Cactus, Inc. Q4 FY2022 Earnings Call

Thank you and good morning. We appreciate you joining us 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 Will Marsh, our General Counsel and Vice President of Administration. 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.

Thanks, John, and good morning to everyone. During the fourth quarter, the company set records for both quarterly revenue and adjusted EBITDA. This was also our eighth consecutive quarter with adjusted EBITDA growth. I was particularly pleased with the margin performance in each of our revenue categories. The fourth quarter is usually our weakest due to seasonal factors, but results were strong across the board and highlighted the company's best-in-class margin and return profile. Some fourth quarter highlights include revenue increased 2% sequentially to a company record $188 million; adjusted EBITDA improved by 4% sequentially to a company record $66 million; adjusted EBITDA margins were 35%, up 90 basis points versus the third quarter. We paid a quarterly dividend of $0.11 per share, and we increased our cash balance to $345 million. I'll now 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. So, Steve?

Thank you, Scott. Note that all the historical and forward-looking data referenced today will be for Cactus on a standalone basis only and not inclusive of any potential impact from the pending FlexSteel transaction, which is expected to close in the coming weeks. As Scott mentioned, Q4 revenues of $188 million were 2% higher than the prior quarter. Product revenues of $125 million were up 2% sequentially, driven primarily by an increase in rigs followed. Product gross margins of 41% rose 120 basis points sequentially due largely to operating leverage and lower branch costs. Rental revenues were $27 million for the quarter, up 1% versus the third quarter. Gross margins were up 420 basis points due to better asset management and lower repair costs as well as declining depreciation expense. Field service and other revenues in Q4 were approximately $36 million, up 1% sequentially. This represented approximately 24% of combined product and rental-related revenues during the quarter, in line with expectations. Gross margins were 24%, up 20 basis points sequentially, driven by lower supplies costs and branch-related expenses. SG&A expenses were $23 million during the quarter, up $6.9 million sequentially. The increase was attributable to higher professional fees and expenses, $7.4 million of which were related to the pending acquisition of FlexSteel. Excluding these transaction-related expenses, SG&A was $15.5 million and 8% of revenue. We expect SG&A exclusive of transaction-related fees to be relatively flat in Q1 2023 with stock-based compensation expense of approximately $3 million. Fourth quarter adjusted EBITDA was approximately $66 million, up 4% from $64 million during the third quarter. Adjusted EBITDA for the quarter represented 35.4% of revenues compared to 34.5% in the third quarter. Adjustments to EBITDA during the fourth quarter of 2022 included approximately $3 million in stock-based compensation, $7 million in FlexSteel acquisition-related fees and expenses, and an add-back of $2 million in other expense related to the revaluation of the company's tax receivable agreement. Consistent with the fourth quarter's presentation, we've now revised the adjusted EBITDA for the third quarter of 2022 to exclude $1 million in FlexSteel acquisition-related expenses that were not previously added back to our adjusted results. Depreciation expense for the fourth quarter was $8.1 million, approximately $8 million is expected in the first quarter of 2023. Income tax expense during the fourth quarter was $7.9 million. During the fourth quarter, the public or Class A ownership of the company averaged 80% and ended the quarter at 80%. Following the equity offering we completed in January of this year, our Class A ownership is expected to average 81% of the total shares outstanding during the first quarter. Barring further changes in our public ownership percentage, we expect an effective tax rate of approximately 21% for Q1 2023. GAAP net income was $41 million in Q4 2022 versus $42 million during the third quarter. The decrease was driven by higher transaction-related expenses, which more than offset increased gross profit across our various revenue categories. We prefer to look at adjusted net income and earnings per share, which were $44 million and $0.57 per share, respectively, during the fourth quarter versus $40 million and $0.52 per share in Q3 2022. Adjusted net income for the fourth quarter applied a 25% tax rate to our adjusted pretax income generated during the quarter. We estimate that the tax rate for adjusted EPS will be 25% during the first quarter of 2023. As previously stated, we've revised the adjustments for the third quarter of 2022 to include the $1 million in acquisition-related expenses that were not previously added back. During the fourth quarter, we paid a quarterly dividend of $0.11 per share, resulting in a cash outflow of approximately $8.4 million, including related distributions to members. In January, the Board approved a dividend of $0.11 per share to be paid in March. We ended the quarter with a cash balance of $345 million, up $24 million sequentially. Operating cash flow was approximately $39 million during the quarter, with net working capital representing a cash outflow of approximately $21 million. This was driven in part by a decrease in accounts payable due to the timing of seasonal payments. In addition, payables declined in advance of anticipated first quarter inventory declines. Excluding non-routine items associated with the FlexSteel transaction, we expect net working capital to be relatively flat during the first quarter of 2023 and down as a percentage of revenue following a strong January. Net CapEx was approximately $6 million during the fourth quarter of 2022. Capital requirements for our business remain modest, and we'll continue to exercise discipline with regards to capital expenditures. For 2023, we expect net capital expenditures to be in the range of $35 million to $45 million. This is inclusive of the potential purchase of a currently leased domestic property for approximately $7 million, the build-out of a new R&D facility in Houston, and it assumes $5 million to $10 million in growth capital dedicated to international expansion toward the end of the year. That covers the financial review, and I'll now turn the call over to Scott.

