Cactus, Inc. Q1 FY2022 Earnings Call

Welcome to the Cactus First Quarter 2022 Earnings Conference Call. My name is Vanessa, and I will be your operator for today. I will now turn the call over to John Fitzgerald, Director of Corporate Development and IR.

Thank you, and good morning. We appreciate your attendance on today's call. Our speakers will be 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. Please note that any comments we make on today's call regarding projections or expectations, 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. Risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review our earnings release and the risks 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'll turn the call over to Scott.

Thanks, John. Good morning to everyone. I'm pleased to report that Cactus posted its fifth consecutive quarter of adjusted EBITDA growth of greater than 10% by capitalizing on continued increases in customer drilling and completion activity. Our results highlighted the consistency and predictability of this business. Some first quarter highlights include: Revenue increased 12% sequentially. Adjusted EBITDA improved by 16% sequentially. Adjusted EBITDA margins were 29%, up 80 basis points versus the fourth quarter. We paid a quarterly dividend of $0.11 per share and ended the quarter with $298 million in cash and no debt. I'll now turn the call over to Steve Tadlock, our CFO, who will review our financial results. And following his remarks, I'll provide some thoughts on our outlook for the near term before opening the lines for Q&A. So Steve?

Thank you. As Scott mentioned, Q1 revenues of $146 million were 12% higher than the prior quarter. Product revenues of $94 million were up 12% sequentially, driven primarily by an increase in rigs followed. Product gross margins at 35% rose 60 basis points sequentially due to leverage of our fixed cost base and continued cost recovery efforts. Rental revenue was $22 million for the quarter, up 16% versus the fourth quarter of 2021, driving an increase in gross margins of 820 basis points sequentially, due primarily to lower depreciation as a percentage of revenue. Field service and other revenues in Q1 were approximately $30 million, up 10% versus the fourth quarter of 2021. This represented 25% of combined product and rental-related revenues during the quarter. Gross margins were 16%, down 210 basis points sequentially, with the reduction largely attributable to labor inflation, higher fuel costs, and increased third-party service expenses, all of which are being addressed in the second quarter. SG&A expenses were $14.1 million during the quarter, up $1.2 million versus the fourth quarter of 2021. The sequential increase was primarily attributable to higher payroll-related costs, driven by higher stock-based compensation expense. During the first quarter, we also incurred approximately $600,000 of SG&A expense evaluating growth opportunities. We expect fees and expenses related to growth opportunities to be a more regular part of our focus this year. Despite these non-operational expenses, SG&A declined to 9.7% of revenue, down from 9.9% during the fourth quarter of 2021. We expect SG&A to be $14 million in Q2 2022, inclusive of stock-based compensation expense of approximately $2.3 million. Q1 2022 adjusted EBITDA was approximately $42 million, up 16% from $37 million during the fourth quarter of last year. Adjusted EBITDA for the quarter represented 29% of revenues compared to 28% for the fourth quarter of 2021. Adjustments to EBITDA during the first quarter of 2022 included approximately $2.7 million in stock-based compensation and $1.1 million related to the revaluation of the TRA liability. We did not add back any of the aforementioned fees related to the evaluation of growth opportunities during the period. Depreciation expense for the first quarter was $8.7 million, and a similar amount is expected in the second quarter. We reported income tax expense of $2.7 million during the first quarter, which was inclusive of a $1 million tax benefit related to the revaluation of our deferred tax assets and a $1.7 million tax benefit related to equity compensation. During the quarter, the public or Class A ownership of the company averaged 78% and ended the quarter at 79%. Barring further changes in our public ownership percentage, we expect an effective tax rate of approximately 21% for Q2 2022. GAAP net income was $27 million in Q1 2022 versus $20 million during the fourth quarter of 2021, with the increase driven by higher operating income and a lower income tax expense. We prefer to look at adjusted net income and earnings per share, which were $22.9 million and $0.30 per share, respectively, during the first quarter versus $18.7 million and $0.25 per share in Q4 2021. Adjusted net income for the first quarter excluded $1.1 million in other income and applied the 26% tax rate to our adjusted pretax income generated during the quarter. We estimate that the tax rate for adjusted EPS will be 26% during the second quarter. During the first quarter, we paid a quarterly dividend of $0.11 per share, resulting in a cash outflow of over $8 million, including related distributions to members. The Board has approved a dividend of $0.11 per share to be paid in June. We ended the quarter with a cash balance of $298 million. Operating cash flow was approximately $17 million, and our net CapEx was $7 million. Inventory rose by approximately $16 million sequentially due to further increases in inventory in transit, higher cost of goods, and the previously mentioned decision to increase product safety stocks to ensure timely delivery. Given the uncertainty regarding the global supply chain, our decision to manufacture additional inventory was taken with a view to alleviating customers' increasing concerns regarding certainty of supply. Working capital outflows are expected to moderate in Q2, which should benefit cash flow relative to the first quarter. Capital requirements for our business remain modest, and we'll continue to exercise discipline with regards to growth expenditures. The first quarter included additional rental assets and expansion to our Bossier facility as we opportunistically purchased an adjacent parcel of land for nearly $3 million. Our net CapEx guidance for 2022 remains at $20 million to $30 million. That covers the financial review, and I'll now turn the call over to Scott.

