Archrock Inc (AROC) 2010 Q2 法說會逐字稿

Welcome to the Exterran Holdings and Exterran Partners second-quarter 2010 earnings conference call. My name is Sandra, and I will be your operator for today's call. (Operator Instructions). Please note that this conference is being recorded. I will now turn the conference to Mr. Ernie L. Danner. You may begin.

Welcome to the call this morning for the second quarter of 2010 Exterran Holdings and Exterran Partners conference call. And joining me on the call today are Michael Anderson, CFO of Exterran Holdings, and also David Miller and Michael Aaronson. Michael Aaronson recently joined our Company and has been approved by the EXLP board to become the Chief Financial Officer of our MLP effective next week. Michael comes to us with over a dozen years of energy expertise with Merrill Lynch.

As to David Miller, who has been our Chief Financial Officer at the LP level since early 2009, he will be moving to our Dubai office and taking on a primary financial officer role for our Eastern Hemisphere operations. We are really pleased with the work that David has done for us over the past couple of years and know he will make a big difference in the Eastern Hemisphere for our operations. Thanks to David for his excellent contributions to date, and congratulations to both of you.

So in today's call, I will provide some highlights of our recent operating results, including an update on our contract ops business, some comments on our second-quarter fabrication performance, and review of our cash flow performance for the quarter.

Starting with the North America contract operations, we see positive trends in our North America contract operations business. In the quarter activity levels continued to strengthen. And while operating horsepower levels declined by about 22,000 horsepower or a little less than 1%, operating horsepower increased in the month of June, and pending orders for contract compression are at a healthy level. We expect operating horsepower to increase modestly in the second half of the year as we put idle units back to work.

This expectation has an underlying assumption of relatively flat natural gas prices, but the continuation of some higher activity levels in the gas fields in North America. The majority of our increase in activity levels has not surprisingly been in the shale plays, and particularly the Marcellus and the Eagle Ford. And in addition to compression, we are also seeing an increase in demand for our treating and processing plants, as well as production equipment in these shale plays. Pricing levels in North America has held up relatively well as average rates for horsepower were basically unchanged for the second consecutive quarter. And while we are beginning to see some tightening in supply of certain horsepower configurations we continue to aggressively price our idle fleet to make sure it goes back to work. And, as a result, we do not anticipate an uptick in pricing in the near term.

Staying in North America, we experienced higher operating expenses and maintenance capital expenditures in the second quarter as we continue to prepare to meet the anticipated growth opportunities. We are spending additional dollars on equipment make ready costs, including costs related to repositioning equipment and incremental field personnel. These investments will allow us to first meet the requirements of the increasing activity levels; second, to maintain excellent customer service quality and equipment operating rates; and third, to ensure our continued high safety standards in our field operations. And while cost and maintenance CapEx did tick up in the quarter, we remain focused on managing the total cash costs of our operations, and I believe we are doing really well on this front in making good long-term decisions.

Turning to the international contract ops business, our quarterly results were positively impacted by a settlement related to the early termination of a project in Brazil. If you strip out this early termination, our contract ops performance for the quarter would have been right in line with our expectations. Mike will provide you a little more details of this when he goes into the financials.

And while we are disappointed with this early termination on the contract, we see continued growth opportunities for contract operations in Latin America and also with this specific customer. And, in fact, we started two projects in Brazil on the second quarter and have additional operations slated to begin in the second half of the year.

During the quarter, we also added to our backlog a new gas plant project in Mexico, and this project will be owned and operated by us and is supported by a seven-year contract with solid returns. We expect this project to be operational in the first half of 2011.

So overall we believe our international contract operations business will continue to be a strong cash flow generator for us and provide excellent growth opportunities as we move forward.

We had disappointing fabrication results in the quarter with lower-than-expected fabrication revenue and margin. Our revenue miss of about $25 million was caused primarily by project delays, which we do expect to recover in the second half of the year. Our margin erosion stemmed principally from execution problems on two projects, and those two projects resulted in $7 million of additional costs that we did not expect. And while the fabrication business always has been and always will be a little bumpy, we are not satisfied with the execution problems we are having and that we experienced in the quarter and are continuing to take steps to enhance our core competencies in manufacturing and project management.

As expected, SG&A was up in the quarter, due principally to compensation expense driven by the resumption of raises for our employees. As a reminder, we froze salaries in 2009 and took various actions, including the suspension of our 401(k) match, and those will be coming online throughout this year and will increase our SG&A as we have previously guided.

Turning to cash flow, we had another solid quarter of cash flow from our businesses and continue to show strong capital discipline. In total, we reduced our borrowings by $63 million in the quarter, which brings the total over the last 12 months to in excess of $425 million or almost $7.00 a share. And we remain committed to generating free cash flow as an operating principle.

Exterran Partners had several encouraging developments this quarter. From an acquisition standpoint, we announced another accretive drop-down of a little in excess of 250,000 horsepower for a total consideration of $214 million. This transaction will improve the LPs distributable cash flow coverage and its credit profile. We expect to close this in the next couple of weeks and believe this transaction continues our pattern of creating economic value for both Exterran Holdings and the MLP.

From an operating standpoint, partners had another strong quarter, adding approximately 32,000 operating horsepower for the second consecutive quarter of HP growth at the MLP level.

So we believe we are making -- that the investment decisions and the operating decisions we are making in managing our business, while difficult at this point in our business cycle, will yield positive economic results over the medium and long term.

