Greetings, and welcome to the Kodiak Gas Services Third Quarter 2023 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Graham Sones, Vice President of Investor Relations. Thank you. You may begin.

Good morning. We appreciate you joining us for the Kodiak Gas Services conference call and webcast to review third 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, third quarter financial results and our updated 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 and also by phone until November 16, 2023. Information on how to access the replay is to be found on the Investors tab of our website at kodiakgas.com. Please note that information reported on this call speaks only as of today, November 9, 2023, and therefore, you're advised that such information may no longer be accurate as of 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 and quarterly report on Form 10-Q available on our website or sec.gov to understand those risks, uncertainties and contingencies. The comments today will also include certain non-GAAP financial measures. Additional details and reconciliations to the most comparable GAAP 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's CEO, Mr. Mickey McKee. Mickey?

Thanks, Graham, and thank you all for joining us today. I'll start by discussing our recently announced inaugural dividend payment to our shareholders. Then I will share some highlights from the third quarter and ultimately provide some commentary on the industry and our company. When I'm finished, John will provide additional financial details from the third quarter and discuss some updates to our 2023 outlook. We are excited to have announced our first quarterly dividend on October 24. Our Board declared a dividend of $0.38 per share for the third quarter of 2023 or $1.52 per share on an annualized basis. The stable positive cash flow provided by our resilient business model supports returning capital to shareholders through a well-covered dividend. We believe that with the initiation of our dividend, Kodiak represents one of the most compelling yields in midstream energy today. It is an important part of our capital allocation strategy that also involves reinvesting a portion of our cash flows to grow our fleet, given the attractive returns we see in the current market environment. To be clear, we intend to generate positive free cash flow after growth capital and dividends are funded, while driving towards our long-term leverage target of 3x to 3.5x. Now turning to yesterday's earnings release. We are very pleased with our third quarter results, which reflect the continued execution of our strategy, focused on deploying large horsepower compression infrastructure assets in high-quality basins with the best customers. The compression market remains tight as many of our competitors are near full utilization of their deployable assets, and we are well positioned as the compression provider of choice for our customers. To touch on a few highlights from the third quarter, we maintained our industry-leading utilization rate, ending the third quarter at 99.9% utilization. We…

Thanks, Mickey. As Mickey emphasized, it's a wonderful time to be in the contract compression business and an even better time to be at Kodiak. Here are some of the results from the quarter. Total revenues for the third quarter were approximately $231 million, up about 14% sequentially and 27% compared to the third quarter of last year. Adjusted EBITDA for the quarter was $110 million, up over $2 million or 2% from Q2, and up over 8% versus the same quarter of last year. Both metrics exceeded our expectations. And since you'll see it in our 10-Q later today, I'll mention it now. Adjusted EBITDA for the quarter included an approximate $2 million allowance for doubtful accounts related to a particular compression customer in the midst of a restructuring. Excluding the impact of that reserve, adjusted EBITDA for the quarter would have been about $112 million. Looking at our segments, Compression Operations revenues were nearly $187 million, up about 14% year-over-year. Revenue-generating horsepower grew by about $112,000 on a year-over-year basis. Consistent with last quarter, revenue growth in this segment was a function of growth in revenue-generating horsepower combined with higher overall fleet pricing. In our Other Services segment, 2023 third quarter revenues were up substantially compared to both last year's third quarter as well as the prior quarter. This was driven mostly by quality execution and faster-than-expected progress on some project completion schedules in particular on one relatively large job. From an adjusted gross margin perspective, our Compression Operations segment generated just shy of a 65% margin, up 70 basis points compared to the second quarter. Our operations team continues to focus on containing costs that are within our control. We continue to chip away at some of the margin compression we experienced in the last couple of…

Thanks, John. In summary, we've 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've concentrated our purpose-built fleet in the most economic cost advantage basins with the best customers under long-term fixed revenue contracts that are resilient to short-term commodity price cycles. And we've built Kodiak with a commitment to sustainability. We are very pleased with our third quarter results, our initiation of a meaningful dividend, and we look forward to continued profitable growth in 2023 and beyond. I'd like to close the call by thanking the extraordinary women and men of Kodiak Gas Services. Their hard work and dedication to safety and our customers are what makes Kodiak special, and we wouldn't be an industry leader without their commitment to excellence. At this point, we'll open up the line for questions. Operator?

[Operator Instructions] And our first question comes from Jeremy Tonet with JPMorgan.

Just wanted to start off, if I could with capital allocation, maybe expanding a bit more, I realize there's probably more to come on this topic. But -- and so far as there's a market with a lot of growth for compression, a lot of need there. Do you have a healthy dividend yield as it is? Yes, it seems like the market is not necessarily giving as much credit as it could for this yield. And so, when you think about further growth CapEx in the future or if you think about raising the dividend or even possibly buying back stock, just wondering at this juncture, any high-level thoughts you could provide with how you view these different options?

