 | $ | 4,075   |      |  | $ | 42,184  |   |  | $ | 13,171  |  
|Income tax expense                                 |  |                                  | 4,741   |   |                                 |   | 1,686   |      |  |   | 15,396  |   |  |   | 5,361   |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net income                                         |  | $                                | 9,403   |   |                                 | $ | 2,389   |      |  | $ | 26,788  |   |  | $ | 7,810   |  
|Preferred stock dividends                          |  |                                  | 375     |   |                                 |   | 375     |      |  |   | 1,125   |   |  |   | 1,125   |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net income allocable to common stockholders        |  | $                                | 9,028   |   |                                 | $ | 2,014   |      |  | $ | 25,663  |   |  | $ | 6,685   |  
|                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Earnings per share:                                |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Basic                                             |  | $                                | 0.53    |   |                                 | $ | 0.12    |      |  | $ | 1.53    |   |  | $ | 0.42    |  
|Diluted                                           |  | $                                | 0.49    |   |                                 | $ | 0.12    |      |  | $ | 1.40    |   |  | $ | 0.41    |  
|Weighted average number of shares of common stock: |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Basic                                             |  |                                  | 17,016  |   |                                 |   | 16,260  |      |  |   | 16,824  |   |  |   | 16,005  |  
|Diluted                                           |  |                                  | 19,307  |   |                                 |   | 16,793  |      |  |   | 19,139  |   |  |   | 16,364  |  

See accompanying notes to unaudited consolidated financial statements.



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NATCO GROUP INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                  |  |                                 |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Nine Months Ended September 30, |        
|                                                                                  |  | 2006                            |         |   | 2005 |  
|Cash flows from operating activities:                                             |  |                                 |         |   |      |   |         |  
|Net income                                                                        |  | $                               | 26,788  |   |      | $ | 7,810   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                 |         |   |      |   |         |  
|Deferred income tax expense (benefit)                                             |  |                                 | 73      |   |      |   | (560    | )
|Depreciation and amortization expense                                             |  |                                 | 4,163   |   |      |   | 3,931   |  
|Non-cash interest expense                                                         |  |                                 | 198     |   |      |   | 369     |  
|Write off of unamortized loan costs                                               |  |                                 | 160     |   |      |   |        |  
|Stock compensation expense                                                        |  |                                 | 3,650   |   |      |   | 1,894   |  
|Tax benefit of stock options exercised                                            |  |                                 | 66      |   |      |   | 1,274   |  
|Minority interest                                                                 |  |                                 | 380     |   |      |   |        |  
|Revaluation of warrants                                                           |  |                                 |        |   |      |   | 1,778   |  
|Interest cost on postretirement benefit liability                                 |  |                                 |        |   |      |   | 630     |  
|Net payments on postretirement benefit liability                                  |  |                                 | (587    | ) |      |   | (1,146  | )
|Loss (Gain) on disposition of property, plant and equipment                       |  |                                 | 272     |   |      |   | (1,011  | )
|Gain on sale of investment                                                        |  |                                 | (2,464  | ) |      |   |        |  
|Change in assets and liabilities:                                                 |  |                                 |         |   |      |   |         |  
|Increase in trade accounts receivable                                             |  |                                 | (8,907  | ) |      |   | (14,061 | )
|(Increase) decrease in inventories                                                |  |                                 | (10,776 | ) |      |   | 5,711   |  
|Increase in prepaid expense and other current assets                              |  |                                 | (126    | ) |      |   | (392    | )
|(Increase) decrease in long-term assets                                           |  |                                 | 1,129   |   |      |   | (566    | )
|Decrease in accounts payable                                                      |  |                                 | (11,763 | ) |      |   | (7,731  | )
|Increase in accrued expenses and other                                            |  |                                 | 3,189   |   |      |   | 9,832   |  
|Increase in other income tax payable                                              |  |                                 | 2,292   |   |      |   |        |  
|Increase in customer advanced billings and payments                               |  |                                 | 24,353  |   |      |   | 3,069   |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                                 | 32,090  |   |      |   | 10,831  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Cash flows from investing activities:                                             |  |                                 |         |   |      |   |         |  
|Capital expenditures for property, plant and equipment                            |  |                                 | (3,565  | ) |      |   | (2,397  | )
|Proceeds from sales of property, plant and equipment                              |  |                                 | 48      |   |      |   | 2,340   |  
|Proceeds from sale of investment                                                  |  |                                 | 3,000   |   |      |   |        |  
|Investments in joint venture                                                      |  |                                 | (412    | ) |      |   |        |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Net cash used in investing activities                                             |  |                                 | (929    | ) |      |   | (57     | )
|                                                                                  |  |                                 |         |   |      |   |         |  
|Cash flows from financing activities:                                             |  |                                 |         |   |      |   |         |  
|Repayments under long-term revolving credit agreements                            |  |                                 |        |   |      |   | (3,936  | )
|Repayments of long-term debt                                                      |  |                                 | (22,893 | ) |      |   | (7,621  | )
|Proceeds from stock issuances related to stock options, net                       |  |                                 | 3,021   |   |      |   | 6,530   |  
|Excess tax benefit of stock options exercised and restricted stock                |  |                                 | 3,273   |   |      |   |        |  
|Change in bank overdrafts                                                         |  |                                 | (2,337  | ) |      |   | (6      | )
|Dividends paid                                                                    |  |                                 | (750    | ) |      |   | (750    | )
|Deferred financing fees                                                           |  |                                 | (454    | ) |      |   | (115    | )
|Treasury shares acquired                                                          |  |                                 | (15     | ) |      |   |        |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Net cash used in financing activities                                             |  |                                 | (20,155 | ) |      |   | (5,898  | )
|                                                                                  |  |                                 |         |   |      |   |         |  
|Effect of exchange rate changes on cash and cash equivalents                      |  |                                 | 730     |   |      |   | 378     |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Increase in cash and cash equivalents                                             |  |                                 | 11,736  |   |      |   | 5,254   |  
|Cash and cash equivalents at beginning of period                                  |  |                                 | 9,198   |   |      |   | 2,194   |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                        |  | $                               | 20,934  |   |      | $ | 7,448   |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Cash payments for:                                                                |  |                                 |         |   |      |   |         |  
|Interest                                                                          |  | $                               | 1,404   |   |      | $ | 2,463   |  
|Income taxes                                                                      |  | $                               | 9,631   |   |      | $ | 5,939   |  

See accompanying notes to unaudited consolidated financial statements.



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

The accompanying
consolidated interim financial statements and related disclosures are unaudited and prepared by NATCO Group Inc. pursuant to accounting principles generally accepted in the United States of America (U.S. GAAP) for interim consolidated
financial statements and the rules and regulations of the United States 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 U.S. GAAP 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 consolidated financial statements should be read in conjunction with the consolidated financial statements and
notes thereto included in the Companys Annual Report on Form 10-K filing for the year ended December 31, 2005.

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 revenue and expenses incurred during the reporting period. Actual results could differ from those estimates.

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

(2) Inventories

Inventories consisted of the following amounts:



|                                         |  |                    |        |   |                   |   |        |  
|---------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | -
|                                         |  | September 30, 2006 |        |   | December 31, 2005 |  
|                                         |  | (unaudited)        |        |   |                   |  
|                                         |  | (in thousands)     |       
|Finished goods                           |  | $                  | 9,861  |   |                   | $ | 9,670  |  
|Work-in-process                          |  |                    | 24,141 |   |                   |   | 15,138 |  
|Raw materials and supplies               |  |                    | 20,874 |   |                   |   | 17,180 |  
|                                         |  |                    |        |   |                   |   |        |  
|Inventories at FIFO and weighted average |  |                    | 54,876 |   |                   |   | 41,988 |  
|Excess of FIFO over LIFO cost            |  |                    | (6,442 | ) |                   |   | (4,794 | )
|                                         |  |                    |        |   |                   |   |        |  
|Net inventories                          |  | $                  | 48,434 |   |                   | $ | 37,194 |  
|                                         |  |                    |        |   |                   |   |        |  

The Companys net inventories as of September 30, 2006 and December 31, 2005 by
valuation method are shown below:



|                      |  |                   |        |                  |   |       
|--------------------- |  | ----------------- | ------ | ---------------- | - | ------
|                      |  | September 30,2006 |        | December 31,2005
|                      |  | (unaudited)       |        |                 
|                      |  | (in thousands)   
|FIFO                  |  | $                 | 9,425  |                  | $ | 7,556 
|Weighted average cost |  |                   | 832    |                  |   | 845   
|LIFO                  |  |                   | 38,177 |                  |   | 28,793
|                      |  |                   |        |                  |   |       
|Net inventories       |  | $                 | 48,434 |                  | $ | 37,194
|                      |  |                   |        |                  |   |       

There were no reductions in LIFO layers as of September 30, 2006 and December 31, 2005.



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##### Table of Contents

NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(3) Costs and Estimated Earnings on Uncompleted Contracts

Costs and estimated earnings on uncompleted contracts were as follows:



|                                                                  |  |                    |         |   |                   |   |         |  
|----------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | -
|                                                                  |  | September 30, 2006 |         |   | December 31, 2005 |  
|                                                                  |  | (unaudited)        |         |   |                   |  
|                                                                  |  | (in thousands)     |        
|Cost incurred on uncompleted contracts                            |  | $                  | 169,242 |   |                   | $ | 109,757 |  
|Estimated earnings                                                |  |                    | 52,068  |   |                   |   | 34,419  |  
|                                                                  |  |                    |         |   |                   |   |         |  
|                                                                  |  |                    | 221,310 |   |                   |   | 144,176 |  
|Less: Billings to date                                            |  |                    | 226,450 |   |                   |   | 128,516 |  
|                                                                  |  |                    |         |   |                   |   |         |  
|                                                                  |  | $                  | (5,140  | ) |                   | $ | 15,660  |  
|                                                                  |  |                    |         |   |                   |   |         |  
|Included in the accompanying balance sheet under the captions:(1) |  |                    |         |   |                   |   |         |  
|Trade accounts receivable                                         |  | $                  | 37,425  |   |                   | $ | 30,705  |  
|Customer advanced billings and payments                           |  |                    | (42,565 | ) |                   |   | (15,045 | )
|                                                                  |  |                    |         |   |                   |   |         |  
|                                                                  |  | $                  | (5,140  | ) |                   | $ | 15,660  |  
|                                                                  |  |                    |         |   |                   |   |         |  

---

|(1) | Trade accounts receivable and Customer advanced billings and payments in this table relate only to major contracts and therefore do not agree
to the balance sheet accounts Trade accounts receivable and Customer advanced billings and payments.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

(4) Goodwill
and Intangible Assets

In accordance with the Statement of Financial Accounting Standard No. 142 (SFAS No. 142),
Goodwill and Other Intangible Assets, the Company evaluates intangible assets with indefinite lives, including goodwill, on an impairment basis, while intangible assets with a defined term, such as patents, are amortized over the useful
life of the asset.

Goodwill

Net goodwill of $81.2 million and $80.9 million at September 30, 2006 and December 31, 2005 was comprised of $47.6 million and $47.4 million for the Oil & Water Technologies reporting unit, $29.2 million and $29.1 million
for the Gas Technologies reporting unit, $4.4 million and $4.4 million for the Automation & Controls reporting unit, respectively. The increase of $308,000 in net goodwill was due entirely to a fluctuation in the exchange rates between the
US currency and Canadian currency.

In accordance with SFAS No. 142, the Company tested each business segment for impairment of
goodwill at December 31, 2005, and, based upon the results of this testing, management determined that goodwill was not impaired. The Company tests each business segment for goodwill impairment annually, as required by the pronouncement, or
more frequently if there are indications of goodwill impairment. No additional testing was performed during the quarter ended September 30, 2006, as management noted no indications of goodwill impairment.



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Intangible assets

Intangible assets subject to amortization as of September 30, 2006 and December 31, 2005 were:



|                          |  |                          |       |                          |   |                       |  |                          |       |  |   |    
|------------------------- |  | ------------------------ | ----- | ------------------------ | - | --------------------- |  | ------------------------ | ----- |  | - | ---
|                          |  | As of September 30, 2006 |       | As of December 31, 2005 
|                          |  | Gross Carrying Amount    |       | Accumulated Amortization |   | Gross Carrying Amount |  | Accumulated Amortization
|                          |  | (unaudited)              |       |                          |   |                      
|                          |  |                          |       | (in thousands)           |   |                      
|Type of intangible assets |  |                          |       |                          |   |                       |  |                          |       |  |   |    
|Deferred financing fees   |  | $                        | 858   |                          | $ | 360                   |  | $                        | 1,112 |  | $ | 711
|Patents                   |  |                          | 582   |                          |   | 116                   |  |                          | 195   |  |   | 77 
|Other                     |  |                          | 693   |                          |   | 195                   |  |                          | 621   |  |   | 128
|                          |  |                          |       |                          |   |                       |  |                          |       |  |   |    
|Total                     |  | $                        | 2,133 |                          | $ | 671                   |  | $                        | 1,928 |  | $ | 916
|                          |  |                          |       |                          |   |                       |  |                          |       |  |   |    

The increase in intangible assets for the nine months ended September 30, 2006 was primarily
due to an investment in intangible assets during the first quarter of 2006 as a result of the Companys purchase of a 50% ownership interest in a joint venture that fabricates a pilotless ignition system for controlling gas-fired heaters used
in connection with oil and gas wellhead equipment.

Amortization expense of $71,000 and $310,000 was recognized related primarily to
Deferred financing fees, Patents and Other for the three and nine months ended September 30, 2006, respectively, compared to $103,000 and $421,000 for the three and nine months ended September 30, 2005, respectively. During the third
quarter of 2006, the Company recorded expense of $160,000 to write-off the majority of the remaining deferred financing fees associated with its 2004 term loan and revolving credit facilities which were refinanced as of July 12, 2006, as
discussed in Note 8, Debt. The estimated aggregate amortization expense for these intangible assets for the fiscal year ending December 31, 2006 and for each of the following four fiscal years is: 2006$380,000; 2007$209,000;
2008$209,000; 2009$209,000; and 2010$209,000. For segment reporting purposes, these intangible assets, net of the related accumulated amortization expense, were allocated to each segment.

(5) Warranty Costs

Estimated future warranty
obligations related to products are charged to cost of goods sold in the period in which the related revenue is recognized. A tabular reconciliation of the changes in the Companys aggregate product warranty liability included in the
Companys Consolidated Balance Sheet liability account Accrued expenses and other for the nine months ended September 30, 2006 is set forth below (unaudited, in thousands).



|                              |  |   |        |  
|----------------------------- |  | - | ------ | -
|Balance at December 31, 2005  |  | $ | 2,773  |  
|Payments/charges              |  |   | (1,968 | )
|Net accruals                  |  |   | 2,480  |  
|Foreign currency translation  |  |   | 110    |  
|                              |  |   |        |  
|Balance at September 30, 2006 |  | $ | 3,395  |  
|                              |  |   |        |  

(6) Closure, Severance and Other

On December 15, 2005, the Board of Directors approved the final phase of restructuring the Companys U.K. operations by consolidating the
Gloucester, England office into our Camberley, England location. At September 30, 2006, the Company had a liability remaining of $149,000 with respect to this phase of the U.K.



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



restructuring. The Company finalized the rationalization of office lease expenses associated with vacating the Gloucester facility and accrued $2.3 million
of estimated costs in the three months ended September 30, 2006. Other related operating costs incurred associated with the office consolidation during the nine months ending September 30, 2006 amounted to $349,000 of non-cash accelerated
leasehold improvement amortization and $488,000 of relocation and other costs. As of September 30, 2006, the total estimated liability is $2.5 million, including foreign currency translation of $65,000.

Pursuant to an amendment to his then effective employment agreement with the Company, entered into in September 2005, Mr. Patrick M. McCarthy agreed
to continue as President of the Company in exchange for certain benefits and payments which included, among other things, payment of certain severance benefits, a guaranteed bonus for 2005, acceleration of vesting of certain options, lapse in
restrictions on a portion of his restricted stock awards and continuation of certain health benefits following termination. The Company recorded a charge of $1.2 million in the third quarter of 2005 related to this amendment, in addition to the
previously accrued expense of $155,000 related to his 2005 bonus. On June 26, 2006, the Company and Mr. McCarthy entered into an amended and restated Employment Agreement (the Employment Agreement), which became effective
July 1, 2006. Under the terms of the Employment Agreement, which was reviewed and approved by the Companys Board of Directors, Mr. McCarthy was named as the Companys President and Chief Operating Officer to serve until
July 1, 2009. While the Company did not incur additional charges with respect to effectiveness of the Employment Agreement, it remains liable for the severance obligation under the former arrangement, to be paid upon Mr. McCarthys
termination. At September 30, 2006, the Company had an aggregate liability of $938,000 related to this matter.

