Archrock Inc (AROC) 2008 Q2 法說會逐字稿

Good morning. Welcome to the Exterran Holdings, Inc. and Exterran Partners LP second quarter 2008 earnings conference call. At the this time I would like to inform you this conference is being recorded and all participants are in a listen-only mode. We will open the teleconference for questions after the presentation.

Earlier today Exterran Holdings and Exterran Partners released their financial results for the second quarter ended June 30th, 2008. If you have not received a copy, you can find the information in the Company's website at Exterran.com.

During this call, the Company will discuss some non-GAAP measures in reviewing performances such as EBITDA as adjusted, EBITDA as further adjusted, gross margin, gross margin as adjusted, and distributable cash flow. You will find a reconciliation of these measures to GAAP measures in the summary pages of the earnings release.

During today's call, Exterran Holdings will be referred to as Exterran and Exterran Partners as either Exterran Partners or EXLP. Because EXLP's financial results and positions are consolidated into Exterran, the discussion of Exterran will include EXLP unless otherwise noted. I want to remind listeners that the news released issued this morning by Exterran Holdings and Exterran Partners, the Company's prepared remarks and the related question and answer session include forward-looking statements. These forward-looking statements include projections and expectations of the Company's performance and represent the Company's current beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements. Information concerning the risk factors, challenges and uncertainties, which could cause actual results to differ materially from those forward-looking statements can be found in the Company's press release, as well as in the Company's annual reports on Form 10-K for the year ended December 31st, 2007 and those set forth from time to time and Exterran Holdings and Exterran Partners filings with the Securities & Exchange Commission, which are currently available at Exterran.com. Except as required by law, the Company's expressly disclaim any intention or obligation to revise or update any forward-looking statements whether a result of new information, future events or otherwise.

Your host for this morning's call is Steve Snider, President and Chief Executive Officer of Exterran Holdings, and also President and Chief Executive Officer and Chairman of Exterran Partners. I would now like to turn the call over to Mr. Steve Snider. Mr. Snider, please go ahead with your conference. Mr. Snider, please, go ahead with your conference.

Thank you, and I would like to also welcome everybody to the second quarter 2008 earnings call for Exterran Holdings and Exterran Partners. Joining me today are Michael Anderson our Chief Financial Officer of Exterran Holdings, Daniel Schlanger who's the Chief Financial Officer of Exterran Partners. To begin the call I would like to provide an overview of where we are as a Company as we approach the first anniversary of the creation of Exterran on August 20th of last year.

Overall, I'm really proud of the accomplishments that our great team of employee has achieved over the past year. We have merged two different companies and cultures together into one and this alone has given me great confidence in our Company and a sold foundation on which to build future success. More specifically I'm pleased with the overall demand we have seen for our products and services, particularly in the international market. We continue to see significant opportunities for both sale and contract operations work throughout the world. Later I will talk more about the progress we made during the second quarter on this front. Additionally we're seeing signs of stabilization in our North American business and we will continue to work diligently to bring this core business back to its historic levels of growth and profitable. I believe we're doing the right thing and focused on the right activities to be successful, but as always, the timing of improvements remains difficult to gauge.

Of course the past year has not been without challenges, and we're not satisfied with our overall progress to date. We will continue to evaluate our position and make changes as necessary to drive success. We announced one such change last quarter with the addition of a new management team into the North American business and we announced another this morning with the departure of Chief Operating Officer, Brian Matusek. With this change I will be more directly involved in the operations of the Company and the management of our profit and loss centers throughout the world. Over the past year, Brian has been tremendously dedicated to the success of Exterran, and I would like to personally thank him for all of his accomplishments and hard work and wish him the best of lucks any future endeavors.

Now I would like to move on to talk about our second quarter results and recent activities that demonstrate the progress we continue to make as a Company. First, during the quarter we generated sequential revenue increases in each of our international contract operations, after market services, and fabrication segments. Second, we were awarded several significant new contracts for international contract operations that more than doubled our backlog in that business to over $121 million in expected annualized revenues. Third, we announced the drop-down transactions between Exterran and Exterran Partners and closed it on July 30th. Fourth, we completed an acquisition of an excellent business that we believe fits very well into our North American contract operations and has growth potential in international markets. Furthermore, we made progress on driving costs down in our North American contract operations segment by $2 million over the first quarter level. Michael and I will discuss you will of this in more detail as we go through the call.

While all of that was good news for the quarter we did face unexpected disappointments, in our fabrication segment we recorded estimated cost overruns totaling $31.8 million on two international sales projects that negatively impacted second quarter results. The overruns included $17.7 million related to a Belleli gas to liquid project and $14.1 million related to a gas processing and total solution project in Kazakhstan. I will cover these and other operational highlights a bit later in our review.

Now I would like to summarize second quarter financial results for both Exterran and EXLP. In the second quarter for Exterran Holdings, revenue was $812 million and EBITDA as adjusted was $166 million. Net income was $21.7 million or $0.33 per diluted share, including merger and integration costs of $1.5 million or about $0.01 a share. The $31.8 million in losses on the two fabrication jobs equated to about $0.29 per share. We are pleased with another solid performance by Exterran Partners in the second quarter. As a reminder Exterran Holdings owns a majority interest of Exterran Partners LP, a master limited partnership, which provides natural gas contract operation services throughout the United States. In the second quarter, Exterran Partners recorded revenue of $35 million and EBITDA as further adjusted of $20.0 million and net income of $6.1 million. Further with the recent completion by Exterran Partners of its previously announced acquisition from Exterran Holdings, we expect that EXLP's cash distributions will increase by approximately $0.15 per unit on an annualized basis. We were very pleased with the drop-down transaction and related financing activity, which Michael will cover in his remarks.

