Archrock Inc (AROC) 2003 Q2 法說會逐字稿

Good morning, and welcome to the Universal Compression second quarter fiscal 2004 earnings conference call. (Operator instructions) I would now like to turn the call over to Mr. David Oatman. Thank you, sir, you may begin.

Thank you. We have prepared a summary page of financial and statistical data about the quarter in our earnings release, which is posted to our universalcompression.com website, under the investor relations tab.

In addition, during this call we will discuss some non-GAAP measures in reviewing our performance, such as EBITDA as adjusted. You will find a reconciliation of these measures to GAAP measures in the summary page of the press release.

As a reminder, during today's conference call we will make certain comments that are not statements of historical fact, and thus constitute forward-looking statements. Investors are cautioned that there are risks, uncertainties and other factors that may cause the company's actual performance to be significantly different from the expectations stated or implied by any comments that we make today. I will now turn the call over to Steve Snider, our president and CEO. Steve.

Thank you, David. Good morning, everyone. Joining me today is our CFO Michael Anderson. I will provide a description of the operating highlights and the business outlook. I will let Michael provide a summary of our recent financial performance and guidance for the fiscal third quarter and for the year.

Universal made significant progress in enhancing our operational and financial performance in the second fiscal quarter which just ended on September 30th. First, as we promised, we turned around the performance of our fabrication segment. We consolidated our Tulsa fabrication activities into our Houston operations during the June quarter. Although the expense of this action negatively impacted results in the June quarter, we recorded significantly higher revenues and gross margins in the September quarter.

Generally, we recently further streamlined our North American operations by integrating our Canadian division with our U.S. division. The combination of these operations is facilitated by the geographic proximity and commonality of customers and business practices.

We expect the benefits of this action to incur increased cross-border sharing of best business practices; improved service levels provided to common customers; and more efficient scheduling of fabrication activities between Houston and Calgary. The company is now better-positioned to take advantage of market opportunities going forward as a result of our reorganization efforts in North America.

Second, we recorded a reduction in interest expense of almost $2m in the second quarter. This positive development is due to our debt refinancing and reduction activities completed earlier this year, which reduced our debt by over $50m and significantly lowered our cost of capital.

Lastly, and most importantly, we recorded higher activity levels in each of our business segments and geographic divisions due to favorable market conditions and the execution of our operating plan. The utilization of our contract compression fleet increased throughout the second fiscal quarter as we continued to emphasis the reactivation of idle units.

The business outlook is good. It’s demonstrated by the recently reported 9 percent increase in domestic gas well completions in the September quarter compared to the June quarter. This activity bodes well for compression demand in the second half of our fiscal year.

I will now turn the call over to Michael Anderson for a summary of the second fiscal quarter results. Michael.

Good morning, everyone. I am certain that by now you’ve all received our press release issued earlier this morning and you’ve had a few minutes to review the material. In my summary of second quarter fiscal 2004 financial results, my primary comparison period will be the fiscal 2004 first quarter as well as the guidance we provided in July for the second quarter.

Total revenues were $175.7m in the second fiscal quarter compared to our guidance of $160m to $170m. Revenues increased by 15 percent, from $152.2m in the first fiscal quarter, due primarily to higher fabrication revenues as well as increased activity in our other segments.

Looking at each of our business segments, our domestic contract compressions revenues increased from $69.2m in the June quarter to $69.7m in the September quarter. In line with guidance, due to increased utilization.

The profit margin in this segment, however, decreased from 64.4 percent from the June quarter to 61.3 percent in the September quarter, due in large part to higher operating costs associated with the reactivation of idle units. We are not pleased with this margin performance, but realize that this is an unavoidable part for digging deeper into the fleet and putting more of our older equipment to work.

Importantly, however, we believe this margin erosion is a temporary issue and we will see margins improve in coming quarters. Steve will cover this subject in a bit more detail later in the call.

Our international contract compression revenues increased from $19.7m in the June quarter to $20.7m in the September quarter, again in line with guidance and due largely to a full quarter contribution for new business in Brazil and increased activity in Argentina.

International contract compression profit margin decreased somewhat from 79 percent to 77 percent, still in line with our guidance levels and our historical levels of margins that are in the high 70 percent range.

Fabrication revenue increased from $29m in the June quarter to almost $50m in the September quarter, above our guidance level of $37m to $43m. We reported fabrication profit margin of 11 percent in the September quarter, also above guidance, due to our improved project management system and reduced cost structure.

Most of the reason for the revenue out-performance was that one of our customers converted about $4m in new units that we were building for a contract compression project into purchased units. So thus, we had $4m more in fabrication revenue than we had anticipated.

Overall we are pleased with our progress in fabrication and with the Tulsa consolidation and believe margins will be in the 10 percent to 12 percent range in the second half of the fiscal year.

In the after-market services business segment, second quarter revenues were inline with guidance while profit margins were at the high end of our guidance. Revenues increased sequentially about 4.5 percent from $34.1m to $35.5m while profit margin decreased slightly from 23 percent in the June quarter to 22 percent in the September quarter. It’s not unusual to see moderate fluctuations in this segment due to business mix and project completion schedules.

SG&A expenses increased from $15.9m in the June quarter to $17.3m in the September quarter, somewhat higher than our expectations. The September quarter results included about $800,000 new expenses in Canada and Latin America that we do not expect to incur going forward, partly due to severance costs.

