Cactus : Q2 2023 Earnings Call Transcript

Cactus, Inc. (NYSE: WHD)

Q2 2023 Earnings Call Transcript

August 08, 2023 @ 09:00 AM Central Time

Call Participants

EXECUTIVES

Scott Bender

Chairman and CEO

Joel Bender

President and Director

Stephen Tadlock

Executive VP, CFO and Treasurer

Steven Bender

COO

William Marsh

Executive VP and General Counsel

Thirucherai "TS" Sathyanarayanan

CEO, FlexSteel

Alan Boyd

Director of Corporate Development and Investor Relations

ANALYSTS

Stephen Gengaro

Stifel, Nicolaus & Co.

J. David Anderson

Barclays Capital

Kurt Hallead

Benchmark Co.

Saurabh Pant

BofA Securities

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Presentation

Operator

Good day and thank you for standing by. Welcome to the Cactus Q1 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the presentation, there will be a question-and- answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Alan Boyd, Director of Corporate Development and Investor Relations.

Alan Boyd

Director of Corporate Development and Investor Relations

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 Steve Tadlock, our Chief Financial Officer. Also joining us today are Joel Bender, President, Steven Bender, Chief Operating Officer, TS, CEO of FlexSteel and Will Marsh, our General Counsel and Executive Vice President.

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.

Scott Bender

Chairman and CEO

Thanks, Alan and good morning to everyone. We are understandably pleased with the company's performance in the second quarter despite a weakening U.S. land market. We are particularly proud to be in a net cash position today, well ahead of our internal plan. As you know, free cash flow generation has always been a strength of our company and has been enhanced further by the FlexSteel acquisition. On a standalone basis, each of Cactus and FlexSteel set records for both quarterly revenue and Adjusted EBITDA. This strength reflects the highly differentiated offerings in each of our segments. Today, we will walk through results in our recently introduced segment reporting format, consisting of Pressure Control (legacy Cactus) and Spoolable Technologies, which represents the FlexSteel business.

Some second quarter total company highlights include:

• Revenue of $306 million;
• Adjusted EBITDA of $115 million;
• Adjusted EBITDA margins of 37.7%;
• We paid a quarterly dividend of $0.11 per share;
• Record cash flow from operations of $108 million;
• Yesterday we announced that our Board approved a 9% increase in the quarterly dividend to $0.12 per share; and
• As of July 31, 2023, we have repaid the full $155 million of debt raised to finance the FlexSteel acquisition, leaving us once again free of bank debt.

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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. Steve?

Stephen Tadlock

Executive VP, CFO and Treasurer

Thanks, Scott. As Scott mentioned, total Q2 revenues were $306 million.

Pressure Control revenues of $199 million were up 2.3% sequentially, driven primarily by increased customer activity despite the decline in U.S. land activity as the quarter progressed. Operating income increased $5.1 million, or 10.3% sequentially, with operating margins increasing 200 basis points primarily due to lower transaction expenses partially offset by an increase in the allowance for doubtful accounts, which was primarily attributable to a single customer. Adjusted Segment EBITDA was $69.9 million, an increase of $0.8 million, or 1.2% sequentially, with margins decreasing slightly by 40 basis points driven substantially by the aforementioned allowance.

As a reminder, we closed the FlexSteel acquisition on February 28th, so the second quarter results represent our first full quarter of ownership of the business, while the first quarter included only March results. Spoolable Technologies revenues were $106.7 million and operating loss was $6.0 million. Operating loss was inclusive of $19.3 million of inventory costs associated with the step-up in value of inventory on hand at acquisition, $8.7 million of intangible amortization expense, and $18.1 million of expense associated with the remeasurement of the earn-out associated with the FlexSteel acquisition. The remeasurement expense this quarter reflects the revenue outperformance versus our prior forecast. This liability will be remeasured and adjusted, if necessary, on a quarterly basis through the final earn-out evaluation date of June 30, 2024. Adjusted Segment EBITDA, which excludes all the above non-cash charges, was $45.5 million with margins of 42.6%, an approximately 1,200 basis point increase from March levels due to the depletion of higher cost material in the prior quarter and improved operating leverage. Note that no corporate costs have been allocated to FlexSteel in the period.

