Kodiak Gas Services, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Report. The following discussion includes forward-looking statements that involve certain risks and uncertainties. For further information on items that could impact our future operating performance or financial condition, see the sections entitled “Risk Factors” in the IPO Prospectus and “Cautionary Statement Regarding Forward-Looking Statements” elsewhere in this Report. We assume no obligation to update any of these forward-looking statements, except as required by law. Unless otherwise indicated or the context otherwise requires, the historical financial information in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” reflects only the historical financial results of Kodiak Gas Services, Inc. and its consolidated subsidiaries and references to the “Company,” “we,” “our,” or “us” are to Kodiak Gas Services, Inc. and its consolidated subsidiaries. Overview We are a leading operator of contract compression infrastructure in the U.S. Our compression operations are critical to our customers’ ability to reliably produce natural gas and oil to support growing global energy demand. We are a market leader in the Permian Basin, which is the largest producing natural gas and oil basin in the U.S. We operate our large horsepower compression units under stable, fixed-revenue contracts with blue-chip upstream and midstream customers. Our compression assets have long useful lives consistent with the expected production lives of the key regions where we operate. We believe our partnership-focused business model positions us as the preferred contract compression operator for our customers and creates long-standing relationships. We strategically invest in the training, development, and retention of our highly skilled and dedicated employees and believe their expertise and commitment to excellence enhances and differentiates our business model. Furthermore, we maintain an intense focus on being one of the most sustainable and responsible operators of contract compression infrastructure. We manage our business through two operating segments: Compression Operations and Other Services. Compression Operations consists of operating Company-owned and customer-owned compression infrastructure for our customers, pursuant to fixed-revenue contracts to enable the production, gathering and transportation of natural gas and oil. Other Services consists of a full range of contract services to support the needs of our customers, including station construction, maintenance and overhaul and other ancillary time and material based offerings. Our Other Services offerings are often cross-sold with Compression Operations. Operational Highlights The following table summarizes certain horsepower, unit count and horsepower utilization percentages for our fleet for the periods presented. As of September 30, Percentage Change 2023 2022 Operating Data (at period end): Fleet horsepower (1) 3,213,096 3,106,316 3.4 % Revenue-generating horsepower (2) 3,210,076 3,098,545 3.6 % Fleet compression units 3,051 3,011 1.3 % Revenue-generating compression units 3,034 3,004 1.0 % Revenue-generating horsepower per revenue-generating compression unit (3) 1,058 1,031 2.6 % Horsepower utilization (4) 99.9 % 99.7 % 0.2 % (1) Fleet horsepower includes revenue-generating horsepower and idle horsepower, which is comprised of compression units that do not have a signed contract or are not subject to a firm commitment from our customer and are no longer generating revenue. Fleet horsepower excludes 31,520 and 60,025 of non-marketable or obsolete horsepower as of September 30, 2023 and 2022, respectively. (2) Revenue-generating horsepower includes compression units that are operating under contract and generating revenue and compression units which are available to be deployed and for which we have a signed contract or are subject to a firm commitment from our customer. (3) Calculated as (i) revenue-generating horsepower divided by (ii) revenue-generating compression units at period end. (4) Horsepower utilization is calculated as (i) revenue-generating horsepower divided by (ii) fleet horsepower. 20 Table of Contents Horsepower The 3.4% and 3.6% increase in fleet horsepower and revenue-generating horsepower, respectively, were primarily attributable to the purchase and deployment of new compression units through organic growth with our existing customer base as well as select new customers in the key regions in which we operate. The 2.6% increase in revenue-generating horsepower per revenue-generating compression unit was due to the purchase and deployment of new, large horsepower units. Financial Results of Operations Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022 The following table presents selected financial and operating information for the periods presented ( in thousands ): For the Three Months Ended September 30, % Change 2023 2022 Revenues: Compression operations $ 186,673 $ 163,662 14.1 % Other services 44,310 18,983 133.4 % Total revenues 230,983 182,645 26.5 % Operating expenses: Cost of operations (exclusive of depreciation and amortization shown below): Compression operations 65,470 55,872 17.2 % Other services 38,820 14,037 176.6 % Depreciation and amortization 46,087 44,111 4.5 % Selling, general and administrative expenses 19,648 11,190 75.6 % Gain on sale of capital assets — (818) nm Total operating expenses 170,025 124,392 36.7 % Income from operations 60,958 58,253 4.6 % Other income (expenses): Interest expense, net (39,710) (49,859) (20.4) % Loss on extinguishment of debt (6,757) — nm Gain on derivatives 15,141 51,862 (70.8) % Other income (expense) 38 (19) (300.0) % Total other income (expenses) (31,288) 1,984 (1,677.0) % Income before income taxes 29,670 60,237 Income tax expense 7,904 14,337 (44.9) % Net income $ 21,766 $ 45,900 (52.6) % Revenues and Sources of Income Compression Operations Compression Operations revenue increased $23.0 million (14.1%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Substantially all, or $22.9 million, of the increase was the result of an increase in average revenue-generating horsepower as a result of increased demand for our compression operations and due to an increase in average revenue per revenue-generating horsepower per month. Other Services Other Services revenue increased $25.3 million (133.4%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This increase was primarily due to a $24.3 million increase in revenue from 21 Table of Contents station construction services driven primarily by increases in demand and scope of station projects, and a $1.0 million increase in revenue from parts and service, driven by increased customer demand. Operating Costs and Other Expenses Compression Operations Compression Operations expenses increased $9.6 million (17.2%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This was primarily due to a $4.6 million increase in direct expenses, driven by increases in pricing and volume of lubricant oil and coolant