Late last month Exterran Partners announced the distribution of $0.425 per limited partner unit, unchanged from the previous quarter and up 21% compared to a distribution of $0.35 per limited partner unit a year-ago in second quarter '07. Our distribution coverage ratio remains very strong as exhibited by the recently completed drop-drown transaction, we will continue to strive to continue to provide attractive distribution growth for MLP investors. Just a few days ago we announced the acquisition of EMIT Water Discharge Technology; a company that provides water management and processing services in the coal bed methane gas producing regions of the the western United States on a contract basis. We're very excited about bringing this business into our North American contract operations. The business is complimentary to our compression, production and processing businesses, and it fits well into our contract operations model. Although a very good acquisition for us just within its existing operating markets, we're hopeful that the business can be broadened to other coal bed methane applications throughout the world.

Now I will provide some more detail on our operational performance in the second quarter. Overall, our operating horsepower was down 46,000 horsepower in the second quarter as we grew the international market, but declined by 63,000 horsepower during the quarter in North America. The North American horsepower decline during the quarter was generally in in line with our forecast. We did see some positive trends during the quarter as the majority of the horsepower decline occurred in April, with lesser declines sequentially in May and then in June. At June 30th, we had a total North America contract compression fleet of 4.5 million horsepower and the fleet utilization for North America was 77% as compared to 79% at March 31st of this year.

A quarter ago we discussed enhancements we made to the North America management team and I remain very confident in this team and believe they are focused on the right activities to regain momentum in the business. Specifically we're increasing account coverage in sales effectiveness to increase revenues while maintaining strict focus on reducing operating costs. We believe these initiatives will lead to positive trends in our North America business. From a macro standpoint, we're optimistic that the growth trends in natural gas production in the United States, as well as the continuing development of shale and other unconventional resource plays should result in growing demand for compression. Overall activity in more mature basins remains brisk while emerging plays hold great potential for future growth.

On the international side of the business we have had a number of recent successes in new business development activity for our international contract operations. The strong demand we have seen throughout the international marketplace resulted in six new contract operations awards, including three projects in the eastern hemisphere. These projects are expected to generate over $75 million of annualized revenue for Exterran and are expected to begin operations in 2009 and a few later. These awards are very significant as compared to the approximately $500 million in annual revenues we currently generate in our international contract operations segment, and they reflect the strength of Exterran's position in a robust international market. Additional during the second quarter, we started operations on projects in Oman and in Venezuela. While a commencement of these two projects reduced our backlog, we were still able to more than double our international contract operations backlog during the quarter from $60 million to $121 million in expected annual revenues. I do caution that new business development activity is generally lumpy. Therefore we do not expect to have this level of new products to report every quarter. Nevertheless business activity is stronger than it's ever been for the international market and we look forward to reporting future progress in this strategic growth area. Largely as a result of the new projects we started during the quarter, our international fleet utilization increased to 94% at June 30th, compared to 92% at March 31st, 2008 on a base of 1.5 million horsepower. Exterran's worldwide fleet totaled just under six million horsepower at June 30th in worldwide utilization was 81% compared to 82% at March 31st.

Our gross margin percentage in the international contract operations segment during the second quarter was negatively impacted by some higher than expected labor repair and maintenance costs in Latin America and expect was impacted by lower revenues due to the energy industry strike in Argentina. We have recovery plans in place on these issues, the strike in Argentina has been settled and we expect to see gross margins in the international contract operations segment improve during the third quarter.

As I highlighted in my introduction, cost overruns of $31.8 million on two projects overshadowed otherwise strong activity levels and performance in our fabrication segment. These two jobs reduced fabrication gross margin percentage in the second quarter by approximately eight points. Due to percentage of completion accounting rules, our losses for the quarter include all of the expected losses on these two projects until their expected completion dates, which should occur around mid-2009. We believe that several key actions that we instituted last fall in conjunction with the merger should reduce the potential for cost overruns of these types of projects in the future. We implemented a new project approval process that evaluates project risks and contingencies more closely and we enhanced our total solutions project management staffing. One result of these changes is that we generally seek to take on the higher risk portion of fabrication projects, such as installations and difficult environments on a cost-plus reimbursement rather than a fixed price basis. Demand for our fabrication services continues to be strong as reflected by brisk inquiry and bid levels and our healthy level of fabrication backlog. Though backlog declining somewhat from $1.27 billion from March 31st to$1.15 billion at June 30th, partially due to our success in converting large projects to contract operations work instead of fabrication sales.

I will now turn the call over to Michael to review our financial performance.

Thank you, Steve and good morning everyone. I'm sure that you have had a chance to look at our press release that we issued earlier this morning. During my discussion I will review the second quarter financial performance for both Exterran Holdings and Exterran Partners and also discuss our earnings outlook for the third quarter. Due to the August 2007 merger, of course, our year-over-year comparisons are still not especially meaningful, so therefore, most of the comparisons that I'll have will be against the first quarter as well as the guidance that was provided during our last earnings conference call. So if we look at our North America business revenue was $195 million in the second quarter, down somewhat on sequential basis from the first quarter but it was in-line with our expectations. We were pleased that costs in the segment declined from $88 million in the first quarter to $86 million in the second quarter. Gross margin percentage was flat at 56%, but we do expect gross margins to gradually improve throughout the remainder of the year. Our international contract operations revenue increased on a sequential basis to $126 million in the second quarter. That was in-line with our guidance range as working horsepower increased by about 17,000. International contract operations gross margin was about 62% in the quarter and that is below the 67% gross margin we had in the first quarter. It's also I little below our mid-60s guidance range, but as cover earlier by Steve, we expect margin performance to improve in the third quarter.

If we move over to fabrication, we generated revenues of $394 million. That was above the first quarter levels, which were $337 million, it was also above our guidance, $340 million to $360 million. Revenue was higher than expected due to better sales of standard compressor packages and production equipment, which is typically sold on a shorter lead time basis. Gross margin was approximately 10% and, of course, that was below our guidance of the mid to high teens as a result of the cost overruns in the two projects discussed by Steve.

