Archrock Inc (AROC) 2010 Q3 法說會逐字稿

Good morning. Welcome to the Exterran Holdings Inc. and Exterran Partners, LP third quarter 2010 earnings conference call. (Operator Instructions). Earlier today Exterran Holdings and Exterran Partners released their financial results for the third quarter ended September 30, 2010. If you have not received a copy you can find this information on the Company's website at exterran.com.

During this call the Companies will discuss some non-GAAP measures in reviewing their performance such as EBITDA as adjusted, EBITDA as further adjusted, gross margin, gross margin as adjusted and distributable cash flow. You will find 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 or 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 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 in this conference call and the related question and answer session include forward-looking statements. These forward-looking statements include projections and expectations of the Company's performance and represent the Company's current beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements. Information concerning the risk factors, challenges and uncertainties that could cause actual results to differ materially from those in the forward-looking statements can be found on the Company's press release as well as in the Exterran Holdings annual report on form 10-K for the year ended December 31, 2009, Exterran Partners annual report on form 10-K for the year ended December 31, 2009, and those set forth from time to time in the Exterran Holdings Inc. and Exterran Partners filings with the Securities & Exchange Commission which are currently available at exterran.com. Except as required by law, the Company has expressly disclaimed 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.

Thanks very much and good morning everyone. Welcome to the third quarter 2010 earnings call for Exterran Holdings and Exterran Partners. And as usual joining me on the call today is Michael Anderson who's the CFO at the Exterran Holdings level and Michael Aaronson who's the CFO at Exterran Partners. In today's call I will provide highlights of our recent results, including commentary on activities and outlook from an operating basis and some recent developments at Exterran Partners level. Then I'll turn the call over to Michael Anderson for the financial review.

So just in summary, I think we are very encouraged by positive trends in our North America business. Where we believe that activity levels are bottoming with a view for an up tick going forward, although at a relatively slow pace over the near-term due to the current natural gas price environment. In summary, we are just increasingly constructive about the demand for our products and services in North America.

Diving into the business a little bit and moving to review I'll start with a review of the North America Contract Ops business. Operating horsepower increased by 11,000-horsepower in the quarter. And this horsepower increase is a positive sign for the compression market in general.

And we're particularly pleased with improving customer service levels at Exterran and the positive feedback we're receiving from our customers. We believe this improved service quality will lead to more opportunities to put our idle equipment to work in the coming years.

We expect operating horsepower levels to be relatively flat to up modestly in the fourth quarter, although our outlook remains somewhat cautious at these natural gas prices. And over the longer term we remain optimistic about our growth opportunities in the North America Contract Ops business. Pricing levels in North America remain relatively steady. Average rates for horsepower were basically unchanged for the third consecutive quarter. But with continuing idle compression capacity we do not expect higher pricing in the near-term.

On the expense side, operating expenses and maintenance capital expenditures increased somewhat in the third quarter. And this is driven principally by labor and parts increases. Associated with equipment make-ready, mobilization expenses, increases in lube oil costs, and some expenditures to upgrade units to increase reliability.

Trade expenses in particular were unusually high in this quarter as we started some sizable projects that required long distance relocations. We've continued to maintain appropriate staffing levels to be well positioned for expected market growth in 2011 and to continue to improve customer service quality, equipment operating rates, and to ensure high safety standards.

So as a result of flat prices and modestly increasing costs, our margin percentages have ticked down a little. And historically we have seen moderate price increases on the compression operating side to cover this inflationary cost pressures.

But that's not our strategy right now. We will continue to price competitively, delivering increasing levels of service and put our idle fleet back to work to the benefit of our customers. Our idle fleet priced appropriately remains at a competitive advantage versus competitors building new units.

Turning to our North America fabrication business. In North America we achieved a higher level of bookings in the third quarter for both compression and the production and processing business lines. Including compression equipment aimed at gathering applications and production equipment for shale plays.

So I'll turn now to talk broadly about the International markets. And overall new business inquiry levels in International markets remain good, but just not at the levels we have seen over the last few years. Longer term we continue to see attractive growth opportunities for our product and expertise as energy infrastructure continues to be developed around the world. But we have seen our customers delay the bidding and start-ups of these larger infrastructure projects. As a result both International Contract Operations and International Fabrication bookings declined in the third quarter. And given the lead time associated with these large projects, we expect that revenue growth opportunities in our International Contract Ops and equipment sales businesses will be limited over the next several quarters.

