Forum Energy Technologies, Inc.

Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies' fourth quarter 2020 earnings conference call. My name is Angela, and I will be your coordinator for today's call. At this time, all participants are on 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 ask to turn the conference over to Lyle Williams, Chief Financial Officer. Please proceed, sir.

Thank you, Angela. Good morning and welcome to Forum Energy Technologies' fourth quarter 2020 earnings conference call. With me today are Chris Gott, Forum's chairman and chief executive officer, and Neil Lux, our chief operating officer. We issued our earnings release after the market closed yesterday and 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. After six years of oil and gas activity decline, 2020 stood out as a particularly challenging year. As a result of the energy demand destruction caused by COVID-19, drilling and well completion activity globally collapsed at the end of the first quarter, before beginning to improve slowly in the second half of the year. FET top line results followed that trend with a 46% decline in annual revenue from 2019 to 2020, as drilling activity measured by the average US rate count declined 55%. The response by the forum team was outstanding. We moved swiftly to manage cash, reducing our cash costs by 39% in the year, and focused on monetizing inventory, generating over $50 million of cash flow from inventory reductions. As a result, our decremental adjusted EBITDA margins were a respectable 24%, and the company posted positive free cash flow each quarter, with the exception of the second, where restructuring and severance payments drove free cash flow negatively. We also made excellent progress shoring up our balance sheet during 2020, reducing our net debt from $342 million to $201 million at year end, and extending the maturities of our bonds to 2025 and our bank credit facility to late 2022. I am proud of our team for their decisive actions to protect the company and its shareholders. The fourth quarter reflected an inflection point in results for FET. Both the U.S. drilling recount and the crack fleet count increased by 22% sequentially. Overall, our bookings increased 34%, and the book-to-bill ratio was our highest level since the market turned over in 2018. Revenues increased 9% sequentially to $113 million, in line with our expectations. Our adjusted EBITDA increased by $7 million to negative 2.6 million ahead of our expectations with the benefit of our strategic cost cutting and favorable mix. We have taken major decisive action at FET during this downturn. As important as our cost cutting and balance sheet repair have been, I think the most transformative change we have made is the recent high grading of our product portfolio. We are now focused on our highest margin and most differentiated products while exiting or de-emphasizing our more commoditized lower margin products. This significant change did result in the asset impairments in Q4 that Lyle will describe shortly. The key point is with these changes, FET will be a simpler, higher margin, and a higher return company. Lyle? Thank you, Chris. During the fourth quarter, the rebound in oil and natural gas prices led to an increase in drilling and completions activity and higher sales of our consumable products. As Chris discussed, we continued to execute on our strategic restructuring actions, resulting in additional operating cost reductions. And we closed on the sale of our ABZ and Quadrant valve brands for $105 million in cash proceeds, lowering our net debt by approximately one-third. Let me start by providing further information about our segment operating results for the fourth quarter. Our drilling and downhole revenue in adjusted EBITDA increased sequentially by approximately $7 million and $5 million, respectively. Our drilling technologies product line accounted for the majority of these increases. The 22% sequential increase in the U.S. rig count resulted in higher demand for our consumable drilling rig components. And international new rig projects drove an increase in our premium handling tools and drilling capital equipment. Our subsea product line continues to penetrate non-oil and gas markets with a substantial contract win which contributed to a total of $28 million of orders for this product line in the fourth quarter. Demand for our artificial lift and casing hardware products was consistent with levels in the third quarter. Let me insert a comment here about the geographic mix of our revenue. While the U.S. is an important source of revenue for FET, our non-U.S. revenues are growing in importance, led by our drilling and substitute product lines. In the fourth quarter, revenue from outside the U.S. accounted for over 40% of our consolidated revenues. We expect activity in this more stable market to expand further in 2021. For our completion segment, the increase in U.S. hydraulic fracturing activity drove a 56% increase in revenues and a $5 million sequential increase in adjusted EBITDA. Revenues were especially higher for our consumable coil tubing and