Cactus(WHD) - 2019 Q4 - Annual Report

PART I Item 1. Business Cactus, Inc. designs, manufactures, and sells wellhead and pressure control equipment for onshore unconventional oil and gas wells, with revenues from products, rentals, and services Overview and Operations The company specializes in wellhead and pressure control equipment, operating service centers in the U.S. and Australia and manufacturing facilities in Louisiana and China - The company designs, manufactures, and sells wellhead and pressure control equipment, including its proprietary Cactus SafeDrill® wellhead systems, frac stacks, and production trees[21][28] - Cactus operates 14 service centers in key U.S. oil and gas regions, three in Eastern Australia, and has manufacturing facilities in Bossier City, Louisiana, and Suzhou, China[20][30] - Following its IPO in February 2018, Cactus Inc. became a holding company whose primary asset is its equity interest in Cactus LLC, owning approximately 62.8% as of December 31, 2019[23][26] Revenue, Costs, and Market Factors Revenue is primarily from product sales, with costs significantly impacted by manufacturing inputs and U.S. tariffs on goods from its Chinese supply chain Revenue Breakdown by Source (FY 2019) | Revenue Source | Percentage of Total Revenue | | :--- | :--- | | Product Sales | 57% | | Rental | 22% | | Field Service and Other | 21% | - The principal costs for products are manufacturing-related, rental costs are primarily depreciation and repairs, and field service costs are mainly labor and equipment depreciation[34] - The company is affected by Section 232 and Section 301 tariffs, with approximately 50% of goods received in 2019 sourced through its Chinese supply chain[36][37] Supply Chain, Manufacturing, and Competition The company utilizes a dual-facility manufacturing strategy in the U.S. and China and competes with major integrated service companies in a highly competitive market - A single vendor in China supplied machined components representing approximately 16% of total third-party vendor purchases in 2019[39] - The Bossier City, LA facility is designed for rapid production, while the Suzhou, China facility is optimized for higher-volume orders; both are API 6A certified[40][42] - The company competes with major integrated service companies like Schlumberger, Baker Hughes, and TechnipFMC in the wellhead market[49][50][52] Regulation, Risk, and Other Information The business is subject to stringent environmental regulations and manages operational risk through insurance, with over 1,100 employees and no collective bargaining agreements - The company is subject to stringent U.S. and international environmental, health, and safety laws, including the Clean Water Act, Clean Air Act, and OSHA[54][57] - Increased regulation of hydraulic fracturing or climate change policies could reduce demand for oil and gas, negatively impacting the company's business[59][60] - As of December 31, 2019, Cactus employed over 1,100 people and is not a party to any collective bargaining agreements[63] Item 1A. Risk Factors The company faces significant risks from oil and gas industry cyclicality, supply chain disruptions, and financial obligations related to its corporate structure Industry and Business Risks Performance is highly dependent on volatile commodity prices, customer spending, and operational risks including the coronavirus impact on its Chinese supply chain - Demand for products and services is directly affected by volatile crude oil and natural gas prices, which influence customer capital spending and drilling activity[67][68] - The coronavirus outbreak in China led to a temporary 10-day closure of the Suzhou facility in early 2020, which could materially impact results if prolonged[77][78] - Pioneer Natural Resources was a major customer, representing 10% of total revenue in 2019[79] - The company faces intense competition from large, well-resourced companies and is subject to risks from new technologies that could create a competitive disadvantage[83][84] Corporate and Financial Risks Financial risks stem from its holding company structure, substantial payment obligations under the Tax Receivable Agreement, and significant shareholder influence - Cactus Inc. is a holding company dependent on distributions from Cactus LLC to pay taxes, dividends, and obligations under the Tax Receivable Agreement (TRA)[108][109] - The TRA requires payments of 85% of certain tax savings to pre-IPO owners, with a potential early termination payment estimated at $331.3 million as of Dec 31, 2019[127][132] - As of Dec 31, 2019, major shareholders Cadent and Cactus WH Enterprises control approximately 11% and 24% of the company's voting