Cactus, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Except as otherwise indicated or required by the context, all references in this Quarterly Report to the “Company,” “Cactus,” “we,” “us” and “our” refer to Cactus, Inc. (“Cactus Inc.”) and its consolidated subsidiaries, unless we state otherwise or the context otherwise requires. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes. The following discussion contains “forward-looking statements” that reflect our plans, estimates, beliefs and expected performance. Our actual results may differ materially from those anticipated as discussed in these forward-looking statements as a result of a variety of risks and uncertainties, including those described above in “Cautionary Note Regarding Forward-Looking Statements,” in the risk factors included in “Item 1A. Risk Factors” in our 2022 Annual Report and included elsewhere in this Quarterly Report, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur. We assume no obligation to update any of these forward-looking statements except as otherwise required by law. Executive Summary Cactus is an equipment solutions provider primarily for onshore oil and gas markets. Founded in 2011 by a management group that previously operated two of the largest wellhead providers at the time, Cactus has rapidly grown to be a leading provider of wellhead solutions to the U.S. onshore market. On February 28, 2023, Cactus acquired FlexSteel, which similarly grew from its founding in 2003 to its current status as a leading provider of spoolable pipe technologies to the U.S. onshore market. We paid cash consideration of approximately $624.2 million upon closing the FlexSteel acquisition, with the final purchase price subject to adjustments for closing working capital, cash on hand and indebtedness as set forth in the merger agreement. In addition to the upfront consideration, there is a potential future earn-out payment of up to $75 million to be paid no later than the third quarter of 2024 if certain revenue growth targets are met by FlexSteel. We believe this acquisition enhances our position as a premier manufacturer and provider of highly engineered equipment to the E&P industry and should provide meaningful growth potential. We further believe FlexSteel’s products are highly complementary to Cactus’ equipment at the wellsite as it expands our exposure to our customers’ operations from production trees to transportation of oil, gas and other liquids as well as to additional customers operating in the midstream area. Demand for our products and services depends primarily upon oil and gas industry activity levels, including the number of active drilling rigs, the number of wells being drilled, the number of wells being completed, and the volume of newly producing wells, among other factors. Revenues Our revenues are derived from three sources: products, rentals, and field service and other. Product revenues are derived from the sale of wellhead systems, production trees and spoolable pipe and fittings. Rental revenues are primarily derived from the rental of equipment used during the completion process, the repair of such equipment and the rental of equipment or tools used to install wellhead equipment or spoolable pipe. Field service and other revenues are primarily earned when we provide installation and other field services for both product sales and equipment rental. During the three months ended March 31, 2023, we derived 70% of total revenues from the sale of our products, 12% of total revenues from rental and 18% of total revenues from field service and other. During the three months ended March 31, 2022, we derived 65% of total revenues from the sale of our products, 15% of total revenues from rental and 20% of total revenues from field service and other. We have predominantly domestic operations with more limited operations in Australia, Canada, and the Middle East as well as sales in other international markets. Following the acquisition of FlexSteel, we now operate in two business segments consisting of the Pressure Control segment and the Spoolable Technologies segment. Pressure Control The Pressure Control segment designs, manufactures, sells and rents a range of wellhead and pressure control equipment under the Cactus Wellhead brand. Products are sold and rented principally for onshore unconventional oil and gas wells and are utilized during the drilling, completion and production phases of our customers’ wells. In addition, we provide field services for all of our products and rental items to assist with the installation, maintenance and handling of the equipment. 