In our North America business, we are ramping up investment in personnel and refurbishing equipment and preparation of increased activity in our contract ops business, our fabrication business and our aftermarket services segment. Internationally we are investing in our engineering and project execution capabilities. And while our backlog has been relatively flat for the last year, when we look further out, we see good demand for our products and expertise as energy infrastructure continues to be built out around the globe.

And despite the near-term market challenges and a difficult economic climate over the past 18 months, we continue to deliver significant positive cash flow and expect to continue to do so. Our business remains tied to the longer-term growth in energy markets worldwide with particular emphasis on natural gas. And with our leadership position in most of our operating markets, we have a great platform from which to grow, and we believe all four of our business segments are well positioned to capitalize on more favorable industry trends going forward.

So now I will turn the call over to Michael for the financial section of the call.

Alright. Thanks a lot and good morning, everybody. I'm sure you have had a chance to look at our press release that we issued earlier this morning. If you have not received a copy, you can find it on our website at exterran.com.

Also, during this call we are going to discuss some non-GAAP measures in reviewing performance such as EBITDAs adjusted, EBITDAs further adjusted, gross margin, gross margin as adjusted, and also distributable cash flow. And you can find definitions and reconciliations of these GAAP -- these measures to GAAP in the summary pages of the earnings release and also on our website at exterran.com.

So, during the call today, Exterran Holdings, as is typical, may be referred to as Exterran, or EXH, and Exterran Partners, either Exterran Partners or EXLP Partners. Because EXLP's financial results and position are consolidated into Exterran, the discussion of Exterran will include partners unless otherwise noted. And also, as you know, the term international for us will be used to refer to our operations outside the US and Canada, while the combination of US and Canada is referred to as North America.

I also remind listeners that the news release that we issued earlier this morning and our prepared remarks here on this conference call and also the related Q&A session will include forward-looking statements. These forward-looking statements will include projections and expectations of our performance, and they do represent our 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, of course, be found in our press release, as well as in Exterran Holdings 10-K for the year ended December 2009, for Partners 10-K ended for the year ended December 2009, and also those that are set forth from time to time in Holdings and Partner's filings with the SEC. And except as required by law, the Companies expressly disclaim any intention or obligation to revise or update any forward-looking statements.

So with that behind us, the quarterly operating performance for us was, of course, mixed as Ernie talked about. We had slightly better horsepower trends and outlook in North America, although our overall financial performance was below expectations. We did, of course, have another great quarter in terms of cash flow. We reduced debt by $63 million, and that equates to about $1.00 per share.

In looking at the results, we will look, first of all, at the second-quarter results for Exterran Holdings. North America contract operations revenue was $152 million in the second quarter, and that's a little bit above our guidance range of $148 million to $150 million. We were helped by about $1.5 million of what we would call non-recurring items such as insurance, proceeds and other benefits.

When we look at the operating horsepower, it did decline by 22,000 during the quarter. That was a little bit better than our guidance and was a small improvement versus the first quarter, which was 29,000 horsepower loss.

Gross margin percentage decreased sequentially to 51%. That was driven by increased operating expenses, which included lube oil, as well as compensation.

Operating cost per horsepower increased about 6% compared to the first quarter, and our total cash costs, which we have talked about, do include maintenance capital, those were up 15% from first-quarter levels. Now, of course, a key component of this increase is the maintenance capital, which for the quarter was $15 million in North America compared to $8 million in North America a quarter ago. So that was the big driver of the variance. Maintenance capital is, of course, higher right now as we're spending more money getting idled units ready to go back to work in this environment.

We had total North America contract compression fleet equating to a 4.31 million horsepower at June 30, and the fleet utilization was 65%.

As we look ahead for the third quarter, we expect North America contract operations revenues of around $150 million. That is going to be fairly similar to second-quarter levels after we exclude those unusual items that I mentioned a minute ago. The third-quarter revenue level would equate to flat to modestly positive operating horsepower levels compared to the second quarter.

We expect flat to slightly lower margins that are going to be driven by continued inflationary cost pressures and things such as increased lube oil costs. We also expect that maintenance capital -- it should be up a little bit compared to the second quarter as we get more units ready for re-application.

Let's switch over now to the international contract operations business. Revenue there was $131 million in the second quarter, and that compares to $110 million that we had in the first quarter. A little bit of explanation here.

In the second quarter, we had the early termination of one of our projects in Brazil. Now this one resulted then in additional revenue and gross margin from this acceleration of about $19 million in the quarter. Also, with the acceleration, we had an additional $1.5 million of SG&A expenses related to the project, $12 million in depreciation expense, and all that results in about a $6 million increase in pretax income.

Now, as we go forward, this specific project had been generating about $5 million in revenue per quarter from our normal operations, and, of course, as we go forward, that is going to fall out of our revenue stream.

So excluding the impact of the accelerated receipts from these projects, revenues were at the low end of our guidance, while gross margin percentage was a little bit below first-quarter margins but really right in the middle of our guidance that we provided for the quarter. Revenues and margins for the ongoing business were certainly helped by the contribution of two new projects, specifically in Brazil. They started generating some revenue in the second quarter, and they also added about 32,000 horsepower during the second quarter.

At the end of the quarter, the international fleet was 1.3 million horsepower, and the utilization rate was 84%.

