Cactus, Inc.: Form 10-Q for the period ended Sep 30, 2024

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. 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. 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 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 earned when we provide installation and other field services for both product sales and equipment rental.

During the nine months ended September 30, 2024, we derived 76% of total revenues from the sale of our products, 9% of total revenues from rental and 15% of total revenues from field service and other. During the nine months ended September 30, 2023, we derived 74% of total revenues from the sale of our products, 10% of total revenues from rental and 16% 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.

Demand for our product sales in the Pressure Control segment is 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 is 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.

(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 third quarter of 2024, U.S. land drilling and completion activity levels were down approximately 3% from the second quarter of 2024 and down approximately 15% from the 2023 full year average. Average oil prices decreased in the third quarter of 2024 compared to the second quarter of 2024 as global oil demand concerns grew in parallel with risks of increased supply from OPEC+ and non-OPEC+ countries. Accordingly, we anticipate activity in the Middle East may decline. Prices remain volatile due to ongoing geopolitical risk concerns. Natural gas prices increased 2% in the third quarter of 2024 from the second quarter of 2024, as higher power generation demand through the summer led to less supply surplus than the market anticipated. U.S. gas storage approached five-year average levels in the third quarter, after remaining above the 5-year maximum range for most of the first half of 2024. The ongoing conflicts in Ukraine and the Middle East have led to heightened commodity price uncertainty and increased risk to the global supply chain.

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 and the Spoolable Technologies segment. 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. Prior to January 1, 2024, Corporate and other expenses were included in our Pressure Control segment. The Company has recast the information for the nine months ended September 30, 2023 to align with the presentation for the nine months ended September 30, 2024.

Three Months Ended September 30, 2024 Compared to Three Months Ended June 30, 2024

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

(in thousands)

21

Pressure Control. Pressure Control revenue for the third quarter of 2024 was $185.1 million, a decrease of $2.1 million, or 1.1%, from the second quarter of 2024 primarily due to decreased sales of wellhead and production related equipment, offset by an increase in rental activity and field service activity. Pressure Control operating income of $52.5 million for the third quarter of 2024 decreased $3.1 million, or 5.6% from the second quarter of 2024 primarily due to miscellaneous charges incurred during the quarter, including reserves taken in connection with customer bankruptcies and other litigation claims.

Spoolable Technologies. Spoolable Technologies revenue for the third quarter of 2024 was $108.2 million, an increase of $4.4 million, or 4.3% from the second quarter of 2024 primarily due to increased customer activity levels. Total operating income for Spoolable Technologies for the third quarter of 2024 was $32.9 million, compared to operating income of $30.0 million for the second quarter of 2024. The increase in operating income was primarily due to a decrease in expense related to the change in fair value of the earn-out payment for the FlexSteel acquisition, partly offset by higher manufacturing input costs.

Corporate and other. Corporate and other revenue represents the elimination of inter-segment sales from our Pressure Control segment to our Spoolable technologies segment. Corporate and other expenses include costs associated with executive management and other administrative functions not directly attributable to our reporting segment. Corporate and other expenses for the third quarter of 2024 were $8.7 million, an increase of $2.8 million, or 46.9% from $5.9 million for the second quarter of 2024. The increase was primarily due to professional fees associated with the evaluation of an inorganic growth opportunity.

Interest income, net. Interest income, net was $2.1 million for the third quarter of 2024, an increase of $0.7 million from the second quarter of 2024. The increase in interest income, net was primarily due to interest income earned on a higher invested cash balance.

Income tax expense. Income tax expense for the third quarter of 2024 was $16.4 million compared to $18.2 million for the second quarter of 2024. The decrease in income tax expense from the second quarter was due to a decrease in operating income quarter-over-quarter, in addition to an overall tax rate reduction due to decreases in permanent items. 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.

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

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

(in thousands)

Pressure Control. Pressure Control revenue was $547.3 million for the first nine months of 2024, a decrease of $29.0 million, or 5.0%, from the first nine months of 2023. The lower revenue 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 decline in customer activity. Operating income of $159.9 million in the first nine months of 2024 decreased $21.0 million, or 11.6%, from the first nine months of 2023. The decrease was primarily attributable to lower gross margins during the period due to the decreased customer activity levels and higher selling, general and administrative ("SG&A") expenses. The increase in SG&A expenses primarily related to higher personnel costs, stock-based compensation expense and other reserves, partially offset by a decrease in bad debt expense.

