Forum Energy Technologies, Inc. (FET) Q2 2021 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies' Second Quarter 2021 Earnings Conference Call. My name is Carmen and I will be your coordinator for today's call. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes. I will now turn the conference over to Lyle Williams, Chief Financial Officer, please proceed, sir.

Thank you, Carmen. Good morning. And welcome to Forum Energy Technologies’ second quarter 2021 earnings conference call. With me today are Chris Gaut, Forum’s, Chairman and Chief Executive Officer; and Neal Lux, our Chief Operating Officer. We issued our earnings release after the market closed yesterday and it is available on our website. Before we begin, we would like to caution listeners regarding forward-looking statements. Our remarks today may contain information other than historical information. Please note that we are relying on the Safe Harbor protections afforded by federal law. All such remarks should be considered in the context of the many factors that affect our business, including those disclosed in our Form 10-K, along with other SEC filings. Management statements may include non-GAAP financial measures. For a reconciliation of these measures, refer to our earnings release. This call is being recorded and a replay of the call will be available on our website for two weeks. I will now turn the call over to Chris.

Thanks Lyle. And good morning. A strong recovery and drilling and completions activity is well underway and FET is taking full advantage. We're announcing our customers placed orders for our manufactured capital equipment, as well as our short cycle consumable products. Our inbound orders increased sequentially by 15%, sequentially the fourth successes quarterly increase in orders for our current business portfolio are now nearly back to pre-pandemic levels. The higher order levels are now beginning to flow through our financial results as revenue increased sequentially by 20% in the second quarter. With our growing backlog and stable, strong brands and products, we expect continued strong revenue growth in the second half of this year and continuing into 2022. Market conditions for FET are favorable as our customers have largely exhausted their ability to cannibalize their stacked equipment and have depleted their inventories of spares. The positive trends and global drilling and completion activity, coupled with our customers’ need to restock their inventory and replace old equipment, sets up outstanding market fundamentals for FET’s domestic and international business. In addition, our non-oil and gas and energy transition businesses continue to expand with excellent opportunities for the future in the areas of GHG reduction, energy efficiency, defense and infrastructure. With the rapid improvement in demand, we are seeing supply chain constraints as others in our industry have commented. Such things as raw materials and logistics have shown, especially rapid and sharp price increases. We cannot pass through these costs increases as quickly as they have changed, but we will make it up over time. Neal, we'll talk more about this in a few minutes. We doubt that we will be able to fully offset the supply chain inflation in Q3, but by Q4, more of our price increases will be flowing through our results. By the end of this year, we expect our EBITDA run rate to be at $10 million to $14 million per quarter. And based on what our customers are now saying about their growth plans and assuming the global economy continues its current trajectory, we have excellent growth prospects for 2022. We generated a nice positive, free cash flow in Q2, despite the increase in our receivables. And we expect to be positive in cash flow in the second half of this year. We believe our liquidity and cash resources will be more than adequate to fund our continued growth. Now let me turn it back to Lyle.

