Archrock, Inc.
Q3 2008 Earnings Call Transcript

Published: 7 Nov 2008

[Operator:]

Good morning. Welcome to the Exterran Holdings Incorporated And Exterran Partners, L.P. Third Quarter 2008 Earnings Conference Call. [Operator Instructions]. Earlier today, Exterran Holdings and Exterran Partners released their financial results for the third quarter ended September 30th 2008. If you have not received a copy you can find the information on the company's website at www.exterran.com. During this call, the companies will discuss some non-GAAP measures in reviewing their performance, such as EBITDA as adjusted, EBITDA as further adjusted, gross margin, gross margin as adjusted and distributable cash flow. You will find a reconciliation of these measures to the GAAP measures in the summary pages of the earnings release, and on the company's website at exterran.com. During today's call, Exterran Holdings will be referred to as Exterran, and Exterran Partners as either Exterran Partners or EXLP. Because EXLP's financial results and position are consolidated into Exterran, the discussion of Exterran will include EXLP, unless otherwise noted. I want to remind listeners that the news release issued this morning by Exterran Holdings and Exterran Partners, 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's performance, and represent the company's current beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements. Information concerning the risk factors, challenges and uncertainties that could cause actual results to differ materially from those in the forward-looking statements, can be found in the company's press release, as well as in the company's Annual Reports on Form 10-K as amended for the year ended December 31st 2007 and those set forth from time to time in Exterran Holdings and Exterran Partner's filings with the Securities and Exchange Commission, which are currently available at exterran.com. Except as required by law, the companies expressly disclaim any intentional, or any intention or obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. Your host for this morning's call is Steve Snider, Chief Executive Officer of Exterran Holdings, and also Chief Executive Officer and Chairman of Exterran Partners. I would now like to turn the conference over to Mr. Steve Snider. Mr. Snider you may begin the conference.

[Stephen A. Snider:]

