Forum Energy Technologies, Inc. (FET) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Forum Energy Technologies, Inc., Earnings Conference Call. My name is Janeda, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Patrick Connelly, Vice President, Strategic Development. Please proceed.

Thank you, Janeda, and good morning and welcome to Forum Energy Technologies' first quarterly earnings conference call for the first quarter of 2012. With us today to present formal remarks is Cris Gaut Forum's Chairman, President and Chief Executive Officer; as well as Jim Harris, Senior Vice President and Chief Financial Officer. Also with us today are Forum's 2 division presidents, Charlie Jones, President of Drilling & Subsea division; and Wendell Brooks, President of our Production & Infrastructure division. We issued our earnings release this morning and it is available on our website at www.f-e-t.com. The statements made during this conference call, including the answers to your questions, include information that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements involve risks and uncertainties that may cause actual results or events to differ materially from those expressed or implied by such statements. Those risks include, among other things, matters that we described in our earnings release and in our filings with the Securities and Exchange Commission. We do not undertake any ongoing obligation other than that imposed by law to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after this call. In addition, this conference call contains time-sensitive information that reflects management's best judgment only as of the date of this live call. This call is being recorded and will be available online for replay through May 4, 2012. Management statements may include non-GAAP financial measures. For reconciliation of these measures, please refer to our earnings news release available on our website. I am now very pleased to turn over the call to Cris Gaut, our CEO.

Thanks, Patrick, and good morning. We recently closed our initial public offering, and I want to begin by welcoming our new shareholders who have placed their trust in the management and employees of Forum. I especially want to thank our employees for their tireless efforts that made the IPO possible and made Forum the good place to work that it is today. With me today is our CFO, Jim Harris, as well as the presidents of our 2 operating divisions, Charlie Jones and Wendell Brooks. I'll start with some highlights from the quarter, offer a few thoughts on the outlook for our business; and then turn it over to Jim, who will provide greater detail on our financial performance. As this is our first earnings conference call, allow me to take a minute and orient you to how we manage Forum. We are organized in 2 divisions, Drilling & Subsea, managed by Charlie; and Production & Infrastructure run by Wendell. Drilling & Subsea focuses on products and technologies from the reservoir to the wellhead on the drilling rig and below the surface. Production & Infrastructure provides products from the wellhead to the refinery. Each division has 3 product lines oriented on their respective markets. The product lines within Drilling & Subsea include Subsea Technologies, Drilling Technologies and Downhole Tools. Production & Infrastructure includes Flow Equipment, Production Equipment and Valve Solutions. We had a good first quarter of the year with strong organic revenue growth, continued improvement in our margins and increased order levels across our 2 divisions. I am pleased to report that in the first quarter, we generated $82 million of EBITDA on $363 million of revenue. We generated EBITDA margins of 22.6% in the first quarter of 2012. Diluted earnings per share in the first quarter of 2012 were $0.57, up significantly from the 2011 first quarter diluted earnings per share of $0.20. This also represented a 33% sequential increase over fourth quarter 2011 earnings per share of $0.43. But please keep in mind our share count increased after the end of the first quarter with the completion of our IPO and the concurrent private placement, so our earnings per share over the rest of 2012 will not be directly comparable to this first quarter. Our Subsea Technologies business was one of our top performers this quarter, generating the highest sequential revenue growth rate among our 6 product lines. Subsea Technologies benefited from strong demand for our Perry work-class remote operating vehicles, or ROVs, that we design, manufacture and sell. The growth in deepwater oil and gas development was -- has increased demand for our ROVs and other subsea tooling and equipment that we sell. Additionally, demand has increased for large specialty vehicles, which support subsea pipeline installation and offshore wind farm projects in Northern Europe. We recently began final testing of a large 1,200-horsepower specialty trenching vehicle that our customer tends to deploy into these markets. It is the largest such vehicle we have ever produced and demonstrates the strength of our subsea design and engineering talent. Our Flow Equipment product line had an exceptional quarter and generated strong sequential top line growth and produced the highest operating margins in the company. This activity-based consumable products business benefited from the growing service intensity in North America. With the sharp drop of North American natural gas prices, many of our customers have redirected their assets to the liquids-rich and oily basins, and these basins tend to be drilled with longer laterals and stimulated with more fracturing stages per well. We believe about 80% of our Flow Equipment revenue is related to field consumable and replacement components. The remaining 20% is flow iron we sell for new frac spreads, and this is the portion of our business that would be more exposed to a decline in orders for new capital equipment. We also saw excellent performance from our Drilling Technologies product line, where drilling activity in North America created strong demand for our consumable products and handling tools. We have also experienced continued strength in demand for our well intervention pressure control equipment such as blowout preventers that we manufacture for coil tubing operations. In addition to the new products we discussed earlier on our Subsea business, other new product development efforts continue. Our Valve Solutions product line introduced new products to serve the upstream infrastructure market, while our Drilling Technologies product line recently began commercial production of the Wrangler Roughneck, a fully automated make-up and break-out tool. We have other product development efforts underway in several of our product lines that we expect to be growth drivers for us in the coming years. Looking forward, we are encouraged by the order level this quarter. Our level of order intake was $409 million for the first quarter of 2012, an all-time high, and a sequential increase of 14% over the fourth quarter of 2011. Our CFO, Jim Harris, will now discuss our financial results in greater detail. Jim?