Thanks, Steve. As previously mentioned, we reported strong revenue growth across all of our business lines during the quarter, and adjusted EBITDA margins reached their highest levels since 2020. U.S. product market share remained strong at 41% during the period as rigs followed increased by over 11%. Despite lower rig efficiencies from our customers during the period associated with service industry constraints, product revenue per U.S. land rig followed increased due to cost recovery efforts, outperforming our prior expectations. Product EBITDA margins improved by 50 basis points in the first quarter, while incremental product EBITDA margins were a robust 40% during the period. Looking at the second quarter of 2022, we anticipate Cactus' rigs followed from our existing customer base to increase in the high single digits percentage-wise. Product revenue is expected to increase 10% in Q2, despite expectations for further reductions in drilling efficiencies during the period. We anticipate product EBITDA margins to be in the low 36% range during the second quarter. Additionally, we've recently commenced a trial with one of the larger independent operators in the U.S. While geopolitical tensions and lockdowns in China have led to further cost headwinds, Cactus remains confident that the compensation it receives will reflect the differentiated equipment and service we provide together with our elevated inventory levels. Cost recovery efforts commenced in the middle of last year. Since then, the company has continuously maintained an active dialogue with its customers as supply chain challenges persist. Internationally, our first South American product order of a high dollar wellhead system is currently in the process of being delivered from Bossier City. We also expect to book our first product order in the Mid-East around mid-year, although our focus to date has remained on honoring our U.S. commitments rather than pursuing high-volume international opportunities. From a supply chain perspective, we've had no major shutdowns at our facility in the Far East. However, transit times continue to increase given disruptions related to loading vessels and ocean freight. As mentioned previously, Cactus stocked up on inventory during the preceding months. Additionally, while many of our competitors rely solely on international locations to source equipment, we continue to have the benefit of our Bossier City facility, which further distinguishes us relative to our peers. We expect our rigs followed to increase with both public and private operators going forward, and we continue to win business with new private customers as we demonstrate market focus and differentiated equipment and our ability to execute. Additionally, certain public operators have, for the first time in recent memory, announced increased CapEx budgets. On the rental side of the business, revenues increased by over 16% during the first quarter and are up nearly 80% year-over-year. For the second quarter, rental revenues are expected to increase by an additional 10%, and EBITDA margins are anticipated to be up modestly during the period. In field service, revenues continue to be driven by both our product and rental activity. Revenue as a percentage of product and rental revenue is expected to be approximately 25% during the second quarter. Labor rate inflation, as well as higher fuel-related costs, are expected to represent continued headwinds to margins. However, we currently forecast field service EBITDA margins to increase into the low to mid-20% range during the second quarter as we implement cost recovery initiatives. Regarding our outlook on M&A, the number and quality of opportunities in the market have increased in recent months. This management team continues to believe that M&A can be a useful tool to expand geographically or enhance our competitive positioning. However, we will continue to evaluate opportunities with a focus on returns to our shareholders. The ability to return cash to our shareholders remains an attractive avenue that we'll continue to carefully assess. Lastly, we announced during the quarter that David Isaac, our Chief Administrative Officer and General Counsel, is retiring. I want to thank David for his outstanding service over the last few years and wish him well in his retirement. We're also proud to announce that Will Marsh will be joining the team to fill this role. Will comes to us from Bracewell and previously spent over 20 years with Baker Hughes as their Chief Legal Officer and General Counsel. Will's unique industry experience and knowledge of international operations, capital markets, and M&A will be a great asset to this team. In summary, Cactus remains well positioned to assuage any customer concerns regarding certainty of supply and quality of service. And with that, I'll turn it back over to the operator, and we may begin Q&A.