Compressors represented about 40% of fabrication revenue, Belleli was about 25% and other production and processing equipment made up of the remaining 35% of revenues for the quarter. If we move to after-market services, second quarter revenue was $98 million, that was above both our guidance of $90 million to $95 million, as well as above the first quarter revenue of $84 million. All of this was driven by increases in North America and also eastern hemisphere. Gross margin percentage came in at 22% and that was in-line with guidance in the low 20s. SG&A expenses were $95 million in the second quarter, that was on track with our expectations. The sequential increase in SG&A over the prior quarter was driven by costs associated with the expansion of our international operations and also the initiation of non-cash amortization expenses associated with Exterran's long-term incentive plan. We generated $166 million in second quarter EBITDA and that, of course, extrudes the $1.5 million we had of merger costs. Interest experience was $30 million in the second quarter. That was also in-line with our expectations and guidance. We had $7 million in equity income from joint venture investments in the second quarter and also $8.6 million of other income primarily related to currency translations and settlement gain. I would like to caution that continued strengthening of the dollar could reduce our quarterly other income line item going forward.

The effective tax rate in the quarter was 41%. It's a little bit higher than what we had in the first quarter, which came in at 37%. The tax rate was higher than expected due largely to losses on the Belleli job, where it's now unlikely that we will not be able to utilize some prior tax losses that we had in Italy before they expire at the end of the year. We do continue to expect a corporate tax rate in the mid-30% range going forward. So we reported diluted net income per share of $0.33 in the second quarter. Merger costs would increase EPS by by about $0.01 per share. Capital expenditures, net CapEx for the second quarter was $130 million. Total Cap Ex included about $99 million in growth capital and $33 million in fleet maintenance capital. If we look at balance sheet, total debt declined by $53 million during in the quarter from operating cash flow and debt stood at $2.3 billion on June 30th. Debt-to-capitalization was 41%.

Now although we believe we are under levered on a consolidated debt base, we did the not repurchase any of our stock under our previously announced $200 million share prepurchase program during the second quarter. The recently completed drop-drown transaction enhanced liquidity at Exterran Holdings and given the current price level of our stock, we will look more aggressively at share repurchases during the third quarter. To that end, we still have $100 million remaining under our share repurchase program.

During May, Exterran Partners added $117.5 million of a term facility, which was undrawn at June 30th and this was added to the existing senior security agreement and that expanded the total amount of that facility from $315 million to $433 million. And that was all done in conjunction with the plan drop-down from Exterran. At June 30th, if we look at Exterran Holdings revolving credit facility, it had $312 million drawn on it. Available debt capacity for Exterran Holdings was $412 million and that includes capacity under the ABS facility. Since the end of the quarter we had a couple of transactions that closed. Of course we funded about $108 million from the Exterran revolver for our acquisition of the EMIT Water business and then we also reduced the Exterran revolver by about $176 million in conjunction with the EXLP drop-down. So that net change from those two transactions resulted in a reduction of about $68 million.

In connection with the drop-down transaction EXLP borrowed about $176 million in new debt and, of course, that included debt under the new term loan and issued to Exterran about 2.4 million common units and 49,000 general partner units. The pro forma for this transaction, EXLP has about $40 million of unused and available debt capacity under it's existing debt agreements. Also with the transaction, EXLP now owns a compressor fleet of about 984,000 horsepower and that's about 22% of the combined Exterran Holdings and Exterran Partners contract operations business in the US. I think you all know that in connection with the drop-down the omnibus agreement between Holdings and EXLP was amended to reflect adjustments in the caps for both SG&A and operating costs. The SG&A cap was increased from $4.75 million per quarter to $6 million a quarter, and then the cap on operating cost was increased from $18 per horsepower per quarter to $21.75 per horsepower per quarter. The termination dates for the caps has now been extended by one year and termination date is currently December 31st, 2009. As Steve previously mentioned, of course, the transaction is expected to be accretive to Exterran Partners cash distribution per unit by about $0.15 per year.

I would like to now talk about our guidance for the third quarter. Let's talk with North America contract operations. We expect average working horsepower to be relatively flat for the third quarter as compacted to second quarter results. We expect that sequential revenue will grow largely due to the contribution to the EMIT acquisition and we expect margins to be flat to modestly higher than second quarter levels.

For the third quarter in international contract operations, we expect revenue growth there with the revenues slated to come in at $129 million to $132 million and margins back again in the mid-60s. We continue to expect our international contract operations business for the year to do well, with revenues of just over $500 million during 2008 and that would represent growth of about 20% year-over-year compared to the 2007 combined international contract operations revenues for the business. If you look at after-market service, we expect to generate third quarter revenues of $90 million to $95 million and margins in the mid to high-teens. And we look at fabrications again for the full-year, 2008 we do think that we'll still be within the $1.5 billion to $1.6 billion guidance range that we earlier expressed, but likely towards the lower end of that. We expect that the net capital expenditures for the full-year, $450 million to $500 million and that is in the upper end of our earlier guidance range, due to expenditures to our new international projects that we added this quarter. We continue to expect fleet maintenance capital of $110 million to $120 million and when we look back at that growth capital, we expected about 60% of it, in fact, will be coming from international.

Let's look at Exterran Partners for a moment. All though operating costs have been higher at Exterran Partner, the omnibus agreement capped EXLP operating cost at that $18 per horsepower per quarter and during the second quarter the SG&A cap was not exceeded. The operating cost cap was exceeded by about $3.5 million and as I note ir, the caps on both were increased in conjunction with the drop-down. With the benefit of the cost caps that we had for the second quarter, EXLP generated EBITDA of $20.3 million and distributable cash flow of $14 million. This distributable cash flow was sufficient to cover the $0.425 per unit distribution by about 1.7 times. Even without the benefit of the cost caps, distributable cash flow covered the distribution by 1.3 times. It's important to note that the coverage ratios for this quarter include the payment of distributions on new units issued to Exterran Holdings in conjunction with the closing of the drop-down transactions since those units were basically issued on July 30th, which is prior to the record date the EXLP's second quarter distribution.

