Forum Energy Technologies, Inc. (FET) Q2 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies Second Quarter 2019 Earnings Conference Call. My name is Prince, and I’ll be your coordinator for today’s call. At this time, all participants are in a listen-only mode. [Operator Instructions] I will now turn the conference over to Mark Conlon, Director of Investor Relations. Please proceed sir.

Thank you, Prince. Good morning, and welcome to Forum Energy Technologies’ second quarter 2019 earnings conference call. With us today to present formal remarks are Cris Gaut, Forum’s Chairman and Chief Executive Officer; as well as Pablo Mercado, our Chief Financial Officer; and Lyle Williams, Senior Vice President of Operations. We issued our earnings release last night and it is available on our website. The statements made during this conference call, including the answers to your questions, may include forward-looking statements. These matters involve risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. These risks include, matters that we have described in our earnings release and in our filings with the Securities and Exchange Commission. We do not undertake any obligation to publicly update or revise any forward-looking statements for any reason. In addition, this conference call contains time-sensitive information that reflects management’s best judgment only as of the date of the live call. Management’s statements include non-GAAP financial measures. For a reconciliation of these measures refer to our earnings release. This call is being recorded. A replay of the call will be available on our website for two weeks following the call. I’m now pleased to turn the call over to Cris Gaut, our Chief Executive Officer. Cris?

Thanks, Mark and good morning, everyone. Our primary focus is on generating significant free cash flow to reduce net debt. And I am pleased to report that we continue to make good progress on this objective. Our free cash flow in the second quarter was $18 million that’s a $3 million from the first quarter, and this was our third consecutive quarter of strong free cash flow. I expect further significant improvement in our free cash flow in the third quarter and I believe it’s worth noting that our free cash flow yield on our current equity market capitalization that since we changed our strategy nine months ago is over 25%. For the first half of the year we have reduced our net debt by $30 million and we ended the second quarter with $242 million of liquidity. Of course, we are not alone in our focus on cash flow and cost efficiency. I think you are all aware that operators and now service companies have significantly constrained their capital spending and are now also reducing their operating and consumable spending. This low level of maintenance spending by our customers is not sustainable in the long run, but it certainly affected Forum’s results in the second quarter. As we announced last month, we experienced a significant reduction in our sales of short-cycle products, primarily in our Completion segment. As a result Forum, had a $26 million sequential decrease in our revenue and a $3 million reduction in our adjusted EBITDA. Consistent with our strategy to manage for the current market environment, we have implemented additional cost reductions and our SG&A costs were down $6 million sequentially. Another element of our strategy is to drive growth with our winning products such as artificial lifts where we are seeing continued strong market share gains for our products. In addition, with the ongoing improvement in international and offshore markets, we are seeing an increased level of inquiries, some of which we expect to turn into orders in the second half of 2019. Looking ahead to the third quarter, we expect roughly flat revenue as increases in our internationally focused Drilling and Downhole, Subsea and other product areas offset softening U.S. land completions and drilling activity. We expect EBITDA to be flat to slightly up compared to the second quarter. Taking into account market conditions and as we shift to a more favorable product mix and continue to become more cost efficient. Now, let me ask Pablo to take you through our results and financial position. Pablo?

