Ladies and gentlemen, thank you for standing by, and welcome to the Cactus Quarter Three 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to our speaker today, Mr. John Fitzgerald, Director of Corporate Development and IR. You may begin.

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, our 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, we issued our earnings release, which is now 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. Reconciliation 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.

Thanks, John, and good morning to everyone. During the third quarter, drilling activity continued to move higher against the backdrop of strengthening commodity prices. I was particularly proud of our incremental margin performance in both product and rental business lines. Cactus remains extremely well positioned to participate in what we believe will be a multiyear up cycle for the industry and the third quarter provided evidence of that. We are preparing now with people and inventory for what is increasingly looking like a very busy 2022. In summary, third quarter revenues increased 6% sequentially with growth in each of our revenue categories. Adjusted EBITDA was up 11% sequentially. Adjusted EBITDA margins were 28%, up 120 basis points, sequentially. We've had a quarterly dividend of $0.10 per share and ended the quarter with $302 million in cash and no debt. I'll now turn the call over to Steve Tadlock, our CFO, who will review our financial results. And following his remarks, I'll provide some thoughts on our outlook for the near term before opening the lines up for Q&A. So Steve?

Thanks, Scott. Q3 revenues of $115 million were 6% higher than the prior quarter. Product revenues of $75 million were also up 6% sequentially, driven primarily by an increase in rigs followed. Product gross margins at 34% rose approximately 200 basis points sequentially as cost recovery efforts offset inflationary pressures across the supply chain. Rental revenues were $15 million for the quarter, up approximately 4% from the second quarter of 2021, while gross margins increased 12 percentage points sequentially due primarily to lower repair and equipment activation costs, as well as lower depreciation as a percentage of revenue. Field service and other revenues in Q3 were $25 million, up 6% versus the second quarter of 2021. This represented 28% of combined product and rental-related revenues during the quarter, which was slightly above expectations. We expect field service revenue to be 27% to 28% of product and rental revenue during the fourth quarter of 2021. Gross margins were 23%, down 320 basis points sequentially with the reduction largely attributable to lower utilization associated with time spent on new higher training, higher fuel and remobilization costs and overtime required to meet increased activity levels. SG&A expenses were $12.1 million during the quarter, up $800,000 versus the second quarter. The sequential increase was primarily attributable to higher salaries and wages, increased professional fees and IT system upgrade costs. SG&A expenses were 10.5% of revenue compared to the same percentage during the second quarter. We expect SG&A to be approximately $12 million in Q4 2021, inclusive of stock-based compensation expense of approximately $2 million. Third quarter adjusted EBITDA was approximately $32 million, up 11% from $29 million during the second quarter of the year. Adjusted EBITDA for the quarter represented nearly 28% of revenues compared to 26.5% for the second quarter. Adjustments to EBITDA…

Thanks, Steve. As previously mentioned, we reported sequential growth across all our revenue categories during the third quarter, while improving overall margins to their highest level this year despite extraordinary supply chain challenges. Following recent conversations with customers, I'm more bullish on U.S. activity levels than I've been in some time. Assuming commodity prices remain supportive and key supplies such as OCTG are available, we would not be surprised to see the U.S. land rig count grow by an additional 10% by the end of the first quarter of next year. Despite nearly all of the U.S. market rig additions coming from private operators who have historically represented a smaller portion of our business, we reported market share at 42% during the period. And what was a testament to our sales, operations and supply chain teams, we improved product margins by 200 basis points during the quarter despite historic levels of material and freight inflation and the increased use of our higher cost Bossier City facility. Looking to the fourth quarter, we currently anticipate our rigs followed to increase by approximately 10%. We remain of the opinion that our publicly-traded customers will respond to the improved commodity environment as we head into 2022 and would expect to see another double-digit increase in the beginning of 2022. Fourth quarter product revenue is expected to be up at least 5% sequentially based on current expectations. Regarding the timing of our latest cost recovery efforts, we expect relatively flat EBITDA margins in Q4 despite continued inflation headwinds. Note that revenue generated per rig typically declines marginally during the fourth quarter as completion activity lags drilling around the holidays. Additionally, in a rising rig environment, product revenue per rig can lag as rigs are fully onboarded. Lastly and importantly, we have noted a modest…

[Operator Instructions] Our first question comes from the line of Chase Mulvehill from Bank of America.

I guess first question, obviously, you talked about the supply chain challenges and other kind of frictional costs around inflation and things like that. So I guess maybe first question is, I asked you this last quarter, I'm going to ask you again, is today better or worse than yesterday from a supply chain friction? And then what are you doing to continue to manage the supply chain? And how easy is it for you to continue to push along price increases to offset kind of inflationary costs?

I think you snuck three questions in there, Chase.

They're all related.

