Exterran Holdings, Inc., Q4 2008 Earnings Call Transcript

Feb.26.09 | About: Archrock Inc. (AROC)

Exterran Holdings, Inc. (EXH) Q4 2008 Earnings Call February 26, 2009 11:00 AM ET

Executives

Steve Snider - CEO

Michael Anderson - SVP and CFO

Analysts

Brad Handler - Credit Suisse

Kevin Pollard - JP Morgan

Mike Urban - Deutsche Bank

Christopher Gillespie - Simmons & Company

Sharon Lui - Wachovia Securities

Joe Gibney - Capital One

Randal Martine - Barclays Capital

Steve Paar -- Equity Analyst

Kent Green - Boston American Asset Management

Glenn Prymake - Broadview Advisors

Hemlin Thompson - Westfield

Operator

Good morning. Welcome to the Exterran Holdings Incorporated and Exterran Partners, L.P. Forth Quarter 2008 Earnings Conference Call. (Operator Instructions) Earlier today, Exterran Holdings and Exterran Partners released their financial results for the fourth quarter ended December 31, 2008. If you have not received a copy you can find the information on the company's website at exterran.com.

During this call, the companies will discuss some non-GAAP measures in reviewing their performances, such as EBITDA as adjusted, EBITDA as further adjusted, gross margin, gross margin as adjusted and distributable cash flow. You will find a 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.

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

Information concerning the risk factors, challenges and uncertainties that could cause actual results to differ materially from those in the forward-looking statements, can be found in the company's press release, as well as in the Exterran Holdings annual report on Form 10-K as amended for the year ended December 31, 2007. Exterran Partners annual report on Form 10-K for the year ended December 31, 2007 and those set forth from time-to-time in Exterran Holdings and Exterran Partners filings with the Securities and Exchange Commission, which are currently available at exterran.com.

Except as required by law, the companies expressly disclaim any intention or obligation to revise or update any forward-looking statements.

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

Mr. Snider you may begin your conference.

Steve Snider

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

Exterran achieved improved operational performance in the fourth quarter despite difficult economic and energy industry conditions. Highlights include the continued improvement in our North America operations and favorable developments in our international business.

In North America operations our working horsepower in the fourth quarter increased sequentially for the first times since the completion of the merger and operating cost decreased for the third consecutive quarter.

The performance of this segment improved significantly in the last half of 2008 due to the implementation of various efficiency initiatives and some great work by our filed employees in returning our high quality customer service back to pre-merger levels.

We performed well in our international operations, improving contract operations margins. We also benefited from a $14 million cost recovery on a total solutions project in Kazakhstan which allowed us to reverse the loss that was previously booked in the second quarter of 2008.

Consequently, we reported a higher than expected gross margin contribution from our fabrication segment in the fourth quarter.

Overall I believe that the world wide Exterran team is performing very will as our merger integration challenges are behind us and we continue to reinforce customer service as a top priority.

On the other hand, fourth quarter results included a non-cash goodwill impairment of approximately $1.1 billion and an asset impairment of $22 million. These impairment charges have no impact on our business operations, our cash flow, our liquidity or importantly, our compliance with the financial covenants in our credit facilities.

With regard to the goodwill impairment, it's helpful to recall that we booked over $1.2 billion of goodwill in 2007 in conjunction with our stock for stock merger that created Exterran.

When we booked the goodwill our stock was $67, the day our stock price like that of the overall market is down significantly and worldwide cost of capital are higher. These lower equity prices and higher cost of capital in the market place. Led us to impair most of the goodwill on our balance sheet.

The asset impairment is related to our Cawthorne Channel operation in Nigeria. As you my recall we have not recognized Cawthorne revenues in over two years, so we believe our future income statement affects the Cawthorne is likely to be mutual to positive. Michael, will discuss the goodwill impairment further in the financial section later in the call.

We had continued solid performance by Exterran Partners in the fourth quarter. As reminder Exterran Holdings on the majority of 57% ownership interest in Exterran Partners including a 2% GP interest.

Last month Exterran Partners announced a cash distribution of $46.25 per limited partner unit for the fourth quarter of 2008 or $1.85 per unit on an annualized basis. This distribution was flat compared to the third quarter of 2008 and represented an increase of 8.8% on a year-over-year basis.

EXLP covered this fourth quarter distribution comfortably by a healthy margin of 1.5 times. With the economic slowdown, tight credit markets and deterioration of commodity prices many of our customers have announced reduced capital expenditure levels for 2009 as compared to 2008.

We believe the outlook for Exterran in 2009 is challenging particularly regarding activity levels in North America which makes up approximately half our revenue. We are already working to adjust our business to better deal with the challenges in today's market.

Despite the difficult market environment we expect Exterran to be comfortably cash flow positive after capital expenditures in 2009. The current challenging market conditions have implications for our North America contract operations activities.

With lower commodity prices, reduced exploration and drilling activity lower capital expenditure by customers and access to capital being very limited. Our customers are focused on cost saving opportunities including rationalization of their compression assets.

In addition, the physical delivery of compression equipment which was sold last year when lead time were much longer made further impact in near term supply demand situation in the North America market.

Potentially somewhat offsetting these challenging near term market trends the desire to conserve capital may lead some customers increase outsourced compression services. With our healthy financial position we believe that we are well positioned from a capital and competitive position to capitalize on financial opportunities that may arise during this period of uncertainty.

