Archrock Inc (AROC) 2006 Q3 法說會逐字稿

Welcome to Universal Compression's earnings conference call. At this time all participants are in a listen only mode. [OPERATOR INSTRUCTIONS] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Thank you. Now I will turn the meeting over to Mr. David Oatman, Universal Compression's Vice President of Investor Relations. Sir, you may begin.

Thank you. Good morning everyone, and welcome to the Universal Compression Holdings earnings conference call for the three months ended September 30, 2006.

We prepared a summary page of financial and statistical data about the quarter in our earnings release, which is posted to our universalcompression.com website in the investor information section for Universal Compression Holdings.

As we have in the past, during this call we will discuss some non-GAAP measures in reviewing our performance, such as EBITDA as adjusted and gross margin. You will find reconciliation of these measures to GAAP measures in the summary page of the earnings release.

As a reminder, in addition to providing statements of historical facts, today's conference call will include certain comments that 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.

These forward-looking statements are affected by, among other things, the risks factors and forward-looking statements described in the company's transition report on Form 10K for the nine months ended December 31, 2005, and those set forth from time to time in the company's filings with the SEC, which are available through the company's website and through the SEC's Edgar system website at www.sec.gov.

The company expressly disclaims any intention or obligation to revise or update any forward-looking statements whether as a result of new information, future events, or otherwise. I will now turn the call over to Mr. Steve Snider, Universal's Chairman, President and Chief Executive Officer.

Thanks David, and good morning everyone. Welcome to our third quarter 2006 earnings conference call. Joining me today is Michael Anderson, the CFO of Universal; as well as Daniel Schlanger, the CFO of our new public entity, Universal Compression Partners.

Today we'll discuss what we believe are exciting and positive developments in the implementation of strategic initiatives at our company, and their expected future impact on the company. We will, of course, also provide a summary of recent operating highlights and financial results.

We're very excited that the initial public offering of our subsidiary, Universal Compression Partners LP, was successfully complete last month. The offering was well received. It was significantly oversubscribed by investors during the IPO marketing period, and was priced at $21 per unit, the high end of the anticipated pricing range.

Universal Compression Partners is a [masted] limited partnership and its units trade on the NASDAQ global market under the symbol UCLP, which is how we will refer to this new entity.

Since the IPO the unit price of UCLP has increased nicely, and yesterday closed at a price of $24.61 per unit, equating to an expected yield of a little under 5.75%. Universal has a 51% equity ownership position in UCLP, and due in part to that ownership, we've seen the positive effects of UCLP on Universal stock, as it has performed quite well since the announcement of the UCLP road show in the early part of October.

It is important to note that we will continue to consolidate UCLP into our financial and operational results, so we will continue to discuss our results on a consolidated basis, unless otherwise noted. Since the UCLP public offering did not close until October, none of our historical results for the third quarter are affected by that transaction.

In another corporate development, we announced this morning that Universal's board of directors has authorized a stock repurchase program of up to $200 million of Universal Compression Holdings common stock. This authorization is open for a two year period, expiring November 2008.

Universal intends to make opportunistic purchases from time to time, as market conditions warrant, in open market purchases and/or in other transactions.

Let's go to the financial results for the quarter now. We're pleased with our overall financial performance in the third quarter. We reported record net income of $25 million or $0.80 per diluted share. Included in these results is approximately $0.07 per share related to employee benefit programs. Without this gain, earnings per diluted share would have been $0.73. Reflecting continued strong demand in all of our segments, revenue was a record $247 million in the third quarter.

Our overall strong financial results in the third quarter reflect continued favorable business conditions in each of our contract compression, fabrication, and after market services segments. However, our continued growth resulted in a few unanticipated consequences.

Due to high activity levels in our fabrication facilities during the quarter, we experienced some unexpected delays in the production of new units for third party sales, as well as for our contract compression fleet, delaying revenue recognition in both the contract compression and fabrication segments.

We also incurred continuing expenses related to our new enterprise resource planning system, and are incurring incremental costs related to UCLP and the additional overhead associated with a separate public entity and business. We believe both of these initiatives are important steps in driving our long term growth strategy.

Now I'll provide operating highlights for each of our business segments. Our domestic contract compression segment continues to record solid financial results. Domestic contract compression gross margin dollars in the third quarter increased 27% compared to the prior year period, but were relatively unchanged on a sequential basis.

In the third quarter our completion rate of new compressor units for our fleet was lower than expected, and as a result, we saw only modest growth in working horsepower from June 30 to September 30. With the scheduled commencement of operation of several new units, we expect an increased contribution from our domestic contract compression segment in the fourth quarter.