and parts to support increased activity, a $3.0 million increase in direct labor expenses related to increased headcount and salaries, a $1.9 million increase in indirect expenses, and a $0.1 million increase in freight and crane charges that are directly reimbursable by our customers. Other Services Other Services expense increased $24.8 million (176.6%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 This increase was primarily due to a $23.7 million increase in expenses from station construction services driven primarily by increases in demand and scope of station projects, and $1.1 million from parts and service, driven by increased customer demand. Depreciation and Amortization Depreciation and Amortization increased $2.0 million (4.5%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This was primarily due to an increase in compression equipment purchased, which resulted in increased depreciation associated with that equipment. Selling, General and Administrative Expense Selling, General and Administrative expenses increased $8.5 million (75.6%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This was primarily due to a $2.5 million increase in stock compensation expense mainly related to share-based compensation awards granted as part of the IPO, a $2.0 million increase in bad debt expense related to expected credit losses from a customer in bankruptcy experiencing financial distress, a $1.1 million increase in labor and benefits, mainly related to increased headcount and salaries, a $1.1 million increase in professional fees mainly related to transaction costs and a $0.6 million increase in other overhead expenses, primarily as a result of higher insurance, office expenses, and other general administrative expenses. Interest Expense, Net Interest expense, net decreased $10.1 million (20.4%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This decrease is primarily due to the extinguishment of the Term Loan in July 2023; partially offset by an increase in the effective interest rate on the ABL Facility. Loss on Extinguishment of Debt Loss on extinguishment of debt increased $6.8 million related to the write off of debt issuance costs and other fees as a result of the extinguishment of the Term Loan during the three months ended September 30, 2023. No such loss was recognized in the three months ended September 30, 2022. Gain on Derivatives Gain on derivatives decreased $36.7 million (70.8%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This is primarily related to an $8.0 million increase in the fair value of derivatives due to an increase in the long-term SOFR yield curve and cash received on derivatives of $7.2 million, as compared to a $53.9 million increase in the fair value of derivatives due to an increase in the long-term SOFR yield curve and cash paid on derivatives of $2.0 during the three months ended September 30, 2023 and 2022, respectively. Income tax expense Income tax expense decreased by $6.4 million (44.9%) for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. This was primarily due to a decrease in pre-tax income of $45.0 million for the three months ended September 30, 2023 compared to pre-tax income for the three months ended September 30, 2022. 22 Table of Contents Financial Results of Operations Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022 The following table presents selected financial and operating information for the periods presented (in thousands) : For the Nine Months Ended September 30, % Change 2023 2022 Revenues: Compression operations $ 545,989 $ 483,965 12.8 % Other services 78,412 44,172 77.5 % Total revenues 624,401 528,137 18.2 % Operating expenses: Cost of operations (exclusive of depreciation and amortization shown below): Compression operations 193,257 167,145 15.6 % Other services 65,907 34,638 90.3 % Depreciation and amortization 136,414 129,913 5.0 % Selling, general and administrative expenses 46,171 32,760 40.9 % Gain on sale of capital assets (721) (825) (12.6) % Total operating expenses 441,028 363,631 21.3 % Income from operations 183,373 164,506 11.5 % Other income (expenses): Interest expense, net (182,030) (104,616) 74.0 % Loss on extinguishment of debt (6,757) — nm Gain on derivatives 42,080 76,972 (45.3) % Other income (expense) 39 (10) (490.0) % Total other expenses (146,668) (27,654) 430.4 % Income before income taxes 36,705 136,852 (73.2) % Income tax expense 9,765 32,496 (70.0) % Net income $ 26,940 $ 104,356 (74.2) % Revenues and Sources of Income Compression Operations Compression Operations revenue increased $62.0 million (12.8%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. The $62.0 million increase was the result of an increase in average revenue-generating horsepower as a result of increased demand for our compression operations and due to an increase in average revenue per revenue-generating horsepower per month. Other Services Other Services revenue increased $34.2 million (77.5%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This increase was primarily due to a $29.8 million increase in revenues from station construction services driven primarily by increases in demand and scope of station projects, and $4.4 million from parts and service, driven by increased customer demand. 23 Table of Contents Operating Costs and Other Expenses Compression Operations Compression Operations expenses increased $26.1 million (15.6%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This was primarily due to a $11.6 million increase in direct expenses, driven by increases in pricing and volume of lubricant oil and coolant and parts to support increased activity, a $9.9 million increase in direct labor expenses related to increased headcount and salaries, a $4.7 million increase in indirect expenses; partially offset by a $0.1 million decrease in freight and crane charges that are directly reimbursable by our customers. Other Services Other Services expense increased $31.3 million (90.3%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This was primarily due to a $27.6 million increase in expenses from station construction services driven primarily by increases in demand and scope of station projects and $3.7 million from parts and service, driven by increased customer demand. Depreciation and Amortization Depreciation and Amortization increased $6.5 million (5.0%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This was primarily due to an increase in compression equipment purchased, which resulted in increased depreciation associated with that equipment. Selling, General and Administrative Expense Selling, General and Administrative expenses increased $13.4 million (40.9%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This was primarily due to a $3.1 million increase in labor and benefits, mainly related to increased headcount and salaries, a $2.8 million increase in stock compensation expense related to equity compensation plans, a $2.0 million increase in bad debt expense related to expected credit losses from a customer