10-K 1 extn-20181231x10k.htm 10-K Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K

(Mark One)
x       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
or
¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to
Commission file no. 001-36875
 
Exterran Corporation
(Exact name of registrant as specified in its charter)
Delaware
47-3282259
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
4444 Brittmoore Road, Houston, Texas 77041
(Address of principal executive offices, zip code)
(281) 836-7000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $0.01 par value
 
New York Stock Exchange
 

Securities registered pursuant to 12(g) of the Act: None 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x  No ¨
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ¨  No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes x  No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
 
 
Emerging growth company
o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
The aggregate market value of the common stock of the registrant held by non-affiliates, based on the closing price on the New York Stock Exchange, as of June 30, 2018 was $791,626,980.
Number of shares of the common stock of the registrant outstanding as of February 19, 2019: 36,142,190 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE 
Portions of the registrant’s definitive proxy statement for the 2019 Meeting of Stockholders, which is expected to be filed with the Securities and Exchange Commission within 120 days after December 31, 2018, are incorporated by reference into Part III of this Form 10-K.
 




TABLE OF CONTENTS 
 
Page



PART I
 
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
 
This report contains “forward-looking statements” intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including, without limitation, statements regarding our business growth strategy and projected costs; future financial position; the sufficiency of available cash flows to fund continuing operations; the expected amount of our capital expenditures; expenditures related to the current governmental investigation; anticipated cost savings, future revenue, gross margin and other financial or operational measures related to our business and our primary business segments; the future value of our equipment; and plans and objectives of our management for our future operations. You can identify many of these statements by looking for words such as “believe,” “expect,” “intend,” “project,” “anticipate,” “estimate,” “will continue” or similar words or the negative thereof. 

Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this report. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, no assurance can be given that these expectations will prove to be correct. Known material factors that could cause our actual results to differ materially from the expectations reflected in these forward-looking statements include those described below, in Part I, Item 1A (“Risk Factors”) and Part II, Item 7 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) of this report. Important factors that could cause our actual results to differ materially from the expectations reflected in these forward-looking statements include, among other things:
conditions in the oil and natural gas industry, including a sustained imbalance in the level of supply or demand for oil or natural gas or a sustained low price of oil or natural gas, which could depress or reduce the demand or pricing for our natural gas compression and oil and natural gas production and processing equipment and services;
reduced profit margins or the loss of market share resulting from competition or the introduction of competing technologies by other companies;
economic or political conditions in the countries in which we do business, including civil developments such as uprisings, riots, terrorism, kidnappings, violence associated with drug cartels, legislative changes and the expropriation, confiscation or nationalization of property without fair compensation;
changes in currency exchange rates, including the risk of currency devaluations by foreign governments, and restrictions on currency repatriation;
risks associated with cyber-based attacks or network security breaches;
changes in international trade relationships, including the imposition of trade restrictions or tariffs relating to any materials or products (such as aluminum and steel) used in the operation of our business;
risks associated with our operations, such as equipment defects, equipment malfunctions and natural disasters;
the risk that counterparties will not perform their obligations under their contracts with us;
the financial condition of our customers;
our ability to timely and cost-effectively obtain components necessary to conduct our business; 
employment and workforce factors, including our ability to hire, train and retain key employees;
our ability to implement our business and financial objectives, including:
winning profitable new business;
timely and cost-effective execution of projects;
enhancing our asset utilization, particularly with respect to our fleet of compressors;
integrating acquired businesses;
generating sufficient cash to satisfy our operating needs, existing capital commitments and other contractual cash obligations, including our debt obligations; and
accessing the financial markets at an acceptable cost;
our ability to accurately estimate our costs and time required under our fixed price contracts;
liability related to the use of our products and services;
changes in governmental safety, health, environmental or other regulations, which could require us to make significant expenditures;

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the results of governmental actions relating to the current investigation; and
our level of indebtedness and ability to fund our business.

All forward-looking statements included in this report are based on information available to us on the date of this report. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this report.
Item 1.  Business

Exterran Corporation (together with its subsidiaries, “Exterran Corporation,” “our,” “we” or “us”), a Delaware corporation formed in March 2015, is a global systems and process company offering solutions in the oil, gas, water and power markets. We are a leader in natural gas processing and treatment and compression products and services, providing critical midstream infrastructure solutions to customers throughout the world. Outside the United States of America (“U.S.”), we are a leading provider of full-service natural gas contract compression and a supplier of aftermarket parts and services. Our manufacturing facilities are located in the U.S., Singapore and the United Arab Emirates.

On November 3, 2015, Archrock, Inc. (named Exterran Holdings, Inc. prior to November 3, 2015) (“Archrock”) completed the spin-off (the ‘‘Spin-off”) of its international contract operations, international aftermarket services and global fabrication businesses into an independent, publicly traded company named Exterran Corporation. Following the completion of the Spin-off, we and Archrock became and continue to be independent, publicly traded companies with separate boards of directors and management.

General

We provide our products and services to a global customer base consisting 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 oil and natural gas producers and oil and natural gas processors, gatherers and pipeline operators. We operate in three primary business lines: contract operations, aftermarket services and product sales. The nature and inherent interactions between and among our business lines provide us with opportunities to cross-sell and offer integrated product and service solutions to our customers.

For financial data relating to our reportable business segments or countries that accounted for 10% or more of our revenue in any of the last three fiscal years or 10% or more of our property, plant and equipment, net, as of December 31, 2018, 2017 or 2016, see Part II, Item 7 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) and Note 22 to our Consolidated Financial Statements included in Part IV, Item 15 (collectively referred to as “Financial Statements,” and individually referred to as “balance sheets,” “statements of operations,” “statements of comprehensive income (loss),” “statements of stockholders’ equity” and “statements of cash flows” herein).

Contract Operations

In our contract operations business, we provide compression and processing and treating services through the operation of our natural gas compression equipment and crude oil and natural gas production and process equipment for our customers. In addition to these services, we also offer water treatment and power solutions to our customers on a stand-alone basis or integrated into our natural gas compression or crude oil production and processing solutions. Our services include the provision of personnel, equipment, tools, materials and supplies to meet our customers’ natural gas compression and oil and natural gas production and processing service needs. Activities we may perform in meeting our customers’ needs include engineering, designing, sourcing, constructing, installing, operating, servicing, repairing, maintaining and demobilizing equipment owned by us necessary to provide these services.


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We generally enter into contracts with our contract operations customers with initial terms ranging between three to 12 years. In many instances, we are able to renew those contracts prior to the expiration of the initial term and in other instances, we may sell the underlying assets to our customers pursuant to purchase options or negotiated sale agreements. If a contract is not renewed or a customer does not purchase the underlying assets, our equipment is generally returned to our premises for future redeployment. Our contracts may include several compressor units on one site or entire facilities designed to process and treat produced oil or natural gas to make them suitable for end use, which may require us to make significant investments in equipment, facilities and related installation costs. Our commercial contracts generally require customers to pay a monthly service fee even during periods of limited or disrupted oil or natural gas feed flows, which we believe provide us with relatively stable and predictable cash flows. Additionally, because we typically do not take title to the oil or natural gas that we compress, process or treat, and because the natural gas we use as fuel for our equipment is supplied by our customers, we have limited direct exposure to short-term commodity price fluctuations.

Our equipment is operated and maintained in accordance with established operational procedures and maintenance schedules. These operations and maintenance procedures are updated as technology changes and as our operations team develops new techniques and procedures. In addition, because our field technicians regularly operate and maintain our contract operations equipment, they are familiar with the condition of our equipment and can readily identify potential problems. In our experience, this in-house expertise and these maintenance procedures maximize equipment life and unit availability, minimize avoidable downtime and lower the overall maintenance expenditures over the equipment life. We believe our contract operations services generally allow our customers to achieve higher production rates and lower unit costs of operation than they would otherwise achieve with their own operations, resulting in increased revenue and margin for our customers. In addition, outsourcing these services allows our customers flexibility for their compression and production and processing needs while limiting their upfront capital requirements.

During the year ended December 31, 2018, approximately 26% of our revenue and 62% of our gross margin was generated from contract operations. As of December 31, 2018, we had approximately $1.4 billion of unsatisfied performance obligations (commonly referred to as backlog), of which approximately $292 million is expected to be recognized as revenue before December 31, 2019. Our contract operations backlog consists of unfilled orders based on signed contracts and does not include potential sales pursuant to letters of intent received from customers. Our contract operations business is capital intensive. As of December 31, 2018, the net book value of property, plant and equipment associated with our contract operations business was $823.4 million.

Aftermarket Services

In our aftermarket services business, we sell parts and components and provide operations, maintenance, repair, overhaul, upgrade, startup and commissioning and reconfiguration services to customers who own their own oil and natural gas compression, production, processing, treating and related equipment. Our services range from routine maintenance services and parts sales done on a transactional basis to the full operation and maintenance of customer-owned equipment under long-term agreements.

We generally enter into contracts with our operation and maintenance customers with initial terms ranging between one to four years, and in some cases, in excess of five years. In many instances, we are able to renew those contracts prior to the expiration of the initial term. We believe that we are particularly well qualified to provide these services because of our highly experienced operating personnel and technical and engineering expertise gained through providing similar services as part of our contract operations business. In addition, our aftermarket services business complements our strategy to provide integrated infrastructure solutions to our customers because it enables us to continue to serve our customers after the sale of any products or facilities manufactured through our product sales business. Our business approach is designed to leverage our aftermarket services with our product sales business to provide full life-cycle services to customers who buy equipment from us and we also seek to sell those same aftermarket services to customers who have bought similar equipment from other companies based on our existing experience and infrastructure available to support them.

During the year ended December 31, 2018, approximately 9% of our revenue and 8% of our gross margin was generated from aftermarket services.


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Product Sales

In our product sales business, we design, engineer, manufacture, install and sell natural gas compression packages as well as equipment used in the treating and processing of crude oil and natural gas primarily to major and independent oil and natural gas producers as well as national oil and natural gas companies around the world. We offer a broad range of equipment designed to process crude oil and natural gas into hydrocarbon commodities suitable for end use. Our products include wellhead, gathering, residue and high pressure natural gas compression equipment, cryogenic plants, mechanical refrigeration and dew point control plants, condensate stabilizers, water treatment equipment, integrated power generation and skid-mounted production packages designed for both onshore and offshore production facilities. We believe the broad range of products we sell through our global operating structure enables us to take advantage of the ongoing, worldwide energy infrastructure build-out.

We design, engineer, manufacture, sell and, in certain cases, install, skid-mounted natural gas compression equipment to meet standard or unique customer specifications. Generally, we manufacture compressors sold to third parties according to each customer’s specifications. We purchase components for these compressors from third party suppliers including several major engine and compressor original equipment manufacturers in the industry. We also sell pre-engineered compressor units designed to maximize value and fast delivery to our customers. Typically, we expect our compressor equipment backlog to be manufactured and delivered within a three to 12 month period.

We also sell custom-engineered, built-to-specification natural gas and oil processing and treating equipment, including designing facilities comprised of a combination of our products integrated into a solution that meets our customers’ needs. Some of these projects are located in remote areas and in developing countries with limited oil and natural gas industry infrastructure. To meet most customers’ rapid schedule requirements and minimize customer downtime, we maintain an inventory of standard products and longer lead-time components used to manufacture our products to our customers’ specifications. Typically, we expect our processing and treating equipment backlog to be produced within a six to 24 month period.

During the year ended December 31, 2018, approximately 65% of our revenue and 30% of our gross margin was generated from product sales. As of December 31, 2018, our backlog in product sales was approximately $706 million, of which approximately $690 million is expected to be recognized as revenue before December 31, 2019. Our product sales backlog consists of unfilled orders based on signed contracts and does not include potential product sales pursuant to letters of intent received from customers.

Competitive Strengths

We believe we have the following key competitive strengths:

Global footprint and expansive service and product offerings positioned to capitalize on the global energy infrastructure build-out.  The global oil and natural gas production and processing infrastructure build out provides us with opportunities for growth. We are well positioned to capitalize on increased opportunities in both the U.S. and international markets. We believe our global customer base will continue to invest in infrastructure projects based on longer-term fundamentals that are less tied to near-term commodity prices and that our size and geographic presence provide us with a unique advantage in meeting our customers’ needs. We provide our customers with a broad variety of products and services in approximately 25 countries worldwide, including compression, production and processing services, natural gas compression, oil and natural gas processing and treating equipment, water treatment solutions, installation services and integrated power generation. By offering a broad range of products and services that leverage our core strengths, we believe we provide unique integrated solutions that meet our customers’ needs. We believe the breadth and quality of our products and services, the depth of our customer relationships and our presence in many major oil and natural gas producing regions place us in a position to capture additional business on a global basis.


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Complementary businesses enable us to offer customers integrated infrastructure solutions.  We aim to provide our customers with a single source to meet their energy infrastructure needs and we believe we have the ability to serve our customers’ changing needs in a variety of ways. For customers that seek to manage their capital spending on energy infrastructure projects, we offer our full project and operations services through our contract operations business. For customers that prefer to develop and acquire their own infrastructure assets, we are able to sell equipment and facilities to support their operations and, following the sale of our equipment, we can also provide commissioning, start-up, operations, maintenance, overhaul, upgrade and reconfiguration services through our aftermarket services business. Furthermore, we can combine our products into an integrated solution where we can design, engineer, procure and, in some cases, construct assets on-site for sale to our customers. Because of the breadth of our products and our unique ability to deliver those products through our different commercial models, we believe we are able to provide the right solution that is most suitable to our customers in the markets in which they operate. We believe this ability to provide our customers with a variety of products and services provides us with more business opportunities, as we are able to adjust the products and services we provide to reflect our customers’ changing needs.

High-quality products and services.  We have built a network of high-quality energy infrastructure assets that are strategically deployed across our global platform. Through our history of operating a wide variety of products in many energy-producing markets around the world, we have developed the technical expertise and experience that we believe is required to understand the needs of our customers and to meet those needs through a range of products and services. These products and services include highly customized compression, production, processing and treating solutions as well as standard products based on our expertise, in support of a range of projects, from those requiring quick completion to those that may take several years to fully develop. Additionally, our experience has enabled us to develop efficient systems and work processes and a skilled workforce that allow us to provide high-quality services. We seek to continually improve our products and services to enable us to provide our customers with high-quality, comprehensive oil and natural gas infrastructure support worldwide.

Cash flows from our contract operations business are supported by long-term contracts.  We provide contract operations services to customers located in 12 countries. Within our contract operations business, we seek to enter into long-term contracts with a diverse collection of customers, including large integrated oil and natural gas companies and national energy companies. These contracts generally involve initial terms ranging from three to 12 years, and typically require our customers to pay a monthly service fee even during periods of limited or disrupted oil or natural gas flows. Furthermore, our customer base includes companies that are among the largest and most well-known companies within their respective regions and countries.

Experienced management team.  We have an experienced and skilled management team with a long track record of driving growth through organic expansion and selective acquisitions. The members of our management team have strong relationships in the oil and gas industry and have operated through numerous commodity price cycles throughout our areas of operations. Members of our management team have spent a significant portion of their respective careers at highly regarded energy and manufacturing companies serving the upstream, midstream and downstream segments of the oil and natural gas market.

Well-balanced capital structure with sufficient liquidity.  We intend to maintain a capital structure with an appropriate amount of leverage and the financial flexibility to invest in our operations and pursue attractive growth opportunities which we believe will increase overall earnings and cash flow generated by our business. As of December 31, 2018, taking into account guarantees through outstanding letters of credit, we had undrawn capacity of $608.3 million under our revolving credit facility, of which $578.4 million was available for additional borrowings as a result of a covenant restriction included in our credit agreement. In addition, as of December 31, 2018, we had $19.3 million of cash and cash equivalents on hand.


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Business Strategies

We intend to continue to capitalize on our competitive strengths to meet our customers’ needs through the following key strategies:

Strategically grow our business.  Our primary strategic focus involves the targeted growth of our core business by expanding our product and services offerings and by leveraging our existing, proven portfolio of products and services. We intend to infuse new technology and innovation into our existing midstream products and services while developing new product and service offerings in water treatment and integrated power generation. Additionally, our strategic focus includes targeting development opportunities in the U.S. energy market and expansion into new international markets benefiting from the global energy infrastructure build-out. We believe our diverse product and service portfolio allows us to readily respond to changes in industry and economic conditions and that our global footprint allows us to provide the prompt product availability our customers require. We have the ability to undertake projects in new locations as needed to meet customer demand and to readily deploy our capital to construct new or supplemental projects that we can build, own, operate and maintain on behalf of our customers through our contract operations business. In addition, we seek to provide our customers with integrated energy infrastructure solutions by combining product and service offerings across our businesses. We plan to supplement our organic growth with select acquisitions, partnerships and other commercial arrangements in key markets to further enhance our geographic reach, product offerings and other capabilities. We believe these arrangements will allow us to generate incremental revenues from existing and new customers and increase market share.

Expand customer base and deepen relationships with existing customers.  We believe the unique, broad range of products and services we offer, the quality of our products and services and our diverse geographic footprint position us to attract new customers and cross-sell our products and services to existing customers. In addition, we have a long history of providing our products and services to our customers which, coupled with the technical expertise of our experienced personnel, enables us to understand and meet our customers’ needs, particularly as those needs develop and change over time. We intend to continue to devote significant business development resources to market our products and services, leverage existing relationships and expedite our growth potential. Additionally, we seek to evolve our products and services offerings by developing new technologies that will allow us to provide differentiated solutions to the critical midstream infrastructure needs of our customers.

Enhance our safety performance.  We believe our safety performance and reputation help us to attract and retain customers and employees. We have adopted rigorous processes and procedures to facilitate our compliance with safety regulations and policies on a global basis. We work diligently to meet or exceed applicable safety regulations, and continue to focus on our safety as our business grows and operating conditions change.

Continue to optimize our global platform, products and services and enhance our profitability.  We regularly review and evaluate the quality of our operations, products and services and portfolio of our product and service offerings. This evaluation process includes assessing the quality of our performance and potential opportunities to create value for our customers. We believe the development and introduction of new technology into our existing products and services offerings will create more value for our customers and us in the market place, which we believe will further differentiate us from our competitors. Additionally, we believe our ongoing focus on improving the quality of our operations, products and services results in greater satisfaction among our customers, which we believe results in greater profitability and value for our shareholders.
 
Industry Overview

Natural Gas Compression

Natural gas compression is a mechanical process whereby the pressure of a given volume of natural gas is increased to a desired pressure for movement from one point to another and is essential to the production and transportation of natural gas. Compression is typically required several times during the natural gas production and transportation cycle, including (i) at the wellhead, (ii) throughout gathering and distribution systems, (iii) into and out of processing and storage facilities and (iv) along pipelines. Natural gas compression can also be used to re-inject associated gas into producing wells to provide enhanced oil recovery.


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Our contract operations business is comprised primarily of large horsepower internal combustion engine or electric motor-driven reciprocating compressors that are typically deployed in facilities comprised of several compressors on one site. A significant portion of this business involves comprehensive projects that require the design, engineering, manufacture, delivery and installation of several compressors on one site coupled with related natural gas treating and processing equipment. We are able to serve our customers’ needs for such projects through our product sales business and with follow-on services from our aftermarket services business, or through the provision of our contract operations services.

