Kodiak Gas Services Q1 2024 Earnings Call Transcript

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May 9, 2024

There are 8 speakers on the call.

Operator

Greetings and welcome to the Kodiak Guest Services First Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Graham Sohn, Investor Relations.

Operator

Thank you. Please go ahead.

Speaker 1

Good morning. We appreciate you joining us for the Kodiak Gas Services conference call and webcast to review Q1 2024 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 high level commentary on the company, our Q1 financial results and our updated 2024 outlook before opening the call for Q and A. Before I turn the call over to Mickey, I have a few housekeeping items to cover.

Speaker 1

There will be a replay of today's call available via webcast and also by phone until May 16, 2024. Information on how to access the replay can be found on the Investors tab of our website at todiattgas.com. Please note that information reported on this call speaks only as of today, May 9, 2024, and therefore you're advised that such information may no longer be accurate as of the time of any replay listing or transcript reading. The comments made by management during this 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.

Speaker 1

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. The comments today will also include certain non GAAP financial measures. Additional details and reconciliations to the most comparable GAAP measures are included in yesterday's earnings release, which can be found on our website. Now, I'd like to turn the call over to Kodiak's CEO, Mr. Mickey McKee.

Speaker 1

Mickey?

Speaker 2

Thanks, Graham, and thank you for joining us today. Let me get started by welcoming all the talented and dedicated CSI employees to the Kodiak family. By joining our team, each of you are contributing to Kodiak's increased scale and scope of service offerings to our customers and helping further expand our industry leading footprint in key operating areas like the Permian Basin and Eagle Ford Shale. I would also like to thank all of our Kodiak employees who have worked on integration planning and execution, while simultaneously staying focused on our ongoing business, which produced record adjusted EBITDA for yet another consecutive quarter, extraordinary execution by an extraordinary workforce. We are now more than a month into the integration process with CSI and are extremely pleased with how the process is going.

Speaker 2

As I have previously stated, we are very confident in our ability deliver upon significant synergies provided by this combination, which will drive incremental value for our combined shareholder base. We are updating our guidance for the year and are very excited to announce revised adjusted EBITDA guidance of CAD580,000,000 to CAD610,000,000 This reflects a full year of Kodiak's contribution, 3 quarters of CSI's contribution and anticipated synergies we expect to realize throughout the rest of the year. John will discuss acquisition synergies further in his remarks along with providing Q1 highlights and reviewing our outlook in more detail. So let's jump into it. Our Q1 results came in better than expected while maintaining our industry leading horsepower utilization at 99.8%.

Speaker 2

In addition to record setting adjusted EBITDA contributions of $118,000,000 for the quarter, up 11% versus the prior year period, we continue to strategically grow our large horsepower Permian focused fleet, increasing revenue generating horsepower by over 26,000 horsepower in Q1. We also paid another quarterly well covered dividend with a compelling yield reinforcing our commitment to returning capital to shareholders consistent with our previously discussed capital allocation strategy targeting a 3.5x leverage by the end of 2025. But as you might imagine, I am even more excited for the future due to the step change we've made at Kodiak by becoming the largest contract compression provider in the industry with over 4,400,000 horsepower. We're still in the early days following the close of the CSI acquisition and are in the evaluation phase of determining if there are small non core assets that we could or should sell. Our strategy of focusing on large horsepower in liquids rich associated gas basins has not changed and the majority of the horsepower acquired in the transaction continues to fit that strategic growth profile.

Speaker 2

This increase in that strategic horsepower is extremely attractive given the long term bullish outlook for natural gas compression and the tight supply as reflected by our industry leading utilization level of 99.8%. As we have previously discussed, Kodiak is fully contracted on our 2024 new unit deliveries, including CSI new unit deliveries and we are now fully contracted through the 1st 3 quarters of 2025. When we couple that contracted growth with our leading position in the Permian Basin, the addition of CSI's more than 600,000 horsepower of large horsepower compressors, the result is a dominant position in the most prolific oil and gas producing regions in the United States. As many of our peers have recently discussed, the U. S.