wireline products required by service companies to increase well completions. Production segment revenues declined sequentially by 20% and adjusted EBITDA declined by $3 million. Our valve solution product line continued to feel the negative impacts of low demand from end customers in the midstream and downstream markets. This low demand was exacerbated by inventory destocking buyer distributors. Revenues for our production equipment product line were also down, primarily due to lower shipments to customers in the northeast, following large shipments in the third quarter. Orders for the production segment were up $1 million sequentially, and the book-to-go ratio was 1.1, indicating higher activity levels anticipated in 2021. On a consolidated basis, our net loss for the fourth quarter was $33 million, or $5.85 per diluted share. Excluding $6 million of net special items, adjusted net loss for the fourth quarter was $4.80 per diluted share, a sequential improvement of $1.20. A complete reconciliation of adjusted net loss is provided in our earnings release for your reference. The $6 million net adjustment to our income is comprised of an $88 million gain on the sale of our ABZ and Quadrant valve brands, which is offset by $85 million of asset impairments and restructuring costs, as well as $7 million in foreign exchange losses and $2 million of transaction expenses. Let me provide additional detail on these adjustments. On December 31st, we sold the assets associated with the ABZ and Quadrant valve brands to Anvil and Smith Cooper International for $105 million in cash. For context, in 2020, the ABZ and Quadrant product families generated revenues of $42 million and EBITDA of approximately $12 million. $2.4 million of that EBITDA was recognized in the fourth quarter. We are pleased with the value of the transaction at nearly 11 times annualized fourth quarter 2020 EBITDA and it being fully funded with cash at closing. The cash received reduced our net debt at December 31st from $306 million to $201 million and provides FET with liquidity to consider strategic alternatives in the current market. In January, we repaid the $13 million outstanding on our ABL with these proceeds. In addition to the sale of ABZ and Quadrant in the fourth quarter, our teams made significant progress executing our strategy of high grading our product portfolio and reducing fixed costs. In the quarter, we made changes to a number of products, consolidating manufacturing facilities and rationalizing our product offerings. Neil will provide details on the benefits of these moves in his prepared remarks. As a result of these changes, we recognized impairments, primarily of inventory, associated with products we are exiting and operating leases for facilities we are closing, as well as costs associated with those facility consolidations and severance charges. These impairments total $85 million. The sale of ABZ and Quadrant and the strategic rationalization actions set FET up for success in this rising market with a strengthened balance sheet, leaner cost structure, and a portfolio of differentiated products. Our free cash flow after net capital expenditures in the fourth quarter was $4 million. This result benefited from improved operations partially offset by costs paid for severance and facility closures. Proceeds from the disposition of certain capital assets generated $2 million of cash in the fourth quarter, and we decreased networking capital by $24 million due to strong collections and a solid reduction in our inventory. In the first quarter, we expect our pre-cash flow to be slightly negative as networking capital increases and the timing of payroll and tax-related payments offset our anticipated increase in EBITDA. Interest expense was $9 million in the fourth quarter, including non-cash amortization of the fair value discount on our bonds. And depreciation and amortization and stock-based compensation were $12 million and $2 million, respectively. We expect these expenses to remain at similar levels in the first quarter. Adjusted corporate expenses were $5 million in the fourth quarter, and we expect them to be up slightly in the first quarter due to timing of certain expenses. We ended the fourth quarter with $129 million of cash and $111 million of availability under our revolving credit facility for total liquidity of $240 million. This should be sufficient to fund operating cash needs for the foreseeable future. Our net debt outstanding at the end of the fourth quarter was $201 million, calculated as $330 million of principal amount of debt outstanding, less $129 million of cash. In the fourth quarter, we redeemed the remaining $13 million of 2021 notes. Following that redemption, no 2021 notes remain outstanding, and our ABL revolving credit facility now matures in October of 2022. In addition, in the fourth quarter, we completed a one for 20 reverse stock split, which brought Forum into compliance with the NYSE's trading requirements. We now have 5.58 million shares outstanding. Now let me turn the call over to Neil to discuss our key initiatives and market opportunities in 2021.