Overall, however we expect contraction in the North America contract operations business in the first quarter and in coming quarters. We are responding with reduced growth capital expenditure levels in our North America contract operations segment in 2009 as we emphasized redeployment of our idle fleet.

Our fabrication backlog remained at a high level approximately $1.1 billion as of December 31, 2008. We believe our fabrication sales activities are more exposed to economic and energy cycles and other parts of our business. And our fabrication business has experienced greater variability during past cycles.

We believe we will likely see order cancellation and request by our customers to delay delivery of existing backlog. We have already seen some weakness in our bid and order activity in North America, which represents about 40% of our fabrication revenues as a result of these challenging market conditions.

This trend may impact our fabrication activity levels in the second half of 2009 and into 2010.

In our international contract operations business activity levels remain relatively healthy due to the longer lead time associated with these projects.

In addition, many international projects are driven partially by factors that are not directly tied to current commodity prices such as the need to curb the flooring of natural gas or the requirement to develop long term energy infrastructure.

Our international contract operations backlog remained relatively strong. Today that backlog represents over $130 million in expected run rate annual revenues for projects expected to start in Latin America and Eastern Hemisphere during the course of 2009 and early 2010.

A quarter ago we reported this backlog at more than $135 million. We have seen some bidding in prospect delays, although our new business development activity is continuing albeit at a slower pace. The outlook for 2010 will be dependant upon the level of new project awards that we receive during 2009.

In Venezuela, one of our largest international markets we are experiencing longer cycles of outstanding receivables like many other service providers and have not received any meaningful payments in the New Year.

We have been operating successfully in these key energy markets for thirty years and our Venezuela operations accounted for approximately 5% of our total Exterran revenues in 2008.

We continue to operate under our contract service agreements in Venezuela while carefully monitoring the political and economic circumstances in the region and we are not going to pursue any new projects in Venezuela until the situation improves.

Bright spot is our [Bolivia] operation which represented about 30% of our fabrication sales activity in 2008 with the significant backlog of approximately $550 million of relatively long-term projects we believe [Bolivia] is well positioned for solid performance throughout 2009 and well under 2010.

I will now turn the call over to Michael Anderson.

Michael Anderson

Okay thanks a lot, Steve and good morning everyone. I'm sure that by now you have had a chance to look at our press release that we issued earlier this morning. As in our third quarter call I believe it's prudent to begin our financial review with the summary of what we believe is our healthy financial position.

So first of all we currently maintain debt levels and financial ratios that are well within our credit facility limitations. We expect the cash generated by our operations in 2009 will exceed our maintenance and growth capital expenditures and we believe that we will be cash flow positive after these capital expenditures during 2009 and in addition we have significant unused credit availability of $364 million under our existing credit facilities to fund short-term needs and other activities.

We have no significant debt maturities until October 2011 at the EXLP in August of 2012 at Exterran.

In terms of debt ratios and the covenants of our primary debt instruments we are limited to a maximum of five times debt-to-EBITDA at both entities and must maintain a minimum EBITDA to interest coverage of 2.25 times at Exterran and 2.5 times at the EXLP.

At year end 2008 Exterran had a 3.1 times debt-to-EBITDA ratio and over six times interest coverage while EXLP 4.2 times debt-to-EBITDA ratio and 4.5 times interest coverage.

Our debt with the benefit of the interest rate swaps is approximately 65% fixed rate and our average all-in rate was less than 5% at December 31. I would like to repeat that the goodwill and other impairment charges that we had in the fourth quarter do not the affect the calculation of or our compliance with any of the required coverage ratios in our debt covenants.

I will now review the fourth quarter financial performance for both Exterran and Exterran Partners and also discuss our earnings outlook for the first quarter of 2009.

Now most of my comparison this quarter will be sequentially against the third quarter as well as against the guidance that was provided during our last earnings conference call. But in general our operating performance was inline or better than the expectations that we outlined to investors back in November.

In looking at our North America contract operations business, revenue was $199 million in the fourth quarter which was inline with our expectations and also up somewhat a bit on a sequentially basis from the third quarter.

We continue to make progress improving the cost structure in North America contract operations where costs declined sequentially for the third consecutive quarter.

In this segment cost totaled $88 million in the first quarter of 2008 and they declined over the course of the year, $86 million in the second quarter, $84 million in the third quarter and $83 million in the fourth quarter.

Now, in this comparison, it is interesting to note that both, the first quarter and the fourth quarter generated the same amount of revenues $199 million.

Gross margins in North America Contract Operations segment increased to $160 million for the fourth quarter for a gross margin percentage of 58%. This compares to gross margin of $130 million or 57% in the third quarter. The improvement is due in large part to our continued disciplined cost management.

At December 31, we had total North America Contract compression fleet of $4.57 million horsepower. The fleet utilization was 76% and that is flat compared to the third quarter.

If we look ahead now, the first quarter of 2009, we expect that North America Contract Operations revenues will be $193 million to $195 million, and that's below fourth quarter levels due to anticipated declines in operating horsepower. We expect margins will be slightly below the fourth quarter levels, which were 58.4%.

Our international contract operations revenue was $136 million in the fourth quarter and that was above our guidance of $130 million to $132 million, helped by the startup of projects in Brazil, Argentina and Peru, but also about $5 million of retroactive revenue receipts for labor cost recoveries that are not expected to occur in the first quarter.

International contract operations gross margins was $86 million, or 63% in the fourth quarter, and that was generally inline with our low 60s guidance range. This was an improvement over third quarter gross margin, which was $81 million or 60% of revenues. The sequential improvement here in gross margins resulted largely from lower repair and maintenance expenses.

