Archrock Inc (AROC) 2003 Q3 法說會逐字稿

Good morning and welcome to the Universal Compression third quarter fiscal 2004 earnings conference call. At this time all participants are in a listen-only mode. After the presentation we will conduct a question and answer session. To ask a question please press star one. Today's conference is being recorded. If anyone has any objections you may disconnect at this time. Now I will turn the meeting over to Mr. David Oatman with Universal Compression. Mr. Oatman you may begin.

Thank you. Good morning everyone. We prepared a summary page of financial and statistical data about the quarter in our earnings release which is posted on the Universal Compression website on the Investor Relations tab. In addition during this call the company will discuss some non-GAAP measures in reviewing our performance such as EBITDA as adjusted. You can find a reconciliation of these measures to GAAP measures in the summary page of the press release. As a reminder during today's conference call we will make certain comments that are not statements of historical fact and thus constitute forward-looking statements. Investors are cautioned that there are risks, uncertainties and other factors that may cause the company's actual performance to be significantly different from the expectations stated or implied by any comments that we make today. I will now turn the call over to Mr. Steve Snider, Universal's President and Chief Executive Officer.

Thank you, David. Welcome everyone, and good morning. Joining me today is our Chief Financial Officer, Michael Anderson. As usual I'll provide a description of the operating highlights and business outlook and Michael will provide a summary of our recent financial performance in the fiscal third quarter ended December 31, 2004; as well as guidance for the remainder of our fiscal year which ends March 31, 2004. I am pleased to report that Universal achieved improved financial performance again in the third fiscal quarter due to the implementation of our strategies and continuing strong market conditions. We recorded a 36% increase in EPS compared to the prior year period, as well as a record level of EBITDA. Now let me review how we got there. First, we significantly improved the performance of domestic contract compression, our largest segment. Our strategy to reactivate older compressor units resulted in unusually high start up related costs in the September quarter.

We resolved those issues and recorded higher domestic contract compression revenue and significantly higher gross profit in the December quarter. This was an issue we discussed in our last conference call and I'm happy with our progress on this front. Second, we streamlined our North American operations early in the December quarter by combining our Canadian division with our U.S. division. We've had some early successes in the integration process. We have generated increasing contract compression activity and inquiries in the Canadian market, a key company initiative, and improved management of significant cross border customers. We are in the process of implementing standardized processes for our fabrication operations in Calgary and Houston, and expect these actions to enhance financial results beginning in the March, 2004 quarter. Finally, on the financial side we have recorded sequential improvements in EPS through the first three quarters of fiscal 2004 while improving or balance sheet through prudent capital management and generating significant free cash flow. Now I'll turn the call over to Michael Anderson for a summary of third fiscal quarter results. Michael?

Thank you, Steve, and good morning everyone. I'm sure that by now you all received and reviewed our press release issued earlier this morning. In my summary of third quarter fiscal 2004 financial results my primary comparison period will be the fiscal 2004 second quarter; as well as the guidance we provided in October for the third quarter. Total revenues were $170 million in the third fiscal quarter, in the midpoint of our guidance of $165 to $175 million. Each of our domestic contract compression, international contract compression, and after market services segments experienced higher activity levels and continued revenue growth. Overall revenues, however, declined modestly by about 3% from last quarter due to the fabrication segment where we, as forecasted, saw slightly lower shipment levels. Looking at each of our business segments, our domestic contract compression revenues increased 2% sequentially from $69.7 million in the September quarter, to $71.1 million in the December quarter; in line with guidance. The profit margin in this segment increased from 61% in the September quarter, which was negatively impacted by costs associated with the reactivation of certain idle units, to 65% in the December quarter; which is much more in line with historical levels. We expect domestic contract compression margins to remain at these higher levels as we move forward. Our international contract compression revenues increased slightly from $20.7 million in the September quarter to $20.8 million in the December quarter, again in line with guidance.