Thank you. Welcome everyone to the third quarter 2008 earnings call for Exterran Holdings and Exterran Partners. Joining me today are Michael Anderson, the Chief Financial Officer of Exterran Holdings; and Daniel Schlanger, the Chief Financial Officer of Exterran Partners. There is no doubt that the past year at Exterran has been a challenging one. Pulling together two great companies into one has entailed a huge amount of work. But we are convinced that the results of creating the world's largest compression service company, as well as a premier provider of production and processing equipment and services, is worth the effort. And we're beginning to see real progress across all of our business segments. We are pleased that we have a largely moved past merger integration, and that these efforts have positioned us well to utilize the power of our service network, people, asset base, and balance sheet, to create profitable growth for our shareholders. Despite the challenging conditions in today's marketplace, we are very enthusiastic about the future of our company. I am pleased to report overall strong operating performance by Exterran in the third quarter, as demonstrated by sequential increases in gross margin contributions in each of our North America contract operations, international contract operations, and fabrication segments. We continue to experience good demand for our products and services, and an ongoing backlog of new business for our contract operations and sales activities. As we go through the call this morning, there are a handful of highlights from the quarter that we will focus on, as being key success measures for Exterran. First, we continue to make progress in terms of the slimming the declines in North American horsepower. Although we lost horsepower for the quarter, the result for the most recent month of September reflected horsepower growth. And we think we're turning the corner on this front. Second, we continued to reduce costs and improve margins in the North America contract operations segment, while improving our service delivery and overall customer service quality. Third, our backlog continues to grow. We grew our fabrication backlog within the compression and production and processing product lines, and we continued our impressive growth in the international contract operations segment by growing our backlog by more than 10% in the quarter. Fourth, our manufacturing and AMS operations had good quarters, and produced strong margins. Highlighting these success points does not mean that we do not have our challenges, which we'll discuss over the course of this call. We will continue to focus on making improvements in these more challenging areas, and we will remain diligent in attempting to conform our business for any changes that maybe created by the uncertainty of today's market. While we are optimistic about the long-term prospects for our business, the recent decline in commodity prices, and the impact of difficult credit and capital market conditions, creates uncertainty around near term activity levels. While some of our North American customers have announced or are currently considering reductions to the 2009 capital spending, we continue to believe there is potential for increased demand, for outsourced compression and other services. As we believe our customers are increasingly looking to maximize returns in the face of more limited capital availability, they could favor outsourcing compression and other services to focus on our higher return core operations. We believe Exterran service infrastructure, strong balance sheet, and 3 million to 6 million horsepower, position us well to capture new opportunities, the current market may afford us. Further, we continue to see positive developments in the international sector, particularly outsourcing area. And we again added new business for our international contract operations backlog in the third quarter. Given the long-term nature of most international energy infrastructure development projects, buying is significant in extended worldwide recession, we believe industry activity outside North America, should remain relatively robust, despite the uncertain current environment. In North America, we believe the relative stability of the existing natural gas production base, and the growth opportunities of shale and other conventional resource plays, provide both near-term, relatively steady demand, as well as long-term growth opportunities for our products and services. Last month, we announced the return of Ernie Danner to our Company, in the role of President and Chief Operating Officer. As many of you know, Ernie last served as Chief Operating Officer at Universal Compression Holdings, after holding positions of increasing responsibility with Universal from 1998 until August 2007, when Universal merged with Hanover Compressor Company to form Exterran. He began with Universal as Chief Financial Officer in 1998, and then became President of Universal's Latin America division in 2002, President of Universal's International division in 2005, and ultimately Chief Operating Officer of Universal in 2006. He also served as a Director at Universal during that period, and became a Director of Exterran upon completion of the merger. Ernie will continue to serve as a Director of Exterran, and was recently elected as a Director of Exterran Partners, general partner. With Ernie's operating and financial experience, he is already adding value to our company, and we are very pleased having him back on board. Ernie is expected to assume the role of Chief Executive Officer of Exterran Holdings upon my planned retirement at the end of June 2009. From a personal perspective, I'm very pleased to have Ernie back. I believe the addition of Ernie to our management team is a real plus for our company that will lead us to greater success. I could not think of a better person to assume the oversight of this company from me. With his experience and capabilities, Ernie is uniquely qualified to help us continue our path toward operating excellence, intelligent use of capital, and growth of shareholder value. Ernie is already actively engaged in enhancing and growing our operations, and while he is not part of our call today, he will begin to be part of our investor discussions in the coming months. Now I'd like to summarize the third quarter financial results for both Exterran and EXLP. In the third quarter for Exterran Holdings, revenue was $796 million, and EBITDA as adjusted was a $193 million. Net income was $37 million or $0.56 per diluted share, including merger and integration costs, and asset impairment charges that totaled $4.7 million or $0.04 per share. Fortunately, we did not incur any injuries as a result of Hurricanes Ike and Gustav during the third quarter. However, we did incur some property damage and disruption to our operations. Our employees have done a terrific job of handling the challenges caused by these storms. We included... incurred $1 million for fleet asset impairment charges, related to uninsured portions of compressor units lost in Hurricane Ike. We also closed our fabrication facilities in the Houston area for about four days and incurred some disruptions to our aftermarket service operations. We are pleased with another solid performance by Exterran Partners in the third quarter. As a reminder Exterran Holdings own a majority 55% LP interest in Exterran Partners, as well as the 2% GP interest. EXLP provides natural gas contract operation services throughout the United States. In the third quarter Exterran Partners recorded revenue of $44.4 million. EBITDA as further adjusted of $22.7 million, and distributable cash flow of $14.8 million. These results reflect the impact of the completion of the previously announced acquisition of 254,000 horsepower by Exterran Partners from Exterran Holdings on July 30th. We were very pleased to get that transaction completed in the way that made sense from a financing and distribution growth perspective, particularly in light of recent turmoil in the MLP capital markets. We remain optimistic about our expectation that we will be able to continue dropping assets into EXLP in the future, as market conditions stabilize. Last week, Exterran Partners announced a cash distribution of $46.025 for the Limited Partners unit for the third quarter of 2008, or $1.85 per unit on an annualized basis. This distribution represents an increase of 15.6% on a year-over-year basis, and includes two months of operations from the additional contract operations assets, Exterran Partners purchased from the Exterran Holdings at the end of July. Now I'll provide some more detail on our operational performance in the third quarter. Overall, our total company operating horsepower declined 28,000 in the third quarter, equating to about one half of 1% of our operating fleet. While this performance is still below our targets, we are making progress in stabilizing our North America contract operations business where in the third quarter; we saw a much more modest decline of 17,000 working horsepower in the United States. Similar to what we experienced in the second quarter, we generated steady monthly horsepower improvement over the course of the quarter. We were pleased to have increased operating horsepower modestly during September in the U.S. And based upon current bookings, we are optimistic about continuing favorable horsepower trends in the fourth quarter. We believe much of this improved horsepower trend is directly tied to our focused efforts, and improved service quality and customer satisfaction. We believe we are doing a better job in the field, and we are getting direct feedback from many of our customers that this is indeed the case. Further, I believe we're making solid progress on the cost side of improving our North America operations. We're please to note that costs continued to decline in this segment, totaling $84 million for the third quarter, compared to $86 million in the second quarter, and $88 million in the first quarter. At September 30th, we had a total North America contract compression fleet of 4.54 million horsepower. Fleet utilization was 76% that's compared to 77% at June 30th. On the international side of the business, we continue to generate success in new business development activity for our international contract operations. I am happy to announce we won additional new contract awards that demonstrate the continuing strong demand for outsourcing services in international markets. During the quarter, we executed three new contract awards, expected to generate more than $25 million in annualized revenue for Exterran. During the third quarter, we started operations on projects in Brazil, Argentina and Oman. While the commencement of these projects reduced our backlog, we were still able to increase our international contract operations backlog during the third quarter, from approximately a $120 million to over $135 million in expected annual revenues. These projects will generate revenue beginning later this quarter, and into 2009, and early 2010. Our International fleet utilization declined to 92% at September 30th, compared to 94% at June 30th, on a base of approximately 1.5 million horsepower. Operating horsepower declined by approximately 8,000 in the third quarter, due to the ending of projects in Mexico and Africa. Exterran's worldwide fleet totaled approximately 6 million horsepower at September 30th, and worldwide utilization was 80% compared to 81% at June 30th. Similar to our results in the second quarter, our gross margin percentage in the international contract operations segment during the third quarter was negatively impacted by higher than expected labor and repair and maintenance costs in Latin America. We were also impacted by about $3 million of unusual items including equipment demobilization costs and costs related to inventory relocations. We have a number of initiatives designed to mitigate the cost pressures in these markets and we are confident in our ability to improve margins as we move forward. I'm pleased that the profitability of our fabrications operation improved nicely in the third quarter over second quarter results, but we had some substantial cost overruns in two of our sale projects. Demand for our fabrication services continues to be strong as reflected by brisk inquiry and bid levels and a healthy level of fabrication backlog. Total backlog was $1.09 billion at September 30th compared to $1.15 billion at June 30th with increases in both compression and production processing equipment backlog during the quarter. I am now going to turn the call over to Michael to review our financial performance. Michael?