The international fleet utilization declined to 91% at December 31. That compares to 92% at September 30th. And that's on a basis of approximately $1.5 million horsepower. Operating horsepower increased by about 13,000 in the fourth quarter. So, if you look at Exterran's worldwide fleet at the end of December, it totaled 6.1 million horsepower. Worldwide utilization was 79%. That compares to 80% that we had at September 30th.

Going back to international contract operations for the first quarter, we expect that revenues will be $124 million to $126 million, with margins in the low 60s. Revenues are expected to decline sequentially somewhat due to the loss of about $5 million in quarterly revenues from jobs that are ending in Brazil and Mexico, and also the $5 million in the retroactive benefits that we received in the fourth quarter that we do not expect to repeat in the first quarter.

While we certainly, typically have some of our longer-term contracts expired in our international contract operations business, a loss of $5 million in quarterly revenues were unexpected, is a little bit larger than typical for us. Still, we expect to startup a larger majority of our $130 million of annualized revenue backlog during the course of 2009. And as a result, we expect that international contract operations quarterly revenues will gradually increase over the course of the year.

If we move to fabrication, we generated revenues of $394 million. That's somewhat above our guidance range of 360 to 380 for the quarter. Gross margin was approximately 22%. Again, above our guidance of mid-teens, due primarily to the benefit of the cost recovery on the Total Solutions project in Kazakhstan as Steve talked about earlier.

For the first quarter, we expect that fab revenues will be $320 million to $340 million with margins in the mid-teens. Looking at aftermarket services, fourth quarter revenue was $101 million, that's a bit above third quarter levels, and also above our guidance which was $90 to $95 million. Gross margin percent was 19% and that was generally inline with our guidance.

For AMS in the first quarter, we see slower market activity and expect to generate slightly lower after market service revenues of $80 million to $85 million with margins in low 20s.

As discussed by Steve earlier given market conditions at year end, we completed our goodwill impairment test we booked the non-cash pretax $1.1 billion write-down of goodwill during the quarter. The impaired goodwill was originally recorded on our balance sheet, principally as a result of the Hanover, Universal stock-for-stock merger that was completed in August 2007.

Now interestingly, actually at EXLP, where goodwill was not affected by the Hanover, Universal merger, there was in fact in no goodwill impairment there. EXLP still has a $124 million of goodwill on its balance sheet.

Now as we have mentioned, the impairment that we had is a non-cash charge. It has no impact on our cash flows. Our cash position or the calculations are able to compliance with the financial convents in our debt instruments.

The non-cash pretax asset impairment of $22 million related to the Cawthorne Channel Project in Nigeria. As a reminder, we have not booked at any revenues on this project over the past two years.

So excluding impairment items and the merger costs, we generated EBITDA of $219 million for the quarter and earnings per share of $0.85. The recovery of the second quarter Kazakhstan loss, which is included in the numbers, benefited the numbers by about $14 million in EBITDA and about $0.13 per share.

Net CapEx for the fourth quarter was a $121 million and total CapEx included about $68 million in growth capital. For full year 2008, net CapEx totaled $453 million, and total CapEx included about $288 million in growth capital, and $141 million in fleet maintenance capital.

We expect that net capital expenditures for 2009 will be less then 2008 levels in the $400 million to $450 million range. About $50 million of our 2009 international growth capital will be reduced during the year by upfront payments on new contract operations jobs, which would actually reduce our cash out the door number for capital expenditures to be more in the $350 million to $400 million level.

We expect the capital sending for 2009 will include about a $120 million to $130 million for fleet maintenance, and $275 million in contract operations growth capital. Most of this growth capital will be in the international arena.

On the balance sheet side of things, total consolidated debt increased by about $45 million during the quarter, due largely to stock buyback activity. Our total debt was $2.5 billion and our debt of CapEx even after the effect of the goodwill impairment was 55% at December 31.

At the end of the year, the Exterran Holdings' $850 million revolving credit facility and $270 million is gone still. Available debt capacity after we take into account letters of credit that are drawn against the facility was $364 million, and that includes capacity under the ABS facility and also the Exterran Partners revolving credit facility.

Let's now look for a minute at Exterran Partners. EXLP now owns a compressor fleet of just over 1 million horse powers, or about 23% of the combined Exterran Holdings and Exterran Partners, US contract operations business.

Beyond this agreement between Exterran and Partners currently caps EXLP's SG&A expense of $6 million a quarter and also the operating cost of $21.75 for operating horsepower for quarter. The operating capital has actually exceeded by about $1.8 million and the SG&A capital exceeded by about $100,000 in the fourth quarter.

And as a reminder for everyone, these caps are due to terminate on December 31, 2009. With the benefit of the cost caps, EXLP generated EBITDA of $24 million and distributable cash flow of $14 million in the fourth quarter. This distributable cash flow was sufficient to cover fourth quarter distribution by 1.5 times. And by comparison, the third quarter's coverage is 1.6 times. And even if we take away the benefit of gas, EXLP coverage during the fourth quarter is 1.3 times.

In the fourth quarter, Exterran Partners fleet average operating horsepower was 908,000, and that compares to 816,000 in the third quarter. The increase was driven by fourth quarter contribution from purchase of units from Exterran in July of 2008. At September 30th, EXLP's fleet had spot utilization rate of 89%. And last bit then is, we do expect to file the Exterran and Exterran Partners' 10-Ks within the next few days.

