Archrock Inc (AROC) 2002 Q2 法說會逐字稿

Good afternoon and welcome to the Hanover Compressor conference call for Monday, August 5th, 2002.

With us this morning is Mr. Victor Grijalva, chairman and chief executive officer of Hanover Compressor, Mr. John Jackson, senior vice president and chief financial officer; and Mark Berg, senior vice president and general counsel.

All participants are in a listen-only mode. Today's call is being recorded. If you do not wish to participate, please disconnect at this time.

Earlier today, Hanover released its earnings results for the second quarter ended June 30th, 2002 and announced the determination of an independent committee of the board. By now, you should have all received a copy by fax or by e-mail. If you did not receive a copy, you can find the information on the Hanover website, www.Hanover-CO.com. I want to remind listeners that the news release Hanover issued this morning, this conference call, and the related question and answer session, include forward-looking statements. This information contains projections and expectations of the company and represents its current beliefs. These forward-looking statements may differ materially from actual results in the future. Such projections and statements of expectations should be interpreted in conjunction with the risk factors and other disclosures that may affect Hanover's results.

A discussion of these risk factors and disclosures can be found in the company's SEC Form 10-K, 10-Q, and 8-K, and other SEC filings.

I will now turn the call over to Mr. Grijalva. Please go ahead, sir.

Good afternoon, ladies and gentlemen. Thank you for your participation in this conference call.

As seen in the press releases Friday and today, Hanover has taken significant steps to position the company for the next phase of its development and growth, while enhancing its transparency to the outside world.

This company has achieved dramatic growth since its inception, growing by a factor of five in five years, three times in three years, and doubling in 2001.

This exceptional growth was achieved both through organic growth and acquisitions. Our people, Hanover people, are among the best and the most competent and entrepreneurial in the industry. The dramatic growth in our business exceeded the capabilities of the company in the area of finance and legal and created some integration and reporting problems.

As a result of this and other factors, some accounting problems appear, leading to the earnings restatement announced in February.

This was a wake-up call for the company. The board of directors acted quickly and started an immediate internal review, recruited a very competent and seasoned CFO, John Jackson, recruited as corporate general counsel Mark Berg, a first-class attorney with great credentials, increased its size and independence of the board by adding three new outside directors - John Bromley, who is the chairman and chief executive officer of anchor acquisition company, Gordon hall, retired managing director at Credit Suisse First Boston, and myself.

The board also assigned John Bromley and myself to form a special litigation committee, with the help of nationally-recognized outside legal counsel, to conduct an in-depth review of the restatement and other transactions.

After more than four months of rigorous review of documents and interviews, the SLC reached its conclusions and presented them to the board of directors on July 28th. The board decided to take proactive steps to achieve full disclosure and transparency and position Hanover for the future, while restoring shareholder confidence.

It has been a very difficult period for Hanover, and I want to recognize and thank Hanover Compressor's employees for the competence and dedication and our customers worldwide for their understanding and support.

I would like - also like to thank our auditors, PricewaterhouseCoopers, for their efforts and professionalism.

Now our focus is on the future.

Hanover Compressor is moving forward. We are in the process of putting the proper structure in place to run a multi-billion dollar company. The search for the new chief executive officer is underway with the assistance of executive recruiters Korn/Ferry international. The new management team will lead efforts to establish long-term strategic goals.

The board of directors has also taken steps to establish Hanover as a corporate governance leader. We want Hanover to be a model of transparency.

As a leader in outsourced natural gas compression equipment and services, Hanover is in a good business with a strong long-term growth opportunity, and we also plan to differentiate further from our competition with new products and services.

Hanover will continue to focus on its customers. The company has experienced field operators located around the world, with the main focus on the customer. This is a significant strength of the company.

As we noted in this morning's news release, as domestic markets continue to be sluggish during the second quarter, due to lower commodity prices affecting the profitability of our customers, the good news is that our international markets continue to strengthen. We have a solid business foundation, and we intend to take a disciplined approach to build upon entrepreneurial experience of this organization.

The past six months have been difficult for everyone at Hanover. Now we look with confidence to the future. And I would like at this time to turn things over to John to address the technical results.

Thank you, Victor, and good afternoon.

I want to just take you through the earnings for a few minutes, and I'm going to do that and then discuss impairments separately.

So as we look at earnings, excluding the impairment charges, we start out with approximately 7 cents a share.

Gross profit margins in the rental business, both domestic and international, continued to stay strong, 69% in the domestic area and 72% in the international area.

The parts and services business, the revenue profile picked up in the second quarter from the first quarter, if you exclude the asset sale that was in the first quarter.

Our profit margins there are a little bit weaker than we'd like to see long-term but they're around 19%.

The fabrication business, both on the compression and production equipment side, continue to experience gross profit margins of around 13%. This, again, reflects the current lower demand, given the environment we find ourself in today with our customer base and everybody retrenching their capital structure.

Our backlog in the compression fabrication business is currently around $70 million and has remained relatively flat over the last four or five months. Since around the first of March, the fabrication backlog has remained fairly steady around that number, 70 to $80 million.

As we move down and talk about EBITDAR, EBITDAR excluding the impairment, 76.4 million for the quarter. You can look at the impairment of 50 and then you add back the two write-downs on noncore and inventory and that takes you back to the 76.

Included in that number, however, are some unusual items. We have FAS 133, which is the ineffectiveness on hedging charge this quarter, the ongoing Argentina impact - and we'll address Argentina more specifically, about where we're going, in a minute, but Argentina was about 2.8 million reduction over what we would anticipate on a go-forward basis. And then the ongoing costs we have with the review and some other ancillary items that total about 7-and-a-half million dollars in EBITDAR that hit us this quarter in a negative way. So you could add that 7-and-a-half to the 76 and you get to a more normalized number in the 83 range.