Thank you, Chris. I'm pleased to report on the strong operating results delivered by the FET team this quarter. Our topline growth exceeded U.S. rig count growth with bookings increasing by 15% and revenue increasing by 20%. The correlation of our revenue with U.S. grid count is holding and we see upside potential as we ship large orders of drilling and subsea capital equipment and as we grow our non oil and gas businesses. Revenue from markets outside the U.S., provide additional, sustainable upside for FET. Total revenue from outside the U.S. was 44% of revenue in the second quarter, up 28% sequentially and 40% when compared with the same period last year. Our second quarter bookings reflect our strong position and activity driven short cycle consumable products and continued demand growth for our differentiated capital equipment. In particular, our drilling in Downhole Segment led the strong order performance with a 39% sequential increase in bookings, including large drilling and subsea orders that Neal will discuss. Our revenue increased by 20% to $137 million in the quarter. Revenue grew in almost every product line, including sizeable project shipments of drilling rig handling tools and North American completion products. EBITDA increased by $5 million to $7 million, which was in line with our $6 million to $8 million guidance for the quarter. We would have generated even higher EBITDA growth in the quarter, but for the impact of freight and steel inflation that we are seeing. Looking ahead, our guidance for the third quarter is revenue to be between $145 million and $155 million and EBITDA to be between $7 million and $9 million. Let me share further information about our segment operating results for the second quarter. On a sequential basis, our Drilling & Downhole revenues increased 26% or $13 million and adjusted EBITDA increased by $4 million. Several large international projects for our drilling technologies product line that shipped in the quarter accounted for the significant revenue increase for the segment. We also saw a nice increase in revenue for our artificial lift and subsea products. In our Completion segment revenue and adjusted EBITDA increased by $9 million and $2 million respectively. Revenue grew for all product lines in the segment led by our pressure pumping products that continue to benefit from the strong activity levels in this market. Incremental EBITDA margins for the Completion segment were lower than we typically experienced due primarily to the aforementioned material and freight cost increases. In our Production segment, bookings and revenue tend to be lumpy due to the size and timing of individual orders. As a consequence, overall segment orders decreased sequentially while revenues increased $1 million and the mix of lower margin production equipment combined with cost inflation resulted in $700,000 of lower EBITDA for the segment. To wrap up segment results, our adjusted corporate expenses were $6.5 million in the first quarter in line with our expectation, we anticipate similar results in the third quarter. The special items called out in the release include a $4 million loss on extinguishment of debt, $3 million of restructuring and other costs and $1 million gain on foreign exchange. Free cash flow of $4 million exceeded our guidance for the quarter as working capital decreased more than expected. We paid $14 million of interest in the second quarter from our semi-annual interest payment and a small additional amount tied to the debt we retired in the second quarter. Net of this interest payment unlevered free cash flow for the quarter was $18 million. We expect free cash flow in the second half and full year to be positive. We ended the quarter with total liquidity of $186 million comprised of cash on hand of $60 million and $126 million of availability under our asset backed credit line, which remains undrawn. In the second quarter, we repurchased $42 million face value of our 2025 convertible notes leaving a total outstanding balance of notes of $259 million. Under the indenture for these notes, we have an obligation related to the net proceeds from our valves divestiture that occurred at the end of last year. This obligation requires us to return what is defined as excess cash proceeds from the divestiture to holders of the notes within one year of the closing of the transaction. Based on the cash deployed to repurchase notes this year and capital expenditures for the remainder of 2021, we are pleased to share that this obligation has been satisfied. And the full $60 million of cash on our balance sheet is now available for deployment and growth initiatives. I’ll wrap up with a discussion of our long-term debt and the benefits of conversion of our debt to equity. Of the convertible notes outstanding at the end of the second quarter roughly one half would mandatorily convert to common stock when stock prices trade above $30 for 20 days. The impact of that conversion would increase our diluted share count from 5.5 million to 10 million, and would be a significant benefit to the FET balance sheet, reducing net debt by approximately $120 million to about $80 million on a pro forma basis as of June 30. Our resulting debt to market capitalization would be approximately 26%. The prospect of this significant reduction to our leverage ratio improving market fundamentals and strong financial results provide confidence in the stability of FET and should improve equity valuation. Other small and mid cap oilfield service equipment companies with low leverage ratios currently trade and an enterprise value of 6 to 10 times 2022 EBITDA. As our core markets and FET financial results continue to improve. We look forward to the conversion of our debt and a significantly improved balance sheet. Now let me turn the call over to Neal.

