Liberty Energy Inc (LBRT) 2022 Q2 法說會逐字稿

Welcome to the Liberty Energy Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Anjali Voria, Strategic Finance and Investor Relations Lead. Please go ahead.

Thank you, Dave. Good morning, and welcome to the Liberty Energy Second Quarter 2022 Earnings Conference Call. Joining us on the call are Chris Wright, Chief Executive Officer; Ron Gusek, President; and Michael Stock, Chief Financial Officer. Before we begin, I would like to remind all participants that some of our comments today may include forward-looking statements reflecting the company's view about future prospects, revenues, expenses or profits. These matters involve risks and uncertainties that could cause actual results to differ materially from our forward-looking statements. These statements reflect the company's beliefs based on current conditions that are subject to certain risks and uncertainties that are detailed in our earnings release and other public filings.

Our comments today also include non-GAAP financial and operational measures. These non-GAAP measures, including EBITDA, adjusted EBITDA and pretax return on capital employed, are not a substitute for GAAP measures and may not be comparable to similar measures of other companies. A reconciliation of net income to EBITDA and adjusted EBITDA and the calculation of pretax return on capital employed as discussed on this call are presented on our earnings release, which is available on our website.

I will turn the call over to Chris.

Thanks, Anjali. Good morning, everyone, and thank you for joining us. I'm proud to discuss our second quarter 2022 operational and financial results. The second quarter was a busy and exciting time as the Liberty team continued to deliver differential quality services in today's robust, but operationally challenged environment. This translated into a notable milestone of fleet financial performance at levels that were last seen in 2018 as measured in annualized adjusted EBITDA per fleet. The hard work and dedication of our employees, combined with deep relationships with our partners across the value chain enabled us to achieve strong operational efficiency in an environment still impacted by supply chain challenges.

In the second quarter, revenue was $943 million, a 19% sequential and 62% year-over-year increase. Net income for the quarter was $105 million or $0.55 per fully diluted share. Adjusted EBITDA for the quarter was $196 million, a 114% increase over the prior quarter. Liberty's first half of 2022 is starting to reveal the value creation from our 2021 acquisitions and our insistence upon getting the business integrations done right, consistent with our focus on long-term results. We've positioned the company to deliver top-tier performance through cycles with a focus on free cash flow generation and maximizing returns. We're driving cash flow expansion that allows us to fund compelling organic investments to grow our competitive advantage while also returning cash to shareholders.

Our strong financial results and a constructive outlook support the reinstatement of our return of capital program, beginning with a Board approved $250 million share buyback program. Our guiding principle is to maximize the value of the Liberty share. We believe the flexibility afforded by share repurchase program gives us the ability to opportunistically act on a dislocated stock price calibrated by market and business conditions. While the global economic recovery outlook has softened on reverberating impacts from higher inflation, rising interest rates and the Russian invasion of Ukraine, oil and gas markets remain constructive.

8 years of underinvestment in upstream oil and gas production, exacerbated by inept global policy initiatives aimed at incentivizing an energy transition has created a mismatch of supply and demand. Today, historically low global oil and gas inventories, limited OPEC spare production capacity and a dearth of refining capacity are colliding with increased energy demand. Oil and natural gas demand growth is coming from the post-pandemic recovery in travel, China's emergence from its enforced COVID lockdowns plus seasonal demand factors. These are all further magnified by the Russia-Ukraine conflict and the potential for sanctions imposed on Russian oil exports, coupled with Russia's decision to constrain natural gas pipeline exports to Europe. The greatest risk to our marketplace is a severe recession that leads to a drop in global demand for oil and natural gas.

A moderate recession typically means only to a slowing in the rate of demand growth for oil and natural gas, which would likely not be overly disruptive to our customers' activity, given today's low inventory levels and tight supply and demand balances. The recovery in oil supply appears to be under greater threat than oil demand. North America is positioned to be the largest provider of incremental oil and gas supply. Today, E&P operators are evaluating the opportunity to deploy incremental capital in North America to modestly grow production while remaining focused on shareholder priorities. The fundamental demand call in North American oil and gas supply is strong. Supply is restricted by a tight frac market where equipment, supply chain and labor constraints limit frac fleet availability and service quality available to our customers.

Many frac companies are struggling to execute in today's environment. Moreover, operators desire ESG-friendly frac fleet technologies that provide the opportunity for both significant emissions reductions and large fuel savings. Liberty is uniquely positioned with the technology, scale and vertical integration to meet demand for service quality and best-in-class technology. The frac market is near full utilization and few service providers have the fleet capacity and supply chain reach to satisfy E&P operators' goals. Liberty was disciplined in restraining fleet reactivations in the post-COVID era of muted returns. Pricing has now recovered to where Liberty, in support of our customers' long-term development needs, is reactivating several of our recently acquired available fleets from the OneStim transaction.

Importantly, these long-term dedicated customers seek additional next-generation fleets that are simply not available today in the market. and Liberty is providing an avenue to serve those customers and simultaneously drive free cash flow from these existing fleets to reinvest in our fleet modernization program and free cash flow. Liberty is also partnering with key customers on the deployment of 2 additional digiFrac electric fleets in early 2023. Demand is very strong for the technically superior design Liberty developed throughout the downturn that drives better safety and efficiency, a rare commodity in a tight market. A strong frac market and specific conversations with our customers give us confidence in the demand for Liberty services into the coming year.