Our domestic fleet passed an impressive milestone during the course of the third quarter, surpassing 2 million total horsepower. To put that in perspective, our domestic fleet was under 600,000 horsepower when we went public in 2000, so we have more than tripled the size of our fleet over the past six years. At September 30 our domestic fleet totaled 2,017,000 horsepower, with a spot utilization of 89.4%. Domestic utilization is currently 88.8%.

In the third quarter of 2006 our domestic average operating horsepower increased 2.3% compared to the prior year period. Although we've put all new builds, consisting entirely of large horsepower units, straight to work, we've been a bit slower than we expected in putting some of the smaller and mid range horsepower idle units back to work at higher rates, since some of these units have returned a reaction to our April 1 price increase.

Part of our issue has been a backup in getting units overhauled in our field shops. We've continued to be pleased with the success of our price increases in recent years, and our overall financial returns in domestic contract compression. We are now shifting our focus on achieving a better balance between overall operating fleet growth and price increases in the future.

I believe we're making progress on that front, and expect operating horsepower to increase on a sequential basis in the fourth quarter of 2006. Still, with the moderation of key operating costs, such as vehicle fuel, we do not currently anticipate anything more than modest price increases for 2007. These expectations could, of course, change should we experience cost increases.

As highlighted earlier, UCLP was formed by Universal in October to provide natural gas contract compression services to customers throughout the United States. In conjunction with UCLP's initial public offering, Universal contributed to UCLP contracts with nine customers and the associated fleet of approximately 330,000 horsepower, or about 17% of Universal Compression's domestic contract compression fleet.

In exchange for those contributions, UCLP assumed debt from Universal while Universal received a 51% ownership interest, including the general partner interest, in UCLP.

We do intend for UCLP to be the primary growth vehicle for our domestic contract compression business, as we believe UCLP will continue to have a lower cost of capital than Universal, we intend to offer to UCLP the opportunity to purchase the remaining 1.7 million horsepower of our domestic contract compression business over time, providing both significant growth opportunities for UCLP, and we believe, substantial value to UCO.

Additionally we believe UCLP's lower cost of capital will give us the opportunity to accelerate the overall growth of the domestic contract compression business through both continued organic fleet growth and potentially through opportunistic acquisitions of customer owned equipment as well as other contract compression service providers.

Our international contract compression segment had another strong quarter. as compared to the prior year period, our average working international horsepower increased by 4.4%, while our revenue increased by 16.6%, helped by higher rates negotiated on contract extensions in Latin America.

With new activity in Mexico and Canada, our international contract compression gross margin dollars in the third quarter increased 2.6% on a sequential basis, and 18.7% compared to the prior year period. Our international fleet totaled 599,000 horsepower at September 30, and international utilization was 91.2% at September 30, and is now 90.8%.

Our backlog of new international projects now totals approximately 45,000 horsepower, as about 14,000 horsepower in Brazil is now generating revenue. For the fourth quarter we have new projects scheduled to commence operations in Brazil, Mexico and Indonesia, while another customer in Latin America, as we had expected, exercised an option to purchase roughly 25,000 horsepower.

In addition we have several projects scheduled to commence generating revenue in 2007. Inquiry and bid activity for new international projects remains strong.

Summarizing our total operating statistics, our overall spot contract compression utilization, including both international and domestic, was 89.8% at September 30, and is currently 89.2%.

We still expect to fabricate about 200,000 horsepower in new domestic and international contract compression units during 2006; although our lower production rate in the fabrication shops may mean that the completion of some of these units could slip into early 2007. On a preliminary basis, we expect new domestic fleet build activity in 2007 to be similar to 2006.

Moving to our fabrication segment, our compressor fabrication backlog was $114 million at September 30, 2005, $275 million at June 30 of this year, and $268 million in the September quarter end. Our fabrication backlog is currently $280 million, and is about ¾ domestic and ¼ international in its composition. Our relatively high level of backlog reflects continuing strong overall demand in customer commitments well into the second half of 2007.

As mentioned earlier, our fabrication revenue in the third quarter of 2006 was somewhat lower than expected, due to delays in our production process. These delays were due to longer than expected production time required on certain units for sale to third parties, stemming, in part, from a tight market for skilled labor in Houston, and the resulting increased employee turnover in our Houston shop.

These issues, along with the higher labor costs, are expected to reduce somewhat the fabrication gross margin percentages in the fourth quarter 2006.

Our after market service segment performed well in the third quarter. In the United States we experienced a nice increase in the volume of large repair orders, and an increase in volume in a number of our geographic locations.

We have also increased pricing in the AMS segment for service work. Within AMS we have seen many of the same labor cost pressures over the past year, as we've seen in the contract compression segment. But we had not been as aggressive in passing cost increases on to AMS customers. We've now begun catching up in many of our service areas.

Now I'll turn the call over to Michael for more detail on our financial returns, and guidance. Michael?