in bankruptcy experiencing financial distress, a $2.5 million increase in professional fees mainly related to transactions costs, and a $2.5 million increase in other overhead expenses, primarily as a result of higher insurance, entertainment and office expenses. Interest Expense, Net Interest expense, net increased $77.4 million (74.0%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This is primarily due to (i) an increase in borrowings under the ABL Facility and Term Loan, of which $825 million was related to the May 2022 recapitalization (as discussed in Note 9 (“Debt and Credit Facilities”) to the Condensed Consolidated Financial Statements included elsewhere in this Report) and (ii) increased effective interest rates on the ABL Facility and Term Loan. This was partially offset by the extinguishment of the Term Loan in July 2023. Loss on Extinguishment of Debt Loss on extinguishment of debt increased $6.8 million related to the write off debt issuance costs and other fees as a result of the extinguishment of the Term Loan during the nine months ended September 30, 2023. No such loss was recognized in the nine months ended September 30, 2022. Gain on Derivatives Gain on derivatives decreased $34.9 million (45.3%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This is primarily related to a $25.8 million settlement on the termination of derivatives attributable to the Term Loan and $29.8 million cash received on derivative settlements on our interest rate swaps and collars, offset by a decrease in the change in fair value of the derivatives of $13.5 million during the nine months ended September 30, 2023, as compared to a $9.7 million cash paid on derivatives on our interest rate swaps and collars, offset by an increase in the change in fair value of derivatives of $86.7 million during the nine months ended September 30, 2022 due to an increase in the long-term SOFR and LIBOR yield curves. 24 Table of Contents Income tax expense Income tax expense decreased by $22.7 million (70.0%) for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. This was primarily due to a decrease in pre-tax income of $114.5 million for the nine months ended September 30, 2023 compared to pre-tax income for the nine months ended September 30, 2022. Liquidity and Capital Resources Overview Our ability to fund operations, finance capital expenditures, service our debt, and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets. Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under the ABL Facility. Our cash flow is affected by numerous factors including prices and demand for our compression infrastructure assets, conditions in the financial markets and other factors. We believe cash generated by operating activities will be sufficient to service our debt, fund working capital, fund our estimated capital expenditures and, as our board of directors may determine from time to time in its discretion, pay dividends. Cash Requirements Capital Expenditures The compression infrastructure business is capital intensive, requiring significant investment to expand, maintain, and upgrade existing operations. Our capital requirements have consisted primarily of, and we anticipate that our capital requirements will continue to consist primarily of, the following: • Growth Capital Expenditures: (1) capital expenditures made to expand the operating capacity or operating income capacity of assets by acquisition of additional compression units, (2) capital expenditures made to maintain the operating capacity or operating income capacity of assets by acquisition of replacement compression units and (3) capital expenditures on assets required to operate the business but not including compression units—such as trucks, wash trailers, crane trucks, leasehold improvements, technology hardware and software and related implementation expenditures, furniture and fixtures, and other general items that are typically capitalized and that have a useful life beyond one year. We make capital expenditures not related to our compression units (as described in clause (3) above) if and when necessary to support the operations of our revenue-generating horsepower. • Maintenance Capital Expenditures: periodic capital expenditures incurred at predetermined operating intervals to maintain consistent and reliable operating capacity of our assets over the near term. Such maintenance capital expenditures typically involve overhauls of significant components of our compression units, such as the engine and compressor, pistons, rings, heads, and bearings. These maintenance capital expenditures are predictable and the majority of these expenditures are tied to a detailed, unit-by-unit schedule based on hours of operation or age. We utilize a disciplined and systematic asset management program whereby we perform major unit overhauls and engine replacements on a defined schedule based on hours of operation. As a result, our maintenance capital expenditures may vary considerably from year to year based on when such assets were added to the fleet. Maintenance capital expenditures along with regularly scheduled preventive maintenance expenses are typically sufficient to sustain operating capacity of our assets over the full expected useful life of the compression units. Maintenance capital expenditures do not include expenditures to replace compression units when they reach the end of their useful lives. The majority of our growth capital expenditures are related to the acquisition cost of new compression units. Maintenance capital expenditures are related to overhauls of significant components of our compression equipment, such as the engine and compressor, which return the components to a like-new condition, but do not modify the application for which the compression equipment was designed. For the nine months ended September 30, 2023, growth capital expenditures were $124.0 million and maintenance capital expenditures were $28.1 million. For the nine months ended September 30, 2022, growth capital expenditures were $163.2 million and maintenance capital expenditures were $27.8 million. The decrease in growth capital expenditures was primarily related to an adjustment to our capital allocation framework in conjunction with the Company's IPO and subsequent desire to pay a regular dividend. The decrease in maintenance capital expenditures was primarily a result of a decrease in scheduled unit overhauls that occurred based on the age and operating hours of such units. 