EBITDA as adjusted was $55.3m for the quarter, up from $52.5m in the first quarter. That’s an increase of 5.4 percent sequentially and it’s 15 percent above the year earlier figure.

Interest expense was $18m in the September quarter, a large reduction compared to $19.9m in the June quarter, due to our debt refinancing and reduction activity. As a reminder, in the June quarter we had refinanced approximately 239m of nine and seven-eighths senior discount notes that were due 2008. We replaced those with $175m of seven and a quarter senior notes due 2010, using excess cash reserves to reduce the overall debt outstanding.

So there was a small benefit of about half a million in the earlier June quarter from the refinancing activity.

EPS were 31 cents in the second quarter, excluding Tulsa facility consolidation expense, compared to our guidance of 28 cents to 33 cents. Tulsa compares to 25 cents before the debt refinancing and facility consolidation expense that we had in the first quarter.

During the second quarter, the facility consolidation expense was 1 cent per diluted share on an after-tax basis. So after this item, the second quarter EPS were 30 cents. We’ve now completed the Tulsa facility consolidation and total costs came in about $200,000 less than our $2m forecast. We are also realizing the benefits of the consolidation as reflected in our second quarter fabrication margins.

In the second quarter we also had another income gain of about $700,000 mostly due to the sale of certain domestic contract compression units. I would like to take just a couple of minutes to briefly explain this item.

We fabricated these specific units last year for a customer and we are leasing these units within our contract compression segment, until that customer elected to exercise a purchase option of the units. The transaction value ended up being about $7m and the gain equated to north of the 10 percent margin.

We view this type of income as really part of our core operations, and this transaction really amounts to a fabrication sale of equipment after the assets were on contract compression for a 12-month period. Now in this instance we will also continue to earn income going forward, as we are still providing maintenance operations for the unit.

Finally on the income statement we had a $900,000 foreign exchange loss, mainly in Canada and Argentina.

We continue to do a good job on the capex front. Capital expenditures totaled about $21m in the September quarter, compared to $17m in the June quarter and $33m a year ago. Capex during the September quarter included about $11m in growth capex and $6.3m in maintenance overhauls. Our growth capex was invested about two-thirds/one-third between domestic and international markets.

As always, all investment is subject to a thorough review and financial return targets are strictly followed. Furthermore, we are modestly increasing both IRR and contract term minimums to ensure that new capital is spent wisely and further supports our goal to increase return on capital.

Our overall debt-to-capitalization ratio declined about half a point to 53.8 percent at September 30th 2003. That’s down from 54.3 percent at June 30th and 57 percent a year ago. The year ago period calculation does include the two operating lease facilities that we consolidated on the balance sheet, effective December 31, 2002.

Now as we look forward on the capital structure side, we are comfortable with our debt levels, but will continue to modestly reduce our leverage towards a target debt-to-capitalization ratio of 50 percent. This is a prudent debt level to leverage against our strong base of assets and recurring income. We believe this debt level range will allow us to 1) maximize returns to our stockholders; 2) minimize our total cost of capital; and 3) still provide us with sufficient financial flexibility when future opportunities arise.

Our liquidity and credit availability remains strong. We generated almost $10m in operating cash flow after capital expenditures in the second quarter and realized another $11m from the sale of fleet units, primarily the option exercise units I referred to earlier. Our cash position increased from $24m at June 30th to almost $44m at September 30th, while working capital, when you take cash out of the equation, increased only slightly.

Our $125m revolver, which extends into 2006, still has no amounts drawn against it and we have an additional $25m of capacity on our asset-backed debt instrument.

Lastly, our 10Q should be filed in mid-November. Steve.

We are very pleased with our progress at the mid-year point of fiscal 2004. Our total fleet utilization has increased steadily throughout the first six months of the fiscal year. It’s actually risen from 84 percent at March 31st to 85 percent at June 30th, to 87 percent at September 30th.

Looking at just the domestic fleet, the spot utilization has mirrored this overall improvement going from 83, to 84, to 86 at the same three time points. This increase in activity levels has occurred across horsepower classes. Our largest horsepower class has the highest average utilization rate, which is in the low to mid 90 percent range.

Overall, domestic contract compression revenue and working horsepower were at record levels in the September quarter. We believe the increasing utilization trend will continue throughout this fiscal year based upon dialog with our customers.

We continue to opportunistically increase rates on our domestic fleet. Our average price per horsepower increased approximately 2 percent as we reported earlier as a result of rate increases implemented in early March, and have increased another 1 percent or 2 percent since then, due to increases on selected higher demand units.

We plan additional selection rate increases in the second half of the year in horsepower categories where demand is the highest and supply is the tightest. We continue to reactivate idle units as we increase domestic utilization. A key part of this strategy involves the enhancement of this equipment for current and anticipated future applications.

This strategy resulted in increased operating expenses in the second quarter. We recorded a similar increase in operating expenses in the same period a year ago when we were activating idle equipment for Alliance customers. We are confident that our current fleet reactivation activity will enhance financial returns and expect our domestic contract compression gross margin will return to our historic level of about 64 percent in the second half of this year.