All right, thanks a lot Steve, and good morning everyone. I'm sure that you've all reviewed our press release that we issued earlier this morning. But in my summary of financial results for the three months ended September 30, 2006, the typical primary comparison period will be the three months that ended in June 30, 2006, as well as the guidance that we provided in August, and for this quarter the modified guidance and operations update that we issued back in the early part of October.

Total revenue for the quarter was $247 million, that's a 13% increase sequentially; it's also a 36% increase on a year-over-year basis. Looking at our domestic contract compression business

Looking at our domestic contract compression business, revenue was $101 million in the third quarter. Now, that's on the lower end of our guidance, due largely to delays that Steve spoke about in building new units. Revenue was relatively unchanged compared to the second quarter. It is, however, a still strong 23% increase, compared to the year-ago quarter.

Gross margin percentage in the domestic segment was 65.5%. Now, before taking into account the benefit related to employee benefit programs, the margin was around 64.5% in the third quarter. That is somewhat lower than the August guidance, due to continuing operating cost pressures primarily in labor. The 64.5% was in line with our October guidance update.

Our international contract compression revenue was $36 million in the third quarter. That again was in line with our guidance. This revenue level, it's an increase of 4% sequentially, and it's also up 17% on a year-over-year basis. International contract compression gross margin was 75% in the September quarter. That too was in line with our guidance.

Inter fabrication operations revenue was $58 million in the third quarter. That was somewhat below the August guidance numbers. And as noted earlier, our revenue was a bit lower than expected due to some delays in the completion of certain projects and overall heavy activity levels on the fabrication floor. I would like to remind everyone that we are on the completed contract basis of accounting, so slipping a job simply to October 1, loses all the revenue for that quarter for that specific unit.

Now our fabrication gross margin percentage was very strong. It's 17% in the third quarter. That was a little bit higher than our guidance range. Then, in comparison, we recorded fabrication margins of 12% in the June quarter as well as 12% in the year-ago period. Our fabrication gross margin percentage increased due to improved pricing available in today's favorable market as well as good project execution by our fabrication team.

Within the after market services business segment, third quarter revenue was $52 million. That was higher than the August guidance range and it was also up 19% sequentially and it's up 30% compared to the prior year period. After market services gross margin percentage was 20.5%, compared to 17% in the June quarter and 20% in the year-ago period.

SG&A expense increased from $29.5 million in the June quarter to $30.1 million in the September. SG&A expenses were a bit higher due to ERP related expenses as well as the additional overhead that we are incurring due to UCLP and the additional accounting tax and other services that it will require.

EBITDA, as adjusted, was $84 million in the third quarter. That's an increase of 12% on a sequential basis and it's an increase of 27% on a year-over-year basis. Interest expense was $15.2 million in the third quarter. That compares to $14.6 million in the June quarter. Looking forward, we expect that interest expense will be in the $14 million range in the fourth quarter of 2006, due to the debt reduction associated with the UCLP offering.

Now this number, of course, does not include any cost related to our refinancing activities that were completed in October and this number also does not account for any additional interest that might be incurred from stock repurchases pursuant to the newly announced stock repurchase program.

Regarding income tax expenses, we had a 34% effective rate in the third quarter. We do expect our tax rate to be a bit higher going forward, closer to the 35% level in the fourth quarter.

We generated record diluted earnings per share of $0.80 in the third quarter. Now, excluding the benefit from the employee benefit programs of $0.07, earnings per share would've been $0.73 per diluted share, which does represent an increase of 4% from the June quarter and 35% over the prior year period results.

Net capital expenditures were $53 million in the third quarter, and that compares to $55 million that we spent in the June quarter. The capital expenditure breakdown during the third quarter included $35 million in growth Cap Ex, $16 million in maintenance overhauls and $8 million in other expenditures, including trucks, equipment and facilities.

As expected, growth capital spending in the third quarter was weighted towards domestic markets. About 80% was domestic, 20% international and growth capital also included about $2 million for the repackaging of existing units.

Debt to capitalization declined slightly to 49.6% on September 30th. Total debt, including capital lease obligation, was $914 million on September 30th. That was up about $15 million during the quarter. Our debt-to-trailing-12-months EBITDA ratio declined to just below 3 times at September 30th from 3.5 times that we had at the beginning of the year. We consolidated debt reductions as a result of the IPO. Our debt-to- trailing-EBITDA ratio, on a pro forma basis, is currently about 2.5 to one.

Now we do expect to file our 10Q for the three months ended September 30th, 2006, sometime tomorrow.

Let me now shift over and summarize our guidance for the fourth quarter ending December 31st, 2006 and also for the full year 2006. Guidance for the fourth quarter includes the impact of UCLP, which we do expect will be mildly dilutive to UCO on an ongoing basis. Now most of the dilution is related to the additional public company expenses associated with UCLP.

