# Cactus, Inc. (WHD) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Cactus, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1699136/000169913623000017/whd-20221231.htm
Accession: 0001699136-23-000017
Filing date: 2023-03-01
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/WHD/
All MD&A years: /company/WHD/mda/
Previous year: /company/WHD/mda/fy2021/ (FY 2021)
Next year: /company/WHD/mda/fy2023/ (FY 2023)

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and related notes. The following discussion contains “forward-looking statements” that reflect our plans, estimates, beliefs and expected performance. Our actual results may differ materially from those anticipated as discussed in these forward-looking statements as a result of a variety of risks and uncertainties, including those described in “Cautionary Statement Regarding Forward-Looking Statements” and “Item 1A. Risk Factors” included elsewhere in this Annual Report, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur. We assume no obligation to update any of these forward-looking statements except as otherwise required by law.

This section includes comparisons of certain 2022 financial information to the same information for 2021. Year-to-year comparisons of the 2021 financial information to the same information for 2020 are contained in “Item 7. Management’s Discussion and Analysis of Financial Condition and Result of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission on February 28, 2022.

Unless specifically noted herein, the historical financial information included herein does not reflect the Merger or the CC Reorganization as they were completed subsequent to December 31, 2022. The post-acquisition results of operations of FlexSteel will first be included in our consolidated financial information for the period ending March 31, 2023.

Market Factors

See “Item 1. Business” for information on our products and business. Demand for our products and services depends primarily upon the general level of activity in the oil and gas industry, including the number of active drilling rigs, the number of wells drilled, the depth and working pressure of these wells, the number of well completions, the level of well remediation activity, the volume of production and the corresponding capital spending by oil and natural gas companies. Oil and gas activity is in turn heavily influenced by, among other factors, investor sentiment, availability of capital and oil and gas prices locally and worldwide, which have historically been volatile.

The key market factors impacting our product sales are the number of wells drilled and placed on production, as each well requires an individual wellhead assembly and, at some time after completion, the installation of an associated production tree. We measure our product sales activity levels against our competitors by the number of rigs that we are supporting on a monthly basis as it is correlated to wells drilled. Each active drilling rig produces different levels of revenue based on the customer’s drilling program and efficiencies, which includes factors such as the number of wells drilled per pad, the timing of rig moves, the time taken to drill each well, the number and size of casing strings, the working pressure, material selection and the complexity of the wellhead system chosen by the customer and the rate at which production trees are eventually deployed. All of these factors may be influenced by the oil and gas region in which our customers are operating. While these factors may lead to differing revenues per rig, we have generally been able to forecast our product needs and anticipated revenue levels based on historic trends in a given region and with a specific customer. 

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Our rental revenues are primarily dependent on the number of wells completed (i.e., hydraulically fractured), the number of wells on a well pad, the number of fracture stages per well and the number of fracture stages completed per day. Well completion activity generally follows the level of drilling activity over time but can be delayed or accelerated due to such factors as availability of drilling rigs, pressure pumping fleets and OCTG, takeaway capacity, storage capacity, oil and gas prices, overall service cost inflation and budget considerations.

Field service and other revenues are closely correlated to revenues from product sales and rentals, as items sold or rented almost always have an associated service component. Therefore, the market factors and trends of product sales and rental revenues similarly impact the associated levels of field service and other revenues generated.

Our business experiences some seasonality during the fourth quarter due to holidays and customers managing their budgets as the year closes out. This can lead to lower activity in our three revenue categories as well as lower margins, particularly in field services due to lower labor utilization.

Recent Developments and Trends

Acquisition of FlexSteel

On February 28, 2023, we completed the acquisition of FlexSteel, which designs, manufactures, sells and installs highly engineered spoolable pipe technologies. FlexSteel’s steel reinforced pipeline solutions are sold principally for onshore oil and gas wells and are utilized during the production phases of its customers’ wells. FlexSteel operates through service centers and pipe yards located throughout the United States and Canada, while also providing equipment and services in select international markets. FlexSteel’s manufacturing facility is located in Baytown, Texas.