So diving into the results on a product line basis a little bit and starting first with the review of our International Contract Operations business for the quarter, revenues were somewhat higher than our guidance and they included a four-quarter contribution of two new projects in Brazil. But as expected, revenues declined sequentially due to previously announced early termination of a sizeable project in Brazil during the second quarter.

Margins were somewhat lower than expected due in part to labor and maintenance cost pressures in the Latin America area. Our operating horsepower declined in the third quarter driven by the cancellation of the aforementioned project. This is the one we booked in the second quarter. Actually came idle early in the third. And the ending of two smaller multiyear approximately four-year compression projects in Brazil.

Now moving to a review of our other product line, starting with AfterMarket Services. Overall competitive market conditions contributed to lower profitability in the third quarter. Breaking that down a little bit, we had part sales at very low margins, we had some higher than expected costs on our retrofit project in Latin America and we saw some slow-moving inventory at depressed margins. But it freed up good cash flow that we can redeploy in the business.

On the Fabrication side, we had better overall project execution which led to improved margin performance in the third quarter. And we are very pleased with the improved performance of our Fab business and are continuing to take the steps to make the investments necessary to enhance our core competencies in manufacturing, project management and engineering.

Now I'll turn and talk about Exterran Partners for a minute. We had a number of positive developments in the quarter. First we completed another accretive drop down, approximately 255,000-horsepower in August which improved EXLP's distributable cash flow coverage and its credit profile.

Next, we sold 5.3 million of EXLP common units that EXH owned in the September 2010 which holdings benefited from and continues to benefit from about 60% for this total distributions on a go-forward basis. This transaction was beneficial for both parties. For EXH it improved its capital position and for Partners it significantly enhanced its unit liquidity. Average volumes have moved from around 25,000 a day to 140,000 units per day traded each day.

Next, Exterran Partners just completed the successful refinancing of all of its debt with a new five-year, $550 million credit facility. Michael Anderson will cover some more details of this in the financial review.

And finally, last week Partners announced a $0.005 distribution increase for the third quarter of 2010. This increases our annualized distribution by about 1% up to $1.87 per unit.

This increase is indicative of improved performance at Exterran Partners. The benefits allowed growth through accretive drop downs and through organic growth we increased horsepower, actually about 15,000-horsepower, in the quarter organically and just a general overall improved outlook for the North America Compression Market.

This increase is also consistent with our long term goal of distribution growth at EXLP. Including the IPO in late 2006, Exterran and the LP have completed five successful drop down transactions representing about 40% of Exterran's US fleet. And EXLP has grown distributions by over 33% over this four-year period. And while future distributions will be determined and approved by the EXLP board, the recent distribution increase is indicative of a shift forward and objective of more measured and steady distribution increases as EXLP matures.

And looking ahead, we remain committed to continuing to grow partnership through accretive acquisitions and organic growth. So I think importantly we now have the pieces in place to make this happen. We have the horsepower in place at Holdings that has not yet been dropped down to the partnership, we have an inflexible capital structure at Exterran Partners and we have a modestly improving US Compression market.

So moving away from Partners and back to Exterran Holdings now. We had another solid quarter of cash flow generation and continue to show strong capital discipline. Holdings benefited from a secondary offering of the Exterran Partners unit or were held by Holdings and using that we reduced our borrowings by $110 million in the quarter. It brings total debt reduction over the last five quarters to $540 million or over $8.50 a share. And we remain committed to generating free cash flow as an operating principle.

So to summarize our overall business outlook, in International our markets continue to be in a lull reflective of delayed projects. And in North America, we were guardedly constructive about overall market conditions. I will add that it is important to note that Compression is a relatively later-stage requirement in the production cycle. As the production profile and relatively new fields mature over time and overall pressure levels naturally decline, we expect Compression service intensely levels to increase in plays like the Eagle Ford and the Marcellus and ultimately the Haynesville.

Longer term with our leading market position in both Compression and Production Process and Treating businesses, we believe we're well positioned to capture growth opportunities in North America. And tied to the energy infrastructure build out on the International markets. And in the meantime, we expect to continue to generate solid cash flow including transferring additional North American assets to Exterran Partners. I'll now turn it over to Michael Anderson for the financial section of the call.

Okay. Thanks a lot, Ernie. And good morning to everyone. I'm sure that you've had a chance to look at the press release that we issued earlier this morning. Overall as you know the quarterly performance was a bit mixed. We had increased operating horsepower in North America offset somewhat by operating cost pressures. But of course as Ernie mentioned, we had another great quarter in terms of cash flow generation reducing debt by $110 million. I'm going to go through now some more detailed summary results and also a look at our forecast going forward.