Thank you, Lyle. Good morning, everyone. To begin, I'd like to thank the employees of FBT for embracing our number one core value, no one gets hurt. Our response to COVID-19 and our safety results were outstanding. in 2020. We finished the year with a total recordable incident rate of 0.53. We should all be incredibly proud of this result. As part of our strategic restructuring effort, we re-evaluated our product portfolio at a granular level. What was evident from this evaluation is that we have a number of products and solutions that provide significant value for our customers with limited competition and growing demand expected in 2021 and beyond. In the aggregate, these businesses generate EBITDA margins between 15% to 20% in a 400 to 450 U.S. recount environment and will have fantastic incremental margins as rig count grows towards 500 and 600 rigs. The teams that run these businesses are focused on maximizing value, developing new products and solutions, and gaining share as the market grows. We are going to continue to invest in these businesses. What was also evident from our portfolio evaluation is that we have a number of products that would struggle to perform even when the rig count rebounds to 800 units. Here, significant cost cutting and restructuring was required. During our last call, I discussed plans to eliminate at least $20 million of annual expenses. In the fourth quarter, these plans turned into actions. Within our underperforming businesses, We are consolidating facilities and product offerings. We are reducing a significant amount of fixed manufacturing costs. We have put our focus on products and solutions that customers value and that have fewer direct competitors. We have set strict profitability guidelines for these businesses, and with this strategy, we expect FEP to generate margins that meet or exceed our peers. As we look ahead to the future, FEP is in a great position to capitalize on normalizing rig count. We have a strong market position in drilling, handling tools and consumables, wireline, coil tubing, artificial lift, defaulters, and well intervention pressure control equipment. We will continue to add engineered solutions like our Serpent Series 15,000 PSI high-pressure flexible hose, which eliminates 90% of the potential leak paths on a track site. This product should significantly decrease non-productive time. We have recently completed field trials and are supplying a leading pressure pumping company six fleets worth of our Serpent Series hoses Also, as an engineered products manufacturer with a wide breadth of experience, we are well positioned to participate in the energy transition towards net zero carbon emissions. In fact, a number of our products are used in the renewable energy industry today. We provide products utilized in offshore wind farm installation, biodiesel production, and emissions capture, to name a few. As this trend continues to materialize, our teams are actively working to repurpose and redesign existing products and solutions for the renewable energy industry. Also, we are developing new products to help operators and service companies meet their greenhouse gas emissions goals. Over the next few quarters, these solutions will be introduced into the market and will have a positive impact for FDT. We have made dramatic changes to our company, These changes have positioned FET to be an industry leader. I'm incredibly excited about our future and the impact we will make. I'll now turn the call back to Chris for closing remarks.

Thanks, Neil. We have made a lot of changes and improvements at FET, and we have significantly increased our earnings power for the new, smaller OFS market we now have. So let me talk about our earnings power and how we see 2021. With commodity prices increasing, E&P spending has increased already this year. Since December, drilling rate count is up at least 13% in the US, and we expect that trend to continue. Given the impact of last week's frigid temperatures in Texas and Oklahoma, where a large percentage of our activity takes place, we are taking a cautious approach to guidance. We expect first quarter revenue to be around $119 million and EBITDA to be roughly breakeven. This compares with the fourth quarter revenue and EBITDA of $104 million and negative $5 million respectively adjusted pro forma for the sale of EBZ and ABZ and Quadrant. Our first quarter guidance is therefore revenue up about 15% with incremental margins in the mid-30s. We would expect further improvement in the second quarter as the full benefit of our cost-cutting and restructuring efforts are realized. Looking to the back half of 2021, we subscribe to the view that overall U.S. crude oil production will remain flat throughout the year. To achieve this production level activity as measured by the number of frack crews working and the number of rigs drilling, will have to increase from current levels. Forms revenues are driven by short cycle, consumable products, and are highly correlated with the US rate cap, although it's not a one-to-one relationship. Therefore, while forecasting the exact level of activity is difficult, we can share the level of EBITDA we believe is achievable at different levels of US rate cap. For example, in a quarter, With average U.S. rig count, total U.S. rig count of 450 rigs, we expect our quarterly EBITDA would be between $7 and $8 million. At an average of 500 total U.S. rigs, we expect our quarterly EBITDA would be roughly $10 to $12 million or $40 to $50 million per year. In the past, the rate count would have needed to be at least 50% higher for us to achieve these levels of profitability. Internally, we sometimes refer to all these changes that we have made as Forum 2.0, a much leaner and more focused company. To mark this new beginning, we have also changed up our brand logo, which you may have noticed. And we have updated our website landing page and our LinkedIn page to showcase new product introductions. Please take a look and follow us for more details. Angela, we're ready for the first question.

