Forum Energy Technologies, Inc. (FET) Q2 2020 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies Second Quarter 2020 Earnings Conference Call. My name is Shanteller and I will be your coordinator for today's call. [Operator Instructions] I will now turn the conference over to Lyle Williams, Chief Financial Officer. Please proceed sir.

Thank you, Shanteller. Good morning, everyone, and welcome to Forum Energy Technologies Second Quarter 2020 Earnings Conference Call. With me today are Cris Gaut, Forum's Chairman and Chief Executive Officer; and Neal Lux, our Executive Vice President of Operations. We issued our earnings release after the market closed yesterday 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 statements involve risks and uncertainties that may cause actual results or events to differ materially from those expressed or implied in such statements. Those risks include, among other things, matters that we have 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 the date of the live call. Management's statements may 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.

Thanks, Lyle and good morning. I will not dwell on the economic devastation that occurred in the second quarter. You have all heard more than enough about that by now. For Forum specifically, a primary piece of our business is selling short-cycle products to service companies to sustain, replace and upgrade their drilling and completion operations. Our customers have sharply reduced their spending in these areas as their equipment utilization evaporated. Eventually, much of this equipment will go back to work, which will drive demand for our products and services, but the timing is uncertain. That is why Forum's recently announced debt exchange that extended our debt maturity to October 2025 was so important. This gives us the extended runway we need to exploit the inevitable upturn in drilling and completion activity. After buying back $72 million of our bonds at about $0.40 on the dollar in the first half of 2020, under our exchange, 350 million of the $328 million of our debt was due in 2021 was rolled into a new security. This new debt has a cash coupon of 6.25%, the same as the old debt, plus another 2.75% that is payable at the company's option in cash or in kind additional notes. In addition, there is a clear path for the company to de-lever as the new notes are partially convertible into for equity. $150 million principal amount of the new notes are convertible at a conversion price of $1.35 per share and are automatically and mandatorily convertible once form stock price trades through $1.50 for 20 business days. The conversion of $150 million of new debt at a conversion price that is more than 2.5 times the current stock price would represent about 50% dilution to current shareholders, while ensuring a strong and sustainable capital structure for the company. This debt exchange provides a number of benefits, the time necessary for a business recovery, a clear path to de-lever the balance sheet. It does not burden the company with a higher required cash cost of financing or restrictive financial maintenance covenants. And it aligns the interest of our debt holders and our legacy stockholders around the long-term success of Forum. The second quarter of 2020 was exceptionally difficult, and Lyle will review our results in a minute. But it did provide the catalysts to resolve Forum's capital structure issues and to significantly restructure our costs for long-term success in a world of lower demand for oilfield equipment. Compared to the year ago quarter, our second quarter cash costs, excluding our purchased materials costs, are down about $150 million or 39%, with most of that savings happening in the most recent quarter. So we now have a very competitive cost structure for the current market environment. As I look ahead, I believe we have seen the bottom in our orders and our EBITDA. For the third quarter, we expect revenues will be comparable to the second quarter as we rebuild the order book with an increase in domestic completions and international well construction activity. We are already seeing some positive signs in this regard. We also expect a modest improvement in EBITDA driven by cost reductions. Looking further ahead, Forum is positioned for renewed success with our new cost and capital structures, dedicated employees and our portfolio of winning products. Lyle?