And before we go to Q&A, I would like to turn the call back over to Steve for guidance.

Steve Snider

So in summary, 2009 is expected to be a very challenging year for Exterran. In North America, we are pleased with improved service levels and operating performance in the second quarter of 2008. Unfortunately, activity levels are under pressure due to difficult market conditions.

In Latin America, we still see fairly steady order activity. We are however concerned about the situation in Venezuela. In the Eastern Hemisphere [Bolivia] business in our backlog are solid. Our new business activity has slowed.

One of the benefits of this merger was enhanced geographic and product diversification. With approximately half of our total company revenues from customers outside of North America, we are much better diversified than during the last industry downturn in the early 2000.

We believe our production-oriented business model coupled with our strong balance sheet position us well to navigate the current challenging market conditions. We believe that we have the service network, people and asset base to continue to deliver in difficult economic times. And that our ability to do so is enhanced by our strong position as a market leader in many of the services and regions in which we operate.

We overcame operational issues during the course of 2008 and believe we are now better positioned to meet market challenges in 2009. We remain enthusiastic about the long-term prospects for Exterran, but are realistic regarding the challenges we will face in 2009 and 2010.

Last fall, we announced the return of Ernie Danner to our company in the role of President and Chief Operating Officer. Ernie is actively engaged in managing our operations and will be part of our Investor discussions in the near future. We continue to expect that Ernie will assume the role of Chief Executive Officer of Exterran Holdings upon my planned retirement at the end of June this year.

Ruben, let us open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). And for our first question, we will go to Brad Handler with Credit Suisse.

Brad Handler - Credit Suisse

Thanks, guys good morning.

Steve Snider

Good morning

Michael Anderson

Good morning, Brad.

Brad Handler - Credit Suisse

Could we please spend a little bit of time in the US? I guess maybe a general question first. Steve, your cautionary comments on the US deal, I guess they make sense. I'm not trying to suggest they don't.

But as you have explained to us overtime, you have a production orientation and some of the demand pullback that you are describing, is it seem inconsistent with that at all. Is it happening a little more quickly than you have might, I guess, given that? Can you just give a little color in that perspective?

Steve Snider

First of all, I don’t think it is inconsistent. Let me explain what we see as occurring in North America at the present. Certainly, our producer friends have been dealing with all the same issues all businesses are today, trying to decide how best to approach 2009, and I think, most of them have now come out with what their company philosophy is going to be. And for most of them, the common theme is cost containment as it is with us. And to do that, they are trying to find ways to economize whether they can in their operations and their production. One of those areas to economize is compression, and they do first by rationalizing their horsepower. And we are seeing returns of some horsepower due to that rationalization. They need as much horsepower as they currently have on their location.

Second issue that we have is that, as we all know gas supply is up considerably year-over-year and demand is somewhat down. So, we have a commodity price issues that’s in play. But we also have customers who are not as actively replacing declining reserves, so there is a natural erosion in horsepower as we get back down to the market demand. And we have some units that will come back due to that.

And then the third one that we talked about is that with long lead time deliveries last year, which were in place up till almost the end of last year, many of our customers committed the purchase equipment which they are now receiving, some of which was for productions that they may have delayed, so they will use that to replace some contract units from time to time.

Now with all of that in play, we haven't seen enormous amounts of erosion at this point, but we have seen the beginnings and I want to be very upfront with everybody that we will probably have more of that continuing through the year as we try to get this situation in balance.

So, I do think that’s consistent and I believe in the long-term that there is a certain amount of gas has to come to market, it's got to be compressed to get there, we will be doing a majority of it in North America. We are very strong about the fact that we will have positive cash flows this year even in spite of some CapEx that we have. So, I think it is still consistent with just a state of the operations right now in North America.

Brad Handler - Credit Suisse

Let me follow-up on just a couple of the points, because I am curious about your visibility beyond 1Q a little bit. It sounds like, perhaps some of the budgeting decisions may have been made and maybe the chunk of some of the longer lead delivery of fabricated ones that you are selling maybe that is already, bracketed out of the way by the first quarter. So, is it plausible that some of the factors that you are describing kind of get out of the way pretty early on in the year and that might suggest stability in '09 borrowing the other issues? Or is it Mike, do you expect to continue with seepage and these issues might still also erupt, if you will?

Michael Anderson

Yes Brad, it's still unfolding, I think it's too soon to tell when the system will get itself in balance but I don’t think it will be by the end of the first quarter. I think we will continue to see some erosion hopefully to lessen as time goes on.

Brad Handler - Credit Suisse

Okay, fair enough. I will get back in queue, and I will turn it back. Thanks.

Operator

And for our next question we go to Kevin Pollard with JP Morgan.

Kevin Pollard - JP Morgan

Thanks. Good morning, guys.

Steve Snider

Good morning.

Kevin Pollard - JP Morgan

I wanted to follow-up on one of the comments you just made, Steve about, E&P rationalizing some of the horsepower. Are you seeing any appetite on the part of customer you own large fleets of some themselves to across monetize and sell it into the market, perhaps recreating something like a sale lease back type opportunity for you?

Steve Snider

Yes, let me answer that little bit differently then how you asked it, you asked if there is any large fleet that are interested in that, and the answer to that question is no, but there are some smaller operators with small to mid sized fleets that have approached us with the concept that we were purchasing with the concept. Nothing is really come to fruition of any magnitude but there is some discussion and more interest now as they try to generate some capital absolutely.

Kevin Pollard - JP Morgan

And is something like that world has been materialize would you expect to happen at the holdings level or would be in the partners?

