Cactus, Inc. (WHD) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the FlexSteel Acquisition Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to John Fitzgerald, Director of Corporate Development and IR. Please go ahead.

Thank you, and good morning. We appreciate you joining us on today's call. Our speakers will be Scott Bender, our Chief Executive Officer; Steve Tadlock, our Chief Financial Officer. We are joined by the rest of the Cactus executive management team; as well as Thirucherai Sathyanarayanan, also known as TS, President and CEO of FlexSteel. 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 non-GAAP measures to the most directly comparable GAAP measures are included at the end of our investor presentation. With that, I'll turn the call over to Scott.

Thanks, John, and good morning to everyone. I'm extremely excited to announce our agreement to acquire FlexSteel today. As we've mentioned on previous calls, we've been on the lookout for ways to utilize our cash to increase shareholder value. FlexSteel represents the high-quality acquisition candidate on the right terms for which we've patiently been searching. We couldn't be happier to have seized this opportunity to combine with one of the few businesses that rivals our own in terms of margins and returns. FlexSteel has been in our radar for a number of years, given our interactions with the company and the reputation the business has with the E&P operators, most of whom we share as customers. In addition, we have the benefit of a deep understanding of this business by virtue of our CFO's prior experience in the spoolable space. The slides we'll walk you today will look familiar, if you've see in our previous investor presentations. And this is a testament to the similarities between the 2 businesses, which are highly complementary. On Slide 3, you'll see how FlexSteel meets the required qualities we've described when considering acquisition candidates. FlexSteel is an innovative manufacturer of a highly differentiated product. Its unique technology is sold directly to the end user like our own. FlexSteel is a variable cost business with a strong margin profile through the cycle. The business is capital-light. The acquisition will allow us to utilize Cactus' existing network of service branches and infrastructures over time. Finally, this business has attractive growth prospects. Turning to Slide 7. I'll show a quick overview of the investment highlights, which mirror our own. FlexSteel designs, manufactures and installs highly differentiated and mission-critical equipment sold directly to end users. Its products are deployed at the wellsite, downstream of the wellhead and are sold to the same customer base, making this a highly complementary acquisition for Cactus. FlexSteel is an industry leader in a growing segment of the market. It generates strong through-cycle margins and does so with modest capital requirements. Finally, there are exciting growth opportunities for the FlexSteel business as this technology is still in its early stages of adoption. I'll now turn the call over to Steve Tadlock, our CFO, to provide a brief overview of the transaction. Following his remarks, TS and I will provide some additional thoughts, before opening the lines for Q&A. So Steve?

Thanks, Scott. As seen on Slide 5, this acquisition increases Cactus' product diversification and enhances our product portfolio. The acquisition increases exposure further downstream into the production and midstream segments of the market. FlexSteel also offers additional growth potential into the shallow-water and carbon-capture markets. While FlexSteel is primarily a U.S. land-focused business, it is further along in its international expansion efforts relative to Cactus. We believe this transaction enhances our international opportunities while we maintain the flexibility to pursue consolidation or organic international growth plans. The acquisition enables Cactus to optimize the existing operating footprint of both companies and given the low CapEx needs and variable cost nature of the business, should be supportive of continued capital returns to Cactus shareholders. Cactus is acquiring FlexSteel for $621 million on a cash-free debt-free basis. Consideration will be paid 100% in cash at closing, which is expected to occur in early 2023. In addition to the upfront consideration, up to $75 million in additional purchase price will be due to the seller in mid-2024, if certain revenue targets are achieved by the business. Together with cash on hand, Cactus has obtained fully committed bridge financing to fund the entire noncash portion of the purchase price, if necessary, at closing. We intend to finance the acquisition through a mix of cash and debt and/or equity. The company is in advanced discussions with lenders regarding longer-term financing solutions, and we anticipate having an expanded ABL and a new term loan facility in place prior to closing. At closing, we would anticipate net debt to '22 adjusted EBITDA of less than 1x. Given the cash flow profiles of both businesses, we would expect meaningful deleveraging on a go-forward basis. Slide 6 provides additional high-level details on the business. FlexSteel, headquartered in Houston, is a market-leading provider of spoolable pipe technologies for the onshore North American market. These offerings are sold to many of the largest exploration and production companies in North America. 100% of the products sold by FlexSteel are manufactured in-house at the company's state-of-the-art facility in Baytown, Texas. FlexSteel services its customers through a network of service centers and yards in various oil and gas basins across the U.S. and in Canada. Historically, the company has generated 5% to 10% of its revenue outside of North America. For the first 9 months of 2022, FlexSteel generated $265 million in revenue and $78 million in adjusted EBITDA for a 29% adjusted EBITDA margin. This has been achieved with net CapEx of approximately $7 million. Like Cactus, FlexSteel is a high-margin variable cost business with modest CapEx needs. I'll now turn it over to TS, FlexSteel's President and CEO, who can provide additional details on the technology.