Ladies and gentlemen, if you have a question at this time, please press the star followed by the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question is from the line of Ian McPherson with Simmons. Please go ahead.

Thanks. Good morning, team, and I'm sorry I missed the beginning. The prior call ran over a little bit, but I think I got most of it, especially helpful there at the end, Chris, with the framework for EVA-DOTS. So just tying that back, I know they're moving pieces near term with working capital, et cetera, but getting down to free cash out of EBITDA, can you just update us on where run rate interest expense is now after the asset sales?

Yeah. Ian, this is Lyle. Thanks for joining, and thanks for the question. With our debt outstanding, about 9% interest rate on those notes, overall interest expense would be, You have 9% of $300 million, so about $27, $28 million a year. We do have an opportunity to pay in kind some of that interest, but I think with our cash from our transaction, we would look to pay that interest expense in cash.

Okay. That's helpful. Thanks, Lyle. And then just looking at your first quarter outlook, I think we've – on what day you've reported earnings, there's been a different perspective on what the weather impact was last week and what the lingering impact could be this week and maybe even into early February as supply chains normalize and delayed well pads start back up. So maybe if you could frame with us what your expectation is for the discrete weather impact and how known or unknown you think the full extent of it is at this point?

Yeah, Ian, that is a difficult question to answer at this point. You know, clearly it was pretty much a lost week last week, one of 13 weeks in Q1, although we will work hard to recover some of that. So, you know, it won't be one-thirteenth, but it won't be zero either, and it affects different businesses in different ways. You know, I think chasing down the revenue side is what we'll be focused on. Obviously, our costs continue during that period. So we'll be trying to recover as much of that revenue as we can, but it clearly has some impact. Sorry we can't be more specific, you know, just a few days after.

No, that's very helpful. Thanks, Chris. Anyway, congratulations on all of the leverage you pulled to free up some runway here. And I just wanted to close my questions with whether your strategic options, looking forward to this year, contemplate any more significant disposals. And if not, what other sort of big issues you're contemplating with regard to shoring up the future.

Yep. You know, we have made great progress on the balance sheet. If you look at the past two years in total, we have reduced our net debt by $270 million. And Forum does have some really good brands and operations. And I think the value of our businesses was demonstrated clearly in the sale of ABG and Quadrants products. $105 million in proceeds cash in this market at 11 times the Q4 run rate. Now, as far as selling other operations, I think what makes for a good sale between a buyer and a seller is when the asset under consideration is worth more to the buyer than it is to the seller. And as we look across our current stable of businesses and what the prospects are from this point forward and the upside that we see, we don't see that, you know, we feel there's a lot of upside and value there. So I don't expect that we'll have other material sales opportunities. like we had of ABZ and Quadrant. But, hey, as I say, if somebody comes in and has a very, very high value, we'll take a look.

Understood. Thank you, Chris.

Thanks, Ian.

Your next question is from one of Dan Pickering with Pickering Energy. Please go ahead.

Morning, guys. Thank you, and congrats on getting through 2020. I know it was a very tough year. So just a couple of questions around some of the things you said here on the conference call. While you said, or maybe it was Chris said, you would expect to meet or exceed the margins of your peers, Can you help us with who you consider the peers? I mean, what public companies should we look at as the bogey that you're comparing yourself to?

