Kodiak Gas Services, Inc.

Hello, and welcome to the Kodiak Gas Service's second quarter 2023 conference call and webcast. If anyone should require operator assistance, please press star zero on your telephone keypad. A question and answer session will follow the formal presentation. You may press star one at any time to be placed in the question queue. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Graham Soans, Vice President Investor Relations. Please go ahead, Graham. Good morning.

We appreciate you joining us for the Kodiak Gas Services conference call and webcast to review second quarter 2023 results. Participating from the company today are Mickey McKee, President and Chief Executive Officer, and John Griggs, Chief Financial Officer. Following my remarks, Mickey and John will provide a high-level commentary on the company, our market, second quarter financial results, and our 2023 outlook before opening the call for Q&A. Before I turn the call over to Mickey, I have a few housekeeping items to cover. There will be a replay of today's call available via webcast on the Investors tab of our website at kodiakgas.com. There will also be a replay you can access by phone until August 17, 2023. Information on how to access the replays can be found in yesterday's earnings release. Please note that information reported on this call speaks only as of today, August 10, 2023, And therefore, you're advised that such information may no longer be accurate at the time of any replay or transcript reading. In addition, the comments made by management during this conference call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views, beliefs, and assumptions of Kodiak's management based on information currently available. Although we believe the expectations referenced in these forward-looking statements are reasonable, various risks uncertainties, and contingencies could cause the company's actual results, performance, or achievements to differ materially from those expressed in the statements made by management. And management can give no assurance that such statements or expectations will prove to be correct. Listeners are encouraged to read Kodiak's prospectus available on our website or at FCC.gov to understand those risks, uncertainties, and contingencies. The comments today will also include certain non-GAAP financial measures. Additional details and reconciliations, the most comparable gap measures, are included in the quarterly press release, which can be found on our website. And now I'd like to turn the call over to Kodiak CEO, Mr. Mickey McKee. Mickey?