Thanks, Steve. Good morning, everybody. My name is TS. I'm President and CEO of FlexSteel, and I'm excited to be here this morning. I'll walk you over a few slides, and then turn it over to Scott. Slide 7 provides an overview of the application of FlexSteel's products. Spoolable line pipe is installed for operators in order to bring their wells on production. This can be in the form of, a, production lines that are installed at the edge of the well pad or connect to a production tree; b, as gathering lines that go from the central tank battery to the midstream sales meter; or c, further downstream as takeaway lines for the midstream industry. FlexSteel sells its spoolable pipe technologies, and like Cactus, charges for the associated installation of the equipment as well. Slide 8 highlights the advantages of our spoolable pipe. Over the last 5 to 10 years, the industry has shifted from conventional equipment to more sophisticated spoolable offerings. This industry shift is much like what has occurred in the wellhead industry since Cactus opened its doors, but is in the earlier stages of adoption. Stick-steel pipe was traditionally used to transport hydrocarbons from a well to a central tank battery, the midstream sales meter and beyond. While reliable, this generally requires relatively short lengths of pipe being laboriously installed, acquiring hundreds of welded connections. Spoolable technologies rolled on to reel oils enabled the rapid installation of thousands of feet of pipe, which save operators significant time and money while enhancing safety. FlexSteel's spoolable technology combines the strength and reliability of steel, the flexibility of high-density polyethylene to meet customer demands at various ID sizes, temperature and pressure ratings. Like Cactus' wellheads, the value proposition for FlexSteel is that its products are more efficient for operators than traditional equipment, generating revenue faster, saving the customer time and money, while maintaining reliability and reducing the overall cost of ownership for an E&P operator. Next slide. Slide 9 highlights how FlexSteel's products, much like Cactus', enable E&Ps to meet their ESG-related goals. FlexSteel's spoolable pipe can be installed faster than conventional equipment, leading to less equipment, fewer people on site and faster time to production. In addition, the prefabricated fittings and the spoolable nature of the equipment require limited welding on site, which improves employee safety and minimizes lost time incidents. Finally, FlexSteel's products are ideally suited for CO2 transportation as they enable the capture and management of permeated gases and result in lower emission systems for operators. The company booked its first large CCUS transportation order this year for a major U.S. operator. While this market is still in its infancy, there is potential for growth given attractive industry dynamics. Scott?

Thanks, TS. Slide 10 highlights the differentiated margin profile of the 2 businesses relative to our peers. FlexSteel generates attractive EBITDA margins today of nearly 30%. And like Cactus, FlexSteel was able to generate strong margins due to COVID-related downturn, highlighting the differentiated nature of the business through the industry cycles. Slide 11 highlights the attractive financial profile of both businesses and showcases the increased scale achieved by the transaction. During the first 9 months of 2022, FlexSteel generated $265 million in revenue, $78 million in adjusted EBITDA. This was done at comparable margins and with fewer CapEx dollars compared to Cactus. The transaction adds considerable financial scale for Cactus while maintaining the differentiated margin profile and capital-light nature of the business. Slide 12 shows the complementary operating footprint of the 2 businesses. FlexSteel utilizes its Baytown, Texas manufacturing facility for 100% of its equipment and then, like Cactus, ships its equipment to its network of locations or directly to the customer. As seen on the map, FlexSteel is active in most of the largest U.S. onshore basins. There is likely room to optimize the roofline footprint of the combined businesses over time, although we're not publicly announcing any synergies related to this. TS?