25 Table of Contents Dividends Our board of directors may elect to declare cash dividends on our common stock, subject to our compliance with applicable law, and depending on, among other things, economic conditions, our financial condition, results of operations, projections, liquidity, earnings, legal requirements, and restrictions in the agreements governing our indebtedness (as further discussed herein). If and to the extent our board of directors were to declare a cash dividend to our stockholders, we expect the dividend to be paid from our Discretionary Cash Flow. The timing, amount and financing of dividends, if any, will be subject to the discretion of our board of directors from time to time. On October 24, 2023, our board of directors declared a quarterly cash dividend to be paid on November 10, 2023 to all stockholders of record as of the close of business on November 3, 2023. See Note 20 (“Subsequent Events”) to the Condensed Consolidated Financial Statements included elsewhere in this Report. Over the long-term, we expect to fund any dividends and our budgeted growth capital expenditures using our Discretionary Cash Flow. In the event our Discretionary Cash Flow is insufficient for the purpose of funding any such dividends and our budgeted growth capital expenditures for such period, we may fund such shortfall (i) with additional borrowings under our ABL Facility, which as of September 30, 2023 had $396.2 million available (subject to the requirement that our availability, in the case of dividends, under the ABL Facility exceeds the greater of (x) 10% of the total commitments under the facility of $2.2 billion or (y) $200 million) or (ii) reduce our growth capital expenditures for such period. Any such additional borrowings under our ABL Facility will result in an increase in our interest expense for such period. Any such reduction in our growth capital expenditures may result in lower growth in our revenue-generating horsepower in future periods. Contractual Obligations Our material contractual obligations as of September 30, 2023 consisted of the following: • Long-term debt of $1.8 billion, which is due in 2028. • Purchase commitments of $215.7 million, of which $182.9 million is expected to be settled within the next twelve months; primarily consisting of future commitments to purchase new compression units ordered but not received. See Note 13 (“Commitments and Contingencies”) to the Condensed Consolidated Financial Statements included elsewhere in this Report. Other Commitments As of September 30, 2023, other commitments include operating lease payments totaling $52.6 million. Sources of Cash Cash Flows The following table summarizes our cash flows for the nine months ended September 30, 2023, and 2022 ( in thousands ): Nine Months Ended September 30, 2023 2022 $ Variance Net cash provided by operating activities $ 203,699 $ 186,854 $ 16,845 Net cash used in investing activities (144,563) (191,770) 47,207 Net cash used in financing activities (73,439) (2,543) (70,896) Net decrease in cash and cash equivalents $ (14,303) $ (7,459) $ (6,844) Operating Activities The $16.8 million increase in net cash provided by operating activities for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was primarily due to a $38.9 million increase in Adjusted Gross Margin and an increase in cash received on derivatives of $65.3 million, partially offset by an increase of interest expense, net of $77.4 million; further impacted by changes in working capital such as a decrease in inventory purchases of $10.1 million, an increase in contract liability of $10.8 million, an increase in accounts receivable, net of $26.4 million, and an increase in prepaid expenses and other current assets of $4.3 million. 26 Table of Contents Investing Activities The $47.2 million decrease in net cash used in investing activities for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was primarily due to a $54.4 million decrease in growth capital expenditures offset by a $7.0 million decrease in proceeds from sale of assets and a $0.3 million increase in maintenance capital expenditures. Financing Activities The $70.9 million increase in net cash used in financing activities for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was primarily due to a decrease in borrowings on debt instruments of $652.6 million, an increase in payments on debt instruments of $475.9 million, an increase in offering costs of $9.2 million, an increase in payments of debt issuance cost of $5.0 million, and an increase in payment related to loss on extinguishment of debt of $1.8 million. This was offset by an increase in net proceeds from the IPO of $277.9 million and a decrease in equity distribution of $795.7 million. Description of Indebtedness ABL Facility As of January 1, 2022, a wholly-owned subsidiary of Kodiak had an ABL Facility with unaffiliated secured lenders and JPMorgan Chase Bank, N.A., as administrative agent. On March 22, 2023, wholly-owned subsidiaries of Kodiak entered into the Fourth Amended and Restated ABL Credit Agreement with the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent (as amended or restated from time to time, the “ABL Credit Agreement”), whereby the total facility (among other things) was increased to $2.2 billion and certain changes were made to our financial covenants and maturity date. On May 31, 2023, the ABL Credit Agreement was amended to, among other things, permit distributions of overallotment proceeds from the IPO and revise the terms related to the payment and prepayment of the Term Loan. On June 27, 2023, the ABL Credit Agreement was further amended to remove the ability to make distributions related to overallotment proceeds from the IPO and to instead require prepayment of the obligations and cash collateralization of any letter of credit exposure upon the issuance of any equity interests by Kodiak pursuant to the overallotment in the IPO. In connection with the IPO, the Company became a borrower under the ABL Facility. In connection with the IPO, the Company became a borrower under the ABL Facility. As of September 30, 2023, there was $14.7 million letters of credit outstanding under the ABL Facility. The maturity date of the ABL Facility is March 22, 2028. See Note 9 (“Debt and Credit Facilities”) to the Condensed Consolidated Financial Statements included elsewhere in this Report. The ABL Credit Agreement requires that we meet certain financial ratios. Commencing with the first fiscal quarter ended September 30, 2023, we must maintain an interest coverage ratio (as defined in the ABL Credit Agreement) of not less than 2.50 to 1.00, determined as of the last day of each fiscal quarter. Additionally, commencing with the first fiscal quarter ending after the completion of the IPO but prior to the occurrence of certain issuances of unsecured debt (for purposes of this description, an “Unsecured Debt Issuance”), our Leverage Ratio (as defined in the ABL Credit Agreement), determined quarterly as of the last day of each fiscal quarter, may not exceed (i) 5.25 to 1.00 for the fiscal quarters ending September 30, 2023 and December 31, 2023, (ii) 5.00 to 1.00 for the fiscal quarter ending March 31, 2024, (iii) 4.75 to 1.00 for the fiscal quarter ending June 30, 2024 and (iv) 4.50 to 1.00 for each fiscal quarter ending on or after September 30, 2024. All obligations under the ABL Facility are collateralized by essentially all the assets of the Company. We were in compliance with all covenants as of September 30, 2023 and December 31, 2022. The ABL Credit