17 Table of Contents We operate through service centers in the United States, which are strategically located in the key oil and gas producing regions, and in Eastern Australia. These service centers support our field services and provide equipment assembly and repair services. We also provide rental and service operations in the Kingdom of Saudi Arabia. Pressure Control manufacturing facilities are located in Bossier City, Louisiana and Suzhou, China. Demand for our product sales in the Pressure Control segment are driven primarily by the number of new wells drilled, as each new well requires a wellhead and, after the completion phase, a production tree. Demand for our rental items is driven primarily by the number of well completions as we rent frac trees to oil and gas operators to assist in hydraulic fracturing. Rental demand is also driven to a lesser extent by drilling activity as we rent tools used in the installation of wellheads. Field service and other revenues are closely correlated with revenues from product sales and rentals, as items sold or rented almost always have an associated service component. Spoolable Technologies The Spoolable Technologies segment designs, manufactures, and sells spoolable pipe and associated end fittings under the FlexSteel brand. Our customers use these products as production, gathering and takeaway pipelines to transport oil, gas or other liquids. In addition, we also provide field services and rental items to assist our customers with the installation of these products. We support our field service operations through service centers and pipe yards located in oil and gas regions throughout the United States and Western Canada. Our manufacturing facility is located in Baytown, Texas. Demand for our product sales in the Spoolable Technologies segment are driven primarily by the number of wells being placed into production after the completions phase as customers use our spoolable pipe and associated fittings to bring wells more rapidly onto production. Rental and Field service and other revenues are closely correlated with revenues from product sales, as items sold usually have an associated rental and service component. Recent Developments and Trends FlexSteel Acquisition As previously discussed, we completed the acquisition of FlexSteel on February 28, 2023. The results of operations of FlexSteel have been reflected in our accompanying condensed consolidated financial statements from the closing date of the acquisition through March 31, 2023. See Note 2 to our accompanying condensed consolidated financial statements for additional information related to the acquisition. Oil and Natural Gas Prices The following table summarizes average oil and natural gas prices in North America over the following periods as well as industry activity levels as reflected by the average number of active onshore drilling rigs during the same periods. Three Months Ended March 31, 2023 December 31, 2022 March 31, 2022 WTI Oil Price ($/bbl) (1) $ 75.93 $ 82.79 $ 95.18 Natural Gas Price ($/MMBtu) (2) $ 2.64 $ 5.55 $ 4.67 U.S. Land Drilling Rigs (3) 742 757 616 (1) EIA Cushing, OK WTI (“West Texas Intermediate”) spot price. (2) EIA Henry Hub Natural Gas spot price per million British Thermal Unit (“MMBtu”). (3) Baker Hughes. Oil and gas industry activity levels remained robust through the first quarter of 2023 with average U.S. land drilling rigs declining by less than 2% from the fourth quarter of 2022. This was despite a significant drop in natural gas prices, with average prices declining by 52% from the fourth quarter of 2022. We expect activity levels in basins driven by gas drilling to respond to the decreases in natural gas price over the coming quarters, as there is a lag between price movements and the ability for oil and 18 Table of Contents gas operators to respond to such movements due to, among other factors, rigs under contract, pads not completed, access to liquefied natural gas terminals and hedges in place. Oil prices declined on an average basis from the fourth quarter of 2022 to the first quarter of 2023 by approximately 8%. We believe oil-driven drilling and completion activity levels will remain relatively stable at these oil price levels but recognize the potential risk of recession on oil prices and diminished cash flow from the sale of associated gas. During the first quarter of 2023, WTI oil prices ranged from $66.61 per barrel to $81.62 per barrel and reached their lows during the regional bank scare precipitated by the collapse of Silicon Valley Bank in March 2023. Oil prices improved subsequently as the U.S. government signaled support for other regional banks. Shortly after the end of the first quarter of 2023, oil prices were further supported by the OPEC+ decision to cut production by over one million barrels per day. However, oil prices have remained volatile as concerns remain on the outlook for regional banks and the potential impact further bank failures could have on the economy. We believe the supply and demand fundamentals are supportive of oil prices at this level assuming overall economic activity remains at current levels. Critical Accounting Policies and Estimates A discussion of our critical accounting policies and estimates is contained in our 2022 Annual Report on Form 10-K. There have not been any changes in our critical accounting policies since December 31, 2022 other than the following additional critical accounting estimate. Determination of Fair Value in Business Combinations Accounting for the acquisition of a business requires th e allocation of the purchase price to the various assets acquired and liabilities assumed at their respectiv e fair va l ues . The determination of fair value requires the use of significant estimates and assumptions, and in making these determinations , management uses all available information. If necessary, we have up to one year after the acquisition closing date to finalize these fair value determinations under the applicable GAAP . For tangible and identifiable intangible assets acquired in a business