In the third quarter, we expect approximately 10% sequential revenue growth, primarily driven by fleet reactivations and modest net pricing increases. Third quarter margins are expected to improve from contribution of incremental fleets and modest price improvements, partially offset by ongoing supply chain, operational and inflationary pressures. Since the 2020 downturn, we have made the decision to refrain from reactivating fleets without the economics and longevity of business to support the onboarding of a new crew and the capital associated with restoring equipment. Today, we are one of the few players in the market with the equipment available to support a rising demand for frac services. We are also one of the only players with the supply chain capacity to support these services as sand and other materials remain in short supply. Reactivating fleets is a long-term strategic decision.

They are not spot fleets but rather fleet that will go to high-quality, dedicated customers that are interested in a road to next-generation solutions over time. Today, next-generation equipment is in short supply and will remain so for the foreseeable future. To maintain the development program, producers seeking a frac crew are willing to take equipment available to support their operations in the near term. For Liberty, reactivated fleets are largely well-maintained Tier 2 diesel equipment that came with the OneStim acquisition. These fleets are coming online at favorable prices that support the hiring and training of the new crew for the long term, our next-generation technology expansion program and increasing our free cash flow generation.

For a minimal capital outlay, the unit economics of these fleets generate free cash flow that provides a source of funding for investment in our fleet modernization program. Over the long term, next-generation fleets will replace older technologies. While we already have one of the largest dual fuel fleets available, our equipment makeup will evolve to an entirely next-generation fleet over time. The fleet reactivations are not market share-driven decisions, but are investments in driving the increase in value of a share of Liberty stock by investing at the right time with the right economics. We are also excited to announce a $10 million investment in Fervo Energy, a next-generation geothermal technology company that develops geothermal assets for dispatchable, reliable baseload grid power with low carbon intensity.

With this investment, Liberty expands into supporting geothermal resource development, leveraging our extensive expertise in subsurface engineering and pressure pumping assets that help create dense underground networks to mine the earth heat for electricity production. We chose this investment opportunity because of our belief in the concept viability, the quality of Fervo's team and the size of the potential resource already captured. Unconventional geothermal applications offer a potential pragmatic solution for a reliable source of low-carbon electricity, and we're excited to be part of the journey. Our team is diligently working to support a world where we are seeing the greatest threat to energy security, reliability and affordability in decades.

Yesterday, we released our 2022 Bettering Human Lives report, placing today's global energy security crisis in proper context and showcasing Liberty's leadership in clean energy technology innovation. Our drive is to bring awareness to the importance of energy access, expanding further into the topics of geopolitics, food security and the 4 pillars of the modern world; cement, steel, plastics and fertilizer, all critically enabled by hydrocarbons. ESG has always been part of our DNA since day 1, and we bring to focus our innovation and investment in digital technology, engine technology, sand, logistics and supply chain as well as our robust governance and the people and culture that find us.

With that, I'd like to turn the call over to Michael Stock, our CFO, to discuss our financial results.

Good morning, everyone. We're pleased with our second quarter results. The entire Liberty family pulled together to provide exceptional execution for our customers and deliver record revenue, net income and adjusted EBITDA. We are now beginning to see the advantages of the transformative work our team accomplished through the integration of OneStim and PropX and is already generating returns at a faster pace than we projected at our Investor Day a little over 1 year ago. Successfully achieving scale of vertical integration by doing the integration the right way has been key to our financial performance and positions us well entering into the second half with the right momentum.

This quarter, we reached annualized adjusted EBITDA per fleet levels that were last seen in 2018, and we believe that we are only at the early stages of the oilfield services upcycle. Liberty is a company with a much different scale of integration today than we were in 2018. We are in an even stronger position to lead the industry in technology and service quality and to expand our profitability. Our best-in-class frac fleet technologies have evolved to include Liberty built for purpose digiFrac fleet that raises the industry standard on providing the lowest emission technology in the market with superior durability, reliability, enhanced automation and controls. Our Tier IV DGB fleet has grown significantly and marries dual fuel pumps with automated controls that maximize gas substitution for diesel in an environment with the savings from fuel cost arbitrage have increased over the last year.

We have an expanded supply chain with 2 of our own sand mines and deeper partnerships with our suppliers that allow us to deliver superior operational execution, in severely restricted markets, riddled with global supply chain challenges. We also have the premier technologies in wet sand handling and last mile proppant delivery solutions through PropX. These transformative changes we've made and continue to make at Liberty are critically important drivers of shareholder value at a time where market fundamentals are increasingly constructive for our industry. The second quarter of 2022 revenue was $943 million, $150 million or a 19% increase from $793 million in the first quarter.

Approximately 60% of our top line growth was driven by activity, mix and a modest contribution from a fleet reactivation while the remainder came from pricing. Net income after tax was $105 million, increased from a net loss after tax of $5 million in the first quarter. Fully diluted net income per share was $0.55 compared to fully diluted net loss of $0.03 in the first quarter. Results included $7 million in fleet reactivation costs incurred from both the fleet deployed in the second quarter and the planned third quarter fleet deployments. General and administrative expenses totaled $42 million, including noncash stock-based compensation of $4 million. G&A increased $4 million sequentially, primarily driven by performance-based compensation, inflationary and activity increases commensurate with the growth in our business and investment in platform IT systems and other process improvements to support our continued expected growth.

