Cactus, Inc.: Form 10-Q for the period ended Mar 31, 2021

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” 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

We design, manufacture, sell and rent a range of highly engineered wellhead and pressure control equipment. Our 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 wellhead and pressure control equipment.

We operate through service centers in the United States, which are strategically located in the key oil and gas producing regions, including the Permian, Marcellus, Utica, Haynesville, Eagle Ford, Bakken and SCOOP/STACK, among other active oil and gas regions in the United States, and in Eastern Australia. These service centers support our field services and provide equipment assembly and repair services. Our manufacturing and production facilities are located in Bossier City, Louisiana and Suzhou, China.

We operate in one business segment. Our revenues are derived from three sources: products, rentals, and field service and other. Product revenues are primarily derived from the sale of wellhead systems and production trees. Rental revenues are primarily derived from the rental and associated repair of equipment used for well control during the completion process as well as the rental of drilling tools. Field service and other revenues are primarily earned when we provide installation and other field services for both product sales and equipment rental. Additionally, other revenues are derived from providing repair and reconditioning services to customers that have previously installed wellheads or production trees on their wellsite. Items sold or rented generally have an associated service component. As a result, there is a close correlation between field service and other revenues and revenues from product sales and rentals.

During the three months ended March 31, 2021, we derived 61% of total revenues from the sale of our products, 15% of total revenues from rental and 24% of total revenues from field service and other. During the three months ended March 31, 2020, we derived 57% of total revenues from the sale of our products, 23% of total revenues from rental and 20% of total revenues from field service and other. We have predominantly domestic operations, with a small amount of sales in Australia.

Market Factors

Demand for our products and services depends primarily upon the general level of activity in the oil and gas industry, including the number of drilling rigs in operation, the number of oil and gas wells being drilled, the depth and drilling conditions of these wells, the number of well completions, the level of well remediation activity, the volume of production and the corresponding capital spending by oil and natural gas companies. Oil and gas activity is in turn heavily influenced by, among other factors, oil and gas prices locally and worldwide, which have historically been volatile.

The key market factors impacting our product sales are the number of wells drilled and placed on production, as each well requires an individual wellhead assembly and, at some time after completion, the installation of an associated production tree. We measure our product sales activity levels against our competitors by the number of rigs that we are supporting on a monthly basis, as it is correlated to wells drilled. Each active drilling rig produces different levels of revenue based on the customer’s drilling plan, which includes factors such as the number of wells drilled per pad, the time taken to drill each well, the number and size of casing strings, the working pressure, material selection and the complexity of the wellhead system chosen by the customer and the rate at which production trees are eventually deployed. All of these factors may be influenced by the oil and gas region in which the customer is operating. While these factors may lead to differing revenues per rig, we have historically been able to broadly forecast our product needs and anticipated revenue levels based on general trends in a given region and with a specific customer. Increases in horizontal wells drilled as a percentage of total wells drilled, the shift towards pad drilling, and an increase in the number of wells drilled per rig are all favorable trends that we believe enhance the demand for our products relative to the active rig count.

Our rental revenues are primarily dependent on the number of wells completed (i.e., hydraulically fractured), the number of wells on a well pad and the number of fracture stages per well. Well completion activity generally follows the level of drilling activity but can be delayed due to such factors as takeaway capacity, storage capacity and budget constraints.

Field service and other revenues are closely correlated to revenues from product sales and rentals, as items sold or rented almost always have an associated service component. Therefore, the market factors and trends of product sales and rental revenues similarly impact the associated levels of field service and other revenues generated.

Recent Developments and Trends

During the three months ended March 31, 2021, the weekly average U.S. onshore rig count as reported by Baker Hughes was

377 rigs compared to 295 rigs for the three months ended December 31, 2020 and 763 rigs for the three months ended March 31, 2020. The increase in commodity prices beginning late in 2020 and into 2021 has led to meaningful increases in the level of U.S. onshore drilling activity since bottoming in August of 2020 at 230 rigs. As of April 30, 2021, the U.S. onshore rig count was 426.

