Archrock Inc (AROC) 2005 Q1 法說會逐字稿

Good morning. Welcome to the Hanover Compressor Company first quarter 2005 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 first quarter ended March 31, 2005. 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 the 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, 2004. (Operator Instructions).

I would now like to turn the call over to our host, Mr. John Jackson. Mr. Jackson, you may begin your conference.

Thank you. I want to welcome everyone to Hanover's first quarter 2005 earnings call. I want to touch on two or three things today, first off our performance in the first quarter and I want to talk about organizational change we announced a couple of weeks ago and give a little color on that, and then turn our attention to the outlook for the rest of ’05.

So starting with our first quarter performance, as you all probably already noted, our EBITDA is up from year end, which was around $67m to approximately $74m in the first quarter. In the first quarter, we really ran a pretty basic, clean operation. There were any significant unusuals, either good or bad, it was just performing. As we said, that has been our goal to just try and execute day in and day out.

A couple of highlights in a couple of our lines of business that I would like to touch on. First off, in the U.S. operations our gross profit got up to just about 61 percent but more importantly, our gross profit dollars that we are delivering with that revenue is the highest in 11 quarters, since the second quarter of 2002. Our U.S. operations have gotten some of their operational efficiencies in place, there is still a lot to go and I don’t think by any means that we are satisfied stopping at this point, because we are not. So we still have, we think, a lot of opportunity to drive out efficiencies and improved utilization and improved operational performance in the U.S., but we are pleased with at least the sequential improvement from last year into the start of this year.

As far as the overall market goes, the pricing continues to improve, we continue to see strong activity. The Barnett Shale continues to be a very strong area for us, South Texas and the Gulf Coast. Those are areas that we think will continue to drive incremental utilization out.

Now as far as the utilization in the U.S. for the first quarter, you will note that it is relatively flat from year end. We did spend a lot of time in the first quarter in a number of our shops getting units ready to be shipped to some of our overseas projects that we mentioned last call that we had been awarded. A lot of those projects will be using a fair amount of horsepower out of the U.S. and we needed to refurbish those units to get them ready to go, so it did tie up some shop space to feed the international market vs. feeding the U.S. market at this point. So we maintained utilization, improved pricing, improved results. We still think there is more to go as we go through the year.

Turning our attention to the fabrication for a minute, again, this is an area we still think we have a lot of improvement that can occur, however on the gross profit dollars, when you add all the fabrication lines up, compression and production and processing from a dollar delivery standpoint, it is the highest since the first quarter of 2003 and yet we still think there is more to do here, more improvement to occur.

The compression fab business was a little slower in the first quarter, we indicated that on the last call, based on component delivery delays. That should be behind us and we should see some improvement in the second quarter as far as revenue, and we would hope to see some improvements in our margins also. As I mentioned on the last call, we’ve had some people in helping us with our efficiency of our shops and we are beginning to see some of the benefit of that late here in the first quarter and now into the second quarter. So Lee can take you through more of our specific outlook numerically when he gets to his discussion.

On the international front, we didn’t really have any significant changes operationally in the quarter. We have been working on a number of the projects that we have been awarded, and most specifically is the Nigerian project. I will cover that when we get to our outlook for the rest of the year, but the international area performed okay, and again, we think there is some room for improvement there as we move ahead, but largely the international focus is going to be bringing on new projects.

We did complete our Pakistan project here in April and bring it online, which is a gas plant, liquid recovery plant, in Pakistan that we have sold to a third party, and we are doing O&M for them. They have begun to produce liquids this month. We are going through the commissioning phase right now and would hope to be on O&M in the May/June timeframe as far as full operation and maintenance revenue stream.

Turning our attention just briefly to the organizational change that we announced a couple of weeks ago, I just wanted to give a little bit more flavor on that. We have now three areas of the world that have different market characteristics and we’ve organized ourselves around that. In the U.S. we have our operations, fabrication and services that we share with the rest of the world where it is most efficient, perhaps, to do it out of the U.S. vs. build infrastructure in other parts of the world. So we have Brian [Matusik] leading that.