In addition, as many of you are aware, we continue to experience the delay fees on the S-4 filing. That S-4 is not yet complete and we'll talk about that more in depth in a little bit but that was another 1.3 million for the quarter.

For the - additionally, in the quarter, we had a change in our effective tax rate. Our effective tax rate, if you look at the bottom line, you'll see is a little over 50%, excluding the unusual item of goodwill. And what we have here is this is a - this is a situation relative to our integration of acquisitions from last year when we did the POI acquisition. We have some South American entities that we're currently accruing tax in both the South American environment, because they're local entities, as well as under U.S. GAAP, because of the ownership structure and the way it's currently set up. We have to provide for U.S. taxes on those same entities.

We do not anticipate paying those taxes on the U.S. side. That would only occur with repatriation of money which we are in control of. this is an idea - this is a sample of some of the integration work that we need to do to restructure our corporations to allow us to be tax-efficient while paying our fair share of taxes where those taxes are due.

As we move on down and talk about what all that adds up to, if you look at the unusual items, that's around 5 cents a share. The change in the effective tax rate, because we had to catch up from the first quarter into the second quarter, is another 4 cents. So that gets you to a 16-cent number, give or take a cent or two. If you just want to look at it, trying to take the unusual items out.

Now let's move to the impairment and discuss that for a minute.

There's really two components to the impairment. One is the goodwill write-down. Under the new FAS 142 that was issued, we stopped amortizing goodwill as did everyone else. What you're required to do now is test your goodwill for impairment on a periodic basis.

We tested that as of June 30th, and we decided that the production and processing equipment goodwill, which totaled 47-and-a-half million dollars, currently estimated at 47-and-a-half million dollars, was impaired and needed to be written off. So we have written off that business line's goodwill. The other business lines, the domestic and international rental, and the fabrication businesses, more than support the goodwill currently allocated to them.

Now, if we move to the noncore asset write-downs and the inventory write-downs, we took a look at our noncore asset base, and as many of you are aware, Hanover in their explosive growth that Victor described earlier has entered many new business areas and many new business opportunities, some of which have worked out, some of which are still struggling to get off the ground. We took a look at the current carrying value of those assets and determined that we needed to have a charge of approximately $14 million for the noncore businesses.

In addition to that, we looked at inventory. Inventory has really two pieces to it. One, we took a write-down of about $6 million related to some turbines which is part of our power generation strategy, and then we had a $6 million provision for our parts and services business.

The parts and services provision is really the integration, again, of many companies coming together and having a lot of parts and services inventory around the company that we are now having a team focused on, trying to reduce that inventory and use inventory efficiently on a go-forward basis.

Let's move to liquidity. Liquidity and some other areas.

Liquidity improved. At June 30th, we have liquidity of over $120 million. And if you recall, back at March, our liquidity was in the $85 million range. And from March through our call in May, when we announced second-quarter results, our liquidity it moved down to around $67 million. 65 to $67 million by mid-May.

As we - as we focused on this, beginning late first quarter till now, in reducing our capital, improving our receivables and our DSOs, focusing on inventory and really focusing on cash management liquidity, we've begun to see a tremendous improvement in this area and as of the end of June, I think this reflects those efforts.

The capital expenditures were $73 million for the quarter. That puts us at about 140 year-to-date, and we're still targeting a full year number of around 250. We believe that we'll still be able to stay within our funded guidelines on a go-forward basis.

Our bank covenants currently do not constrain us on our liquidity. Our liquidity restraint is our revolver.

From an utilization perspective, the fleet is currently - currently has an utilization of 89%. It moved down to around 90% by early May and it's stayed relatively flat, other than some asset sales where people exercised purchase options. So our adds to the fleet and our deletions from the fleet have remained fairly steady for the last 60 days.

The fabrication backlog we've talked about, around $70 million, again the fabrication business continues to remain fairly steady. So when we look at the environment we're in before we talk about Argentina, we've seen the environment - the business environment slide down in the first quarter into the early second quarter, and flatten out here in the second quarter. And we see that kind of continuing for the near term.

Now, as we move to Argentina, what we have in our results for this month is that we talked about earlier, again, a diminution in the value we've been used to experiencing in Argentina. We have, however, renegotiated probably 80% on an EBITDA basis our contracts in Argentina.

In the second quarter, we have approximately $1 million of positive effect already reflected in our results, based on the retroactive renegotiation.

We would anticipate in the third quarter to have between 8 and $9 million of earnings impact on a positive basis reflecting those renegotiated contracts, pretax.

On a - in addition to that, we would expect then to see the ongoing normalized results from those renegotiated contracts to begin to occur in the third quarter, as those contracts now have been renegotiated.

We do have a series of minor contracts relative to the overall EBITDA basis that have not been renegotiated yet. These are primarily with customers who sell into the gas market in Argentina and are constrained from their own dollars that they receive in pesos now. We've renegotiated the crude oil-based contracts.

As we move to the restatement, I want to just touch on this very briefly. I think the restatement comments in the press release generally speak for themselves. What I want to do is step you through the time line of what this means.

We anticipate filing our Q on time in August for the second quarter. We then plan to move to our 10-K amendments and file those amendments by the end of August or around that general time frame.

We have received comments from the SEC relative to our filing back in late May on the S-4. We would anticipate then, after filing the 10-K amendments, to refile our S-4 in early September relative to those comments received from the SEC.

Depending on how quickly the SEC reviews those comments and gets back with us, we would hope to go effective 30 days after - excuse me. We would hope to go effective shortly after that, and then do the exchange, where we exchange the private notes for the public notes, which takes about another 30 days.