[J. Michael Anderson:]

Already. Thanks a lot, Steve, and good morning everyone. I'm sure that you've now had a chance to look at our press release that we issued earlier this morning. I would like to start up the financial portion of the call by commenting on the recent turmoil in the financial markets and also the heightened interested investors in the financial strength of companies. Now we want to reassure investors and customers that we believe our financial position remains very healthy. We have a strong balance sheet and sufficient credit availability to fund existing capital projects and also allow us to take advantage of growth opportunities. We expect the cash generated by our operations will exceed our maintenance and growth capital expenditures for the foreseeable future. In addition, we have significant unused availability of more than $400 million under our credit facilities to fund short-term needs in other activities. We believe we have a very attractive debt structure at Exterran. We were fortunate that the timing of our merger last year prompted us to refinance virtually all of our debt at a very favorable time in the capital markets. The Exterran Holdings credit facility totals $2.65 billion and the senior secured revolver part of that includes a broad group of more than 30 financial institutions. The Exterran Partners credit facility totals $433 million and it includes more than 20 financial institutions. We have very attractive pricing, and no significant debt amortization until 2011 for EXLP, in 2012 for EXH. The primary debt covenants are a maximum of five times debt to EBITDA of both entities. And we also had minimum interest coverage of 2.25 times at holdings and 2.5 times at EXLP. For the quarter that just ended on September 30th, the covenant calculation reflected EXH debt at three times debt-to-EBITDA and also six times interest coverage, while EXLP was at four times debt-to-EBITDA and just under five times interest coverage. Our total debt with a benefit of interest rate swap is about 63% fixed and our average all-in rate today is just a little bit less than 5.5%. So, now let's move on now and talk about the third quarter financial performance for both Exterran Holdings and Partners and also discuss the earnings outlook for the fourth quarter. Of course, due to the merger in August of last year, our year-over-year comparisons are still not especially meaningful and as a result, most of my comparisons this quarter will be against the second quarter as well as the guidance that we provided in our last earnings call. But in general, as I go through the performance, our operating performance this quarter was inline with expectations. If we look first of all at North America contract operations, revenue was $198 million in the third quarter. That was inline with expectations and was up somewhat on a sequential basis from the second quarter due in large part to the inclusion of the contract water treatment business that we acquired during the quarter. Gross margin percentage in North America contract ops increased to 57% from 56%, as cost continued to decline in the segment. International contract operations revenue increased on a sequential basis to $135 million in the third quarter. That's a little above our guidance range of $129 million to $132 million, and that was driven by the start-up as a projects throughout the world. In addition, the third quarter revenues did include about $3 million in benefit from some unusual items including some retroactive rate increases in Argentina and Brazil. International contract operations gross margin was about 60% in the quarter and that's a bit below the 62% that we posted in the second quarter and it's also below our guidance of the mid 60s and the reason for that is the cost pressures that Steve talked about particularly in Latin America. If we move to fabrication, we generated revenues of $365 million that was a little bit below of our guidance range of $370 million to $390 million. Gross margin was about 20%, that is somewhat above our guidance level of mid to high teens and is also significantly higher then the second quarter margin of 10% as the profitability of our Bellei operations returned to a much stronger level. Compressors represented a bit more than 40% of fabrication revenue for the quarter. Bellei was just a little bit more than 30%; and then the other production and processing equipment made up the remaining percentage of revenues for the quarter. If you look aftermarket services, third quarter revenue was $98 million that's a bit above second levels and also above the guidance that we had of $90 million to $95 million. Gross margin percentage was 20% and that again was inline with guidance. SG&A expenses were $94.5 million in the third quarter and that's down about $800,000 sequentially from second quarter. We generated $193 million in the third quarter EBITDA and that excludes $3.7 million of merger costs as well as $1 million in asset impairment costs incurred due to Hurricane Ike. Interest expense was $33 million in the third quarter that was up from 30 million in the second quarter due to increase debt outstanding and also some slightly higher interest rates in the quarter. We had $6.7 million in equity income from joint venture investments in the third quarter and almost just little bit lower than the $7 million in the second quarter. We had $5.7 million of others expense in the third quarter, versus $8.6 million in other income that we had during the second quarter. So, this is basically a $14 million sequential decrease in earnings related to this lined item and it obviously had a large impact on the bottom-line results for the quarter, equated to about $0.14 per share. Now the other income expense line item, it does include things by currency translation effects, gains on trading securities, interest income and also gains on used unit sales. With the strength of the dollar against some key currencies such as the euro and the Brazilian riyal we did have a currency translation loss during the quarter of about $10 million, so that made up most of the difference. This compares to currency a translation effect of about zero we had in the second quarter and the first quarter we actually had a gain of about $8 million. The effective tax rate was about 34% in the third quarter compared to about 41% in the second quarter. The second quarter if you recall was higher due to losses from the below the job that resulted in it been unlikely that we would be able to utilize prior period tax losses in those regions before they expire. We do expect that the tax rate in the mid 30s should be the normal course for us we go forward. We put all this together we reported diluted net income per share of $0.56 in the third quarter, if we add back the merger in fleet impairment cost that would increase third quarter performance by about $0.04 per share. Net capital expenditures for the third quarter were $101 million, total CapEx included about $58 million growth capital and about $41 million in fleet maintenance capital. If you look at the balance sheet, total consolidated debt increased by about a $195 million during the quarter due largely to the funding of our acquisition and also stock buyback activity during the quarter. This increased total debt to $2.5 billion and debt to capitalization to 43%. At September 30, Exterran Holdings revolving credit facility had $324 million drawn against it. Available debt capacity after taking into letters of credit into account, and also actually just taking letters of credit into account that got into debt capacity of $388 million, and that does include what's available under the ABS facility. In the last call we did note that the dropdown transaction with EXLP resulted in improved liquidity Exterran Holdings and coupled with a reduced price level of our stock, we said that we look more aggressively at share repurchases during the third quarter, and we did that. We repurchased almost 1.1 million shares of our stock during the third quarter at an average price of about $46 per share and that totaled $50 million. We still have $50 million remaining under our $200 million share repurchase program and as we look at the fourth quarter we will continue to balance the importance of capital and liquidity in this challenging marketplace against the opportunity to repurchase Exterran shares at prices that we believe are attractive. I'd like to now talk a little about our guidance for the fourth quarter. Starting with North America contract operations, we expect modest sequential revenue growth, as we anticipate flat to modest growth in northern horsepower, and we expect margins to be flat, compared to third quarter levels. For the fourth quarter, we expect international contract operations revenues of a $130 million to $132 million, with margins in the low 60s. Revenues are expected to be somewhat lower than third quarter levels, primarily due to the end of a project in Mexico. And also, the $3 million in non-recurring revenue benefits that we had in the third quarter. If you look at our guidance revenue in the fourth quarter that does represent an increase of about 17% to 18%, compared to what we had in the fourth quarter of 2007. In aftermarket service segment, we expect that we will generate fourth quarter revenues of about $90 million to $95 million, with margins around 20%. In fabrication for the fourth quarter, we expect revenues of $360 million to $380 million, with margins in the mid to high teens. We expect that net capital expenditures for the full year will be around $500 million. That's at the upper end of our earlier guidance range, due to the expenditures for our new international projects. And we expect fleet maintenance capital will be about a $120 million to a $125 million for the year. If we look at the growth capital portion for the year, we should have about 60% of that spent internationally, and 40% in the U.S. Look for the just a minute now at Exterran Partners. As we had mentioned, earlier at the end of July, EXLP did complete the purchase from Exterran of a fleet of compressor units that totaled about 254,000 horsepower. So if you look at EXLP today, it has a compressor fleet of just over a million horsepower, and that's about 23% of the combined Exterran Holdings and Exterran Partners U.S. contract operations business. In connection with the closing with the dropped down transaction, the Omnibus Agreement between the two parties was amended to reflect adjustments in the cap on SG&A and operating costs. The SG&A cap was increased from $4.75 million a quarter to $6 million in quarter, and the operating cost cap went from $18 per horsepower per quarter, to $21.75 per horsepower per quarter. And the termination date for these caps was extended by one year, and it is now December 31st, 2009. Now with the benefit of the cost caps, EXLP generated EBITDA of $22.7 million. Distributable cash flow of $14.8 million. This distributable cash flow was sufficient to cover the distribution that we declared for the third quarter, by 1.6 times. And by comparison in the second quarter with the cost caps EBITDA was around $20 million, distributable cash flow $14 million, and coverage was 1.7 times. If you look at the third quarter, even without the benefit of the cost caps, EXLP generated distributable cash flow that was sufficient to cover the distribution by 1.2 times in the third quarter. In the third quarter, Exterran Partners fleet averaged operating horsepower was 816,000, and that compares to 652,000 in the second quarter. At September 30th, the EXLP fleet had spot utilization of 89%. And now, as we have discussed in the past, we are converting Exterran contracts to the MLP service contract format. And that includes about 92,000 horsepower that we converted during the third quarter. So today, we have over 1.7 million horsepower of the combined fleet now covered by the new contracts. That compares to 1.6 million horsepower that we had at June 30th. And this total horsepower that's been converted to the service contract form now represents about 39% of the combined U.S. fleet. And lastly, we do expect to file the Holdings and Partners 10-Q in the next day or so. Now before we go to questions, I just wanted to take a quick opportunity to highlight a couple of aspects of our company that I believe, make us an attractive investment opportunity, particularly in today's uncertain market. First of all, we want to reiterate that we believe we have a core business model was stable in the current cash flows. Our production related products and services have historically experienced more stable demand than that for exploration focused energy service companies. Secondly, we believe we have a strong market position. We believe we are the clear market leader in many of the services and regions in which we operate. And we're also geographically diverse. If you look at 2008 nine months' numbers, we had about 52% of our revenues from North America, and 48% from outside North America. Thirdly, we believe we have a strong balance sheet and good capital position. We expect to internally generate sufficient cash flow for the foreseeable future, to cover our growth and maintenance capital. And we also have over $400 million of availability under committed credit facilities. Fourth point, we believe that the long-term outlook for the worldwide growth of natural gas production, which is the key driver for our business, is very favorable, and should provide us with many growth opportunities in coming years. And lastly, we believe the equity valuations for both Holdings and Partners represent attractive investment opportunities. For instance, if you look at Exterran Holdings, it's currently trading at about 50% of book value, and less than five times trailing EBITDA. Meanwhile, EXLP is trading at less than its 2006 IPO price, despite having grown distributions by 32% in the past two years, and is currently paying a quarterly distribution that equates to an annual yield of about 12.8%. So in summary, we certainly believe we are well positioned both in our industry and with our financial position, and that our equity also represents a good investment with attractive upside potential. So this time, let's turn the call over to questions. Operator, if you could do that? Question And Answer

