Archrock Inc (AROC) 2009 Q2 法說會逐字稿

Good morning. Welcome to the Exterran Holdings Incorporated and Exterran Partners LP second quarter 2009 earnings conference call. At this time, I'd 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 second quarter ended June 30th, 2009. 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 can find definitions and a reconciliation of these measures to 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 may be referred to as Exterran EXH 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 Exterran Partners unless otherwise noted. Also, the term international will be used to refer to Exterran's international operations outside the US and Canada, and the combination of US and Canada will be referred to as North America.

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 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 forward-looking statements can be found in the company's press release as well as Exterran Holdings' annual report on Form 10-K for the year ended December 31st, 2008, Exterran Partners' annual report on Form 10-K for the year ended December 31st, 2008, and those set forth from time to time in Exterran Holdings' and Exterran Partners' filings with the Securities and Exchange Commission which are currently available at exterran.com. Except as required by law, the companies expressly disclaim any intention or obligation to revise or update any forward-looking statements. Your host for this morning's call is Ernie Danner, President and Chief Executive Officer of both Exterran Holdings and Exterran Partners. I would now like to turn the call over to him. Mr. Danner, you may begin your conference.

Thank you. Welcome to the second quarter 2009 earnings conference call for Exterran Holdings and Exterran Partners. Joining me are Michael Anderson, our Chief of Staff and Chief Financial Officer at the Holdings level; and David Miller, who is the CFO of Exterran Partners.

In our last earnings call, I highlighted four key issues affecting our business, and I still think these are the right topics for us to discuss. These areas are the status of our North America contract operations business, the outlook for our fabrications segment, the status on the expropriation of our Venezuela operations, and international growth opportunities.

So we'll start with the North America contract operations. In summary, the market remains very difficult. Operating horsepower was down across all of our horsepower classes and all geographic regions in the quarter with the exception of the northeast basin, which showed a slight improvement. And though we continue to see a high level of horsepower stops, the rate of stops in this current market downturn appears to have peaked in March and April, as field optimization activities and well shut-ins have slowed. At the same time, the pace of new starts has remained low but stable, due to the commodity pricing and industry conditions. When you combine those two factors in with the moderating stock labels and stable albeit low starts, we expect continued but less severe net operating horsepower declines in the second half of 2009.

Going forward, there are a few other dynamics that could affect our North America operating levels. We continue to be concerned about the potential for natural gas production declines due to current production levels and storage builds, and we are also concerned about the risk of a sustained low natural gas price environment. On the positive side, we believe that our customers have put to work much of the new equipment that they had purchased over the past several months, essentially all of which was ordered prior to the market downturn, and have also put to work much of their used [auto] equipment through the optimization efforts. Subject to the overall market, it should increase the opportunities to put our equipment to work going forward.

Turning to our cost control efforts, we've done a solid job reducing both operating costs and capital expenditures. We're driving absolute dollar costs out of the system while managing personnel headcount and becoming more efficient on our parts and labor hours. So as you can see from the results, we improved margins in the second quarter, and costs will continue to be a central focus going forward, while maintaining our commitment to safety and service quality. I spent much of the last quarter visiting our North America basins, and these visits have demonstrated to me that while we have been lowering our cost structure, we have also successfully improved our customer service levels. Feedback we are getting from customers is that our level of service is significantly better than a year ago, which validates my belief that we have recovered from the poor service levels that were being delivered during the period following the merger.

During the second quarter, we made a decision to retire approximately 250,000 horsepower compression assets, and this decision was driven by our desire to reduce costs and improve cash flow. While these units may have gone back to work for us over time, we believe that the best alternative was to take these units out of the fleet now, which will reduce our operating costs. Most of these units at higher operating and make ready costs than the rest of our fleet, and we will use their parts in components as replacement inventory. Of the remaining 4.3 million horsepower in our fleet, over 94% of these units have successfully operated for customers within the last 24 months.

So turning to our fabrication segment and first focusing on the compression portion, in North America, bid and order activity for compression assets remains at very low levels. However, on the international side, the bid activity for compression fabrication has been healthier, particularly in Asia and Australia. In our production and processing businesses, we're seeing some increase in inquiries and bookings for our production and processing equipment in North America, particularly in some of the shale plays. Internationally, we were awarded some significant production and processing projects in the second quarter. Finally, our Belleli fabrication operation continued to demonstrate healthy revenues and gross margins in the second quarter. So in summary on fabrication, while certain parts of the segment are weak, particularly compression, we have a diversified business in terms of product and geography. Our backlog was down a bit in the quarter, but we also had over $200 million in bookings.