Steve Snider

We probably depend upon the customer, if they are holdings customers or partners customer, because we have broken our customer base between the two entities. And then our operating procedure here is that it's a brand new customer it will probably go into the partnership.

Kevin Pollard - JP Morgan

Okay. And if I switch over to the international side, how much of the 130 million project backlog if any is in Venezuela?

Steve Snider

Very little of that I think would be in Venezuela that’s largely eastern hemisphere and the rest of Latin America.

Kevin Pollard - JP Morgan

Okay. So you don't have any projects that basically get deferred or cancel there due to lack of payment. Ordinary (inaudible) businesses.

Steve Snider

I don't know those backlog numbers that we gave you, no. That’s all came from backlog elsewhere.

Kevin Pollard - JP Morgan

Okay, and then last question and I will turn it back. On the margin front you obviously got in a lot of release from some of the fuel price pressure you were seeing in the first half of '08. Is there any more to benefit that to come, we have pretty much seen that backed out at this point.

Steve Snider

We got some release and it's probably improved over the last six months sequentially month after month, but we haven’t really seen the benefit yet is our lube oil cost, because lube oil contract has just rolled over into an area where we will have a little bit lower lube oil cost. However, most of the reduction that Michael refer to is efficiency in the field, fewer repairs, less parts consumption, better control of labor hours and most of the improvement in margins and operating efficiency has been just in good from operating practice not the price of the components.

Kevin Pollard - JP Morgan

Okay. So, if I think about your cost as you go forward with a little bit lower revenue for the reasons you articulated. Would you expect your cost to stay relatively flat was kind of a Q4 level and then perhaps the margin pressure being from the drop in revenue or we see some further cost reduction as well?

Steve Snider

We may see some further cost reductions and maybe massed by the kind of down creep in utilization, but our management team in the field certainly has that cash in front of them to hold their operating cost where they are and not to see them increase as this market changes.

Kevin Pollard - JP Morgan

Okay. Thanks a lot. I appreciate it.

Steve Snider

Sure.

Operator

For our next question we will go to Mike Urban with Deutsche Bank.

Mike Urban - Deutsche Bank

Thanks. Good morning.

Steve Snider

Good morning.

Mike Urban - Deutsche Bank

I want to follow-up on the North America a little bit, how much impact have you seen from customers shutting in production and as kind of follow-on to that. I know in some cases when that has happened, they have often held on to the equipment onto the assumption that they will start backup pretty soon. To the extent you have seen shut in the production and they are now returning that equipment just given the capital situation in the gas price environment?

Steve Snider

I don’t think we have yet seen anyone return or cancel their contract or try to get out of their contract, because they are shutting in production. I have not heard of any shut in production in North America that's impacting us. It doesn’t mean there haven’t been some there maybe some out there in small units, but none of the bigger guys have done that. And you are right they do shut in production quite often the unit there, some prices rebound we can start to back-up again, it hasn’t been a piece yet.

Mike Urban - Deutsche Bank

Okay, that’s helpful. And on the international side, have you seen additional bookings or continued interest in new total solutions projects or is that something that’s been put on hold given the situation out there?

Steve Snider

We have seen some but it’s definitely much more active than it was six or eight or nine months ago. That’s an area that commodity prices definitely will impact because of the gas processing we are dealing with liquids prices to help justify the project. So it is slower, there are projects still live out there and we have a backlog of projects under construction that we will definitely foresee.

Mike Urban - Deutsche Bank

And last question, just kind of a housekeeping thing. Do you have the breakdown in the fabrication revenue between compressor fab and another?

Michael Anderson

On the revenue or the backlog

Mike Urban - Deutsche Bank

The revenue side, I said backlog initially I don't remember that, sorry.

Michael Anderson

Yes, I think (inaudible) was about $110 million and the remaining most of that was compression with production and processing being the smaller part of what’s remained.

Mike Urban - Deutsche Bank

Okay. That’s all from me. Thank you

Operator

We go next to Chris Gillespie with Simmons & Company.

Christopher Gillespie - Simmons & Company

Thanks, good morning

Steve Snider

Good morning

Christopher Gillespie - Simmons & Company

First question is with the international contract compression project that you expect to startup over the course of the year. Do you see any significant startup cost following through in the next couple of quarters?

Michael Anderson

No. The startup costs were all worked into the project itself. So, we delivered the running product to the customer with those cost baked in.

Steve Snider

Yes. We have, Chris, at times when we startup in the first couple of months, sometimes we have had some problems. Typically that’s been we had some projects perhaps in the past, we took some existing equipment and had some trouble getting it started. A lot of this stuff that we got in the backlog is going to be some new equipment. And so that typically works a lot smoother off the start. So we wouldn’t anticipate those.

Christopher Gillespie - Simmons & Company

Okay. And turning to fabrication. Have you seen any cancellations to-date?

Steve Snider

Yeah. We have had a handful of cancellations not very many, we have had some handful of delays also. So far we have begun to see a little bit of playing around the edges. Most of with speculative kind of equipment that we haven't cancelled or delayed. Not a big number yet as you can tell by our backlog still being high.

Christopher Gillespie - Simmons & Company

And do you have a number on how much of fabrication backlog you expect to flow through in over 2009?

Michael Anderson

Yes. It's basically, all of it except for about $300 million.

Christopher Gillespie - Simmons & Company

Okay. That’s very helpful. Thank you.

Steve Snider

Sure.

