Archrock Inc (AROC) 2008 Q3 法說會逐字稿

Good morning. Welcome to the Exterran Holdings Inc. and Exterran Partners LP third-quarter 2008 earnings conference call. At this time, I would like to inform you this conference is being recorded and that 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 third quarter ended September 30, 2008. If you have not received a copy, you can find the information on the Company's website at exterran.com.

During this call, the companies will discuss some non-GAAP measures in reviewing their performance such as EBITDA as adjusted, EBITDA as further adjusted, gross margin, gross margin as adjusted and distributable cash flow. You will find a reconciliation of these measures to the GAAP measures in the summary pages of the earnings release and on the Company's website at Exterran.com.

During today's call, Exterran Holdings will be referred to as Exterran and Exterran Partners as either Exterran Partners or EXLP. Because EXLP's financial results and position are consolidated into Exterran, the discussion of Exterran will include EXLP unless otherwise noted.

I want to remind listeners that the news release issued this morning by Exterran Holdings and Exterran Partners, the Company's prepared remarks on this conference call and the related question-and-answer session include forward-looking statements. These forward-looking statements include projections and expectations of the Company's performance and represent the Company's current beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements.

Information concerning the risk factors, challenges and uncertainties that could cause actual results to differ materially from those in the forward-looking statements can be found in the Company's press release as well as in the Company's annual reports on Form 10-K as amended for the year ended December 31, 2007 and those set forth from time to time in Exterran Holdings and Exterran Partner's filings with the Securities and Exchange Commission which are currently available at Exterran.com. Except as required by law, the Companies expressly disclaim any intentional or any intention or obligation to revise or update any forward-looking statements whether as a result of new information, future events or otherwise.

Your host for this morning's call is Steve Snider, Chief Executive Officer of Exterran Holdings and also Chief Executive Officer and Chairman of Exterran Partners. I would now like to turn the conference over to Mr. Steve Snider. Mr. Snider, you may begin the conference.

Thank you. Welcome everyone to the third-quarter 2008 earnings call for Exterran Holdings and Exterran Partners. Joining me today are Michael Anderson, the Chief Financial Officer of Exterran Holdings, and Daniel Schlanger, the Chief Financial Offer of Exterran Partners.

There is no doubt that the past year at Exterran has been a challenging one. Pulling together two great companies into one has entailed a huge amount of work but we are convinced that the results of creating the world's largest compression service company as well as a premier provider of production and processing equipment and services is worth the effort and we are beginning to see real progress across all of our business segments.

We are pleased that we have largely moved past merger integration and that these efforts have positioned us well to utilize the power of our service network, people, asset base and balance sheet to create profitable growth for our shareholders. Despite the challenging conditions in today's marketplace, we are very enthusiastic about the future of our Company.

I'm pleased to report overall strong operating performance by Exterran in the third quarter as demonstrated by sequential increases in gross margin contribution in each of our North America contract operations, international contract operations, and fabrication segments. We continue to experience good demand for our products and services in an ongoing backlog of new business for our contract operations and sales activities.

As we go through the call this morning, there are a handful of highlights from the quarter that we will focus on as being key success measures for Exterran. First, we continue to make progress in terms of stemming the declines in North American horsepower. Although we lost horsepower for the quarter, the result for the most recent month of September reflected horsepower growth and we think we are turning the corner on this front.

Second, we continued to reduce costs and improve margins in the North America contract operations segment while improving our service delivery and overall customer service quality. Third, our backlog continues to grow. We grew our fabrication backlog within the compression and production and processing product lines and we continued our impressive growth in the international contract operations segment by growing our backlog by more than 10% in the quarter. Fourth, our manufacturing and AMS operations had good quarters and produced strong margins.

Highlighting these success points does not mean that we do not have our challenges which we will discuss over the course of this call. We will continue to focus on making improvements in these more challenging areas and we will remain diligent in attempting to conform our business to any changes that may be created by the uncertainty of today's market.

While we are optimistic about the long-term prospects for our business, the recent decline in commodity prices and the impact of difficult credit and capital market conditions creates uncertainty around near-term activity levels.

While some of our North American customers have announced or currently considering reductions to the 2009 capital spending, we continue to believe there is potential for increased demand for outsourced compression and other services. As we believe our customers are increasingly looking to maximize returns in the face of more limited capital availability, they could favor outsourcing compression and other services to focus on their higher return core operations. We believe Exterran's service infrastructure, strong balance sheet and fleet of 6 million horsepower position us well to capture new opportunities the current market may afford us.

Further, we continue to see positive developments in the international sector, particularly in the outsourcing area and we again added new business to our international contract operations backlog in the third quarter. Given the long-term nature of most international energy infrastructure development projects, barring a significant and extended worldwide recession, we believe industry activity outside North America should remain relatively robust despite the uncertain current environment.