Now, I'll give you a quick update on the Venezuela situation. As you are aware, PDVSA assumed control over all of our wholly owned assets and operations in Venezuela during the second quarter. As you may remember in the first quarter, PDVSA assumed control over our JV investments. The loss of our assets and investments in Venezuela has resulted in a financial statement loss of about $475 million in the first half of 2009. We believe the fair value of our seized Venezuela operations materially exceeds the historical costs that we have indicated, and we intend to pursue full compensation related to the loss of our expropriated business in international arbitration. In this connection, on June 16th, 2009, we delivered to the Venezuela government and PDVSA an official notice of dispute.

The fourth point will be our international activity. It continues to be a key part of our growth and diversification strategy. We believe that our total solutions approach, featuring bundled product lines and services, provides a competitive advantage in international markets. Our fabrication bookings in the second quarter included contracts to design and build large gas processing facilities in Kazakhstan and Egypt. We are seeing enough international activity, particularly in the Eastern hemisphere, that we are adding significant engineering and project management capabilities in Dubai and in Chennai, India to support our growth and help us execute our backlog of international projects.

In our international contract operations segment, we started meaningful new projects in Brazil and in Mexico during the second quarter. With the startup of these new projects, our international contract operations backlog is now $110 million on an annual revenue, and includes projects in Latin America, and Eastern hemisphere, which are expected to start throughout the balance of 2009, and into early 2010. This existing backlog represents a nearly 30% increase in our current international contract operations revenue, after you take into account the starts that we had in the second, and is expected to effectively replace the contract ops revenue that we had lost in Venezuela. And we'll get that accomplished by the middle of next year.

Now I'd like to discuss briefly two other key focus areas for Exterran -- free cash flow and Exterran Partners. In response to the challenging market conditions, we have taken multiple steps to right-size our costs. We reduced our operating and SG&A costs in the second quarter significantly. We're in the process of consolidating our fabrication activities in North America, and we have tightened controls on capital spending. In North America, our focus will be on putting idle equipment to work, and internationally, we expect lower levels of capital expenditures over the next 18 months, as we complete this large backlog of international contract operations jobs. If we manage our costs effectively, we anticipate our business will generate significant free cash flow.

Finally, Exterran is fully committed to the success of Exterran Partners. EXLP's cash flow generation remains strong in the second quarter, and recent unit price performance of EXLP makes the economics of a potential drop-down transaction between Holdings and Partners much more attractive than even a quarter ago. We firmly believe that the MLP is the right ownership structure for our US contract ops business, and we remain committed to transferring all other US contract operations business to the LP over time. And since Exterran Holdings owns approximately 57% of Partners, we have a strong interest in ensuring the ongoing success of EXLP during these challenging markets.

With that, I'll turn the call over to Michael for the financial discussion.

Okay. Thanks a lot, Ernie, and good morning, everyone. I'm sure that by now, you've had a chance to look at our press release issued earlier this morning. As we start the financial review, it's certainly important to point out that due to the expropriation of our operations in Venezuela during June, the Venezuelan contract operations and aftermarket services business have been reflected as discontinued operations in both our current and historical financial results. So even though the expropriation occurred during June, our second quarter results from continuing operations do not include any contribution from these Venezuelan operations.

And as a reminder, in terms of sizing Exterran's Venezuelan business, during 2008, our wholly owned operations in the country generated revenues of about $155 million, $97.5 million in gross margin, and $21 million of SG&A. So doing the math there, if you take the gross margin, minus the SG&A, that totaled about $76 million. We also generated another $24 million during 2008 that was in equity income from the joint venture. So that's giving you some perspective on the size there. And, of course, during the first half of 2009, we had the total charges of about $475 million related to the Venezuelan expropriation. Ernie talked about us vigorously pursuing the compensation from this loss, and that also includes the claim under our $50 million political risk insurance policy.

Let's now look at the second quarter financial performance for both Exterran and Exterran Partners. In general, the operating performance was in line with expectations. North America contract operations revenue -- that was $178 million in the quarter, and that was slightly below our guidance due to horsepower losses that were greater than expected. Gross margin percentages actually increased sequentially during the quarter to 58% due to strong operating cost management. Cost of sales per average operating horsepower were actually down 6% compared to the first quarter as well as compared to the year-ago figures.

We had a total North America contract compression fleet of 4.34 million horsepower at June 30th, and the fleet utilization there was 72%. If we look at the third quarter, we expect North America contract operations, revenues of $164 million to $166 million, and operating costs per average horsepower to be relatively consistent with second quarter levels. Now, this third quarter revenue level would equate to a horsepower decline that would be a little less than what we saw during the second quarter.