When you add all that up, what that says is that our penalty process will continue until sometime mid to late fourth quarter and then we would have the S-4 effective and that exchange completed.

That completes my comments and now we'd like to open it up as a group here for questions. 00:21:00

Thank you. Today's question and answer session will be conducted electronically. If you would like to ask a question at this time, please press the star key followed by the digit 1 on your touch-tone telephone. Once again, to ask a question, please press star 1 on your touch-tone phone. We'll pause for a moment.

Once again, that's star 1 on your touch-tone phone for questions.

Our first question today will come from Mike Clark with Merrill Lynch.

Good afternoon, gentlemen.

Hey, Mike.

Just wondering, given all the accounting restatements, what is your level of comfort that we will not see any further restatements?

Well, we have conducted, with the help of outside counsel, an in-depth review of thousands of documents and a very large number of interviews. We are pretty confident that the review was all exhaustive, and as you see by the numbers that came out of that, we are reaching the point where the numbers are pretty small.

So we feel confident that we are about there, and that - we don't foresee at this time, we have no knowledge of anything else that could be there that could result in further action.

Okay. Great.

SG and A in the quarter was high for some of the reasons you pointed out. John, what do you see for SG and A in the September and December quarters?

Well, there's a couple things I want to point out on SG and A. I'd say given the review process we've gone through, we're going to see high SG and A through at least the third quarter, and you'll have some ongoing costs into the fourth quarter relative to our ongoing inquiry.

The other thing that we've done is we've moved bad debt charges, bad debt reserve, into G and A, and I believe in prior years, it's been reflected in other revenue. So there's a couple million dollars in there year-to-date on bad debt reserve that's more of a conforming issue than truly a G and A increase.

So to answer your question, Mike - I'm not trying to avoid it but I was trying to give you some color - I would anticipate probably upper 30s in the third quarter and then moving down a little bit from there, say a million or so, million-and-a-half in the fourth quarter, but that - that at this point is a very preliminary estimate.

Just following up on your comment about bad debt expense, do you see, you know, much, if any, exposure from some of your pipeline customers right now?

Well, we can specifically talk about Williams because I think everybody's probably very - very cognizant of what they've gone through.

Williams is one of our largest customers, and they're current, and they're in great shape. We continue to have a great relationship with them. All of our major customers, U.S. major customers specifically, because that's really more where the environment is, we're monitoring very closely, but currently don't have any problems that are significant.

Okay.

And things, you know, seem to have been picking up here a little bit in the last week or so. So we're monitoring it closely, we'll see what happens, but right now we don't have any major exposures.

And last question before I hand it off to the next person, just wondering what the status is on obtaining nonrecourse financing for the [P-GAP II] project.

The [P-GAP II] project is a project, just for everyone on the call here, that we're a 30% owner in with Williams, who owns 70%, a project in South America that non-recourse financing has been underway for a while as far as putting in place.

We would anticipate late third quarter going to the committees of the lenders on this with Williams. Williams is leading this process. Given the fact that they've been able to put their financing in place, we anticipate that this project will move ahead and we're fully supporting it. And until - until we go to committee, we really won't have any further comment.

Okay. And that's been running at roughly 5 million plus of equity income a quarter?

That's been about 4.

Okay. Thank you very much.

All right. Mike.

Our next question today will come from Jim wickland, Banc of America Securities.

Good afternoon, guys.

Hey, Jim.

John, on a go-forward basis, what should we be using for your tax rate? And -

I would say for the rest of this year, until you hear differently, we need to use the 50, 51% rate, but we are - this is a plannable, controllable item, so when we are able to deal with that, we'll let you know.

Okay. In terms of cash taxes paid?

Cash taxes paid, we've been using 25%, and it will probably be less than that now. Probably more in the 15 to 25%. But I'd say I'd stay with 25 at this moment.

Okay. You had talked on your previous conference call about how you were going to try and get your banks to basically allow you to do a shelf of in excess of the $125 million they have a limit on, to try and do a 200, $300 million shelf and use term debt to pay down the revolver to increase your liquidity. Have you had any movement on that yet? Can you catch us up with that?

Sure. We did process a bank amendment at the end of June, and that does allow us to issue up to $300 million of senior sub-notes whenever we'd like. We have not completed to doing that. We - it just gives us flexibility. There was a number of things we worked with our banks on, as far as just creating flexibility for our liquidity situation, and we've been able to achieve all that.

So we can go to market when we'd like. However, I think at this time what you're going to see us do is focus on internal cash management and getting all this stuff behind us and then we'll look in the fall and see where we are.

Yeah. Those kind of improvements in liquidity in one quarter, just keep doing what you're doing there.

Yeah. No doubt about it.

On your S-4, the penalty phase, you said into the fourth quarter. You've paid 1.3 million in this quarter. What should we look for in the third quarter? The same 1.3?

Yes.

And where does that fall in your income statement?

Lease expense.

Oh, in the lease expense, okay.

Yeah. We pay it to the holders of the note.

Okay. One of the concerns - and this is both to you, Victor, and to John - one of the concerns that people have is in the last, you know, six months, less than that, you've lost your COO, CFO, and CEO. There's only two companies out there, but I mean this has clearly been - had to be some disruption in your field operations. You know, your customers are - there's bound to be some loss of focus.

Can you talk to us about losing market share, if you've done any, or attrition of people, if you've lost any, what the impact of this has been at the field level?

Well, so far, so good. I have looked at that very carefully, and so far, we have not seen attrition higher than the normal of last year.

I have met with our personnel manager, name by name, on the people who have left and I have to say there is no abnormal thing there. So so far, so good. There have been some mechanics loss in some places, where the competitors are - have tried to capitalize on the situation, but I think overall, we're holding our own quite well.

