Archrock Inc (AROC) 2002 Q3 法說會逐字稿

Good morning and welcome to the Hanover Compressor third quarter conference call for Thursday, October 31st, 2002. With us this morning are Mr. Victor Grijalva, Chairman of Hanover Compressor, Mr. Chad Deaton, Chief Executive Officer, 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 earning results for the third quarter ended September 30th, 2002. By now you should have all received a copy by fax or e-mail. If you have not received 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'll now turn the call over to Mr. Grijalva. Please go ahead, sir.

Good morning ladies and gentlemen and welcome to the Hanover Compressor conference call. I'm very happy to report that significant progress has been made since our last conference call. Starting with, I'd like to say how excited the Board of Directors and I are to welcome Chad Deaton to Hanover as our new Chief Executive Officer. That was a real charge to take Hanover to the next level and we are thrilled to have him on board. I've personally known Chad for over 15 years and a attest for his competence and integrity. He is a very respected industry expert with more than 25 years of [Inaudible] service experience including 10 years of overseas experience.

I know his experience will help Chad and his efforts at Hanover. I'm also happy today to report that his (ph) transition with the new management team has taken place over the last few months. And turning to another area of progress, last week Hanover announced a completion of an exhaustive internal investigation, which resulted in the restatement of several small transactions from 1999. Although, the dollar amount associated with this transactions were relatively small. Management along with the Board of Directors and outside auditors felt that restatement was necessary in order to preserve and enhance Hanover's financial transparency.

As a result of the internal investigation, management is committed to certifying the company's financial result for the past 3 years. Management and the Board of directors are comfortable that these results reflect to the best of our knowledge Hanover's true financial performance and we've also incorporated fully with SEC's in all matters concerning this transaction. We are encouraged that last week's announcement would mark an end of what has been a very difficult period for Hanover.

I'd like again to recognize and thank Hanover employees for their competence and dedication. But we are now moving to a new and exciting phase of Hanover history and with that I'd like to turn the microphone to our CEO, Chad Deaton.

Thank you Victor and good morning everyone. As Victor mentioned in his earlier comments, we've now reached a point were we at Hanover can now turn our focus more towards the future than the past and as kind of what you call the new kid on the block, I wanted to just take 4 or 5 minutes this morning and tell you a little bit about what I've seen in the last two and a half months with some of my ideas going forward. And while these current market conditions are certainly challenging out there for us right now, I've no doubt and I'm very optimistic about what's long-term growth prospects we could be facing here at Hanover.

This whole idea or concept or model of taking and consolidating what in the past was a very heavily fragmented business, I'm talking about compression roll business here and in the end the result being a company such as Hanover that now has the critical mass in order to be able to serve the customers needs not only domestically, but now on a global basis. It's actually one of the main reasons, which attracted me to this company in the first place. If you also turn around and combine this with the fact that many in people's eyes and I share this with you that natural gas is the field of future. It will encourage to see that, Hanover has a very significant opportunity. Just arriving a couple of months ago, I have been able to see some things that, you know I would like to see change, but I have also seen some things that I have been very impressed with and I would like share some of those with you.

First of all, the Hanover field personnel, those people that everyday they are out there servicing our clients, selling to our clients, talking to our clients and these people have a tremendous service culture and customer service culture. I was told this prior to joining the company, I heard it from the customers since I have been here over the last two and half months, in field visits talking to people I have actually seen it and it is one of the true strengths of this company.

I have also seen that this company reacts very quickly to its customers. If there is a problem, once it is identified, the company will take it on with a vengeance and also a part of all this is that, Hanover has a truly entrepreneurial spirit. We want to maintain that spirit and we want to focus it in the right direction.

And finally some of the things that I was very pleasantly surprised with is the breadth of products and services that Hanover offers. A lot of people and I was one among the first who looked at Hanover, I considered it a compressor company. When you look at, the company is very well positioned and it produces very large portfolio production and processing equipment such as heaters, separators, dehydrators, [Inaudible] plants, CO2 plants etc. And also impressive Hanover's engineering capability and I am not just talking about the engineers that are designing the equipments and turn it to manufacturing, but those engineers and people that sit down with the customer can offer a full solution. In design what needs to done for everything on the surface, take a back, design it, build it take it forward, note it, and take a full risk, install it, construct it, commission it, if necessary operator going forward.

Now the company's focus over the last few years is on growth. Revenue growth and market share gains and acquisition, but I believe we now reached the point that we need to begin to shift that focus, from growth to one of improved efficiency therefore improved bottom line performance. If we looked at some of the media's attention that we are going to be focusing on in the next few months, there are three main areas. Number one is to improve Hanover's organizational structure. By this I mean, establishing areas of accountability, responses, responsibility, and reporting line. Another area where we need to work on the organizational structure is, the company over the last several years has made a lot of acquisitions and we now reached a point close to 5000 employees. We have not kept up with bringing these people line under common policies and procedures and so we need to do a lot in the area of human resources, we need to say change the succession planning, performance reviews, recruiting so that we can continue to bring in new talent and very importantly we have to establish an employee training and development so that our employees can reach the goals where they want to reach within the company.

