Good morning, and thank you for standing by. Welcome to the Cactus Second Quarter 2022 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, John Fitzgerald.

John?.

Thank you, and good morning. We appreciate you joining us on today's call. Our speakers will be Scott Bender, our Chief Executive Officer; and Steve Tadlock, our Chief Financial Officer.

Also joining us today are Joel Bender, Senior Vice President and Chief Operating Officer; Steven Bender, Vice President of Operations; and Will Marsh, our General Counsel and Vice President of Administration.

Please note that any comments we make on today's call regarding projections or expectations for future events are forward-looking statements covered by the Private Securities Litigation Reform Act. Forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control.

These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC.

Any forward-looking statements we make today are only as of today's date, and we undertake no obligation to publicly update or review any forward-looking statements. In addition, during today's call, we will reference certain non-GAAP financial measures.

Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in our earnings release. And with that, I will turn the call over to Scott..

revenue increased 17% sequentially to a company record of $170 million. Adjusted EBITDA improved by 31% sequentially. Adjusted EBITDA margins were 33%, up 360 basis points versus the first quarter. We paid a quarterly dividend of $0.11 per share and increased our cash balance to $312 million.

I'll now turn the call over to Steve Tadlock, our CFO, who will review our financial results. Following his remarks, I'll provide some thoughts on our outlook for the near-term before opening the lines for Q&A.

So Steve?.

Thank you. As Scott mentioned, Q2 revenues of $170 million were 17% higher than the prior quarter. Product revenues of $112 million were up 19% sequentially, driven primarily by an increase in rigs followed and successful cost recovery efforts.

Product gross margins at 38% rose 320 basis points sequentially due to leverage of our fixed cost base and cost recovery efforts.

Rental revenues were $24 million for the quarter, up 6% versus the first quarter, driving an increase in gross margins of 280 basis points sequentially due to reduced equipment repair costs and lower depreciation as a percentage of revenue. Field service and other revenues in Q2 were approximately $34 million, up 16% sequentially.

This represented 25% of combined product and rental-related revenues during the quarter. Gross margins were up 600 basis points sequentially, driven largely by the company's measures implemented to address inflationary fuel and labor costs. SG&A expenses were $14.7 million during the quarter, up $0.6 million sequentially.

The increase is primarily attributable to higher bonus accruals due to stronger-than-expected financial performance. SG&A declined to 8.7% of revenue, down from 9.7% during the first quarter. We expect SG&A to be slightly above $15 million in Q3 2022, excluding any nonrecurring expenses.

Stock-based compensation expense in 3Q is expected to be approximately $2.6 million. Second quarter adjusted EBITDA was approximately $56 million, up 31% from $42 million during the first quarter. Adjusted EBITDA for the quarter represented 33% of revenues compared to 29% in the first quarter.

Adjustments to EBITDA during the second quarter of 2022 included approximately $2.4 million in stock-based compensation. Depreciation expense for the second quarter was $8.9 million and a similar amount is expected in the third quarter. We reported income tax expense of $8.8 million during the second quarter.

During the quarter, the public or Class A ownership of the company averaged 80% and ended the quarter at 80%. Barring further changes in our public ownership percentage, we expect an effective tax rate of approximately 21% for Q3 2022. GAAP net income was $36 million in Q2 2022 versus $27 million during the first quarter.

The increase was driven by higher operating income during the period. We prefer to look at adjusted net income and earnings per share, which were $33.4 million and $0.44 per share, respectively, during the second quarter versus $22.9 million and $0.30 per share in Q1.

Adjusted net income for the second quarter applied a 25% tax rate to our adjusted pretax income generated during the quarter. We estimate that the tax rate for adjusted EPS will be 25% during the third quarter.

During the second quarter, we paid a quarterly dividend of $0.11 per share, resulting in a cash outflow of approximately $8 million, including related distributions to members. The Board has approved a dividend of $0.11 per share to be paid in September. We ended the quarter with a cash balance of $312 million, up $14 million sequentially.