Processing and Treating

Crude oil and natural gas are generally not marketable products as produced raw at the wellhead and must be processed or treated to meet hydrocarbon commodity specifications before they can be transported to market. Processing and treating equipment is used to separate and treat oil and natural gas as they are produced to achieve a marketable quality of product. Production processing typically involves the separation of oil and natural gas and the removal of contaminants or the separation of marketable liquids from the gas stream prior to transportation. The end result is “pipeline” or “sales” quality crude oil and natural gas. Further processing or refining is almost always required before oil or natural gas is suitable for use as fuel or feedstock for petrochemical production. Production processing normally takes place in the “upstream” and “midstream” sectors, while refining and petrochemical processing is referred to as the “downstream” sector. Wellhead or upstream processing and treating equipment include a wide and diverse range of products.

We manufacture custom-engineered, built-to-specification natural gas and oil processing and treating equipment. We also provide integrated solutions comprised of a combination of our products into a single offering, which typically consist of much larger equipment packages than standard equipment and are generally used in much larger scale production operations. The custom equipment sector is primarily driven by global economic trends, and the specifications for purchased equipment can vary significantly. Technology, engineering capabilities, project management, available manufacturing space and quality control standards are the key drivers in the custom equipment sector.

Outsourcing

Natural gas producers, transporters and processors choose to outsource their operations due to the benefits and flexibility of contract operations services. In particular, we believe outsourcing compression, production and processing operations to experienced operators like us offers customers:
access to our specialized personnel and technical skills, including engineers, operators and field service and maintenance employees, which we believe generally leads to improved production rates and increased throughput and therefore higher revenues and margins;
the ability to increase their profitability by transporting or producing a higher volume of natural gas through decreased equipment downtime and reduced operating, maintenance and equipment costs by allowing us, as the service provider, to efficiently manage their operations; and
the flexibility to deploy their capital on projects more directly related to their primary business of hydrocarbon exploration and production by reducing their investment in compression, production and processing equipment and related maintenance capital requirements.

Oil and Natural Gas Industry Cyclicality and Volatility

Changes in oil and natural gas exploration and production spending normally result in changes in demand for our products and services. However, we believe our contract operations business is less impacted by commodity prices than certain other energy service products and services because compression, production and processing services are necessary for oil and natural gas to be delivered from the wellhead to end users. Furthermore, our contract operations business is tied primarily to global oil and natural gas production and consumption trends, which are generally less cyclical in nature than exploration activities.

Demand for oil and natural gas is cyclical and subject to fluctuations. This is primarily because the industry is driven by commodity demand and corresponding price movements. When oil and natural gas price increases occur, producers typically increase their capital expenditures, which generally results in greater activity levels and revenues for equipment providers to the oil and gas industry. During periods of lower oil or natural gas prices, producers typically decrease their capital expenditures, which generally results in lower activity levels and revenues for equipment providers to the oil and gas industry.


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Seasonal Fluctuations

Our results of operations have not historically reflected material seasonal tendencies and we do not believe that seasonal fluctuations will have a material impact on us in the foreseeable future.

Markets, Customers and Competition

Our global customer base consists primarily of companies engaged in all aspects of the oil and natural gas industry, including large integrated oil and natural gas companies, national energy companies, independent producers and natural gas processors, gatherers and pipeline operators.

During the year ended December 31, 2018, MPLX LP (“MPLX”) accounted for approximately 15% of our total revenue. During the year ended December 31, 2017, Archrock accounted for approximately 12% of our total revenue and during the year ended December 31, 2016, Petroleo Brasileiro S.A. (“Petrobras”) accounted for approximately 10% of our total revenue. No other customer accounted for more than 10% of our revenue in 2018, 2017 and 2016. The loss of our business with MPLX, Archrock or Petrobras, unless offset by additional sales to other customers, or the inability or failure of MPLX, Archrock or Petrobras to meet its payment obligations could have an adverse effect on our business, results of operations and financial condition.

We currently operate in approximately 25 countries. We have manufacturing facilities in the U.S., Singapore and the United Arab Emirates and offices in most of the major oil and gas regions around the world.

The markets in which we operate are highly competitive. Overall, we experience considerable competition from companies that may be able to more quickly adapt to changes within our industry and changes in economic conditions as a whole and to more readily take advantage of available opportunities. We believe we are competitive with respect to price, equipment availability, customer service, flexibility in meeting customer needs, technical expertise, quality and reliability of our compression, processing and treating equipment and related services. We face vigorous competition throughout our businesses, with some companies competing with us in multiple business segments. In our product sales business, we have different competitors in the standard and custom-engineered equipment sectors. Competitors in the standard equipment sector include several large companies and a large number of small, regional fabricators. Our competition in the custom-engineered sector consists mainly of larger companies with the ability to provide integrated projects and product support after the sale.

We expect to face increased competition as we seek to diversify our customer base and increase utilization of our service offerings.

The separation and distribution agreement from the Spin-off contained certain noncompetition provisions addressing restrictions on our ability to provide compression contract operations and aftermarket services in the U.S. and on Archrock’s ability to provide compression contract operations and aftermarket services outside the U.S. and product sales to customers worldwide which expired on November 3, 2018.

Sources and Availability of Raw Materials

We manufacture natural gas compression and oil and natural gas processing and treating equipment to provide contract operations services and to sell to third parties from components which we acquire from a wide range of suppliers. These components represent a significant portion of the cost of our compression and processing and treating equipment products. Increases in raw material costs cannot always be offset by increases in our products’ sales prices. While many of our materials and components are available from multiple suppliers at competitive prices, we obtain some of the components, including compressors and engines, used in our products from a limited group of suppliers. We occasionally experience long lead times for components, including compressors and engines, from our suppliers and, therefore, we may at times make purchases in anticipation of future orders.


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Environmental and Other Regulations

Government Regulation

Our operations are subject to stringent and complex U.S. federal, state, local and international laws and regulations that could have a material impact on our operations or financial condition. Our operations are regulated under a number of laws governing, among other things, discharges of substances into the air, ground and regulated waters, the generation, transportation, treatment, storage and disposal of hazardous and non-hazardous substances, disclosure of information about hazardous materials used or produced in our operations, and occupational health and safety.

Compliance with these environmental laws and regulations may expose us to significant costs and liabilities and cause us to incur significant capital expenditures in our operations. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, imposition of investigatory and remedial obligations, and the issuance of injunctions delaying or prohibiting operations. In certain circumstances, laws may impose strict, joint and several liability without regard to fault or the legality of the original conduct on classes of persons who are considered to be responsible for the release of hazardous substances into the environment. In addition, it is not uncommon for third parties to file claims for personal injury, property damage and recovery of response costs allegedly caused by hazardous substances or other pollutants released into the environment. We currently own or lease, and in the past have owned or leased, a number of properties that have been used in support of our operations for a number of years. Although we have utilized operating and disposal practices that were standard in the industry at the time, hydrocarbons, hazardous substances, or other regulated wastes may have been disposed of, or released, on or under the properties owned by us, leased by us or other locations where such materials have been taken for disposal by companies sub-contracted by us. In addition, many of these properties have been previously owned or operated by third parties whose treatment and disposal or release of hydrocarbons, hazardous substances or other regulated wastes were not under our control. These properties and the materials released or disposed thereon may be subject to various laws that could require us to remove or remediate historical property contamination, or to perform certain operations to prevent future contamination. We are not currently under any order requiring that we undertake or pay for any cleanup activities. However, we cannot provide any assurance that we will not receive any such order in the future.

We believe the global trend in environmental regulation is to place more restrictions on activities that may affect the environment, and thus, any changes in these laws and regulations that result in more stringent and costly waste handling, storage, transport, disposal, emission or remediation requirements could have a material adverse effect on our results of operations and financial position.

Employees

As of December 31, 2018, we had approximately 4,300 employees. Many of our employees outside of the U.S. are covered by collective bargaining agreements. We generally consider our relationships with our employees to be satisfactory.

Available Information

Our website address is www.exterran.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available on our website, without charge, as soon as reasonably practicable after they are filed electronically with the Securities and Exchange Commission (the “SEC”). Information on our website is not incorporated by reference in this report or any of our other securities filings. Paper copies of our filings are also available, without charge, from Exterran Corporation, 4444 Brittmoore Road, Houston, Texas 77041, Attention: Investor Relations.

The SEC also maintains a website that contains reports, proxy and information statements and other information regarding issuers who file electronically with the SEC. The SEC’s website address is www.sec.gov.

Additionally, we make available free of charge on our website:
our Code of Conduct;
our Corporate Governance Principles; and
the charters of our audit, compensation and nominating and corporate governance committees.


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Item 1A.  Risk Factors

As described in Part I (“Disclosure Regarding Forward-Looking Statements”), this report contains forward-looking statements regarding us, our business and our industry. The risk factors described below, among others, could cause our actual results to differ materially from the expectations reflected in the forward-looking statements. The risk factors described below are not the only risks we face. Our business could also be affected by additional risks and uncertainties not currently known to us or that we currently consider to be immaterial. If any of the following risks or any other risks actually occurs, our business, financial condition, results of operations and cash flows could be negatively impacted.

Risks Related to Our Business and Industry

Low oil and natural gas prices could depress or reduce demand or pricing for our natural gas compression and oil and natural gas processing and treating equipment and services and, as a result, adversely affect our business.

Our results of operations depend upon the level of activity in the global energy market, including oil and natural gas development, production, processing and transportation. Oil and natural gas exploration and development activity and the number of well completions typically decline when there is a sustained reduction in oil or natural gas prices or significant instability in energy markets. Even the perception of longer-term lower oil or natural gas prices by oil and natural gas exploration, development and production companies can result in their decision to cancel, reduce or postpone major expenditures or to reduce or shut in well production.

Oil and natural gas prices and the level of drilling and exploration activity can be volatile. In periods of volatile commodity prices, the timing of any change in activity levels by our customers is difficult to predict. As a result, our ability to project the anticipated activity level for our business, and particularly our product sales segment may be limited.

During periods of lower oil or natural gas prices, our customers typically decrease their capital expenditures, which generally results in lower activity levels. A reduction in demand for our products and services could force us to reduce our pricing substantially, which could have a material adverse effect on our business, financial condition, results of operations and cash flows. For example, due to the low oil and natural gas price environment during 2015 and the majority of 2016, our customers sought to reduce their capital and operating expenditure requirements, and as a result, the demand and pricing for the equipment we manufacture was adversely impacted. Recently, oil and natural gas prices have declined again, reversing a recent upward trend. We do not know whether this will be a prolonged decline and, if so, whether and to what degree it will impact the demand and pricing for the equipment we manufacture. Any reduction in demand for our products and services could result in our customers seeking to preserve capital by canceling contracts, canceling or delaying scheduled maintenance of their existing natural gas compression and oil and natural gas processing and treating equipment, ceasing commitments for new contract operations services contracts or new compression and oil and natural gas processing and treating equipment, or canceling or delaying orders for our products and services, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The erosion of the financial condition of our customers could adversely affect our business.

Many of our customers finance their exploration and development activities through cash flows from operations, the incurrence of debt or the issuance of equity. During times when the oil or natural gas markets weaken, our customers are more likely to experience a downturn in their financial condition. A reduction in borrowing bases under reserve-based credit facilities, the lack of availability of debt or equity financing or other factors that negatively impact our customers’ financial condition could result in our customers seeking to preserve capital by reducing prices under existing contracts or cancelling contracts with us, determining not to renew contracts with us, cancelling or delaying scheduled maintenance of their existing natural gas compression and oil and natural gas processing and treating equipment, determining not to enter into contract operations agreements or not to purchase new compression and oil and natural gas processing and treating equipment, or determining to cancel or delay orders for our products and services. Any such action by our customers would reduce demand for our products and services. Reduced demand for our products and services could adversely affect our business, financial condition, results of operations and cash flows. In addition, in the event of the financial failure of a customer, we could experience a loss on all or a portion of our outstanding accounts receivable associated with that customer.


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Failure to timely and cost-effectively execute on larger projects could adversely affect our business.

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 for these projects typically specify delivery dates, performance criteria and penalties for our failure to perform. Any failure to estimate the cost of and execute these 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.

We may incur losses on fixed-price contracts, which constitute a significant portion of our business.

In connection with projects and services performed under fixed-price contracts, we generally bear the risk of cost over-runs, operating cost inflation, labor availability and productivity, and supplier and subcontractor pricing and performance, unless additional costs result from customer-requested change orders. Under both our fixed-price contracts and our cost-reimbursable contracts, we may rely on third parties for many support services, and we could be subject to liability for their failures. Any failure to accurately estimate our costs and the time required for a fixed-price project at the time we enter into a contract could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our operations in international markets are subject to many risks.

The majority of our contract operations and aftermarket services businesses, and a portion of our product sales business, are conducted in countries outside the U.S. We currently operate in approximately 25 countries. With respect to any particular country in which we operate, the risks inherent in our activities may include the following, the occurrence of any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows:
difficulties in managing international operations, including our ability to timely and cost effectively execute projects;
unexpected changes in regulatory requirements, laws or policies by foreign agencies or governments;
work stoppages;
training and retaining qualified personnel in international markets;
the burden of complying with multiple and potentially conflicting laws and regulations;
tariffs and other trade barriers;
actions by governments or national oil companies that result in the nullification or renegotiation on less than favorable terms of existing contracts, or otherwise result in the deprivation of contractual rights, and other difficulties in enforcing contractual obligations;
governmental actions that: result in restricting the movement of property or that impede our ability to import or export parts or equipment; require a certain percentage of equipment to contain local or domestic content; or require certain local or domestic ownership, control or employee ratios in order to do business in or obtain special incentives or treatment in certain jurisdictions;
potentially longer payment cycles;
changes in political and economic conditions in the countries in which we operate, including general political unrest, the nationalization of energy related assets, civil uprisings, community protests, blockades, riots, kidnappings, violence associated with drug cartels and terrorist acts;
potentially adverse tax consequences or tax law changes;
currency controls or restrictions on repatriation of earnings;
expropriation, confiscation or nationalization of property without fair compensation;
the risk that our international customers may have reduced access to credit because of higher interest rates, reduced bank lending or a deterioration in our customers’ or their lenders’ financial condition;
complications associated with installing, operating and repairing equipment in remote locations;
limitations on insurance coverage;
inflation;
the geographic, time zone, language and cultural differences among personnel in different areas of the world; and
difficulties in establishing new international offices and the risks inherent in establishing new relationships in foreign countries.


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In addition, we may expand our business in international markets where we have not previously conducted business. The risks inherent in establishing new business ventures, especially in international markets where local customs, laws and business procedures present special challenges, may affect our ability to be successful in these ventures or avoid losses that could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The results of the United Kingdom’s referendum on withdrawal from the European Union may have a negative effect on global economic conditions, financial markets and our business.

We have subsidiaries in the United Kingdom and elsewhere in Europe more generally; although these subsidiaries do not have significant active operations in the United Kingdom or Europe. In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union (“E.U.”) in a national referendum (“Brexit”). The referendum was advisory, but the United Kingdom initiated its withdrawal process on March 29, 2017. As a result, the United Kingdom has until March 29, 2019 to negotiate the terms of its withdrawal from the E.U. After extensive negotiations, a deal was reached between the United Kingdom and the E.U., but this deal was recently rejected by the House of Commons in the United Kingdom. It is unclear whether a revised agreement will be approved by the House of Commons or whether the United Kingdom could be forced to leave the E.U. without an agreement in place regarding the various trade, immigration and other laws currently negotiated by the E.U. on behalf of its member states. As a result, Brexit has created significant uncertainty about the future relationship between the United Kingdom and the E.U. and has given rise to calls for certain regions within the United Kingdom to preserve their place in the E.U. by separating from the United Kingdom, as well as for the governments of other E.U. member states to consider withdrawal.

The uncertainty surrounding the exact terms of any Brexit, or whether there will be a negotiated agreement at all, has rippled through the global economy and may in the future have a material and adverse effect on global economic conditions and the stability of the global financial markets, and significantly reduce global market liquidity and restrict the ability of key market participants to operate in certain financial markets. Asset valuations, currency exchange rates and credit ratings may be especially subject to increased market volatility as a result. Lack of clarity about applicable future laws, regulations or treaties as the United Kingdom finalizes its withdrawal, including financial laws and regulations, tax and free trade agreements, intellectual property rights, supply chain logistics, environmental, health and safety laws and regulations, immigration laws, employment laws and other rules that would apply to us and our subsidiaries could increase our costs, restrict our access to capital within the United Kingdom and the E.U., depress economic activity globally and decrease foreign direct investment in the United Kingdom.

If the United Kingdom and the E.U. are unable to negotiate acceptable withdrawal terms or if other E.U. member states pursue withdrawal, barrier-free access between the United Kingdom and other E.U. member states or within the European Economic Area overall could be diminished or eliminated. This could affect, amongst other items, the ability to move cash between our United Kingdom and E.U. subsidiaries. Any of these factors could have a material adverse effect on our business, financial condition and results of operations.

Our contract operations segment is dependent on companies that are controlled by the government in which it operates.

The countries with our largest contract operations businesses include Argentina, Brazil and Mexico. We generate a significant portion of our revenue in these countries from national oil companies, including Yacimientos Petroliferos Fiscales in Argentina, Petrobras in Brazil and Petroleos Mexicanos in Mexico. Contracts with national oil companies may expose us to greater commercial, political and operational risks than we assume in other contracts. Our ability to resolve disputes or enforce contractual provisions may be negatively impacted by the significant bargaining leverage that national oil companies have over us. If our national oil company customers cancel some of our contracts and we are unable to secure new contracts on a timely basis and on substantially similar terms, or if a number of our contracts are renegotiated, it could adversely affect our business, financial position, results of operations or cash flows.


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We are exposed to exchange rate fluctuations in the international markets in which we operate.

We operate in many international countries and anticipate that there will be instances in which costs and revenues will not be exactly matched with respect to currency denomination. Gains and losses from the remeasurement of assets and liabilities that are receivable or payable in currencies other than our subsidiaries’ functional currency are included in our statements of operations. In addition, currency fluctuations cause the U.S. dollar value of our international results of operations and net assets to vary with exchange rate fluctuations. A decrease in the value of any of these currencies relative to the U.S. dollar could have a negative impact on our business, financial condition, results of operations or cash flows. As we expand geographically, we may experience economic loss and a negative impact on earnings or net assets solely as a result of foreign currency exchange rate fluctuations. In the future, we may utilize derivative instruments to manage the risk of fluctuations in foreign currency exchange rates that could potentially impact our future earnings and forecasted cash flows. However, the markets in which we operate could restrict the removal or conversion of the local or foreign currency, resulting in our inability to hedge against some or all of these risks.

See further discussion of foreign exchange risks under Item 7A “Quantitative and Qualitative Disclosures about Market Risk” included elsewhere in this Annual Report.

We are involved in governmental investigations, which may result in substantial financial and other penalties, and could adversely affect our business, financial condition and results of operations.

Contemporaneously with filing the Form 8-K on April 26, 2016, we self-reported the errors and possible irregularities related to our Belleli EPC business to the SEC. Since then, we have been cooperating with the SEC in its investigation of this matter. The SEC’s investigation related to the circumstances giving rise to the restatement is continuing, and we are presently unable to predict the duration, scope or results or whether the SEC will commence any legal action. If we are found to have violated securities laws or other federal statutes, we may be subject to criminal and civil penalties and other remedial measures, including, but not limited to injunctive relief, disgorgement, civil and criminal fines and penalties, modifications to business practices including the termination or modification of existing business relationships, modifications of compliance programs and the retention of a monitor to oversee compliance. The imposition of any of these sanctions or remedial measures could have a material adverse impact on our reputation, business, results of operations, financial condition, liquidity and stock price.