The ongoing COVID-19 pandemic negatively impacted our business and revenues beginning in March 2020 and has continued to have an adverse impact. The inability to control the spread of the virus, the emergence of variants and another resurgence of cases in the U.S. and worldwide has prolonged travel restrictions, school closures, reduced businesses operations and stay-at-home orders. As vaccines have begun to be administered all over the world, oil prices have shown significant improvement, trading above $60 per barrel in April 2021. Even with these recent increases in commodity prices, our customers’ activity continues to be significantly lower than 2019 and early 2020 levels, resulting in reduced demand for our products and services. However, we are cautiously optimistic regarding signs of recovery and have seen growth and improvement in our business and revenues in the first quarter of 2021.

In response to the drop in demand and customer activity in 2020, we had implemented certain workforce, wage and capital expenditure reductions throughout last year. Given the significant service component of our business, we adjusted our headcount to reflect activity levels and by mid-year 2020, we had reduced our global workforce by almost half. As demand and activity started showing signs of recovery in late 2020, we began rehiring our associates and have added over 100 associates during the first three months of 2021 with plans to continue adding more as demand dictates. In January 2021, we reinstated approximately 50% of the wage and salary reductions that were implemented in 2020 with the remainder reinstated effective April 2021. As we add field service and other branch personnel, we have been adding fleet vehicles accordingly. We continue to actively review all opportunities to manage costs and efficiently deploy capital relative to market conditions. Our required capital expenditures have historically tended to be lower than most other oilfield service providers due to the asset-lite nature of our business model.

Over the past year, there has been an increase in large-scale merger and acquisition activity among exploration and production (“E&P”) companies that operate in the United States. These transactions may be driven in part by an effort to reduce the cost of hydrocarbon production per barrel equivalent and increase overall company efficiencies. These transactions generally increase the size and scale of the counterparties involved, which may provide better access to capital and lead to a healthier overall industry. We have historically focused on providing our products and services to large and well capitalized customers. Consolidation of E&P companies presents both risks and opportunities depending on a number of factors, primarily whether the companies involved are existing customers.

Increased Raw Material and Freight Costs

Our ability to source low cost raw materials and components, such as steel plate, tube and bar stock, forgings and machined components is critical to our ability to successfully compete. Due to a shortage of steel caused primarily by production disruptions during the pandemic, steel prices have recently escalated. Additionally, freight costs, specifically ocean freight costs, have risen due to a number of factors including, but not limited to, a shortage of shipping containers, congested seaports, capacity constraints on vessels and lockdowns in certain markets. We believe many of these cost increases are temporary and as supply catches up with the pent-up demand created by the pandemic and the resulting economic slowdown in 2020, prices should normalize. However, we cannot be certain if this will occur before the end of the year or at all, nor can we be confident that prices will return to their historic lows. As such, our results of operations may be adversely affected by these rising costs to the extent we are unable to recoup them from our customers.

Critical Accounting Policies and Estimates

A discussion of our critical accounting policies and estimates is contained in our 2020 Annual Report on Form 10-K. There have not been any changes in our critical accounting policies since December 31, 2020.

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.

Three Months Ended March 31, 2021 Compared to Three Months Ended December 31, 2020

The following table presents summary consolidated operating results for the periods indicated:

(in thousands)

Revenues

Product revenue for the three months ended March 31, 2021 was $52.0 million, an increase of $8.9 million, or 21%, from $43.0 million for the three months ended December 31, 2020. The increase was primarily related to increased sales of wellhead and production related equipment resulting from higher drilling and completion activity by our customers in response to increasing oil prices.

Rental revenue for the three months ended March 31, 2021 was $12.5 million, an increase of $3.9 million, or 45%, from $8.6 million for the three months ended December 31, 2020. The increase was primarily attributable to greater customer completion activity and an increase in their use of our innovative technologies.

Field service and other revenue for the three months ended March 31, 2021 was $20.0 million, an increase of $3.5 million, or 21%, from $16.5 million for the three months ended December 31, 2020. The increase was mainly due to increased billable hours and ancillary services as a result of the rise in overall customer activity during the quarter despite adverse weather conditions experienced in February 2021.

Costs and expenses

Cost of product revenue for the three months ended March 31, 2021 was $36.5 million, an increase of $6.8 million, or 23%, from $29.8 million for the three months ended December 31, 2020. The increase was primarily attributable to the increase in product sales but also due to increased costs associated with tariffs, materials, freight and wages.