Now at this point, I would like to note that we believe EBITDA should become a more important metric going forward in forecasting and analyzing the Universal business.

A potentially growing portion of our business will be encompassed within UCLP. Now, this is an entity whose valuation is based almost entirely on cash flow. Now as such, we believe it will be more meaningful to evaluate UCO on more of a cash flow basis as well. Now, I believe this point is actually highlighted by the value uplift that we've seen in UCO stock from the IPO transaction, despite the fact that the transaction is mildly dilutive to UCO on an EPS basis.

Let's get back to the guidance for the fourth quarter. Our guidance does not include expenses associated with the write off of deferred financing fees associated with the October refinancing activity. Those refinancing costs, however, should total about $1 million or about $0.02 per share during the quarter.

Looking at revenue now, for the fourth quarter we expect revenue to be between $240 million and $250 million. This would represent a 7% to 11% increase over the prior year period. Domestic contract compression revenue is expected to be $103 million to $104 million in the fourth quarter. And that would give the domestic contract compression business about a 20% year-over-year growth rate.

International contract compression revenue is expected to increase to about $38 million in the fourth quarter. That would give international contract compression about a 14% year-over-year growth rate.

Gross margin percentages are expected to be around 64% to 65% domestic, and in the low to mid-70% area for the international contract compression segment.

Looking at fabrication now, fabrication revenue is expected to be between $55 million and $60 million for the fourth quarter, with a gross margin percentage around 12%. After market service revenue is expected to be in the $44 million to $48 million range, with a gross margin of around 20%.

And finally, that brings us to diluted earnings per share, which is expected to be $0.70 to $0.74 in the fourth quarter. Now, this earnings per share guidance would represent an increase of 17% to 23% compared to the year-ago period. And again, let me remind you the guidance number does not include the $0.02, roughly, for the debt refinancing activity that we have incurred in the fourth quarter.

Now moving to guidance for the full calendar year 2006, we now expect the revenues of $935 million to $945 million. That would represent an increase of about 16% over calendar year 2005 revenues. Our previous revenue guidance was $950 million to $970 million for 2006. The variance here is primarily in the fabrication segment.

We expect earnings per diluted share for 2006 to be $2.88 to $2.92. Now this full year guidance, again, excludes the fourth quarter debt refinancing activity but it does include the diluted impact of UCLP. Our new guidance represents an increase of about 35% over adjusted earnings per share of $2.15 that we had in calendar 2005.

We now expect that net capital expenditures, after sales of PP&E, that debt will total approximately $210 million for 2006. Our prior guidance was $210 million to $240 million. New growth capital for 2006 is expected to be split about two-thirds domestic and one-third international.

Now as you all likely know, in connection with the UCLP IPO on October 20th, 2006, Universal entered into a new senior secured credit agreement. The new credit facility consists of a five-year $500 million revolving credit facility, and we currently have an approximately $320 million advance under that facility. So, that brings total debt at the UCI level, which excludes UCLP debt, the total is about $680 million today.

Now, we've also got $125 million at the UCLP level because on October 20th, on that same date, UCLP entered into its own senior secured credit agreement. That credit facility consists of a five-year $225 million revolving credit facility and $125 million of it was drawn at closing. UCLP has fixed all $125 million of its debt for five years at an all-in interest rate, including the credit spread, of 6.53%.

Now with our stable base of recurring cash flow, we do believe that we are somewhat under leveraged after the UCLP transaction with pro forma debt to EBITDA, on a consolidated basis, of about two-and-a-half times.

Now Steve mentioned earlier today, we announced a $200 million stock repurchase program, which extends until November, 2008. Universal intends to make purchases, from time to time, as market conditions warrant, providing us with the flexibility to make opportunistic purchases of Universal stock.

Now although we now have a stock repurchase program in place at Universal, it's important to note that we remain committed first to seek to reinvest capital back into the business for future growth. We do remain optimistic about both the short-term and long-term prospects for the gas compression business. We believe we are well positioned domestically, with our newly created MLP structure, and have opportunities inherent with being a first mover in the segment.

We also believe there are favorable fundamentals internationally and we will continue to deploy both people and capital in pursuit of these opportunities.

At this point, we've concluded our prepared remarks for the conference call and we would now like to open up the call for questions.

[OPERATOR INSTRUCTIONS]

Our first question comes from Jim [Wicklund], with Bank of America Securities. You may ask your question, sir.

Mr. Wicklund, your line is open. Please check your mute button.

Mr. Wicklund?

I'll go to the next question. Geoff Kieburtz, with Citigroup, your line is open.

Thanks, good morning. Can you tell us anything more about the likely pace at which assets will move between the UCO and UCLP?

