Archrock Inc (AROC) 2004 Q4 法說會逐字稿

Good morning. Welcome to the Hanover Compressor Company fourth quarter full-year 2004 financial results conference call. With us this morning is John Jackson, President and Chief Executive Officer, and Lee Beckelman, Vice President and Chief Financial Officer. Earlier today, Hanover released its financial results for the fourth quarter and full year-end December 31, 2004. 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, the Company's prepared remarks on this conference call, and the related question-and-answer session include forward-looking statements. These forward-looking statements include projections and expectations of the Company and represent the Company's current beliefs. Various factors could cause Hanover's results to differ materially from those projected in its forward-looking statements.

Information concerning the factors which could cause Hanover's actual results to differ materially from those in its forward-looking statements can be found in the earnings press release, as well as the Company's SEC Form 10-K for the year end December 31, 2003, the Company's SEC Form 10-Q for the 3 months end September 30, 2004, and the Company's other SEC filings.

Currently, the teleconference participants are in a listen-only mode to prevent background noise, as today's call is being recorded. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). I would now like to turn the call over to our host, Mr. John Jackson. Mr. Jackson, you may begin your conference.

Thanks a lot. I want to welcome everyone to Hanover's fourth quarter 2004 earnings call. And also I want to welcome Lee Beckelman as the new CFO of Hanover. We're very excited to have him on board in his new role and expect a lot of good things out of him as we move ahead.

I want to comment on a couple of things overall today. First I want to talk about 2004 some, and then I want to turn the attention to 2005 and kind of what we see in the future and what's happening here at Hanover that we get excited about. I want to pass that on to you.

So let's start with 2004. As we look at the end of the year, certainly our performance isn't where we want it to be yet. We have made a lot of improvement over the course of this last year, but it is not anywhere close to hitting on all cylinders and we still have a lot more we can extract out of the asset base we have. And we are going to talk about that as we go through it a little bit.

But there have been some bright spots this year. International rental revenues and gross profit has improved quite dramatically. It's up over $20 million year-on-year. And that's without putting very much capital to work at all. Most of our capital we spent this last year was maintenance capital. We had very little in the way of new projects, it's just improved execution and improved margins.

On the fabrication front, we have some positives and we have some things that we still have to improve on. On the positive front, our backlog has dramatically increased year-over-year as far as the entry rate into the year. If we look at last year we started the year with about $153 million backlog. We start this year with 291. Looking into January, we increased that 291 to 301. So we continued to build the backlog that we moved into '05.

Last year our shops were not near as full as they needed to be. We took a number of low marriage jobs. We began to ramp up our business activity. We felt the impact of the low margin jobs on our business during the year, as you would expect. We also had some warranty issues that hit us during the quarter on some jobs that we didn't perform as well on as we had hoped, whether that's timing and delivery, or whether that's actually starting up and getting running the way we wanted them to do. But those are in the minority, a very small number, but they did hurt to us some degree.

We also have some of our international fabrication facilities exposed to the dollar, and if you recall in the fourth quarter there was a lot of weakness in the U.S. dollar relative to the Euro and the pound and the Canadian dollar and we experienced some margin degradation from that. However, as we look into '05 I think we think we are in much better shape to perform better in the fabrication business. We are going to talk about what we are doing on that front as we move into the '05 outlook.

In the U.S. rental business, for the full year we had 3 business units in the U.S. One performed really well all year. One performed okay and has a decent room for improvement in '05. And they are taking actions to try and deliver that improvement. And one, as we discussed on the last call, didn't perform well at all. We have made a number of changes there. We are starting to see the fruits of those changes being born out here, but they're just starting to take effect and we should expect to continue to see improvement in margins in the U.S. rental business as we move ahead. I am going to talk about the market outlook on the U.S. market here in a minute.

In the area of safety, every area of the Company had dramatic safety record improvement during the year, whether it was the U.S. or international operations, or whether it was our fabrication facilities really did a good job in improving their safety records across the board. And for that, everyone in the Company is to be commended. We still have room to work there, but we made really dramatic improvement here. That's kind of the quick operational overview.

From a financial standpoint, if we step back and look at the fact that we've sold Canada and now reflect that as discontinued operations and take out the positive or negative effect of the shareholder settlement, our EBITDA year-on-year is up 8.5 percent from 2.66 to 2.88. Our capital is down from 142 million to 90 million, that's down 37percent. And we reduced debt $150 million during the year. So we really focused on reigning in spending and paying down debt and being disciplined during the year. And we expect to continue discipline as we move ahead, but I think we'll begin to expand the growth theme, and I am going going to talk you about specific projects in a minute.

The third area that affected us in 2004 was really Sarbanes 404. We spent a lot of time on that in this organization. Given the fact that Hanover's been in a turn-around situation, the affect of 404 on us was probably more dramatic than other companies, in that we had a lot of documentation to do. When had put a new system in. We had to document the controls around that system. And we were putting in a lot of new management, organization and structure and we spent a lot of time and money on that this year. And while our 404 opinion is not yet complete, we will complete the process and we expect to have that opinion completed by the time we file our K, which we expect to file on time.

Finally, from a management perspective, our operations personnel as we exit '04 and enter '05 are really going to spend -- have much more ability to spend more and more time on the business. We began to turn our attention to it in 2004. We finished implementing Oracle in the front half of this year in most of our large locations, manufacturing and some international locations, and we spent a lot of time on 404 in the second half of the year.

Now our management team is having much more visibility -- senior management team, on customers and the investors. So I think as we move into '05, you'll see more of the management team on those fronts, the investor base and the customer base, as we're able to really tell you how the business is performing and get in front of the customers and try and get some additional business, both in the U.S. and international markets. So overall, 2004 is improving, but not enough and we still have room to work.

If we look at 2005 now for a minute, step back and look at the overall market. The macro environment is very strong. We like what we see. I think everybody would agree with that. The commodity prices are strong. We have a healthy rig count. There's a lot of activity. A lot of people's balance sheets are strong and are still looking to spend money, especially in the international markets.