Agreement also restricts the Company’s ability to: incur additional indebtedness and guarantee indebtedness; pay dividends or make other distributions or repurchase or redeem equity interests; prepay, redeem or repurchase certain debt; issue certain preferred units or similar equity securities; make loans and investments; sell, transfer or otherwise dispose of assets; incur liens; enter into transactions with affiliates; enter into agreements restricting the Company’s restricted subsidiaries’ ability to pay dividends; enter into certain swap agreements; amend certain organizational documents; enter into sale and leaseback transactions; and consolidate, merge or sell all or substantially all of the Company’s assets. The applicable interest rate under the ABL Facility is (i) in the case of SOFR-based borrowings, the Term SOFR or Daily Simple SOFR rate then in effect (subject to a floor of 0%) plus 0.10% plus a spread that depends on our Leverage Ratio as of the most recent determination date ranging from 2.00% if our Leverage Ratio is less than or equal to 3.00:1.00 to 3.00% if our Leverage Ratio is greater than 5.50:1.00 and (ii) in the case of prime rate-based borrowings, the prime rate (subject to 27 Table of Contents a floor of 2.5%) plus a spread that depends on our Leverage Ratio as of the most recent determination date ranging from 1.00% if our Leverage Ratio is less than or equal to 3.00:1.00 to 2.00% if our Leverage Ratio is greater than 5.50:1.00. The applicable interest rates as of September 30, 2023 were 10.25% (prime rate plus 1.75%) and 8.28% (Term SOFR rate plus 0.10% plus 2.75%). The applicable interest rates as of December 31, 2022 were 9.50% (prime rate plus 2.00%) and 7.60% (Term SOFR rate plus 0.10% plus 3.00%). We pay an annualized commitment fee of 0.25% on the unused portion of our ABL Facility if borrowings are greater than 50% of total commitments and 0.50% on the unused portion on the ABL Facility if borrowings are less than 50% of total commitments. Term Loan As of January 1, 2022, a wholly-owned subsidiary of Kodiak had a term loan (the “Term Loan”) pursuant to a credit agreement with unaffiliated unsecured lenders and Wells Fargo Bank, N.A., as administrative agent. On May 19, 2022, we entered into the Term Loan Credit Agreement (as amended from time to time, the “Term Loan Credit Agreement”) whereby we increased the aggregate commitments under the Term Loan from $400 million to $1 billion. On March 31, 2023, our wholly-owned subsidiary entered into the First Amendment to the Term Loan Credit Agreement, which extended the maturity date to September 22, 2028. On July 3, 2023, we used the net proceeds of our IPO, together with the proceeds resulting from the Term Loan Derivative Settlement and borrowings under our ABL Facility, to repay $300 million of borrowings outstanding under the Term Loan. In connection with the IPO, all of the Company’s and its subsidiaries’ remaining obligations under the Term Loan were assumed by a parent entity of Kodiak Holdings, and the Company’s obligations thereunder were terminated. As a result, the Company is no longer a borrower or guarantor under, nor otherwise obligated with respect to the debt outstanding under the Term Loan. We were in compliance with all financial covenants as of December 31, 2022 and through the date of termination. The applicable interest rates were 12.16% and 10.67% as of June 30, 2023 and December 31, 2022, respectively. Derivatives and Hedging Activities To mitigate a portion of the exposure to fluctuations in the variable interest rate of the ABL Facility and the Term Loan, we have entered into various derivative instruments. Our interest rate swaps exchange variable interest rates for fixed interest rates. We have not designated any derivative instruments as hedges for accounting purposes and do not enter into such instruments for speculative or trading purposes. See Note 10 (“Derivative Instruments”) to the Condensed Consolidated Financial Statements included elsewhere in this Report. Parent Entity Distribution On June 27, 2023, we made a cash distribution of $42.3 million to a parent entity of Kodiak Holdings prior to the consummation of the IPO, of which $11.0 million was funded with cash on hand and $31.3 million was funded with borrowings under the ABL Facility. Non-GAAP Financial Measures Management uses a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include the non-GAAP financial measures of Adjusted Gross Margin, Adjusted Gross Margin Percentage, Adjusted EBITDA, Adjusted EBITDA Percentage, Discretionary Cash Flow and Free Cash Flow. Adjusted Gross Margin and Adjusted Gross Margin Percentage Adjusted Gross Margin is a non-GAAP financial measure. We define Adjusted Gross Margin as revenue less cost of operations, exclusive of depreciation and amortization expense. We believe that Adjusted Gross Margin is useful as a supplemental measure to our operating profitability. Adjusted Gross Margin is impacted primarily by the pricing trends for service operations and cost of operations, including labor rates for service technicians, volume and per compression unit costs for lubricant oils and coolants, quantity and pricing of routine preventative maintenance on compression units and property tax rates on compression units. Adjusted Gross Margin should not be considered an alternative to, or more 28 Table of Contents meaningful than, gross margin or any other measure of financial performance presented in accordance with GAAP. Moreover, Adjusted Gross Margin as presented may not be comparable to similarly titled measures of other companies. Because we capitalize assets, depreciation and amortization of equipment is a necessary element of our costs. To compensate for the limitations of Adjusted Gross Margin as a measure of our performance, we believe that it is important to consider gross margin determined under GAAP, as well as Adjusted Gross Margin, to evaluate our operating profitability. Adjusted Gross Margin for Compression Operations Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 (in thousands) (in thousands) Total revenues $ 186,673 $ 163,662 $ 545,989 $ 483,965 Cost of sales (excluding depreciation and amortization) (65,470) (55,872) (193,257) (167,145) Depreciation and amortization (46,087) (44,111) (136,414) (129,913) Gross margin $ 75,116 $ 63,679 $ 216,318 $ 186,907 Gross margin percentage 40.2% 38.9% 39.6% 38.6% Depreciation and amortization 46,087 44,111 136,414 129,913 Adjusted Gross Margin $ 121,203 $ 107,790 $ 352,732 $ 316,820 Adjusted Gross Margin Percentage (1) 64.9% 65.9% 64.6% 65.5% (1) Calculated using Adjusted Gross Margin for Compression Operations as a percentage of total Compression Operations revenues. Adjusted Gross Margin for Other Services Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 (in thousands) (in thousands) Total revenues $ 44,310 $ 18,983 $ 78,412 $ 44,172 Cost of sales (excluding depreciation and amortization) (38,820) (14,037) (65,907) (34,638) Depreciation and amortization — — — — Gross