The second area focus that I mentioned earlier is the shifting emphasis from revenue and market share growth to bottom line improvement and the third area focus will be to identify and pursue the market opportunities that fit our strengths and capability. By this I don't mean looking for new product lines or acquisitions when looking at geographical markets around the world, where we can take the Hanover model and install it there. Long-term, you might say that our business strategy is to provide the customers with a total product and service solution for all of the service production and processing means, all the way from the well head through the pipeline to the point in delivery. Now I would like to pass it on to John Jackson, who is going to go into some of the details for the quarter.

Thanks Chad. I am just going to set through very briefly a few of the items in the P&L and then touch on the cash flow and balance sheet. In the rental business, we have seen that the business has been relatively flat from the revenue perspective of he last quarter, second quarter and third quarter. Domestic margins are down somewhat from the second quarter moving to the third quarter and some of that is reflective of just some estimates in our property taxes that we are catching up with over the second half of the year. International business continues to be relatively strong even after you factor out the Argentina accrual catch up that we got this month in cash, this quarter in cash, we were down to, we are still at 70 percent gross margins factoring that out.

Moving to the parts and service business, you look at the revenue line there, we did have customers exercise and purchase options for approximately 12 million dollars in the quarter. Taking that out, our gross margins would be about 28 percent in that business. The remaining business in that line, continues to reflect customers to bring maintenance and that area continuous to be the soft spot for us, that is what's going on with the customer base pulling maintenance on their own equipment.

In the fabrication lines, if you look at what we have got on a combined basis, the combined revenues are relatively flat, quarter-over-quarter. The backlog has continued to maintain itself in the 70 to 80 million-dollar range month in and month out for the last 6 to 8 months. We did maintain the 13 percent gross margin in the compression fabrication business and the production equipment business has improved their gross profit margin in the quarter up closer to 19 percent. On the equity line you'll notice the equity income is down slightly and if you read in the press release you will see a million and half dollar charge on Hanover Measurement Service and that's where that's reflected in that line. SG&A continues to be higher than what we like to be on a long-term basis. This reflects the ongoing costs that we've had associated with the investigation which we've previously spoken about, and that has about three and half million dollars in that line associated with a variety of costs. The lease expense continues to burdened by the lack of the fact, we haven't got the S4 done and filed because of what's been going on. That's another, closer to a million and half dollars in the quarter.

If you move down the tax rate line I think last quarter we talked about tax rate that moved up to a little over 50 percent, you'll notice now that on a year to date basis we're in the 46 percent range and we've made some progress on our tax liability there we continue to work on that, we still anticipate 03 being more in the 40 percent range as we continue to work on those initiatives in that area. Turning to the cash flow and the balance sheet our CAPEX for the third quarter is noted with 37 million dollars. To give you a little color on that we had net suite additions of ten thousand horsepower, if you look at what we reported last time at this time, our compression horsepower is up about ten thousand. However, as I mentioned we sold some equipment in the quarter, and we also built some equipment in the quarter, so gross additions were 26 thousand horse power at a cost of around 12 million dollars, which gave us a cost per horsepower in the 465 range, and then we spent some money on plants and generation steps and we had about 15 to 20 million dollars of maintenance and that's how we got our 37 million dollars of CAPEX. What I would anticipate is in the fourth quarter that that capital expenditure number to be higher as we have some international jobs that we plan to spend some money on to begin installation on so that number will ramp back up from 37 but we still believe that we will be on target for our stated goal of 250, 270 million dollars of capital for this year.

We turn to liquidity; liquidity has continued to improve in the third quarter relative to the second quarter. And really, if we go back to mid-second quarter we hit our low point at that time of about 50 million dollars of liquidity, and today it is in the mid-one thirties. So the organization has done a tremendous job of really focusing on cutting our capital back, being more efficient with our working capital, and as a result driving our debt balance down. Our debt balance at the end of September was approximately 194 million on the revolver, all the other debt has remained relatively static. The debt balance today has turned to about 188, we've continue to take that down into October. Now there is one item as far as our availability on the revolver, we are somewhat covenant restricted and if you would calculate those covenants today, our tightest covenant would put us somewhere around 20 million dollars of access under the revolver. We continue to work on that, we continue to work on our liquidity in total, which we continue to believe, that we'll be able to improve that quarter-on-quarter as we go forward.

If we do look at working capital and what we have achieved in the third quarter, working capital is down about 18 million dollars from where we were at the second quarter. Receivables are down 13 million dollars, inventory is up slightly and we have talked about that a little bit in the past, but really we've got in a focused group of people here in the third quarter on an inventory project team and we would anticipate over the coming quarters, to see inventory begin to be reduced. So, that is another opportunity that sits in front of us.

We look ahead and in the fourth quarter, there are a couple of items that I just want to point out, one is we do have some further future Argentina benefits to be received. It's relatively minor, we would anticipate that to be in the range of about a million dollars and probably would be receiving that over the next couple of quarters. The other item is, we are transforming some of our current investment in Valelli. We have loans and investments, we're moving some of our loans to investment and as we do that, we'll be upping our percentage interest in Valelli, we believe in the fourth quarter to 51 percent and in doing that, it will be reflected in the fourth quarter of the fact that we will have full consolidation accounting, which means our revenues will go up quite a bit and our cost will go up quite a bit. Because Valelli is currently ramping it's business up and is at breakeven to marginally profitable. So, we would anticipate seeing 15 to 20 million dollar revenue increase in the fourth quarter but not a corresponding bottom line impact of any significance. That's what I wanted to comment on relative to the financials, the last thing I want to comment on before we turn it over to questions is that, one of the measures I have talked to a number or you about in the past is, how are we doing on improving our process in internal control environment is, are we able to move our reporting cycle up and report to you information and data on a more timely basis? And I think today is the, perhaps the first evidence of the progress, we've made over the last four or five months.