Now for international contract ops, if we look forward at the third quarter, we expect that revenues will be somewhere between $107 million and $109 million, and that is adjusting for not only the early termination of that project, but also the loss of that project now in the revenue stream going forward. This is a little bit offset by some modest amount of new project revenue.

From a margin standpoint, we expect that margins in the third quarter will be around 60%, in part as the Brazil job that we got the accelerated termination on was generating higher than average margin percentages. As we look forward a little bit more, the international contract operations backlog totals about $40 million of annualized revenue today, and a large portion of that we expect will be placed into operation over the next 12 months.

Let's look at fabrication now. For the quarter we generated revenue of $277 million. Gross margins were 11%. Revenue was lower than expected due to the project delays, while margins were lower primarily due to higher than expected costs on the two projects highlighted earlier by Ernie.

For the third quarter, we expect fabrication revenues to rebound a bit. We expect them to be $280 million to $300 million with margins rebounding a bit as well, and we expect those to be in the mid-teens.

If we look at Aftermarket Services, second-quarter revenue was $83 million. The gross margin was 16%. We saw some higher revenues in North America, although some of those revenues were also at a lower margin really directly as a result of competitive market conditions there. And, as we look forward at the third quarter, we expect that Aftermarket Services revenues should be in the $75 million to $80 million range and margins in the mid to upper teens.

SG&A expenses, they were up in the quarter, $94 million for the second quarter. It is a little bit higher than we had expected, and it was certainly up from the $84 million in the first quarter. The increase was largely driven by the pay raises and other compensation related items, in part from the pay raises that we reinstated in April after the year-long salary freeze, and also some additional investment into our infrastructure and building for future growth, especially in the Eastern Hemisphere.

About $3 million or so of the SG&A expense was not expected. That did include about $1.5 million of additional costs associated with that Brazil project. As we look forward, we expect SG&A expenses to probably decline modestly in the third quarter, although over the medium and longer term, we do expect to see continued higher SG&A to support the infrastructure of our international business.

We had $2.5 million in other income in the second quarter. That was mainly driven by the gain on sale of assets and also currency translation gains. EBITDA was $118 million for the second quarter. That compares to $124 million for the first quarter. Interest expense was $33 million, and within that, there is about $5 million of non-cash interest expense, primarily related to the convertible notes that we have.

D&A, that increased from $92 million in the first quarter to $106 million in the second quarter, and as I mentioned, about $12 million of that increase was related to that Brazil project. As we look forward into the third quarter, we would expect that depreciation will be in the kind of mid to high $90 million type range.

Income from discontinued operations was $39 million for the second quarter. That was driven primarily by the gain from the sale of the two projects in Venezuela that had been previously written off due to the expropriation there in that country. So the net income attributable to Exterran shareholders was $0.28 per diluted share, but taking away the nonrecurring and the discontinued items, we had a loss on a per share basis of $0.33 per share.

When we look at net capital expenditures for the quarter, they were $49 million. When we look at the total CapEx, it included about $35 million of growth capital, primarily for the international contract operations business, and maintenance capital I mentioned that it was $15 million for North America, $4 million for the rest of the business, so maintenance capital was $19 million in total. We expect now that net capital expenditures for all of 2010 will be $225 to $250 million, and that is down a bit from our previous guidance range of $250 million to $300 million.

And of this total CapEx amount, we have yet to commit about $30 million of it earmarked for growth capital for 2010. If we look specifically at maintenance capital, we expect maintenance capital to be in the $70 million to $80 million range for the year, and that is also down a bit from our previous guidance, which was $90 million to $100 million.

If we look at the balance sheet, we mentioned consolidated debt declined by $63 million during the quarter. We went from $2.14 billion to $2.08 billion at June 30. About $32 million of our cash flow in the quarter did come from the discontinued operations sale of equipment in Venezuela, and as a reminder, over the past four quarters, we generated cash flow that reduced our debt balances by $428 million. We are in good financial position from available or undrawn debt capacity at June 30, which was about $664 million.

Now a few comments on Exterran Partners. I think last week you certainly know that EXLP announced the distribution for the second quarter of 2010. $0.4625, that is $1.85 on an annualized basis, and that is consistent with both the first quarter of 2010, as well as the year ago period. Partners generated an EBITDA of about $23 million for the quarter. Distributable cash flow was $13 million for the second quarter, and distributable cash flow covered the second-quarter distribution by 1.1 times.

During the quarter, the Exterran Partners fleet average operating horsepower was just over 1 million horsepower, 1,076,000. That is up a little bit from first quarter when it was 1,060,000. EXLP grew operating horsepower for the second consecutive quarter. Horsepower was up about 32,000 horsepower from beginning of quarter to end of quarter, and that is about a 3% increase.

At June 30, the Partners fleet had a spot utilization rate of 80%, and it totaled about 1.37 million horsepower, and that's about 33% of the combined Holdings and Partners' risk contract operations business.

Also, as a reminder, last week Partners did agree to acquire from Exterran contracts and equipment, representing about 254,000 horsepower of compression and 43 customers. The value of the transaction is about $214 million. That is about $840 per horsepower. The transaction is going to be financed entirely by partnership equity to be issued to holdings, and that total is about 8.2 million common units and 167,000 general partner units.

As Ernie mentioned, we certainly believe that the transaction will create economic value for both Exterran Holdings and Exterran Partners, specifically through enhancing Partners' financial position and also increasing distributable cash flow.