Thank you, Cris. I am pleased to represent the Forum team with Cris and Neal at this exciting inflection point for the company. The decrease in activity and spending by our customers resulting from the COVID-19 pandemic and the dramatic reduction in drilling and completion activity due to low oil prices had a significant impact on our second quarter financial results. Our total revenue for the quarter was $113 million, down 38% from the first quarter. Our book-to-bill ratio was 76% as orders for our consumable products, which are typically booked and shipped in the same period, were most severely impacted. In response to the forecasted declines in our revenue, we initiated a significant cost reduction plan in March and completed many of our identified cost reduction actions early in the second quarter. We focused our plans on cash costs included in SG&A and cost of goods sold, except from the purchased materials. In total, we reduced these costs by $24 million compared to the first quarter, a 30% reduction. These cost reductions, which have all occurred since March, amount to approximately $100 million in total savings on an annualized basis. Our cost reduction actions included significant headcount reductions, especially at senior levels of the organization; facility closures, including production and distribution facilities located in the US; salary reductions across the company; suspension for our US and Canadian retirement plans; and other reductions in variable costs. As a direct result of these cost savings, sequential decremental EBITDA margins were limited to 23%, resulting in adjusted EBITDA of negative $11 million for the second quarter. We are particularly pleased with this result given the weak pricing environment and the COVID-related under absorption of fixed costs that had a direct impact on our gross margins. For clarity, adjusted EBITDA results exclude roughly $3 million of noncash stock compensation expense for the second quarter. This treatment is a change for Forum, which now aligns with the presentation of our peers, and we have applied this change to the comparable periods in our earnings release. Our free cash flow after net capital expenditures in the second quarter was negative $3.5 million as the impact of lower earnings was mostly offset by reductions in working capital from strong collections of receivables and inventory management. Included in this result were approximately $5 million of cash severance and other restructuring costs paid in the quarter. But for these restructuring costs, Forum was free cash flow positive in the quarter and has generated positive free cash flow for the past seven quarters. Over this period, Forum generated $109 million of free cash flow. In the quarter, we decreased our net inventory position by $15 million and expect the monetization of excess inventory to continue in 2020 and beyond. Net loss for the quarter was $5 million or $0.05 per diluted share. Excluding a $39 million gain on extinguishment of debt and $9 million of special items, adjusted net loss was $0.29 per diluted share. Special items for the quarter on a pre-tax basis included $4 million of severance and other restructuring costs, $4 million of inventory and other working capital impairments and $1 million of foreign exchange loss. We've provided a reconciliation table of these special items in our earnings release for your reference. I will now summarize our segment results on a sequential basis. In our Drilling & Downhole segment, orders were $42 million, a 40% decrease from the first quarter, resulting from significant declines in drilling and well construction activity in North America. This decrease was mitigated by our international exposure in this segment. To put that in context, despite the low commodity price environment in the second quarter, our drilling product line was awarded a multiyear contract to supply rig handling tools and related equipment for a 24-rig new build program in the Asia market. Orders for the second quarter include $14 million for this award with additional orders under the award anticipated in the second half of the year. Segment revenue was $47 million, a $29 million or 38% sequential decrease as book and ship activity across the segment was impacted by lower activity levels and lockdowns due to the COVID-19 pandemic. Adjusted EBITDA for the segment was negative $3 million in the second quarter, a sequential decrease of $10 million. In our Completions segment, orders decreased 72% to $14 million. Segment revenue was $18 million, a sequential decrease of $33 million or 65% due to the virtual standstill and well completion activity in the quarter. The segment was also impacted by shipping delays from one of our international customers due to the impacts of COVID-19. Adjusted EBITDA for the segment was negative $6 million, a $10 million sequential decrease. Despite the significant cost reductions mentioned earlier as well as additional furloughs in several facilities within the segment, the magnitude of the decline in revenue and resulting loss of operating leverage from unabsorbed fixed costs had an outsized impact on our Completions segment EBITDA. Production segment orders were $29 million, a sequential decrease of 43%, primarily due to a significant decline in customer bookings activity for our valves product line as customer activity ground to a halt due to the pandemic due to pandemic-related lockdowns and significant distributor destocking. Segment revenue was $49 million, a 13% decrease due to lower sales of valves. This decrease was partially offset by a slight increase in shipments of surface production equipment for our customers focused on natural gas production in the Northeastern United States. Adjusted EBITDA for the segment was $2 million, up $2 million sequentially due to lower overhead expenses from cost reductions. I will now discuss some additional details about our results and financial position at the Forum level. Our capital expenditures in the second quarter were less than $1 million. We are a capital-light business, and we expect our total capital expenditures for 2020 to be less than $5 million. In the second quarter, we reduced net debt by $32 million, primarily due to the repurchase of $72 million principal amount of senior notes at a discount. We ended June with $110 million of cash on the balance sheet and availability under our revolving credit facility of $84 million, resulting in total liquidity of $194 million. Our debt at the end of June included $85 million outstanding on our revolving credit facility and $328 million of unsecured notes due 2021. Following the debt exchange completed earlier this week, we now have $315 million of new secured notes due in 2025 and $13 million remaining on the old unsecured notes. In connection with the debt exchange, we also amended our revolving credit facility. The changes include: a reduction in the size of commitments from $300 million to $250 million, an increase in the interest rate margin, a limit on the amount of availability derived from our inventory collateral and certain other administrative changes. The maturity of the revolving credit facility will be October 2022 with the resolution of the small remaining stub of all notes. Pro forma for the credit facility amendment, our liquidity at the end of the second quarter would have been $126 million. Interest expense was $6 million in the second quarter. While we do expect higher interest expense following our debt exchange, the 6.25% of cash interest on the new convertible notes is consistent with cash interest on the previous notes. In the second quarter, depreciation and amortization and stock-based compensation were $12 million and $3 million, respectively. We expect these expenses to remain at similar levels in the third quarter. Adjusted corporate expenses were $6 million in the second quarter, and we expect them to be similar in the third quarter as well. We will continue to have some tax expense despite an overall net loss as we are not recognizing tax benefits in loss-making jurisdictions, but we continue to recognize tax expense for some international jurisdictions with income. Once we turn profitable in the loss-making jurisdictions, we expect to 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 Neal to discuss some of our key operating initiatives.