International contract compression revenues were also at record levels in the second quarter. International utilization has increased from 86 percent at the end of March to 88 percent at the end of June to 90 percent at the end of September. We benefited from a full quarter contribution from two new pipeline stations in Brazil, and additional activity in Argentina where Repsol IPF is making sufficient investment to maintain production and has committed to their first gas storage project.

In Mexico, [Conex] exercised an option to purchase some of our working contract compression units that totaled about 11,000 horsepower, and they did that earlier this month. However, we have recently been awarded a new 11,000 horsepower contract for [Conex] for operations in Vera Cruz. That project is scheduled to start near the end of this fiscal year and will use currently idle equipment. We also continue to add modestly to our operations in Thailand, Indonesia and Australia.

In Canada, increased fabrication activity in the second quarter was the bright spot in an otherwise lackluster business environment. As I mentioned in the introduction, we recently streamlined our North American operations by integrating our Canadian division with our U.S. division. The reorganization of this unit is expected to improve operating efficiencies on both sides of the border.

Improved coordination and scheduling of fabrication projects in Houston and Calgary is expected to enhance this segment’s operating efficiency and financial returns. Our push to expand contract compression operations in Canada and to improve our after-market service performance is expected to benefit from increased cross-border sharing of best business practices as well as a coordinated North American marketing effort.

This integration, which resulted in some severance-related charges in the September quarter should have a positive impact on our cost structure going forward.

Our after-market service segment continues to slowly and steadily improve as second quarter revenues increased 4 percent over first quarter and 16 percent over the same period last year. We continue to see improvement from cross-selling our after-market services with our other segments. We are increasing activity with Alliance customers and have new business in international markets.

In the second quarter, increased activity in the U.S., Argentina, and Australia more than offset a slight decline in Canadian activity.

During the fiscal first quarter, we transferred substantially all fabrication activities based in Tulsa, Oklahoma to our existing facility in Houston. This move has resulted in better project management and financial control through the consolidation of application and project development personnel into our Houston headquarters.

Fabrication revenues increased by over $20m in the second quarter, while the gross margin increased to 11 percent. Our fabrication backlog has increased nicely across the year. It was $56m at March 31st, rose to $81m at the end of the June quarter and was $101 at the end of September. Our current fabrication backlog is approximately $104m, and that is split about 60-40 percent in favor of domestic versus international business.

This backlog includes units for a large gathering and pipeline project in Colorado and Wyoming and to meet Alliance customer requirements in Canada. We’ve also recently secured new business for Indonesia and captured our first order directly for Khuzestan.

Michael will now provide guidance for the September quarter and fiscal year 2004. Michael.

Looking first of all at guidance for the third quarter of fiscal 2004, revenues are expected to be $165m to $175m. Domestic contract compression revenues are expected to be $70m to $71m and international contract compression revenues are expected to be $20m to $21m.

Profit margins are expected to be more in line with the historical averages. In the 64 percent area for domestic and the high 70 percent range for the international segment.

Our guidance is based upon total utilization averaging between 87 percent and 88 percent in the third quarter of fiscal 2004, up somewhat from our current spot utilization rates. Fabrication revenues are expected to be $40m to $45m with a profit margin of approximately 10 percent to 11 percent while after market revenues are expected to be $33m to $38m with a profit margin in the low 20 percent range. Finally, third quarter fiscal EPS are expected to be 30 cents to 34 cents per share.

Turning to the fiscal year ending March 2004, we expect total revenues of $670m to $700m, a slight increase in the lower end of the range from previous guidance, due mostly to improved fabrication activity. EPS before the facility consolidation and debt extinguishment items are expected to be $1.22 to $1.32 with a reduced high end in the range from previous guidance due primarily to higher operating expenses in the second quarter related to the reactivation of idle fleet units.

This EPS target performance would still provide earnings growth of 13 percent to 22 percent over fiscal 2003 results. Now after the charges related to the facility consolidation and debt refinancing, earnings are expected to be 90 cents to a dollar per share.

We continue to expect capital expenditures of $90m to $110m in the fiscal 2004 year, including maintenance capex for overhauls of approximately $30m. We expect an operating cash flow after capital expenditures will continue to be positive for the year. As we look out to the fourth quarter, revenues and EPS are expected to increase compared to third quarter levels.

I will now turn it back to Steve for our conclusion.

Thanks, Michael. As we predicted 90 days ago when we had this same discussion, Universal has continued to achieve slow, steady --

We are losing -- please stand by. Please continue to stand by for today’s conference. Once again, please continue to stand by for today’s conference. Please continue to hold. Please continue to stand by for the Universal Compression Conference. Thank you. Mr. Oatman has rejoined.

Well I guess we are back. Sorry about that, we had a phone fluctuation, we will call it. I was starting to tell you, as we predicted a quarter ago when we had this meeting, Universal continues to achieve slow steady improvement in the utilization and implement the business process improvements as we fine-tune our business model.

International operations are gaining momentum in Asia Pacific and growing steadily in Latin America. We continue to be optimistic, as there is nothing on the horizon to diminish our enthusiasm for the future. The increasing compression requirements in the [Tunnor] Gas Reservoirs, international expansion and outsourcing benefits continue to drive long-term growth opportunities for the company.

With this favorable outlook, our goal is to enhance financial returns for our stock holders and achieve continuing year over year growth in EPS. Operator, let’s take the questions at this point.

Thank you. (Operator instructions) Our first question comes from Michael Urban, Deutsche Bank Securities, Inc.