margin $ 5,490 $ 4,946 $ 12,505 $ 9,534 Gross margin percentage 12.4% 26.1% 15.9% 21.6% Depreciation and amortization — — — — Adjusted Gross Margin $ 5,490 $ 4,946 $ 12,505 $ 9,534 Adjusted Gross Margin Percentage (1) 12.4% 26.1% 15.9% 21.6% (1) Calculated using Adjusted Gross Margin for Other Services as a percentage of total Other Services revenues. Adjusted EBITDA and Adjusted EBITDA Percentage We define Adjusted EBITDA as net income (loss) before interest expense, net: income tax expense (benefit); and depreciation and amortization; plus (i) loss on extinguishment of debt; (ii) loss (gain) on derivatives; (iii) equity compensation expense; (iv) transaction expenses; (v) loss (gain) on sale of assets; and (vi) impairment of compression equipment. We define Adjusted EBITDA Percentage as Adjusted EBITDA divided by total revenues. Adjusted EBITDA and Adjusted EBITDA Percentage are used as supplemental financial measures by our management and external users of our financial statements, such as investors, commercial banks and other financial institutions, to assess: • the financial performance of our assets without regard to the impact of financing methods, capital structure or historical cost basis of our assets; 29 Table of Contents • the viability of capital expenditure projects and the overall rates of return on alternative investment opportunities; • the ability of our assets to generate cash sufficient to make debt payments and pay dividends; and • our operating performance as compared to those of other companies in our industry without regard to the impact of financing methods and capital structure. We believe that Adjusted EBITDA and Adjusted EBITDA Percentage provide useful information because, when viewed with our GAAP results and the accompanying reconciliation, they provide a more complete understanding of our performance than GAAP results alone. We also believe that external users of our financial statements benefit from having access to the same financial measures that management uses in evaluating the results of our business. Adjusted EBITDA and Adjusted EBITDA Percentage should not be considered as alternatives to, or more meaningful than, revenues, net income, operating income, cash flows from operating activities or any other measure of financial performance presented in accordance with GAAP as measures of operating performance and liquidity. Moreover, our Adjusted EBITDA and Adjusted EBITDA Percentage as presented may not be comparable to similarly titled measures of other companies. Given we are a capital intensive business, depreciation, impairment of compression equipment and the interest cost of acquiring compression equipment are necessary elements of our costs. To compensate for these items, we believe that it is important to consider both net income and net cash provided by operating activities determined under GAAP, as well as Adjusted EBITDA and Adjusted EBITDA Percentage, to evaluate our financial performance and our liquidity. Our Adjusted EBITDA and Adjusted EBITDA Percentage exclude some, but not all, items that affect net income and net cash provided by operating activities, and these measures may vary among companies. Management compensates for the limitations of Adjusted EBITDA and Adjusted EBITDA Percentage as an analytical tool by reviewing the comparable GAAP measures, understanding the differences between the measures and incorporating this knowledge into management’s decision-making processes. The following table reconciles net income, the most directly comparable GAAP financial measure, to Adjusted EBITDA, its most directly comparable Non-GAAP financial measure, for each of the periods presented (in thousands) : Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Net income $ 21,766 $ 45,900 $ 26,940 $ 104,356 Interest expense, net 39,710 49,859 182,030 104,616 Income tax expense 7,904 14,337 9,765 32,496 Depreciation and amortization 46,087 44,111 136,414 129,913 Loss on extinguishment of debt 6,757 — 6,757 — Gain on derivatives (15,141) (51,862) (42,080) (76,972) Equity compensation expense (1) 2,544 — 3,452 619 Transaction expenses (2) 440 — 1,713 1,600 Gain on sale of capital assets — (818) (721) (825) Adjusted EBITDA $ 110,067 $ 101,527 $ 324,270 $ 295,803 Adjusted EBITDA Percentage 47.7% 55.6% 51.9% 56.0% (1) For the three months ended September 30, 2023, there was $2.5 million of non-cash adjustments for equity compensation expense. For the three months ended September 30, 2022, there was no such adjustment. For the nine months ended September 30, 2023 and 2022, there were $3.4 million and $0.6 million, respectively, of non-cash adjustments for equity compensation expense. (2) Represents certain costs associated with non-recurring professional services, our equity owners’ expenses and other costs. 30 Table of Contents The following table reconciles net cash provided by operating activities to Adjusted EBITDA for each of the periods presented (in thousands) : Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Net cash provided by operating activities $ 85,731 $ 59,207 $ 203,699 $ 186,854 Interest expense, net 39,710 49,859 182,030 104,616 Income tax expense 7,904 14,337 9,765 32,496 Deferred tax provision (5,551) (11,833) (6,312) (26,807) Cash (received) paid on derivatives (7,163) 1,992 (55,631) 9,704 Loss on extinguishment of debt 2,398 — 2,398 — Transaction expenses (1) 440 — 1,713 1,600 Other (2) (3,705) (5,066) (16,814) (11,978) Change in operating assets and liabilities (9,697) (6,969) 3,422 (682) Adjusted EBITDA $ 110,067 $ 101,527 $ 324,270 $ 295,803 (1) Represents certain costs associated with non-recurring professional services, our equity owners’ expenses and other costs. (2) Includes amortization of debt issuance costs, non-cash lease expense, provision for credit losses and inventory reserve. Discretionary Cash Flow We define Discretionary Cash Flow as net cash provided by operating activities less (i) maintenance capital expenditures;(ii) gain on sale of capital assets; (iii) certain changes in operating assets and liabilities; and (iv) certain other expenses; plus (x) cash loss on extinguishment of debt; and (y) transaction expenses. We believe Discretionary Cash Flow is a useful liquidity and performance measure and supplemental financial measure for us in assessing our ability to pay cash dividends to our stockholders, make growth capital expenditures and assess our operating performance. Our ability to pay dividends is subject to limitations due to restrictions contained in our ABL Credit Agreement as further described elsewhere herein. Discretionary Cash Flow is presented for supplemental informational purposes only and should not be considered a substitute for financial information presented in accordance with GAAP, such as revenues, net income, operating income (loss) or cash flows from operating activities. Discretionary Cash Flow as presented may not be comparable to similarly titled measures of other companies. Free Cash Flow We define Free Cash Flow as net cash provided by operating activities less (i) maintenance capital expenditures;(ii) gain on sale of capital assets; (iii) certain changes in operating assets and liabilities; (iv) certain other expenses; and (v) net growth capital expenditures; plus (x) cash loss on extinguishment of debt; (y) transaction expenses; and (z) proceeds from sale of capital assets. We believe Free Cash Flow is a liquidity measure and useful supplemental financial measure for us in assessing our ability to pursue business opportunities and investments to grow our business and to service our debt. Free Cash Flow is presented for supplemental informational purposes only and should not be considered a substitute for financial information presented in accordance with GAAP, such as revenues, net income (loss), operating income (loss) or cash flows from operating activities. Free Cash Flow as presented may not be comparable to similarly titled measures of other companies. 