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EXH > SEC Filings for EXH > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for EXTERRAN HOLDINGS INC.

Form 10-K for EXTERRAN HOLDINGS INC.


26-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Financial Statements, the notes thereto, and the other financial information appearing elsewhere in this report. The following discussion includes forward-looking statements that involve certain risks and uncertainties. See Part I ("Disclosure Regarding Forward-Looking Statements") and Part I, Item 1A ("Risk Factors") in this report.

Overview

We are a global market leader in the full-service natural gas compression business and a premier provider of operations, maintenance, service and equipment for oil and natural gas production, processing and transportation applications. Our global customer base consists of companies engaged in all aspects of the oil and natural gas industry, including large integrated oil and natural gas companies, national oil and natural gas companies, independent producers and natural gas processors, gatherers and pipelines. We operate in three primary business lines: contract operations, aftermarket services and fabrication. In our contract operations business line, we use our fleet of natural gas compression equipment and crude oil and natural gas production and processing equipment to provide operations services to our customers. In our aftermarket services business line, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression, production, processing, treating and other equipment. In our fabrication business line, we fabricate compression and oil and natural gas production and processing equipment for sale to our customers and for use in our contract operations services. In addition, our fabrication business line provides engineering, procurement and fabrication services related to the manufacturing of critical process equipment for refinery and petrochemical facilities, the fabrication of tank farms and the fabrication of evaporators and brine heaters for desalination plants. We offer our customers, on either a contract operations basis or a sale basis, the engineering, design, project management, procurement and construction services necessary to incorporate our products into production, processing and compression facilities, which we refer to as Integrated Projects.

Industry Conditions and Trends

Our business environment and corresponding operating results are affected by the level of energy industry spending for the exploration, development and production of oil and natural gas reserves. Spending by oil and natural gas exploration and production companies is dependent upon these companies' forecasts regarding the expected future supply, demand and pricing of oil and natural gas products as well as their estimates of risk-adjusted costs to find, develop and produce reserves. Although we believe our contract operations business is typically less impacted by commodity prices than certain other energy service products and services, changes in oil and natural gas exploration and production spending normally result in changes in demand for our products and services.

Natural gas consumption in the U.S. for the twelve months ended November 30, 2013 remained relatively flat compared to the twelve months ended November 30, 2012. The EIA forecasts that total U.S. natural gas consumption will decrease by 1.3% in 2014 compared to 2013 and increase by an average of 0.7% per year thereafter until 2040. The EIA estimates that the U.S. natural gas consumption level will be approximately 30 trillion cubic feet in 2040, or 16% of the projected worldwide total of approximately 185 trillion cubic feet.


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Natural gas marketed production in the U.S. for the twelve months ended November 30, 2013 increased by approximately 1.1% over the twelve months ended November 30, 2012. The EIA forecasts that total U.S. natural gas marketed production will increase by 2.2% in 2014 compared to 2013 and U.S. natural gas production will increase by an average of 1.5% per year thereafter until 2040. The EIA estimates that the U.S. natural gas production level will be approximately 33 trillion cubic feet in 2040, or 18% of the projected worldwide total of approximately 187 trillion cubic feet.

Our Performance Trends and Outlook

Our revenue, earnings and financial position are affected by, among other things, market conditions that impact demand and pricing for natural gas compression and oil and natural gas production and processing and our customers' decisions among using our products and services, using our competitors' products and services or owning and operating the equipment themselves.

In the second half of 2011, we embarked on a multi-year plan to improve the profitability of our operations. We implemented certain key profitability initiatives associated with this plan in 2012, and implemented additional process initiatives intended to improve operating efficiency and reduce our cost structure throughout 2013. These initiatives have positively impacted all of our business segments, and we expect additional positive impact in 2014.

During 2013, we saw steady activity in North American shale plays and areas focused on the production of oil and natural gas liquids. This activity has increased the overall amount of compression horsepower in the industry; however, these increases continue to be offset by horsepower declines in more mature and predominantly dry gas markets, where we provide a significant amount of contract operations services. In early 2012, natural gas prices in North America fell to their lowest levels in more than a decade, but prices recovered somewhat during 2013. Historically, natural gas prices in North America have been volatile. During periods of lower natural gas prices, natural gas production growth could be limited or decline in North America, particularly in dry gas areas. Booking activity levels for our North America fabricated products during the year ended December 31, 2013 have decreased from relatively high levels in the prior year. Approximately 38% of the reduction in the North America backlog during 2013 compared to year-end 2012 was related to an installation project for one customer that was completed in 2013. Despite lower booking levels for our fabricated products, our North America fabrication revenue during 2013 was higher than the results achieved during 2012. We believe our fabrication backlog has stabilized as of year-end 2013.