Speaker 2

Is poised to see a step change in natural gas demand as numerous factors are shaping up to lay the foundation for a multi year period of above average growth. The next wave of U. S. Gulf Coast LNG export capacity is expected to become operational soon with the first project slated to start up in the Q4 of this year. Natural gas exports to Mexico are set to increase at a faster rate over the next several years.

Speaker 2

Lastly, we are expecting to see exponential growth in power demand due to the proliferation of AI and data center technology, which will largely have to be sourced from natural gas fired power generation. In total, we are seeing estimates that are calling for as much as a 20% increase in natural gas demand by 2,030. The Permian is strategically positioned to meet this incremental demand and supply the U. S. And the world with clean, reliable and cheap fuel to power energy security, while reducing worldwide emissions and energy poverty.

Speaker 2

However, in order to achieve this, there will need to be a large increase in horsepower compression capacity. Given the historical relationship between compression horsepower and domestic natural gas production, that much incremental demand would require more horsepower than the current combined fleets of Kodiak, our truck and USA Compression, which took decades to build. Combined with the well documented supply and demand macro trends for our industry, we believe Kodiak is well positioned to be the critical infrastructure partner of choice. Our focus on customers and employees, industry leading mechanical availability and utilization and our market position will be instrumental to meet this expected demand. And now I'll pass the call on to John Griggs to review Q1 financial highlights and discuss our updated outlook.

Speaker 2

John?

Speaker 3

Thanks, Mickey. Here's the key takeaway. 1st quarter Kodiak results came in better than expected, and we're optimistic about steady profitable growth in 'twenty four and beyond. That said, let me now highlight a few aspects of our Q1 standalone results. Total revenues were just under $216,000,000 up 13% compared to the Q1 of 2023.

Speaker 3

The increase in revenues was driven by year over year growth in both of our operating segments. Adjusted EBITDA was 118,000,000 dollars up over 3% from Q4 and nearly 11% compared to the same quarter of last year. Looking at our segments, compression operations revenues for the quarter were $193,000,000 up 2% 9% when compared to the Q4 and the same quarter a year ago respectively. The top line growth was driven by a combination of higher pricing on the incumbent fleet as the tight market has allowed us to recontract at higher rates as well as an increase in our overall revenue generating horsepower from fleet additions. Revenue generating horsepower increased by over 26,000 sequentially and 116,000 year over year.

Speaker 3

Fresh and Operations adjusted gross margin percentage was just shy of 66%, which is the high end of our guidance range. In our other services segment, revenues were $22,000,000 in the Q1 of $24,000,000 compared to $12,000,000 in the Q1 of last year. Other services adjusted gross margin was $4,400,000 compared to $3,400,000 in the Q1 of 2023. As we've discussed in prior calls, our other services segment is lumpy, but strategic. Station construction projects are synergistic with our compression business and require no capital.

Speaker 3

Every dollar of incremental cash flow adds to both our overall return on capital employed and discretionary cash flow, which in turn allows us to pay more dividends and invest in high return growth capital projects. In terms of CapEx for the Q1, our maintenance capital expenditure figure was just under $11,000,000 As a reminder, our maintenance spend is a function of the hours and age of our equipment and will vary by year depending upon when units were added to the fleet. Growth CapEx was $59,000,000 for the quarter, of which $6,000,000 was non new unit CapEx. As we mentioned last quarter, our growth CapEx this year is front end loaded, basically a function of when we ordered new units last year and you're seeing that in Q1. Moving to the balance sheet.

Speaker 3

As of March 31, we had debt of $1,900,000,000 consisting of the $750,000,000 in senior unsecured notes we issued in February and the rest borrowings under our ABL facility. Our credit agreement leverage ratio was just under 4 times. We ended the Q1 with approximately $1,100,000,000 of availability on the ABL facility. On April 1st, in connection with the closing on CSI, we drew down on our ABL to retire all of CSI's debt. Pro form a for the transaction and including fees and expenses paid on the closing date, we had total debt of approximately 2,600,000,000 dollars Let's turn to the updated 2024 outlook.

