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, which are difficult to predict, including those described above in “Cautionary Note Regarding Forward-Looking Statements,” and in the risk factors included in “Part I, Item 1A. Risk Factors” in our 2023 Annual Report. 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 primarily to the U.S. onshore market. We believe this acquisition enhances our position as a premier manufacturer and provider of highly engineered equipment to the exploration and production ("E&P") industry and should provide meaningful growth potential. We further believe FlexSteel’s products are highly complementary to Cactus’ equipment 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, 2024, we derived 76% of total revenues from the sale of our products, 8% of total revenues from rental and 16% of total revenues from field service and other. 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. We have predominantly domestic operations with more limited operations in Australia, Canada, and the Middle East as well as sales in other international markets. We 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. We operate through service centers in the United States, which are strategically located in the key oil and gas producing regions, and in 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 and production facilities are located in Bossier City, Louisiana and Suzhou, China. 18 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 primarily 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. See Note 2 to the unaudited 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 indicated 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, 2024 December 31, 2023 March 31, 2023 WTI Oil Price ($/bbl) (1) $ 77.50 $ 78.53 $ 75.93 Natural Gas Price ($/MMBtu) (2) $ 2.15 $ 2.74 $ 2.64 U.S. Land Drilling Rigs (3) 602 600 742 (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. In the first quarter of 2024, U.S. land drilling and completion activity levels were flat compared to the fourth quarter of 2023 and down approximately 10% from the 2023 full year average. Average oil prices also remained flat in the first quarter of 2024 compared to the fourth quarter of 2023 as prices remain elevated due to geopolitical risk concerns and continued strong global demand. Natural gas prices declined 22% in the first quarter of 2024 from the fourth quarter of 2023, as continued strong production and warmer weather have led to U.S. storage levels well above five-year average levels, despite announced activity reductions and curtailments from several U.S. gas producers. The ongoing conflicts in Ukraine and the Middle East have led to heightened commodity volatility and increased risk to our global supply chain. In recent weeks, risk of a broader Middle East conflict has increased, which could have broad impacts on the global economy and our business. 19 Pillar Two Framework The Organization for Economic Cooperation and Development (“OECD”) enacted rules (“Pillar Two”) for a new, global minimum tax of at least 15% on income arising in low-tax jurisdictions. We are currently evaluating the potential impact this new legislation will have on our consolidated financial statements; however, based on current enacted Legislation, Management anticipates the impact of Pillar Two to be immaterial to the Company for 2024. Critical Accounting Policies and Estimates A discussion of our critical accounting policies and estimates is contained in our 2023 Annual Report on Form 10-K. There have not been any changes in our critical accounting policies since December 31, 2023. 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. We have two operating segments consisting of the Pressure Control segment (legacy Cactus) and the Spoolable Technologies segment (FlexSteel). Our results of operations are evaluated by the Chief Executive Officer on a consolidated basis as well as at the segment level. The performance of our operating segments is primarily evaluated based on segment operating income (in addition to other measures), which is defined as income before taxes and before interest income (expense), net, other income (expense), net and corporate and other expenses not allocated to the operating segments. Corporate and other expenses were previously included in our Pressure Control segment. The Company has recast the information for the three months ended March 31, 2023 to align with the presentation for the three months ended March 31, 2024. Three Months Ended March 31, 2024 Compared to Three Months Ended December 31, 2023 The following table presents summary consolidated operating results for the periods indicated: Three Months Ended March 31, 2024 December 31, 2023 $ Change % Change (in thousands) Revenues Pressure Control $ 175,028 $ 180,454 $ (5,426) (3.0) % Spoolable Technologies 99,095 94,412 4,683 5.0 Total revenues 274,123 274,866 (743) (0.3) Operating income Pressure Control 51,675 56,053 (4,378) (7.8) Spoolable Technologies 16,393 28,168 (11,775) (41.8) Total segment operating income 68,068 84,221 (16,153) (19.2) Corporate and other expenses (5,518) (5,668) 150 (2.6) Total operating income 62,550 78,553 (16,003) (20.4) Interest income (expense), net 689 (182) 871 nm Other income, net — 686 (686) nm Income before income taxes 63,239 79,057 (15,818) (20.0) Income tax expense 13,424 16,983 (3,559) (21.0) Net income 49,815 62,074 (12,259) (19.7) Less: net income attributable to non-controlling interest 10,850 13,127 (2,277) (17.3) Net income attributable to Cactus Inc. $ 38,965 $ 48,947 $ (9,982) (20.4) % nm = not meaningful 20 Pressure Control. Pressure Control revenue for the first quarter of 2024 was $175.0 million, a decrease of $5.4 million, or 3.0%, from $180.5 million for the fourth quarter of 2023 primarily due to decreased customer activity resulting in reduced sales of wellhead and production related equipment in addition to decreased rental activity. Pressure Control operating income of $51.7 million for the first quarter of 2024 decreased $4.4 million, or 7.8% from $56.1 million for the fourth quarter of 2023 primarily due to decreased equipment sales and rental activity, slightly offset by higher field service activity. Pressure Control selling, general and administrative expenses (“SG&A”) decreased $0.1 million from the fourth quarter primarily due to lower bad debt expense and professional fees, partially offset by higher stock-based compensation expense. Spoolable Technologies. Spoolable Technologies revenue for the first quarter of 2024 was $99.1 million, an increase of $4.7 million, or 5.0% from $94.4 million for the fourth quarter of 2023. Total operating income for Spoolable Technologies for the first quarter of 2024 was $16.4 million, a decrease of $11.8 million, compared to operating income of $28.2 million for the fourth quarter of 2023. The decrease in operating income was primarily due to a $13.3 million loss related to the change in fair value of the earn-out payment for the FlexSteel acquisition in the first quarter of 2024 compared to a $1.9 million loss in the fourth quarter of 2023. Corporate and other expenses. Corporate and other expenses for the first quarter of 2024 was $5.5 million, a decrease of $0.2 million, or 2.6% from $5.7 million for the fourth quarter of 2023. The decrease was primarily due to lower stock-based compensation expense. Interest income (expense), net. Interest income, net was $0.7 million for the first quarter of 2024 compared to interest expense, net of $0.2 million for the fourth quarter of 2023. The increase in interest income, net was primarily due to higher interest income earned on a higher invested cash balance. Other income, net. Other income, net of $0.7 million for the fourth quarter of 2023 represented non-cash adjustments for the revaluation of the liability related to the tax receivable agreement. Income tax expense. Income tax expense for the first quarter of 2024 was $13.4 million compared to $17.0 million for the fourth quarter of 2023. The decrease in income tax expense from the fourth quarter was primarily due to a decrease in operating income quarter over quarter. 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. 21 Three Months Ended March 31, 2024 Compared to Three Months Ended March 31, 2023 The following table presents summary consolidated operating results for the periods indicated: Three Months Ended March 31, 2024 2023 $ Change % Change (in thousands) Revenues Pressure Control $ 175,028 $ 194,655 $ (19,627) (10.1) % Spoolable Technologies 99,095 33,750 65,345 nm Total revenues 274,123 228,405 45,718 20.0 Operating income Pressure Control 51,675 63,171 (11,496) (18.2) Spoolable Technologies 16,393 249 16,144 nm Total segment operating income 68,068 63,420 4,648 7.3 Corporate and other expenses (5,518) (13,732) 8,214 (59.8) Total operating income 62,550 49,688 12,862 25.9 Interest income, net 689 1,002 (313) (31.2) Other income, net — 3,538 (3,538) nm Income before income taxes 63,239 54,228 9,011 16.6 Income tax expense 13,424 1,940 11,484 nm Net income 49,815 52,288 (2,473) (4.7) Less: net income attributable to non-controlling interest 10,850 9,394 1,456 15.5 Net income attributable to Cactus Inc. $ 38,965 $ 42,894 $ (3,929) (9.2) % nm = not meaningful Pressure Control. Pressure Control revenue was $175.0 million for the first quarter of 2024, a decrease of $19.6 million, or 10.1%, from $194.7 million for the first quarter of 2023. This was primarily due to decreased sales of wellhead and production related equipment resulting from lower drilling and completion activity by our customers. In addition, rental of drilling and completion equipment and field service associated with product and rental revenues decreased as a result of the abovementioned decline in activity. Operating income of $51.7 million in the first quarter of 2024 decreased $11.5 million, or 18.2%, from $63.2 million in the first quarter of 2023. The decrease was primarily attributable to lower gross margins during the period due to the decreased activity levels and higher SG&A expenses. The increase in SG&A expenses primarily related to higher personnel costs, bad debt expense and stock-based compensation expense. Spoolable Technologies. Spoolable Technologies revenue for the first quarter of 2024 was $99.1 million, an increase of $65.3 million from $33.8 million for the first quarter of 2023, as results for the first quarter of 2023 only included one month of revenues (from the FlexSteel acquisition date of February 28, 2023). Total operating income was $16.4 million in the first quarter 2024, an increase of $16.1 million, compared to $0.2 million in the first quarter of 2023, which included only one month of income. Operating income