Cactus, Inc. Q3 FY2024 Earnings Call

Thank you, and good morning. We appreciate you joining us on today's call. Our speakers will be Scott Bender, our Chairman and Chief Executive Officer; and Jay Nutt, our Chief Financial Officer. Also joining us today are Joel Bender, President; Steven Bender, Chief Operating Officer; Stephen Tadlock, CEO of Flex Steel; and Will Marsh, our General Counsel. 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'll turn the call over to Scott.

Thanks, John, and good morning to everyone. I'm pleased to report our third quarter results, which highlighted the unique resilience of both of our business segments. Despite the continued decline in U.S. land rig activity, total company revenue improved sequentially during the third quarter. Our spoolable Technology segment reported record quarterly revenue. As I noted on last quarter's call, we expected that most of the domestic activity decline was behind us. While that has largely played out as anticipated, software activity continued throughout the third quarter. Given the subdued market conditions, I continue to be very proud of our associates' ongoing commitment to customer execution that has led to this consistent record of outperformance. Some third quarter total company highlights include revenue of $293 million, adjusted EBITDA of $100 million, an adjusted EBITDA margin of 34.2%, and we increased our cash balance to $303 million. I'll now turn the call over to Jay Nutt, our CFO, who will review our financial results in more detail. Following his remarks, I'll provide some thoughts on our outlook for the balance of the year before opening the lines for Q&A.

Good morning. As Scott mentioned, we had another solid quarter resulting in total Q3 revenues of $293 million which were up 1% sequentially. Total adjusted EBITDA of $100 million was down 3% sequentially. For our Pressure Control segment, revenues of $185 million were down 1.1% sequentially as unforecasted shipments of production equipment that benefited the second quarter didn't repeat to the same extent during this period. Operating income decreased $3.1 million or 5.6% sequentially with operating margins decreasing 130 basis points. The decline in operating margin was driven by miscellaneous charges incurred in the quarter, including reserves taken in connection with customer bankruptcies and other litigation claims. Adjusted segment EBITDA decreased $3.3 million or 5.1% sequentially with margins decreasing by 140 basis points for the reasons just noted. Excluding the aforementioned charges, segment adjusted EBITDA margins were essentially flat versus the second quarter. In our spoolable Technology segment, revenues were up 4.3% sequentially due largely to resilient domestic customer activity. Operating income increased $2.9 million sequentially, primarily due to lower expense booked as a result of the remeasurement of the earn-out liability associated with the Flexsteel acquisition offset by some higher input costs. Note that the earn-out liability was paid in full and closed out during the quarter. Adjusted segment EBITDA at $42.5 million was flat sequentially while margins decreased by 160 basis points resulting from the increased input cost. Corporate and other expenses were $8.7 million in Q3, up $2.8 million sequentially resulting from professional fees associated with the pursuit of an inorganic growth opportunity that we're no longer pursuing. Adjusted EBITDA was flat sequentially. On a total company basis, third quarter adjusted EBITDA was $100 million. Adjusted EBITDA margin for the third quarter was 34.2% compared to 35.7% for the second quarter. Adjustments to total company adjusted EBITDA during the third quarter include noncash charges of $5.6 million in stock-based compensation, a $100,000 charge related to the final remeasurement of the Flexsteel earn-out liability upon settlement, and the $2.8 million for professional fees associated with the evaluation of an inorganic growth opportunity. Depreciation and amortization expense for the third quarter was $15 million which includes $4 million of amortization expense related to intangible assets resulting from the Flexsteel acquisition. During the quarter, the public or Class A ownership of the company averaged and ended the period at 84%. GAAP net income was $62 million in the third quarter versus $63 million during the second quarter. The slight decline was primarily driven by the professional fees incurred at corporate, mostly offset by small quarterly changes in the remeasurement of the Flexsteel earn-out liability. Book income tax expense during the third quarter was $16 million reflecting an effective tax rate of 21%. Adjusted net income and earnings per share were $63 million and $0.79 per share, respectively, compared to $65 million and $0.81 per share in the second quarter. Adjusted net income for the third quarter was net of a 26% tax rate applied to our adjusted pretax income. During the quarter, we paid a dividend of $0.13 per share, resulting in a cash outflow of approximately $11 million including related distributions to members. Additionally, we paid $37.1 million to close the Flexsteel earn-out liability. The final payment associated with the 2023 TRA liability was deferred to the fourth quarter. This residual payment is approximately $5.5 million excluding accrued interest and associated distributions. Due to our continued strong operating earnings and disciplined working capital management, we increased our cash and cash equivalents balance by $57 million notwithstanding the aforementioned payments, and we closed the quarter with a cash balance of $303 million. Capital spending was $10 million during the third quarter. In a moment, Scott will give you our fourth quarter operational outlook. Some additional financial considerations when looking ahead to the fourth quarter, including effective tax rate similar to the third quarter rate of 22% and an estimated tax rate for adjusted EPS of approximately 26%. Total depreciation and amortization expense during the fourth quarter is expected to be $15 million with $6.5 million associated with our Pressure Control segment and $8.5 million in spoolable Technologies. Our full year 2024 CapEx outlook has been reduced to be in the range of $32 million to $37 million due to the timing of equipment receipts and our international expansion efforts. Finally, the Board has approved a quarterly dividend of $0.13 per share, which we've paid in December. That covers the financial review and outlook. And I'll now turn the call back over to Scott.

