Archrock, Inc. (AROC) FY 2023 MD&A

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 2023 Form 10–K. The following discussion includes forward–looking statements that involve certain risks and uncertainties. See “Forward–Looking Statements” and Part I, Item 1A. “Risk Factors” in this 2023 Form 10–K.

This section primarily discusses 2023 and 2022 items and comparisons between these years. For a discussion of changes from 2021 to 2022 and other financial information related to 2021, refer to Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10–K for the year ended December 31, 2022 filed with the SEC on February 23, 2023.

Overview

We are an energy infrastructure company with a pure–play focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the oil and natural gas industry throughout the U.S., in terms of total compression fleet horsepower, and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. Our business supports a must–run service that is essential to the production, processing, transportation and storage of natural gas. The natural gas that we help transport satisfies demand from electricity generation, heating and cooking and the industrial and manufacturing sectors. Our geographic diversity, technically experienced personnel and large fleet of natural gas compression equipment enable us to provide reliable contract operations services to our customers.

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We operate in two business segments:

• Contract Operations. Our contract operations business is comprised of our owned fleet of natural gas compression equipment that we use to provide compression operations services to our customers.

• Aftermarket Services. Our aftermarket services business provides a full range of services to support the compression needs of our customers that own compression equipment, including operations, maintenance, overhaul and reconfiguration services and sales of parts and components.

Significant 2023 Transactions

In November 2023, we agreed to serve as the lead investor in a series A financing round for Ionada, a global carbon capture technology company committed to reducing GHG emissions and creating a sustainable future. Ionada has developed a post-combustion carbon capture solution to reduce carbon dioxide emissions from various small to mid-sized industrial emitters in the energy, marine and e-fuels industries, among others. See Note 12 (“Investments in Unconsolidated Affiliates”) to our Financial Statements for additional information about this investment.

Trends and Outlook

The key driver of our business is the production of U.S. oil and natural gas. Approximately 75% of our operating fleet is deployed for midstream natural gas gathering applications, with the remaining fleet being used in gas lift applications to enhance oil production.  As our business is so closely aligned with production and is typically less directly impacted by commodity prices, we are not exposed to the volatility often faced in shorter–cycle oil field service businesses.

Domestic natural gas production generally occurs in either basins where natural gas is produced alongside oil, also known as “associated” gas, such as the Permian and Delaware Basins, the Eagle Ford and the Mid–Continent or in natural gas basins, such as the Marcellus, Utica and Haynesville Shales. Significant investment in domestic exploration and production and midstream infrastructure across the energy industry has been made over much of the past decade, particularly in the low–cost basins characterized by oil and associated natural gas production. The development of these basins producing both commodities has created additional incremental demand for natural gas compression over the recent past as it is a critical method to transport associated gas volumes or enhance oil production through gas lift.

Current Trends

According to the EIA Outlook, average U.S. oil and dry natural gas and production were as follows:

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During 2023, U.S. natural gas and oil production grew to record levels, resulting in strong demand for our compression services and we increased our investment in new fleet units. Our contract operations revenue and total operating horsepower increased 19% and 5%, respectively in 2023. Similar increases in demand in 2023 were seen in our aftermarket services business, where we experienced an increase of 8% in aftermarket services revenue.

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Outlook

The EIA Outlook forecasts the following year–over–year changes:

The EIA Outlook expects natural gas production to continue to increase to all-time highs in 2024 and 2025. Natural gas consumption is also expected to increase, reflecting consistent usage of natural gas in the electric power generation and residential sectors, as well as increased LNG exports and exports of natural gas via pipeline to Mexico.

We believe the outlook for the energy industry in the U.S. is positive. While we anticipate that the combination of commodity prices and demand may likely have a positive impact on activity levels in both the upstream and midstream sectors, we cannot predict the ultimate magnitude of that impact on our business and expect it to be varied across our operations, depending on the region, customer, nature of our services, contract term and other factors. However, we continue to believe that overall the long–term demand for our compression services will continue given the necessity of compression in facilitating the transportation and processing of natural gas.

Regarding our aftermarket services business, the base of owned compression in the U.S. has increased over the past several years, which we believe will help sustain our aftermarket services business over the long term.