Operating cash flow was approximately $31 million, and our net CapEx was $6 million. Inventory rose by approximately $13 million sequentially, primarily due to activity increases, longer lead times and our decision to increase product safety stocks to ensure timely delivery.

Capital requirements for our business remain modest, and we will continue to exercise discipline with regards to growth expenditures. Our net CapEx guidance for 2022 remains unchanged with the remaining expenditures expected to be weighted towards the third quarter. That covers the financial review, and I'll now turn the call over to Scott..

Thanks, Steve. The company generated record revenue during the second quarter and reported its highest quarterly EBITDA since mid-2019. U.S. product market share remained strong at 39.5% during the period as rigs followed increased by over 8%. Product revenue per U.S.

land rig followed increased by over 10%, highlighting the success of our cost recovery efforts during the period. Product EBITDA margins improved by 300 basis points during the quarter to 39%. Looking to the third quarter of 2022, we anticipate Cactus' rigs followed to rise more than 5%.

Product revenue is expected to increase in the mid- to high-single digits percentage-wise. Product EBITDA margins are forecasted to remain strong during the third quarter. We're confident that our public and large private customers will be adding rigs through the end of the year, which bodes well for our market share.

As addressed in our earnings release, we're increasingly focused on maintaining and improving the quality of our customer base. Last quarter, we mentioned a trial with a major independent operator. Our team has executed well for this customer.

And although not reflected in the second quarter, we are now servicing additional rigs with more expected through the end of the year. During the quarter, we progressed our efforts in the Mid-East with direct discussions with a major NOC.

We now expect to complete equipment testing this year, trial order deliveries in 2023 and commercialization by 2024. In the immediate-term, we expect to book our first product revenues in the Mid-East and South America during the third quarter.

We'll continue to selectively target international markets as we progress plans for more meaningful growth abroad. Regarding our supply chain, tightness in overseas freight and transit times from the Far East have started to moderate. In addition, raw material and component costs are starting to show signs of improvement.

Accordingly, we are cautiously optimistic that this will lead to continued margin improvement by early 2023 following the utilization of our existing inventory. On the rental side of the business, revenues increased by over 6% during the quarter and were up over 60% year-over-year. Incremental EBITDA margins were nearly 90% during the second quarter.

For the third quarter, rental revenues are expected to increase by an additional 10%, and EBITDA margins are expected to be relatively flat during the period. In field service, the company implemented a number of measures to offset wage and transportation inflation early in the second quarter.

This resulted in a 570 basis point improvement to field service EBITDA margins and highlights the ability of the company to quickly address headwinds. Field service revenue for 3Q is expected to be approximately 24% of product and rental revenue.

We expect field service EBITDA margins to be in the mid-27% range for the third quarter, up slightly on a sequential basis. Overall, we're excited about the momentum of the business going into Q3, which is typically the strongest quarter of the calendar year.

Regarding our outlook on M&A, management continues to believe that it can be a useful tool to enhance shareholder returns. However, this team will continue to exercise discipline and patience in the evaluation of any such opportunities and keep a narrow focus on high-quality businesses with characteristics similar to our own.

The ability to return cash to our shareholders remains an attractive avenue to deploy capital. So in summary, Cactus remains well positioned to deliver continued growth and returns as well as assuaging customers' concerns regarding the timely supply and quality of service. So with that, I'll turn it back over to the operator, and we can begin Q&A.

Operator?.

[Operator Instructions] Our first question is coming from Scott Gruber from Citigroup..

So I wanted to ask about rental. It sounds like you'll get a nice 10% move higher in 3Q.

But just thinking about the running room in that segment, given that you guys kind of solitarily let your share slip when pricing really collapsed, are you seeing pricing recover sufficiently in that market, and that market gets sufficiently tight that we have several quarters of share recapture ahead of us in rental?.

Yes. Scott, we're finally seeing some relief, not across the board, but we're absolutely seeing some indication of some tightness in the market and resulting opportunities for increases in price..