Okay. Mike left, [inaudible] left owing the company a couple million bucks, and in the recent environment of, you know, management loans, what are you going to do with that? I know the maturity of some of it was actually this year.

Mark, would you handle that, please?

Sure. With Mike's arrangement, all of his loans remain outstanding. They have not been discharged. Mike has one loan of $2.2 million that matures in 2006, and that remains unaffected and will continue to mature as it was originally written. He has a $400,000 loan that is due in 30 days, and that will become due and be paid off.

As part of our separation arrangements with Mike, he's agreed to pledge additional collateral for these loans, and - in the form of his stock options, and that's being put in place as we speak. So the company will have additional collateral for repayment. But, again, to emphasize, the loans have not been discharged and have not been amended.

And this last 400,000 was actually, you know, for him to buy stock as kind of a vote of confidence by management, right?

Well, this happened in January, I believe, so -

That was before you guys - okay.

- I cannot speak for the reason why that was given.

Okay. Last question. Argentina. John, you mentioned that, you know, we could have a 8 to $9 million benefit in the March - excuse me, in the September quarter, you know, on a retroactive basis as everything gets cleared up. That would be like a nonrecurring? You'd catch everything up through the beginning of this year that you'd lost so far?

That's correct. I mean, just like we took the charge in the first quarter and had an ongoing negative impact on the second quarter, we would catch that up and then hopefully be back to relatively business as usual.

Are you gentlemen brave enough to give us any guidance in '03?

'03? No. (Laughter)

Gee, we had to try, we had to try.

You have to crawl before you walk, before you run, before you enter the Olympics.

Thanks, guys.

We're at the crawling state.

Okay. Thanks.

Our next question will come from Jason - Justin tugman with Simmons and Company.

Hi. Good afternoon, Victor and John. Wondered if you could talk a little bit about some of the management changes. You've mentioned that you have hired an outside consulting firm to help you in your search for your replacement, but can you give us a sense in terms of timing, what exactly you're looking for, any of that criteria, things along that line?

Yeah. We - the board determined that - to hire Korn/Ferry International to help us to look for the CEO, and we are focusing very intense efforts in that way. We are optimistic that something will happen in a relatively short term, and we're looking for somebody with a proven oil field experience and knowledge of the business and the field that - who can come in right now to the next stage of Hanover to build up a billion-dollar company by essentially taking into account the good things that the company has. The good things are the people. The people are excellent. There's almost like a team, very dedicated to the company. They have been upset for all the things that have gone on, and I think we need a - a person who is very much in tune with the people to be able to take it to the next level of proficiency. So we think that we will have some news in the not too long future, distant future, on that.

Okay. John, I think one of the things that helped out your liquidity is an improvement in working capital. Can you give us what the balance for your working capital is, and also on your days sales outstanding?

Yeah, I'll - let me address the DSO first.

Our DSO, daily sales outstanding, went from, say, low 80s, 81, 82, in March down to about 71, 72 in June, so obviously that was a big component for us. So that was - that was very helpful.

We also - we have some rearrangement going on on the balance sheet relative to the restatement and so forth, so it makes the working capital numbers a little bit less clear than what really happened with the cash, because of some of the charges we took and so forth, which really were non-cash but do hit the EBITDAR line.

But I think the real focus has been on receivables and on collection and on focusing now - I think you'll see in the second half of the year us focus on inventory management, in addition to receivables, and move from there.

What type of improvement going forward do you think is realistic in terms of improving on your days sales outstanding, and then also what would be your - your target goal for getting your working capital down to?

We haven't established a target goal for getting our working capital down to yet because hopefully we'll grow the business and your receivables will grow with it, so what we're trying to do is establish metrics like inventory turns where it makes sense for turns, amount of overstock we might have, what's in our finished goods basket that we want to keep on hand to supply customers on a quick basis. So we're setting individual metrics for individual targets, like days sales outstanding, so that we can hopefully drive the right behavior here and yet grow the company. So if we said we want to reduce receivables, we might achieve that through the wrong method. Or reduce inventory. We might just sell inventory off. Yet we really want to establish individual metrics.

So we are establishing a number of those internally and giving people those tasks, and then measuring against that. So we've established an internal score card of probably 15, 20 metrics that we'll be putting out to the group on a quarterly and monthly basis.

Okay. And then also, it looks to me - and correct me if I'm wrong, but did you have some used equipment sales that flew through - that flowed through the P and S segment?

We did have some - an exercise of a purchase option on some equipment for about $12 million. There was some gain on that, and then we had some purchase options on some other equipment that hasn't closed yet that we recognized a loss on. So from a gain/loss perspective, it was negligible. Basically zero.

Okay. And final question. What is your outlook for capex in Q3? You mentioned you want to keep '02 around 250, but can you give us some light on Q3?

Yeah. I'd hope we'd be in between 60, $65 million, something like that.

The - what we're balancing here is we've said we want to stay within cash flow, and we are clearly doing that from March forward. Whether we're going to be able to balance within cash flow for the full year because of our spending coming into the year is unknown yet and what we're balancing right now is some really good international opportunities with our cash flow. So we're keeping a very close eye, a daily eye, on liquidity, and we're also looking at our investment opportunities and really trying to be very disciplined in that area. But as Victor mentioned in his comments, the international arena is doing quite well and we don't want to miss out on some what we'll call very good returns in that area.

Okay. And let me just ask you a quick follow-up to that, because if we're looking at 65 million in capex for Q3, that takes you to around 215 for the year, and I understand that the 250 is a pretty fluid number.

Right.