We've now moved in to October and are reporting results and my hats off to everyone in the organization for all the work they have done to focus on the process improvement. So, with that we'll turn it over to questions.

Thank you sir. 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 one on your touchtone phone. If you are on a speakerphone please make sure your mute function is turned off, so you'll allow your signal to reach our equipment. Once again, that is star one for any questions. Our first question comes from James Wicklund with Banc of America Securities.

Good morning gentlemen, this is Ashish Gupta, speaking on behalf of Jim. Just have a question, revenues for fabrication and parts climbed quite a bit, can you provide any expectations or any guidance for the fourth quarter?

As far as earnings and revenues, no I think at this time, you know Chad has mentioned, we're focused on organizational changes and where we are taking the company, I think from a business environment Chad may want to comment on this some, but we are seeing the business environment from the third quarter, I think continuing into the fourth quarter it would be relatively flat.

Okay, turning over to margins what I guess parts and productions applications they are more in line with last years numbers, can we expect these kinds of margins going forward and can you provide me may a little color why margins increase so dramatically for production/fabrication?

On the parts and services, I think we can continue to expect that until we see the customer, the margins, we're going to continue to expect to see in 25% to 30% range. That's what we've traditionally seen in the normal environment, I believe that until the customers begin to pull maintenance on their equipment, that we won't see much change in that, but we would, we again expect '03 to improve in that area. You can only defer maintenance for so long. And the production and processing equipment, the revenues picked up there and I think they have done a good job of managing their shop there. I think the overall environment in production and processing equipments, is probably a little bit more active than it has been in the compression fabrication business. We're seeing a little bit more activity there and they've been able to, to do a better job there handling their cost and in improving margins.

I might add one point on that parts and services side of the business. We are starting to hear from sales people that the clients are beginning to talk about having reduced something in terms of repairs and obligations. Our best guess, we would probably see potentially some of that starting in Q1 and starting and just increasing quarter-to-quarter throughout the year, it's overall now.

Okay great, some housing keeping, I guess related to depreciation going up because of the fewer acquisitions, can you add a little more color on that and expectations for depreciation going forward?

Our depreciation for the quarter, I think was in the low thirties, obviously with our CAPEX being cut back here in the second half of the year, that rate of growth on depreciation, it will slow, but we spent 750 million dollars last year in August to IPLI that depreciation, in fact year-on-year is coming through as well as the capital that we've spent this year. I would anticipate that to be in the, you know 32, 33 range in the fourth quarter and then as we outline our plans for '03, we'll have a better feel for the '03 CAPEX, we're still going through the budget process internally and how much capital we are going to allocate and to what.

Okay, thank you gentlemen.

We'll now go to Justin Thugman of Simmons.

Hi, good morning.

Good morning.

Good morning.

Chad, you've, you have been CEO now for several months, you have a chance to kind of look through, look undert the hood to see what needs what you need to work on and what is actually going, well. You have alluded to the fact that you want to look improved returns, can you tell me what steps you are taking to improve returns and second part of that question would be do you look to the dispose of some non-core assets and if so what would those be?

Okay, Justin, the first one, what steps we are taking, John alluded earlier to the budgeting process and this is a step that we've recently introduced. A lot of the Hanover field and VPs and people were not concerning to this in the past, it's been more of kind of directed in terms of what revenue numbers to reach. We asked them to do just the opposite and coming from the ground up after the client and put together a plan and the other thing that we have asked them to start considering, is our ERP system is able to rollout and we're albe to get better numbers, we are going to be at, looking at our management team from an accountability standpoint more towards a bottom line versus just gross profit. Though as they spend CAPEX to work over equipment, I mean, the expense money to work over equipment and goes on an 18 months type project when it comes back of that project it that depreciation will remain with that and this is causing a whole new life in the field organization in terms of looking at what is spending is in the inventory levels and so on that they will be held accountable for that and your second question was?

In regards to a possible disposition of non-core assets?

As John referred to we have identified several non-core assets that we believe we do not want to have as far as Hanover going forward, I guess--

We have talked in the past about determining what we are going to do with power generation in California, we are actively looking at that right now, determining if we can give the appropriate value for those assets so my guess would be, there will be some non-core assets that we will dispose off in the coming months but we don't have that particularly outlined to articulate specifically what those would be, but we are taking a hard look at everything right now and we talked specifically about power generation, we are looking up, as many of you know we have three or four measurement ventures and we are trying to fully focus our attention on where we want to take the company with each line of business we are in and be focused in kind of effective in [Inaudible], I think we will make those determinations here over the coming months.

Okay and turning to international projects, you, can you kind of give us your outlook on the Venezuelan market and so in relationship to the you got the PGAP2 project and there is a put back feature to that [inaudible], that was Schlumberger, any key talks for that stand?

Yeah, the PGAP2 project, as our financing goes to, there's two financiers, two groups financing us, OPEC and SACHE. OPEC is genuinely there and approved and SACHE goes to their board in the month of November and we are waiting that approval and there are some couple of things that peta vesa has to sign off on. Subject to both being signed off on, the financing would be closed and done by the end of the year. I still I say there is a reason of likelihood that will get done. And so at this point that's really where we are focusing our attention effort, is getting all the things done and that need to occur to have that in place.