We have Latin America, which we are very well established in but it has a lot of growth opportunities and we will touch on how those projects are going as well as some other projects we are quoting on in a minute. But again, it is a market that we are well-established in but have a lot of growth opportunity.

Looking back at the U.S., we still see growth in the U.S. That growth is just going to be a lot slower. It is much more of an efficiency and cost containment, cost reduction effort. That is what we are going to be continuing to focus on as we move ahead.

That leaves the rest of the world, which we’ve hired [Nori Mckay] from Schlumberger, he will be joining us in mid-June. He is going to be looking at where do we really want to be? We have got an effort focused in Russia right now, we have a lot of activity in the Middle East and as we continue to talk about, we have a lot of activity in the West Coast of Africa, specifically Nigeria.

There are other pockets of that part of the world that have activity, between Indonesia, China, Malaysia and we need to figure out where we want to focus our incremental dollar and attention and effort. But having someone who is based in Europe running that part of the world with a lot of P&L management experience out of a large company we think will help us in that area, along with focusing the rest of our management attention into Latin America and the U.S. operations. So we are excited about all of the opportunities we see in that part of the world and we are excited about having Nori join us here in mid-May.

We think this will allow us to focus on each of these three areas more closely and speed the improvements in each of these areas, speed up the improvement in these areas by having management narrow their focus on each of these areas.

As we turn our attention to the rest of 2005 in the U.S., we think we can continue to improve the U.S. rental market performance, from our perspective. We have some operational efficiencies we would like to continue to see driven out, as well as improved revenues, albeit from pricing and/or utilization, we think we should see some improvement on both fronts through the rest of the year.

Fabrication, business activity on the compression front remains strong. We have a pretty optimistic view on that for the rest of the year, but production and processing business is less predictable. There are a lot of projects out there of size, but they come in in much lumpier segments, so we still hope for good things there, but we expect to have double digit margins in both of those as we move into the rest of the year. I think if you look at the first quarter, production and processing delivered something around 12 percent and we would hope to be able to maintain those kind of numbers while moving compression fabrication up.

Still on the international front, really this is where the growth is going to come from in the second half of this year. Nigeria, Hawthorne Channel Barge, which is just under $1m a month of gross profit, should come online late second quarter, early third quarter as we’ve been saying. We are very close to completion now, the pipeline in essence is constructed, the river crossings are constructed, the off take vessel from another company has been moved into Nigeria and is in position. So everything is very, very close to actually starting the commissioning of gas flow through the plant. It may be another month or two before that is actually up and running and fully operational, but we would expect the June/July window to be complete.

We would expect revenue to start on this in the third quarter, even if we start gas flow in June, we will probably be going through some commissioning phases and debottlenecking any issues or working through any plant issues. So we would expect revenue to come out of the third quarter, but everything has actually gone pretty well so far this year to get this to this point.

We have another project over there, it is smaller in scale. It is ready to go, we are just waiting for gas from Shell. That could take up to a month or so before that comes online, but we would expect to have both of our Nigerian projects online no later than early third quarter.

On the last call we mentioned a number of other projects that we have been awarded, those projects are well underway as I just mentioned earlier on getting the equipment ready to go, and we still expect those projects to begin to phase in late third quarter and really come online primarily in the fourth quarter which would add another $1m or so a month of gross profit, give or take a little bit. As those come in and phase in. We actually have one project that is actually going to start in January/February ’06 that would add a little bit to that also.

We have a number of other projects quoted around the world. If we were to be awarded a representative share of those projects, we would then be at a point where we would be capital constrained based on our intent and plan to not lever up at all.

So we are very optimistic about what we see in front of us, they are very good rates of return, most of these projects are in Latin America, in our backyard, add ons to what we already have so our ability to execute, we think, is very high. So we look forward to hearing a little bit more about these projects in the second quarter and giving you an update on the second quarter calls to what is going on there.