Thank you Cris. Good morning. Our second quarter revenue was $246 million, down $26 million sequentially due to the slow down in U.S. drilling and completions activity. Our adjusted EBITDA for the second quarter was $18 million or 7.5% of revenue. I would note that our adjusted EBITDA does not add back $4 million of non-cash equity-based compensation, but we do subtract out $2 million of foreign exchange gains. Net loss for the quarter was $14 million or $0.12 per diluted share. GAAP results for the quarter included pretax charges of $1 million for restructuring costs and $2 million of foreign exchange gains. Our tax expense included a $5.9 million increase in our valuation allowance, writing down our deferred tax assets in accordance with the accounting rules. We provided a reconciliation table of these special items in our earnings release for your reference. Adjusted net loss for the second quarter was $0.08 per diluted share, excluding these special items. I will now summarize our segment results on a sequential basis. In our Drilling & Downhole segment, orders were $78 million, a 4.5% decrease. Segment revenue was $82 million, a decrease of $4 million or 4%. This was due to the lower rig count in North America, partially offset by higher revenue recognition on subsea projects. Adjusted EBITDA for the segment was $7.5 million or 9% of revenue, an improvement of 210 basis points, driven by higher margin artificial lift products and a seasonal improvement in our subsea joint venture. In our Completions segment, orders decreased 12% to $71 million. Segment revenue was $82 million, a decrease of $13 million. This was due to lower sales of pressure pumping products and the previously announced non-recurring offshore coiled line pipe project delivered in the first quarter. During the second quarter, we saw a significant shift in customer spending patterns. Pressure pumping customers began to defer maintenance spend, destock consumables and cannibalize idle fleets. As a result of the lower volumes of higher margin pressure pumping products and decreased operating leverage, adjusted EBITDA margins decreased approximately 290 basis points to 14%. We have moved swiftly to reduce both fixed and variable costs in this area. Production segment orders were $76 million, a decrease of 5%. Segment revenue was $83 million, a 9% decrease, primarily due to lower sales of upstream and midstream valves with distributors deferring orders and destocking their inventory levels as they focus on improving free cash flow like others in our industry. Adjusted EBITDA margins were 7% for the segment, essentially flat from the first quarter. One factor that affected the results of our valves product line was the ERP implementation that we completed during the quarter. It had an impact on our ability to ship products at the end of the quarter as well as to the book-and-ship orders we were able to receive. The new system is working well and it will not be a factor in the third quarter. I’ll now discuss some additional details about our results and financial position at the Forum level. Our free cash flow after net capital expenditures in the second quarter was $18 million, an improvement of over $3 million from the third quarter – from the first quarter. Our program to aggressively reduce excess inventory is underway and we expect this reduction to contribute to our cash flow generation in the second half of the year. Our primary use of free cash flow is to further reduce debt and improve liquidity. Our net capital expenditures in the second quarter were $5 million. We expect our total capital expenditures for 2019 to be under $20 million. Our balance sheet and financial position remained strong. Our liquidity position at the end of the second quarter improved to approximately $242 million. Net debt was $442 million and our net debt-to-total capitalization ratio was 30%. We expect to continue to reduce debt and improve liquidity in the coming quarters. Our reported diluted share count for the second quarter was 110 million shares. Interest and depreciation and amortization were $8 million and $16 million, respectively in the second quarter. We expect these expenses to remain at similar levels in the third quarter. Adjusted corporate expenses were $6.8 million in the second quarter and we expect them to remain at similar levels in the third quarter. Our corporate expenses are down more than 15% in the first half of 2019 compared to the prior year because of our cost-reduction actions. With respect to our tax rate, we continue to have some tax expense despite an overall net loss as we are not recognizing tax benefit in loss-making jurisdictions, but continue to recognize tax expense for some international jurisdictions with income. Once we turn profitable in the loss-making jurisdictions, we will have a relatively low tax rate as we begin to use our net operating losses. For more information about our financial results, please review the earnings release on our website. Now let me turn the call over to Lyle to discuss some key operating initiatives.