Spoolable Technologies. Spoolable Technologies revenue for the first nine months of 2024 was $311.0 million, an increase of $65.1 million, or 26.5%, from the first nine months of 2023, as results for the first nine months of 2023 only included seven months of revenues from the FlexSteel acquisition, which closed on February 28, 2023. Total operating income was $79.3 million in the first nine months of 2024, an increase of $45.3 million, compared to operating income of $34.0 million in the first nine months of 2023, which included only seven months of income. Operating income for the first nine months of 2024 included $16.3 million of expense related to the change in fair value of the earn-out liability for the FlexSteel acquisition and $12.0 million of intangible amortization. Operating income for the first nine months of 2023 included approximately $13.1 million of expense related to the change in fair value of the estimated earn-out liability, $23.5 million of inventory step-up expense and $16.3 million of intangible amortization expense, as well as depreciation expense of $9.9 million primarily associated with the step-up of fixed assets in connection with accounting for the purchased assets at fair value in conjunction with purchase accounting.

Corporate and other. Corporate and other revenue represents the elimination of inter-segment sales from our Pressure Control segment to our Spoolable technologies segment. Corporate and other expenses include costs associated with executive management and other administrative functions not directly attributable to our reporting segment. Corporate and other expenses for the first nine months of 2024 was $20.1 million, a decrease of $9.0 million, or 31.0% from the first nine months of 2023. The decrease was largely attributable to professional fees related to transaction costs associated with the closing of and accounting for the FlexSteel acquisition.

Interest income (expense), net. Interest income, net for the first nine months of 2024 was $4.2 million, compared to interest expense, net of $6.3 million for the first nine months of 2023. The increase was due to an increase in interest income earned on cash invested during the 2024 period. Interest expense in 2023 was primarily related to borrowings outstanding through July 2023 under the Amended ABL Credit Facility.

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.

Income tax expense. Income tax expense for the first nine months of 2024 was $48.0 million compared to $30.6 million for the first nine months of 2023. The increase in income tax expense from the first nine months of 2023 was primarily due to an increase in operating income during the first nine months of 2024, and fewer reductions in income tax expense for items specific to the comparable period of 2023. Income tax expense for the first nine months of 2023 included approximately $38.3 million of expense associated with 2023 income, offset by a $12.1 million benefit associated with the release of our valuation allowance previously provided for our investment in Cactus Companies. The valuation allowance was 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, $0.5 million of expense related to the finalization of our 2022 tax returns, and a $0.4 million benefit associated with permanent differences related to equity compensation.

Liquidity and Capital Resources

At September 30, 2024, we had $303.4 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 September 30, 2024, we had $220.7 million of available borrowing capacity under our Amended ABL Credit Facility with no outstanding borrowings, and $2.5 million in letters of credit outstanding. We were in compliance with the covenants of the Amended ABL Credit Facility as of September 30, 2024.

The contingent consideration earn-out period related to the FlexSteel acquisition ended on June 30, 2024 and resulted in an earn-out liability of $37.0 million, which was paid in September 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. As of September 30, 2024, $146.3 million remained authorized for future repurchases of Class A common stock under the program.

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 $32 million to $37 million. In the Pressure Control segment, capital expenditures are primarily related to rental fleet investments, international expansion and diversification of our low cost supply chain. 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 would likely choose to further reduce our spending on capital expenditures and operating expenses to ensure we operate within the cash flow generated from our operations.

Cash Flows

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

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

(in thousands)

Net cash provided by operating activities was $249.5 million and $248.6 million for the nine months ended September 30, 2024 and 2023, respectively. Operating cash flows for 2024 increased primarily due to an increase in operating income and stronger customer collections, partially offset by an increase in cash outflows associated with increased purchases of inventory, in addition to the payment of the earn-out liability.

Net cash used in investing activities was $24.1 million and $645.2 million for the nine months ended September 30, 2024 and 2023, respectively. The current year decrease was primarily due to the non-recurrence of 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 $6.4 million primarily due to the $7.0 million purchase of a previously leased facility during the first half of 2023.

Net cash used in financing activities was $56.4 million for the nine months ended September 30, 2024 as compared to net cash provided by financing activities of $116.7 million for the nine months ended September 30, 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. The first nine months of 2023 also included payments of approximately $6.9 million of debt issuance costs. The first nine months of 2024 includes a $4.7 million increase in share repurchases, primarily associated with the Company's share repurchase program, higher dividend payments of approximately $2.6 million and $6.0 million payment related to the contingent consideration established as of the FlexSteel acquisition date. These increases are partially offset by a $3.5 million decrease in member distributions.

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.

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 end 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 Securities and Exchange Commission ("SEC"). Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2024 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 third quarter of 2024 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 2023 Annual Report and the risk factors and other cautionary statements contained in our other filings with the SEC, 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 2023 Annual Report or our other SEC filings.