But do you think you would actually be in a position to cut capex spending down to about 35 million in Q4, if you had to?

Well, that's why I say we're balancing that. That 25 is where we're targeting, balancing the international opportunities, so we could be as low as 50 million in the third quarter, and if you get to 50, you got a 50 and 50 stacking up on yourself, so I'm just hedging my bet there a little bit that if these international opportunities work out and we're successful, we may move that 250 more up to 270 in connection with balancing our liquidity and maintaining a strong liquidity position.

Okay. Thank you.

Okay.

Mark van Holland with American Express.

Yeah. Hi. Good afternoon, guys.

Could you give me horsepower domestically and international at the end of the quarter?

Sure. Internationally, we had horsepower of a little over 800,000 horsepower, and we had 3.6 million in total, so you had about 2.8 domestically.

Okay. Two eight domestically. And I know you've talked about Argentina a little bit. Could you quantify that on an EBITDA basis in the second quarter? Was it a negative two or three million versus, you know, I guess typically it's probably positive five to eight or so?

I think it was about two-and-a-half to 3 million EBITDA positive for the quarter.

Okay.

So that's why we're, you know, down the 2-and-a-half to 3 million for the quarter.

Okay. And again, before devaluation, that was usually 5 to 8 million on the positive side, is that right.

Yeah. Correct. I mean our parts and service business moved around, but looking at the core rental and the core parts of service, you're looking at around 5.

Yeah. Okay. And I remember back when the bond deals were done, some of the JVs that were bought from POI, I think there were some put agreements back to Schlumberger. I was just wondering if you could talk about the circumstances that you can exercise that put and what the value of that is, and whether or not you've considered doing that as a source of additional liquidity.

Well, the put option is really defined and narrow to the [P-GAP II] project in South America which we talked about just a few minutes ago as far as the nonrecourse financing and what's going on there.

Uh-huh.

If that nonrecourse financing were to not be done by 12/31, we would have a put option - and I believe we describe this in our Q and K - a put option where we could put that investment back to Schlumberger and we would have about a 30-day window to exercise that put option.

We would put that back for basically what we've allocated to it in the purchase price. We really haven't spent much time analyzing, detailing what we would do and how that would work, if that were to come about, because the financing is still moving ahead and we're really putting our energy in there. We're the minority partner in this. We are supporting the financing, and we're trying to get that accomplished.

Okay. And you can do that irrespective of what Williams wants to do, correct?

No, it's a combined financing, the two of us together.

Oh, but I mean you can - you would have to put it with Williams?

Oh, no, no, no. I'm sorry. Our put option, yes, is just for our 30% interest, correct.

Okay. And how much of the purchase price did you allocate to that again?

About 120 million - $125 million.

Okay. Great. All right. Thanks, guys.

Our next question today will come from Jeff [inaudible]. Salomon Smith Barney.

Good afternoon. Just a couple of things to clean up.

The parts and service revenue only had, you said, John, $12 million of used equipment sales flow through there.

That's correct, that's correct.

We had 27-and-a-half million in the prior quarter.

That's correct.

So you had a pretty big bump-up in parts and service.

Yes.

What do we learn from that?

Well, I think what we had in the first quarter is two things. We had a fairly significant impact in Argentina, because of the ability for us to ship spare parts into the country was incredibly hampered given the volatile economic and political environment in-country, so we had a fairly significant reduction as a result of that. And then domestically, I think we had a number of things going on around the country - weather, people's focus on capital and so forth - where people deferred maintenance, and we still believe there's a fairly significant pent-up demand on maintenance, where people have put maintenance off, because our parts and services business is still not where we think it would be on a normalized basis.

Okay. So we can look at this - the 68 million, less the used equipment sale, and see that as a - not only a sound but maybe growing level of parts and service revenue?

We would hope.

Okay. The - just, again, I've heard - I'm not sure I've completely captured what's going on in Argentina. If I heard the last response correctly, you think you're running about two-and-a-half million a quarter below the standard run rate in the second quarter, so you're going to have a makeup gain - or makeup positive benefit in the third quarter, and then following that, you should be back at that 5-ish million a quarter EBITDA.

You're right on it.

Okay. Cash taxes, the 20 - you said 15, 20, and 25% and I wasn't quite sure whether -

No. I said 15 to 25. I mean, we've been - we've been saying 25, but given our incredible - our tax rate moving up, it's probably more down in the 15% range. But somewhere in there.

Yeah. Now, is - is that a percentage of pretax income that's going to be cash taxes or a percentage of book taxes that's going to be -

A percentage of book taxes.

Gotcha. Okay. And what do you expect year-end horsepower - if you stick with that - the base case 250 capex, what would you expect to end the year at in terms of total horsepower?

It probably won't move up dramatically. What we're really focused on and what some of the projects - a couple of the projects we've seen in South America that are really exciting us is using existing fleet equipment and we have an internal project where we're really focused on using our existing fleet. So we are not really focused on growing our horsepower as much as using the horsepower we have. But there are instances where we need to build for our customers because they have certain demands and so forth, so I would say, you know, we're at three six today. You might be at three seven, thirty seven fifty. I don't think you'll see a huge change.

Okay. I'm intrigued because I would have - if maintenance capital expenditures are, let's call it, 70 million and you're going to spend 250, how come horsepower doesn't go up more?

From - from - well, the other thing you're looking at here is you're looking at a net change in horsepower. We've had a fairly significant number of purchase options exercised during the year.

Right. Okay.

For example, in the quarter, we had a $115,000 gross increase in horsepower but we had about a 50, $55,000 - on 50 or 55,000 house power come out of the fleet through purchase options so you see a net change in the 50 to 60 range. But you may see capex on the gross side, because that's what you see, but the net fleet addition is less than that.