Net interest expense and associated fees totaled $5 million for the quarter. Adjusted EBITDA increased to $196 million, more than doubling from $92 million achieved in the first quarter, showcasing solid incremental margin expansion on activity and pricing gains. We ended the quarter with a cash balance of $41 million and net debt of $213 million. Net debt increased by $34 million in the first quarter, primarily due to an increase in working capital. As of June 30, we had $150 million of borrowings on our ABL credit facility. On July 15, we exercised the accordion feature on our ABL credit facility, thereby increasing our borrowing capacity from $350 million to $425 million.

Total liquidity, including availability under the credit facility, was $263 million pro forma for the accordion. Net capital expenditures totaled $127 million on a GAAP basis for the second quarter of '22. The CapEx was driven by Tier IV DGB upgrade, the defrac spending of $65 million, sand logistics and other margin enhancing projects of $29 million and the remainder relating to ongoing capitalized maintenance spending. In the third quarter, we expect approximately 10% sequential revenue growth. This is primarily driven by fleet reactivations and -- including 1 full quarter of contribution from a crew deployed in the latter part of the second quarter and modest price increases.

We also expect margin improvement primarily for the contribution of incremental fleets and modest net pricing increases, partially offset by ongoing supply chain, operational and inflationary pressures, including in commodities, raw materials and labor costs. As market fundamentals continue to improve for our industry, we are well positioned to support global energy needs by continuing to invest in its early part of the cycle to maximize free cash flow over the long term. We are now targeting capital expenditures of $500 million to $550 million for full year 2022. The approximately $200 million increase reflects an additional next-generation technology investments, including incremental spending, the additional digiFrac fleet and PropX sand handling up with sand equipment as well as capital investment in the frac fleet reactivation and Libertization of approximately $55 million to $60 million, including the 1 fleet deployed in the second and the balance that will be deployed in the second half of the year.

The incremental adjusted EBITDA, we are on track to achieve in 2022 relative to the beginning of the year, is expected to far more than exceed the additional CapEx spending in our budget. As a result, we expect to be free cash flow positive for the full year of '22 after investing in these long-term competitive advantages. We expect to enter 2023 with an active frac fleet count in (inaudible). Investments we are making in 2022 will further expand earnings potential in 2023, and our fleet modernization plan is expected to continue in 2023. We believe capital spending is likely to be at or below in 2022 -- in 2023. We anticipate strong 2023 free cash flow conversion of over 50%, driven by both incremental profitability from 2022 investments and a continued margin expansion in the initiatives. We are planning ahead to have the fleet of the latest technologies as we enter what we expect to be a longer duration oil and gas cycle.

As we stated at the beginning of the year, we have significant flexibility in adjusting our capital spending targets depending on economic conditions, customer demand and returns expectations. As we look to the future, the increased free cash flow generation capability of our repositioned business, successful OneStim integration, operational execution and fundamental outlook allows us to meet our capital allocation priorities of disciplined investment to expand earnings per year, balance sheet strength and return of capital to shareholders.

With that, I will now turn it over to Chris before we open for Q&A.

Thanks, Michael. The world is gripped today by a serious energy and food crisis that is of our own making. It is not, in fact, due to any shortage of available resources, it is due entirely to investment decisions and a growing myriad of barriers to investment in hydrocarbons. The very hydrocarbons without which the modern world is simply not possible. It is admirable that the public regulators in our industry are keen to improve the quality and cleanliness of our activities. It is not admirable that so many emotionally driven fact-free impediments to investment have come from government regulations, NGO litigation lobbying and Wall Street too often equating lower greenhouse gas with better in all cases. The blame for the current energy crisis also falls on our industry for, too often, compliantly going along with the endless anti-hydrocarbon fashion of today.

If it is not for us to speak candidly, honestly and loudly about the critical role hydrocarbon play in the modern world, and most critically, for those desiring simply to join the modern world, then who else will play this role. Certainly, it has not been political leaders, activists, academics or celebrities, it is us that must carry that torch. Otherwise, the immense human damage we see today from the lack of investment in hydrocarbon production and hydrocarbon infrastructure will be only the beginning of a calamitous crisis.

Towards that end, I strongly encourage everyone to read Liberty's improved and expanded version of Bettering Human Lives that was released on our website last night. It touches on many critical issues that are either overlooked, misunderstood or simply ignored. We welcome all feedback on this report as we strive to be honest brokers for information on how the world is energized today, how it might be energized in the future and what inevitable trade-offs must be made. Individuals are all entitled to their own opinions, they're not entitled to their own set of facts. That idea from Daniel Patrick Moynihan.

I will now turn it over to the operator for questions.

(Operator Instructions) Our first question comes from Chase Mulvehill with Bank of America.

I guess, first thing I wanted to hit on just the CapEx, obviously, a big bump here. You've got the new builds -- the incremental new builds, the DigiFrac fleets in the first half of next year. So could you just kind of split up the CapEx of the $500 million to $550 million between upgrades and reactivations versus new builds versus maintenance, just so we can kind of get a context of kind of where the CapEx is going?

Yes Chase, I mean really -- so I'll take you back to sort of what we announced in the beginning part of the year. Really the 200 change was announced, we think about it, there's going to be 2 new builds, digiFrac fleet about $120 million, probably in the $50 million to $58 million worth of reactivations and the balance is just some additional wet sand handling technologies and some margin improvement projects that we've greenlighted with the improved pricing.