In July and December
2004, the Company recorded severance expense of $2.5 million and $1.3 million, respectively, related to the termination of two executives and certain other administrative and operating personnel in the U.S., U.K. and Canada. At September 30,
2006, the Company had an aggregate liability of $633,000 related to these matters.

Following is a summary of Closure, severance and other
expense:



|                            |  |                                       |       |                                      |   |       |  |      |       |  |   |      
|--------------------------- |  | ------------------------------------- | ----- | ------------------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                            |  | Three Months Ended September 30, 2006 |       | Nine Months Ended September 30, 2006
|                            |  | 2006                                  |       | 2005                                 |   | 2006  |  | 2005
|                            |  | (unaudited, in thousands)            
|Severance                   |  | $                                     | 49    |                                      | $ | 2,032 |  | $    | 293   |  | $ | 2,072
|Closure cost                |  |                                       | 2,276 |                                      |   |      |  |      | 2,276 |  |   |     
|Contract expenses and other |  |                                       |      |                                      |   | 44    |  |      | 1     |  |   | 94   
|                            |  |                                       |       |                                      |   |       |  |      |       |  |   |      
|                            |  | $                                     | 2,325 |                                      | $ | 2,076 |  | $    | 2,570 |  | $ | 2,166
|                            |  |                                       |       |                                      |   |       |  |      |       |  |   |      

A roll forward of the Companys accrued Closure, severance and other expense from
December 31, 2005 to September 30, 2006 follows (unaudited, in thousands):



|                              |  |   |       |  
|----------------------------- |  | - | ----- | -
|Balance at December 31, 2005  |  | $ | 2,197 |  
|Payments                      |  |   | (830  | )
|Severance accrual and other   |  |   | 294   |  
|Closure cost                  |  |   | 2,276 |  
|Foreign exchange impact       |  |   | 124   |  
|                              |  |   |       |  
|Balance at September 30, 2006 |  | $ | 4,061 |  
|                              |  |   |       |  



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The estimated payment schedule for these remaining liabilities at September 30, 2006 is $405,000
in 2006; $1,430,000 in 2007; $473,000 in 2008; $765,000 in 2009; and $482,000 in 2010.

(7) Income Taxes

The Companys effective income tax rate for the nine months ended September 30, 2006 and 2005 was 36.5% and 40.7%, respectively, 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, permanent differences, tax credits and the change in valuation allowances recorded.
The decrease in the effective tax rate was primarily attributable to a decrease in permanent book versus tax differences and the generation of tax credits. The main decrease in permanent book versus tax differences was due to a nondeductible
mark-to-market expense on warrants exercised in 2005 that was not incurred in 2006.

(8) Debt

The Company had the following consolidated borrowings as of the date indicated:



|                                                                                                                                                                                                     |  |                   |       |                   |   |        |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ----- | ----------------- | - | ------ | -
|                                                                                                                                                                                                     |  | September 30,2006 |       | December 31, 2005 |  
|                                                                                                                                                                                                     |  | (unaudited)       |       |                   |  
|                                                                                                                                                                                                     |  | (in thousands)    |      
|2004 term loan and revolving credit facilities with variable interest rate (6.25% to 6.44% at December 31, 2005) and quarterly payments
of principal and interest of $1.6 million due March 31, 2007 |  | $                 |      |                   | $ | 27,393 |  
|2006 revolving credit facilities with an interest rate of 6.56% at September 30, 2006 and scheduled to mature on June 30,
2011                                                                       |  |                   | 4,500 |                   |   |       |  
|Revolving credit bank loans (export sales facility) with variable interest rate and monthly interest payments due March 31,
2007                                                                     |  |                   |      |                   |   |       |  
|                                                                                                                                                                                                     |  |                   |       |                   |   |        |  
|Total                                                                                                                                                                                                |  | $                 | 4,500 |                   | $ | 27,393 |  
|Less current installments                                                                                                                                                                            |  |                   |      |                   |   | (6,429 | )
|                                                                                                                                                                                                     |  |                   |       |                   |   |        |  
|Long-term debt                                                                                                                                                                                       |  | $                 | 4,500 |                   | $ | 20,964 |  
|                                                                                                                                                                                                     |  |                   |       |                   |   |        |  

On July 12, 2006, the Company terminated the 2004 term loan and revolving credit facilities
and entered into a new 2006 revolving credit facilities agreement with a maturity of June 30, 2011. During October 2006, we paid down the remaining $4.5 million of our debt outstanding under the 2006 facilities.

2006 Revolving Credit Facilities

The
2006 revolving credit facilities provide for a total borrowing capacity of $85.0 million, consisting of a U.S. revolving facility with a borrowing capacity of $65.0 million, a Canadian revolving facility with a borrowing capacity of $5.0 million and
a U.K. revolving facility with a borrowing capacity of $15.0 million. These revolving credit facilities are scheduled to mature on June 30, 2011. The borrowing capacities under the 2006 revolving credit facilities agreement are not subject to
any monthly borrowing base limitations. In addition to the base commitments, these new facilities permit the Company to require an increase in the aggregate borrowing capacity by $50.0 million if certain requirements are met.

We incurred $454,000 of deferred financing fees related to the 2006 revolving credit facilities agreement, which are amortized over the 2006 revolving
credit facilities agreements five-year term, using straight-line amortization method.

The 2006 revolving credit facilities agreement
provides for interest at a rate based upon the ratio of Funded Debt to EBITDA, as defined in the credit facility (EBITDA), and ranging from, at the Companys election,



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(1) a low of the London Interbank Offered Rate (LIBOR) plus 1.00% to a high of LIBOR plus 2.00% or (2) a low of a Base Rate, as defined
in the credit facility (Base Rate) plus 0.00% to a high of a Base Rate plus 1.00%. The Company is obligated to pay commitment fees related to this agreement on the undrawn portion of the facility, depending upon the ratio of Funded Debt
to EBITDA, which was calculated at 0.25% of the undrawn portion of the facility at September 30, 2006.

Aggregate borrowings of $4.5
million were outstanding under the 2006 revolving credit facilities at September 30, 2006, which bore interest at a rate of 6.56%. The Company had letters of credit outstanding of $11.4 million at September 30, 2006. Availability under the
2006 revolving credit facilities is reduced by the amount of our outstanding letters of credit and loans. Fees related to these letters of credit were approximately 1.0% of the outstanding balance at September 30, 2006. These letters of credit
support contract performance and warranties and expire at various dates through June 2009.

During the quarter ended September 30,
2006, we decreased our debt, both under the 2004 term loan and the 2006 revolving credit facilities, by $15.3 million, from $19.8 million at June 30, 2006 to $4.5 million at September 30, 2006. During October we paid the remaining $4.5
million of our debt outstanding under the 2006 facilities.

The 2006 revolving credit facilities agreement is secured by a first lien or
first priority security interest in or pledge of substantially all of the assets of the borrowers and certain subsidiaries, including accounts receivable, inventory, equipment, intangibles, equity interests in U.S. subsidiaries, 661/3% of the equity interest in active, non-U.S. subsidiaries and interests in certain contracts.
Assets of the Company and its active U.S. subsidiaries secure the US, Canadian, U.K. revolving facilities, assets of the Companys Canadian subsidiary also secure the Canadian facility and assets of the Companys U.K. subsidiaries also
secure the U.K. facility. The U.S. facility is guaranteed by each U.S. subsidiary of the Company, while the Canadian and U.K. facilities are guaranteed by NATCO Group Inc., each of its U.S. subsidiaries and the Canadian subsidiary or the U.K.
subsidiaries, as applicable.

The 2006 revolving credit facilities agreement contains restrictive covenants including, among others, those
that limit the amount of Funded Debt to EBITDA, impose a minimum fixed charge coverage ratio and impose a minimum tangible net worth requirement. We were in compliance with all restrictive debt covenants as of September 30, 2006. Pursuant to
the 2006 revolving credit facilities, the Company is not permitted to make any distributions of any property or cash to its stockholders other than dividends required under its Series B Preferred Stock and certain other dividends not to exceed, in
the aggregate, $3.0 million per year, if certain conditions related to Funded Debt to EBITDA and borrowing capacity are met, or $1.5 million per year, in the aggregate, if such conditions are not met. Subject to certain restrictions, the Company
also has the ability to buy back up to $25.0 million in value of its common stock.

Export Sales Facility

On July 23, 2004, the Company and two of its subsidiaries entered into an international revolving credit agreement with Wells Fargo HSBC Trade Bank,
N.A. providing for loans of up to $10.0 million, subject to borrowing base limitations. This working capital facility for export sales is secured by specific project inventory and receivables, as well as certain other inventory, accounts receivable
and equipment, and is partially guaranteed by the U.S. Export-Import Bank. Loans under this facility mature on March 31, 2007, and bear interest at either (1) a Base Rate, as defined in the agreement, less 0.25% or (2) LIBOR plus
2.00%, at the Companys election. There were no loans outstanding at September 30, 2006. Letters of credit outstanding under this facility as of September 30, 2006 were $9.8 million. This facility had fees related to letters of credit
of approximately 1.00% of the outstanding balance.



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Other

At September 30, 2006, the Company had unsecured letters of credit and bonds totaling $317,000.

(9) Accrued
Expenses and Other

Accrued expenses and other consisted of the following:



|                                     |  |                   |        |                  |   |       
|------------------------------------ |  | ----------------- | ------ | ---------------- | - | ------
|                                     |  | September 30,2006 |        | December 31,2005
|                                     |  | (in thousands)   
|                                     |  | (unaudited)       |        |                 
|Accrued compensation and benefits    |  | $                 | 10,194 |                  | $ | 9,182 
|Accrued insurance                    |  |                   | 3,433  |                  |   | 2,447 
|Accrued warranty and product costs   |  |                   | 3,395  |                  |   | 2,773 
|Accrued project costs                |  |                   | 25,355 |                  |   | 21,832
|Accrued closure, severance and other |  |                   | 2,596  |                  |   | 2,197 
|Taxes and other                      |  |                   | 2,516  |                  |   | 3,350 
|                                     |  |                   |        |                  |   |       
|Totals                               |  | $                 | 47,489 |                  | $ | 41,781
|                                     |  |                   |        |                  |   |       

(10) Postretirement Benefits

The Company maintains postretirement benefit plans that provide health care and life insurance benefits for retired employees of a predecessor company. These plans are accounted for in accordance with SFAS
No. 106, Employers Accounting for Postretirement Benefits Other than Pensions. The Company has adopted SFAS No. 132, Employers Accounting for Pensions and Other Postretirement Benefits, which revised
disclosures about pension and other postretirement benefit plans.

From May 2004 to December 31, 2005, the Company accounted for the
prescription drug benefit under its retiree medical plans in accordance with SFAS No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. On
December 31, 2005, the Company amended the postretirement benefit plans to eliminate prescription drug coverage for post-age 65 participants along with increases in retiree premiums and elimination of dental coverage for one of the groups of
retirees of a predecessor company. Under the amended plans, retirees bear additional costs of coverage. As a result, SFAS No. 106-2 no longer applied to the Company starting January 1, 2006, and our SFAS No. 106 net periodic cost has
been reduced since that date. As of December 31, 2005 the recorded liability for the accumulated postretirement benefit obligation was $10.0 million, while the actuarially determined amount for this obligation was $7.8 million. This difference
is primarily due to the plan amendments made in December 2005 that increased retiree premiums and reduced certain plan benefits.

SFAS
No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, requires an employer with publicly traded equity securities to recognize the funded status of a benefit plan and the related disclosure
requirements. The Company will adjust the liability according to SFAS No. 158 and does not expect any potential negative impact on its consolidated results of operations, financial position or cash flows resulting from the adoption of the
standard upon the effective date of December 31, 2006.



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table summarizes the components of net periodic benefit cost under the Companys
postretirement benefit plans as of September 30, 2006 and 2005, respectively:



|                                |  |                                 |      |   |                                |   |      |      |  |   |        |   |  |   |      |  
|------------------------------- |  | ------------------------------- | ---- | - | ------------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ---- | -
|                                |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|                                |  | 2006                            |      |   | 2005                           |   |      | 2006 |  |   | 2005   |  
|                                |  | (unaudited, in thousands)       |     
|Unrecognized prior service cost |  | $                               | (484 | ) |                                | $ | (177 | )    |  | $ | (1,152 | ) |  | $ | (531 | )
|Interest cost                   |  |                                 | 108  |   |                                |   | 210  |      |  |   | 323    |   |  |   | 630  |  
|Unrecognized loss               |  |                                 | 276  |   |                                |   | 177  |      |  |   | 829    |   |  |   | 531  |  
|                                |  |                                 |      |   |                                |   |      |      |  |   |        |   |  |   |      |  
|Net periodic benefit cost(1)    |  | $                               | (100 | ) |                                | $ | 210  |      |  | $ |       |   |  | $ | 630  |  
|                                |  |                                 |      |   |                                |   |      |      |  |   |        |   |  |   |      |  

During the quarter ended September 30, 2006, the Company made an adjustment of $100,000 to reduce the net
periodic benefit cost as a result of lower participation in the plans.



|(1) | Net periodic benefit cost is referred to as Interest cost on postretirement benefit liability in the Unaudited Consolidated Statements of Operations and
the reconciliation of the total segment profit to net income in Note 15, Industry Segments.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

(11) Litigation

The Company and its subsidiaries are defendants or otherwise involved in a number of other legal proceedings in the ordinary course of their business.
While we insure against certain risks to the extent deemed prudent by our management, we can 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. While we cannot predict the outcome of any legal proceedings with certainty, in the opinion of management, our ultimate liability with respect to these pending lawsuits is not expected to have a material adverse effect on
our consolidated financial position, results of operations or cash flows.

(12) Stock-Based Compensation

Stock-Based Compensation information under SFAS No. 123R

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R). This amendment requires expensing of stock
options and other share-based payments and supersedes SFAS No. 123, which allowed companies to choose between expensing stock options or showing pro forma disclosure only. This standard became effective for the Company as of January 1,
2006 and applies to all awards granted, modified, canceled or repurchased after that date as well as the unvested portion of prior awards.

On November 10, 2005, the FASB issued a FASB Staff Position (FSP) FAS 123 R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The Company evaluated the alternative
methods provided in this Statement and elected to apply the long-haul method starting January 1, 2006.

Certain of our employees and
non-employee directors participate in long-term incentive compensation plans that provide, among other things, for grants of options to acquire shares of the Companys common stock, and awards of restricted stock and other forms of stock-based
compensation. Stock options currently outstanding under these plans have no performance requirements, vest annually over periods of three to four years and have a maximum term of up to ten years. The Company had 992,130 shares available for future
awards under its incentive compensation plans as of September 30, 2006. Under SFAS No. 123R, share-based compensation cost



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



is measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the employees requisite service
period. The requisite service period for stock options and fixed awards are based on the vesting period determined at date of grant. The requisite service period for performance-based awards is based on the best estimate of the period over which the
performance criteria is expected to be met. Under the Companys long-term incentive plans, the fair market value of the restricted stock awards is determined on the date of grant and is amortized and ratably charged to income. The Company has
issued both fixed and performance-based restricted stock awards under its plans. Under SFAS No. 123R, fixed awards are amortized over the vesting period provided in the award (typically, from one to three years), while performance awards are
amortized over the period the Company expects will be required to meet the performance requirements. The Company uses a modified prospective application methodology permitted under SFAS No. 123R, which provides for certain changes to the method
for valuing share-based compensation. Under the modified prospective application, prior periods are not revised for comparative purposes.

The Company values share-based options by applying the Black-Scholes-Merton Single OptionReduced Term valuation method which was previously used for the Companys pro forma information required under SFAS No. 123 and SFAS
No. 148. This valuation model requires management to make assumptions about the volatility of the Companys common stock, the expected term of outstanding stock options, the Companys risk-free interest rate and expected dividend
payments during the contractual life of the options.

The following assumptions were used to determine the fair value of stock option
awards granted during nine months ended September 30, 2006. There were no options granted during the three months ended September 30, 2006:



|                        |  |                                    
|----------------------- |  | -----------------------------------
|                        |  | Nine months endedSeptember 30, 2006
|                        |  | (unaudited)                        
|Expected term           |  | 6.0 years                          
|Volatility              |  | 45.00%                             
|Risk-free interest rate |  | 4.22%  4.91%                      
|Dividend yield          |  | 0.00%                              

Volatility was evaluated based upon historical data of the Companys stock price from the New
York Stock Exchange from the date of our initial public offering, January 28, 2000 to June 30, 2006.

The risk-free interest
rate, as determined on the date of grant, was based upon observed interest rates associated with U.S. Treasury zero coupon instruments with a term similar to the expected term calculated as discussed below. The Company does not anticipate paying any
dividends on its common stock for the foreseeable future.