[Operator:]

Thank you. [Operator Instructions]. And our first question comes from Chris Gillespie with Simmons & Company.

[Christopher Gillespie:]

Thanks. Good morning.

[J. Michael Anderson:]

Good morning.

[Stephen A. Snider:]

Good morning.

[Christopher Gillespie:]

First question; looking at 2009 and your preliminary thoughts regarding North America, do you have... given the fact that the NLP market right now is, credit constrained, a dropdown I would assume less than likely, do you have any plans to move some of your North American horsepower into the international sphere or no?

[Stephen A. Snider:]

We are continually moving horsepower to whatever market we can utilize it in. We move North American units and international more frequently than the reverse. It's not a large number however. We do move some of the equipment there when there is a job for particularly with an idle fleet that we have that's ready to go, quite often it helps to secure more projects than international.

[Christopher Gillespie:]

Okay. And in terms of looking internationally, can you give us an update in terms of some projects and some markets you're looking for to get into next year and kind of the capital expenditure that will be necessary to go in there, kind of along the lines of, what we saw last quarter? And if you see any projects like down on the horizon?

[Stephen A. Snider:]

Well, we have a continual backlog of projects in the international market that have a very long gestation period. And it's a long book of business, some of which becomes real projects and some of which, of course goes away. And its spread through all the place you would expect it to be that I will kind of doing business, being Asia, Africa, Middle East, Latin America. We generally tell you what we come up with in the amount of contract value that we had in every quarter, which we did this quarter. But we haven't been disclosing particular projects for a variety of reasons, but we have a pretty full book of opportunities there that we're converting as you can see by the increase in back log.