So you look back at 2019, you guys were doing about $40 million in quarterly revenue in rental.

Is there any possibility of getting back to that mark in, call it, 12, 18 months or so?.

I think that despite the fact that rental prices are firming, they're still significantly below 2019 pricing. So I can't envision them getting back to that level, but certainly improving, I think, to the point where it would be a meaningful improvement. There's still too many players in this business, too fragmented a market.

And frankly, customers don't really, I think, respect the [moat] around our rental products, or anybody's rental products for that matter, the way they respect the moat around our products, our [indiscernible] products..

And then if I could just ask one additional one on the macro side, just a lot of moving pieces today with some recessionary fears [indiscernible] an oil price.

But at the same time, we're hearing those indications that we're going to get a few rigs added here by the public operators late in the year, and maybe a few more to start the year once budgets reset.

Can you talk about that intersection between maybe some risk to private activity if oil prices continue to draw down versus what's likely to be some adds on the public side? Well, I guess, one, can you frame up if the forward curve is accurate, where the U.S. rig count could land in, say, 6 months' time.

So after some of the budget refresh rig additions but also what oil price could imperil that growth where you could get some declines from the privates that would offset the growth and it kind of just goes flat?.

Let me start with my view on privates versus publics. So not going to surprise you when I tell you that I believe that the privates will not display the same sort of disproportionate gains at $90 oil as they did during the second quarter and the first quarter.

And we have pretty good visibility for Q3 and Q4, is that we expect to gain market share with privates in the third quarter, and then we expect that to flip towards our large publicly traded customers in the fourth quarter and into the first quarter of next year.

So that's why I made the comment that I feel good about market share by the end of the year, that our strength is in the large publicly traded E&Ps. I think that whether or not the large publicly traded E&Ps can offset weakness in the privates.

My gut feeling is it will, but it probably will mean that the rig count in the first quarter will hang in there in the low 800s. I wouldn't look for a large increase in Q1. Budgets are going to be reset for sure, but our customers are exercising pretty extraordinary capital discipline.

But as of right now, we have much better visibility into the publics than we do in the privates. And so that's just my best guess. Don't look for a tremendous amount of growth in Q1, but the growth that does come will come from our core customer base..

And our next question is coming from Connor Lynagh from Morgan Stanley..

I was wondering if you could help us think through what the raw material deflation and potential easing in freight means for your margins or your cost structure. Is there any way of sort of identifying how much those items have run up or what your margins might be on a normalized deck? Any sort of framework you can provide would be helpful..

I will let Steve respond to that..

Yes. I mean, Connor, we kind of said in the script that we expect margins on the product side to remain strong through the end of the year as we run off this inventory, and we just aren't in the habit of providing guidance beyond the next quarter just given all the ins and outs and puts and takes of customer activity and material costs.

But like we said, we expect them to be beneficial, and you can kind of look to our history at what our product margins in the past have been, considering tariffs. And I'd use that as a guide for the future. But like we said, that's a 2023 thing..

Maybe the other side of the question then is it would suggest in what you're saying that you expect to hold pricing despite raw material deflation.

Can you just discuss how you've approached customers with price increases thus far? Is there any degree of sort of surcharge or a thing like that, that will roll off? Or is most of this just pricing in the absolute that you expect to stay?.

Connor, we never talk about pricing, ever..

So within the product business, is there anything beyond the tariffs that you would point to that is structurally different from '18, '19 that you would expect to influence your margin in a more normal commodity input environment?.

Certainly, currency is a very, very constructive tailwind for us. because you know that we bring about half of our products. and maybe slightly more than half of our products. from the Far East. So the strengthening dollar is going to prove, I think, to be a tailwind, really. I mean, you can quantify the change in the U.S.

dollar to the Chinese yuan on easily, and then figure half of our product comes from the Far East. In terms of other fundamental changes other than the constant sort of evaluation of lower-cost designs, I really can't point to anything substantial. Let me just follow that up.