Okay last question from me Chad. When you look at EEO, I sense that there is a growing conservatism when it comes to the capital expenditures planned. Can you talk a little bit about your plans, I know it's early, but when you start to look at it '03, we, you know, what your plans are there for the CAPEX?

Yeah, from what we did, Justin, as we going through this budgeting exercise we are clearly holding the operations people accountable for the projects as they are coming to us and putting in our budgets, and in many cases we are increasing the hurdle rate in terms of the IRR that we are looking at. What we have told the people is that we are going to live within our operating cash flow and, of course, that still has to be determined as we are going through budgets, but we are not going to exceed that in 2003 and then any of the additional cash that may be generated through the sales of the assets that we previously talked about and also we believe that we could see some significant gains in working capital as we ask these managers team forum software for inventory and receivables levels and that can be, funds that we will need to begin to pay down some debts.

All right. Thanks very much guys.

Our next question comes Yves Siegel with Wachovia Securities.

Thanks. Good morning.

Good morning Yves.

John, where are you in the process of getting the S4 done?

We are in the process of doing the 10-KA's, the restatements, certifying those, pre-clearing some particular comments with the SEC and my estimation on the S4 being filed somewhere around Thanksgiving and that would be the last event in the chain of events, which would be filing the Q, filing the 10-KA's, having the documents pre-cleared and then we file the S4. So, that would be the last thing you see happen, but anywhere from the, I would say the 20th to the 28th somewhere in there, we plan to file the S4, if we can do it faster, we will but that is kind of our timeline at this point.

Once you have filed, does the bounty go away or is it going to be with you until, to when?

Once you have file, then the SEC still has a chance to review again and give us comments and if they give us further comments, we will have to respond to that. However, even once we file and the SEC then has to declare the S4 effective, which could take a week or it could take a month, it is up to them. Then we have to do the exchange of the privately held notes for publicly held notes, which is expected to take up to approximately 20 work days. At the end of the exchange, the penalty stops.

Okay. So, we will hope that by the beginning of next year that is gone?

That is what we hope too... [Laughter] .

[Laughter] Okay, second is, in terms of the burden of, the extra burden of cost that you have had to incur, any sense of when that burden starts getting lifted as well?

Well, I think it will begin to taper over time, I mean the SEC investigations, that is nothing that is going to finish this quarter, so, you will have some ongoing cost with things, but I believe in the fourth quarter, you may see a little bit of reduction in cost and I think you will see a lot more reduction in cost for the first quarter and then at that point it will probably stabilize for a while until we are able to put some of this behind us.

And then Chad, in terms of putting a little bit more responsibility in terms of the operating units. When do you expect that you can hold those guys accountable for the assets and I guess that is the question?

I think a lot of that is obviously a function of when we be able to have the financial systems to be able to track it properly, you know, that is going through the ERP system, which were on a 17 month track. We are already starting to ask the managers to present through a spreadsheet beginning to start calculating what some of those depreciations and other costs would be. So, the main thing we are trying to do now is set the stage, so that we are ready to go forward when we have the information.

And then finally, could you talk about the competitive landscape, how that has changed, you know, over the recent past and what you look for going forward, by that I mean, you know, have you seen any pressure on pricing, any erosion in market share and what is your, you know, outlook for the international markets? Thank you.

Yeah, I mentioned in my opening comments that there is consolidation of fragmented businesses. It's exciting, you would think that, as a result of that, we would probably be able to see some margin improvements in pricing, but in the short time that I have been here and I am going to the field and looking at the recent projects, we have lost about three fairly large projects recently and from what I gathered from our people who it was due to price. We are expanding the course by telling our people that we need to be improving our pricing. We need to improve our bottom margins, but at the same time, and we have, I believe in the last few months we have lost the market share and you know, there comes a time when you do have to draw that line in the sand, where you'd say enough is enough. We are not there yet, but you know, we would like to see, able to see some kind of funding there going forward.

Has that been largely domestic projects?

Yeah, it is domestic. International, we are still winning more than our share and that is getting the much better pricing.

Thank you.

We will go next Dan Eggers with Credit Suisse First Boston.

Good morning.

Hey Dan.

Good morning.

I guess my first question, you guys, looks like you sold about 16,000 horsepower this quarter and 50,000 last quarter. You know, where do you guys stand as far as evaluating and continuing to move these domestic assets to enhance returns, is this something that is going to accelerate, you know, at this rate or could ... back now that you have made your first run?

Well, Dan I think the horsepower you've seen us sell has not been something that we've gone out and actively marketed, number of our contractors have purchase options embedded in them and what happened in this particular case was a one company sold a field to another company and that particular company had the view of owning versus leasing compression and chose to exercise little purchase options. I believe that you know, we are, with Chad here has really focused the organization on utilizing existing arm we've around the organization to the extend we can win some international contracts, find a way to use existing horsepower that's exactly what our focus is, as well as domestic we've added some horsepower to the fleet this quarter, we guys try and trim that up to the tightest level possible on a go forward basis and use the existing arm. So, I do believe that the theme that you heard from number of questions and comments today is CAPEX discipline that's using the existing arm, that's minimizing our building of new equipment where we don't have to.

Okay very good. On the rental side of the business, can you give us, just a little color on the domestic side what, if there is any regional variations as far as good activity versus bad?