International contract operations revenues were $95 million in the second quarter. Gross margin percentage was 60%, and that was generally in line with the guidance range that we had at the beginning of the quarter. The international fleets stood at 1.2 million horsepower at June 30th. That's after adjusting for the loss of 325,000 horsepower in Venezuela, and the fleet internationally had a utilization rate of 85%. Operating horsepower increased by about 19,000 during the second quarter as a result of increased activity in Brazil, Mexico, and Thailand. Looking at the third quarter, we expect international contract operations revenues will increase to $97 million to $99 million. Margins will be slightly below second quarter levels. The margins are due to a second quarter exercise of a customer purchase option on one of our higher margin contract operations jobs as well as continuing labor cost pressures we see in Argentina.

Moving to fabrication, we generated revenue of $326 million in the quarter, a little above guidance, and gross margin of about 15%, which was in line with guidance. The fabrication backlog declined about 10% sequentially, but is still at a pretty healthy level of $944 million at June 30th. As we look at the third quarter, we expect fabrication revenues of $280 million to $300 million with margins in the mid teens.

If we look at after market services, second quarter revenues there were $79 million. That was in line with our guidance after backing out about $2 million of revenues from Venezuela. Gross margin percentage was 21%. That was in line with guidance. And as we look at the third quarter, we expect to generate aftermarket services revenues of $80 million to $85 million with margins in the low 20s.

On the cost front we incurred restructuring charges of about $8 million in the second quarter related to the elimination of approximately 450 positions in the company, and also the continuing consolidation of our Oklahoma and Calgary fabrication facilities. About half of the positions that were eliminated are reflected in cost of sales, and these actions are expected to enable us to attain operating margins in line with our expected performance. Meanwhile, the reductions within the SG&A groups are expected to reduce SG&A expenses by $3 million to $4 million per quarter. So if you do the math, we would expect SG&A for the third quarter to be in the $82 million to $83 million range.

For the second quarter, our results did include several charges. There was an $8 million restructuring charge I spoke about, a $343 million loss related to the discontinued operations in Venezuela, and also a $151 million goodwill impairment charge related to our international contract operations that resulted from the expropriation of our Venezuelan operations. Lastly, there was also the $87 million non-cash fleet impairment charge related primarily to the North American contract operations. Excluding the charges and the loss on discontinued operations, we generated EBITDA of $151 million for the quarter and earnings per diluted share of $0.39. The EPS figure includes the diluted impact for the conditional shares associated with our convertible debts.

Net CapEx declined during the quarter from $119 million in the first quarter to $96 million for the second quarter. The second quarter total CapEx included about $72 million in growth capital, the vast majority of which was for our international backlog work. We now expect that capital expenditures for 2009 will be slightly reduced, so we are looking at a guidance range of $400 million to $425 million for total CapEx, and that includes maintenance capital in the $110 million to $120 million range. We continue to expect that the vast majority of the 2009 and 2010 growth capital will be invested in international markets. And as a reminder, we continue to see that about $50 million of our 2009 international growth capital is expected to be reduced by up-front payments on contract operations jobs, resulting in the cash number for these expected capital expenditures during 2009 to be more in the $350 million to $375 million level.

If you look at the balance sheet, total consolidated debt was $2.5 billion at June 30th. During the quarter, we did enhance our overall position with the issuance of $355 million of 4.25% convertible notes that are due in 2014. We did use $36 million of the proceeds to increase the effective conversion price on this debt. The remaining proceeds from the offering were used to repay approximately $309 million of secured indebtedness. As a result, available but undrawn debt capacity at the end of the quarter was more than $600 million.

Although the cash interest cost of the new convertible debt at 4.25% is very similar to the rate to the debt that was repaid, accounting for the convertible debt will impute a higher implied interest cost on this new debt. So as a result, as we go forward, we will be reflecting approximately $4 million per quarter in non-cash interest expense, and if we look at our expected reported total book interest expense that we expect to see during the third quarter, this should be somewhere in the $33 million to $34 million level. Our debt with the impact of the interest rate swaps is now approximately 75% fixed, and our average all-in interest rate was just a little bit more than 5% at June 30th.

Let's now look at Exterran Partners. As of June 30th, EXLP owned a compressor fleet of 1.034 million horsepower. That's about 24% of the combined Holdings and Partners US contract operations business. Last week, EXLP did announce its second quarter distribution of $0.4625, and this equates to $1.85 on an annualized basis. This distribution represents an 8.8% increase over the annualized rate that we had a year ago.