Thanks, Steve. As stated earlier, the company generated record revenue and EBITDA during the quarter. US product market share increased to 40.2% during the period as rigs followed rose by approximately 7%. From 3Q 2022 through December of 2022, we added 26 rigs in line with projections provided during our last earnings call. Product EBITDA margins improved by 110 basis points during the quarter to 41%. During the fourth quarter, the majority of our rig additions came from public companies, but we also increased our rig count with private operators. Thus far, during 2023, we have witnessed a mid-single-digit percentage increase in public rigs followed, which has been partially offset by a slight decrease in private rigs followed, particularly in gas basins. For the first quarter of 2023, we still expect Cactus' average rigs followed to be up 3% to 5% sequentially despite the overall decline in the US land rig count. As you know, our core customers tend to be larger, well-established oil producers who are less reactive to short-term swings in commodity prices. Nonetheless, we're prepared to deal with the impact that lower natural gas prices will likely have on the industry, particularly in the Haynesville, an area weighted towards privates. We are also excited to be introducing several technical wellhead enhancements, which are in the final stages of testing. First quarter of 2023 product revenue is expected to be up approximately 5% versus 4Q. Product EBITDA margins are forecasted to be in the 41% to 42% range for the first quarter. We feel good about the prospects of market share gains as evidenced by our ability to achieve market share of over 42% in February. From an international perspective, there are really no changes regarding our plans for product commercialization in the Mid-East by 2024. In addition, we continue to benefit from opportunities outside of Saudi. On the rental side of the business, revenues increased 1% during the fourth quarter and were up over 40% year-over-year. International increases drove the sequential top line improvement. For the first quarter of 2023, we expect rental revenue to remain relatively flat. EBITDA margin should be in the low 60% range, with potential for expansion late this year as we introduce cost-saving enhancements. In field service, EBITDA margins improved by 20 basis points during the fourth quarter, overcoming what is typically the weakest seasonal quarter of the year. Revenue was 23.6% of combined product and rental revenue during the period. Fuel service revenue for the first quarter of 2023 is expected to remain between 23% and 24% of product and rental revenue. Fuel service EBITDA margins are expected to be approximately 28%. Regarding the FlexSteel acquisition, management is excited and optimistic about this unique combination. As noted earlier this month, we received no comments from the FTC or DOJ during the HSR waiting period. From a financing perspective, we successfully raised $166 million of net proceeds from an equity offering in January and have made substantial progress regarding our permanent debt financing. At this time, we expect to close on a new $125 million Term A facility with a new $225 million upsized revolving credit facility upon transaction closing, which had occurred during the first quarter of this year. FlexSteel's fourth quarter financial performance was in line with our expectations. Following the closing of the transaction, Cactus will provide additional details on the expected financial impact of the first quarter. We look forward to sharing the same once we close. Despite recent weakness in natural gas prices, we're optimistic regarding our customer base, which is larger and primarily oil-focused. Cactus remains well-positioned to deliver for shareholders against an overall healthy market backdrop. And with that, I'll turn it back over to the operator, and we can begin Q&A.

Yes, thank you. Our first question comes from David Anderson of Barclays. Your line is open.

Hey, good morning Scott. How are you?

Hey David. How are you?

I'm doing great. I was hoping you could take a step back and discuss the overall US onshore market and how you view the duration of this cycle compared to previous ones, like the period from 2008 to 2012 or 2013. You mentioned this at the end. Many are anticipating the impact of the natural gas situation, leading some to believe it could disrupt the US services market. Would you argue that the market is more resilient this time? There are fewer players, and companies seem to be more disciplined with capacity and pricing, which I think is evident in your business as well. Shouldn't this contribute to a longer cycle? Could you elaborate on that?

