| Summary of Significant Accounting Policies and Other Items | 2. Summary of Significant Accounting Policies and Other Items
Basis of Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These consolidated financial statements include the accounts of Cactus Inc. and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated upon consolidation.
Cactus Inc. is the sole managing member of Cactus LLC and consolidates the financial results of Cactus LLC and its subsidiaries and reports a non-controlling interest related to the portion of CW Units not owned by Cactus Inc., which reduces net income attributable to holders of Cactus Inc.’s Class A common stock.
Use of Estimates
In preparing our consolidated financial statements in conformity with GAAP, we make numerous estimates and assumptions that affect the accounting for and recognition and disclosure of assets, liabilities, equity, revenues and expenses. We must make these estimates and assumptions because certain information that we use is dependent on future events, cannot be calculated with a high degree of precision from available data or is not otherwise capable of being readily calculated based on accepted methodologies. In some cases, these estimates are particularly difficult to determine, and we must exercise significant judgment. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our consolidated financial statements.
Segment Information
We operate in a single operating segment, which reflects how we manage our business and the fact that all of our products and services are dependent upon the oil and natural gas industry. Substantially all of our products and services are sold in the U.S., which consists largely of oil and natural gas exploration and production companies. We operate in the United States, Australia and China. Our operations in Australia and China represented less than 10% of our consolidated operations for all periods presented in these consolidated financial statements.
Concentrations of Credit Risk
Our assets that are potentially subject to concentrations of credit risk are cash and cash equivalents and accounts receivable. We manage the credit risk associated with these financial instruments by transacting only with what management believes are financially secure counterparties, requiring credit approvals and credit limits and monitoring counterparties’ financial condition. Our receivables are spread over a number of customers, a majority of which are operators and suppliers to the oil and natural gas industry. Our maximum exposure to credit loss in the event of non‑performance by the customer is limited to the receivable balance. We perform ongoing credit evaluations and monitoring as to the financial condition of our customers with respect to trade receivables. Generally, no collateral is required as a condition of sale. We also control our exposure associated with trade receivables by discontinuing sales and service to non-paying customers. We had one customer representing 10% of total revenues for the year ended December 31, 2019 and one customer representing 11% of total revenues in each of the years ended December 31, 2018 and 2017.
Significant Vendors
We purchase a significant portion of supplies, equipment and machined components from a single vendor. During 2019, 2018 and 2017, purchases from this vendor totaled $36.5 million, $46.7 million and $33.4 million, respectively. These figures represent approximately 16%, 21% and 22% for the respective periods, of total third party vendor purchases of raw materials, finished products, equipment, machining and other services. Amounts due to the vendor included in accounts payable, in the consolidated balance sheets, as of December 31, 2019 and 2018 totaled $4.3 million and $5.0 million, respectively.
Tax Receivable Agreement (TRA)
In connection with our IPO, we entered into the TRA with certain direct and indirect owners of Cactus LLC (the “TRA Holders”). The TRA generally provides for payment by Cactus Inc. to the TRA Holders of 85% of the net cash savings, if any, in U.S. federal, state and local income tax or franchise tax that Cactus Inc. actually realizes or is deemed to realize in certain circumstances. Cactus Inc. will retain the benefit of the remaining 15% of these net cash savings.
We account for amounts payable under the TRA in accordance with Accounting Standards Codification (“ASC”) Topic 450, Contingencies. As such, subsequent changes to the measurement of the TRA liability are recognized in the statements of income as a component of other income (expense), net. For the year ended December 31, 2019, we recognized a $5.3 million gain on the change in the TRA liability. See Note 9 for further details on the TRA liability.
Revenue Recognition
The majority of our revenues are derived from short-term contracts for fixed consideration. Product sales generally do not include right of return or other significant post-delivery obligations. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Revenues are recognized when we satisfy a performance obligation by transferring control of the promised goods or providing services to our customers at a point in time, in an amount specified in the contract with our customer and that reflects the consideration we expect to be entitled to in exchange for those goods or services. The majority of our contracts with customers contain a single performance obligation to provide agreed upon products or services. For contracts with multiple performance obligations, we allocate revenue to each performance obligation based on its relative standalone selling price. We do not assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer. We do not incur any material costs of obtaining contracts.
We do not adjust the amount of consideration per the contract for the effects of a significant financing component when we expect, at contract inception, that the period between the transfer of a promised good or service to a customer and when the customer pays for that good or service will be one year or less, which is in substantially all cases. Payment terms and conditions vary, although terms generally include a requirement of payment within 30 to 45 days. Revenues are recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. We treat shipping and handling associated with outbound freight as a fulfillment cost instead of as a separate performance obligation. We recognize the cost for the associated shipping and handling when incurred as an expense in cost of sales.
