Kodiak Gas Services Inc

NYSE:KGS

Earnings Call Analysis

Kodiak Gas Services Reports Strong Q3 Results with Increased Revenue and Improved Margins

In Q3, Kodiak Gas Services achieved total revenues of $325 million, up 5% sequentially, driven by strong performance in Other Services and steady gains in Contract Services. Despite a net loss of $6.2 million impacted by noncash items, adjusted EBITDA rose 9% to $168 million, boosting margins to 52%. The company increased guidance, now expecting full-year revenues between $1.15 billion and $1.18 billion, with adjusted EBITDA between $600 million and $610 million. Looking ahead, Kodiak anticipates adjusted EBITDA of $675 million to $725 million for 2025. The dividend remains secure at $0.41 per share, reflecting confidence in cash flows and ongoing growth.

Strong Q3 Performance Signals Growth

In the third quarter, Kodiak Gas Services reported total revenues of $325 million, marking a sequential increase of 5%. This uptick was primarily driven by significant gains in the Other Services segment and steady progress in Contract Services. Despite a net loss of $6.2 million, which included several noncash items totaling nearly $41 million, the underlying financials were positive. Adjusted EBITDA rose to $168 million, a 9% increase over the previous quarter, with an impressive adjusted EBITDA margin expanding to 52% from 50% in Q2.

Cost Synergies and Margin Expansion

The integration of two companies has allowed Kodiak to realize cost synergies, strengthening its profit margins. The adjusted gross margin in the Contract Services segment reached 66%, aligning with the high end of their annual guidance. The growing demand for large horsepower compression services supports this strong margin performance, and management is optimistic that similar margins can be maintained as they focus on operational efficiency and repricing their fleet.

Revised Guidance and Future Expectations

Looking ahead, Kodiak has updated its revenue guidance for 2024, now predicting a range between $1.15 billion and $1.18 billion. Additionally, adjusted EBITDA guidance was raised, expecting it to land between $600 million and $610 million, largely due to improved margins in the Contract Services segment. For 2025, early projections suggest an adjusted EBITDA range between $675 million and $725 million, further indicating confidence in continued performance.

Strategic Asset Divestitures Underway

Kodiak is actively refining its portfolio by divesting nonessential assets, including a recent exit from the GasJack business, which involved about 90,000 horsepower that was underutilized. This strategic move is aimed at focusing on high-demand areas within the Permian Basin, where Kodiak sees substantial growth opportunities. Continued efforts to prune lower-margin units are ongoing, ensuring the fleet is optimized for profitability.

Commitment to Shareholder Value and Capital Allocation

The company’s Board recently approved a quarterly dividend of $0.41 per share, which translates to an annualized yield of $1.64 per share. Kodiak remains committed to returning around 35% of its discretionary cash flow to shareholders through dividends. Additionally, they have initiated a share repurchase program, showcasing their confidence in the business's outlook, all while aiming to maintain leverage below 3.5x by the end of 2025.

Electric Motor Initiatives and Infrastructure Demand

Looking forward, Kodiak expects electric motors to comprise approximately half of its new units in 2025, addressing industry trends towards reduced emissions. The growing power demand in West Texas, driven by natural gas production and data centers, necessitates significant investments in power infrastructure. The state’s commitment to enhancing electric generation capacity is crucial for the sustainability of oil and gas operations in the region.

Focus on Operational Efficiency and Growth

The Kodiak team highlights their operational focus, ensuring maximum fleet utilization and maintaining high service standards for clients. Currently, fleet utilization stands at over 96%, with the core large horsepower assets showcasing utilization rates exceeding 99%. This operational excellence not only reinforces their market position but also contributes to predictable cash flow streams, critical in a fluctuating market.

Earnings Call Transcript 2024-Q3

[Operator]

Greetings, and welcome to the Kodiak Gas Services Third Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Graham Sones, Vice President of Investor Relations. Thank you. You may begin.

[Graham Sones, executive]

Good morning. We appreciate you joining us for the Kodiak Gas Services conference call and webcast to review third quarter 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 review recent developments, discuss our third quarter financial results, our updated 2024 outlook and some initial thoughts on 2025 before opening the call for Q&A.

There will be a replay of today's call available via webcast and also by phone until November 21, 2024. Information on how to access the replay can 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 7, 2024, and therefore, you're advised that such information may no longer be accurate as of the time of any replay listening 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. 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. Details and reconciliations to the most comparable GAAP measures are included in yesterday's earnings 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?