In the U.S. market, we see steady rental growth, nothing dramatic, maybe 1, 2, 3 percent over the course of the year as far as utilization increase. U.S. production is relatively flat, so we don't expect dramatic changes. There are pockets that are more robust than others. If you look at the Rocky Mountain area, there is a lot of activity selling assets, selling production equipment, selling compression. If you look in the Barnett area, there is rental going on. So there are areas in the U.S. where the rental is strong. There are areas in the U.S. where selling is strong. But overall, we don't anticipate a dramatic change in our contracted horsepower in the U.S., just slow, moderate growth over the course of the year.

In the international arena, there is definitely an expanding rental market and an expanding sales market. We have firm pricing. We have growth opportunities, both in our existing markets where we are strong and what we'd call frontier markets, being the West Coast of Africa, the Middle East, the Far East, Russia and so forth. There is a lot going on in the market that we think we are going to be well-positioned to take advantage of it.

So how is Hanover positioned to do take advantage of that? Well, there are 4 things I think we have for 2005. First off, Hanover is still finishing turning its story around. We expect to continue to improve performance on our existing asset base. We have a price increase in the U.S. market effective the first quarter of 2005. That's averaging somewhere in the 4 to 5 percent range on the third of our fleet that's available for price increases.

We had underperformance in 1 GBU significantly in 2004 that we expect to dramatically improve in 2005, which overall should improve our margins and improve the dollars that we deliver to the Company overall. And the improvement is underway already and we are seeing some effects of that improvement already.

The contracted horsepower in the 1,000-horsepower range is a target area for us to try and improve what we have there in our utilization in particular spot of the fleet. You move into the higher horsepower range, the 1,500, 1,250 up, we have very high utilization, but in the 900 to 1,200-horsepower we have I think an opportunity to increase our utilization, because that area is very active right now in the U.S.

And we are going to continue to work on converting units from single-stage to multi-stage. That area of the market continues to be active and if you look at the U.S. production landscape and profile, I think we would all expect multi-stage units to continue to be needed well out into the future.

Fabrication margins, we've hired an efficiency consulting group over the last couple of months and they will be here for 2 or 3 more months to look at our fabrication facilities and help us drive out cost. Already we've identified a number of cost savings areas that we are in the process of implementing and we expect to begin to see those improvements over the course of this year starting the second quarter on, from this effort.

Besides the fact that we will run off the last of our low margin jobs here in January, I believe we will continue to see fabrication margin improvements as we move ahead, assuming the market stays at the level it is. But we are having a going activity in our product lines across the spectrum here and now it's up to us to reduce the cost structure and deliver the margins that should go with that activity.

Parts and service continues to have a number of opportunities internationally. One specifically for us is the Pakistan gas plant compression that we've installed. We will be finished installing at the end of the first quarter and we should have the O&M contract on that beginning by April of this year. So we will begin to see that happen. We have some other opportunities out there that we are pursuing. We think on the international arena, that's an area for have us of long-term growth.

The second thing for us is going to continue to be debt reduction. We don't have a lot of prepayable at par debt right now, but the focus on not over spending and continuing to reduce absolute dollar debt is a must inside this Company.

The third area, the third theme for this year, which is different than last year, it is incremental to last year, is going to be growth. Last year we spent about $28 million in growth capital. This year we have already been awarded, in the fourth quarter of last year and the first quarter of this year, projects that will commit us to approximately $40 million of growth capital over the course of the rest of this year. They will be using some idle assets on some of those projects. We certainly have that ongoing focus to try and put our idle equipment to work.

If we break it into 2 big pieces, the first is Nigeria, we still have a little bit of capital to spend on that. We've been talking about that for a couple of quarters November. We have 2 projects in Nigeria, one very large one. Those 2 projects we're expecting to get on line late second, early third quarter. They would approximate about $1 million a month of EBITDA, $1.5 million of revenue, somewhere in that range.

We are very close to having those on line. However, obviously operating in Nigeria has its issues that we can't control, as far as all the other people and factions and so forth that we have to operate within in that country. So it's not all within our control, but based on what is, we look ahead and we see in the next couple of quarters those projects having a great chance of getting on line and having a real significant impact for us.

We have a number of other projects, several other projects that we've been awarded in the last 3 to 4 months that we would expect to be on line beginning in the mid-quarter of '03 through January of -- excuse me, the mid-third quarter of 2005 through January of '06. These would encompass revenues of approximately $1.5 to $2 million a month and gross margin delivery of $1 million to $1.5 million a month.

All of these are in Latin America and they are primarily expansions of existing Hanover sites that we already operate today. So our ability to deliver these on time, on budget, know the operating cost, are very high. There are some new areas for us, but they are in countries we already operate in with customers we already do business with, but largely they are expansions of existing facilities.

So overall with Nigeria and these projects, we would expect by the end of the year to have $3 to $3.5 million of additional revenue, and $2 to $2.5 million of additional gross margin. That's what gets us excited here. When we think about the future. We are now moving into putting idle equipment to work overseas, pursuing really good rate of return projects, fitting it within our cash flow profile and bringing these on line. That's not what we did in '04, we really focused on only debt reduction. Now we are going to find that balance of growing and continuing to pay down debt.

We have a number of other opportunities that are still in front of us that we are in the process of bidding or evaluating or awaiting on a response on a bid; that are not only in Latin America, but in frontier market. We will not, however, overspend our cash flow. We will not lesser up. That is what we committed to last year and we still have that commitment this year. We will find a way to either fund these or high-grade the opportunities in front of us.

The fourth thing and the final thing, the final element for 2005 for us is a strategic plan, a long-range strategic plan. We've been operating the 6 to 12-month kind of horizon, trying to run our business better, get our business organized and get the past behind us, and now we are looking to be, where do we want to be in 2008, '09 and '10? How do we want to position ourselves to get there? Nothing is sacred as we go through this plan. Changes will occur. Our goal is to improve return on capital.