EXLP generated EBITDA of $21.1 million and distributable cash flow of $12.7 million in the second quarter. We saw some positive trends in EXLP costs, as SG&A, operating costs, and maintenance capital expenditures were all down quarter over quarter. Distributable cash flow was sufficient to cover the second quarter distribution by 1.4 times, and even without the benefit of the cost caps, distributable cash flow covered distributions by about 1.2 times.

In the second quarter, Exterran Partners' fleet average operating horsepower was 859,000, and at June 30th, the EXLP fleet had a spot utilization rate of 81%. As Ernie mentioned, we believe EXLP is an advantageous part of our strategy, and we remain committed to transferring our US contract operations business to EXLP over time.

And lastly from me, we do expect to file the Exterran and Exterran Partners 10-Qs within the next couple of days. So at this point, I'd like to turn the call back over to Ernie for some closing comments before we get to Q&A.

So real quickly, we stressed on this call that we are currently in a tough market. But just in closing, I want to touch on why I am positive about the long-term aspects of Exterran. First, we are aggressively managing our cost structure to withstand this downturn, and this should lead to increased cash flow over time. Second, we have 1.4 million of idle horsepower that would cost at least $1 billion to replicate. We're optimistic that over the next two to three years, we can generate substantial cash flows from these assets. So we plan to use this free cash flow both from increased cash flow from the idle and our existing fleet to continue focusing our business outside of North America. We are the dominant players in our markets internationally, and the build-out of the global natural gas infrastructure represents a tremendous opportunity for us at Exterran, and we're excited about that opportunity, and it should do well going forward.

I'll now turn the call back over to the operator for the Q&A session.

(Operator Instructions). We'll go first to Mike Urban with Deutsche Bank.

Thanks. Good morning.

Good morning.

You talk a little bit about the impact of shut-ins in the US, and that does appear to being slowing down a little bit. I was wondering if you can characterize what the customers were doing. In the past, they would let the equipment sit there on the assumption that they would reopen those wells shortly. Are you continuing to see them do that, or are they now returning those assets? Can you give us a sense of what's happening with the shut-ins that have been happening in the US this year?

We do see -- and this is -- I I don't think we see any behavior than what we saw in other lower commodity price environments. And a number of the customers are happy to shut in the well and leave the unit there with the anticipation of better commodity prices on the forward curve. But other ones are saying, this well is just not going to be economic in seeing it back. We've seen both, and I don't think it's any different than what we've seen historically.

For the customers that are on-site, do they generally pay the full contracted rate, or is there a stand-by rate associated with that?

I think from a practical standpoint, if we're in the primary term of the contract, we actually will work with our customers to come to an agreeable rate that looks like a standby if we're going to shut it in. For people outside the primary term, we do something that's less than that. Sometimes we just leave it sit there for free; and sometimes, if it's a unit that's in demand, we'll go with a better stand-by rate.

Okay. Great, Michael, I had a question on your guidance for North America. I got the revenue number for the third quarter. Did you stay relatively flat operating cost, and if so, is that in absolute terms?

What we said was operating cost per horsepower.

Okay.

Would be flat. So we think we would be doing a good job of managing our costs on that front.

All right.

That's the guidance for that segment.

Okay. So presumably -- so that would imply, I guess, a little bit lower gross margin. Because you have some fixed costs in there, or no?

No, not necessarily. I think it's really going to depend on where pricing falls out. It could be steady to potentially declined gross margins, not likely to be improved gross margins.

Okay. That's helpful. That's all for me. Thanks.

We'll go next to Joe Gibney with Capital One Southcoast.

Thanks, good morning, everybody. Michael, just on the cost control side, good execution in bringing the G&A cost down -- can you clarify your guidance for the sequential change? I understand for the third quarter, down $3 million to $4 million, $82 million to $83 million; but directionally another iteration of that in the fourth quarter? Did I hear you correctly?

No. We didn't really talk about the fourth quarter. If you look at the SG&A components, we enacted virtually all of the savings in terms of head-count reductions effective July 1. And so fourth quarter would not necessarily have anything that would be beneficial as we go forward. And we do have the off-set, which is some SG&A increase as we move forward from the international side of the business. There are some taxes and operating cost -- I shouldn't say operating costs, but taxes associated with new contract ops jobs that get embedded into SG&A as we bring things online. So we have that working against us as you look into the fourth quarter and into 2010.

Okay. Understand. And, Ernie, if you could, just touch a little bit on the fabrication side, general thoughts on orders? Are we starting to somewhat find a bottom here in this low $2 million per quarter order range, and obviously there will be more of a weight on the production and processing side of your backlog in the back half of this year and looking into 2010? But general thoughts here? I mean, your order indication and interests at least stabilizing. I'm curious on some color there.