First of all looking at Exterran Holdings. North America Contract Operations revenue was $152 million in the third quarter. That was a little bit above our guidance range of around $150 million. It was helped by an above-average level of freight revenue.

Operating horsepower increased by 11,000 during the quarter. That was in line with our guidance of flat to modestly positive. And of course it was also a nice improvement versus the 22,000-horsepower loss that we had in the second quarter.

Gross margin decreased sequentially during the quarter to 49%, driven by the higher operating cost that Ernie had mentioned. Operating costs for horsepower increased 5% compared to the second quarter period. Maintenance capital was $16 million in North America during the third quarter and that compares to $15 million in the second quarter. We still believe we're doing a good job on the operational side on maintenance capital front, although spending is likely to be higher as we are getting more idle units ready to go back to work.

At the end of the quarter we had a total North America contract Compression of 4.27 million-horsepower, and that includes the fleet utilization of 66% which is up from 65% a quarter ago.

If we look ahead at the fourth quarter we expect North America Contract Operation revenues of again around $150 million. That's actually in line with third quarter levels once we adjust for the freight revenue. This fourth quarter revenue level would equate to again relatively flat to modestly positive operating horsepower compared to the third quarter. We expect relatively flat margins while maintenance capital again is expecting to be up slightly compared to the third quarter.

Shifting over to International Contract Ops, revenue there was $112 million in the third quarter. That too was above the guidance range which was $107 million to $109 million. Here we were helped by some retroactive standby revenue for a project that we had in Brazil.

The gross margin percentage was somewhat below our guidance due to some increased costs, payroll and maintenance costs that we had more particularly in Argentina and Mexico. And as another reminder, when you're doing the sequential comparison I think you'll remember in the second quarter International Contract Ops revenue was $131 million, and that included about $21 million from that project in Brazil that was terminated during the second quarter.

At the end of the third quarter, the International fleet stood at 1.3 million-horsepower and the utilization rate was 80%. The horsepower and utilization were down sequentially during the quarter primarily, as Ernie mentioned, that large Brazil job actually came off the operating horsepower numbers in the very first part of July.

Looking at the fourth quarter for this segment, International Contract Ops revenues we expect them to be in the $108 million to $110 million range. And this is expected to be a modest sequential increase after we adjust for the retroactive standby revenue that we had in the third quarter. We expect margins will be around 60% in the fourth quarter for the segment.

Let's move over to Fabrication. There we had revenue of $279 million in the third quarter. In gross margins of about 17%. Revenue was near the lower end of our guidance due to some project delays mainly on some installation work while margins were somewhat higher than expected. So good job there in terms of the margin performance.

Revenues during the quarter from a product line perspective consisted of the following. It was about 40% Compression, 25% Belleli and 35% or so in production in processing our product line. If you look at the same revenue mix now from a geographic standpoint, about one fourth of the third quarter Fab revenues were in North America and the balance, the other 75%, were in International markets.

And with stronger bookings that we saw during the quarter in North America as we look forward the backlog that we have in place, the $691 million, it consists about 35% of North American business and 65% of International. Assuming that together and looking forward into the fourth quarter we expect Fabrication revenues of $250 million to $270 million and margins in the mid-teens.

Looking at AfterMarket Service, third quarter revenue $82 million. Margins lower than expected at 10%. As Ernie mentioned, we saw some improved revenue in North America although the margins were lower than expected as a result of both competitive market conditions and some low margins on some parts sales in North America. When we look forward at the fourth quarter, we expect the revenues for AfterMarket Services be in the $75 million to $80 million range and improved margins back into the mid-teens.

SG&A expenses during the quarter, $88 million. They were somewhat lower than we had expected and of course it's down from $94 million. That $94 million in the second quarter had been inflated somewhat by some one-time items. As we look forward into the fourth quarter we expect SG&A expense to increase modestly over the $88 million.

We had $2.9 million in other income in the third quarter. That was mainly driven by gains on asset sales that took place during the quarter. You sum to that EBITDA which was $110 million for the third quarter and that compares to $118 million that we had in the second quarter.

Interest expense was $33 million and as is typical about $5 million of that interest expense is noncash interest expense. Net loss attributable to Exterran shareholders was $0.29 per diluted share. If you adjust it by taking away the impairment charge and discontinued items we had a loss of $0.25 per share.

Net capital expenditures were $52 million in the third quarter. And we look at total capital spending that included about $33 million of growth capital, and that was actually primarily for new projects in Latin America and also some in North America which were specifically for the gas processing plant that we announced earlier in the year that we're building in the Northeast US.