power, respectively[112] - Future sales of the 28.0 million shares of Class A common stock issuable upon redemption of CW Units could adversely affect the market price[123][124] Item 2. Properties The company owns and leases key properties including manufacturing facilities in Louisiana and China, service centers, and its administrative headquarters in Houston Principal Facilities as of December 31, 2019 | Location | Type | Own/Lease | | :--- | :--- | :--- | | United States | | | | Bossier City, LA | Manufacturing Facility and Service Center | Lease | | Bossier City, LA | Assembly Facility and Warehouse / Land | Own | | Houston, TX | Administrative Headquarters | Lease | | Hobbs, NM | Service Center / Land | Own | | New Waverly, TX | Service Center / Land | Own | | China and Australia | | | | Suzhou, China | Production Facility and Offices | Lease | | Queensland, Australia | Service Centers and Offices / Land | Lease | Item 3. Legal Proceedings The company is involved in routine litigation incidental to its business but does not expect any material adverse financial impact from pending matters - The company is subject to routine litigation related to its business activities but does not expect any pending cases to have a material adverse effect on its financial results[141] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's stock trades on the NYSE under "WHD", a quarterly dividend was initiated in 2019, and shares were repurchased to cover employee tax obligations - The company's Class A common stock is traded on the New York Stock Exchange under the symbol "WHD"[145] - On October 29, 2019, the board authorized a regular quarterly cash dividend of $0.09 per share of Class A common stock[145] - In Q4 2019, the company repurchased 740 shares from employees at an average price of $28.16 to cover tax withholding on vested restricted stock units[148][149] Item 6. Selected Financial Data Historical data shows significant revenue and net income growth since 2016, elimination of long-term debt in 2018, and the initiation of a dividend in 2019 Selected Financial Data (2017-2019) | Metric (in thousands) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Total revenues | $628,414 | $544,135 | $341,191 | | Income from operations | $183,150 | $177,701 | $88,863 | | Net income | $156,303 | $150,281 | $66,547 | | Net income attributable to Cactus Inc. | $85,612 | $51,683 | $0 | | Earnings per Class A share - diluted | $1.88 | $1.58 | $0 | | Total assets | $834,964 | $584,744 | $266,456 | | Long-term debt, net | $0 | $0 | $241,437 | | Cash dividends declared per share | $0.09 | $0 | $0 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Revenue increased 15.5% in 2019 due to market share gains, but operating income growth was limited by rising costs, while liquidity remains strong with no debt Market Factors and Recent Developments Despite a lower U.S. rig count in 2019, performance was supported by drilling trends, though the recent coronavirus outbreak caused a temporary factory shutdown - The average U.S. onshore rig count decreased by 9% in 2019 to 918 rigs, compared to 1,011 in 2018[158] - The company's factory in Suzhou, China, was temporarily closed for 10 days due to the coronavirus outbreak but is not expected to have a material adverse impact on Q1 2020 results[164] Consolidated Results of Operations (2019 vs 2018) Total revenues grew 15.5% in 2019, driven by product sales, but a 21.5% rise in costs and expenses constrained operating income growth to 3.1% Consolidated Results of Operations (2019 vs. 2018) | Metric (in thousands) | 2019 | 2018 | % Change | | :--- | :--- | :--- | :--- | | Total Revenues | $628,414 | $544,135 | 15.5% | | Product revenue | $357,087 | $290,496 | 22.9% | | Rental revenue | $141,816 | $133,418 | 6.3% | | Field service and other revenue | $129,511 | $120,221 | 7.7% | | Total costs and expenses | $445,264 | $366,434 | 21.5% | | Income from operations | $183,150 | $177,701 | 3.1% | | Net income | $156,303 | $150,281 | 4.0% | | Net income attributable to Cactus Inc. | $85,612 | $51,683 | 65.6% | - The 26% increase in cost of product revenue was driven by higher sales volume and tariff costs[170] - SG&A expense increased 27% due to higher compensation, stock-based compensation, and costs associated with losing Emerging Growth Company (EGC) status[173] Liquidity and Capital Resources The company maintains strong liquidity with $202.6 million in cash, no debt, and a $75.0 million credit facility, alongside a significant TRA liability - As of December 31, 2019, the company had $202.6 million in cash, no outstanding borrowings, and $75.0 million of available capacity under its ABL Credit Facility[177] Cash Flow Summary (2019 vs. 2018) | Cash Flow (in