When we look at EXLP in comparison to the first quarter, with the cost cap, EBITDA for EXLP in the first quarter was $19.2 million. Distributable cash flow was steady at that $14 million level and coverage was 1.9 times. In the second quarter, Exterran Partners fleet average operating horsepower was 652,000 and that compares to 659,000 in the first quarter. At June 30th, EXLP had total available horsepower of 742,000 and that equates to a spot utilization rate of 88%. I think it's important to note that we made very good progress in converting contracts during the quarter as we added about 350,000 convert the horsepower in the secretary. So now we have over 1.6 million horsepower of Exterran Holdings and EXLP's combined contract fleet, now covered by contracts converted to service agreements and that compares to 1.3 million horsepower we had an March 31st. If you look at totaled horsepower converted it now represents about 37% of the combined US contracts operations horsepower.

And lastly, we do expect to file both 10-Qs for Exterran Holdings and Exterran Partners within the next couple of days. So operator at this point let's turn the call over for questions.

The question and answer will be conduct electronically. (OPERATOR INSTRUCTIONS) And we'll take our first question from Mike Urban with Deutsche Bank.

Thanks, good morning.

Good morning, Mike.

So in the US or North American business you got it to flat utilization, flat horsepower employed. What would you attribute the decline that you have seen? Is it continued share loss as you alluded to before, or are you seeing any change in customer preferences as kind of a lot of these larger guys and kind of centralized gathering systems gain favor? What are the trends that you are seeing out there at the leading edge?

I don't think the trend is any different than, Mike, than it was last quarter. The difference that we have see a diminish over the duration of the last quarter. As I said in my comments it was very heavily front-end loaded and appeared to be the residual of the market share loss we had earlier, but we're stemming the tide pretty aggressively. I haven't seen a change in the buying habits necessarily. I think the market for contract compression remains real strong in North America, certainly with all the guess work that's going on. Again, we need to get back in the game with our market share. A lot of effort with customers and a lot of work around the sales side and a lot of work around execution and I think it's paying off.

So to be clear as we sit here today at the leading edge, you don't feel like the share losses are continuing and you think you have stabilized it?

We hope that we have stabilized it, yes and hope the third quarter shows more stable numbers like Michael has guided to. We'll see at the end of the quarter how it turns out.

Okay, on the international side you spoke to some of the issues that drove the margin there, but you also mentioned that you are having some success in converting folks from fabrication-type projects to operate. Do you feel like there is any impact on the margin going forward? Are those inherently your low-margin businesses, or are you trying to entice people to do that by perhaps, offering a lower margin than what the traditional contract business has been internationally?

No, not at all. The margins on those projects will be just fine and be in alignment with the internation margins we've had on other projects. I think the difference is simply that we're aggressively pursuing them in the eastern hemisphere now. Whereas in the past you will have automatically defaulted to a sale and now we're taking some of the customers over to the contract side and it's being accepted very readily and hence, the success in this quarter with landing three eastern hemisphere total solutions projects.

Okay. And finally, you mentioned that you are going to hopefully be a little more aggressive this quarter on the buyback, given the greater liquidity at the EXH level. With where the stock is now, you are almost at a level where per horsepower basis and we can debate what the valued at, but for horsepower basis you are trading at or may be below what you can build at. But why -- $100 million is where you are now. In theory, shouldn't you by buying every -- every dollar of capital you can come up with should be going into the buyback in theory. What is the deal on that?

I think we just reiterate the fact we have gotten $100 million left on the buyback program and we're going to look more aggressively at analyzing this over the course of the quarter and can't really disagree with anything you have said, Mike.

Is there anything magical about the $100 million other than that's what the Board authorizes, would there be anything liquidity wise that would preclude you from going higher than that?

We mentioned in the details of the call that the Exterran Holdings credit availability is a little bit north of $400 million. The magic of the $100 million is that we have a $200 million share buyback program and we already bought $100 million already in previous quarters.

Okay. So if you are able to finish that, there is no reason you couldn't go back to the Board and re-up?

That is correct.

Okay, I will pass it over to someone else. Thanks.

Thanks, Mike.

Thank you. We'll take our next question from Robert Christensen from Buckingham Research.

I want to be clear on this, the overruns on the two projects, will they have any kind of tail? Will they be ongoing? Your guidance suggests it won't and take me through the percentage completion-type of accounting.

Bob, just really quick on that, both of these are lost contracts, so percentage of completion accounting says you'll take all the loss that you have for the rest of the project in this current quarter. So basically the forecast for the rest of these two projects is a 0% margin in coming quarters. From a percentage completion standpoint, the Belleli job is probably in the order of 75% complete from a revenue recognition standpoint and the other job is about 50% complete from a revenue standpoint.

The fact that it was in Belleli appears to me this is the second disappointment from Belleli. I know those two reactors -- couple reactors had to be sent back and had to be reworked, that cost you. Previously, I think, the Company has mentioned Belleli, you just enjoy the future and the robust period for their product lines and no need to even contemplate a divestiture because the business might not fit. Does this motivate you to reconsider?

This is outside of that consideration and the facts here is that these are are products that we had elected to build in our Dubai facility that normally would have been built in Italy and it's the first time this type of equipment has been attempted in our Dubai facility. I think we're paying the price for the learning curve in Dubai. And the project that we had the first time that you were referring to on the reactor vessel is this same project and it's the same one being built in Dubai. I think if we built it in Italy, where they build this type of equipment all the time, we might have had different results, but that water is past of the dam at this point. So this doesn't do anything to change the capabilities of Belleli. It was more of air start-up cost issue in a new facility.

How about the Kazakhstan, a little more color there. It sounds like the installation was the problem area. Could you spend a little time on that for us?

The installation was the biggest part of the issue there and that is a job that we probably went a little too aggressively to get into a new market area and took a job that we probably hadn't done enough homework on with all the issues in doing business in Kazakhstan and we had some surprises early on and they manifested themselves over the last quarter and we got to this point, which we also believe is a full summation of the cost of this project going forward. So this one is definitely a learning curve on a sales project in Kazakhstan, new market, new customer, and the installation bit us and bit us badly.