The exception will be, as transit times improve from the Far East, you'll see less contribution from our higher-cost Bossier City operation and more contribution from our Far East supply chain..

And now we are going to hear from Stephen Gengaro. Stephen is with Stifel..

2 things for me. If we could start, just thinking about your guidance, you had a nice step-up in sort of revenue per rig followed in the quarter.

And I was just curious, without maybe giving too much detail on sort of cost recovery efforts, but is there a rig efficiency element to that? And will that likely come off a little bit next quarter?.

Rig efficiencies have actually been fairly constant, I would say, constant to down, but I attribute the decrease in rig efficiencies to be more related to an increase in laterals and lateral length. So obviously, the longer the laterals, the longer a rig is over a hole; the longer a rig is over the hole, fewer wells it can drill per month.

I think that we saw earlier in the year some significant rig inefficiencies due to labor issues among the other service contractors. I think that still exists to some extent. But honestly, I think it's pretty much stabilized. I mean, I heard horror stories during the first half of the year with rigs waiting on cement, waiting on pipe.

They seem to have abated..

And then second, I mean, you obviously talked about the balance sheet and the cash generation.

Can you give us an update on kind of what you see on the M&A side? Is there anything out there that's interesting and/or just kind of how the market has evolved as far as those opportunities? Is it better, worse, the same as maybe 3 months ago?.

In terms of opportunities?.

Exactly, yes..

I would say definitely better. I’d say that’s a very interesting question. I know that a lot of our investors are interested in me answering. I’d say the opportunities are greater. I’d say the disparity between the bid and ask is pretty significant. I’d say the population of qualified buyers is probably reduced.

So I’m sort of guardedly optimistic that there is something to be done over the medium term. I feel better today than I did a year ago, or even 6 months ago..

David Anderson from Barclays will be asking our next question..

I was wondering if you could go back to the visibility question, the answer you gave on the publics versus privates. Just sort of just in general on the wellhead side, just curious how that's kind of looked from the beginning of the year.

Are your customers already starting to talk about 2023? I'm just curious, with all the equipment and supply chain concerns out there, have you seen a change of behavior in either the privates or the publics in terms of ordering their wellheads in terms of up in front of their jobs?.

Yes, David, we're seeing far better forecasting now than we've ever seen before, pardon me, from the large E&Ps and the public E&Ps. So that's been a great benefit. Interestingly, because of the OCTG pressures, and because they have to forecast if they want to get pipe, they are now including us in their pipe forecasts, which is a pretty good gauge.

This is really something that just began to occur this year. And that's why I'm confident that we have a pretty good view towards the third and fourth quarters. In terms of the privates, far less visibility..

So I guess that kind of goes back to what you're saying about the fourth quarter and how you think about those programs evolving. So we know all about these equipment shortages out there we're hearing. I know not [so] your business, but [within] capital discipline across the industry.

There's not many rigs or pressure bumping fleets that can go back to work.

So with your businesses tied to both of those markets, is there a concern that while pricing and margins can continue to move higher in products, that a lack of capacity, I guess price and rentals, that a lack of capacity could ultimately moderate growth in activity over the next few years if there just aren't enough rigs or pressure on the equipment to go out there? How are you thinking about that dynamic?.

First, let me talk about frac. Our market share is so low, right? If there was not another pressure pumping crew added, we have room to grow, okay? Drilling rigs, another story. I'm going to take a little contrary view here just based upon the decades I've been in this business.

Yes, rigs are in tight supply, and I know there are a lot of folks who believe that we're going to be constrained by the availability of rigs. But I'm going to bet that some of the rigs that are stacked now, the less efficient rigs, are going to go back to work because the day rates are going to be high.

So I think you're going to see some people spend some money to upgrade rigs that perhaps they would not have upgraded 6 months ago. I think we'll be constrained, but we won't be nearly as constrained as many people feel. Money moves into this business so quickly..

We've certainly seen that. On your pressure control business, you'd talked about your market share, and very fragmented. Curious about the capital discipline in that market overall.