Thank you, Lyle. Good morning, everyone. First off, I want to thank our employees for the remarkable resilience during these incredibly difficult times. Together, we made sacrifices to dramatically reduce costs and position Forum for the future. The market will recover, and when it does, our employees will be the key differentiator in our success. As Cris and Lyle have mentioned, the unprecedented decline in drilling and completions activity due to COVID-19 significantly reduced demand for many of our products. In response, we have sized our businesses to produce positive EBITDA with only a modest market rebound. We remain committed to controlling costs while generating cash flow from inventory. The second quarter presented the most challenging market conditions in a generation. Our ability to execute will increase as the market improves. Forum's customers rely on our products to increase their productivity and reduce their cost. For example, within our Forum Multi-lift solutions product portfolio, we provide sand management tools and cable plants that extend the life of electric submersible pumps, or ESPs. These products witnessed an increase in monthly demand after bottoming out in May, and we expect demand for these products to continue as we as more wells are brought back online. Another example of Forum's winning products was the large multiyear rig handling tool award Lyle referenced earlier. In an industry where capital is limited and tight, our customer selected the premium product of our handling tools and we are very excited to play a key role in this rig new build program. Let me provide one more example. In the midst of last quarter's meltdown, one service company customer was proud to post a picture of social media with one of their frac fleets working. Among the key components in that picture, seven were supplied by Forum, seven. Our 3,000 horsepower pumps, our JumboTron radiators, our ICBM single-line manifold, our high-pressure flow wire, our AMT wireline pressure control equipment, our Hydraulic Latch Assemblies and our newest product from quality wireline and wireline cables. In addition, after the frac work was completed, our DURACOIL coiled tubing from Global Tubing was used for drilling out the plugs and our Forum SandGuard with Cannon clamps was used with the artificial lift installation. This picture reinforced to me that Forum has the products, the people and the desire to be the leading solutions provider in our space. These are just a few examples, and I can name many more from our valve solutions, production equipment and subsea product lines. The market rebound may take many months to occur, but when it does, we are positioned to win. I'll now turn the call back over to Cris for his closing remarks.

Thanks, Neal. The second quarter presented an extremely challenging market environment, but I am proud of the way our team has navigated through the significant cost reductions. I am also pleased with the outcome of our debt exchange, which leaves us well positioned for future growth. We now have the cost structure and the balance sheet to prosper in a lower-for-longer environment. Forum has excellent earnings power potential with our stable of well-positioned completions products, artificial lift accessories and well construction products, to name a few. With our new much more efficient cost structure, we can realize this earnings potential at a much lower level of drilling and completions activity than in the past. Thank you for your interest in Forum. And at this point, we will open the line for questions. Shanteller, let's take the first question.

Okay. And your first question will come from the line of Dan Pickering with Pickering Energy Partners.