Speaker 3

We provided updated guidance ranges in yesterday's earnings release. Given that we've only owned CSI for a few weeks, we felt it was appropriate to provide relatively high level guidance this quarter. You should expect us to come out with more fulsome updated guidance in our Q2 earnings call in August. With that said, I'll reiterate what Mickey mentioned at the outset. We are more than pleased with the CSI acquisition.

Speaker 3

Our original investment thesis is proving true and at this point our previously estimated cost synergies seem conservative. For the full year, which includes 12 months of Kodiak but only 9 months of CSI and synergies, we expect revenues will range between $1,125,000,000 $1,175,000,000 and we estimate adjusted EBITDA to range between $580,000,000 $610,000,000 We expect maintenance CapEx to come in between $55,000,000 $65,000,000 In terms of growth CapEx, we're forecasting between 215,000,000 to $235,000,000 for the year. Bear in mind that the lion's share of that growth CapEx was committed by each of Kodiak and CSI during 2023 given the lead times on new equipment. Not included in that figure is approximately $35,000,000 of extraordinary capital expenditures related to the acquisition. Prior to close, we knew there would be a variety of cleanup items, but now that we've owned them for a few weeks, we have a good handle of what those are and what we need to spend.

Speaker 3

These are items like fleet upgrades to meet Kodiak's safety and emission standards, plus facilities and rolling stock to meet the needs of the combined company. We think it's important to knock as much of this out in 2024 as we can to get it behind us and solidify the foundation. Also, a meaningful portion of that $35,000,000 figure relates to non cash accounting accruals triggered by the transaction, including the conformance between our 2 companies of lease accounting methodologies and sales and use taxes on equipment purchases. We're obviously not guiding on 2025, but we don't see this type of CapEx spend being repeated in the future. To wrap things up, last week, our Board declared a quarterly dividend payment of $0.38 a share, which will be paid on May 20.

Speaker 3

This equates to an annualized dividend of $1.52 per share, yielding about 5.4% at a 2.4 times discretionary cash flow coverage ratio. Dividends are a key component of our capital allocation framework, which I will remind you encompasses measured growth plus an attractive return of and return on capital, all while living within cash flow and driving towards our 3.5 times leverage target by the end of 'twenty five. That's it for my prepared comments. Thank you for your participation and support. I'll hand it back to Mickey.

Speaker 2

Thanks, John. In summary, I would like to close the call by thanking the extraordinary women and men of Kodiak Gas Services and again welcoming the CSI employees to the Kodiak family, a company that is stronger than the sum of the parts. Each team member's hard work and dedication to safety and our customers are what makes Kodiak special and we would not be an industry leader without this commitment to excellence. We are very happy with the start of the year and we look forward to continuing profitable growth in 2024 and beyond, which we expect will further enhance value for all of our shareholders. At this point, we will open the line up for questions.

Speaker 2

Operator?

Operator

Thank you. We will now be conducting a question and answer session. Thank you. Our first question is coming from John McKay of Goldman Sachs. Please go ahead.

Speaker 4

Hey, good morning. I appreciate the time. Definitely appreciate all the comments and you guys just closed a month ago. And we're kind of probably going to look towards the Q2 call for a more kind of quantitative update. But would just love to hear any initial reads of potential revenue synergies or other pieces now that you've had your hands on these assets just for a little bit now and kind of what we can think about for maybe timeframe on rolling those out, understand it's still going to be high level?

Speaker 2

Yes, John. Hey, this is Mickey. Thanks for joining us today. Look, I think we're still trying to get our arms around kind of what potential revenue synergies are here. Our commercial team has been working diligently trying to align contracts with customers that are on contracts that are both Kodiak and CSI paper coming into the deal.

