Cactus, Inc. Q3 FY2020 Earnings Call

Thank you and good morning everyone. We appreciate your participation in today's call. The speakers on today's call, Scott Bender, our Chief Executive Officer and Steve Tadlock, our Chief Financial Officer. Also joining us today are Joel Bender, Senior Vice President and Chief Operating Officer; Steven Bender Vice President of Operations and David Isaac, our General Counsel and Vice President of Administration. Yesterday, we issued our earnings release which is available on our website. Please note that any comments we make on today's call regarding projections or expectations for future events are forward-looking statements covered by the Private Securities Litigation Reform Act. Forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC. Any forward-looking statements we make today are only as of today's date and we undertake no obligation to publicly update or review any forward-looking statements. In addition, during today's call we will reference certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in our earnings release. With that I will turn the call over to Scott.

Thank you, John. Good morning to everyone. I am again pleased with our performance during the quarter despite the macro environment. Our results were reflective of the differentiated nature of our products and services. Our dedicated associates who showed a tremendous commitment to safety and execution during these difficult times, and our industry leading supply chain model reducing the overall cost of production has never been more important for our industry. Cactus products and services are truly enabling our customers to increase efficiencies and savings. While our overall revenues were down during the third quarter as expected, we achieved strong margins across our business lines and increased market share in our product business to a record 38%. In summary, the third quarter revenues were approximately $60 million adjusted EBITDA approached $5 million, with adjusted EBITDA margins at 41%. Our cash balance increased to nearly $274 million and we paid a quarterly dividend of $0.09 per share. I'll turn the call over to Steve Tadlock, our CFO, who will review our financial results. Following his remarks, I'll provide some thoughts on our outlook for the near term before opening the lines for Q&A.

Thanks, Scott. In Q3, revenues of $60 million were 10% lower than the prior quarter, but ahead of expectations. Product revenues at $36 million were 12% lower sequentially, while the U.S. onshore rig count fell by 37% quarter-over-quarter. Product gross margins increased to 45% of revenues, up 810 basis points on a sequential basis due in part to $5.4 million in tariff-related benefits to product cost of goods sold during the quarter, up from $3.1 million during the second quarter. Rental revenues were approximately $10 million, down 14% from the second quarter. While revenue was higher than the latter months of the second quarter, on average, it was significantly lower than the April run rate. Although gross margins declined on a sequential basis, we were able to maintain positive margins through the achievement of cost reductions in both direct and branch expenditures. Field service and other revenues in Q3 were $14 million, relatively flat versus the second quarter. This represented just under 31% of combined product and rental-related revenues during the quarter, well ahead of expectations. We expect field service revenue to be slightly under 30% of product and rental revenue during the fourth quarter. Gross margins increased almost 1,500 basis points sequentially, largely due to lower payroll and depreciation expenses and a continued rationalization of our field service vehicle fleet. SG&A was down $0.3 million sequentially to $8.4 million during the quarter. The decrease was primarily attributable to lower payroll-related expenses. We expect SG&A to be approximately $9 million in Q4 2020, with stock-based compensation expense flat at slightly over $2 million. Third quarter adjusted EBITDA was approximately $25 million, up from $22 million during the second quarter. Adjusted EBITDA for the quarter represented 41% of revenues. Adjustments during the third quarter of 2020 included $2 million in stock-based compensation. Depreciation expense was $9.8 million during the period, down from $10.5 million during the second quarter due largely to the reduction in our fleet of service trucks. Our public or Class A ownership was relatively stable in Q3 and was 63% at the end of the quarter. This should result in an effective tax rate of approximately 19% in Q4, 2020, assuming no changes in our public ownership percentage. GAAP net income was $10.9 million in Q3, 2020. This was inclusive of a $1.9 million noncash expense related to the revaluation of the tax receivable agreement liability. Book income tax expense was negligible during the third quarter as the company recorded a $2.2 million benefit associated with the revaluation of our deferred tax asset as a result of changes to our forecasted blended state tax rate. Internally, we prefer to look at adjusted net income and earnings per share, which were $9.5 million and $0.13, respectively, compared to $7.4 million and $0.10 per share in Q2 2020. We estimate that the tax rate for adjusted EPS will be 25.5%. During the third quarter, we paid out $6.8 million resulting from our quarterly dividend of $0.09 per share. The Board has also approved a dividend of $0.09 per share to be paid in December of this year. Early in the third quarter, we also made our annual TRA payment and associated distribution of approximately $23 million. The recent payment was especially large due to our strong 2019 results and the associated tax savings arising from our corporate structure. We expect the next payment and the associated distribution to be substantially lower in 2021 as such disbursements vary directly with computed tax liability. Net of the aforementioned TRA and dividend-related outflows; our cash position increased by $3 million during the quarter to almost $274 million at September 30, highlighting the continued free cash flow generation of the company. For the quarter, operating cash flow was $19 million, and our net CapEx was negligible. As disclosed in our release, Cactus recognized $6 million in refunds during the quarter associated with tariff exclusions granted in March of this year. The refunds reduced the cost of revenue, with $5.4 million being allocated to our product business. As previously disclosed, we were notifying the risk that the tariff exclusions granted in March on certain imported goods were not extended by the USTR. At this point, we do not expect any further meaningful tariff refunds to be received due to prior exclusions. The capital requirements for the business remain modest as evidenced by a reduction to our net CapEx guidance for 2020 to be between $17.5 million and $22.5 million. That covers the financial review, and I'll now turn you back to Scott.