combination, the determination of fair value utilizes s e veral valuation methodologies including discounted cash flows which has assumptions with respect to the timing and amount of future revenue and expenses associated with an asset. The assumptions made in performing these valuations include, but are not limited to, discount rates, future revenues and operating costs , projections of capital costs, and other assumptions believed to be consistent with those used by principal market participants . Due to the specialized nature of these calculations, we engage third-party specialists to assist management in evaluating our assumptions as well as appropriately measuring the fair value of assets acquired and liabilities assumed. Consolidated Results of Operations The following discussions relating to significant line items from our condensed consolidated statements of income are based on available information and represent our analysis of significant changes or events that impact the comparability of reported amounts. Where appropriate, we have identified specific events and changes that affect comparability or trends and, where reasonably practicable, have quantified the impact of such items. 19 Table of Contents Three Months Ended March 31, 2023 Compared to Three Months Ended December 31, 2022 The following table presents summary consolidated operating results for the periods indicated: Three Months Ended March 31, 2023 December 31, 2022 $ Change % Change (in thousands) Revenues Pressure Control $ 194,655 $ 187,774 $ 6,881 3.7 % Spoolable Technologies 33,750 — 33,750 nm Total revenues 228,405 187,774 40,631 21.6 Operating income Pressure Control 49,439 48,221 1,218 2.5 Spoolable Technologies 249 — 249 nm Total operating income 49,688 48,221 1,467 3.0 Interest income, net 1,002 2,370 (1,368) (57.7) Other income (expense), net 3,538 (1,920) 5,458 nm Income before income taxes 54,228 48,671 5,557 11.4 Income tax expense 1,940 7,932 (5,992) (75.5) Net income 52,288 40,739 11,549 28.3 Less: net income attributable to non-controlling interest 9,394 9,750 (356) (3.7) Net income attributable to Cactus Inc. $ 42,894 $ 30,989 $ 11,905 38.4 % nm = not meaningful Pressure Control. Pressure Control revenue for the first quarter of 2023 was $194.7 million, an increase of $6.9 million, or 3.7%, from $187.8 million for the fourth quarter of 2022 primarily due to increased sales of wellhead and production related equipment and associated field services. Pressure Control operating income for the first quarter of 2023 was $49.4 million, an increase of $1.2 million, or 2.5%, from $48.2 million for the fourth quarter of 2022. The increased revenues and associated gross margins related to equipment sales and field services in the segment were largely offset by increased rental equipment redeployment expenses as well as $1.1 million in higher professional fees and expenses recorded in connection with the FlexSteel acquisition. Spoolable Technologies. Spoolable Technologies revenue for the first quarter of 2023 was $33.8 million, an increase of $33.8 million from the fourth quarter of 2022, as results only include revenues from the FlexSteel acquisition date of February 28, 2023 to March 31, 2023. Spoolable Technologies operating income for the first quarter of 2023 of $0.2 million increased $0.2 million from the fourth quarter of 2022 as this operating profit only includes results from the FlexSteel acquisition date to March 31, 2023. The results for Spoolable Technologies included $4.2 million of inventory step-up expense and $3.7 million of intangible amortization expense as well as increased depreciation for the step-up of its fixed assets in connection with accounting for the purchased assets at fair value in conjunction with purchase accounting. Interest income, net. Interest income, net for the first quarter of 2023 of $1.0 million decreased $1.4 million from the fourth quarter of 2022 as the first quarter included one month of interest expense associated with FlexSteel acquisition-related borrowings from the Amended ABL Credit Facility which offset interest income earned on the invested cash balance. Other income (expense), net. Other income, net for the first quarter of 2023 of $3.5 million and other expense, net of $1.9 million for the fourth quarter of 2022 primarily represented non-cash adjustments for the revaluation of the liability related to the tax receivable agreement as a result of changes to the state tax rate. Income tax expense. Income tax expense for the first quarter of 2023 was $1.9 million compared to $7.9 million for the fourth quarter of 2022. Income tax expense for the first quarter of 2023 included an approximately $11.0 million expense associated with current income offset by a $12.1 million benefit associated with the release of our valuation allowance previously provided for our investment in Cactus Companies based on the determination that the deferred tax asset was realizable due to our ability to 20 Table of Contents generate sufficient taxable income of the appropriate type. Additionally, we recognized $4.3 million expense associated with the revaluation of our deferred tax asset as a result of a change in our forecasted state tax rate and a $1.3 million benefit associated with permanent differences related to equity compensation. Income tax expense for the fourth quarter of 2022 primarily included approximately $10.1 million expense associated with current income and a $1.8 million tax benefit related to the revaluation of our deferred tax asset as a result of a change in our forecasted state tax rate. Cactus Inc. is only subject to federal and state income tax on its share of income from Cactus Companies. Income allocated to the non-controlling interest is only taxable to the non-controlling interest. Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022 The following table presents summary consolidated operating results for the periods indicated: Three Months Ended March 31, 2023 2022 $ Change % Change (in thousands) Revenues Pressure Control $ 194,655 $ 145,899 $ 48,756 33.4 % Spoolable Technologies 33,750 — 33,750 nm Total revenues 228,405 145,899 82,506 56.6 Operating income Pressure Control 49,439 30,990 18,449 59.5 Spoolable Technologies 249 — 249 nm Total operating income 49,688 30,990 18,698 60.3 Interest income (expense), net 1,002 (100) 1,102 nm Other income (expense), net 3,538 (1,115) 4,653 nm Income before income taxes 54,228 29,775 24,453 82.1 Income tax expense 1,940 2,692 (752) (27.9) Net income 52,288 27,083 25,205 93.1 Less: net income attributable to non-controlling interest 9,394 6,467 2,927 45.3 Net income attributable to Cactus Inc. $ 42,894 $ 20,616 $ 22,278 108.1 % nm = not meaningful Pressure Control. Pressure Control revenue was $194.7 million in the first quarter of 2023, an increase of $48.8 million, or 33.4%, from $145.9 million for the first quarter of 2022. This was primarily due to higher sales of wellhead and production related equipment resulting from higher drilling and completion activity by our customers. In addition, increased rental of drilling and completion equipment and field service associated with product and rental revenues increased as a result of the above mentioned activity. Pressure Control operating income of $49.4 million in the first quarter of 2023 increased $18.4 million, or 59.5%, from $31.0 million in the first quarter of 2022. The increase was primarily attributable to higher gross margins during the period due to the increased volume partially offset by higher SG&A expenses of $8.6 million associated with professional fees and expenses incurred in 2023 due to the FlexSteel acquisition. Spoolable Technologies. Spoolable Technologies revenue in the first quarter of 2023 was $33.8 million, an increase of $33.8 million, from the first quarter of 2022 as results only include revenues from the FlexSteel acquisition date of February 28, 2023 to March 31, 2023. Spoolable Technologies operating profit of $0.2 million in the first quarter of 2023 increased $0.2 million from the first quarter of 2022 as this operating profit only includes results from the FlexSteel acquisition date to March 31, 2023. The results for Spoolable Technologies included $4.2 million of inventory step-up expense and $3.7 million of intangible amortization expense as well as increased depreciation for the step-up of its fixed assets in connection with accounting for the purchased assets at fair value in conjunction with purchase accounting. Interest income (expense), net. Interest income, net for the first quarter of 2023 of $1.0 million increased $1.1 million from the first quarter of 2022. The increase was driven by higher interest income earned on cash invested as rates increased over 2022 21 Table of Contents and into early 2023. This was partially offset by one month of interest expense in the first quarter of 2023 associated with FlexSteel acquisition-related borrowings from the Amended ABL Credit Facility. Other income (expense), net. Other income (expense), net for both periods presented primarily related to non-cash adjustments for the revaluation of the liability related to the tax receivable agreement as a result of changes to the state tax rate. Income tax expense. Income tax expense in the first quarter of 2023 was $1.9 million compared to an income tax expense of $2.7 million in the first quarter of 2022. Income tax expense for the first quarter of 2023 included an approximately $11.0 million expense associated with current income offset by a $12.1 million benefit associated with the release of our valuation allowance previously provided for our investment in Cactus Companies based on the determination that the deferred tax asset was realizable due to our ability to generate sufficient taxable income of the appropriate type. Additionally, we recognized $4.3 million of expense associated with the revaluation of our deferred tax asset as a result of a change in our forecasted state tax rate and a $1.3 million benefit associated with permanent differences related to equity compensation. Income tax expense for the first quarter of 2022 included an approximately $6.2 million expense associated with current income offset by a $1.7 million benefit associated with permanent differences related to equity compensation, a $1.0 million benefit associated with the revaluation of our deferred tax asset as a result of a change in our forecasted state tax rate and a $0.8 million tax benefit associated with the partial valuation allowance release in conjunction with first quarter 2022 redemptions of CW Units. Partial valuation releases occur in conjunction with redemptions of CW Units (or CC Units, in the case of redemptions