[Robert McKee, executive]

Thanks, Graham, and thank you for joining us today. I'd like to start the call, as we do every internal meeting at Kodiak, discussing safety. As a company, we set a high bar for safety with a goal to make certain that every employee goes home safe and sound to their families every night. We have invested in an industry-leading training program to make certain that all of our employees have the knowledge and the training needed to do their job safely. The focus of each and every Kodiak employee on this topic truly embodies the philosophy that we've adopted at Kodiak, safety first all the time.

Before we talk about our financial results, I'd like to briefly touch on a few noteworthy events that happened during the third quarter. We've been actively evaluating opportunities to high-grade our compression fleet. The first step in that process was the divestiture of the small horsepower GasJack business that we acquired in the CSI transaction. The sale, which we completed in September, involved about 90,000 horsepower, less than half of which was being utilized. The transaction also allowed us to fully exit Canada and Romania, simplifying our operations while increasing the average horsepower of our fleet and reducing our exposure to dry gas basins. As you know, Kodiak's strategy is focused on large horsepower compression in liquids-rich basins, and you should expect us to continue to high-grade our fleet over time.

Another notable development during the quarter was the successful completion of the first marketed follow-on offering by EQT, our largest shareholder, which allowed us to take a large step towards diversifying our shareholder base. At the start of the year, our top 5 shareholders collectively represented about 84% of our shareholder base, limiting our trading liquidity and float. As of today, we have reduced that concentration by about 20% and the trading liquidity in Kodiak stock has increased by over 100%, making Kodiak a more attractive investment for large institutions. I want to thank the investors who participated in the offering, which we completed in September. We had very strong demand, and it was one of the tightest priced follow-on offerings in the energy sector in the last few years. We view the success of this transaction as a vote of confidence in our strategy and future earnings growth potential.

We were pleased to complete our first share repurchase in connection with the offering, demonstrating our confidence in the outlook of our business and adding to our multipronged approach to delivering shareholder value. Measured growth, a strong and growing dividend and now share repurchases, all while driving leverage to 3.5x or less by the end of next year, have proven to be the right formula and delivered total shareholder returns of approximately 110% since our IPO.

Yesterday, we released third quarter 2024 financial results, including another record quarter with revenues of $325 million and adjusted EBITDA of $168 million. We also generated $53 million of free cash flow in the quarter. Through the combination of putting idle equipment back to work, divesting lower-margin small horsepower and adding new large horsepower units, Kodiak's fleet utilization increased sequentially to over 96%. Our core large horsepower assets remain near full utilization in excess of 99%, reflecting the continued tightness and capital discipline of the large horsepower compression market. Demand for large horsepower compression remains as strong as ever. During the third quarter, we added roughly 50,000 horsepower of new units to our fleet. All were Permian-focused large horsepower, averaging over 2,000 horsepower per unit, and they were deployed at rates well above the fleet average. Additionally, we were able to redeploy approximately 38,000 horsepower that was previously idle. Our commercial team has done a great job working with our customers and recontracting units of all sizes that were up for renewal and realizing prices closer to current market rates that are also above our current fleet average. We continue to differentiate our compression offering through our mechanical availability guarantee and the service we provide.

After realizing cost synergies, returning idle equipment back to work and another strong quarter of recontracting, I am pleased to announce that we delivered a third quarter adjusted gross margin of 66% in our Contract Services segment. Not only does that match the high end of our annual guidance, but it also matches our historical record margin even before the CSI acquisition. This is no small accomplishment and reflects the great results our team has been able to achieve through the integration process.

Switching to our Other Services segment. As a reminder, this segment primarily consists of our station construction and aftermarket services businesses, which are somewhat less predictable than contract compression, but generate significant free cash flow with very little capital investment. We realized strong revenue growth from our station construction business in the third quarter and delivered an adjusted gross margin in line with our expectations. One great example of our segments working together to provide customized integrated solutions for our customers is a project that we were currently working on in Midland, Texas. A midstream customer needed to add a compressor station inside the city limits where the compression equipment must meet strict emissions and noise requirements. The location is close to reliable grid power, so we were able to authorize a customized electric motor-driven large horsepower solution. We were hired to design and install the compression infrastructure, as well as contracted to deliver 4 large horsepower electric-driven compressors. We recently completed the engineering, the site construction expected to begin before year-end, and we are currently on schedule to set the 4 new units in the second quarter of 2025.