Thank you, Cris, and good morning. We continued our strong growth trends in the first quarter with revenues of $363 million, up 79% from last year and representing an 8% increase sequentially. On a pro forma basis, organic revenue growth for the first quarter was 38% over last year. References to pro forma get full effect for the 8 acquisitions we completed last year as if they had occurred at the beginning of 2011. Our earnings for the quarter were $0.57 per diluted share compared to $0.20 for the first quarter of 2011, an increase of 185%, and up from $0.43 in the fourth quarter 2011. These earnings are based on the shares outstanding in the first quarter and do not include shares issued in the offering or the concurrent private placement. Our consolidated EBITDA margins for the quarter improved to 22.5%, up from 19.1% for the fourth quarter 2011, which was burdened by a $6.3 million charge for marking to market contingent consideration issued in 2 acquisitions. EBITDA for the quarter was approximately $82 million, up 169% over the same period last year and up 27% sequentially. I will now review our segment results comparing the first quarter of 2012 sequentially with the fourth quarter of 2011. Both of our segments contributed to revenue growth, with Drilling & Subsea up 10.1% and Production & Infrastructure up 5.2%. As Cris mentioned, the highest revenue growth in the quarter was achieved by our Subsea Technologies product line, almost -- up almost 25%, generating record revenue for the business and for large work-class ROVs specifically. We also had a particularly successful quarter in terms of new subsea orders with contracts for 10 additional work-class ROVs signed during the quarter. In the Production & Infrastructure division, our Flow Equipment product line led with 16% revenue growth on strong demand for our flow iron products that are consumed in the well stimulation and completion process. Both segments also achieved higher EBITDA margins for the quarter with Drilling & Subsea posting 25.6% margins and Production & Infrastructure reaching 21.8%. Our Drilling Technologies product line achieved the most improvement with margins almost 600 basis points better, approaching 27% on record shipments. The higher margins reflect the benefits of continuing engineering and manufacturing process improvement initiatives occurring throughout the business. I will now explain our expectations for the second quarter and provide guidance for the full year results. Based on continuing strong demand across our product lines, we expect operating income for the second quarter to come in between $68 million and $73 million, and for the year, in the range of $275 million and $300 million. This includes depreciation and amortization charges of approximately $12.5 million for the second quarter and $50 million for the year. The company projects net income for the second quarter to be between $40 million and $45 million, and for the year, between $175 million to $185 million. In the first quarter, Drilling & Subsea contributed approximately 59% of revenue, and on the year is expected to approach 60%. Corporate G&A cost should be approximately $25 million for the year. Net debt at the end of the first quarter was approximately $640 million and interest expense for the quarter was $5.8 million. Subsequent to the quarter, net debt was reduced by approximately $308 million with the proceeds from the IPO and concurrent private placement. Interest expense for the year, excluding any additional debt incurred for possible acquisitions, should be approximately $15 million. Our tax rate for the quarter was 34%, and we think this rate is a reasonable estimate for the year. Our diluted share count for the first quarter was approximately 74.7 million shares. Adjusting for the 16.6 million shares issued in the IPO and the private placement, we anticipate our diluted share count for the second quarter 2012 to be approximately 92.3 million shares while diluted shares for the full year should be approximately 87.5 million. Cash flow from operations was $21 million for the quarter, which included a continued investment in net working capital. We expect to see operating cash flows improve for the rest of the year as incremental investments and inventories globally are expected to decline going forward, and as our credit and collection initiatives to reduce days sales outstanding yield the anticipated results. We expect CapEx for the year will be approximately $60 million with about 2/3 designated as growth CapEx as we are investing in capacity expansions in both segments. For more information about our financial results, please review the earnings release on our website. We expect to issue our full Form 10-Q next week. We would like to welcome our new investors in the company and affirm to each of you that we take seriously our commitment to be good stewards of our shareholders' capital. I'll now turn the call back over to Cris for concluding remarks and to moderate any Q&A.