Thanks, Scott. Slide 13 emphasizes some of the growth opportunities for FlexSteel. First is continued growth in our coal production line products. The industry continues to shift towards spoolable pipe technologies, and FlexSteel will be a beneficiary of that. FlexSteel, as an industry leader, will benefit from its higher diameter offerings and more reliable equipment and is well positioned to capitalize on this trend. In addition, we are tremendously excited about introducing the FlexSteel team and its technology to the deep pool of loyal customers at Cactus. Second is the expansion of spoolables further downstream into the midstream space. This is a large market relatively untapped by spoolables due to the limited diameter capabilities witnessed historically. Again, FlexSteel is well positioned to benefit, due it its unique capability of offering, higher diameter products of up to 10 inches. Third is CCUS. Again, CO2 has historically been transported utilizing traditional stick-steel pipe. The same benefits that have allowed spoolable technologies to grow in the production line market are apparent in the CCUS world. FlexSteel is actively engaged in multiple customer opportunities for this potential market. Additionally, FlexSteel has been working on the development of a product that will target shallow water oil and gas development. While not yet commercialized, the benefits of the product should translate well to this additional market. Finally, like Cactus, FlexSteel can attribute most of its success to strong performance in the U.S. market. FlexSteel products are also well suited for application in international markets. We have had a multiyear relationship with Saudi Aramco in the Middle East and have sold our products into over 20 countries since inception. While penetration of international markets is still in its early stages, FlexSteel has the ability to open additional doors for Cactus products abroad. Like Cactus, FlexSteel prides itself on its technological differentiation and constant stream of innovation and improvement. Our company continues to innovate by offering technologies that incorporate larger ID sizes, higher temperature ratings or increased product flexibility. We're excited to share further product developments in the future. In closing, I'm incredibly proud of the business that FlexSteel has become and our ability to grow over the last several years. We see so many similarities between Cactus and ourselves, and the complementary nature of these 2 businesses should enable continued success. I'd like to reiterate our excitement about becoming part of the Cactus family and the incredible opportunities for FlexSteel product and people that will come as a result of this combination. Back to you, Scott.

Thanks, TS. I'd like to close by reiterating how thrilled we are to combine these 2 industry leaders. FlexSteel is a logical fit for Cactus given the similarities between the 2 companies, both design, manufacture and install differentiated equipment that increases operator efficiency while providing improved reliability. Both have achieved above-market growth via market share gains in recent years. Both businesses generate industry-leading margins while operating under a capital-light business model, and both have significant growth potential on a go-forward basis. This combination is a great fit given the complementary nature of these 2 businesses. We're excited about the potential to generate significant value for our shareholders and from the combination going forward. And with that, I'll turn it back over to the operator to take any questions. Operator?

[Operator Instructions] And our first question comes from the line of Chase Mulvehill with Bank of America.

Scott, I guess first...

Happy new year.

Yes, happy new year to you as well. So first question, just kind of wanted -- Slide 7, I thought was a pretty interesting slide when you talked about the total addressable market. Could you maybe walk through and take a minute just kind of walking through FlexSteel's position in each of those addressable markets and maybe kind of how you plan to further penetrate each of these end markets.

Well, Chase, I'm going to let TS probably expand on that. But I do want to tell you, we're not going to give you market share numbers. So I think we can provide at least a comparison of how well FlexSteel has penetrated these different markets and our plans going forward. So, TS?

Yes. This slide here, Slide 7 in the deck, talks about, broadly speaking, where FlexSteel plays in the oil and gas space. There are 3 columns here. First one is the production line or pipe-under-pad segment, then to the right of it is a gathering line segment. And the final one on the right is the takeaway lines. As you can see from the graphics, they start with the wellhead on the left and end with the refining on the right. The place where FlexSteel currently plays is really on the left side of the segment primarily. That's the place where FlexSteel entered the market, really in 2014 to '15. And we've been really making a lot of headway in gaining a lot of customers in the left side of the space. On the right side of the middle column as well as the right most, the takeaway lines are relatively newer spaces with lots of white space on the board for FlexSteel, and we'll be making our focus to penetrate those segments going forward.