It's really a tale of three different markets. On the domestic compression side, it just can't get much lower there. So we don't have much downside there. And we also don't see much upside on the domestic compression side. We continue to see healthy inquiry levels throughout the production and processing side of our business, both in North America and outside the US. Certainly when we execute those big plants outside the US, they have some component -- a major component of compression in them. So we use that to keep our shops running at a low, but running rate.

So I think -- in summary, we see good business, production, and processing. Outside the US, some of that in the US, particularly [Tide 2] as they build out the shale plays and deal with the various components of the gas drain there. And Belleli really continues to have a healthy level of business that's just ongoing and we're pleased with. So is the $200 million a bottom? Doesn't feel like it can go a lot lower in the next 12 months, and we'll see how that goes from there.

That's helpful. I appreciate that, guys. I'll turn it back.

We'll go next to Chris Gillespie with Simmons and Company.

Thanks, good morning.

Good morning, Chris.

First question pertains to pricing. Are we still holding up relatively well in the 1% to 2% range in North America for the contract operations?

Yes. I think, when you run it across the whole fleet, that feels about right. There are certainly pockets where it's more competitive, and there are pockets where we're seeing no particular decline in pricing. So as you model it out and think about it on a quarter to quarter change, that probably feels right for the next six months or so, anyway.

How about with regard to the international aspect of your fabrication orders? Are you seeing those -- are those bids coming in at lower levels, but the volume is staying the same? Any color on that would be helpful.

On the production and processing side outside the US, pricing has held up just fine. If we -- to the extent we're seeing compression opportunities, those are competitive, and we're seeing a little more pricing pressure. And then, I think as Belleli looks at their big jobs, there's enough of a downturn going on. We're seeing a couple points of deterioration there as well. But a big part of what we booked in the quarter and what we continue to be hopeful for on the production and processing, we're not seeing a big decline in pricing there.

Okay. Just one last one. With regard to retiring equipment in the US, what's your outlook in terms of how much more equipment, you deem necessary to -- or that's a viable candidate for retirement going forward?

Well, we took a hard look at it now. If we thought it was a candidate, it would have been retired as part of what we just did. I think the nature of our business is that if we manage this well, we'll have some (inaudible) if units don't run well, but develop. But there's nothing big left, or we would have taken it.

Okay. Thank you very much.

We'll go next to James [Levinson] with Buckingham Research Company.

Yes, Bob Christensen speaking. A question for you. How aggressive are you getting on the Marcellus shale? We see a quadrupling of the rig count. We're looking at probably 2.4 billion a day of gas coming out of here 18 months from now. To me that would suggest a few spot million horsepower -- or excuse me, 1,000 horsepower gets you 5 million a day of gas. It seems to me about 500 compressors would have to go up there. Can you comment about how aggressive you're getting on the Marcellus? Thank you.

Thanks. As I said in the call, the northeast basin is the basin where we did see growth during the most recent quarter. An in terms of being aggressive we are very focused on it. And we think -- we agree that it is a big positive for us as the gas play gets built out. I think there are geographic challenges there that will lead to more compression per unit per gas produced. That bodes very well for us. So we're building out that infrastructure. We're talking to our customers in the area, and so we're very optimistic about it. We haven't seen a lot of compression directly from the Marcellus so far, but if you go forward two years from now, I think it will be a big part of our business.

I just want to make sure that you're deadly focused on it. I'd just go back three years with your predecessor, and saw the Fayetteville Shale coming, and saw basically private companies come in and do most of the business there. And I think you got a real opportunity in the Marcellus. I just want to be assured that you're going to be there in a bigger way than any other player.

I think your comments are very fair, and we certainly would have liked and would love to have a bigger part of Fayetteville, and we do not intend to not have the biggest part of the Marcellus. I was there over in July and talking with customers and with our employees and getting an update on that, and I will be there routinely. We are very focused on it. So I appreciate your comments a lot, and I think they're spot on, and I will use them to spur better performance priorities.

Well, thank you very much. I'll turn the call over.

We'll go next to Tom Curran of Wells Fargo.

Good morning, guys. Nice quarter.

Hi, Tom.

Ernie, have you guys -- I know this is something -- I get the impression you've only turned your focus to studying relatively recently. But have you come up with an estimate within the newer shale plays as the horsepower that's working there has expanded? Have you seen a disproportionate percentage of it being in-house horsepower? In other words, as you look across the north shale plays, as the horsepower work there has expanded over the 12 to 18 months, is a much higher percentage of it owned by the E&Ps than elsewhere in the lower 48?