The termination of or any price reductions under certain of our contract operations services contracts could have a material impact on our business.

The termination of or a demand by our customers to reduce prices under certain of our contract operations services contracts may lead to a reduction in our revenues and net income, which could have a material adverse effect upon our business, financial condition, results of operations and cash flows. In addition, we may be unable to renew, or enter into new, contracts with customers on favorable commercial terms, if at all. To the extent we are unable to renew our existing contracts or enter into new contracts on terms that are favorable to us or to successfully manage our overall contract mix over time, our business, results of operations and cash flows may be adversely impacted.

Product sales backlog may be subject to unexpected adjustments and cancellations.

The expected future revenues reflected in our product sales backlog may not be realized or, if realized, may not result in profits. Due to potential project cancellations or changes in project scope and schedule, we cannot predict with certainty when or if backlog will be performed. In addition, even where a project proceeds as scheduled, it is possible that contracted parties may default and fail to pay amounts owed to us or poor project performance could increase the cost associated with a project. Delays, suspensions, cancellations, payment defaults, scope changes and poor project execution could materially reduce the revenues and reduce or eliminate profits that we actually realize from projects in backlog. We may be at greater risk of delays, suspensions and cancellations during periods of low oil and natural gas prices.

Reductions in our product sales backlog due to cancellation or modification by a customer or for other reasons may adversely affect, potentially to a material extent, the revenues and earnings we actually receive from contracts included in our backlog. Contracts in our product sales backlog provide for cancellation fees in the event customers cancel projects. These cancellation fees usually provide for reimbursement of our out-of-pocket costs, revenues for work performed prior to cancellation and a varying percentage of the profits we would have realized had the contract been completed. However, we typically have no contractual right upon cancellation to the total revenue reflected in our backlog. Projects may remain in our backlog for extended periods of time. If we experience significant project terminations, suspensions or scope adjustments to contracts reflected in our backlog, our financial condition, results of operations and cash flows may be adversely impacted.


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From time to time, we are subject to various claims, litigation and other proceedings that could ultimately be resolved against us, requiring material future cash payments or charges, which could impair our financial condition or results of operations.

The size, nature and complexity of our business make us susceptible to various claims, both in litigation and binding arbitration proceedings. We are currently, and may in the future become, subject to various claims, which, if not resolved within amounts we have accrued, could have a material adverse effect on our financial position, results of operations or cash flows. Similarly, any claims, even if fully indemnified or insured, could negatively impact our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future.

We depend on particular suppliers and may be vulnerable to product shortages and price increases.

Some of the components used in our products are obtained from a single source or a limited group of suppliers. Our reliance on these suppliers involves several risks, including price increases, quality and a potential inability to obtain an adequate supply of required components in a timely manner. Additionally, we occasionally experience long lead times from our sources for major components and may at times make purchases in anticipation of future business. We do not have long-term contracts with some of these sources, and the partial or complete loss of certain of these sources could have a negative impact on our results of operations and could damage our customer relationships. Further, a significant increase in the price of one or more of these components could have a negative impact on our results of operations.

We face significant competitive pressures that may cause us to lose market share and harm our financial performance.

Our businesses face intense competition and have low barriers to entry. Our competitors may be able to adapt more quickly to technological changes within our industry and changes in economic and market conditions and more readily take advantage of acquisitions and other opportunities. Our ability to renew or replace existing contract operations services contracts with our customers at rates sufficient to maintain current revenue and cash flows could be adversely affected by the activities of our competitors. If our competitors substantially increase the resources they devote to the development and marketing of competitive products, equipment or services or substantially decrease the price at which they offer their products, equipment or services, we may not be able to compete effectively.

In addition, we could face significant competition from new entrants into the compression services and product sales businesses. Some of our existing competitors or new entrants may expand or develop new processing, treating and compression equipment that would create additional competition for the products, equipment or services we provide to our customers.

Our ability to manage and grow our business effectively may be adversely affected if we lose management or operational personnel.

We believe that our ability to hire, train and retain qualified personnel will continue to be challenging and important. The supply of experienced operational and field personnel, in particular, decreases as other energy and manufacturing companies’ needs for the same personnel increase. Our ability to grow and to continue our current level of service to our customers will be adversely impacted if we are unable to successfully hire, train and retain these important personnel.

Our employees work on projects that are inherently dangerous. If we fail to maintain safe work sites, we can be exposed to significant financial losses and reputational harm.

Safety is a leading focus of our business, and our safety record is critical to our reputation and is of paramount importance to our employees, customers and stockholders. However, we often work on large-scale and complex projects which can place our employees and others near large mechanized equipment, moving vehicles, dangerous processes and in challenging environments. Although we have a functional group whose primary purpose is to implement effective quality, health, safety, environmental and security procedures throughout our company, if we fail to implement effective safety procedures, our employees and others may become injured, disabled or lose their lives, our projects may be delayed and we may be exposed to litigation or investigations.

Unsafe conditions at project work sites also have the potential to increase employee turnover, increase project costs and raise our operating costs. Additionally, many of our customers require that we meet certain safety criteria to be eligible to bid for contracts and our failure to maintain adequate safety standards could result in reduced profitability, or lost project awards or customers. Any of the foregoing could result in financial losses or reputational harm, which could have a material adverse impact on our business, financial condition and results of operations.


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Our operations entail inherent risks that may result in substantial liability. We do not insure against all potential losses and could be seriously harmed by unexpected liabilities.

Our operations entail inherent risks, including equipment defects, malfunctions and failures and natural disasters, which could result in uncontrollable flows of natural gas or well fluids, fires and explosions. These risks may expose us, as an equipment operator and developer, to liability for personal injury, wrongful death, property damage, pollution and other environmental damage. The insurance we carry against many of these risks may not be adequate to cover our claims or losses. In addition, we are substantially self-insured for workers’ compensation, employer’s liability, property, auto liability, general liability and employee group health claims in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Further, insurance covering the risks we expect to face or in the amounts we desire may not be available in the future or, if available, the premiums may not be commercially justifiable. If we were to incur substantial liability and such damages were not covered by insurance or were in excess of policy limits, or if we were to incur liability at a time when we are not able to obtain liability insurance, our business, financial condition and results of operations could be negatively impacted.

We may be subject to risks arising from changes in technology.

The supply chains in which we operate are subject to technological changes and changes in customer requirements. We may not successfully develop or implement new or modified types of products or technologies that may be required by our customers in the future. Further, the development of new technologies by competitors that may compete with our technologies could reduce demand for our products and affect our financial performance. Should we not be able to maintain or enhance the competitive values of our products or develop and introduce new products or technologies successfully, or if new products or technologies fail to generate sufficient revenues to offset research and development costs, our business, financial condition and operating results could be materially adversely affected.

Our information technology infrastructure could be subject to service interruptions, data corruption, cyber-based attacks or network security breaches, which could result in the disruption of operations or the loss of data confidentiality.

We rely on information technology networks and systems, including the internet and third-party service providers, to process, transmit and store electronic information, and to manage or support a variety of business processes and activities, including procurement, manufacturing, distribution, invoicing, collection, communication with our employees, customers, suppliers, dealers and suppliers, business acquisitions and other corporate transactions, compliance with regulatory, legal and tax requirements, and research and development. These information technology networks and systems may be susceptible to damage, disruptions or shutdowns due to failures during the process of upgrading or replacing software, databases or components, power outages, hardware failures or computer viruses. While we have business continuity plans and other safeguards in place, if these information technology systems suffer severe damage, disruption or shutdown and business continuity plans do not effectively resolve the issues in a timely manner, our business, financial condition, results of operations, and liquidity could be materially adversely affected. Further, we cannot ensure we have insurance coverages to cover these issues.

In addition, information technology security threats and sophisticated cyber-based attacks, including, but not limited to, denial-of-service attacks, hacking, worms, “phishing” attacks, computer viruses, ransomware, malware, employee or insider error, malfeasance, social engineering, or physical breaches, may cause deliberate or unintentional damage, destruction or misuse, manipulation, denial of access to or disclosure of confidential or important information by our employees, suppliers or third-party service providers. Additionally, advanced persistent attempts to gain unauthorized access to our systems and those of third-party service providers we rely on are increasing in sophistication and frequency. We have experienced attacks on our information technology systems and networks, and we expect to continue to confront attempts by hackers and other third parties to disrupt or gain unauthorized access to our information technology systems and networks. These attacks to date have not resulted in unauthorized access to confidential information regarding our customers, suppliers or employees and have not had a material impact on our business. However, we could in the future experience attacks that materially disrupt our business or result in access to such confidential information about our customers, suppliers and employees or material information about our operations that could have a material adverse effect on our business, financial condition, results of operations or liquidity.

We are continuously developing and enhancing our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage, or unauthorized access. This continued development and enhancement will require us to expend additional resources, including to investigate and remediate any information security vulnerabilities that may be detected. Despite our ongoing investments in security resources, talent, and business practices, we are unable to assure that these enhanced security measures will be effective.


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We can provide no assurance that our efforts to actively manage technology risks potentially affecting our systems and networks will be successful in eliminating or mitigating risks to our systems, networks and data or in effectively resolving such risks when they materialize. A failure of or breach in information technology security of our own systems, or those of our third-party suppliers, could expose us and our employees, customers, dealers and suppliers to risks of misuse of information or systems, the compromise of confidential information, manipulation and destruction of data, defective products, production downtimes and operations disruptions. Any of these events in turn could adversely affect our reputation, competitive position, including loss of customers and revenue, business, results of operations and liquidity. In addition, such breaches in security could result in litigation, regulatory action and potential liability, as well as the costs and operational consequences of implementing further data protection measures.

To conduct our operations, we regularly move data across national and state borders, and consequently we are subject to a variety of continuously evolving and developing laws and regulations in the U.S. and abroad regarding privacy, data protection and data security. The scope of the laws that may be applicable to us is often uncertain and may be conflicting, particularly with respect to foreign laws. For example, the European Union’s General Data Protection Regulation, which greatly increases the jurisdictional reach of E.U. law and adds a broad array of requirements for handling personal data, including the public disclosure of significant data breaches, became effective in May 2018. Other countries have enacted or are enacting data localization laws that require data to stay within their borders and various states are enacting additional data laws that may impact us. All of these evolving compliance and operational requirements impose significant costs that are likely to increase over time.

We are subject to a variety of governmental regulations; failure to comply with these regulations may result in administrative, civil and criminal enforcement measures and changes in these regulations could increase our costs or liabilities.

We are subject to a variety of U.S. federal, state, local and international laws and regulations relating to, for example, export controls, currency exchange, labor and employment and taxation. Many of these laws and regulations are complex, change frequently, are becoming increasingly stringent, and the cost of compliance with these requirements can be expected to increase over time. From time to time, as part of our operations we may be subject to compliance audits by regulatory authorities in the various countries in which we operate. Our failure to comply with these laws and regulations may result in a variety of administrative, civil and criminal enforcement measures, including assessment of monetary penalties, imposition of remedial requirements and issuance of injunctions as to future compliance, any of which may have a negative impact on our financial condition, profitability and results of operations.

Our international operations require us to comply with U.S. and international laws and regulations, including those involving anti-bribery and anti-corruption. For example, the U.S. Foreign Corrupt Practices Act and similar laws and regulations prohibit improper payments to foreign officials for the purpose of obtaining or retaining business or gaining any business advantage.

We operate in many parts of the world that experience high levels of corruption, and our business brings us in frequent contact with foreign officials. Our compliance policies and programs mandate compliance with all applicable anti-corruption laws but may not be completely effective in ensuring our compliance. Our training and compliance program and our internal control policies and procedures may not always protect us from violations committed by our employees or agents. If we undergo an investigation of potential violations of anti-corruption laws or if we fail to comply with these laws, we may incur significant legal expenses or be subject to criminal and civil penalties and other sanctions and remedial measures, which could have a material adverse impact on our reputation, business, financial condition, results of operations and liquidity.

We also are subject to other laws and regulations governing our operations, including regulations administered by the U.S. Department of Treasury’s Office of Foreign Asset Control and various non-U.S. government entities, including applicable export control regulations, economic sanctions on countries and persons and customs requirements. Trade control laws are complex and constantly changing. Our compliance policies and programs increase our cost of doing business and may not work effectively to ensure our compliance with trade control laws. If we undergo an investigation of potential violations of trade control laws by U.S. or foreign authorities or if we fail to comply with these laws, we may incur significant legal expenses or be subject to criminal and civil penalties and other sanctions and remedial measures, which could have a material adverse impact on our reputation, business, financial condition and results of operations.


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Tax legislation and administrative initiatives or challenges to our tax positions could adversely affect our results of operations and financial condition.

We operate in locations throughout the U.S. and internationally and, as a result, we are subject to the tax laws and regulations of U.S. federal, state, local and foreign governments. From time to time, various legislative or administrative initiatives may be proposed that could adversely affect our tax positions. In addition, U.S. federal, state, local and foreign tax laws and regulations are extremely complex and subject to varying interpretations. Moreover, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. There can be no assurance that our tax positions will not be challenged by relevant tax authorities or that we would be successful in any such challenge. Changes to our tax positions resulting from tax legislation and administrative initiatives or challenges from taxing authorities could adversely affect our results of operations and financial condition.

U.S. federal, state, local and foreign legislative and regulatory initiatives relating to hydraulic fracturing as well as governmental reviews of such activities could result in increased costs and additional operating restrictions or delays in the completion of oil and natural gas wells, and adversely affect demand for our products.

Hydraulic fracturing is an important and common practice that is used to stimulate production of natural gas and/or oil, from dense subsurface rock formations. We do not perform hydraulic fracturing, but many of our customers do. Hydraulic fracturing involves the injection of water, sand or alternative proppant and chemicals under pressure into target geological formations to fracture the surrounding rock and stimulate production. Hydraulic fracturing is typically regulated by state agencies, but recently, there has been increased public concern regarding an alleged potential for hydraulic fracturing to adversely affect drinking water supplies, and proposals have been made to enact separate U.S. federal, state and local legislation that would increase the regulatory burden imposed on hydraulic fracturing.

For example, at the U.S. federal level, the U. S. Environmental Protection Agency (“EPA”) issued an Advance Notice of Proposed Rulemaking to collect data on chemicals used in hydraulic fracturing operations under Section 8 of the Toxic Substances Control Act, and proposed regulations under the CWA governing wastewater discharges from hydraulic fracturing and certain other natural gas operations. On March 26, 2015, the Bureau of Land Management (“BLM”) released a final rule that updates existing regulation of hydraulic fracturing activities on U.S. federal lands, including requirements for chemical disclosure, wellbore integrity and handling of flowback water. The final rule never went into effect due to pending litigation and on December 28, 2017, the BLM announced that it had rescinded the 2015 final rule, in part citing a review that found that each of the 32 states with federal oil and gas leases has regulations that already address hydraulic fracturing.

At the state level, several states have adopted or are considering legal requirements that could impose more stringent permitting, disclosure, and well construction requirements on hydraulic fracturing activities. For example in May 2013, the Texas Railroad Commission adopted new rules governing well casing, cementing and other standards for ensuring that hydraulic fracturing operations do not contaminate nearby water resources. Local governments may also seek to adopt ordinances within their jurisdictions regulating the time, place and manner of, or prohibiting the performance of, drilling activities in general or hydraulic fracturing activities in particular. In addition, certain interest groups have also proposed ballot initiatives and constitutional amendments designed to restrict oil and natural-gas development generally and hydraulic fracturing in particular. For example, in 2018, Colorado voters ultimately rejected Proposition 112, a Colorado ballot initiative that would have drastically limited the use of hydraulic fracturing in Colorado. If new or more stringent federal, state or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where our natural gas exploration and production customers operate, those customers could incur potentially significant added costs to comply with such requirements, experience delays or curtailment in the pursuit of exploration, development or production activities and perhaps even be precluded from drilling wells. In countries outside of the U.S., including provincial, regional, tribal or local jurisdictions therein where we conduct operations, there may exist similar governmental restrictions or controls on our customers’ hydraulic fracturing activities, which, if such restrictions or controls exist or are adopted in the future, our foreign customers may face the same challenges as our U.S. customers. Any such restrictions, domestically or foreign, could reduce demand for our products, and as a result could have a material adverse effect on our business, financial condition, results of operations and cash flows.


17


Our customers’ inability to acquire adequate supplies of water or dispose of or recycle the water used in operations, could result in operating restrictions or delays in the completion of oil and natural gas wells, and adversely affect demand for our products.

Oil and gas development activities require the use of water. For example, the hydraulic fracturing process to produce commercial quantities of oil and natural gas from many reservoirs requires the use and disposal of significant quantities of water. In certain areas, there may be a scarcity of water for drilling activities due to various factors, including insufficient local aquifer capacity or government regulations restricting the use of water. Our customers’ inability to secure sufficient amounts of water or dispose of or recycle the water used in operations, could adversely impact our or our customers’ operations in certain areas. The imposition of new environmental initiatives and regulations, could further restrict our customers’ ability to conduct certain operations disposal of waste, including, but not limited to, produced water, drilling fluids and other materials associated with the exploration, development or production of oil and natural gas. Any such restrictions could reduce demand for our products, and as a result could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We are subject to a variety of environmental, health and safety regulations. Failure to comply with these regulations may result in administrative, civil and criminal enforcement measures and changes in these regulations could increase our costs or liabilities.

We are subject to a variety of U.S. federal, state, local and international laws and regulations relating to the environment, and worker health and safety. These laws and regulations are complex, change frequently, are becoming increasingly stringent, and the cost of compliance with these requirements can be expected to increase over time. Failure to comply with these laws and regulations may result in administrative, civil and criminal enforcement measures, including assessment of monetary penalties, imposition of remedial requirements and issuance of injunctions as to future compliance. Certain of these laws also may impose joint and several and strict liability for environmental contamination, which may render us liable for remediation costs, natural resource damages and other damages as a result of our conduct that may have been lawful at the time it occurred or the conduct of, or conditions caused by, prior owners or operators or other third parties. In addition, where contamination may be present, it is not uncommon for neighboring land owners and other third parties to file claims for personal injury, property damage and recovery of response costs. Remediation costs and other damages arising as a result of environmental laws and regulations, and costs associated with new information, changes in existing environmental laws and regulations or the adoption of new environmental laws and regulations could be substantial and could negatively impact our financial condition, profitability and results of operations.

We may need to apply for or amend facility permits or licenses from time to time with respect to storm water or wastewater discharges, waste handling, or air emissions relating to manufacturing activities or equipment operations, which subjects us to new or revised permitting conditions. These permits and authorizations may contain numerous compliance requirements, including monitoring and reporting obligations and operational restrictions, such as emission limits, which may be onerous or costly to comply with. Given the large number of facilities in which we operate, and the numerous environmental permits and other authorizations that are applicable to our operations, we may occasionally identify or be notified of technical violations of certain requirements existing in various permits or other authorizations. Occasionally, we have been assessed penalties for our non-compliance, and we could be subject to such penalties in the future.