So in summary, our forward focus is going to be continued improvement in the U.S., provide additional EBITDA from fabrication, both from revenue increases and margin percentage increases and add our international growth projects to our portfolio and integrate new management into Hanover’s new organizational structure as we move ahead.

So we are excited about the rest of the year and the progressive improvement we hope to see from here. I am going to turn the call over to Lee now to take you through the numbers.

Thanks, John. I will be going over the financial results for the quarter and my main point of comparison will be with the fourth quarter 2004 results. Starting with domestic rentals, we did show a good improvement in that area in the quarter. Revenues were up about 2 percent from $85m to approximately $87m and that was primarily due to the price increase initiative that we began in January, that led to approximately $500,000 per month of increased revenue.

Gross margin was also up in the quarter from 58 percent to 61 percent. Basically that was driven by lower repair and maintenance expenses, we continue to focus on operational efficiencies. As John already discussed, utilization was basically flat in the quarter at 77 percent. As we go into the second quarter, we expect revenue to margins will be flat to slightly up. As John highlighted, we are focused on continuing operational efficiencies, and we are optimistic that this effort will lead to improved margins over the course of the year.

Going on to international rentals, as we highlighted on the last call, we anticipated that international rental revenue would be down a little this quarter as we didn’t have any significant projects coming online in the quarter, and revenues were down about 3 percent from $56m to $54m. Gross margin was up slightly, 68 percent vs. 67 percent as we had some lower repair and maintenance expense.

Also in the quarter, the first quarter of 2005 margins were negatively impacted by about 2 percent for expected startup costs in Nigeria, as we continue to work to get those projects online. Utilization remains at strong levels of 98 percent. As we go into the second quarter, we would expect revenues to be up slightly in the $54-56m range with margins continuing to be in the high 50 percent range. We do have a couple of smaller projects coming on line this quarter.

Parts and service was down from $46m last quarter to $33m this quarter in revenues, the margins improved from 19 percent to 25 percent. Revenues were down primarily because of lower base parts and service business as we had some one-off parts and service business in the fourth quarter for repairs for third-party customers. Going into the second quarter we expect the base parts and service business to be up slightly with margins in the mid-20 percent range. We didn’t have any significant used equipment sales or installations in the first quarter of this year.

Moving onto compressor fabrication, as John has discussed and we highlighted on the last call, we anticipated revenues being down because of the deliverability issues for major equipment components. That has stabilized and we believe that not to be a major impact going into the second quarter. Revenues were down to around $33m from $40m last quarter. The margins did show improvement to 9 percent from 6 percent.

As John discussed, we continue to be focused on operational improvement efficiencies in our fabrication business. Our compression backlog today is around $64m which is the highest backlog we’ve had in three years in compressor fabrication and a 13 percent increase over backlog at year end.

Going into the second quarter, we anticipate the revenues and compressor fabrication to pick up and to be in the high $30m to low $40m range and we expect margins to be in the 9-11 percent range.

Moving on to production processing equipment, we did show improvement in this area, revenues were up about 15 percent sequentially from $78m to $90m and margins improved from 12 percent to 8 percent. In the fourth quarter last year margins were negatively impacted by currency fluctuations and some increased warranty expense. Backlog for this sector was at solid levels but a little down from fourth quarter results with backlog decreasing from $234m at year end to $206m currently. Expectations for this going into the second quarter, we anticipate revenues to be in the low $90m range and would expect margins to be consistent with first quarter results, assuming we don’t have any significant currency fluctuations in the quarter.

Also, just in general and fabrication, as John discussed, we are continuing to focus on operational improvements. We continue to work with the outside consultants to improve our processes, and we are starting to see the benefit of our investment in our information and reporting systems to give us more timely data to manage our business. We hope these things will all lead to improved margins over the course of the year.

Discussing, as John talked about, we had good improvement in EBITDA for the quarter, it was up 9 percent sequentially from $67m to $74m. Additionally, if you recall in the fourth quarter of last year we had a net benefit of about $3m from foreign currency fluctuations that we didn’t have in the first quarter of this year.