One more, if I may and I will get back in line. The departure of the Chief Operating Officer, was he under any kind of contract and did it have more term on it, and does he have a non-compete clause?

Nobody is under contract at Exterran. And I'm looking for the non-compete clause, he's got a change of control agreement at the merger and as part of that he's got a non-compete agreement for a while.

Very good. I will get back in line. Thank you.

Thank you. We'll go next to Geoff Kieburtz with Weeden.

Good morning. I also want to ask about the fabrication costs overruns and just to clarify here as to whether the charges taken were because of performance deterioration during the quarter or whether any part of this was related to the post-merger review of probings already in-house?

No, this was all related to realization in the quarter that we had cost overruns in these projects in Dubai that I already talked about and as we began to go into execution on the Kazakhstan projects it became apparent we're having cost overruns there, too. It all occurred in the last quarter. No, it has nothing that has to do with project review. One of the projects, the Belleli project was on the books at the time of the merger, the other project for Kazakhstan was actually booked since the merger.

Okay, and I think Steve, you mentioned in your comments that you instituted procedures and policies that will reduce the risk of these kinds of problems recurring and I wondered two things, could you clarify this S that for both total solutions projects, as well as fabrication sales projects? And can you give us a little bit of sense as so what the nature of those new policies and procedures are?

Well, yes, they are comments to both. When you bid a job like that it's immaterial to us whether it's a sale or contract operation from the risk-assessment and project management side. And we have significantly increased the rigor around product analysis, risk analysis, certainty around cost, contingency control, margins that we're willing to take, and have put, I can't explain how much more discipline we have in the process now than we probably had nine months ago when some of these jobs were first coming through the system. So I have a high degree of confidence that jobs post this Kazakhstan job and the new ones that we just booked will be executed at the kind of margins that we'll be proud of and we'll be reporting those when they are occur.

Would you say the problems on these two projects were more at the up front contract -- you kind of mentioned not doing enough homework and so on, or were they really operational, because you did mention sort of Dubai being a first-timer in this type of project?

They are each different answers. On the Belleli's project that's operations, we just didn't execute because we didn't have the people with the experience to build it the way we needed to build it in Dubai and we're kind of paying the price for that. We had manufacturing issues there that ate up man hours and ate up material.

In the Kazakhstan project, that was up front poor estimating of the real cost of doing that job and running into the real cost later on when we came in pretty aggressively to capture a new project. So I think it was risk assessment and cost analysis and certainty of cost before we went in.

And quickly a question on the North American market. I do appreciate your comment about the difficulty and precisely forecasting when margins can get back to an acceptable level, but can you share with us at least an approximation?

Well, I gave you an approximation. You think I just gave you a forecast that I told you just can't give you . What we've said is and we'll be consistent with this and I am still believing it -- that over 2008 we're going to continue to improve North America. And we have, I think, guarded the last two quarters with don't expect things to change a lot over 2008. By the end of the year, hopefully, we're seeing some small gains in margins in North America. But our focus right now is on the revenue side, stopping the horsepower loss, and making certain that we're beginning to participate in our share of the market. The cost improvements will help us towards the margin goal, but it's too soon to tell you if we're going to get there in the third quarter, fourth quarter, second quarter of next year. We'll just have to take it a quarter a

Okay. Thank you.

Yes.

We'll take our next question from Sharon Lui with Wachovia.

Good morning.

Good morning, Sharon.

This question is for the MLP. When you guys are setting the distribution for the third quarter, would you consider raising the distribution above the $0.15 accretion given your high coverage ratio right now?

Sharon, I think we're going to have to look at that whenever we get to the third quarter and we see the performance. We think the transaction is going to be $0.15 accretive, we have also said that -- to date we have generally relied upon the drop-downs to provide distribution growth for us, but we do certainly have high coverage ratios, but we'll have to take a look at that a quarter from now.

Okay. And I guess looking to the third quarter, you mentioned that you expect the margins for North America to remain relatively flat. Is that the same type of forecast for EMLP?

Yes.

Thank you.

And we'll take our next question from [Christopher Gillespie] with Simmons & Company.

Good morning, guys.

Good morning.

My question pertains to North America and going back to the margin question. Last quarter kind of we talked about a lot of issues with the rising costs and labor, lube oil and diesel and I was wondering what are we seeing now? Is that going to -- with North American costs down $2 million quarter-over-quarter, can we expect it's kind of being mitigated by the synergies or what can we expect there?

I think the costs are still increasing. There hasn't been any let up on labor cost increases. Certainly, lube oil, et cetera, is still on the high-end of the range, so I can't say that that has reduced itself. I would say all the gains we made in the second quarter were just streamlining the operation, getting more efficient at what we do and basic execution and blocking and tackling. Scheduling people better, taking care of the units better. So I'm optimistic that that beginning change, the little flip we have seen in the second quarter is representative of what we're going to continue to see.

Okay. That is it. Thanks a lot.

We'll go next to [Glen Primic] with Broadview.

Good morning. What are the return on capital assumptions for the recent international project?

They are very much in line what we have historically talked about and in international we're look at returns on capital on an unlevered basis in the high teens getting into the low 20s.

Okay.

They are in line with that.

And then in North America I guess over time you think you can earn your cost of capital there?

Absolutely. We do very well in terms of incremental fleet investment and what kind of returns and revenues and margins that we get on new fleet investment.

Okay, and then current lead times, if I was going to order 1,000 horsepower unit and I had to call up Cat and had to call up [Barrial], what would that take to get delivery from them and then put the skid and stuff together?

If we have to go back to the manufacturers to get the engines and compressors, we would be looking at six months to deliver that compressor to you at this point in time. But we -- a lot of fabricators have engines and compressors coming through that we're fabricating along the way. So we're generally quoting shorter lead times to customers now because we have inventory coming in that we can apply to it. Two or three months to get a compressor to you instead of six.