As we have previously discussed, electric motor-driven large horsepower compression units are going to represent an increased portion of our capital spend as we strive to help customers lower their emissions to produce oil and natural gas. Approximately half of the new units we plan to install next year will use electric motors. However, large horsepower electric compression presents unique challenges as the motors require a significantly higher voltage than smaller motors, requiring a step-up transformer and increasing the overall power demand for the project.

As many of you know, West Texas power demand has been increasing at a materially faster pace than the rest of Texas, growing by approximately 11% per year over the last decade. This demand increase has been driven by oil and natural gas production, cryptocurrency mining and data centers, and has resulted in regional power shortages. Thankfully, this summer, we saw several meaningful steps by the state of Texas to address the sizable demand growth, including the Public Utility Commission moving forward with more than $5 billion in loans for 17 new natural gas-fired power plants, which are expected to add approximately 10 gigawatts of electricity. Then in September, the Permian Basin Reliability Plan was approved, calling for $13 billion to $15 billion of investments in electric transmission line upgrades in West Texas. These investments in the security of the supply of power are crucial for the oil and gas industry to continue powering our economy.

In last night's earnings press release, we increased the low end of our full year revenue guidance for both segments, as well as our full year 2024 adjusted EBITDA guidance. Given the third quarter GasJack sale, plus a handful of small additional divestitures, we thought it would be helpful to provide an early outlook on our financial expectations for 2025. After factoring in these asset sales, along with our new unit expectations for the fourth quarter, we expect to exit the year with roughly $4.25 million of operating compression horsepower. With that in mind, we expect adjusted EBITDA for the full year 2025 to be in a range of $675 million to $725 million.

In summary, we're very pleased with our third quarter results. The realized transaction synergies, as well as strong industry fundamentals resulted in improved margins and increased cash flows. We made progress high-grading our fleet and our commercial team has been actively redeploying idle assets, improving fleet utilization. Our dividend remains well covered, and we are on track to achieve our increased guidance for the year. The ramp-up of natural gas demand remains highly visible. The U.S. needs to continue to add electric generation capacity and natural gas remains the most reliable and affordable fuel of choice. And that's on top of the wage of LNG export terminals expected to enter service in the coming years. The increase in gas production required to meet this demand is going to require significant compression infrastructure development, and we continue to believe that Kodiak is well positioned to be the compression provider of choice. Our focus on customers and employees, industry-leading mechanical availability and our market position separates us from our peers.

And now, I'll pass the call to John Griggs to review third quarter financial highlights and our guidance. John?

[John Griggs, executive]

Thanks, Mickey. We had another great quarter with revenue growth and realized cost synergies driving margins and results above expectations. The strong financial performance wouldn't have been possible without the focused efforts of our employees to successfully integrate 2 companies while continuing to deliver differentiated service to our customers. I couldn't be more proud of this company and all the things we have accomplished this year.

Now, let's drill down into the numbers. Total revenues for the quarter were $325 million, a 5% sequential increase. This growth was driven by a strong quarter in the Other Services segment and steady gains in Contract Services. The bullish fundamentals of the compression market, in particular, within the large horsepower subsector remained strong, and we continue to realize nice rate increases as part of our recontracting efforts.

For the quarter, we reported a net loss of $6.2 million. Included in the loss were several noncash items totaling nearly $41 million. This sum was comprised of 3 main items: a $10 million loss on asset sales related mostly to the successful exit from the GasJack business, a $9.9 million asset impairment charge on some of our older units and a $20 million mark-to-market loss on interest rate hedges. As it relates to the hedges, our interest rate swaps are designed to mitigate cash flow volatility and not trying to predict rate moves. As of today, we swapped floating rates were fixed on about 70% of our ABL exposure. And if you include the bonds, we're at about 80% fixed on all our debt. Our hedging strategy has served us well over the Fed's hiking cycle that began in 2022. But now that the Fed has begun to ease rates, the quarterly mark-to-market value of our swaps is declining, and we report this unrealized and noncash change on our income statement. As the Fed raised rates, we saw noncash mark-to-market increases boost net income. But now that rates appear to be going the other way, we'll see the opposite. But importantly, the underlying cash flows will remain highly predictable, which is the priority.

Moving on. Adjusted EBITDA for the quarter was $168 million, an increase of 9% compared to the second quarter. Not only did we realize sequential growth, but our adjusted EBITDA margin expanded as well with a third quarter margin of 52% versus 50% in the prior quarter.