Key Challenges and Uncertainties

In addition to general market conditions in the oil and natural gas industry and competition in the natural gas compression industry, we believe the following represent the key challenges and uncertainties we will face in the future.

Capital Requirements and the Availability of External Sources of Capital. We have funded a significant portion of our capital expenditures and acquisitions through borrowings under our Credit Facility and have issued a substantial amount of debt, which could limit our ability to fund future planned capital expenditures. Current conditions could limit our ability to access the debt and equity markets to raise capital on affordable terms in 2024 and beyond. If we are not successful in raising capital within the time period required or at all, we may not be able to fund these capital expenditures, which could impair our ability to grow or maintain our business.

Cost Management. In order to improve our operations and further reduce operating expenses, we are investing significant resources into a process and technology transformation project that has, among other things, replaced our existing ERP, supply chain and inventory management systems and expanded the remote monitoring capabilities of our compression fleet. Cost management continues to be challenging, however, and there is no guarantee that our efforts will result in a reduction in our operating expenses. Natural gas production growth and resulting demand for our services could cause us to experience increased operating expenses as we hire employees and incur additional expenses needed to support the rebound in market demand.

Further, we depend on suppliers for the materials, parts, equipment and lube oil necessary to our operations, which exposes us to volatility in prices. Significant price increases for these inputs could adversely affect our operating profits.  Supply chain disruptions could also adversely affect our ability to obtain, or increase the cost of, such items. While we generally attempt to mitigate the impact of increased prices through strategic purchasing decisions, diversification of our supplier base, where possible, and the passing along of increased costs to customers, there may be a time delay between the increased commodity prices and the ability to increase the price of our services.

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Labor. We believe that our ability to hire, train and retain qualified personnel will continue to be important. Although we have been able to historically satisfy our personnel needs, retaining employees in our industry continues to be a challenge. Our ability to grow and to continue our current level of service to our customers will depend in part on our success in hiring, training and retaining our employees. Further, the cost of labor has increased and may continue to increase in the future with increases in demand, which will require us to incur additional costs.

Demand for natural gas-powered compression. Demand for our services is dependent on the demand for natural gas in the markets we serve. Although the EIA currently forecasts natural gas demand will grow through 2050, technological advances and accelerated adoption of renewable sources of energy could reduce demand for natural gas in our markets and have an adverse effect on our business. In addition, increased focus of our customers on reducing emissions from, or the use of, combustion engines in compression could increase demand for electric motor-driven compressors or require us to make modifications to our existing natural gas-powered units.

Operating Highlights

(1) Defined as idle and operating horsepower. Includes new compressors completed by third party manufacturers that have been delivered to us.

(2) Defined as horsepower that is operating under contract and horsepower that is idle but under contract and generating revenue such as standby revenue.

Non–GAAP Financial Measures

Management uses a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include the non–GAAP financial measure of gross margin.

We define gross margin as total revenue less cost of sales (excluding depreciation and amortization). 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), 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 SG&A activities, our financing methods and income taxes. In addition, depreciation and amortization may not accurately reflect the costs required to maintain and replenish the operational usage of our assets and therefore may not portray the costs of current operating activity. As an indicator of our operating performance, gross margin should not be considered an alternative to, or more meaningful than, net income (loss) as determined in accordance with GAAP. Our gross margin may not be comparable to a similarly–titled measure of other entities because other entities may not calculate gross margin in the same manner.

Gross margin has certain material limitations associated with its use as compared to net income (loss). These limitations are primarily due to the exclusion of SG&A, depreciation and amortization, impairments, restructuring charges, interest expense, debt extinguishment loss, gain on sale of assets, net, other (income) expense, net, and provision for (benefit from) income taxes. 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 is necessary to support our operations and required corporate activities. To compensate for these limitations, management uses this non–GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.

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The reconciliation of net income to gross margin is as follows:

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RESULTS OF OPERATIONS

Summary of Results

Revenue was $990.3 million and $845.6 million during the years ended December 31, 2023 and 2022, respectively. The increase in revenue was due to increased revenue from both our contract operations business and aftermarket services business. See “Contract Operations” and “Aftermarket Services” below for further details.