Good morning, guys. My question is on as you reactivate the older and smaller horsepower units in the domestic market, it is clear to me that there are some reactivation expenses which you’ve talked about, but is there something about the nature of those units, be it less efficiency or higher maintenance requirements or whatever that is going to drive or cause some margin issues as you continue to add them to the fleet, or return them to the fleet?

Mike, no, not really. That’s why we said we’d be back in the 64 range. What’s occurring is when we start up older and older assets we have more incidents at start up, some from lack of training of our personnel who haven’t run that type of equipment in a while, and some from just overhauling older equipment, you get surprises every now and then.

We had several of them in the last quarter, that brought the margins down for a quarter. All of those units are up and running fine at the moment and we don’t foresee it being an ongoing situation, so we will be back up with our normal margins here next quarter.

So there is nothing about the nature of those units that would cause that to be an issue or efficiency such that it’s going to be a challenge to move the margin higher going forward?

No. If there is anything that is a danger to margins or inefficiency of the unit we take care of it when we overhaul and modify it to go back to work.

Great, that’s all for me. Thanks.

Yves Siegel, your line is open.

Thank you, it’s Wachovia Capital Markets, I think. It used to be Securities. Hello, Steve, hello Michael. Jut a couple of questions. One is in terms of the sale of compression that came out of the fleet, can you just describe how much might still come out of the fleet? Because I noticed, if you look at the horsepower at the end of the quarter it’s down.

Yes, there is a combination of things that go on there, Yves. We’ve had some horsepower come out of the fleet through purchase option exercise, most notably the big one that Michael talked about, and then after that there is some fleet purging that continually goes on as we strip older inefficient units that are not worthy of repair and overhaul out of the fleet and sell them or break them down for components.

That’s why the fleet horsepower changed somewhat. Recall we are not adding much to the fleet these days, so any change seems to go to the negative for fleet size. As an ongoing business, we always have some purchase option opportunities. They usually are fairly small and disappear in the overall numbers, but this one was some fairly big equipment as such.

What about the 11,000 HP that you described in Mexico? Will that be a sell? And also, will you manage those assets?

I’m unclear on whether we’ll manage them yet, I’ll answer your second question first. We are still talking to [Conex] about that and I believe that is going to shore up below the line, in October in other income. That will be another reduction in the fleet, however we had put that in our original plans. We knew this would happen when this went out.

And then the last two are on the pricing. Could you just describe, in terms of the additional benefits that you discussed before Steve, how much of that is just older units getting re-priced versus what you are bidding new equipment for?

It’s probably about half and half on the 1 percent to 2 percent we had earlier in the year, and 1 percent to 2 percent now. We’ve gone back to, as you know, units that are out of their initial turn and brought them up closer, if not all the way, to market prices and then we have continued to raise the market level. We do that every quarter, we go back and comb through our fleet to see what high demand units we have out at rates that are too low, raise those rates and then we also raise the price book if we have a tight market.

There’s a price book across the board?

No. Price book opportunistically, thank you. We do it in specific horsepower categories and configuration of compressor categories where we see specific demand requirements that we would like to get a better return on what we have before we consider building anything new.

Okay. And then, are you still gaining market share domestically, number 1, and the last one is, Michael, can you review in terms of the growth capex, what is the nature of those expenditures?

Let me answer the market share issue. I can’t really speak to that at this point, because I don’t know where our major competitors are on their utilization, but I can say that we continue to see opportunities and add horsepower, some of it replacing competitors, some of it for new implications, so I guess we will find out here in a little while, if market share is shifting still.

But we’ve seen a relatively robust U.S. market. I’m kind of intrigued by how strong the market is right at this moment.

Yves, the growth capex that we talked about, which was about $6.5m, pretty well spread evenly, geographically, in terms of U.S. and international markets. It’s mainly going for larger horsepower units.

Okay. Well that’s great. Thanks so much.

Thank you. Brad Handler; Blaylock & Partners, Your line is open.

Thanks and good morning, guys. I guess maybe I can start by asking you to step through the guidance in a little more detail, maybe with an eye on the following. If I take the midpoint -- if I’m doing the math right, I guess, that’s the starting point -- if I take the midpoint of your guidance it suggests 32 cents for the December quarter, 39 cents in the March quarter. So again, if I’m doing the math right, yet I feel like you are saying look, your margin has popped back up to their normal historical levels and the December quarter. Why is the progression the way that the midpoint in your guidance describes it? Maybe you can step me through that a little bit.

Well let me give a try at that, and let me know if I answer your question or not, because I am not sure I captured all of it. But basically when you look at our core businesses in contract compression and aftermarket service I think you are going to continue to see some good, although moderate, increases in margins back in line with what we talked about. The thrux factor here for us tends to always be fabrication. So when you look at a ramp up with regard to what you have to back into for fourth quarter EPS, it’s a result of a good chunk of fabrication being in that fourth quarter and that’s part of the evidence that we’ve seen from the building backlog.

I think you have answered it, but let me just firm it up. So the fabrication revenue number, we might expect that to be higher, significantly higher in the March quarter versus the December quarter, comparable margins, that helps explain kind of a few pennies more in earnings in that quarter. Several pennies more. Okay.