As we look forward just for Partners, we expect that full-year maintenance capital should be in the $15 million to $18 million range for all of 2010. I will also note at this point, as we come back to you on the third-quarter call, our third-quarter distribution coverage will likely be a little bit tighter as EXLP is going to get the benefit from the drop-down operations for only about half a quarter, but it will be on the hook for paying the full distribution on the new units whenever we get to the end of the quarter.

Last comment is that we expect to file both the Holdings and the Partners' 10-Qs in the next day or two.

So at this point, operator, we would like to open up the call for questions.

(Operator Instructions). Brad Handler, Credit Suisse.

Forgive me, I always hate it when people do this, but I did miss actually parts of your comments, Michael. So could you give me again the North America revenue outlook for the third quarter?

Yes, from a revenue standpoint, pretty flat with the second quarter. The second quarter needs to have a $1.5 million adjustment from revenues. So we are right around $150 million. That is our guidance for the third quarter, and that incorporates an outlook for operating horsepower to be flat to modestly up. Margins are expected to be fairly consistent with second quarter, although there may be some pressure to move those downward a little bit with inflation costs.

Okay. Thank you. So given that and just to make sure we are starting from the same point, so, Ernie, you had some optimistic comments about, I guess, it is bidding levels; it's about putting older equipment back to work. Is that more of a Q4 phenomenon then where we start to see some of that benefit rolling into the US ops, or is there pricing pressure that is offsetting some of the volume increases you are looking for?

I think you're right on both counts. We will see more in the fourth quarter. We will move the stuff out in the third. There is always a little bit of a lag in terms of getting a full quarter of revenue, and we still continue to thing there is some risk for pricing pressure. We have not seen it in our numbers over the last two quarters, but we continue to roll contracts just in the normal part of our business, and they are going out at lower prices than what they were on. So that is factored into the equation. We are saying we are going to have more horsepower working, but we also are worried a little bit about net pricing per horsepower.

Understood. Thank you. And then on the margin side, I just want to try to understand a couple of the things we just heard as well. So you are spending some money to retrofit equipment to put it back to work. That is fine, maintenance, but it sounds like there are some operating costs, if you will, issues either to meet higher activity levels or just to meet overall service quality expectations that you have set for yourself? Can you maybe just go through that again? I understand the margin guidance. But just our operating costs, are we in the midst of operating costs per horsepower trending upwards because again of service excellence goals or something?

Yes, it is a little bit of all of that. So certainly as we move equipment around to position it well and anticipate future increases, a lot of what we do there gets expensed, and it gets expensed before the stuff ever goes to work. So that drives up the operating expense in effect for operating horsepower ahead of it.

Also, some of the work we will do gets capitalized as well, so that shows up in the maintenance capital ahead of where it goes. And then the third factor, you are spot on is that we continue to spend money to increase our service-levels, and some of that will continue on. We are committed to providing better service all along, and that is going to cost us a little more money. I think it is going to help us in the long run and it is great investment, but it is going to cost us our operating cost going up a little bit.

Thanks for that and let me just slip in one more, please, a quickie. How much cash did you generate on the sale of assets be it from discontinued ops or continuing ops in the quarter?

We had the $32 million in Venezuela, and we had about $10 million other included in other assets.

Okay. So $42 million of the cash generated in the quarter from that, okay.

I would just -- you may have another question on that. Working capital for us was actually a modest use of cash. We did not get any benefit out of that for the quarter. Actually working capital went the other way on us about $8 million. So I think that fills in the rest of your blank about what we generated from pure operations.

Okay. Thanks. (multiple speakers) Go ahead.

Just to expand on that a little bit more and how we're thinking about the business and evolving it. Sale of assets from our fleet, I think that is going to be for us over the next long period of years kind of continuing operations. We are going to not sell a lot of assets, but as we continue to work on refreshing our capital and keeping and getting our fleet younger, we are going to be moving assets out. And I would encourage you to not think about those is one-time, but as a core part of our business.

Tom Curran, Wells Fargo.

Sticking with the tall cost theme here for North American contract operations, your maintenance CapEx per unit of operating horsepower increased about 90% sequentially. So it almost doubled. And in prior conversations, you have acknowledged that introducing in the field the shift in the focus for managing and controlling costs from just operating expenses to total cash costs that in some cases they might have taken the cuts in maintenance spending too far. And that part of this has been experimental, and there has been a learning process underway.

And so I'm curious, how much of the jump we have seen in the maintenance CapEx per unit of operating horsepower represents that adjustment and would be expected as a new run-rate as opposed to just being related to putting -- gearing up to put some of the idle horsepower back to work?

Yes, Tom, I would take a slight difference in what you said. On a micro basis, I'm sure and I would fully expect that we have people making decisions in the field all the time. Some of them are going to be right and some of them are going to be wrong. I don't think -- and that is just part of making mechanical decisions. I don't think our guys have erred on not doing enough maintenance. I think they are learning, and we are evolving in terms of how we think about this. But I think they done an excellent job. And you're going to make decisions as you go, and we have encouraged them to make those decisions with cash in mind but with service as an equal component to it.

So I don't think a lot of it is from bad decisions that have been made. I think a lot of it is from the fact that you cannot continue to push stuff out forever. And so there is some increased run-rate that will come of this, but our guys will look at service intervals very well, and where they can, they push them out, and where they can not, they execute them.