The modification or interpretation of existing environmental, health and safety laws or regulations, the more vigorous enforcement of existing laws or regulations, or the adoption of new laws or regulations may also negatively impact oil and natural gas exploration and production, gathering and pipeline companies, including our customers, which in turn could have a negative impact on us.


18


Global climate change is an increased international concern and could increase operating costs or reduce the demand for our products and services.

Continuing political and social attention to the issue of global climate change has resulted in both existing and pending international agreements and national, regional or local legislation and regulatory measures to limit greenhouse gas emissions, such as cap and trade regimes, carbon taxes, restrictive permitting, increased fuel efficiency standards and incentives or mandates for renewable energy. For example, in December 2015, the U.S. joined the international community at the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change in Paris that prepared an agreement requiring member countries to review and represent a progression in their intended greenhouse gas emission reduction goals every five years beginning in 2020. While the U.S. announced its intention to withdraw from the Paris Agreement, several U.S. state and local governments and major corporations headquartered in the U.S. announced an intent to honor the U.S.’s commitments. Several U.S. cities, counties and state governments have also filed lawsuits against certain oil and gas companies seeking compensatory damages and equitable relief to abate alleged climate change impacts. To date, none of these suits has been successful, and we are not a party to these proceedings. In the U.S., the EPA has also begun to regulate greenhouse gas emissions under the federal Clean Air Act and regulatory agencies and legislative bodies in other countries where we operate have adopted greenhouse gas emission reduction programs. The adoption of new or more stringent legislation or regulatory programs restricting greenhouse gas emissions in any of the jurisdictions where we or our customers operate could require us to incur higher operating costs or increase the cost of, and thus reduce the demand for, the hydrocarbon products of our customers. These increased costs or reduced demand could have an adverse effect on our business, profitability or results of operations.

Further, some scientists have concluded that increasing greenhouse gas concentrations in the atmosphere may produce physical effects, such as increased severity and frequency of storms, droughts, floods and other climate events. To the extent there are significant changes in the Earth’s climate in the markets we serve or the areas where our assets reside, we could incur increased expenses, our operations could be materially impacted, and demand for our products and services could fall. Demand for our products and services may also be adversely affected by conservation plans and efforts undertaken in response to global climate change. Many governments also provide, or may in the future provide, tax advantages and other subsidies to support the use and development of alternative energy technologies. Our operations and the demand for our products and services or our customers’ products could be materially impacted by the development and adoption of these technologies.

Recently, activists concerned about the potential effects of climate change have directed their attention at sources of funding for companies engaged in business involving fossil fuels, which has resulted in certain financial institutions, investment funds and other sources of capital restricting or eliminating their investment in oil and natural gas activities. This could make it more difficult for our customers to secure funding for exploration and production or midstream energy business activities.

Risks Related to Our Level of Indebtedness

Our outstanding debt obligations could limit our ability to fund future growth and operations and increase our exposure to risk during adverse economic conditions.

At December 31, 2018, we had a long-term debt balance of $403.8 million. Many factors, including factors beyond our control, may affect our ability to make payments on our outstanding indebtedness. These factors include those discussed elsewhere in these Risk Factors and those listed in the Disclosure Regarding Forward-Looking Statements section included in Part I of this Annual report.

Our debt and associated commitments could have important adverse consequences. For example, these commitments could:
make it more difficult for us to satisfy our contractual obligations;
increase our vulnerability to general adverse economic and industry conditions;
limit our ability to fund future working capital, capital expenditures, investments, acquisitions or other corporate requirements;
increase our vulnerability to interest rate fluctuations because the interest payments on borrowings under our revolving credit facility are based upon variable interest rates and can adjust based upon certain financial covenant ratios;
limit our flexibility in planning for, or reacting to, changes in our business and our industry;
place us at a disadvantage compared to our competitors that have less debt or less restrictive covenants in such debt; and
limit our ability to borrow additional funds in the future.


19


Covenants in our debt agreements may restrict our ability to operate our business.

Our credit agreement, consisting of a $700.0 million revolving credit facility expiring in October 2023, contains various covenants with which we, Exterran Energy Solutions, L.P. (“EESLP”), our wholly owned subsidiary, and our respective restricted subsidiaries must comply, including, but not limited to, limitations on the incurrence of indebtedness, investments, liens on assets, repurchasing equity, making distributions, transactions with affiliates, mergers, consolidations, dispositions of assets and other provisions customary in similar types of agreements. Additionally, we are required to maintain certain financial covenant ratios. If we fail to remain in compliance with these restrictions and financial covenants, we would be in default under our credit agreement. In addition, if we experience a material adverse effect on our assets, liabilities, financial condition, business or operations that, taken as a whole, impact our ability to perform our obligations under our credit agreement, this could lead to a default. A default under one of our debt agreements might trigger cross-default provisions under our other debt agreement, which would accelerate our obligation to repay our indebtedness under those agreements. If the repayment obligations on any of our indebtedness were to be accelerated, we may not be able to repay the debt or refinance the debt on acceptable terms, and our financial position would be materially adversely affected. As of December 31, 2018, we were in compliance with all financial covenants under our credit agreement.

As a result of a covenant restriction included in our credit agreement, $578.4 million of the $608.3 million of undrawn capacity under our revolving credit facility was available for additional borrowings as of December 31, 2018.

Changes in the method pursuant to which the LIBOR rates are determined and potential phasing out of LIBOR after 2021 may adversely affect our results of operations.

LIBOR and certain other “benchmarks” are the subject of recent national, international and other regulatory guidance and proposals for reform. These reforms may cause such benchmarks to perform differently than in the past or have other consequences which cannot be predicted. In particular, on July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, publicly announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. It is unclear whether, at that time, LIBOR will cease to exist or if new methods of calculating LIBOR will be established. As of December 31, 2018, $35.0 million of the borrowings under our revolving credit facility had interest rate payments determined directly or indirectly based on LIBOR. Any uncertainty regarding the continued use and reliability of LIBOR as a benchmark interest rate could adversely affect the performance of LIBOR relative to its historic values. If the methods of calculating LIBOR change from current methods for any reason, or if LIBOR ceases to perform as it has historically, our interest expense associated with our outstanding indebtedness or any future indebtedness we incur may increase. Further, if LIBOR ceases to exist, we may be forced to substitute an alternative reference rate under our revolving credit facility or rely on base rate borrowings in lieu of LIBOR-based borrowings. At this point, it is not clear what, if any, alternative reference rate may replace LIBOR, however, any such alternative reference rate may increase the interest expense associated with our existing or future indebtedness. Any of these occurrences could materially and adversely affect our borrowing costs, business and results of operations.

We may increase our debt or raise additional capital in the future, which could affect our financial condition, may decrease our profitability or could dilute our shareholders.

We may increase our debt or raise additional capital in the future, subject to restrictions in our debt agreements. If our cash flow from operations is less than we anticipate, or if our cash requirements are more than we expect, we may require more financing. However, debt or equity financing may not be available to us on terms acceptable to us, if at all. If we incur additional debt or raise equity through the issuance of preferred stock, the terms of the debt or preferred stock issued may give the holders rights, preferences and privileges senior to those of holders of our common stock, particularly in the event of liquidation. The terms of the debt may also impose additional and more stringent restrictions on our operations than we currently have. If we raise funds through the issuance of additional equity, our shareholders’ ownership in us would be diluted. If we are unable to raise additional capital when needed, it could affect our financial health, which could negatively affect our shareholders.


20


Risks Related to the Spin-off

We are subject to continuing contingent tax liabilities of Archrock.

Certain tax liabilities of Archrock may become our obligations. Pursuant to the U.S. Internal Revenue Code and the related rules and regulations, each corporation that was a member of the Archrock consolidated U.S. federal income tax reporting group during any taxable period or portion of any taxable period ending on or before the effective time of the Spin-off is jointly and severally liable for the U.S. federal income tax liability of the entire Archrock consolidated tax reporting group for that taxable period. In connection with the Spin-off, we entered into a tax matters agreement with Archrock that allocates the responsibility for prior period taxes of the Archrock consolidated tax reporting group between us and Archrock. If Archrock is unable to pay any prior period taxes for which it is responsible, we could be required to pay the entire amount of such taxes.

Our prior and continuing relationship with Archrock exposes us to risks attributable to businesses of Archrock.

Archrock is obligated to indemnify us for losses that third parties may seek to impose upon us or our affiliates for liabilities relating to the business of Archrock that are incurred through a breach of the separation and distribution agreement or any ancillary agreement by Archrock or its affiliates other than us, or losses that are attributable to Archrock in connection with the Spin-off or are not expressly assumed by us under our agreements with Archrock. Any claims made against us that are properly attributable to Archrock in accordance with these arrangements would require us to exercise our rights under our agreements with Archrock to obtain payment from Archrock. We are exposed to the risk that, in these circumstances, Archrock cannot, or will not, make the required payment.

In connection with our separation from Archrock, Archrock will indemnify us for certain liabilities, and we will indemnify Archrock for certain liabilities. If we are required to act on these indemnities to Archrock, we may need to divert cash to meet those obligations, and our financial results could be negatively impacted. In the case of Archrock’s indemnity, there can be no assurance that the indemnity will be sufficient to insure us against the full amount of such liabilities, or as to Archrock’s ability to satisfy its indemnification obligations.

Pursuant to the separation and distribution agreement and other agreements with Archrock, Archrock has agreed to indemnify us for certain liabilities, and we have agreed to indemnify Archrock for certain liabilities, in each case for uncapped amounts. Under the separation and distribution agreement, we and Archrock will generally release the other party from all claims arising prior to the Spin-off that relate to the other party’s business, subject to certain exceptions. Also pursuant to the separation and distribution agreement, we have agreed to use our commercially reasonable efforts to remove Archrock as a party to certain of our contracts with third parties. In the event that Archrock remains as a party, we expect to indemnify Archrock for any liabilities relating to such contracts. Indemnities that we may be required to provide Archrock will not be subject to any cap, may be significant and could negatively impact our business, particularly indemnities relating to our actions that could impact the tax-free nature of the Spin-off.

With respect to Archrock’s agreement to indemnify us, there can be no assurance that the indemnity from Archrock will be sufficient to protect us against the full amount of such liabilities, or that Archrock will be able to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Archrock any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. Each of these risks could negatively affect our business, cash flows, results of operations and financial condition.

Risks Related to Our Common Stock

The market price and trading volume of our common stock may be volatile.

The market price of our stock may be influenced by many factors, some of which are beyond our control, including the following:
the inability to meet the financial estimates of analysts who follow our common stock;
strategic actions by us or our competitors;
announcements by us or our competitors of significant contracts, acquisitions, joint marketing relationships, joint ventures or capital commitments;
variations in our quarterly operating results and those of our competitors;
general economic and stock market conditions;
risks relating to our business and our industry, including those discussed above;

21


changes in conditions or trends in our industry, markets or customers;
cyber-attacks or terrorist acts;
future sales of our common stock or other securities;
material weaknesses in our internal control over financial reporting; and
investor perceptions of the investment opportunity associated with our common stock relative to other investment alternatives.

These broad market and industry factors may materially reduce the market price of our common stock, regardless of our operating performance. In addition, price volatility may be greater if the public float and trading volume of our common stock is low.

Our amended and restated certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers or other employees.

Our amended and restated certificate of incorporation provides that, unless we consent in writing to the selection of an alternate forum, the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation or our bylaws, in each case, as amended from time to time, or (iv) any action asserting a claim governed by the internal affairs doctrine, shall be the Court of Chancery of the State of Delaware, in all cases subject to the court’s having personal jurisdiction over the indispensable parties named as defendants. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock is deemed to have received notice of and consented to the foregoing provision. This forum selection provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable or cost-effective for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and employees.
 
Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

The following table describes the material facilities we owned or leased as of December 31, 2018:
Location
 
Status
 
Square Feet
 
Uses
Houston, Texas
 
Owned
 
261,609
 
Corporate office and product sales
Camacari, Brazil
 
Owned
 
86,112
 
Contract operations and aftermarket services
Port Harcourt, Nigeria
 
Leased
 
47,333
 
Contract operations and aftermarket services
Neuquen, Argentina
 
Owned
 
43,233
 
Contract operations and aftermarket services
Reynosa, Mexico
 
Owned
 
28,912
 
Contract operations and aftermarket services
Santa Cruz, Bolivia
 
Leased
 
22,017
 
Contract operations and aftermarket services
Bangkok, Thailand
 
Leased
 
51,667
 
Aftermarket services
Houston, Texas
 
Owned
 
301,127
 
Product sales
Hamriyah Free Zone, UAE
 
Leased
 
212,742
 
Product sales
Broken Arrow, Oklahoma
 
Owned
 
145,755
 
Product sales
Singapore, Singapore
 
Leased
 
111,693
 
Product sales


22


Item 3.  Legal Proceedings
 
In the ordinary course of business, we are involved in various pending or threatened legal actions. While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from any of these actions will not have a material adverse effect on our financial position, results of operations or cash flows. However, because of the inherent uncertainty of litigation and arbitration proceedings, we cannot provide assurance that the resolution of any particular claim or proceeding to which we are a party will not have a material adverse effect on our financial position, results of operations or cash flows.

Contemporaneously with filing the Form 8-K on April 26, 2016, we self-reported the errors and possible irregularities at Belleli EPC to the SEC. Since then, we have been cooperating with the SEC in its investigation of this matter. The SEC’s investigation related to the circumstances giving rise to the restatement is continuing, and we are presently unable to predict the duration, scope or results or whether the SEC will commence any legal action.

Item 4.  Mine Safety Disclosures

Not applicable.

PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is listed and traded on the New York Stock Exchange under the stock symbol “EXTN.” As of February 19, 2019, there were approximately 987 holders of record of our common stock.

We have not paid, and we do not currently anticipate paying cash dividends on our common stock. Instead, we intend to retain our future earnings to support the growth and development of our business. The declaration of any future cash dividends and, if declared, the amount of any such dividends, will be subject to our financial condition, earnings, capital requirements, financial covenants, applicable law and other factors our board of directors deems relevant. Therefore, there can be no assurance as to what level of dividends, if any, will be paid in the future.

For disclosures regarding securities authorized for issuance under our equity compensation plans, see Part III, Item 12 (“Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”) of this report.


23


Comparison of Cumulative Total Return

The performance graph below shows the cumulative total stockholder return on our common stock, compared with the S&P 500 Composite Stock Price Index (the “S&P 500 Index”) and the Oilfield Service Index (the “OSX Index”) over the period from November 4, 2015, the first day of trading volume, to December 31, 2018. The results are based on an investment of $100 in each of our common stock, the S&P 500 Index and the OSX Index. The graph assumes the reinvestment of dividends and adjusts all closing prices and dividends for stock splits.
chart-bb8b9c5a3ba03516b3d.jpg
The performance graph shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate this information by reference, and shall not otherwise be deemed filed under those Acts.

Unregistered Sales of Equity Securities and Use of Proceeds

None.


24


Repurchase of Equity Securities

The following table summarizes our repurchases of equity securities during the three months ended December 31, 2018:
Period
 
Total Number of
Shares Repurchased (1)
 
Average
Price Paid
Per Unit
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
 
Maximum Number of Shares
yet to be Purchased Under
 the Publicly Announced 
Plans or Programs
October 1, 2018 - October 31, 2018
 

 
$

 
N/A
 
N/A
November 1, 2018 - November 30, 2018
 
42,231

 
21.61

 
N/A
 
N/A
December 1, 2018 - December 31, 2018
 
1,029

 
19.83

 
N/A
 
N/A
Total
 
43,260

 
$
21.57

 
N/A
 
N/A
 
(1) 
Represents shares withheld to satisfy employees’ tax withholding obligations in connection with vesting of restricted stock awards during the period.

Share Repurchase Program

On February 20, 2019, our board of directors approved a share repurchase program, under which the Company is authorized to purchase up to $100.0 million of its outstanding common stock through February 2022. The share repurchase program may be effected through a variety of methods, including open-market purchases and Rule 10b5-1 trading plans among others. The amount and timing of any repurchases will depend on general market conditions, among other factors, and may be discontinued at any time.


25


Item 6.  Selected Financial Data

The table below presents certain selected historical consolidated and combined financial information as of and for each of the years in the five-year period ended December 31, 2018. The selected historical consolidated financial data as of December 31, 2018 and 2017 and the selected historical consolidated financial data for the years ended December 31, 2018, 2017 and 2016 has been derived from our audited Financial Statements included elsewhere in this report. The selected historical consolidated and combined financial data as of December 31, 2016, 2015 and 2014 and for the years ended December 31, 2015 and 2014 has been derived from our financial statements not included in this report.

Our Spin-off from Archrock was completed on November 3, 2015. Selected financial data for periods prior to the Spin-off represent the combined results of Archrock’s international services and product sales businesses. The combined financial data may not be indicative of our future performance and does not necessarily reflect the financial condition and results of operations we would have realized had we operated as a separate, stand-alone entity during the periods presented, including changes in our operations as a result of our Spin-off from Archrock. As discussed in Note 4 to our Financial Statements, the results from continuing operations for all periods presented exclude the results of our Venezuelan contract operations business, Canadian contract operations and aftermarket services businesses (“Canadian Operations”), Belleli CPE business (the manufacture of critical process equipment for refinery and petrochemical facilities) and Belleli EPC business (the manufacture of tanks for tank farms and the manufacture of evaporators and brine heaters for desalination plants). Those results are reflected in discontinued operations for all periods presented. The selected financial data presented below should be read together with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements contained in this report.
 