Yeah, I think across the board it is about the same probably in our Western area, the Arlington area, the activity is down because we did loose a couple of contracts area that I referred to a minute ago, but all on all the activity is running down at the same rate.

Okay. Chad, I guess a question for you, given your long and distinguished background at Schlumberger and you know that relationship you still have there, you know have you started to lever those as far as expanding the international market as part of the deal or Schlumberger come out of POI?

You know, Dan I have spent quite a bit of time working on that over the last few weeks. We've been able to identify some of the problems that had been taking place and why the alliance hasn't been working and really it boils down to I guess what you call misalignment. The committees that were assigned, people assigned each of them in the committee, it didn't really line up in terms of the areas of expertise and direction. We've had several meetings with the senior management there [inaudible] one of the recent ones we just held with the people in London. We identified those problems. There were some areas were Hanover hasn't performed and some areas were Schlumberger hasn't performed. We agreed to where those are. One of the things that we'd not taken advantage of over the last year was Schlumberger had an offer that we could place up to six engineers in six of their geo markets around the world and we had not moved on and so, we instructed Schlumberger that we are going to move immediately on that. We've identified 3 of those areas. We would do all six but right now we need to find the right people to place in there and we're also just in the process of naming an engineer to handle this alliance on the full time basis to get these three individuals placed and of course then they will be in Schlumberger offices and we'll be working jointly to try to identify the products and solutions for the best.... I think we've made quite a bit of stride on that, we still have some ways to go, and I'm comfortable that we are moving in the right direction.

Can I ask which are the 3-geo markets that you guys have picked so far?

Why don't you give me a little time, so I can get the people placed before I tell everybody where we are going.

Okay fair enough. [Laughter] Hey guys just one detail question for looking to fourth quarter John, there any speculations of any more, you know, big [Inaudible] sales in the person service business this quarter?

We don't have anything pending at this time I am not aware of anything in the queue moving on that path.

Okay very good. Thank you guys.

Okay.

Our next question comes from Terry Darling of Goldman Sachs.

Thanks and good morning.

Good morning.

Gentlemen I wanted to first try to understand the domestic business, the domestic rental business on a sequential basis, revenues were basically rather flat down, you know, a little bit and then you had some margin deterioration about 400 basis points as you indicated that your utilization for the fleet, but the company overall is down a 100 basis points I wonder if you get in a little more detail on, you know, what happened in the quarter on that margin and where you see that heading going forward?

There is a couple of things one is yeah you did have the utilization drop but that is the revenue piece. I think what we are seeing other than the purchase options if you take the purchase options that have been exercised or less 90 to 120 days out we've been pretty flat utilization wise. As far as the margins we were looking at our property... with although in access for all these acquisitions we've done are probably tax basis moved around on us a lot and we've been doing a lot of work on understanding what our property tax accruals were and where they are appropriate. We felt like at the end of June next we had a chance for looking at our property tax accruals we would be somewhat light on our property tax accruals by the end of the year. So we bump that accrual out and changed our estimate on a go forward basis, for the second half of this year that has cost us probably a 180 of those 400 basis points.

Okay.

So, into '03 we will expect that to normalize back out. The other is there is that we've been moving people between parts and services and the rental business and the burden rights associate we are trying to align our cost structure up to appropriately present each line of business and there is a little bit of switch between parts and services margin and the rental margin probably in this quarter of maybe you know, 100 basis points, give or take a little bit and then you have some a little bit of margin deterioration.

And the first settlement of the property tax John, does that continue to wave on you in the fourth quarter or get all product this quarter?

Yes, it will it's just an estimate your accrue we started accruing in the third quarter little bit higher rate and that will continue to the rest of the year so you would anticipate to see a little bit of that same margin kind of deterioration in the fourth quarter and that improved beginning in the first quarter.

Okay and on the foreign side, trying to understand what the Argentina effect is both revenue and profits on the fourth quarter you detailed what the items were in the press release, what happens to the 7.9 million of revenue in the fourth quarter presumably that goes away...?

That's correct.

What happens with the one-time 5 million dollars cost items there?

Well the 7.9 goes away and as I indicated, you know, we might have a little bit in the fourth quarter 500,000 or million dollars that comes through. The one-time cost items the million and a half, excuse me, the million and a half that our equity should be a one-time item, so we should be back to our normalized equity income in the fourth quarter and then we go to the SG&A line of 3.5 million dollars, I would anticipate those one-time items in the fourth quarter relative to what we put in here in the past to be, you know, down a million to a million and half from what we have experienced this quarter but still probably in the 2 million dollar range because of, you know, as you can see we have the S4 and the 10-Ks and all that is still filed.

So all of these, all these items that you mentioned in press release of 5 million that was 3 million, 3 and a half million of that was in SG&A and 1 and a half was in the operating cost of the compression rental business?

The 5 million, let me break it down another way, I am sorry the 5 million and the 1 and a half are additives, so it's six and a half in total. One and a half we are articulated separately, three and a half is in SG&A and then the other million and half are balance in round numbers is the S4 filing penalty that's in interest or lease, excuse me least cost.

What was the margin on the 7.9 million dollar number? What was your, essentially your gross operating income from that? Was that a 100 percent margin that goes away in the fourth quarter?

Yes. That is why we go from 74 percent to 70 percent on a gross margin on an apples-to-apples basis if you factor that 7 million out.