Thanks, Graham, and thank you all for joining us today. I'm extremely proud of what Kodiak has accomplished for a company that was founded just 13 years ago, including the pricing of our IPO on June 28th. I want to start out our first earnings call by thanking the extraordinary women and men of Kodiak Gas Services on the accomplishment of getting Kodiak where it is today. It has been no easy task. In becoming a publicly traded company, Kodiak is one of six energy IPOs since the beginning of the COVID-19 pandemic and the first contract compression IPO in 10 years. It's quite a milestone. And I'm thrilled that through this IPO process, we were able to make each and every Kodiak employee a shareholder of the company. I'll begin our first public conference call by discussing a few highlights from the second quarter. And then I'll provide some commentary on the industry and our company. When I'm finished, John will provide additional financial detail from the second quarter and discuss our 2023 outlook. To start and to address the 8K that was released yesterday, Kodiak identified an error in the accounting for unrealized gains on our interest rate hedges that showed up in the Q1-22 comparable financial statements in our S-1 filing. The error understated our net income of Q1 of 22, was non-cash in nature, and did not affect the annual audited financials for 2022 or any non-GAAP measures such as adjusted EBITDA, adjusted gross margin, or discretionary cash flow. Kodiak is taking appropriate steps to make sure this doesn't happen again, and John will go into more detail in this section. We're happy to take any questions about it in Q&A. Now turning to yesterday's earnings release. To touch on a few highlights from the second quarter, we maintained our industry-leading utilization rate, ending Q2 at 99.9% utilization. This allowed us to deliver record revenues of over $203 million and an all-time high adjusted EBITDA of almost $108 million in the quarter. As we look to the remainder of 23, our new unit deliveries are completely contracted and are exclusively large horsepower units, which we define as over 1,000 horsepower. We know the cost of the equipment. The customer will be deployed with and the contract rate it will earn. And because equipment lead times remain extended at over a year, we're already busy firming up new equipment orders and customer contracts into the back of 2024. This provides further support for what we believe is going to be an exciting 2023 and beyond, as TODIAC continues to deliver exceptional results. We're also very excited to issue our first public guidance for full year 2023 that shows record adjusted EBITDA of $425 to $440 million and indicates what we believe will be a very compelling annualized dividend of between $1.40 and $1.60 per share, subject to the approval of our board, with the first payment being in the fourth quarter. Many of you are new to the Kodiak story, so I want to take a few extra minutes today to discuss our company, our role in the industry, and what makes Kodiak different. To start, Kodiak is a leading provider of critical energy infrastructure, enabling the reliable flow of natural gas and oil to feed growing global demand. As the world searches for a clean, affordable, and secure energy source to fuel the energy transition, the US is poised to supply the world with clean-burning natural gas through the development of Gulf Coast LNG export capacity. Kodiak is uniquely positioned to take advantage of this trend, as we have intentionally focused on deploying our assets predominantly in the Permian Basin with the right partnership-based customers and employing the hardest working and most loyal workforce in the industry. At Kodiak, we have purpose-built a fleet of nearly 3.2 million horsepower of predominantly large horsepower compression equipment that is the youngest, most technologically advanced and emissions-friendly fleet in the space, specifically engineered and built to operate in rich gas environments like the Permian Basin, where over 70% of our horsepower is deployed. The demand for large horsepower compression, specifically in low-cost to produce basins like the Permian, has grown significantly due to the development of unconventional resources. Improvements in drilling technology have allowed our customers to centralize wells and design systems for field-wide oil lift and gas gathering infrastructure that use more efficient large horsepower compression to lower their production costs and emissions footprint. These large infrastructure investment decisions being made by our customers require large horsepower compression for longer time spent on location, which in turn leads to more stable and predictable cash flows for Kodiak. We also charge a fixed monthly revenue rate for our services, meaning our business is largely insulated and has shown extreme resiliency across multiple commodity price cycles. In fact, Spot Henry Hub prices averaged $2.16 per MMBTU in Q2, down over 70% versus the same period last year. yet our fleet continued to be effectively fully utilized. We generated record revenues and adjusted EBITDA, and our customers continued to contract with us for future horsepower deployments into 2024. Though the energy transition is well underway, we believe that natural gas and oil demand will continue to grow for many decades to support global population and GDP growth. Last year was a wake up call to the world as to the importance of secure and affordable energy. The global geopolitical events and resulting price spikes of 2022 set off a race by energy importing countries to secure ample supplies of LNG to fuel their respective economies. As the world's number one exporter of clean burning natural gas, the U.S. is standing at the ready to grow production and continue to provide that gas for the benefit of the world. As evidence of that growth, approximately 14 BCF a day of LNG liquefaction capacity is currently under construction. There's roughly an additional 12 BCF a day of projects that are approved and pending final investment decision. What's more, those new LNG plants are destined for the Gulf Coast. from the southern tip of Texas to the eastern border of Mississippi. Added together, those new LNG export facilities represent approximately 26 BCF a day of additional liquefaction capacity, requiring a stable source of feed gas and associated compression to deliver it to the Gulf Coast. To put that in perspective, that's a 25% increase in domestic natural gas production. That LNG feed gas has to come from somewhere. Despite an abundance of reserves, it's very challenging to get new transportation pipelines permitted to move gas from the northeastern United States to the Gulf Coast, which means that gas will likely have to come from the Permian, the Eagleford, or the Hainesville. Most forecasters predict that Permian gas volumes will grow substantially from now through the end of the decade. Here's the important point for Kodiak and our investors. In order for Permian and Eagleford gas to be processed and move from the point of production to the point of demand, it has to be compressed multiple times. And that's before we consider additional compression required for gas-lifted oil production, lower field pressures from unconventional resources, and rising gas-to-oil ratios from new and existing wells. Given that roughly 2.7 million, or about 84%, of Kodiak's existing horsepower is currently operating in the Permian and Eagleford. We feel great about the outlook for compression services demand and think we're well positioned to take advantage of expected market growth. We believe that the continued capital discipline in our industry, increasing desire to outsource compression by producers and midstreamers, and elongated delivery times for new engines supports a continued constructive market. Finally, I want to touch on what I believe is another true differentiator for Kodiak in our industry, and that is our focus on sustainability and ESG. Our goal is to be the most responsible and sustainable company in our industry. As you know, many energy companies, including some of our customers, have announced significant GHG emissions reduction initiatives. We're actively working on solutions to help them achieve those goals. One example is EcoView, our proprietary data acquisition and emissions monitoring system that was awarded patent protection earlier this year. EcoView is in the early stages of commercial deployment and will help our customers manage their emissions footprint while giving Kodiak real-time operational visibility to allow us to further optimize the performance of our fleet. We're also proud to have received a Top Workplaces USA award earlier this year with cultural excellence honors for employee appreciation and professional development. Kodiak is a great place to work with competitive pay and benefits that help us attract and retain the best talent. We're also very focused on the safety of our employees and we have a culture that produces exceptional safety results in conjunction with our superb financial I say it all the time, making sure that our employees get home safely to their families every night is the most important part of my job. In summary, we believe the broader energy market is highly supportive with a multi-decade runway for conventional energy and particularly large horsepower compression to feed the growing LNG export base on the Gulf Coast. Our strategy is to continue to provide compression services safely and sustainably in the best basins with the best customers, while providing investors with an attractive return on their investment through steady growth in cash flows and a compelling dividend. Now I'll hand the call over to John to discuss our financial results for the quarter and 2023 outlook, and I'll come back with some additional closing comments before we move into Q&A. John?