In North America, we believe the relative stability of the existing natural gas production base and the growth opportunities of shale and other unconventional resource plays provide both near-term relatively steady demand as well as long-term growth opportunities for our products and services.

Last month we announced the return of Ernie Danner to our Company in the role of President and Chief Operating Officer. As many of you know, Ernie last served as Chief Operating Officer at Universal Compression Holdings after holding positions of increasing responsibility with Universal from 1998 until August 2007 when Universal merged with Hanover Compressor Company to form Exterran.

He began with Universal as Chief Financial Officer in 1998 and then became President of Universal's Latin America division in 2002, President of Universal's international division in 2005 and ultimately Chief Operating Officer of Universal in 2006. He also served as a Director at Universal during that period and became a Director of Exterran upon completion of the merger. Ernie will continue to serve as a Director of Exterran and was recently elected as a Director of Exterran Partners general partner.

With Ernie's operating and financial experience, he is already adding value to our Company and we are very pleased having him back on board. Ernie is expected to assume the role of Chief Executive Officer of Exterran Holdings upon my planned retirement at the end of June 2009.

From a personal perspective, I am very pleased to have Ernie back. I believe the addition of Ernie to our management team is a real plus for our Company that will lead us to greater success. I could not think of a better person to assume the oversight of this Company from me. With his experience and capabilities, Ernie is uniquely qualified to help us continue our path toward operating excellence, intelligent use of capital and growth of shareholder value. Ernie is already actively engaged in enhancing and growing our operations and while he's not part of our call today, he will begin to be part of our investor discussions in the coming months.

Now I'd like to summarize the third-quarter financial results for both Exterran and EXLP. In the third quarter for Exterran Holdings, revenue was $796 million and EBITDA as adjusted was $193 million. Net income was $37 million or $0.56 per diluted share including merger and integration costs and asset impairment charges that totaled $4.7 million or $0.04 per share.

Fortunately we did not incur any injuries as a result of Hurricanes Ike and Gustav during the third quarter. However, we did incur some property damage and disruption to our operations. Our employees have done a terrific job of handling the challenges caused by these storms. We incurred $1 million for fleet asset impairment charges related to uninsured portions of compressor units lost in Hurricane Ike. We also closed our fabrication facilities in the Houston area for about four days and incurred some disruptions to our aftermarket service operations.

We are pleased with another solid performance by Exterran Partners in the third-quarter. As a reminder, Exterran Holdings owns a majority 55% LP interest in Exterran Partners as well as the 2% GP interest. EXLP provides natural gas contract operations services throughout the United States. In the third quarter, Exterran Partners recorded revenue of $44.4 million, EBITDA as further adjusted of $22.7 million, and distributable cash flow of $14.8 million. These results reflect the impact of the completion of the previously announced acquisition of 254,000 horsepower by Exterran Partners from Exterran Holdings on July 30.

We were very pleased to get that transaction completed in a way that made sense from a financing and distribution growth perspective particularly in light of recent turmoil in the MLP capital markets. We remain optimistic about our expectation that we will be able to continue dropping assets into EXLP in the future as market conditions stabilize.

Last week Exterran Partners announced a cash distribution of $0.4625 for the limited partner unit for the third quarter 2008 or $1.85 per unit on an annualized basis. This distribution represents an increase of 15.6% on a year-over-year basis and includes two months of operations from the additional contract operations assets Exterran Partners purchased from Exterran Holdings at the end of July.

Now I will provide some more detail on our operational performance in the third quarter. Overall, our total Company operating horsepower declined 28,000 in the third quarter equating to about one-half of 1% of our operating fleet. While this performance is still below our targets, we are making progress in stabilizing our North America contract operations business where in the third quarter we saw a much more modest decline of 17,000 working horsepower in the United States. Similar to what we experienced in the second quarter, we generated steady monthly horsepower improvement over the course of the quarter.

We were pleased to have increased operating horsepower modestly during September in the US and based upon current bookings, we are optimistic about continuing favorable horsepower trends in the fourth quarter. We believe much of this improved horsepower trend is directly tied to our focused efforts on improved service quality and customer satisfaction. We believe we are doing a better job in the field and we are getting direct feedback from many of our customers that this is indeed the case.

Further, I believe we are making solid progress on the cost side of improving our North America operations. We are pleased to note that costs continued to decline in this segment totaling $84 million for the third quarter compared to $86 million in the second quarter and $88 million in the first quarter. At September 30, we had a total North America contract compression fleet of 4.54 million horsepower, fleet utilization was 76% as compared to 77% sign at June 30.

On the international side of the business, we continued to generate success in new business development activity for our international contract operations. I am happy to announce we won additional new contract awards that demonstrate the continuing strong demand for our outsourcing services in international markets. During the quarter, we executed three new contract awards expected to generate more than $25 million in annualized revenue for Exterran.