Thanks, Jim. We've met with many of our new shareholders earlier this month during our IPO marketing effort, and we discussed our intent to build and operate a world-class organization. We will remain focused on operational execution, serving our customers' needs and building Forum for the long term. For those of you attending the Offshore Technology Conference in Houston next week, please stop by Forum's booth and check out some of our new products including the Tomahawk ROV and our new subsea intervention tool used for closing subsea BOP powered only with an ROV. I am pleased with the progress Forum has made and look forward to reporting to you on our progress in the future. Thanks for your attention. And at this point, we'll open the line for questions. Janeda, please begin the Q&A session.

[Operator Instructions] Your first question comes from the line of David Anderson with JPMorgan.

So I guess it is a question overall in terms of looking at your 2012 guidance and then thinking about revenue progression as it goes through 2013. I was wondering, maybe it should be probably a good time, perhaps, you can give us some guidepost for what we should be tracking. In other words, you've got a bunch of different businesses in here within your 2 segments, each of which has fairly distinct drivers. Maybe you -- perhaps, you could help us to understand what are kind of the 2 or 3 most important industry trends we should be paying attention to the -- that you think is going to impact your top line the most.

Yes. Thanks, David. Some of the drivers that we would look to and refer people to would be, on our Subsea business, the number of new project awards related to these trees are a forward indicator. Obviously, there's a long time between the award of those trees and projects to the actual construction work commences, but it does give that longer-term indicator of -- and certainly directional indicator there; and I think the activity that, in general, that one sees in the subsea construction and installation of these manifolds and flow lines as well as trees. On the onshore side, the upgrade in spending by the drilling contractors on their rigs, both onshore and offshore, and the level of completions for onshore activity would be a good indicator for our more production and completions-oriented businesses.

And then as you're kind of thinking about kind of sort of the longer-term goals and aspirations of your company, and obviously, you've done a number of acquisitions over the last couple of years, can you help us understand how you're thinking about that incremental growth? I mean, is there a sense of kind of what that split is going to look like in between M&A and organic growth? And I guess, obviously, without tipping your hand too much, what does Forum look for in an acquisition? Is there like an ideal size? How are you thinking about it? Is it kind of product lines? Is it technology plays? What's the best fit for your company as you look in acquisitions?

I think the key driver for our growth going forward will be the organic growth, and we think we can continue to grow in the 15% to 20% organic growth rate. And on top of that is the acquisitions. And the things that we look for in acquisitions are, first, strategic fit with our 6 existing product lines. So we're looking to add and deepen our product offering within those 6 product lines. We look for businesses that have good brand names, that also have the ability for us to grow the businesses once we own them. But again, these businesses need to have good exposure to the 3 primary drivers that we're looking for, for our businesses: the deepwater development activity, well complexity and service intensity. In terms of scope, size of acquisitions, most of our deals will be in the, probably, $30 million to $150 million acquisition cost range. That's not exclusive. Occasionally, we'll look at things that are larger. But that would be really the sweet spot for us in that size category.