Thank you, Lyle. Good morning, everyone. To begin, I’d like to thank the employees of FET for their dedication and professionalism. While we are a smaller, more focused company today. Our employees continue to deliver big results and they have met rapidly increasing customer demand while maintaining a strong safety culture. We have some of the best employees in the industry and is exciting to be a part of this great team. Shifting to our customers, momentum for FET’s products and solutions continues to increase. Demand for consumable and aftermarket products is very strong. We are capitalizing on outstanding brands and market share to deliver great results in our wireline handling tools, mud pump consumables, coil tubing, artificial lift, and subsea businesses. These businesses deliver high incremental margins and will grow as fast or faster than rig count over the long term. In our last call, I mentioned strong quoting activity for capital equipment components. These components are either packaged on new assets or use upgrade under utilized assets for use in more challenging environments. And during the second quarter, quotes were turned into orders. The subsea team booked three remotely operated vehicles and launch and recovery systems for use at offshore Brazil, including two ROV orders received in the third quarter, we have booked a total of seven ROVs this year. These are highly engineered products using incredibly challenging environment and FET is the preferred choice. In addition to that great win, we were awarded a large handling to order for a 17 rig new build program in Asia. The end users technical specifications are challenging and the Forum BNZ [ph] oil tools team had the best solution. Even in an environment where price still matters, the customer recognized our value proposition. We have a lot of great products. And I could talk all morning about each of them. But for the sake of time, I land with our FR120. This is another solution where FET stands above the competition. Our Iron Roughneck pipe handling tool has a lowest cost of ownership in the industry and is the ideal device for larger diameter drill pipe. The FR120 meets drilling contractor requirements to go deeper, faster and straighter. It is a clear winner in the market and we're doing everything we can to meet surging demand. As with many others in our industry, we are seeing headwinds relating to raw material prices, lead time and freight costs. Depending on the product, steel costs are up from 40% to 200% since the start of the year. Shipping costs from Asia to the U.S. are three times higher year-over-year along certain lane. Deliveries of key hydraulic sub-components have been delayed significantly. The combination of these issues had a second quarter cost impact in the range of a couple of million dollars. These issues will have a similar impact in the third quarter. To combat this inflation, we are pushing price increases for most products. This will have a positive impact on our book and ship business, but will not affect the backlog which we have already booked at a fixed price. Well, no one likes the price increase. Our customers understand the supply chain challenges our world economy is experiencing and given the strong demand for their services, they have been able to raise prices to their customers as well. What does this mean for FET? With our considerable backlog, existing contracts and competitive conditions, and a few markets, price increases will not materially improve our results above the third quarter guidance provided by Lyle. However, given our strong consumable and aftermarket sales mix, we should see a meaningful improvement in EBITDA during the fourth quarter, as Chris mentioned in his opening remarks. Looking ahead to the future, we are very encouraged by the macro environment. World GDP is expanding towards pre-COVID levels. Oil and natural gas demand is outpacing supply and prices are signaling the need for investment. And the oil field equipment cannibalization cycle has run its course. Our customers need to upgrade their equipment for today's more challenging environment and to buy more consumables for their drilling and completion operations. FET is well positioned to capitalize on this trend with our strong brand and excellent service. We are also well positioned to participate in the coming energy transition. Our breadth of experience and engineered solutions from submarines and wind farm support vehicles to methane capture and processing to geothermal application. We will be a key contributor in decarbonizing the world. In fact, this is not just a vision, but a reality. We are currently supplying critical components for carbon sequestration project. Over the project's lifetime, many millions of tons of industrialist source CO2 will be captured and sequestered. As an added benefit, our product has a significantly smaller carbon footprint versus the competition. This is a great start and we're excited to be a key contributor to reducing CO2 emissions. I will now turn the call over to Chris for closing remarks.

Thanks, Neal. There are a few points I'd like to highlight for you this morning. First, the fundamentals have moved in FET’s favor. Over recent months, there has been a significant shift in our customer's attitude and motivations from finding ways to avoid spending money to now needing to spend money to sustain operations and put more equipment back to work. Second, we see our orders and revenue continuing to grow with a positive shift in spending momentum by our customers. The increasing revenue will unleash these significant operating leverage in our business, given our now favorable structure for our fixed and overhead costs, although our variable raw material logistic costs are temporarily impacting our gross margins. We are taking price actions that will restore our incrementals. Third, with the increased revenue and operating leverage driving our improving EBITDA, we have a clear path to de-leveraging our balance sheet, which should be to a rerating of the stock and multiple expansion on the higher EBITDA. I believe FET is on the right course and we have an excellent team. Thank you. Carmen, let's take the first question.