Years Ended December 31,
(in thousands, except per share data)
2018
 
2017
 
2016
 
2015
 
2014
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Revenues
$
1,360,856

 
$
1,215,294

 
$
905,397

 
$
1,687,264

 
$
1,986,184

Cost of sales (excluding depreciation and amortization expense)
977,428

 
868,154

 
596,406

 
1,189,361

 
1,395,007

Selling, general and administrative
178,401

 
176,318

 
157,485

 
210,483

 
252,130

Depreciation and amortization
123,922

 
107,824

 
132,886

 
146,318

 
163,538

Long-lived asset impairment
3,858

 
5,700

 
14,495

 
20,788

 
3,851

Restatement related charges (recoveries), net
(276
)
 
3,419

 
18,879

 

 

Restructuring and other charges
1,997

 
3,189

 
22,038

 
31,315

 

Interest expense
29,217

 
34,826

 
34,181

 
7,272

 
1,878

Equity in income of non-consolidated affiliates

 

 
(10,403
)
 
(15,152
)
 
(14,553
)
Other (income) expense, net
6,484

 
(975
)
 
(13,046
)
 
35,516

 
5,572

Income (loss) before income taxes
39,825

 
16,839

 
(47,524
)
 
61,363

 
178,761

Provision for income taxes
39,433

 
22,695

 
124,242

 
39,438

 
79,210

Income (loss) from continuing operations
392

 
(5,856
)
 
(171,766
)
 
21,925

 
99,551

Income (loss) from discontinued operations, net of tax
24,462

 
39,736

 
(56,171
)
 
4,723

 
15,741

Net income (loss)
24,854

 
33,880

 
(227,937
)
 
26,648

 
115,292

Income (loss) from continuing operations per common share: (1)
 
 
 
 
 
 
 
 
 
Basic
$
0.01

 
$
(0.17
)
 
$
(4.97
)
 
$
0.64

 
$
2.90

Diluted
0.01

 
(0.17
)
 
(4.97
)
 
0.64

 
2.90

Weighted average common shares outstanding used in income (loss) from continuing operations per common share: (1)
 
 
 
 
 
 
 
 
 
Basic
35,433

 
34,959

 
34,568

 
34,288

 
34,286

Diluted
35,489

 
34,959

 
34,568

 
34,304

 
34,286

Other Financial Data:
 
 
 
 
 
 
 
 
 
Total gross margin (2)
$
383,428

 
$
347,140

 
$
308,991

 
$
497,903

 
$
591,177

EBITDA, as adjusted (2)
205,498

 
173,155

 
155,993

 
282,031

 
338,050

Capital expenditures:
 
 
 
 
 
 
 
 
 
Contract Operations Equipment:
 
 
 
 
 
 
 
 
 
Growth (3)
$
186,240

 
$
104,909

 
$
53,005

 
$
105,169

 
$
97,931

Maintenance (4)
6,616

 
15,691

 
14,440

 
27,282

 
24,377

Other
22,252

 
11,073

 
6,225

 
22,893

 
24,164

Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
19,300

 
$
49,145

 
$
35,678

 
$
29,032

 
$
39,361

Working capital (5) (6)
108,746

 
134,048

 
177,824

 
408,488

 
366,135

Property, plant and equipment, net
901,577

 
822,279

 
790,922

 
846,977

 
890,627

Total assets (6)
1,567,054

 
1,460,807

 
1,374,778

 
1,788,396

 
1,999,303

Long-term debt (7)
403,810

 
368,472

 
348,970

 
525,593

 
1,107

Total stockholders’ equity (6) (7)
552,821

 
554,786

 
556,771

 
805,936

 
1,364,335

 
(1) 
For the periods prior to November 3, 2015, the average number of common shares outstanding used to calculate basic and diluted net income (loss) from continuing operations per common share was based on 34,286,267 shares of our common stock that were distributed by Archrock in the Spin-off on November 3, 2015.
(2) 
Total gross margin and EBITDA, as adjusted, are non-GAAP financial measures. Total gross margin and EBITDA, as adjusted, are defined, reconciled to income (loss) before income taxes and net income (loss), respectively, and discussed further below under “Non-GAAP Financial Measures.”
(3) 
Growth capital expenditures are made to expand or to replace partially or fully depreciated assets or to expand the operating capacity or revenue generating capabilities of existing or new assets, whether through construction, acquisition or modification. The majority of our growth capital expenditures are related to installation costs on contract operations projects and acquisition costs of new compressor units and processing and treating equipment that we add to our contract operations fleet. In addition, growth capital expenditures can include the upgrading of major components on an existing compressor unit where the current configuration of the compressor unit is no longer in demand and the compressor unit is not likely to return to an operating status without the capital expenditures. These latter expenditures substantially modify the operating parameters of the compressor unit such that it can be used in applications for which it previously was not suited.
(4) 
Maintenance capital expenditures are made to maintain the existing operating capacity of our assets and related cash flows further extending the useful lives of the assets. Maintenance capital expenditures are related to major overhauls of significant components of a compressor unit, such as the engine, compressor and cooler, that return the components to a “like new” condition, but do not modify the applications for which the compressor unit was designed.
(5) 
Working capital is defined as current assets minus current liabilities.
(6) 
Amounts include balance sheet data for discontinued operations.
(7) 
Pursuant to the separation and distribution agreement with Archrock and certain of our and Archrock’s respective affiliates, on November 3, 2015, we transferred $532.6 million of net proceeds from borrowings under our credit facility to Archrock to allow it to repay a portion of its indebtedness in connection with the Spin-off.

Non-GAAP Financial Measures

We define gross margin as total revenue less cost of sales (excluding depreciation and amortization expense). We evaluate the performance of each of our segments based on gross margin. Total gross margin is included as a supplemental disclosure because it is a primary measure used by our management to evaluate the results of revenue and cost of sales (excluding depreciation and amortization expense), which are key components of our operations. We believe gross margin is important because it focuses on the current operating performance of our operations and excludes the impact of the prior historical costs of the assets acquired or constructed that are utilized in those operations, the indirect costs associated with our selling, general and administrative (“SG&A”) activities, the impact of our financing methods and income taxes. Depreciation and amortization expense may not accurately reflect the costs required to maintain and replenish the operational usage of our assets and therefore may not portray the costs from current operating activity. As an indicator of our operating performance, total gross margin should not be considered an alternative to, or more meaningful than, income (loss) before income taxes as determined in accordance with generally accepted accounting principles in the U.S. (“GAAP”). Our gross margin may not be comparable to a similarly titled measure of another company because other entities may not calculate gross margin in the same manner.

Total gross margin has certain material limitations associated with its use as compared to income (loss) before income taxes. These limitations are primarily due to the exclusion of interest expense, depreciation and amortization expense, SG&A expense, impairments and restructuring and other charges. Each of these excluded expenses is material to our statements of operations. Because we intend to finance a portion of our operations through borrowings, interest expense is a necessary element of our costs and our ability to generate revenue. Additionally, because we use capital assets, depreciation expense is a necessary element of our costs and our ability to generate revenue, and SG&A expenses are necessary to support our operations and required corporate activities. To compensate for these limitations, management uses total gross margin, a non-GAAP measure, as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.


26


The following table reconciles our net income (loss) before income taxes to total gross margin (in thousands):
 
Years Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
Income (loss) before income taxes
$
39,825

 
$
16,839

 
$
(47,524
)
 
$
61,363

 
$
178,761

Selling, general and administrative
178,401

 
176,318

 
157,485

 
210,483

 
252,130

Depreciation and amortization
123,922

 
107,824

 
132,886

 
146,318

 
163,538

Long-lived asset impairment
3,858

 
5,700

 
14,495

 
20,788

 
3,851

Restatement related charges (recoveries), net
(276
)
 
3,419

 
18,879

 

 

Restructuring and other charges
1,997

 
3,189

 
22,038

 
31,315

 

Interest expense
29,217

 
34,826

 
34,181

 
7,272

 
1,878

Equity in income of non-consolidated affiliates

 

 
(10,403
)
 
(15,152
)
 
(14,553
)
Other (income) expense, net
6,484

 
(975
)
 
(13,046
)
 
35,516

 
5,572

Total gross margin
$
383,428

 
$
347,140

 
$
308,991

 
$
497,903

 
$
591,177


We define EBITDA, as adjusted, as net income (loss) excluding income (loss) from discontinued operations (net of tax), cumulative effect of accounting changes (net of tax), income taxes, interest expense (including debt extinguishment costs), depreciation and amortization expense, impairment charges, restructuring and other charges, non-cash gains or losses from foreign currency exchange rate changes recorded on intercompany obligations, expensed acquisition costs and other items. We believe EBITDA, as adjusted, is an important measure of operating performance because it allows management, investors and others to evaluate and compare our core operating results from period to period by removing the impact of our capital structure (interest expense from our outstanding debt), asset base (depreciation and amortization), our subsidiaries’ capital structure (non-cash gains or losses from foreign currency exchange rate changes on intercompany obligations), tax consequences, impairment charges, restructuring and other charges, expensed acquisition costs and other items. Management uses EBITDA, as adjusted, as a supplemental measure to review current period operating performance, comparability measures and performance measures for period to period comparisons. In addition, the compensation committee has used EBITDA, as adjusted, in evaluating the performance of the Company and management and in evaluating certain components of executive compensation, including performance-based annual incentive programs. Our EBITDA, as adjusted, may not be comparable to a similarly titled measure of another company because other entities may not calculate EBITDA in the same manner.

EBITDA, as adjusted, is not a measure of financial performance under GAAP and should not be considered in isolation or as an alternative to net income (loss), cash flows from operating activities or any other measure determined in accordance with GAAP. Items excluded from EBITDA, as adjusted, are significant and necessary components to the operation of our business and therefore, EBITDA, as adjusted, should only be used as a supplemental measure of our operating performance.


27


The following table reconciles our net income (loss) to EBITDA, as adjusted (in thousands):
 
Years Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
Net income (loss)
$
24,854

 
$
33,880

 
$
(227,937
)
 
$
26,648

 
$
115,292

(Income) loss from discontinued operations, net of tax
(24,462
)
 
(39,736
)
 
56,171

 
(4,723
)
 
(15,741
)
Depreciation and amortization
123,922

 
107,824

 
132,886

 
146,318

 
163,538

Long-lived asset impairment
3,858

 
5,700

 
14,495

 
20,788

 
3,851

Restatement related charges (recoveries), net
(276
)
 
3,419

 
18,879

 

 

Restructuring and other charges
1,997

 
3,189

 
22,038

 
31,315

 

Investment in non-consolidated affiliates impairment

 

 

 
33

 
197

Proceeds from sale of joint venture assets

 

 
(10,403
)
 
(15,185
)
 
(14,750
)
Interest expense
29,217

 
34,826

 
34,181

 
7,272

 
1,878

(Gain) loss on currency exchange rate remeasurement of intercompany balances
5,241

 
(516
)
 
(8,559
)
 
30,127

 
3,614

Loss on sale of businesses
1,714

 
111

 

 

 
961

Penalties from Brazilian tax programs

 
1,763

 

 

 

Provision for income taxes
39,433

 
22,695

 
124,242

 
39,438

 
79,210

EBITDA, as adjusted
$
205,498

 
$
173,155

 
$
155,993

 
$
282,031

 
$
338,050


Off-Balance Sheet Arrangements
 
We have no material off-balance sheet arrangements.


28


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 systems and process company offering solutions in the oil, gas, water and power markets. We are a leader in natural gas processing and treatment and compression products and services, providing critical midstream infrastructure solutions to customers throughout the world. Outside the U.S., we are a leading provider of full-service natural gas contract compression and a supplier of aftermarket parts and services. We provide our products and services to a global customer base consisting 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 oil and natural gas producers and oil and natural gas processors, gatherers and pipeline operators. We operate in three primary business lines: contract operations, aftermarket services and product sales. The nature and inherent interactions between and among our business lines provide us with opportunities to cross-sell and offer integrated product and service solutions to our customers. In our contract operations business line, we provide compression and processing and treating services through the operation of our natural gas compression equipment and crude oil and natural gas production and process equipment for our customers. In our aftermarket services business line, we sell parts and components and provide operations, maintenance, repair, overhaul, upgrade, startup and commissioning and reconfiguration services to customers who own their own oil and natural gas compression, production, processing, treating and related equipment. In our product sales business line, we design, engineer, manufacture, install and sell natural gas compression packages as well as equipment used in the treating and processing of crude oil and natural gas to our customers throughout the world and for use in our contract operations business line. We also 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.

Our chief operating decision maker manages business operations, evaluates performance and allocates resources based on the Company’s three primary business lines, which are also referred to as our segments. In order to more efficiently and effectively identify and serve our customer needs, we classify our worldwide operations into four geographic regions. The North America region is primarily comprised of our operations in Mexico and the U.S. The Latin America region is primarily comprised of our operations in Argentina, Bolivia and Brazil. The Middle East and Africa region is primarily comprised of our operations in Bahrain, Iraq, Oman, Nigeria and the United Arab Emirates. The Asia Pacific region is primarily comprised of our operations in China, Indonesia, Thailand and Singapore.
 
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, and to a lesser extent our product sales business, is typically less impacted by short-term commodity prices than certain other energy products and service providers, changes in oil and natural gas exploration and production spending normally result in changes in demand for our products and services.

Industry observers anticipate strong continued global demand for hydrocarbons, including demand for liquefied natural gas. However, customer cash flows and returns on capital could drive customer investment priorities. Industry observers believe shareholders are encouraging management teams of energy producers to focus operational and compensation strategies on returns and cash flow generation rather than solely on production growth. To accomplish these strategies, energy producers may need to better prioritize capital spending, which could impact resource allocation and ultimately the amount of new projects and capital spending by our customers.


29


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 to use our products and services, use our competitors’ products and services or own and operate the equipment themselves.

Historically, oil, natural gas and natural gas liquids and the level of drilling and exploration activity in North America have been volatile. The Henry Hub spot price for natural gas was $3.25 per MMBtu at December 31, 2018, which was 12% lower than prices at both December 31, 2017 and 2016, and the U.S. natural gas liquid composite price was $6.98 per MMBtu for the month of November 2018, which was 11% lower than prices for the month of December 2017 and 5% higher than prices for the month of December 31, 2016, respectively. In addition, the West Texas Intermediate crude oil spot price as of December 31, 2018 was 25% and 16% lower than prices at December 31, 2017 and 2016, respectively. Increased stability of oil, natural gas and natural gas liquids prices in 2017 and most of 2018 encouraged increased customer spending and investments in equipment that have led to increased activity and bookings in North America. Booking activity levels for our manufactured products in North America during the year ended December 31, 2018 were $916.2 million, which represents increases of 10% and 177% compared to the years ended December 31, 2017 and 2016, respectively, and our North America product sales backlog as of December 31, 2018 was $542.3 million, which represents increases of 29% and 128% compared to December 31, 2017 and 2016, respectively. Additionally, our North America contract operations services backlog as of December 31, 2018 was approximately $70 million.

Longer-term fundamentals in our international markets partially depend on international oil and gas infrastructure projects, many of which are based on the longer-term plans of our customers that can be driven by their local market demand and local pricing for natural gas. As a result, we believe our international customers make decisions based on longer-term fundamentals that may be less tied to near term commodity prices than our North American customers. Over the long term, we believe the demand for our products and services in international markets will continue, and we expect to have opportunities to grow our international businesses. Booking activity levels for our manufactured products in international markets during the year ended December 31, 2018 were $219.5 million, which represents increases of 278% and 118% compared to the years ended December 31, 2017 and 2016, respectively, and our international product sales backlog as of December 31, 2018 was $163.5 million, which represents increases of 312% and 139% compared to December 31, 2017 and 2016, respectively. Additionally, our international contract operations services backlog as of December 31, 2018 was approximately $1.3 billion.

Aggregate booking activity levels for our manufactured products in North America and international markets during the year ended December 31, 2018 was approximately $1.1 billion, which represents increases of 28% and 163% compared to the years ended December 31, 2017 and 2016, respectively. Fluctuations in the size and timing of customers’ requests for bid proposals and awards of new contracts tend to create variability in booking activity levels from period to period.

The timing of any change in activity levels by our customers is difficult to predict. As a result, our ability to project the anticipated activity level for our business, and particularly our product sales segment, is limited. We experienced increases in product sales bookings in 2018 and 2017. However, volatility in commodity prices could delay investments by our customers in significant projects, which could result in a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Our level of capital spending largely depends on the demand for our contract operations services and the equipment required to provide such services to our customers. We have invested more capital in our contract operations business in 2018 than we did in 2017. The increased investment during 2018 was driven by several large multi-year projects contracted in 2017 and 2018 that have started earning revenue or are scheduled to start earning revenue in 2019.


30


Certain Key Challenges and Uncertainties

Market conditions and competition in the oil and natural gas 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 future:

Global Energy Markets and Oil and Natural Gas Pricing. Our results of operations depend upon the level of activity in the global energy markets, including oil and natural gas development, production, processing and transportation. Oil and natural gas prices and the level of drilling and exploration activity can be volatile. If oil and natural gas exploration and development activity and the number of well completions decline due to the reduction in oil and natural gas prices or significant instability in energy markets, we would anticipate a decrease in demand and pricing for our natural gas compression and oil and natural gas production and processing equipment and services. For example, unfavorable market conditions or financial difficulties experienced by our customers may result in cancellation of contracts or the delay or abandonment of projects, which could cause our cash flows generated by our product sales and services to decline and have a material adverse effect on our results of operations and financial condition.

Execution on Larger Contract Operations and Product Sales Projects. Some of our projects are significant in size and scope, 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. We believe our ability to grow may 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.

Summary of Results

As discussed in Note 4 to the Financial Statements, the results from continuing operations for all periods presented exclude the results of our Venezuelan contract operations, Belleli CPE and Belleli EPC businesses. Those results are reflected in discontinued operations for all periods presented.

Revenue. Revenue during the years ended December 31, 2018, 2017 and 2016 was $1,360.9 million, $1,215.3 million and $905.4 million, respectively. The increase in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was due to revenue increases in our product sales and aftermarket services segments, partially offset by a decrease in revenue in our contract operations segment. The increase in revenue during the year ended December 31, 2017 compared to the year ended December 31, 2016 was due to a significant increase in revenue in our product sales segment, partially offset by decreases in revenue in our contract operations and aftermarket services segments.


31


Net income (loss). We generated net income of $24.9 million during the year ended December 31, 2018, net income of $33.9 million during the year ended December 31, 2017 and net loss of $227.9 million during the year ended December 31, 2016. The decrease in net income during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to an increase in income taxes, an increase in depreciation and amortization expense, a decrease in income from discontinued operations, net of tax, and an increase in foreign currency losses of $7.8 million. These activities were partially offset by an increase in gross margin for our product sales segment and a decrease in interest expense. Net income during the years ended December 31, 2018 and 2017 included income from discontinued operations, net of tax, of $24.5 million and $39.7 million, respectively. Income for discontinued operations, net of tax, was positively impacted by installment payments received of $19.8 million and $19.7 million associated with our Venezuelan subsidiary’s sale of its previously nationalized assets during the years ended December 31, 2018 and 2017, respectively, and recoveries from liquidated damages releases and customer approved change orders related to Belleli EPC during the year ended December 31, 2017. The increase in net income during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to non-cash valuation allowances of $119.8 million recorded against U.S. net deferred tax assets during 2016, an increase in income from discontinued operations, net of tax, an increase in gross margin for our product sales segment, a decrease in depreciation and amortization expense and a decrease in restructuring and other charges. These activities were partially offset by an increase in SG&A expense. Net income (loss) during the years ended December 31, 2017 and 2016 included income from discontinued operations, net of tax, of $39.7 million and loss from discontinued operations, net of tax, of $56.2 million, respectively. Income from discontinued operations, net of tax, for 2017 was positively impacted by recoveries from liquidated damages releases and customer approved change orders related to Belleli EPC. Loss from discontinued operations, net of tax, for 2016 included impairment charges of $68.8 million related to Belleli CPE.

EBITDA, as adjusted. Our EBITDA, as adjusted, was $205.5 million, $173.2 million and $156.0 million during the years ended December 31, 2018, 2017 and 2016, respectively. EBITDA, as adjusted, during the year ended December 31, 2018 compared to the year ended December 31, 2017 increased primarily due to an increase in gross margin for our product sales segment. EBITDA, as adjusted, during the year ended December 31, 2017 compared to the year ended December 31, 2016 increased primarily due to an increase in gross margin for our product sales segment, partially offset by an increase in SG&A expense and decreases in gross margin for our aftermarket services and contract operations segments. EBITDA, as adjusted, is a non-GAAP financial measure. 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.