Thanks, Jay. I'll now touch on our operational expectations for the fourth quarter by reporting segment. Based upon preliminary revenue for October, we expect Pressure Control revenue to reflect a mid-single digit dip versus the third quarter due to the combination of lower average U.S. land drilling activity and seasonal factors, including potential customer budget exhaustion. These factors are resulting in less visibility into production equipment shipments around year-end. Although we are closely monitoring the potential impacts of operator consolidations, preliminary discussions with our current customers indicate activity increases in the early part of next year. Adjusted EBITDA margins in our Pressure Control segment are expected to be 33% to 35% for the fourth quarter as cost management and ongoing cost efficiencies are expected to offset the impact of the anticipated revenue decline. The adjusted EBITDA guidance excludes approximately $3 million of stock-based compensation expense within the segment. We believe product costs will trend lower during the second half of 2025 due to ongoing efficiency improvements as well as our supply chain diversification efforts. Regarding our spoolable Technologies segment, we expect fourth quarter revenue to be down in the mid to high single digits quarter-over-quarter. As a reminder, seasonal declines approaching 10% in this business during the fourth quarter are not uncommon. We expect adjusted EBITDA margins in this segment to be approximately 36% to 38% in Q4, which excludes $1 million of stock-based compensation in the segment. Lower operating leverage in Q4, combined with some ongoing higher material costs, are the primary drivers of the expected Q4 margin progression. The higher material cost and impacted results during the third quarter are expected to persist through year-end before easing. These higher material cost increases have been partly the result of spot purchases to address increased demand relative to prior expectations. Additionally, we look forward to expanding the benefits of using the Pressure Control supply chain to source certain components of our Flexsteel products in 2025. This initiative, in combination with supply chain improvements, could improve margins by over 100 basis points in this segment by the end of next year. Adjusted corporate EBITDA is expected to be a charge of approximately $4 million in Q4, which excludes approximately $1.7 million of stock-based compensation. Regarding our international expansion plans, we remain focused on establishing a Mideast business, and we'll continue to take a disciplined approach to evaluating strategic opportunities. We continue to dedicate significant resources in both segments. As an example of our success to date, international revenue in spoolable Technologies for 2024 has already doubled 2023's full-year performance. While the U.S. market continues to be challenging, I remain optimistic and very pleased with the market positioning of Cactus, our portfolio of high-margin, high-return products and services, and the commitment of our organization to exceed customer expectations. I'm eager to responsibly roll out our latest generation wellhead system to our customers to enable them to achieve reduced drilling times while enhancing safety and reliability. In addition, we will complete prototype testing of our new frac valve design, which will significantly reduce maintenance costs. In summary, our primary objectives for the next year remain unchanged and include meaningful contributions from our new non-Section 301 manufacturing facility to enhance the cost and risk profile of our supply chain, increased availability of our next-generation wellhead system, continued customer additions and increases within our customer base for both segments supported by the introduction of new products and services, and international expansion in both segments. And with that, I'll turn it back over to the operator, so we may begin Q&A.

Thank you. Our first question comes from the line of Arun Jayaram of J.P. Morgan Securities LLC. Your line is now open.

Hey, good morning, team.

How are you doing?

I'm doing great. How are you?

I'm doing fine. Great.