Thank you, Pablo. Hello, everyone. Forum’s employees continue to make good progress toward achieving our strategic objectives. I will provide a brief update on our inventory reductions, our improving cost structure and how some of our winning products are performing. In the second quarter, we experienced a decrease in revenue versus our expectations and, therefore, lower shipments from inventory. Despite these significant headwinds, our inventory dropped by $10 million during the first half of 2019. We were reducing the level of incoming material for the second half of the year by changing our distribution system to tighten the connection between our customers and manufacturing locations and by improving our partnership with our vendors who are holding more inventory on our behalf. We were also making progress in reducing inventory we have on hand by liquidating slower-moving inventories and through substitution at our manufacturing plants. Further inventory reductions will enhance our cash flow in upcoming quarters. Our financial results this quarter reflect a lower cost structure resulting from our restructuring efforts. In total, we have reduced SG&A by $24 million on an annualized basis compared to the first half of 2018. We continue to streamline our organizational structure, moving functional accountability and authority back into our product lines. We have also reduced our facility footprint. For example, we have exited our Houston distribution facility, consolidated our corporate office into our operating headquarters and consolidated offices in international locations. On the direct cost front, we are also adjusting labor and overhead costs in line with demand. Despite the challenges we are facing from a slowing domestic market, we are benefiting from activity increases in offshore and international markets. Our subsea product line continues to see strong inquiry activity in nonoil and gas applications, such as defense, as well as from traditional oil and gas customers. And our drilling product line received a number of capital equipment orders this quarter destined for international rig applications. Some of these products have not seen meaningful order activity since 2015 and we are encouraged by this change in direction. Our growing portfolio of artificial lift products continues to gain market share and increase revenues. This portfolio increases the longevity of ESP artificial lift systems by addressing critical failure modes of sand and gas lugs and failure of electric cabling. These products are gaining acceptance with customers across North America. We also see significant opportunity in international markets, which we’re only now beginning to penetrate. Our engineering team is working to address other failure modes associated with ESPs as well as applying our innovative solutions to other artificial lift technologies. We are very pleased with the progress of our artificial lift products and look forward to continued growth in this area. Another example of product innovation driving growth for Forum is our EnviroLite greaseless wireline cable. Forum introduced this product in 2018 and we have seen strong market penetration. While greaseless cable was initially developed as a more environmentally friendly solution than conventional wireline, operators have obtained significantly reduced running time and gained other operating efficiencies through its use. Customers have found that Forum’s unique design for this product enables better adhesion of the exterior coating to the wireline, which increases durability of the coating and longer life of the cable. We believe this product will continue to gain market share based on these strong features and benefits. Let me turn the call back over to Cris for concluding remarks.

Thanks, Lyle. We are facing some headwinds in our domestic land business due to a widespread reluctance to spend money by operators and by service companies. The resulting under investment deferred maintenance and cannibalization of equipment is not a sustainable strategy, yet it is difficult to say how long it will last. However, a benefit of Forum’s balanced portfolio is a substantial exposure we have to be improving international and offshore markets. We at Forum will focus on the things we can control. We will generate even more cash as we monetize our excess working capital to reduce debt. We will become more cost efficient and we will grow on winning products. Before closing, I want to thank our employees for their dedication and commitment, particularly those who have taken on additional responsibilities as a result of our cost actions. Thank you. Operator, let’s take the first question.

Thank you. [Operator Instructions] First question comes from the line of Sean Meakim from JPMorgan. Your line is now open.

Thank you. Good morning.

Hi, Sean.

So Cris, I was hoping to maybe just dive in a little bit more into the developing situation with respect to cannibalization. You’re at our conference last month, we talked about the cannibalization within completions we’re seeing among the pumpers. Could you maybe just compare and contrast how that looks across frac providers versus drilling contractors? We heard from a number of them yesterday and the forward outlook, particularly as we exit 3Q from an activity perspective as maybe gapping lower than we would have thought previously. And so try and get a sense of how you’re seeing that portion of your customer base approach similar types of challenges for the back half of the year.