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,
 
2018
 
2017
 
2016
Revenue:
 
 
 
 
 
Contract Operations
$
360,973

 
$
375,269

 
$
392,463

Aftermarket Services
120,676

 
107,063

 
120,550

Product Sales
879,207

 
732,962

 
392,384

 
$
1,360,856

 
$
1,215,294

 
$
905,397

Gross Margin: (1)
 
 
 
 
 
Contract Operations
$
238,835

 
$
241,889

 
$
248,793

Aftermarket Services
31,010

 
28,842

 
33,208

Product Sales
113,583

 
76,409

 
26,990

 
$
383,428

 
$
347,140

 
$
308,991

Gross Margin Percentage: (2)
 
 
 
 
 
Contract Operations
66
%
 
64
%
 
63
%
Aftermarket Services
26
%
 
27
%
 
28
%
Product Sales
13
%
 
10
%
 
7
%
 
(1) 
Gross margin is defined as revenue less cost of sales (excluding depreciation and amortization expense). We evaluate the performance of each of our segments based on gross margin.
(2) 
Gross margin percentage is defined as gross margin divided by revenue.


32


Operating Highlights

The following table summarizes the expected timing of revenue recognition from our contract operations backlog (in thousands):
 
December 31,
2018
Contract Operations Backlog: (1)
 
2019
$
292,002

2020
197,036

2021
202,837

2022
164,551

2023
147,709

Thereafter
394,509

Total contract operations backlog
$
1,398,644

 
(1) 
At December 31, 2018, three contracts, each of which were signed in 2018 and in aggregate represent approximately 10% of the total value of our backlog, are accounted for as operating leases. For these contracts, revenues are recognized on a straight line basis and represent approximately 18% of total backlog expected to be recognized in 2019 and thereafter represent no more than 14% for each subsequent periods. Revenues recognized during the year ended December 31, 2018 and assets assigned to these contracts at December 31, 2018 were not material to our statements of operation and balance sheets, respectively.

The following table summarizes our product sales backlog (in thousands):
 
December 31,
 
2018
 
2017
 
2016
Product Sales Backlog: (1)
 
 
 
 
 
Compression equipment
$
471,827

 
$
254,745

 
$
160,006

Processing and treating equipment
229,258

 
178,814

 
85,044

Production equipment (2)
2,438

 
14,138

 
36,119

Other product sales
2,246

 
13,349

 
25,053

Total product sales backlog
$
705,769

 
$
461,046

 
$
306,222

 
(1) 
We expect that approximately $690 million of our product sales backlog as of December 31, 2018 will be recognized as revenue before December 31, 2019.
(2) 
In June 2018, we completed the sale of our North America production equipment assets (“PEQ assets”), which included $12.0 million in backlog.


33


Results of Operations

The Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017

Contract Operations
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2018
 
2017
Change
 
% change
Revenue
$
360,973

 
$
375,269

 
$
(14,296
)
 
(4
)%
Cost of sales (excluding depreciation and amortization expense)
122,138

 
133,380

 
(11,242
)
 
(8
)%
Gross margin
$
238,835

 
$
241,889

 
$
(3,054
)
 
(1
)%
Gross margin percentage
66
%
 
64
%
 
2
%
 
3
 %

The decrease in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to decreases in revenue of $17.1 million and $12.6 million in the Latin America region and North America region, respectively, partially offset by increases in revenue of $13.1 million and $2.3 million in the Middle East and Africa region and Asia Pacific region, respectively. The revenue decrease in the Latin America region was primarily driven by an $18.2 million decrease in Argentina primarily due to a devaluation of the Argentine Peso during the current year period. The revenue decrease in the North America region was primarily due to a project that terminated operations in the first quarter of 2018 and renegotiations on a contract extension that resulted in lower revenue in the current year period. The revenue increase in the Middle East and Africa region was primarily driven by the start-up of projects in Oman and Iraq that were not operating or began operating in the prior year period. The revenue increase in the Asia Pacific region was primarily driven by a $2.8 million recovery of an early termination fee for a contract that terminated in January 2016. Gross margin decreased during the year ended December 31, 2018 compared to the year ended December 31, 2017 primarily due to the revenue decrease explained above. Gross margin percentage during the year ended December 31, 2018 compared to the year ended December 31, 2017 increased primarily due to customer approved contract changes during the current year period that resulted in a reduction of $3.3 million in costs of sales and a recovery of an early termination fee discussed above.

Aftermarket Services
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2018
 
2017
 
Change
 
% change
Revenue
$
120,676

 
$
107,063

 
$
13,613

 
13
 %
Cost of sales (excluding depreciation and amortization expense)
89,666

 
78,221

 
11,445

 
15
 %
Gross margin
$
31,010

 
$
28,842

 
$
2,168

 
8
 %
Gross margin percentage
26
%
 
27
%
 
(1
)%
 
(4
)%
 

The increase in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to increases in revenue of $10.5 million, $3.5 million and $1.1 million in the Middle East and Africa, North America and Latin America regions, respectively, partially offset by a decrease in revenue of $1.5 million in the Asia Pacific region. The revenue increase in the Middle East and Africa region was primarily driven by an increase in part sales. The revenue increase in the North America region was primarily driven by increases in commissioning services and part sales. Gross margin increased during the year ended December 31, 2018 compared to the year ended December 31, 2017 primarily due to the revenue increase explained above. Gross margin percentage during the year ended December 31, 2018 compared to the year ended December 31, 2017 remained relatively flat.


34


Product Sales
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2018
 
2017
 
Change
 
% change
Revenue
$
879,207

 
$
732,962

 
$
146,245

 
20
%
Cost of sales (excluding depreciation and amortization expense)
765,624

 
656,553

 
109,071

 
17
%
Gross margin
$
113,583

 
$
76,409

 
$
37,174

 
49
%
Gross margin percentage
13
%
 
10
%
 
3
%
 
30
%
 

The increase in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to increases in revenue of $137.3 million in the North America region and $12.9 million in the Asia Pacific region, partially offset by decreases in revenue of $2.2 million in the Latin America region and $1.8 million in the Middle East and Africa region. The revenue increase in the North America region was primarily due to increases of $94.9 million and $92.3 million in processing and treating equipment revenue and compression equipment revenue, respectively, partially offset by a decrease of $49.7 million in production equipment revenue. In June 2018, we completed the sale of our North America PEQ assets. The revenue increase in the Asia Pacific region was primarily due to an increase in compression equipment revenue. The revenue decrease in the Latin America region was primarily due to a decrease of $4.5 million in compression equipment revenue, partially offset by an increase of $3.1 million in production equipment revenue. The revenue decrease in the Middle East and Africa region was primarily due to decreases of $20.0 million and $5.6 million in compression equipment revenue and production equipment revenue, respectively, partially offset by a $24.8 million increase in processing and treating equipment revenue. Gross margin and gross margin percentage increased during the year ended December 31, 2018 compared to the year ended December 31, 2017 due to the revenue increase explained above, a shift in product mix in the North America region during the current year period and increased productivity relating to the manufacture of compression equipment.

Costs and Expenses
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2018
 
2017
 
Change
 
% change
Selling, general and administrative
$
178,401

 
$
176,318

 
$
2,083

 
1
 %
Depreciation and amortization
123,922

 
107,824

 
16,098

 
15
 %
Long-lived asset impairment
3,858

 
5,700

 
(1,842
)
 
(32
)%
Restatement related charges (recoveries), net
(276
)
 
3,419

 
(3,695
)
 
(108
)%
Restructuring and other charges
1,997

 
3,189

 
(1,192
)
 
(37
)%
Interest expense
29,217

 
34,826

 
(5,609
)
 
(16
)%
Other (income) expense, net
6,484

 
(975
)
 
7,459

 
(765
)%

Selling, general and administrative
SG&A expense during the year ended December 31, 2018 compared to the year ended December 31, 2017 remained relatively flat. During the years ended December 31, 2018 and 2017, SG&A expense as a percentage of revenue was 13% and 15%, respectively.

Depreciation and amortization
Depreciation and amortization expense during the year ended December 31, 2018 compared to the year ended December 31, 2017 increased primarily due to an increase in depreciation expense of $8.9 million for our compression equipment driven by changes in estimates relating to the useful lives and salvage values made in the fourth quarter of 2017. Additionally, depreciation expense of capitalized installation costs increased by $5.9 million primarily due to additional depreciation on projects that were not operating in the prior year period. Capitalized installation costs, included, among other things, civil engineering, piping, electrical instrumentation and project management costs.


35


Long-lived asset impairment
We regularly review the future deployment of our idle compression assets used in our contract operations segment for units that are not the type, configuration, condition, make or model that are cost efficient to maintain and operate. During the year ended December 31, 2018, we evaluated for impairment idle units that had been previously culled from our fleet and are available for sale. Based upon that review, we reduced the expected proceeds from disposition for certain units. This resulted in an additional impairment of $2.1 million to reduce the book value of each unit to its estimated fair value during the year ended December 31, 2018. During the year ended December 31, 2017, we determined that one idle compressor unit would be retired from the active fleet. The retirement of this unit from the active fleet triggered a review of the active fleet for impairment, and as a result, we recorded an asset impairment of $0.6 million, to reduce the book value of the unit to its estimated fair value.

In the fourth quarter of 2017, we classified certain PEQ assets primarily related to inventory and property, plant and equipment, net, within our product sales business as assets held for sale in our balance sheets. In June 2018, we completed the sale of our PEQ assets. During the years ended December 31, 2018 and 2017, we recorded impairments of $1.8 million and $2.1 million, respectively, to reduce these assets to their approximate fair values based on the expected net proceeds. For further details, see Note 8 to the financial statements. Additionally, in the fourth quarter of 2017, we determined that certain other assets within our product sales business were assessed to have no future benefit to our ongoing operations. In conjunction with the assessment of these other assets, we recorded an impairment charge of $3.0 million to write-down these assets.

Restatement related charges
As discussed in Note 14 to the Financial Statements, during the first quarter of 2016, our senior management identified errors relating to the application of percentage-of-completion accounting principles to specific Belleli EPC product sales projects. During the years ended December 31, 2018 and 2017, we incurred $0.9 million and $6.2 million, respectively, of external costs associated with an SEC investigation and remediation activities related to the restatement of our financial statements. During the years ended December 31, 2018 and 2017, we recorded recoveries from Archrock pursuant to the separation and distribution agreement of $1.2 million and $2.8 million, respectively, for previously incurred restatement related costs.

Restructuring and other charges
In the second quarter of 2018, we initiated a relocation plan in the North America region to better align our contract operations business with our customers. As a result of this plan, during the year ended December 31, 2018, we incurred restructuring and other charges of $2.0 million primarily related to relocation costs and employee termination benefits.

In the second quarter of 2015, we announced a cost reduction plan primarily focused on workforce reductions and the reorganization of certain facilities. As a result of this plan, during the year ended December 31, 2017, we incurred restructuring and other charges of $2.6 million primarily related to employee termination benefits. Additionally, during the year ended December 31, 2017, we incurred $0.6 million of costs associated with the Spin-off related to retention awards to certain employees. The charges incurred in conjunction with the relocation plan, cost reduction plan and Spin-off are included in restructuring and other charges in our statements of operations. See Note 15 to the Financial Statements for further discussion of these charges.

Interest expense
The decrease in interest expense during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to an increase in capitalized interest resulting from increased construction activities during the current year period and interest expense of $2.4 million recorded for the settling of non-income-based tax debt during the prior year period in connection with two Brazilian tax programs we entered into, partially offset by a higher average balance of long-term debt. During the years ended December 31, 2018 and 2017, the average daily outstanding borrowings of long-term debt were $428.6 million and $374.3 million, respectively. For further discussion on the Brazilian tax programs, see Note 16 to the Financial Statements.

Other (income) expense, net
The change in other (income) expense, net, was primarily due to foreign currency losses of $8.5 million and $0.7 million during the years ended December 31, 2018 and 2017, respectively. Foreign currency losses included translation losses of $5.2 million and translation gains of $0.5 million during the years ended December 31, 2018 and 2017, respectively, related to the currency remeasurement of our foreign subsidiaries’ non-functional currency denominated intercompany obligations. Other (income) expense, net, also included a loss of $1.7 million on the sale of our PEQ assets during the year ended December 31, 2018 and penalties of $1.8 million incurred for the settling of non-income-based tax debt during the year ended December 31, 2017 in connection with the two Brazilian tax programs discussed above. For further discussion on the sale of our PEQ assets, see Note 8 to the Financial Statements.


36


Income Taxes
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2018
 
2017
 
Change
 
% change
Provision for income taxes
$
39,433

 
$
22,695

 
$
16,738

 
74
 %
Effective tax rate
99.0
%
 
134.8
%
 
(35.8
)%
 
(26.6
)%

Our effective tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amounts of income we earn, or losses we incur, in those jurisdictions. It is also affected by discrete items that may occur in any given year but are not consistent from year to year. Our effective tax rate is also impacted by valuation allowances recorded against loss carryforwards in the U.S. and certain other jurisdictions, foreign withholding taxes and changes in foreign currency exchange rates.

The following items had the most significant impact on the difference between our statutory U.S. federal income tax rate of 21.0% and our effective tax rate for the year ended December 31, 2018:
A $28.3 million increase (71.0% increase) resulting primarily from foreign withholding taxes, $16.1 million in negative impacts of foreign currency devaluations in Argentina, and deemed distributions to the U.S. from certain of our non-U.S. subsidiaries.
A $19.0 million reduction (47.6% reduction) resulting from the release of valuation allowances primarily recorded against U.S federal net operating losses and certain deferred tax assets of our foreign subsidiaries.
An $8.3 million increase (21.0% increase) resulting from deductions of foreign taxes paid previously recorded as deferred tax asset carryforwards.
A $9.5 million increase (23.8% increase) related to unrecognized tax benefits recorded in the current year.

For the year ended December 31, 2017, our provision for income tax and effective tax rate of 134.8% was positively impacted by the reversal of previously recorded valuation allowances of $5.6 million against our U.S. corporate alternative minimum tax (“AMT”) carryforwards due to the Tax Cuts and Jobs Act (“Tax Reform Act”) which provided for the cancellation of the AMT and allows for a future refund and/or credit against regular income tax carryforwards. In addition, as a result of the reduction in the U.S. corporate tax rate from 35% to 21%, we recorded a provisional estimate of $15.5 million due to the re-measurement of deferred tax assets and liabilities and recorded a provisional estimate of $10.1 million due to the transition tax on undistributed earnings. Both of these were offset by a tax benefit from the reduction of the valuation allowance previously recorded against our U.S. deferred tax assets. Our effective tax rate was negatively impacted by a $17.1 million additional valuation allowance we recorded on our net U.S. deferred tax assets because beginning in 2016, we were no longer able to support that it was more likely-than-not that we would have sufficient taxable income in the future to realize our U.S. deferred tax assets. In addition, we recorded a $3.1 million benefit for the change in tax rates due to tax legislation enacted and signed into law in 2017 in Argentina. Our income tax expense for the year ended December 31, 2017 included benefits related to the reversal of valuation allowances previously recorded against deferred tax assets of $15.2 million related to income tax loss carryforwards that were utilized under two Brazilian tax programs.

The following items had the most significant impact on the difference between our statutory U.S. federal income tax rate of 35.0% and our effective tax rate for the year ended December 31, 2017:
A $48.1 million reduction (285.4% reduction) resulting from the release of valuation allowances primarily recorded against certain deferred tax assets of our foreign subsidiaries and federal net operating losses and credits in the U.S.
A $44.9 million increase (266.5% increase) resulting primarily from foreign withholding taxes, negative impacts of foreign currency devaluations in Argentina, and deemed distributions to the U.S. from certain of our non-U.S. subsidiaries. The increase includes a reduction resulting from rate differences between U.S. and foreign jurisdictions.
A $15.5 million increase (92.2% increase) resulting from changes to the tax rates at which certain deferred taxes are recorded due to U.S. tax reform legislation enacted and signed into law in 2017.
An $11.2 million reduction (66.7% reduction) resulting from claiming foreign taxes as credits primarily for foreign withholding taxes. The foreign tax credits are available to offset future payments of U.S. federal income taxes.
A $10.1 million increase (59.7% increase) resulting from transition tax charges related to U.S. tax reform legislation enacted and signed into law in 2017.


37


Discontinued Operations
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2018
 
2017
 
Change
 
% change
Income from discontinued operations, net of tax
$
24,462

 
$
39,736

 
$
(15,274
)
 
(38
)%

Income from discontinued operations, net of tax, includes our Venezuelan subsidiary’s operations that were expropriated in June 2009, including compensation for expropriation, and our Belleli EPC business.
 
Income from discontinued operations, net of tax, during the year ended December 31, 2018 compared to the year ended December 31, 2017 decreased primarily due to a $15.4 million decrease in income from Belleli EPC. The decrease in income from Belleli EPC was primarily due to recoveries in the first quarter of 2017 resulting from our release of liquidated damages by a customer in exchange for us releasing them from certain extension of time claims and the obtainment of customer approved change orders. Additionally, during the years ended December 31, 2018 and 2017, we received installment payments, including an annual charge, of $19.8 million and $19.7 million, respectively, from PDVSA Gas, S.A. (“PDVSA Gas”) in respect to our Venezuelan subsidiary’s sale of its previously nationalized assets. As of December 31, 2018, we have received all payments from PDVSA Gas. For further details on our discontinued operations, see Note 4 to the Financial Statements.

The Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016

Contract Operations
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2017

2016
 
Change
 
% change
Revenue
$
375,269

 
$
392,463

 
$
(17,194
)
 
(4
)%
Cost of sales (excluding depreciation and amortization expense)
133,380

 
143,670

 
(10,290
)
 
(7
)%
Gross margin
$
241,889

 
$
248,793

 
$
(6,904
)
 
(3
)%
Gross margin percentage
64
%
 
63
%
 
1
%
 
2
 %
 
The decrease in revenue during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to a $15.4 million decrease in revenue in Mexico primarily driven by projects that terminated operations in 2016 and a decrease in revenue of $7.7 million resulting from an early termination of a project in Indonesia in January 2016 that had been operating since the third quarter of 2009. These decreases were partially offset by an $8.0 million increase in revenue in Brazil primarily driven by the start-up of a project during the second half of 2016. Gross margin decreased during the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the revenue decrease explained above, partially offset by demobilization expenses of $6.1 million incurred in 2016 on the early termination of a project in Indonesia discussed above. Gross margin percentage during the year ended December 31, 2017 compared to the year ended December 31, 2016 remained relatively flat.


38


Aftermarket Services
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2017

2016
 
Change
 
% change
Revenue
$
107,063

 
$
120,550

 
$
(13,487
)
 
(11
)%
Cost of sales (excluding depreciation and amortization expense)
78,221

 
87,342

 
(9,121
)
 
(10
)%
Gross margin
$
28,842

 
$
33,208

 
$
(4,366
)
 
(13
)%
Gross margin percentage
27
%
 
28
%
 
(1
)%
 
(4
)%
 

The decrease in revenue during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to a decrease in operations and maintenance services of $5.2 million in Colombia, a decrease in parts sales of $7.1 million in China, a $3.3 million decrease in revenue due to the sale of our North America refurbishment and services business in the first quarter of 2017 and a $3.5 million decrease in revenue on a contract in the Middle East resulting from ongoing customer negotiations. These decreases were partially offset by a $4.6 million increase in Brazil primarily driven by increased maintenance services. Gross margin decreased during the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the revenue decrease explained above. Gross margin percentage during the year ended December 31, 2017 compared to the year ended December 31, 2016 remained relatively flat.