Total maintenance capital for the Company, I mentioned earlier we had $16 million in North America, we had $4 million elsewhere so a total of $20 million of maintenance capital for the business. As we look for the rest of the year we now expect net capital expenditures of $200 million to $220 million in 2010. That's down a little bit from our prior estimate last quarter of $225 million to $250 million.

Of the total CapEx amount we have yet to commit about $13 million of growth capital that was originally earmarked for new Contract Operations projects. And for the year we continue to expect that maintenance capital will be in the $70 million to $80 million range for 2010.

Shifting over to the balance sheet, total debt declined by $110 million during the quarter. So it went from $2.08 billion at June 30 to $1.97 billion at September 30. And of the $1.97 billion at the end of the quarter, we had $436 million that was on the EXLP balance sheet.

Total cash and equivalents for the business on a consolidated basis was $89 million at September 30. Available but undrawn debt capacity at September 30 was approximately $596 million, so certainly we're in good shape from a credit availability standpoint.

A few comments now with regard to Exterran Partners. As everyone knows, EXLP completed the purchase from Exterran of 43 customers and about 255,000-horsepower of compressor assets that was completed in August. EXLP now has a total fleet of 1.65 million-horsepower and that includes about 40% of the combined holdings in Partners' fleet within the US Contract Ops business.

Last week the LP announced its distribution for the quarter of $46.75 per quarter that equate to $1.87 on an annualized basis. So that distribution is $0.005 higher than the second quarter distribution. For the quarter EXLP generated EBITDA of $28 million in distributable cash flow of $19.3 million. Distributable cash flow covered the third quarter distribution by 1.23 times, so good coverage there.

This is a little better than expected as we paid in full quarter's worth of distributions on the shares that we issued in conjunction with that August drop down, but of course we only had the benefit of the new assets in operation for about half of the quarter at the partnership. Distribution coverage from the quarter was benefited not only by the drop down but also by organic growth of about 15,000-horsepower within Partners.

If you look overall at the fleet, EXLP's fleet had a spot utilization rate at the end of the quarter, 82%. And when we think about maintenance capital, guiding that number down just a little bit at Partners as well expect it to be in the $14 million to $16 million range for 2010. That's down just $1 million or $2 million from our prior guidance which was $15 million to $18 million.

The other press release that we had today was that Exterran Partners announced the execution of a new $550 million senior secured credit facility. I'll provide a couple of details about that now.

The new facility matures five years from now in November 2015. And it basically replaces the whole debt structure that was at Exterran Partners. So the former senior secured credit facility as well as the asset-backed securitization facility at Partners.

In conjunction with the financing, the refinancing, we repaid about $15 million that was outstanding under interest rate swap agreements. So pro forma for the refinancing debt at Partners will be about $454 million. And that is consisting of two parts. First part is a $150 million term loan, that is priced at LIBOR plus 2.75 points. Or 2.75%. Then we also have $304 million that is going to be funded on a $400 million revolving credit facility. The revolver is priced at LIBOR plus 2.5%.

As we go forward once we've hedged the rate on the new debt we believe that total cash interest expense at Partners will be about the same or even slightly below the $5.5 millionto $6 million in quarterly cash interest expense that we've typically incurred at Partners. We also believe that available credit that we have on the revolver of about $100 million at EXLP should provide that capital for a future drop down.

We also have an accordion feature within the new facility that with lender approval will allow us to expand that facility by another $150 million. So we've got some flexibility there.

So all in all when you look at Partners it was a really busy quarter. We had a drop down, a secondary sale of equity, an increase in the quarterly distribution and a complete refinancing of its capital structure. So we think with all of these factors it really positions Partners well for future growth.

That's really the end of my comments. We will be filing the Exterran Partners and Exterran Holdings 10-Q's in the next day or two. So at this point, operator, we'd like to open up the call for questions.

Thank you. (Operator Instructions) . Our first question comes from Brad Handler from Credit Suisse. Please

Thanks. Good morning, everybody.

Good morning, Brad.

I guess let's come back, please, just to the US cost front just so I have a better understanding of that. Maybe one way to ask it is, to the extent that you can, when you spoke to us three month ago, things happened more or less the way you looked for them to happen in terms of additional cost pressures. I suppose I want to turn that back on you and ask you if that's the case, or did some aspects of it catch you to some degree by surprise?

No. I think it's very accurate to say that it's more or less in line. The numbers get moved around a little bit on the freight stuff where we have rebuilt freight where the revenue benefits from it a little bit but you have the total expense really in there. We don't make any effective margin on that. So it throws your percent margin down a little bit.