Cost of rental revenue for the three months ended March 31, 2021 was $12.2 million, an increase of $2.8 million, or 29%, from $9.4 million for the three months ended December 31, 2020. The increase was mainly the result of higher repair and equipment reactivation costs as well as higher branch expenses resulting from significant growth in our rental activities.

Cost of field service and other revenue for the three months ended March 31, 2021 was $14.5 million, an increase of $2.9 million, or 26%, from $11.5 million for the three months ended December 31, 2020. The increase was primarily related to increased personnel costs associated with the addition of field and branch personnel as activity recovers as well as a partial reinstatement of the 2020 wage reductions.

Selling, general and administrative expenses for the three months ended March 31, 2021 were $9.6 million, an increase of $0.7 million, or 7%, from $9.0 million for the three months ended December 31, 2020. The increase was primarily due to higher personnel costs primarily related to higher salaries, payroll taxes and accrual for annual incentive bonuses based on current year targets. The first quarter of 2021 included a partial rollback of the 2020 wage and salary reductions as well as a modest increase in personnel.

Other expense, net. Other expense for the three months ended March 31, 2021 of $0.4 million related to professional fees and other expenses associated with the 2021 Secondary Offering. There were no such expenses in the fourth quarter of 2020.

Income tax expense (benefit). Income tax benefit for the three months ended March 31, 2021 was $4.1 million compared to income tax expense of $2.1 million for the three months ended December 31, 2020. The income tax benefit for the first quarter of 2021 included a $5.1 million benefit associated with a partial valuation allowance release and a $1.1 million benefit associated with permanent differences related to equity compensation. The partial valuation allowance release was recorded in conjunction with the redemption of CW Units as part of the 2021 Secondary Offering, allowing a portion of our deferred tax asset from our investment in Cactus LLC to become realizable.

Cactus Inc. is only subject to federal and state income tax on its share of income from Cactus LLC. Income allocated to the non-controlling interest is not subject to U.S. federal or state tax.

Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

The following table presents summary consolidated operating results for the periods indicated:

(in thousands)

Revenues

Product revenue was $52.0 million in the first quarter of 2021 compared to $87.0 million in the first quarter of 2020. The decrease of $35.1 million, representing a 40% reduction from the prior year, was the result of lower sales of wellhead and production related equipment resulting from lower drilling and completion activity in 2021 by our customers. Our first quarter 2020 results were only partially impacted by the industry downturn resulting from depressed commodity prices exacerbated by the COVID-19 pandemic.

Rental revenue of $12.5 million in the first quarter of 2021 decreased $23.7 million, or 65%, from $36.2 million in the first quarter of 2020. The decrease was primarily due to reduced drilling and completion activity by our customers resulting from depressed energy demand.

Field service and other revenue was $20.0 million in the first quarter of 2021, a decrease of $11.0 million, or 35%, from $30.9 million in the first quarter of 2020. The decrease was attributable to lower customer activity compared to the prior year, resulting in lower billable hours and ancillary services.

Costs and expenses

Cost of product revenue for the first quarter of 2021 was $36.5 million, a decrease of $19.6 million, or 35%, from $56.1 million for the first quarter of 2020. The decrease was largely attributable to the reduction in product sales.

Cost of rental revenue of $12.2 million for the first quarter of 2021 decreased $7.2 million, or 37%, from $19.3 million for the first quarter of 2020. The decrease was primarily attributable to lower repair costs, decreased scrap and rework expense and lower depreciation expenses on our rental fleet as well as other savings resulting from lower activity.

Cost of field service and other revenue was $14.5 million for the first quarter of 2021, a decrease of $9.3 million, or 39%, from $23.8 million for the first quarter of 2020. The decrease was mainly related to lower payroll costs associated with fewer field and branch personnel compared to 2020 as well as lower depreciation, fuel and repair expenses on a reduced fleet of vehicles.

Selling, general and administrative expenses for the first quarter of 2021 were $9.6 million compared to $13.7 million for the first quarter of 2020. The $4.0 million decrease was largely attributable to lower personnel costs primarily related to headcount and wage and salary reductions effective after the first quarter of 2020 as well as a reduction in foreign currency losses and credit loss reserves.

Severance expenses in the first quarter of 2020 of $1.0 million were due to severance benefits associated with headcount reductions announced during the quarter.