Thanks, Steve. We often note that Cactus has performed well historically during market downturns, and this was the case during the third quarter. As most exploration and production companies understand, there is little room for further service pricing concessions. Their attention turns to efficiency gains to lower well costs. This aligns well with our offerings, which provide disproportionately high time savings and productivity gains. In our product business, market share grew to nearly 38% during the third quarter. This was driven by new customer additions, including privates, and increased market share with recently acquired customers. One particular area of strength was in Haynesville, where our rigs followed increased during the quarter despite the region's overall decline in activity. Recall that our customers typically utilize us to source all their wellhead and production tree equipment. Additionally, given that our equipment is tailored to pad and batch drilling programs, the larger and relatively well-capitalized operators tend to appreciate our value proposition. Since there are still large operators who have yet to realize the efficiency gains offered by our equipment and services, our conviction as to further market share gains remains strong. Based on our customers' most recently disclosed plans, we believe that the U.S. rig count bottomed out in August and expect further rig additions through the year-end. For this reason, we expect Cactus' rigs followed to increase by approximately 20% during the fourth quarter. Product revenues are expected to witness a similar increase. Our general expectation is for a general increase in rig activity through the fourth quarter, but recent oil price weakness now provides some reason for caution for the remainder of the year. Our product EBITDA margins were expected to be in the low 30s during the fourth quarter, flat or slightly higher than our product EBITDA margins during the third quarter, excluding the impact of the $5.4 million arising from tariff refunds. On the rental side of the business, revenue was in line with our prior guidance for a low double-digit percentage decline. While our third quarter activity was improved from levels seen in May and June, our second quarter benefited from a relatively strong April, thus hindering our ability to record sequential growth. That said, we believe that a further focus on DUC reductions early next year should provide opportunities for expansion of our rental business, although we have the same concerns mentioned earlier regarding the impact of oil price weakness. We continue to maintain discipline in evaluating business opportunities for our rental equipment, recognizing the value of our goods and recognizing the value our goods and services bring to customers. This discipline was key to our ability to maintain EBITDA margins above 70% during the third quarter. Looking to Q4, we expect flattish revenue on a sequential basis, assuming there's not a significant slowdown tied to recent oil price weakness or the holidays. We'll continue to exercise pricing discipline and currently expect EBITDA margins in the mid-60 percentage for the fourth quarter. Revenue from our innovations was meaningfully depressed during the early part of the third quarter but improved sequentially each month. As an update on R&D in our rental business, we've made substantial progress during this year on the development of additional products, which will further eliminate iron from location and allow users greater remote capabilities. These remote capabilities provide our technicians, other contractors and our clients with safer, real-time digital monitoring and automation of frac activities. Importantly, these additional offerings require minimal capital expenditures. Nonetheless, we expect to be paid for such enhancements, and we anticipate a more constructive environment next year. Regarding fuel service, revenues in this segment continued to be driven by both our product and rental activity. This segment typically witnesses lower margins during the fourth quarter due to seasonal elements. And accordingly, we expect to see EBITDA margins slightly below 30% for the fourth quarter, still higher than we've achieved in recent years. We attribute most of this improvement to additional questions. Internationally, while travel restrictions have impeded our momentum in most markets, we are currently prepping equipment for our first shipment into the Middle East. This should begin to benefit revenue in 2021, and we expect to provide additional details next quarter. Regarding M&A, we continue to believe that consolidation within our industry makes the most sense where there is scope for significant tangible synergies. As I remind you regularly, management or long-term investors in this business are highly aligned with our shareholders. As activity rebounds, our team will continue to evaluate capital deployment with returns and free cash flow as our main priorities. In summary, we're optimistic about the opportunities that the upcoming activity recovery will present. Structurally, Cactus is now better positioned than it was only a year ago. As activity and revenue begin to recover, we expect Cactus' results to benefit disproportionately. With that, I'll turn it back over to the operator and we can begin Q&A.