We have our first question from David Anderson with Barclays.

Your business continues to perform well in both products and rentals. You're constructive in the near term, oil fundamentals are really supportive. Growth is, of course, never in a straight line. I just want to get some of your thoughts on some of the risks out there. Aside from global demand, what's the most concerning to you over the next 12 months? Is it the private, kind of potentially running out of inventory, large capital spending? Is it industry-wide kind of lack of equipment that could level growth? Is it customers experiencing some pricing sticker shock? Just how are you thinking about some of those risk niches out there?

Yes, David, I think that my near-term concern has to do with ancillary supply issues because we're hearing a lot of comments about pipe availability, rig availability, sand availability, even cement availability. So I think that there's a desire probably to increase activity beyond the industry's capacity to support that. And I've mentioned that in previous calls that, that was my greatest concern; it's probably even more a concern today. Unless you're a very large publicly traded E&P and you've secured supply, I think you're going to see some of these privates come under pressure to add rigs as a result of that. I think longer term, there's no question that the quality and availability of drilling prospects, particularly in West Texas, is diminishing. I also think that the larger publicly traded E&Ps probably have a more secure inventory of prospects than some of the independents. So near term, it's really supply constraints; it's not sticker shock over price increases.

Yes, it sounds like you're able to push through pricing, at least in your products pretty effectively. So now, Scott, you're a man who's seen some cycles before. This one to me feels like 2004 again. When activity ramped up, and equipment was tight. We've heard from some of the larger service companies in the past couple of weeks, and they view this as being a margin cycle and not a build cycle. Can you comment on that? Do you agree with that? I mean, 2004 again, but this time, we're seeing capitalists across everywhere, driving pricing and returns. Your returns on my numbers are already in the low teens this year, which is pretty remarkable. But maybe just kind of comment on how you think this could play from that perspective?

I think it's fair to say that we are entering a phase of potential significant margin expansion. However, I expect that the growth in shipment volumes will be limited. Unlike some of our competitors, we have the capacity to handle increased volumes, which we could benefit from. In fact, I believe we have two key opportunities ahead: margin expansion and volume expansion, both of which will depend on us increasing our market share. Although no one has directly asked me about this yet, I anticipate that I will be asked, as I often am. I think having inventory available is advantageous for gaining market share at a price we find acceptable. I have mentioned before that we will not pursue market share just for the sake of it; our primary focus will likely be on margin expansion.

We have our next question from Stephen Gengaro with Stifel.

You mentioned market share, so let me start by discussing the trials you’re conducting with a large independent. You also touched on the expectation of potentially gaining market share. Could you elaborate on your experiences with the private sector over the past year? It appears you’ve made some progress with private entities, and I’d like to hear more about that.

Yes. As you know, private companies have never been our main focus. The fact that we've managed to keep a market share above 40% while private companies make up more than 60% of active rigs shows that we are performing better with privates now than we ever have. However, our business was not built on privates; we are primarily focused on publicly traded companies, including larger operators, both international oil companies and independents. Our penetration of private companies is clear, and I expect it to grow this year as these companies become more sophisticated and consolidate. As they grow larger and more sophisticated, our products will become more appealing to them. They are not limited by capital constraints, and we are actively pursuing the clients where it makes economic sense. I feel positive about our engagement with private companies, but I would feel even better if our public companies increased their activity levels, and we are starting to see some of that now. I'm optimistic that this combination could drive our market share even higher.

Great. And then can you talk about a little bit more about the sort of the interplay between, we'll call it, cost recovery efforts and rig efficiency/timing of rigs getting added? And how you think that kind of unfolds over the next few quarters? And I imagine some of that's going to be just pace of rig additions. But any color you could add around that sort of revenue per rig number, which was awfully healthy in the quarter, given some of the headwinds?