Commodity Prices and Geopolitical Conflict

Oil prices were volatile throughout 2022 primarily due to global import restrictions enacted on Russian oil, including a price cap set by the International Group of Seven (G7) members in response to the conflict in Ukraine, releases of oil from the Strategic Petroleum Reserve and subsequent plans to replenish it, enacted and planned production cuts by OPEC+, fears of a global recession and easing COVID-19 restrictions in China. Oil prices reached their peak in March 2022 with West Texas Intermediate (“WTI”) prices increasing to over $123 per barrel. Prices dropped below $80 per barrel in late November 2022 and remained under $80 per barrel for the majority of December 2022 before ending the year at slightly above $80 per barrel. Oil prices dropped below $80 several days in early 2023, but remained above $73 per barrel and averaged approximately $78 per barrel through February 24, 2023. In mid-February 2023, the International Energy Agency raised its forecast for global crude oil demand for 2023, raising the projection for 2023 to two million barrels per day above 2022.

Prices for natural gas were elevated, but also volatile, throughout 2022 in the United States due to several factors including higher demand for heating due to a colder winter early in the year, a nationwide heat wave during the summer and record-high liquified natural gas (“LNG”) exports due to a rise in global LNG demand. Henry Hub natural gas spot prices increased from an average of $3.76 per one million British Thermal Units (“MMBtu”) in December 2021 to an average high of $8.14 per MMBtu in May 2022 to an average of $5.53 per MMBtu in December 2022. Natural gas prices began to moderate toward the end of 2022 primarily due to increased levels of domestic production, the shutdown of a large LNG export facility and relatively mild winter weather in Europe, which have driven inventories in underground storage to levels in-line with the five-year average from levels below the five-year average. These impacts continued into early 2023, with natural gas prices declining to an average of $3.27 per MMBtu for January 2023 down even further to $2.07 per MMBtu on February 24, 2023. Although weakening natural gas prices could negatively impact the oil and gas industry, our customers are primarily oil-focused, thus slightly moderating the adverse impacts to demand for our products and services.

The ongoing conflict in Ukraine has had repercussions globally and in the United States by continuing to cause uncertainty, not only in the oil and natural gas markets, but also in the financial markets and global supply chain. Such uncertainty could continue to result in stock price volatility and supply chain disruptions as well as higher oil and natural gas prices which could cause higher inflation worldwide, impact consumer spending and negatively impact demand for our goods and services. Moreover, additional interest rate increases by the U.S. Federal Reserve to combat inflation could further increase the probability of a recession.

Notwithstanding the significant commodity price volatility in 2022, U.S. onshore drilling activity increased meaningfully during the year. At the end of 2022, the U.S. onshore rig count as reported by Baker Hughes was 762 rigs as compared to 570 at the end of 2021. The weekly average U.S. onshore rig count for the three months ended December 31, 2022 was 757 rigs, a 39% increase as compared to 543 rigs for the comparable period in 2021. U.S. onshore drilling activity has been

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relatively stable during the first part of 2023. As of February 24, 2023, the U.S. onshore rig count was 734, reflecting weakening natural gas prices in early 2023.

Inflation and Increased Costs

Supply chain disruptions, geopolitical issues, increased money supply and significantly increased demand for goods and services worldwide resulted in substantial increases in the cost of fuel, raw materials, component parts, ocean freight charges and labor in 2022. Inflation, measured by the U.S. Consumer Price Index (“CPI”) as reported by the U.S. Bureau of Labor Statistics, increased substantially during 2022, rising to an average of 8.0% on a year-over-year basis in 2022 from an average of 4.7% on a year-over-year basis in 2021. While year-over-year inflation rates remained elevated relative to historical levels, the rate of increases began to moderate late in 2022 and were reported at 6.5% in December 2022, the lowest that figure has been in more than a year. Salaries and wages remain elevated as a result of competitive labor markets, especially in certain key oil and gas producing areas, but also due to broader inflation trends and labor shortages. We expect we will continue to experience inflationary pressures on portions of our cost structure; however, tightness in overseas freight and transit times from China have eased. Additionally, raw material and component costs are moderating due in part to improvements in the global supply and demand dynamics for steel. Nonetheless, we cannot be confident that transit times or input prices will return or stabilize at the lower levels experienced in prior years.