If I was competing against you, would it take me longer to get one with higher horsepower versus when you could receive it?

Generally it depends on who has inventory and shop space, but since we have such a large allocation, we have a pretty good advantage on delivery most of the times. So I would say that we would be as competitive as anybody on delivery.

Going back to Mike Urban's comment, not only with your stock -- I think be trading under liquidation, but for someone to put together the whole fleet it would take them anyway, on top of that?

Absolutely.

All right. And what percent -- are you starting to book business in the US for '09?

Yes. There is some business coming in definitely on the fabrication side. We're booking a lot of '09 business with longer lead times and on contract units, some will be starting in '08 or '09. Yes.

Okay, and those customers that buy direct, they just come through your fabrication side or do they go back through your supplier base and then put a unit together themselves.

No, the supplier base is just going to refer them to us or one of the other fabricators that distributes for the supplier. So either Cat or [Area] would send them back to us. They don's sell engines and compressors direct to third-party users.

Okay, and any pre-existing contracts at all from the Universals and Hanovers, all that, that's all been converted into Exterran contracts.

Yes.

Yes, there are pre-existing or yes everything's been converted?

Everything's been converted over to Exterran at this point in time.

Okay, thanks.

We'll take our next question from Paul Carpenter with Semafor.

Good morning, a few questions. The first one -- not to beat a dead horse too much on the value of the Company relative to the cost of reproducing the whole fleet, but just like a little more detail on your capital allocation mindset. You've gone out and made this acquisition of these assets recently, the new purchased EMIT whereas it could have been an opportune time to go back and buyback the stock instead. And instead, as you mentioned you did buyback $100 million of stock post the merger since the formation of Exterran. If I believe correctly much higher prices than what it's trading at today. So my question for you is how do you balance that kind of capital allocation decision between making that acquisition, buying back the stock? Is there a way you can dial-down the growth CapEx? I understand for a custom job you can't just take equipment that might be idle elsewhere, but is there a way too get the growth CapEx down maybe to move some the idle equipment in North America internationally as you see with some other field service companies?

We're actually taking that. If you listen to the comments, the international utilization went up because they are reapplied some existing equipment into their market and in the North American market the first place we look for equipment is the idle fleet and to that end I would say the last three months or so, four months maybe, we have become more more aggressive on refurbishing existing units and putting them on ready line to get them to a customer very quickly. And it's tall about keeping existing outsets utilized. The only place we're building new assets is in horsepower category where we're essentially utilized and the market is absorbing more and that is the 1,000 to 1300 horsepower range. So the new investments are going there where the returns are just outstanding and we don't have assets to cover the market on where it sits.

On the allocation of capital between stock buybacks and acquisitions and what not, we do continually look for acquisitions that fit our long-term game plan for the Company and yes, we do internally balance our available cash and make conscientious decision where we're going to spend it. The EMIT Water Technology we have been talking to for a while and they are at the very beginning of coal bed methane gas production and their customers are largely the customers we do business with later with on the compressor side. To get the gas out of coal bed -- operations -- to get the methane to flow, you have to take the water off and these folks have developed a wonderful technology to do that and they do it on a contract basis. Not on a sales basis, so it fits our contract operations, gives us earlier entry into coal bed methane projects and over the long term should help us around the world in produced water from coal. So we thought it was a strategic fit and made sense and that is how that acquisition came about.

Michael, I will let you comment.

No, I think with regard to capital allocation, I think we have typically said we like the returns in our business and would like to reinvest those into things that make a lot of sense. We think EMIT makes a lot of sense, we think international contract operations -- these new jobs make a lot of sense, as does continued sective investments in the US market. That being said, it's a business that in this last quarter basically generated $53 million of free cash flow that we used to pay down debt, despite some of the growth opportunities that we had. So there is probably some opportunity to do both.

And just another question, if I could. With the utilization in the US, it's my understanding having the universal side of the business since the transaction that created it, which I think was about 10 years ago -- that the North American utilization now is in frankly the very low-end of the range, and in a price environment for natural gas, which compared to the last 10 years, is a much favorable price environment. Anecdotally I heard stories about customers who have been leaving you frankly because they can't get the sales person to return their call because of problems with integration or such from the merger and that is surprising to me given it's now been something like a year, a year since the merger. So what can you do to address this some what can you do besides pulling in a new COO in charge of the North American business?

A new COO in charge of that is not going to change that dynamic. We have been aware of that as well over recent months. And the answer to that was contained -- encrypted in my comments and that one of the major things we have done in the last 90 days in North America is aggressively reassess our sales effort and we have put additional increment sales talent in placements, we have gone through an intensive training of every sales person in North America and we have added a substantial amount of new management talent -- sales management talent into the organization to stop exactly those kind of issues that you are bringing up. Because they are very painful. When you hear a customer that is not getting calls returned from a sales man, you can't stay in business very long. It's not a complicated business. It's pretty straightforward. You call on the customer, you have the equipment, you execute your operations and do a good job and you get more business. We're are at the low-end of our utilization. The market has taken -- the competitors have taken market share from us in a robust and growing market. There is nothing that can I do, but agree with that. All I can tell you is that the entire effort of our North American group is around change that and I think we made some significant progress. We got our costs reduced in the second quarter and we also began to trail down on releases in the second quarter. It's a long answer and more than you asked, but hopefully it's fulsome for you.

The point I was trying to get to, it's been a year since the merge and Wall Street is your worst friend at the worst of times. They love you when you're doing well and they push you to buy back your stock at any time. Now you are in an environment where you haven't been doing well. The stock trades at a discount -- what it looks like the value to replace the Company and disregarding what people may have urged you to do back when you were buying back the stock a year-ago, post-merger, now I guess I just don't understand why there is not more urgency either to rush to fix the business more aggressively in North America or to push for a big drop down to the MLP because if there is ever a time to give up a bid on the financing rate there and the cost for the drop-down to buy back the stock, it sounds to me that this would be a very accretive investment for all your shareholders and you wouldn't have to take the risk of Belleli not being able to execute on a project or you are buying a business which you think is good but dont' really know. Your buying your own assets and you should know them better than any other assets. To me it seems like a low-risk play and I don't understand why there is not more enthusiasm or urgency about that from the management team.