We expect this to be vetted and laid out in front of our management team and Board by late this year, and when we get that completed we will get back to you with specific details of what changes will occur. But we are not going to accept the return profile we have today. We do believe, based on the projects we see in front of us, our ability to execute on those, as well as the base business we have, we have a lot of opportunities and a great ability to grow and deliver, position this Company for the long term over the next 2 to 3 years.

So with that, I am going to turn the call over to Lee now, and let him take you through more of the specific numbers for the quarter. Lee?

Thanks, John. You should all have the press release and the press release really covers the numbers for our year-over-year comparisons for the full year, so I am going to focus on comparing our numbers to the third quarter of 2004. Starting with the domestic rentals, revenues were relatively flat in the quarter. We had steady activity early in the quarter that faced a little slow down late in the quarter from holiday time, et cetera. Overall, it was a good quarter on the activity level.

Margins were up to 58 percent versus 56 percent in the third quarter. As John alluded to, we still have some clean-up issues and items in one GBU in our U.S. operations. We do have a new management team in place there. We've actually named a new District Manager for one of their districts. We are expecting to see improvement in that area over the course of 2005. As John also alluded to, we do see room for improvement in margins going forward, particularly from more focus on controlling costs and improving our processes and controls in our domestic business.

Utilization for the quarter was up about 1 percent. That was primarily driven by some disposal of some units and some increase of tagging idle units to international applications as we are getting those ready for international projects coming on in the first half and in 2005. Overall, as we go into first quarter, our expectations for revenue are basically flat to slightly up from the fourth quarter. We expect margins to be kind of the 58 to 60 percent range.

January started off a little slow, but we are seeing a good pick up in our rental backlog. And would expect activity to kind of pick up in February and March. Also, as John talked about, we did have the price increase initiative and we are starting to see some of the benefit of that in the first quarter.

Going on to international rentals, the revenues were up about 6 percent quarter-over-quarter. Basically, one of the projects in Nigeria did come on line in the quarter and we also had some increased activity in the Far East and some inflation adjusted about $500,000, related -- inflation adjustment in Venezuela. Margins decreased slightly to the 67 percent from 68 percent. That was due primarily to some increased repairs expenses and start-up costs of our Nigeria projects, and we did have some repair expense for some projects of about $500,000, incremental repair expense of some projects in international markets.

Utilization actually improved to 98 percent from 96. That primary is from the benefit, from the sale of the Canadian horsepower, it was about 84,000-horsepower, and at the time we sold Canada its utilization was around 78 percent.

For the quarter coming up, in the first quarter we expect revenues to be flat to slightly down. As John talked about, we don't have a lot of new projects coming on in the first quarter. We really expect that to be more in the latter half of the year. Margins right now look to be in the high 60s to low 70s range.

On the parts and service side, revenues were down quarter-to-quarter about 6 percent. And margins declined from 29 percent to 19 percent. That was primarily driven that we had a, if you recall in the last quarter we had a sale of a plant in our international markets, roughly $10 million that we experienced a $6 million gain on that. So that helped both benefit the revenues and the margins in the third quarter relative to the fourth quarter.

In the fourth quarter, we did have a pick up in our base business. It increased from roughly 37 million, our base parts and service business increased from roughly 37 million in the third quarter to 42 million in the fourth quarter. That was driven by some increased activity in the U.S. We had some customer-owned units that had some repairs, and we got some call-out work on that that helped benefit our U.S. business.

Going into the first quarter of '05, we expect the base business to be flat to slightly down. As I just talked about in the U.S., we had that kind of call-out activity that is not re-occurring necessarily. And that repair, which is non-recurring, so we expect overall revenues with margins to be in the mid-20 percent range.

Going on to compressor fabrication. As we highlighted on the last call, we had expected revenues to go down a little bit in the fourth quarter. We were down about 10 percent and margins declined if 12 percent to 6 percent. Margins were lower than anticipated due primarily to increased warranty expense that John talked about. And also the low -- the continuation of some low margin jobs that we committed to earlier in the year that are still working their the way to the shops. The increased marketing expense quarter-over-quarter was about $400,000.

Our backlog in fabrication has actually picked up. At year end compressor fabrication was 57 million versus 43 million at the end of September. Activity continues to be good and the backlog is actually improving. In January we had an exit rate of around $60 million. We are experiencing some increases in equipment deliveries, so our turnover backlog is actually slowed down a little bit because of delivery schedules for major equipment.

And so as we go into the first quarter, our revenues are right now looking to be slightly down from fourth quarter levels in the low to mid $30 million range. We do see improvement in margins, with the margins coming back to 9 to 11 percent range. And we expect the exit rate for the quarter to pick up as we stabilize these equipment deliveries in our backlog. Our backlog is strong, but it's just taking long to get those jobs to the shops because the equipment orders are having a longer lead time than they had in the past. That should stabilize at the end of the quarter and we should expect revenue increases in the second quarter.

Production and processing equipment, revenues were basically flat. Belleli was down about 5 percent, the non-Belleli piece of the business was up about 10 percent. Margins decreased slightly from 9 percent to 8 percent. The big impact on the margins in the fourth quarter, we had about $1.7 million in negative impact from currency fluctuations, primarily related to the Euro and the Canadian dollar. Most of our contracts are dollar based, but the cost in those locations are in the local currency and so we had some impact there. And we did have some increased warranty expense in the production and processing side as well.

The backlog for Belleli is up to about 143 million, actually up to about 150 million from 143 million at the end of September and has improved 162 million at the end of January. The non-Belleli backlog improved to 84 million from 72 million at the end of September, and is actually around 78 million currently. Expectations for the first quarter for production and processing, it looks like revenues should be in the mid to high 80s range and margins to be around 10 percent.

As we go into other areas of the income statement, SG&A did increase in the quarter by about $3 million. That was primarily related to about 800,000 incremental SOX expense in the quarter, and we did he have some severance expense primarily at Belleli of about 1.2 million.