Consolidated Results of Operations

The following discussions relating to significant line items from our condensed consolidated statements of income are based on available information and represent our analysis of significant changes or events that impact the comparability of reported amounts. Where appropriate, we have identified specific events and changes that affect comparability or trends and, where reasonably practicable, have quantified the impact of such items.

Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

The following table presents summary consolidated operating results for the periods indicated: 

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

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nm = not meaningful 

Revenues

Product revenue for 2022 was $452.6 million compared to $280.9 million for 2021. The increase of $171.7 million, representing a 61% increase from 2021, was primarily due to higher sales of wellhead and production related equipment resulting from increased activity by our customers as well as the impact of cost recovery efforts.

Rental revenue of $100.5 million in 2022 increased $38.8 million, or 63%, from $61.6 million in 2021. The increase was primarily attributable to higher drilling and completion activity by our customers and associated repairs.

Field service and other revenue for 2022 was $135.3 million, an increase of $39.2 million, or 41%, from $96.1 million for 2021. The increase was attributable to increased customer activity, resulting in higher billable hours and ancillary services as well as cost recovery measures.

Costs and expenses

Cost of product revenue of $277.9 million in 2022 increased $88.8 million, or 47%, from $189.1 million in 2021. The increase was largely attributable to an increase in product sales and increased costs associated with materials, freight and overhead.

Cost of rental revenue for 2022 was $62.0 million, an increase of $7.7 million, or 14%, from $54.4 million for 2021. The increase was primarily due to higher repair and equipment reactivation costs, scrap expense, freight costs and increased personnel, ancillary and branch expenses, partially offset by lower depreciation expense on our rental fleet.

Cost of field service and other revenue for 2022 was $106.0 million, an increase of $32.3 million, or 44%, from $73.7 million for 2021. The increase was mainly related to higher personnel costs resulting from an increase in the number of field and branch personnel and higher wages as well as higher fuel and third-party service costs associated with increased field service activity levels.

Selling, general and administrative expense (“SG&A”) for 2022 was $67.7 million, an increase of $21.7 million, or 47%, from $46.0 million for 2021. The increase was largely attributable to increased personnel costs primarily related to higher salaries and wages and their associated payroll taxes, increased benefits including health insurance and retirement funding, higher stock-based compensation and annual incentive bonus expense. Additionally, professional fees increased from 2021 primarily due to approximately $8.4 million of transaction costs associated with the Merger. Additional increases in SG&A from 2021 were attributable to higher information technology expenses and increased travel costs.

Interest income (expense), net. Interest income, net was $3.7 million in 2022 compared to interest expense, net of $0.8 million in 2021. The increase in interest income, net of $4.5 million was primarily due to higher interest income earned on cash invested resulting from increased interest rates in 2022.

Other income (expense), net. Other expense, net of $1.9 million in 2022 represented a non-cash adjustment for the revaluation of the liability related to the tax receivable agreement. Other income, net of $0.5 million in 2021 related to a $0.9 million non-cash gain associated with the revaluation of the liability related to the TRA and $0.4 million for professional fees and other expenses associated with the 2021 Secondary Offering.

Income tax expense. Income tax expense for 2022 was $31.4 million (17.8% effective tax rate) compared to $7.7 million (10.2% effective tax rate) for 2021. Income tax expense for 2022 primarily included approximately $36.4 million of expense associated with current income offset by a $1.7 million benefit associated with permanent differences related to equity compensation, a $1.7 million benefit resulting from a change in our forecasted state rate and a $1.4 million tax benefit associated with the partial valuation allowance release in conjunction with CW Unit redemptions during the year. Partial valuation releases occur in conjunction with redemptions of CW Units as a portion of Cactus Inc.’s deferred tax assets from its investment in Cactus LLC becomes realizable. Income tax expense for 2021 was primarily related to approximately $16.3 million expense associated with our 2021 operations and $1.3 million expense resulting from a change in our forecasted state tax rate. This tax expense was partially offset by a $1.1 million benefit associated with permanent differences related to equity compensation and a $9.0 million tax benefit associated with the partial valuation allowance release in conjunction with 2021 redemptions of CW Units.