Okay. So the first one is easy. It's worse than it was when you last asked the question. I think this quarter was probably significantly worse than what we've seen in previous quarters. So that's why I'm particularly proud of the job the team did in increasing our incremental margins. What are we doing to address supply chain in as much as our competitors have access to this call, you're probably not going to get much of an answer to that. But you know the secret sauce. We've talked about it before. We have Bossier City. We forecast -- we do -- we just do a number of things, but it's sort of -- it's one of the things I prefer not to discuss openly. And then what was your last question?

Ability [indiscernible].

Did you forget. Well, I'm not going to discuss pricing, but having told you now that cost increase by more than we expected in the third quarter, but our margins went up. That should give you some indication that we've been successful. That's a smart answer, Chase.

Okay. All right. And then when you think about activity, and I think you said up 10% on rig activity between now and kind of the end of the first quarter, let's call it, roughly 50 rigs, horizontal rigs. So could you maybe kind of characterize what you're seeing of those 50 rigs? Like, are those more public, private? Just trying to understand the mix there between publics and privates.

Third quarter was mostly private. Fourth quarter, we expect to see an increasing -- an increasing participation by publics.

Our next question comes from the line of Scott Gruber from Citigroup.

So just to check, the product forecast as rigs followed up 10% and revenues of at least 5%. Did I hear that correctly?

You did.

Got you. And just some additional color on the revenue per rig trend, obviously taken down a little bit. Is that a mix issue with more privates in the mix and they just tend to drill a little bit slower? Is it supply chain issues starting to impact everybody. And is any fluctuation with wellhead sales driving that number as well?

Yes. So this is a -- that's a very, very good question with a -- really, it's a straightforward answer, but it has many components. So let me start by saying that in general, we see fewer wells drilled per rig per month by privates than we do by publics. So that's not helpful. Number two, we monitor the well efficiency of our overall customers. And for the first time in, I don't know, how many quarters. I'm looking at my team, we actually saw rig efficiencies drop in Q3. And by that, I mean fewer wellheads ship out per month per rig than we've seen the entire year and maybe in the last two years as far as I know, it was a surprising drop. And then, of course, as the DUCs began to deplete the need for production trees also fell off. So it's that combination, I think, of really broadly rig efficiencies, which could also result from maybe the incremental rigs being added, being less efficient, crews being less efficient or it could be the -- I think it's really a function of privates in the overall mix. But that really has more to do with that the fact that we've seen the reduction in DUCs have the most to do with the fact that our revenue per rig have dropped. Now what I expect and what the team expects and what our inventory levels reflect is our belief based upon the conversations we've had with our core customer base who are the publics that we're going to see the public reemerge going into 2022.

Got you. So yes, just in terms of trends.

There's hope.

Go ahead. It's okay. And I was going to ask about the 2022 trend with publics coming back and do you have a stabilization in the production presales such that, that revenue per rig trend should start to stabilize? Or do you expect it to potentially degrade a little bit more in 1Q and 2Q?

Yes, I think that fourth quarter will be challenging just because of seasonality. I mean in the best of times, people just tend to put on fewer production trees in the fourth quarter. They take a couple of days off as well, which is not helpful. So I don't expect to see great results in the fourth quarter. I'm much more optimistic as we get into the first and second quarters of next year, seeing us return to our historic levels. You're going to have the benefit of some cost recovery.

Got you. And then just one additional one. You and peers have been building extra inventory just given the issues on the supply chain side. Is that coming to an end? Do you have some more build to go? And how are you thinking about managing inventory levels after we get past all these supply chain loads, do you bring them down, you kind of keep them as an insurance policy? How are you thinking about it longer term?

Right now, I can tell you that the industry is stressed with shortages right now. So we've always been sort of opportunistic. And because we have so much cash, it's a great place for us to put our cash. I think the second point is we have historically high levels of in-transit inventory and by that mean inventory on the water, that we can't get our hands on. And I'm looking at Steve Tadlock like, I think we're at 3x. Our -- 3x, that's a huge amount of inventory that we have that's been on a cruise now for an extended period of time. So that has not been helpful. And we have to accommodate that. The broader -- your broader question, do I see inventory levels coming back down? Yes. Once Joel gets more confident in the supply chain once the transit times and they will become closer to historic transit times, you'll see inventory levels drop back down to our normalized run rate.

Yes. I would just add, obviously, inventory is based on prospective sales, not historical sales. And given our view for 2022, we are, like Scott said, taking advantage of that with what we expect to come. I think working capital as a percent of annualized revenues was pretty good. This quarter, it was more in line with our normal, which is 25% to 27%. We were at 26% in Q3. I think in Q4, you would expect -- we expect that to be more 27.5% maybe of annualized revenues.

Our next question comes from the line of Stephen Gengaro from Stifel.

Two things for me. Year-to-date, obviously, we've talked about this public private mix. And I know historically, your relationships tend to be very sticky. Are you seeing that same stickiness with the private operators as you have historically with the public?

Yes, sir.