Also in the quarter, interest expense was up quarter-over-quarter. In the quarter we terminated an interest rate swap that was associated with one of our synthetic leases that had a cost of about $2.6 million, then that flows through our interest expense line item in the quarter.

Depreciation was up around 3 million in the quarter. That was due to write-offs from the fees associated with the pay down of synthetic leases in the fourth quarter. We also had some acceleration of depreciation on installations pieces of some international projects. And we did have some new capital come on line in the quarter. Going into the first quarter we would expect depreciation to get more back in line in the $44 to $46 million level.

In the quarter we did have a $4.5 million benefit that was mentioned in the press release. That benefit was from the remeasurement of our dollar denominated intercompany debt with our foreign subsidiaries. Most of that was related to Belleli. If you recall in the last quarter, the third quarter we did have a $4 million benefit that flowed through the quarter in EBITDA related to the extinguishment of a note associated with the Securities litigation settlement. Just to go back at last third quarter's EBITDA, if you factor out Canada, it was roughly $76 million which if you include the $6 million gain plus the $4 million benefit, it had a run rate really in the $66, $67 million range in the third quarter.

Going into taxes, we had a roughly $6 to $7 million additional taxes spent in the quarter related to our current deferred [ph] tax asset position. And the fact that we still have booked losses in the U.S. We are still working this issue. As we do anticipate that it will continue on in 2005.

There is a lot of things we are trying to do to plan around this and we will work through that throughout 2005, but right now our estimate that we will continue to have roughly a 7 to 9 million -- a $6 to $8 million additional expense factored into our taxes each quarter in 2005. Right now our current share count is roughly $0.07 to $0.09 per share. Just a reminder to everybody, this is a non-cash issue and it's something that we are working on to try to minimize that number over time.

In liquidity, John has already highlighted that we had a net-debt reduction of 149 million for the year. At year end our outstandings and our revolver was roughly $7 million. We had LCs at the time of around 100 million. At the end -- currently we had LCs about 107 million. In the second quarter -- in the first quarter we have -- we are planning to pay down the remaining balance that we have on the 2000 B synthetic lease that was coming due in October. That will occur within the next week and we will draw down some of our revolver to do that.

So our revolver outstandings at the end of February are going to increase to roughly $60 million. That's really just the refinancing of the synthetic lease debt into the revolver. And the end of March we also typically, we had heavy interest payments in March and September of each year. We had roughly $32 million of interest payments that are coming due in March that we will have some -- some of that will be covered by draw downs under our revolver. So our revolver outstandings may increase a little bit from the $60 million level by the end of March.

Overall, on asset sales, as you should already be aware of and was disclosed in our last conference call, we did cell our Canadian rental business for roughly $57 million in the fourth quarter and those proceeds were primarily used to pay down debt.

Finally going into kind of the capital expenditures. In the quarter our capital expenditures increased to 33 million from 20 million in the third quarter. Of that 33 million the split was 15 million on growth capital, that growth capital was primarily related to working to get our Nigerian projects on line. We had 13 million in maintenance and 4 million of other capital.

For the year, capital is $90 million, and that included 28 million of growth, 43 million of maintenance and 19 million of other. We anticipate CapEx for 2005, as we put in the press release, to be $125 to $150 million range. As John alluded to, we will have -- we expect to have an increase in some of our growth capital this year.

Finally, on guidance for 2005, in addition to the CapEx, we have given guidance that our EBITDA we expect to be in the range of $280 to $320 million. The driver to the high-end of that range would be the Nigerian projects coming on line as expected, and some of these other projects as John alluded to in his discussion, coming on line in the time frames we talked about.

I think now we are ready to open it up for questions.

(Operator Instructions). Your first question is from Ken Sill.

Good morning, guys. One question to clarify what John was talking about on the Nigeria stuff. Were those annual run rates or quarterly run rates on the revenue and EBITDA contribution of --?

Monthly.

Oh, monthly.

Monthly run rates.

So that's --.

$2 to $2.5 million of gross margin a month.

That's good stuff. Now it sounds like those have slipped a quarter?

Yes, we had some -- we had some problems in Nigeria that were not of our making. If you were to understand the Nigerian project, what we have is we have our facilities in one river channel, there's a piece of pipe that goes 15 miles or so across to a deeper river channel, that pipeline is what has to be completed, and that pipeline got shut down for awhile by the local people until they got some issues sorted out with the people who were installing the pipe.

So there are different local tribes along the way that we go through, many different communities that get touched and they ask everyone to shut down for a month or 2 and that's what happened. We shut down, worked our way through how these issues were going to be done by the pipeline installer. And I think they've worked through those at least for the moment, and they are back up working. And based on the current schedule, they would expect to finish the pipeline in the next 45 to 60 days and then we could hook up to the storage vessel, begin testing and so forth and that would lead us to a late second, early third quarter. If new events arise that are outside of our control, then we will just deal with those as they come along. But right now, everything is proceeding ahead.

Looking at the EBITDA guidance of 280 to 320 that's essentially kind of flat, down a little bit to up a little bit. And I guess Nigeria coming on as expected takes you to the high-end so you are looking for a little bit better international with Nigeria coming in, that would be about $12 million gross I guess in the second half. And then a little bit --.

Nigeria is 1 million a month. The other projects are another 1 million to 1.5 million.

Yes, I was just wondering about 2 million a month with new projects in the second half.

Yes.

So the 280 million EBITDA number, that would imply, I mean what in addition to Nigeria not coming on.

That would imply -- 280 is in essence where we are today.

Yes.

Nothing is going to change much in the first quarter. So we are assuming these projects come on line as expected and we don't have any other operational issues and the 280 basically says status quo, nothing comes on line of any significant and nothing goes off-line of any significance. That's definitely the low end of the range. But that's about where we are right now. If you look at our -- what we just delivered.

Yes, with Canada gone.