During the third quarter, we started operations on projects in Brazil, Argentina and Oman. While the commencement of these projects reduced our backlog, we were still able to increase our international contract operations backlog during the third quarter from approximately $120 million to over $135 million in expected annual revenues. These projects will generate revenue beginning later this quarter and into 2009 and early 2010.

Our international fleet utilization declined to 92% at September 30 compared to 94% at June 30 on a base of approximately 1.5 million horsepower. Operating horsepower declined by approximately 8000 in the third-quarter due to the ending of projects in Mexico and Africa. Exterran's worldwide fleet totaled approximately 6 million horsepower at September 30 and worldwide utilization was 80% compared to 81% at June 30.

Similar to our results in the second quarter, our gross margin percentage in the international contract operation segment during the third quarter was negatively impacted by higher-than-expected labor and repair and maintenance costs in Latin America. We were also impacted by about $3 million of unusual items including equipment demobilization costs and costs related to inventory relocations. We have a number of initiatives designed to mitigate the cost pressures in these markets and we are confident in our ability to improve margins as we move forward.

I'm pleased that the profitability of our fabrications operation improved nicely in the third quarter over second quarter results when we had some substantial cost overruns in two of our sale projects. Demand for our fabrication services continues to be strong as reflected by brisk inquiry and bid levels and a healthy level of fabrication backlog. Total backlog was $1.09 billion at September 30 compared to $1.15 billion at June 30 with increases in both compression and production processing equipment backlog during the quarter.

I'm now going to turn the call over to Michael to review our financial performance. Michael?

Thanks a lot, Steve, good morning everyone. I'm sure that you have now had a chance to look at our press release that we issued earlier this morning.

I would like to start off the financial portion of the call by commenting on the recent turmoil in the financial markets and also the heightened interest of investors in the financial strength of companies. Now we want to reassure our investors and customers that we believe our financial position remains very healthy, we have a strong balance sheet and sufficient credit availability to fund existing capital projects and also allow us to take advantage of growth opportunities.

We expect that cash generated by our operations will exceed our maintenance and growth capital expenditures for the foreseeable future. In addition, we have significant unused availability of more than $400 million under our credit facilities to fund short-term needs and other activities.

We believe we have a very attractive debt structure at Exterran. We were fortunate that the timing of our merger last year prompted us to refinance virtually all of our debt at a very favorable time in the capital markets. The Exterran Holdings credit facility totals $2.65 billion and the senior secured revolver part of that includes a broad group of more than 30 financial institutions. The Exterran Partners' credit facility totals $433 million and it includes more than 20 financial institutions. We have very attractive pricing and no significant debt amortization until 2011 for EXLP and 2012 for EXH.

The primary debt covenants are a maximum of five times debt to EBITDA at both entities and we also have minimum interest coverage of 2.25 times at Holdings and 2.5 times at EXLP. For the quarter that just ended on September 30, the covenant calculations reflected EXH debt at three times debt to EBITDA and also six times interest coverage while EXLP was at four times debt to EBITDA and just under five times interest coverage. Our total debt with the benefit of interest-rate swaps is about 63% fixed and our average all-in rate today is just a little bit less than 5.5%.

So now let's move on now and talk about the third-quarter financial performance for both Exterran Holdings and Partners and also discuss the earnings outlook for the fourth quarter. Of course due to the merger in August of last year, our year-over-year comparisons are still not especially meaningful and as a result, most of my comparisons this quarter will be against the second quarter as well as the guidance that we provided in our last earnings call. But in general as I go through the performance, our operating performance this quarter was in line with expectations.

If we look first of all at North America contract operations, revenue was $198 million in the third quarter and that was in line with expectations and was up somewhat on a sequential basis from the second quarter due in large part to the inclusion of the contract water treatment business that we acquired during the quarter.

Gross margin percentage in North America contract ops increased to 57% from 56% as costs continued to decline in the segment. International contract operations revenue increased on a sequential basis to $135 million in the third quarter. That's a little above our guidance range of $129 million to $132 million and that was driven by the start up of some new projects throughout the world. In addition, the third-quarter revenues did include about $3 million in benefit from some unusual items including some retroactive rate increases in Argentina and Brazil.

International contract operations gross margin was about 60% in the quarter and that is a bit below the 62% that we posted in the second quarter and it's also below our guidance of the mid-60s and the reason for that is the cost pressures that Steve talked about particularly in Latin America.

If we move to fabrication, we generated revenues of $365 million. That was a little bit below our guidance range of $370 million to $390 million. Gross margin was about 20%. That is somewhat above our guidance level in the mid-to high teens and it is also significantly higher than the second-quarter margin of 10% as the profitability of our Belleli operations returned to a much stronger level.