Thanks, Nicky. To start out, I want to provide more color on the AK Nicky highlighted earlier. During Q1 of last year, we incorrectly recorded the journal entry related to the unrealized gain on our interest rate hedges, understating Q1 2022 net income by about $22 million. There was no impact on cash or our non-GAAP measures, including adjusted gross margin, adjusted EBITDA, or discretionary cash flow. We identified the error in Q2 of last year. and corrected it by adjusting the Q2-22 financials rather than restating the Q1-22 results. Obviously, we were private at the time and not publicly reporting quarterly results. Unfortunately, those numbers were presented in the quarterly comparable financials in our S-1 filing. As a result, we will restate the impacted line items and are soon to be released in Q. Notably, there's no change to the full year 22 audited figures. We've taken action to mitigate the possibility of something like this happening again. Things like strengthening our accounting team, retaining a big four accounting firm to lead our ongoing SOX implementation, and upgrading certain business systems. We set high standards at Kodiak, and we take great pride in all aspects of our work. We view challenges as opportunities for improvement, and that's how we're approaching this one. All right, back to the quarter. So as Mickey emphasized, it is a great time to be in the contract compression industry and an even better time to be at Kodiak. Here are some of the results from the quarter. Total revenues for the second quarter of 23 were a bit over 203 million, up about 7% sequentially and about 15% compared to the second quarter of 22. Adjusted EBITDA for the quarter was almost 108 million, up modestly from Q1 and up 11% versus the same quarter of last year. Both metrics were consistent with our expectations. Looking at our segments, compression operations second quarter 23 revenues were nearly 182 million, up about 12% year over year. Revenue generating horsepower grew by about 103,000 from last year at this time, or a little over 3%. We grew overall compression operations revenue at a faster rate than we grew revenue generating horsepower, while utilization was effectively flat at 99.9%. This growth can be explained by higher overall fleet pricing driven by a combination of one, new contracts on new horsepower with compelling unit economics, two, renewed contracts on existing horsepower at higher rates, and three, the annual PPI inflators included in about 84% of our contracts. In our other services segment, 2023 second quarter revenues were up 51% compared to last year's second quarter. Our station construction revenues were generally in line with our expectations during the quarter, and we've got a substantial backlog of 2023 business in this segment, plus multiple new opportunities that we're working on now that would impact results both in the back half of this year and into 24. From an adjusted gross margins perspective, our compressions operations segment generated a 64.2% margin, flat versus a year ago quarter, and down a touch on a sequential basis. However, it was higher than our expectations for the quarter, which we attribute to the team's continued focus on optimizing key cost drivers like fleet repair and maintenance, lubricants, and labor. On an absolute dollar basis, the adjusted gross margin and our other services segment was about 3.6 million, up a bit from last quarter, but up nearly 40% from the same quarter of 22. From an adjusted gross margin percentage basis, the margin for Q2 of this year came in at about 16.5%. Each project's different, but generally speaking, we expect the other services segment to produce adjusted gross margins ranging from 15 to 20%. The percentage can vary from quarter to quarter based on the mix and status of particular projects, but overall, the Q2 margin percentage is in line with what we expect. Turning to SG&A, we continue to invest in the people, processes, and systems to allow us to achieve our growth goals. Excluding non-recurring expenses and stock compensation expense, SG&A dollars have risen from about 10.1 million in the same quarter of last year to about 12.3 million this quarter. In terms of the efficiency of those dollars, both figures translate into about 6% of revenues. Turning to CapEx, for the quarter, our maintenance CapEx was about 11 million. Of the 33 million in overall growth CapEx, roughly 5 million went towards things other than fleet additions. Moving over to the balance sheet. The timing of our IPO relative to the end of the quarter plus all the balance sheet activities completed in conjunction with the IPO requires further explanation. While we priced the IPO on June 28th, we didn't officially close it and receive the proceeds until July 3rd. So the balance sheet as of June 30th still shows the $1 billion term loan that was removed as a result of the IPO. After giving effect to the transaction, on the first business day of Q3, we had roughly $1.85 billion drawn on our ABL and about $350 million in borrowing capacity. A few weeks later, the underwriters exercised their green shoe over allotment of 2.4 million shares, resulting in $36 million in incremental net proceeds that we immediately applied to the ABL. Taking that into account, plus a normal working capital movement, Our ABL balance is now closer to $1.8 billion, leaving us about 4.1 times levered, moving us even closer to our long-term leverage target of 3 to 3.5 times. We expect to hit that leverage target in 2025. Last thing on our debt. We have a policy of hedging between 50% to 80% of our floating interest rate risk. Today, we're hedged at just shy of 70% of our outstanding debt balance. and we'd expect to remain in that general vicinity through 2024. Let's move on to our 2023 outlook. We included full-year 23 guidance in our earnings release. For the year, we estimate adjusted EBITDA will range between 425 to 440 million. In our compression operations segment, we expect full-year 23 revenue to be in the range of 730 to 740 million. which at the midpoint would result in a year-over-year increase of about 12%. The increase can largely be explained by an approximately 4% year-over-year increase in revenue-generating horsepower alongside higher overall fleet pricing while maintaining consistent utilization. We also expect to see some nice growth this year in our customer-owned contract operations business, but that business line comprises less than 5% of revenues for the overall segment. As for segment margin, we expect to maintain roughly the same percentage where we came in this quarter for the balance of the year. In our other services segment, we forecast full year revenue of 70 to 90 million. We have a nice backlog of contracts plus some high probability projects in this segment that get us through the year and into 24. And though the margins on these projects can vary from project to project, in aggregate, they're within the 15 to 20% range I mentioned earlier. So the biggest determinant and the ultimate margin for 2023 will really be related to the timing of individual project completion. We see full-year adjusted SG&A coming in between $52 and $56 million. Adjusted SG&A as a percentage of revenues will be higher post-IPO due to our continued investment in our infrastructure to support our growth. Turning to capital expenditures. On a full year basis, we expect maintenance capex of between 32 and 36 million. We anticipate growth capex of 165 to 175 million, which will allow us to add somewhere around 140,000 of incremental horsepower to our fleet, all of it large horsepower and destined for the Permian Basin. Not surprisingly, given the roughly one year lead times on new orders, the capex associated with 2023 new horsepower is all under contract. Unit economics are compelling and better than historical paybacks and returns. Closing out CapEx, roughly $15 million of full-year growth CapEx is associated with non-fleet related items. We're committed to creating and returning value to our shareholders through a disciplined capital allocation approach. With that said, our board recently approved our dividend policy. We expect to begin returning capital to shareholders by paying a regular quarterly dividend beginning with the third quarter paid out in Q4. The specific dollar per share amount will be subject to board approval, but our intention remains to pay out something in the neighborhood of 35 to 40% of our annual discretionary cash flow for the foreseeable future. To that end, in our guidance, we've utilized a range of 35 to 40 cents per share per quarter or $1.40 to $1.60 annualized. At the midpoint, that would represent just over an 8% yield on our closing share price as of Tuesday. Dividend coverage ratio at that level would be in excess of two times. To reduce confusion, I'd like to point out that our Q2 non-GAAP measure of discretionary cash flow included nearly $26 million related to the realized gain from the termination of interest rate hedges that were utilized to pay down the term loan at IPO close. So we won't factor them into our dividend math for the year. That's it for my prepared comments. Thanks again for your participation and support. Now I'll turn it back over to Mickey.