Moving into other expenses, SG&A decreased sequentially by about 10 percent to $42m in the quarter vs. fourth quarter 2004. As you recall, in the fourth quarter we did have about $1m of severance expense and about $2m of incremental Sarbanes Oxley expense. We’d expect SG&A in the second quarter to be in the $44-45m range.

Going on to taxes, we had approximately $6m in the quarter of additional tax expense that is primarily due to our current deferred tax asset position and our expectations of continued U.S. tax losses in the near future. We are continuing to work to minimize this issue but anticipate that it will continue throughout the course of 2005. We estimate that going forward that this will continue to have an effect of approximately $6-8m of additional tax expense each quarter.

As we move into liquidity, we had $84m of outstanding on our revolver at quarter end. This is up from around $7m at year end. We did pay off $58m of synthetic lease obligation during the quarter and used some of our revolver for that, as well as in March we had significant interest payments of around $30m and that led to the increase in the revolver. As of today, the revolver stands at about $79m. At the end of the quarter we had LC’s outstanding of about $109m. Today that is down slightly to around $106m. So currently, under our $350m revolver today we have over $150m of availability and currently have no covenant constraints so we have full access to that availability if we need it.

Going on to capital expenditures, looking at the quarter we had capital expenditures of $26m that was down slightly from the fourth quarter of $33m. During the quarter we had approximately $13m of growth, most of which went to the Nigerian project into the growth projects in Latin America, as John discussed. Had $11m of maintenance and approximately $2m of other capital in the quarter.

With that, I think we are prepared to open it up for questions.

(Operator instructions) Your first question comes from Terry Darling; Goldman Sachs.

Thanks. Good morning, gentlemen.

Hi, Terry.

Clearly regaining some momentum here and I wanted to ask about the U.S. rental business, or that you have the highest margins since the third quarter of ’03 so congratulations on the improvement there. Lee had mentioned some benefit from the pricing, John you had mentioned that you got some cost efficiencies going on but you think you are in the early stages of that, I was wondering if you could talk about timing and magnitude of harvesting some of the additional efficiency gains you see out there.

The efficiency gain from the operational side really go all the way down to the field people who are spending the money day in and day out, so I think we are going to see gradual improvement on that throughout the year on the efficiency side. This is overtime dollars we spend, repair and maintenance work that we spend and how we go about doing it, there is just a lot of different things that can occur, but I would expect to see improvement this year, quarter to quarter to quarter. So you will just see a little bit of improvement as we go along.

And then on the revenue side, on the pricing side, every time a unit comes off lease, whether it is an alliance, whether it is just a term lease or whether it is month to month and it goes back out, we are able to push pricing a little bit every time we put that out because of the scarcity of certain types of equipment.

So I think on both fronts we would continue to see, based on the market activity that is going on and the revenue improving and efficiencies throughout this year. And they will carry on into next year, but our goal is to see a lot of this this year.

And is the first quarter, John, reflecting the full benefit of the pricing? You mentioned you put it in January 1st.

Yes, the January 1 price increase on the month to month was right across the board, so it has the full impact of that in.

So we are not waiting for contracts to roll over?

No, but as they do, because we have some that are on term and so forth, those go and we get price increases at that time. Like, we may have something on a two-year contract term, it comes up and it either gets returned to us or goes back out and we are going back and getting a price increase every time one of those comes up. But on our month to month, that is what we did in January.

Okay, and on the 77 percent fleet utilization, do we have any write-off risk? Is there a situation where a part of the fleet is sitting idle or are you just sort of turning the fleet over and there is a good circulation through all sizes and horsepowers there?