[Christopher Gillespie:]

Right.

[J. Michael Anderson:]

And Chris, I'll give you some details on the CapEx. We talked about the contract operations backlog internationally; it's a $135 million today. We would expect it will spend just a little bit north of $100 million in 2009 related to those projects.

[Christopher Gillespie:]

Okay. That's helpful. And just one quick final question, at this point, what are you seeing from your North American customers in terms of how... are they pretty much completely come back to you or are you still feeling pricing pressure and trying to get them back and regain the market share that you lost?

[Stephen A. Snider:]

Amazingly, we haven't had a lot of pricing pressure even with this kind of strange environment that we are in right now. So, the price has never been the issue. It's really been service quality and as you can see, we are starting to get some of our customers coming back and actually ramping up more horsepower with us. The anecdotal references from our customers have been terrific lately as to what we have been able to accomplish in our North America operations. So, we are seeing more equipment come back... or go to work rather for our customers, gain more market share back, like we did in one month. All we have is September so far to hang our head on.

[Christopher Gillespie:]

Right.

[Stephen A. Snider:]

But we are optimistic that judging by the book of business we have, that fourth quarter is going to be strong as well. In general, the customers are... in North America, some of them are cutting back on their programs; some of them are accelerating their programs. They are all over the map as far as where they think they are going to be going in 2009 and I think that just mean they don't know yet.

[Christopher Gillespie:]

Thanks a lot. That's all I had.

[Stephen A. Snider:]

Thanks.

[Operator:]

And next we'll hear from Brad Handler with Credit Suisse.

[Brad Handler:]

Thanks. Good morning guys

[J. Michael Anderson:]

Good morning, Brad.

[Stephen A. Snider:]

Good morning, Brad.

[Brad Handler:]

Maybe you can just flush out a little bit more some of the steps you've taken that have resulted in the improved service quality as well as reasonably stabilizing here from a customer touch standpoint. Just maybe some extra detail would be interesting to hear can you can do that?

[Stephen A. Snider:]

Yes, I'll give you some generalities of what we've done and the things we've talked for the last two or three quarters that are now really beginning to come to flourishing I think. First of all I think we talked about two quarters ago that we wanted to take increase and improve our sales effort. So we have done that and we're seeing some merits from that. I think the biggest portion however, of the improvement has been in our service delivery and service excellence and continually working to make ourselves more user friendly and more customer oriented and accessible to customers and listening to customers in what their needs and desires would be a little bit more acutely. And along with that, lots and lots of training. Training new people up to speed faster, continually training our field operations people, our management team, and I think that the management change that we made back in the winter of last year where we put in a new North American crew, I think that whole team has done a terrific job in increasing the intensity around accelerating our change. Does that help you?

[Brad Handler:]

Sure, it gives me some things to feed off of. So, let me... I don't want to ignore that. Let me come back to it. But, how much of the cost improvement in the quarter that you saw was a function of fuel costs coming off as in lets address something on the slide first of all we come to back to the benefits of the training perhaps.

[J. Michael Anderson:]

That were really not much we didn't have much of benefited all in the third quarter would you go to fuel prices and part of that is lube oil which really has in even more delayed affect. So, we'll start to hopefully see some benefit on in the fourth quarter.

[Brad Handler:]

Okay. So therefore that you would start to attribute I suppose of the training and the efficiencies and you have a better trained workforce for the cost reduction?

[Stephen A. Snider:]

I will think a better job in doing preventive maintenance and a better job in overhauls and a better job of scheduling time for individuals and making certain that we're using our labor force appropriately. There are a lots of pieces that go into it.

[Brad Handler:]

Okay. That's fine. Before I turn it over to somebody if I could I was trying to punch it up numbers in the model very quickly and I'm getting to an EPS for the fourth quarter based on that your operating guidance in the low 60s. Is that...am I in the right ball park or I'm missing something perhaps below the line?

[J. Michael Anderson:]

Well, we don't provide EPS guidance Brad. So, I mean what we're doing is, is going to get people focused on the segment-by-segment revenues and margins. One of the things that obviously for this quarter was highlighted in fact that's some time it's hard to predict is the other income, which historically has been a numbered this from positive for us in this quarter was pretty negative. So we're not going to provide guidance that one, because a lot of that based upon what happens when you go to currencies.

[Brad Handler:]

Right. Fair enough. Okay, guys thanks.

[Operator:]

Our next question comes from Joe Gidney [Ph] with Capital One South Coast [Ph].

[Unidentified Analyst:]

Good morning everybody.

[J. Michael Anderson:]

Good morning.

[Stephen A. Snider:]

Hey.

[Unidentified Analyst:]

Just wanted to follow up where we stand on the buyback front we've finished a 150 out of your 200 as you are you looking to your CapEx growth. It looks like 40% of your targeted growth on the CapEx side in North America, just refer to see where you stand given where you are in the market and allocation else of this given the fact that, NAV of your feet alone is certainly a most more compelling where the stock is now, so I'm curious where you guys doing, that I appreciate it?

[J. Michael Anderson:]

Joe, I think we've been pretty consistent with regard to the fact that we think this is a pretty good business model and we think that on the capital that take a very hard look at and when we put it into projects whether that's going to be in U.S. or in international, we think that's our job. We think that that generates good returns and that's the first priority with regard to capital allocations. We don't anticipate, we don't think it's a good idea to take capital away from the ability do to that. But as we've said, we think that the internal operating cash flow that we've generate is sufficient to be able to cover that maintenance in that growth, then you posted with a question what you do with things that are extra armed. And we certainly have bought back a decent sized chunk of stock $150 million. We've got $50 million left under the existing program. And right now, I think it's just a little bit more challenging time with regard to I think a lot of people are finding that the capital structure and liquidity are really, really important things. We found that to be the case. And then we're focused on that in third quarter. But still felt it was prudent to go ahead and buy $50 million of stock during the third quarter. And we basically have to go to that all process again in the fourth quarter. And right now, I think there is, it's certainly a challenge, because we think our stock is... represents a really attractive value. And we think we have good availability, and credit availability. But we just have to balance those things as things go along in this kind of a dynamic equation.