But that catches up, and there's only so much of that you go. You push it out a year because you can and keep service up. Well, that year goes by, and now you back to kind of that run-rate. And I think that is a lot of what we are seeing. So we will see higher maintenance capital, but it's not going to be back to old levels.

Yes, and just to put some specific numbers to that, I think if you look back at us a couple of years ago, we talked about maintenance capital in the $120 million a year range. We talked earlier this year that kind of a typical, more typical rate would be $100 million with opportunities to make it better than that. And now you go back and you say, okay, where were we at the end of the first quarter?

Well, at the end of the first quarter, we were at about $45 million on an annualized run-rate. We kicked it up this quarter, but we are still less than $80 million. So while you have the increase, I think we want to see that right now because that means we're getting units ready to go out to work. And even at an $80 million type annualized run-rate, just based on this quarter, that is a pretty good number overall in terms of good performance for our fleet, I think.

Sure. And I appreciate both of the arguments you just made. I'm just trying -- and the two of you combined have basically answered it, but it sounds as if the jump we saw sequentially is more a reflection of where we are at in the maintenance cycle, and the normalized expectation as a go forward run-rate has not really changed.

Well, it certainly changed from (multiple speakers) where it was a year ago, but it has not changed from the last quarter. Let me put it that way.

That is what I meant. From the prior quarter, from the new lower target.

And we don't know exactly how much of what we have seen sequentially quarter to quarter is just -- we have done what we can in pushing stuff out and how much of it is getting new ready to go to work because it becomes a little bit of a fungible issue as we optimize units and move them around. But it is certainly some of both.

Okay. And then shifting gears to fabrication, could you please share some color on the nature and root causes of both the delay and the poor execution, and then provide us with some reasons as to why we should be confident that they are unlikely to recur?

Yes, so the delays are kind of twofold, and we have called them delays, and I will tell you they are not all technically delays. I think part of it was that we had not done a great job of really analyzing from a forecast standpoint and guidance standpoint when our revenues would be recognized. And so the percentage -- we are getting better at percentage of completion. So a part of the delay miss is just poor forecasting and not delays on an execution standpoint.

The part that is truly delays are really related to early in the first quarter -- or in the first quarter, we got really busy on the engineering front, and that part led to everything kind of being backed up. And we added engineers, and so I don't expect us to have that again from a delay standpoint.

On the second half, on the cost of margin and the cost, so there were two principal projects we have referred to. One was a major construction project in Nigeria. We have those are up -- that project is 99.5% complete, which means we have got some punch work that we are having to do. But that one should be mostly behind us, and it has been a very painful project and lost to us, involved a huge component of construction, which we are very much shying away from and don't have really in our backlog, other than kind of in some areas where we can really control it.

The other project also was more engineering-related where we did not do a great job engineering -- and doing enough engineering before we went to the shop floor on some compressors that were going into an integrated project. And because we did not do enough engineering on that project -- this was again related to the first-quarter timeframe -- we had to do a bunch of rework on the shop floor, and it led to some inefficiency and cost overruns.

So I think we have solved it. I wish I could tell you definitively. Only time answers these things, but we have certainly staffed up to solve it, and I think we have put in place better systems around analyzing these issues to avoid them going forward.

And it sounds as if those remedies would have mainly been related to the engineering staff (multiple speakers) given the overarching theme to the extent that there was one?

Half of it was engineering; the other half was around the construction management itself. I would call it really the issue there happened two years ago when we accepted the contract we did, and we are executing it, and we are building a fine plant for the customer, but it's over now. So that one was not as much engineering as it was contractually related.

Okay. Great. Thanks for the detailed candor. I will get back in line.

Robert Christensen, Buckingham Research.

The production equipment and treating and all that, we hear so much on the E&P for liquids, etc. Where would we see that in this quarter? Would it be in backlog somewhere? Can you spend a little time on that, please?

Yes, so it does not hit much for us in backlog. We actually have kind of two pieces of this business. We have the Production Equipment, which really is the smaller side of this. The orders come in very quick in turn, and they really never sit in backlog. This is about $100 million a year of our revenue of our business. It has ticked up. That stuff goes to all the shale plays and all the starts, and I think we are seeing good business there and it's going to go.

It is hard to see it in any backlog. You actually see it in the fabrication business that goes, and it has probably upticked a little quarter over quarter. This business generates good cash flow and is an important business to us, but it's equally as important because it gets us on the site really fairly early so that we then get better opportunities on compression on the production equipment.

On the bigger side, the process and treating, what we saw mostly in the second quarter -- and this is the liquids -- a lot of it is the liquids business in both the Marcellus and the Eagle Ford. We did not book a lot in the first quarter, so I don't think it is seen there. But what you are hearing is a lot of the optimism is around what we expect to happen in the next quarter. So there is not a lot in there on the liquids-rich business. We do continue to execute on aiming plants, which are the CO2 treating around the Haynesville, and some of that is in both the bookings and the revenue.

So long answer to a good question, Bob, but it is -- you saw a little bit in the second quarter, and you heard a lot more in tone added toward the third and the fourth.

Mike Urban, Deutsche Bank.

You talked about some of the expenses you are incurring in North America, and it sounds like some of that is moving some assets around and repositioning the fleet. I'm assuming that that includes or is primarily moving assets from some of that slower more conventional gas basins into some of the hotter, more unconventional plays? Is that a fair assessment?