Yes, Jeremy, this is Mickey. I think all of those things are possibilities going forward and things that we will be discussing with our Board more over the next couple of quarters. But I think right now, we're focused on executing the business and making sure that we have a good yield and a return on capital to shareholders and increasing discretionary cash flow, so that we can continue to grow CapEx and dividend over a long period of time.

Got it. That makes sense there. And then kind of pivoting towards the compression market as a whole, very tight market. We've heard about it across the industry how tight it is and the need there. Just wondering, if you could expand a bit more on how you're dealing with supply chain challenges out there servicing your customers, securing large equipment, fulfilling these orders here; given some of the disruptions and tightness that we see out there. Just wondering, if you could talk a bit more about that.

Yes. I mean it's an ongoing management that we have to do with not only our customers but with our suppliers as well to make sure that, a) Our customers are planning out well in advance to secure equipment at this point with Caterpillar engine deliveries out longer than a year. It's a challenge, but it's something that we work on pretty much daily with our customers and making sure that they're in the right position, as well as with our suppliers in making sure that deliveries and the ability for them to produce equipment for us and make sure that it's ready when they say it's going to be ready is something that's an ongoing supply chain management process that we do every day, too. So we are out into discussing Q1 2025 potential equipment needs with our customers right now and looking at a very productive and fully subscribed kind of 2024 year already. So, it's a challenge that we deal with on a daily basis, but it's something that we're used to managing and been doing this a long time. So, we know how to handle it.

And our next question comes from Theresa Chen with Barclays.

First, I'd like to touch on the comments about 2024, understanding that you're not giving guidance today, but on that fully subscribed asset-level trajectory, can we get some color on the puts and takes on risk to the upside and downside from here, as to how you see both pricing and margins evolving relative to 2023 and even some of the base IPO materials for the 2024 year?

Yes, Theresa, we've -- again, going back to what we discussed a moment ago with Jeremy, we worked with the these suppliers for a long, long period of time. And we know really what's coming down the pipeline from them from the standpoint of price increases, and then it's going to happen from our suppliers. And so, we're able to plan that out ahead of time and make sure that as we price our equipment into 2024 and even early 2025 that we're getting an adequate return on capital investment that we're planning and making sure that we have to continue to maintain and hopefully expand margins over time.

Got it. And on capital allocation, related to the small real estate transaction, are there other opportunities similar to this that you see within the realm of possibility within the near term? Or should we think about the capital primarily -- the free cash flow primarily going towards in returning cash to shareholders?

I think that we're going to stick to our kind of stated capital allocation policies that we've had where 35% to 40% of our discretionary cash flow is planned to pay a dividend. And the majority of the balance of that discretionary cash flow to go to growth CapEx, I think, this specific real estate transaction was one that was just pretty opportunistic that came along and we said, we looked around and said, "Man, this is a really good opportunity for us to control our own density" and make sure that we don't have any kind of unforeseen interruptions in our operations group up in the Permian Basin. So, it was something that we wanted to take advantage of, but we were in a position to where we could execute on the transaction and still remain cash flow positive is one of our stated goals and still take advantage of that opportunity and save some money in rents along the way. So we decided to take advantage of that. I don't foresee too many of those -- too many significant opportunities like that popping up over time. But if they are -- if they do, we'll evaluate it and make sure that we're making the right decisions for the business.

And our next question comes from Neal Dingmann with Truist.

Nice quarter. Mickey, I'm going to ask just a demand maybe question in another way that, you all have one of the sort of best demand pictures out there, obviously, talking to customers in '25. I'm just wondering because of that, are you able to potentially structure contracts longer? Are you able to -- what are the benefits given -- again, I see you all is having, as I said, one of the best sort of demand pictures out there. I'm just wondering what are the sort of benefits or changes you might be able to take advantage of this.

Yes. Thanks for the question, Neal. I think you hit on it. We -- there are some things that we've been pushing on. We have been able to secure longer contract tenors throughout the last year. We've seen our average contract tenor move up a little bit over time. So that's a quality thing that we'd like to see. As I said in the prepared remarks, we're below 7% of our contracts -- on month-to-month contracts right now. So we really are pushing to have everything contracted up that we can have contracted out. We think that's the right thing to do to really secure the visibility of our cash flows, going forward. As well, we're able to push some renewal increases that -- we've seen some rate increases along the period of time over the last couple of years that have that have gone to kind of combat the inflationary pressures we saw last year, and maintain margin where we expect it to be, in that -- kind of that 64% to 65% range, and we expect that we can hopefully continue to expand on that, on the positive margin expansion we had this quarter.

