Ladies and gentlemen, thank you for standing by, and welcome to the Cactus Q3 2019 Earnings Call. [Operator instructions] Please be advised that today's call is being recorded. I would now like to hand the conference over to your speaker today, Mr. John Fitzgerald. Thank you. Please go ahead, sir.

Thank you, and good morning, everyone. We appreciate your participation in today's call. The speakers on today's call 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 David Isaac, our General Counsel and Vice President of Administration. Yesterday afternoon, we issued our earnings release, which is available on our website. 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. With that, I will turn the call over to Scott.

All right. Thanks, John, and good morning to everyone. I'm pleased to report positive third quarter results showcasing the resiliency of our business and the Company's strong free cash flow business model. Revenues outperformed the trajectory of the U.S. land rig count which was down 7% sequentially in Q3, and we maintained our overall margin profile despite the weaker-than-expected macro environment. In summary, revenues, $161 million. Adjusted EBITDA was $59 million. Adjusted EBITDA margins were nearly 37%. Our cash balance increased by $36 million to $168 million, and our Board of Directors authorized the initiation of a regular quarterly cash dividend of $0.09 per share. I'll now turn the call over to Steve Tadlock, our CFO, who will review our third quarter 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?

Thanks, Scott. Q3 revenues of $161 million declined 5% sequentially but were up 7% year-over-year. Product revenues at $93 million were 17% higher than in Q3 2018 and 2% lower sequentially despite the 7% decline in the U.S. onshore rig count. This relative outperformance was achieved due to higher equipment sales relative to rigs followed. Product gross margins decreased modestly on a sequential basis to approximately 38% of revenues due primarily to the impact of additional Section 301 tariffs announced in May. Rental revenues were just under $36 million, down 10% from the second quarter. The decline was attributable to reduced industry completion activity, which was only partially offset by higher revenue from our recent innovations. Rental gross profit margins improved 70 basis points sequentially despite higher depreciation expense, as expenses associated with asset utilization declined as a percent of rental revenue and our innovations served to bolster our margin profile. Field service and other revenues in Q3 were $33 million, down 5% from the second quarter. This represented just under 26% of combined product and rental-related revenues during the quarter in line with expectations. As a reminder, product revenues and our recent rental innovations have lower associated field service revenues than our legacy rental business, and this percentage is likely to moderate further as these innovations become a greater portion of our rental revenue mix. In Q4, we would expect this field service ratio to be approximately 25%. SG&A was flat sequentially at $13.3 million for the quarter. We would expect SG&A to be down slightly in 4Q '19 to approximately $13 million, with stock-based compensation expense running at just under $2 million during Q4. As you're aware, we maintain a relatively lean HQ organization despite the costs associated with being a public company. Depreciation and amortization expense during…

Thanks, Steve. Despite declining the, pardon me. Despite declining drilling and completion activity, the third quarter highlighted our ability to once again outperform the market on a relative basis. Efficiency gains resulting in more wells per rig continue to be beneficial to our business and to our customers. Our differentiated products and services again resulted in a less volatile margin profile than many of our public company peers, and we expect this to continue to be the case going forward. While our product market share dipped to 28.6% during the third quarter as large E&Ps, our primary customer base, continue to pull back spending in order to stay within budget plans, product revenue per rig actually increased by 8% sequentially versus the second quarter. Additionally, rigs followed in October moved slightly higher relative to September levels, and our market share is currently above third and even second quarter levels. That being said, we expect Cactus' rigs followed to be down in the mid-single digits percentage-wise quarter-over-quarter. Product revenues are likely to be down slightly more as production equipment sales historically suffer from a more pronounced pullback in completion activity tied to budget exhaustion. Initial indications for 2020 point toward a sequential improvement in activity relative to Q4 levels as several customers have indicated they plan to pick up rigs in the new year, and we believe that completion activity will rebound in a similar fashion [Audio Gap] in 2019. Despite the increase in Section 301 tariffs that occurred in May, our product margins have held up well. The combination of more favorable foreign exchange rates and our continued focus on reducing costs has enabled us to offset a large portion of the tariff cost increase. That said, we expect a relatively modest reduction in product margins during the fourth quarter…

[Operator instructions] Your first question comes from the line of George O'Leary.

You guys hanging in there, it's a good day for your stock.

Well, I haven't looked.

Well, it was up before and now that you've spoken, it's up more. So you did a good job. The revenue per rig trend that you guys continue to put up is super impressive. And I know during the quarter, we discussed that a little bit, but I'm curious if you can kind of peel back the onion here a little bit. Is that really just rig efficiencies or you guys selling more production trees per rig? Kind of what's the mix there that's driving that impressive revenue per rig uptick for you guys?