Well, it's great to get through the roof. Is that my first question? I'm going to ask for maybe a little grace this morning. Quickly, I'd love to hear your thoughts on obviously, you pursued an inorganic kind of growth opportunity. I'd love to hear about just thoughts on your overall portfolio and strategically at a high level, how are you thinking about kind of augmenting the portfolio? Obviously, you've had a really, really interesting acquisition with spoolables, which has been really, really successful, but wanted to get your thoughts on just the portfolio.

Okay. That's your only question?

I have a follow-up.

How do you know you have a follow-up if I have an answer to this question? I've changed my medication, so I might be a bit snarkier than usual. Consistent with what I have always said, our primary objective is international growth. However, if another opportunity similar to Flexsteel arises, we would take advantage of it. Our balance sheet supports this, as you know, and we have the capacity with our line of credit. Regarding Flexsteel, even after the earn-out payment, they have already returned $190 million to us. It would be unwise for our shareholders not to consider this, but my main focus would remain on international opportunities.

Understood. And just maybe a separate question. We're just days away from the election, and I'm not going to ask you to comment on who you think is going to win, but one of the candidates has talked a lot about tariffs and I just wanted to get your general thoughts on that. It does appear that you're mitigating that risk through your expansion to a third manufacturing base. But just talk about that general risk and how you think about that for Cactus, just given your current production base between the U.S. and China?

Yes. I believe we are better positioned than our competitors because Bossier City handles nearly half of our production. Additionally, all of our competitors rely on imported goods, mainly from China, which is affected by Section 301. The big concern is whether tariffs or tariff increases will impact China disproportionately. We have heard President Trump mention potential tariffs ranging from 60% to as high as 200%. I expect significant pushback against this approach. Even Kamala has expressed a desire to raise tariffs. Given our current strategy and the advantages provided by Bossier City, I think we are gaining a significant competitive edge, especially since Flexsteel manufactures entirely in the U.S.

Yeah. You make that in Baytown, right, that product?

Yes. Short answer is, I think we're in the best position of anybody I know in this business.

Great. Thanks a lot.

I wanted to kind of ask a follow-up to Arun's question. You mentioned continued interest in pursuing acquisitions, but can't help but notice that your cash balance keeps rising after another strong free cash quarter. So should the expectation be that you'll continue to grow the cash balance as you pursue acquisitions or is there a level of cash at which you'd consider returning some of it to shareholders? Just your latest thoughts on the cash balance and deployment.

That's a good question, Scott. We have a surplus of cash. If we weren't actively looking to expand, I would have already returned this cash. As I mentioned before, when you all were patient about our increasing cash balance, I asked you to continue being patient because we were considering some opportunities. There will come a time, particularly by the end of next year, when we would look to increase the cash returned to our shareholders if nothing materializes. Currently, our capital structure isn't ideal, but as you know, I have a strong aversion to debt.

Right. And actually, by the end of 2025, just to be clear, you can let it go for a few more quarters?

Yes.

Okay. And then just a follow-up on getting your wellhead system qualified in the Middle East. Can you just provide an update on that process and timing of building a facility there? It seems to be pushed to the right a bit, but some color there would be great as well.

Okay. I think that we're continuing our testing, and I don't think, frankly, that testing is the limiting factor. It's the decision about the direction that we're going to go, and so I wouldn't worry about the former. We have several alternatives, and this has taken us way longer than I had expected, but we are by nature very cautious people. But Scott, it's full speed ahead. We're going to get this done. It's just we're going to get it done in a very responsible way. Yes, I'm incredibly proud that we have survived all of this without ever having to take an impairment charge, and I don't intend to ever take an impairment charge. So just bear with us, Scott. I'm going to tell you trust me because I've never lied to you. I'm not going to lie to you now.

Got it. I appreciate these guys. Thanks, Scott. I'll turn it back.

Good morning, everybody. Thanks for taking the questions. I think the first one, when we think about what we see in the U.S. from a consolidation perspective and it feels like the dynamics of the business have changed. Have you seen much change from your perspective and your conversation with customers versus sort of prior cycles and how they either utilize or view your high-performance products versus peers and pricing? I know you don't love to talk about pricing, but just in general, has the world changed much versus prior sort of soft periods?