Thanks, John. So to quickly recap, we're very pleased with our second quarter results and look forward to continued profitable growth in 2023 and beyond. So what have we built here at Kodiak? Built a market leader, in contract compression infrastructure with a focus on large horsepower compression and its critical role in the energy value chain. We concentrated our purpose-built fleet in the most economic, cost-advantaged basins with the best customers under long-term fixed revenue contracts that are resilient to short-term commodity price cycles. We've assembled an experienced leadership team that's honored to support the best employees in the business every one of which is now a fellow shareholder. And we've built Kodiak with a commitment to sustainability. And with that, I'd like to close by again thanking everyone who has worked hard to get us where we are today, including all of our stakeholders that share in our vision as we continue our role as mission-critical infrastructure for the future of domestic energy production. At this point, we'll open up the line for questions.

Operator? Thank you. And I'll be conducting a question and answer session. If you'd like to be placed in the question queue, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star 1. One moment please while we poll for questions. Our first question today is coming from John McKay from Goldman Sachs. Your line is now live.

Hey, Mickey, team. Thank you and congrats for the first release here. Wanted to just start on pricing trends. Would just be curious to hear what you're seeing in the market now, where you kind of think that trends from here, and then acknowledging your high utilization level and high contracting level. But just any thoughts on how long it could take to turn the overall fleet up to some of these higher numbers we're seeing?

Yeah. Hey, John. This is Mickey. Thanks for joining us today. You know, on the pricing trends, I mean, I think that it's pretty obvious between our calls and several of the others that we're in one of the tightest markets we've ever seen in the compression industry here, and it's really good times to be in the market. You know, we're signing contracts into the second half of 2024 right now, and they're at a considerable premium to where the current fleet is priced today. And we're excited about those rates. So it's all looking good and going up from here. I think that, like you said, we have a pretty highly contracted fleet. Only about 5.5% of our fleet today is under month-to-month contracts. So it's basically all effectively fully contracted fleet. And so with an average kind of primary term of contract of three to five years, I would expect that we kind of would expect the 25 to 30% of our fleet to be available for recontracting and repricing every year to kind of give you some color there.

That's great. Thanks for that. Maybe just as a follow-up, and John, you had some comments here, but just on On gross margins on the core compression business, talked about some positive trends, I guess, you know, cost efforts, kind of tracking ahead of schedule, acknowledging the guidance for the rest of the year is kind of in-line-ish or maybe slightly above it, largely in-line-ish. For what you saw in the second quarter, where could gross margins go from here? What would higher pricing that, Mickey, you were just talking about, what could that mean for gross margins, let's say, going into 24 or beyond?

Yeah, thanks, John. So I'll touch on the overall topic. Not going to speculate too much about what's going to happen in 24 at this point. But I'd say cost optimization is something that gets a ton of attention here at Kodiak. As you mentioned, our compression operations margin was consistent with where it was last year, just a tick down from where we were a quarter ago. That's not something that gets a lot of concern on our end because we kind of understand exactly what drove that tick down. So what we're really doing here internally is focusing on our needs and wants, making sure that we're optimizing every dollar that's spent. We've got a great leadership team on our operations side that's focused on that. So the guidance that we put forth is kind of where we think we'll be, but rest assured, we're focused on trying to see the operating leverage and see that margin expansion as we move beyond 2023.

Yeah, and I'll just add that we've seen some beginning signs of relief in inflationary pressure from kind of lube oil and those kind of things. And so I would think we'd see some upward momentum on some margins going forward.

All right. That's great. I appreciate it. Appreciate the time.

Thank you. Thanks, Sean. Thank you. Next question is coming from Jeremy Tonnet from J.P. Morgan. Your line is now live.

Hi. Good morning.

Hey, Jeremy. Hi.

Hey, I just want to start off, you know, thanks for the color with the release here in talking about where the initial dividend could fall out. But wondering if you could provide maybe a bit more color on capital allocation, you know, the company's thought process going forward here in kind of, you know, with energy, we've seen the sector shift to living within cash flows. And just wondering, I guess, how you wrap everything together today as far as capital allocation, given this tremendous growth outlook as you talked about.