Geoff, the short answer to that is no. You know, we will certainly look at market conditions and how the respective entities are trading and other activity. Our intention is certainly that we will move it over time but we have not provided any guidance with regard to what kind of timing that would be.

Can you describe sort of what the parameters are that you're looking at? What are the conditions? I mean, at the extreme, why wouldn't you just move it all at once?

I think that the right way to grow the business over time is through drop downs over some kind of measured basis. The easy answer to why we wouldn't do it all at once is the fact that we have not converted all of our contracts to the MLP format. So once we do that I still think that a better strategy is to move those down over time. It will depend upon what the value of the units is. It will depend upon the needs of Universal, it will depend on what other activity that might be ongoing with regard to other growth opportunities that UCLP has; whether it be other acquisitions, whether it be purchases of customer owned equipment, all those things are going to factor into the mix.

And it will also depend upon what the appetite for the capital markets is. Although the MLP market is relatively big, going out and raising huge chunks of equity are not things that a lot of MLPs have actually done. So I think that needs to be on a measured basis as well.

And where do you stand today in terms of the contract conversions?

We've got over half of our domestic contract compression business converted to the new form of contract.

Okay so no update since the S1?

No update.

Okay. And Steve, you talked about bringing more focus to the balance between the fleet size and pricing. Could you elaborate a little bit on what you mean by that?

We had some pretty good price increases last year, as you know Geoff, and on our big horsepower units the price increases flowed through very nicely, and we continue to grow the big horsepower. We did get some push back on our small and midrange horsepower, and with the costs kind of abating now, that were going up before, I think we're going to take a look at whether our price increase philosophy of a twice a year kind of increase across the board makes sense, or whether we more opportunistically look at price increases.

We'll have to see what happens to costs as we move forward as well. But I think, particularly with UCLP being in place, and our cost of capital coming down, it does give us some opportunities to look at the balance between growth and pricing, and that's exactly what we're doing.

So you are seeing some moderation in the cost inflation?

Yes, particularly, well I'm not seeing much moderation at this point on the labor side, but some of the other costs that have been rising, such as vehicle fuel, lube oil, those types of things, are starting to moderate a little bit. And on the labor side I think we're pretty well caught up, and at least it seems like we're in pretty good shape right now. So we're seeing a bit of an abatement there.

Okay. And my last question is, I'm just a little bit confused about the fabrication, what happened in fabrication. Because you commented about delays, but I think that Michael talked about the margins in fabrication being, in part, a product of good execution. I just was having a little hard time reconciling those two.

Well I think the good execution comment was related to a 17% margin on what we actually produced in the quarter, and that is tremendous execution. If you remember there's days we've been on the phone talking about low single digit margins.

On the other side of the coin however, the labor market for that type of labor that works in our fabrication facilities is very robust here in Houston. And because we had faced that market, we had some turnover in our shop, which until we adjusted wages recently, got a little bit higher than it should have, and we got some less experienced people who came in. So it took us more hours to produce units. While the margins were still strong, it clogged up the shop like a traffic jam.

Because when you're just in time manufacturing you need to get unit A out so you can move unit B in, and that's what happened to our deliveries, and it caused us to slip some of our fabrication revenue out of Q3. And probably more importantly, caused us not to complete some contract compression units that should have gone to work in Q3, and are really going to go out in Q4. So that's what all that clutter was about.

Did that create some costs that are going to show up in subsequent quarters, when those units do get shipped?

Yes there'll be some cost, because we had to adjust the cost of labor in the fabrication facility in Houston, and so that will have to be absorbed in the newer packages that we're building now.

And Geoff that's why we look at the fourth quarter in fab being about a 12% margin quarter.

Right, right. Okay, thank you very much.

Sure.

Mike Urban with Deutschebanc, your line is open.

Thanks, good morning. On the utilization side, especially domestically, the -- I think you noted that the current levels were a little below spot, and I think a little bit below where you had been. Was that some of the issues you had addressed in terms of some of the smaller units being a little slow to get out, or some maintenance issues? Or is there any kind of weakening in certain markets?

No, no weakening in the markets at this point Mike. The small and midrange horsepower units, you know anything up to 500 or 600 horsepower, and from that on down, with the price increases last year we saw some of those units come back, as we knew we would, and we thought we could turn around pretty quickly and put them back to work. And in fact the market supports that; the market would like to have the units.

We've had trouble getting them through our field overhaul facilities, partially because they're so busy with after market service work that our AMS business is competing with contract compression business for shop space. We're trying to move that around now and make sure these units get run through the shop and get reapplied, and get back out there in the marketplace, and get our utilization back to where it should be. So that's kind of what's happening.

So the demand is pretty robust for the small and midsize units?

Yes, there's no problem on the demand side.