The expected term for options was six years and was computed using the
Simplified Method as permitted by SFAS No. 123R. This assumption was based on the Companys opinion that the recent option exercise history may not necessarily reflect future exercise behavior and that historical data for the
previous years approximates this term.

Share-based compensation expense was recognized in the Unaudited Consolidated Statement of
Operations for the three months and nine months ended September 30, 2006 based on awards ultimately expected to vest. SFAS No. 123R requires forfeitures to be estimated at the date of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. Forfeitures were estimated at annual rates of 2.833% and 3.0%, respectively for stock options granted and restricted stock awarded during the three and nine months ended September 30, 2006
based on the Companys historical cancellation and forfeiture experience. The Company



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##### Table of Contents

NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



changed its estimated forfeiture rate for restricted stock from 0.833% to 3.0% due to forfeitures during the third quarter of 2006 as required by SFAS
No. 123R. The cumulative effect of this change decreased compensation expense for the three months ended September 30, 2006 by $51,000.

The components of total share-based compensation expense, related to all of the Companys share-based awards, recognized for the three and nine months ended September 30, 2006 follow:



|                                                      |  |                                      |       |   |                                     |   |        |  
|----------------------------------------------------- |  | ------------------------------------ | ----- | - | ----------------------------------- | - | ------ | -
|                                                      |  | Three Months EndedSeptember 30, 2006 |       |   | Nine Months EndedSeptember 30, 2006 |  
|                                                      |  | (unaudited, in thousands)            |      
|Share-based compensation expense                      |  | $                                    | 2,552 |   |                                     | $ | 3,650  |  
|Less: Tax benefit of share-based compensation expense |  |                                      | (949  | ) |                                     |   | (1,351 | )
|                                                      |  |                                      |       |   |                                     |   |        |  
|Share-based compensation expense, net of tax          |  | $                                    | 1,603 |   |                                     | $ | 2,299  |  
|                                                      |  |                                      |       |   |                                     |   |        |  

Share-based compensation expense includes $1.1 million of non-cash compensation expense, net of
$650,000 tax benefit or $1.7 million pre-tax, for the correction of an error that should have been recorded in the fiscal year 2005 related to stock options issued in 1998, at a price set in anticipation of an initial public offering, which were
subsequently canceled and re-issued at a lower price in March 1999. We later became a public company in January 2000. Compensation expense should have been determined using variable accounting per FASB Interpretation No. (FIN) 44,
Accounting for Certain Transactions involving Stock Compensation, which was issued subsequent to the time these options were re-priced but had retroactive effect. Management discovered the error in the quarter ended September 30, 2006
and has deemed it to be immaterial for both the 2005 and 2006 periods and with respect to the quarterly trends in earnings for both periods. The Company has corrected the accounting to properly recognize the compensation expense by applying variable
accounting to these awards as required by FIN 44. Effective with the January 1, 2006 adoption of SFAS No. 123R, variable accounting is no longer applicable to these re-priced stock options and therefore there will be no further impact related to
these options in 2006 or future periods.

Reconciliation

A tabular reconciliation of the changes in long-term incentive compensation plans for the nine months ended September 30, 2006 is set forth below
(unaudited).



|                              |  |                    |   |  |                               |       |                                                    |      |                                        |   |       
|----------------------------- |  | ------------------ | - |  | ----------------------------- | ----- | -------------------------------------------------- | ---- | -------------------------------------- | - | ------
|                              |  | Stock OptionShares |   |  | WeightedAverageExercise Price |       | WeightedAverageRemainingContractual Term(in years) |      | Aggregate IntrinsicValue(in thousands)
|Balance at December 31, 2005  |  | 1,066,789          |   |  | $                             | 9.17  |                                                    |      |                                        |   |       
|Granted                       |  | 222,221            |   |  | $                             | 35.53 |                                                    |      |                                        |   |       
|Exercised                     |  | (341,504           | ) |  | $                             | 8.83  |                                                    |      |                                        |   |       
|Canceled / forfeited          |  | (51,891            | ) |  | $                             | 12.81 |                                                    |      |                                        |   |       
|                              |  |                    |   |  |                               |       |                                                    |      |                                        |   |       
|Balance at September 30, 2006 |  | 895,615            |   |  | $                             | 15.63 |                                                    | 6.68 |                                        | $ | 11,798
|Vested                        |  | 532,859            |   |  | $                             | 9.07  |                                                    | 5.03 |                                        | $ | 10,514
|Unvested                      |  | 362,756            |   |  | $                             | 25.26 |                                                    | 9.10 |                                        | $ | 1,284 

There were no options granted during the three months ended September 30, 2006. The weighted
average grant date fair value of stock options granted during nine months ended September 30, 2006 was $17.81. The weighted average grant date fair value was $5.02 for stock options granted during the three and nine months ended
September 30, 2005. The total intrinsic value of share options exercised during the three and nine months ended September 30, 2006 was $2.6 million and $9.0 million, respectively, and for the three and nine months ended September 30,
2005 was $4.4 million and $5.2 million, respectively. As of September 30, 2006 there was $3.8 million of unrecognized compensation cost related to stock options granted. This cost is expected to be recognized over a weighted-average period of
2.2 years.



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##### Table of Contents

NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



A tabular reconciliation of the changes in restricted stock for the nine months ended
September 30, 2006 is set forth below (unaudited).



|                               |  |                  |   |  |                                       |      
|------------------------------ |  | ---------------- | - |  | ------------------------------------- | -----
|                               |  | Number of Shares |   |  | WeightedAverage Grant Date Fair Value
|Unvested at December 31, 2005  |  | 238,071          |   |  | $                                     | 10.29
|Granted                        |  | 72,081           |   |  | $                                     | 32.87
|Vested                         |  | (56,147          | ) |  | $                                     | 8.33 
|Forfeited                      |  | (14,040          | ) |  | $                                     | 18.16
|                               |  |                  |   |  |                                       |      
|Unvested at September 30, 2006 |  | 239,965          |   |  | $                                     | 16.78
|                               |  |                  |   |  |                                       |      

The weighted average grant date fair value of restricted shares awarded during nine months ended
September 30, 2006 and September 30, 2005 was $32.87 and $10.12, respectively. There were no restricted shares awarded during the three months ended September 30, 2006 or September 30, 2005. The total intrinsic value of
restricted shares vested during the three and nine months ended September 30, 2006 was $0.4 million and $2.2 million, respectively. The total intrinsic value of restricted shares vested during the three and nine months ended September 30,
2005 was $1.0 million and $1.1 million, respectively. As of September 30, 2006 there was $2.4 million of unrecognized compensation cost related to restricted stock arrangements. This cost is expected to be recognized over a weighted-average
period of 2.03 years.

The Company may elect to issue new shares or treasury shares, if any, under its long-term incentive compensation
plans. The Company had no treasury stock as of September 30, 2006.

Pro Forma Information under SFAS No. 123 for Periods Prior
to Fiscal 2006

Prior to the effective date of SFAS No. 123R, the Company accounted for its employee stock option plans by applying
the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, as permitted by SFAS No. 123, Accounting for Stock Based Compensation. SFAS No. 123
allowed entities to recognize as expense over the vesting period, the fair value of all stock-based awards on the date of grant. If entities applied the provisions of APB Opinion No. 25, pro forma net income and earnings per share disclosures
were required for all employee stock option grants made in 1995 and subsequent years, as if the fair value-based method defined in SFAS No. 123 had been applied.

Pro forma disclosures required by SFAS No. 123 for the three and nine months ended September 30, 2005 were as follows:



|                                                                                                                                   |  |                                                     |       |   |                                     |   |       |  
|---------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------- | ----- | - | ----------------------------------- | - | ----- | -
|                                                                                                                                   |  | Three Months EndedSeptember 30, 2005                |       |   | Nine Months EndedSeptember 30, 2005 |  
|                                                                                                                                   |  | (unaudited; in thousands, except per share amounts) |      
|Net income allocable to common stockholdersas reported                                                                            |  | $                                                   | 2,014 |   |                                     | $ | 6,685 |  
|Add: Restricted stock expense, net of related tax effects                                                                          |  |                                                     | 589   |   |                                     |   | 1,126 |  
|Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                                                     | (602  | ) |                                     |   | (887  | )
|                                                                                                                                   |  |                                                     |       |   |                                     |   |       |  
|Pro forma income                                                                                                                   |  | $                                                   | 2,001 |   |                                     | $ | 6,924 |  
|                                                                                                                                   |  |                                                     |       |   |                                     |   |       |  
|Earnings per share:                                                                                                                |  |                                                     |       |   |                                     |   |       |  
|Basicas reported                                                                                                                  |  | $                                                   | 0.12  |   |                                     | $ | 0.42  |  
|Basicpro forma                                                                                                                    |  | $                                                   | 0.12  |   |                                     | $ | 0.43  |  
|Dilutedas reported                                                                                                                |  | $                                                   | 0.12  |   |                                     | $ | 0.41  |  
|Dilutedpro forma                                                                                                                  |  | $                                                   | 0.12  |   |                                     | $ | 0.42  |  



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##### Table of Contents

NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company utilized the Black-Scholes-Merton valuation method to calculate the pro forma information
for stock-based compensation expense as it relates to stock options as presented above. The following table summarizes assumptions used to determine pro forma compensation expense under SFAS No. 123 as of June 30, 2005:



|                        |  |              
|----------------------- |  | -------------
|Expected Term           |  | 3.5  7 years
|Volatility              |  | 47%          
|Risk-free interest rate |  | 1.49%  6.52%
|Dividend yield          |  | 0.0%         

(13) Warrants

On March 25, 2003, the Company issued 15,000 shares of Series B Convertible Preferred Stock and warrants to purchase 248,800 shares of NATCOs common stock to a private investment fund. The warrants had an
exercise price of $10.00 per share of common stock and were to expire on March 25, 2006. The Company had the ability to force the exercise of the warrants if NATCOs common stock traded above $13.50 per share for 30 consecutive trading
days, at which point the holder could elect to (1) exercise the warrants in full, (2) exercise for the net amount of shares issuable after deduction of the exercise price from the current market price of the shares on the date preceding
the exercise date or (3) not to exercise the warrants, resulting in their termination. The warrants contained a provision whereby the holder could require the Company to make a net-cash settlement for the warrants in the case of a change in
control. The warrants were deemed to be derivative instruments and, therefore, the warrants were recorded at fair value as of the issuance date. Fair value, as agreed with the counter-party to the agreement, was calculated by applying a pricing
model that included subjective assumptions for stock volatility, expected term that the warrants would be outstanding, a dividend rate of zero and an overall liquidity factor. The Company recorded the resulting liability of $99,000 as of the
issuance date.

On August 26, 2005, the investment fund exercised all of the warrants pursuant to the cashless exercise provision
contained in the warrant instrument, resulting in no cash payment to the Company. The number of shares of common stock issued to the investment fund was calculated based on the average of the closing price of the Companys shares on the New
York Stock Exchange for the ten trading-day period ending on the day prior to the exercise. The average price was $17.933, resulting in the issuance of 110,061 shares of common stock in exchange for the warrants.

(14) Earnings per Share

In accordance with SFAS
No. 128 Earnings per Share, the Company computed basic earnings per share by dividing net income allocable to common stockholders by the weighted average number of shares outstanding for the period. Net income allocable to common
stockholders at September 30, 2006 represented net income less preferred stock dividends accrued. The Company determined diluted earnings per common and potential common share at September 30, 2006 as net income allocable to common
stockholders divided by the weighted average number of shares outstanding for the period, after applying the if-converted method to determine any incremental shares associated with convertible preferred stock, stock options and
restricted stock outstanding.

As of January 1, 2006, the Company adopted SFAS No. 123R and computed incremental shares according
to SFAS No. 123R requirements. The assumed proceeds used in the Treasury Method include the windfall tax benefit related to unrecognized compensation expense. For purposes of the weighted average shares calculation, restricted
shares as to which the performance criteria have not been met were excluded.

If anti-dilutive common shares were included for the three
and nine months ended September 30, 2006, the impact would have been a reduction of approximately 63,823 and 79,060 shares, respectively. The lapse of



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##### Table of Contents

NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



restrictions on certain shares of restricted stock in the second and third quarters of 2006 and various new grants of stock options during the second quarter
of 2006 accounted for the changes in the weighted average number of shares for basic and diluted common stock for the three and nine months ended September 30, 2006. For the three months and nine months ended September 30, 2006,
1.9 million shares issuable upon conversion of the Series B Preferred Shares were included in the calculation of incremental shares, as the inclusion of these shares was dilutive at the level of income in these two periods.

The following table presents the computation of basic and diluted earnings per common and potential common share for the three and nine months ended
September 30, 2006 and 2005, respectively:



|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|--------------------------------------------------- |  | --------------------------------------------------- | ------ | ------------------------------------- | ---------------------------------- | ------ | ---------------- | - | ------ |  | - | ---------------------------------- | - | ---------------- | ------ |  | - | ----
|                                                    |  | Three Months Ended September 30, 2006               |        | Three Months Ended September 30, 2005
|                                                    |  | Income                                              |        |                                       | Weighted AverageShares Outstanding |        | Per-share Amount |   | Income |  |   | Weighted AverageShares Outstanding |   | Per-share Amount
|                                                    |  | (unaudited; in thousands, except per-share amounts)
|Net income                                          |  | $                                                   | 9,403  |                                       |                                    |        |                  |   |        |  | $ | 2,389                              |   |                  |        |  |   |     
|Less: Convertible preferred stock dividends accrued |  |                                                     | (375   | )                                     |                                    |        |                  |   |        |  |   | (375                               | ) |                  |        |  |   |     
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Basic EPS:                                          |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Income allocable to common stockholders             |  |                                                     | 9,028  |                                       |                                    | 17,016 |                  | $ | 0.53   |  | $ | 2,014                              |   |                  | 16,260 |  | $ | 0.12
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Effect of dilutive securities:                      |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Warrants                                            |  |                                                     |        |                                       |                                    |       |                  |   |        |  |   |                                    |   |                  | 55     |  |   |     
|Stock options                                       |  |                                                     |        |                                       |                                    | 310    |                  |   |        |  |   |                                    |   |                  | 368    |  |   |     
|Restricted stock                                    |  |                                                     |        |                                       |                                    | 59     |                  |   |        |  |   |                                    |   |                  | 110    |  |   |     
|Convertible preferred stock                         |  |                                                     |        |                                       |                                    | 1,922  |                  |   |        |  |   |                                    |   |                  |       |  |   |     
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Diluted EPS:                                        |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Plus: Convertible preferred stock dividends accrued |  |                                                     | 375    |                                       |                                    |        |                  |   |        |  |   |                                   |   |                  |        |  |   |     
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Income allocable to common stockholders             |  | $                                                   | 9,403  |                                       |                                    | 19,307 |                  | $ | 0.49   |  | $ | 2,014                              |   |                  | 16,793 |  | $ | 0.12
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|                                                    |  |                                                    
|                                                    |  | Nine Months Ended September 30, 2006                |        | Nine Months Ended September 30, 2005 
|                                                    |  | Income                                              |        |                                       | Weighted AverageShares Outstanding |        | Per-share Amount |   | Income |  |   | Weighted AverageShares Outstanding |   | Per-share Amount
|                                                    |  | (unaudited; in thousands, except per-share amounts)
|Net income                                          |  | $                                                   | 26,788 |                                       |                                    |        |                  |   |        |  | $ | 7,810                              |   |                  |        |  |   |     
|Less: Convertible preferred stock dividends accrued |  |                                                     | (1,125 | )                                     |                                    |        |                  |   |        |  |   | (1,125                             | ) |                  |        |  |   |     
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Basic EPS:                                          |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Income allocable to common stockholders             |  | $                                                   | 25,663 |                                       |                                    | 16,824 |                  | $ | 1.53   |  | $ | 6,685                              |   |                  | 16,005 |  | $ | 0.42
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Effect of dilutive securities:                      |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Warrants                                            |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  | 32     |  |   |     
|Stock options                                       |  |                                                     |        |                                       |                                    | 341    |                  |   |        |  |   |                                    |   |                  | 252    |  |   |     
|Restricted stock                                    |  |                                                     |        |                                       |                                    | 52     |                  |   |        |  |   |                                    |   |                  | 75     |  |   |     
|Convertible preferred stock                         |  |                                                     |        |                                       |                                    | 1,922  |                  |   |        |  |   |                                    |   |                  |       |  |   |     
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Diluted EPS:                                        |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Plus: Convertible preferred stock dividends accrued |  |                                                     | 1,125  |                                       |                                    |        |                  |   |        |  |   |                                   |   |                  |        |  |   |     
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     
|Income allocable to common stockholders             |  | $                                                   | 26,788 |                                       |                                    | 19,139 |                  | $ | 1.40   |  | $ | 6,685                              |   |                  | 16,364 |  | $ | 0.41
|                                                    |  |                                                     |        |                                       |                                    |        |                  |   |        |  |   |                                    |   |                  |        |  |   |     



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(15) Industry Segments

The Companys operating segments are Oil & Water Technologies, Gas Technologies and Automation & Controls.



| |  |  | The Oil & Water Technologies segment includes both standard and traditional oil and gas separation and dehydration equipment sales and related services and built-to-order
systems focused primarily on oil and water production and processing.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Gas Technologies segment includes our CO2membrane business, the assets and operating relationship related to our gas processing facilities in West Texas, H2S
removal technologies including Shell Paques and
other built-to-order gas-related technologies that focus on removing contaminants from the gas stream.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Automation & Controls segment focuses on the manufacture and sale of new control panels and systems which monitor and control oil and gas production, as well as field
service activities including repair, maintenance, testing and inspection services for existing systems.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Company
allocates corporate and other expenses to each of its business segments. This allocation is driven by a formula based on headcount, total assets, revenue and bookings. Corporate assets are allocated to the segments based on the total assets of the
segment. The accounting policies of the reportable segments were consistent with the policies used to prepare the Companys consolidated financial statements for the respective periods presented. The Company evaluates the performance of its
operating segments based on total segment profit, which is defined as net income that includes minority interest expense but before net interest expense, depreciation and amortization expense, closure, severance and other, interest cost on
postretirement benefit liability, other, net and income taxes.