Compressors represented a bit more than 40% of fabrication revenue for the quarter; Belleli was just a little bit more than 30%; and then the other production and processing equipment made up the remaining percentage of revenues for the quarter.

If we look at aftermarket services, third-quarter revenue was $98 million. That is a bit above second-quarter levels and also above the guidance that we had of $90 million to $95 million. Gross margin percentage was 20% and that again, was in line with guidance.

SG&A expenses were $94.5 million in the third quarter and that is down about $800,000 sequentially from second quarter. We generated $193 million in third-quarter EBITDA and that excludes $3.7 million of merger cost as well as $1 million in asset impairment cost incurred due to Hurricane Ike.

Interest expense was $33 million in the third quarter. That was up from $30 million in the second quarter due to increased debt outstanding and also some slightly higher interest rates in the quarter. We had $6.7 million in equity income from joint venture investments in the third quarter and that was just a little bit lower than the $7 million we had in the second quarter.

We had a $5.7 million of other expense in the third quarter versus $8.6 million in other income that we had during the second quarter. So this was basically a $14 million sequential decrease in earnings related to this line item and it obviously had a large impact on the bottom-line results for the quarter, equated to about $0.14 per share. Now the other income expense line item does include things like currency translation effects, gains on trading securities, interest income and also gains on used unit sales.

With the strength of the dollar against some key currencies such as the euro and the Brazilian real, we did have a currency translation loss during the quarter of about $10 million. So that made up most of the difference. This compares to a currency translation effect of about zero that we had in the second quarter and in the first quarter we actually had a gain of about $8 million.

The effective tax rate was about 34% in the third quarter compared to about 41% in the second quarter. The second quarter if you recall was higher due to losses from the Belleli job that resulted in it being unlikely that we would be able to utilize prior period tax losses in those regions before they expire. We do expect that a tax rate in the mid-30s should be the normal course for us as we go forward.

If we put all this together, we reported diluted net income per share of $0.56 in the third quarter. If we add back the merger and fleet impairment cost, that would increase third-quarter performance by about $0.04 per share. Net capital expenditures for the third quarter were $101 million. Total CapEx included about $58 million in growth capital and about $41 million in fleet maintenance capital.

If we look at the balance sheet, total consolidated debt increased by about $195 million during the quarter due largely to the funding of our acquisition and also stock buyback activity during the quarter. This increased total debt to $2.5 billion and debt to capitalization to 43%.

At September 30, Exterran Holdings' revolving credit facility had $324 million drawn against it. Available debt capacity after taking into letters of credit and also actually just taking letters of credit into account, that got into debt capacity of $388 million and that does include what is available under the ABS facility.

In the last call, we did note that the drop-down transaction with EXLP resulted in improved liquidity at Exterran Holdings and coupled with the reduced price level of our stock, we said that we would look more aggressively at share repurchases during the third quarter. And we did that. We repurchased almost 1.1 million shares of our stock during the third quarter at an average price of about $46 per share and that totaled $50 million. We still have $50 million remaining under our $200 million share repurchase program and as we look at the fourth quarter, we will continue to balance the importance of capital and liquidity in this challenging marketplace against the opportunity to repurchase Exterran shares at prices that we believe are attractive.

I'd like to now talk a little bit about guidance for the fourth quarter. Starting with North America contract operations, we expect modest sequential revenue growth as we anticipate flat to modest growth in working horsepower and we expect margins to be flat compared to third-quarter levels.

For the fourth quarter, we expect international contract operations revenues of $130 million to $132 million with margins in the low 60s. Revenues are expected to be somewhat lower than third-quarter levels primarily due to the end of a project in Mexico and also the $3 million in nonrecurring revenue benefits that we had in the third quarter. If you look at our guidance revenue in the fourth quarter, that does represent an increase of about 17% to 18% compared to what we had in the fourth quarter of 2007.

In aftermarket service segment, we expect that we will generate fourth-quarter revenues of about $90 million to $95 million with margins around 20%. In fabrication for the fourth quarter, we expect revenues of $360 million to $380 million with margins in the mid to high teens. We expect that net capital expenditures for the full year will be around $500 million. That is at the upper end of our earlier guidance range due to the expenditures for our new international projects and we expect that fleet maintenance capital will be about $120 million to $125 million for the year. If we look at the growth capital portion for the year, we should have about 60% of that spent internationally and 40% in the US.

Look for just a minute now at Exterran Partners. As we had mentioned earlier, at the end of July, EXLP did complete the purchase from Exterran of a fleet of compressor units that totaled about 254,000 horsepower. So if you look at EXLP today, it has a compressor fleet of just over 1,000,000 horsepower and that is about 23% of the combined Exterran Holdings and Exterran Partners US contract operations business.