It is exactly right. Yes.

And associated with that, is there some sort of additional infrastructure that you have to put in place, again especially in some of these markets where there may not have been a lot of activity in the industry in the past, or is it truly just related to getting the equipment ready to go and moving that around?

It is not as much infrastructure. We do have some facilities that are undersized, if you will, and we will have to spend some money to get them sized appropriately as the market size has changed. But it really is not as much infrastructure as it is changes in sizing so that as we grow into Eagle Ford and we grow into Marcellus and we grow there, we are having to add people. We add those people ahead, and you end up with some dislocation around. And we are very focused on -- it has not been that long ago from 2007 where we were very challenged on providing great service. So we are really focused on making sure we have the people trained and ready, and we are probably -- you know, for the active business we have today, we don't have all the people in exactly the right spots. So there is some relocation of people and adding of people, and that leads to a little bit of inefficiencies. But we want to make sure that we have high-quality people in the field ready to go for these opportunities. We do not want service issues, again.

That makes sense. That was definitely a problem last time around, so I agree with that. On some of the other costs, more the just underlying inflationary costs, lube oil was certainly one thing that you mentioned. Just given the competitive environment, is that something that you basically have to eat for now, or is the pricing erosion you're talking about more just net? I guess what I'm trying to say, are you able to get that passed through at all, or is that part of what the margin pressure is that we are seeing?

Yes, it's really part of the margin pressure. I mean it is kind of an industry that has way too much capacity. It is hard to pass those through. And there have been times where our customers provided lube oil but not much. And so generally that is on our ticket, and as those go up, they just kind of eat into the margin.

Okay. Got you. And I think that is it for me. Thank you.

Joe Gibney, Capital One.

Just a couple of quick ones for me. Michael, I apologize but did you give any tax expectations going forward?

I did not give tax expectations. In part, they are pretty tough to provide right now. With the kind of negligible to negative pretax income that we have in this past quarter, you can see in this quarter we had about a 0% effective tax rate. So some losses that we did not benefit, and I would expect that if we are on this side of positive income -- so we are having some losses, I think the tax rate around 0% for the next couple of quarters would be very reasonable. If we spring into income, I think that you're going to have some inefficiency on that side as well. And part of that is related to where some of our operations are, still in some small markets for us. We have got some jobs in areas that are still growing, and we will have losses in low tax rate jurisdiction. And there is some fixed cost component when you look at things like state taxes and Texas' margin tax. So the tax issue is a pretty tough one for us to predict right now, but that may give you a few pieces as you look at the model.

That is helpful. And just one last one, I just generally wanted to get your thoughts a little bit on selling equity here in the MLP given the most recent drop-down. Your guys held the ownership percentage certainly higher than where you want it to be. I'm just kind of curious if you can comment there on timing expectations and how you approach that in your strategy for the MLP?

Absolutely. It is a great question, and we started the MLP with about a 50% ownership, and as we have continued drop-downs in what have been tough markets, we have got that up to -- when you look at the completion of this next drop-down, we will be about 75% ownership. That is not where we want to be long-term.

We do have some issues with regard to making sure that we get the case filed on the acquired assets and the audited financials associated with that. So there are probably some timing issues before we could even begin to consider what we do with regard to equity. But where you are going with the question and asking us about it, very consistent with our thinking, which is we don't need to own and we don't want to own and I don't think our LP unit holders want us to own 75%. It would be beneficial over the long term to get more float of those units, and we will just have to look at market conditions and our ability to be able to do that over time. But directly yes, we certainly want to be much closer to that 50-50 place that we started a couple of years ago.

Sharon Lui, Wells Fargo.

I'm just wondering if you could just comment on the acquisition economics of the last drop-down? Is it reasonable to assume that it is in the $90 to $100 of EBITDA per horsepower?

I mean there is no real big differences here with regard to the other drop-downs that we have done. So you have got that number pretty close. I mean if you look specifically at these assets, we talked about the value, the value for horsepower, about $840 for horsepower. The operating statistics for this business that I will give you a little bit of guidance on, the drop-down assets are $30 million to $31 million of gross margins dollars. There is probably $5 million or so of SG&A associated with it, and maintenance capital was $3 million to $4 million. Those are all annualized type numbers or the assets that are going to go into the MLP.

Okay. I guess I was little surprised about your maintenance CapEx guidance for the partnership after, I guess, pro forma for the drop-down. Because it really -- I guess last quarter I think the guidance was 18 to 22, and now it is down to 15 to 18.

Yes, I think it is just a result of continuing to be very efficient on the maintenance capital spending. We have now got two quarters under our belt. I think when we looked at it last quarter, we had a really efficient quarter, but we still had three quarters to go. We really did not bring the guidance down. And now we are doing that despite the fact that we will have a quarter and a half of additional operations with the drop-down. So I think a function of that is just getting closer towards the end of the year and continuing to see that efficiency that we really have on maintenance capital.

Any thoughts on growth CapEx at the partnership for the year?

Yes, we actually have some in the second quarter that equated to I think a little bit less than $10 million. But I'm going to go back to what we have pretty consistently said about North American growth capital, and that is we are going to be very judicious about it in this kind of market. The only time that we would really be looking at doing that, if there are assets that we don't have such as we talked about the processing plants from last quarter or some selected components of very large horsepower units, and we can get those in the right kind of transaction, i.e. a four- or five-year kind of deal, that is where we would look at spending growth capital. So there may be some selected opportunities for that, but I don't know that I would bake a lot into those numbers at this point.