Speaker 2

So I think that there are revenue synergies to be had there. I think that we can bring a lot of business also in the ancillary revenue side of the business as well to CSI's legacy AMS business and I think that's going to be pretty impactful for us as well. But I think there's definitely some revenue synergies there And like you said, we're not quite ready to unpack those yet today.

Speaker 4

Maybe just looking at the quarter on kind of I guess talking legacy business now, margins are trending really well kind of top end of your range. Understand that will change a little bit for the 2Q numbers plus bringing the CSI business. But maybe just give us a read on kind of what's happening there? How you're feeling about that kind of underlying margin trajectory looking forward?

Speaker 2

Yes. So I think that I'll let John jump in here too and talk a little bit about that. But I think that what you're seeing here is a combination of both revenue rate increases, but also cost control. And I think what you'll see once we get the 2 businesses put together, you'll see a little bit of a drop in that gross margin just because CSI's contribution is a little bit lower than ours. So blended, it'll come back a little bit, but I think that's where you'll see those synergies start to take place in renewable purchasing power parts and pieces and that kind of thing that comes with a transaction like this.

Speaker 2

So we'll start to realize those synergies throughout the second half of

Speaker 3

the year. Yes. And I was just going to add to a little bit of what Mickey said. We're going to come back in the Q2 and kind of realign how the segments work because they had some different businesses than we have. So in addition to them in their contract services having just a lower margin, they also have different product lines.

Speaker 3

So this is the last you'll see of kind of the Kodiak compression operations. But I will leave you with being at the top end of the guidance range of 64% to 66% that we gave to start the year feels good, feels right and it feels sustainable. So we hope to carry that momentum into the back half of the year.

Speaker 4

Awesome. Appreciate that color. See you guys in 2 weeks. Thanks.

Speaker 2

Sounds good, John. Thanks.

Operator

Thank you. The next question is coming from Neal Dingmann of Truist Securities. Please go ahead.

Speaker 5

Good morning, guys. Thanks for the time. Guys, my first question is around I'd love to comment in there on the prepared remarks around the prospects for U. S. Natural gas demand to support AI and of course a lot of others have talked about that.

Speaker 5

My question around that is, do you all I know it's further down the line, but do you all envision a potential forming partnerships or do you all think there's something different strategically you all might be able to do on this build out versus what you've done historically?

Speaker 2

Potentially, Neil, I mean we're going to look at opportunities like that non going forward and looking at like kind of that strategic rationale there. There could be things we want to do there. I think that at this point in time though, we kind of look at that incremental demand as a really strong fundamental base for our growth and of the business and supporting our capital allocation strategy that we have in place already. So opportunities for different kind of lines of work and that kind of thing I think is something we'll be constantly evaluating. But at the end of the day that fundamental base business, which is the contract compression business is really going to be benefited from this incremental demand.

Speaker 5

Yes, I love that tailwind mix between that and LNG. My just follow-up is maybe for you or John, just one your contract volumes continue to be just extremely high, one of the obviously the best in the group. I'm just wondering because of this, would you all have or have you all considered potentially running with a bit more debt and boosting the shareholder return? I only ask because the contract margins look so phenomenal. I'm just wondering if you're able to run a little bit more because of that?

Speaker 2

I mean, I think that look, we're as a private company, I think you've heard some of my peers talk about it. As a private company, we ran with higher leverage than what we are today. But I think that our capital allocation strategy is something that we believe is focused on the right sort of mix between return of capital to shareholders and growth and living within our free cash flow to do so. So I think that the combination with CSI gives us a good amount of scale that we can kind of ratchet up some growth CapEx in the next couple of years after we get this thing kind of integrated and smoothed out here. But I think that something that's pretty key is our focus on that 3.5 times leverage by the end of 2025.

Speaker 2

That's a commitment we've made to shareholders and it's something we're going to stand pretty firm on. And yes, we do understand that Go

Speaker 5

ahead, John.

Speaker 2

Yes, we do understand that there's opportunity of balance for great return projects out there, but we're focused on that leverage.