That is a good question, Terry. I think really we haven’t spent a lot of time talking about the details around this, but we are pretty much churning the fleet we have and adding a little bit to it as we go along and have time to work it through the shop. But through the acquisition phase this company went through for a number of years, we did buy a lot of units that we have, for example, a good engine on one and a good frame on another and a good skid somewhere else, and to really configure for what we want to be a true rental unit that can be applied in many applications, some of these units that are moving from 77 to 80, 82, 83 or to get into the low to mid 80s, we are going to have to do some reconfiguring.

We’ve talked a little bit last year about taking two stage units, converting them to three stage, those are on the smaller 50-100 horsepower units. We’ve been doing that actively, but as we move to the larger end of the horsepower range, we are going to have to do the same kind of thing where we either recylinder the unit, reframe it or repower it and that is going to take a little bit of work that we haven’t had the shop space to do yet because of the international work.

So to answer your question, we have some out there that can just feed the utilization but we have a fair but that we are going to have to do some work on to reconfigure it.

But you don’t see write-off risk based on what I am hearing?

No, I don’t see write-off risk based on that. We are going through a fleet evaluation right now, more on the standpoint of, where do we want to be? I talked on the last call about a three-year to five-year strategic plan, we are going through the process this year. Right now we are going through a unit by unit evaluation of where do we want to be three years from now as far as the fleet and the composition of it, more from a standardization perspective of let’s get rid of some units that may not fit in our standard fleet, just like an airline company may want to standardize their fleets.

So as we go through that process, there may be units we want to dispose of and get rid of, but as a general rule, I am not sitting here going, well we need to have a write-off here in the next quarter or two on that. We just need to figure out what we want to have as a rental fleet and we may need to dispose of some units.

But that is not anything we concluded on at this point, we are really trying to figure that out right now.

And on the international side, clear that margins ought to improve here as the Nigeria costs work their way out, but it sounds like you are going to have two steps to that process. Up a little bit in the second quarter but more full run rate in the third quarter. Have I got that right?

Yes, I would say you might see a little improvement in the second quarter and then we have Nigeria on in the third quarter and then the Latin America project on in the fourth quarter, so you have a small step change in the second quarter but really, your significant changes that you would see is a step up in the third and a step up in the fourth. Maybe a million a month in the third and $750,000 to $1m a month in the fourth as far as EBITDA or gross profit generation from those projects.

Okay, and then you had also talked about a number of projects that are in the works, and if you win your fair share you would at that point be capital constrained. Help me understand what you are really saying there from two perspectives. First, how much capital are we talking about if you win your fair share? Two, what are your thought processes at the end of that line in terms of accessing additional capital?

We have somewhere in the – I think we said $125-150m is our CapEx target on the year as far as the guidance, given what we expected our performance to be. I think when we say capital constrained we are saying constrained within that $125-150m number and we have our typical maintenance of $40-50m and $10m of odds and ends and others between vehicles. So the rest is gross. Let’s call it $70-80m and that is a number I am talking about. We have probably committed somewhere in the $50m range today, give or take a little bit and we’ve got some other projects quoted out there, a couple of which are fairly sizeable that could easily eat up the rest of what we would consider to be our available capital this year.

As far as what that means as far as the rest of the capital, I mean raising additional capital, at this time we are focused on living within cash flow and not really focused on any other efforts to raise additional capital, other than from the standpoint that from time to time we have customers who will choose to buy equipment from us that they have on lease or that is idle, and if we are able to do that or raise the money that way, then we might look at our capital spending increasing and a little bit of people actually bought assets from us, and redeploy that way.

Okay. Thanks very much, John.

Thanks, Terry.

Your next question comes from Ken Sill - Credit Suisse First Boston.

Yes, I just wanted to follow up on Terry’s question. So the magnitude of these international projects where you’ve got bids outstanding, it sounds like you are looking at stuff that is $20-30m, or in total could it be significantly greater than that?

You mean as far – individually there is nothing that is $20-30m. But in total, yes, absolutely, we are looking at projects that may have $20-40m worth of capital associated with it that we have not been awarded yet that we are bidding on in various phases and stages. We are very cognizant of where we are as far as capital committed, so we are very careful about how we bid those projects and which ones we want to bid more aggressively vs. less aggressively.