International contract compression profit margin decreased somewhat from 77% to 76%, substantially in line with our guidance levels of margins in the high 70% range. We are pleased with our international contract compression growth over the past year. Gross profit in dollar terms in the third fiscal quarter was 24% higher than the years ago level. Fabrication revenue decreased from $49.7 million in a very strong September quarter to $42.1 million in the December quarter, well within our guidance range of $40 to $45 million. Our fabrication profit margin declined somewhat from 11% in the September quarter to 9% in the December quarter, somewhat below our guidance levels due to lower than expected results in our Calgary, Canada, fabrication facility. In the after market services business segment, third quarter revenues and profit margins were in line with guidance. Revenues increased sequentially from $35.6 million to $36.2 million, while profit margin decreased slight from 22% in the September quarter to 20% in the December quarter due to lower margins in Canada. We continue to see good growth in many of our international markets, although the AMS business typically has more fluctuations in both revenues and gross profit due to business mix and scheduling issues.

Still we saw AMS gross profit dollar terms in the quarter was up 10% over the year ago performance. SG & A expenses decreased from $17.3 million in the September quarter to $16.1 million in the December quarter, that's slightly lower than our forecast number. The September quarter results had included about $800,000 in unusual items in Canada and Latin America, so SG&A was, in reality, down only modestly on a sequential basis. EBITDA as adjusted was $58.1 million for the quarter, a record level for the company, and up from $55.3 million in the second quarter. So on a year-over-year basis EBITDA is up 14% versus the third quarter of last year. Interest expense was $18 million in both the December and September quarters. EPS were 38 cents in the third quarter compared to our guidance level of 30 to 34 cents. By comparison we earned 31 cents in the second quarter excluding the Tulsa facility consolidation expense that we had and 28 cents in the third quarter of last year. Now our third quarter results were helped by a couple of key items that totaled about $2 million or 4 cents per share.

First of all, like last quarter, we generated other income related to gains from the sale of some domestic contract compression units from the exercise of customer purchase options. Gains this quarter were $1.6 million compared to $0.7 million in the second quarter. We have experienced an above average amount of unit sales in the last two quarters due in part to capital budget related year end spending by some of our customers. As we have stated in the past, we view this type of income as part of our core operations as it really amounts to an acceleration of contract compression income. As such this $1.6 million gain number is included as part of our EBITDA calculation. So the bad news is that we lost contract compression revenues and gross profit going forward but the good news is that we realized a significant gain on the sale of the equipment, we realized $20 million in cash from the sales this quarter, and we will continue to earn income going forward on these units as we will still provide maintenance operations. These customers relationships will still provide continuing attractive financial returns with now significantly less capital employed for Universal. Also during the quarter we had about a $.5 million foreign exchange gain. Turning to capital expenditures, they totalled $31 million in the December quarter compared to $21 million in the September quarter; and $40 million a year ago. Capital expenditures through nine months have totaled $69 million.

Capital expenditures during the December quarter included about $20.6 million in growth cap ex, $7.6 million in maintenance overhauls, and $3 million in other capital expenditures. Investments in international markets increased in the third quarter as international growth capital spending increased from about one-third of the total in the September quarter to slightly over one half of the total in the December quarter. As always, all of our capital investment is subject to a thorough review and financial return targets are strictly followed. We have maintained our IRR and contract term minimums to ensure that new capital is spent wisely and it further supports our goal to increase returns on capital. As we look back over the past couple of years the new capital we have deployed in the business, has generated our target returns and assisted in improving Universal's overall returns and profit. We are pleased that we've been able to strengthen our balance sheet while we improve our financial results. Our overall debt to capitalization ratio was 53.3% at December 31; that's down from 53.8% at September 30, and 57.2% a year ago.

Our financial liquidity has improved and our credit availability still remains strong. We generated almost $38 million in operating cash flow after capital expenditures in the third quarter, and we realized another $20 million from the sale of the fleet units I spoke about a minute ago. Our cash position increased from almost $44 million at September 30 to over $101 million at December 31, 2003. Our cash position was boosted somewhat by about $22 million in customer progress billings received for some large fabrication jobs. Nevertheless, the positive cash flow we've generated again validates our business model and the returns we've been generating on our assets. Our $125 million revolver, which extends into 2006, currently has no amounts drawn against it; and we have an additional $25 million of capacity on our asset backed debt instrument. Lastly our 10-Q should be filed by mid-February. Steve?