Morning, guys. A couple of questions, I guess, Cris, I mean, the exchange offer here definitely extends the runway, which is critical. Given you've got runway now kind of from a strategic perspective, can you talk a little bit about how you claw back out of the hole that we're in from an industry perspective? And do we look for divestitures? Do we look for acquisitions? Do we look for status quo? I mean, what's the how do we play offense from here given the balance sheet is now in better shape?

Yes. I we're very pleased that we're getting off defense and playing offense again, Dan, and that offense will be in a number of forms. The organic side will be, as Neal and I have talked about, emphasizing our strong products that have good market position, good share, solutions capability for our customers and where we can see that near-term earnings power potential and we're putting the resources most behind those. We have been thinning out our operations at our facilities and our product offering here, so we can emphasize those that have the greatest potential in the near and medium term. One of the benefits from the debt exchange and the new debt structure is we do have the liquidity and we do have the flexibility to once again look at acquisitions with the condition that we're not looking to lever up the company for sure. But we do have that flexibility, and that's getting back, I think, to a historic strength of the company. So our focus will be on products that have really good earnings power potential in the new market environment, rounding out that portfolio, but taking advantage of the much lower cost structure, so we can be successful at a lower level of rig activity, lower level of completions activity and still deliver good returns for our shareholders and taking advantage of our runway and the path to deleveraging that we were talking about.

And a follow-up there just on the numbers. You talked about revenues flattish for the third quarter and EBITDA improved. I just want to test some math with you to make sure I understand kind of the dynamic here, adjusted EBITDA for the quarter, $11.6 million negative. You talked about, I think, realizing about $100 million of cost savings, but expecting $150 million, which implies sort of another $50 million of cost savings to come, which should be about $12 million a quarter. I mean that math would say we get EBITDA back close to breakeven in the third quarter just from cost savings alone. Am I missing anything? Is my math in the right ballpark?

Yes. Let me clarify it. That's not entirely correct, actually. What we said was that year-over-year second quarter 2019 to second quarter of 2020, its $150 million of savings annualized. Sequentially, from Q1 to Q2, it's $100 million. But we did implement some of those cost savings during the course of Q2. So Q3 will have more benefit from the cost savings, and that will and we have ongoing plans as well. And so we do expect the third quarter cost to be lower, which will drive the improvement in EBITDA. On the revenue side, obviously, there was deterioration during the course of Q2 from April to May to June as activity came down. We're already seeing some improvement, look at the frac fleets going back to work, for example. So we expect the reverse to occur during the third quarter and to be coming out of the third quarter at a better run rate from a revenue standpoint. So although we're flat quarter-to-quarter, we'll be coming out of Q3 with a better run rate and the lower cost structure.

Got it, thank you, I'll let others ask questions. I've got a couple of more. I'll queue back end. Thank you.

Okay, thank you.

[Operator Instructions] And you have a question from the line of Aaron Maggie.

Hi, good morning. I'm a shareholder. Just had a question about getting back into compliance with the New York Stock Exchange minimum of $1 per share. Did we get any extension to that six months or do we have a drop-off drop-dead date for that?

Yes. So we do have shareholder approval to do a reverse split to get back in compliance with that. We have been waiting on that until we had the success of the debt exchange, which has now occurred. We still have some time on that. But yes, we do expect to move ahead with the shareholder approved reverse split that will put our stock back in appliance. And as you know, a stock split or a reverse stock split is just arithmetic, and it a 10% move in the stock is still a 10% move in the stock. It should be transparent and no impact on shareholders and just a matter of the math. And so you should expect that, that will occur this year.

Okay, thank you.

And we do have a follow-up question from the line of Dan Pickering with Pickering Energy Partners.

So you've got a lot of working capital in the second quarter. I'm just curious around I assume inventories become this kind of primary source of working capital improvement. Can you talk about how you think about targeting inventories? Is there a dollar number? Is it the turns are pretty low right now, but how do we think about that inventory monetization and is it how do we?

Yes. So given the level of activity we have now, we have excess inventory, and we're looking to move that aggressively and turn that to cash. So that is our liquidity bank, if you will, that's in addition to what we talk about when we talk about our liquidity from our bank facility or cash on hand. And so we are aggressively moving in that direction. Maybe, Neal, you can give some examples of areas where we think we can focus on inventory movement.