Okay. All right. That's great.

Okay.

And just in terms of the comment about transparency, are you considering the possibility of getting a cash flow and balance sheet out along with the earnings, you know, in the future?

We are considering that, Jeff, but we've obviously had -

No, I don't - I'm not criticizing you for not having it today. I'm just wondering -

No, we would like to move to that, where we put the balance sheet and cash flow out together, but we have not made a final determination on that and really, we need to - that's part of our process that we're going through right now is looking at what we can do.

Great. Thank you.

Okay.

[Inaudible] with Goldman Sachs.

Thanks. John, I wanted to start with the base rental base and try to understand what happened in the quarter sequentially. Your revenues were up about 400,000, your costs were down about 4.4 million, your utilization was down sequentially, so I'm trying to understand, did you have a pickup in pricing? Is that a mix, international versus domestic?

And then on the expense line, how were you able to reduce your expenses by 4-and-a-half million sequentially? And, you know, you mentioned earlier, I guess, in that context, a shift in the allowance for - I think it was bad debts. I might have missed that. But that may have been a driver there as well.

No. The bad debt wasn't, but really what you had is you had - the pickup in Argentina from the first quarter to the second quarter, you know, helped out a little bit there. And then you combine that with - because our revenue base was up higher in the second quarter than the first quarter in Argentina. We also had - you know, we put 115,000 of horsepower - of new horsepower to work in the second quarter, but we also had some purchase options exercised. So it's largely mix, and I know that's probably not the greatest answer for you, but that's really what it is. We had some international mix and some domestic mix with purchase options exercised that the numbers end up kind of where they do.

I mean is the 70%, you know, gross margin level for that business a sustainable level, in your mind, here going forward?

From what we see on the new projects, they continue to support around that 70% number. Could it - could it move around a percent one way or the other? Sure. But I think it's - from what we're seeing internationally, we believe it's sustainable.

Okay. And your depreciation, amortization jumped up sequentially. Can you give us a sense of where you see that number headed on a go-forward basis and specifically in the quarter what was the - the driver of that 3 million increase, and any consideration being given to shifting your depreciation policies back to the - back to the old way?

The answer to your second question first is I don't think you'll see us shifting back to the old way. I mean we went through a fairly exhaustive review before. We had used a fairly simplistic approach but given the range of our fleet and so forth, we've decided that, you know, looking at our horsepower and its age and so forth, that the range of lives makes a lot of sense to us.

As far as depreciation on a go-forward basis, I think you'll just see it move linearly with capex from where we are today. The change in the second quarter was largely the result of two items. One, the capex we spent in the quarter, and, two, we had a little bit of catchup depreciation from the first quarter that we didn't have all sorted out. But I think it's all there, and it's - it's correct, and going forward I think you just look at depreciation, use your useful life, add it, and add it to depreciation that we've had to date. I think the base is pretty good.

Okay. That's helpful.

And, you know, on the - on the liquidity improvement, what has happened since the end of the quarter? You know, has that continued to improve? And I'm wondering if it's possible to break out, in that improvement, the - any impact on how the letters of credit issue is being treated.

Okay. The letters of credit have been relatively static, between 35 and $40 million at any data point that we've discussed. So what you're seeing is really the combination of cash and the drawn revolver.

I think we talked about in mid-May the drawn revolver was at 250-plus million dollars, and today it's at a little under $205 million. So we have actually paid down our revolver quite a bit, and our cash position was relatively high at the end of the quarter. We did have some lease payments and so forth that were due in July that we've made, so our current liquidity position, including the LCs, which is just a constant number, let's call it at 40, is in the 110 to $115 million range. So it's holding fairly constant week to week.

Okay. And can you give us an update on the progress with the implementation of the MIS system? Are you still thinking stage I complete by - I guess it was early first quarter of '03, if I remember correctly, but maybe you could just bring us up-to-date overall there.

Sure. We had a board meeting last week and delegated to the audit committee the approval process which we anticipate to occur in August, and if that occurs and we don't see foresee a problem with that's correct we would anticipate that same time line we've discussed before, which is early '03, probably consolidated ledgers, and then throughout '03, staging in the other financial applications, and then moving into '04, looking at more the enterprise applications like inventory and purchasing and so forth.

Okay. Great. Thanks very much.

All right.

We'll go next to Eve [inaudible] with Wachovia Securities.

Thank you. Good afternoon. One, Victor, could you just comment in terms of the special litigation committee's review, are you comfortable going forward that there aren't any other shoes to drop?

Yeah. I can tell you that I'm satisfied that after four months of investigation, or review, if you want, that the number of interviews, the number of documents reviewed, that the outside counsel has done an outstanding job in getting to anything they could get.

So that gives me a large degree of comfort that everything we know is out there. We don't know of anything. And given the fact that we haven't been able to come up with anything big, we feel pretty good about it. I think this is the - close to the end of it, or is the end of it, other than anything that we don't know that would be very small. But I am very confident that as far as I'm concerned, we've reached the end of the line on this long, drawn-out investigation. I don't know of any investigation in which I have been involved myself in ordering has been as thorough, complete and serious as this one and I think we can feel very good about it, what has been done, the board of directors was very appreciative, and the conclusions are very solid in this regard.

That's terrific.

Do you anticipate any other changes to the board of directors at this time?

No. At this time we don't plan any changes to the board of directors. I think we have, as you know, improved the governance considerably by adding a lot of - a large number of outside directors, and we plan to continue looking at recommendations from NYSE, et cetera, so that we would have the best possible corporate governance going forward. And you may want to ask Mark, if you want to expand on that.