Operator

Thank you. The next question is coming from Jeremy Tonet of JPMorgan Chase. Please go ahead.

Speaker 6

Hey, good morning, everyone. This is Eli on for Jeremy. Just wanted to maybe start on your views of the compression market overall. I think some of your competitors framed a 9 month lead time on some equipment, which maybe is coming in a bit from previously times of a year or more. I appreciate some of the commentary on increased nat gas demand you frame, but maybe if you can just speak to what you're seeing in the compression market more in the near term and your expectations?

Speaker 6

Thanks.

Speaker 2

Yes, absolutely. And yes, Caterpillar has brought in some deliveries on their large horsepower engines from kind of over a year to inside to kind of that 9 month range. Still takes an extraordinary amount of planning with our customers to get that equipment ordered out there that far in advance. I'll remind you that we don't spend $1 of CapEx on speculation that all of our CapEx spend a year plus out has a signed contract to back it up and support it. So we're not spending any speculative CapEx out there and planning with our customers very, very, very early on there.

Speaker 2

But I think that the delivery times coming in from Caterpillar there is, I wouldn't say is indicative of any softness in the market. Caterpillar has alleviated some supply chain bottlenecks and they are bringing in some deliveries a little bit. But I think what you'll see what we look at is the amount of capital discipline in the industry that's keeping and continuing in our peers and us and some of our customers and not overspending and flooding the market with equipment and we like to see it that way.

Speaker 3

Yes. And I'll chime in too and remind everybody, we said in the prepared remarks, but we've committed our CapEx all the way through the Q3 of next year on growth CapEx and that's indicative again of customer demand, not necessarily tied to that lead time on Caterpillar equipment. And when we reference industry structure and the discipline we're seeing, it's obvious to see it in the public guys, you track that. We of course monitor the private guys as well. And we really see discipline there as well.

Speaker 3

Capital is more difficult to access than it was in the past. That's more expensive. So we see the industry structure, the combination of demand and supply staying stronger for longer as a result of this new artificial intelligence driven boom in power, which ultimately results in more gas demand too. So we're really excited about the multiyear outlook.

Speaker 6

Awesome. Yes, that's helpful commentary and seems like a good shape for the market ahead. Maybe just pivoting a little bit to the revised guidance. You talked a bit about hitting the higher end of the compression operations gross margin, which is really great. Maybe can you just talk a bit about what might drive you guys to the higher end of that guide and things that we should be watching in the second half of the year?

Speaker 3

So I'll chime in there instead. I really want to come back to the comment I made earlier and that when we come out in Q2, you're going to see slightly different segment breakups and you're going to see slightly different margin profiles. So our 64% to 66% that we guided on for Kodiak standalone is going to be a different number. It's going to be a lower number by virtue of just doing simple math of combining CSI plus us. So you need to remember that we're not going to be talking about the same numbers.

Speaker 3

That said, on a standalone basis, as I mentioned earlier, being at the top end of the range in the Q1 feels good and it feels like it's sustainable. And I think the combination of our standalone business plus the synergies will allow us continue to chip away as we move forward throughout the year at improving that margin again, too. So expect us to come out in August in our Q2 earnings call with fulsome guidance and a better margin breakdown for you to model.

Speaker 6

All right. We'll look forward to that. Thanks, guys.

Operator

Thank you. The next question is coming from Zach Van Evernen of TPH. Please go ahead.

Speaker 7

Perfect. Thanks for taking my question, guys. Just one on maybe future bolt on acquisitions. You mentioned that you're focusing on liquids rich plays, but curious if you would ever look outside your key markets of the Permian, especially with the natural gas demand ramp happening in more of the dry gas regions?

Speaker 2

I think we'll be interested in looking at all sorts of M and A going forward. But I think that this our philosophy and theory of focusing on liquids rich associated gas basins is really proven to take really good care of us in the past. So I think we'll kind of stick with that strategy. I don't know if we jump into something that was really tied to dry gas basins and gas prices quite as much as any more than what we do now, which is very little. But from an M and A perspective, we'll be interested in looking at lots of different opportunities, compression and kind of associated ancillary services as well that are complementary to our business today.