Looking at our segments. In Contract Services, revenues for the quarter were $284 million with an adjusted gross margin percentage of 66%, matching the high end of our annual guidance range. We were pleased with this result, and we expect to continue to deliver margins like this going forward as we set new horsepower at market rates, reprice the existing fleet, divest lower-margin smaller horsepower and maintain our relentless focus on operational efficiency.

In our Other Services segment, revenues were $40 million in Q3 with an adjusted gross margin of 19%. As Mickey discussed, we have been very active on the station construction side of our business. This quarter, we realized an $11 million sequential increase in station construction revenues. This is a business line in which we believe we provide a differentiated customer value proposition, and we think it's highly complementary to our contract compression activities despite its inherent lumpiness and lower margin profile.

In terms of CapEx for the quarter, maintenance capital expenditures came in just shy of $22 million, up from the second quarter. The third quarter spend represents what we expect to be a peak for the year due to the timing of some large engine overhauls. We expect maintenance CapEx to decline sequentially in the fourth quarter. Growth CapEx for the third quarter was approximately $65 million, and we added nearly 50,000 horsepower to the fleet. Capital expenditures related to the addition of new fleet units represented about 3/4 of our total growth CapEx for the period.

Moving to the balance sheet. As of September 30, we had total debt of $2.6 billion, consisting of the 2029 senior unsecured notes and borrowings under our ABL facility. Our credit agreement leverage ratio at the end of the quarter was 3.9x. We had approximately $306 million of availability on the revolver. We remain confident that we will exit 2025 with leverage at below 3.5x.

Let's turn to the updated 2024 outlook, where we've adjusted a few items. Specifically, we now expect revenue to range between $1.15 billion and $1.18 billion. We also raised our adjusted EBITDA guidance by bringing up the low end of the range and think we'll land between $600 million and $610 million, with the improvement driven primarily by adjusted gross margin strength in the Contract Services segment. We've left discretionary cash flow growth and maintenance CapEx guidance unchanged.

And as Mickey highlighted, we gave some initial guideposts for 2025. We'll deliver our traditional guidance metrics in our fourth quarter earnings release, but we thought it would be helpful to provide a preliminary adjusted EBITDA range of $675 million to $725 million. This early outlook factors in the transactions that Mickey referenced earlier, all of which are designed to high-grade our fleet, simplify our operations and further our U.S.-focused large horsepower strategy.

To wrap things up, our Board approved our quarterly dividend of $0.41 per share, which will be paid this Friday, November 8. This equates to an annualized dividend of $1.64 per share.

That's it for my prepared comments. Thank you for your participation and support. I'll hand it back to Mickey.

[Robert McKee, executive]

Thanks, John. To wrap up, we had a strong third quarter with revenue growth and margin expansion in both of our segments. Our revised 2024 guidance and the early outlook we've provided for 2025 indicates that we expect this strength to continue. We progressed against a number of strategic objectives and continue to deliver shareholder value. I want to thank the women and men of Kodiak for their focus on serving our customers safely, which allowed us to deliver such great results.

With that, we're happy to open up the line for questions. Operator?

[Operator]

[Operator Instructions] First question is from Doug Irwin from Citi.

[Douglas Irwin, analyst]

I just want to start with gross margin here. You talked about being at the high end of your range for the quarter, which is great. Just wondering if you could provide any more color around maybe what you're assuming for '25. And then just kind of where you see margins trending here over the near term as you continue to see more synergies from CSI and maybe continue to divest more lower-margin horsepower?

[John Griggs, executive]

Yes, you bet. Doug, it's great to talk to you. This is John, and I'll turn it over to Mickey, too, if he wants to have some incremental comments. So we're not going to talk about the '25 margins on this call. We'll do that when we give formal guidance at the end of Q4. But I will say the 66% adjusted gross margin in that Contract Services segment was something that we're really proud of. If you think about kind of how we get there, we finished last quarter at 64%. But recall, we had a unique $3 million sales tax accrual that happened in that particular segment. So if you remove that, it was roughly 65%. So that 1% increase, how did we get there? Again, it's a factor of continued repricing of the fleet, setting new horsepower-type pricing, continued realization of the transaction synergies and frankly, just good old-fashioned cost management. So we're not done at the 66%. It's our ambition to continue to increase that margin, and that will really move the needle in the business. That's kind of where we are now.

[Douglas Irwin, analyst]

Great. And then my second question, just on capital allocation. Just wondering if you could talk about how you're thinking about balancing buybacks versus maybe the benefits of some increased liquidity in the shares moving forward. Just wondering if we can maybe see you be a bigger buyer in the future if we see more secondaries.