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Our effective tax rate is typically lower than the federal statutory rate of 21% due to the fact that Cactus Inc. is only subject to federal and state income tax on its share of income from Cactus LLC. Income allocated to the non-controlling interest is not subject to U.S. federal or state tax.

Liquidity and Capital Resources

At December 31, 2022, we had $344.5 million of cash and cash equivalents. Our primary sources of liquidity and capital resources are cash on hand, cash flows generated by operating activities and, if necessary, borrowings under our ABL Credit Facility (as defined in Note 4 in the notes to the Consolidated Financial Statements). Depending upon market conditions and other factors, we may also have the ability to issue additional equity and debt if needed. As of December 31, 2022, we had no borrowings outstanding under our ABL Credit Facility and $79.9 million of available borrowing capacity. We had $0.1 million in letters of credit outstanding at December 31, 2022 which reduced our available borrowing capacity. We were in compliance with the covenants of the ABL Credit Facility as of December 31, 2022.

We expect that our existing cash on hand, cash generated from operations and available borrowings under our ABL Credit Facility will be sufficient for the next 12 months to meet working capital requirements, anticipated capital expenditures, expected TRA liability payments, anticipated tax liabilities and dividends to holders of our Class A common stock as well as pro rata cash distributions to holders of CW Units (or, in the case of dividends declared after the completion of the CC Reorganization, to the holders of CC Units), other than Cactus Inc.

In connection with the signing of the Merger Agreement in December 2022, we obtained fully committed bridge financing that could be used to fund a portion of the upfront purchase price of $621.2 million for the Merger (excluding working capital adjustments). On January 13, 2023, we completed an underwritten offering of 3,224,300 shares of Class A common stock for net proceeds of $165.6 million and used the net proceeds to finance a portion of the Merger in lieu of utilizing the bridge facility. On February 28, 2023, in connection with the Merger, we replaced the remainder of the bridge facility commitment with the Amended ABL Credit Facility, which includes a term loan facility and a revolving facility, with a syndicate of lenders and JPMorgan Chase Bank, N.A., as administrative agent for such lenders and as an issuing bank. For a description of the ABL Credit Facility and the Amended ABL Credit Facility, please see Note 4 and Note 15, respectively, in the Notes to the Consolidated Financial Statements.

Not including the impact of the acquisition of FlexSteel, we currently estimate our net capital expenditures for the year ending December 31, 2023 will range from $35 million to $45 million, mostly related to rental fleet investments including drilling tools but also related to the potential purchase of a currently leased facility, international expansion and development of a newly-leased research and development facility in Houston, Texas. We continuously evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including, among other things, demand for rental assets, available capacity in existing locations, prevailing economic conditions, market conditions in the E&P industry, customers’ forecasts, volatility and company initiatives.

Our ability to satisfy our long-term liquidity requirements, including cash distributions to CC Unit Holders to fund their respective income tax liabilities relating to their share of the income of Cactus Companies and to fund liabilities related to the TRA, depends on our future operating performance, which is affected by, and subject to, prevailing economic conditions, market conditions in the E&P industry, availability and cost of raw materials, and financial, business and other factors, many of which are beyond our control. We will not be able to predict or control many of these factors, such as economic conditions in the markets where we operate and competitive pressures. If necessary, we could choose to further reduce our spending on capital projects and operating expenses to ensure we operate within the cash flow generated from our operations.

Tax Receivable Agreement (TRA)

The TRA generally provides for the 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 and franchise tax that Cactus Inc. actually realizes or is deemed to realize in certain circumstances. Cactus Inc. retains the benefit of the remaining 15% of these net cash savings. To the extent Cactus Companies has available cash, we intend to cause Cactus Companies to make pro rata distributions to its unit holders, including Cactus Inc., in an amount at least sufficient to allow us to pay our taxes and to make payments under the TRA.