Let me add a point there Brad, if I could. That doesn’t mean that we are going to be having less activity in the December quarter, that is really based upon shipment dates to customers. We may complete activity on December 31st and not ship it until January 5th and it becomes a next-quarter piece of activity, so there are timing on these big, lumpy jobs as to when they come out of the shop and when the customer takes them. Some of that is in the fourth quarter variance.

That’s fine. I’ll say it just so you can confirm it, but it sounds like what you are not saying to us is the contract compression margin, you would expect that to be a lot higher in the March quarter versus the December quarter because you are still making your way back to historical norms. Is that correct? You are not telling us that.

We are not telling you that, correct.

That’s great. I guess maybe one other question then I’ll get off. Last quarter we were talking about a lot of competition in the fabrication side and you were saying you hoped to get back to historical margins because of all the competitive pressures. Can you speak to the competitive environment now? Has demand just kind of soaked up a lot of that additional capacity and so you are able to very quickly get back to your historical margin?

No, the competition is still about the same. We’ve gotten back to historical margins through our operations and our fabrication groups are consolidating in two facilities, which needed to be done. On the demand side, our backlog is certainly increasing, but part of the reason is, is that we are targeting larger projects, more complex projects that have fewer competitors. There’s only a few companies that can do it, staying away from the day to day type activities that are highly competitive. And, we’ve gotten some nice international business which is usually a little bit better margins even though there is competition on the international side as well.

That’s fine, thanks very much.

Thank you. Joe Aguilera, your line is open. You may state your company name and ask your question.

Sure, Johnson Rice. Steve, a general question. I don’t know if you can help me out on this or not, but going back a few years, at what point of utilization domestically do you start to see it become a little bit easier to push price?

Historically the only time we were able to push price up until the last couple of years was when we were in the 90 percent plus range, or possibly on some given sizes when you were highly utilized on those sizes. But the market wasn’t very receptive to price increases and we have had much better success since we started putting in price increases, even at low utilizations, about nine months ago.

I think it’s an issue of getting the prices up to where they really should have been for quite a while, and it’s just a more disciplined market now, so we are able to do that.

Okay, so I guess maybe -- I am understanding what you are saying a little bit better is that you are just going to try and be opportunistic here, the market is getting better, if you can take advantage of that whether you are in the high 80s or wherever it may go, that’s what you’ll try to do?

Well to some extent that’s right. Now on the other side of the coin we are increasing mostly large horsepower that are highly utilized, that’s where the demand is. So as individual segments get more competitive, we can increase those segments, I guess is a better way to say it. All of this is basically coming because the market is a little more consolidated now, there are a lot fewer players out there trying to fight over every job, so it’s a more rational business.

Forgive me if you’ve mentioned this already, but could you comment on regions within the United States where activity is strong?

Sure, activity continues to be strong in the Rocky Mountains. We’ve seen some good levels of activity out of West Texas, we’ve seen some up in the Arkansas/Oklahoma area, so those areas have grown fairly nicely on contract compression. After market has done pretty well in some of the far-flung areas; Michigan, California have had good months on after-market, and kind of a combination in fabrication and sales, but again, we’ve had a bit of Rocky Mountain type activity.

Right. And one question on your guidance. For the next quarter, if I am understanding correctly, I missed the range that you gave for EPS on the December quarter.

It’s 30 cents to 34 cents.

Okay, but you are also I guess indicating that you expect margins to improve. It seems pretty hard for you to not have a sequential improvement in earnings.

Well I would caution you there, and again this is kind of back to the question I answered earlier about fabrication. In the second quarter we tended to have a pretty good fabrication quarter both in terms of revenues and margins, topping up that $4m extra that we got we thought it was going to be a contract compression unit and it ended up being fabrication.

So I think it is going to be difficult to replicate the fabrication levels we did in the second quarter again in the third quarter, so we see that ticking down a little bit.

Right.

Well, we’ve got to make it up some place else.

That makes sense. And just one final question, SG&A guidance for the next couple of quarters?

We continue to target that we should be in the $16.5m or $17m quarter range for SG&A. A little higher than that this quarter, we were a little lower last quarter.

Okay. Thank you very much.

Thank you. Janice Rego, your line is open. Please state your company name and you may ask your question.

Hi, it’s Wes Maat with Silicone Global Partners. Good morning. Two questions, the first of which is for Michael. Any thoughts from what you can see thus far about the foreign currency impact in the December quarter?

We don’t have a real good read on that yet. I mean, with regard to Fx for us it is mainly an accounting issue, it’s not a real economic impact, it mainly results from inter-company balances. We are doing our best in places like Argentina where we have exposure to, basically we pay inter-company amounts and lessen that Fx risk. At this point we don’t have any guidance whether it is going to be gain or loss either way.

Secondly, the question is more conceptual. In terms of contract compression pricing in the North American market, it’s been done opportunistically by region, by category of horsepower, meaning higher horsepower. The question that I have for you is, what is it going to take to get the smaller to mid-size horsepower units back to more historic pricing levels? Do we need, for example, to see the rig count move higher to move production levels higher? Do we need to see more consolidation among the players in those regions or categories? Any thoughts on this at all?