[Robert McKee, executive]

Yes. Doug, this is Mickey. I think we're certainly open to entertaining that. We've definitely modeled some into our next year's kind of models. That will depend on when EQT comes back to market with some additional follow-ons. But keeping in mind that whatever we do is going to drive towards our goal of making sure we get to our 3.5x leverage target by the end of next year. So I don't think that what you'll see will be drastically different than what you've seen in the past.

[Operator]

Our next question is from Gabe Moreen from Mizuho.

[Gabriel Moreen, analyst]

I wanted to ask about Mickey's comments on high-grading assets, just kind of where things stand in terms of the divestiture program. And also, now that you have a couple more months of Compressco under your belt, to what extent you're kind of looking at some of the regions where you might have a little bit of a smaller horsepower presence, whether you're committed to being there, those might be candidates for divestiture and high-grading the portfolio.

[Robert McKee, executive]

Yes, Gabe, I appreciate it. This is Mickey. We're always looking at the fleet and evaluating it to figure out if it's a basin we want to be in and if it's units that we want to potentially divest over time. Right now, we don't have any plans to exit any basins. We're pretty -- we're a Permian-centric company because that's where the opportunity has been for the last decade or so. But there's other basins out there that certainly meet kind of our strategic goals of being in oil-directed basins with liquids-rich type of opportunities with associated gas. So just because it's not the Permian doesn't mean we don't want to be there. So there's lots of other opportunities, lots of good people that we can find outside of the Permian as well. However, most of our growth is happening within the Permian Basin.

So we've got a couple of other small divestitures planned for this year of some packages of small horsepower units as we continue to just kind of prune the fleet and get rid of some nondesirable stuff. But really and truly, it's not needle-moving horsepower or funds that are going to be moving. It's just really just prudent and shaping the fleet and making sure that we're focused with our people in the best possible place to create shareholder value.

[Gabriel Moreen, analyst]

Mickey, and then maybe if I could follow up with the Permian-related question. It seems like things are going from bullishness to bullishness here on the Permian gas outlook. Can you just talk about directionally what that may mean for your CapEx next year? I mean, we certainly heard some midstreamers continuing to slot in additional processing and gathering system upsizing. So I'm just wondering if that's kind of going to be pulling on your CapEx maybe a little bit into '25.

[Robert McKee, executive]

I don't think anything is going to change here, Gabe. We've got a capital allocation strategy that is what we believe creates the most value for our shareholders, which is to pay a nice and growing dividend to make sure that we live within our cash flows and reinvest the balance of our discretionary cash flow into growing the fleet with organic growth at very, very attractive margins. But like I said, to end up having more cash at the end of the year than we did when we started the year. So, it's a combination of all those things, working in some share buybacks along the way and living within our means and within our cash flow. So, I know people will be asking probably about any change to capital allocation priorities because of the results of the election and that kind of thing. But really, from our standpoint, it doesn't. It's just kind of -- we believe we have the best plan no matter what administration is in the White House and as far as capital allocation priority, and it's going to be the same either way. And we believe that's the best way to create shareholder value.

[John Griggs, executive]

And, Gabe, I was just going to follow up quickly. I was just going to say -- this is John, too. So we've shown in our presentations that we expect to add around 160-ish thousand horsepower to our fleet in 2024. And what we said at the time of the CSI acquisition, given the long lead times on new horsepower, for the most part, the '24 horsepower was pretty fully baked by the time we bought the company. As you look forward to '25, we always said you should look to us to be kind of there or a shade lower since we can control the CapEx spend in 2025. So we'll put a finer pin on that as we get to 2025 guidance in our Q4 earnings release. But I would say that kind of should set some bounds as to what to expect in terms of new horsepower for next year.

[Operator]

Our next question is from John Mackay from Goldman Sachs.

[John Mackay, analyst]

I just wanted to start on some of these new unit additions kind of a little bit on forward year CapEx. Are you guys still seeing higher costs for new units, higher per unit CapEx? And maybe just give us an update on how that's been flowing through into ability to push through higher prices?

[Robert McKee, executive]

Yes, I mean the cost of compression isn't going down. It is -- in fact, it goes up consistently year-over-year. We're not seeing the same level of inflation on CapEx costs that we've seen in the past, but you are going to see kind of mid-single digits inflationary costs on the cost of that equipment as it results from major component suppliers and that kind of thing. So, we have been able to pass that kind of cost on to our -- in our contracts because us just targeting that same amount of return on capital with more expensive units, we need a higher return and higher rates and higher contribution margin to justify spending that capital and spending that money. So, yes, I mean, it's going up marginally, I think, for next year, and we continue to see that trend, but we've had really good luck at contracting that out and making sure that we're getting the same returns that our expectations are.