Yes, sure. So, I think it’s more significant at this point for the pressure pumpers in terms of percentage of the available fleets right for the kinds of products we provide. So, as pressure pumping activity would decline and a service company would choose to stack in a frac fleet, for instance, that would mean that for their working equipment. They would be able to cannibalize that stack feet or send out a pumping unit to replace one in the field that needs repair or service. And until they have absorbed the available equipment from the stack unit, stripped off of the flow iron from the stack unit, used any available manifold trailers, that they would have, used the available stock of fluid ends. So I think that’s what’s happening now and will continue as long as the utilization of frac equipment continues to decline. Clearly with margin pressure for the pressure pumping service companies with pricing pressure that they’re seeing and in an effort to preserve their margins, they’re wanting to do what they can to avoid spending money on operating expense and show as good margins as possible. And adding to this pressure to cannibalize and de-stock. But there’s only so far that can go. From the drilling side, of course, the largest decline in drilling activity from the peak has already taken place and for consumable drilling equipment. The largest part of that has gone on over the past several years. In percentage terms, the change in drilling activity that is expected from this point forward is a smaller percentage of the fleet. I would say, Sean, for our Drilling and Downhole segment, particularly for the drilling and subsea parts of that segment that we’re at an inflection point given the improvement in international and offshore activity. And we expect our Drilling and Downhole segment to show improving revenue from this point forward.

Right. That makes sense. Cris, thank you for all the details. That was really helpful. We’ve heard some indications discerning season of E&Ps when they addressing their balance sheets into quarter-end on a cash basis and that’s had an impact on collections potentially for some of the service companies. So I’m curious if you’ve seen any of that behavior in terms of the service companies as your customers, and to the extent that, that becomes a trend as something like this moves through the supply chain, given the critical nature of working capital management as part of your free cash flow plan. Could you speak to any other levers you have in terms of stretching payables? Or how you think about managing a scenario like that, which seems like it could be at least getting some inklings of that starting to work its way through the system.

Hey, Sean, it’s Pablo. It is a good question. And something we’ve been thinking about, and that’s sort of been with us for several quarters in terms of our customers really watching their balance sheets, particularly at quarter end and slowing payments. I think, first thing to know is our customer base is tends to be mostly strong companies. So there is less of a credit risk if you will, and much more of a just slow paying us. It’s actually tends to be the best capitalized companies that are the worst payers there at the end of the quarter. So what we’ve been doing is really working hard internally to help our process. So that we can do everything that’s under our control to collect faster from our customers, so not to give them any excuses. And we have been successful in reducing our DSOs, which were fairly high in – call it third quarter of last year, there were about 76%. We ended the second quarter at 69%. So we’ve been able to do that.

Days sales outstanding is a measure of how quickly we’re getting paid.

So we continue to work on that – continue to work on our process and drive collections. But it is something that is happening. It could be more pronounced in the fourth quarter. So that’s why we’re working on our internal process.

So that’s on the receivables and payables side, maybe Lyle, you can address inventory. And that’s probably where we have the greatest lever available to us at this point. And it’s a pretty big one actually.

It is. It is – thanks, Cris. Yes. So as we’ve said, our overall inventory reduction, our inventory turn target goal is three, and we’re still hovering around 1.5 turns. So we’ve got a lot of opportunity in the aggregate to reduce our inventory levels. And we think about what we’ve been doing, it’s really like draining the swimming pool and that’s a combination of slowing down what’s coming in and speeding up what’s going out. So some of my comments were aimed at that and what we’ve been doing and working with our vendors to slowdown, what’s coming into our inventory, but also growing success at getting inventory out on the other side. On the other side, through material substitution and through some very good liquidation of some of our inventory that’s been slower to move. In the second quarter alone things that we saw is a pretty rapid deceleration of short cycle sales in both completions and valves that we’ve talked about in the earnings release. And those negatively impacted how much inventory we were able to pull out in the quarter. So if we had been closer to what our expectations where we would’ve expected to see a much more significant draw in our inventory. So by slowing down those inbounds, but by increasing what we’re doing on the outbound side, we expect to see inventory to continued to come down even on an accelerated rate and enhance our cash flows going forward.

That’s very helpful. Thank you, gentlemen.