Okay. Looking at the timing of some of the stuff internationally, these growth projects, to ballpark it, from the time you sign up to do a deal, start investing the capital to when you start getting a return, what is the timeframe of some of these deals.

The projects we are looking at right now, if they get awarded here in the second quarter or early third quarter, which is what we anticipate, we would anticipate that these projects, looking at the cash flow streams – I have them right here in front of me – would be late first quarter, early second next year.

So typically you are looking at a nine to 12 month timeframe from award to actually starting to see the benefit of the cash flow coming from the project.

Okay, and then looking at the capital structure, obviously the most onerous piece of debt out there is the old production operator’s note which is accreting.

Yes, we agree.

What can you do with that and when can you do it?

Well it is callable next March, March 31 of 2006. It matures in March of 2007 and really prior to that, there is not much we can do with it. It is not callable so it is going to continue to accrete until sometime in the first quarter of next year at which time we will look at our options on what we can do to, as you say, get rid of our most onerous piece of paper.

But you can’t issue debt to take that out, or can you when it is callable?

Well sure.

Sure.

We can’t prior to it being callable, but when it is callable we can issue debt and then depending on certain factors, how far up we can move it in the capital structure relative to other debt and how subordinated it would have to be, that is just what we will have to evaluate, where we are that time. There are different features that allow it to move up or down.

I am still, [inaudible] on that piece of paper, but if you issued equity or did something like that you could call it early, or is it only callable next March?

Ken, we couldn’t call it early until March of next year.

Okay, well that takes care of that question. I will let somebody else ask one. Thanks.

Thanks, Ken.

Your next question comes from the line of Gary Stromberg; Bear Stearns.

Good morning.

Hi, Gary.

Most of my questions were answered. Lee, can you give us a cash flow number for the quarter.

Cash flow from operations was approximately, slightly positive around $5m for the quarter, Gary.

Okay, so was there some working capital drain there?

There was some working capital build-up in the quarter, we are starting to ramp up the fabrication in the second quarter, and then we do have some installations that are in process. Also, we had the accrued liability of the interest payments we made that reduced the accrued liability so that reduced working capital as well.

Okay, and for the rest of the year where do you stand on working capital? Do you think that continues to build as you grow?

I think we anticipate trying to moderate that with the goal to being relatively working capital neutral for the year.

Okay, and you talked a lot about the budget in 2005. It sounds like you can reach the high end of your forecast. The first quarter was a little bit light. Do you see that quarterly run rate ramping from here pretty considerably? Is it going to be more back half loaded?

I think based on John’s comment, the projects coming online would drive EBITDA and performance to improve on the back half, second half of the year. See some margin improvement in the third quarter with Nigeria coming online, hopefully, and the fourth quarter seeing incremental improvement from the Latin America project.

I think if you look at it, based on first quarter and what we expect, we are certainly in the middle of our guidance range at this point as far as if we continue to perform at this level.

Last question, can you give us a split of what that capital budget looks like by region? I seem to recall a 70-80 percent international, 20-30 percent domestic split being talked about in the past. Is that still roughly accurate?

If you are talking about on the growth capital side, yes it is going to be 80 percent plus international and a little bit in the U.S. Once you get to the maintenance side, obviously we have a lot more of our fleet in the U.S. so we probably have 75 percent of our maintenance capital is U.S., 25 percent international which is in line with our fleet split, but on the growth side, yes, about 80-20 international.

And you said that growth today was around 50?

Today committed, yes.

Okay. Great. That is all I had. Thank you.

You have a follow-up question from Mr. Ken Sill with CSFB.

It’s a busy day. I get to talk to you more. I wanted to follow up, Lee, the Nigeria start-up costs, you said that was about 2 percent of revenue or 2 percent increase in the costs?

Basically about 2 percent increase in costs, it hit the margins about 2 percent in the quarter.

And that will be pretty similar this quarter again, or do those costs –

I would anticipate to having continued start-up costs in the second quarter.