Okay. Let me ask you this, the fleets that you're reactivating in the back half of the year. Are those upgrades -- are you spending to upgrade those or are those just going to be kind of your Tier 2 fleets?

Yes they are Tier 2. We're not upgrading into Tier IV DGB, at that price, obviously, you couldn't. But they are being, to some degree, Libertized to where they are. They would be a Liberty Tier 2 fleet. So they have longevity with them, which will then support the long generation move of those clients to next-generation fleets is kind of planned with each of those clients, that has a different cadence with every one of them, but during the next 5 years.

Okay. That makes sense. And if I can ask on the buyback, if I can kind of poke around this a little bit and try to think about how you think about pacing that $250 million. I know you didn't really kind of commit to it at this point. But should we think about it kind of more matching about kind of how free cash flow evolves or is it kind of more opportunistic buybacks based on kind of how -- what's your view of intrinsic value versus where the stock's trading?

Yes, entirely, entirely opportunistic Chase. No formulaic money is going to flow out at X. Buybacks, to us, are opportunities when you have a balance sheet to support them and you have a large compelling difference between the intrinsic value of the share and the price at which you can buy shares. So the rate at which we'll buy back our stock is strongly dependent on the magnitude of that dislocation between intrinsic value and market price.

Okay. Could I ask how you define intrinsic value or how you calculate it?

Well, I mean obviously, I won't share the details, but it's just that common sensical discounted cash flow, incorporating our weighted average cost of capital in a range of possible scenarios going out to the future in our business.

Our next question comes from Stephen Gengaro with Stifel.

So 2 things from me, if you don't mind. The first, when we think about the fleet reactivations in the back half of the year, you talked about, I think, exiting next year or starting next year -- starting next year about with 40 plus. Are you -- are we coming off of a base of around 35 in the second quarter? I'm just sort of trying to calibrate kind of the percentage increase you're seeing in the third quarter and how I should think about the digiFrac fleets entering in 2023?

Yes, Stephen, yes, we're probably mid-30, mid-35 number-ish. We're obviously activating 1 right at the end of the second quarter, and then the balance will be activated, so as you go through the year through the end of fourth quarter. It's a straight line (inaudible)

Okay. Okay. And then when we think about I guess, it's a 2-part question, but the steep increase in profitability per fleet in the second quarter up to, give or take, I think, about $23 million of EBITDA per fleet. So did that bridge from the first quarter? And I assume it's price utilization and there's probably some value from the sand business in there, I would think. How should we think about the sort of the potential of that number without giving us guidance, I mean is this something that could go to the high 20s as 2023 evolves or is that too aggressive? I mean any parameters around sort of the bridge and where this thing -- where that could go as we go forward?

Where it could go, Chase, from my point of view, really more dependent on the demand side of the oil -- supply-demand equation, right? It depends on how -- kind of how any sort of any potential recession may affect demand for next year. Generally, internal numbers, we would see it from late Q2 and the industry is running maybe around 250 fleets going to move to 275 by the end of the year, kind of modeling that to stay flat at this present point in time. So yes, there is definitely upside on pricing, but I think that's still going to be seen as -- obviously, you've seen a lot of movement in the market for frac fleets and in general -- in the general economy. But I think we need to kind of take sort of watch it as we go.

Yes Stephen, I'll just add. We don't know the future. Obviously, the trends are pretty positive right now, but it's a combination of how well we perform operationally, what the trends in pricing and they're still migrating positive direction and also our just quality of operations, as Michael said, some of our capital these margin enhancement factors. We're trying to figure out how to run our business more efficiently to get more done at a lower cost in a safer fashion. So there's a lot of moving factors in that.

So we're always little shy about predicting the future, except we did say a year ago that we would return to mid-cycle economics this year and that wasn't based on anything specific. It's just based on when margins are awful, supply shrinks and eventually, demand will grow. But just supply shrinkage alone, we've got to fix the marketplace given that 2 or 2.5 years of poor frac market conditions.

Great. Very good. And just one quick one -- and Michael, you mentioned this, but as the market evolves over the next couple of years, do you view the upgrades and the digiFrac as ultimately replacements for these Tier 2s that you're reactivating and it's sort of a bridge to newer higher-end assets?

Generally, what we see at the moment, Stephen, is in the market (inaudible) going to announce for new builds, is approximate about what the attrition cycle is for frac fleets. If you think about the 10-year life of some of the older these diesel fleets, et cetera, the sort of the announced numbers that are coming out are approximately the same. So we had a pretty balanced market, a very disciplined approach by ourselves and our competitors and we think that's good for the freight market overall.

Our next question comes from Arun Jayaram.

Chris, I was wondering if you could give us a little bit more bigger picture around the scope or the ambitions of your fleet modernization program. You mentioned $500 million to $550 million of CapEx this year and at or a little bit below that kind of next year. I was wondering if you could give us a little bit more scope on how long do you expect the higher CapEx trend relative to maintenance to continue? And what type of capacity as do you expect over the next couple of years?

We don't have any plans to add capacity, per se. Our plan, and we do have a plan, on fleet modernization is sort of a continued gradual program. Of course, what's actually going to happen is not going to be our plan. It might be accelerated if the demand pulls there, it might be slowed down. We never put anything in stone, but I would say the migration to next-generation fleets, the economics are going to pull back pretty strongly. Both these next-generation fleets have meaningfully lower emissions.