Summarized financial information concerning the Companys reportable
segments is shown in the following table.



|                                      |  |                           |         |                 |   |                      |  |              |        |  |       |        |   |  |   |        
|------------------------------------- |  | ------------------------- | ------- | --------------- | - | -------------------- |  | ------------ | ------ |  | ----- | ------ | - |  | - | -------
|                                      |  | Oil & WaterTechnologies   |         | GasTechnologies |   | Automation &Controls |  | Eliminations |        |  | Total
|                                      |  | (unaudited, in thousands)
|Three Months Ended September 30, 2006 |  |                           |         |                 |   |                      |  |              |        |  |       |        |   |  |   |        
|Revenue from unaffiliated customers   |  | $                         | 94,018  |                 | $ | 15,478               |  | $            | 22,682 |  | $     |       |   |  | $ | 132,178
|Inter-segment revenue                 |  | $                         | 2,013   |                 | $ |                     |  | $            | 1,199  |  |       | (3,212 | ) |  | $ |       
|Segment profit                        |  | $                         | 7,645   |                 | $ | 4,899                |  | $            | 3,306  |  | $     |       |   |  | $ | 15,850 
|Total assets                          |  | $                         | 224,717 |                 | $ | 61,678               |  | $            | 33,033 |  | $     |       |   |  | $ | 319,428
|Capital expenditures                  |  | $                         | 733     |                 | $ | 217                  |  | $            | 142    |  | $     |       |   |  | $ | 1,092  
|Depreciation and amortization         |  | $                         | 735     |                 | $ | 452                  |  | $            | 112    |  | $     |       |   |  | $ | 1,299  
|                                      |  |                           |         |                 |  
|Three Months Ended September 30, 2005 |  |                           |         |                 |   |                      |  |              |        |  |       |        |   |  |   |        
|Revenue from unaffiliated customers   |  | $                         | 76,114  |                 | $ | 12,798               |  | $            | 13,488 |  | $     |       |   |  | $ | 102,400
|Inter-segment revenue                 |  | $                         | 98      |                 | $ |                     |  | $            | 1,254  |  | $     | (1,352 | ) |  | $ |       
|Segment profit                        |  | $                         | 2,961   |                 | $ | 6,546                |  | $            | 697    |  | $     |       |   |  | $ | 10,204 
|Total assets                          |  | $                         | 180,533 |                 | $ | 59,099               |  | $            | 23,360 |  | $     |       |   |  | $ | 262,992
|Capital expenditures                  |  | $                         | 452     |                 | $ | 98                   |  | $            | 44     |  | $     |       |   |  | $ | 594    
|Depreciation and amortization         |  | $                         | 628     |                 | $ | 556                  |  | $            | 92     |  | $     |       |   |  | $ | 1,276  



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|                                     |  |                           |         |                 |   |                      |  |              |        |  |       |        |   |  |   |        
|------------------------------------ |  | ------------------------- | ------- | --------------- | - | -------------------- |  | ------------ | ------ |  | ----- | ------ | - |  | - | -------
|                                     |  | Oil & WaterTechnologies   |         | GasTechnologies |   | Automation &Controls |  | Eliminations |        |  | Total
|                                     |  | (unaudited, in thousands)
|Nine months Ended September 30, 2006 |  |                           |         |                 |   |                      |  |              |        |  |       |        |   |  |   |        
|Revenue from unaffiliated customers  |  | $                         | 270,650 |                 | $ | 44,959               |  | $            | 63,042 |  | $     |       |   |  | $ | 378,651
|Inter-segment revenue                |  | $                         | 6,023   |                 | $ |                     |  | $            | 3,527  |  | $     | (9,550 | ) |  | $ |       
|Segment profit                       |  | $                         | 21,528  |                 | $ | 18,382               |  | $            | 8,630  |  | $     |       |   |  | $ | 48,540 
|Total assets                         |  | $                         | 224,717 |                 | $ | 61,678               |  | $            | 33,033 |  | $     |       |   |  | $ | 319,428
|Capital expenditures                 |  | $                         | 2,836   |                 | $ | 275                  |  | $            | 454    |  | $     |       |   |  | $ | 3,565  
|Depreciation and amortization        |  | $                         | 2,403   |                 | $ | 1,462                |  | $            | 298    |  | $     |       |   |  | $ | 4,163  
|                                     |  |                           |         |                 |  
|Nine months Ended September 30, 2005 |  |                           |         |                 |   |                      |  |              |        |  |       |        |   |  |   |        
|Revenue from unaffiliated customers  |  | $                         | 215,186 |                 | $ | 27,972               |  | $            | 42,546 |  | $     |       |   |  | $ | 285,704
|Inter-segment revenue                |  | $                         | 620     |                 | $ |                     |  | $            | 3,175  |  | $     | (3,795 | ) |  | $ |       
|Segment profit                       |  | $                         | 6,878   |                 | $ | 14,426               |  | $            | 3,581  |  | $     |       |   |  | $ | 24,885 
|Total assets                         |  | $                         | 180,533 |                 | $ | 59,099               |  | $            | 23,360 |  | $     |       |   |  | $ | 262,992
|Capital expenditures                 |  | $                         | 1,914   |                 | $ | 153                  |  | $            | 330    |  | $     |       |   |  | $ | 2,397  
|Depreciation and amortization        |  | $                         | 1,999   |                 | $ | 1,653                |  | $            | 279    |  | $     |       |   |  | $ | 3,931  

The following table reconciles total segment profit to net income as set forth below:



|                                                  |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                  |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                  |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005   |  
|                                                  |  | (unaudited, in thousands)       |       
|Total segment profit                              |  | $                               | 15,850 |   |                                | $ | 10,204 |      |  | $ | 48,540 |   |  | $ | 24,885 |  
|Interest expense                                  |  |                                 | 491    |   |                                |   | 942    |      |  |   | 1,922  |   |  |   | 3,033  |  
|Interest income                                   |  |                                 | (96    | ) |                                |   | (5     | )    |  |   | (215   | ) |  |   | (70    | )
|Depreciation and amortization                     |  |                                 | 1,299  |   |                                |   | 1,276  |      |  |   | 4,163  |   |  |   | 3,931  |  
|Closure, severance and other                      |  |                                 | 2,325  |   |                                |   | 2,076  |      |  |   | 2,570  |   |  |   | 2,166  |  
|Interest cost on postretirement benefit liability |  |                                 | (100   | ) |                                |   | 210    |      |  |   |       |   |  |   | 630    |  
|Other, net                                        |  |                                 | (2,213 | ) |                                |   | 1,630  |      |  |   | (2,084 | ) |  |   | 2,024  |  
|                                                  |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income before income taxes                    |  | $                               | 14,144 |   |                                | $ | 4,075  |      |  | $ | 42,184 |   |  | $ | 13,171 |  
|Income tax provision                              |  |                                 | 4,741  |   |                                |   | 1,686  |      |  |   | 15,396 |   |  |   | 5,361  |  
|                                                  |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income                                        |  | $                               | 9,403  |   |                                | $ | 2,389  |      |  | $ | 26,788 |   |  | $ | 7,810  |  
|                                                  |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  

The following table provides further information on revenue by product line within the
Oil & Water Technologies segment for the three and nine months ended September 30, 2006 and 2005.



|                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                               |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                               |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005    |  
|                                               |  | (unaudited, in thousands)       |       
|Traditional/standard/used equipment            |  | $                               | 63,153 |   |                                | $ | 46,671 |      |  | $ | 182,617 |   |  | $ | 141,921 |  
|Built-to-order                                 |  |                                 | 33,825 |   |                                |   | 30,754 |      |  |   | 95,603  |   |  |   | 77,678  |  
|Eliminations                                   |  |                                 | (947   | ) |                                |   | (1,213 | )    |  |   | (1,547  | ) |  |   | (3,793  | )
|                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total Oil & Water Technologies segment revenue |  | $                               | 96,031 |   |                                | $ | 76,212 |      |  | $ | 276,673 |   |  | $ | 215,806 |  
|                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(16) Disposition

On July 20, 2006, the Company sold a portion of its investment in NATCO Japan Company Ltd. to Modec Inc. and Daiichi Jitsugyo, Ltd., an existing shareholder, for a total cash consideration of $3.0 million. The Company
recognized a $2.5 million gain on the sale in the quarter ended September 30, 2006, net of the existing equity cost basis and legal fees.

The Company continues to own 60% of NATCO Japan after the sale. The Company continues to exercise financial control over NATCO Japan and will consolidate its activities into the Companys consolidated financial statements. In addition,
the Company will record a minority interest expense for the portion of earnings related to the minority interest ownership of its joint venture partners. For the three months ended September 30, 2006, the Company recorded $400,000 as a minority
interest expense.

(17) Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4. SFAS No. 151 amends ARB No. 43,
Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production
overhead to inventory be based on the normal capacity of the production facilities. SFAS No. 151 became effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted this pronouncement on
June 15, 2005, with no material impact on its consolidated results of operations, financial position or cash flows.

In December 2004,
the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges
of nonmonetary assets should be measured based on the fair value of the assets exchanged. The amendment made by SFAS No. 153 eliminates the exception for exchanges of similar productive assets and replaces it with a broader exception for
exchanges of nonmonetary assets that do not have commercial substance. This statement became effective on June 15, 2005. The Company adopted the standard as of the effective date with no material impact on its consolidated results of
operations, financial position or cash flows.

In March 2005, the FASB issued Interpretation No. (FIN) 47, Accounting for
Conditional Asset Retirement Obligations. FIN 47 clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to
perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within control of the entity. The obligation to perform the asset retirement activity is unconditional
even though uncertainty exists about the timing and (or) method of settlement. Uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when
sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Interpretation is effective no later than the end of fiscal years
ending after December 15, 2005. The Company adopted this standard on January 1, 2006. The adoption of this standard did not have a material effect on the Companys consolidated results of operations, financial position or cash flows.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error CorrectionsA Replacement of APB Opinion
No. 20 and FASB Statement No. 3. The new standard changes the requirements for the accounting for and reporting of a change in accounting principle. Among other changes, SFAS No. 154



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new
accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (1) a change in method of depreciating or amortizing a long-lived non-financial asset be accounted for as a change in estimate (prospectively) that
was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a restatement. The new standard is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005. The Company adopted this standard on January 1, 2006. The adoption of this standard did not have a material effect on the Companys consolidated results of operations, financial
position or cash flows.

In September 2005, the FASBs Emerging Issues Task Force (EITF) issued EITF No. 04-13, Accounting
for Purchases and Sales of Inventory with the Same Counterparty. This pronouncement provides additional accounting guidance for situations involving inventory exchanges between parties to that contained in APB Opinion No. 29,
Accounting for Nonmonetary Transactions and SFAS No. 153, Exchanges of Nonmonetary Assets. The standard is effective for new arrangements entered into in reporting periods beginning after

March 15, 2006, and to all inventory transactions that are completed after December 15, 2006 for arrangements entered into prior to March 15, 2006. The
Company adopted this standard on January 1, 2006. The adoption of this standard did not have a material effect on the Companys consolidated results of operations, financial position or cash flows.

In September 2005, the U.S. Securities and Exchange Commission (SEC) staff revised EITF No. D-98, Classification and Measurement of
Redeemable Securities, primarily to provide guidance on (1) the earnings per share treatment of redeemable common stock and (2) the application of EITF No. D-98 to share-based payment arrangements with employees. The guidance on the
earnings per share treatment of redeemable common stock in EITF No. D-98 to share-based payment arrangements with employees is effective in the first fiscal period beginning after September 15, 2005. The Company adopted EITF No. D-98 as of the
effective date as it relates to the earnings per share treatment of redeemable common stock, and has applied the application to share-based payment arrangements with employees concurrently with the adoption of SFAS No. 123R. The adoption of
this standard did not have a material effect on the Companys consolidated results of operations, financial position or cash flows.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140, which is effective for fiscal years beginning after
September 15, 2006. The statement was issued to clarify the application of FASB Statement No. 133 to beneficial interests in securitized financial assets and to improve the consistency of accounting for similar financial instruments,
regardless of the form of the instruments. The Company is in the process of evaluating the impact, if any, of this standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement
No. 140, which is effective for fiscal years beginning after September 15, 2006. This statement was issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement
attributes. The Company is in the process of evaluating the impact, if any, of this standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In March 2006, the EITF issued EITF No. 05-01, Accounting for the Conversion of an Instrument that Became Convertible upon the Issuers
Exercise of a Call Option. This issue requires that the issuance of equity securities to settle a debt instrument that became convertible on the issuers exercise of a call option be accounted



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



for as a conversion if the debt instrument contains a substantive conversion feature as of its issuance date. Absent a substantive conversion feature, it
should be accounted for as a debt extinguishment. EITF No. 05-01 is effective for periods beginning after June 28, 2006. The Company adopted this standard as of July 1, 2006. The adoption of this standard did not have a material
effect on the Companys consolidated results of operations, financial position or cash flows.

In March 2006, the EITF issued EITF
No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF No. 06-03 requires that the presentation of taxes
assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer on either a gross (included in revenue and costs) or a net (excluded from revenue) basis is an accounting policy
decision that should be disclosed pursuant to APB Opinion No. 22. In addition, if any of such taxes are reported on a gross basis, a company should disclose, on an aggregate basis, the amounts of those taxes in interim and annual financial
statements for each period for which an income statement is presented if those amount are significant. This issue will be applied to financial reports for interim and annual reporting periods beginning after December 15, 2006. The Company
currently reports Revenue on a net basis. The Company is in the process of evaluating the impact, if any, of this standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes. This Interpretation clarifies the accounting
for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return as well as provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and
transition. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact, if any, of this standard on its consolidated results of operations, financial position or
cash flows and will adopt it on January 1, 2007.

In September 2006, the FASB issued FSP No. AUG AIR-1, Accounting for
Planned Major Maintenance Activities, which prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods. FSP AUG AIR-1 is effective for the fiscal
year beginning after December 15, 2006. The Company is in the process of evaluating the impact of FSP AUG AIR-1 on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which will become effective for the Company as of
January 1, 2008. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures of fair value measurements. The Company has not yet determined the impact of
this Standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2008.

In
September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans. The statement requires an employer with publicly traded equity securities to recognize the funded
status of a benefit plan and the related disclosure requirements as of the end of the fiscal year ending after December 15, 2006. The Company currently measures the plans assets and benefit obligations as of the Companys fiscal year
end date. The Companys recorded liability for the accumulated postretirement benefit obligation is currently greater than the actuarially determined amount of this obligation. Therefore, the



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NATCO GROUP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Company does not expect any potential negative impact on its consolidated results of operations, financial position or cash flows resulting from the adoption
of the standard as of December 31, 2006.

In September 2006, the SEC released Staff Accounting Bulletin No. 108 (SAB 108),
Considering the effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which provides interpretive guidance on the U.S. Securities and Exchange Commissions views regarding the
process of quantifying materiality of financial statements. SAB No. 108 is effective for fiscal years ending after November 15, 2006, with early application for the first interim period ending after November 15, 2006. The Company is in the process
of evaluating the impact, if any, of this provision on its consolidated results of operations, financial position and cash flows.