Speaker 7

Perfect. That makes sense. And then just one on the synergies. The original $20,000,000 or greater than $20,000,000 you guys noted at the time of the acquisition. Is a lot of that on the cost side and should we see that show up fully in 2024 and then I'm sure there'll be some more in 2025 beyond once you guys get the business under your name?

Speaker 3

Yes. So Zach, good question. So when we announced the deal, and I think in all the first quarter the Q4 calls, we always stuck to our greater than $20,000,000 of cost synergies and that's all we referenced. If you do simple math on kind of where we've guided and used the midpoint of the range, you took the midpoint of where Kodiak was before $475,000,000 you take 3 quarters of the midpoint of where CSI guided, that's $105,000,000 that equals $580,000,000 in order to get to the midpoint of our range that would imply $15,000,000 realized synergies. The way we think about it and again in Q2 we'll come back with more detail is we're doing really, really well as a Kodiak standalone basis.

Speaker 3

CSI is kind of at or better kind of where they thought they would be. So those synergies are somewhere between 15% and something less than 15%. Remember, that's in 9 months. It's not an annualized figure that's realized during the back half of the year. So it's pretty easy to grow set up and say, hey, there's better than $20,000,000 in cost synergies.

Speaker 3

The question was asked earlier for Mickey on revenue synergies, and again, not guiding on that, not extrapolating, but they're there and we're optimizing against that fleet. So we're extremely confident that when we get through, call it, that 12 to 18 month timeframe that we will fully realize well beyond that original $20,000,000 of cost synergies that we always knew would be there.

Speaker 7

Perfect. That's all I had. Thanks, guys.

Operator

Thank you. The next question is coming from Bill Austin of Daniel Energy Partners. Please go ahead.

Speaker 3

Hey, guys. Thanks for taking my question. So you guys talked a little bit about the CapEx and the new units that you as you're seeing out there. How are you seeing deliveries for the remainder of this year on that new unit side? I know you committed all that CapEx last year and now you're kind of getting to all those coming in, are they coming in the next this quarter, next quarter, how are you guys seeing that?

Speaker 2

Yes, it's going to come in pretty smooth throughout the rest of the year. I think there's a big chunk in Q2 that CSI had ordered previously from last year, but that's all that'll be pretty evenly spread throughout the rest of the year for the combined entities. So we're not seeing anything slide or any supply chain issues or bottlenecks that would affect that right now and that's knock on wood. So you'll see those coming in pretty ratably throughout the rest of the year.

Speaker 3

Great. Yes, it's nice seeing that the supply chain stuff is getting a little bit more predictable. Yes. Anything yes, and I know you guys have addressed it a little bit on the M and A side. From an organic perspective, any other basins that you guys are looking at that sound exciting to start more focusing on or just kind of sticking to the knitting these days?

Speaker 2

Yes, I mean we obviously have plenty of work to do in the Permian Basin, but labor is a challenge there. So we're going to be open definitely to working on some additional type of basins that are are important to us. The Eagle Ford, Rocky Mountain region, some of the some stuff up in the Northeast, those are all areas that we think are opportunistic that have some liquids rich type of opportunities with associated gas that kind of fit into our overall thesis for the business.

Speaker 3

Great. Well, hey, thanks for taking my question, guys. Congrats on the quarter. I'll leave it to everyone else.

Speaker 2

Thanks, Bill.

Operator

Thank you. This brings us to the end of the question and answer session. I would like to turn the floor back over to Mr. McKee for closing comments.

Speaker 2

Thank you, operator, and thanks to everyone who participated in today's call. We look forward to speaking with you again after we report our Q2 results.

Operator

Ladies and gentlemen, this concludes today's event. You may disconnect your lines at this time and enjoy the rest of your day.

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Kodiak Gas Services Q1 2024
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