Adjusting for that it happened pretty much in line with what we expected to happen. We continue to invest in providing superior service and really working on our service quality. And it's driven our costs up and our margin percent down a little bit.

Help me understand the labor pressures. It seems that can't be a compression-specific comment, but perhaps it's more of an oil patch poaching, more generally comment? Given higher levels of drilling activity? Is that right way for us to think about it? And therefore might those labor pressures continue?

Yes. We certainly share a lot of the same labor pool and the guys all talk to each other so they see what's going on from a labor-rate standpoint in the field. But part of it I would say is also that in 2009 we didn't give increases. 2010 we had to return to that. And so we're giving modest increases on the rate side.

But part of the labor increase really is just making sure that we're staffed well for growth. It is the two components of the labor-rate and the number of people per production unit, if you will, and we're staffed well for growth at this time.

So hence the outlook for flat margins in the very near-term just because you're staffed adequately. I guess you're not incrementally being charged with putting that much more equipment back to work, so it's a bit more of steady state at least for the next couple of months?

Yes.

That's right. Okay. Just one more for me if I you would. And I do not mean to be tongue in cheek about this at all, but Michael Anderson, when you talk about modest changes, can you put some parameters around that for us?

And I guess maybe specifically on the SG&A side. And this is unfair because you're good enough to give us guidance on a number of fronts, but when we looked at SG&A I think the tone was for some modest decline in the third quarter in SG&A. Hence the guidance from last quarter.

Clearly there were some pieces in it that made that much more than a modest decline. And so I'm just trying to get a feel for the parameters, how we should think about that term, frankly.

I'll put a broad parameter around it $1 million to $3 million.

Okay. On the SG&A side specifically, obviously. Okay. That works. Thanks, guys.

Thank you.

Our next question comes from Tom Curran from Wells Fargo. Please go ahead.

Good morning, guys.

Good morning, Tom.

Good morning, Tom.

Curious as you look out over the next few quarters just given the extent of the visibility you have right now, does it look as if you could see more incremental revenue potential when it comes to US Compression on the Fabrication side as opposed to the Contract compression side?

Yes. I think our bookings mix moved more to North American this quarter. And as we produce that over the next two or three-quarters, that would suggest that mix turns towards North America in the nearer term.

And how about incremental demand as well from here? So not just executing on the orders you've already received but as of today have you continued to see relatively more incremental demand on the Fabrication side as opposed to the Contract side?

Well, we've certainly seen more things book. We continue on the International front while the quoting level and the activity level still feels pretty good, the bookings level feels a little softer. So I think we see things actually getting contracted more rapidly in the US for us in the nearer term than we do International.

Okay. And then for both North American and International Contract Ops, could you share with me what the revenues were for each in Q-3 that were non-compression related?

Yes, Tom, we don't track that quite as specifically in terms of data for this call. I could give you a ball park. I think we've been pretty consistent about this. When you look at North America, we've got something less than 10% that is non-contract compression within Contract Operations.

When you shift over to Latin America, that number is probably more in the 15% to 20% level that is non-compression related. And in Latin America it is primarily gas processing facilities. And just to complete the puzzle, when you look over in Eastern hemisphere it's probably about half and half, horsepower-related and then you've got production and processing facilities that comprise the rest of Contract Ops.

Okay. Thank you. That's helpful. And that's on a revenue basis right, Michael?

Yes.

And then last one for me, Michael, could you just provide the standard breakout I always ask for Fabrication revenues by segment and geographically for Q-3?

Yes. I tried to put some of that into the script. So some of that is going to show up later, anyway. But I'll just go back over that again.

As you look at, first of all the backlog as we go forward, it shifted more towards North America. So we've got about a 35% that is North America with the balance 65% International. I think last quarter when I talked about it was more 25% to 75%.

The revenue breakout we had I mentioned about 40% was Compression. We had about a quarter that was Belleli and the other 35% or so that was Processing and Treating. And geographically we had said that about a third of it or so was North America and the rest was International. That's on the revenue side.

Great. Sorry I missed that. And thanks for beginning to include it in your remarks. It's very helpful.

No problem.

Our next question comes from Blake Hutchinson from Howard Weil. Please go ahead.

Good morning, guys.

Good morning, Blake.

Good morning, Blake.

First just exploring the North American Contract Compression fleet for the quarter, I'd imagine you're still, although optically we see a small gain in horsepower employed, you're still dealing with large number of horsepower going down, and a large number being added. Could you just give us a little color in terms of maybe size that goes out versus size that comes in? And maybe as well where you're seeing the outs regionally and the ins regionally.