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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. 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 bookings and backlog levels in 2006 (see Liquidity and Capital Resources). Our expectations about our business outlook, customer spending, oil and gas
prices, our business environment and that of the industry in general are only our expectations regarding these matters. Actual results may differ materially from those expressed in the forward-looking statements 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 OPEC, conflict involving the United States or in major petroleum producing or consuming regions, acts of terrorism, the development of technology that could lower overall
finding and development costs, weather patterns, the overall condition of capital and equity markets for countries in which we operate.

Overview

Our organization has three operating segments: Oil & Water Technologies, Gas Technologies and Automation & Controls.



| |  |  | The Oil & Water Technologies segment includes both standard and traditional oil and gas separation, dehydration equipment sales and related services and built-to-order
systems focused primarily on oil and water production and processing.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Gas Technologies segment includes our CO2membrane business, the assets and operating relationship related to our gas processing facilities in West Texas, H2S
removal technologies including Shell Paques and
other built-to-order gas-related technologies that focus on removing contaminants from the gas stream.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Automation & Controls segment focuses on the manufacture and sale of new control panels and systems which monitor and control oil and gas production, as well as field
service activities including repair, maintenance, testing and inspection services for existing systems.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Critical Accounting Policies

The preparation of our consolidated financial statements requires us 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 our 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, 2005, contains a summary of our significant accounting policies. We believe the following accounting policies are the most critical in the
preparation of our consolidated financial statements:

Revenue Recognition: Percentage of Completion Method. We recognize revenue and
related costs when products are shipped or services are rendered for (1) time and materials and service contracts, (2) manufactured goods produced in standard manufacturing operations and sold in the ordinary course of business through
regular marketing channels and (3) certain customized manufactured goods that are smaller jobs with less customization, making them similar to such standard manufactured goods (that is, contracts valued at $250,000 or less having



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contract durations of four months or less). We recognize revenue using the percentage of completion method on contracts greater than $250,000 and having
contract durations in excess of four months that represent customized, engineered orders of our products and qualify for such treatment in accordance with the requirements of AICPA Statement of Position 81-1, Accounting for Performance of
Certain Production-Type Contracts (SOP 81-1). In addition, we use the percentage of completion method on all Automation & Controls segments equipment fabrication and sales projects that qualify for such treatment in
accordance with the requirements of SOP 81-1. The Automation & Controls segment sells customized products fabricated to order pursuant to a large number of smaller contracts with durations of two to three months, with occasional large
systems projects of longer duration. The segment does not produce standard units or maintain an inventory of products for sale. Due to the nature of the segments equipment fabrication and sales operations, and the potential for wide variations
in our results of operations that could occur from applying the as shipped methodology to smaller contracts for these customized, fabricated goods, this segment recognizes revenue, regardless of contract value or duration, applying the percentage of
completion method. For the nine months ended September 30, 2006, approximately 50.4% of total Company revenue was recorded on an as shipped or as performed basis and approximately 49.6% was recorded using the percentage
of completion method.

With respect to contract revenue recorded utilizing the percentage of completion method, 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. Total estimated contract cost is a critical accounting estimate because it can materially
affect revenue and net income and it requires us to make judgments about matters that are uncertain. Total costs expected to be 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, 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 estimates during the progress of work is reflected in the period in which these changes become known. Earned
revenue reflects the original contract price adjusted for agreed claims and change order revenue, if applicable. Losses expected to be incurred on the jobs in progress, after consideration of estimated probable 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 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 is applied over a period of two to nine 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 our operating results should be evaluated over a term of one to three years to evaluate our performance under long-term contracts, after all change orders, scope changes and cost recoveries have been negotiated and realized.

Estimates are subjective in nature and it is possible that we could have used different estimates of total contract costs in our
calculation of revenue recognized using the percentage of completion method. For the nine months ended September 30, 2006, the Company had $134.5 million in revenue attributable to open percentage completion projects having an aggregate gross
margin of 20.7%. If we had used a different estimate of total contract costs for each contract in progress at September 30, 2006, a 1% increase or decrease in the estimated margin earned on each contract would have increased or decreased each
of total revenue and pre-tax income for the nine months ended September 30, 2006, by approximately $1.7 million. At September 30, 2006, the Company had three contracts in a loss position estimated at an aggregate of $1.4 million.

Impairment Testing: Goodwill. As required by Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets, we evaluate goodwill annually for impairment by comparing the fair value of operating assets to the carrying value of those assets, including any related goodwill. As required by SFAS No. 142,
we identify separate reportable units for purposes of this evaluation. In determining carrying value, we segregate assets and liabilities that, to the extent possible, are clearly identifiable by specific reportable unit. Certain corporate and other
assets and liabilities, that are not clearly identifiable by specific reportable unit, are allocated in accordance with the standard. Fair value is determined by discounting projected future cash flows



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at our cost of capital rate, as calculated. In determining projected future cash flows for each segment, we make

assumptions regarding the following key indicators: future market and sales growth rates (domestic and international), cost inflation, margin expectations, capital
expenditure levels and tax levels. The fair value is then compared to the carrying value of the reportable unit to determine whether or not impairment has occurred at the reportable unit level. In the event an impairment is indicated, an additional
test is performed whereby an implied fair value of goodwill is determined through an allocation of the fair value to the reporting units assets and liabilities, whether recognized or unrecognized, in a manner similar to a purchase price
allocation, in accordance with SFAS No. 141, Business Combinations. Any residual fair value after this purchase price allocation would be assumed to relate to goodwill. If the carrying value of the goodwill exceeded the residual
fair value, we would record an impairment charge for that amount.

Net goodwill of $81.2 million and $80.9 million at September 30,
2006 and December 31, 2005, was comprised of $47.6 million and $47.4 million for the Oil & Water Technologies reporting unit, $29.2 million and $29.1 million for the Gas Technologies reporting unit, $4.4 million and $4.4 million for
the Automation & Controls reporting unit, respectively. The increase of $0.3 million in net goodwill was due entirely to the fluctuation in the exchange rates between the U.S. currency and Canadian currency.

In accordance with SFAS No. 142, the Company tested each business segment for impairment of goodwill at December 31, 2005, and, based upon the
results of this testing, management determined that goodwill was not impaired. The Company tests each business segment for goodwill impairment annually, as required by the pronouncement, or more frequently if there are indications of goodwill
impairment. No additional testing was performed during the quarter ended September 30, 2006, as management noted no indications of goodwill impairment.

Deferred Income Tax Assets: Valuation Allowance. We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires us to provide a valuation
allowance for any deferred income tax assets we believe may not be utilized through future operations. Deferred income tax assets, not requiring valuation allowances largely relates to U.S. post-retirement obligations, accrued liabilities and
reserves that have not been deducted for tax purposes, and the carryforward of foreign tax credits. Based upon the level of historical taxable income and projected future taxable income over the periods to which our deferred tax assets are
deductible in the U.S. and Canadian tax jurisdictions, we believe it is more likely than not we will realize the benefits of these deductible differences and carry forwards. However, the amount of the deferred tax asset considered realizable could
change if future taxable income differs from our projections in the U.S. and Canadian tax jurisdictions. In all other foreign tax jurisdictions, we are currently not considering projections of future taxable income to determine the realizability of
our deductible differences and carryforwards. As of September 30, 2006, we have a valuation allowance of $1.6 million related to our U.K. operations and another $142,000 related to other international operations.

Recent Accounting Pronouncements

In
November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of Accounting Research Bulletin (ARB) No. 43, Chapter 4. SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal
amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to inventory be based on
the normal capacity of the production facilities. SFAS No. 151 became effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted this pronouncement on June 15, 2005, with no material
impact on its consolidated results of operations, financial position or cash flows.

In December 2004, the FASB issued SFAS No. 153,
Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be
measured based on the fair value of the



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assets exchanged. The amendment made by SFAS No. 153 eliminates the exception for exchanges of similar productive assets and replaces it with a broader
exception for exchanges of nonmonetary assets that do not have commercial substance. This statement became effective on June 15, 2005. The Company adopted the standard as of the effective date with no material impact on its consolidated results
of operations, financial position or cash flows.

In March 2005, the FASB issued Interpretation No. (FIN) 47, Accounting
for Conditional Asset Retirement Obligations. FIN 47 clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to
perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within control of the entity. The obligation to perform the asset retirement activity is unconditional
even though uncertainty exists about the timing and (or) method of settlement. Uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when
sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Interpretation is effective no later than the end of fiscal years
ending after December 15, 2005. The Company adopted this standard on January 1, 2006. The adoption of this standard did not have a material effect on the Companys consolidated results of operations, financial position or cash flows.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error CorrectionsA Replacement of APB Opinion
No. 20 and FASB Statement No. 3. The new standard changes the requirements for the accounting for and reporting of a change in accounting principle. Among other changes, SFAS No. 154 requires that a voluntary change in
accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (1) a change in method of
depreciating or amortizing a long-lived non-financial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements
should be termed a restatement. The new standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company adopted this standard on January 1, 2006. The
adoption of this standard did not have a material effect on the Companys consolidated results of operations, financial position or cash flows.

In September 2005, the FASBs Emerging Issues Task Force (EITF) issued EITF No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty. This pronouncement provides
additional accounting guidance for situations involving inventory exchanges between parties to that contained in APB Opinion No. 29, Accounting for Nonmonetary Transactions and SFAS No. 153, Exchanges of Nonmonetary
Assets. The standard is effective for new arrangements entered into in reporting periods beginning after March 15, 2006, and to all inventory transactions that are completed after December 15, 2006 for arrangements entered into prior
to March 15, 2006. The Company adopted this standard on January 1, 2006. The adoption of this standard did not have a material effect on the Companys consolidated results of operations, financial position or cash flows.

In September 2005, the SEC staff revised EITF No. D-98, Classification and Measurement of Redeemable Securities, primarily to provide
guidance on (1) the earnings per share treatment of redeemable common stock and (2) the application of EITF No. D-98 to share-based payment arrangements with employees. The guidance on the earnings per share treatment of redeemable common
stock in EITF No. D-98 to share-based payment arrangements with employees is effective in the first fiscal period beginning after September 15, 2005. The Company adopted EITF No. D-98 as of the effective date as it relates to the earnings per
share treatment of redeemable common stock, and has applied the application to share-based payment arrangements with employees concurrently with the adoption of SFAS No. 123R. The adoption of this standard did not have a material effect on the
Companys consolidated results of operations, financial position or cash flows.



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In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instrumentsan amendment of FASB Statements No. 133 and 140, which is effective for fiscal years beginning after September 15, 2006. The statement was issued to clarify the application of FASB Statement No. 133 to
beneficial interests in securitized financial assets and to improve the consistency of accounting for similar financial instruments, regardless of the form of the instruments. The Company is in the process of evaluating the impact, if any, of this
standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In March
2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assetsan amendment of FASB Statement No. 140, which is effective for fiscal years beginning after September 15, 2006. This statement was
issued to simplify the accounting for servicing rights and to reduce the volatility that results from using different measurement attributes. The Company is in the process of evaluating the impact, if any, of this standard on its consolidated
results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In March 2006, the EITF issued EITF
No. 05-01, Accounting for the Conversion of an Instrument that Became Convertible upon the Issuers Exercise of a Call Option. This issue requires that the issuance of equity securities to settle a debt instrument that became
convertible on the issuers exercise of a call option be accounted for as a conversion if the debt instrument contains a substantive conversion feature as of its issuance date. Absent a substantive conversion feature, it should be accounted for
as a debt extinguishment. EITF No. 05-01 is effective for periods beginning after June 28, 2006. The Company adopted this standard as of July 1, 2006. The adoption of this standard did not have a material effect on the Companys
consolidated results of operations, financial position or cash flows.

In March 2006, the EITF issued EITF No. 06-03, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF No. 06-03 requires that the presentation of taxes assessed by a governmental authority
that are directly imposed on a revenue-producing transaction between a seller and a customer on either a gross (included in revenue and costs) or a net (excluded from revenue) basis is an accounting policy decision that should be disclosed pursuant
to APB Opinion No. 22. In addition, if any of such taxes are reported on a gross basis, a company should disclose, on an aggregate basis, the amounts of those taxes in interim and annual financial statements for each period for which an income
statement is presented if those amount are significant. This issue will be applied to financial reports for interim and annual reporting periods beginning after December 15, 2006. The Company currently reports Revenue on a net basis. The
Company is in the process of evaluating the impact, if any, of this standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.

In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes. This Interpretation clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be taken in a tax return as well as provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
The interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact, if any, of this standard on its consolidated results of operations, financial position or cash flows and
will adopt it on January 1, 2007.

In September 2006, the FASB issued FSP No. AUG AIR-1, Accounting for Planned Major
Maintenance Activities, which prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods. FSP AUG AIR-1 is effective for the fiscal year beginning
after December 15, 2006. The Company is in the process of evaluating the impact of FSP AUG AIR-1 on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2007.



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In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which will
become effective for the Company as of January 1, 2008. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures of fair value measurements. The
Company has not yet determined the impact of this Standard on its consolidated results of operations, financial position or cash flows and will adopt it on January 1, 2008.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.
The statement requires an employer with publicly traded equity securities to recognize the funded status of a benefit plan and the related disclosure requirements as of the end of the fiscal year ending after December 15, 2006. The Company
currently measures the plans assets and benefit obligations as of the Companys fiscal year end date. The Companys recorded liability for the accumulated postretirement benefit obligation is currently greater than the actuarially
determined amount of this obligation. Therefore, the Company does not expect any potential negative impact on its consolidated results of operations, financial position or cash flows resulting from the adoption of the standard as of
December 31, 2006.

In September 2006, the SEC released Staff Accounting Bulletin No. 108 (SAB 108),
Considering the effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which provides interpretive guidance on the U.S. Securities and Exchange Commissions views regarding the
process of quantifying materiality of financial statements. SAB No. 108 is effective for fiscal years ending after November 15, 2006, with early application for the first interim period ending after November 15, 2006. The Company is
in the process of evaluating the impact, if any, of this provision on its consolidated results of operations, financial position and cash flows.

Industry and Business Environment

As one of the leading providers of wellhead process equipment, systems and services used
in the production of oil and gas, our revenue 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. These companies generally
invest more in exploration and development efforts during periods of favorable oil and gas commodity prices, and invest less during periods of unfavorable oil and gas prices. As supply and demand change, commodity prices fluctuate, producing
cyclical trends in the industry. During periods of lower demand, revenue for service providers such as NATCO generally decline, as existing projects are completed, new projects are postponed and pricing decreases due to competitive pressures. During
periods of recovery or growth, revenue for process equipment 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 average price of domestic crude oil and Brent crude oil per barrel, the wellhead price of natural gas per thousand cubic
feet (mcf), as published by the U.S. Department of Energy; the number of rotary drilling rigs in operation, as published by Baker Hughes Incorporated, for the nine months ended September 30, 2006 and 2005, as well as averages for
the years ended December 31, 2005 and 2004:



|                                                            |  |                                |       |                                 |   |       |  |      |       |  |   |      
|----------------------------------------------------------- |  | ------------------------------ | ----- | ------------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|                                                            |  | Nine Months EndedSeptember 30, |       | Twelve Months EndedDecember 31,
|                                                            |  | 2006                           |       | 2005                            |   | 2005  |  | 2004
|Average price of crude oil per barrel in the U.S.           |  | $                              | 68.10 |                                 | $ | 55.37 |  | $    | 56.54 |  | $ | 41.47
|Average price of Brent crude oil per barrel                 |  | $                              | 67.04 |                                 | $ | 53.66 |  | $    | 54.47 |  | $ | 38.26
|Average wellhead price of natural gas per mcf in the U.S.   |  | $                              | 6.54  |                                 | $ | 6.62  |  | $    | 7.52  |  | $ | 5.50 
|Average U.S. rig count                                      |  |                                | 1,739 |                                 |   | 1,452 |  |      | 1,380 |  |   | 1,190
|Average International rig count (excludes North America)(1) |  |                                | 949   |                                 |   | 852   |  |      | 850   |  |   | 781  

---

|(1) | The Iran and Sudan rig counts were discontinued from the Baker Hughes publication beginning January 2006. For comparative purposes, the 2005 and 2004 rig count
numbers presented above exclude Iran and Sudan.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Historically, we have viewed operating rig counts as a benchmark of spending in the U.S. oil and gas
industry for exploration and development efforts. Our standard and traditional equipment sales and parts and services business generally correlates to changes in rig activity, but tends to lag behind the North American rig count trend.