Product Sales
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2017

2016
 
Change
 
% change
Revenue
$
732,962

 
$
392,384

 
$
340,578

 
87
%
Cost of sales (excluding depreciation and amortization expense)
656,553

 
365,394

 
291,159

 
80
%
Gross margin
$
76,409

 
$
26,990

 
$
49,419

 
183
%
Gross margin percentage
10
%
 
7
%
 
3
%
 
43
%
 

The increase in revenue during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to increases of $316.3 million and $32.4 million in North America and in the Middle East and Africa region, respectively, partially offset by a decrease of $16.7 million in the Asia Pacific region. The increase in revenue in North America was primarily due to a significant increase in North America booking activities during 2017 compared to 2016. In North America, compression equipment revenue and processing and treating equipment revenue increased by $168.6 million and $160.6 million, respectively, partially offset by a decrease of $10.3 million in production equipment revenue. The increase revenue in the Middle East and Africa region was primarily due to an increase of $29.6 million in processing and treating equipment revenue. The decrease in revenue in the Asia Pacific region was primarily due to a decrease of $15.1 million in compression equipment revenue. Gross margin and gross margin percentage increased during the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the revenue increase explained above and a shift in product mix during 2017.


39


Costs and Expenses
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2017

2016
 
Change
 
% change
Selling, general and administrative
$
176,318

 
$
157,485

 
$
18,833

 
12
 %
Depreciation and amortization
107,824

 
132,886

 
(25,062
)
 
(19
)%
Long-lived asset impairment
5,700

 
14,495

 
(8,795
)
 
(61
)%
Restatement related charges
3,419

 
18,879

 
(15,460
)
 
(82
)%
Restructuring and other charges
3,189

 
22,038

 
(18,849
)
 
(86
)%
Interest expense
34,826

 
34,181

 
645

 
2
 %
Equity in income of non-consolidated affiliates

 
(10,403
)
 
10,403

 
(100
)%
Other (income) expense, net
(975
)
 
(13,046
)
 
12,071

 
(93
)%

Selling, general and administrative
SG&A expense increased during the year ended December 31, 2017 compared to the year ended December 31, 2016 primarily due to the reinstitution of certain incentive compensation that was suspended in 2016 and an increase in third-party professional expenses primarily related to the redesign of our internal controls framework in an effort to remediate previously identified internal control deficiencies, partially offset by cost savings resulting from the portions of our cost reduction plan previously implemented. During the years ended December 31, 2017 and 2016, SG&A expense as a percentage of revenue was 15% and 17%, respectively. The facility previously utilized to manufacture products for our Belleli EPC business has been repurposed to manufacture product sales equipment. As such, certain personnel, buildings, equipment and other assets that were previously related to the Belleli EPC business will remain as part of our continuing operations. As a result, SG&A expense during the years ended December 31, 2017 and 2016 included $2.4 million and $2.3 million, respectively, of costs associated with our ongoing operations at our repurposed facility.

Depreciation and amortization
Depreciation and amortization expense during the year ended December 31, 2017 compared to the year ended December 31, 2016 decreased primarily due to depreciation expense of $22.2 million recognized during the year ended December 31, 2016 on a contract operations project in Indonesia that early terminated operations in January 2016. The depreciation expense recognized on this project in 2016 primarily related to capitalized installation costs, which included, among other things, civil engineering, piping, electrical instrumentation and project management costs. The project had been operating since the third quarter of 2009.

Long-lived asset impairment
We regularly review the future deployment of our idle compression assets used in our contract operations segment for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. During the years ended December 31, 2017 and 2016, we determined that one idle compressor unit and 62 idle compressor units, respectively, would be retired from the active fleet. The retirement of these units from the active fleet triggered a review of these assets for impairment, and as a result, we recorded asset impairments of $0.6 million and $12.7 million, respectively, to reduce the book value of each unit to its estimated fair value.

In the fourth quarter of 2017, we classified certain assets within our product sales business that we expect to sell within the next twelve months as assets held for sale. We also determined that certain other assets within our product sales business were assessed to have no future benefit to our ongoing operations. In conjunction with the planned disposition and assessment of certain other assets, we recorded an impairment of long-lived assets that totaled $5.1 million to write-down these assets to their approximate fair values.

During the year ended December 31, 2016, we evaluated other assets for impairment and recorded long-lived asset impairments of $1.7 million on these assets.


40


Restatement related charges
As discussed in Note 14 to the Financial Statements, during the first quarter of 2016, our senior management identified errors relating to the application of percentage-of-completion accounting principles to specific Belleli EPC product sales projects. During the years ended December 31, 2017 and 2016, we incurred $6.2 million and $30.1 million, respectively, of external costs associated with an SEC investigation and remediation activities related to the restatement of our financial statements, of which $2.8 million and $11.2 million, respectively, was recovered from Archrock pursuant to the separation and distribution agreement.

Restructuring and other charges
In the second quarter of 2015, we announced a cost reduction plan primarily focused on workforce reductions and the reorganization of certain facilities. These actions were in response to unfavorable market conditions in North America combined with the impact of lower international activity due to customer budget cuts driven by lower oil prices. As a result of this plan, during the year ended December 31, 2017, we incurred restructuring and other charges of $2.6 million primarily related to employee termination benefits. During the year ended December 31, 2016, we incurred $18.1 million of restructuring and other charges as a result of this plan, which primarily related to $14.5 million of employee termination benefits and a $2.9 million charge for the exit of a corporate building under an operating lease. Additionally, during the year ended December 31, 2017, we incurred $0.6 million of costs associated with the Spin-off primarily related to retention awards to certain employees. During the year ended December 31, 2016, we incurred $3.9 million of costs associated with the Spin-off, of which $3.1 million related to retention awards to certain employees. The charges incurred in conjunction with the cost reduction plan and Spin-off are included in restructuring and other charges in our statements of operations. We have substantially completed restructuring activities related to the Spin-off and cost reduction plan. See Note 15 to the Financial Statements for further discussion of these charges.

Interest expense
The increase in interest expense during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to an increase in the effective interest rate on our debt and interest expense of $2.4 million recorded for the settling of non-income-based tax debt during 2017 in connection with two Brazilian tax programs we entered into in 2017, partially offset by an increase in capitalized interest resulting from increased construction activities and a lower average balance of long-term debt and letters of credit outstanding. As discussed in Note 11 to the Financial Statements, the proceeds received in April 2017 from the issuance of our 8.125% senior secured notes due 2025 (the “2017 Notes”) were used to repay all of the borrowings outstanding under the term loan facility and revolving credit facility. For further discussion on the Brazilian tax programs, see Note 16 to the Financial Statements.

Equity in income of non-consolidated affiliates
In March 2012, our Venezuelan joint ventures sold their assets to PDVSA Gas. We received installment payments, including an annual charge of $10.4 million during the year ended December 31, 2016. As of December 31, 2017, the remaining principal amount due to us was approximately $4 million. Payments we receive from the sale are recognized as equity in income of non-consolidated affiliates in our statements of operations in the periods such payments are received.

Other (income) expense, net
The change in other (income) expense, net, was primarily due to foreign currency losses of $0.7 million during the year ended December 31, 2017 compared to foreign currency gains, net of foreign currency derivatives, of $5.8 million during the year ended December 31, 2016. Foreign currency gains and losses included translation gains of $0.5 million during the year ended December 31, 2017 compared to translation gains, net of foreign currency derivatives, of $8.6 million during the year ended December 31, 2016 related to the currency remeasurement of our foreign subsidiaries’ non-functional currency denominated intercompany obligations. The change in other (income) expense, net, was also due to penalties of $1.8 million incurred for the settling of non-income-based tax debt during the year ended December 31, 2017 in connection with the two Brazilian tax programs discussed above and a decrease of $0.5 million in gain on sale of property, plant and equipment.


41


Income Taxes
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2017
 
2016
 
Change
 
% change
Provision for income taxes
$
22,695

 
$
124,242

 
$
(101,547
)
 
(82
)%
Effective tax rate
134.8
%
 
(261.4
)%
 
396.2
%
 
(151.6
)%

For the year ended December 31, 2017, our provision for income tax and effective tax rate of 134.8% was positively impacted by the reversal of previously recorded valuation allowances of $5.6 million against our U.S. AMT carryforwards due to the Tax Reform Act which provided for the cancellation of the AMT and allows for a future refund and/or credit against regular income tax carryforwards. In addition, as a result of the reduction in the U.S. corporate tax rate from 35% to 21%, we recorded a provisional estimate of $15.5 million due to the re-measurement of deferred tax assets and liabilities and recorded a provisional estimate of $10.1 million due to the transition tax on undistributed earnings. Both of these were offset by a tax benefit from the reduction of the valuation allowance previously recorded against our U.S. deferred tax assets. Our effective tax rate was negatively impacted by a $17.1 million additional valuation allowance we recorded on our net U.S. deferred tax assets because beginning in 2016, we were no longer able to support that it was more likely-than-not that we would have sufficient taxable income in the future to realize our U.S. deferred tax assets. In addition, we recorded a $3.1 million benefit for the change in tax rates due to tax legislation enacted and signed into law in 2017 in Argentina. Our income tax expense for the year ended December 31, 2017 included benefits related to the reversal of valuation allowances previously recorded against deferred tax assets of $15.2 million related to income tax loss carryforwards that were utilized under two Brazilian tax programs.

For the year ended December 31, 2016, our provision for income tax and effective tax rate of (261.4)% was adversely impacted by valuation allowances recorded against U.S. deferred tax assets and activity at our non-U.S. subsidiaries, which included valuation allowances against certain deferred tax assets, foreign currency devaluations and the settlement of a foreign audit. These negative impacts were partially offset by nontaxable Venezuelan joint venture proceeds and a net nontaxable capital contribution related to the Spin-off.

Our effective tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amounts of income we earn, or losses we incur, in those jurisdictions. It is also affected by discrete items that may occur in any given year but are not consistent from year to year. The following items had the most significant impact on the difference between our statutory U.S. federal income tax rate of 35.0% and our effective tax rate.

For the year ended December 31, 2017:
A $48.1 million reduction (285.4% reduction) resulting from the release of valuation allowances primarily recorded against certain deferred tax assets of our foreign subsidiaries and federal net operating losses and credits in the U.S.
A $44.9 million increase (266.5% increase) resulting primarily from foreign withholding taxes, negative impacts of foreign currency devaluations in Argentina, and deemed distributions to the U.S. from certain of our non-U.S. subsidiaries. The increase includes a reduction resulting from rate differences between U.S. and foreign jurisdictions.
A $15.5 million increase (92.2% increase) resulting from changes to the tax rates at which certain deferred taxes are recorded due to U.S. tax reform legislation enacted and signed into law in 2017.
An $11.2 million reduction (66.7% reduction) resulting from claiming foreign taxes as credits primarily for foreign withholding taxes. The foreign tax credits are available to offset future payments of U.S. federal income taxes.
A $10.1 million increase (59.7% increase) resulting from transition tax charges related to U.S. tax reform legislation enacted and signed into law in 2017.

For the year ended December 31, 2016:
A $124.9 million increase (262.7% reduction) resulting from valuation allowances primarily recorded against U.S. deferred tax assets and certain deferred tax assets of our subsidiary in Nigeria.
A $29.4 million increase (61.9% reduction) resulting primarily from foreign withholding taxes, negative impacts of foreign currency devaluations in Argentina and Mexico, settlement of a Nigeria tax audit and deemed distributions to the U.S. from certain of our non-U.S. subsidiaries. The increase includes a reduction resulting from rate differences between U.S. and foreign jurisdictions primarily related to income we earned in Oman and Mexico where the rates are 12.0% and 30.0%, respectively.
A $9.5 million reduction (20.0% increase) resulting from claiming foreign taxes as credits primarily for foreign withholding taxes. The foreign tax credits are available to offset future payments of U.S. federal income taxes.

42


A $3.6 million increase (7.6% reduction) resulting from unrecognized tax benefits primarily from additions based on tax positions related to 2016.
A $3.6 million reduction (7.7% increase) due to $10.4 million of nontaxable proceeds from sale of joint venture assets in Venezuela.
A $2.9 million reduction (6.1% increase) primarily due to $11.2 million of cash recovered from Archrock with respect to our restatement related charges. Payments between Archrock and us are treated as nontaxable capital contributions or distributions pursuant to the tax matters agreement.

Discontinued Operations
(dollars in thousands)
 
Years Ended December 31,
 
 
 
2017
 
2016
 
Change
 
% change
Income (loss) from discontinued operations, net of tax
$
39,736

 
$
(56,171
)
 
$
95,907

 
(171
)%

Income (loss) from discontinued operations, net of tax, includes our Venezuelan subsidiary’s operations that were expropriated in June 2009, including compensation for expropriation, and our Belleli CPE and Belleli EPC businesses.
 
Income from discontinued operations, net of tax, during the year ended December 31, 2017 compared to the year ended December 31, 2016 increased primarily due to asset impairment charges totaling $68.8 million recorded during the year ended December 31, 2016 for the planned disposition of Belleli CPE and a $42.8 million increase in income from Belleli EPC in 2017 compared to 2016 primarily due to recoveries in 2017 resulting from our release of liquidated damages by a customer in exchange for us releasing them from certain extension of time claims and the obtainment of customer approved change orders. These increases were partially offset by a $19.5 million decrease in income from our Venezuelan subsidiary. During the years ended December 31, 2017 and 2016, we received installment payments, including an annual charge, of $19.7 million and $38.8 million, respectively, from PDVSA Gas in respect to our Venezuelan subsidiary’s sale of its previously nationalized assets.

For further details on our discontinued operations, see Note 4 to the Financial Statements.

Liquidity and Capital Resources

Our unrestricted cash balance was $19.3 million at December 31, 2018 compared to $49.1 million at December 31, 2017. Working capital decreased to $108.7 million at December 31, 2018 from $134.0 million at December 31, 2017. The decrease in working capital was primarily due to increases in contract liabilities and accounts payable and decreases in accounts receivable and current assets held for sale, partially offset by increases in contract assets and inventory. The increase in contract liabilities was primarily driven by the timing of milestone billings on a product sales project in the Middle East and Africa region. The increases in inventory, contract assets and accounts payable were primarily driven by higher product sales activity in the North America region. The decrease in accounts receivable was driven by the timing of payments received from customers during the current year period. The decrease in current assets held for sale was driven by the sale of our PEQ assets in June 2018 as discussed in further detail in Note 8 to the Financial Statements.

Our cash flows from operating, investing and financing activities, as reflected in the statements of cash flows, are summarized in the following table (in thousands):
 
Years Ended December 31,
 
2018
 
2017
Net cash provided by (used in) continuing operations:
 
 
 
Operating activities
$
153,296

 
$
150,420

Investing activities
(207,578
)
 
(121,913
)
Financing activities
6,897

 
(32,154
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(3,841
)
 
(792
)
Discontinued operations
21,013

 
17,781

Net change in cash, cash equivalents and restricted cash
$
(30,213
)
 
$
13,342



43


Operating Activities.  Net cash provided by operating activities during the year ended December 31, 2018 compared to the year ended December 31, 2017 remained relatively flat primarily due to improved gross margins in the current year period for our product sales segment and a decrease in income taxes paid in the current year period, offset by lower current period decreases in working capital. Working capital cash changes during the year ended December 31, 2018 included an increase of $62.9 million in contract liabilities, an increase of $59.7 million in inventory and an increase of $34.6 million in contract assets. Working capital cash changes during the year ended December 31, 2017 included an increase of $62.0 million in account payable and other liabilities, an increase of $65.3 million in accounts receivable and a decrease of $40.9 million in costs and estimated earnings versus billings on uncompleted contracts.

Investing Activities.  The increase in net cash used in investing activities during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily attributable to an $83.4 million increase in capital expenditures. The increase in capital expenditures was primarily driven by an increase in growth capital expenditures on contract operations services projects in the Middle East and Africa region and Latin America region.

Financing Activities.  The decrease in net cash used in financing activities during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily attributable to a $26.0 million decrease in cash transferred to Archrock pursuant to the separation and distribution agreement and an increase in net borrowings of $9.9 million on our long-term debt. The transfers of cash to Archrock during the years ended December 31, 2018 and 2017 were required under the separation and distribution agreement upon our receipt of payments from PDVSA Gas relating to the sale of our previously nationalized assets and our occurrence of a qualified capital raise in 2017 that required a payment of $25.0 million to Archrock.

Discontinued Operations.  The increase in net cash provided by discontinued operations during the year ended December 31, 2018 compared to year ended December 31, 2017 was primarily attributable to working capital changes related to our Belleli EPC business. Net cash provided by discontinued operations included proceeds received from the sale of our Venezuelan subsidiary’s assets to PDVSA Gas of $19.8 million and $19.7 million during the years ended December 31, 2018 and 2017, respectively.

Capital Requirements.  Our contract operations business is capital intensive, requiring significant investment to maintain and upgrade existing operations. Our capital spending is primarily dependent on the demand for our contract operations services and the availability of the type of equipment required for us to render those contract operations services to our customers. Our capital requirements have consisted primarily of, and we anticipate will continue to consist of, the following:
growth capital expenditures, which are made to expand or to replace partially or fully depreciated assets or to expand the operating capacity or revenue generating capabilities of existing or new assets, whether through construction, acquisition or modification; and
maintenance capital expenditures, which are made to maintain the existing operating capacity of our assets and related cash flows further extending the useful lives of the assets.

The majority of our growth capital expenditures are related to installation costs on contract operations services projects and acquisition costs of new compressor units and processing and treating equipment that we add to our contract operations fleet. In addition, growth capital expenditures can include the upgrading of major components on an existing compressor unit where the current configuration of the compressor unit is no longer in demand and the compressor unit is not likely to return to an operating status without the capital expenditures. These latter expenditures substantially modify the operating parameters of the compressor unit such that it can be used in applications for which it previously was not suited. Maintenance capital expenditures are related to major overhauls of significant components of a compressor unit, such as the engine, compressor and cooler, that return the components to a “like new” condition, but do not modify the applications for which the compressor unit was designed.

Growth capital expenditures were $186.2 million, $104.9 million and $53.0 million during the years ended December 31, 2018, 2017 and 2016, respectively. The increase in growth capital expenditures during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to an increase in installation expenditures on a contract operations services project in Oman and an increase in compression expenditures on a contract operations services contract in Bolivia during 2018. The increase in growth capital expenditures during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to an increase in installation expenditures on contract operations services projects in Oman during 2017.


44


Maintenance capital expenditures were $6.6 million, $15.7 million and $14.4 million during the years ended December 31, 2018, 2017 and 2016, respectively. The decrease in maintenance capital expenditures during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily driven by decreased overhaul activities as a result of delayed discretionary spending. The increase in maintenance capital expenditures during the year ended December 31, 2017 compared to the year ended December 31, 2016 was primarily due to increased overhaul activities. We intend to grow our business both organically and through third-party acquisitions. If we are successful in growing our business in the future, we would expect our maintenance capital expenditures to increase over the long term.

We generally invest funds necessary to manufacture contract operations fleet additions when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new equipment expenditure is expected to generate economic returns over its expected useful life that exceeds our targeted return on capital. We currently plan to spend approximately $205 million to $215 million in capital expenditures during 2019, including (1) approximately $170 million on contract operations growth capital expenditures and (2) approximately $35 million to $45 million on equipment maintenance capital related to our contract operations business and other capital expenditures.
 