Okay. I guess in terms of the growth profit margin percentage without the cost cap, is your comments, I guess, relating to the [C-Cor] in terms of costs also apply at the partnership?

It does. And I will say that there is a little bit of extra inefficiency right now at the Partners -- at the partnership level that results in the lower gross margin dollars, and that results from the inner-company arrangements that we have got allows for Partners as it needs units to be able to grow its business to lease some of those units, which should be on a temporary basis. But right now they are leasing a decent number of units. That goes into the cost of sales and is pushing that up a little bit. And, as a result, the Partners' gross margin is a little bit less than what you see at EXH.

That leasing issue will over time, I think, even itself out and go away. But right now, as you have got most of the idle units that are available at EXH, a lot of times when the Partners has an opportunity to grow, that extra compression unit is likely to be idle at the Exterran Holdings fleet level, and that is going to typically have us lease that unit initially into the Partners.

That is great. Thank you, Michael.

Tom Curran, Wells Fargo.

A few more I have here. First, could you maybe just do a quick world tour and update us on some of the near-term non-compression-related opportunities you have spoken to over the last year or so? Specifically I'm thinking of the FPSO package opportunity in Brazil with Petrobras and then noncompression sale or contract ops related opportunities elsewhere in the world?

So the FPSO, we continue to work really hard on this and remain excited about it. Brazil is moving forward with their demands. Petrobras is as they developed their offshore reserves. We continue to be well positioned here and excited about that. Nothing hard has landed to date, but it continues to be a good opportunity.

The next place I would go to is Iraq, and these are pre-production facilities, mostly around the oil buildout that is going on there. And I think we continue to be optimistic about second-half bookings that will come there, and we're just really well positioned. And a lot of the engineering and work we are doing in the Eastern Hemisphere is aimed at capturing that market.

We have some contract ops opportunities, which we continue to chase Oman. Mexico continues to be a good market there, Brazil as well. Australia is one we have talked about for some time as they build out their coal scene, opportunities that is a compression cell. Those projects continue to work and continue to get stretched out. None of those have really landed yet to any packagers, including us, but everybody continues to work them pretty hard. That's a very big opportunity.

And then the only other one I would hit, in Kazakhstan we continue to see a lot of inquiries there around treating and processing and building out their -- and taking care of some other liquids-rich stuff.

And then I would add into that I think in North America the shale plays and what we're seeing there has just become very active. They are maturing in ways, and the Eagle Ford all with their own dynamics, but all of them are great markets for us. So those are the kind of world tours is what we are thinking about.

That is very helpful, Ernie, thank you. Michael, just a few housekeeping items here. I just wanted to make sure I did hear you correctly in your introductory remarks. Just for North American contract ops, maintenance CapEx did increase from $8 million last quarter to $15 million this quarter, correct?

Correct.

Okay. And then that was the surge I was referring to earlier. And then turning to fabrication, could you give me the breakout, please, for quarterly revenues between compression and production and processing?

Yes. I think for the quarter the mix was probably a little bit north of 20% for Belleli, about 30% or so for production processing, and about 45% for compression. And most of the mix geographically, if you would just hold below Belleli out of it and you just look at compression and production processing, it was probably 60% international; 40% North America.

Okay. And then turning to orders, could you just give me the geographic split, please, for the orders for both compression and then production and processing?

Yes, I mean the orders for this quarter were kind of split, 50/50 between international and North America. But if you look at what we've got left in the backlog, it is 60% to 70% international stuff.

On both sites?

On both sites.

Okay. That is all I had. Thanks, guys.

[Tareq Usufi], [Fogpoint Partners].

Just a couple of questions. So pro forma this recent drop-down, how many LP units does EXH own of EXLP?

Well, we have got 16 million, and then we will get another 8 million with the drop-down. So get to 24.

And can you give us a sense for pro forma, what the GP cash flow is going to be?

I will tell you what it is right now, and it is -- the GP is getting just under -- it obviously has its normal 2% ownership, and it's getting close to just under 5% of the total cash flow. So I think that it's equating to about $2.25 million per quarter -- per year, I'm sorry. $2.25 million per year in cash flow.

Okay. And where are you going to be in the split pro forma this deal, or where are you right now?

Right now we are at the 25% of split, and it is all dictated upon what the distributable cash flow per unit is. So we are about $1.85 now. The next split level is at $2.10, and then at $2.10 we would get into the 50% split level.

Okay. Can you give a sense for where you are going to be pro forma the deal?

We have said it is going to be accretive from a distributable cash flow standpoint. But we are going to look at the distributions on a quarter by quarter basis in terms of the operating performance, and a lot of that is going to be based upon how the North America business continues to do and what kind of cash flow the LP generates. So that is going to be a question for the LP board at the end of the third quarter. So I don't have guidance for you specifically on that.

And you said that you want to improve the flow of EXLP. Do you guys know -- are you evaluating your options with the 24 million shares that you own at this point?

Yes, we are always doing that, and we will look at it based upon the market conditions. But, as I mentioned a minute ago in an earlier question, we don't want to own 75% of the units on a go forward basis.

And then finally, with the free cash that you are generating, you have been using it to pay down debt. Are there other alternative options that you could consider, including the possibility of buying back stock at some point?