Net income was $105.0 million and $44.3 million during the years ended December 31, 2023 and 2022, respectively. The increase was primarily driven by a higher gross margin from both our contract operations business and aftermarket services business and decreases in long-lived asset impairment expense and SG&A. These changes were partially offset by a decrease in the gain on sale of assets and the unrealized change in fair value of our investment in an unconsolidated affiliate and increases in our provision for income taxes, interest expense, depreciation and amortization and restructuring charges.

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Year Ended December 31, 2023 Compared to Year Ended December 31, 2022

Contract Operations

(1) Defined as gross margin divided by revenue.

Revenue in our contract operations business increased primarily due to higher rates for contract compression in response to market conditions and an increase in average operating horsepower, partially offset by the impact of strategic dispositions of horsepower in 2022.

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The increase in cost of sales was primarily due to a $10.8 million increase in parts expense as a result of an increase in maintenance activities and a $1.9 million increase in lube oil expenses which were both driven by higher pricing throughout our supply chain, as well as increased volumes associated with unit redeployment as customer activity accelerated. The increase in cost of sales was also due to an increase of $8.1 million in total employee compensation expense. Further, cost of sales for the year ended December 31, 2023 includes an increase of $9.1 million for sales tax as a result of a change in tax compliance for sales tax associated with contract operations cost of sales. Prior to 2023, contract operations sales tax amounts were recognized in SG&A. Partially offsetting these cost increases was the decrease in expense attributable to the horsepower sold in 2022.

Gross margin percentage increased primarily due to an increase in revenue which exceeded the increase in cost of sales.

Aftermarket Services

Revenue in our aftermarket services business increased primarily due to higher service activities and parts sales from the continuation of the market recovery which began in the prior year and continues to drive an increase in customer demand.

Gross margin increased in our aftermarket services business as a result of increased revenues which exceeded the increase in cost of sales due to differences in the scope, timing and type of activities performed. The increase in cost of sales resulted from an increase in cost of service activities of $5.0 million attributable to increased labor and parts costs, which was partially offset by a reduction in the use of parts and labor from third party providers, which resulted in savings of $3.2 million.

Costs and Expenses

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Selling, general and administrative. The decrease in SG&A was primarily due to a decrease of $8.0 million for sales tax as a result of a change in tax compliance for sales tax associated with contract operations cost of sales. Beginning in 2023, contract operations sales tax amounts are recognized in contract operations cost of sales. Further, SG&A for the year ended December 31, 2023 includes a $2.2 million decrease in professional expense and a $1.3 million decrease in accrued expenses, partially offset by a $5.4 million increase in long-term performance-based incentive compensation expense, a $4.0 million increase in short-term incentive expense and a $1.6 million increase in software and maintenance expense.

Depreciation and amortization. The increase in depreciation and amortization expense was primarily due to an increase in depreciation expense associated with fixed asset additions and accelerated depreciation associated with certain assets. These increases were partially offset by a decrease in depreciation expense resulting from assets reaching the end of their depreciable lives, the impact of compression and other asset sales, and long-lived asset impairments.

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Long–lived and other asset impairment. We periodically review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. We also evaluate for impairment our idle units that have been culled from our compression fleet in prior years and are available for sale. During the years ended December 31, 2023 and 2022, we recognized $12.0 million and $21.4 million, respectively, of impairment charges to write down these compressors to their fair value. The decrease in impairment charges on compressors is due to an increase in customer demand and as a result, higher utilization of our equipment. See Note 21 (“Long-Lived Asset and Other Impairments”) for further details on these impairment charges. The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment:

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Restructuring charges. Restructuring charges of $1.8 million during the year ended December 31, 2023 consisted of severance and consulting costs related to our restructuring activities. See Note 22 (“Restructuring Charges”) for further details on these restructuring charges.

Interest expense. The increase in interest expense was due to an increase in interest rates, a higher average outstanding balance of long–term debt and the write-off of $1.0 million of unamortized deferred financing costs as a result of the Amended and Restated Credit Agreement, partially offset by an increase in capitalized interest.