In connection with the closing of the drop-down transaction, the Omnibus Agreement between the two parties was amended to reflect adjustments in the cap on SG&A and operating costs. The SG&A cap was increased from $4.75 million a quarter to $6 million a quarter and the operating cost cap went from $18 per horsepower per quarter to $21.75 per horsepower per quarter. And the termination date for these caps was extended by one year and it is now December 31, 2009.

With the benefit of the cost caps, EXLP generated EBITDA of $22.7 million, distributable cash flow of $14.8 million. This distributable cash flow was sufficient to cover the distribution that we declared for the third quarter by 1.6 times. And by comparison in the second quarter with the cost caps, EBITDA was around $20 million, distributable cash flow $14 million and coverage was 1.7 times.

If we look at the third quarter, even without the benefit of the cost caps, EXLP generated distributable cash flow that was sufficient to cover the distribution by 1.2 times in the third quarter.

In the third quarter, Exterran Partners fleet average operating horsepower was 816,000 and that compares to 652,000 in the second quarter. At September 30, the EXLP fleet had spot utilization of 89%, and as we have discussed in the past, we are converting Exterran contracts to the MLP service contract format and that includes about 92,000 horsepower that we converted during the third quarter. So today we have over 1.7 million horsepower of the combined fleet now covered by the new contracts. That compares to 1.6 million horsepower that we had at June 30.

This total horsepower that has been converted to the service contract form now represents about 39% of the combined US fleet. And lastly, we do expect to file the Holdings' and Partners' 10-Q in the next day or so.

Now before we go to questions, I just wanted to take a quick opportunity to highlight a couple aspects of our Company that I believe make us an attractive investment opportunity particularly in today's uncertain market.

First of all, we want to reiterate that we believe we have a core business model with stable and recurring cash flows. Our production related products and services have historically experienced more stable demand than that for exploration focused energy service companies. Secondly, we believe we have a strong market position. We believe we are the clear market leader in many of the services and regions in which we operate and we are also geographically diverse. If you look at 2008 nine month's numbers, we had about 52% of our revenues from North America and 48% from outside North America.

Thirdly, we believe we have a strong balance sheet and good capital position. We expect to internally generate sufficient cash flow for the foreseeable future to cover our growth and maintenance capital and we also have over $400 million of availability under committed credit facilities. Fourth point, we believe that the long-term outlook for the worldwide growth of natural gas production which is the key driver for our business is very favorable and should provide us with many growth opportunities in coming years.

And lastly, we believe the equity valuations for both Holdings and Partners represent attractive investment opportunities. For instance, if we look at Exterran Holdings, it is currently trading at about 50% of book value and less than five times trailing EBITDA. Meanwhile, EXLP is trading at less than its 2006 IPO price despite having grown distributions by 32% in the past two years and is currently paying a quarterly distribution that equates to an annual yield of about 12.8%.

So in summary, we certainly believe we are well positioned both in our industry and with our financial position and that our equity also represents a good investment with attractive upside potential.

So at this time, let's turn the call over to questions. Operator, if you could do that?

Thank you. (Operator Instructions) [Chris Gillespie], Simmons & Company.

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

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

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

Well, we have a continual backlog of projects in the international market that have a very long gestation period and it's a long book of business, some of which becomes real projects and some of which of course goes away. It is spread through all the places you would expect it to be that we are doing business in now, being Asia, Africa, Middle East, Latin America.

We generally tell you what we come up with and the amount of contract value that we add in every quarter which we did this quarter. But we haven't been disclosing particular projects for a variety of reasons. But we have a pretty full book of opportunities there that we are converting as you can see by the increasing backlog.

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

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

Amazingly, we haven't had a lot of pricing pressure even with this kind of strange environment that we are in right now. So the price has never been the issue. It has really been service quality and as you can see, we are starting to get some of our customers coming back and actually ramping up more horsepower with us. The anecdotal references from our customers have been terrific lately as to what we have been able to accomplish in our North America operations.

So we are seeing more equipment come back -- or go to work rather for our customers, gain more market share back like we did in one month. All we have is September so far to hang our hat on. But we are optimistic judging by the book of business we have, that fourth quarter is going to be strong as well. In general, the customers in North America some of them are cutting back on their programs, some of them are accelerating their programs. They are all over the map as far as where they think they are going to be going in 2009 and I think that just means they don't know yet.

That's all I had.

Brad Handler, Credit Suisse.

Maybe you can just flesh out a little bit more some of the steps you have taken that have resulted in the improved service quality as well as presumably sort of stabilizing from a customer touch standpoint just maybe some extra detail would be interesting to hear if you can do that?