First of all, I don’t think the prices on small horsepower have declined any, I just don’t think there’s been an opportunity to increase them very much, it’s a more competitive marketplace there on the small horsepower side. Certainly, any help for small producers, who are the folks who use the smaller compressors for the most part would be helpful. At these gas prices, most people however are compressing whatever they can to put into the grid. So we will need some, I guess as the current production continues to decline we will get into smaller compressors on individual wells and get our wellhead compression segment back up to a higher utilization level, but that is kind of the solution there. There are proposals in the energy bill which may help, there are some things that may help in that area, but I think it’s just a continued depletion of small wells, individual compression.

Some if it’s been offset by big gathering systems which have centralized fields that used to have some small wellheads in it.

The last question relates to your thoughts about expanding into the pipeline segment. You had broached that subject, perhaps this time last year, maybe a little bit earlier. Any update?

No, when I did broach it a year ago I said it was going to take two or three years to make any noticeable inroads there. However, we continue to place more sold equipment in pipeline service and build a bridge relationship with the pipeline companies. I will say that the aftermarket companies that we brought into the fold a couple of years ago to target that market have seen success in doing continued maintenance work and repair work for the pipeline companies.

So the activity level is building. It’s not enough to be noticeable or for us to try to give you some kind of update at this point as to how much we’ve grown in that segment, but we are still moving down the path. I’m pleased with what we’ve done so far. It’s definitely helping our fabrication group, there’s no doubt about that.

Thank you very much.

Thank you. Justin Kinsey, your line is open. Please state your company name and you may ask your question.

Simmons and Co. Good morning, guys. Regarding the idle capacity that’s being brought back to work, is that going to start working in Q3 or when do you expect that to start?

Well, some of it’s started working in Q2, some of its coming online in Q3, and some will be delivered in Q4. We have an active backlog of units to be reconditioned and put back to work, so it’s really spread out depending on a combination of how soon we can build it or reconfigure it, I should say and how soon the customer wants it.

Right. Can you explain the reasoning for bringing that idle capacity back to work when utilization levels really haven’t seen much improvement and the pricing environment is still fairly tight?

Well, let me back up. The utilization improvement from 84 percent and 87 percent is big in this industry, so I think utilization has picked up nicely. Plus, large horsepower is utilized in the low to mid-90’s as we said, that’s 1,000 horsepower and up, so we are seeing good utilization there and we’ve had the pricing power in that price range to bring returns up very, very nicely.

So we will continue to dig through equipment and take idle assets that are not generating any returns today, put a little bit of incremental capital into them and generate a nice return ongoing.

Okay. Do you expect, do you have an idea of how much of that capacity you plan on eventually moving to international markets, or do you plan on keeping that pretty much in the domestic market?

Well, the way we are approaching it is that every job, no matter where it is in the world, we first go through out existing fleet to see what would fit that project. So we’re taking reconditioned units and sending them internationally and U.S. and only if we do not have a serviceable or repairable or unit that fits, will we consider capex for new equipment. So that’s the methodology we’re using, it doesn’t matter where it goes.

Okay. And you said you expect the domestic margins to return back to normal levels during the second half, do we expect that improvement or that return back immediately next quarter or will it be a modest increase?

No, we should see it in Q3. There were some one-time charges in Q2 as we started up older stuff that I don’t think we are going to see again.

Okay, and finally, regarding Mexico you are seeing some additional projects there. Do you have an idea of where you think horsepower in that country will eventually grow to?

Couldn’t tell you -- define eventually -- but… let me answer it this way. That Mexico is one of our most active markets for bidding in projects. There’s a continual stream of projects coming from [Pemex] and we are getting our share and the competition is getting their share.

We had several contracts come to finality in this year which lowered our horsepower in Mexico. We had the purchase option exercise, which took 11,000 horsepower out of Mexico. Now we have projects that will begin putting horsepower back into Mexico in the fourth quarter. So we are beginning to build our horsepower base back up there, but it is an area, and I can tell you how much [Pemex] is going to put out for bid in the next several years, but they are outsourcing almost everything and have a continual flow of projects. So it’s hard to say where we will end up, but it will certainly be a growth area for us.

Thank you, guys.

Thank you. Yves Siegel, your line is open.

Steven, I apologize, but in terms of the reactivation of the old units and the costs that you incurred this quarter, I hate to beat a dead horse, but could you just explain it one more time for me in terms of, what is the normal -- wouldn’t you normally have costs associated with bringing idle units back on? Was it the fact that as you said, you had utilization go from 84 to 87 percent, that it was just an unusually large number? Or is there something else going on that I just missed?

It was a combination of things, Yves. First of all, we’re bringing in almost all older equipment at this point in time. We are building very little. As we are bringing that on, there is always a cost for it, but last quarter we had some pretty significant growth so we put a lot of older equipment out.

When you put that equipment out, you need to add things, you need to modify and you need to train your employees on how to run some of that equipment that some of the newer guys haven’t seen for a while. So there is a learning curve you go through. We had some problems on startup with some equipment that didn’t perform as it should and we had to do some work on it in the field, so all of those charges and issues come together.

It will eliminate itself somewhat because we are running out of older equipment. If you compare us to a couple of years ago, most of what we were putting to work was new equipment, and new equipment, of course is very easy to start up and to run. So it was just some quarterly surprises based on the volume of big, older equipment that we put out to work. Does that come closer to answering your question?

yes it does, but it seems to me that as you bring the older equipment back, you would still incur some costs associated with that.