Thank you. [Operator Instructions] We have a question from Dan Pickering with Pickering Energy. Your line is open.

Good morning guys. A couple of couple of questions. When you talked about and thank you for the color on the impact of the cost inflation. So when I do the math of a couple million bucks of cost hits to next quarter, and you're kind of midpoint of your guidance that would say, revenues up $12 million or $13 million in EBITDA, up $1.5 million, that'd be $3.5 million if you didn't have the $2 million of cost. That's sort of a 30% incremental EBITDA level x, the cost is that how we should be thinking about Q4 or should incrementals actually be better given the pricing impacts?

Dan, thanks. This is Lyle. I'll take a little bit of that. And as we think about our incremental is going forward, what we do see is with our backlog that we have in place today, have fixed prices. Our price increases are going to have a better impact on some of our short cycle products and after that backlog bleeds through. So Q3, therefore, being a little bit softer, we will have some backlog that's already been booked in the fourth quarter. But we do expect to see improving incrementals on that backlog as we see call it net price from here, on some of those new bookings.

Okay. And Lyle, while I've got you talking the working capital increase on the receivable side was pretty big $18 million on a $23 million increase in revenues quarter-to-quarter, was that these big international projects that are shipping, but they take a while to pay. And how do we think about sort of working capital impacts in the second half of the year?

Good question, Dan, thanks. From a day sales outstanding or DSO perspective, which is how we look at receivables, we're roughly in line with where we were at the end of the first quarter. So, those receivables call it in the 70 to 80 day range on average or where the industry pushed us with customers, not necessarily an impact from a change in mix. Typically with our international customers, we work hard to secure that payment or some sort of guarantee of that payment upfront. And it can have a little bit of mix as far as timing. But generally that’s where that is. So we were comfortable with the DSOs that we have and therefore the resulting increase in AR.

Okay. And yes, if revenues then continue to increase in Q3 and Q4, sort of how do you view the working capital requirement for the – for that revenue build?

Yes, really, really two big pieces for us in terms of working capital. So we said and would expect that our receivables would continue to grow as our revenue grows. On the other hand is inventories. And so in the second quarter, we saw inventories come down nicely and it would expect that with the inventory that we do have the ability to hold those generally. So maybe not have those come down the way that they would we’ll have activity picking up, be able to hold roughly consistent inventory level. So our big drag on working capital improvement is going to be receivables, but net net about similar with inventories.

And Chris as you talked about 2022 as a kind of a further growth year, we’re exiting fourth quarter in the $10 million to $14 million range, so $12 million at the midpoint there. So we’ve got a call it a $50 million run rate for 2022. And as you think about growth, are you thinking about growth from the Q4 level? So we should be thinking about at least $50 million of EBITDA for 2022 or is it growth from the average of 2022?

So thanks, Dan. We’re thinking about growth from the exit rate from 2021. We’re not putting a quantification on that yet at this point, but we think that with the ongoing improvement in drilling completion activity that need to reinvest our customers increasingly finding that they need to restock their inventories and update their capital equipment. All of those things should lead to a higher revenue for us and that flowing through at good margins in 2022 and growth in 2022 from the exit rate in 2021.

Okay. And potentially some expanding incremental then from that 30% level, just because of hopefully some pricing and operating leverage.

Yes. I mean the thing about incremental is they do vary from quarter-to-quarter a bit. There is a mixed element there. We had very high incrementals in Q1. I think over the course of this year, if you look over several quarters, our incrementals will be fine. And I think we’ll show good incrementals in 2022 as well.