So just focusing on starts and stops in general, we continue to see the level of stops decline sequentially quarter on quarter. And we think that's driven to the dynamic we've talked about historically that a lot of the optimization or right sizing that our customers could do is mostly behind them. So you have ongoing now. We don't have the catch up that really occurred throughout 2009 in the early part of 2010.

So the corollary to that is, whenever you right size something you go to a smaller unit. So what had been happening is a lot of smaller units going out as part of that right-sizing deal. So as we look then at the starts that we have today, they're probably modestly more on the bigger size than the smaller size but it's not a big change in the average working horsepower that we have.

So we continue to start and have opportunities on the big side, but small side is a very important part of our business. And we're not seeing a big mix change over time.

Okay. And so given that dynamic with the starts you do have, we should continue to be burdened a little bit by the labor in part and make-ready expenses for the foreseeable future?

Yes. Whenever you have increasing utilization, you're going to have higher cost for horsepower and effect. Because in the first couple of months of putting units to work they're more expensive. You have the freight to move it there and you have start up costs and you have just a little bit of incremental costs to line everything out. So increasing utilization will lead to a little higher costs in those early months.

And Blake, let me just add in one fact here related to the question. If you look at the average size of the unit that's working in North America in this past quarter, third quarter is 443-horsepower.

Okay.

And at the beginning of the year it was 437. So right along with what Ernie said, average size is up 6-horse power. So very consistent.

Okay. Great. And then just thinking about your comments with regard to some delays internationally, just to be clear, has anything fallen off the radar screen or is it just pursuit of the same projects but it looks like decisions are just being delayed until early next year?

Well, it's some of both. Just a couple of weeks ago the first of the big projects in Australia, there's four big LNG directed [coasing] projects, the first of those was awarded to one of our competitors. So that one drops off the radar. Others come on.

There's still more to go there. So that one was a just dropoff. The rest of it feels more like delays. We're not seeing projects canceled per se.

Okay. Great. If we have a few quarters here where we're relatively flat on an International basis, is it safe to assume that the 60% type margin range the lower end of the range you've done over the last few years is what we're going to be look at until you can start to add some of these new project wins?

Yes.

Okay.

Great. I appreciate it. Thanks for the time, guys.

Our next question comes from Robert Christensen from Buckingham Research. Please go ahead.

Could you spend a little more time on the contract that your competitor won in Australia? Were you bidding on that? And what were the differentiating factors?

Yes. We were definitely bidding on it. The customer there chose a competitor and actually chose it, we believe, and our belief is they chose it based on the compressor frame that was bid by our competitor versus ours. We went with a different configuration early on, and the customer had a particular manufacturer preference that we did not go with in the initial stages. And it put us behind.

So the equipment selection always matters. We chose what we thought would be an excellent application. The one they chose certainly really a good high quality product, but it just wasn't the one we went with.

Did it have anything to do with your pricing? And what is the contract like that look like when they solicit? Is it terms, conditions, or were you off by price on that?

No. We don't know because everybody does a little bit different as how that goes. But we concluded that as we did our analysis of why we did not win that project that equipment selection was the factor and not price. But we don't know the details. Were they a percent below or percent above or whatever than what we were. We just don't have that level of knowledge.

Are there more solicitations by the other players at the moment for compression?

Yes. There are active, ongoing bid processes going for the other projects.

Thank you very much. I'll get back in line.

Thanks, Bob.

Our next question comes from Sharon Lui from Wells Fargo. Please go ahead.

Hi. Good morning.

Good morning, Sharon.

Good morning, Sharon.

My questions relate to Partners. Just wondering if the goal is to deliver quarterly distribution increases versus an increase driven by an event like a drop down going forward?.

Yes Sharon, we've intimated in the deal that we think that a better plan for us now that we have more stability and decent size within the LP that a better plan for us is to do modest but steady increases. So that would be our goal. We recognize that distribution growth is an important factor and we think the business now allows that both from a size standpoint and what we see going forward.

You can't make any commitments about what you're going to do in the future,but our plan would be to go away of doing sizeable increases at a drop down and to go to more measured, steady quarterly.

Okay. That's helpful. And also if you can comment I guess on the utilization at Partners. I guess I thought the number was a bit low given the drop down assets are 100% utilized.

Yes. We ticked up from 80% to 82% with the assets that are getting dropped down into the LP, so I think the math is correct.