[John Mackay, analyst]

That's clear. Second, just on electrification. I appreciate all the comments on how long it's going to take to build the grid and the Permian, et cetera. I guess, just maybe when you're having your conversation with customers, let's say, for adds in 2026. Is it that top-down kind of grid discussion that's driving their demand for electric motor units? Or is it something else? I guess, like what's driving the pace of those deployments overall?

[Robert McKee, executive]

Yes. I mean, it's 100% exclusively access to reliable power, whether that's through a tie-in to the grid or them building their own microgrids or them just supplying their own generating capacity. It's -- that's what is driving the adoption rate on the electric motor units access to reliable power.

[John Mackay, analyst]

Can I ask a quick follow-up on that? Just is there an opportunity for you guys to get involved on kind of that slight extension, I guess, we could say of the value chain getting into the power side a little bit more?

[Robert McKee, executive]

Potentially. It's something that we'll probably evaluate, but we'll look at how that would might bake into our capital allocation priorities and see if there's a spot for it there. Not sure, something that we'll have to evaluate pretty considerably more over the next coming year.

[Operator]

Our next question is from Neal Dingmann from Truist Securities.

[Neal Dingmann, analyst]

Another nice quarter. Maybe I'll just start to ask my first a little bit different on margins specifically. Could you all speak to -- you were notably able to bring your segment margins back to that 66% level after acquiring CSI. I'm just wondering what were the drivers, how you're able to do that so quickly? And then now that those assets seem to be pretty fully integrated, does that just keep going?

[John Griggs, executive]

Yes, Neal, great question. It's John. Great to talk to you. I guess, what I'd point out, one of the things that really strikes us is that, before we acquired CSI, Kodiak's compression operations business operated at a 66% gross margin. Of course, we were trying to move that up. CSI was somewhere in the mid-50s. So now we put the 2 together, we've captured some synergies. We've raised some prices, and we're right back to kind of where we started. So we think that's really notable.

To be more specific about how we get there. So, again, I said it earlier, but it's setting new units at market rates, repricing the existing fleet as it rolls over. Those are probably the biggest levers that get us there. And then the synergies, we called out probably $30 million in synergies. For the most part, the vast majority of those synergies have already been achieved by this quarter. We'll still continue to capture incremental synergies. Maybe those are related to when a contract had to kind of naturally roll off or maybe it's the result of the negotiation with a major vendor now that we have increased scale, but they're really not moving the needle. And the further we get from the CSI transaction, the more, I guess, I'd say the murkier it gets as to, well, heck, was that a synergy? Or was that just hard work on us trying to manage our costs? So we're not really looking at those synergies as much as we are. Let's manage our costs. Let's think about automation. Let's think about rethinking the process. I think it's a combination of those 2 things that have really led to those margins where we are now. And as I said before, we have better ambitions. We'll give better -- or higher ambitions. We'll give guidance again in Q4, but we are not going to stop at 66%.

[Neal Dingmann, analyst]

Great details. And, John, maybe just a follow-up for you as well. Just on debt and shareholder return. I'm just wondering, can we assume shareholder return will sort of remain around the same sort of pace? And has that targeted leverage level changed going forward?

[John Griggs, executive]

Yes, I'll repeat what Mickey said. So our capital allocation framework, it's really simple, and it remains unchanged. We seek to grow adjusted EBITDA in the upper single-digit range annually. You see that on a pro forma basis with the guidepost we've given for '25. We've been very vocal about how we want to pay out roughly, call it, 35% of our discretionary cash flow to shareholders in the form of a recurring dividend. And so, as we grow EBITDA, DCF should grow as well. So the expectation should be that the dividend should grow as that percentage holds. That's, of course, subject to the Board, but that's the model that we use and the mental math that we use. And then the most important, maybe our true north is, we want to get to that 3.5x leverage by the end of 2025. So those 2 variables plus the new variable of a share repurchase, that repurchase is important. We think that studying prior sell-downs by other private equity-backed energy businesses that have gone successfully, the ones that have gone the best tend to be done the same way we just accomplished ours. It's a formula that's worked for them, and we think it's a formula that's going to work for us with the incremental repurchases. But just know that as we do it, we're not going to take our eyes off our leverage target of 3.5x by the end of next year.

[Operator]

Our next question is from Jim Rollyson from Raymond James.