[Unidentified Analyst:]

Okay, it's helpful. Curious to I know certainly the FX effects, can certainly downturn a lot of heard to predict. Curious on the integration merger expense outlook, any other lingering costs, as we move into the third quarter on that line?

[J. Michael Anderson:]

Not a whole lot. We think we'll probably finish up with that in the fourth quarter. And we just have a few more people tailing off with regard to exit from the company. But for the most part that integration's been done. Everyone's been notified. So, if we have anything in the fourth quarter, it would be pretty small.

[Unidentified Analyst:]

Alright. Last one for you, you mentioned that given the current capital availability issues, and maybe a customer mindset more towards contracts and our ownership. Certainly in North America, you guys appeared to be reaching the point where you were stemming some of the horsepower declines. Any other anecdotal evidence out there, about that mindset shifting given this market right now. Just kind of curious any color there? Thanks.

[Stephen A. Snider:]

About the mindset. Shifting the outsourcing, you mean?

[Unidentified Analyst:]

Correct.

[Stephen A. Snider:]

I can't say there is been any overwhelming shifts. I mean, we have certainly been more successful. I attribute that more internal into the market, right at this point in time. And I'd think the market is still a bit confused as I said earlier, about where there are headed. So I wouldn't be optimistic that we've seen a real shift, the markets now decide to do more outsourcing. We believe it makes financial sense for them to do that. We always have. And we are hoping we'll more opportunity to tell our story with a less credit availability that we've got. So nothing report there yet, that's concrete.

[Unidentified Analyst:]

Alright. I appreciate guys I'll turn it back.

[Operator:]

we'll now hear from Jeff Keybrids with Needham [ph].

[Unidentified Analyst:]

Thanks good morning.

[Stephen A. Snider:]

Yes.

[Unidentified Analyst:]

Steve, I guess, maybe request for a little history lesson. Could you walk us through in the event that we see a steep decline in U.S. drilling activity, how has that impacted the compression business in the past, both from the volume and from a margin perspective?

[Stephen A. Snider:]

Yes, really good Jeff. That question, a lot of people may not understand the dynamics there. And generally speaking, when you go into a drilling slowdown, as we may with commodity prices being a little bit lower here now. In North America, we still continue to have fairly stable gas demand. We've not been very good in the past about demand for gas coming off lot of it come from power generation and with a stable demand for gas the flow rate stays about the same and wells continue to decline and the bottom-line is our fleet stays busy and our utilization may drop a few percentage points as customer rationalize some horsepower. But overall, we are kind of impervious to reduction in the drilling and then what happens after that is the depletion takes its toll, the production falls off by some gas coming back up, the biggest back door and then start gross cycle. So it impacts us on a gross cycle more than a dozen on an ongoing basis in North America.

[Unidentified Analyst:]

As that production falls off do you suffer some decline in utilization with a lag effect behind the drilling cycle because it what you have just described is kind of I guess the not to be drive to it conventional wisdom that rig count falls, you guys stayed solid as long as production stays steady but then do you suffer utilization decline latter on as part of that rebalancing effect?

[Stephen A. Snider:]

You can but usually modest in that's what I referred to as the rationalizing horsepower of customers. Because if the customer has 2000 horsepower of moving the gas then they're now drawing new house per year and that production falls off and they need 1500 horsepower next year and so sort of single bit of horsepower back. It usually not a major percentage of our fully biggest turn around in that case, well it does tail off the longer it goes with less drilling and more production declines.

[J. Michael Anderson:]

And Jeff, stating the obvious here, but I think is a point that's worth mentioning, I mean if this business does slowdown in America see to starting by the income state from our capital expenditure standpoint growth CapEx can be can be paid back in less and that generates potentially whole lot of cash flow if you look at this year we're spending on a course of $100 million to $150 million in growth capital in North America. Now we hope that continues but if it doesn't and it slowdowns, there is the opportunity to realize that in terms of additional cash flow. Its one of the main expects about this business.

[Unidentified Analyst:]

And kind of two follow-up questions on that, given where as you acknowledge is loss of market share that seems to resulted from the distraction merger and so on, do you think if what we have just described is sort of the, that the standard sequence of events in a situation like this that you could actually realize growth through that period by continuing to gain market share or is that a little bit too optimistic?

[Stephen A. Snider:]

No I think there is some polarity to that. Partially because we have a million idle horsepower that we're preparing to back to work that we don't have to invest anything in, it's there, it's ready it can go out and it can take in projects. Secondly, we believe our customers are going to be tighter with their capital, and therefore they're not going buy as much as equipment they probably outsource more the next period of time, and would outsource things so they would probably have purchased in 2007 or early 2008. So I think there maybe a shift that actually helps us a bit. It's hard to say but that's the rationale around here at the movement.

[Unidentified Analyst:]

And the other follow-up with the million idle horsepower does that pretty much eliminate any consideration of acquisitions, if for instance the competitor would get into some financial difficulty?

[Stephen A. Snider:]

Not necessarily because many of our competitor have utilization as we do have changed around the landscape here in the last year and adding fully utilized horsepower is always beneficial.

[Unidentified Analyst:]

Okay. And would that be done, through the partnership or through sequel?

[Stephen A. Snider:]

No idea depends on who it is and where it is and what time it is.

[Unidentified Analyst:]

Okay. Thank you.

[Operator:]

Our next question comes from Kevin Pollard with JPMorgan.