Except in cases where we elect to terminate the TRA early, the TRA is terminated early due to certain mergers, asset sales, or other forms of business combinations or changes of control relating to Cactus Companies or if we have available cash but fail to make payments when due under circumstances where we do not have the right to elect to defer the payment. We may generally elect to defer payments due under the TRA if we do not have available cash to satisfy our payment obligations under the TRA. Any such deferred payments under the TRA generally will accrue interest. In certain cases, payments under the TRA

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may be accelerated and/or significantly exceed the actual benefits, if any, we realize in respect of the tax attributes subject to the TRA. In these situations, our obligations under the TRA could have a substantial negative impact on our liquidity.

Assuming no material changes in the relevant tax law, we expect that if the TRA were terminated as of December 31, 2022, the estimated termination payments, based on the assumptions discussed in Note 9 of the Notes to the Consolidated Financial Statements, would be approximately $291.2 million, calculated using a discount rate equal to one-year LIBOR plus 150 basis points, applied against an undiscounted liability of $456.6 million. A 10% increase in the price of our Class A common stock at December 31, 2022 would have increased the discounted liability by $10.8 million to $302.0 million (an undiscounted increase of $18.3 million to $474.9 million), and likewise, a 10% decrease in the price of our Class A common stock at December 31, 2022 would have decreased the discounted liability by $10.8 million to $280.4 million (an undiscounted decrease of $18.3 million to $438.3 million).

Cash Flows

Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

The following table summarizes our cash flows for the periods indicated: 

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","2021"],["","(in thousands)"],["Net cash provided by operating activities","$","117,884","","$","63,759"],["Net cash used in investing activities","(25,536)","","(11,633)"],["Net cash used in financing activities","(47,382)","","(39,388)"]]
[[/GREPCENT_TABLE]]

Net cash provided by operating activities was $117.9 million in 2022 compared to $63.8 million in 2021. Operating cash flows increased primarily due to an increase in income offset by an increase in working capital, largely related to the increase in inventory and increased accounts receivable associated with higher revenues, a $2.0 million increase in TRA payments and a $1.0 million increase in taxes paid, net of refunds.

Net cash used in investing activities was $25.5 million and $11.6 million for 2022 and 2021, respectively. The increase was primarily due to increased investments associated with our rental fleet and additional investment in and expansion of our Bossier City location. 

Net cash used in financing activities was $47.4 million and $39.4 million for 2022 and 2021, respectively. The increase was primarily comprised of a $5.6 million increase in dividend payments, a $1.3 million increase in share repurchases from employees to satisfy tax withholding obligations related to restricted stock units that vested during the period, a $0.9 million increase in payments on finance leases and $0.4 million in deferred financing costs.

Critical Accounting Policies and Estimates

In preparing our financial statements in accordance with generally accepted in the United States of America (“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 generally 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 financial statements. We identify certain accounting policies as critical based on, among other things, their impact on the portrayal of our financial condition and results of operations and the degree of difficulty, subjectivity and complexity in their deployment. Note 2 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies used in the preparation of the accompanying consolidated financial statements. The following is a brief discussion of our most critical accounting policies and related estimates and assumptions.

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Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is determined using standard cost (which approximates average cost). 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. We evaluate the components of inventory on a regular basis for excess and obsolescence. Reserves are made based on a range of factors, including age, usage and technological or market changes that may impact demand for those products. The amount of reserve recorded is subjective and is susceptible to change from period to period.

Long‑Lived Assets

Key estimates related to long‑lived assets include useful lives and recoverability of carrying values. Such estimates could be modified, as impairment could arise as a result of changes in supply and demand fundamentals, technological developments, new competitors with cost advantages and the cyclical nature of the oil and gas industry. We evaluate long‑lived assets for potential impairment indicators whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Long‑lived assets assessed for impairment are grouped at the lowest level for which identifiable cash flows are available, and a provision made where the cash flow is less than the carrying value of the asset. The estimation of future cash flows and fair value is highly subjective and inherently imprecise. Estimates can change materially from period to period based on many factors. Accordingly, if conditions change in the future, we may record impairment losses, which could be material to any particular reporting period.