The very latest next-generation fleets are also going to have greater safety, higher reliability, better performance. And then just from a straight numbers perspective, the delta in fuel costs today between burning natural gas and burning diesel is large. It's a big deal. So just the economic driver of fuel cost savings is likely going to have continued customer pull to get next-generation fleet equipment. But again, for us, it's not expanding, it's not growing our fleet. It's just simply a disciplined, returns-driven upgrade cycle in our fleet that will be and is being pulled by our customers.

Great. I was wondering if you could just follow up, just give us a sense for the 2 digiFrac fleets that were to be deployed starting in the third quarter or later this year. Give us a sense of how those deployments are going in terms of timing and perhaps how the contract terms for the latest 2 new build are trending relative to your initial 2 that you plan to put in the field?

Arun, this is Ron. Yes obviously, customers are excited to see that technology out in the field, and we're excited to get it deployed out there. We continue to see strong demand. We are navigating some supply chain challenges, not so much on the pump side. We have pumps being delivered on schedule. We're struggling a little bit more on the power generation side, so that's holding us back a bit. We still expect to deploy our first 2 fleets this year in Q4 likely, and the next 2 fleets probably in Q1 is our expectation to-date. And as you think about how that contracting has evolved, you kind of want to think about how the business really the market has evolved over time.

If you think about when we announced those first contracts, we were in a little bit different environment than versus where we find ourselves today, leading-edge pricing even for a Tier 2 diesel fleet has moved pretty dramatically over the last 3 to 4 months. And so, as we think about contracting next-generation fleets to the point Chris made earlier, the fuel savings opportunity there is massive, maybe $20 million to $25 million annually. And so, we think about we're leading-edge Tier 2 diesel pricing is and then the fuel savings opportunity there that of course, we want to capture some meaningful piece of as well. And that provides guidance as to where we want to set pricing for our next-generation capacity we're deploying.

Our next question comes from Neil Mehta with Goldman Sachs.

Great. Chris and Michael, congrats on a solid quarter here. I wanted to build on some of your comments here. You mentioned you don't expect to add capacity, but broadly speaking, do you see current profitability levels as incentivizing your competitor set about adding capacity to the market overall? I guess where we're going with it is, do you see discipline fading at all?

We haven't seen any of that. And look, obviously, we're close to all the equipment builders. There's -- I don't know of any fleets being built that are not really driven by ESG or spec, I don't know of any straight kind of capacity adds, they probably are, but if there is, it's very small, very little. Certainly among the bigger plays, who aren't increasing share of the marketplace these days, I don't think there's any appetite.

Look, A, you couldn't do it. The market is great today. I want 3 more fleets, well, sign up for 15 months, and you'll get them. What's the market going to be in 15 months? And people, I think, are obviously burned from overbuilding or redeploying too many idle equipment in the past. So no, we have not seen a fading of discipline. We've seen a pretty rational dialogue between us and our customers in a marketplace today where our customers have just spent (inaudible) returns. And we're still lagging the ways behind that, but we're moving in that direction as well.

Just to point out, I mean, really, if you think about it, there's about 10% attrition a year. Now the attrition can be delayed somewhat, it's a very strong market but eventually, it comes, right? So I think that's one of the things you've got to look at when we look at sort of what's being built, but it seems to be balancing with attrition over the long term.

Good perspective. And the follow-up is just around labor. A year ago on these calls, we were spending a lot of time talking about how tight the labor environment is. And just talk about what you're seeing right now? Are you still facing labor challenges? And how are you mitigating some of those risks?

Yes labor markets remain tight. I would say, you're seeing a fewer people coming back into the labor force. So incrementally better than it was 6 months ago, but still a very tight labor market, nothing like we've seen in the last 10 or 12 years. So incremental improvement in the right direction. What we focused on is very Liberty specific opportunities about why it's a great place to work at Liberty. Why people love their jobs here, why we have low turnover, so (inaudible) is on the ground effort. And we're going to trade schools where people are learning to become electricians and welders, and standing in those groups, having them do internships at Liberty that having NCAA like signing ceremonies as people sign on to join Liberty, whether it's out of Alabama or Mississippi or somewhere that may not be right in the middle of the oil patch.

So I give huge credit to our recruiting and HR team who just had to change the game a bit to find and attract people to come in, but people come in and if you treat them well and they have a great job, this is an exciting industry. So they're all solvable problems, but yes, it is a challenge, and it is a significant constraint. I would say others turnover in our industry as a whole, I would say, it's probably still quite high. And most everything in our industry is shorthanded today. So I don't want to get too much comfort on the labor from, they're real, but I think Liberty has been doing a pretty good job navigating that.

Our next question comes from John Daniel with Daniel Energy Partners.

Phenomenal quarter. Congratulations. A quick question on the incremental fleets. How much of that growth is driven by your ability to tie your own sand and access to that sand versus just better overall industry demand?

Look, it's people -- this is almost all from existing customers, right, that either want to do a little bit of incremental activity or maybe they split their work between Liberty and somebody else and somebody else is struggling and they're not getting consistent throughput, they're not getting things done the way they'd like them to be done. But if -- I think that the pull there is we know you guys, we trust you guys, you can deliver. And what are the economics it would take to get a little more of that? So it's all of that package, of course, John, but we buy a lot of sand from third parties as well. Look we're in a bunch of different basins. So it's not just that we have sand mines, but it's that we have relationships and a history that are in a tight procurement market. I would say our goal has always been to not just be the preferred provider, but to be the preferred partner to our suppliers as well.