From a longer-term perspective, the US Department of Energy projects that the worldwide and U.S. demand for and consumption of petroleum and natural
gas products will increase through 2030, with expected higher global consumption rates, driven by demand for refined products and the use of natural gas to power plants that generate electricity. As demand grows and reserves in the United States
decline, producers and service providers in the oil and gas industry may continue to rely more heavily on global sources of energy and expansion into new markets. The industry continues to seek more innovative and technologically efficient means to
extract hydrocarbons from existing fields, as production profiles change. As a result, additional and more complex equipment may be required to produce oil and gas from these fields. Also, many new oil and gas fields produce lower quality or
contaminated hydrocarbon streams, requiring more complex production equipment. In general, these trends should increase the demand for our products and services.

Results of Operations

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

Three Months Ended September 30, 2006 Compared to Three Months
Ended September 30, 2005 (unaudited)

Consolidated Revenue and Gross Profit



|                                   |  |                                          |         |   |        |   |         |                  |  |   |        |   |  |    |  
|---------------------------------- |  | ---------------------------------------- | ------- | - | ------ | - | ------- | ---------------- |  | - | ------ | - |  | -- | -
|                                   |  | Three Months EndedSeptember 30,          |         |   | Change |   |         | PercentageChange | 
|                                   |  | 2006                                     |         |   | 2005   |   |         |                 
|                                   |  | (unaudited)                              |        
|                                   |  | (in thousands, except percentage change) |        
|Revenue(1)                         |  | $                                        | 132,178 |   |        | $ | 102,400 |                  |  | $ | 29,778 |   |  | 29 | %
|Cost of goods sold and services(1) |  |                                          | 95,964  |   |        |   | 77,551  |                  |  |   | 18,413 |   |  | 24 | %
|                                   |  |                                          |         |   |        |   |         |                  |  |   |        |   |  |    |  
|Gross profit                       |  | $                                        | 36,214  |   |        | $ | 24,849  |                  |  |   | 11,365 |   |  | 46 | %
|                                   |  |                                          |         |   |        |   |         |                  |  |   |        |   |  |    |  
|Gross margin                       |  |                                          | 27      | % |        |   | 24      | %                |  |   | 3      | % |  | 13 | %

---

|(1) | The table above includes inter-segment elimination amounts for both Revenue and Cost of goods sold and services of $3.2 million and $1.4 million for the three months
ended September 30, 2006 and 2005, respectively.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenue. Revenue of $132.2 million for the three months ended
September 30, 2006 increased $29.8 million, or 29%, from $102.4 million for the three months ended September 30, 2005 as a result of increased business activity in each of our three operating segments, particularly in the Oil &
Water Technologies segment where year over year increases were experienced in standard equipment sales along with higher parts and service sales.

Gross Profit.Gross profit for the three months ended September 30, 2006 increased $11.4 million, or 46%, to $36.2 million, compared to $24.8 million for the three months ended September 30, 2005 primarily due to increased
sales, improved pricing and overall job execution improvements. As a percentage of revenue, gross margin was 27% and 24% for the quarters ended September 30, 2006 and September 30, 2005, respectively.



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Oil & Water Technologies



|                                |  |                                          |        |   |        |   |        |                  |  |   |        |   |  |    |  
|------------------------------- |  | ---------------------------------------- | ------ | - | ------ | - | ------ | ---------------- |  | - | ------ | - |  | -- | -
|                                |  | Three Months EndedSeptember 30,          |        |   | Change |   |        | PercentageChange | 
|                                |  | 2006                                     |        |   | 2005   |   |        |                 
|                                |  | (unaudited)                              |       
|                                |  | (in thousands, except percentage change) |       
|Revenue                         |  | $                                        | 96,031 |   |        | $ | 76,212 |                  |  | $ | 19,819 |   |  | 26 | %
|Cost of goods sold and services |  |                                          | 72,802 |   |        |   | 61,814 |                  |  |   | 10,988 |   |  | 18 | %
|                                |  |                                          |        |   |        |   |        |                  |  |   |        |   |  |    |  
|Gross profit                    |  | $                                        | 23,229 |   |        | $ | 14,398 |                  |  | $ | 8,831  |   |  | 61 | %
|                                |  |                                          |        |   |        |   |        |                  |  |   |        |   |  |    |  
|Gross margin                    |  |                                          | 24     | % |        |   | 19     | %                |  |   | 5      | % |  | 26 | %

Oil & Water Technologies segment revenue increased $19.8 million, or 26%, for the three
months ended September 30, 2006, compared to the three months ended September 30, 2005. Of the increase, $6.3 million was attributable to an increase in international built-to-order projects and $13.5 million resulted primarily from the
growth in standard and traditional equipment sales of $11.7 million in North America and Mexico along with a $1.8 million increase in parts and service sales.

Inter-segment revenue for this business segment was $2.0 million for the three months ended September 30, 2006 compared to $98,000 for the three months ended September 30, 2005.

Gross profit for the Oil & Water Technologies segment increased $8.8 million, or 61%, for the three months ended September 30, 2006
compared to the three months ended September 30, 2005, primarily due to increased sales, improved pricing and overall job execution improvements. Partially offsetting the improved gross profit is an additional reserve recorded for projected
cost overruns on a built-to-order project scheduled for completion and delivery in the first quarter of 2007 amounting to approximately $700,000. As a percentage of revenue, gross margin was 24% and 19% for the three month period ended
September 30, 2006 and 2005, respectively. The increase in gross margin, net of the recorded cost overruns, is attributable to a variety of factors including a greater percentage of higher margin parts and service activities, improved pricing
across the product lines and overall favorable job execution as compared to the prior year period.

Gas Technologies



|                                |  |                                    |        |   |        |   |        |                  |  |   |       |    |  |     |   
|------------------------------- |  | ---------------------------------- | ------ | - | ------ | - | ------ | ---------------- |  | - | ----- | -- |  | --- | --
|                                |  | Three Months EndedSeptember 30,    |        |   | Change |   |        | PercentageChange | 
|                                |  | 2006                               |        |   | 2005   |   |        |                 
|                                |  | (unaudited)                        |       
|                                |  | (in thousands, except percentages) |       
|Revenue                         |  | $                                  | 15,478 |   |        | $ | 12,798 |                  |  | $ | 2,680 |    |  | 21  | % 
|Cost of goods sold and services |  |                                    | 7,937  |   |        |   | 4,968  |                  |  |   | 2,969 |    |  | 60  | % 
|                                |  |                                    |        |   |        |   |        |                  |  |   |       |    |  |     |   
|Gross profit                    |  | $                                  | 7,541  |   |        | $ | 7,830  |                  |  | $ | (289  | )  |  | (4  | )%
|                                |  |                                    |        |   |        |   |        |                  |  |   |       |    |  |     |   
|Gross margin                    |  |                                    | 49     | % |        |   | 61     | %                |  |   | (12   | )% |  | (20 | )%

Revenue of $15.5 million for the three months ended September 30, 2006 for the Gas
Technologies segment increased $2.7 million, or 21%, compared to $12.8 million for the three months ended September 30, 2005 primarily as a result of the substantial completion of a CO2membrane built-to-order project in Southeast Asia which added an incremental $6.5 million over the prior years quarter. Partially offsetting this
increase in revenue was a $4.0 million decrease in replacement membrane sales over the prior years quarter.

There was no
inter-segment revenue for this business segment for the three months ended September 30, 2006 and September 30, 2005.

Gross
profit for the Gas Technologies segment for the three months ended September 30, 2006 decreased $289,000, or 4%, compared to the three months ended September 30, 2005. Gross margin, as a percentage of



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revenue, was 49% and 61% for the three months ended September 30, 2006 and 2005, respectively. The decrease in gross margin reflects a revenue mix
weighted more heavily to built-to-order projects in the quarter, which typically have lower margins than replacement membrane sales and CO2processing operations.

Automation & Controls



|                                |  |                                    |        |   |        |   |        |                  |  |   |       |   |  |     |  
|------------------------------- |  | ---------------------------------- | ------ | - | ------ | - | ------ | ---------------- |  | - | ----- | - |  | --- | -
|                                |  | Three Months EndedSeptember 30,    |        |   | Change |   |        | PercentageChange | 
|                                |  | 2006                               |        |   | 2005   |   |        |                 
|                                |  | (unaudited)                        |       
|                                |  | (in thousands, except percentages) |       
|Revenue                         |  | $                                  | 23,881 |   |        | $ | 14,742 |                  |  | $ | 9,139 |   |  | 62  | %
|Cost of goods sold and services |  |                                    | 18,437 |   |        |   | 12,121 |                  |  |   | 6,316 |   |  | 52  | %
|                                |  |                                    |        |   |        |   |        |                  |  |   |       |   |  |     |  
|Gross profit                    |  | $                                  | 5,444  |   |        | $ | 2,621  |                  |  | $ | 2,823 |   |  | 108 | %
|                                |  |                                    |        |   |        |   |        |                  |  |   |       |   |  |     |  
|Gross margin                    |  |                                    | 23     | % |        |   | 18     | %                |  |   | 5     | % |  | 28  | %

Revenue for the Automation & Controls segment of $23.9 million for the three months ended
September 30, 2006 increased $9.1 million, or 62%, compared to $14.7 million for the three months ended September 30, 2005. This increase was primarily due to continued storm damage repair work in the Gulf of Mexico of approximately $5.3
million related to the after-effects of hurricanes Katrina and Rita, incremental packaged automation product sales of $2.8 million and higher contributions of $1.0 million from international activities, primarily in West Africa and Kazakhstan. The
prior years quarter was impacted by approximately $1.2 million of revenue loss in the segments Gulf of Mexico operations due to facility and work interruptions related to the effect of hurricanes Katrina and Rita.

Inter-segment revenue for this business segment was $1.2 million for the three months ended September 30, 2006, compared to $1.3 million for the
three months ended September 30, 2005.

Gross profit for the Automation & Controls segment increased $2.8 million, or 108%,
for the three months ended September 30, 2006 compared to the three months ended September 30, 2005, primarily due to the increased revenue. There was an approximate $400,000 of margin loss in the prior years quarter from decreased
activity in the Gulf of Mexico due to the effect of hurricanes Katrina and Rita as well as a loss provision recorded on a job due to project execution problems. Gross margin, as a percentage of revenue increased to 23% for the three months ended
September 30, 2006 from 18% for the three months ended September 2005 primarily as a result of improved pricing and job execution on the Gulf of Mexico work along with a relative increase in the higher margin international service work in West
Africa and Kazakhstan.

Selling, General and Administrative Expense.Selling, general and administrative expense of $20.0 million
for the three months ended September 30, 2006 increased $5.3 million or 36%, compared to the three months ended September 30, 2005. The increase was primarily due to increased compensation expense of approximately $1.6 million associated
with stock-based incentive compensation, employee retention programs and increased headcount related to higher activity levels, relocation costs of $400,000 associated with the office move in the UK, as well as a gain of $630,000 on the sale of a
facility in the prior years quarter not reflected in the 2006 quarter results. Other general increases of approximately $1.0 million in support costs were incurred year over year associated with the increased business activity.

In addition, during the three months ended September 30, 2006, the Company recorded $1.7 million of non-cash compensation cost for the correction of an
error that should have been recorded in the fiscal year 2005 related to stock options issued in 1998, at a price set in anticipation of an initial public offering, which were subsequently canceled and reissued at a lower price in March 1999. We
later became a public company in January 2000. Compensation expense should have been determined using variable accounting per FASB Interpretation No. (FIN) 44, Accounting for Certain Transactions involving Stock Compensation,
which was



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issued subsequent to the time these options were re-priced but had retroactive effect. Management discovered the error in the quarter ended September 30,
2006 and has deemed it to be immaterial for both the 2005 and 2006 periods and with respect to the quarterly trends in earnings for both periods. The Company has corrected the accounting to properly recognize the compensation expense by applying
variable accounting to these awards as required by FIN 44.

Overall headcount increased from 1,799 employees at September 30, 2005 to 1,928 employees at September 30, 2006 primarily in our manufacturing
and field service staffing levels as a direct result of the higher business activity.

Depreciation and Amortization Expense.
Depreciation and amortization expense of $1.3 million for the three months ended September 30, 2006, increased $23,000, or 2%, compared to the three months ended September 30, 2005.

Closure, Severance and Other. Closure, severance and other expense of $2.3 million for the three months ended September 30, 2006 represents
our estimated and accrued U.K. office closure costs. Closure, severance and other expenses of $2.1 million for the three months ended September 30, 2005 included $1.2 million for the then-anticipated separation of the Companys President
and severance costs of $799,000 related to the restructuring of our UK operations.

Interest expense. Interest expense of $491,000
for the three months ended September 30, 2006 decreased by $451,000 or 48%, compared to the three months ended September 30, 2005 primarily as a result of debt reduction over the past year.

Interest Cost on Postretirement Benefit Liability. Interest Cost on Postretirement Benefit Liability for the three months ended September 30,
2006 was reduced by $100,000 to reflect the lower participation in the plan primarily as a result of changes made to the plan in late 2005 which reduced benefits and increased participant contributions.

Interest Income.Interest income of $96,000 for the three months ended September 30, 2006 increased $91,000 compared to the three months
ended September 30, 2005, reflecting higher cash balances during the current period and higher interest rates.

Minority
Interest. Minority interest expense of $400,000 for the three months ended September 30, 2006 reflects the Companys recognition, beginning this quarter, of the expense for the portion of earnings related to the minority interest
ownership in our consolidated joint ventures.

Other, net.Other, net was a $1.8 million gain, which consisted of a $2.5 million
gain on the sale of a partial interest in NATCO Japan, offset by $400,000 due to minority interest expense associated with our Japan joint venture, $160,000 of write-off of unamortized deferred financing fees associated with the terminated 2004 term
loan and revolving credit facilities and $92,000 of net realized and unrealized foreign exchange transaction losses. Other, net was a $1.6 million expense for the three months ended September 30, 2005 related primarily to $1.2 million resulting
from the change in valuation of the outstanding warrants to purchase our common stock and net realized and unrealized foreign currency exchange transaction losses of $351,000.

Provision for Income Taxes.Income tax expense for the three months ended September 30, 2006 was $4.7 million compared to $1.7 million for
the three months ended September 30, 2005. The change in tax expense was primarily attributable to an increase in pre-tax income to $14.1 million for the three months ended September 30, 2006 from pre-tax income of $4.1 million for the
three months ended September 30, 2005. The effective tax rate for the three months ended September 30, 2006 was 33.5% compared to 41.4% for the three months ended September 30, 2005. The decrease in the effective tax rate was
primarily attributable to a decrease in permanent book versus tax differences and the generation of tax credits. The main decrease in permanent book versus tax differences was due to a nondeductible mark-to-market expense on warrants exercised in
2005 that was not incurred in 2006.



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Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005 (unaudited)

Consolidated Revenue and Gross Profit



|                                   |  |                                    |         |   |        |   |         |                  |  |   |        |   |  |    |  
|---------------------------------- |  | ---------------------------------- | ------- | - | ------ | - | ------- | ---------------- |  | - | ------ | - |  | -- | -
|                                   |  | Nine Months EndedSeptember 30,     |         |   | Change |   |         | PercentageChange | 
|                                   |  | 2006                               |         |   | 2005   |   |         |                 
|                                   |  | (unaudited)                        |        
|                                   |  | (in thousands, except percentages) |        
|Revenue(1)                         |  | $                                  | 378,651 |   |        | $ | 285,704 |                  |  | $ | 92,947 |   |  | 33 | %
|Cost of goods sold and services(1) |  |                                    | 276,043 |   |        |   | 217,172 |                  |  |   | 58,871 |   |  | 27 | %
|                                   |  |                                    |         |   |        |   |         |                  |  |   |        |   |  |    |  
|Gross profit                       |  | $                                  | 102,608 |   |        | $ | 68,532  |                  |  | $ | 34,076 |   |  | 50 | %
|                                   |  |                                    |         |   |        |   |         |                  |  |   |        |   |  |    |  
|Gross margin                       |  |                                    | 27      | % |        |   | 24      | %                |  |   | 3      | % |  | 13 | %

---

|(1) | The table above includes inter-segment elimination amounts for both Revenue and Cost of goods sold and services of $9.6 million and $3.8 million for the nine months
ended September 30, 2006 and 2005, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenue.Revenue of $378.7 million for the nine months ended
September 30, 2006 increased $92.9 million, or 33%, from $285.7 million for the nine months ended September 30, 2005 as a result of increased business activity in each of our three operating segments, particularly the Oil & Water
Technologies segment.

Gross Profit.Gross profit for the nine months ended September 30, 2006 increased $34.1 million, or 50%,
to $102.6 million compared to $68.5 million for the nine months ended September 30, 2005 as a result of increased sales, improved pricing and overall job execution improvements. As a percentage of revenue, gross margin was 27% and 24% for
the quarters ended September 30, 2006 and September 30, 2005, respectively.