Yes. We lost $2 million a quarter on Canada.

Yes. Like I said that low end of the range seemed kind of conservative, but that's fine. And then another question. On parts and service, if you ran the $42 million of revenue, it looks like margins there were actually around 19 percent. Because if you run 42 at 22 you get more gross margin than you reported. Is there something strange in those numbers or is the calculation in the press release --.

No, there was little margin compression in the fourth quarter because of the mix international and domestic, because international is at higher margins and domestic is a little lower margin, so that impacted the number. Because the U.S. was higher in the quarter than normally is the case, and we expect the mix to get more back to normal in the first quarter.

So back into the low to mid 20s on the margin side.

We are still looking to the low to mid 20 margin level.

Okay. And then one final question and I will let somebody else ask. We're starting to see price and cost pressures coming in. Looked like there was a little bit of that in your numbers. You're looking at this 5 percent U.S. price increase which is going to translate to 1.5 to 2 percent. Is that going to be able to offset the increases in basically parts and service costs? Or do you guys get to -- is that a net price increase on top of pass through for higher part costs.

I would expect there would be some cost increase. Obviously, you have wage increases and things like that, so it won't all flow through. However, if you go back and look at what we delivered cost structure wise in 2004, we believe we can take cost out of the system. So if you were to say, we are going to continue to run as we are, yes, it would not all flow through.

But we think based on using the 57, 58 percent margins we've delivered the last couple of quarters, we think we will get some of that price increase benefit, but we will also get some margin improvement because we can take cost out. But we do have absolute cost going up. We just have been inefficient in our overall cost structure. I don't know if that makes sense to you.

No, it does.

Okay.

You still think there's more wood to chop, and benefits to get from just running the business.

Absolutely. So if we were running a really clean, pure, pristine operation, yes, we wouldn't get every piece of the price increase because we just have, you're right, cost structures going up overall, but we think we can offset most of that with cost savings.

Thank you.

Your next question comes from -- one moment. Your next question is from Arvin Rajpaul.

Hi, guys. This is Arvin Rajpaul with Morgan Stanley. Just a quick question, I'm sort of new to the credit. But you said 62 million EBITDA for the quarter and your guidance suggests $75 million run rate and I was trying to bridge that, if you can break it out between domestic, international and the other divisions?

I wouldn't say we were at a $75 million run rate, we're probably closer to upper 60s to 70s, somewhere in that. If you took the FX out. I think what you just quoted was taking the FX out. If you put the dollar impact on the margin back in, the severance cost in, and what we would consider to be very high Sarbanes cost in for the quarter, which is $3 million-plus, we won't be running at those rates for next year. So you have 3 million for Sarbanes, next year hopefully it's going to cost us $0.75 million a quarter. So pick up a couple million there. Pick up a million on severance, pick up 2 million on dollar compression on the margin and you get close to 70. And that's kind of our 280 range number that we were just talking about.

I was just thinking the midpoint, the --.

Oh, okay, yes. We are at 280 and we expect to be able to improve on our cost side and our margin side on fabrication and rental businesses over the course of the year, and that's kind of -- plus new projects coming on line that we articulated earlier we think we would get us -- that's kind of how you get to midpoint .

Okay.

Your next question is from Thiru Ramakrishnan.

Good morning, guys. On the fabrication side of the business, I wanted to know how rising material costs are affecting your margins, if at all?

They are -- we are actual able to pass those material costs on in our bid. What caught us earlier this year and we did have some steel price impact in our margins this year, both at Belleli and in the U.S. operations, is that we had some bids that were, kind of had a long time clock on them, say 6 months for them to come back and accept them, and when they did, steel prices are had run on us. But as we worked our way through the year, we have tightened up our bid process, we put escalators in our contracts so that the bids are good for only a very short amount of time, or if they want them to be good for a long period of time, we just say, steel prices float and you will get whatever it is. And that's how we've taken care of it going into '05.

So in Q4 did we see any of the kind of uncovered higher steel cost?

We did on Belleli, on one particular job, that they had quoted 2 tank farms way back early in the year, one at the front and one to be done at their option 9 months later and they exercised that option about 8 months and 28 days later, and steel prices had run on us so we did have some margin compression on steel prices at Belleli on that one particular job. That's the only significant job that I'm aware of and there will be a little bit of that impact into next year, but I think we've captured most of it.

Great. And does your low end of the guidance, kind of the 280 million in EBITDA for '05, is that assuming that pricing stays kind of flat from current levels in the domestic U.S. market?

Absolutely. Absolutely.

And then kind of diving into the U.S. domestic market a little further, what would you say is your utilization on kind of your higher end multi-stage units are, is that greater than 90 percent?

Well, the multi-stage unit typically -- well on the higher end, let's call it 1,250 horsepower and up on that side, we are in the mid to upper 80s, okay? Whether it's a single stage or multi-stage, that stuff is utilized. Now as you move into 1,000, 900 to 1,200-horsepower range we are not where we want to be. We are still in the upper 70s there. From our perspective, that's our opportunity, though. What we have is we have units sitting on the fence that we could get ready and put back to work, much more cheaply than having to obviously build a brand new one. So that's where our opportunity is.

On the multi-stage units, especially on the smaller horsepower, that's where we see the opportunity to convert some of our single stage small horsepower units or 2-stage small horsepower units to multi-stage, spend a few thousand dollars on each of those and get those back to work. Because that equipment is just, it's just a much more competitive market on the small end of the horsepower range.

Are there any in bottlenecks in terms of repackaging, refurbishing some of your single-stage units into multi-stage units in terms of getting parts?

There have been. It's not a part issue, it's a shop space issue so we've begun to instead of adding shop space, we've turned our attention to balancing our load and using third-party facilities to run units through there where it make sense that we can be cost effective with it. So there is an issue there, but we are working it.