Long-Term Debt. On October 9, 2018, we and EESLP entered into a Second Amended and Restated Credit Agreement (the “Amended Credit Agreement”), which among other things, increased the borrowing capacity under our revolving credit facility from $680.0 million to $700.0 million. The Amended Credit Agreement also extended the maturity date of our revolving credit facility from November 2020 to October 2023.

During the years ended December 31, 2018 and 2017, the average daily borrowings of long-term debt were $428.6 million and $374.3 million respectively. The weighted average annual interest rate on outstanding borrowings under our revolving credit facility at December 31, 2018 was 4.3%. As of December 31, 2017, there were no outstanding borrowings under the revolving credit facility.

As of December 31, 2018, we had $56.7 million in outstanding letters of credit under our revolving credit facility and, taking into account guarantees through outstanding letters of credit, we had undrawn capacity of $608.3 million under our revolving credit facility. Our Amended Credit Agreement limits our senior secured leverage ratio (as defined in the Amended Credit Agreement) on the last day of the fiscal quarter to no greater than 2.75 to 1.0. As a result of this limitation, $578.4 million of the $608.3 million of undrawn capacity under our revolving credit facility was available for additional borrowings as of December 31, 2018.

The Amended Credit Agreement contains various covenants with which we, EESLP and our respective restricted subsidiaries must comply, including, but not limited to, limitations on the incurrence of indebtedness, investments, liens on assets, repurchasing equity, making distributions, transactions with affiliates, mergers, consolidations, dispositions of assets and other provisions customary in similar types of agreements. We are required to maintain, on a consolidated basis, a minimum interest coverage ratio (as defined in the Amended Credit Agreement) of 2.25 to 1.00; a maximum total leverage ratio (as defined in the Amended Credit Agreement) of 4.50 to 1.00; and a maximum senior secured leverage ratio (as defined in the Amended Credit Agreement) of 2.75 to 1.00. As of December 31, 2018, Exterran Corporation maintained a 9.3 to 1.0 interest coverage ratio, a 1.8 to 1.0 total leverage ratio and a 0.2 to 1.0 senior secured leverage ratio. As of December 31, 2018, we were in compliance with all financial covenants under the Amended Credit Agreement.

In April 2017, our 100% owned subsidiaries EESLP and EES Finance Corp. issued the 2017 Notes, which consists of $375.0 million aggregate principal amount of senior unsecured notes. The 2017 Notes are guaranteed by us on a senior unsecured basis.

Prior to May 1, 2020, we may redeem all or a portion of the 2017 Notes at a redemption price equal to the sum of (i) the principal amount thereof, and (ii) a make-whole premium at the redemption date, plus accrued and unpaid interest, if any, to the redemption date. In addition, we may redeem up to 35% of the aggregate principal amount of the 2017 Notes prior to May 1, 2020 with the net proceeds of one or more equity offerings at a redemption price of 108.125% of the principal amount of the 2017 Notes, plus any accrued and unpaid interest to the date of redemption, if at least 65% of the aggregate principal amount of the 2017 Notes issued under the indenture remains outstanding after such redemption and the redemption occurs within 180 days of the date of the closing of such equity offering. On or after May 1, 2020, we may redeem all or a portion of the 2017 Notes at redemption prices (expressed as percentages of principal amount) equal to 106.094% for the twelve-month period beginning on May 1, 2020, 104.063% for the twelve-month period beginning on May 1, 2021, 102.031% for the twelve-month period beginning on May 1, 2022 and 100.000% for the twelve-month period beginning on May 1, 2023 and at any time thereafter, plus accrued and unpaid interest, if any, to the applicable redemption date of the 2017 Notes.


45


We may from time to time seek to retire, extend or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such extensions, repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

Historically, we have financed capital expenditures with a combination of net cash provided by operating and financing activities. Our ability to access the capital markets may be restricted at the time when we would like, or need, to do so, which could have an adverse impact on our ability to maintain our operations and to grow. If any of our lenders become unable to perform their obligations under the Amended Credit Agreement, our borrowing capacity under our revolving credit facility could be reduced. Inability to borrow additional amounts under our revolving credit facility could limit our ability to fund our future growth and operations. Based on current market conditions, we expect that net cash provided by operating activities and borrowings under our revolving credit facility will be sufficient to finance our operating expenditures, capital expenditures and other contractual cash obligations, including our debt obligations. However, if net cash provided by operating activities and borrowings under our revolving credit facility are not sufficient, we may seek additional debt or equity financing.

Unrestricted Cash. Of our $19.3 million unrestricted cash balance at December 31, 2018, $18.7 million was held by our non-U.S. subsidiaries. In the event of a distribution of earnings to the U.S. in the form of dividends, we may be subject to foreign withholding taxes. We do not believe that the cash held by our non-U.S. subsidiaries has an adverse impact on our liquidity because we expect that the cash we generate in the U.S., the available borrowing capacity under our revolving credit facility and the repayment of intercompany liabilities from our non-U.S. subsidiaries will be sufficient to fund the cash needs of our U.S. operations for the foreseeable future.

Dividends.  We do not currently anticipate paying cash dividends on our common stock. We currently intend to retain our future earnings to support the growth and development of our business. The declaration of any future cash dividends and, if declared, the amount of any such dividends, will be subject to our financial condition, earnings, capital requirements, financial covenants, applicable law and other factors our board of directors deems relevant.

Contractual Obligations.  The following table summarizes our cash contractual obligations as of December 31, 2018 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):
 
Total
 
2019
 
2020-2021
 
2022-2023
 
Thereafter
Debt:(1)
 
 
 
 
 
 
 
 
 
Revolving credit facility due October 2023
$
35,000

 
$

 
$

 
$
35,000

 
$

8.125% senior notes due May 2025 (2)
375,000

 

 

 

 
375,000

Other
687

 
449

 
238

 

 

Total debt
410,687

 
449

 
238

 
35,000

 
375,000

Interest on debt
215,030

 
34,578

 
69,156

 
68,222

 
43,074

Purchase commitments
483,074

 
480,422

 
2,652

 

 

Facilities and other operating leases
34,997

 
6,076

 
10,512

 
6,794

 
11,615

Total contractual obligations
$
1,143,788

 
$
521,525

 
$
82,558

 
$
110,016

 
$
429,689

 
(1) 
For more information on our debt, see Note 11 to the Financial Statements.
(2) 
Amounts represent the full face value of the 2017 Notes and do not include unamortized debt financing costs of $6.4 million as of December 31, 2018.

As of December 31, 2018, $27.8 million of unrecognized tax benefits (including discontinued operations) have been recorded as liabilities in accordance with the accounting standard for income taxes related to uncertain tax positions, and we are uncertain as to if or when such amounts may be settled. Related to these unrecognized tax benefits, we have also recorded a liability for potential penalties and interest (including discontinued operations) of $4.7 million.


46


Indemnifications. In conjunction with, and effective as of the completion of, the Spin-off, we entered into the separation and distribution agreement with Archrock, which governs, among other things, the treatment between Archrock and us relating to certain aspects of indemnification, insurance, confidentiality and cooperation. Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of Archrock’s business with Archrock. Pursuant to the agreement, we and Archrock will generally release the other party from all claims arising prior to the Spin-off that relate to the other party’s business, subject to certain exceptions. Additionally, in conjunction with, and effective as of the completion of, the Spin-off, we entered into the tax matters agreement with Archrock. Under the tax matters agreement and subject to certain exceptions, we are generally liable for, and indemnify Archrock against, taxes attributable to our business, and Archrock is generally liable for, and indemnify us against, all taxes attributable to its business. We are generally liable for, and indemnify Archrock against, 50% of certain taxes that are not clearly attributable to our business or Archrock’s business. Any payment made by us to Archrock, or by Archrock to us, is treated by all parties for tax purposes as a nontaxable distribution or capital contribution, respectively, made immediately prior to the Spin-off.

Off-Balance Sheet Arrangements

We have no material off-balance sheet arrangements.

Effects of Inflation

Our revenues and results of operations have not been materially impacted by inflation in the past three fiscal years.

Critical Accounting Policies, Practices and Estimates

This discussion and analysis of our financial condition and results of operations is based upon the Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and accounting policies, including those related to bad debt, inventories, accrued demobilization costs, fixed assets, intangible assets, income taxes, revenue recognition, contingencies and litigation. We base our estimates on historical experience and on other assumptions that we believe are reasonable under the circumstances. The results of this process form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences can be material to our financial condition, results of operations and liquidity. See Note 2 to our Financial Statement for a summary of significant accounting policies.

Allowances and Reserves

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The determination of the collectability of amounts due from our customers requires us to use estimates and make judgments regarding future events and trends, including monitoring our customers’ payment history and current creditworthiness to determine that collectibility is reasonably assured, as well as consideration of the overall business climate in which our customers operate. Inherently, these uncertainties require us to make judgments and estimates regarding our customers’ ability to pay amounts due to us in order to determine the appropriate amount of valuation allowances required for doubtful accounts. We review the adequacy of our allowance for doubtful accounts quarterly. We determine the allowance needed based on historical write-off experience and by evaluating significant balances aged greater than 90 days individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. During the years ended December 31, 2018, 2017 and 2016, we recorded bad debt expense of $0.1 million, $0.9 million and $3.0 million, respectively. Our allowance for doubtful accounts was approximately 2% of our gross accounts receivable balance at December 31, 2018 and 2017.

Inventory is a significant component of current assets and is stated at the lower of cost and net realizable value. This requires us to record provisions and maintain reserves for obsolete and slow moving inventory. To determine these reserve amounts, we regularly review inventory quantities on hand and compare them to historical demand and management estimates of market conditions and production requirements. These estimates and forecasts inherently include uncertainties and require us to make judgments regarding potential outcomes. During 2018, 2017 and 2016, we recorded $0.1 million, $1.3 million and $0.8 million, respectively, in inventory write-downs and reserves for inventory which was obsolete or slow moving. Significant or unanticipated changes to our estimates and forecasts could impact the amount and timing of any additional provisions for obsolete or slow moving inventory that may be required. Our reserve for obsolete and slow moving inventory was approximately 10% and 11% of our gross raw materials inventory balance at December 31, 2018 and 2017, respectively.

47



Accrued Demobilization Costs

The majority of our contract operations services contracts contain contractual requirements for us to perform demobilization activities at the end of the contract, with the scope of those activities varying by contract. Demobilization activities typically include, among other requirements, civil work and the removal of our equipment and installation from the customer’s site. Demobilization activities represent costs to fulfill obligations under our contracts and are not considered distinct within the context of our contract operations services contracts. Accrued demobilization costs are recorded, if applicable, at the time we become contractually obligated to perform these activities, which generally occurs upon our completion of the installation and commissioning of our equipment at the customer’s site. We record accrued demobilization costs as a liability and an equivalent demobilization asset as a capitalized fulfillment cost. As of December 31, 2018, we had current and long-term accrued demobilization costs liability balances of $14.8 million and $19.5 million, respectively. Accrued demobilization costs are subsequently increased by interest accretion throughout the expected term of the contract. As of December 31, 2018, we had capitalized fulfillment costs relating to demobilization assets of $6.6 million. Demobilization assets are amortized to cost of sales on a straight-line basis over the expected term of the contract. Any difference between the actual costs realized for the demobilization activities and the estimated liability established are recognized in cost of sales in our statement of operations.

Accrued demobilization costs recorded represent the fair value of the estimated cost for future demobilization activities. The initial obligation is measured at its estimated fair value using various judgments and assumptions. Fair value is calculated using an expected present value technique that is based on assumptions of market participants and estimated demobilization costs in current period dollars that are inflated to the anticipated demobilization date and then discounted back to the date the demobilization obligations are expected to be incurred. Changes in assumptions and estimates included within the calculations of the value of the accrued demobilization costs could result in significantly different results than those identified and recorded in our financial statements. In future periods, we may also make adjustments to accrued demobilization costs as a result of the availability of new information, contract amendments, technology changes, changes in labor costs and other factors.

Accrued demobilization costs are based on a number of assumptions requiring professional judgment. These include estimates for: (1) expected future cash flows related to contractual obligations; (2) anticipated timing of the expected cash flows; (3) our credit-adjusted risk free rate that considers our estimated credit rating; (4) the market risk premiums; and (5) relevant inflation factors. If the expected future cash flows relating to our estimated accrued demobilization costs had been higher or lower by 10% in 2018, accrued demobilization costs would have decreased or increased by approximately $3.4 million at December 31, 2018. We are unable to predict the type of revisions to these assumptions that will be required in future periods due to the availability of additional information, contract amendments, technology changes, the price of labor costs and other factors.

Depreciation

Property, plant and equipment is carried at cost. Depreciation for financial reporting purposes is computed on a straight-line basis using estimated useful lives and salvage values, including idle assets in our active fleet. The assumptions and judgments we use in determining the estimated useful lives and salvage values of our property, plant and equipment reflect both historical experience and expectations regarding future use of our assets. We periodically analyze our estimates of useful lives of our property, plant and equipment to determine if the depreciable periods and salvage values continue to be appropriate. The use of different estimates, assumptions and judgments in the establishment of property, plant and equipment accounting policies, especially those involving their useful lives, would likely result in significantly different net book values of our assets and results of operations. In the fourth quarter of 2017, we evaluated the estimated useful lives and salvage values of our property, plant and equipment. As a result of this evaluation, we changed the estimate of useful lives and salvage values for our compression equipment from a maximum useful life of 30 years to 23 years and a maximum salvage value of 20% to 15% based on expected future use. During the years ended December 31, 2018 and 2017, we recorded an increase in depreciation expense of $8.9 million and $1.2 million, respectively, as a result of these changes in useful lives and salvage values.


48


Long-Lived Assets

We review long-lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressor units from our active fleet, indicate that the carrying amount of an asset may not be recoverable. Compressor units in our active fleet that were idle as of December 31, 2018 comprise a net book value of approximately $83.1 million. The determination that the carrying amount of an asset may not be recoverable requires us to make judgments regarding long-term forecasts of future revenue and costs related to the assets subject to review. For idle compression units that are removed from the active fleet and that will be sold to third parties as working compression units, significant assumptions include forecasted sale prices based on future market conditions and demand, forecasted costs to maintain the assets until sold and the forecasted length of time necessary to sell the assets. These forecasts are uncertain as they require significant assumptions about future market conditions. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Given the nature of these evaluations and their application to specific assets and specific times, it is not possible to reasonably quantify the impact of changes in these assumptions. An impairment loss exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. When necessary, an impairment loss is recognized and represents the excess of the asset’s carrying value as compared to its estimated fair value and is charged to the period in which the impairment occurred.

Income Taxes

Our income tax provision, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. We operate in approximately 25 countries and, as a result, we and our subsidiaries file consolidated and separate income tax returns in the U.S. federal jurisdiction and in numerous state and foreign jurisdictions. In addition, certain of our operations were historically included in Archrock’s consolidated income tax returns in the U.S. federal and state jurisdictions. Our tax provision for periods prior to the Spin-off was determined on a separate return, stand-alone basis. Differences between the separate return method utilized and Archrock’s U.S. income tax returns and cash flows attributable to income taxes for our U.S. operations were recognized as distributions to, or contributions from, parent within parent equity. Significant judgments and estimates are required in determining our consolidated income tax provision.

Deferred income taxes arise from temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and changes in accounting policies and incorporate assumptions including the amount of future U.S. federal, state and foreign pretax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax-planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income (loss).

The accounting standard for income taxes provides that a tax benefit from an uncertain tax position is only recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. In addition, guidance is provided on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adjust reserves for unrecognized tax benefits when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax provision in the period in which new information is available.

We consider the earnings of substantially all of our subsidiaries to be indefinitely reinvested, and accordingly, we have not provided for taxes on these unremitted earnings. If we were to make a distribution from the unremitted earnings of these subsidiaries, we could be subject to taxes payable to various jurisdictions. If our expectations were to change regarding future tax consequences, we may be required to record additional deferred taxes that could have a material effect on our consolidated statement of financial position, results of operations or cash flows.



49


Revenue Recognition — Product Sales Recognized Over Time

In our product sales segment, we recognize revenue from the sale of compression equipment and processing and treating equipment over time based on the proportion of labor hours expended to the total labor hours expected to complete the contract performance obligation when the applicable criteria are met. During the year ended December 31, 2018, approximately 98% of our total product sales revenues were recognized over time. This calculation requires management to estimate the number of total labor hours required for each project and to estimate the profit expected on the project. The recognition of revenue over time based on the proportion of labor hours expended to the total labor hours expected to complete depends largely on our ability to make reasonable dependable estimates related to the extent of progress toward completion of the contract, contract revenues and contract costs. Recognized revenues and profits are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known using the cumulative catch-up method. Due to the nature of some of our contracts, developing the estimates of costs often requires significant judgment.

Factors that must be considered in estimating the work to be completed and ultimate profit include labor productivity and availability, the nature and complexity of work to be performed, the impact of change orders, availability of raw materials and the impact of delayed performance. Although we continually strive to accurately estimate our progress toward completion and profitability, adjustments to overall contract revenue and contract costs could be significant in future periods due to several factors including but not limited to, settlement of claims against customers, supplier claims by or against us, customer change orders, changes in cost estimates, changes in project contingencies and settlement of customer claims against us, such as liquidated damage claims. If the aggregate combined cost estimates for uncompleted contracts that are recognized over time based on the proportion of labor hours expended to the total labor hours expected to complete in our product sales business had been higher or lower by 5% in 2018, our income before income taxes would have decreased or increased by approximately $11.3 million.

Contingencies and Litigation

We are substantially self-insured for workers’ compensation, employer’s liability, property, auto liability, general liability and employee group health claims in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses up to deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. We review these estimates quarterly and believe such accruals to be adequate. However, insurance liabilities are difficult to estimate due to unknown factors, including the severity of an injury, the determination of our liability in proportion to other parties, the timeliness of reporting of occurrences, ongoing treatment or loss mitigation, general trends in litigation recovery outcomes and the effectiveness of safety and risk management programs. Therefore, if our actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period in which the difference becomes known. As of December 31, 2018 and 2017, we had recorded approximately $1.1 million and $1.3 million, respectively, in insurance claim reserves.

In the ordinary course of business, we are involved in various pending or threatened legal actions. While we are unable to predict the ultimate outcome of these actions, the accounting standard for contingencies requires management to make judgments about future events that are inherently uncertain. We are required to record (and have recorded) a loss during any period in which we believe a loss contingency is probable and can be reasonably estimated. In making determinations of likely outcomes of pending or threatened legal matters, we consider the evaluation of counsel knowledgeable about each matter.

We regularly assess and, if required, establish accruals for income tax as well as non-income-based tax contingencies pursuant to the applicable accounting standards that could result from assessments of additional tax by taxing jurisdictions in countries where we operate. Tax contingencies are subject to a significant amount of judgment and are reviewed and adjusted on a quarterly basis in light of changing facts and circumstances considering the outcome expected by management. As of December 31, 2018 and 2017, we had recorded approximately $37.6 million and $27.6 million, respectively, of accruals for tax contingencies (including penalties and interest and discontinued operations). Of these amounts, $32.5 million and $24.8 million are accrued for income taxes as of December 31, 2018 and 2017, respectively, and $5.1 million and $2.8 million are accrued for non-income-based taxes as of December 31, 2018 and 2017, respectively. Furthermore, as of December 31, 2018