after the CC Reorganization) as a portion of Cactus Inc.'s deferred tax assets from its investment in Cactus LLC (or, after the CC Reorganization, its investment in Cactus Companies) becomes realizable. Liquidity and Capital Resources At March 31, 2023, we had $75.4 million of cash and cash equivalents. Our primary sources of liquidity and capital resources are cash on hand, cash flows generated by operating activities and borrowings under our Amended ABL Credit Facility (as defined in Note 7 in the notes to the unaudited condensed consolidated financial statements). Depending upon market conditions and other factors, we may also have the ability to issue additional equity and debt if needed. As of March 31, 2023, we had $193.3 million of available borrowing capacity with $30.0 million of borrowings outstanding under our revolving loan, $125.0 million of borrowings outstanding under our term loan and $1.7 million in letters of credit outstanding. Subsequent to March 31, 2023, we made $60.0 million in discretionary payments to our term loan lenders which reduced the balance of our term loan outstanding as of the date of this filing. We were in compliance with the covenants of the Amended ABL Credit Facility as of March 31, 2023. We believe that our existing cash on hand, cash generated from operations and available borrowings under our Amended ABL Credit Facility will be sufficient for at least the next 12 months to meet working capital requirements, debt service obligations, anticipated capital expenditures, expected TRA liability payments, anticipated tax liabilities and dividends to holders of our Class A common stock as well as pro rata cash distributions to holders of CC Units other than Cactus Inc. We currently estimate our net capital expenditures for the year ending December 31, 2023 will range from $45 million to $55 million. In the Pressure Control segment, capital expenditures will be primarily related to rental fleet investments, the recent purchase of our previously leased Odessa, Texas branch facility, international expansion and development of a recently-leased research and development facility in Houston, Texas. In the Spoolable Technologies segment, capital expenditures will be primarily related to manufacturing plant enhancements and additional deployment equipment to facilitate installation of recent product introductions. Our ability to satisfy our long-term liquidity requirements, including cash requirements to fund income tax liabilities and the TRA liability at Cactus Inc. along with associated distributions to holders of CC Units relating to their ownership of Cactus Companies, depends on our future operating performance, which is affected by, and subject to, prevailing economic conditions, market conditions in the E&P industry, availability and cost of raw materials, and financial, business and other factors, many of which are beyond our control. We will not be able to predict or control many of these factors, such as economic conditions in the markets where we operate and competitive pressures. If necessary, we could choose to further reduce our spending on capital expenditures and operating expenses to ensure we operate within the cash flow generated from our operations. 22 Table of Contents Cash Flows Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022 The following table summarizes our cash flows for the periods indicated: Three Months Ended March 31, 2023 2022 (in thousands) Net cash provided by operating activities $ 60,462 $ 17,209 Net cash used in investing activities (633,152) (7,294) Net cash provided by (used in) financing activities 303,163 (14,180) Net cash provided by operating activities was $60.5 million and $17.2 million for the three months ended March 31, 2023 and 2022, respectively. Operating cash flows for 2023 increased primarily due to an increase in income and a decrease in cash outflows associated with working capital, largely related to decreased purchases of Pressure Control inventories. Net cash used in investing activities was $633.2 million and $7.3 million for the three months ended March 31, 2023 and 2022, respectively. The increase was primarily due to cash paid to acquire FlexSteel for $624.2 million less $5.3 million in cash acquired. Additionally, our capital expenditures increased approximately $8.3 million primarily due to the $7.0 million purchase of a previously leased facility. Lastly, proceeds from sales of assets increased approximately $1.3 million from 2022. Net cash provided by financing activities was $303.2 million for the three months ended March 31, 2023 as compared to net cash used in financing activities of $14.2 million for the three months ended March 31, 2022. The increase in net cash provided by financing activities was primarily related to certain equity and debt financing activities in the first quarter of 2023 associated with the FlexSteel acquisition. We received approximately $169.9 million of proceeds, net of issuance costs, from issuing shares of our Class A common stock during the period. Additionally, we received $155.0 million from total borrowings under our Amended ABL Credit Facility. Payments of approximately $6.7 million in debt issuance costs and higher dividend payments of approximately $0.7 million partially offset these increases in net cash provided by financing activities during 2023.