Certainly, David. First, let me address the situation with natural gas. We’ve noticed some weakness in the Haynesville region, which I believe you are aware of. However, we don’t see the same issues in the Northeast. The Haynesville operates at a high cost and is largely run by private companies, so it’s expected that lower gas prices would impact it negatively. Customers with exposure to multiple basins are shifting rigs from the Haynesville to those areas. Now, looking at regions where we anticipate ongoing activity, our customers have not indicated any reduction in their operations. They did not plan for $100 oil, and based on our discussions with major clients, I am actually observing signs of increased activity, particularly in those basins. These gains should help balance out the losses from the Haynesville. Although I’m not sure how far the downturn in the Haynesville could go, I do see enough demand in the Permian and Bakken. When it comes to oil fundamentals, I’m feeling more optimistic than many others. Current U.S. production rates and operational efficiencies are underwhelming. I expect that as China reopens, it will affect costs and that the impact of Russian sanctions will begin to be felt. Overall, I’m confident about the longevity of the current oil cycle. As for gas, I won’t speculate much, but $2 gas seems reasonable for the Haynesville.

So, you're not really worried that the natural gas situation could disrupt things; it seems that it might just be a temporary issue. Is that a fair way to look at it?

Well, David, I always worry about our customers' cash flow. Therefore, when natural gas prices are low, cash flow will decline. However, I do not have significant concerns about the effects of natural gas on our other customers. I have spoken with many of them in the last two weeks, so this perspective is very current.

That's good to hear. I know everyone loves to ask about mergers and acquisitions, and you're eager to share details on the deals you're currently working on. You just mentioned the smaller FlexSteel deal related to the well site and various other projects. However, I want to discuss the market. Most of the bad actors have exited, and it seems there isn't much private equity involvement at the moment. Is it accurate to say that pursuing M&A will be quite challenging over the next two to three years? Additionally, regarding the organic opportunities you've mentioned in the Middle East and Latin America, does this suggest that organic growth might be a more feasible option than M&A due to the limited opportunities in a more consolidated market?

I believe there are certainly still many opportunities, David. While there are fewer buyers, the opportunities remain abundant. Many people are looking to monetize during this time. However, I want to emphasize that my focus has always been and will continue to be on consolidating this market. When considering M&A opportunities, I think about consolidation. FlexSteel was an exceptionally unique opportunity for our company, and there are valid reasons for that. I can't recall another company we examined that met all our criteria. Is there another company like FlexSteel out there? We haven't encountered one yet. That doesn't mean another FlexSteel doesn't exist, but I would suggest focusing on organic growth or exploring international opportunities.

Thanks a lot, guys.

Thank you, David.

Thank you. This question comes from the line of Steve Gengaro of Stifel. Go ahead, your line is open.

Thanks. Good morning, everybody.

Good morning, Steve.

Could you start by discussing your strong margins in the fourth quarter and how that impacts your first quarter outlook? Additionally, can you share insights on your conversations with customers regarding product pricing in relation to inflation and how we should consider the margin trajectory for the rest of the year? You mentioned some technical enhancements that I assume will positively influence the second half of the year.

Yes, I believe the team is quite confident about maintaining margins despite the cost implications. Joel has done an excellent job managing our costs, and many of our input costs are just starting to impact our finances now. We still need to work through some of the higher-cost inventory, but we are noticing a decrease in replacement costs. Therefore, from a cost viewpoint and its effect on margins, I feel quite optimistic.

And just along those lines, I know you mentioned potentially increasing capacity in Louisiana due to some supply chain issues. What is the current status of those supply chain issues?

Transit times have significantly improved. I can refer to Joel on this.

The supply chain is actually sort of returned to some normalcy. There are pockets of it that are still problematic, elastomers, resin material, things like that. It's available. You just have to plan ahead for it, which we've done. In terms of vessels and things, you can ship out of China now and pick up a weekly shipment, drop it off of the port and pick it up in about a week. So, that's returned to normal. I think the only challenge there is maybe light sailings. But if you prepare yourself and you have contracts like we do, there should be no disruption in terms of getting the product.

Okay, great. Thank you, gentlemen.

Thank you, Steve.

Thank you. Our next question comes from the line of David Smith of Pickering Energy Partners. Your line is open.

Hey, good morning. Thank you for taking my questions and congratulations on the quarter and really looking forward to the first to close Q&A. But for now, my bigger questions were asked. So, we'll ask a couple of minor ones. Circling back to the natural gas theme. Sorry if I missed this, but I wanted to ask if you're having any conversations with clients who indicate that they might accelerate oil programs if additional frac spreads became available to them.