I with an to take the first one off the table and you made an indication that maybe there wasn't enough urgency around the situation in North America and I would invite you to come talk to the North American people around the sense of urgency that we have around the issue. It's not that we're ignoring it, not taking action. I think the plans have been well-thought out and they are being implemented and we're making progress.

On the second point, we just completed a drop-down, which was only a week and a half ago. So I think what you suggested is worth us considering. We have had several suggestions on how we can be more aggressive on stock buybacks. Interest is no one more upset about the value of our stock than we are, but I would also challenge you that the comment was made that we're not executing very well and I agree with that in North America. At the beginning of merger what we said is that we're going use North America cash flow drop-downs into the MLP to fund some extensive international growth and that would be a big catalyst for us. I to suggest that we're executing extremely well in that regard, finding new projects, moving to contract operations and getting new projects on the books. So I think in some areas we're doing fine and some areas that we need to have some improvements.

I will let someone else ask a question. Thank you.

Thank you, we'll go next to Rick Johnson with Thai Capital.

Thank you, I assume it's the Kazakhstan project that is 50% complete, is that correct?

Correct.

Now your ability, your visibility, I guess, on estimating those costs at 50% complete in that area of the world, how do you feel about that? Because I have seen lots of these types of situations where the costs continue to escalate; the estimates continue to get worse, and the charges don't stop.

Now we have been through that contract and when you are 50% into one of these turnkey contracts like that, you have got your hard cross hammered and now we have the firm prices on installation. We have the firm prices on transportation and all of those add-on costs that we didn't have nailed down as well as we should have at the bid time. We know what it's going to cost and that is how we got to these numbers today. And I think we scrubbed it about well as you can scrub a project.

So you think you have the installation costs set? I think we have the installation costs set?

I think we have the installation cost for what we have proposed to build at this time is set, yes. Now there is always risk. We are in a new country. There are unexpected things that happen. You never know what is going to end up. You are correct about that, but from what we know and where we are today, we took everything that we thought we needed to make this become whole for that particular job.

Okay. Thanks.

Sure.

We'll take our next question from [Hamlin Thompson] with Westfield Capital.

Thanks for taking my call and just a quick question on what competitors are doing on pricing on North America contract and market. I understand that (inaudible) cost pressures that (inaudible). Are you seeing any of them raising prices and do you expect to follow that any time?

The only one -- the only place we have seen price increases that we're able to document is a competitor that is in the small horsepower segment who indicated they were going to raise their price by a few percentage points. I can't say that we have seen a tremendous amount of pricing improvement in North American market, nor have we seen pricing erosion. We seem to be sitting on these prices right now and I suspect there are a couple of reasons. I think our competitors are enjoying taking market share from us right now and with that market share erosion, we're in a weakened position to go out and try to increase price and drive the market. So we're kind of in a balance where the market seems to be sitting tight with where it is.

And just remind me, historically what has pricing been in this business, is it inflationary year in and year out?

Yes.

So would you expect to -- and I'm assuming pricing hasn't moved at all this year. Would you expect to go back to that inflationary pricing next year?

If with were in a more normal market and not suffering the erosion that we suffered we would be going to our customers now and asking them for cost increase adjustments to cover our labor costs and lube oil costs. We just don't feel strong enough to do that right now. We need to execute better first.

Thank you.

We'll take a follow-up question from Robert Christensen with Buckingham Research.

Thank you. Many of the EMP companies are siting the overpressured nature of the Hainesville Shale? And no immediate need for compression. What are your thoughts there?

We have had some success in the Hainesville Shale, so it can't all be overpressured. I'm going to have to claim ignorance on that detail at this point in time. I haven't paid close attention to that play.

Where is most of your new horsepower going then? I mean try to track you around and find you in the Fayetteville Shale. I don't find much entry there. There so where is most of the growth coming from for Exterran domestically?

Some of is coming out of the existing basins we have served for a long time and we're seeing a nice uptick in the Northeastern US and beginning to see a nice uptick in the northern Rockies as well. Basically the Rocky Mountain area, out in the west and up to the east are areas where we have always been strong and we're see something nice growth there.

The backlog that you provide us in the press release, what was the amount related to Belleli?

It was about $600 million.

And if I looked at the total backlog of the Company compressor fab and production and processing, how would those break-out between domestic and international?

I think it's probably about a 50/50 mix when we look at those two segments for that, which is not much of change that we've talked about historically.

If I might -- maybe I'm a little confused, when you site that you have $120 million of annual revenues in your backlog related to international, how does that tie to the backlog that you have published? I guess that's what you're going to build and this is what you're going to be seeing in the way of future revenues related to the rental of equipment. I'm just not totally clear. If you could just help me in that.

I'm glad you asked that question if you're confused about because we don't want anybody to be confused. The backlog numbers that we put out in the press release are fabrication backlog and that's the number that today is $1.1 billion and up until this point you and I have been talking about that -- $600 million of that is Belleli -- and the split -- international and domestic on fabrication, on compressor fabrication and production and processing.

Completely separate from that is a number that we talked about in our call that typically the international contract operations backlog, that number today is a little bit north of $120 million of annualized revenue, is how we measure that. So today we talked about 2008 international contract operations being about a $500 million revenue business. We have another $120 million of annualized revenue that we will be adding to that, that is in backlog -- firm backlog for us today.

And Bob, on the fabrication side, all that fabrication is sold to third parties. That does not include anything we build for ourselves.

Okay, and then I guess -- another one. You hired more management for the domestic business that was a big part of your first quarter conference call and here you are saying you have hired more people. Who are these people? Where did they come from? Other companies that they worked for in the compression business? Who are these people? How many? What is the cost of this management initiative towards the domestic?