It's a mixed bag. I think if you think about the two that have the most development -- which would be the Barnett and the Fayetteville, a lot of outsourcing in the Fayetteville, as was pointed out by Mr. Christensen. We didn't participate in that as much as we would have liked to, but it's a big outsourcing part. In the Barnett, it's some of both. And frankly there hadn't -- our view is as that applies to other than the horsepower that Regency has through CDM, there hasn't been a lot of horsepower added yet in the Haynesville or in the Marcellus directly tied to that shale gas. So that part, we're in early stages of trying to effect that decision, and we're very focused on our idle horsepower. And we're going to do whatever it takes to make sure that it gets used as opposed to people building new and insourcing that activity.

Okay. And at what point -- what's the earliest you think we might see an assessment that could lead to another impairment?

Another impairment?

Yes.

We look quarter to quarter on that. So we will be looking at it in a much more rigorous way going forward. Not that we didn't always look at it, but I think we're pretty focused on it. We took the hard part. I don't think you'll see anything meaningful for awhile. As I pointed out, 94%, I think, of our units have worked within the last two years -- successfully worked on customer sites. So there's not going to be another one. That doesn't imply the other 6% is bad. We looked at it as well, decided it's solid compression that we can use. So I don't -- we don't anticipate any more impairments.

Okay. That's helpful. On fabrication, would you please share what percentage of fabrication revenues were production and processing both this quarter and last? And then also Belleli's share of the backlog?

Sure, Tom. I've got at my fingertips this quarter's performance. Last year, I think, was pretty similar. But if you look at the total fabrication performance of $326 million, it's something close to 60% that was production in and processing, about 40% that was compression. And if you look at the backlog, Belleli is just a little bit north of $400 million of the backlog. So about $425 million of the $653 million.

Okay. And last quarter, Belleli was around $525 million, right, Michael?

Yes.

Okay. Great. Thanks a lot, guys. I appreciate the color.

We'll go next to Brad Handler of Credit Suisse.

Good morning, Brad.

Thanks, good morning. Could you please speak to, I guess, international contract operation opportunities and focus?

International contract opportunities -- opportunities and focus. Okay. So our focus right now is really executing what we have. And we've got a big backlog, and we have to get it executed and earning cash flow for us. Opportunities continue out there. I think we are seeing, frankly, a little less today than we probably saw over the last six to nine months, as we built this backlog. So I think it -- there's a good chance the backlog comes down, and that really fits with our near-term strategy of free cash flow. We still see a lot of opportunities for the outsourced model in Mexico, in Brazil, and our classic international growth areas. We're seeing some inquiries in the Middle East region as well. So probably not as robust as what we saw a year ago, but continuing.

Interesting. Is it -- it sounds like the compression fabrication -- well, I guess you're saying those were tucked into the production and processing anyway. So maybe it's consistent with what you're seeing on the compression fabrication opportunity side?

Yes, I think it is.

It is. Okay. But also to some degree a statement of your strategy, perhaps focusing a little more on the selling of equipment versus the outsourcing, the renting?

Yeah. We're making sure that in the next 12 to 18 months, we're going to still look at those contract ops -- opportunities that make sense for us. But we've ratcheted up the required returns to invest in those in the near term.

Okay. Got it. And then just a couple of followups, Michael, please on -- maybe just for Q3, can you give us maybe the depreciation run rate? I just don't want to -- I don't know if I'm looking at something that's got -- it's got some averaging in the second quarter.

Well, in the second quarter, we did have a fairly clean number, because we took Venezuela out of it. So we came in at that mid 80s number. We will have sequential increases in depreciation, because we're spending capital in the international segment. If you look historically, we're typically adding it at a $2 million or $3 million increase in depreciation, and with the spending we've got right now for international, I would expect that to continue.

That's fair enough. A similar sort of question on the tax rate going forward. Still in the mid 30s?

Yes. We're still in mid 30s. We ended up with a little bit lower 30s rate during this quarter. That's hard to calculate when you look at all of the other stuff that's going on during the quarter. But as we look at it, mid 30s is about right. As you change your mix to more international, that rate may come down a little bit. But right now we're looking at 36% ish.

Okay. Fine. Thanks very much, guys.

We'll next go to Kevin Pollard with Decade Capital.

Thanks, good morning, guys.

Hi, Kevin.

I wanted to follow up a up a little bit on Brad's question on the international strategy. It seems like the move back to the servicing more with fabrication as opposed to the contract is a somewhat market -- change in the recent strategy. I'm wondering, do you view that as a temporary thing to generate some cash over the next year or two, or is this what you would characterize more as a permanent shift?