The short answer is no. Our customer base is primarily comprised of larger players, which makes them less reactive. Most of our major customers have reported slight increases in activity, and they have not indicated any changes in their plans due to the availability of additional frac pressure pumpers.

That makes sense, but I had to ask. I wanted to follow up on the enhancements or innovations you plan to introduce in the product segment. I'm really looking forward to hearing about those. I'm open to any details you can share, but should we consider these potential changes as beneficial to market share or more focused on improving margins? I'm asking because your market share and margins are already quite strong.

Yes, we have always believed that if we do not continue to innovate, we risk losing market share. Therefore, I think these enhancements will appeal to those who may not have been Cactus customers before. The primary goal is to further differentiate our offerings from our competitors. This not only helps us maintain our market share but also protects our margins significantly.

Great answer. Appreciate the color. And if I can slip in one minor one. The field service margins fall up remarkably well in the fourth quarter. And I wanted to ask if that was just exceptional execution, if you were able to get maybe better margin protection, basically trying to think through this year and going forward, whether you figured out how to mitigate the historical seasonal hit to the margins.

Yes, I'm going to let Steven answer that. That's his department piece. We were all very, very pleasantly surprised with our fourth quarter as our field service results.

Yes, I think just to reiterate, we were very proud of what we achieved in the fourth quarter. I think we're optimistic that things will continue in that trajectory. There's still quite a bit of pressure on wage inflation in the field service levels, so we're keeping an eye on that, but concentrating more on utilization at this point.

David, I haven't worked for many competitors, but we do an excellent job of monitoring utilization. We are particularly attentive to this during the fourth quarter when it typically declines due to the holidays. I believe we planned and executed better this year, and I think we will carry those lessons forward.

Thank you for all that color. Between the acquisition and the international expansion, there's a lot of good stuff we're looking forward to. Thank you all for your time.

Thank you.

Thank you. We have another question from Stephen Gengaro of Stifel. Stephen, your line is now open.

Thanks for taking the questions gentlemen. Two quick ones. One was on the market share improvement we saw sequentially and what you highlighted in February, is this more rigs from existing customers? Or is it new customers? Or is it a combination?

It's a combination.

Thank you. I know I asked this during the FlexSteel call, but could you provide a brief overview of the key differentiating factors that FlexSteel offers? This is a significant aspect of the Cactus story, and it would be helpful to get another summary of how FlexSteel stands out from its competitors.

Steve, do you want to take that?

Sure. Yes, I think it comes down to a lot of what makes Cactus in the wellhead side so special, which is really, in our mind, they just have a superior product and they do a better job of executing on the service and customer interactions than everybody else. When you look at the sort of the formulation of their product, they're the only spoolable composite that utilizes steel. So, it has a robustness that the others lack. And in my experience, customers really value that just because less problems, less things to worry about, they've got enough to worry about out there in the field.

Is the ultimate benefit to the customer one of sort of cost savings, efficiency, less maintenance? How should we think about sort of the value prop to the customer?

Yes, it's really multifold. You get a cost benefit in terms of more rapid installation, getting wells online faster. What are some of the other aspects?

This product handles higher pressures. So, it has a much larger addressable market.

Larger diameters offered.

Larger diameter, which means that it can be used further downstream of the choke or the wellhead. So, it has greater exposure to the market.

You do have less maintenance as well versus steel corrosion.

It has had no fuel failures since the product was introduced, which I believe is due to it being made of steel rather than fiberglass or aramid fiber. However, it still requires joining with couplings. It's much more effective to connect steel to steel than to connect steel to plastic.

Thank you. I have one more question about FlexSteel. When you announced the equity raise, our calculations indicated that you could reduce leverage quickly without needing to do an equity raise. I'm curious about the reasoning behind that decision. Does it suggest that you're considering other opportunities and wanted to maintain financial flexibility?

I think that's right, Stephen. We've certainly been rewarded by having the strength in our balance sheet to date, and we let the cash balance grow over time with no debt, and that gave us an opportunity like the one we saw with FlexSteel. And so, it doesn't necessarily mean that it's because there's some other M&A trades that would be imminent or that's out there right now, but having the flexibility to provide those options is something that we certainly had in mind when we did the equity raise.

And to summarize it, it's definitely on our minds.

Great. Okay. Thank you all for the color. Appreciate it.

Thank you. I'd like to now turn the call back to John Fitzgerald for closing remarks.

We appreciate everyone's interest in Cactus and look forward to speaking with you on the next quarter's earnings call.

Thanks everybody. Have a great day.

Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.