in the first quarter of 2024 included a loss of $13.3 million related to the change in fair value of the earn-out payment. Operating income for the first quarter of 2023 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. Corporate and other expenses. Corporate and other expenses for the first quarter of 2024 was $5.5 million, a decrease of $8.2 million, or 59.8% from $13.7 million for the first quarter of 2023. The decrease was largely attributable to lower professional fees related to transaction costs associated with the closing of and accounting for the FlexSteel acquisition. Interest income, net. Interest income, net for the first quarter of 2024 of $0.7 million decreased $0.3 million from the first quarter of 2023 primarily due to lower interest income earned on lower cash invested during the period. Other income, net. Other income, net for 2023 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. 22 Income tax expense. Income tax expense for the first quarter of 2024 was $13.4 million compared to $1.9 million for the first quarter of 2023. The increase in income tax expense from the first quarter of 2023 was primarily due to an increase in operating income during the first quarter of 2024 and fewer reductions in income tax expense for items specific to the first quarter of 2023. Income tax expense for the first quarter of 2023 included $11.0 million of 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. Liquidity and Capital Resources At March 31, 2024, we had $194.3 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, 2024, we had $216.7 million of available borrowing capacity under our Amended ABL Credit Facility with no outstanding borrowings and $1.1 million in letters of credit outstanding. We were in compliance with the covenants of the Amended ABL Credit Facility as of March 31, 2024. In June 2023, our board of directors authorized the Company to repurchase shares of its Class A common stock for an aggregate purchase price of up to $150 million. Under our share repurchase program, shares may be repurchased from time to time in open market transactions or block trades, in privately negotiated transactions or any other method permitted under U.S. securities laws, rules and regulations. The repurchase program does not obligate the Company to purchase any particular amount of shares, and the repurchase program may be suspended or discontinued at any time at the Company’s discretion. 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, repurchases of shares of our Class A common stock, 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, 2024 will range from $45 million to $55 million. In the Pressure Control segment, capital expenditures are primarily related to rental fleet investments, international expansion, diversification of our low cost supply chain and development of a research and development facility in Houston, Texas. In the Spoolable Technologies segment, capital expenditures are primarily related to manufacturing plant enhancements and additional deployment equipment used for product installation. 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. 23 Cash Flows Three Months Ended March 31, 2024 Compared to Three Months Ended March 31, 2023 The following table summarizes our cash flows for the periods indicated: Three Months Ended March 31, 2024 2023 (in thousands) Net cash provided by operating activities $ 86,263 $ 60,462 Net cash used in investing activities (6,808) (633,152) Net cash provided by (used in) financing activities (20,127) 303,163 Net cash provided by operating activities was $86.3 million and $60.5 million for the three months ended March 31, 2024 and 2023, respectively. Operating cash flows for 2024 increased primarily due to a decrease in cash outflows associated with working capital. Net cash used in investing activities was $6.8 million and $633.2 million for the three months ended March 31, 2024 and 2023, respectively. The decrease was primarily due to cash paid to acquire FlexSteel for $621.5 million less $5.3 million in cash acquired during the first quarter of 2023. Additionally, our capital expenditures decreased approximately $8.0 million primarily due to the $7.0 million purchase of a previously leased facility during the first quarter of 2023. Net cash used in financing activities was $20.1 million for the three months ended March 31, 2024 as compared to net cash provided by financing activities of $303.2 million for the three months ended March 31, 2023. The decrease in net cash provided by financing activities was primarily related to certain financing activities in 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 2023. Additionally, we received $155.0 million from total borrowings under our Amended ABL Credit Facility of which all $155.0 million has been repaid. The first quarter of 2023 included payments of approximately $6.7 million of debt issuance costs. The first quarter of 2024 includes a $3.9 million increase in share repurchases primarily associated with the Company's share repurchase program. Item 3. Quantitative and Qualitative Disclosures About Market Risk. For quantitative and qualitative disclosures about market risk, see Part II, Item 7A., “Quantitative and Qualitative Disclosures about Market Risk,” in our 2023 Annual Report. Our exposure to market risk has not changed materially since December 31, 2023.