Yes, I will give you some generalities as to what we've done and it's things we've talked about for the last two or three quarters that are now really beginning to come to fruition I think. First of all, I think we talked about two quarters ago that we wanted to increase and improve our sales effort so we have done that and we are seeing some merits from that. I think the biggest portion however, of the improvement has been in our service delivery and service excellence and continually working to make ourselves more user-friendly and more customer-oriented and accessible to customers and listening to customers and what their needs and desires would be a little bit more acutely.

And along with that, lots and lots of training. Getting new people up to speed faster, continually training our field operations people, our management team. And I think that the management change that we made back in the winter of last year where we put in a new North America crew, I think that whole team has done a terrific job in increasing the intensity around accelerating our change. That help you?

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

Brad, really not much. We didn't have much of a benefit at all in the third quarter with regard to fuel prices and part of that is lube oil which really has an even more delayed effect. So we will start to hopefully see some benefit in the fourth quarter.

Okay. So therefore, you would start to attribute I supposed to the training and the efficiencies inherent in having a better trained workforce for the cost reduction?

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

Okay, that is fine. Before I turn it over to somebody else, I was trying to punch up numbers in the model very quickly and I am getting to an EPS for the fourth quarter based on your operating guidance in the low 60s. Is that -- am I in the right ballpark or am I missing something perhaps below the line?

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

Right, fair enough. Great okay, guys. Thanks.

Joe Gibney, Capital One Southcoast.

Good morning everybody. Just wanted to follow up where we stand on the buyback front. We finished 150 out of your 200 as you are looking to your CapEx growth, it looks like 40% of your targeted growth on the CapEx side to North America. Just refresh us here where you stand given where we are in the market and allocation relative to this given the fact that NAV of your fleet alone is certainly almost more compelling than where the stock is now. So curious where you guys stand on that. I appreciate it.

Joe, I think we have been pretty consistent with regard to the fact that we think this is a pretty good business model and we think that the capital that we take a very hard look at and when we put it into projects whether that's going to be in the US or international, we think that is our job. We think that that generates good returns and that is the first priority with regard to capital allocation.

We don't anticipate and don't think it is a good idea to take capital away from the ability to do that. But as we've said, we think that the internal operating cash flow that we generate is sufficient to be able to cover that maintenance and that growth. And then you are posed with the question of what to do with things that are extra? And we certainly have bought back a decent size chunk of stock, $150 million. We've got $50 million left under the existing program.

And right now I think it's just a little bit more challenging time with regard to I think a lot of people are finding that the capital structure and liquidity are really, really important things. We found that to be the case and we are focused on that in third quarter but still felt it was prudent to go ahead and buy $50 million of stock during the third quarter. And we basically have to go through that thought process again in the fourth quarter. And right now, I think it's certainly a challenge because we think our stock is -- represents a really attractive value and we think we have good availability and credit availability but we just have to balance those things as those things go along and it's kind of a dynamic equation.

That is helpful. Curious I know certainly the FX effects can certainly dance around a lot. It's hard to predict. Curious, on the integration merger expense outlook, any other lingering costs as we move into the third quarter on that, Michael?

Not a whole lot. We think we will probably finish up with that in the fourth quarter and we just have a few more people tailing off with regard to exit from the company. But for the most part, that integration has been done, everyone has been notified. If we have anything in the fourth quarter, it would be pretty small.

Last one for you. You mentioned given the current capital availability issues and maybe a customer mindset more towards contract than ownership, certainly in North America you guys appear to be reaching the point where you are stemming some of the horsepower decline there. Any other anecdotal evidence out there about that mindset shifting given this market right now? I'm just kind of curious, any color there. Thanks.

About the mind shift -- the shifting to outsourcing, you mean?

Correct.

I can't say there has been any overwhelming shift. I mean, we have certainly been more successful. I attribute that more internal into the market right at this point in time. I think the market is still a bit confused, as I said earlier, about where they are headed. I wouldn't be too optimistic that we've seen a real shift that the markets now decide they'll do more outsourcing.

We believe it makes financial sense for them to do that. We always have, and we're hoping we'll have more opportunity to tell our story with less credit availability to these guys. So nothing to report there yet that is concrete.

I appreciate it, guys. I will turn it back.

Geoff Kieburtz, Weeden.

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

I'm really glad you asked that question, because a lot of people may not understand the dynamics there. Generally speaking, when you go into a drilling slowdown as we may with commodity prices being a little bit lower here now, in North America we still continue to have fairly stable gas demand. We've not been very good in the past about demand for gas coming off since a lot of it is going to power generation.

And with a stable demand for gas, the flow rate stays about the same, the wells continue to decline. And the bottom line is our fleet stays busy, and our utilization may drop a few percentage points as customers rationalize some horsepower. But overall, we are impervious to the reduction in the drilling.