Yeah, we certainly have more growth opportunities than capital that we're willing to spend on those growth opportunities. And really, I met with some of the leadership from our commercial team this morning, and really it's probably two to three times more opportunities than capital that we're willing to spend at this point in time, looking at 2024. So obviously, again, really tight market. But from a capital allocation framework, we've made a commitment to our investors that we're going to live within our free cash flow. And everybody defines free cash flow very differently. But the way we define it is living within free cash flow after we spend our growth capex and after we pay our dividends. So that's our commitment. And we want to make sure that public world knows that in our first kind of call here. So when we look at our discretionary cash flow, we've got our EBITDA minus our cash taxes minus our interest and minus our maintenance capital equaling our discretionary cash flow. We take that and we are roughly allocating 35 to 40% of that to our dividend now coming out of the gate. And then right now with the compelling opportunities that we have in front of us with strong returns on that capital deployed, we think the best thing to do right now obviously is to maximize our growth in that realm. And so making sure that we're spending 60 to 65 percent of that discretionary cash flow on growth capital going forward, but those being the governors of what we're going to spend going forward and making sure that we're not borrowing money to pay a dividend ultimately.

Jeremy, I was just going to follow that up. The only other thing I would add is that we're going to do all that while we protect the balance sheet, preserve financial flexibility, and ultimately move towards our long-term leverage target. which is that three to three and a half times, which we think will be there in 2025.

Got it. That's very helpful. Thanks. And so, you know, given, you know, the focus on capital discipline there, just wondering if you could talk maybe a little bit more on where those dollars are going to be deployed. Seems like it's largely Permian-based. It seems like there are some, you know, some key customers that you're growing alongside with. Is the focus to kind of, you know, look there or look to expand the portfolio? Or just wondering how, you know, you think about where to deploy the capital as far as basin and customer-wise?

Yeah, I mean, Jeremy, at this point in time, we can't keep up with what our core customers really need us to keep up with from a capital allocation perspective anyways. So, So we're doing our best to service the bulk of their needs and making sure that we stay aligned with the customers that kind of got us here. So I wouldn't suspect that we're going to make a concerted effort to go expand the portfolio unless there's a really, really compelling opportunity to do so. And like I said, I think taking that a step farther, I think what you're probably getting at a little bit is I think that the majority of those dollars are going to be deployed and head into the Permian Basin.

Got it. Makes sense. Very helpful. I'll leave it there. Thanks.

All right. Thanks, Jeremy.

Thank you. Next question is coming from Neil Dingman from Truist Securities. Your line is now live.

Morning, all. Great first quarter. My first question is just maybe, John, for you, is on the EBITDA guidance. Obviously, very positive on the 730 to 740 and compression, the 750. 70 to 90 on the other. I'm just wondering, you all have spoken today even on the prepared remarks about kind of what's going on with the compression market and all. I'm just wondering, is there anything you could speak to on just major assumptions behind this? Any changes we should be, you know, that you have kind of in that guide, or is it just sort of steady as we go? Is there going to be those stellar numbers?

Yeah, so speaking, thanks, Neil, but speaking to the compression operations guidance, it's Pretty consistent with everything we've talked about in the past, you know, gave in my prepared remarks earlier, kind of what we think the horsepower is going to increase on a year-over-year basis. So that's, what, about 140,000 or so horsepower. I will say it's about two-thirds back-end loaded in 2023 in terms of when the horsepower will be delivered. So we do see a step up in terms of kind of the capex as well as the revenue potential for when those additions come on board. And then the rest of our guidance is reasonably self-explanatory around the margins.

Okay, that's great to hear. Now, it's obviously fantastic margins and contracts. Making my last for you is just on the prepared marks, definitely very always exciting to hear about the LNG opportunities. I'm just wondering, is there anything you could speak to yet just on, is it still too early just on any developments or Anything you could realize, because obviously, you know, to your point, just the amount of potential compression that's needed is just, you know, really crazy to see how much could be out there. I'm just wondering any early talks or just any other color you could give around how you all could be involved in the maybe near term on this.