Operator

For our next question, we go to Sharon Lui with Wachovia.

Sharon Lui - Wachovia Securities

Hi. Good morning.

Steve Snider

Good morning, Sharon.

Sharon Lui - Wachovia Securities

My question relates to EXLP, just wondering if you could provide color on your outlook for operating horsepower at the partnership. Do you expect I guess the deterioration in Q1 revenues to be the same magnitude as the parent?

Steve Snider

Proportionally our guess it would be somewhat similar, yes. But with the coverage we have, I don't think that there would be any problem. The other thing I mean if you look historically, EXLP has done a little bit better, and part of that has been boosted by the fact that there was the new customer to the Exterran family that would go to EXLP.

Sharon Lui - Wachovia Securities

Okay. Also I guess given EXLP's yield and current market condition, what are your thoughts or commitments you did drop down acquisition model?

Steve Snider

From a commitment standpoint, you will read in our 10-K. I mean our strategy has not changed. We still believe it's a preferred vehicle over the long-term. Those North American assets, the US assets into the LP, but where market conditions are today and the visibility in cost to capital, we are likely that it, at least in the near-term it would be little bit slower.

We still think it's the right thing to do, but we are not going to do something we don’t think makes a lot of sense from a financial standpoint. As we talked about from the cash flow standpoint, in Exterran Holdings we are going to be free cash flow positives. There is not something that really drives our business model generating cash from the LP it's really only a supplement in terms of making the story better.

So we will hopefully perform well and weight that out.

Sharon Lui - Wachovia Securities

Okay. And just one housekeeping item for growth CapEx at the partnership is there a budget for '09.

Steve Snider

We certainly have one internally. It's not one that we have provided in terms of guidance.

Sharon Lui - Wachovia Securities

With the fourth quarter run rate be reasonable?

Steve Snider

In terms of growth capital?

Sharon Lui - Wachovia Securities

In terms of growth CapEx.

Steve Snider

On that's probably a reasonable number.

Sharon Lui - Wachovia Securities

Okay, great. Thank you.

Operator

We will go next to Joe Gibney with Capital One.

Joe Gibney - Capital One

Thank you. Good morning, everybody.

Steve Snider

Good morning.

Joe Gibney - Capital One

Just a follow-up question Michael for you on international contract and you picked a 124 to 126 for Q1. You talked about the gradual ramp expectations in revenues throughout the year.

Just opening calibrate a little bit more with your backlog there at the 130 million is it lumpy ED we get a more pronounced to start for some projects in Q2 and Q3 or should just view it as sort of a ratable ramp through the year building on some of that backlog?

Michael Anderson

I think we have given you a pretty strong answer that no leverage coming through the first quarter, but some of the, it’s a gradual ramp up there is some step that is not going to start necessarily or seen much revenue in back in 2009. And the fourth quarter is probably anticipated right now to be a little bigger then the rest, but we will project starting up in every quarter.

Joe Gibney - Capital One

Okay, that's helpful. And then one minor item, just curious on the any incremental merger integration related expenses that you would anticipate in your first quarter?

Michael Anderson

No, we think that is behind us.

Joe Gibney - Capital One

Thanks guys, I will turn it back.

Operator

We go next to [Randal Martine] with Barclays Capital.

Randal Martine - Barclays Capital

Hi guys, good morning. I am just wondering on the partnership side, are there you seeing any business in contract all over?

Steve Snider

No, in the contracts conversion process no its continuing a pace that reminding you that we have down to the smaller customers, so it just takes more time.

Randal Martine - Barclays Capital

Okay.

Operator

Any further questions sir?

Randal Martine - Barclays Capital

No, thank you.

Operator

And we go next to [Justin Tully with Tully Brothers.

Steve Paar -- Equity Analyst

Good morning. Actually this is [Steve Parr], an equity analyst. Thanks for taking my call. Could you elaborate on the fact there is behind the fourth quarter increase in working horsepower.

I assume that you gained market share, did you? Does this suggest that your market share losses have now bottom? Does this suggest that the sales and marketing organization consolidation is complete?

And then secondly could you discuss the post right of debt-to-cap ratio, what is your target in comfort levels and your ability to act on potential opportunities in light of it? Thank you.

Steve Snider

I will talk to the horsepower portion of it. And yes I would say that when we gain horsepower in the fourth quarter that certainly we had either bottom out or had began to recover a little bit of the market share that you asked about.

And I think it's a result of the sales force revamp that we went through early in 2008 reaching its stride and I get was partially the fact that we had our equipment in better shape and our service model in better conditions. So, yes all of the things that you need to get your horsepower moving in the right direction occurred in the fourth quarter.

Now I think all that same quality of service delivery is still applicable in 2009, but we have a market where our customers are trying to rationalize their horse power and reduce their cost. So, we will see some additional losses of horse power, but I don't think it's going to be out of proportion to the market.

Steve Paar -- Equity Analyst

Okay. And you do again suggest that most of the sales and marketing consolidation between the organizations is done and starting to get extract?

Steve Snider

Yes.

Steve Paar -- Equity Analyst

Okay, thanks. Could you address the balance sheet question?

Steve Snider

Yup, post goodwill impairment the debt-to-capital is going from about 42% to 55% that actually is about the same level that the individual companies were prior to the merger it has really no effect it’s not a part of any of our financial covenants and the debt instruments. Those are more cash flow and interest coverage based and those numbers don’t change from any kind of affect for us going forward.