Good morning, guys. I'm doing well. I wanted to congratulate you on a good quarter. On the rental side, it seems like pricing is not exactly where you guys wanted it to be, as it does seem like underlying completions activity ramped through Q3 and is continuing to increase in October. So is a flattish revenue commentary there more just a reflection of holding out for higher prices? Or is that just some conservatism around seasonality in the fourth quarter? Just trying to understand the guidance thought process there.

Primarily pricing-related. When you say pricing is not exactly where we want it to be, it's not even close to where we want it to be. The market share you guys have put together on the wellhead side in terms of rigs followed continues to be impressive and ahead of our expectations for sure. The 38% with kind of the commentary that you guys think you can grab incremental market share, is that more of a longer-term prospect? Or are you seeing continued market share gains as we progress through the fourth quarter? Where do you see those opportunities? Is that driven by some of the E&P consolidation? Or is it selling more products to the same people? Where are you guys seeing it?

George, you seem to have cram four questions into one. I mean obviously, market share is always an interesting topic for our group of investors. So let me first say that if we look at our market share gains to date, they've been disproportionately leveraged toward majors and privates. So our core customer base, which are the large publicly traded E&Ps, while we've experienced increases, it's fair to say they've lagged. As we look forward to this quarter and first quarter of next year, we have much better visibility into that group. I would look to that group to account for the additional market share gains. So the large E&Ps, at least in our customer base, have lagged behind those other two groups, and they provide us with optimism that we have not reached the ceiling.

Hey, good morning everybody. So, Scott, you mentioned capital allocation and M&A, so I'm going to see if I can dig a little deeper. On the capital allocation side, obviously, you've got about $280 million of cash on the balance sheet. You've got a dividend. So how do you think about allocation between raising the dividend, buying back shares, or saving some cash for M&A?

What a surprising question. Let me first tell you that we've just come off the trough in terms of activity. So having cash is not a bad thing—that's point number one. The second point is we clearly have enough money, and we continue to generate free cash flow that sustainability of the dividend or even an increase would not be problematic. Share buybacks—I’ve never been a fan of them; I think maybe I was for one quarter since we went public, but that may have been when the price was $8. I'm just not a fan of that. I think the timing rarely works out. When it comes to M&A opportunities, which I really can't comment too much on, except to say that there are an increasing number of opportunities out there. We haven't moved on any, as you know, and I'm hesitant to give you any further color, except to say that I'd be very surprised over the next year, better opportunities don't present themselves.

So the guide was low 30s for Q4, and as far as tariff headwinds, I mean, last quarter, we said on an absolute worst-case scenario, if it didn't get extended, it would be 3% impact, and we noted 1% to 2% is more likely on an absolute basis. I think we still believe that 1% to 2% is the more likely scenario and probably closer to the one.

Good morning, and thanks for taking my questions. Scott, I wanted to start on the market share topic. You indicated that a lot of the gains have come from larger E&Ps and privates versus your more traditional customer base.

No, most of the gains have come from majors and privates.

We haven't seen much consolidation yet. On the service side of the business, although I think it's fair to say that the weaker players are getting weaker. They probably are at the early stages of needing working capital to continue, and I think they're going to struggle to come up with working capital, both to finance receivables and then money to affect repairs. But to be fair, to date, I haven't seen much on the part of consolidation.

I think on a percentage basis, the majors accounted for the highest percentage, as I say, of growth. But they were closely followed by privates. So it was a large percentage, so it's progressing very well. I just want to emphasize to you that if I look at our market share gains, I've been very surprised that they have not resulted from the large publicly traded E&Ps.

Thanks and good morning, gentlemen. Two for me: the first being you mentioned potential or likely shipments to the Middle East next year. As you think about earnings expectations in the model and etc., when do you think you start to see a material contribution from the international side?

Yes, we're going to talk about that in the next call.

Do you want to give us a preview? I guess not.

But if I can come back to tariffs, obviously, you talked about it a little bit. We'll see what shakes out with the President here and what it means for tariffs.

Yes, I mean, typically, it would be about six months or so. So you'd be looking at Q1 into Q2, so full impact probably in Q2. I would just say that we clearly set it at a level where we felt comfortable that we would be able to increase it steadily over time. I don't think we want to get into on the call specific payout ratios that with the analysis of how we set the level, but certainly, we would like to be in a position where we can pay the dividend and continue to grow the cash balance. So your question about efficiencies. The problem we have right now is that the rental business has been hit in a similar fashion as the pressure pumping business in terms of expectations for lower prices. The good news is a high percentage of our new enhancements require very little capital, at least in comparison to frac valves. But nonetheless, we expect to be paid for it. And what I've learned in 43 years in this business, once you begin to give that away, it's very hard to get it back. So we have the most years of experience in this industry at Cactus, and it's more of an art and a science. Thanks, everybody. Stay safe, and I appreciate your support of the company.

Ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now disconnect.