Well, I think that, look, the LNG build-out that we're looking at on the Gulf Coast of the United States is really – farther downstream of us, and it's not a market that we typically play in, and kind of the long-haul pipeline and the regasification kind of, or the liquid refraction piece and that kind of thing. So really what we stand to benefit from in that dynamic is the fact that we're just going to have, there just has to be an enormous amount of upstream infrastructure build-out that has to be built to support Just the feed gas for all of that. And I think that, you know, gas prices where they're at today, that feed gas is going to have to come from Permian and Eagleford type of places and not necessarily the Haynesville yet until we see gas prices creep up a little bit more. And, you know, when you think about with those rich gas environments like the Permian and having to add multiple BCF a day of additional capacity, then you're talking about, you know, you need gas lift for oil compression or gas lift compression for oil lift, and you need processing capacity that's going to need residue compression and centralized gathering facilities. And all of those applications need multiple stages of compression with low pressure gathering and low pressure gas coming out of a tight rock, which is the reservoir of the Permian Basement. and the Eagle Ford. So, you know, it's, it's, it's the interesting part is for every, every molecule of gas that comes out of the ground that has to be compressed multiple times over multiple stages of compression. So it just lends to an environment that us and, and everybody in our space, I think is going to greatly, uh, benefit from being in this world and, and having to be, uh, uh, have an enormous amount of demand for compression coming at us. And I think that is, uh, in a market that's vastly undersupplied and underinvested in compression right now.

Well, we would agree. Well said. Thanks, Mickey. Thanks.

Thank you. Next question is coming from Jim Rolison from Raymond James. The line is now live.

Good morning, guys.

Hey, Jim.

Mickey, kind of circling back to Neil's question and your commentary, How well aware are your customers of this? You know, just kind of how tight things are and how much tighter that might go because when you look at everything being essentially sold out today and the lead times for equipment, the capital discipline by you and your big peers, it kind of seems like we have a long-term problem in terms of actually adding enough capacity quick enough to actually fulfill some of the LNG export capacity growth. So just kind of curious your perspective on the cap there and the sustainability of that, but really how freaked out your customers are about this kind of challenge.

Well, I think that the realization is happening more and more. Eyes are opening more and more every day about how tight the market is with not only us, but with our peers in the industry right now. And And, you know, that's why we have some of our core customers already coming to us right now for commitments for 2025 horsepower and commitments so they can get their names kind of in the hat for the portion of the capital allocation that they'll have for even almost looking at potentially 18 months to two years out right now. So I think that the... Intellectual ones and the smart ones right now are looking and saying, look, we've got to plan our business potentially two years ahead of time right now. And to us, that's a great thing because it allows us to plan. It allows us to forecast. It allows us to do some things that we really have been a challenge in the past. So it's an interesting dynamic right now. really in an environment I don't see getting less tight anytime soon because you don't see supply chain kind of tightness lifting anytime soon and shop space to get equipment built or engine deliveries or anything like that. So, you know, these customers are snapping to the realization right now that they better plan well in advance to get in the queue.

Makes perfect sense. And then just circling back to the pricing question, maybe another way to ask kind of what they're trying to get to is if you look at the contracts you're pricing out now for later 24 or even 25, how much higher is that roughly than what you just averaged in the second quarter? Just as a thinking about a bogey that you guys would be rolling over too, assuming it didn't keep going up?

Not sure. I don't know right off the top of my head exactly how much higher it is as far as a percent of revenues or that kind of thing. What I can say is that we've got a capital return hurdle that we have put in place. And so for every dollar that we put in place that we deploy from a growth capital perspective, we have a return hurdle that we make sure that we can cover that threshold. And so at that point in time, if the dollars are higher and they buy less horsepower, we're still going to get the same return on those dollars when they come back to Kodiak.

Got it. Appreciate the answers.

Yeah, I appreciate it, Jim. Thank you. Next question is coming from Salman Akhil from C4. Your line is now live.

Thank you. Good morning. So just kind of going back to 25 briefly in your outlook there, I presume your conversations are still at higher prices relative to what you're seeing today as you discuss things with customers and setting those expectations.

Hey, good morning, Selman. Yeah, I mean, right now, I mean, especially with the tightness in this market, if we want to, if somebody wants to get in the queue for that capital allocation well out into the future, that We're going to have to set pricing to make sure that we can get the returns on those dollars that we deploy.

Got it. And then in terms of just revenues for this quarter, you talked about sort of three drivers. You talked about the additional fleet. you know, renewing contracts at higher prices, and then you also talked about inflation adjustments running through. So in terms of looking at the overall revenue, can you say which one was the largest contributor to the higher revenues?