Thank you, Michael. We are very pleased with the company's development during the third quarter of fiscal 2004. As I mentioned in the introduction, the highlight of the third quarter was the significant improvement in financial results for domestic contract compression, our largest business segment. Throughout fiscal 2004, we have implemented a multi-faceted strategy to improve the returns in this segment, including redeployment of idle units, selectively increasing our rate sheet on units with strong demand, increasing rates on active units that are below current market, and increasing operating efficiency in the field. We clearly saw the benefits of these activities in the third quarter of fiscal '04, as the revenues increased 2% and gross profit increased almost 8% over the September quarter level. This achievement is even more remarkable considering our domestic fleet declined somewhat over the course of the third quarter due to the unit sales under customer purchase options, that Michael referenced earlier, as well as sales of disposals of non-core units. Average domestic contract compression rates were over 3% higher compared to year ago period. Mainly larger horsepower units had rate increases earlier in the fiscal year, while certain smaller and mid-size units and some additional larger units had rate increases as well in the third quarter.

Our domestic spot utilization was 83% at March 31, 2003, and fairly steady at 86% at the end of September and December. Although the current spot utilization of our domestic fleet has declined slightly to approximately 85.4%, we are optimistic about the redeployment of recently returned units during the March, 2004 quarter at rates generally exceeding old contract terms. Current industry conditions and natural gas prices provide optimism that we will see adequate pricing levels and good utilization going forward. We met a major goal stated in our last conference call by reducing domestic contract compression operating costs to historical levels in the third quarter. Operating costs had increased by over $2 million from the June quarter to the September quarter due to start up costs associated with the reactivation of certain idle units. We resolved these start up related issues in the December quarter and overall operating expenses have returned to more normal levels. International contract compression revenues increased somewhat in the December quarter, as the contribution from new business more than offset the loss of a key project in Mexico early in the quarter as Pemex exercised an option to purchase. As a result of our initiative to activate idle assets our international utilization has increased from 86% at March 31 to 90% at September 30, to 91% at December 31. Growth areas include Argentina, Canada, and Thailand which continue to be active markets. Our current international spot utilization remains at 91%. This gives us a total fleet spot utilization of 86.3% at present.

In Argentina we expect to start over 14,000-horsepower in the March quarter with about a 50/50 split between new equipment and redeployment of currently idle units. In Mexico, Pemex exercised an option to purchase some of our working contract compression units, totaling approximately 11,000 house power, but we have a 9,000 horsepower new contract from Pemex for operations in Vera Cruz, which is scheduled to start around March, 2004. This new job will utilize currently idle equipment. We also recently received our first contract with one of the winners of the Master Service contracts awarded by Pemex in Mexico, as well as a new contract in Peru. We recently added new units in Indonesia and Thailand and are starting to make progress in the contract compression market in Canada, where we added two units to the fleet in December and are transferring two additional smaller units from the United States. Our after market service segment continued it's slow but steady improvement, as third quarter revenues increased 2% over second quarter and 16% over the prior year period. Internationally we had good demand in Canada, Australia, Argentina and Mexico. We are having increasing success in cross-selling our services and capitalizing on alliance opportunities. Our fabrication operations have improved since the first fiscal quarter when we transferred fabrication activities based in Tulsa, Oklahoma, to our existing facility in Houston. We have been standardizing manufacturing processes and improving the coordination of activities between the facilities in Houston and Calgary, since the United States and Canadian operations were combined under the new North American division in the fall.

We expect these activities to further enhance returns beginning in the March, 2004, quarter. Fabrication demand remains strong as demonstrated by a healthy backlog of orders. Our fabrication backlog was approximately $92 million dollars at the end of December, compared to approximately $101 million at the end of September; and $56 million in the year ago period. The order flow has increased somewhat since the end of the holidays, and our backlog is approximately $99 million currently, comprising about a 60/40 mix of domestic versus international. Our backlog includes units for a large gathering and pipeline project in the Rocky Mountains area and several new units for Indonesia. We are formally opening office in Beijing in the March quarter. China is a potentially large market for compression due to plans to increase its natural gas infrastructure. These plans include the construction of a massive cross country pipeline which is about half completed. We are positioning ourselves to provide compression in the producing fields that feed China's expanding natural gas system. We have already placed fabrication units into China and are working to establish an after market service presence there. Michael will now provide guidance for the March quarter and fiscal year 2004. Michael?

