Forum Energy Technologies, Inc. (FET) on Q3 2021 Results - Earnings Call Transcript
Operator: Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies Third Quarter 2021 Earnings Conference Call. My name is Annie and I will be your coordinator for today's call. At this time, all participants are in a listen-only mode, and all lines have been placed on mute to prevent any background noise. 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.
Lyle Williams: Thank you Annie. Good morning, and welcome to Forum Energy Technologies third 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's 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.
Chris Gaut: Thanks, Lyle, and good morning. The improvement in drilling and completions activity is continuing with strong rig count additions during the third quarter both domestically and internationally. We are also seeing more interest in offshore oil and gas activity, as well as subsea opportunities in defense and for the energy transition. All of this improvement in activity drove another strong increase in our inbound orders, the fifth increase in quarterly bookings in a row. We are now seeing higher orders across all of our product lines and in the third quarter we had a record high book-to-bill ratio for the company. Our longer lead time capital equipment businesses such as subsea and parts of our drilling product line are seeing strong orders that stretch into next year. Even our short-cycle businesses are seeing high orders as customers become more concerned about availability. However, this sharp increase in demand is running into the same supply chain issues affecting all manufacturing companies and indeed affecting us all now in our daily life. Cost of raw materials are up significantly and virtually everything is taking longer to ship or is on back order with freight costs up several-fold. Although our team at FET is doing a good job managing these issues, we are not immune. And supply chain did have even more of an impact on our revenue and margins in the third quarter than we previously anticipated. Without these additional supply chain delays our, revenue would have been $10 million to $15 million higher than the level we actually achieved in the third quarter. We are, of course, raising our prices as a result of cost inflation and we did realize some pricing improvement in Q3 to partially offset higher input costs. However, we expect that in this fourth quarter, our pricing will begin to catch up with cost inflation and our margins will start to improve again. Given the current level of supply chain constraints and resulting limits on productivity, our guidance for FET's fourth quarter are revenue in the range of $145 million to $155 million and EBITDA of $9 million to $11 million. So revenue $145 million to $155 million, EBITDA $9 million to $11 million. With higher activity levels and our strong orders, we expect an improved growth rate in 2022 as supply chain issues become more manageable. Industry fundamentals have improved with high oil and gas prices very attractive economics for drilling and completion and the need to reactivate and maintain more oil service equipment. So we believe the outlook for FET is very attractive. We also believe our stock is undervalued relative to other asset-light manufacturing companies in our sector, especially given our high international exposure, expanding opportunities as part of the energy transition and the clear path we have to automatically delever our balance sheet once our stock exceeds $30. For these reasons, our Board has authorized a $10 million stock buyback program, representing about 8% of our shares outstanding at the current stock price. We feel our own stock represents the highest return, best investment available to us now. And with that, I'll turn it back to Lyle.
Lyle Williams: Thank you, Chris. In the third quarter, the FET team was able to deliver $141 million of revenue and $7 million of adjusted EBITDA, a 9% sequential increase. In addition, orders grew sequentially by 11% to $176 million. The strong backlog we now have sets the stage for meaningful revenue growth into next year. Let me share further information about our segment operating results for the third quarter. On a sequential basis, our Drilling and Downhole revenues increased 3% or $2 million and adjusted EBITDA also increased by $2 million. Incremental margins for the segment were well over 100% sequentially. All three product lines in the segment contributed to the strong operating performance. Subsea led with fulfillment of large capital equipment orders. Our artificial lift product offerings continued market share gains and our drilling product line benefited from favorable product mix. In our Completions segment, revenue increased by 7% to $50 million as North American well completions activity trended higher in the quarter. In addition, orders for this segment grew 26% to $60 million, due primarily to orders for new product offerings, which we expect to deliver over the next six months. However, due to significant material and freight cost increases, adjusted EBITDA for the segment decreased by $1 million. In our production segment, the timing of customer order patterns is relatively lumpy compared to our other product lines. As such, orders for the third quarter grew sequentially 6%, due to large orders of desalinization process equipment and revenues decreased by $1 million, due to lower sales in our Production Equipment product line, partially offset by higher sales of valves into the downstream market. Adjusted EBITDA was roughly in line with second quarter results, despite the lower revenues. The production segment has been particularly impacted by cost inflation and supply chain disruption, due to the long lead time between customer order placement and order fulfillment. We are actively pushing pricing in this segment to recover future profitability. To wrap up segment results, our adjusted corporate expenses were $6.5 million in the third quarter, in line with the previous quarter. The special items called out in the release for the third quarter include, $3 million of restructuring transaction and other costs and a $4 million gain on foreign exchange. Free cash flow in the third quarter was negative $6 million. Our net income adjusted for noncash items improved by $6 million sequentially. However, changes in net working capital consumed $14 million of cash in the quarter. Customers held back trade receivable payments at the end of the third quarter, driving up our accounts receivable faster than we grew our revenues. We also paid $7 million for the termination of a benefit plan. Due to the aforementioned supply chain