31 Table of Contents The following table reconciles net cash provided by operating activities, to Discretionary Cash Flow and Free Cash Flow, for each of the periods presented (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Net cash provided by operating activities $ 85,731 $ 59,207 $ 203,699 $ 186,854 Maintenance capital expenditures (1) (12,312) (10,340) (28,056) (27,771) Loss on extinguishment of debt 2,398 — 2,398 — Transaction expenses (2) 440 — 1,713 1,600 Gain on sale of capital assets — (818) (721) (825) Change in operating assets and liabilities (9,697) (6,969) 3,422 (682) Other (3) (3,516) (7) (4,833) (1,700) Discretionary Cash Flow $ 63,044 $ 41,073 $ 177,622 $ 157,476 Growth capital expenditures (4)(5) (55,671) (36,572) (124,015) (163,162) Proceeds from sale of capital assets — 8,010 1,055 8,023 Free Cash Flow $ 7,373 $ 12,511 $ 54,662 $ 2,337 (1) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources —Cash Requirements —Capital Expenditures” for information regarding amounts designated as maintenance capital expenditures. (2) Represents certain costs associated with non-recurring professional services, our equity owners’ expenses and other costs. (3) Includes non-cash lease expense, provision for credit losses and inventory reserve. (4) For the three months ended September 30, 2023 and 2022, growth capital expenditures include a $16.4 million increase and a $6.8 million decrease in accrued capital expenditures, respectively. For the nine months ended September 30, 2023 and 2022, growth capital expenditures includes a $6.5 million increase and a $8.8 million decrease in accrued capital expenditures, respectively. (5) For the three months ended September 30, 2023 and 2022, there were $3.5 million and $1.7 million of non-unit growth capital expenditures, respectively. For the nine months ended September 30, 2023 and 2022, there were $10.7 million and $3.9 million of non-unit growth capital expenditures, respectively. Remaining amounts for the nine months ended September 30, 2023 and 2022 represent growth capital expenditures to expand our compression fleet. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Cash Requirements—Capital Expenditures” for information regarding amounts designated as growth capital expenditures. 32 Table of Contents The following table reconciles net income to Discretionary Cash Flow and Free Cash Flow, for each of the periods presented (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Net income $ 21,766 $ 45,900 $ 26,940 $ 104,356 Depreciation and amortization 46,087 44,111 136,414 129,913 Change in fair value of derivatives (7,978) (53,854) 13,551 (86,676) Loss on extinguishment of debt 6,757 — 6,757 — Deferred tax provision 5,551 11,833 6,312 26,807 Amortization of debt issuance costs 189 4,241 11,260 9,453 Equity compensation expense (1) 2,544 — 3,452 619 Transaction expenses (2) 440 — 1,713 1,600 Gain on sale of capital assets — (818) (721) (825) Maintenance capital expenditures (3) (12,312) (10,340) (28,056) (27,771) Discretionary Cash Flow $ 63,044 $ 41,073 $ 177,622 $ 157,476 Growth capital expenditures (4)(5) (55,671) (36,572) (124,015) (163,162) Proceeds from sale of capital assets — 8,010 1,055 8,023 Free Cash Flow $ 7,373 $ 12,511 $ 54,662 $ 2,337 (1) For the three months ended September 30, 2023, there was $2.5 million of non-cash adjustments for equity compensation expense. For the three months ended September 30, 2022, there was no such adjustment. For the nine months ended September 30, 2023 and 2022, there were $3.4 million and $0.6 million, respectively, of non-cash adjustments for equity compensation expense. (2) Represents certain costs associated with non-recurring professional services, our equity owners’ expenses and other costs. (3) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Cash Requirements—Capital Expenditures” for information regarding amounts designated as maintenance capital expenditures. (4) For the three months ended September 30, 2023 and 2022, growth capital expenditures include a $16.4 million increase and a $6.8 million decrease in the change in accrued capital expenditures, respectively. For the nine months ended September 30, 2023 and 2022, growth capital expenditures include a $6.5 million increase and a $8.8 million decrease in the change in accrued capital expenditures, respectively. (5) For the three months ended September 30, 2023 and 2022, there were $3.5 million and $1.7 million of non-unit growth capital expenditures, respectively. For the nine months ended September 30, 2023 and 2022, there were $10.7 million and $3.9 million of non-unit growth capital expenditures, respectively. Remaining amounts for the nine months ended September 30, 2023 and 2022 represent growth capital expenditures to expand our operating capacity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Cash Requirements—Capital Expenditures” for information regarding amounts designated as growth capital expenditures. Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based upon certain financial estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. We base our estimates on historical experience, available information and various other assumptions we believe to be reasonable under the circumstances. On an ongoing basis, we evaluate our estimates; however, actual results may differ from these estimates under different assumptions or conditions. The accounting policies that we believe require management’s most difficult, subjective or complex judgments and are the most critical to its reporting of results of operations and financial position are as follows: Business Combinations and Goodwill Goodwill acquired in connection with business combinations represents the excess of consideration over the fair value of net assets acquired. Certain assumptions and estimates are employed in determining the fair value of assets acquired and 33 Table of Contents liabilities assumed. Goodwill is not amortized, but is reviewed for impairment annually, or more frequently if impairment indicators arise that suggest the carrying value of goodwill