Great. And then last questions is, looking into '05 it looks like the rental -- domestic rental fundamentals are pretty good. Could you -- could you walk us through kind of return on capital for incremental compression unit, multi-stage compression unit that's added into the U.S. fleet verse some of the international projects that you expect to take on in the second half of '05.

Well, I would say that the -- let's just do some real top-level math, I guess internationally what would you expect to see is probably 1.5 to 2 times the rental rate because of location and export costs and so forth, but you also get turn. You get 3, 5, 7 9-year term kind of thing with it. So your returns are higher internationally obviously because of the risk, but some of the benefit you get is term. On the U.S. side on an incremental unit, multi-stage unit, you may have it on lease for 6 months or 9 months and then you may have to move it. But the fall through on it is pretty high. So your incremental margin on that incremental unit is not going to be 60 or 58 percent, it's going to be 80 percent. Because we have the infrastructure in place in the U.S. today that we don't have to add people to put 10 more units out. So if we are talking about the marginal unit in the U.S., the return on that marginal unit is very high.

I guess that just just leads my next question. With 80 percent of the your CapEx going towards international expansion throughout 2005, do you see maybe that mix shifting to maybe upgrading more units to multi-stage?

We have, oh, $10 to $15 million of capital allocated to the U.S. market today.

Right.

If we get to the point where we have opportunities in the U.S. overwhelming us that are going to deliver those high incremental returns, we will certainly step back and take a look at what our opportunities are both internationally and in the U.S. What we do like about the international markets though is that's where the growth is occurring, that's where the production gross is occurring, that's where we can get long-term contracts, and it does just shrink our overall U.S. excess capacity versus renting a unit and then having to go rent it again 6 months later.

So, they are both very good. They are both very attractive. We just won't be -- we are not yet in a position to add a lot of horsepower to our U.S. fleet because we don't think we need to. There is some we are doing on the very high end, the pockets we just talked about, where we are building that marginal unit and getting a lot of that fall through. But your point's well taken, and where we can and will, we will put though those units back to work in the U.S.

So if we get to the point where we're out of money to pursue those opportunities, we will sit back and at the -- what can we do to optimize our asset base we have today. Is there something we should sell that's low margin return to pursue that. We are not at that point yet, but it's a good point and we continue to monitor that closely.

Great.

Your next question is from Elise Palmer.

It's Elise Palmer, by the way, Tassel's Investment Management. Can you hear me?

Yes.

I think the average daily volume on Hanover is something over 600,000 shares a day, right? And yesterday it traded 2.8 million shares. And this morning I saw your quarterly release and it's not good and the stock is down. But why was the stock down 6.5 percent yesterday on such huge volume?

We don't know other than the fact that we did have a downgrade we experienced yesterday.

What was that?

We had a downgrade from CSFB. Basically, if you read the note, basically, they still believe we have good long-term fundamentals, but near-term momentum versus other players in the sector is not as great, and that's what they led from an outperform to a neutral. That may have had something to do with the flow of our shares yesterday.

You don't think it has anything to do with the quarterly release that came out the next day?

I don't know why it would. We didn't put the release out until last night. We certainly haven't talked to anybody about anything relative to our earning other than what's been talked about as we move along at the webcast conference 3 weeks ago. So, no.

Okay, that's fine. It just doesn't look good, does it?

No, but I think if you look back at when we are downgraded from time to time or upgraded from time to time, you see volume pick up and you see a lot of activity. We had over 1 million shares trade earlier in the week. And our stock was up. So we had 1.1, 1.2 million shares traded in the front part of the week. While we do average 600,000 shares if you look back at our trading volume, you will see some 200,000 share days and you will see 1.5 million shares days and there's no news on us out there, it's just people moving in and out.

It didn't look good. And today is the follow through [ph] is there. Anyway, okay. Thanks.

Your next question is from Eric Dobeslon.

Good morning. Just a question on debt leverage here. If we take the mid range of the EBITDA guidance and also give you credit for some additional debt reduction throughout 2005, you are still at least 5 times levered on a total debt to EBITDA for 2005. Is this a comfort level when it comes to leverage for you? And if not, what's your goals on leverage and how do you expect to get there? If you could discuss that?

Eric, I think as John alluded to, we still are focused on debt reduction. We did pay $150 million of debt down last year. We still have 180 million over 3 years that was still the guidance that we gave a year ago still applies today. I think we got $60 million of prepayable debt this year that we will look to some portion of that will be paid down through cash flow. And so I think we are still focused and focused on debt reduction.

Right now we don't have any maturities that are really facing us to drive us to do anything in the capital structure, so we are really evaluating, seeing how the business closes this year, seeing the opportunity for growth and see how that will help improve cash flow, and over the course -- in the strategic plan of the next 3 to 5 years is to continue to drive down debt. The 5 times is probably a level that we want to move down into some before range and continue to work on that.

So we are still focused on debt reduction, but as John said, this year as we had the opportunities coming up from the year, we want to balance our excess cash flow between growth opportunities and some debt reduction.

And if you look ahead at our debt that matures the first quarter of next year we have our 0 coupon, 11 percent accreting note that matures and, obviously, that's our most expensive piece of paper and our least attractive from our standpoint piece of paper, and we see opportunities that are on the near-term horizon to do something about it, whether through cash flow or asset sales, whatever the case may be, there is just, as Lee pointed out, nothing to really jump up and down about in the next quarter or 2 that is maturing on us.

You have some callable debt, I guess late summer.

Right.

And it was more sort of a big picture question. Where do you want to get your leverage to?

We'd like to get down to something that has a 4 on it on turns and we would like to get down to something that has a 5 on it as far as debt to cap, 55 -- 50 to 55 over time. That's part of a, certainly a longer range perspective to try and get there, but that's where we want to get.

Thank you very much.

Your next question comes from Anthony Arisino.

Good morning. Just wanted to see if you can give us a little more color what you're seeing in terms of the bigger picture in the U.S. compression rental market? It was just a little surprising that that, not seeing some more improvement on your end given what would be expected to be the stronger fundamentals. Just wondering do you have a sense as to, has the overall market kind of stagnated somehow, the concept of customers looking to rent incrementally, are you still seeing any growth in that or is it a matter of competition being much greater? Whatever you can say.