Thanks, Steve. I will start off with providing fourth quarter guidance and then a summary of what that guidance means for the full fiscal year. Revenues are expected to be $185 to $195 million in the fourth quarter of fiscal 2004. Domestic contract compression revenues are expected to be $70 to $71 million. That's down modestly from the third quarter due to the customer purchase options and loss of horsepower that we spoke about earlier. International contract compression revenues are expected to increase to $21 to $22 million. Profit margins are expected to be in line with historical averages for both segments, in the 64% area for the domestic, and in the mid to high 70% range for the international segment. Our guidance is based on total average utilization of about 87% in the fourth quarter of fiscal 2004. That's in line with the third quarter average utilization and up somewhat from our current spot utilization rates. Fabrication is expected to have an outstanding quarter.

Revenues are expected to be $60 to $65 million with a profit margin of approximately 10%. After market service revenues are expected to be $35 to $40 million with a profit margin in the low 20s. Finally, fourth fiscal quarter earnings are expected to be 35 to 39 cents per share. With these fourth quarter numbers our guidance for fiscal year 2004 would be as follows. We expect total revenues of $683 million to $693 million in fiscal '04. That's a 9 to 11% increase over fiscal 2003 revenues of $625 million. EPS before the facility consolidation and debt extinguishment items we had in the first half of the year, these are expected to be $1.29 to $1.33. This EPS target performance will provide earnings growth of 19 to 23% over fiscal 2003 results. Now after the 32 cents in charges related to the facility consolidation and debt refinance the EPS numbers are expected to be between 97 cents and $1.01. We now expect capital expenditures of $90 to $100 million in fiscal year 2004, including maintenance capital expenditures for overhauls of approximately $30 million. Now this is down somewhat from previous guidance as we continue our emphasis on redeploying idle units. We expect that operating cash flow after capital expenditures will be positive for the year. Through the first nine months of the fiscal year, Universal generated operating cash flow after capital expenditures of more than $70 million. Our annual budget process takes place over the coming weeks.

We will provide guidance for the June, 2004 quarter and fiscal year 2005 in our next earnings conference call. As we work through the planning process, we remain optimistic about our business model and our ability to prudently deploy capital at attractive rates of return. We certainly appreciate the support of our shareholders as we've implemented our growth strategies this fiscal year and we're optimistic about our prospects to improve EPS at attractive growth rates over the next several years. Steve?

The business outlook remains encouraging as we move towards completion of this fiscal year and the commencement of fiscal 2005. Economic growth and strong levels of industry exploration and development activity, are positive indicators of continuing strong levels of demand for our services. Indicative of this is the increase of U.S. gas well completions, up 4% sequentially in the December quarter and up 34% year over year again in the December quarter. Increasing compression requirements in mature gas reservoirs, rising gas well completions, international expansion, and outsourcing benefits continue to drive long-term growth opportunities for Universal. With this favorable environment our goal remains to enhance financial returns for our stockholders and achieve continuing year over year growth in EPS. Operator, would you open us up for questions?

Thank you. We will now begin the Q&A session. I you would like to ask a question, please press star then one. One moment, please, for the first question. Our first question comes from Mr. Mike Urban with Deutsche Bank. Mr. Urban you may ask your question.

Thanks, good morning. I was wondering if-- I don't know if it's proper to call it an acceleration but seeing a lot of customers exercising purchase options, if you have indeed seen an acceleration; if so, does that reflect a change in terms of dynamics and value proposition that you are able to offer? In other words is there that tipping point at which your ability to increase price pushes them to then go ahead and exercise an option to purchase equipment rather than rent it?

There certainly is a tipping point at which we become too aggressive on pricing and it becomes more beneficial for ownership by our customers; but I don't think what we've seen last quarter is indicative of that. It appears that most of the purchase options exercises last quarter involved assets that had proven themselves as long-term assets for their customers, which they suspected in the beginning which is why they asked for a purchase option and then as the year drew to a close they had excess cash on their balance sheet and elected to apply it to those units and convert them to own. So it wasn't a necessarily a reaction event to, or a shift in the market, I think as you stated it. We see it more as a capital issue and an opportunity for some big customers to put some units back on their balance sheet.

So that being said are you seeing opportunities to push price any more? I know you've been doing that pretty consistently and you've done a good job so far. What do you see going forward?

Well, Michael, we pushed price aggressively all through 2003 and we just stated utilization has dropped a tad. And with utilization backing off a few tenths of a percent, we are not likely to push price unless there was a certain segment of our fleet that seemed to be in high demand suddenly and we saw an opportunity there. We are not anticipating anything right now. Our efforts now are to redeploy the equipment to get our utilization back up above where it was last quarter.