So a little color on that, too. I mean the activations are not in on specific basin, right? They are actually spread across all our basins, which, to some degree, helps in the ability to source labor and support those fleets and the supply chain to support those fleets. But the key things you're asking at this present point in time when you're activating a fleet is really is, can you source the labor? Can you source -- can supply chain support them? That's a key event because you are putting your fleet to work, and it's delayed or it's sort of has issues, is not an excellent choice.

Okay. Got it. The other one for me is just if we look at the backdrop, I mean, clearly, demand is good. You guys are obviously performing well. How did we transition -- do you think there's opportunity, Chris, Ron, Mike, to transition finally to sort of take-or-pay arrangements for these fleets? Just what would happen if you went in an asset customer today to lock something up? I mean the transition was from dedicated fleets, is that in line of sight?

I mean, there are deals like that today where the buyer needs something and so, we'll have guarantees of our economics that they struggle on operations and aren't able to have a frac pace move as fast as we'd like. We have some contract protections in there that protect our economics. So those absolutely exist today. But again, for us, the winning in the long run in this industry is always about how can we win together?

Not, hey, if things change, you're screwed and we win. That's just that's -- they did exist in our industry, even then we generally did not engage in that. We've always had a partnership mentality. We always will have a partnership mentality. Now I know you're rolling your eyes right now and say, well, Chris that partnership was harsh for you guys the last 2 or 3 years, and there's some truth to that or the benefits disproportionately going to swing a bit more our way going forward? Yes. Yes, of course, they are. But we've got to always be prepared to deal with what comes.

Scared, you've got a camera in my truck, okay. Last one for me hopefully -- at this one, but you noted you'll start the year in '23 with a fleet kind of in the low 40s. Is that assuming 2 digiFrac fleets and can you say how many in Canada, just remind me?

We don't give fleet breakdowns by basin and all that, John. We've always been bit careful about that. So low 40s is sort of vague, but yes, I would say that's taken in a couple of digiFrac fleets that are going to be rolling and they will be rolling in the fourth quarter.

Our next question comes from Roger Read with Wells Fargo.

I guess some of these questions have been asked, maybe dig in just a little bit deeper on what you're seeing in terms of who's coming to you to bid for potential new fleets or any future reactivations? And have we seen that as a difference between sort of oil and gas basins understanding you don't like to disclose exactly where the fleets are, but as you think about what's going on in the bidding side, what you're seeing from your customers?

I would say it's pretty balanced right now. It's strong across the sector. Well strong, meaning that the economics are good, if there's pull for incremental demand, but the pull is for very small incremental demand. The fleet count -- the fleet cap from the start of the year to today maybe has moved 10%, growing a little bit faster at the start of the year, probably moves a few percent from here to the end of the year, and we sort of model next year at sort of flattish at the end of this year because there simply isn't -- people wanting 20 more fleets next year, I simply don't think they're there.

So we expect to see the continued sort of flattish with a slow creep upwards in active fleet count. And I would say, reasonably balanced between oil and gas. The end markets in both are pretty strong right now. But in both markets, everyone across our customer and just friends, your current customers, the mindset across everyone is, it's hard to add incremental supply, and it wouldn't be good, if we all added a lot of incremental supply. That's oil and gas production and frac fleet. So I think it's a pretty disciplined silver state of affairs in the industry today.

And then maybe as a way to tie that into sort of production expectations as we look to the end of this year and next year. You mentioned earlier in the call challenges for operating efficiency for the industry. This would tie in a little bit with the labor issues, but if you think about a relatively stable capacity in '23, I mean, does that imply that if we don't get significant operating efficiency improvements, trained labor, et cetera, that it will be hard to deliver more wells and more production in '23?

Well, Roger, the current activity level and sort of like the biggest proxy for what's going to happen to U.S. oil and gas production in the rate at which pound of sand are going underground, way more important than rig count, frac leads better than rig count, but really it's held the sand going underground. That's the metric we base production predictions and drive. Now it's not straight simple as where is the sand going underground, how is it going be there are some details around that.

But the current level of activity is driving today modest growth in both U.S. oil and natural gas production. I think we've said at the beginning of this year, we expected 700,000 or 800,000 exit-over-exit oil production growth this year. I think that's a reasonable estimate. We might be a bit above that, but we might be a bit below that. I think that's a reasonable pace at which we're running right now. And if you keep going at the current rate, we would see a similar growth rate next year.

So I think you'll see, again, probably a little less than a million barrels a day of U.S. over exit over exit rate oil production growth this year, probably on track to see a similar level next year. Now wide bands on that, but 500,000 to 1 million barrels a day of exit over exit growth rate next year, probably. And continued to be even more cautious here. Natural gas is growing and production rates will grow, but again, also at a modest rate. And at current activities in next year's plans, I think it continues to grow next year at a modest rate.

Our next question comes from Scott Gruber with Citigroup.

So as we've talked to investors in the last couple of quarters, you sensed a general kind of disconnect between market expectations for frac fleet utilization and the trajectory of per fleet profitability. Many initially looked at the 2017-2018 upcycle as a comp, not using just how weak that upcycle was. If you look back at 2011, 2012, per fleet profitability at closer to $30 million. Is that a level of profitability possible for the underlying frac business alone this cycle separate from the other businesses or does the partnership model or cost inflation prevent you and peers to pushing the frac profitability towards that $30 million level that we saw about a decade ago?