Interest income (expense), net. Interest expense, net for the first quarter of 2021 was $0.2 million compared to interest income, net of $0.4 million for the first quarter of 2020. The increase in expense from 2020 was primarily due to lower interest income on cash invested as a result of lower interest rates in 2021.

Other expense, net. Other expense for the first quarter of 2021 of $0.4 million related to professional fees and other expenses associated with the 2021 Secondary Offering. There were no such expenses in the first quarter of 2020.

Income tax expense (benefit). Income tax benefit for the first quarter of 2021 was $4.1 million compared to income tax expense of $7.5 million for the first quarter of 2020. The income tax benefit for the first quarter of 2021 included a $5.1 million benefit associated with a partial valuation allowance release and a $1.1 million benefit associated with permanent differences related to equity compensation. The partial valuation allowance release was recorded in conjunction with the redemption of CW Units as part of the 2021 Secondary Offering, allowing a portion of our deferred tax asset from our investment in Cactus LLC to become realizable.

Liquidity and Capital Resources

At March 31, 2021, we had $292.0 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, if necessary, borrowings under our ABL Credit Facility. 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, 2021, we had no borrowings outstanding under our ABL Credit Facility and $63.7 million of available borrowing capacity. Additionally, we were in compliance with the covenants of the ABL Credit Facility as of March 31, 2021.

We believe that our existing cash on hand, cash generated from operations and available borrowings under our ABL Credit Facility will be sufficient for at least the next 12 months to meet working capital requirements, anticipated capital expenditures, expected payments related to the TRA, anticipated tax liabilities and dividends to holders of our Class A common stock as well as pro rata cash distributions to the holders of CW Units other than Cactus Inc.

For the three months ended March 31, 2021, net capital expenditures totaled $2.0 million, which were primarily related to rental fleet investments, particularly upgrades associated with our innovative technologies. We currently estimate our net capital expenditures for the year ending December 31, 2021 will range from $10 million to $15 million. We continuously evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including, among other things, demand for rental assets, available capacity in existing locations, prevailing economic conditions, market conditions in the E&P industry, customers’ forecasts, volatility and company initiatives.

Our ability to satisfy our long-term liquidity requirements, including cash distributions to CW Unit Holders to fund their respective income tax liabilities relating to their share of the income of Cactus LLC and to fund liabilities related to the TRA, 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 projects and operating expenses to ensure we operate within the cash flow generated from our operations.

Cash Flows

Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

The following table summarizes our cash flows for the periods indicated:

(in thousands)

Net cash provided by operating activities was $15.7 million and $45.2 million for the three months ended March 31, 2021 and 2020, respectively. Operating cash flows for 2021 decreased from 2020 primarily due to a decrease in net income adjusted for certain noncash items.

Net cash used in investing activities was $2.0 million and $8.3 million for the three months ended March 31, 2021 and 2020, respectively. The decrease was primarily due to lower capital expenditures associated with our rental fleet in 2021 due to reductions in planned purchases announced earlier this year.

Net cash used in financing activities was $10.5 million and $9.6 million for the three months ended March 31, 2021 and 2020, respectively. The increase was attributable to a $1.8 million increase in share repurchases from employees to satisfy tax withholding obligations related to restricted stock units that vested during the period and a $0.2 million increase in dividend payments offset by a $0.6 million reduction in payments on finance leases and a $0.5 million decrease in Cactus LLC member distributions.

For quantitative and qualitative disclosures about market risk, see Part II, Item 7A., “Quantitative and Qualitative Disclosures about Market Risk,” in our 2020 Annual Report. Our exposure to market risk has not changed materially since December 31, 2020.

Evaluation of Disclosure Controls and Procedures

In accordance with Exchange Act Rules 13a-15 and 15d-15, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the period covered by this report. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2021 at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the first quarter of 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the information set forth in this Quarterly Report, you should carefully consider the risk factors and other cautionary statements described under the heading “Item 1A. Risk Factors” included in our 2020 Annual Report and the risk factors and other cautionary statements contained in our other filings with the Securities and Exchange Commission, which could materially affect our business, results of operations, financial condition or cash flows. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, results of operations, financial condition or cash flows. There have been no material changes in our risk factors from those described in our 2020 Annual Report or our other Securities and Exchange Commission filings.