[Kevin Pollard:]

Thanks. Good morning.

[Stephen A. Snider:]

Good morning, Kevin.

[J. Michael Anderson:]

Hi.

[Kevin Pollard:]

I wanted to follow-up on your comments on the margins in North America, you had pretty nice sequential improvement here in your guidance has come flat and going forward, I'm wondering is that because you feel like you've a realized a lot of the cost savings and synergies that you had attempted to achieve in that business, and of course 57 range is kind of the new base line going forward or do you still some further improvement on that as we walk through 2009?

[J. Michael Anderson:]

Yes, Kevin I think we want to be cautious about as we see improvements I think that we've been pretty consistent that over the longer term we do expect to see improvements as we've not baked that into the number with regard to the fourth quarter in our guidance. I will mention to you that the contract operations business that we bought during the quarter the water contracting business is a little bit dilutive to our margins. They are kind of in the mid 40's. So, that pulls the margins down just a tad. But we think that over the medium and longer term that we will be able to do better than the margin level that we are at right now.

[Kevin Pollard:]

Would you have to get pricing power back to move from here or do you think you can take more costs out of this?

[Stephen A. Snider:]

I think we can keep working on efficiencies in the field, I think that's the biggest issue for a company this size that merged two groups together that this things differently. You get a standard operating procedure and continue to eek out efficiencies as the things we talked about earlier and continue to look at our costs and try to drive all the costs out that we possibly can. There is more work to be done there.

[J. Michael Anderson:]

And as we have talked before I mean there is potential for price increases down or below for the past year and half for 2 years was not past those on to our customers. We've kind of evened inflation portion of that and obviously if you pass on a percent or two or something like that to customer that can help margins as well.

[Kevin Pollard:]

Okay. If guess just shift the international segments for just a second, the margins there a couple of quarters have being you below expectations. I'm wondering with that business growing a little faster they has historically in a wider geographic set of markets. Are things like start up cost and similar issues to going to you kind of continuing for shows margin down portion lower into the 60% range versus may be the mid the higher into we have seeing in past?

[J. Michael Anderson:]

No, we should be back in that mid to higher end over the long term. What has pushed them down somewhat in Latin America I think is the fact that we are in more maturing business there now, there is a lot more over fall work going on and a lot more reassignment of compressors that are moving around. But even with that I think that we probably just... what is efficient a we should have been for the last couple of quarters and it pop up in that area and surprise those in Eastern Hemisphere. I think there doing just about as well as they can right at the moment with a very diverse geographic spread that you pointed out. They have got a lot of equipment going to lot of far places with the long distance between them. So, there is some pressure from that but we continue to build that revenue and get those projects lined out we should be back up in those mid 60s.

[Kevin Pollard:]

Do most of the various geographies that you're operating internationally they have similar gross margins or is the Eastern Hemisphere higher than Latin America or vise versa?

[Stephen A. Snider:]

It varies by the type of equipment and location and ambient conditions and all the different think that and they come in as we learn how to operate in some markets too. That's another issue, operating in the desert in the Middle East is different than operating in Texas. So, there is bit of a learning curve, but no I couldn't say that they are all the same for us, they should be all pretty close, by the time, we materialize some more.

[Kevin Pollard:]

Okay. Thanks. That's all I have.

[Stephen A. Snider:]

Thanks.

[Operator:]

And next regard to Mike Urban [ph] with Deutsche Bank.

[Unidentified Analyst:]

Thanks. Good morning.

[Stephen A. Snider:]

Good morning.

[Unidentified Analyst:]

You've talked at length about your business in the U.S., and it looks like you've hopefully stabilized the share that help to continue move that forward, specific to Exterran. But do you feel like the overall market is continuing to grow and will do so going forward given what you've seen with the cuts out there, with your customers?

[Stephen A. Snider:]

Well Mike, it seems like it's going to continue to grow, but as I said earlier in the call I think, every company seems to have a different philosophy and a difference set of concerns and theories going forward in the ones that I'm aware of. And I think it's too soon to tell whether they are going to be real conservative in 2009 or not. But I do believe many of them continue their programs, simply because they've got the gas hedged, and they are going to put it in the market and there is going to be some growth from those companies. So, our competitors seem to have a good book of business as well. And I think the robust nature of our market and our confidence in the fourth quarter increase is just represented over the fact that, I don't think that the 2009 story is yet to be told.

[Unidentified Analyst:]

Okay. And, in the past when we've gotten into markets like this and slowdowns in North America, in addition to greater outsourcing on new equipments, something you have been able to do from time-to-time in the past is acquire existing fleets from your customer, from E&P companies, is that something that is a possibility? And then if so, is that something you have an appetite for given the current capital markets and liquidity situation?

[Stephen A. Snider:]

Sure, we believe the outsourcing model makes sense for our customers and we have a team that kind of constantly works with customers on trying to find assets that it might make more sense for them to sell to us and contract back. And I think they are getting more reception now with the crunch on capital that's out there. So, I'm hoping that becomes a modest part of the growth story for Exterran.

[Unidentified Analyst:]

And then last one; is nice growth in the backlog in the international side, how much if any of that, are total solution type projects or are those more traditional compression-oriented contracts and projects?

[Stephen A. Snider:]

They are almost all total solutions in that, the minimum they are going to have a installation of compressor station along with the compressors. And almost everything we put out has some kind of production equipment and processing equipment with it. So the majority of this stuff is total solutions.

[Unidentified Analyst:]

Great, it's helpful for me. Thank you.

[Stephen A. Snider:]

Thanks Mike.

[Operator:]

And our next question comes from Paul Carpenter with Semaphore.

[Paul Carpenter:]

Good morning. I think your operating results were good, especially domestically which was encouraging. I have a few questions. I had a question about the domestic competitors and their credit readiness. Has your customers, and never on is between more concerned with credit, is that the way for you to win more business domestically, because your competitors are all smaller. And I would guess not as well or as strongly capitalized?