Okay, and one last question. You mentioned the -- I think a little more than $400 million in orders this quarter. Would it be possible just to break that down a little bit for us in terms of how that breaks down in terms of the segments and business lines? And I guess, second, if you could just help us understand a little bit the dynamics of order, how that flows into revenue. In other words, how long is that cycle time and roughly how much of your revenue on a quarterly basis flows out of backlog?

Yes, our cycle time from order to revenue recognition is fairly quick, certainly with inside -- being inside 12 months, and on average, probably about 6 months. And we are not a backlog-driven business, which is why we're not emphasizing that but rather, the order flow. Relative between our 2 segments or 2 divisions, both are up sequentially. The Drilling & Subsea division was up more this quarter, particularly driven by some very strong orders we had in the subsea side. And of course, that -- orders, as we all know, the subsea side can be lumpy but a very good order flow there.

Your next question comes from the line of John Lawrence with Tudor, Pickering, Holt.

Just a question on the ROV side, a lot of positive commentary there. Can you just remind us what your production capacity is per year? And then, are you guys mostly sold out in the 2012, and what's the visibility in the 2013?

We do have additional capacity to deliver units in 2012, so we're not sold out. We have, I think, a good idea of what our production slots are, and not all of them are sold at this point, although there are good discussions underway. The level of these big specialty vehicles that we build do impact that a bit because they absorb a disproportionate amount of capacity. Of course, they're more expensive in terms of the price that we charge customers, but they do absorb more capacity. So the mix there between those specialty vehicles and other work-class vehicles is a factor. But John, we do have -- and we can take on some more units than we have currently in orders for today. And then we have, on the other hand, some orders that go out to early part of 2013 at this point, too.

Okay, that's helpful. And then just a question on iron roughneck. What's realistic as far as installed units in the next 12 to 18 months?

Charlie?

We think that the market we're targeting with this iron roughneck is primarily the land market. We think there's more than 1,000 in service that are getting kind of old, and we think that there's quite an opportunity for replacement. So we think our ability to sell is really going to be based on our ability to produce, and we are gearing up to be able to produce quite a few. But we do think the opportunity in the market is quite substantial.

Okay, great. And I guess just the last one, just maybe touching the valve business. It seems like a pretty big opportunity in Brazil and Australia. Could you just touch on that as well?

We're seeing good global demand for the valves on a global scale. We do have valve sales representatives located in Brazil, and so that is a market that we're specifically addressing, and in Australia. So those are markets that we expect to see expanding. At this point, in Australia, it gives us some exposure not only to the upstream side but also to the mining side. We also have some exposure to the mining business in Africa. But back to Brazil, it's not just the upstream side there either, it's also the industrial market, too. Having said that, though, the -- still, the majority of what we're seeing orders for in our valve business are in North America midstream pipeline installations and terminals, as well as the natural gas pipeline replacement market. Heavy oil in Canada, we're seeing, is very strong, and serving the upstream market valve business as well.

Your next question comes from the line of Blake Hutchinson with Howard Weil.

First off, congratulations on completing the offering. I know it's a tough road when it gets to the end of that -- end of line there. First question, just can you take us back in good sequential comparison here within flow control? Obviously, the leader here. Can you take us back through kind of your capacity expansion in that business, when you kind of reach max capacity, and then maybe kind of qualify the growth sequentially as Forum getting up to capacity versus is this more just driven by the fact that the fleet out there is larger and that's the type of growth that's more or less just organic? Kind of trying to get a handle around capacity expansion, utilization versus just having a larger fleet out there to service.