Okay. Great.

That doesn't mean we are reducing price, by the way.

Sure. I wouldn't have expected it. Absolutely. Last question was, it's pretty well documented at this point that last quarter you had some start up costs, you seem to have done a good job of getting those under control in the current quarter. Is that more indicative of kind of where the run rate is or were you kind of focused on some of the projects that had issues and getting the costs under control there; and maybe you let it over shot to the other side? In other words, if you are going to be adding equipment and starting up equipment is there some more normalized or some costs that might be expected to creep back in or should we kind of assume this is the norm?

I'd say that the December quarter is more the norm. That should be the run rate margin contribution from contract compression, and when we investigated our problems in the September quarter they were internal process problems that are now solved.

Okay. And one more question. The integration of the North American business, the U.S. Canadian business, are you willing to quantify what that impact might be at this point?

It's too soon to tell. It's kind of a slow rebuilding of our Canadian operation, as we made some major changes there, as most of you are aware. With the changes in place we've got to rebuild the team. I'm gratified that we now have much better attention on contract compression, have seen some early successes there; but it is still a very competitive market and we are in the early stages of making that transition, so it's too soon to tell.

Great.

Mr. Brad Handler with Blaylock and Partners you may ask your question.

Thanks, good morning. Maybe I could ask you to pick up on the Canadian thing a little more. It sounded like a couple of the-- relative to our own expectations about margins stem from issues in Canada. Is that perhaps tied to some of the integration work, in other words the fabrication margins or the after market services issues?

Not necessarily. Some of that is tied to some prior activities that occurred. But it's not really tied directly this quarter to that transition.

Okay. So they were just one off projects that happened to perhaps be just a touch lower than you were expecting on the margin side?

From the most cases. There were some adjustments on some prior activities, as well, that showed up in this quarter. So a bit of a timing sequence.

Fabrication demand, I guess you're sticking with your general guidance of about 10% in terms of fabrication margins. The demand is reasonably healthy. Should we read anything into the 10% guidance in the sense that the integration benefits aren't quite kicking in yet for the March quarter, but perhaps that number starts to move up as we look at fiscal '05?

It will move up. It's not going to move up a lot. We've said all along that the size of equipment we are now involved in, and the size projects we have generate a 10%, maybe 11%, sometimes 12% return, depending upon mix. And we have been just under the 10% returns, with the projects we have in-house we think that we will see a solid 10% return in this quarter. They may move up in future quarters, but again it won't be dramatic.

Just one more for me. Could you add a little color on the units that were returned, that got utilization down to the 85.5% range?

We had a handful of units returned in the last two months that came in from-- they're mostly larger horsepower, that came back from projects that either were complete or projects where the customer elected to use a different compression philosophy. So they came back to us, and over the Christmas season it was kind of quite here so we haven't put them back to work. We are now busily finding new homes for that equipment.

Thanks very much.

Mr. Joe Agular with Johnston Rice & Company you may ask your question.

Thank you. I was wondering if you could give us some guidance on maybe where you expect your horsepower levels to be at the end of March.

I guess I'd answer that by saying that we don't have any known dispositions in this quarter that I'm aware of at this point in time. I'm looking around the table and everybody is shaking their heads. So we had some growth occurring in Latin America which we just talked about that will boost horsepower a bit. However, a good portion of that growth is coming from the exiting fleet; and we will be reapplying assets we have, so there won't be a tremendous growth in the fleet. Slight growth in this quarter and I'm struggling to quantify it.

Just mainly on the international side it sounds like.

That's correct.

Okay. The reason I guess I'm asking is your cap ex estimate for the March '04 year end, $90 to $100 million, I have in my notes that you all roughly have maintenance cap ex needs annually of about $30 million. Is that still a good number?

That's correct.

Then I don't know if there's some other non-growth cap ex such as office space, that type thing, that may be in that number.

There's always trucks in the shop and things like that.

I guess I was trying to get down to what amount of cap ex is going to be made in this fiscal year on horsepower actual compressor units?

One of the pieces you are missing in your equation is that I said some of that equipment going to Latin America is existing equipment. It will be overhauled and probably repackaged and reconfigured for the new application. That will be a cap ex item for us in this quarter.