[Stephen A. Snider:]

We certainly think about that is the scenario that could play out in 2009, because our capital strength, and in our cash flow we have coming through this company and the idle fleets that we have available to us that we think there is some real opportunities here. Most of our competitors are very small. Most are privately owned. So there may the less in finding to invest capital in new assets than they have for last two or three years.

[Unidentified Analyst:]

And then are couple of other quicker questions. One was on; where you have the replacement cost would be for your six million horsepower, could you ballpark where you think that would be?

[Stephen A. Snider:]

So far, I mean, you really have to take it on a unit by unit basis. But you can put it into big buckets. We have talked about now in the U.S. market that's it's probably a cost of the $650 to $750 per horsepower for some of the larger units that we build today. But if you look at some of the smaller units, and you look at the 200, and 300, and 400 kinds of sizes, you get into a 1,000 and 12,000 per horsepower that would cost you to do that. If you look at international, where our average horsepower is right around that 1000, a unit. It does cost a little bit more to get things over there, and get it manufactured. So it's probably more like an 8 or 850 type number. So you can kind of piece those together, in terms of coming up with an average. It's going to be something that is $700 or $800 a horsepower.

[Unidentified Analyst:]

Okay, thank you. And then, just on the domestic side, if there was a slight decrease in horsepower for the quarter revenues were up. Does that mean that you passed through a small rate increase? I mean, what is the... that must be the conclusion, right?

[Stephen A. Snider:]

Probably a mix issue.

[J. Michael Anderson:]

Yeah, it's actually also the fact that we had the water contracting business that we added in during the quarter. We had two months of that. And that added $5 million to $6 million of revenue.

[Unidentified Analyst:]

Okay, thanks. And just a last question. Just looking at the difference in the last couple of weeks, between the trading and EXH and EXLP just wondering of you had been contemplating trying to take advantage of that somehow in that or I'm sure you don't want to sale units in the EXLP or, just a difficult time to sell any units of any kind in this market. If you are able to do so even at a less than ideal price with that the be worth it because of would be added fire power to buyback more EXH stock which was even more depressed to those of kind of thinks you are considering between the think out of the box in a time like this to take advantage of the current stock price of the sequence?

[J. Michael Anderson:]

We certainly trying to think about all kinds of different things currently to the order priority for us with regard to heavy to allocate capital everything that selling units that we owned would be far down the list of things we will think make a lot of sense right now we do think we are in pretty decent capital position and still have open availability under the existing stock repurchase program, so although it's interesting idea I don't think that we would necessarily put that real high on the risk now. We think that the units are almost 13% yield or something that going to change at some point for the better going forward.

[Unidentified Analyst:]

Thank you.

[Operator:]

And our next question comes from Rick Johnson with TYGH Capital.

[Unidentified Analyst:]

Thanks, on the currency just make sure I understand, so in the other income line there was a 10 million included in the $5.68 million loss another income there is a $10 million negative hit there on the other income is that correct?

[J. Michael Anderson:]

That's correct.

[Unidentified Analyst:]

Okay, so that's pretty big if we assume currency rates stay approximately where they are. So we continue to see that kind of heat going through the next few quarters?

[J. Michael Anderson:]

It generally happens whenever the dollar strengthens and primarily against the Euro, there is a little bit of exposure that we have against the Brazilian riyal but so far this quarter it's continue to move in terms of the strengthening dollars or that would say with that number could be negative again. But there is a pretty big move into the third quarter, so we certainly help and say anything that kind of magnitude but it's obviously tough to predict.

[Unidentified Analyst:]

And is that hit, can you just go through how that hit occurs. Is it revaluation of accounts payable? What is the mechanism? How that currency hits you?

[J. Michael Anderson:]

No I think you pretty much hit it right there. It's basically for some of the foreign operations like the blowy operation where the euro denominated and Brazil with their riyal denominated. They will have some basically short-term liabilities that are going to dollar denominated and when the dollars strengthens basically that becomes more expensive for them to repay those and that kind of flows through into our other income line.

[Unidentified Analyst:]

So, it's the change quarter-to-quarter I mean within sequentially so who stay flat right for the next three quarters if it were if it were?

[J. Michael Anderson:]

If you stay flat, that number should be around zero.

[Unidentified Analyst:]

That number should be around zero, correct. Okay, and then the other differential, because you have a $14.3 million swing due to the Q3 and other income so $10 million of that $14.3 million was currency, how about the other $4.3 million?

[J. Michael Anderson:]

It's a variety of things that include gains that have on asset sales, some interest income, we have putting been income down into some of our Latin American countries. We have gains related to some of those currency swaps and we had less in the quarter of the third quarter then we had in the second quarter.

[Unidentified Analyst:]

And is there any, do you have any visibility on ex currency, but those other all other things combined going forward, are those positive or negative flat don't know?

[J. Michael Anderson:]

We tend not to like to predict those because there are little bit difficult. But you can go back and with the information we have given can see in the first second and third quarter that number net of the currency translation has ranged in the $3 to $6 million positive per quarter type range. So we would expect there should be fairly modest to the positive side of things for us.

[Unidentified Analyst:]

Okay very good, thanks.

[Operator:]

And there are no further questions at this time I would like to turn the conference back to Mr. Snider for any additional or closing comments.

[Stephen A. Snider:]

At this time, I'll make a real quick wrap up here. Most of you have heard us talk as we met and discussed this over the last year that to get these two companies merged and performing properly was going to take a really big effort by all of our employees over the entire calendar year 2008 and we should come out of 2008 a much better company. And what I'm holding is that today we've demonstrated our progress along that path and the fact that we're beginning to deliver what we've said we were deliver several months ago. So with that I'll close and tell you that I'll look forward to talking to you first quarter next year. Thanks everybody. .