It has no effect in terms of capital resources. We've got $364 million of availability under existing credit lines and anticipate that will be capital positive in 2009 after our capital expenditures, so we don't think that that is really much at all of an issue with regard to our financial resources.

Steve Paar -- Equity Analyst

Thank you have you established a target level for that ratio or a comfort level?

Steve Snider

Our target ratios which we haven’t really changed much has generally been around at three times debt-to-EBITDA cash flow

Steve Paar -- Equity Analyst

Right

Steve Snider

That test is opposed to the debt-to-capital.

Steve Paar -- Equity Analyst

Thanks gentlemen

Operator

We go next to Kent Green with Boston American Asset Management.

Kent Green - Boston American Asset Management

Hi yes my questions pertain to the partnership I don't know you ran after partnership 89% utilization that was down from mid-90s last year, is that, because of a drop down not fully utilizing their equipment?

Steve Snider

No that's from the maturities of partnership. When we initiated the partnership we put all working assets into the partnership. It has nothing idle. And overtime, it will be near more to the Holdings fleet as that partnership has units released. The new customers come in and new units are put to work, so it's just a part of the rationalization process.

Michael Anderson

And as that happens overtime, it's more a function of it's going to add idle equipment as it matures as opposed to the necessarily that the level of equipment stays the same and operating horsepower would drop, understand my point there.

Kent Green - Boston American Asset Management

Yeah. There was a some small equipment sales, that is obsolete equipment that you are selling or what do the sales do? Third party or back to the parent.

Steve Snider

No. That was to one of our customers who wanted to buy that equipment. And moving off outsourced compression.

Kent Green - Boston American Asset Management

Okay. And then you mentioned earlier is that if you have new customers that want to lease and I assume these are net, net leases. There are no operating expenses involved. The customer takes care of the operating expenses. Then it would go to the partnership, would that be significant and if there is a switch to leasing on dropdowns? Is that a source of revenue for the partnership in the future more so than dropdowns?

Steve Snider

First of all, it’s a service business. It's not a leasing business. So, what we provide is a service of moving and compressing natural gas for a fixed fee, and with that we utilize our own equipment and we pay all of our own operating cost.

Kent Green - Boston American Asset Management

So there is, I mean, obviously, you have fuel charges, fuel charges are coming down with the commodity prices here.

Steve Snider

No the customer supplies the fuel. Being compressed this supply fuels.

Kent Green - Boston American Asset Management

Okay. So there is the operating expenses would not be variable with commodity prices.

Steve Snider

No. Other than things like lube oil, if the price of oil goes up, we pay more for lubricating oil.

Kent Green - Boston American Asset Management

But this is a source of growth having more new customers switch to leasing to free up cash in their balance sheets.

Steve Snider

That certainly is a goal.

Kent Green - Boston American Asset Management

Is there any product mentioned the partnership like, more pipelines then gathering systems or is it just the normal mix.

Steve Snider

No that only thing in our partnership is compression assets that are out there producing gas. They could be producing it as a part of gathering system, could be well headed compression, would not be any pipeline compression in the US business.

Kent Green - Boston American Asset Management

Okay is there, is this mostly smaller customers or do you have large customers, large customers have a tendency to buy their own equipment.

Steve Snider

No we have a mixture in the partnership, many of whom are the major producers in the US.

Kent Green - Boston American Asset Management

Thank you.

Operator

Our next question we go to [Glenn Prymake with Broadview Advisors].

Glenn Prymake - Broadview Advisors

Good morning.

Steve Snider

Good morning.

Glenn Prymake - Broadview Advisors

Well two quick ones, One has the mix model technology been fully integrated in the company. And if so have you taken the service to other regions?

Michael Anderson

Yes the first one, [Emid] has been integrated into the company and we have begun to work with some other markets and applying their technology and we are trying to see where they might actually fit with their band of services. So as you can tell from that response we had no success in that area yet, as probably little early we just really started trying to find where else in the world they could be applicable. They continue to do the job they have done in the Northern Rockies and their business continues to move out along the way that we thought it would.

Glenn Prymake - Broadview Advisors

Okay because it seems like in the Marcellus there were issues over there that potentially could take their technology in that market?

Michael Anderson

Yeah that technology and in the way out of my element here but it’s applicable to certain quality standards and not to other. So we have to determine what is in each one these areas and which one is biding that and which one is down.

Glenn Prymake - Broadview Advisors

Okay and then early in the call you mentioned that during this downturn and the combined entity is in much better shape financially and operationally versus the prior downturn. That said should we expect to see given is more inside or buying during this time period because it seems as all the stock is priced at, in such a way that, that this downturn towards the company is in more shape during this time period versus the prior time period and then I have to agree with you that to much better, stronger combined company to-date versus five years ago?

Michael Anderson

I think the answer to your question from me personally is, I was not stupid enough to spend all my available capital at $50 share I couldn't wait down to 18. So you may see some more, I can not speak for my co-workers here but I think most of us have invested quite a bit in the company and would love to see this stock rebound. So I am looking seem or not.

Glenn Prymake - Broadview Advisors

Okay thank you.

Operator

And with a follow-up question we return to Brad Handler with Credit Suisse.

Brad Handler - Credit Suisse

Hi again.

Steve Snider

Hi.

Brad Handler - Credit Suisse

Could you give us a little more color please on, some of I am back to the US contract compression market. I guess I am just trying to understand little bit better maybe some of the weakness, small versatile versus, medium versus large. Did you see more I guess point you have seen a little more turn backs on the small turn?