Joe to give you a little bit more color on that the $21 million in growth cap ex that we spent this past quarter that was on new compressors of $16 million, we repackaged $3.5 million, and we also had $1 million that was related to installation capital expenditures; and we mentioned it was kind of split between U.S. and Latin America. We continue to have some Latin America projects, and we will spend some cap ex and that horsepower will, again, evidence itself in future quarters.

I want to make sure I understand, Michael, you mentioned that when you we get your cash flow statement that it will show roughly $70 million of free cash flow generation through nine months.

Through nine months, that's right.

Obviously that's very strong. Congratulations. Thank you very much.

Thank you.

Yves Siegel with Wachovia you may ask your question.

Good morning, Michael. Good morning, Steve. Just a follow up. Number one, fabrication, a big jump in revenues this quarter coming up. Can you just elaborate on that?

It's a variety of projects coming through, one very large project for the Rocky Mountains that will come out in this quarter; and really a blend of projects, you know that business is lumpy and this is one of the good lumps.

Okay. And that's pretty visible, right, the scheduling of the fabrication?

Yes. It's usually visible out a quarter or two with some flip flop at the end of each quarter as some units make the cut off and some miss.

Just to confirm what we've said before, the $60 to $65 million that we've got in there for guidance, again our accounting method is completed contract. So if something makes shipment not until April 1, it's not going to be counted as this quarter. Therefore it's one of the reasons why we tend to have ability more volatility on our fabrication and we'll talk about some shipments shipping a bit late, things getting delayed. But it certainly is going to be a big quarter for us on fabrication; but it's also one that we really thought was on it's way given the backlog as it developed over the course of these last few quarters.

Could you also just review what Pemex is thinking in terms of rent versus owning, is there any sort of trend there?

I would say no. They have a tendency, as do many of our customers to do a bit of both. On their new projects they seem to be, in large part, using contract compression. On long-term projects after they have proven out the field like they did with the 11,000-horsepower they exercised, they may buy it and put it into their own fleet. But the new projects coming out are all contract compression and the new project that we have is, of course, contract compression. So it's a blend.

Where is your idle horsepower internationally right now?

Mostly in Latin America and Canada. We have some smaller horsepower units idle in Canada. That's improving, but we still have some idle fleet opportunities there. And then there are some pieces of idle equipment in the Latin America fleet.

As did you make the big push internationally into Asia, could you sort of frame how large some of those potential markets are, some of the projects that you might be bidding on, and how that might translate into capital requirements looking out next year?

I don't think there will be huge projects in the Asian market within the next fiscal year. I think there will be a steady flow of smaller projects, but I don't know of any giant project that involves contract compression upcoming for the remainder of this year; or, from what we see right now, for fiscal '05. What we see is the ever growing presence of a unit here and a unit there in the markets we've been working, and China is a new venture for us and has not yet opened it's doors to contract compression. We think it will. I would be hard pressed to speculate on what I think the projects might be, when and if they do that; but there will be substantial compression needs throughout and they'll buy some more contracts then.

Then it does sound like you should generate substantial free cash flow next year just based on what you said?

Probably so, it depends to some extent as to how much activity we see accelerating in Latin America; which we believe will have a fairly strong year next year. But, yes, there will still be cash generation we believe next year.

Lastly for me, Steve or Michael, have you seen any sort of paradigm shift in the business? Within that, do you think you get back to that 93% utilization domestically? I guess that's the question.

Yeah, well I said from the beginning and consistently I think that, yes, I believe we will work our way back up to utilization in the low 90s as we were at one point in time. Will it stay there? Probably not. It will probably be a maximum utilization for us. As we continue looking through the fleet for units to apply and moving fleet units between divisions, I believe we will continue to move up toward that goal. As you can see we are not spending a lot of cash for new equipment, so meeting market demand means using what's in the yard. That's the prime goal.

Thanks again.

Dustin Tugman with Simmons & Company you may ask your question.

Good morning. Steve, I wanted to dig a little bit deeper into the pricing question. You had mentioned that you have gotten some pricing either through new contracts or bringing some existing projects back up to more market type rates. Can you quantify how much pricing you were able to gain during the third quarter?

Oh, during the third quarter.

On a sequential basis.

Probably 1 to 2%.