Yes. I believe that rig efficiencies will continue to decline due to several factors. Generally, private companies tend to be less efficient than public ones, and as privates represent a larger portion of the total rig count, we can expect an overall drop in rig efficiencies. Additionally, we have experienced occasional supply chain disruptions with our customers, where we find ourselves waiting for another service company to either arrive or finish a job, and this has become unfortunately more common. There is also an increase in the deployment of marginal equipment, and we anticipate seeing more as the U.S. rig count exceeds 700 and approaches just below 800 by year-end. Therefore, rig efficiencies are not working in our favor. We do track these metrics, and while they differ by basin, they have definitely decreased overall. We are observing a few customers drilling longer laterals, although this does not necessarily indicate improved efficiencies. However, I believe our team is confident in our ability to maintain our revenue per rig through cost recovery strategies. Going forward, I think the focus will be more on margin expansion for the remainder of the year rather than significant gains in activity levels.

We have our next question from Cameron Lochridge with Stephens.

So I wanted to start just on the supply chain, a couple of questions there. One, just if you could talk a little bit about where you're seeing some of the biggest bottlenecks today? And what kind of gives you the confidence and the visibility to those potentially improvement going forward? And then just related, as it relates to South America, Middle East, how challenging is it to get equipment into those geographies? And what are some of the levers you can pull to potentially offset some of that?

Well, Joel is in the room today. He can talk about what's happening in China. So Joel?

Yes. I mean the biggest challenges from China for us right now are just the vessel loadings and the vessel sailings right now. That situation, we understand, is going to improve mid-May. We have a lot of containers staged right now in our forwarder's facility at the port ready to be loaded. We've been able to pick up a few spot vessels here and there, but we've been moving product mainly through charters, which has helped us move anywhere from 50 to 100-plus containers on a vessel. So we feel like that's going to improve, but we did make a choice last year to elevate our inventory and raise the levels that we talked about so that we'd have stock available for customers. I feel like the issue of sailings is going to be challenging for the remainder of the year. If we have these COVID spikes over there, certainly, that's going to cause us a couple of extra weeks in terms of delivering a product to the U.S. In terms of product moving to other areas like the Middle East, South America, we haven't seen any challenges in terms of that. Those kinds of shipments are available and the product is moving, again, depending upon where the product is coming from. South America typically comes from Bossier City. So we're able to move that. Any product that's going to come out of the Far East has its issues. And again, it's the issues you're seeing today. And I think that will sort of be episodic as well.

Got it. That's helpful. As a follow-up to the discussion on cost recovery, it's reasonable to assume that all of your competitors are facing similar challenges across their portfolios. I was curious if you could share any anecdotes about what some of your competitors might be doing regarding price or cost recovery. How do you see them potentially aligning with your approach or holding back to maintain market share? What insights do you have on that?

Wow, Cameron, I wish you wouldn't ask a question like that. First of all, there's never a customer that comes up and says, "Cactus, you can raise your price by X percent because your competitors just demanded a price increase of Y." They don’t really share that information with us. Generally, I think our larger competitors are being more responsible in terms of cost recovery. On the other hand, some of the smaller players are probably less responsive to their increasing costs. However, I expect that will change over the course of this year because many smaller competitors lack access to working capital lines. If they don’t raise their prices or implement some form of cost recovery, they may find themselves squeezed out of the market. There are not many lenders willing to extend credit to smaller oilfield service companies. So overall, yes, our larger competitors are, in my opinion, being more responsible.

Our next question is from Ian MacPherson with Piper Sandler.

Scott, we always appreciate your peak into the crystal ball on rig count limits over the next few quarters. And we’re looking towards exiting this year around 700 Lower 48 rigs. Do you think that that will be challenged to be attained based on rig constraints or lead times? Or do you think we get there? And then after that, I had a follow-up question on rig count beyond that threshold.

Ian, are you talking about horizontal rig count? Because I think the U.S. rig count is going to exit the year just closer to 800, frankly, the total U.S. rig.

Really?

Yes. I’m not sure where the 700 figure came from, but we are already very close to it and are adding a couple of 2 or 3 rigs each week.

The drilling contractor guidance for this calendar quarter was definitely slowing down in aggregate, but certainly not.