Like it as two-and-a-half million not eight million but some other offsets are clearly, that's really helpful and then the tax rate on the fourth quarter, where do you end up there?

The same. Right now we are anticipating the same rate 46 and a half that we have on a year-to-date basis now.

All right. On the working capital, you mentioned the improvement in receivables. How much of that is due to just a drop in revenues versus, you know, what you think you have done to fundamentally improve your, you know, that that whole, you know, process?

I think some of it is due to that. Our DSO has come, the way we calculate DSO on a consistent basis has come down about a day or two. So you probably have about half and half, two-thirds something like that as improvement half from just a drop.

And then on the capital spending outlook for the fourth quarter 70 to 90 million, that's obviously a very large jump implied by the, you know, 250 to 270 less the first three quarters unless I have got the first three quarters wrong.

Yes.

Can you talk to us in a little more detail about where you are going to spend, you know, that incremental capital?

Well we have some jobs there in Argentina that we anticipate spending a reasonable amount of money on putting some idle horsepower to work and that job is underway. We anticipate that to be where the bulk of the incremental capital comes. I still say 70 to 90 is probably on the high side but I am not moving off. I don't want to move off what we have articulated in the past but I would hope to do better much better than that.

Is any of that going into Valelli, John?

No. No

And you just mentioned, you just said that, you know, idle equipment. Why do you, you know, if you get idle equipment, why is there incremental CAPEX or is it other things around compressors or something like that?

Well, you have to some of this idle equipments in US. So you have to ship it, save air taxes, install it, you know, there is that kind of stuff that you have to spend and then there is some new capital that you are going to spend to put some other equipment around it but the idle horsepower, we are trying to put to work and that is good half of the CAPEX.

Okay. On Valelli, you mentioned the P&L impact. What is the balance sheet impact? Going to be picking up some incremental debt there or receivables or....?

They are fairly nominal debt, may be 10 million dollars of debt something like that and yeah we will have the full balance sheet consolidation. I don't have it in front of me right now Terry and we'll try and lay that out for you when we put the fourth quarter together because it will gross things up quite a bit.

As we think about '03, also nominal impact from Valelli, on an EPS basis or what do you think you can improve that?

Yeah, I would say I wouldn't factor anything on the EPS basis for Valelli in '03.

Okay. Last question, you indicated that you are not through the budget, you know, process for '03, but can you share with us where you know, where do you think your philosophy will be in terms of either trying to grow, you know, just balancing the growth versus balance sheet there or balancing growth versus living within cash flow, where your thought process is there now?

I think this is kind of recapping what Chad said earlier. We are definitely committed to not spending any more than cash than we generate from operations on CAPEX and we have an internal focus to look at our non-core assets and working capital and take that money, whatever that is, that's five million or 55 million dollars and imply that to debt reduction. On top of that, since we are going through the budget process and our high grading projects and pushing up our returns that we are requesting. We are not yet committed to spending all of our cash flow on capital at this time but we have not gone through the process to see what projects we have nor discussed it with board or where we think our opportunities are. So that's why we are at that point at this time.

Okay. Really helpful. Thanks guys.

Just a reminder to our audience, please press star, one if you would like to ask a question. We will now go to Mike Clark of Merrill Lynch.

Good morning.

Hi Mike

A lot of good questions have been asked already, but I was wondering, John if you had the cash flow statement worked out, you know what cash flow from operations was in the quarter?

Well, I do. Working capital provided by operations is in the 40 million dollar range and net cash provided by operations is 28 because we have some long-term liability asset shifts even though, we had a working capital improvement. Is that what you're looking for?

Help me understand that, it would seem that, you know; D&A plus that income roughly 40 million, Delta working capital 58 million, could you help me understand some of those other items?

Well, I'd really rather wait until we get the balance sheet filed with the Q and we could talk about it a little bit more in depth, because you just had something moved between long-term assets and long-term liabilities that, you know show up as a use of cash, that I would I like to grow through at time as we filed it and are able to put some disclosure around it, that's why we are the cash flow with the financials, but I can give you the big metric numbers like that.

Okay.

All right.

I guess the VP has expressed some reluctance to spend lot of capital on legacy assets with the POI acquisition obviously Amoco is a big customer or at least is in the four corners region, have you seen any change in their spending habits or just in their approach?

No actually, we are seeing increased activities with BP if we look at that on a global basis.

Okay. The Rockies obviously has been fairly weak with the differentials, you guys have a good presence there with the PAMCO acquisition, can you comment on what you are seeing there?

Just what I mentioned earlier, I mean, the Rockies [Inaudible] to the, the Burlington contract which we lost and some of the Chevron-Texaco stuff, we are down in the Rockies, but I would say that really that much worse than anywhere else.

Could you put a number on it as far as revenues?

I don't have that right now, you know, we are just going through the budgeting process with the managers and, you know, we are all learning on this when we get the first pass and they are working on it again.

You mentioned that liquidity is covenant restraint now at 20 million that would, you know, some people might think that's a little tight [Laughter] I am wondering if your, you know, what you are doing as far as talking with your banks?