It's certainly possible. It's certainly -- look, it's just supply and demand. It's -- yes, well, fleet profitability are low 20s now. Does that likely drift higher? I suspect it probably does. But yes, it's hard to predict where it goes. I would say, we would hope it doesn't go to $40 million. If it goes to outrageously high levels that, of course, will be the start of some unwinding of discipline, but that there's still a lag there. There's still little risk in there. The economics look awesome, but then I can't get equipment for over a year. I still think you see some restraint on that. But when we see people that really need activity and are willing to pay for it and we deploy these incremental fleets may be personally to offset people doing whacky things to get wells online and where they are. And so, yes, we don't know where the fleet profitability is going to go, likely to continue to drift higher in the next -- in the coming quarters, how much or how far, we'll see.

Got it. Got it. And then how should we think about the contribution from the contract businesses? It looked like you had a nice step-up in that contribution in 2Q. So as we think about 3Q, 4Q and into '23, will the non-frac business' profitability contribution expand at a faster pace than the underlying frac business or more in line? How should we think about the cadence of that contribution?

So I think the underlying frac business is totally the one that expanded a bit quicker -- the non-freight businesses are a little steadier. The majority of that sand, we have the sand mines we've picked up from OneStim really come to go through our frac fleets. So that's really a small portion of sort of additional sort of like say, third-party sales that go there. So I would say kind of the first half, the underlying frac business is the one that's expanded at a faster rate.

And that would be expected to continue to lead in the second half?

I think that's a fair assumption. I think so.

Relative to our fleet business.

Our next question comes from Connor Lynagh with Morgan Stanley.

Just a question around capital allocation, and I frankly asked this a little bit facetiously. But given where your stock is and just how cheap the valuation is relative to these leading-edge numbers that you're putting up here, why spend anything, but the bare level of maintenance CapEx and divert the -- not divert the rest into buybacks? What's your thinking around that?

That is very much a dialog we have internally, very much. And I think one could make -- you can make an argument for that. The question is we're always playing for the long term, right? Our success are way above average, not just order, but the S&P 500 return on capital employed since we launched this business, cash return on cash invested, I think is closely tied to the great partnerships we've had with our customers that want to work with us for the long run, they want to make long-term decisions together with us.

So it's very important that we run this business in a way that keeps us the best partner for E&Ps available. That competitive advantage in our business definitely helps keep us to deliver elevate the returns over the long run. So we'll always continue to invest and keep that competitive advantage. But you're right, today, the attractiveness -- fortunately, we're coming into a place where we're going to have the free cash flow to pursue a bit of an all of the above approach. But yes, at today's valuations, buybacks are pretty compelling.

And just to clarify about how you're thinking about the balance sheet and executing those buybacks. Obviously, you got a fair bit of CapEx for the duration of the year here. And it sounds like probably a decent amount of the market remains strong in 2023. Would you feel comfortable levering up a little bit in order to execute buybacks based on where the share price is trading or is that something you think of as more of excess free cash flow is what you're going to use for that program?

No, the opportunity today is compelling. The window of free cash flow in the very near future, we're quite confident in. So no, buybacks timing matters. I can say the same thing about CapEx and investment. People tend to invest hugely in their businesses, CapEx and buybacks when their business is just killing it and minting cash. But that's not the best time to invest in CapEx in your business and in buybacks. So no, you have to be willing to do those with a lag. And we talked about this since our IPO. At the beginning of cycle is the best time to invest CapEx in your business. And when the share price is most dislocated is the best time to do buybacks as long as you're not taking balance sheet risk, right? So the very start of the downturn. You don't know how long it's going to be, but you've got to be careful or cautious there. But no, the timing of these things is not tied -- it's not specifically tied to the timing of cash flow.

Our next question comes from Derek Podhaizer with Barclays.

I wanted to hit on pricing a little bit more. Could you talk about where the reactivated Tier 2 diesel fleets were priced relative to the next gen fleets priced at the end of last year and early this year? How much does this raise the bar for next gen pricing recontracting? And what run rate do you have now for profitability expansion that these are repriced in the next 6 to 12 months?

So I've got to be cautious. We always want to be careful about not giving specific projections because we don't know the future. But you make a good point there, Derek, that right now, these reactivation fleets are obviously contracted at very strong economics, very strong economics. And if you said, hey, let's take the exact same market environment and add a next-generation fleet with huge fuel cost savings and lower emissions, yes, the value of that is enormous. And will that impact repricing of fleet? Sure. Of course, it will.

Got it. That's helpful. Switching over to the digiFrac. So you'll have 4 fleets by early next year. You talked about the pressure on the power side. Would you supplement with third-party turbine providers or grid power or battery power to help get you to where you need to be with those MTU natural gas recip engines?

Look, I think we certainly contemplate most of the above you listed, never a turbine. We don't view that as an appropriate solution to put out in the field. So I don't think that's the right answer for us. But in terms of an opportunity to use some amount of grid power, I think that's certainly on the table and the conversation we're having with some of the potential digiFrac customers, call it a bit of a hybrid approach, in terms of how the power is ultimately provided on location. As you know, there are some folks in the third-party business that have natural gas recip now, have come to the same conclusion we have around the emissions profile for that technology. And so those would also represent a potential option for us as we think about pace of deployment for digiFrac going forward.