Okay. I’m monopolizing the Q&A, but I’m going to keep doing it for just a second. I’m – I was encouraged by the fact that you’ve given guidance right for awhile the industry, it was too hard to know what was going on. It seems like from an order perspective, you’re comfortable now with some visibility. So I’m sort of struck by improving visibility, improving profitability and stock price that’s underperforming or at least been weak. And I’m just curious, is there anything associated with the debt? I know its convert or is there any – our folks is there an arm here where folks are shorting the stock to be long the debt or something like that, that might have an influence on stock price performance? Or is it just this is the way small cap oilfield service stocks are trading right now?

Well, there’s certainly an element of the ladder. But yes, to the extent, an owner of the converts who is a high yield investor is going to be converted in equity. I think they’re probably thinking about pre-positioning for that. So that’ll be something we’ll have to work through, but the fundamentals should rule the day, right. And as our EBITDA gets up and it becomes clear that we’re on our way to forcing the conversion un-leveraging, not just de-leveraging but un-leveraging the balance sheet that should get attention. And as I say driving a rewriting of a stock.

Right. And, remind me, there's the mandatory conversion with the 30-day, or 20-day stock price over $30, is there – when is the first time you can kind of push conversion other than that stock price trigger?

Dan you're right. The mandatory convert happens when our stock trades above $30 for 20 days. There's not an opportunity for us to force a conversion, there is an optional conversion at $27 for holders, but our view would be unlikely that a holder would convert. So probably we're looking at that conversion happening at the $30 period.

Got it.

The alternatives for us are going to be looking at a call, which that window opens for us about this time next year.

Okay.

Hey you got any other questions? Thank you, Dan.

Thank you.

Carmen.

Yes our next question comes from Peter Merrett with ERS.

Hey, great. Thanks for taking the call and a terrific quarter. It's been a long time, right. But it's nice to see things moving in such a great direction now. Just a few things, what do you see your CapEx needs is being now? And I guess really kind of a little perspectively here now that things have just sorted out so much, what's the CapEx that we should think about?

Yes. Thanks Peter. So, our CapEx numbers are still very low. And our needs would be really low going forward. As an equipment manufacturer, our big capital expenditures are going to be facilities, machine tools, things like that. And even with our restructuring efforts that we undertook late last year, we have significantly – we still have significant capability and capacity in terms of both of those. So as we look forward, even for the rest of the year, we've kind of guided that our full year CapEx would be under $10 million. And our forecast is lower than that. So, we see a pretty low need for CapEx, as a general rule on a go-forward basis.

This is not a [indiscernible].

Okay. Just a quick question about, so are you going to pick that extra portion of the coupon or do you think you'll pick that up in cash?

Yes, we've been paying that in cash and would expect that we would continue to do that, given the cash that we have on the balance sheet.

Yes. That's what I would expect, but just wanted to ask. And then just the amount, that would follow the mandatory conversion, what's the dollar amount you see that as currently?

Sure. Using the data that's in our indenture, Peter, that roughly looks like somewhere about $120 million of that outstanding debt would convert at the time of the mandatory conversion.

Okay, so $120.

[Indiscernible]. Yes.

Okay. And a few comments just on the overall M&A environment. Just what do you see out there?

Yes, I think Peter that there are interesting things developing in the M&A market, whether it is, privately owned companies, private equity owned companies that have been kind of stuck, or the opportunity for consolidation. Forums’ view is that we would like to get our equity value up and the clearest way to do that is the de-leveraging and rewriting of the stock. So our first priority is in that direction. But we are following what's available out there and we're seeing an improving, M&A landscape with less competition.

Okay. Okay, that's really it. But yes, again, next quarter. Thanks.

Thanks Peter.

Thanks Peter.

Thank you. And this ends our Q&A Session. I would like to turn it back to Chris Gaut for his final remarks.

Carmen, thank you. And we appreciate the interest. And we're going to keep up the hard work, here at FET. Thank you very much. And we'll talk to you next quarter. Good bye.

And with that, we conclude our conference for today. Thank you for your participation. You may now disconnect.