Sure. Dan, so I think with our product portfolio and our wide reach, we're able to go to many markets across the world. As an example, our stimulation product line has historically been focused on the United States. We utilizing our sales network across other product lines, we've begun to move a lot of that inventory into other markets in Asia and in the Middle East. So we do have a lot of options to do that, and we continue to move forward on that.

Yes. Good. From a - and then obviously, orders on the Completions side were quite low. How what should we be watching to kind of find the bottom here? Do we watch frac counts out in the field? Or are they still cannibalizing equipment? How what do you think the lag time is between your activity improvement and you guys seeing orders and revenues?

Sure. Dan, Neal again. We are starting to get inbound calls, and customers are looking for frac readiness. There is a lot of equipment out there. I guess I would compare it to having a race car sitting on the shelf for six months, expecting it to run Indy 500, 20 days in a row. It's a challenge to do that. And I think we're going to see customers realize they do need newer equipment or at least a significant service on that equipment. So we are seeing those types of calls and some initial orders from that. So I think the rig count bottoming is definitely a good indicator for our Completions segment.

Yes. I mean operators are very picky these days. They want that equipment to be working and the stages to be done, and they have no patience for downtime. So it's hard for service companies to take risk on equipment that they're not confident in. And then, of course, we sell other products that are associated with that pickup in completions, whether its wireline cable or coiled tubing strings, which don't store real well. So there are a number of areas in this short-cycle space on completions that we're beginning to see some positive signs.

Good. And do you view the valve slowdown as more COVID related? Or is it more energy downturn related? In other words, do we think that the valves pick back up as kind of pandemic stuff eases off?

Yes, Dan, good question. Our valves business, as you know, is spread not only upstream, but also through midstream, downstream and even into industrial applications. So the upstream portion of our slowdown, and upstream represents a smaller piece of our valves business, was really energy related. The downstream portions in industrial were COVID lockdown related. So many facilities, whether those be refineries or chemical plants, were locked down to an essential personnel-only basis, and they really move to only doing emergency copiers to minimize the chance of any kind of covet impact. So definitely, a big piece in sales is tied to that lockdown of activity for coronavirus. And as you see, the economy starts to open back up we would expect those things to rebound as well.

Last question, when you think about all of the adjustments that you've had to make to the business to stay at this level of profitability, and I commend you, I know it's been hard, what do you think like what's happened to revenue-generating capacity? When we think about things getting better, can revenues do you have to start adding costs back when revenues go up 10%? Can we double revenues without changing the cost structure? What's - kind of what's our capacity at this point in time with the structure that you've got in place right now?

Yes. I think they're I'd put that in two buckets, probably. The overhead cost, the SG&A, we have a lot of capacity for growth. Although our SG&A costs are significantly lower than they were. On the cost of goods sold side, how many folks we have working in our facilities, we would need to hire that folks back. But that cost, of course, goes directly into inventory and product cost to be sold, so it's directly related to our volume. So we would be needing to add some cost, but that is the cost of goods sold, if you will. But I think the benefit is that our fixed costs in terms of facilities and our fixed costs and SG&A is significantly lower than it is and so brings down our cost structure and brings up our earnings potential for any improvement in completions and drilling activity from here.

Yes. I fibbed. One more, guys, sorry. So it feels like what you're essentially telling us without giving formal guidance is we've now kind of hit the bottom in terms of revenue and profitability. Rig count probably isn't going much lower. COVID is probably not getting much worse, cost cutting, etc. So when you guys look at the second half of the year here, in a flattish revenue environment, maybe even it's a little bit better, you've been generating free cash, a lot of that's coming off of the balance sheet. But it sounds like you should generate free cash in the second half of the year even at these revenue levels, assuming no incremental downturn.

Yes, Dan, I think from a guidance perspective, that's exactly right. And spot on with respect to the free cash flow generation of the business. That's been a major focus for us. As we I mentioned in the remarks, seven quarters of free cash flow, and we do expect to be free cash flow positive in the back half of the year as we're able to bring down inventories in the balance sheet even further.

Well done, guys. Thank you.

Thank you, Dan. We will wrap up the call at this point. Shanteller, thank you very much. And we'll talk to all of our good friends and shareholders next quarter. Thank you very much.

Thank you everyone. This does conclude today's conference call. You may now disconnect.