Oil & Water Technologies



|                                |  |                                    |         |   |        |   |         |                  |  |   |        |   |  |    |  
|------------------------------- |  | ---------------------------------- | ------- | - | ------ | - | ------- | ---------------- |  | - | ------ | - |  | -- | -
|                                |  | Nine Months Ended September 30,    |         |   | Change |   |         | PercentageChange | 
|                                |  | 2006                               |         |   | 2005   |   |         |                 
|                                |  | (unaudited)                        |        
|                                |  | (in thousands, except percentages) |        
|Revenue                         |  | $                                  | 276,673 |   |        | $ | 215,806 |                  |  | $ | 60,867 |   |  | 28 | %
|Cost of goods sold and services |  |                                    | 213,065 |   |        |   | 174,220 |                  |  |   | 38,845 |   |  | 22 | %
|                                |  |                                    |         |   |        |   |         |                  |  |   |        |   |  |    |  
|Gross profit                    |  | $                                  | 63,608  |   |        | $ | 41,586  |                  |  | $ | 22,022 |   |  | 53 | %
|                                |  |                                    |         |   |        |   |         |                  |  |   |        |   |  |    |  
|Gross margin                    |  |                                    | 23      | % |        |   | 19      | %                |  |   | 4      | % |  | 21 | %

Oil & Water Technologies segment revenue increased $60.9 million, or 28%, for the nine
months ended September 30, 2006, compared to the nine months ended September 30, 2005.Approximately $33.0 million of the increase was due higher international and domestic business and project awarding activities in the
built-to-order product line and approximately $27.0 million of this increase was due to higher demand for our standard and traditional equipment and services.

Inter-segment revenue for this business segment was $6.0 million for the nine months ended September 30, 2006, compared to $620,000 for the nine months ended September 30, 2005.

Gross profit for the Oil & Water Technologies segment increased $22.0 million, or 53%, for the nine months ended September 30, 2006
compared to the nine months ended September 30, 2005. Continued strength in sales of our standard and traditional equipment and services accounted for $14.5 million of the increase. Built-to-order projects both domestically and internationally
contributed $7.5 million of the increase, net of approximately $1.7 million recorded for projected cost overruns on a built-to-order project scheduled for



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completion and delivery in the first quarter of 2007. Higher profitability and margins were a result of pricing increases especially in North American
activities and continued improvements in overall job execution. As a percentage of revenue, gross margin was 23% and 19% for the nine-month periods ended September 30, 2006 and 2005, respectively.

Gas Technologies



|                                |  |                                    |        |   |        |   |        |                  |  |   |        |    |  |     |   
|------------------------------- |  | ---------------------------------- | ------ | - | ------ | - | ------ | ---------------- |  | - | ------ | -- |  | --- | --
|                                |  | Nine Months EndedSeptember 30,     |        |   | Change |   |        | PercentageChange | 
|                                |  | 2006                               |        |   | 2005   |   |        |                 
|                                |  | (unaudited)                        |       
|                                |  | (in thousands, except percentages) |       
|Revenue                         |  | $                                  | 44,959 |   |        | $ | 27,972 |                  |  | $ | 16,987 |    |  | 61  | % 
|Cost of goods sold and services |  |                                    | 20,887 |   |        |   | 10,118 |                  |  |   | 10,769 |    |  | 106 | % 
|                                |  |                                    |        |   |        |   |        |                  |  |   |        |    |  |     |   
|Gross profit                    |  | $                                  | 24,072 |   |        | $ | 17,854 |                  |  | $ | 6,218  |    |  | 35  | % 
|                                |  |                                    |        |   |        |   |        |                  |  |   |        |    |  |     |   
|Gross margin                    |  |                                    | 54     | % |        |   | 64     | %                |  |   | (10    | )% |  | (16 | )%

Gas Technologies segment revenue of $45.0 million for the nine months ended September 30,
2006 increased $17.0 million or 61%, compared to $28.0 million for the nine months ended September 30, 2005. This increase was primarily due to higher built-to-order project activity levels of $17.5 million, primarily related to a major
Southeast Asian project, and higher CO2processing revenue of $1.0 million partially offset by a decrease in
membrane sales of approximately $1.5 million.

There was no inter-segment revenue for this business segment for the nine months ended
September 30, 2006 and 2005.

Gross profit for the Gas Technologies segment for the nine months ended September 30, 2006
increased $6.2 million, or 35% compared to the nine months ended September 30, 2005 primarily as a result of the increase in sales. Gross margin, as a percentage of revenue, for Gas Technologies was 54% and 64% for the nine month periods ended
September 30, 2006 and 2005, respectively. The decrease in gross margin was attributable to the lower margin revenue mix due to a higher concentration of built-to-order projects and lower membrane sales in the 2006 period.

Automation & Controls



|                                |  |                                    |        |   |        |   |        |                  |  |   |        |   |  |    |  
|------------------------------- |  | ---------------------------------- | ------ | - | ------ | - | ------ | ---------------- |  | - | ------ | - |  | -- | -
|                                |  | Nine Months EndedSeptember 30,     |        |   | Change |   |        | PercentageChange | 
|                                |  | 2006                               |        |   | 2005   |   |        |                 
|                                |  | (unaudited)                        |       
|                                |  | (in thousands, except percentages) |       
|Revenue                         |  | $                                  | 66,569 |   |        | $ | 45,722 |                  |  | $ | 20,847 |   |  | 46 | %
|Cost of goods sold and services |  |                                    | 51,641 |   |        |   | 36,630 |                  |  |   | 15,011 |   |  | 41 | %
|                                |  |                                    |        |   |        |   |        |                  |  |   |        |   |  |    |  
|Gross profit                    |  | $                                  | 14,928 |   |        | $ | 9,092  |                  |  | $ | 5,836  |   |  | 64 | %
|                                |  |                                    |        |   |        |   |        |                  |  |   |        |   |  |    |  
|Gross margin                    |  |                                    | 22     | % |        |   | 20     | %                |  |   | 2      | % |  | 10 | %

Revenue for the Automation & Controls segment of $66.6 million increased $20.8 million or
46%, for the nine months ended September 30, 2006 compared to $45.7 million for the nine months ended September 30, 2005. This increase was primarily due to the continued strength in the Gulf of Mexico field services work related to the
after effects of hurricanes Katrina and Rita of approximately $10.2 million, an increase in the packaged automation product sales contributing approximately $9.7 million and an increase in our international field service work primarily in West
Africa and Kazakhstan of approximately $1.0 million.The prior years quarter was impacted by approximately $1.2 million of revenue loss in the segments Gulf of Mexico operations due to facility and work interruptions related to
the effect of hurricanes Katrina and Rita.



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Inter-segment revenue for this business segment was $3.5 million for the nine months ended
September 30, 2006 compared to $3.2 million for the nine months ended September 30, 2005.

Gross profit for the
Automation & Controls segment increased $5.8 million, or 64%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 primarily due to the increased revenue. Gross margin as a percentage
of revenue was 22% and 20% for the nine months ended September 30, 2006 and 2005, respectively. The increase in gross margin is primarily a result of increased pricing for the field services work in the Gulf of Mexico and higher packaged
automation product sales, along with improved job execution.

Selling, General and Administrative Expense.Selling, general and
administrative expense of $53.7 million for the nine months ended September 30, 2006, increased $10.0 million, or 23%, compared to the nine months ended September 30, 2005. Approximately $4.0 million was due to higher compensation costs
associated with the increased headcount, employee retention programs and variable stock-based incentive compensation; $2.2 million was due to higher support costs related to the increased business activity; approximately $600,000 was

associated with the office move in the U.K.; $500,000 related to higher pre-order engineering costs associated with increased bid activities; and $1.0 million was
attributable to a gain on the sale of assets in the prior year.

In addition, during the nine months ended September 30, 2006, the Company
recorded $1.7 million of non-cash compensation cost for the correction of an error that should have been recorded in the fiscal year 2005 related to stock options issued in 1998, at a price set in anticipation of an initial public offering, which
were subsequently canceled and reissued at a lower price in March 1999. We later became a public company in January 2000. Compensation expense should have been determined using variable accounting per FASB Interpretation No. (FIN) 44,
Accounting for Certain Transactions involving Stock Compensation, which was issued subsequent to the time these options were re-priced but had retroactive effect. Management discovered the error in the quarter ended September 30, 2006
and has deemed it to be immaterial for both the 2005 and 2006 periods and with respect to the quarterly trends in earnings for both periods. The Company has corrected the accounting to properly recognize the compensation expense by applying variable
accounting to these awards as required by FIN 44.

Overall headcount increased from 1,799 employees at September 30, 2005 to 1,928 employees at September 30, 2006 primarily in our manufacturing
and field service staffing levels as a direct result of the higher business activity.

Depreciation and Amortization Expense.
Depreciation and amortization expense of $4.2 million for the nine months ended September 30, 2006, increased $230,000, or 6%, compared to the nine months ended September 30, 2005. The increase was attributable primarily to depreciation
from additions in the second quarter of 2006 of operating equipment and to the amortization of intangible assets associated with our investment in a joint venture that fabricates a pilotless burner ignition system for controlling gas-fired heaters
used in connection with oil and gas wellhead equipment.

Closure, severance and other. Closure, severance and other expenses of $2.6
million for the nine months ended September 30, 2006 represented $2.3 million of our U.K. office closure cost and approximately $300,000 related to severance and other costs. Closure, severance and other expenses of $2.2 million for the nine
months ended September 30, 2005 consisted of the $2.1 million Closure, severance and other expenses recorded during the third quarter 2005 and a miscellaneous other expense of approximately $100,000.

Interest expense. Interest expense of $1.9 million for the nine months ended September 30, 2006 decreased by $1.1 million or 37%, compared to
the nine months ended September 30, 2005 due primarily to debt reductions over the last twelve months.

Interest Cost on
Postretirement Benefit Liability. Interest cost on postretirement liability of $0 for the nine months ended September 30, 2006 decreased by $630,000 compared to the nine months ended September 30,



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2005 due to the lower participation in the plan primarily as a result of changes made to the plan in late 2005 which reduced benefits and increased
participant contributions.

Interest Income.Interest income of $215,000 for the nine months ended September 30, 2006 increased
$145,000, compared to the nine months ended September 30, 2005 reflecting the higher cash balances during the current period and higher interest rates.

Minority Interest. Minority interest expense of $380,000 for the nine months ended September 30, 2006 reflects the Companys recognition, beginning this period, of the expense for the portion of earnings
related to the minority interest ownership in our consolidated joint ventures.

Other, net.Other, net for the nine months ended
September 30, 2006 was a net $1.7 million gain, which included the $2.5 million gain related to the sale of a partial interest in our Japan joint venture, offset by $380,000 due to minority interest expense associated with that venture,
$160,000 of write off of unamortized debt costs associated with the termination in the third quarter of 2006 of the 2004 term loan and revolving credit facilities and the nine months of net realized and unrealized foreign exchange transaction losses
of $199,000. Other, net was a $2.0 million expense for the nine months ended September 30, 2005 related primarily to $1.8 million of expense related to the change in valuation of the outstanding warrants to purchase our common stock and
$171,000 related to net realized and unrealized foreign currency exchange transaction losses.

Provision for Income Taxes.Income
tax expense for the nine months ended September 30, 2006 was $15.4 million compared to $5.4 million for the nine months ended September 30, 2005. The change in tax expense was primarily attributable to an increase in pre-tax income to
$42.2 million for the nine months ended September 30, 2006 from pre-tax income of $13.2 million for the nine months ended September 30, 2005. The effective tax rate for the nine months ended September 30, 2006 was 36.5% compared to
40.7% for the nine months ended September 30, 2005. The decrease in the effective tax rate was primarily attributable to a decrease in permanent book versus tax differences and the generation of tax credits. The main difference in permanent
book versus tax differences was due to a nondeductible mark-to-market expense on warrants exercised in 2005 that was not incurred in 2006.

Liquidity and Capital Resources

Financial Condition and Liquidity

2006 Revolving Credit Facilities

On
July 12, 2006, the Company terminated the 2004 term loan and revolving credit facilities and entered into a new 2006 revolving credit facilities agreement with a maturity of June 30, 2011.

The 2006 revolving credit facilities provide for a total borrowing capacity of $85.0 million, consisting of a U.S. revolving facility with a borrowing
capacity of $65.0 million, a Canadian revolving facility with a borrowing capacity of $5.0 million and a U.K. revolving facility with a borrowing capacity of $15.0 million. These revolving credit facilities are scheduled to mature on June 30,
2011. The borrowing capacities under the 2006 revolving credit facilities agreement are not subject to any monthly borrowing base limitations. In addition to the base commitments, these new facilities permit the Company to require an increase in the
aggregate borrowing capacity by $50.0 million if certain requirements are met.

We incurred $454,000 of deferred financing fees related to
the 2006 revolving credit facilities agreement, which are amortized over the 2006 revolving credit facilities agreements five-year term, using straight-line amortization method.

The 2006 revolving credit facilities agreement provides for interest at a rate based upon the ratio of Funded Debt to EBITDA, as defined in the credit
facility (EBITDA), and ranging from, at the Companys election,



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(1) a low of the London Interbank Offered Rate (LIBOR) plus 1.00% to a high of LIBOR plus 2.00% or (2) a low of a Base Rate, as defined
in the credit facility (Base Rate) plus 0.00% to a high of a Base Rate plus 1.00%. The Company is obligated to pay commitment fees related to this agreement on the undrawn portion of the facility, depending upon the ratio of Funded Debt
to EBITDA, which was calculated at 0.25% of the undrawn portion of the facility at September 30, 2006.

Aggregate borrowings of $4.5
million were outstanding under the 2006 revolving credit facilities at September 30, 2006, which bore interest at a rate of 6.56%. The Company had letters of credit outstanding of $11.4 million at September 30, 2006. Availability under the
2006 revolving credit facilities is reduced by the amount of our outstanding letters of credit and loans. Fees related to these letters of credit were approximately 1.0% of the outstanding balance at September 30, 2006. These letters of credit
support contract performance and warranties and expire at various dates through June 2009.

During the quarter ended September 30,
2006, we decreased our debt, both under the 2004 term loan and the 2006 revolving credit facilities, by $15.3 million, from $19.8 million at June 30, 2006 to $4.5 million at September 30, 2006. During October we paid the remaining $4.5
million of our debt outstanding under the 2006 facilities.

The 2006 revolving credit facilities agreement is secured by a first lien or
first priority security interest in or pledge of substantially all of the assets of the borrowers and certain subsidiaries, including accounts receivable, inventory, equipment, intangibles, equity interests in U.S. subsidiaries, 661/3% of the equity interest in active, non-U.S. subsidiaries and interests in certain contracts.
Assets of the Company and its active U.S. subsidiaries secure the US, Canadian, U.K. revolving facilities, assets of the Companys Canadian subsidiary also secure the Canadian facility and assets of the Companys U.K. subsidiaries also
secure the U.K. facility. The U.S. facility is guaranteed by each U.S. subsidiary of the Company, while the Canadian and U.K. facilities are guaranteed by NATCO Group Inc., each of its U.S. subsidiaries and the Canadian subsidiary or the U.K.
subsidiaries, as applicable.

The 2006 revolving credit facilities agreement contains restrictive covenants including, among others, those
that limit the amount of Funded Debt to EBITDA, impose a minimum fixed charge coverage ratio and impose a minimum tangible net worth requirement. We were in compliance with all restrictive debt covenants as of September 30, 2006. Pursuant to
the 2006 revolving credit facilities, the Company is not permitted to make any distributions of any property or cash to its stockholders other than dividends required under its Series B Preferred Stock and certain other dividends not to exceed, in
the aggregate, $3.0 million per year, if certain conditions related to Funded Debt to EBITDA and borrowing capacity are met, or $1.5 million per year, in the aggregate, if such conditions are not met. Subject to certain restrictions, the Company
also has the ability to buy back up to $25.0 million in value of its common stock.

Export Sales Facility

On July 23, 2004, the Company and two of its subsidiaries entered into an international revolving credit agreement with Wells Fargo HSBC Trade Bank,
N.A. providing for loans of up to $10.0 million, subject to borrowing base limitations. This working capital facility for export sales is secured by specific project inventory and receivables, as well as certain other inventory, accounts receivable
and equipment, and is partially guaranteed by the U.S. Export-Import Bank. Loans under this facility mature on March 31, 2007, and bear interest at either (1) a Base Rate, as defined in the agreement, less 0.25% or (2) LIBOR plus
2.00%, at the Companys election. There were no loans outstanding at September 30, 2006. Letters of credit outstanding under this facility as of September 30, 2006 were $9.8 million. This facility had fees related to letters of credit of
approximately 1.00% of the outstanding balance.