thousands) | 2019 | 2018 | | :--- | :--- | :--- | | Net cash provided by operating activities | $209,632 | $167,180 | | Net cash used in investing activities | ($55,948) | ($68,154) | | Net cash used in financing activities | ($21,669) | ($35,004) | - The company estimates net capital expenditures for 2020 to range from $30 million to $40 million[179] Contractual Obligations as of December 31, 2019 (in thousands) | Obligation | Total | Payments Due 2020 | | :--- | :--- | :--- | | Operating leases | $30,637 | $7,691 | | Finance leases | $11,644 | $7,434 | | Liability related to TRA | $216,532 | $14,630 | | Total | $258,813 | $29,755 | Critical Accounting Policies and Estimates Critical accounting policies involve significant estimates for inventory valuation, asset impairment, income taxes, and the highly complex Tax Receivable Agreement liability - Critical accounting policies require significant management estimates regarding inventory obsolescence, impairment of long-lived assets, income taxes, and the TRA liability[192] - The TRA liability calculation is highly sensitive; a 100 basis point change in the assumed blended tax rate would change the TRA liability by approximately $12.0 million[201] - The company evaluates long-lived assets for impairment if events indicate the carrying amount may not be recoverable[195] Item 8. Financial Statements and Supplementary Data This section contains the audited consolidated financial statements and notes, with the auditor's report highlighting the Tax Receivable Agreement as a critical audit matter Auditor's Report and Management's Assessment Management and the independent auditor concluded that internal controls were effective, with the auditor issuing an unqualified opinion and flagging the TRA liability as a critical audit matter - Management assessed its internal control over financial reporting as effective as of December 31, 2019[212] - PricewaterhouseCoopers LLP issued an unqualified audit opinion on both the consolidated financial statements and the effectiveness of internal control over financial reporting[216] - The auditor identified the liability related to the Tax Receivable Agreement (TRA) as a Critical Audit Matter due to significant complexity and judgment in its calculation[224][225] Consolidated Financial Statements The financial statements show significant asset growth to $835.0 million in 2019, driven by cash and deferred tax assets, with a corresponding increase in liabilities from the TRA Consolidated Balance Sheet Data (as of Dec 31) | (in thousands) | 2019 | 2018 | | :--- | :--- | :--- | | Cash and cash equivalents | $202,603 | $70,841 | | Total current assets | $414,883 | $274,505 | | Total assets | $834,964 | $584,744 | | Total current liabilities | $91,126 | $74,624 | | Liability related to TRA (non-current) | $201,902 | $138,015 | | Total liabilities | $318,569 | $222,416 | | Total stockholders' equity | $516,395 | $362,328 | Consolidated Income Statement Data (Year Ended Dec 31) | (in thousands) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Total revenues | $628,414 | $544,135 | $341,191 | | Income from operations | $183,150 | $177,701 | $88,863 | | Net income | $156,303 | $150,281 | $66,547 | | Net income attributable to Cactus Inc. | $85,612 | $51,683 | $0 | Notes to Consolidated Financial Statements Key disclosures include the adoption of a new lease standard, details on the $216.5 million TRA liability, and the redemption of 9.3 million CW Units for stock - The company operates in a single segment and relied on a significant vendor in China for 16% of total third-party purchases in 2019[248][250] - The company adopted the new lease standard (ASC 842) on Jan 1, 2019, recognizing $25.3 million in operating lease right-of-use assets and liabilities[277] - As of Dec 31, 2019, the total liability related to the Tax Receivable Agreement (TRA) was $216.5 million[314] - During 2019, legacy holders redeemed 9.3 million CW Units, which were exchanged for 9.3 million shares of Class A common stock[319][320][336] Item 9A. Controls and Procedures Management concluded that disclosure controls were effective as of year-end 2019, having successfully remediated a previously reported material weakness related to the TRA - The principal executive and financial officers concluded that disclosure controls and procedures were effective as of December 31, 2019[339] - A material weakness in internal control related to the Tax Receivable Agreement (TRA), identified in the prior year, was successfully remediated as of December 31, 2019[340][341] - Remediation steps included replacing the outside tax service provider, hiring an experienced Tax Director, and redesigning control activities for TRA