Gain on sale of assets, net. The decrease in gain on sale of assets was primarily due to gains of $7.6 million on compression asset sales during the year ended December 31, 2023 compared to gains of $38.5 million on compression asset sales during the year ended December 31, 2022.

The net gain on the sales of assets during 2022 was primarily the result of $28.1 million of gains recognized on sales of certain contract operations customer service agreements and approximately 770 compressors and $12.4 million of gains recognized on other compression asset sales and transportation and shop asset sales during the period.

Other expense (income), net. The decrease in other expense (income), net was primarily due to a $0.9 million decrease in the unrealized change in the fair value of our investment in an unconsolidated affiliate during the year ended December 31, 2023 compared to the year ended December 31, 2022.

Provision for Income Taxes

The increase in provision for income taxes was primarily due to the tax effect of the increase in book income during the year ended December 31, 2023, compared to the year ended December 31, 2022.

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LIQUIDITY AND CAPITAL RESOURCES

Overview

Our ability to fund operations, finance capital expenditures and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets. Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under our Credit Facility. Our cash flow is affected by numerous factors including prices and demand for our services, oil and natural gas exploration and production spending, conditions in the financial markets and other factors. We have no near-term maturities and believe that our operating cash flows and borrowings under the Credit Facility will be sufficient to meet our future liquidity needs.

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

Cash 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 compression equipment required for us to provide those contract operations services to our customers. Our capital requirements have consisted primarily of, and we anticipate will continue to consist of, the following:

• operating expenses, namely employee compensation and benefits, inventory and lube oil purchases;

• growth capital expenditures;

• maintenance capital expenditures;

• interest on our outstanding debt obligations; and

• dividend payments to our stockholders.

Capital Expenditures

Growth Capital Expenditures. The majority of our growth capital expenditures are related to the acquisition cost of new compressors when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new compressor is expected to generate economic returns that exceed our cost of capital over the compressor’s expected useful life. In addition to newly–acquired compressors, growth capital expenditures include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures. These expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.

Growth capital expenditures were $190.3 million and $146.3 million during the years ended December 31, 2023 and 2022, respectively. The increase in growth capital expenditures from 2022 to 2023 was the result of increased investment in new compression equipment as a result of higher customer demand.

Maintenance Capital Expenditures. Maintenance capital expenditures are related to major overhauls of significant components of a compression package, such as the engine, compressor and cooler, which return the components to a like–new condition, but do not modify the application for which the compression package was designed.

Maintenance capital expenditures were $92.2 million and $84.2 million during the years ended years ended December 31, 2023 and 2022, respectively. The increase in maintenance capital expenditures from 2022 to 2023 was the result of an increase in scheduled maintenance activities due to maintenance cycle requirements as well as additional make–ready investment as we return idle equipment to work to meet customer demand.

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Projected Capital Expenditures. While market activity continues to be strong, we currently anticipate reducing capital expenditures in 2024 compared to 2023 to support free cash flow generation after dividends, and plan to spend approximately $275.0 million to $290.0 million in capital expenditures during the year ended December 31, 2024, primarily consisting of approximately $175.0 million to $180.0 million for growth capital expenditures and approximately $80.0 million to $85.0 million for maintenance capital expenditures.

Dividends

On January 25, 2024, our Board of Directors declared a quarterly dividend of $0.165 per share of common stock, or approximately $25.9 million, which was paid on February 13, 2024 to stockholders of record at the close of business on February 6, 2024. Any future determinations to pay cash dividends to our stockholders will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, and credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.

Share Repurchase Program

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On April 27, 2023, our Board of Directors authorized the 2023 Share Repurchase Program which allows us to repurchase up to $50.0 million of outstanding common stock.  Under the 2023 Share Repurchase Program, shares of our common stock may be repurchased periodically, including in the open market, privately negotiated transactions, or otherwise in accordance with applicable federal securities laws, at any time until April 27, 2024. The actual timing, manner, number, and value of shares repurchased under the program will be determined by us at our discretion.