No, I think Victor and the board have made it very clear that one of the principal values in the company going forward will be adherence to the highest corporate governance standards, and that's certainly one of the key missions for me and for management.

Great. Now if I could ask John just a couple of questions.

John, could you split out the percentage of revenues between domestic and international?

Sure. Give me just one second to - to - the percentage of revenues in total -

Or what the actual number is.

Oh, okay.

Yeah. Just how that's split out.

For the rental business and so forth?

Yes.

If I look at the international rental business revenue for the quarter, it was - I'm sorry. If you'll just bear with me a second here.

What's your next question, eve, while I pull this up? It's coming up on me.

Yeah. Just what's the status of Venezuela right now.

The status, I think, is pretty solid. I mean, we've got four - three - two or three, three or four customers that sell into the gas market that have obviously issues on renegotiating the pay - on the equivalent basis they were paying on before, but otherwise the peso seems to have stabilized, you know, three-and-a-half to four, it's been there for quite a while. Obviously the IMF continues to work with the country to work on a financing package, but things seem to have moderated there, and our customers have gotten much more comfortable and we've been able to put ourself in a situation where, I think, on a go-forward basis it's not much different than where we were before.

Great.

So -

And then also as you look at the - the other business units, do you have a sense of where the profit margin should be, you know, on the parts and services business? Is 30% the goal or, you know, where can you go from the 19%?

Parts and services, we would anticipate mid to upper 20s is where we'd like to take it. Obviously, 30% would be great, but I think mid to upper 20s is - that's where we'd like to take it.

And on the two -

Near term.

Uh-huh.

If you're looking for the international rental revenue it's about 90 million and the domestic rental revenue is 169, thereabouts.

And my last two questions -

That's year-to-date.

- would be then on the fabrication businesses. Is it in the 13, 15% range?

Yeah. I think as you - when we see business begin to pick up, it has a combining effect of both earnings as well as margins, because you're able to spread your labor over - the same labor over a smaller - larger number of projects, so we would anticipate as the business environment picks up, that the gross profit margins would pick up more into the 15 to 16% range like we've seen in the past, when times are much stronger than they are right now.

And then on the parts and services going forward, for the next quarter, would you anticipate any used equipment sales in there or -

We've been notified by a couple of customers that are interested in at least looking at purchasing some assets, but we're talking - at this point, to my knowledge, I'm not aware of anything else. If you add all those up, it's $10 million or less.

Okay. And the last - last question would be: Just on the balance sheet, if you have a sense of where debt to cap is and shareholders' equity.

Debt to cap at this point is - well, I don't have it. I'm sorry.

Okay.

Debt to cap, I don't have it in front of me, Eve.

Okay. Do you know what shareholders equity is at the end of the quarter?

Shareholders equity at the end of the quarter was $995 million.

Did you have goodwill as well or just tell me if I'm pressing my luck here.

No. I'm sorry. Goodwill was - you know, we had 243 million of goodwill. We wrote 48 million off. So you should have 195, or thereabouts.

Great. All right. Thank you.

Okay.

Before moving on to our next question, we would like to ask that due to time constraints, that you please limit yourself to one question.

Our next question today will come from Dan eggers with CS First Boston.

Good afternoon.

Hey, Dan.

I guess my first question is, you know, at the end of the day, this restatement seems pretty immaterial, you know, 2 cents over two years. What was the motivation for going ahead and restating versus taking a small charge?

Well, I think as I said at the beginning, the company has been [inaudible] for six months on questions, reports and so on, about the restate - first restatement. We wanted to get to the bottom of it. We wanted to have an exhaustive review of the whole thing, and we wanted to put out everything that is out there so we can move forward with total transparency and confidence from you guys that this is the end of the thing.

So I know the thing looks rather small, but you should look at it in the context that it's in the interest of total transparency. You know everything is out there, and therefore, going forward, we want to bring up the confidence of the shareholders. So that's all we know at this time. You know, in terms of you make a review, you find out what it is, and at this point we don't know of anything else that would be there. So we can move forward to a new level of confidence with the company.

I think we're all tired of having a question mark over the company, and by putting everything on the table, we can let you guys judge whether you can trust us going forward or not.

Great. I'm going to cheat and ask one related question.

You know, given the fact that there were the dismissals or departures on Friday and then, you know, the special litigation committee with their determinations today, there's obviously a pretty strong relationship between those two. Should we look for any other management departures or changes here, or are we all done with the changes internally?

No, at this time we don't see any further departures.

Okay. Thank you, guys.

Okay.

Our next question, gentlemen, will come from Tim [Clovis], J. P. Morgan.

Good afternoon. Most of my questions have been answered, but John, do you, by chance, have the breakout of debt at the end of the quarter?

I'm sorry.

Both the on and off balance sheet.

I'm sorry. I could barely hear you. Do I have a breakout of what?

Of the debt at the end of the quarter, both on and off balance sheet?

Yeah. We have the synthetic leases that we've had that are just under 1.2 billion. They're about 1.1, one - something like that. 1.17, something like that. And we have the revolver that's - that's outstanding. We have the convertibles, which I've already addressed, the two - a little over $200 million. We have the convertible senior notes, which are about 192 million. We have the POI note of $150 million. And we have a number of other very small under $10 million kind of items, and that would be the big chunks of debt.

Then we have the [Theis] offering which is more of an equity item but that's $86 million.

Okay. And could you just remind me, when does the POI note go cash pay?

The interest is non-interest paid, you accrue it until it matures or until you take it out, and that's a five-year bullet that we're - from last August.

Great. Thanks, John.

Okay.

Tom Grbac with national Citibank.

Hi. My questions have been answered. Thanks.

Okay.

We will move on to Jeff Nicholson.