In international markets, we believe demand for our contract operations and fabricated projects will continue and we expect to have opportunities to grow our international business through our contract operations, aftermarket services and fabrication business segments over the long term.

Our level of capital spending depends on our forecast for the demand for our products and services and the equipment required to provide services to our customers. We anticipate investing more capital in our contract operations business in 2014 than we did in 2013.

Based on current market conditions, we expect that net cash provided by operating activities and availability under our credit facilities will be sufficient to finance our operating expenditures, capital expenditures and scheduled interest and debt repayments through December 31, 2014; however, to the extent it is not, we may seek additional debt or equity financing. We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity or other debt securities, in open market purchases, privately negotiated transactions or otherwise and from time to time seek to purchase our equity. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

We intend to continue to contribute over time additional U.S. contract operations customer contracts and equipment to the Partnership in exchange for cash, the Partnership's assumption of our debt and/or our receipt of additional interests in the Partnership. Such transactions depend on, among other things, market and economic conditions, our ability to agree with the Partnership regarding the terms of any purchase and the availability to the Partnership of debt and equity capital on reasonable terms.


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Certain Key Challenges and Uncertainties

Market conditions in the natural gas industry, competition in the natural gas compression industry and the risks inherent in international markets continue to represent key challenges and uncertainties. In addition to these challenges, we believe the following represent some of the key challenges and uncertainties we will face in the near future:

North America Market and Natural Gas Pricing. During 2013, we saw steady activity in North American shale plays and areas focused on the production of oil and natural gas liquids. This activity has increased the overall amount of compression horsepower in the industry; however, these increases continue to be offset by horsepower declines in more mature and predominantly dry gas markets, where we provide a significant amount of contract operations services. In early 2012, natural gas prices in North America fell to their lowest levels in more than a decade, but prices recovered somewhat during 2013. Historically, natural gas prices in North America have been volatile. During periods of lower natural gas prices, natural gas production growth could be limited or decline in North America, particularly in dry gas areas, and as a result, the demand for our natural gas compression services and oil and natural gas production and processing equipment could be adversely affected. The recent investment of capital in new equipment by our competitors and other third parties could also create uncertainty in our business outlook. Many of our North America contract operations agreements with customers have short initial terms and are typically cancelable on short notice after the initial term, and we cannot be certain that these contracts will be extended or renewed after the end of the initial contractual term. Any such nonrenewals, or renewals at reduced rates, could adversely impact our results of operations.

Execution on Larger Contract Operations and Fabrication Projects. Some of our projects have a relatively larger size and scope than the majority of our projects, which can translate into more technically challenging conditions or performance specifications for our products and services. Contracts with our customers generally specify delivery dates, performance criteria and penalties for our failure to perform. Any failure to execute such larger projects in a timely and cost effective manner could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Personnel, Hiring, Training and Retention. Both in North America and internationally, we believe our ability to grow will be challenged by our ability to hire, train and retain qualified personnel. Although we have been able to satisfy our personnel needs thus far, retaining employees in our industry continues to be a challenge. Our ability to continue our growth will depend in part on our success in hiring, training and retaining these employees.

Activity in the Global Energy Markets. Our results of operations depend upon the level of activity in the global energy markets, including natural gas development, production, processing and transportation. Oil and natural gas prices and the level of drilling and exploration activity can be volatile. For example, oil and natural gas exploration and development activity and the number of well completions typically decline when there is a significant reduction in oil or natural gas prices or significant instability in energy markets. In international projects, some business activity is related to infrastructure development or regulatory requirements such as regulations to prevent the flaring of natural gas. The timing and financial impact of these projects is difficult to predict as they typically have longer lead times and larger scope, which can lead to variations in our results of operations internationally on a year over year basis.

Summary of Results

As discussed in Note 2 to the Financial Statements, the results from continuing operations for all periods presented exclude the results of our Venezuelan contract operations business, Canadian Operations and contract water treatment business. Those results are reflected in discontinued operations for all periods presented.