Now along those lines, I think Hanover had noted that they might shift their emphasis a little more, not entirely in that direction, but go from building almost entirely large horsepower units to maybe building a little more, or adding a little more capacity in that low or maybe more the middle end of the range. Are you guys still focused on, in terms of adding to fleet, the large units, or is there some scope for adding some of those smaller units?

No we're not really adding anything in the smaller size. Occasionally we'll build a specialty unit or a couple of units for somebody that needs some horsepower we don't have, or is a different configuration. But far and away the majority of our build program is big horsepower dollars.

I think maybe what Hanover was referring to is they took their 200,000 horsepower program they announced a year or two ago to refurb some old units and put them back into the marketplace. I guess it was this year they announced it. I think some of that is small horsepower, and kind of like we did three years ago when we went through our small horsepower fleet and upgraded it. I think that's what they're doing.

I think their dollars on new manufacturing is also pretty much in big horsepower, but I don't know that for a fact.

Okay, that's all for me, thanks.

Martin Malloy with South Coast Capital, you may ask your question.

Good morning. Could you talk a little bit about the tax situation with your NOLs and the impact of the offering, the impact of the new structure with respect to your ability to use the NOLs?

Sure, we can talk about that. Now Marty are you more concerned with what the effective tax rate is, or are you concerned with how you move assets from one entity to another and what the tax effect is?

The latter.

Okay, with regard to the initial drop down, we were able to do that on a fairly efficient basis. Whenever you take back units, it's basically a non-taxable type transaction, and also structured so it was fairly tax efficient. So there weren't really any taxable events or gains to speak of.

Now over time it is likely that the ability to do that will diminish, although we'll still be able to take back units as consideration, which is a nontaxable transaction. Some of the other stuff, with regard to pushing down debt, may not be as readily available to us. It could be that over time, therefore you have more taxable events associated with drop downs. I think there that is a likely good use of Universal's NOL to the extent that that were to happen, which today is around $350 million.

Okay. And does this transaction, do you expect it to change your target debt to total capital ratios that you talked about in the past? I think you've targeted around 50%.

Well and actually we've really targeted more on a debt to EBITDA basis, I think, which is a better measure, especially when you start talking about stock buy backs. You change the equity account. But I think our 3 to 3.5 times debt to EBITDA is a range that is pretty comfortable with us.

When you look at UCLP and you look at just the domestic contract compression business, which inherently has more stability to it. I think maybe that ratio is up a little bit, maybe it's more 3.5 to 4 times. But I think one of the primary reasons for our stock repurchase announcement is the fact that on a consolidated basis we're down to 2.5 times debt to EBITDA, and so we think that number should be more in the 3 to 3.5 times.

Thank you very much.

Thiru Ramakrishnan with Simmons, your line is open.

Hey guys.

Good morning Thiru.

On the -- is it safe to assume that as you draw more assets into the MOP that you'll be transferring debt as well each time?

We will certainly look at that that can sometimes be a very efficient way to transact the business. That's the way we did it the first time.

Okay, what would be the other option?

You just get cash back where you get units back as consideration.

Great. And then on the, you talked about some of the costs moderating in the domestic side of the business and maybe reevaluating some of the pricing strategies. Is it still safe to say that you guys don't expect any margin erosion, correct?

That's correct.

And one quick housekeeping question, the employee benefits that rolled through the quarter, what line item did that roll through?

It actually rolled through a lot of line items. It helped the domestic contract compression business by about a point in margin. It rolled through fabrication and AMS, and also a little bit through SG&A.

How much rolled through fabrication?

About a point worth. So instead of a 17% you could have normalized that to about 16%.

And the down quarter in fabrication, with respect to margins, is being driven on the cost side, not on the pricing and project execution side, correct?

Ask me that again.

The sequential down tick in fabrication margins, that's being driven predominantly from the cost side, not from a pricing or project execution, correct?

It's a little blend of both. It's driven from the cost side in that our labor costs have come up a bit, but it's also driven that before we adjusted our rates we had some less qualified labor that caused more hours to be taken on building the projects. So it's a kind of a combination all tied to the cost of labor.

Great. Thanks.

Therese Fabian with Sidoti and Company, your line is open.

Thank you. Just to follow up on that, are you satisfied with where your labor costs and performance is now, or do you think there's still going to be some increases there?

I think labor cost in the shop is under control now, I think both fabrication facilities we've adjusted where appropriate and now have the workforce we need. So we're still under field pressure for wages, but that's even mitigated just a little bit I think.

Okay. Another question on your use of cash, one use would be to buy back stock, another might be to, as you had mentioned, acquire company owned fleets, compressor fleets. What kind of a market is there to do that?

Well as we've discussed kind of openly before, there's probably four or five what we'd call midrange competitors that would be nice size companies, they're all privately owned, and they would all be nice additions to Universal, and it would be a wonderful thing if we could get one or two of those to come into our organization. Then there's a whole raft of small mom and pop kind of compressor companies that usually deal in small horsepower. So there may be something there that's of some value. But the other ones are more large horsepower regional players that I think would probably do well.