Got it. That's helpful color. Last one, if I could squeeze it in, just on the unconventional geothermal investment. Can you talk about how big of an opportunity this could be for you over the next few years, 3 to 5? Could you frame that and maybe put some numbers around it for us?

I think too early to do that. But obviously, we did the investment because we foresaw there was a reasonable chance that this would be a meaningful business. So we're excited about that opportunity. Too early to really give numbers around that. But yes, we're obviously not doing it for show or for window dressing. We believe in that business. We believe it can grow to some scale.

Our next question comes from Keith Mackey with RBC Capital Markets.

Just curious if you can talk a little bit more about what portion of that low 40s fleet count would be non-next-generation fleets under your definition, which I think is Tier 2 dual plus?

Yes instead of getting to specific numbers, it's definitely less than half, maybe meaningfully less than half, but it's still a meaningful slice.

Okay. Got it. And under next year's initial look at CapEx of close to 2022 levels. Can you talk a bit more about how many digiFrac fleets that might contemplate?

When we look at that, the majority of that CapEx above and beyond maintenance CapEx is kind of at the moment soft circled to digiFrac. I gave you those numbers to give you kind of a general view of where things could go. Obviously, those plans will actually be made 1 customer at a time we'll announce them as we go. But yes, the majority of -- outside of maintenance CapEx, the majority of that will be spent on the digiFrac complex.

Next question comes from Waqar Syed with AltaCorp Capital.

Congrats, gentlemen, great quarter, first of all. Mike, just quick housekeeping questions. #1, do you envision some peaks out of cost in Q3? And if so, what will be the size? And H2, would that be second half? Would that be a source of cash from working capital or still use of cash?

Sorry, Waqar you broke up while you were asking, I think. Could you repeat the first part of the question?

Yes. So in Q3, do you expect any fleet start-up costs? And if so, what size?

Yes, we do. And I think order will be probably similar to Q2 with Q3 and Q4, I'd say.

And then working capital, do you expect that to be a source of cash in H2, second half?

It will be a slight use of cash, probably balances in Q4 as we had the seasonal -- the normal seasonal rollover seasonal way to roll over, it might be a small use of cash in Q3 and possibly it's more in Q4.

And just, Chris, just one last question from me. With this recent pullback in oil prices, have you seen any change in discussions with your customers in terms of the direction of leading-edge pricing or in any way other concerns about reducing activity or anything like that, anything negative on pricing and activity?

No, nothing there. I don't think pullback has been significant enough. But in the out years, it's not meaningful. So no changes yet.

Our next question comes from Marc Bianchi with Cowen.

I wanted to go back to the 23% CapEx if it is flat or slightly down. Michael, could you just give us the buckets because I'm assuming that the maintenance number is going up because of just the active fleet counts going up, but maybe just level set us on the 3 buckets or however you want to describe it for '23?

Yes, it's really a soft circle, Marc. I think you used sort of our rough rule of -- $3.5 million of fleet. We got up in that low 40s. Obviously, we've got -- you've got inflationary pressures on the maintenance cap, et cetera but that's getting -- as we improve equipment, as we're doing our best to offset that. But I think if you take those maintenance then I think the balance is really a soft circle on the decisions that we made customer by customer, the majority will be spent on digiFrac.

Got you. Okay. And one other -- Pardon go ahead.

It can easily change. I mean the market changes, we have a lot of flexibility in kind of moving CapEx or adjusted CapEx as markets change.

Yes, we saw that this quarter, right? I guess the other one for you, Michael, is the 2022 and 2023 cash taxes. Can you give us any sense of what we should be assuming there? Because I'm assuming that's quite a bit different from the book tax we'll see?

Cash tax is relatively minimal. Second half of the year, probably of order $10 million to $15 million, and it's probably not too similar from book taxes. Obviously, we've got a fairly large valuation announced related to the TRA that protects that. 2023, we'll probably talk about that in the next -- because they haven't bottled it out, I've got to spend a little time with my tax director on some of the interplay there.

Okay. But not a meaningfully different number perhaps in the second half as we're just trying to triangulate on cash flow?

Yes, I would say, in general, I think we will be in cash tax payment situation next year. So yes I think next year will be probably be a drag on cash flow to the extent we haven't modeled yet.

Okay. Super. And then the last one for me is just kind of higher level on customer budgets here. I mean E&Ps have absorbed a lot of inflation over the course of the year, and there's at least for the public, there's a commitment to not increase CapEx too much. Are you seeing any customers adjust plans and activity because of the amount of inflation that they've seen? And how are you thinking about that interplay into '23?

I would say people's goals are based on what they want to do with their production. They want to keep production flat, they want to have very modest production growth. I think that's generally the targeted activity levels and then they want to work as efficiently as they can to get those activity levels done. And obviously, frac pricing is a piece of that, but it shifts the piece, right? You could pay a higher frac pricing, book pricing to Liberty versus someone else, but if the wells come on sooner and the efficiency of operations is greater, there's some offsetting cost savings from that. So no, I think what producers are keeping relatively anchored is their activity and production plans.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Wright for any closing remarks.

Yes. I just want to say thanks for everyone's time today for following Liberty's business as for being involved in the energy business. Huge shout out to everyone on team Liberty that 24/7 is working hard to make our business successful and to make the world go around. Thanks all to our customers and suppliers and everyone we'll talk to you next quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.