may not be recovered. Goodwill - Impairment Assessments We evaluate goodwill for impairment annually and whenever events or changes indicate that it is more likely than not that the fair value at the reporting unit level could be less than its carrying value (including goodwill). We estimate the fair value based on a number of factors, including macroeconomic conditions, industry and market considerations, cost factors, overall financial performance and Company specific events. Estimating projected cash flows requires us to make certain assumptions as it relates to future operating performance. Application of the goodwill impairment test requires judgments, including a qualitative assessment to determine whether there are any impairment indicators, and determining the fair value of the reporting unit. A number of significant assumptions and estimates are involved in the application of the income approach to forecast future cash flows, including revenue and operating income growth rates, discount rates and other factors. While we believe that our estimates of current value are reasonable, if actual results differ from the estimates and judgments used including such items as future cash flows and the volatility inherent in markets which we serve, impairment charges against the carrying value of those assets could be required in the future. No events or circumstances occurred that indicated that the fair value of the entity may be below its carrying amount; therefore, no goodwill impairment was recorded for the three and nine months ended September 30, 2023 and 2022. Impairment of Long-Lived Assets Long-lived assets, including property, plant, and equipment, and other finite-lived identifiable intangible assets, are reviewed for impairment whenever events or changes in circumstances, including the removal of compression units from our active fleet, indicate that the carrying amount of an asset may not be recoverable. Such events and changes may include significant changes in performance relative to expected operating results, significant changes in asset use, significant negative industry or economic trends, and changes in our business strategy, among others. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to estimated future undiscounted net cash flows expected to be generated by the asset. Impairment losses are recognized in the period in which the impairment occurs and represent the excess of the asset carrying value over its fair value estimated future undiscounted net cash flows. No impairment was recorded for the three and nine months ended September 30, 2023 and 2022. Estimated Useful Lives of Property, Plant and Equipment Property, plant and equipment is carried at cost. Depreciation is computed on a straight-line basis using useful lives that are estimated based on assumptions and judgments that reflect both historical experience and expectations regarding future use of our assets. The use of different assumptions and judgments in the calculation of depreciation, especially those involving useful lives, would result in significantly different net book values of our assets and results of operations. Commitments and Contingencies From time to time, we may be involved in various claims and litigation arising in the ordinary course of business. Additionally, our compliance with state and local sales tax regulations is subject to audit by various taxing authorities. Certain taxing authorities have either claimed or issued an assessment that specific operational processes, which we and others in our industry regularly conduct, result in transactions that are subject to state sales taxes. We and others in our industry have disputed these claims and assessments based on either existing tax statutes or published guidance by the taxing authorities. We utilize both internal and external counsel in evaluating our potential exposure to adverse outcomes from orders, judgments or settlements. While we are unable to predict the ultimate outcome of these actions, the accounting standard for contingencies requires management to make judgments about future events that are inherently uncertain. We are required to record a loss during any period in which we believe a contingency is probable and can be reasonably estimated. To the extent that actual outcomes differ from our estimates, or additional facts and circumstances cause us to revise our estimates, our earnings will be affected. We record legal costs as incurred, and all recorded legal liabilities are revised, as required, as better information becomes available to us. 34 Table of Contents As of September 30, 2023, based on the information currently available, we have accrued a contingent liability of approximately $28.7 million relating to the Sales Tax Audit for the periods currently under audit classified in accrued liabilities on the consolidated balance sheet. For the year ended December 31, 2020, we wrote off an outstanding receivable balance of $3.7 million, due to us from a previous acquisition, to bad debt expense. Additionally, we recorded a contingent liability of $3.7 million related to the remaining 50% of the receivable balance due to the seller in accrued liabilities. As of September 30, 2023, none of the outstanding receivables had been collected. As of September 30, 2023, there are no other legal matters for which resolution could have a material adverse effect on the consolidated financial statements. Fair Value of Derivative Instruments We use any of three valuation approaches to measure fair value: the market approach, the income approach, and the cost approach in determining the appropriate valuation methodologies based on the nature of the asset or liability being measured and the reliability of the inputs used in arriving at fair value. We record derivative instruments at fair value using level 2 inputs of the fair value hierarchy. The interest rate swaps and interest rate collars are valued using a discounted cash flow analysis on the expected cash flows of each derivative using observable inputs from actively quoted public markets. including interest rate curves and credit spreads. As of September 30, 2023, $51.8 million was recorded for the fair value of the asset of the derivative instruments compared to $65.3 million asset of the derivative instruments recorded as of December 31, 2022. Recently Adopted Accounting Pronouncements In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments—Credit Losses (“Topic 326”): Measurement of Credit Losses on Financial Instruments which changes the impairment model for financial assets measured at amortized cost and certain other instruments, including trade and other receivables, held-to-maturity debt securities and loans, and requires entities to use a new current expected credit loss model that will result in earlier recognition of allowance for losses. The Company adopted this Topic 326 on January 1, 2023. The adoption of this amendment did not have a material impact on the Company’s consolidated financial statements.