Okay, so it is not going up but it is still there.

It’s not going up, it may moderate a little bit, but it is still going to be there.

Okay, and when those units come online, is that going to impact depreciation? How is the D&A going to progress as we move from Q2 to Q3?

It will impact depreciation, that will pick up a little bit sequentially each quarter those projects come online. So depreciation will pick up slightly in the third quarter and then have a little incremental depreciation pick up in the fourth quarter assuming the projects come online as anticipated.

And Q2? Roughly flat, or is it going to be up a bit too?

Q2 will be up a little bit, not substantially but up a little bit. We got some new projects coming online on a small nature, so it will be a slight increase in Q2.

Okay, and I think that answers those questions. Thanks.

Your next question comes from the line of Eric Kalomerez with Wachovia Securities.

Hi John, I have a quick question for you. We are kind of getting back to this capital constrainment issue. How long would you operate in that philosophy? Is that something we would see you do potentially next year as well, stick to a CapEx budget? How long could we see that going for?

Okay, I am trying to make sure I understand your question. How long would I stick with a CapEx budget? You mean living within cash flow or what?

Yes, I mean you indicated you don’t want to be capital constrained and put any more debt on the balance sheet, which I certainly understand that. I am just curious as to how long you –

I think that is going to be the case for the foreseeable future until such time as our operations come on and start performing in a manner that we can start seeing some delevering come out of that. I mean, obviously you can grow your way into your debt structure or you can pay your debt down to the structure that you have today, and right now we are trying to grow our way into our debt structure. So from our standpoint, we are going to maintain the discipline of living generally within our cash flow, give or take a little bit. But we don’t plan to lever up to feed whatever project shows up.

Sure. And where will you – can you handicap a target for us as to when you would feel more comfortable being a little more lenient with capital?

No, not yet. What I would like to see is I have seen a couple notes so far this morning from different people saying sustainability and growth would be interesting to see, and that is exactly what we feel. We need to sustain what we have done so far, add to it and grow from there. So I think we need to put another couple of quarters up from that standpoint before we would feel comfortable to come back – not comfortable, before we would even reevaluate our leverage positions. So I don’t think you are going to see – in fact you won’t see anything happen this year relative to us changing our leverage position by just saying, we are going to go borrow money to feed capital projects.

So I think it would be more for the budget process for ’06 that we would even sit back and look at that. But I can’t really give you a target as to when we would feel comfortable to lever up because we are not comfortable with the leverage level we are at now. I think we would like to see us refinance the Schlumberger note, the POI note, whatever you want to call it, get some of that done and see where our cash flow ends up after that.

Sure, no, I understand. Thank you.

Okay.

Your next question comes from the line of Martin Malloy with Previa Southcoast.

I was wondering if you could talk a little bit about the Belleli unit backlog there, and what the outlook is?

Sure. For the quarter, [inaudible] backlog was about $133m, it was down from $150m. They had a little bit of slowdown in anticipation of some orders coming online that have slipped in the second quarter. Overall their revenues were up sequentially and their performance was better vs. the fourth quarter and their activities regionally looking reasonably good going into the second quarter and the rest of the year.

I tell you though, there are two pieces to Belleli. One is the Middle East business which is building desalt plants, tank farms, that kind of activity that we really think fits very well with everything else that we are doing over in the Middle East. And then there is the [Montava] business which has seen higher backlog since we’ve had it. It’s really grown quite a bit. Our goal on that side is to begin to push the margin. The margins that they are achieving over there really just allow that operation to breakeven at this point, and that is not going to be a sustainable model from our perspective, so we are going to try and work with that group to really push the bidding on the margin side so we can show operational improvement on that side, or we will need to bring the cost structure more in line with what our performance is.

So we had some severance at year end associated primarily with Belleli we continue to evaluate the [Montava] piece of that as far as its performance, and we will continue to do that and try and drive some improvement out of that side of the business.

Thank you.