One follow-up. I know you're hesitant to give guidance for '03, but have you given any thought to capex and keeping it within your free cash flow model, or is that something you're going to want to grow as soon as possible?

I think what you're going to see us do, to answer the question here, and then Victor can chime in, if he has anything to add to this, is given all the magnitude of changes that have occurred with the company, from a leadership perspective, from a focus perspective, and from a liquidity perspective, we are near-term focused on liquidity and upgrading what we invest our dollars in. Not that we haven't had good projects in the past, but basically we're paring off lower-return projects to deploy our finite amount of capital on higher-return projects. So it's a return focus.

As we go through the next 2 to 3 months, this will include adding a CEO to the organization, going through our budgeting process and our five-year plan process, we've committed to the board that over the course of the next few months, we will develop the one-year and five-year vision and the CEO obviously will be integral to that. So I think this will be a later in the year kind of item.

Yeah. That's hard to say. We continue to apply the policy of you eat what you hunt, and I think this will keep us going till the end of the year, when we'll have a five-year strategy, if you want, and a one-year plan, and decide which are the areas in which we're going to grow. The company will grow again. That's a - there is no question about it. But we have to grow in a controlled way, in an area that makes sense for the shareholders, and in the meantime, we continue on a strict discipline type of approach, but I can tell you one thing, that no good opportunity will be lost if it makes sense to the company.

So I think you will - we will have a good answer to this question towards the end of the year when we have a new management team in place, when we have a five-year strategy and a one-year business plan.

That sounds good. Will that be made public or is that something we should inquire about as the year comes to a close?

I don't know at this time if we will make that public, but we will perhaps be able to give you the guidance you require.

Okay. Thank you.

Rich Tyson with wonder capital.

Good afternoon, gentlemen. John, for the first six months of the year, do you have any feel for what amount of new business came from GE and your partnership with Schlumberger?

GE, we've had a number of - I don't have it quantified in numbers, but we've had a number of opportunities that have come out of the GE alliance where we received business and leads and so forth that have translated into real business.

From the Schlumberger alliance perspective, I believe we had our first - our first event relative to the Schlumberger alliance occur this quarter in South America, relative to the South American venture, and that project should start coming on-line later this year, I believe, where we'll start spending money on it. So we've had - it's a very attractive opportunity and we're very excited about it so we've had really our first Schlumberger activity of any note come forward this quarter.

All right. Are we likely to see some other activity with Schlumberger, in particular, in order to take it to the next step? Because it seems like that - that relationship has been slow in getting started on a worldwide basis.

Sure. I think what we've done, obviously we've had our own issues internally on focus and as Victor said, a lot of the employees, including myself, are ready to move on, and focus on business. And I think what you'll see us here is really working with the Schlumberger folks to try and see where the opportunities are. So we have - we have a team back at Hanover that's very dedicated to the South American operation. I think there's a lot of opportunities that can come out of Schlumberger - the Schlumberger alliance with that. We have active dialog with them. There's a Schlumberger alliance of folks at Schlumberger working with us, and we're working our way through that now. So we would anticipate seeing more and we're very hopeful of that.

Thank you.

Our next question will come from Francisco Garcia with J. P. Morgan.

Good afternoon, guys. It's actually Michael Lamont. Most of the questions have been answered. I wanted to, John, first of all just say it's nice to hear the enthusiasm and energy level back in your voice. (Laughter)

Secondly, as - and I can see why, given the priorities of cleaning up the accounting issues and working on liquidity, and you touched on the issue of balance sheet and capital structure, but I was hoping that you could provide a little bit more color in terms of specific focus over the course of the next six months with respect to capital structure, whether or not, you know, you really view it as critical or necessary to take advantage of the improved shelf size, talk about the Schlumberger note. I understand that that's so deeply subordinated that you don't have a lot of options in terms of replacing that with another debt form.

Can you - can you give us a sense of more specifics there?

Sure. I mean obviously we've had a focus on liquidity that is now bearing fruit and we're going to continue to monitor that. If we could - if we could continue to pay down debt and not lose the opportunities that Victor just addressed, we would probably go down that path.

However, given the uncertainty in today's markets and so forth, of what can happen on the long-term horizon, we'll continue to monitor that. I think there's a good chance you'll see us in the debt markets sometime this year, the second half of the year. If it makes sense for us, once we kind of clean the decks here and restore a little bit of confidence in our results and the management team and so forth, we'll see what those trading levels are at. And if it makes sense from an economic perspective and a liquidity perspective, I think that's the near-term event you would see us in the capital markets for.

From the Schlumberger note, you're right, it's deeply subordinate. We would like to - we're working with Schlumberger on that. We'd like to take that out but we're exercising patience and caution, so we just don't want to run out and do something just to take the Schlumberger note out and then regret the action we took for six years and try and work that out.

So we're really focused on liquidity near term. I think the bond deal will be something we look at and consider over the course of the year and the Schlumberger note I think will just - we'll just be patient and see where we are in the fourth quarter.

Fair enough. Thanks.

Okay.

This would conclude today's question and answer session. I'd like to turn the conference back to our speakers at this time.

Thank you, everyone, for participating in today's call. As you can tell, we're excited about the prospects for the new Hanover, and if you have any further questions, please do not hesitate to call either John, myself, or Mark. Thank you very much.

Thanks.

Thank you.

Thank you. A replay of today's conference call will be available at 4:00 p.m. eastern time today, August 5th, running through midnight Monday, August 12th. To listen to the replay, please call 719-457-0820. Again, that's 719-457-0820. The access code for the Hanover Compressor replay is 263214. Again, that's 263214.

This concludes today's conference call. Thank you for your participation. You may disconnect at this time.