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The following table summarizes shares repurchased under the 2023 Share Repurchase Program during the year ended December 31, 2023:

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Contractual Obligations

Our material contractual obligations as of December 31, 2023 consisted of the following:

• Long–term debt of $1.6 billion, all of which is due in 2027 and 2028;

• Estimated interest on our long–term debt of $428.8 million, consisting of annual payments of approximately $108.3 million in 2024 through 2026, approximately $82.5 million in 2027, and approximately $21.4 million in 2028;

• Purchase commitments of $192.7 million, of which $151.6 million is due in 2024, that primarily consist of commitments to purchase fleet assets and information technology–related costs; and

• Operating lease payments of $18.0 million that are spread relatively evenly in 2024 through 2032.

In addition, we had $19.5 million of unrecognized tax benefits (including discontinued operations) recorded as liabilities related to uncertain tax positions at December 31, 2023, which are uncertain as to if or when such amounts may be settled. We had a liability of $2.5 million recorded for potential penalties and interest (including discontinued operations) related to these unrecognized tax benefits at December 31, 2023, which we are uncertain as to if or when such amounts may be settled.

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Sources of Cash

Revolving Credit Facility

During the years ended December 31, 2023 and 2022, our Credit Facility had an average daily balance of $298.8 million and $235.4 million, respectively. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 7.7% and 6.9% at December 31, 2023 and 2022, respectively. As of December 31, 2023, there were $4.5 million of letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.1%. We amended and restated our Credit Facility on May 16, 2023; see Note 15 (“Long-Term Debt”) to our Financial Statements for details on the Amended and Restated Credit Agreement.

Credit Facility Terms. Our Credit Facility matures on May 16, 2028 (or December 2, 2026 or December 3, 2027, as applicable, if any portion of our 2027 Senior Notes and 2028 Senior Notes, respectively, remain outstanding at such date) and has an aggregate revolving commitment of $750.0 million. Portions of the Credit Facility, up to $75.0 million, are available for the issuance of swing line loans and $50.0 million is available for the issuance of letters of credit. Subject to certain conditions, including approval by the lenders, we are able to increase the aggregate commitments under the Credit Facility by up to an additional $250.0 million. The Credit Facility borrowing base consists of eligible accounts receivable, inventory and compressors.

Covenants. Our Credit Facility agreement requires that we meet certain financial ratios (see Note 15 (“Long-Term Debt”) and contains various additional covenants including, but not limited to, mandatory prepayments from the net cash proceeds of certain asset transfers, restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay distributions. As of December 31, 2023, we were in compliance with all covenants under our Credit Facility agreement. Additionally, all undrawn capacity on our Credit Facility was available for borrowings as of December 31, 2023.

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Senior Notes

As of both December 31, 2023 and 2022, we had a principal balance of $1.3 billion of outstanding senior notes that consisted of the following:

• $800.0 million of 6.25% senior notes due in April 2028 and

• $500.0 million of 6.875% senior notes due in April 2027.

See Note 15 (Long-term Debt”) to our Financial Statements for further details of these notes.

At–the–Market Continuous Equity Offering Program

Under our ATM Agreement, we may sell, from time to time, shares of our common stock having an aggregate offering price of up to $50.0 million. The agreement terminates upon the earlier of (i) the sale of all shares of common stock subject to the agreement or (ii) the termination of the agreement by us or by each of the sales agents. Any sales agent may also terminate the agreement but only with respect to itself. We used the net proceeds of these offerings for general corporate purposes. During the year ended December 2022, we sold 447,020 shares of common stock, respectively, for net proceeds of $4.2 million, pursuant to the ATM Agreement. There were no shares of common stock sold during the year ended December 31, 2023.

Other Sources of Cash

Business Dispositions and Other Asset Sales. We received proceeds of $72.2 million and $120.3 million from business dispositions and other asset sales during the years ended December 31, 2023 and 2022, respectively. We typically use the proceeds from these sales to repay borrowings outstanding under our Credit Facility, however, we are not able to estimate the timing of asset sales nor the amount of proceeds to be received and as such, we do not rely on asset sale proceeds as a future source of capital.

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Cash Flows

Cash flows provided by (used in) each type of activity were as follows:

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Operating Activities.

The increase in net cash provided by operating activities was primarily due to increased cash inflows of $115.2 million from gross margin and changes of $15.4 million in deferred revenue, partially offset by changes of $24.3 million in contract costs, $12.2 million in accounts payable and other liabilities and decreased cash inflows of $9.1 million from accounts receivable.