Okay. I think what you see in the U.S. market is you see a market where production isn't changing much. You may have a lot of rigs running, we are replacing production. So, yes, we see incremental growth as well pressures decline and more compression is needed, we see the U.S. market growing as far as its compression needs, but the U.S. market is not growing as far as production. So we see single-digit growth rates. And low single-digit growth rates, and the low single-digit growth rates as far as overall need for compression in the U.S. We are expecting 3 to 5 percent overall growth in the U.S. compression market overall, and some customers are buying and some customers are leasing and they are always contemplating the switch between one or the other. And I haven't seen much shift in that dynamic between the types of producers that buy and the types of producers that rent. And so I think the market is still there. The appetite is still there. It's just there is not a market that's growing a lot.

And any change, significant change would you say, let's say the past few months versus a year ago in terms of the competitive landscape?

I would say what we've seen in the last 6 months or so, 6 to 9 months, is a much firmer pricing environment. We see an ability to go out and extract a little bit more value for the service we are providing and see that happen with pretty much ease. I shouldn't say ease, the sales guys will kill me for that. With some good work on selling what we are delivering in value, people are more willing to pay for it than they were a year or 2 ago because of where prices are and where service costs are for everyone. So I think the pricing environment is stronger or firmer than it was.

The upper end of our fleets like we talked about, I think of where we are going to continue to see healthy activity, and the smaller end of the fleet is where it's much more commoditized and you have a much more competitive landscape and that's where you are more just on delivering the product at the cheaper price. So there's kind of a 2 tier of service here in the U.S., high to low, as far as high horsepower to low horsepower.

Very good. And also if you, if there's any more help you can give us on the, what to expect for 2005 in SG&A overall or relative.

I think we are going to be in the 44 to 46 million, $46.5 million a quarter kind of number. We wouldn't expect it to be near as high as it was in the fourth quarter. As Lee pointed out, we had some severance and we had a healthy dose of Sarbanes 404 that we would expect to cut back off.

I'm sorry, you said 46.5 range?

Yes, 44 to 46 million a quarter range.

Okay. Thank you.

Your next question comes from Blake Hutchinson.

Good morning, guys. First question, with regard to the 4 to 5 percent price increase in the U.S., was this -- in terms of timing, was this something that you had prepared the client base for and then announced on January 1 or is this a new initiative that you are taking on, or when was the announcement and how should we expect this to roll through the fleet timing line?

We sent out letters to our client base in the fourth quarter announcing either a January or February price increase depending on the notice period we had for that client. And we discussed it with them over that window of time and so it's in effect staging in in effect in the first quarter. Some took effect in January, as I said, the rest should take effect in February. Obviously, as we go through the year, and a term customer comes up or an alliance customer comes up, we certainly pursuing price increases on that. But as far as an overall 1-shot deal, yes, January, February effect.

Okay. Great. And maybe to help us get a little better idea of how each of the GBUs or how the under performing GBU can help drive margins a little bit during the year. Are all those GBUs in the U.S. relatively the same size or is the best performing GBU much larger and how does that work?

The GBUs are all relatively the same size in terms of horsepower and revenue.

Great. A couple more quick -- I'm not sure if I missed it, did you give a break out in the backlog between the regular fab and Belleli? I can go back if you gave it already.

Yes, Belleli's backlog was 150 million at the end of the quarter, and non-Belleli was 84 million.

Great. You mentioned what you are seeing right now versus last year on the fabrication side has improved in terms of the imbedded margin as long as you are able to execute. When you say that it's improved to the extent that at this point maybe you get back to the original kind of goal of 12 percent or so margins, or is it just something where you are a little happier that you might be able to secure high single-digit margins in a more consistent basis?

I would say on the compression we are talking in that 11 to 12 percent range is where we would like, we think based on what we are seeing on the backlog builds that's where we ought to -- somewhere between 10 and 12, let's stay that way, not high single-digit. Our production and processing, X the dollar, we are in that same 10 to 12 percent expectation, and trying to drive it higher based on shop load.

Good to hear. And finally, looking at the international market, you mentioned you're looking at a bunch of projects now. In terms of lead times we have some stuff coming on the back half of this year. When do you expect if you do understage a couple of these projects that you have in the slate that they come into being? Are we looking at stuff that can hit in late '05, early '06 or are we waiting for the back half of '06 to really see a large project tie bump up in revenue run rate.

If we were to wen some additional projects? Is that what you're saying?

Yes, just in terms of the slate of things that you guys are looking at.

Based on what we have got out there right now, if we were to win some of these additional projects that we are working on, they would be really right at the end of '05, into the front of '06 is the impact. Obviously, if we don't win them, we would pursuing other projects that would then push this window out, because they are kind of 9 to 12 month on the projects that we're looking at right now. But that's always a portfolio we are working our way through. So yes, there's a chance that if we can win a couple of these projects that are fairly sizeable that could come on the front half of '06, but we wouldn't expect any significant additional '05 impact on the projects that are in front of us today on the international side.

Thanks a lot. Your next question comes from Eric Halamaro.

John, I have a question regarding the warranty issues, what's the typical customer reaction of that? Is there a follow on expense on your part or to retain these guys, attrition, how much you can make there on that?

I don't think we are seeing much in the way of attrition or customer fall off because these were really 2 or 3 specific jobs that were very high spec, had a lot of issues surrounding them that you sit down with a customer and negotiate, we had some delay penalties in, we had some things like that that that we worked our way through, and I think as long we are both reasonable on both sides of the table, I think it works out okay in the end. So at the end of the day, I don't expect any significant negative impact from this.

In fact, by delivering and getting the unit up and running at the end of the day, I've met with some customers recently that that's really the ability to deliver the project that they want at the end of the day and in good working condition. If there is a little bit of warranty work to do up front, in we get it done and get them still close to on time, that actually goes a long way to the next project.