Thanks, John

Next question comes from the line of George O’Leary from Tudor, Pickering, Holt & Company. Your line is now open. George O’Leary: Morning Cris, morning Pablo, morning Lyle. Just starting off the international drilling commentary kind of squares what we’re hearing from the larger service companies, I’m just curious if you could speak to what geomarkets or countries are kind of driving the dialogue there and driving the revenue growth in the ensuing quarters? And then if you guys are engaged with any discussions with customers for kind of longer lead capital equipment type items that maybe even materializing beyond the end of this year or 2020 plus?

Yes, we are seeing an improvement in capital equipment orders in our drilling business. We’re seeing an improvement in handling tool orders and in some cases associated with new capital build internationally. And an uptick in our subsea business, which is more capital-oriented. So on the drilling side, the geomarkets where we’re seeing the strongest improvement in drilling the bandits are clearly the Middle East, where there is a push towards new generation of bigger, more capable land drilling equipment in a number of countries. So and you’ve heard about this from both the drilling contractors. So as they are awarded new rig contracts for long-term work, they place the orders for that new-build equipment. And then we are in a position to book orders ourselves and that is happening. And it’s the driver for the improvement in the capital equipment in several handling tools that we’re seeing there. We’re seeing an improvement in handling tool orders for some offshore rigs that are going back to work and some ancillary upgrade equipment as well as some of those rigs go back to work. So that would be in Asia Pacific, to some extent in the North Sea areas. So I would say, George, to answer the question – to answer your question, Middle East, Asia Pacific and North Sea would be the geomarkets outside the U.S. that are seeing improvement. For their downhole market, we might add in certain countries in Latin America. But that is less of a factor from the capital equipment side. And then on the subsea market, another driver there is we’re seeing a continued improvement as we put more effort into the nonoil and gas side. So our capital equipment orders for subsea equipment, not only driven by the improvement in FIDs for big new subsea projects finally, but also the defense and renewables markets as well.

Great. Just – sorry, it’s Pablo. Just to add borders in – for capital equipment do tend to be lumpy. But you asked about whether we expected to get some of those that would go into 2020, so build in backlog, so I’d say, yes, later this year, we expect some of that to begin to build for 2020. Inquiries are definitely up, as Cris described, both in drilling as well as in subsea. George O’Leary: Great. That’s very, very helpful. And then on the artificial lift side. Clearly, an area where you guys are taking market share and also looking to grow that portfolio. You mentioned in your comments that there, outside of ESP, there are opportunities on other forms of lift. Just curious where you see the largest opportunities, I mean what forms of lift those might apply to you outside of ESPs.

Sure, George. It’s Lyle. The opportunity given the nature of the tools that we have especially are really effective SandGuard tool which prevents sand from falling back onto a pump applied to – can be broadly applied to – can be really broadly applied to a bunch of different broad lift and progressive cavity pump lift tools are two areas that the team is working on to be able to apply the technology. In addition to outside of ESPs, the team is looking at and testing now some new tools which will be able to help enhance what we’re doing even on the ESP side. So we think, we’ve got ability to grow penetration with new technology on the ESP side as well as a broad lift and progressive cavity pumps going forward.

Some things that clearly are a negative factor for longevity of several types of downhole artificial lift are sand in the well and the gas slugs. And so our – when we talk about Forum’s artificial lift portfolio we don’t make rod lift equipment, we don’t make PCPs, we don’t make ESPs, what we do make are the ancillary equipment that helps keep that equipment working, protects it and extends its life and clearly with this effort to become more efficient. Our products that extend live are of interest to the operators as well as the service companies. George O’Leary: Great. I’d sneak in one more if I could. I think recently you guys talked a little bit about on the separation skin side of the production side of the business, aligning with larger customers. I assume with you guys were doing large multi-well pads where the kits may be more bespoke in nature, and I just wonder if there’s larger more bespoke opportunities or one, margin-accretive to that business; and then two, just kind of how you guys are strategically positioning or strategically marketing that effort and making headway there.