constraints, we have targeted inventory purchases to secure materials for 2022 revenues and we expect customers to once again withhold payments at the end of the fourth quarter. So, we currently forecast fourth quarter free cash flow will be negative, roughly equal to our $12 million semi-annual interest payment with cash flow from operating activities net of working capital changes to be approximately breakeven. Despite the build in net working capital in the back half of 2021 our liquidity position remains strong. In September we amended our ABL credit facility to subject to certain exceptions extend the maturity to September 2026 and reduced the facility size to $179 million. This new facility size reduces loan commitment fees, while providing significant flexibility to grow our borrowing capacity along with revenue. Following this amendment, we ended the third quarter with total liquidity of $181 million comprised of $50 million of cash on hand plus $131 million of availability under our credit facility which remains totally undrawn. We ended the quarter with net debt of $207 million comprised of $257 million of senior notes due August 2025 less the $50 million of cash on hand. Now let me turn the call over to Neal to further discuss our operating initiatives. Neal?
Neal Lux: Thank you, Lyle. This morning I will provide additional details on our strong bookings, supply chain challenges, price increases and energy transition. At FET our team of experts work closely with customers to develop products and solutions to make energy production safer, cleaner and more efficient. A great example of these efforts is our Serpent Series high-pressure flexible hose and single-line manifold system. This solution with our patent-pending modular end connections, eliminates nearly all failure points and lead path experienced with traditional high-pressure flow wire while increasing uptime. Since its introduction in the second quarter, we have booked eight fleets of our Serpent Series solution at a value of just under $20 million. This is a great start and as high-pressure flexible hoses replaced flow iron more broadly in 2022 and beyond the addressable market should be significant. We have an excellent growth opportunity ahead. Switching gears from US onshore to international offshore our subsea product line had another very successful quarter. With four remotely operated vehicles booked during the quarter, the team has landed 11 for the year. When paired with our launch and recovery systems, the value of these orders is nearly $5 million each. These vehicles are utilized in harsh environments. Very few companies can meet the technical challenge, FET can with the engineering capabilities we have developed over the last few decades. And we believe we are only scratching the surface. Our vehicles and expertise are well suited to serve the offshore wind market during site survey in preparation construction and maintenance. This product line is poised for growth in the coming energy transition. Additionally, our Subsea product line continues to serve the defense sector. During the quarter we completed sea trials and final delivery of our LR11 rescue submarine. Also, we have a number of ongoing naval projects with various countries around the world ongoing. We are very pleased by the results delivered by our Subsea product line and their prospects for the future. In addition to the examples I just provided, we maintained good order flow across many markets including our consumables and aftermarket products. Overall, for FET the third quarter was a strong one for bookings. As Chris mentioned in his opening remarks more of those bookings would have been turned into revenue without the supply chain disruptions experienced in the quarter. We had disruptions for inbound raw material and outbound shipments of finished goods. On the inbound side, our vendors struggled to meet delivery commitments due to employee constraints and a lack of key components. These issues were then compounded by shortages of containers and vessel space. Outbound shipping was also an issue for the delivery of finished goods. There are fewer vessels sailing each month and booking space is limited with roughly 40% of our revenue shipped internationally, this is impactful. In other instances, our customers have lacked the manpower due to COVID-19 and associated quarantines to pick up and receive their orders. Our teams are working closely with vendors to mitigate the impact of these delays. In some cases, we can substitute components, in others we air freight the material to meet customer deadlines. Also as Lyle mentioned, we are building strategic inventories to buffer ongoing supply chain uncertainties. Given the current environment around the world and across industries, it will take some time to catch up. While getting the supply chain to line is important, it is also important that we regain our margins through price increases. We have been strategic with our pricing and thoughtful of the markets we participate in. That said, we have raised prices on almost all products and will likely do so again. While price increases are never popular, our customers understand that inflationary pressures are pervasive throughout our economy from grocery stores, to the gas station. This is a fluid situation and we'll continue to monitor our costs and adjust prices accordingly. My last topic this morning, is with regards to energy transition. At FET, we solve problems for our customers by utilizing our engineering and manufacturing talent and we reach a lot of different markets. This gives us many opportunities to participate in the energy transition space. A good example in the third quarter was seen in our production equipment product line. Historically, we have focused on providing well site equipment like gas processing units. However, by combining our core manufacturing competencies with innovative process engineering, we were able to secure a sizable biogas equipment order. With our product, animal and food waste will be turned into renewable natural gas. This is a great first order, in what could be a fast-growing and impactful market. Another area of focus is helping our customers reduce methane emissions. Our team at FET, will begin marketing a new choke early next year that aligns with that goal. Importantly, our trim kit can be inserted into existing chokes, allowing our customers to immediately reduce their methane emissions in a cost-effective manner. With a growing focus on ESG by operators, this new product is really exciting. I cannot wait to see what they develop next. Thank you for your time this morning and I'll now turn the call over to Lyle, for closing remarks.