We do have some units there that are leased that distorts some of the numbers that we've got there. Because LP does lease, it actually ends up being a couple hundred thousand horsepower from EXH, over time that will go away. But it's a temporary fix that we've got in place that's a way to most efficiently operate the businesses with one fleet.

So everybody doesn't have to be building up lots of idle units. So it did up tick. And those numbers are right at 82%.

Yes Sharon, I would just add onto that. Even absent the drop down, working horsepower at the LP ticked up 15,000-horsepower in the quarter. So we had both organic growth and the drop down growth. The math I suspect is getting a little skewed by the leases that Michael mentioned.

Okay. That's helpful. And I guess my last question if you could just comment on the pace of the contract conversions?

Yes. So we continue to make some progress. We added additional contract conversions over the course of the last quarter. Still not big.

And if you look at our progress we made great progress coming out of the gates. I think when the market was quite good. We still have 68% I think is the number that is converted to the contract form that we want to put into the MLP. That 68% of the whole Exterran family contracts.

And I think over the course of the last year or two, it's just been a tough market to go back out with what's happened from a macro economic standpoint and compression standpoint to be changing the contracts with a lot of our customers. Now as things are starting to improve and stabilize, we're taking a more proactive role to get back on track in terms of the contract conversions. So we don't think it's going to be at all a hindrance for us in terms of drop downs. And we see some improved activity in conversions on the horizon.

Okay. Great. Thank you.

Our next question comes from Jim Altschul from Aviation Advisory. Please go ahead.

Good morning.

Good morning.

Just one quick question. In conjunction with the drop down, did you extend the term of the agreement pursuant to which holdings will basically inject new equity if SG&A is above a certain level? Or is that still due to expire at the end of the year?

No. The [toss] caps are now due to expire at the end of 2011. So in conjunction with the drop down they were extended for the year.

Fantastic. Thank you very much.

Our next question comes from Brad Handler from Credit Suisse. Please go ahead.

Thanks. Hi, again. We hadn't really talked very much beyond your comments about the AfterMarket results. So maybe if we could just come back to that for a couple of minutes. Can you describe the competitive landscape in just a little greater detail, I guess? Are we talking about entrance of anybody new? Do you sense a change in tone by a particular competitor with respect to some of the services? I recognize the parts sale was part of what we saw in particular this quarter. But what's driving the more competitive environment, do you think?

Well, there's a couple of aspects of this. On the competitive side a lot of it really has to do with just in down-cycles. What you have is there's a lot of this stuff that -- since they're a low capital barriers to entry on AfterMarket services, you will see a lot of start ups of mechanic shops that just tick over into this area and hit very aggressively on price. And with us, we actually have a fairly natural barrier to pricing here because our warranty and the warranties we give, we stand behind them in very meaningful ways. And start ups, they can offer some pricing that if the warranty doesn't tick or doesn't keep, then it doesn't hurt them too much. They just go away. So I will tell you that's not to be discounted as a factor.

The other factor that we don't talk a lot about that I think has certainly affected our business in 2010 in North America has been that we have been very focused on improving our service levels for our Contract Operations business. That is crucial for us to have achieved what we have achieved in terms of customer satisfaction and the way we're going. And when you do that and you concentrate on that which is certainly the higher margin and the higher incremental return business from a [sump] cost basis. That detracted a little bit from our focus on the AfterMarket.

And now that we have our service levels to where we believe they're very good and continuing to improve and in fact probably slightly better than the competitive landscape, now we can turn back to the AfterMarket in terms of growth. But we have sacrificed focus on AfterMarket to make sure that our Contract Operations service is excellent.

So that factor goes in there as well. So we're optimistic that can turn around over the next year. And we'll start growing that business again.

Okay. I guess I was just thinking, unfortunately I don't have the model right in front of me, but my recollection is that at least for the universal compression side the AMS business was pretty steady in that 20% gross margin level. Maybe you'd even say cycle-in, cycle-out? Is that a fair statement, so we haven't quite seen the same competitive issues?

So that's certainly true. But there's a big mix issue there in terms of how much parts goes in there and how much is labor. So it actually can move around a little bit between that 15% to 20% range on that mix issue. But yes, it's like a lot of things in this business right now. It's competitive. So margins have slipped on competitive pressures as well as mix.

So perhaps it's reasonable for us to think more in that I guess mid-teens range for the next several quarters just given the flattish outlook?

Yes.

Okay. All right. Thanks again. Appreciate it.

Our next question comes from Joe Gibney from Capital One. Please go ahead.

Thanks good morning, Ernie and Michael.

Good morning, Joe.

Good morning, Joe.