You know, most of these are from taking equipment that hasn’t run for quite some time, doing a rebuild, getting it tuned out in the field, there is lots of work in the field after you send an overhauled piece out to get it to run properly for the customer to meet environmental standards. And once you’ve got all that done you’ve got a machine that’s going to be good to run for the next seven to ten years with normal maintenance. So we’re going through kind of a backlog of all those old units that we are spending some extra money on and it’s in the income statement.

I think I’ve got it now. Then, just a follow up. In terms of the outsourcing trend, is that something that continues in terms of steady creep in outsourcing, or have we sort of seen a plateau there?

You know, I think it’s like it has been Yves that for the past several years we’ve seen an increase in outsourcing and what we’re seeing is new fields, new areas, reconfiguration of horsepower tends to go outsourcing, replacement of older assets that are retired, quite often is outsourced. And then some companies like to have a balance of what they outsource and what they own, so there is still a fairly sizeable segment that takes equipment and purchases it.

But nonetheless, outsourcing continues to grow in our perspective and certainly our fleet continues to improve utilization, you’ve got lots of market for it, both here and international. I’d say international outsourcing is definitely growing, it just takes longer for them to understand any new market, the entire concept and why it makes sense, so it takes time to get it up and running.

Okay. And the last question is just perception. In terms of putting in place a much stronger capital discipline, from your perception has there been business that you’ve turned away because it just didn’t meet hurdles, or have you been able to come up with solutions and capture those business opportunities without necessarily having to spend the capital or a combination of both of those things?

Well it’s a combination of both. First I’ll say that with our increased financial returns from our bidding projects, we decided what return is appropriate for the project and we don’t always get them, so one would say that we would have lost some business because we raised our return. That may or may not have been the reason, but there are jobs we don’t get.

On the other side, we have continued this effort to take idle assets and put a little bit of cash into the idle assets compared to what it would have cost to build a new one, and put them to work at excellent returns, but spend less capital on them and get the same types of results or better. So it’s a combination of taking the older assets and bidding better returns on new assets. And as we run out of older assets, we will be building some new, bigger horsepower assets for the U.S. and for international markets and will continue to move the returns up.

Yves Siegel That’s great. Thank you.

Thank you. Geoff Kieburtz; Salomon Smith Barney.

Good morning. One question, you talked about consolidating your North American operations, Steve. Do you have any sort of idea of what kind of impact that may have on margins as you start to realize the benefits?

Well what we hope it is going to do is really solidify the fabrication margins by consolidating the two pieces together and having all of our fabrication kind of in one big happy family between Houston and Calgary and solidify those margins at a solid 10 percent, 12 percent quarter-in, quarter-out as we have the same estimating and engineering procedures and fabrication procedures in both locations.

So from a fabrication perspective, it’s a stability issue. On contract repression, I hope to see more success with contract repression in Canada than we have in using some of our U.S. expertise and customer contacts to do that, and then on aftermarket service, that’s been a big portion of our business in Canada, but I don’t know that we have shared best practices very well between the U.S. market and the Canadian market, and yet at some of the same customers and essentially the same type of equipment, so I am hoping we can get some revenue pick up there without much increase in fixed costs, and maintain the margins.

So what we are looking for is a gain in Canada/U.S. revenue, maintain or improve margins and get more consistency and standardization between the two. And then of course some back office consolidation to help us better manage the business efficiently.

Enough on the latter two. Impact to SG&A?

Won’t dramatically.

Okay. So it sounds like, apart from solidifying the fabrication margins or stabilizing them, it’s really more of a revenue sort of importing U.S. practices into the Canadian contract market and maybe importing some Canadian after-market practices into the U.S. market.

To some extent. It’s also a customer service issue that we have so many cross-border customers now that need to be treated similarly and with a cohesive marketing plan, both sides of the border, that I think the cooperation of the two will help us significantly.

And don’t forget the focus on contract compression, I still believe there is a contract compression market there.

Okay. The other question had to do with the capital expenditures, I may have missed something, but I thought out of the $21m, $11m was identified as growth and $6.5m as capex, and I didn’t catch the other part.

I’m glad you came back to it, because actually I think in the Q&A segment I misspoke and got those transposed. What you said was right. It was $21m, $11m in growth, about $6.3m in maintenance and then we had about another $3m or $3.5m that was for things such as equipment in the fab shops and trucks for the service component part of the business.

All in infrastructure.

Yes.

Okay. Now if I’m correct you’ve spent about $37m in capex through the first half, and you are looking for a fairly significant acceleration in that pace in the second half. Can you give us any idea of what the mix is going to be along those three categories?

We’ll start by telling you what looks like is going to happen for the next two quarters. As we’ve been putting idle assets to work, we’ve been gobbling up our available equipment pretty rapidly. We’re down to a relatively small number of bigger horsepower units and in the face of significant demand for additional compression that we don’t have, we are going to begin building for our customer needs, new equipment that make the hurdle rates.

We already have some significant opportunities in that area. So capex will increase for the next two quarters. Will it be above our cash regenerate? No. Will it be above our guidance for the year? No. It will just bring us back up to what we said we would spend, and it is somewhat of a shift from international back to domestic.

The components of that, our maintenance capex we said at the beginning of the year will run about $30m for the year, so you take the rest of that and you know what we’ve done so far, there will be a declining amount of overhaul and refabrication and an increase in the amount of new construction. I don’t have the breakdown exactly, but that’s the trend that you will see for the next two quarters.