I don't think -- it is not a shift necessarily in strategy. So we believe strongly in the international contract ops model, and we want to continue to execute it. What we've done is take a look at the return levels we think we should be getting on our contract ops business, and we've moved them up. And at the same time, we've done that at a period where the project -- particularly because compression is a little bit down -- the projects just haven't been there as much. Or -- and sometimes it's just a function of timing and mix, and a lot of what we're seeing right now is that, and not necessarily a strategy. Having said all that, we are focused on free cash flow over the next 12 to 18 months. So if we get a project and it's marginal and could go either way from the customer's standpoint, we might move it to the sell side right now, and then just take our cash and go. There's enough risk and unknown out there in today's markets that we think free cash is something we will value a lot. So that's dancing around a lot of your answer, but I think it gives you a flavor of how we're thinking.

As I think about the investment requirements going forward, close to 70% of your CapEx has been for the international growth. When does that begin to tail off? Because most of your backlog you said beyond in the first half of 2010. So do the capital requirements stay at these current levels through mid 2010, and then drop off, or how would we expect that -- ?

Kevin, we have the most intense amount of capital spending for the international contracts ops over the third and fourth quarter; and the guidance we gave during this call is that we still think CapEx will be down a little bit from our prior guidance. But third and fourth quarter will be pretty heavy for those projects. Some of it trips into the first quarter of 2010. And then it really is, for the most part, gone in terms of the CapEx that we have for the current backlog that we certainly hope we will be adding more projects to it, and you'll see some spending. But right now 2010 is looking to be a lighter year in terms of capital expenditures. Part of that is the market, and part is that we did such a good job of adding international contract ops jobs, and the $10 million backlog on a business that is $380 million of total revenue today on a run rate basis -- that's a big increase. So I think it's unlikely that you're going to continue to have 25% to 30% backlog that you're going to be building into the business all the time. So we should expect to see some slowdown, especially after the first quarter.

Okay. So if I think about 2010 CapEx, just real broadly speaking -- I know you don't want to give an exact number yet, but you've got $120 million or so of maintenance capital. Then you've had a growth component in 2009 that will be coming down. Is the right way to think about it is to take that maintenance level, and maybe split -- cut the growth component in half? Or is that too big of a cut to the CapEx?

Well, I think it's kind of hard to look at. That's just taking a broad generalization. I'll try to build it up a little bit differently for you. I mean, you've got this $120 million odd of fleet maintenance. We've got a little bit in terms of maintenance for the rest of the business. Let's just call that $20 million in terms of vehicles and equipment and fab shops and things like that. Let's call international backlog something in the order of $30 million ish that we'd have to spent in 2010, and we'll spend a little bit in growth capital in North America, which is going to be mainly in repackaging and not in new unit builds.

So you add all those up together, and you're probably at a minimum threshold of $2 million. And the rest of it would be dependent on what would happen, if anything good, in North America and probably more likely what's going to happen with regard to international projects we'll be able to book between now and then.

Okay. Thanks a lot. Appreciate.

And we take our final question from William Adams from FAMCO.

Thanks, guys. I just wanted to get on -- I have a question about the EXLP. And a big variable here was the drop in maintenance capital spending for the quarter. And I guess I just wanted to get some understanding. Do you view this lower level of maintenance capital spending as sustainable?

I think there's two things going on. One, we did have a drop in horsepower, so with the drop in horsepower, there will be a little less maintenance. Secondly, I think we're taking a much harder overall company, looking at focusing on maintenance capital. And think we're doing a better job of doing it the right way at some lower dollars. That gets to the point of -- I think maintenance capital in this past quarter is a fairly good number. We may have outperformed a little bit, but I think we can sustain it near these levels.

Okay. Are you looking at on an absolute dollar basis, or relative to horsepower or relative to EBITDA?

The maintenance capital is going to be driven mostly by the horsepower. There's going to be a correlation there.

Okay.

But when -- because of the change in horsepower is not likely to be meaningful one way or the other on a gross dollar basis, that's probably going to be a decent number to be looking at.

I guess when I'm trying to add the numbers up, you said $110 million to $120 million for your entire fleet, and you -- I guess what I'm trying to understand, I think about 25% of your fleet is at the partnership level. I'm just trying to make sure those numbers are -- ?

You have to keep in mind that there is a decent chunk of that total maintenance capital that's going to the international capital markets. So if you look at EXLP, it is fairly close to about 20% of the overall maintenance capital we'd spent in North America, in the US market.

Okay. So I previously had been using around $20 million. So that's just too high for this year.

Well, we would say that would be the top end of maintenance capital for the year. Our guidance for maintenance capital at EXLP for the year is $16 million to $20 million.

Okay. $16 million to $20 million. Okay. And then you all gave guidance for revenues at the parent, EXH. What is your revenue guidance for the third quarter at EXLP?