Just the part, I missed this Ernie, I wonder if you could address the incremental FPSO outlook on use of the topic du jour within equipment manufacturing from a strategic side. You guys have been open talking about top side equipment opportunities for you as well. Just curious on the pulse of that here in the near-term.

Yes, we actually got some not so great news this quarter on the FPSO side. One of the opportunities we were very interested in on the nearer term in Brazil went in a different direction than our favor. This is something that would have benefited us in late 2011.

And so we're having to push out our optimism there a little bit. We're still very committed and Petrobras is still encouraging us and other people to get into this business. We're making good progress there. But we lost the first round on this one.

Okay. That's helpful. And Michael, just some tax guidance, the ready, fire, aim scenario every quarter. But any help you could give us there looking in the fourth quarter at all?

Short answer Joe, is probably not. Since it's my job I'll do my best. This quarter we were able to benefit the losses so we were closer to an effective rate. But in terms of guidance, I think we're still going to say that we're going to be a very low rate in terms of benefit if we have losses. And a lot of that is just right when you're at the cusp of break even, a little bit below, a little bit above, a lot of the fixed tax stuff hits you. And so I think we actually did pretty well this quarter in our effective rate of something close to 30. And I wouldn't really anticipate that. Last quarter we were basically at zero. So I think it's going to be something that's real low if we have a negative pretax number. We're not going to get a lot of tax benefit.

Got it.

Appreciate, guys. I'll turn it back.

Thanks, Joe.

Our next question comes from Steve Ferazani from Sidoti. Please go ahead.

Good morning, everyone.

Good morning, Steve.

Good morning, Steve.

I wonder if given current natural gas price environment if you think the timetable for compression demand in some of the developing shales has changed or pushed off at this point.

We haven't seen any change yet. People continue to drill. They continue to hold their leases and be focused in production, and so we haven't seen a change yet.

There's certainly a lot of talk about changing behavior. It justhadn't happened so far. So we remain concerned at pricing levels, the more recent up tick probably gives us a little breathing room. I would say we haven't seen change but we remain watchful.

At what point do you think we start seeing demand in places like the Marcellus and Haynesville towards the well head? How do you think that markets are going to develop now given the current environment?

Well, the Marcellus will happen sooner than the Haynesville. But it's still at the well head stuff. It still feels a quarter or two away in those areas. Maybe longer for the Haynesville.

Fair enough. Thanks for the comments.

Our next question comes from Robert Christensen from Buckingham Research. Please go ahead.

Yes. A followup if I may. The inflationary costs in the domestic compression side, could you just come back to how you might address these rising cost in the future? Is there any light at the end of the tunnel for stemming the tide of costs running on you?

Yes, Bob, I actually think there is. I don't want to make any excuses. We stay very focused on the cost side of the equation.

As our North America team has worked very hard on recovering service reputation, we've erred on the side of allowing to make sure that we're ahead of that curve. So our guys are doing a very good job of increasing run times and increasing the value of our service to our customers. And we've allowed that to go.

We do believe we can start focusing more on costs over the next year now that we have service levels up. So I think there is room there. It is a ton of room to improve if from this point? Probably not.

Is there certainly room to marginally improve and hold where we are? Yes. There certainly is.

Okay. Well, thank you.

Our next question comes from Tom Curran from Wells Fargo. Please go ahead.

I figured I'd jump back in here on the International Contract Ops side. Just curious, could you give us maybe a quick world tour of your existing Contract Ops markets both in Latin America and Eastern hemisphere and just where you're seeing the most encouraging signs of demand potentially emerging from here?

Yes. So, Mexico. If you look at the Latin markets, Mexico, would certainly be the most encouraging today. Brazil is still a great developing market. In the nearer term the focus tends to me more off shore then on, so I don't think we'll see a big bump there in the next year as they really focus on the offshore stuff. But Brazil is certainly developing place we like.

As you go outside there, Oman and some of the areas around there is a good market for us. Indonesia remains of interest on Contract Ops. And I guess those would be the main ones I'd point to right now -- is the main. We see one off stuff coming time after time. But those would be the main Contract Ops.

If you turn to the sales side of it you pick up some other areas. West Africa, Kazakhstan and some other places in Russia. But on the Contract Ops those would be the main ones.

It doesn't sound as if though, Ernie, that based on that overview that there's been any notable incremental developments either positively or negatively since we were in Boston.

That would be correct.

Great. Thanks for the color. I'll turn it back.

We have no further questions at this time.

Well, thanks everybody for your attention today, and we look forward to talking to you after the end of the year. Thanks.

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