Net Income (loss) attributable to Exterran stockholders and EBITDA, as adjusted. We recorded net income attributable to Exterran stockholders of $123.2 million during the year ended December 31, 2013 and net loss attributable to Exterran stockholders of $39.5 million and $340.6 million during the years ended December 31, 2012 and 2011, respectively. The increase in net income attributable to Exterran stockholders during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to an increase in gross margins in our fabrication and North America contract operations segments, a decrease in long-lived asset impairments of $108.0 million, an increase in income from discontinued operations and an increase in gain on sale of property, plant and equipment, partially offset by a decrease of $32.7 million in cash payments received from the sale of our Venezuelan joint ventures' assets and an increase in income tax expense. The decrease in net loss attributable to Exterran stockholders during the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily due to goodwill impairments of $196.8 million recorded during the year ended December 31, 2011, an increase in gross margin in all of our business segments, equity in income of non-consolidated affiliates of $51.7 million from the sale of our Venezuelan joint ventures' assets during the year ended December 31, 2012 and an increase in income from discontinued operations. These decreases in net loss were partially offset by an increase in long-lived asset impairments of $130.5 million during the year ended December 31, 2012 compared to the year ended December 31, 2011. Our EBITDA, as adjusted, was $633.6 million, $460.7 million and $388.1 million during the years ended December 31, 2013, 2012 and 2011, respectively. EBITDA, as adjusted, during the year ended December 31, 2013 compared to the year ended December 31, 2012 and during the year ended December 31, 2012 compared to the year ended December 31, 2011, was favorably impacted by higher gross margins as discussed above. For a reconciliation of EBITDA, as adjusted, to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP, please read Part II, Item 6 ("Selected Financial Data - Non-GAAP Financial Measures") of this report.


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Results by Business Segment. The following table summarizes revenue, gross margin and gross margin percentages for each of our business segments (dollars in thousands):

                                            Years Ended December 31,
                                        2013          2012          2011
Revenue:
North America Contracts Operations   $   627,844   $   596,011   $   570,780
International Contract Operations        476,016       463,957       445,059
Aftermarket Services                     395,600       385,861       371,327
Fabrication                            1,660,944     1,348,417     1,225,459
                                     $ 3,160,404   $ 2,794,246   $ 2,612,625
Gross Margin(1):
North America Contracts Operations   $   345,355   $   311,308   $   276,971
International Contract Operations        279,072       279,349       260,654
Aftermarket Services                      86,182        82,271        59,567
Fabrication                              252,397       156,480       123,222
                                     $   963,006   $   829,408   $   720,414
Gross Margin percentage(2):
North America Contracts Operations            55 %          52 %          49 %
International Contract Operations             59 %          60 %          59 %
Aftermarket Services                          22 %          21 %          16 %
Fabrication                                   15 %          12 %          10 %



(1) Defined as revenue less cost of sales, excluding depreciation and amortization expense. Gross margin, a non-GAAP financial measure, is reconciled, in total, to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP in Part II, Item 6 ("Selected Financial Data - Non-GAAP Financial Measures") of this report.

(2) Defined as gross margin divided by revenue.

Operating Highlights



The following tables summarize our total available horsepower, total operating
horsepower, average operating horsepower, horsepower utilization percentages and
fabrication backlog (in thousands, except percentages):



                                                Years Ended December 31,
                                                2013        2012     2011
Total Available Horsepower (at period end):
North America                                    3,429       3,376   3,545
International                                    1,255       1,265   1,260
Total                                            4,684       4,641   4,805
Total Operating Horsepower (at period end):
North America                                    2,884       2,900   2,830
International                                      986       1,007     960
Total                                            3,870       3,907   3,790
Average Operating Horsepower:
North America                                    2,871       2,839   2,784
International                                      995         991     978
Total                                            3,866       3,830   3,762
Horsepower Utilization (at period end):
North America                                       84 %        86 %    80 %
International                                       79 %        80 %    76 %
Total                                               83 %        84 %    79 %


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                                                             December 31,
                                                   2013          2012           2011
Compressor and Accessory Fabrication Backlog    $  157,893    $   256,315    $  249,724
Production and Processing Equipment
Fabrication Backlog                                475,565        563,826       415,968
Installation Backlog                                46,429        245,573        69,576
Fabrication Backlog                             $  679,887    $ 1,065,714    $  735,268

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012



                       North America Contract Operations

                             (dollars in thousands)



                                                   Years Ended December 31,        Increase
                                                    2013             2012         (Decrease)
Revenue                                         $     627,844    $     596,011             5 %
Cost of sales (excluding depreciation and
amortization expense)                                 282,489          284,703            (1 )%
Gross margin                                    $     345,355    $     311,308            11 %
Gross margin percentage                                    55 %             52 %           3 %

The increase in revenue during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily attributable to an increase in rates, a 1% increase in average operating horsepower and a $6.5 million increase in revenue with no incremental cost due to the termination of contracts resulting from the exercise of purchase options by our customer on two natural gas processing plants, partially offset by a $7.4 million decrease in revenue due to the termination of three natural gas processing plant contracts during the second quarter of 2013. The increases in gross margin (defined as revenue less cost of sales, excluding depreciation and amortization expense) and gross margin percentage during the year ended December 31, 2013 compared to the year ended December 31, 2012 were primarily caused by the revenue increase explained above and improved management of field operating expenses from the implementation of profitability improvement initiatives. Gross margin, a non-GAAP financial measure, is reconciled, in total, to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP in Part II, Item 6 ("Selected Financial Data - Non-GAAP Financial Measures") of this report.