On a total company basis, second quarter Adjusted EBITDA was $115 million, up 45% from $79 million during the first quarter. Adjusted EBITDA margin for the quarter was 37.7% of revenues, an increase from the first quarter due to operating leverage and higher contribution from the Spoolable Technologies segment.

Adjustments to Total Company EBITDA during the second quarter of 2023 included approximately $2.2 million in transaction-related fees and expenses and non-cash charges of $5.3 million in stock-based compensation, $18.1 million related to the FlexSteel earn-out liability, and $19.3 million of purchase accounting related step-up in inventory, which impacted Spoolable Technologies cost of sales.

Depreciation and Amortization expense for the second quarter was $22 million, which again includes $9 million of amortization expense related to intangible assets booked as part of purchase accounting. Total Depreciation and Amortization expense during the third quarter is expected to be approximately $15 million, $7 million of which is associated with our Pressure Control Segment and $8 million of which is associated with Spoolable Technologies. This figure is inclusive of an expected $4 million of intangible amortization expense within Spoolable Technologies during the third quarter. Intangible amortization expense is expected to remain relatively stable at $4 million per quarter for the next several quarters as the longer-lived acquisition intangibles amortize at a steady rate.

Net interest expense during the second quarter was approximately $5.9 million. Interest expense increased sequentially due to the debt level and accelerated amortization of deferred financing fees, which contributed approximately $3.3 million to interest expense as we paid down debt faster than our forecast and recognized these expenses in the second quarter. We expect interest expense of approximately $1 million during the third quarter.

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Income tax expense during the second quarter was $10 million. Tax expense increased due to higher expected earnings and the elimination of the benefit related to a release of our valuation allowance utilized in the first quarter.

During the second quarter, the public, or Class A ownership of the Company averaged 81% and ended the quarter at 81%. Barring further changes in our public ownership percentage, we expect an effective tax rate of approximately 21% for Q3 2023.

GAAP Net income was $32 million in the second quarter versus $52 million during the first quarter. The decrease was driven by higher income tax expense, higher interest expense, increased inventory step-up expense, increased purchase price intangibles amortization, and the expense related to the remeasurement of the earn-out liability associated with the outstanding performance of FlexSteel.

We prefer to look at Adjusted Net Income and earnings per share, which were $67 million and $0.84 cents per share, respectively, during the second quarter versus $51 million and $0.64 cents per share in the first quarter. Adjusted net income for the second quarter applied a 26% tax rate to our adjusted pre- tax income generated during the quarter. We estimate that the tax rate for adjusted EPS will be 26% during the third quarter of 2023.

During the second quarter, we paid a quarterly dividend of $0.11 per share, resulting in a cash outflow of approximately $9 million, including related distributions to members. The board has also approved a 9% increase to the quarterly dividend to $0.12 per share, which will be paid in September. Additionally, we repurchased approximately 4,000 shares of Class A common stock in the final days of the second quarter under our new authorization for approximately $159,000.

We ended the quarter with a cash balance of $64 million and gross bank debt of $55 million. Since the end of the quarter, we repaid the entirety of our bank debt outstanding and are once again in a net cash position. Looking ahead to the third quarter, we expect to make our 2022-related TRA payment and distribution, which will be approximately $34 million, along with an estimated 2023 cash tax payment of $9 million and quarterly dividend of $10 million.

Net capex was approximately $6 million during the second quarter of 2023. We are reducing our full year 2023 capex outlook to $35 to $45 million on lower expectations for near-term growth spending at Pressure Control given moderating activity levels. This range is inclusive of planned investments in low- cost supply chain diversification, but excludes investments in the Middle East which we now believe will occur in early 2024.

That covers the financial review, and I will now turn the call over to Scott.

Scott Bender

Chairman and CEO

Thanks Steve. I'll now touch on our expectations for the third quarter based on our reporting segments.