Okay. And going forward you had mentioned that since utilization has declined a little bit on the spot versus where you ended the quarter, that you may not be looking to push pricing further but won't be cutting. How many more units, or what percentage of your fleet do you think you can bring back up to market type rates?

We are pretty well through the low hanging fruit of the units that were significantly below market that we could bring up quickly and easily. If there were more to do, we would do it. Most of our fleet is still under contract where we are not allowed to change price or it's already at a price that's pretty attractive for that unit. The price increase issue on existing units that are under market is fairly well taken. We review it every quarter and we look for individual units that are opportunities, but there are fewer each quarter as we move on. So I won't look for tremendous benefits from price increases in this quarter.

Okay. You've done an excellent job of redeploying existing horsepower. When you look at your fleet, how much additional horsepower do you think you can either repackage or redeploy to where the economics make sense versus investing significant amounts of capital for very old horsepower, just to bring those back into other markets?

We continue to dig deeper in the fleet and find more and more opportunities to repackage what we have. And then in addition I am hoping that we see a bit of an uptick in the well head market over this coming year; as gas prices hold up and we get some more depletion in our field, we will put some of the smaller horsepower to work. We've seen a little bit of the improvement in the very small horsepower over the last couple of quarters. We would hope to see more improvement there, and that would begun begin to consume more of our fleet. I am optimistic, there is more work to be done on repackaging existing units and building utilization that way.

Okay. So if I'm looking at this correctly you've got approximately 300,000-horsepower domestically that isn't utilized. If you were to make a guess as to how much of that you think you can redeploy or repackage at an economical rate what percentage of that do you think it would be?

I would hate to hazard a guess at that. It's a sizeable percentage, but it depends on the requirements of the customer and what the economics are to make it into a two, three or four-stage unit, depending on how it's configured. It's all good runnable horsepower we just have to find the right application for it.

Final question and I'm glad I can ask this one, but Michael and Steve, you built a substantial amount of cash on the balance sheet now. You are going to likely generate continued free cash flow in FY '05. What do you begin to focus on for uses of cash?

I think it is kind of nice to hear that question, because it's not one we've heard much in the past. It is a high class problem for us. We certainly think that there is going to be continuing growth opportunities. And opportunities to utilize some of that cash and capital. One of the boxes that we are in right now is that there's not a lot of other places to put our cash on the balance sheet. We've talked before that a stock buy back really doesn't make sense given the limited float that we've got and ownership concentration issues. We don't have any debt that is callable at this point. So it's one of these issues that doesn't have a clear and obvious answer.

Okay. Thank you very much.

Our last question comes from Geoff Kieburtz with Smith Barney. Mr. Kieburtz you may ask your question.

I'd like to go back to your guidance for a moment. I did a quick calculation. I'm having a hard time coming to a number lower than this quarter's EPS. I just wondered if there was something I was missing.

Well, Geoff, there probably is something that you're missing, and it's in the depreciation line. Our depreciation is sequentially going to go up a bit more than it has in the past several quarters. Primarily we've got some Latin American jobs that are going to be in full operations mode and the depreciation is going to kick up. So I wouldn't be surprised at all to see depreciation move up $1 million or $1.5 million sequentially, and that may be part of what's driving your equation.

So you could kind of offset the benefits of the increased fabrication revenues that you're looking for?

Yes.

Okay. A couple of other questions. It sounds like you're not really expecting another big contribution from gains coming through the other line in the coming quarter?

We don't see anything large on the horizon with any of our customers at this point. It's something that we actually do every quarter with regard to small units, but it ends up being very little impact to that line in terms of profit or loss. But right now we don't see anything.

And there's no better way to project that line item going forward than we've had in the past which is basically to guess?

There really isn't at this point, Geoff. Such a small portion of our fleet even has a purchase option involved with it, and we get notice from the customer it's usually the first we are aware of it and then we proceed with the transaction. But as Michael said it happened so rarely up until the last quarter, that it's very hard to project.

All right.

We didn't predict it very well last quarter.

What was the horsepower associated with the $20 million sale?

How much horsepower?

It was about 38,000-horsepower.

On the SG&A line you pointed out that it really wasn't as big a sequential decline as it might have appeared. Is $16.1 something that you think is stable or what kind of trends do you see there in the SG&A line?