Our revenues are derived from three sources: products, rentals, and field service and other:
Product revenue. Product revenues are primarily derived from the sale of wellhead systems and production trees. Revenue is recognized when the products have shipped and the customer obtains control of the products.
Rental revenue. Rental revenues are primarily derived from the rental of equipment, tools and products used for well control during the drilling and completion phases to customers. Our rental agreements are directly with our customers and provide for a rate based on the period of time the equipment is used or made available to the customer. In addition, customers are charged for repair costs either through an agreed upon rate or as incurred. Revenue is recognized ratably over the rental period, which tends to be short-term in nature with most equipment on site for less than 90 days.
Field service and other revenue. We provide field services to our customers based on contractually agreed rates. Other revenues are derived from providing repair and reconditioning services to customers who have installed wellheads and production trees on their wellsite. Revenues are recognized as the services are performed or rendered.
Foreign Currency Translation
The financial position and results of operations of our foreign subsidiaries are measured using the local currency as the functional currency. Revenues and expenses of the subsidiaries have been translated into U.S. dollars at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance sheet dates. The resulting translation gain and loss adjustments have been recorded directly as a separate component of other comprehensive income in the consolidated statements of comprehensive income and stockholders’ equity.
Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in our consolidated statements of income as incurred.
Stock‑based Compensation
We measure the cost of equity‑based awards based on the grant date fair value and we allocate the compensation expense over the corresponding service period, which is usually the vesting period, using the straight‑line method. The grant date fair value is determined by the average price of the trading high and trading low of our Class A common stock on the effective date of the grant.
Income Taxes
Deferred taxes are recorded using the asset and liability method, whereby tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We regularly evaluate the valuation allowances established for deferred tax assets for which future realization is uncertain. In assessing the realizability of deferred tax assets, we consider both positive and negative evidence, including scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax planning strategies and results of recent operations. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, a valuation allowance is recorded.
Cactus Inc. is a corporation and is subject to U.S. federal as well as state income tax related to its ownership percentage in Cactus LLC. Cactus LLC is a limited liability company treated as a partnership for U.S. federal income tax purposes and files a U.S. Return of Partnership Income, which includes both our U.S. and foreign operations. Consequently, the members of Cactus LLC are taxed individually on their share of earnings for U.S. federal and state income tax purposes. However, Cactus LLC is subject to the Texas Margins Tax. Additionally, our operations in both Australia and China are subject to local country income taxes. See Note 5 “Income Taxes” for additional information regarding income taxes.
Cash and Cash Equivalents
Cash in excess of current operating requirements is invested in short-term interest-bearing investments with maturities of three months or less at the date of purchase and is stated at cost, which approximates fair value. Throughout the year we maintained cash balances that were not covered by federal deposit insurance. We have not experienced any losses in such accounts.
Accounts Receivable
We extend credit to customers in the normal course of business. We do not accrue interest on delinquent accounts receivable. Accounts receivable includes amounts billed and currently due from customers and unbilled amounts for products delivered and services performed for which billings had not yet been submitted to the customers. Total unbilled revenue included in accounts receivable as of December 31, 2019 and 2018 was $23.8 million and $26.8 million, respectively. We maintain an allowance for doubtful accounts to provide for the estimated amount of receivables that will not be collected. In our determination of the allowance for doubtful accounts, we assess those amounts where there are concerns over collection and record an allowance for that amount. Estimating this amount requires us to analyze the financial condition of our customers, our historical experience and any specific concerns. Earnings are charged with a provision for doubtful accounts based on this review of the collectability of accounts. Accounts deemed uncollectible are applied against the allowance for doubtful accounts. Accounts receivable is net of allowance for doubtful accounts of $0.8 million and $0.6 million as of December 31, 2019 and 2018, respectively. The following is a rollforward of our allowance for doubtful accounts:
Balance at
Balance at
Beginning of
Expense
End of
Period
(recovery)
Write off
Other
Period
Year Ended December 31, 2019
$
576
$
355
$
(94)
$
—
$
837
Year Ended December 31, 2018
740
—
(164)
—
576
Year Ended December 31, 2017
851
(100)
(3)
(8)
740
Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is determined using standard cost (which approximates average cost) and weighted average methods. Costs include an application of related direct labor and overhead cost. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Reserves are made for excess and obsolete items based on a range of factors, including age, usage and technological or market changes that may impact demand for those products. The inventory obsolescence reserve was $9.8 million and $7.3 million as of December 31, 2019 and 2018, respectively. The following is a rollforward of our inventory obsolescence reserve:
Balance at
Balance at
Beginning of
End of
Period
Expense
Write off
Other
Period
Year Ended December 31, 2019
$
7,310
$
2,552
$
(90)
$
—
$
9,772
Year Ended December 31, 2018
5,885
1,451
—
(26)
7,310
Year Ended December 31, 2017
4,770
1,259
(103)
(41)
5,885
Property and Equipment
Property and equipment are stated at cost. We manufacture or construct most of our own rental assets and during the manufacture of these assets, they are reflected as construction in progress until complete. We depreciate the cost of property and equipment using the straight‑line method over the estimated useful lives and depreciate our rental assets to their salvage value. Leasehold improvements are amortized over the shorter of the remaining lease term or economic life of the related assets. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss are reflected in income for the period. The cost of maintenance and repairs is charged to income as incurred; significant renewals and improvements are capitalized. Estimated useful lives are as follows:
Land
N/A
Buildings
10
-
30
years
Machinery and equipment
2
-
12
years
Vehicles under finance lease
3
years
Rental equipment
2
-
8
years
Furniture and fixtures
5
years
Computers and software
4
years
Property and equipment as of December 31, 2019 and 2018 consists of the following:
December 31,
2019
2018
Land
$
3,203
$
3,614
Buildings and improvements
21,655
20,803
Machinery and equipment
55,494
47,606
Vehicles under finance lease
24,275
25,165
Rental equipment
161,156
124,002
Furniture and fixtures
1,684
1,623
Computers and software
3,317
3,094
Gross property and equipment
270,784
225,907
Less: Accumulated depreciation
(123,397)
(96,412)
Net property and equipment
147,387
129,495
Construction in progress
14,361
12,559
Total property and equipment, net
$
161,748
$
142,054
Depreciation and amortization was $38.9 million, $30.2 million and $23.3 million for 2019, 2018 and 2017, respectively. Depreciation and amortization expense is included in the consolidated statements of income as follows:
Year Ended December 31,
2019
2018
2017
Cost of product revenue
$
3,304
$
3,262
$
3,169
Cost of rental revenue
24,881
17,997
14,912
Cost of field service and other revenue
9,986
8,456
4,786
Selling, general and administrative expenses
683
438
404
Total depreciation and amortization
$
38,854
$
30,153
$
23,271
Impairment of Long‑Lived Assets
We review the recoverability of long‑lived assets, such as property and equipment, when events or changes in circumstances occur that indicate the carrying value of the asset or asset group may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of the asset or asset group from the expected future pre‑tax cash flows (undiscounted) of the related operations. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. We concluded there were no indicators evident or other circumstances present that these assets were not recoverable and accordingly, no impairment charges of long‑lived assets were recognized for 2019, 2018 and 2017.
Goodwill
Goodwill represents the excess of acquisition consideration paid over the fair value of net assets acquired. All of the goodwill recorded on our consolidated balance sheets resulted from the acquisition of a manufacturing facility in Bossier City, Louisiana in 2011. The facility supports our full range of products, rentals and services. Goodwill is not amortized, but is reviewed for impairment on an annual basis (or more frequently if impairment indicators exist). We have established December 31 as the date of our annual test for impairment of goodwill. We perform a qualitative assessment of the fair value of our reporting unit before calculating the fair value of the reporting unit in step one of the two‑step goodwill impairment model. If, through the qualitative assessment, we determine that it is more likely than not that the reporting unit’s fair value is greater than its carrying value, the remaining impairment steps would be unnecessary.
If there are indicators that goodwill has been impaired and thus the two‑step goodwill impairment model is necessary, step one is to determine the fair value of the reporting unit and compare it to the reporting unit’s carrying value. Fair value is determined based on the present value of estimated cash flows using available information regarding expected cash flows of each reporting unit, discount rates and the expected long‑term cash flow growth rates. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired and no further testing is performed. The second step is performed if the carrying value exceeds the fair value. The implied fair value of the reporting unit’s goodwill must be determined and compared to the carrying value of the goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, an impairment loss equal to the difference will be recorded. We concluded that there was no impairment of goodwill in 2019, 2018 or 2017 based on our annual impairment analysis.
Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities as of December 31, 2019 and 2018 are as follows:
December 31,
2019
2018
Payroll, incentive compensation, payroll taxes and benefits
$
10,708
$
7,842
Accrued international freight and tariffs
3,794
1,418
Income based tax payable
2,481
2,061
Accrued professional fees and other
1,790
1,512
Deferred revenue
1,371
1,110
Taxes other than income
767
1,414
Accrued workers' compensation insurance
600
—
Product warranties
556
293
Total
$
22,067
$
15,650
Self-Insurance Accrued Expenses
We maintain a partially self-insured health benefit plan which provides medical and prescription drug benefits to certain of our employees electing coverage under the plan. Our exposure is limited by individual and aggregate stop loss limits via third-party insurance carriers. Our self-insurance expense is accrued based upon the aggregate of the expected liability for reported claims and the estimated liability for claims incurred but not reported, based on historical claims experience provided by our third-party insurance advisors, adjusted as necessary based upon management’s reasoned judgment. Actual employee medical claims expense may differ from estimated loss provisions based on historical experience. The liabilities for these claims are included as a component of payroll, incentive compensation, payroll taxes and benefits in the table above and were $1.6 million and $0.5 million as of December 31, 2019 and 2018, respectively.
Product Warranties
We generally warrant our manufactured products 12 months from the date placed in service. The estimated liability for product warranties is based on historical and current claims experience.
Fair Value Measurements
The carrying value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximates fair value based on the short-term nature of these accounts. We had no long-term debt outstanding as of December 31, 2019 or 2018.
Employee Benefit Plan
Our employees within the United States are eligible to participate in a 401(k) plan sponsored by us. These employees are eligible to participate on the first day of the month following 30 days of employment and if they are at least eighteen years of age. All eligible employees may contribute a percentage of their compensation subject to a maximum imposed by the Internal Revenue Code. During 2019, 2018 and 2017, we matched 100% of the first 3% of gross pay contributed by each employee and 50% of the next 4% of gross pay contributed by each employee. We may also make additional non‑elective employer contributions at our discretion under the plan. Similar benefit plans exist for employees of our foreign subsidiaries. During 2019, 2018 and 2017, employer matching contributions totaled $3.1 million, $3.7 million and $2.2 million, respectively. For the year ended December 31, 2019, we made a non-elective contribution of $0.1 million under the Plan. No such contributions were made in 2018 or 2017.
Recent Accounting Pronouncements
Standards Adopted
Effective January 1, 2019, we adopted Financial Accounting Standards Board (“FASB”) ASU No. 2016-02, Leases (Topic 842) by utilizing the modified retrospective approach. There was no cumulative effect adjustment required to the opening balance of retained earnings as we utilized the package of practical expedients permitted under the transition guidance within the standard. The expedient package allowed us to not reassess whether existing contracts contained a lease, to not reassess the lease classification of existing leases, and to not consider the initial direct cost for existing leases. In addition to the package of practical expedients, we also utilized expedients and elections allowing for the exclusion of leases with terms of less than twelve months across all asset classes, use of the portfolio approach and the election to not separate non-lease components from lease components. Adoption of this standard resulted in the recognition of operating lease right-of-use (“ROU”) assets of $25.3 million, reversal of previously recorded deferred rent of $0.5 million and corresponding operating short-term and long-term lease liabilities of $6.2 million and $19.6 million, respectively, on the consolidated balance sheet. Our accounting for finance leases remained substantially unchanged under the new guidance. Additionally, as a lessor, recognition of lease revenue associated with short-term equipment rentals remained consistent with previous guidance. Adoption of the standard did not have a material impact on our consolidated statements of income and consolidated statements of comprehensive income or consolidated statements of cash flows. See Note 8 for further details regarding leases.
Standards Not Yet Adopted
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350), which simplifies the accounting for goodwill impairment by eliminating Step 2 of the current goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the new standard, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The new guidance should be adopted for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We do not expect the adoption of this pronouncement will have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 changes the measurement of credit losses on financial assets measured at amortized cost, including but not limited to trade receivables. The new guidance replaces the current methodology for recognizing credit losses when it is probable that a loss has been incurred with an expected loss model that requires consideration of a broader range of information to estimate expected credit losses over the lifetime of an asset. Application of this new guidance may result in an earlier recognition of credit losses as the allowance for credit losses is measured and recorded upon the initial recognition of the financial asset. The allowance for credit losses under the new guidance represents the portion of the asset’s amortized cost basis that we do not expect to collect over the asset’s contractual life, considering past events, current conditions and reasonable and supportable forecasts of future economic conditions. We finalized our methodology for estimating expected credit losses, including the assumptions used in order to pool receivables with similar risk characteristics and adopted the new standard effective January 1, 2020. Adoption of the standard did not impact our consolidated financial statements. |