Lyle Williams: Thanks, Neal. I'll wrap up today's prepared remarks by thanking our fellow employees, for their diligent effort and by taking a look back at what FET has accomplished, over the past year. In the third quarter of last year, we completed the exchange of our long-term notes for convertible notes extending significant debt maturities to 2025 and providing a clear path to further leverage reduction. In December, we sold a business for over $100 million, which reduced our net debt by approximately one-third. At the beginning of 2021, we improved EBITDA by another $20 million annually through portfolio cost restructuring. While all of these efforts were underway, the team grew our top line maintaining the long-range correlation of our revenue with US rig count. Pro forma for the business divestiture, our quarterly revenue is up $48 million compared with the third quarter 2020 and our bookings have more than doubled. Over this same time period our quarterly annual -- I'm sorry our quarterly adjusted EBITDA has improved to $20 million or $80 million annually reflecting 42% incremental EBITDA margins. We are now a leaner, more profitable enterprise with a clear path to significant debt reduction and substantial upside in earnings. Annie, may we please open the call for our first question.
Operator: Thank you, sir. Our first question comes from the line of Ian MacPherson from Piper Sandler. Your line is open. You my ask your questions.
Ian MacPherson: Hi. Good morning, everyone.
Chris Gaut: Hi, Ian.
Lyle Williams: Hi, Ian.
Ian MacPherson: So I wanted to ask just a couple of questions upfront. Obviously, I think the positive highlight of your report here is the orders, which continue to show strong improvement. And I was wondering if you could maybe tease for us how Q4-to-date order trajectory is looking and what that means in terms of your visibility into top line improvement in Q1 and Q2? And then -- that's the first question. Then the second one I had is really just, what needs to get unstuck and fixed in order to get past the margin impacts that everyone is suffering, everyone, I guess, in your world and many businesses are suffering, near term, if we're going to get to the margins that you aspire to. Is it within your realm of control right now to get margins where you think they should be, or do you really need to see the macro factors with supply chain normalize before we can get to better margins than what you're envisioning for Q4?
Neal Lux: Sure. Ian, I'll start with the first part on bookings and the trajectory. We continue to see strong inbound quoting activity for our key products. In the third quarter, we had some fairly large bookings come through with our ROVs and with our single-line manifold systems. And so we think that those are pretty large ones, chunky. But I think our overall trend is continuing forward and may or may not equal what we did in the Q3 with those large ones, but I think the overall momentum continues forward.
Chris Gaut: And demand is strong, Ian, as you can imagine with activity continuing to improve. So that relationship between higher activity, using rig count as the benchmark there, and our revenue and orders continues to hold. As for your second question regarding margins, I think we are making progress there. If you look at the segment level, we've made great progress in our Drilling, Downhole and Subsea segment and pleased with the margin progression there. And they're doing well. Our Completions business has also made very good progress and I think they've got more running room to go, as they implement some of these price changes we talked about and overcome some of the cost increases for steel and so forth. So really good progress there. Obviously, we'll benefit from the operating leverage of higher revenue that within the Production segment, I think, they have been particularly impacted by the supply chain challenges, Ian, and that's really held back the margins there. A couple of reasons for that, one, within our production equipment, we took orders months and months ago, late last year first quarter this year that, we're delivering now, and we've had significant cost increases that were not anticipated then. So that has impacted the margins, similar on the Valves business, with a long supply chain there, but also given our sourcing a lot from Asia significant delays in – which affects fulfillment, as well as cost increases, right? So price increases to overcome that, catching up with the cost increases, and now getting in some of those delayed orders. So we have the material on the shelf to supply the demand that we see, realize the operating leverage within the Valves business, and the Forum overall. So I think, those will be key elements to the higher margins going forward. And we don't want to understate the potential for price improvement in many of our businesses.