Right. So we, under the Flow Equipment business, through acquisition, acquired a series of companies last year, and we saw that this was a rapidly growing market. So as we acquired these companies, we also implemented plans to increase their capacity. And each of our facilities has seen a significant increase in people, employees, in equipment and in roof line, and we have further plans to expand that as well. So the throughput that we've been able to deliver has obviously grown a great deal, but that's been in anticipation of the demand that we've seen from our growing list of customers because of the larger installed base out there, the higher level of activity. And what we do try to do in -- as how we manage the business is look out 12 to 18 months at what we see the demand will be for our products and equipment, and then look at what our ability to deliver is and how we need to further allocate resources to meet that potential demand.

And I guess, maybe put another way, even given the success for the quarter, had you had more capacity, could you have done even more with the quarter, given the fleet size?

I'm sure there are areas where we were constrained. And one of our issues in this business over the past few quarters has been the order intake, has been -- has outstripped from time to time our ability to deliver and has caused some deferrals. We're working hard to catch up on that, wouldn't you say, Wendell?

Yes. I think our capacity is in line with the demand we see now. There are spots where we still have orders to fill. But as Cris said, the activity level is very high, and we see a continued demand, particularly as people focus more on the utilization of the equipment.

And we're now having an opportunity to expand our customer base as well, and that's part of our planning for the future.

Great. And then, I guess, for the oil service landscape as a whole right now, a lot of the interbasin navigation in the U.S. is kind of at the forefront of questioning and understanding. As more of a capital equipment and consumable provider, you probably don't have as much rearrangement to do. But is there anything systemwide that you guys need some -- to do some catch-up on as we see this kind of interbasin shift in activity or you feel pretty good about where you're positioned today?

Blake, there are opportunities for us there. Although we have -- I think, a key to our Flow Equipment business, for instance, is the service we offer our customers and our ability to go out and recertify their equipment and have the spare parts located in close proximity that we can supply when the company -- when the customer needs it. So we have these service bases in a number of the key basins, in most of the key basins, but there are areas that we want to expand into. And I think Wendell and the team, for instance, are going to make -- be making a trip in that regard up to the Bakken here shortly so that we can have a more direct involvement in that market in a -- with a bigger -- with our own facility. Of course, Charlie, you've got -- in the drilling side, you've got a facility there now, and we'll be looking to leverage across our businesses. But that's an example of an area where we see greater potential.

Great. And then, again, because it's been highlighted, I just wanted to touch on -- fill out some metrics here as we explore Forum as a public company. The ROV, in the new equipment orders versus consumables, is that roughly usually kind of the same relationship in terms of cap equipment to consumables as overall? And do new unit margins -- are new unit margins more or less in line typically with the rest of the segment? Or is it new unit that's lower than the consumables within that segment?

The Subsea Technologies product line is one -- for us, 1 of probably the only 2 of the 6 that is more capital equipment oriented. So our Subsea business, our ROVs is more capital equipment oriented. We sell the units. We sell the tooling. We sell the software that users -- our customers use in association with that. Yes, we sell some replacement parts there, but we do pride ourselves on reliability. So we're not dependent upon the replacement part business there, for sure. But across Forum as a whole, the majority of our revenue is from consumable and aftermarket products. That is not true for the Subsea product line and it's not true for surface production equipment business over in Production & Infrastructure side.

Okay. And then just one follow-up, and I'm sorry, I'm taking up a lot of time here. Maybe for Charlie. Is it -- just because we haven't had really an ROV manufacturers publicly here, is it your position that perhaps the offshore construction industry has under replaced, under ordered, or is there new generational kind of replacement cycle going on? I mean, is that something that thematically we need to be thinking about here, or is the new order really just in line with kind of expansion in capacity in that industry?