Well, what we are, we certainly are talking with a couple of large banks just to let them know where we are and overall, if we see like we are going to have a problem on meeting our covenants that will be in an active, more active dialogue with our banks but we have a forecast for the fourth quarter and cash flow items that we've identified that we believe will put us in, okay shape for the fourth quarter and then as you move into next year, there are events that we are looking at doing that will improve each of our covenants. You can look at different ones, seeing your debt to adjusted EBITDA, which is one of the tight ones if we do a subordinated debt offering in the first quarter that would give us a lot of relief on that one. One of our covenants, it has some tightness to it, is EBITDA to interest. The interest calculation is burdened by the S4 filings at least. If we, should get the S4 filing cleaned up beginning in the first quarter of next year, the interest will ramp down on that and that will begin to give us quite a bit of relief. So, I really think the next quarter is the key quarter and we believe we have the ability to meet our covenants and have some room underneath it, they would have what we think we are going to do in the fourth quarter and then going forward, I think things will ease up quite a bit in 2003.

Thank you very much.

Okay, Mike.

Next is Edward Okine with DKR Capital.

Hi, I just wondered, if you could give us the components of the liquidity, you just said you are just seeing 135 to 136 million of liquidity at the end of September quarter. I was just wondering if you can give the components between cash and other items which may be there?

Okay you are looking for the different pieces of how we get to 135 or 136?

Right.

Okay we have an available line of 350 we had as I mentioned earlier our debt balance of the quarter was about 193, we have LC's, letters of credit, in the low 40's like 43, 44, that leaves us a capacity of 113 thereabouts and we have cash in the 20 to 25 million dollars range.

Okay but I mean the actual I mean availabilities you just mentioned was 20 million dollars so I mean how come you counted it I mean you cannot borrow it can you because of the covenant of restrictions?

That's correct whether there is obviously one of the things we can do if we chose to is go to our banks and ask for covenant relief, which would give us, capacity. We've choose not to do that yet because we think we can work our way out of this on our own but we are trying that's why we are trying to articulate both numbers. We have availability under our revolver, however it is constrained down to the 20 million dollar level at this point.

Okay.

But we can seek relief on that if we chose to and perhaps get it, we have not chosen to do that at this time.

Okay thank you.

Okay.

Our next question comes from Byron Lynn with Sykes Investments.

Yes, do you have any specific targets for what you think your debt leverage since it seems pretty high? Or is it going to be a case where whatever money you have for left over from after the CAPEX and free cash flow. Just [inaudible] on there and it is more of a - just sort of an ongoing mix?

We want to take the excess cash and pay down debt. We haven't yet laid out specific targets. We will begin doing that as part of our budget process when we finish the operational review and see what the targets are there as far as returns and what - which path we want to take. We will try and balance this path. There are some really nice international projects that have very effective returns. I think you will see a lot of a capital next year going there as far as new capital, new assets going into the international arena because we have a lot of existing equipment in the US that we can put to work that still grow in the US. So, to answer your question now we don't have specific targets yet. We are working on those and are discussing those with our board and finance committee in December and throughout the early part of next year.

And you know, is there a level that you would like to get it down to as that of sort of a run rate say in the long-term maybe four times or is it something that you haven't thought out yet?

Well we would like to release our debt-to-cap; I mean that is one that we look quite at quite a bit. We would like to reduce our debt-to-cap quite a bit. In the big overhang we talked about many times is the Schlumberger note and 10 dollars, 11 dollars, 12 dollars a share just not attractive price at what we would like to do on issue equity and so right now what we are focused on as we believe we are going to focus on running the business, being efficient with our capital deployment going forward and as we demonstrate that and as we improve our results and as Chad said focus on our bottom line results and try to be as efficient as we can. We believe over time we will see equity response from that as people begin to believe that we are actually going to do what we say we are going to do.

If that happens then down the road, whenever that time is and I don't have a time but whatever that time is we would look taking Schlumberger note out and that alone would move us from the low sixties to the mid-to-low fifties and then we can do other things that we have in mind that we are not really ready to talk about now but we will continue to improve that but beyond just paying down with free cash flow. So, we would like to move debt-to-cap down quite a bit. It just may not happen in the next six to nine months but that is our longer-term target.

Right and in the fourth quarter with the CAPEX that you have, is that going to be within the cash flow that the company is generating or is this - capital spending within the operating cash flow is going to be something that is going to be starting from 2003 on?

Operating, CAPEX within the operating cash flow is 2003 on in the fourth quarter we have committed these projects and those [Inaudible] we believe will be somewhere around debt neutral in the fourth quarter to fund these capital projects and that may come from a variety of ways, operating cash flow and working capital beginning in '03 our capital budget will reflect what we believe to be operating cash flow or less when we get to the budget process regardless of asset sales and working capital improvement which we still believe there is opportunity in both of those areas.

A lot of that fourth quarter capital needs in some projects that were won quite sometime ago and have been under construction and some shift in there is additional going out for more.

Okay and the senior subnotes that you talked about possibly doing in the first quarter and that is basically to just free up some of the bank debts?

Yes.

And to give you a little bit more room?

Yes it helps our covenant and does free up the revolver quite a bit.

And would you be able to do use any of the money for these Schlumberger note?

No, it's subordinated in a fashion that we could not do that.

Okay thank you.

Okay.

Once again that is star one for questions. We will go next to Tim Kolkar with JP Morgan.

Good morning. John just quickly on the Schlumberger note, I know in the past you have talked about the possibly approaching Schlumberger in order to temporarily structured that, have you done that or is there any potential for that?