And then the other area that we've explored in the past, but we think we have a better vehicle now, is to go after customer owned equipment, and maybe easier to do than competitors fleets would be to purchase equipment from a customer then enter into a contract to provide that compression back to them on a contract basis. So we may have some opportunities in those lines.

Those wouldn't be big bites of horsepower, they'd probably be little bit here and there, but it certainly might be an opportunity.

So the company could then do that as a sale. Is there very much interest in that? I mean have you explored it with companies as such, or is it still in the thinking stage?

There was a period about three or four years ago when some of it was done, it never really, not a lot of it was done. Sometimes there was a cost of capital argument from the bigger customers, saying "Why should we do that because our cost of capital is lower than yours?" Now with the LP in place the playing field's a little bit more level on cost of capital.

And it's actually something that we have done from time to time, but it will typically be in very small bites. It may just be a handful of units or even just one unit at a time that we would purchase from a customer and convert over to contract compression.

And then, I have just one last question; and I'm sorry. You probably have gone through this in other conference calls, but I'm new here.

In terms of your international project, Hanover expressed some difficulties with their work in Nigeria and you have long-term contracts written on your international work. How do you structure that to avoid - how do you build in a risk premium to avoid problems there?

Well, in the areas where there's increasesd risk, we analyzed it and did exactly what you stated. We built in a risk premium, get a higher return for that risk.

The contracts they specifically refer to in Nigeria have been difficult contracts for them now for some time. And, we don't have any equipment at risk in places like Nigeria at this point in time. We've been a little cautious as to where we go, but as we get bigger and spread out further, we will have more equipment that's at risk in various markets. And, we'll have to take a portfolio approach to that and look at the balanced risk for the entire international fleet and decide what our position should be on that.

Okay, thank you.

Did I answer your question?

Yes, thank you.

Brad Handler, with Wachovia Capital Markets, your line is open.

Hi, it's actually [Yvonne Fletcher], filling in for Brad. My first question is if you look over time or the past few quarters, it looks like your day sales outstanding has been trending up slightly. We were just wondering, does this relate to any issues with the new ERP system? Or, is there something else going on that you can give us color on?

Sure. I will say that our ERP system has slowed things down just a little bit over the course of the past couple of quarters. But there's also a little bit of a changing mix there.

The contract compression business is a business that has receivables turn very, very quickly. As we're doing more in the fabrication arena, which is what we're doing right now, those receivables tend to be a little bit longer, in term; same thing for the AMS.

So, it's really a combination of all those factors; changing mix in the business, as well as the ERP taking a little bit longer for us to get that process moving as smoothly, in collections, as smoothly as we'd like.

Okay, so we could look to that improving a bit in the coming quarters?

Yes, we do look to improve that ratio a good bit.

Okay, and my next question is, we were wondering if you could give us some of your thoughts on the Dominion announcement last week, to sell their ENP business. We know they're a significant domestic customer and maybe you could help us think about whether or not their compression needs have been growing and if the sale maybe suggests a pause? Or, maybe it's just a more positive or neutral for you?

Well, they are certainly a large customer for Universal. We have an alliance with Dominion and provide, by far, the bulk of their equipment, particularly their big-horsepower equipment. And, they have been one of our faster growing customers. They're also the biggest customer in UCLP. So, we're watching pretty closely what happens with Dominion.

In most of these cases, we've found that, at least in the early stages after a sale or an acquisition, depending on which side you're on, there's not a lot of change in the operating parameters of the acquired company. So, I think we're probably, for the next couple of years no matter what happens, in pretty good shape.

There's also difficulty in just replacing equipment because there's not a lot available. So, I'm not too concerned about it. Potential suitors that you read about that everybody on this phone call writes about and we read about, are all customers of Universal anyway. So, usually it works out fine, that it comes together and they just keep on going. We have seen no slowdown in their activity as a result of this announcement.

Okay, great. And lastly, I missed the growth Cap Ex number for the quarter. Could you repeat that for me please?

Absolutely. The growth Cap Ex number for the quarter was $35 million.

Okay, great. Thank you.

Karen David-Green, with Oppenheimer; your line is open.

Thank you. Gentlemen, I was wondering if you can just comment a little bit more on your 200,000-plus program, in terms of how many units you may be adding in the fourth quarter? And then, also into '07 because, per my calculations, and there may have been some sales in there, there's been about 70,000, I guess, horsepower that you [inaudible] at the end of 2000 for that.

I think I may have confused you, because, the 200,000-plus program is Hanover's program. We did something similar back about two or three years ago. And, we've kind of went through our fleet of idle equipment in the small horsepower and reconfigured those and a lot of that's gone back to work.