Then what happens after that is, as we know, the depletion takes its toll, the production falls off, the price of gas comes back up, everybody goes back to work, and then we start a growth cycle. So it impacts us on a growth cycle more than it does on an ongoing basis in North America.

As that production falls off, do you suffer some decline in utilization with a lag effect behind the drilling cycle? Because what you've just described is kind of, I guess, not to be derogatory but conventional wisdom that rig count falls, you guys stay solid as long as production stays steady. But then do you suffer a utilization decline later on as part of that rebalancing effect?

You can, but it's usually modest and it's what I referred to as the rationalizing horsepower of our customers. If a customer has 2000 horsepower out moving their gas and they don't drill any new wells for a year and their production falls off, they may need 1500 horsepower next year instead of -- so they will send a little bit of horsepower back.

It is usually not a major percentage of our fleet that gets turned around in that case. But it does tail off the longer it goes with less drilling and more production declines.

Geoff, stating the obvious here, but I think it's a point that is worth mentioning. If this business does slow down in North America, Steve is talking about the income statement (inaudible), from a capital expenditure standpoint growth CapEx can be pared back in the US, and that generates potentially a whole lot of cash flow if you look at this year. We're spending in the course of $100 million to $150 million in growth capital in North America.

Now we would hope that continues but if it doesn't and there are slowdowns, there's the opportunity to realize that in terms of additional cash flow. It's one of the nice aspects about this business.

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

No, I think there is some validity to that, partially because we have one million idle horsepower that we are preparing to go back to work that we don't have to invest anything in. It is there, it's ready. It can go out and it can take incremental projects.

Secondly, we believe our customers are going to be tighter with their capital and therefore they're not going to buy as much equipment. They will probably outsource more over the next period of time and would outsource things that they would probably have purchased in 2007 or early 2008. So I think there may be a shift that actually helps us a bit. It's hard to say but that is the rationale around here at the moment.

Okay. And the other follow-up was with one million idle horsepower, does that pretty much eliminate any consideration of acquisitions if for instance a competitor were to get into some financial difficulty?

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

And would that be done through the partnership or through the C Corp.?

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

Okay, thank you.

Kevin Pollard, JPMorgan.

Thanks, good morning. I wanted to follow up on your comments on the margins in North America. You've had pretty nice sequential improvement here and your guidance is kind of flat going forward. I'm wondering is that because you feel like you have realized a lot of the cost savings and synergies that you had attempted to achieve in that business and the 57 range is kind of the new baseline going forward? Or do you still see some further improvement on that as we work through 2009?

Kevin, I think we want to be cautious about as we see improvements I think that we've been pretty consistent that over the long term we do expect to see gradual improvements. We have not baked that into the numbers with regard to the fourth quarter in our guidance. I will mention to you that the contract operations business that we bought during the quarter, the water contracting business, is a little bit dilutive to our margins. They are kind of in the mid-40s. So that pulls the margins down just a tad.

But we think that over the medium and longer term, that we will be able to do better than the margin level that we are at right now.

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

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

Yes, and as we have talked before, there is potential for price increases down the road. For the past year and a half or two years, we have not passed those on to our customers. We have kind of eaten the inflation portion of that. And obviously if you pass on a percent or two or something like that to customers, that can help margins as well.

Okay. If I can shift over to the international segment for just a second. The margins there the last couple of quarters have been below expectations. I am wondering with that business growing a little faster than it has historically and in a wider geographic set of markets, are things like start up costs and similar issues going to continually push those margins down toward the lower end of the 60% range versus maybe the mid to higher end that we have seen in the past?

No, we should be back in that mid to higher end over the long term. What has pushed them down somewhat in Latin America I think is the fact that we are a more maturing business there now. There's a lot more overhaul work going on and a lot more reassignment of compressors that are moving around.

But even with that, I think that we probably just weren't as efficient as we should have been for the last couple of quarters and it popped up in that area and surprised us. And in Eastern Hemisphere, I think they are doing just about as well as they can right at the moment with a very diverse geographic spread that you pointed out. They've got a lot of equipment going to a lot of far places with a long distance between them.

So there is some pressure from that but as we continue to build that revenue and get those projects lined up, we should be back up in those mid 60s.

Do most of the various geographies that you are operating in internationally still have similar gross margins or is the Eastern Hemisphere higher than Latin America or vice versa?

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

Okay, thanks. That is all I have.

Mike Urban, Deutsche Bank.

Good morning. You have talked at length about your business in the US and it looks like you have hopefully stabilized the share there and hope to continue to move that forward specific to Exterran. But do you feel like the overall market is continuing to grow and will do so going forward given what you have seen with your -- the cuts out there with your customers?