Bob, I think what we said actually at the end of the first quarter, when we went into the second quarter, that we had reassigned a group of talent from Exterran into North America and the changes we made in North America at that time were all internal people who got reassigned from one position to a position to help out the North America effort. In sales, in sales management in the field, there are always hiring, losing people, adding, subtracting. What we have done is we tried to increase then number of sales people and improve the level of sales management that we have holding those people accountable. So I don't know if we need to go into how many sales men we have and how many we hired and where they came from. Some have come from the industry and some have come from outside the industry. I think the issue here is that we are aggressively finding ways to get in front of our customers, communicate better and trying to do everything we can in our brief experience, only 50 years in the business to drive this market forward. So that is where we are.

If I may, certainly appreciate the hands on nature of the Investor Relations effort and the ability to reach out and talk to you and get information, but it seems to me that there is a void between our conference calls. Nice to be greeted and be updated every 90 days, but there there is very little information flow as to what is happening in the way of international business or domestic business mid-quarter. Is there any way your Company could provide more interim updates or information? Do you see a necessity for that? Because I feel it.

I feel the opposite. I think that the shareholders are better served if this management team keeps their head down and keeps moving the ball ahead and report on a quarterly basis, what we've done. The business doesn't change on a monthly basis that is anything major. And I think that we need all hands on deck making this business perform properly.

So I wouldn't say -- you obviously know I'm not in favor of your suggestion at this point in time. I appreciate the idea and I wish we could kind of communicate better with everybody and tell our story on a regular basis but it's more complicated than that right now.

Very good. Thank you.

Thanks you. We'll take a follow-up question from Geoff Kieburtz with Weeden.

This will be a lot easier.

Thanks.

The sales of PP&E in the quarter kind of jumped up. Can you tell us anything about that?

We had customer purchases of some equipment and actually a portion of those were in the MLP. Nothing really out of the norm. That happens from time to time. This one was a little bit bigger than other quarters, but we're always moving in and out of the fleet.

Was that principally domestic?

Yes.

Great. Thank you.

Thank you. And at this time we have time for one additional question. We'll go to Glen Primic with Broadview.

Given the robust demand internationally, and the orders that you have booked that, I guess, start to flow through next year and more it seems like in 2010, your gross profit dollars from the international renal business at some point, I guess, eclipse domestic as we move out of '09 into 2010. Is that a fair assumption?

I think that is too soon. I don't think we can eclipse the US contract operations -- the North American contract operations with international by then but it's certain is on a track to get there at some pointed in time. If we're able to add most of that $120 million by the middle of 2010, we'll have, as Michael said, significantly increased where we are in contract revenue, but I don't think it's going to equal North America. Unless North America going down, but that is not the game plan.

Okay.

Does that answer your question?

Yes, if I kind of flatten out of the North American and I put in $120 million with the given margins where they are kind of at today, the international gets a lot closer towards your domestic -- it doesn't eclipse it. I'm thinking 2010 could be a timeframe where international gross profit dollars are ahead of the domestic.

And that is what we suggested at the time of the merger would be the outcome of this new combined Company, and we're really getting the successes are getting eclipsed by some of the other issues we face, as well they should. But the international execution and demand that we're seeing and the ware we're able to respond to it, I think is just outstanding and it's making us move towards that vision we had when we started.

Okay. And then just lastly in the US , if someone -- are there -- you have a different pricing schedule for rental versus someone wants to purchase, so that potentially you capture a little more maybe on a purchase versus a way to entice somebody to rent more or does that really not

They do, but remember they can buy compressors really air in the US. There's lots of fabricators that build compressors. So you have only so much leverage to raise a price to you push them over to the other side. We do try to balance that though and our first effort is alway to contract equipment. We sell only as a second choice.

How about global alliances? Do you have anything like that in place with the larger customers?

Both companies have had global alliances and regional alliances and country alliances with different customers and probably our biggest is Chevron, it's a worldwide alliance with them and we do work with them all over the world.

Okay, the reason I ask is if I go back to the original conference call when you announced the merger and that last question came from a customer who made it sound like potentially you guys had a velvet hammer, post-integration and everything and it maybe not until you get some of your share back and execute or maybe not at all domestically.

I always find it interesting when Royal Dutch Shell is concerned that Exterran is going to take advantage of Shell Oil Company.

I know.

I am glad they are thinking like that, but somehow I don't think that is going to pan out correctly for them.

That kind of got me excited that they were thinking like that.

Us too temporarily until we figured out it was one guy who wanted a compressor.

Okay. Thank you.

Okay, this will conclude our question and answer session. I will like to turn it back over to Mr. Snider for any additional or closing remarks.

Just a couple of comments, one is that I made an error that we have to correct so we don't have to issue any paperwork after this meeting; and that is that Brian Matusek doesn't have a non-compete with Exterran. So take back what I said before that he might have an (inaudible) control and the actual correct answer is that he does not have a non-compete.

I think other than, that I would just like to reiterate a couple of things here that I think is important for everybody on the phone to understand. This is not a complicated business that we run. It is a business where we take assets and we put them to work and we run them very well. It's all about execution. It's all about customer communication, doing what you say you are going to do, charging a fair price for it and getting it done. We have been doing it in the legacy companies to Exterran for 30 years, 40 years, 50 years. Many of you have been around the legacy companies that we came from and I have talked to them over the years and they have executed well. We're going to get this right. We have enough management in place with a deep amount of experiences to how this business works and what we're going through right now is clutter. We will get it cleaned up. We will get it performing properly and I think we have the right team focused on taking it there.

So with that, I'm going to conclude for this quarter and in 90 days we'll get back together and have a much more pleasant conversation. Thank you everybody for joining us today. I really do appreciate your interest in Exterran. Bye-bye.

Thank you. This will conclude our conference call for today. We appreciate your participation. Have a good day.