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 laws and rates expected to apply to taxable income in the year in which the differences are expected to reverse. We assess the likelihood that our deferred tax assets will be recovered through adjustments to future taxable income. To the extent we believe recovery is not likely, we establish a valuation allowance to reduce the asset to a value we believe will be recoverable based on our expectation of future taxable income. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and results of recent operations. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates management is using to manage the underlying business. If the projected future taxable income changes materially, we may be required to reassess the amount of valuation allowance recorded against our deferred tax assets.

Tax Receivable Agreement

The TRA generally provides for the 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 and franchise tax that Cactus Inc. actually realizes or is deemed to realize in certain circumstances as a result of (i) certain increases in tax basis that occur as a result of Cactus Inc.’s acquisition (or deemed acquisition for U.S. federal income tax purposes) of all or a portion of such TRA Holder’s CW Units in connection with our IPO or any subsequent offering (or, following the completion of the CC Reorganization, such TRA Holder’s CC Units), or pursuant to any other exercise of the Redemption Right or the Call Right, (ii) certain increases in tax basis resulting from the repayment of borrowings outstanding under Cactus LLC’s term loan facility in connection with our IPO and (iii) imputed interest deemed to be paid by Cactus Inc. as a result of, and additional tax basis arising from, any payments Cactus Inc. makes under the TRA. We retain the remaining 15% of the cash savings. The TRA liability is calculated by determining the tax basis subject to TRA (“tax basis”) and applying a blended tax rate to the basis differences and calculating the iterative impact. The blended tax rate consists of the U.S. federal income tax rate and an assumed combined state and local income tax rate driven by the apportionment factors applicable to each state.

Redemptions of CW Units resulted in adjustments to the tax basis of the tangible and intangible assets of Cactus LLC. These adjustments were allocated to Cactus Inc. Such adjustments to the tax basis of the tangible and intangible assets of Cactus LLC would not have been available to Cactus Inc. absent its acquisition or deemed acquisition of CW Units. In addition, the repayment of borrowings outstanding under the Cactus LLC term loan facility resulted in adjustments to the tax basis of the tangible and intangible assets of Cactus LLC, a portion of which was allocated to Cactus Inc. These basis adjustments are expected to increase (for tax purposes) Cactus Inc.’s depreciation and amortization deductions and may also decrease Cactus Inc.’s gains (or increase its losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets. Such increased deductions and losses and reduced gains may reduce the amount of tax that Cactus Inc. would otherwise be required to pay in the future. 

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Estimating the amount and timing of the tax benefit is by its nature imprecise and the assumptions used in the estimates can change. The tax benefit is dependent upon future events and assumptions, the amount of the redeeming unit holders’ tax basis in its CC Units (formerly CW Units) at the time of the relevant redemption, the depreciation and amortization periods that apply to the increase in tax basis, the amount and timing of taxable income we generate in the future and the U.S. federal, state and local income tax rate then applicable, and the portion of Cactus Inc.’s payments under the TRA that constitute imputed interest or give rise to depreciable or amortizable tax basis. The most critical estimate included in calculating the TRA liability to record is the combined U.S. federal income tax rate and an assumed combined state and local income tax rate, to determine the future benefit we will realize. A 100 basis point decrease/increase in the blended tax rate used would decrease/increase the TRA liability recorded at December 31, 2022 by approximately $14.2 million. 

Recent Accounting Pronouncements

There were no new accounting standards adopted in 2022 and there are no new accounting pronouncements issued but not yet effective that are expected to have a material impact on our consolidated financial statements.

Inflation

While inflationary cost increases can affect our income from operations’ margin, we believe that inflation generally has not had, and is not expected to have, a material adverse effect on our results of operations. In 2022, the United States experienced the highest inflation in decades primarily due to supply-chain issues, a shortage of labor and a build-up of demand for goods and services. The most noticeable adverse impact to our business was increased costs associated with freight, materials, vehicle-related costs and personnel expenses. While we have seen some of these costs begin to moderate, we are unsure how long an elevated rate will continue. Additionally, we cannot be confident that costs will return to the lower levels experienced in prior years.