No, that's great. Great to hear. And then maybe taking that demand over to John's question. John, because this sort of long-term demand picture you have, does that give you all more confidence? You obviously, really materially raised your distribution, 9% again obviously starts [ too cheap ] and that should readjust. But I'm just wondering, does that give you confidence to continue to raise that? Or when you think about the shareholder return, your coverage seems more than ample. So John, just wondering, does it factor in when you're seeing this demand and sort of the certainty around there? Or what drivers sort of help shape that?

Yes. So thanks. As it relates to the dividend, it's all part of that big capital allocation framework that Mickey described a couple of times. We obviously regularly discussed the strategy on capital allocation framework with our Board. For the foreseeable future, we like that 35% to 40% of our discretionary cash flow being paid out in the form of the dividend. If you just roll our business model forward based on '24, '25 and kind of the demand picture that we see. We see the ability to grow EBITDA in that upper single-digit range for the foreseeable future, that would translate into increases in discretionary cash flow. So, we will evaluate growth in the dividends over time, but we do think we'll see growth in the discretionary cash flow to afford it.

Our next question comes from Jim Rollyson with Raymond James.

And again, congratulations on a good quarter. Mickey, just kind of circling back to the roughly 140,000 horsepower being delivered this year. And you obviously mentioned that you're pretty well fully committed for what's on order next year. Just as we think through, what you would -- like just trying to understand how much incremental horsepower you think gets delivered next year? And based on the way conversations are going for '25, just kind of thinking about that incremental growth rate on horsepower additions beyond '23. Maybe some color around that?

Yes. I mean, thanks for the question, Jim, and it's good to talk to you. We are not quite finished up the whole budgeting process yet with -- for 2024 and not ready to provide guidance yet. But I will tell you that like the horsepower deployment for 2024 will look a lot like what 2023 look like and maybe a fraction more. And I think that, you'll see that same kind of trend towards 2025. Again, just like John was saying about our capital allocation strategy here, already today, it's -- if we can grow EBITDA by that upper single-digit percentage mark and that grows discretionary cash flow by that same amount, then I think that you could translate that into being able to allocate that both out to dividend and growth capital growth over time.

That's helpful. And then, since no one else asked, I figured I'd ask your -- one of your largest customers is getting taken out here early next year? And just kind of curious, how you see that from a potential opportunity standpoint going forward given their kind of growth plans?

Yes. I mean, look, I mean, Exxon is buying Pioneer, and Pioneer is one of our biggest customers, one of our longest tenured relationships, and -- but we're excited about the opportunity to work with Exxon, going forward. They've got great plans for the Permian Basin. They wouldn't be making this investment in the Permian unless they had a pretty long-term outlook about the opportunities in the Permian, which we think bodes really well for our business, as well as, I mean, Exxon is already a customer of ours on a smaller scale. So we already have a relationship with them. And so, we're excited to get to move forward working with them and becoming one of their bigger providers.

Our next question comes from Jackie Koletas with Goldman Sachs.

Just wanted to start more on the cost side. So as we're seeing pricing continue to rise, could you comment on what you're seeing more so on the cost side and how inflation pressures have been abating? And how you see that going into 2024?

Yes, Jackie, thanks for the question. I think, we've dealt over the last couple of years with pretty significant inflationary pressures hitting us kind of left and right. And we've combated that as much as we could, and I think we've done a pretty good job of keeping margins pretty flat. So looking towards 2024, I think that we expect those inflationary pressures to kind of abate a little bit, and remain pretty flat going into 2024. I think obviously, you'll have some increases from a labor perspective as you do every year. But I think that, we're kind of expecting our kind of our cost of operations metrics to stay relatively flat next year from the standpoint of costs from our suppliers and lube oil providers.

Okay. Great. And then lastly, just as a follow-up. I know, that the cat engine availability overall is now over a year plus. Is it specifically worse than what you saw during the second quarter? And has there been any update from cat on that easing at all either in the near or long term?

Haven't had any updates on that easing anytime soon, so we expect to keep having to deal with that. And it's kind of typical for these kind of up cycles that those deliveries get out to be that long. Although, we expect for this up-cycle to last longer than traditionally you've seen them in the past, just because we think that the supply side is so depressed, and as well as such incremental high demand for compression services with the dynamic of the fact that the Permian Basin is providing a lot of the guests production growth in the United States, and it requires so much more compression to just produce the Permian Basin gas to get out of their feed LNG plant. So like I said, high, high demand that we foresee for a long time and really tight supply for a long time, so we expect this to continue on. And I don't foresee much relief in delivery times from caterpillar anytime soon either.

And there are no further questions at this time. I'll hand the floor back to Mickey McKee for closing remarks. Thank you.

Okay. Thanks, operator, and thanks to everyone for participating in today's call. We look forward to speaking to you again in the new year and with our fourth quarter and full year 2023 results. Thanks.

Thank you. And we conclude today's conference. All parties may disconnect. Have a good day.