I believe there is no doubt about the rate of increase. There were weeks where we saw double-digit rig count growth. While those numbers may not be entirely out of reach, I expect we will stabilize at around 2 to 3. There's still much time until the end of the year, so I believe we can aim for close to 800. Looking ahead to next year, 2023, I anticipate our average rig count will align more closely with the end of 2022, likely around or just below 800 rigs, indicating an approximate 12% average increase in 2023 compared to 2022. While we face a shortage of high-spec rigs, the principles of capitalism apply. If there's sufficient demand at the right price, potentially $35,000 a day, we can expect some rigs to enter the market. As we plan for our business, we are currently focusing on supporting an average rig count of about 800 for next year, especially concerning our supply chain.

I wanted to ask about the transition from 700 rigs to 800 rigs. I believe that the last 100 rigs may be inherently less efficient, with fewer walking rigs and total super-spec units. Do you agree with that perspective? Additionally, how does your value proposition and efficiency enhancement play a role in this situation?

Yes, I completely agree with you, Ian, that the next 100 rigs will likely be less efficient than the rigs currently operating. In planning our business, we assess each customer, their expected rig count, and continuously refine our calculations on their average wells drilled per month. Each customer has a unique profile. For the first time, we may need to adjust our approach depending on specific cases, such as a customer with 8 super-spec rigs and 2 lower-tier rigs, but we have the capability to make those adjustments and will proceed accordingly.

We have our next question from Don Crist with Johnson Rice.

You mentioned field service costs in the press release and some mitigation efforts you're undertaking. Can you provide details on what you're doing regarding either labor or fuel to reduce those costs?

There’s not much we can do. We attempted to purchase some hybrid vehicles, but they aren’t available. In terms of cost management, our options regarding labor and fuel are limited. What we are focusing on are cost recovery initiatives that we began implementing at the start of the second quarter. The supply chain is one issue, but when it comes to diesel and labor, the options are minimal. We're already operating our service techs at a very high utilization rate, making it nearly impossible to increase further. One area we’ve noted as a challenge is the cost associated with third-party contractors. Due to their rising prices, we are also increasing the rates for employing them. While we don’t rely heavily on them, we do use a substantial amount of external crane services, mobilization, and demobilization for on-frac jobs, much of which is handled by third-party contractors, who have been quite assertive with their pricing due to lack of capacity. We admit that we may have been slow to pass those costs onto our customers.

I have a question that comes up every quarter. With the amount of cash you have on the balance sheet, which is a positive, are there any new initiatives or plans to return money to shareholders that you are considering? Or do you prefer to keep that cash on the balance sheet for the time being?

Let me answer that. Really, I have two answers. The first is, as you can tell by our SG&A for the first quarter, we are really the most active we've ever been looking at M&A opportunities. They're better and there are more of them. So I know that our investors have a limited amount of patience for that. But I've said before, the management team owns 20% of this business. This is our money. We're going to be very careful about how we deploy it. And we're going to make sure that wherever we deploy it, we have a clear line of sight to a 30% return on our capital employed. That's not immediate, but that's a clear line of sight. So taking us a while because we're being very careful, but we're looking at more deals than ever. So I really feel like that cash will be used in that endeavor. We also are committed to sustaining our dividend with a view to being able to periodically increase the dividend. So they're not mutually exclusive. I think we want to do both. And until we feel like the opportunities are no longer viable, then I think we're going to probably sit on most of this cash.

And I appreciate the color on that and the candidate response. Can we assume that if you're looking at some M&A opportunities that it would be something that you possibly did in either a previous company or have experience in? Or do you think you'd step out into something that is new when you'd have to bring new managers in to run that for you?

Yes, I have mentioned this multiple times. Our preference is for consolidation within the industry because we excel at it. This approach presents the lowest risk for deploying our cash, making it our top priority. However, we are also observing other businesses that share our customer base, are manufacturing-focused, and have unique technologies that could benefit from our extensive service network. We would consider stepping into these opportunities if it makes sense. That said, the potential rewards must outweigh the risks, especially in comparison to acquiring a competitor, which is inherently riskier for us.

We have no further questions. I will now turn the call over to John Fitzgerald for closing remarks.

Thanks, everyone, for your participation. We look forward to following up with you on the next call.

Thanks, everybody. Have a good day.

And thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.