Your next question comes from the line of Megan Stickle with Smith Barney.

Just as a follow up on the Belleli question, you used to break out the actual revenue and gross profit from that. Could you give us those figures?

Sure, revenues for Belleli in the fourth quarter was approximately $45m and the gross profit or the gross margin for Belleli in the first quarter was around 9 percent.

Okay, great. Thanks so much.

Your next question comes from Arvin Rojpal with Morgan Stanley.

Hi guys, just a quick question on the capital structure again. Looking in the second half, does the 8.5 become callable? Have you started thinking about how to refinance these yet?

Arvin, we always are looking and evaluating our options, but we don’t have any specific plans currently on that. They come callable in the third quarter in September and we have to look at what the interest rates are at the time and our options and refinancing that debt. They are not due until 2008, so it is the first call and I guess we are going to maintain flexibility in terms of what we want to do on that paper.

Okay, and as a follow-up, there was a question about leverage earlier on. I am a debt analyst, so I definitely like to see leverage come down. Is there any sort of target you guys have for the end of this year, end of next year, debt to EBITDA?

Obviously what we are focused on at this point is last year we spent a lot of effort on paying down absolute dollar debt, we’ve done that, moved it down over $100m, close to $150m. We would like to continue to move the debt level down some, but we are going to balance that with our EBITDA opportunities. So to talk to your debt to EBITDA, we certainly want to have our EBITDA grow more rapidly, that is what we would like to see and that is what our focus is on right now so that our debt to EBITDA ratios come more in line. But there is no specific target by the end of this year. It is really relative to the projects we are bringing online. But again, we are not looking to lever up, we are just looking to try and grow our EBITDA and execute better with what we have.

With the goal of not levering up, our EBITDA should improve when these projects come online in the second quarter, third quarter and fourth quarter we ought to show improvement on that debt to EBITDA level.

Okay, thanks. Good quarter, guys.

Thank you.

Your next question comes from the line of Alan Brooks with PPHB.

Lee, in your comments you talked about the foreign exchange impact. Is there anything you can do to kind of dampen that impact?

Right now, not really. A lot of that impact comes from inter-company balances we have with foreign subsidiaries, that led to, as the Euro strengthened vs. the dollar, for example, in the fourth quarter that led to a benefit for the inter-company balances we have with our Belleli operations. So those currency fluctuations happen in quarter, that will impact our numbers. That is really not a cash issue, it is just remeasuring inter-company balances on a quarterly basis and then secondly, we do have some fluctuation and exposure in our margins. Production processing in particular for our international fabrication facilities in Canada, the U.K. and primarily in Italy. We have local currency costs with a lot of dollar-based contracts and that does impact us. We have not currently looked to hedge that exposure. That had about $1.7m negative impact in the fourth quarter that kind of flowed through fabrication margins and actually we had around a $500,000 benefit in the first quarter of this year.

So it is something right now that we haven’t really looked to try to mitigate that exposure.

Okay. Second question is, in the discussion about the CapEx constraint, any possibility of your clients buying some of the rental equipment, has there been any change in companies with respect to owning vs. renting? In any of the markets?

Not really. What happens is as leases and gathering systems get turned over and different people buy and sell, different companies have different philosophies. So as people will buy leases or buy production or buy gather systems, their philosophy may be to own equipment and so they will come in and say, I would just like to buy what is here. But we have not seen really a significant shift one way or the other, although with a lot of the growth in certain areas like the Barnett Shale, there is a lot of rental going on up there. These are from people who both buy and rent. That is the same trend we see. It really depends on the play, how big they are, what the production profile looks like. But we haven’t really seen any change in people’s attitudes. It is really more a shift of ownership.

Okay, thank you.

Okay.

Ladies and gentlemen, we have reached the end of allotted time for questions and answers. Mr. Jackson, are there any closing remarks?

No, we just look forward to a second quarter call. We will talk to you then. Thanks.

This concludes today’s Hanover Compressor first quarter 2005 conference call. You may now disconnect.