[James Rollyson, analyst]

Mickey, you made a couple of comments around setting new units at higher prices, obviously, around the fact that inflation is still muted from what it was but ongoing. Maybe just a level set of kind of where leading-edge pricing is today relative to your fleet average because that number, I think both have been moving higher, but just kind of curious where that spread sits today, ballpark.

[Robert McKee, executive]

Yes. Jim, I think that probably -- let me just do it. I think that new unit spot prices are probably 20% higher than what the fleet average is -- looks like right now, maybe 25% higher. So like I said in the question earlier, a lot of that's driven by the higher capital cost of the equipment that is around today. So -- and what we're paying for this equipment, as well as labor costs, too. Everybody knows that labor is a challenge in the Permian. And when labor prices go up, they certainly don't retreat typically, everybody -- nobody likes getting a pay reduction. So, like I said, that's some inflationary cost drivers right there, plus capital costs is driving us to kind of think about spot prices being 20% or 25% higher than what the fleet average is right now.

[James Rollyson, analyst]

That's great. Obviously, you get to keep capturing that as you reprice things. And then on the kind of the fleet composition as you've sold off the GasJack business, you mentioned a few other kind of targeted smaller divestitures. How do we think about utilization? Because prior to the CSI transaction, right, you guys were in high 90% utilization across the Kodiak fleet. And then that dipped when you kind of merged in those low utilization, low horsepower units. And as you kind of migrate away from those and maybe reposition some of the CSI units on the larger horsepower side, just this quarter, you were a little over 96%. Does that get back up to the 99-plus percent range at some point?

[Robert McKee, executive]

We hope so, and that's what we're going to be shooting for, Jim. So that's the goal here is to make sure that we get that utilization back in hand and not just utilization for the sake of utilization, right? We want it to be the right utilization with the right customers in the right basins with the right contracts and that kind of thing. So, that's what we work on every day and make sure that we have the longevity and the stability of those cash flows and not just sacrificing some of the things that are kind of strategically important to us for the sake of utilization.

[Operator]

Our next question is from Jeremy Tonet from JPMorgan Chase & Co.

[Elias Jossen, analyst]

This is Eli on for Jeremy. Maybe just back to the 2025 outlook. I know the portfolio is largely contracted and the utilization upside has kind of been touched on. But can you just reframe the dynamics that could actually drive you guys to the higher end of that range next year?

[Robert McKee, executive]

Yes. I think, look, I mean, it's -- we're a pretty highly contracted business, but we do have the variability in a lot of our contracts rolling off of contract and being up for renewal for the year. So about 30% of our contracts will come up for renewal over the next 12 to 15 months. So, based on the success of that renewal and the kind of the increase in those rates to get them closer to market rates is probably the variability that we have in the contribution for next year. And so, as well as making sure that we continue to realize, I think, John said it earlier, we're most of the way there on the synergies, but there are some additional synergies to be had here, and it's going to depend on our ability to execute on those and make sure that we keep our eye on the ball and keep moving forward there and make sure that we execute in the way that we've been executing.

[Elias Jossen, analyst]

Got it. Sounds good. And then maybe just as a follow-up, I respect that the compression market continues to remain hot. And previously, there was discussion around lead times. So maybe just where you see lead times right now? And if those were to come in, how that would affect your ability to deploy compression units over the next couple of years and kind of deliver those to your customers?

[Robert McKee, executive]

Yes. Lead times today to get a new package built and ordered and built from scratch, from Caterpillar and Ariel are about 9 months, maybe a tick under that. So still is elongated lead times, still working with our customer base well in advance of when they need the equipment and making sure that we have that stuff contracted up before we spend any capital. So, as you recall, we don't spend any capital on speculation here. So like I said, almost a 9-month lead time right now, still elongated lead times. I wouldn't expect -- if those lead times did come in at all, I wouldn't expect them to come in any shorter than probably 6 months at the most. So -- and looking at the activity that we have coming up and the massive amount of compression infrastructure that has to be installed over the balance of the decade to handle increased LNG volumes to handle AI and data center gas demand -- gas-driven demand, it really is -- I don't foresee lead times coming in, in any significant manner anytime soon.

[Operator]

Our next question is from Sebastian Erskine from Redburn Atlantic.