Okay. Perfect. Maybe as a follow-up, you mentioned international. And for Cactus, Scott, obviously, the next leg of the story has kind of been about international penetration. So maybe talk about FlexSteel's international presence today. You said it was a little bit ahead of kind of where Cactus was, and talk about maybe the regions where FlexSteel has had some penetration and the opportunity on a combined basis to maybe pull through some of Cactus' legacy business with like still on the international side.

Yes, Chase. Let me just say that, similar to Cactus, FlexSteel's penetration internationally has been opportunistic, low CapEx requirements. But unlike Cactus, where our penetration has been limited to a handful of countries. As you know from the deck, FlexSteel has been a lot more successful, particularly in areas like Latin America. They have a much deeper and longer relationship with Saudi Aramco. But frankly, they've been successful in virtually every continent in the world. They're very well known and very well regarded. In terms of pull-through, I'm not going to kid you. Just because the company buys a Cactus wellhead doesn't mean they're going to buy a spoolable FlexSteel or vice versa. But to the extent that we're able to leverage both international teams and utilize, I think, that infrastructure, I think you'll see some benefits. And also, it's fair to say that one company, particularly FlexSteel, can provide some introductions for Cactus that may be a bit more difficult for us without the large footprint. I view this as just -- I can't quantify it for you, Chase, but this has got to be a positive for both companies. It's just more products offered to the same customer base.

Our next question comes from Stephen Gengaro with Stifel.

Good morning and happy New Year, gentlemen.

Good morning. Happy new year to you, Steve.

Two things for me. What I'd start with is, I mean, the differentiation you talked about and you walked through in the presentation is obviously a key aspect of this and kind of maintaining what Cactus is. What -- how do you feel about how defendable the FlexSteel product line is? And any color on kind of what else is out there nipping at their heels, if there's anything, would be helpful.

Yes, you can feel free to pipe in. I can just tell you from the Cactus perspective because this was a key consideration. This company is at least as differentiated as Cactus. And that is both in terms of the way the product, nobody else has a steel reinforced spoolable pipe. No one. No one makes it as efficiently or as FlexSteel produces it. And no one has the same sort of deployment tools, all protected by IP as FlexSteel. So when I look at the package, the technology, the manufacturing skill and the deployment model, there's not a competitor, in our view, that comes close to FlexSteel. So again, I have to tell you, it's at least as defensible as the Cactus model. In terms of -- what's your -- in terms -- what was the next question?

No, just if there's anybody out there nipping at the heels of that, but it sounds like the margin is wide.

Well, Stephen, there are other spoolable manufacturers that -- NOV makes a spoolable. Sharp core makes a spoolable. Baker makes a spoolable, but none of them make the steel reinforced onshore product that FlexSteel makes.

And then the follow-up was -- and my math might be a little bit off, but you're basically buying 50% of your EBITDA for 16% of your market cap. So I'm just curious about the valuation discussion, and it seems to be a pretty accretive deal from a Cactus perspective. And whether there was any thought to the buyer taking equity at a participate in the upside.

Do you mean to the seller taking equity?

Excuse me, the seller. Yes, sorry.

We never offered them any equity.

Next question please come from Connor Lynagh with Morgan Stanley.

Happy New Year.

Happy new year to you.

Just wondering if you could give a little bit more color on financing and just sort of how you're thinking about what you're looking for in the market? I know you said equity is possibility, you said debt and then obviously, got a lot of cash and cash generation to work with. So just maybe help us think through the puts and takes and what you'd be looking for out there to solidify the mix of the financing.

Yes, I can take that. It's Steve. I mean as we mentioned, obviously, we -- our patience has helped us build up our cash position. So first and foremost, it's a good piece of that cash. We have committed financing. But obviously, we're looking for more permanent financing. We've had, I would say, advanced discussions with lenders looking at a term loan as well as an expanded ABL. Our ABL has always been sort of undersized versus our capacity just because we haven't needed it. Longer term, we'll, at closing, regardless of whether we were to look to equity, we expect to be 1x net debt-to-EBITDA on a '22 basis. So we intend to continue to be conservative in our leverage profile. Ultimately, we want to be low net debt, maybe net cash position again to be able to take advantage of opportunities in the future. And that's about all we're willing to say at this point in time, just continue to be flexible.

Yes, we have lots of flexibility.

Yes, yes, that's clear.

I wish we could be...

Go ahead. Sorry.