Probably the new horsepower deployments, I would guess, would be the largest portion of that. I think that we've had some opportunities for some recontracting throughout the second quarter there. I'm not sure exactly what the distribution was there, but I'd probably say that was second and then the PPI adjustments was probably the smallest effector of the of the revenues.

Got it. And then just the last one for me. I know labor's tight for everybody, so I'm just kind of curious how that's going for you.

It's definitely tight. I think that, you know, you see it in the market, especially in the Permian was one of the The double-edged sword of being so heavily weighted towards the Permian is that we have to deal with the labor issue for a larger part of our fleet than in the Permian Basin. But we're fighting that battle every day. And we're really making sure that we pay attention to our training and our mentoring within our operations group. And I think that somebody had brought up earlier some lower margins there in the second quarter, which I think 50 basis points is pretty normal type of fluctuation, but we did make a concerted effort in the second quarter to really beef up our operations group and make sure, because we recognize that there's a lower, the ability to hire experienced personnel in the Permian Basin is less today than it ever has been. So we want to make sure that we're hiring enough people. We make sure we have enough people that are on board so we can spend more time training them and getting them up to speed and having them be successful contributors within the workforce as soon as possible and make sure they're doing that safely. So as the ability to hire experienced personnel goes down, we need to beef up that operating group and make sure that they have adequate time and resources to train those personnel that to operate safely.

All right. Thank you very much.

Yeah, thanks, Simon.

Thank you. Next question is coming from Theresa Chang from Barclays. Your line is now live.

Good morning. Thank you for taking my questions. Mickey, I'd like to go back to some of your earlier comments about the lack of investment in compression and overall tightness in this part of the valley chain. So do you think this will constrain feed gas growth and potentially delay the pace of liquefaction growth for projects that have already passed FID? And how do you think the market resolves this?

Good morning, Teresa. It's good to talk to you. Thanks for joining us. It's going to be interesting. I think there's going to have to, you know, we talk about the LNG capacity. I think there's going to have to be a lot of T. movement of an optimization of compression horsepower within the United States, I mean you talk about other more conventional resource natural gas plays have to bring some of that horsepower to the Permian to be able to. T. To support that, but you know I think that that you're going to end up having. kind of winners and losers in the deal. And the winners are going to be the ones that are willing to plan well in advance. And the losers are going to be the ones that get caught holding the bag at the last minute and not have the the planned infrastructure in place to support their operating needs and that kind of thing. And I think we've heard rumblings about rigs being laid down and lower rig counts in the Permian Basin, and we haven't seen any of that manifest itself into demand for our compression services at all because you're seeing higher gas-to-oil ratios and that kind of thing. obviously pipeline and takeaway capacity and processing capacity in the Permian, and it's going to have to be able to feed that LNG capacity. So I think that it's going to continue to be a tight market, and the market will do what it has to do to make sure that there's adequate compression. It may be that equipment is more highly utilized than it ever has been before, which we're seeing that trend today. It's just a tight market, and I think that hopefully there's not a massive shortfall in compression, but I think that the investment is going to be an underinvested market for the next several years for sure.

Understood. And maybe more near-term, have your conversations with your producer customers been as they put together the 2024 CapEx budget? What's your overall expectation for top-line growth across the basins you operate in?

You know, I think that what we're projecting for the next year, I mean, we haven't released official guidance yet, but, you know, if you kind of back into what we've done in our capital allocation strategy, right, of 60 to 65% of our discretionary cash flows go into growth capital, I think that, you know, I think that high single digits kind of top line revenue and EBITDA growth is pretty reasonable to expect for 2024.

Understood. And lastly, if I can squeeze one more in, to your earlier comments about having two to three times more opportunities and capital that you're willing to spend, is that within contract compression alone, your bread and butter, or is that including more downstream opportunities as well?

That's the bread and butter with our existing customer base. That's not even going out and chasing new customers that we would even want to bring into the portfolio. That's That's just the existing customers that we deal with on a day-to-day basis for core contract compression opportunities.

Got it. Thank you very much.

Great. Thanks, Teresa. Thank you. We reached the end of our question and answer session. I'd like to turn the floor back over to management for any further closing comments.

Well, thanks, everybody, for joining us for our inaugural Kodiak quarterly earnings call. It's been a It's been a fun morning for us, and we look forward to updating you again in our November earnings call. Thanks for joining us. Bye.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.