Well, I think the -- first, the customers that are buying these vehicles are doing the installation and construction work, and their visibility to future work coming at them next year and the year after has increased dramatically in the last year. And we've seen orders associated with that. They had not been buying for a number of years, and we're selling a lot of equipment now as replacements going on existing vehicles, but also technical upgrades. There has been a lot of technology brought to the market in the past 5 years that is now starting to flow out as these orders are being placed and are hitting the market. In addition to that, we are seeing, and Cris mentioned, some work associated with some very highly specialized to gear, as well as the ROV. And the outlook for that is even more buoyant today than it was 6 months ago. So I think there's a very complicated work anticipated to be done in the future, and our customers are trying to position themselves to be able to execute that work. And I think the key thing is that they have to be able to show, when they bid the business, that they have the ability to perform the work in an efficient manner. And they're relying on us to help them do that with their customers as they bid jobs.

[Operator Instructions] Your next question comes from the line of David Smith with Johnson Rice.

I want to reiterate the congratulations for the successful IPO.

Thanks very much.

I want to follow up on the Flow Equipment side, and I'm sorry if you addressed this and I missed it. But just noting that it more than doubled the 1Q '11 pro forma revenue, if I think about the horizontal rig count as a proxy for that demand, servicing the active base of pressure pumping capacity, your -- that number was up less than 20% year-over-year. So if I'm correct in understanding that the growth of your report is off the pro forma figure, which it is, can you help us understand the revenue growth for that business year-over-year being so far above? It seems like a lot of market share gain.

Yes, I think that's right. We have significantly increased our capacity and our ability to meet customer requirements and taken on new customers. And as we brought these companies together that we acquired and integrated them, we were now able to offer a comprehensive solution to the Flow Equipment side and the flow iron and work with these customers on inspecting and recertifying their flow iron and then providing the full range of replacement parts. So now we're able to fully participate in the growing service intensity there. But it was really over the course of the year and we're still working, I would say, Wendell, on bringing together these companies and realizing the full benefits of the integration.

Yes, that's exactly right, Cris. We had some holes initially when we put the 3 companies together from a product offering standpoint, and we spent a lot of '11 filling in the holes and expanding the distribution network. We were really limited in how many clients we could serve in the beginning as we put the companies together. But as our capacity expanded, we've now got a pretty broad range of clients. And as we add more services, we think we're able to serve a larger market with the complete product offering. And the aftermarket services and repair we offer, we think, plays into a very important aspect of this year's business. So the growth has really been based on how fast we could fill out the product line, fill out the distribution network, and I think we've done a pretty good job so far.

Good color. Are you close to where you like to be in terms of market share? Or do you have a target in mind for market share gains that would make you satisfied a year from now?

This is a big market. And we see a lot of potential in runway, not just in Flow Equipment but in each of our markets. So we see good growth potential across the board, including in the Flow Equipment space.

Okay, appreciate it. And my follow-up was just, was hoping you could provide maybe some broader or detailed color on how the U.S. onshore switch from gas to liquids is affecting your overall business.

The switch is certainly something that, I think, anyone in the service space has to be very conscious and proactive about, and I'll ask Wendell and Charlie to comment. But many of our businesses are kind of indifferent as is our rig business, and the Flow Equipment side has managed the conversion well. The business that's actually benefited quite nicely is our valve business. We've seen a significant increase in valves for the petrochemical industry, and we see that the potential in the order flow from petrochemical plants coming back onstream due to low natural gas prices looks quite favorable. And then Wendell, to the Production Equipment business, wellhead separation, equipment that we manufacture, I know that's something you have been watching and managing for very closely. You might talk a bit about how the switch has affected that business.

Sure. It's actually quite interesting. The amount of equipment around the wellhead for surface production is more for oil than it is for gas, and that really is a result of additional fluid handling. So on a per well basis, the revenue we're able to generate on an oil well is higher than a gas well, and we've moved quite quickly with the rotation. For us, the supply of equipment is not so much based on where the location is, it's closest to where our plants are. So we're positioned in all the major basins, except North Dakota. And I think we are seeing a good growth in our surface production equipment business because of the fluid volume, which requires more separation, more storage tanks, more free water knockout equipment. So it's a bigger product offering around an oil well than a gas well.

Well, we want to thank you all for your attention and your questions this quarter. And we look forward to talking to you again for our second quarter earnings conference call in July. Thanks very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.