Yes. George, it's mostly rig efficiencies, but it's also product mix, higher pressure, large bore, healthy stream.

You guys are always so on top of kind of leading-edge trends and trying to help make your customers more efficient. We've started to hear on our side of the table more about monoline fracs and simul-fracs starting to gain some share in various places. I was wondering if you could speak to whether you guys are seeing that start to play out in the business and just any other notable kind of completion or drilling trends that you all have noticed that may stand out.

Yes, I'd say that's absolutely the case. There's been, I guess, over the last quarter or 2 quarters a pretty significant move towards reducing the amount of frac iron on location, which of course is solved by the use of monolines from pressure pumpers into the factory. So I think that's -- I think we predicted earlier that we don't think there's going to be a whole lot of frac iron on locations in the next -- by the end of the next year or 2.

Your next question comes from the line of Chase Mulvehill.

I guess if we could talk about the international growth opportunities that you see kind of over the medium term. So if you can kind of lay that out for us, maybe which regions you think you have the best opportunity for growth here. And maybe if we should be layering in any incremental R&D or OpEx or CapEx as we think about international growth opportunities for you.

Well, I think in terms of, let me first speak to CapEx. We've increased our CapEx in Australia this year, and we'll probably continue to increase CapEx in Australia next year. Those figures have been reflected in the levels that Mr. Tadlock recited earlier. The Australian market is a lot like the U.S. market in terms of frac activity, and so the requirements are pretty much similar to U.S. requirement. Not a lot of CapEx requirements for 2020 internationally, although we will undoubtedly see some increases in SG&A as we begin to penetrate or at least set ourselves up for market penetration internationally. Chase, it's not going to be a significant amount of money. I don't really think it will move the needle, but there will be additional SG&A related to that. In terms of areas, you probably can appreciate my reluctance to discuss those areas because very often, our competitors listen on all these calls.

Yes, yes, understood. And then if we just come back to the U.S. a little bit and talk to the success that you may or may not be having at this point with kind of penetrating the majors on the wellhead product set.

What a surprising question. Chase, you know I so hate this question because when it happens, it happens. And telling you when it's going to happen, it's just not very constructive. I feel good about the prospect. How's that?

Okay. We'll leave it there.

Your next question comes from the line of Tommy Moll with Stephens Inc.

So, I wanted to start on the decision to initiate a dividend, which is one I know you and the Board did not take lightly. One of the factors you called out a couple of times is confidence and through-cycle capital returns due to the variable cost nature of the business. Can you remind us how that strategy -- what that strategy looks like for you guys and how you're able to flex up and down in terms of the costs, and why that gives you confidence to go ahead and start with the dividend now and then signal that we may see that number raised over time?

Okay. Tommy, I'm going to try to give you an abbreviated response to this. Our business has grew from 2011 to the level where we are today with a maximum debt, I think, of $9 million in only 1 month, and that occurred in 2016. So, the entire business has been financed with internal cash flow, and that includes that very, very difficult period 2015 and 2016 when we had our Term B loan, you may recall, of about $275 million. So, during that period, we were able to maintain our positive liquidity and still make payments of primarily interest, some principal as well as early retirement of some of that debt in excess of $20 million a year. So as I look back at '15 and '16 and our ability to continue to generate cash during that period, that's what gives rise to our optimism that this is a highly sustainable level of dividend. Did that help at all?

It does. If I could just follow up on the variable cost strategy. Can you remind us how you've been [indiscernible].

Yes. Okay. Tommy, because this is primarily -- we are in our core products business, and we have very, very low fixed cost requirements or capital requirements to support our products business. And you'll recall that the way our supply chain is set up, we do -- fully a majority of our -- increased -- we fulfill the majority of our increased product requirements out of China where we operate very, very low CapEx structure. We have about 75 or 80 people there. And I'll remind you that we tripled the size of that plant in 2017 at a capital cost of $500,000. So because of the way we're set up in China, we're able to increase capacity, and we're able to decrease capacity without impacting, I think, our returns. So that's what I meant by the variable cost nature of this business.

Yes. No, that hits the nail on the head. If I could shift to M&A, specifically among E&Ps, it's a trend we've seen continue this year, potentially see more of that into next year. When that occurs, what are the risks and opportunities for Cactus, specifically on the wellhead side of the business? I presume when you've got a relationship with the buyer and a transaction that's maybe a net opportunity for you, maybe it's the flip side of that when you work for the seller but not the buyer. But if you can just help us understand how you look at the risks and opportunities in those transactions, I think it would be helpful.

Well, I mean, clearly, when you're doing business with the seller, there's a certain degree of anxiety. But on the other hand, if the past is any indication of the future, when the buyer has forced them to put us on trial by default, so he buys one of our customers, the results have been very positive. So it's sort of like getting a default trial where maybe before we couldn't get on a trial. So the results have been very positive so far.