Is it just too much capacity and too many players? Or have people been building out? And maybe just also on the side of that, is there much attrition in pressure pumping in the pressure control? Or is that sort of the reason why we still have too much capacity in there?.

I think the barriers to entry are just too low. I think that the availability of Chinese valves, although they've been -- clearly, the supply has been intermittent over the first 6 months because of the issues in the Far East.

There appear to be plenty of frac valves available in the market, and this would be I think that our larger competitors aren't adding to their fleets, but I think the smaller players are having no trouble getting valves right now..

And our next question is coming from Cameron Lochridge from Stephens Inc..

You mentioned in the release you're working towards increasing the quality of your customer base. I thought that was an interesting snippet there.

I just wanted to ask if you could offer some more color on what you're doing on that front and what maybe the implications are? I know you don't like talking about price, but on cost recovery efforts, what are some of the implications there as we fine-tune that customer base?.

Cameron, I think you probably know the answer to this. In a market like this that's tight, particularly the labor side of the market, we're blessed with adequate inventories, but labor remains tight.

When you go out to market, you have to go out to market to those customers who are going to value the execution excellence, the service excellence, as well as the products. And so, by and large, the larger players place greater value on our offerings than some of the privates.

So as we approach the market, we're just having to be a little bit more discriminating, and we are being a little bit more discriminating about who we approach. The second thing is, as we applied to our cost recovery plans, we promised -- and we took it seriously -- we promised our large customers that, if they supported us, we would support them.

And that meant that we would have adequate people and inventory to take care of their needs. And I can tell you the name of this business is repeat business. I'm proud to say I can't remember the last time we lost a customer, and I don't intend to lose any customers, certainly don't intend to lose any because we can't deliver on time.

And so that plays a large part in the way we view the opportunities out there..

And then moving back to the topic of M&A. We've gotten a few questions from folks just asking, basically, as you've been looking at this pipeline of deals over the past several quarters, pretty healthy balance sheet, obviously.

Just wondering if you can comment on -- difficulty may be a strong word, but the difficulty of sourcing or looking for the right target, the right candidate that complements your profile of having a differentiated product, a differentiated service model, what are some of the puts and takes there? And how plentiful, or not plentiful, are candidates like that in the market today?.

I would never characterize them as being plentiful, Cameron, any stretch of the imagination. But I would say that there are more suitable candidates. We're seeing more suitable candidates today than we have, say, 6 months ago or 12 months ago.

And it could very well be that owners see this as an opportunity to monetize finally after a very tough couple of years. I suspect that's the reason. I also made mention of the fact that the bid-ask disparity is pretty significant, but that's why you have to practice a little bit of patience.

But I do believe the opportunities are better with those candidates who meet most of our criteria. So that's why I feel pretty good about this..

[Operator Instructions] And now David Smith from Pickering Energy Partners has a question..

Just hoping to circle back to a comment you made on the call regarding discussions with an NOC in the Middle East. You mentioned product testing next year, commercialization expected by '24.

Is this something that envisions distribution from your existing facilities or something that could entail building a regional manufacturing presence?.

The latter..

And could you remind us on kind of the rough expected lead times to establish a new manufacturing facility in the Middle East?.

Yes, David, it's in the neighborhood of 12 to 18 months..

Yes, most of my questions have been asked, but just a quick one.

Given the improving visibility you have for drilling activity on the public E&Ps, wondering if this might translate at all into maybe more forward visibility on the types of customers who place more value on your rental offering and if you're seeing anything positive in that mix?.

I mean, the short answer is yes, David. The more activity, the higher the percentage of activity that is being conducted by the larger publicly-traded companies, the better for our pressure control business for our frac business. There's no question about that. We don't do very well at all with privates in terms of frac valve rentals. So you're right..

Thank you so much, David, and thank you for the questions. And now I would like to turn it back to the gentleman for closing remarks..

Thanks, everyone, for joining the call. We look forward to connecting with you next quarter..

Okay. Everybody, have a great end of the summer. Thanks..