                       International Contract Operations

                             (dollars in thousands)



                                                   Years Ended December 31,        Increase
                                                    2013             2012         (Decrease)
Revenue                                         $     476,016    $     463,957             3 %
Cost of sales (excluding depreciation and
amortization expense)                                 196,944          184,608             7 %
Gross margin                                    $     279,072    $     279,349             0 %
Gross margin percentage                                    59 %             60 %          (1 )%

The increase in revenue during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to rate increases in Argentina and Indonesia that provided $32.7 million of additional revenue in 2013 and increases in revenue in Mexico and Bahrain of $17.7 million primarily due to contracts that commenced or were expanded in scope in 2012 and 2013. These increases were partially offset by a $37.1 million decrease in revenue in Brazil primarily as a result of the recognition of revenue with little incremental cost on terminated contracts during the prior year period. Gross margin percentage during the year ended December 31, 2013 compared to the year ended December 31, 2012 decreased due to the recognition of revenue on terminated contracts in Brazil during the year ended December 31, 2012 mentioned above, partially offset by the rate increases mentioned above.


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                              Aftermarket Services

                             (dollars in thousands)



                                                   Years Ended December 31,        Increase
                                                    2013             2012         (Decrease)
Revenue                                         $     395,600    $     385,861             3 %
Cost of sales (excluding depreciation and
amortization expense)                                 309,418          303,590             2 %
Gross margin                                    $      86,182    $      82,271             5 %
Gross margin percentage                                    22 %             21 %           1 %

The increase in revenue during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to an increase in revenue in the Eastern Hemisphere of $8.9 million and an increase in revenue in Latin America of $6.7 million, partially offset by a decrease in revenue in North America of $5.9 million. Gross margin increased during the year ended December 31, 2013 compared to the year ended December 31, 2012 primarily due to increases in gross margin in Latin America and North America, partially offset by lower current period gross margins on work performed in the Eastern Hemisphere.

                                  Fabrication

                             (dollars in thousands)



                                                  Years Ended December 31,        Increase
                                                     2013            2012        (Decrease)
Revenue                                         $    1,660,944    $ 1,348,417            23 %
Cost of sales (excluding depreciation and
amortization expense)                                1,408,547      1,191,937            18 %
Gross margin                                    $      252,397    $   156,480            61 %
Gross margin percentage                                     15 %           12 %           3 %

The increase in revenue during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to $188.9 million of higher revenue in the Eastern Hemisphere, $74.6 million of higher revenue in North America and $49.0 million of higher revenue in Latin America. The increase in revenue in the Eastern Hemisphere was due to increases of $114.3 million, $38.9 million and $35.7 million in compressor revenue, production and processing equipment revenue and installation revenue, respectively. The increase in North America revenue was due to increases of $80.7 million and $88.4 million in installation revenue and production and processing equipment revenue, respectively, partially offset by a $94.5 million decrease in compressor revenue. The increase in Latin America revenue was primarily due to an increase in installation revenue of $54.4 million. The increases in gross margin and gross margin percentage were primarily caused by the revenue increase explained above, a reduction in operating expenses from the implementation of profitability improvement initiatives and improved pricing associated with projects in North America and the Eastern Hemisphere. These improvements in results were partially offset by cost overruns on three large turnkey projects during the year ended December 31, 2013.

                               Costs and Expenses

                             (dollars in thousands)



                                                      Years Ended December 31,        Increase
                                                       2013             2012         (Decrease)
Selling, general and administrative                $     358,173    $     375,647            (5 )%
Depreciation and amortization                            327,505          346,177            (5 )%
Long-lived asset impairment                               28,637          136,614           (79 )%
Restructuring charges                                          -            6,471          (100 )%
Interest expense                                         115,745          134,376           (14 )%
Equity in income of non-consolidated affiliates          (19,000 )        (51,483 )         (63 )%
Other (income) expense, net                              (24,501 )            506        (4,942 )%

The decrease in SG&A expense during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to a $15.1 million decrease in state and local taxes primarily related to the impact of sales tax audits in . . .

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