Your next question comes from the line of Scott Gruber with Citigroup.

Where did the new tech revenues sit as a percent of Q3 sales? Do you have that number?

We're not really disclosing. I mean Scott talked about 10% to 15%. That's somewhere in line with what we were -- with what we expect over the coming quarters. Heading to 20%, I think you mentioned no later than Q2 or optimistic by Q2 2020 at this point.

Got you. I was just trying to peel apart kind of growth for new tech relative to the legacy business within rental. Any color you can provide on the kind of bridge from 3Q to 4Q?

Yes, I think the innovation side of our business is going to grow faster to be sure than the legacy side of our business. But in all honesty, there's significant headwinds right now in terms of new customer adoptions, not because of the value proposition, Scott, as much as the attitude right now is, if it costs $1 more, even if it could potentially save me $3, I am not going to spend $1 more. So it's probably fair to say it's a tougher sale today than it was in the spring. But it's also fair to say that the value proposition is much better than we thought it was in the spring. So I didn't really want to get into this, but I feel comfortable, and I think the team feels comfortable that as we put more and more installations behind us, and we're able to generate more data in terms of the actual returns to our customers, data that we can share with others, that we'll be able to significantly overcome some of that reluctance to spend that incremental dollar. It's just right now, the last thing a customer wants to talk to you about is another dollar.

So we certainly hear that. Do you think that reticence, that breaks pretty quick in '20 with a budget reset?

It certainly is going to relax, I think, some of that reticence, that and more installations. So I mean I'm proud to say that those who use it, use them, love them. They still use them. It's just getting that next customer now to come to terms with having to spend $1 to save maybe $3. So yes, this is a terrible environment right now to ask a customer to spend $1.

And any color on why you think the value proposition is better than you originally thought?

Because we're always cautious going in. I think that -- well, I mean, there are a lot of reasons. We're cautious by nature. I think secondly, the more you use it, our customers use it, we use it, the faster we are in mobilizing and demobilizing. And then as you might understand with new products, you make tweaks to them along the way. So we've always been -- I've always been proud of the group we have here. When they see a better way to do something, we quickly make a modification. So virtually, every one of these products has undergone some level of modification to increase their efficiency.

Got it. And one last one. Do you think the legacy rental business is down at a similar rate to the market around that 25% mark? Or do you think it could be a little bit worse if you're not chasing work, given where pricing is going?

Yes, the latter.

Got it thank you.

And your final question comes from the line of Sean Meakim with JP Morgan.

Hey good morning.

So Scott, it's interesting to hear your comments about the new tech conversations are tougher now as convincing customers spend an extra dollar makes it more difficult to justify than it was in the spring. Is it fair to say that there's some seasonality to that mentality? You all did famously well during the downturn, taking market share, perhaps, because folks were able to spend a little more time listening to you. Does that give you a little bit more confidence as you head into next year and budgets reload? Not that it won't still be a -- in a bit [indiscernible], but is that also a factor that could help you in the first part of 2020?

I'd be very disappointed if it didn't.

And then I guess as we think about -- as these new technologies are getting rolled out, can you give us a sense of the appetite and/or, I guess, kind of the queue of incremental technology that you guys have kind of in the -- either in the works and/or just things that are kind of on the drawing board and just how you think about cycle times from idea generation either coming from the field or something internally and converting that into a commercial product? Just how you think about time lines for those types of opportunities over -- kind of on a medium and long-term basis.

Okay. I would say that right now, we have 2 very near-term rollouts. And when I say near term, within the next couple of quarters and one beyond that. The next one to roll out, we expect to roll out at the very end of this year. Some of that will depend upon when, of course, a pad starts, one pad ends and the next pad starts. But it will roll out for trial I hope by the end of the year, for deployment probably by the end of the first quarter. We began to work on this product about -- Steve, when would you say?

6 months ago.

6 months ago. It's probably the most technically ambitious of all of our products. It has an element of digitization to it. And so on the one hand, the capital cost is low. On the other hand, of course, that's offset by the technological demand. So 6 months, which I don't think is too bad. The next product is more sort of equipment heavy and technology heavy. We've been working on that for about 4 months, and we'll roll that out I hope some time at the end of the first quarter. So in general, we're looking at maybe 6 months on average.

I think that's really helpful. And just one point around the context around each of those in terms of how they were developed or kind of where the idea generation came from. Were they internally developed or there's kind of in-the-field partnering with customers? Just curious how those evolved from the early stage.

Yes, virtually every idea we have comes from our customer.

And there are no final questions at this time.

Thank you, everybody. Have a good day.

This concludes today's conference call. You may now disconnect.