Okay. Good. And then as we think about next year in aggregate, I know you gave some good color on the beginning of the year. Are you seeing the same type of expectations as we have been hearing from many of the frac companies like looking at kind of a 20% plus rise in spending and probably a bit lower increase in activity? Or are you -- is your insight different than that?

So I have to be honest, I don't really listen to the pressure pumpers cause. I'm looking at my man, John Fitzgerald here. Is that 20%, and I assume that includes what they considered to be inflation? So what's the real activity increase they're projecting, having said?

Probably close to half of that.

So 10%. I would be very surprised if our frac activity was only up 10% next year. It's going to be better than that. And I'm talking about excluding inflation, I think it would be better than that.

Great. And just if I could slip in one final. The competitive landscape in the U.S. market, right, it obviously has changed a little bit over the last couple of years. Are you seeing any material changes in the competitive landscape in the folks that are fighting against you?

I would say there are a lot of smaller players out there fighting amongst each other. But I wouldn't say that we're not really seeing the impact. They're clearly -- they're clearly taking a disproportionate share of the privates that are drilling, which is what you'd expect. But in the -- I think in a market where we participate, we really haven't seen much of a change.

Our next question comes from the line of Ian MacPherson from Piper Sandler.

The -- it is -- to follow on Steven's question, it is an emerging disconnect, I think, between expected rates of activity increase in E&P spending that there's not enough money and 20% E&P spend growth to accommodate the service and product cost inflation that's happening plus 20s activity, it just doesn't fit. So I'd be curious to see how that unfolds. But my question is different. Really, your market share is has sustained in the low 40s for about a year now. You cited OCTG is a specific threat or bottleneck that could grab and growth over the near term with casing, et cetera. But I was going to ask if shortages in your niche as well could emerge. And if you could actually outcompete the other 60% or so of the market on deliverability in this tight supply chain market and actually take you -- take more market share, not just on the basis of premium differentiation and efficiency, but also just sheer availability and deliverability of wellheads.

That's the plan.

Okay. Do you see evidence of competitors stumbling on deliverability out there today? Is that an abstract or a real opportunity?

Yes, we are seeing some of that, Ian.

And then I was going to ask also you...

Ian, don't ask me too many more questions about my competitors.

Okay. This one is only for Cactus. [indiscernible], you're up and running. How are you thinking about scalability of that opportunity going into 2022?

I think that you're talking about just within the kingdom or beyond the kingdom?

Yes, sure. Total international.

Yes. I think as I've said before, our hope and our plans are to continue the expansion in the Mid East with an ASR. We're using Saudi kind of as our test case. And the performance has been very good, very pleased with it. I think that we'll continue to deploy more assets in Saudi. I can't see exactly when. And I think you'll see us deploy assets in other areas of the Mid East in conjunction with NES. I also feel increasingly optimistic that we'll turn some of this exposure into product sales later next year.

Our next question comes from the line of [indiscernible] from Tudor, Pickering, Holt.

My first one is on M&A, and you talked about the continued need for M&A and likely continuing to evaluate deals. And I guess my question is, in this commodity price environment, it feels like stellar expectations have probably gone up significantly. So just curious if you could frame just generally speaking, where bid-ask spreads sit today and if the commodity price environment is hindering the likelihood of M&A over a near-term horizon maybe the next 12 months at all?

Well, we haven't had too many bid ask. So I can't really speak to you from experience. I mean it would be logical that sellers would want more, but it also be logical that we could afford to pay more with our currency. So honestly, I don't think that we're disadvantaged given the improving dynamics in the macro. In fact, I feel probably the opposite because as long as this company continues to perform, I think our investors will continue to reward us. And as long as they continue to reward us, I think we'll be in an excellent position to move forward on M&A. So I mean that leads me to answer a question you haven't asked yet, and that is why don't you give up some of this $300-plus million, you're going to have positive free cash flow in the fourth quarter. Why don't you release that to the shareholders? And I'm going to answer the way I normally do. And that is that we are the largest shareholders, and I personally love dividends. But I still see some opportunities to deploy that cash in M&A manner. So I know I've asked all of you to be patient with us. We were just very careful about how we spend money, but don't misinterpret that to mean we don't -- we're not willing to spend money. We are willing and we are -- we're pretty active looking.

Well, you answered both my questions there. Maybe I'll sneak one in on market share, 40 to 50 rigs being added through Q1 based on the 10% metric that you provided. I suspect as the public start to come back a little bit more in the coming months that the market share probably has room to move higher. But just curious how you frame that for Cactus over the next couple of quarters?

I think your conclusion was correct.

There are no further questions at this time. Please continue, Mr. Scott Bender.

All right. Again, thank you, everybody, for your continued attention to Cactus and interest in Cactus, and we do look forward to seeing you, hopefully, in person over the next 12 months. Everybody, have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you, everyone, for participating. You may all disconnect.