Other

At September 30, 2006, the Company had unsecured letters of credit and bonds totaling $317,000. At September 30, 2006, available borrowing capacity under the 2006 revolving credit facilities and export sales



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credit agreement were $73.6 million and $200,000, respectively. Although no assurances can be given, we believe that our operating cash flow, supported by
our borrowing capacity, will be adequate to fund operations for at least the next twelve months. Should we decide to pursue acquisition opportunities, the determination of our ability to finance these acquisitions will be a critical element of the
analysis of the opportunities.

Cash and Cash Equivalents

The company had cash and cash equivalents of $20.9 million as of September 30, 2006, which includes highly liquid, short-term investments totaling $19.7 million that accrue interest at a weighted average rate of
4.37%.

Working capital

As of
September 30, 2006, we had cash and cash equivalents and working capital of $20.9 million and $71.4 million respectively, compared to $9.2 million and $49.1 million as of December 31, 2005, respectively. The increase in working capital
from December 31, 2005 to September 30, 2006 of $22.3 million or 45% was due primarily to an $11.7 million increase in cash and cash equivalents, an $11.9 million increase in trade receivables and an $11.2 million increase in inventory,
primarily work in progress attributable to the increased business activity, offset by a net increase of $13.5 million in current liabilities primarily related to increased accrued expenses and customer advances partially offset with a decrease in
trade accounts payable and the elimination of the current portion of long-term debt.

Cash Flow



|                                                             |  |                                        |         |   |      |   |        |  
|------------------------------------------------------------ |  | -------------------------------------- | ------- | - | ---- | - | ------ | -
|                                                             |  | For the Nine Months EndedSeptember 30, |        
|                                                             |  | 2006                                   |         |   | 2005 |  
|                                                             |  | (in thousands)                         |        
|                                                             |  | (Unaudited)                            |        
|Net cash provided by (used in):                              |  |                                        |         |   |      |   |        |  
|Operating activities                                         |  | $                                      | 32,090  |   |      | $ | 10,831 |  
|Investing activities                                         |  |                                        | (929    | ) |      |   | (57    | )
|Financing activities                                         |  |                                        | (20,155 | ) |      |   | (5,898 | )
|Effect of exchange rate changes on cash and cash equivalents |  |                                        | 730     |   |      |   | 378    |  
|                                                             |  |                                        |         |   |      |   |        |  
|Net increase in cash                                         |  | $                                      | 11,736  |   |      | $ | 5,254  |  
|                                                             |  |                                        |         |   |      |   |        |  

Net cash provided by operating activities for the nine months ended September 30, 2006 was
$32.1 million compared to $10.8 million provided by operating activities for the nine months ended September 30, 2005. The increase in net cash provided by operating activities in 2006, compared to 2005 was largely due to the significant
increase in net income in the nine months ended September 30, 2006 versus 2005 as adjusted for non-cash items, offset by an increase in working capital consisting primarily of trade receivables and inventories, as a result of increased business
activity. Trade receivables will fluctuate depending on business levels, invoice terms, timing of collections and, for large projects particularly, achieving contractual milestones that permit invoicing for interim payments.

Net cash used in investing activities for the nine months ended September 30, 2006 was $929,000 compared to net cash used in investing activities of
$57,000 for the nine months ended September 30, 2005. The proceeds of $3.0 million from the sale of a partial interest in NATCO Japan was offset by $3.6 million of capital expenditures related primarily to leasehold improvements and expansions
of certain manufacturing and processing facilities. The Company also made a $412,000 investment in other long-term intangible assets related to the purchase of a 50% ownership interest in a joint venture that fabricates a pilotless ignition system
for controlling gas-fired heaters used in connection with oil and gas wellhead equipment. The primary use of funds for the nine months ended September 30, 2005 was for capital expenditures of $2.4 million, largely offset by $2.3 million in
proceeds from the sale of certain operating assets.



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Net cash used in financing activities for the nine months ended September 30, 2006 and 2005 was
$20.2 million and $5.9 million, respectively. The primary use of cash for the nine months ended September 30, 2006 was $2.3 million related to bank overdrafts, $750,000 in payment of dividends on our preferred stock, $454,000 of financing costs
and $22.9 million of repayments of long-term debt, of which $7.6 million related to the terminated 2004 term loan and revolving credit facilities and $15.3 million related to the 2006 revolving credit facilities. Sources of cash for the nine months
ended September 30, 2006 were $3.3 million of excess tax benefit related to stock options exercised and lapse of restrictions on restricted stock and $3.0 million net proceeds from stock issuances related to stock options exercises. The primary
use of cash for the nine months ended September 30, 2005 was primarily long-term debt repayment of $11.6 million and $750,000 in payment of dividends on our preferred stock, offset in part by $6.5 million of proceeds from the exercise of stock
options.

Preferred Shares

On March 25, 2003, we issued 15,000 shares of Series B Convertible Preferred Stock (Series B Preferred Shares), and warrants to purchase 248,800 shares of our common stock, to a private investment fund, for an aggregate
price of $15.0 million. Approximately $99,000 of the aggregate purchase price was allocated to the warrants. Proceeds from the issuance of these securities, net of related issuance costs of $679,000, were used to reduce our outstanding revolving
debt balances and for other general corporate purposes.

Each of the Series B Preferred Shares has a face value of $1,000 and pays a
cumulative dividend of 10% per annum of face value, which is payable semi-annually on June 15 and December 15 of each year, except the initial dividend payment which was payable on July 1, 2003. Each of the Series B Preferred
Shares is convertible, at the option of the holder, into (1) a number of shares of common stock equal to the face value of such Series B Preferred Share divided by the conversion price, which was $7.805 (or an aggregate of 1,921,845 shares) at
September 30, 2006, and (2) a cash payment equal to the amount of dividends on such share that have accrued since the prior semi-annual dividend payment date.

In the event of a change in control, as defined in the certificate of designations for the Series B Preferred Shares, each holder of the Series B Preferred Shares has the right to convert the Series B Preferred Shares
into common stock or to cause the Company to redeem for cash some or all of the Series B Preferred Shares at an aggregate redemption price equal to the greater of (1) the sum of (a) $1,000 (adjusted for stock splits, stock dividends, etc.)
multiplied by the number of shares to be redeemed, plus (b) an amount (not less than zero) equal to the product of $500 (adjusted for stock splits, stock dividends, etc.) multiplied by the aggregate number of Series B Preferred Shares to be
redeemed less the sum of the aggregate amount of dividends paid in cash since the issuance date, plus any gain on the related stock warrants, and (2) the aggregate face value of the Series B Preferred Shares plus the aggregate amount of
dividends that have accrued on such shares since the last dividend payment date.

We have the right to call for redemption, the Series B
Preferred Shares for cash on or after March 25, 2008, at a redemption price per share equal to the face value of the Series B Preferred Shares plus the amount of dividends that have been accrued but not paid since the most recent semi-annual
dividend payment date.

Due to the cash redemption features upon a change in control as described above, the Series B Preferred Shares do
not qualify for permanent equity treatment in accordance with the Emerging Issues Task Force Topic D-98: Classification and Measurement of Redeemable Securities, which specifically requires that permanent equity treatment be precluded
for any security with redemption features that are not solely within the control of the issuer. Therefore, we have accounted for the Series B Preferred Shares as temporary equity in the accompanying balance sheet, and have not assigned any value to
our right to redeem the Series B Preferred Shares on or after March 25, 2008.

If the Series B Preferred Shares were redeemed under
contingent redemption features, any redemption amount greater than carrying value would be recorded as a reduction of income allocable to common shareholders when the event becomes probable.



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If we were to fail to pay dividends for two consecutive periods or any redemption price due with respect
to the Series B Preferred Shares for a period of 60 days following the payment date, we would be in default under the terms of such shares. During a default period, (1) the dividend rate on the Series B Preferred Shares would increase to 10.25%
and (2) we would be restricted from paying dividends on, or redeeming or acquiring our common or other outstanding stock, with limited exceptions. If we were to fail to set aside or make payments in cash of any redemption price due with respect
to the Series B Preferred Shares, and the holders elect, our right to redeem the shares may be terminated.

Warrants

We issued warrants to purchase Company common stock to a private investment fund in 2003 that had an exercise price of $10.00 per share of common stock
and were to expire on March 25, 2006. The Company adjusted this liability to fair value from the date of issuance through the date of exercise and recorded an expense of $1.8 million for the year ended December 31, 2005.

On August 26, 2005, the investment fund exercised in full its warrants pursuant to a cashless exercise provision contained in the warrant
instrument, which resulted in no cash payment to the Company. The final number of shares of common stock issued to the investment fund was calculated based on the average of the closing price of the Companys shares on the New York Stock
Exchange for the ten trading-day period ending on the day prior to the exercise. The average price was $17.933, resulting in the issuance of 110,061 shares of common stock in exchange for the warrants.

Bookings and Backlog

Bookings

The Companys bookings for the three months and nine months ended September 30, 2006 and 2005 were:



|                          |  |                                 |         |                                |   |         |  |      |         |  |   |        
|------------------------- |  | ------------------------------- | ------- | ------------------------------ | - | ------- |  | ---- | ------- |  | - | -------
|                          |  | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30,
|                          |  | 2006                            |         | 2005                           |   | 2006    |  | 2005
|                          |  | (unaudited, in thousands)      
|Bookings:                 |  |                                 |         |                                |   |         |  |      |         |  |   |        
|Oil & Water Technologies. |  | $                               | 79,934  |                                | $ | 92,122  |  | $    | 273,812 |  | $ | 273,914
|Gas Technologies          |  |                                 | 10,059  |                                |   | 24,445  |  |      | 91,652  |  |   | 41,848 
|Automation & Controls.    |  |                                 | 22,837  |                                |   | 18,442  |  |      | 62,595  |  |   | 49,299 
|                          |  |                                 |         |                                |   |         |  |      |         |  |   |        
|Total bookings            |  | $                               | 112,830 |                                | $ | 135,009 |  | $    | 428,059 |  | $ | 365,061
|                          |  |                                 |         |                                |   |         |  |      |         |  |   |        

Our bookings were $112.8 million compared to $135.0 million for the three months ended
September 30, 2006 and 2005, and $428.1 million compared to $365.1 million for the nine months ended September 30, 2006 and 2005, respectively. For the three months ended September 30, 2006, bookings decreased $12.2 million or 13% in
the Oil & Water Technologies segment, primarily due to delays in built-to-order project awards and lower orders pursued for traditional product sales. For the three months ended September 30, 2006, bookings decreased $14.4 million or
59% in the Gas Technologies segment but increased $49.8 million or 119% for the nine months ended September 30, 2006 due to a $46.4 million Southeast Asian project that the Company was awarded during the second quarter of 2006. Bookings in the
Automation & Controls segment increased $4.4 million or 24% due primarily to continuing field services work in the Gulf of Mexico on hurricane repair jobs of $2.0 million and an increase in field services work in Kazakhstan of $1.6 million.



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Backlog

The Companys backlog as of September 30, 2006 and December 31, 2005 were:



|                         |  |                           |         |                         |   |        
|------------------------ |  | ------------------------- | ------- | ----------------------- | - | -------
|                         |  | As of September 30,2006   |         | As of December 31, 2005
|                         |  | (unaudited, in thousands)
|Backlog:                 |  |                           |         |                         |   |        
|Oil & Water Technologies |  | $                         | 152,933 |                         | $ | 131,383
|Gas Technologies         |  |                           | 57,119  |                         |   | 15,908 
|Automation & Controls    |  |                           | 10,380  |                         |   | 9,640  
|                         |  |                           |         |                         |   |        
|Total backlog            |  | $                         | 220,432 |                         | $ | 156,931
|                         |  |                           |         |                         |   |        

Our sales backlog at September 30, 2006 was $220.4 million, compared to $156.9 million at
December 31, 2005, an increase of $63.5 million or 40%. Backlog increased by $21.6 million in the Oil & Water Technologies segment by $41.2 million in the Gas Technologies segment and by $740,000 in the Automation & Controls
segment from December 31, 2005 to September 30, 2006.

Item 3.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, which mitigates 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. We have currency risk on our U.K. activities because a
significant portion of their current backlog is in U.S. dollars. We attempt to minimize our exposure to foreign currency exchange rate risk by requiring settlement in our functional currencies, when possible. However, we do not currently enter into
forward contracts or other currency-related derivative hedge arrangements.

Our financial instruments are subject to changes in interest
rates, including our revolving credit facilities and our working capital facility for export sales. We replaced our 2004 term loan and revolving credit facilities on July 12, 2006 as discussed in detail in the notes to our financial statements
included in Part I, Item 1 of this report. At September 30, 2006, we had borrowings of $4.5 million outstanding under the 2006 revolving credit facilities, at an interest rate of 6.56%.

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 the 2006 revolving credit facilities would decrease our current quarter net income
and our cash flow from operations by $7,000. 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.

Item 4.Controls and Procedures

Controls and Procedures

We maintain controls and procedures designed to ensure that the information that we are required to disclose in the reports we file with or submit to the
SEC under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Commissions rules and



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is accumulated and communicated to our management, including its principal executive and principal financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required disclosure.

There was no change in our internal control over
financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting. It should be noted that the
design of any system of internal control is based, in part, upon assumptions about the likelihood of certain future events, and there can be no assurance that any design will be successful in achieving its stated objectives under all potential
future conditions, regardless of how remote. In addition, an internal control system, no matter how well conceived and operated, can only provide reasonable, not absolute, assurance the objectives of the internal control system will be met.
Therefore, we do not expect our disclosure controls to prevent all errors and fraud.

As of September 30, 2006, we carried out an
evaluation, with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2006.



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PART IIOTHER INFORMATION

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

The following table
summarizes the surrenders of the Companys equity securities during the three months ended September 30, 2006:



|                                      |  |                                  |  |                              |  |                                                                             |  |                                                                                    
|------------------------------------- |  | -------------------------------- |  | ---------------------------- |  | --------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------
|Period                                |  | TotalNumber ofSharesPurchased(1) |  | AveragePricePaid perShare(2) |  | Total Number ofShares Purchasedas Part ofPubliclyAnnounced Plansor Programs |  | ApproximateDollar Value ofShares that MayYet be PurchasedUnder the Plansor
Programs
|July 1 to 31, 2006                    |  |                                 |  |                             |  |                                                                            |  |                                                                                   
|August 1 to 31, 2006                  |  | 14,040                           |  |                             |  |                                                                            |  |                                                                                   
|September 1 to 30, 2006               |  |                                 |  |                             |  |                                                                            |  |                                                                                   
|                                      |  |                                  |  |                              |  |                                                                             |  |                                                                                    
|Three months ended September 30, 2006 |  | 14,040                           |  |                             |  |                                                                            |  |                                                                                   
|                                      |  |                                  |  |                              |  |                                                                             |  |                                                                                    

---

|(1) | This acquisition of equity securities was the result of the forfeiture of restricted stock on termination of employment pursuant to the terms of the Companys shareholder
approved equity compensation plans and the terms of the equity grants pursuant to those plans.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Excludes forfeited restricted stock since the purchase price was zero.
|--- | ----------------------------------------------------------------------

Item 6.Exhibits



|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|10.1        |  | Form of Performance Unit Award Agreement                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | 
|10.2        |  | Employment Agreement dated October 9, 2006 between Bradley P. Farnsworth and the Company, incorporated by reference to Exhibit 10.1 to the Companys Current Report on form 8-K filed
October 13, 2006, File No. 1-15603                                                                                                                                                                                                                                                                                             
|            | 
|10.3        |  | Loan Agreement dated as of July 12, 2006 among NATCO Group Inc., as Borrower, NATCO Canada, Ltd., as Canadian borrower, Axsia Group Limited, as UK Borrower, Wells Fargo Bank, National
Association, as US Agent and Lead Arranger, HSBC Bank Canada, as Canadian Agent, HSBC Bank PLC, as UK Agent, Bank of America, N.A., as Syndications Agent, and the other lenders parties thereto, incorporated by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K filed July 14, 2006, File No. 1-15603
|            | 
|31.1        |  | Certification of Chief Executive Officer of NATCO Group Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                               
|            | 
|31.2        |  | Certification of Chief Financial Officer of NATCO Group Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                               
|            | 
|32.1        |  | Certification of Chief Executive Officer and Chief Financial Officer of NATCO Group Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002                                                                                                                                                                                                                                                                                                                    



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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.
|                       |  |  | 
|Date: November 9, 2006 |  |  |  | By:              |  | /s/    JOHN U. CLARKE       
|                       |  |  |  |                  |  |                              |  | John U. Clarke Chairman of the Board and Chief Executive Officer       
|                       |  |  | 
|Date: November 9, 2006 |  |  |  | By:              |  | /s/    BRADLEY P.
FARNSWORTH
|                       |  |  |  |                  |  |                              |  | Bradley P. Farnsworth Senior Vice President and Chief Financial Officer



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