During the third quarter we expect Pressure Control revenue to be down approximately 10% versus the $199 million reported in the second quarter as the decline in drilling activity impacts our business, which remained resilient through the declining rig count in the first half of the year. As of last Friday, the Baker Hughes U.S. land rig count is down 17% from year-end 2022 levels and down 14% from Q1 2023 average levels; our differentiated Pressure Control business continues to outperform this activity decline. We expect the rig count may continue to be pressured in the third quarter, although customer indications suggest activity will be flat to up in the fourth quarter if commodity prices remain constructive. Our larger, well-capitalized customers remain committed to investing in their business through commodity cycles, and our revenue outperformance of the declining rig count year-to-date is reflective of this commitment.

Adjusted EBITDA margins in our Pressure Control segment are expected to be 32.5% to 34% for the third quarter, inclusive of Pressure Control SG&A and general corporate expenses. This Adjusted EBITDA

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guidance excludes approximately $4.0 million of stock-based compensation expense within the segment as well as transaction-related expenses. Margins are expected to be down sequentially on lower operating leverage, although we have begun to see deflation in our supply chain costs after many months of inflationary pressures. We expect the benefits of this to begin to materialize in the third quarter and more significantly in the fourth quarter.

In the Middle East, we continue to work through testing and trials, which are progressing on schedule. We are also continuing our work on evaluating ownership structures in the region, and upon the completion of our evaluation, expect customer acceptance and first orders in late 2024. As mentioned earlier, we now expect to finalize our investment structure in the region in early 2024.

Switching over to our Spoolable Technologies segment, we expect revenue to be relatively flat versus the second quarter driven by continued penetration in share of wallet and share of market. This outperformance of the market highlights the benefits of the product diversification achieved with the acquisition. As discussed last quarter, our Spoolable Technologies segment was also working through some higher cost inventory during the first quarter, and that headwind is now behind us.

We expect Adjusted EBITDA margins in this segment to be approximately in the 40% range for Q3, moderating slightly from record Q2 levels with volatility in our supply chain. Note that this margin guidance excludes approximately $1 million of stock-based compensation in the segment. Also, given the high inventory turnover, we have now completed the amortization of the non-cashstep-up in value of the inventory associated with purchase price accounting ahead of plan, and we will not have that cost or add-back going forward.

As mentioned in the form 8K that was filed last night with our earnings release, we announced a few changes. Our Chairman, Bruce Rothstein, who has served in that role since the Company's founding in August 2011, has stepped down from the Chairman role after his many years of valuable service. He will remain a director and continue to contribute to the Board, for which I am very thankful. I have assumed the role of Chairman in addition to continuing my current responsibilities as CEO. Given my additional responsibilities as Chairman and my role supporting the integration of FlexSteel, Joel Bender has assumed the role of President. As President, Joel will continue to oversee our supply chain including our manufacturing and production facilities. Steven Bender has assumed Joel's role of Chief Operating Officer, where he will continue to oversee our branch and field operations, managing the majority of our associates and introducing significant technology enhancements to our service delivery and invoicing processes. Gary Rosenthal, an independent board member since 2018, has assumed the Lead Director role. You should not infer any retirement plans from these changes.

We are still in the early innings of introducing the FlexSteel product line to Cactus' much larger customer base through joint meetings and are highly encouraged by early efforts to integrate our sales organizations, both in the US and internationally. Just like Cactus, the FlexSteel team is highly technical, delivers a superior product and service, and strives to exceed customer expectations. I'm confident that, as with the Cactus legacy business, more customers will learn to appreciate the many benefits associated with the FlexSteel spoolable product, including speed of installation, total cost of ownership reduction, increased safety, and reduced emissions from more efficient field operations. We anticipate introducing new products and services in early 2024, the details of which will be discussed when appropriate.

As stated previously, our substantial free cash flow in the five months since the acquisition closed enabled us to repay all of our $155 million of bank debt, well ahead of our plan. The debt free balance sheet and increased confidence in the strong, through cycle cash flow profile of the combined business has led us to re-evaluate our cash return priorities, as evidenced by our June announcement of the inaugural share repurchase program and the increase to the base dividend announced yesterday. Going forward, we expect to remain discerning buyers of our own stock, as we believe we will continue to be rewarded for having the flexibility to invest in attractive organic and inorganic growth opportunities with our excess cash while maintaining a strong balance sheet.

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