Mike, it seems like it's going to continue to grow but as I said earlier in the call, I think every company seems to have a different philosophy and a different set of concerns and theories going forward in the ones that I am aware of. I think it is too soon to tell whether they are going to be real conservative in 2009 or not. But I do believe many of them are going to continue their program simply because they've got the gas hedged and they are going to put it in the market and there is going to be some growth from those companies.

So our competitors seem to have a good book of business as well and I think the robust nature of our market and our confidence in the fourth quarter increases just representative of the fact that I don't think the 2009 story is yet to be told.

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

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

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

They are almost all total solutions in that at a minimum they are going to have an installation of a compressor station along with the compressors but the now almost everything we put out has some kind of production equipment or processing equipment with it. The majority of the stuff is total solutions.

Great, that is all for me. Thank you.

Paul Carpenter, Semaphore.

Good morning. I thought your operating results were good especially domestically which was encouraging. I have a few questions. I had a question about the domestic competitors and their creditworthiness. As your customers and everyone is becoming more concerned with credit, is that a way for you to win more business domestically because your competitors are all smaller and I would guess not as well more strongly capitalized?

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

A couple other quicker questions. One was on what you thought the replacement cost would be for your 6 million horsepower. Could you ballpark what you think that would be?

Paul, you really have to take it on a unit-by-unit basis. But you can put it into big buckets. We have talked about in the US market that it is probably a cost of $650 to $750 per horsepower for some of the larger units that we build today. But if you look at some of the smaller units and you look at the 200 and 300 and 400 kind of sizes, you get into $1000 and $1200 per horsepower that it would cost you to do that.

If you look at international where our average horsepower is right around that 1000 a unit, it does cost a little bit more to get things over there and get it manufactured so it's probably more like an $800 or $850 type number. So you can kind of piece of those together in terms of coming up with an average. It's going to be something that is $700 or $800 [for the] horsepower.

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

Probably a mix issue.

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

Okay, thanks. Just the last question, looking at the difference in the last couple of weeks between the trading in EXH and EXLP, I was wondering if you had been contemplating trying to take advantage of that somehow and that while I'm sure you don't want to sell units in EXLP or just a difficult time to sell units of any kind in this market. If you were able to do so even at a less than ideal price, would that be worth it because it would be added firepower to buy back more EXH stock which is even more depressed? Are those the kind of things you are considering trying to think out of the box and at a time like this to try to take advantage of the current stock price of the C Corp?

Paul, we are certainly trying to think of all kinds of different things. I kind of went through the order of priority for us with regard to how we would allocate capital. I would think that selling units that we own would be far down the list of things that we would think would make a lot of sense right now. We do think we are and pretty decent capital position and still have open availability under the existing stock repurchase program.

So although it's an interesting idea, I don't think that we would necessarily put that real high on the list right now. We think that the units are at almost 13% yield are something that is going to change at some point for the better going forward.

Okay, thank you for answering the questions.

Rick Johnson, Tygh Capital.

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

That is correct.

Okay so that is pretty big. If we assume currency rates stay approximately where they are, should we continue to see that kind of hit going through the next few quarters?

It generally happens whenever the dollar strengthens and primarily against the euro, there is a little bit of exposure that we have against the Brazilian real but so far this quarter, it has continued to move in terms of the strengthening dollar so that would say that that number could be negative again. But there was a pretty big movement in the third quarter. So we certainly hope it's not going to be anything of that kind of magnitude but it's obviously tough to predict.

And is that hit -- can you just go through how that hit occurs? Is it revaluation of accounts payable? Is it -- what is the mechanism of how that currency hit you?

No, I think you pretty much hit it right there. It is basically for some of our foreign operations like the Belleli operation where they are euro denominated and Brazil where they are real denominated. They will have some basically short-term liabilities that are going to be dollar-denominated and when the dollar strengthens basically that becomes more expensive for them to repay those. And that kind of flows through and into our other income line.

So it is the change quarter-to-quarter. I mean within sequentially -- so if we were to just stay flat, right, for the next three quarters, if it were?

If you stay flat that number should be around zero.

That number should be around zero. Correct. Okay. And then other differential, because you had a $14.3 million swing Q2 to Q3 in other income, so $10 million of the $14.3 million was currency. How about the other $4.3 million?

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

Do you have any visibility on ex currency but those other all other things going to forward, are those positive, negative, flat, don't know?

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

Okay. Very good. Thanks.

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

I'm just going to make a real quick wrap up here. Most of you have heard us talk as we met and discussed this over the last year that to get these two companies merged and performing properly was going to take a really big effort by all of our employees over the entire calendar year 2008. And we should come out of 2008 a much better company. What I am hoping is that today we have demonstrated our progress along that path. And the fact that we are beginning to deliver what we said we would deliver several months ago.

So with that, I will close and tell you that I will look forward to talking to you first part of next year. Thanks, everybody.