Okay. So this sounds like maybe a little bit more on the growth, but more importantly it is going to be building new large horsepower units.

That’s correct.

That is driving that.

That’s correct.

With, I think you said a greater focus on the U.S. market.

Correct also.

Very good, that’s all I needed. Thank you.

Thank you. Brad Handler; Blaylock & Partners.

I guess I am sort of beating the horse again, but I am curious. I am trying to integrate the capex requirements on the overhauls with bringing the old equipment back to work. Can you split out the $6m, $6.3m into those categories? Is that possible? Or relevant?

Well the overhauls are different than bringing the old equipment back to work. Overhaul is taking a unit that has been in our fleet for a period of time, it needs a complete overhaul to rejuvenate it, we do it about every seven years. That’s the overhaul category Mike talked about.

The combination of growth capex is partially new units and partially refabrication where we take an old compressor and engine combination and we almost completely repackage it. We redesign it for a new application and we add new components to it, we update it and that’s the other half of our growth capex number.

So it’s three things in capex.

Brad, to give you the numbers breakdown, the reconfiguring is included in growth capex, so of the $11m about $8m was basically new units and $3m was reconfiguring, repackaging.

I guess I am glad I asked, that helps. Okay. So as you step up, so your spot market in the U.S., you said the spot utilization was 86 percent, so has that -- that’s closer to 90 percent. I guess I hear you saying that you don’t have very much idle equipment left. Help me kind of integrate. You don’t have that much old equipment left that you can reconfigure, you are going to need to build new ones. Is that just because what is idle is too small?

Yes, take that segment. Our overall utilization in the U.S. is about 86 percent. If you looked at 1,000 HP and up it’s in the mid-90’s. So when you are in the mid-90’s, you are running out of equipment.

That makes sense.

That’s exactly where we are and it is interesting that anything we have released seems to be going right back to work at higher rates as soon as we have it released, so we are confident that demand is sucking up everything that we can come up with. That’s why we are beginning to look at capex again.

Sure, sure. And again, sorry to everybody on the line, sorry to go through it again, but hence your confidence that the margins are -- you are not going to see any kind of surprises like you did this quarter because you are basically buying new units?

Well yes, but those new units aren’t going to show up until the end of the fourth quarter, probably, if we start today.

Okay.

So I can’t say the conversion to new units is going to cause that, I think the units that we had issues with last month are now out of the equation, they are running fine and we don’t anticipate having that again this quarter.

One other non-related question. I understand that you were planning on or considering integrating a new supplier for parts, maybe it’s [Endine]. Is that something that is material in the quarter or coming up? Is that something that is meaningful, and how is that going if that’s happening?

Well, let me explain that. Endine is a supplier of parts from certain types of equipment, and we have utilized Endine at various levels for the past 25 years. They are a quality supplier of after-market components, and we have increased our relationship with Endine and they are ramping up to supply us more components in Canada, a reverse alliance arrangement. We are doing much more work with Endine now so they are providing us more equipment.

As far as integration, they are a vendor to us and they just replace other vendors. We feel that they are a more reliable and more cost-effective source of components for our fleet.

Is it impacting enough to actually potentially see something in the margins over the next few quarters?

No. It’s really a strength of supply chain on that side, there is a little bit of advantage on price, but they are, to put it simply, they are an easier supplier to do business with.

Fair enough. That’s fine, I’ve taken up enough time. Thanks.

Operator, we have time for one more question.

Thank you. Geoff Kieburtz; Salomon Smith Barney.

Just coming back to the earnings guidance, specifically in the third quarter, I take your point in regard to the uncertainty about the fabrication business, but just so I am clear, here. It seems to me that if we just assumed a flat contract revenue in the third quarter and the rebound in margins and we assume that you maintain the 11 percent margins on fabrication, to have a sequential decline you’d have to have basically fabrication revenues fall by 50 percent sequentially. Is that really possible?

I don’t think that that math works out exactly the way I have it. If you look at within almost $50m of fabrication in the second quarter, we provided guidance for $40m to $45m which in general is going to be pretty good, because that stuff is basically in the backlog, so we are going to see some come down with regard to revenues, and that is just going to be a little bit more difficult to make out.

I may have mispunched the calculator, but it just seemed like there is a possibility of a sequential decline in earnings, seemed to be at least pessimistic.

We have reported in prior quarters that occasionally at the end of the quarter we end up with fabrication projects slipping to future quarters, and that can always happen and hits your fabrication revenues as well.

I think we’ll continue to see contract compression do well and sequentially continue to up tick. We have the same expectations for after market service, but fabrication is just going to be something that tends to cycle a little bit more, certainly on the revenue side.

Well maybe I will just walk through my math offline.

Good enough.

Thanks very much.

Thank you. I do show that as our final question for today. I would now like to turn the call back over to our speakers for final comments.

I don’t have any final comments other than I would like to point out that the company as we talked about today is sitting with some record backlogs at this point in time; our fabrication backlog is over $100m, our utilization is up, our backlog of contract compression projects is up, our international activity is pretty active. So things went well for Universal and I think we will see that in the two quarters going forward and I look forward to talking to you in 90 days. Thank you, bye, bye.

That concludes today’s conference call. Thank you for participating and you may disconnect at this time.