It's hard for us to really deviate much from what we said before which is $16.5 to $17 million. We did a little bit better this quarter. Part of that may be related to things that we are doing in Canada, but I'm hard pressed to forecast that we can continue below that $16.5 to $17 million range. That should be about right for us.

So it was a little below your run rate in the quarter?

Yes.

On the Canadian market, there were a couple of questions earlier about that. You'd mentioned that the parts and service margin was a little bit lower due to Canada. Is that structural or was that just sort of incidental mix effects in the quarter?

It's more of a competitive basis in Canada. The margins can see pressure in Canada, both on fabrication and after market; there's more vendors than there is market in Canada. So we tend to have some bounces in margins there.

Okay. I mean I guess the question is, hopefully you are successful in rebuilding your business there in Canada; but will that be somewhat of a little bit of a drag on international margins?

No, it's two l too small to really be much of a drag on international margins I believe and it will take some time to build that business but it's not performing horribly right now. It's doing reasonably well. We just need to get it up to a little bit better level.

Okay. Kind of coming back to your answer to the first question in regards to depreciation. It sounded like you didn't expect total horsepower to change much in the quarter, but we are going to see a meaningful uplift in depreciation. Can you help me with that? What's the dynamics?

Sure. It basically results from a lot of timing delays. Cap ex that you may see in this quarter isn't actually going to hit a horsepower report and-- maybe until next quarter and then it doesn't start depreciation until it's actually up full and running.

Gotcha. So it's the activation of that horsepower that is really driving that depreciation?

Right. So there's a bit of a timing delay on those three events.

You mentioned that the target for your cap ex internationally has been Latin America. Can you be any more specific on that?

The opportunities have been in Latin America. We don't actually have a target for any one location. But since we've been in Latin America the longest of all of our international markets, it's where the majority of the growth has been because our infrastructure is there. So it's not necessarily a target there; but, nonetheless, because of our size it is where it occurs.

Our immediate projects on the margin are more in Argentina and Mexico, specifically.

Okay. And then lastly this comment you made earlier, Steve, in regards to the pricing on the smaller units now starting to show a little upward mobility, that appears to be a somewhat significant change from the recent past. Are you considering it a pretty important change?

No. What we did is we went back last quarter and really checked through all of our small units to go find opportunities that were there, and then we implemented them. I think we have good stable pricing on small horsepower, particularly very small horsepower. And I'm pleased with that but I don't think there's opportunities to raise it very much. It was more of a clean up effort.

Very good. Thanks very much.

We have one follow-up question from Mr. Brad Handler.

I'm hoping we can step through a little of what I thought we heard last quarter on the conference call versus today. It was like a quarter ago we heard we've reactivated a number of units, there were some costs associated with that, the risk of issues happening again are low because we are basically out of big things to reactivate, we are going to have to turn our attention to U.S. focus, new horsepower development. Whereas today, it sounds like the cap ex is really spent internationally we're actually having some-- I don't know about issues, that's probably not the right word, it's probably too strong; but the pace of utilization certainly slows in the U.S. I guess I'm wondering if there's a little bit of a change that you guys have seen over the last month or two? Have I characterized things right and so maybe now there is a little bit of a moderation in growth in the U.S. market, realistically, relative to what you were thinking you saw three months ago.

Let me explain it this way. The steady growth that we have seen since January of '03 just kind of month after month after month, nothing tremendous but good steady growth; led us to the comment we made in last quarter's conference call that we had placed almost all of our idle large horsepower to work and to continue to grow at that pays we would be adding some cap ex in that bigger horsepower segment. As the December quarter unrolled we got sufficient units released to meet increased applications for new projects, so we just rolled that equipment over from incoming to outgoing on new projects. So, yes, we did not see as much growth in the December quarter as we had seen in the prior three quarters; and we think, from what we see now, that that was more than an anomaly than a shift in the market, but we will know by the end of this quarter as to where we are. In other words we have seen pretty good demand so far early in the March quarter that we are in now.

That makes sense. We are talking about the larger units here. On the small units did you continue to see things pick up and, or too small to add up to anything?

Small units haven't changed much. Their utilization has been good, not great but it hasn't picked up a lot.

Okay. All right. That helps. Thanks.

This concludes the question and answer session. I would now like to turn the call back over to Mr. Steve Snider for closing comments.

Thank you. Thank everybody for calling in. We will talk to you in a quarter. Good bye.