Steve Snider

No, it's pretty much across the board and the way I worked is somebody with 3 1500 horsepower compressors because now they can do it too. Somebody with a 1500 horsepower compressor in terms of they can use 600 horsepower line down the food chain. So we see customers are downsizing the size units or the number of units they have and it kind of rolling effect you get some big units back you get some small units back. We get down at the real small producers; generally there is no way to downsize. If commodity prices stay low they plug and abandon and release little bit compressor, but we have not seen that at this point in time any flood of small equipment coming back.

Brad Handler - Credit Suisse

Could I ask the same question perhaps regionally within the US, if there is some areas in the same way that we can look at rate count and something about how things are pulling back, how you seen some pull backs in some specific regions?

Steve Snider

No, there is no real regional difference to this that I have been informed over, I know about it seems like it just kind of a general operating trend amongst the producers across the country.

Brad Handler - Credit Suisse

And then I guess just the last one for me for now. Any sense of, as you try to redeploy those assets. You sort of have a sense that you will be shifting the concentration into the unconventional place, that accelerate and that has been happening anywhere I suppose but does it accelerate over the course of is it almost real time, does it happen through the course of '09, or is that more of a longer term trend?

Steve Snider

It's long- term trend. It has been, assets have been shifting into unconventional gas for 10 years now or so. And they are going to continue to shift since that's where all the major drilling now is in unconventional as you know. So, we will continue to see that shift is not going to be a one year thing.

Brad Handler - Credit Suisse

I guess the other way of asking it, I'm trying to ask is, I'm sort of wondering if there is a cost option and there is some efficiency associated with that concentration in some of the shale plays versus having things in some other regions if there are some operating costs offset in that concentration. But I think you are answering the question on that basis. It’s not real time enough to allow you to do that. But you know I'm getting at it does that make any sense?

Steve Snider

I think I know what you’re getting at in there are some efficiencies in the big unconventional plays that I guess what happened in the newer unconventional plays over time it seems to keep moving around as we know.

Brad Handler - Credit Suisse

Okay that's fine. We can take it offline.

Steve Snider

Okay, if that did not answer your question we can talk about it.

Brad Handler - Credit Suisse

Okay, that's great thank you guys.

Steve Snider

Sure

Operator

And we go next to [Hemlin Thompson with Westfield].

Hemlin Thompson - Westfield

Yes thank you taking my call. Two questions one can you give me a historical perspective on gross margins on North American contract operations during the down cycles how much swing has there historically been and the second question is related to the growth CapEx in the international markets how long the dollar spent before it starts generating revenues and what type of returns we are looking for?

Michael Anderson

Sure on the gross margin question in downturns we have historically not seen wide variations in the gross margin dollars to the horsepower as we call it and we generate because we are able to move our variable cost around at the same time we are having reduction in units so the margin percentage or the margin dollar per horsepower is not really impacted too much by a turndown what's impacted versus the revenue because we have less horsepower. On the international question, depending on the type of project, from the time we begin to spend capital, it can be as short as probably 90 days and as long as probably a year that we are spending capital before we start to generate revenue.

Hemlin Thompson - Westfield

That’s helpful. Just a follow-up on the gross margin, for North America. It was my impression, and maybe it was wrong, but it was my impression that target was to get to sort of a normalized flows 50 gross margin in North America and clearly there are operational issues during 2008, which you guys fought hard to fix. In the downturn, can you get back to that target, or was that target wrong, if that sort of a more normalized gross margin for the business?

Michael Anderson

That target was not correct. Post the merger when you looked at the way that you are looking at the old gross margin percentage performance for Universal which was up in the low 60s. Universal and Hanover accounted differently for gross margin and we normalize it for the way we were accounting post merger. That margin should be in the high 50. And that's roughly where it is right now. The way to improve the margin is to deal the raise in price and cost, but obviously and this is not an environment where we are going to be raising prices any time soon.

Steve Snider

But on pricing, I think, its interesting to note that we really haven’t raised pricing for our customers over the past couple of years and have worked really hard on cost management.

Hemlin Thompson - Westfield

Do you think at this point we are lowering pricing at some point during the year?

Steve Snider

Its hard to say. We're avoiding that voraciously at this point in time. And most of our producers are aware that we have not raised prices for the last two and half years while their gas prices have gone from $3 to $12. And now it is coming back down, we kind of worked with them on the idea was not fair to ask us to reduce; it did not go up we are not going to reduce.

And that's the tact we are taking right now and it seems to be, it's the way we have always done our business at Exterran, well I think the customers are inline with it.

Hemlin Thompson - Westfield

Can you just give me just a sense of the magnitude of lube oil cost in the operations?

Michael Anderson

Yeah, I mean we have, we talked about North American contract operations, we typically combined lube oil and gasoline as being about 15% of the cost structure, those were more on the commodity based things. Lube oil is the majority of that 15%.

Hemlin Thompson - Westfield

That’s appreciating.

Operator

And with that ladies and gentleman we have no further questions on our roster therefore Mr. Snider I will turn the conference back over to you for any closing remarks.

Steve Snider

Great, I would like to thank everyone for joining the call today and as always I want to express my appreciation to the employees, customers and financial stakeholders of Exterran for all the efforts they put it in our behalf we look forward to talking with everybody again in about three months. Thank you.

Operator

And again ladies and gentlemen this does conclude the Exterran Holdings Incorporated and Exterran Partners LP fourth quarter 2008 earnings conference call. We do appreciate your participation and you may disconnect at this time.

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