Yes, Karen, if you're talking about the 200,000 horsepower that we talked about adding over the course of 2006 -

Exactly.

…yes, that's a number that there is a pretty significant build in the fourth quarter. It's one of the reasons that the fabrication shops are pretty jammed up. But, we actually look at building something on the order of 50,000 horsepower for the domestic market in the fourth quarter; another 25,000 sold internationally. And, those numbers get us really close to around 200,000.

Some of those may not necessarily appear in the fleet, as of December 31st, because, until they go to work, they actually don't get recorded into the numbers. We have been affected a little bit by sales over the course of the year.

If you total up what we sold in the domestic market, it was actually a little bit north of 20,000 horsepower that we've lost through sales over the course of this year. So, that's one way that you need to net the number to get to what our new build is for 200,000.

What was the amount of international horsepower that is going to be sold, or has been sold in the fourth quarter?

25,000.

Okay, and how much of the horsepower that's coming out in the fourth quarter is already contracted?

Basically, everything for the rest of the year is contracted for. We pretty much always do that in the international arena. And then, the way that we've been building for the domestic is that we're usually out three, four months in terms of things that are in the shop already have a home committed for them. We're fully booked through the end of this year and into '07 as well.

Okay, so we should assume, then, you will also be adding close to 200,000 new horsepower in 2007 as well. Is that correct, based on comments that were made earlier?

Yes, that's correct.

You know, part of that is also related to what happens in the international arena, in terms of new projects and backlogs etc. But yes, that is our target.

Okay, cost to build relatively the same, year-over-year?

Yes. There'll be some modest increases but nothing major.

Great. That's all I have; thank you, gentlemen.

Jason [Pedraza], with Howard Weil, your line is open.

Good morning, guys. Just a quick housekeeping question for you, Michael; I may have missed it in the guidance. But, you talked a little about the UCLP mildly dilutive moving forward, principally, from additional costs, I gather, just flowing through SG&A.

Just wondering if at some point you were needing to back off a minority interest associated with that as well, or, if so, when?

Oh sure. I mean, in terms of the overall financial presentation for Universal, we will have a minority interest item within the income statement, representing the 49% that's owned by the public. So, that is going to be in there.

And any guidance as it relates to that for 4Q maybe based on run rate?

Well sure. I mean, you can go into the S1 and you can pull out the roughly $15 million of net income that we forecast for the UCLP business for the full year, 12 months ended December - I'm sorry, September 2007 and take 49% of that and that's going to basically equate to what the minority interest is.

All right. And then, on the additional costs, as it relates to the subsidiary here, most of that will hit in the G&A line, or some of that in the top line cost number as well?

No, it should all hit in the SG&A line.

Okay, fair enough. Thank you.

[Derek Calamaras], with Wachovia Securities, your line is open.

Any success in reconfiguring the lines to reduce some of the man hours?

On our standard products that we've built for our fleet, we've been continually cost reducing those. That's how we're able to hold the cost of compression relatively constant in the face of increased prices for the components.

And that's kind of a continual fleet reengineering that the fleet engineering group goes through. And then, we applied some of the same savings to units that we've built for customers that look just like our fleet units.

And on the engineered products, the specials, the one-off builds, no, we have to meet customer specs there. So, we're kind of stuck with complying with what they want us to build.

Okay and then, I guess, Michael, in relation to the leverage in the notes, how do you see the restricted payment basket at this stage? And, as it relates to UCLP, and/or the share repurchase program?

Well, share repurchases, at the UCO level, would certainly work against the restricted payment basket, with regard to the notes. So, that's certainly one of the facts. But I mean, right now the restricted payments basket is fine. It's something in the order of $170 million or so. And, it, of course, grows over time by 50% of net income.

Sure, and then, in addition to that, does the sales at UCLP, do they count against that?

No, they don't.

Okay, thank you.

Operator, we have time for about one more question.

Thank you. Our last question comes from Martin [Perlman], with Perlman Associates. Your line is open.

Hi. Congratulations; good morning. You mentioned next year about 200,000 horsepower, again; three quarters domestically and the amount that you think you will add to your fleet, as opposed to outright sales?

That is the 200,000. That's just the fleet addition.

Okay, that was it.

Oh, and the client, the client-owned units that you buy, would that - would you buy them at the parent level and then, ultimately, as you continue to do business with your MLP, do, you know, drop it down? Or, might the MLP buy them directly?

It really depends upon who the customer is. There's basically a non-compete agreement between UCLP and UCO and, if they're a UCLP customer, they would go straight into UCLP. If they're a UCO customer, they'd go into UCO.

Thank you.

Well, thank you, everybody. I appreciate your participating in our call today and we'll look forward to seeing you early in 2007.