Investing Activities.

The increase in net cash used in investing activities was primarily due to a $58.8 million increase in capital expenditures and a $99.6 million decrease in proceeds from the sale of business, partially offset by a $51.6 million increase in proceeds from sales of property, plant and equipment and a $7.4 million decrease in investments in non-consolidated affiliates.

Financing Activities.

The increase in net cash used in financing activities was primarily due to $8.9 million of common stock purchased under the 2023 Share Repurchase Program, a $6.0 million payment for debt issuance costs related to the Amended and Restated Credit Agreement, a $5.5 million increase in dividends paid to stockholders and a $4.2 million decrease in proceeds from the sale of shares under the ATM Agreement, partially offset by a $19.0 million increase in net borrowings of long-term debt.

Critical Accounting Estimates

We describe our significant accounting policies more fully in Note 2 (“Basis of Presentation and Significant Accounting Policies”) to our Financial Statements. As disclosed in Note 2, the preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosures of contingent assets and liabilities. We evaluate our estimates and accounting policies on an ongoing basis and base our estimates on historical experience and 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 cash flows.

Depreciation

Property, plant and equipment, net, at December 31, 2023 was $2.3 billion and depreciation expense was $159.3 million for the year ended December 31, 2023. Property, plant and equipment are carried at cost and depreciated using the straight–line basis over the estimated useful life of the asset.

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Our estimate of useful lives and salvage values are based on assumptions and judgments that reflect both historical experience and expectations regarding future use of our assets, including wear and tear, obsolescence, technical standards, market demand and geographic location. The use of different assumptions and judgments in the calculation of depreciation, especially those involving useful lives, would likely result in significantly different net book values and results of operations.

The estimated useful life of an asset is monitored to determine its appropriateness, especially when business circumstances change. For example, changes in technology, excessive wear and tear, or unanticipated government actions may result in a shorter estimated useful life than originally anticipated. In these cases, we would depreciate the remaining net book value over the new estimated remaining life, thereby increasing depreciation expense per year on a prospective basis. Likewise, if the estimated useful life is increased, the adjustment to the useful life would decrease depreciation expense per year on a prospective basis.

Impairment of Assets

During the year ended December 31, 2023, we recorded long–lived and other asset impairments of $12.0 million.

Impairment Assessments of Property, Plant and Equipment and Identifiable Intangible Assets

We review long–lived assets, which include property, plant and equipment and intangibles assets that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressors from our active fleet, indicate that the carrying amount of an asset may not be recoverable. An impairment loss may exist when the estimated undiscounted cash flows expected from the use of the asset and its eventual disposition are less than its carrying amount. Determining whether the carrying amount of an asset is recoverable requires us to make judgments regarding long-term forecasts of future revenue and costs related to the asset subject to review. 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.

Compression Fleet. The fair value of a compressor is estimated on the expected net sale proceeds compared to fleet units we recently sold, a review of other units recently offered for sale by third parties or the estimated component value of the equipment we plan to use. See Note 21 (“Long-Lived and Other Asset Impairment”) and Note 26 (“Fair Value Measurements”) to our Financial Statements for further details of our fleet asset impairments.

Income Taxes

Our income tax expense, 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 the U.S. and have investments in unconsolidated affiliates that operate in the U.S. and international locations. Significant judgments and estimates are required in determining consolidated income tax expense.

Deferred income taxes arise from temporary differences between the financial statements and the tax basis of assets and liabilities. In evaluating our ability to recover our deferred tax assets, 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 results of discontinued operations and changes in accounting policies and incorporate assumptions, including the amount of future U.S. federal, state, and international 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 use to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative income (loss) before income taxes.

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Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on our financial position, results of operations or cash flows. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various state and local jurisdictions.

The accounting standards for income taxes provide that a tax benefit from an uncertain tax position may be 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. We adjust these liabilities 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 liabilities. Such differences are reflected as increases or decreases to income tax expense in the period in which the new information becomes available.

Recent Accounting Developments

See Note 3 (“Recent Accounting Developments”) to our Financial Statements.