Yes, I've mentioned this before. I used to find it amusing when Scott Sheffield suggested that there might be only five operators left in the Permian. At the time, I thought that seemed unlikely, and I still don't think it will happen. However, I believe we could see a significant portion of the market controlled by just a few major players. This is a first for me, and I think it will lead to considerable improvements in their supply chain, which would be beneficial for us. I believe some of our smaller competitors will face significant challenges as the industry shifts from relationship-based purchasing to a more technical buying approach, which may make it hard for many small independent wellhead providers. While I previously mentioned that when one company with 20 rigs acquires another with 20, it doesn't equate to a combined total of 40, I still stand by that. However, in terms of market share, this situation could be favorable for us.

Great. Thanks. That's helpful information. As a follow-up, I'm curious about your thoughts on the potential for modest growth in EBITDA next year, considering the fourth quarter softness you mentioned and the fact that some customers might show signs of slight increases early next year. If the rig counts remain relatively flat from current levels, do you believe Cactus can achieve this growth?

Yes.

Okay. Good. That's how we've been modeled, so I'm glad you said that. No, thank you for the color. This is very helpful.

So question on kind of the level of sales per rig in the second quarter in Pressure Control. You kind of highlight how they were much higher and they've kind of revised they're going to revise a bit lower in fourth quarter. Can you just expand a little bit more about how that moves up and down? I would think kind of the wellhead demand relative to rigs would say pretty consistent. So is it really just a function of utilization of the rest of the queue on your site? And does the shift in 4Q, is that just a function of just like as you said, the customer is just a little bit more overly cautious on the rest of your business?

Yes. David, it really is most it's primarily impacted by the production tree call-offs, and they are so difficult to predict. So we see customers take a large number of production trees, then they kind of go quiet, then they take a large quantity of production trees. And that's really the primary driver for the change in revenue per rig.

Got you. And then the other question. So I was looking at the model kind of going back over time and kind of getting back to this hypothetical tariff question. That happened in 2018. So in 2019 and 2020, your revenue per rig went up substantially. And I'm just kind of thinking back and I don't remember maybe to refresh on a little bit here. I don't remember you necessarily expanding your manufacturing in the U.S. or did you? And I guess sort of my question is, is this just sort of a natural function, hey, you have kit you're making this in the U.S. versus out, so you can provide a lower cost to your customer therefore share increases and the like. Do you think the same thing can happen again this time? Would you do anything different? Do you ramp up manufacturing capacity like faster?

Are you asking me if we're going to if we would ramp it up faster in the U.S?

I'm wondering if you would have approached things differently the last time or if this is just a natural part of the transition. Looking at the numbers, particularly in 2019 and 2020, there was a significant increase in revenue per week. I'm curious about how much of that was influenced by tariffs and customers choosing your product over others.

Yeah. I don't think really that tariffs had much impact because even with the tariffs, our costs are lower importing than they are producing domestically. So I really don't think that's an issue. I think that what really was an issue was that we did have a period of tariff exclusion, which helped. I don't know if you remember that. There was a brief period. What was it, Joel? A couple of two, three months?

A little bit longer than that.

I don't believe it was too long. The tariff exclusion significantly affected the situation. However, I can't think of what I would have done differently. I still have a strong belief in maintaining a low-cost manufacturing source. Right now, I firmly believe that we need to address the geopolitical risks coming from China, and I think we are making substantial progress in addressing those concerns.

Great. Okay. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Jeff LeBlanc with TPH. Your line is now open.

I guess the question I wanted to ask is if you could quantify the magnitude of the International spoolable Technologies revenue. And then also should we think about this as a base load moving forward, on which future growth would be good? So just steady revenue in international moving forward?

Yes. We're in the kind of high single digits as a percent of spoolable that's coming from international. And like Scott mentioned that's double over where it was last year. And yes, we view this as like an active growth area for us, dedicating resources, both additional hires, repurposing some people in the organization to focus on international as well as expanding service capacity to support that.

I think further to that, if I could just interject, we're even doing very preliminary work on some capacity expansion because we think that this international business for Flexsteel in the next couple of years could be 40% of our business. That's a lot.

Is that 40% of spoolables or 40% of overall?

I'm talking about spoolables.

Okay. Thank you very much. I'll hand the call back to the operator.

We appreciate your interest in Cactus. Thank you for joining us, and we look forward to speaking with you on next quarter's call.

We appreciate your interest in Cactus. Thank you for joining us, and we look forward to speaking with you on next quarter's call.