Ian MacPherson: Got it. Thank you very much, Chris and Neal. Appreciate the color.
Chris Gaut: Great. Thanks, Ian.
Operator: Thank you, sir. We have another question from the line of Dan Pickering from Pickering Energy Partners. Your line is open. You may ask your question.
Dan Pickering: Hi. Good morning, guys. Thanks for taking my questions. I just want to check my math. I think Lyle or Chris, I heard you say that, we think the supply chain issues cost us $10 million to $15 million in – on the revenue side, I'm not sure, if I heard an EBITDA implication. Do we think that that 25% 30% incremental margins would make sense and so we would have had a another $2 million or $3 million of EBITDA in Q3, if not for the supply chain?
Lyle Williams: Dan, I think you're on with that kind of a number. We definitely felt that $10 million to $15 million with supply chain challenges and 25% to 30% incrementals would have been very reasonable given the impact of those. We look ahead and think about a similar knock-on effect in the fourth quarter. And hence, we've taken down our guidance, a bit from what we had previously done at the EBITDA level. Supply chain challenges continue to be out there. But also, we saw in the third quarter something that will be incremental to that is a bit of a slowdown with operations in some of our service company customers. They delayed operations and therefore delayed pick up of what would have been more book and ship revenue for us. So we saw kind of an incremental to that, a knock-on effect in the third quarter. So yes, we could quantify $10 million to $15 million worth of product that we couldn't get out the door and we know that there was a bit more. So, definitely an impact from not only supply chain, but also from COVID operations in the field.
Chris Gaut: Well, when you say delayed by our service company customers, you're not saying that they didn't have the work. You're saying that, they had problems with labor or with quarantines, or things like that where they couldn't staff or perform the work that they had contracts.
Lyle Williams: That's right.
Dan Pickering: Well, we will blame COVID for what looks like you would have probably exceeded your guidance, if not for those issues. And I appreciate you incorporating that in the go-forward guidance. On the share repurchase kind of a two-pronged question here. Is there any specific timing associated with the authorization? And have you given any thought to sort of the -- any parameters around what you're going to implement that repo?
Chri Gaut: Yes. I mean, we think this is a great value here as we said Dan. And so there's nothing that stands in the way of us beginning that program. As you know there are rules about volume limitations and so forth. And of course we'll be abiding by those. But we've got the resources and we've got the will to move forward with the plan.
Dan Pickering: Yes. And Chris is there any -- so $10 million -- I mean, obviously 8% of the shares is a meaningful number. You've got $50 million of cash. Do you -- are you using a debt-to-cap measure, or how are you thinking about 10 turning into 20 or why won't 5? How do you think about sizing?
Chri Gaut: Yes. We do have some constraints within our credit agreements as things stand at this point in time. So that's a factor Dan. And also let's see how this program proceeds right?
Dan Pickering: Sure, sure. Last question. I usually ask 10, I'm only going to ask three this time. Energy transition you talked about some new products there. You talked about growth opportunities. Do we think about that as similar margin opportunity to your existing business? Is it a better margin opportunity? How could it impact the kind of mix as we move ahead?
Lyle Williams: Yes, we're starting to get these new opportunities and it's great to see them. And I think with our -- again our wide reach and our ability to touch a lot of different adjacent markets gives us a lot of shots at this. As we think about it I think the margins should be in line with our existing businesses. And depending on the amount of innovation we can add potentially more with some new thoughts and new ideas because we are entering new territory here. But yes I think it's a great opportunity and I'm really pleased that we have so many shots on goal here.
Dan Pickering: Okay. So no need to buy your way into that market you're getting acceptable profitability as is and maybe some margin upside?
Lyle Williams: Right no loss leaders there. That's right.
Dan Pickering: Okay. Thank you very much. Appreciate it guys.
Chris Gaut: Well, Annie we're going to end the call at this point. We appreciate the interest and the questions and we will talk to you all next quarter. Thank you very much.
Operator: Thank you, sir. Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Thank you for participating. You have a good day.