[Sebastian Erskine, analyst]

Just to start, I mean, I guess, one of the issues that has been facing E&Ps in the Permian has been the lack of kind of sufficient pipeline infrastructure. And that's meant that they kind of held a bit back on production. And obviously, in the third quarter, we've seen that the Matterhorn pipeline has come online, and there are several more to come online in the coming years. So I'm just curious, in your conversations with your customers, are you expecting this new infrastructure to allow new wells to come online, production to be boosted in the Permian? And obviously, kind of the read across from that to compression demand as well would be great.

[Robert McKee, executive]

Sebastian, thanks for the question. All of our customers that we're dealing with and planning out 9 months and 12 months ahead of time are all very cognizant of what the takeaway capacity is in the Permian. Most of them have firm takeaway already committed to long before they decide to commit to compression horsepower. And so, they know when the Matterhorn pipeline is coming on and when the pipelines are coming on next year. So they're basing their drilling programs around that -- them having that takeaway capacity in place.

So I think that some of this capacity that's coming online is just as planned, and it shouldn't affect the demand for our services at all. It's going to be kind of baked into that planning process that's 9 months or 12 months out.

[Sebastian Erskine, analyst]

Really appreciate that. And the second one, if I may. I just noticed in the third quarter, there was quite a large sort of working capital cash outflow. I think it was about sort of $85 million. And just if you could give us some color on kind of what drove that and maybe what we can expect on working capital movements going forward, that would be really appreciated.

[John Griggs, executive]

Sebastian, this is John. Yes, that's something that we've got our eye really closely on. After we brought the 2 businesses together, we continue to work in 2 systems across our inventory, which makes it difficult to -- for people that are using one aspect of the system to know what's in the other side. Pretty natural thing in acquisitions like this. So that's caused us to have an elevated level of inventory. As we migrate those 2 systems into 1, we would expect for that to go down during 2025, and that's something that we're keenly focused on.

The other is accounts receivable. That's a temporal thing as well. We have migrated into one billing system. And a lot of the challenges as you do that are making sure that you can get set up with your customers so you can effectively bill them. I'd remind everybody that probably 85% to 88% of our revenues are contractually driven and our counterparties are some of the largest household names in the upstream and midstream energy industry. So we're absolutely unconcerned with the credit quality of those customers. We just need to work through the invoicing process, make sure that we're set up and get caught back up. We'd expect to get there by the end of the year and then into next year as well. A great question and something that the management team is keenly focused on.

[Sebastian Erskine, analyst]

Congratulations on the quarter.

[Operator]

Our next question is from Theresa Chen from Barclays.

[Theresa Chen, analyst]

Just a quick one on your recontracting outlook. You've given a lot of commentary on the tightness of the supply chain and how that's translating to economic tailwinds for your assets. I'm just curious, as you think about recontracting going forward, do you consider trading some rate for term and elongating your weighted contract duration? How do you generally think about that trade-off?

[Robert McKee, executive]

Typically, we don't -- we like to have our equipment under contract for sure. But personally, I'm not willing -- I wouldn't be willing to trade contract rate for term. The way we look at it at Kodiak, Theresa, as you know, is we look at the life and the longevity of the production that's sitting underneath our compressors as kind of the contract term that we have, right? I've said before, if I put a large horsepower compressor on 20-year life production and I sign a 1-year contract, I'm going to renew that contract 20 years if we're -- 20x if we take care of our business operationally, and we're providing the best level of service operationally. So, like I said, when we look at contract term, we're looking at the life of the production, which is what drives our strategy of wanting to be in liquids-rich oily basins with associated gas, right? So those basins tend to have longer life to them. The Permian is certainly is a great example of that. And we want our equipment on long-life production that we know will provide a stability of cash flows for many, many years.

[Operator]

Next question is from Zack Van Everen from TPH.

[Zackery Van Everen, analyst]

Just one quick one from me. With 2025 fully contracted, could you give an update on how 2026 is coming along?

[Robert McKee, executive]

Some quick discussions in 2026, Zack. Nothing really hard booked up for 2026. We've seen deliveries from Caterpillar come in to 9 months right now. So really looking at kind of end of second quarter type of deliveries right now. So our customers aren't super concerned right now about starting to work on contracts out into 2026 quite yet, having some preliminary conversations, but we don't have contracts pending out there right now. So I kind of feel like we've got about probably 4 to 6 months of runway before we really need to start looking at deliveries into 2026.

[Operator]

This concludes today's question-and-answer session. I'd like to turn the floor back to management for any closing comments.

[Robert McKee, executive]

Yes. Thank you, operator, and thanks to everyone participating in today's call. We look forward to speaking with you again after we report our results for the fourth quarter. Thanks.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.