When we start the Schlumberger about, you know, they have - - they have a desire for cash. They are really not in this note for a money making proposition, to sit on for four more years and we talked to them about what can we do to, wanted some create options where we can get payments in cash and perhaps gets regularly. We don't have any - - anything to report on that at this time. The one thing I will comment on, just to make sure every one is aware, under the agreement alliance revenue that is generated can go do pay down on the debt and we anticipate having some of that to apply in the fourth quarter and perhaps into '03 with some jobs that we're - thinking about joint bidding on and so forth. So, that is an area, that 's one of the things that we have - - really talked about lot that we are trying to really work hard with Schlumberger and there will be alliance not only because we want to develop the alliances and use leverage Schlumberger, but that is the one vehicle we can use to pay our 12.5 percent debt and we very much will take advantage of that also.

Fair enough. Just on the covenant issues what are the specific covenants with regard to senior debt? Do you have interest coverage?

On senior debt?

Yeah, this is the senior debt to adjust that EBITDA, what is that number? What is the actual covenant?

What it is is it's your senior debt and the adjusted EBITDA as EBITDA on the US and Canada and the UK. So it is basically excludes foreign earnings and applies to only your senior debt and that - - that covenant is, I believe mostly it's four times that's what you're looking for.

Yeah, and what about the EBITDA interest?

EBITDA interest is two and half times that excludes the paying current interest on the Schlumberger notes.

Okay, and now just last one, this or as you know, the weakness that you've seen in the parts and services business, do you have any feel for how much of that weakness could actually be a result, what's going on in the merchant energy business?

I don't know how much of it, but I am certain that a component of is, is what is going on the merchant energy business when you look ad El Paso and Dynergy and Williams and Duke. There is a repairing the balance sheets or protecting the balance sheets. And I don't have a good percentage for you, but there is no doubt there is an effect.

Great, thanks.

We have also seen it with the [Inaudible] we think on terms of [Inaudible] in terms of their services and repairs, they've been very hesitant going forward as well.

Our next question comes from Adam Lighte with Credit Suisse First Boston.

Good morning. After all that, I think almost every thing has been answered, but one remainder, have you got a sense of your projection updated of what's your minimum maintenance level of CAPEX would be next year?

Well, that's something that through this budget process I think there has been a lot of discussion about that we've really been focusing the organization on trying to cut that numbers much, back as much as possible and we don't have a, I think in the past we said 60 to 65 million dollars as the maintenance CAPEX we think that we'll be spending and I think that's what we'll be seeing this year, but I believe you will see that number begin to be reduced going forward as we try and drive some of these efficiencies in the organization and be very diligent with capital.

Now, I mentioned earlier about this entrepreneurial spirit in this company when we focused on some thing you need to just get out of the way. In terms of budget process we focused very deeply on this maintenance CAPEX and they are aggressively looking at it and coming up with plans and they themselves and they themselves keep coming back and lowering it and of course it's a balancing point, you need to balance your service quality with your maintenance CAPEX, but, you know, in the past they, they haven't really been required to look at in this light, and now they, they are going to be held accountable for it. So, I am very pleased with reaction we're getting from these people.

Great. Thanks.

Okay.

We will now go to Anthony Orseno with Munich & Company.

My questions have been answered. Thanks.

Next is Gary Norman of Alpine Associates.

Yes. You guys had mentioned earlier operating cash flow was around 28 million and then CAPEX is 37 million, you know and then saying CAPEX is within self-funded levels. Is the short fall there coming from equipment sales?

Yes.

And at what point do you expect - if you can give a quarter rough estimate do you expect operating cash flow to be covering CAPEX?

We will hope to start seeing that in the first quarter of 2003.

First quarter. Thank you very much.

Okay.

Next is Eric Snow with Wachovia Securities.

Well, I'm at the back of the bus. Good Morning.

Yes. [Laughter]

Just to clarify, what is your total on balance sheet debt as of 9/30? Is that about 620? I am just translating based upon the revolver you gave us?

Well it is probably about 700.

Okay and also, you may go through all this discussion, you know, you guys have promised and delivered on, you know, your capital preservation and going forward, you know, I visited with you guys last week, but you know, what do you guys see, you know, a kind of a, on an HR kind of outlook. Are you guys going to change some of your compensation strategies, in a moving for more of a, you know, from gross margin to more of an operating margin and you know, you are talking and penalizing for idel depreciation. Is that kind of the transition?

No. I think from the HR side. It's very broad in terms of all that we need to do and as I mentioned earlier from succession planning to recruitment to, as well as the annual performances reviews where you can set objectives and of course some of those objectives going forward will be return on investments and profitability driven and this hasn't been done in the past. We have to really set up reviews and do those things. It's part of the idea is even focused people in that direction and over the calendar whether we are going to success and we may solve the problems and that is why we are trying to engage ourselves.

Thanks a lot guys.

Thanks.

Gentlemen, we have no further questions at this time.

All right. We want to thank everyone for participating in today's call. We are really excited about where Hanover is going in the future. So, if you have any questions, don't hesitate to call myself and Chad and we'll go forward from here. Thanks.

Thank you. A replay of today's conference will be available from 2'O clock Eastern Time today, October 31st through midnight Wednesday, November 6th. To listen to the replay, please call 719-457-0820. Again that is 719-457-0820. The access code for the Hanover Compressor replay is 441442. Again that is 441442. This concludes today's conference call. Thank you for your participation. You may disconnect at this time.