Sure. I think in the near term you will see us continue to delever, but this business does lend itself to having a fair amount of debt. So, at some point, we will have to turn to either growth in terms of acquisitions or debt repayment or special dividends or something. But I think we're still a few quarters or a year away from doing that. In the near term, we are going to keep de-levering.

Got it. And finally, so the reduced CapEx guidance, you're going $2.25, $2.50 relative to $2.75 midpoint before. What has driven that?

It is really efficiency on the maintenance capital. It is reduced efficiency throughout the business in terms of other capital that we spend. The growth capital has not changed that much because we are still -- we have still got in those numbers about $30 million or so of uncommitted growth capital. So most of the efficiency is coming from maintenance and other CapEx.

Omar Jama, Owl Creek.

Ernie, you guys made some comments in the past you've talked about stabilization within the North American compression business, and now you are saying you are seeing some positive trends. You talked a little bit about that, but can you give us a little bit more there and maybe discuss the market share trends? It sounds like you're putting horsepower back to work. You know what kinds of markets you are seeing that incremental demand? And can you just help us understand a little bit because previously it sounded like you were looking for just the stabilization there, but now it sounds like you may be making some positive noises. But I'm not sure.

That is fair, and I will tell you, you got to get stable before you can grow. I would really encourage everyone to pay attention that we have set modest growth for the second half of the year. And so I don't think it is going to be a sea change over the next six months, but we are definitely -- our orders are going up. Our team is doing a very good job, particularly around the shale plays, Marcellus and Eagle Ford. We are growing. We are also growing in some conventional plays mostly in the West.

So it is at a variety of areas. A lot of it is driven by the fact simply that over the last year that all the excess horsepower that was owned by producers has been really put to work. And they have not been -- on the producer side, they have not been investing in new compression. And production levels across the US are up for natural gas, and that will require more compression over time. Some of that has been filled by the Haynesville, which has not taken a lot of compression to date. I still think we are probably six months away from it taking a fair amount. But, as production shifts and as production goes up, compression goes out. And if the producers are not adding it, that is our chance to shine and add outsource compression to it.

So I think that's why we're getting more optimistic over the longer term. We just had enough pending orders that have hit our books that I think we are going to see positive trends for the second half. So it's not earth-shattering to date, but it is positive.

And then in terms of pricing on compression, given the fairly low pricing levels, how are the discussions going by producers on outsourcing versus producers building their own? How sensitive are they to the pricing, or do they not care so much about that and really they just care about having control or just -- they just like owning it regardless of the returns they generate on that equipment.

Well, it is a great question, and it is all over the page in terms of how customers view it. If you stay in the gathering space, it's a little bit of what you said. Those customers want to own.

If you go to the producer area, some have a bias to it, as Chesapeake would. Some have a bias to outsourcing, and then you get the whole spectrum in between. And certainly at lower monthly costs and with lower gas prices, they will tend to outsource more and keep their flexibility. That is the role we play, and so right now there is a time where we should be putting utilization and increasing it. But I would tell you our focus is much more on increasing utilization than it is on getting prices up at the current time. While we would love to get prices up, there is just simply too much capacity out there for us to make that move in the near term.

And then I guess, finally, can you -- I asked about market share. Can you give us an update on how you feel like you are doing now with marketshare?

Well, I think we are competing extremely well. I will not tell you that I think we are capturing a lot of marketshare from our competitors. I think our competitors are also competing well, and everybody is just kind of fighting tooth and nail to grow and take marketshare. But nobody has got a big edge. I think over time with our fleet and the work we are doing to get our idle fleet in good condition and be ready and the fact that we have a variety of quality units at all different sizes will allow us to get marketshare in the future. We have some cost equipment that is fully paid for. Some of our competitors have less of that and have more narrowed focus. So I think I get more optimistic about getting marketshare ahead of us as we go than I am right now. But our team has done a great job at the service action and solving those issues, and then we will start getting marketshare in the future.

Brad Handler, Credit Suisse.

Actually I'm sorry, guys. Let me take myself out of the queue. Thanks very much.

I think we have time for maybe one more question, and then we are pretty much over the limit. So if there is anybody else?

Robert Christensen, Buckingham Research.

When I look at the numbers here in terms of pricing in North America, I did not see much deterioration sequentially in your rates.

Yes, we have had no deterioration sequentially in the last two quarters really, Bob. You strip out -- Michael told you -- as Michael said in his, we had a little favorable kind of one-time stuff that skewed it a little and actually made it look like it went up. It was really pretty flat.

I will tell you pricing has held up relatively well. And so everybody has showed pretty good discipline, but it is aggressive, and so we're being conservative in how we think and talk about pricing. I think there is more risk on the downside than there is opportunity on the upside over the next six to nine months on pricing.

Yes, I was never a price guy for this year. But do you think it's -- will we see some deterioration in your numbers? So far so good it kind of looks like.

Yes, and it's probably better today than it was three to six months ago. There are classes of compression in certain areas where it is getting a little shorter, and I think those classes will start seeing some uptick in prices. And we did not have that opportunity six months ago.

So I think having some opportunities in some pockets will allow us to offset some continued deterioration from rolling of contracts. So we will probably have a better pricing scenario today than before, but it's still far from optimistic.

Thanks, everyone, for the call today and for your interest in, and we look forward to talking to you in 90 days.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.