We don't typically provide guidance for EXLP. But I can tell you that when you look at historical performance, EXLP typically does better from a horsepower standpoint than overall EXH. And one of the primary reasons for that is that if there are new customers to the Exterran family, that they are designated to roll into EXLP. So they get the benefit some of the new growth. And that's one of the reasons why, on a horsepower basis, EXLP has consistently done better than overall EXH.

Right. Were you looking at a similar decline in revenues quarter over quarter for EXLP as for the parent?

No, because if you look at horsepower, again, the horsepower guidance that we had for overall EXH was a decline that would be less than what we saw in the second quarter. And so if you just correlate that over to EXLP, the same guidance -- the horsepower performance should be better sequentially, in our view.

I'm talking about revenues. Revenues -- you gave us a revenue decline of 7% for the parent. I just didn't know if that order of magnitude -- ?

It would be the same thing as I mentioned with horsepower. It would not be as significant of a decline.

Not as significant. Okay.

Yes.

And I know your strategy is to drop down assets. Can you -- and you mentioned that the valuation of your -- of the EXLP currency has improved. Can you just give us a little bit more color about the timing or the economics of doing that? And I guess I'm just questioning, given the very low utilization rate of the assets up at the parent, would that potentially defer the timing of a drop-down? Because I know you like the drop-down assets that have a high utilization rate. So if you can just give us some color on those questions.

I think we've been fairly consistently about never providing timing about when we will do a drop-down. We talked today about the economics with the EXLP unit price have gotten better. So it makes the economics work better with regard to a drop-down. The way we do the drop-downs is we're basically taking customers and dropping the customers, along with the equipment that they're using at that time, into the LP. It's basically 100% utilized equipment when we do that. So I don't know that the utilization rate at EXH is really that much of a factor. And we have plenty of eligible contracts and customers to be able to drop-down significant chunks today if we chose to do that. So I don't really think there's anything that's necessarily negative at EXH that stops drop-downs from happening.

Okay. And could you give us -- you talked about a decline rate for both the parent and the partnership dropping, and can you give us the spot level of utilization rates, say, at the end of July?

Yes. We have it in the press release. We have it at the end of June. And that's typically the only time we do it. You can see the horsepower both on the average for the quarter as well as the ending June 30th number for all the entities, EXH in total, North America, international, and EXLP. But we don't provide any interim numbers outside of the end of the quarter.

Okay. I just -- I didn't know if -- so the rates decline at a lesser rate, but you're not going to give us a number at the end of July?

Correct.

Okay. Okay. Great. Thanks for the call.

You bet.

And we do have one final question from Robert [Wigand] with New Salem Investment Capital.

Hi. Thanks for taking it. Just on the heels of previous callers' questions, I see that the [Dutch] capital at the limited partnership is fairly high still, pushing 70%. Do you have a target for where you would like that to be? And given the recent increase in price, wouldn't it make sense to possibly sell some shares and get that back to a more normalized level?

I think we've been pretty consistent with that. We are a little more leveraged at EXLP than the plan, and that stems from the fact that we did the drop-down from a year ago. We did not sell third market equity. We got the deal completed right at the time of the financial crisis and things started changing a lot. So we didn't get a chance to sell that last slug of equity. And so what you said is, I think, exactly right. We want it to be a little less levered than it is today. We've got equity that we want to bolster it with at some point in the near future, and we're going through ways that we can do that. And that could come as a sale of equity or could come as part of a future drop-down or other things as well. We're with you in terms of the direction we want to go. Just haven't decided on the transaction in which that takes place.

And regarding, I guess, future transaction, would you lean towards the Exterran Holding increasing its equity stake into the LP -- basically taking some stock for a transaction, as well as trying to find some cash for it? And also, again, what would a longer-term debt to capital rate be?

The way we would look at EXLP, we think it is -- the leverage ratio, which we've been pretty consistent, more focused on debt to EBITDA, probably in the 3 to 3.5 range, and we're probably a little north of 4 right now. So that finalizes the answer from earlier. And I would say that we are consistent in our belief and commitment at Exterran to the Partners' business model and moving the assets over there. We've also been very consistent in being an equity provider. The drop-down transactions that we've done, Exterran has either taken half or all of the equity. We would believe that right now, that's probably a likely model in terms of that range, where Exterran would look at continuing to take equity in the partnership as part of drop-down transactions.

Great. Thanks a lot, and great quarter.

Thank you. That does conclude today's question-and-answer session. I'd like to turn the call back over to Mr. Danner for any closing remarks.

No, no closing remarks. Thanks to everyone for participating, and we look forward to the next call in about three months.

That does conclude today's conference. We thank you for your participation.