Yes. I mean that’s a dogfight business, well side production equipment. We have made, I think good progress recently over the past couple of years in improving our customer base, but importantly, improving our efficiency and improving the margins. So whether it is in the Northeast or in Mid-Continent or in Texas, we have good positions with a number of customers with ongoing programs and we are able to maintain those positions because of our quality engineering, our safety record and ability to deliver. And we become more efficient and better margins with how we can produce that equipment, which is a key to success in that highly competitive space. George O’Leary: Thank you guys very much for the call. I’ll turn it back over.

[Operator Instructions] Next question comes from the line of John Watson from Simmons Energy. Your line is now open.

Thank you. Good morning.

Hi, John.

Hi, John.

Hey guys. The free cash flow generation continues to impress and the guidance for improvement in 3Q is encouraging. Can you provide any further detail regarding the level of uplift you’re expecting? Is this primarily a function of your cadence of semiannual interest payments?

Well, certainly, the cadence of semiannual interest payments would be helpful. But I think there are other factors as well that give us confidence that the third quarter will see improvement. Lyle addressed the progress that we’re making on inventory. We didn’t make as much progress in Q2 on inventory as we expected to, frankly, just because of the slowing sales and outflow of inventory, particularly later in the quarter as orders got deferred. Those will occur in the third quarter. And yes, so the combination of increased progress on working capital, receivables and not having an interest payment all give us very good confidence of improved free cash flow.

Okay. Thanks for that, Cris. Within stimulation, are there certain products that are being affected by the softness and completion activity, and the cannibalization of equipment more so than others? I’m just curious if there’s additional detail you could share there.

No, I think it’s just that the service companies really don’t want to spend money and they’d rather use up anything they have, whether it’s iron or fluid ends, or working at power ends or new missile trailers that are more efficient than what they have or radiators, all the things we’re making, we’ve just seen that our customers have interest, but say – they tell us, hey, we’re just not in a position to buy right now.

I would just add John, just to clarify, we reported as stimulation and intervention. So what Cris was referring to, certainly all the stimulation products and it’s there across the board. but on the intervention side, we – it’s not the same. There’s not the same kind of destocking or cannibalization and we’re having really good traction with the wireline cable that Lyle talked about, for example, as well as with the hydraulic latch that really helps the super fracs. So that momentum continues and there is some international revenue there as well. So I think it’s not all Completions coil tubing and interventions are not seeing that kind of destocking and cannibalization.

All right. Thanks, Pablo. And lastly, on the SG&A side, we have your targets by year-end and you’ve shown really significant progress already. but I was curious if you could update us on what some of the further initiatives are to decrease G&A. Are there specific countries that you might exit or facilities that you could close? Any additional color there would be great. Thanks.

So, in terms of our international consolidation, we’ve achieved the major part of what we want to do there and we feel we’re more efficient from that standpoint. So, and also, we’ve made great progress on our major facilities here in the U.S. but as we have further attrition, we’re taking a hard look at what we can do there or what we need to do. And we have reorganized – last quarter, we reorganized our segments, which has given us a chance to become more efficient in that regard. in this market though, you need to do what you need to do and we are absolutely committed to being successful in the current market. our emphasis is on free cash flow and putting that first and foremost, but then driving EBITDA dollars, and costs are certainly, a part of that. I think we are making progress. I think we have very good alignment internally on our goals. And I’m optimistic that we are going to get to a more successful point, both in terms of cash flow and EBITDA. And part of that well – as well is shifting our resources to our higher margin, better brands, winning products, where we can see growth even in the current market environment.

Great to hear. Thanks for that, Cris. I’ll turn it back.

Well, thanks very much. We appreciate the interest this quarter and look forward to talking to you again, in the near future. Thank you.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day. You may all disconnect.