accounting[340][344] PART III Item 10. Directors, Executive Officers and Corporate Governance The company is led by a separated Chairman and CEO, with an eight-member staggered board that includes four independent directors and has adopted comprehensive governance policies - The board consists of eight members, including Chairman Bruce Rothstein, CEO Scott Bender, and COO Joel Bender, and is divided into three staggered classes[346][363] - The board has standing Audit, Compensation, and Nominating and Governance committees, and the Audit Committee has a designated financial expert[365][366][368][371] - The company has adopted a Code of Business Conduct and Ethics and policies that prohibit directors and executive officers from hedging or pledging company stock[372][374][387] Item 11. Executive Compensation Executive compensation is pay-for-performance, with a high percentage of at-risk pay tied to EBITDA and safety metrics, resulting in a 111.3% STI payout in 2019 - The executive compensation program is heavily weighted towards at-risk pay, with 86% for the CEO and an average of 80% for other NEOs in 2019[393] - The 2019 short-term incentive plan was based on EBITDA and safety metrics, resulting in a total payout of 111.3% of the target bonus[416][419][422] 2019 NEO Summary Compensation | Name | Position | Total Compensation ($) | | :--- | :--- | :--- | | Scott Bender | President, CEO & Director | 2,163,931 | | Joel Bender | SVP, COO & Director | 2,164,949 | | Stephen Tadlock | VP, CFO & Treasurer | 2,030,614 | - The company has stock ownership guidelines requiring the CEO to hold 6x base salary and non-employee directors to hold 3x their annual cash retainer[434] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Significant beneficial ownership is concentrated with Cactus WH Enterprises and Cadent Energy Partners, with management and directors as a group holding 24.2% of voting power Beneficial Ownership (as of Feb 11, 2020) | Owner | Combined Voting Power | | :--- | :--- | | Cactus WH Enterprises, LLC | 23.8% | | Cadent Energy Partners II, L.P. | 11.1% | | The Vanguard Group | 5.7% | | Scott Bender (CEO) | 23.9% | | Joel Bender (COO) | 23.9% | | All directors and executive officers as a group | 24.2% | - As of December 31, 2019, there were 2,036,788 securities remaining available for future issuance under the company's equity compensation plans[495] Item 13. Certain Relationships and Related Transactions, and Director Independence The company engages in several related-party transactions, including TRA payments and an aircraft lease, governed by an Audit Committee approval policy - The company has a written policy requiring the Audit Committee to review and approve related party transactions exceeding $120,000[500][501] - The Tax Receivable Agreement (TRA) obligates the company to pay 85% of realized tax savings to original owners; 2019 payments included $6.3 million to Cadent and $2.1 million to a company controlled by the Benders[512][525][526] - A Stockholders' Agreement provides Cadent and Cactus WH Enterprises the right to designate directors to the board as long as they maintain specified ownership levels[533][536] - Cactus LLC leases an aircraft from an entity wholly owned by CEO Scott Bender, with $0.3 million in lease expense recognized in 2019[538] Item 14. Principal Accounting Fees and Services Total fees paid to the independent auditor, PricewaterhouseCoopers LLP, were $1.763 million in 2019, a decrease from 2018, with all services pre-approved by the Audit Committee Auditor Fees (in thousands) | Fee Type | 2019 | 2018 | | :--- | :--- | :--- | | Audit Fees | $1,760 | $1,645 | | Audit-Related Fees | $3 | $10 | | Tax Fees | $0 | $328 | | All Other Fees | $0 | $0 | | Total | $1,763 | $1,983 | - All audit and non-audit services provided by PricewaterhouseCoopers LLP in 2019 and 2018 were pre-approved by the Audit Committee[542] PART IV Item 15. Exhibits, Financial Statement Schedules This section lists the financial statements and exhibits filed with the report, including key corporate governance and financial agreements - The consolidated financial statements of Cactus, Inc. are included in Part II, Item 8 of the report[544] - All financial statement schedules have been omitted because they are not applicable or the required information is already present in the financial statements or notes[545] - Key exhibits filed with the report include the Certificate of Incorporation, the LLC Operating Agreement, the Tax Receivable Agreement, and various employment agreements[547][548] Item 16. Form 10-K Summary The company has indicated that a Form 10-K summary is not applicable or has not been provided in this filing - No Form 10-K summary is provided[552]