Okay. Thank you.

Operator, I think we can take 1 more question.

Okay. Your last question will come from Geoff Kieburtz.

3 questions, the first, John you've talked about EBITDA comparisons a couple of times in prior periods, and I just wondered if you could back up, and when you adjust for the change in Canada some of the other incident issues, in your mind what's the right EBITDA number to think about for the fourth quarter of '04, the third quarter of '04 and the fourth quarter of '03 that we should be really focusing on a clean kind of underlying run rate?

Without getting too far a field of what we -- quoting a clean EBITDA number and getting into all those issues, from our perspective, just look at the 67, you take about net FX effect, both the loss -- I mean the gain and the margin impact on the dollar compression, that's another $2 or $3 million, that puts you down to 64, let's say. We had severance, which we don't expect to have every quarter obviously from time to time you will look at that. That's $1 million you add back. We have $3 million associated with Sarbanes, so that's going to put you up in the upper 60s. I think we had a lot of warranty work and a lot of issues that hit us operational that we hope wouldn't on a continual basis recur. We don't see them quarter in, quarter out. There's another $2 or $3 million in there. So that's why our guidance is 280 to 320 and our 280 is based on 70 million kind of is where we think we are, give or take a couple million dollars today.

And if we look at the prior quarter and that adjust for Canada.

You are at the same place.

Right. If you take the prior quarter, Geoff, it was roughly just out of Canada, it was roughly $77 million. We had a $6 million gain in the prior quarter on the sale of the plant, and we had the $4 million benefit on the shareholders. So that gets you down rough to the 66.

And then we had some inventory charges that we took physicals and so forth, had some issues in Argentina and up here in the U.S. that were a couple million dollars back the other way. So got us close to 70 again. If we look at the last 2 quarters sort of adjusted after all that. Give or take a couple million dollars. We think we are around the $70 million number.

And if we think about the year-ago period in the same kind of terms, something in the 66 range?

Yes.

Okay. It's just you'd made some references --

We started out the year ago for the fourth quarter, in the press release, we said it was 58.9 million. Which included some expense for the share of the settlement around 2.8 million so that gets you around to about 62. So the run rate last year on the fourth quarter '03 on a consistent basis, factoring out Canada, is around 62 million.

That's helpful. I'm not trying to get you to break the rules here, but. Second question. Wanted to understand your comments, John, with regard to the U.S. market, because I thought I heard 1 to 2 percent growth and then I thought I heard 3 to 5 percent growth and I just, maybe I'm splitting hairs here.

I think we would hope to see 2 to 3 percent growth in our utilization in the U.S. over the course of the year. Could it be -- we had 1 percent change in the fourth quarter. Could it be as low as 1? Yes, it could. I think we expect over time this to be kind of a 3 to 5 percent market, but it's not clean and pure. It could be, you've seen production actually ramp down in the last quarter in some spots in Texas that have been 5 percent or more. So could you have a slow down in certain markets and pick up in others? Yes. So somewhere between 1 to 5 percent and hopefully we will be in the 2 to 3 percent effect of that, kind of in the middle of that range.

Yes.

And part of that is going to be driven by units moving out of the domestic market into the international market, so, that's utilization, some increasing in contracted horsepower plus the addition of moving idle horsepower to international.

We would like to see a 4 percent move in utilization this year's, 2 and 2, 2 in the U.S. and 2 in international, whether we can achieve that or not, we'll just have to see. But that's how you kind of get to that 3 to 5.

Imbedded in that view of the market, are you indicating that the outsourcing phenomena is at least for the time being pretty much stalled and that the driver in the U.S. horsepower market is really volume of production?

I wouldn't say the concept of outsourcing is stalled. I would say if you look at the entire fleet of horsepower in the U.S. today, the last 3 years it's maybe gone up about a few hundred thousand horsepower over 3 years. Whereas if you looked at the previous 5 it probably went up 3 or 4 million-horsepower.

Right.

So the growth in horsepower, whether it's rented or owned, has slowed dramatically in the last 3 years from 2001 forward. So we were just saying that that's how we see the market. The outsourced market is there. It's just I think the competitive, the larger competitors in this market have chosen to put their capital overseas and move assets overseas and not spend a lot of money building new units.

Now I know one of our competitors has started talking about building a few new units for the U.S. and we are, too, but it's at the very high-end of the horsepower range where the utilization is high and expects to remain high and we see the contracted ability for a long period of time. On the low end of the fleet, it's just a very, very competitive market with 100, 200, 300-horsepower range and we haven't built one of those for a long time for the U.S. market. We don't expect to ever build another one again.

The last question is just if I read the numbers right, it looks like your international horsepower went down about 156,000 horsepower from the prior quarter?

Yes, some of that -- obviously a lot of that was the Canada sale. Some of that was we sold some assets and we did have some units -- some units, some horsepower that we had been counting as production and processing equipment, or gen sets, or gas plants that had horsepower, the conceptual horsepower associated with it that we've taken out that we were including in the international markets and weren't including in the U.S. market and we're now just -- that's just a clean compression horsepower number. So we had some decline from really cleaning that out.

Ballpark, do you know what was the reclassification effect?

I don't know. I can have Lee get back with you.

Okay.

I'll have him call you.

Anything you sold was showing up as revenue in compression.

Yes. But we sold some units at break even in the quarter and pluses and minuses.

And, Geoff, 84,000 was the Canadian and so the difference is really the reclassification effect.

Okay. Plus the other 70 are or so.

There was another maybe 8,000 to 10,000 of other units sold. So 95,000 to 100,000 from sold units and the remaining is really the reclassification.

Got you. That's great. Thanks very much.

Okay.

Okay.

At this time there are no further questions.

Thanks a lot for everyone for joining us on the call. We look forward to seeing you next quarter.

This concludes today's Hanover Company conference call. You may now disconnect.