Yeah, so, yeah, Neil was talking about the – as we see the long-term benefit of what we're doing from our portfolio high grading. And we have quite a few businesses that generate very attractive EBITDA margin stands. and we want to grow those businesses. And so, you know, I would say manufacturing peers normalized are, you know, in the teens to upper teens, even down margins, and that is our longer-term objective. I think we'll be not out of the single digits in 2021, but I think we're, you know, with the progress we're making, and as I pointed out, the tremendous operating leverage we have as the rate count begins to improve, we'll be on our way towards that path and hope to achieve that level of EBITDA margins in the medium term.

Okay, so call it a mid to upper tunes EBITDA margins 2022-23 kind of goal. That certainly makes sense. You also mentioned the renewable sector or the energy transition sector is an area where you're selling things. I assume that's fairly small right now, but, I mean, any quantification that you could help us with there? Is it 5% of total, less, 10%? Roughly, where are we at right now?

Yeah, I mean, it is small, but if we add all of our non-oil and gas operations, it's more significant. A lot of what we're doing in subsea space is in non-oil and gas now. Wind Farm and others. Neil?

Yeah, Dan, I think with, you know, a lot of our products have a dual purpose where they can service, you know, oil and gas as well as the energy, renewable energy industry. You know, for example, our subsea, you know, with trenchers, you know, has both a pipeline and a cable application. You know, our valve solution line, production equipment line, they have equipment that can be utilized in multiple applications. You know, we're also, you know, evaluating other product lines and determining what new markets, you know, we can address. And we're finding good opportunities. You know, as an example, you know, heat is an important part of, you know, removal of heat is an important part of renewable applications. And, you know, we see, you know, some of the technology we have in, you know, for example, our cube radiators. They may have a good application in the renewable industry as well. So we think there's a lot of opportunities there. And, again, it's a wide range of our experience that we can take a lot of shots to find our target.

Okay. Thank you. A couple more, if you'll humor me. You talked about Q1 as kind of roughly break-even EBITDA 15% revs with mid-30s kind of incrementals. You know, rig count's obviously up more than that. I understand the lost week, but I think my takeaway would be that your revenue guidance at least feels pretty conservative given where rig count's at and the likelihood that rig count probably continues to increase. So no need to respond to that. That's more of a comment. But as we think about the levers around free cash, again, You know, inventory has continued to be one, but at what point as we move through the year do we think about working capital not contributing to free cash, if you will? So growth in revenues, receivables, et cetera, should be going up. Or do we have enough inventory still to monetize that working capital is a source of cash in 2021? Sure.

Dan, let me take both of those, actually. So look into Q1. I would highlight that we do have a high correlation of our revenue to U.S. rig count activity. That being said, as we look within each of our different product lines, we've got a mix of businesses, including a combination of really short cycle consumables that move really quickly when activity does, as well as some longer-lived capital equipment. So as we look down through the segments in our guidance and think about that, We have assumed activity does increase, and in our completions product lines, we expect those to move pretty linearly with activity increases. Drilling downhole won't move quite as much, and really that's because in the fourth quarter, we mentioned some sizable shipments of packages of premium drilling handling tools for new rig builds in the eastern hemisphere. So those look more like a capital or more of a lumpy revenue transaction. So when we normalize out over time, we'd expect that correlation to hold quarter to quarter. We might see some softness based on when larger shipments go out. So good pickup that you have there on our correlation. And then thinking about inventory and cash from working capital, just to reiterate what we did, if we net out the impairments, and inventory that we took in 2020, we did generate roughly $50 million of cash in the year from inventory reductions. So, moving forward, we still have what I would call excess inventories, and they have the ability to reduce those inventories where revenue stays at lower levels of activity. As revenue picks up, I think that inventory, instead of growing quickly, any kind of growth in inventory would be muted. We do think accounts receivable will grow through the year as revenues do. So net-net, we think working capital still is a contributor to cash flow, but at a much smaller level than it has been in the last couple of years. That's very helpful.

Last question from me, at least this go-round.

is could you just spend a little bit of time on the production segment, and that was clearly the soft spot in Q4. Can you just talk to us about about trends in that business, and have we seen an indication? I mean, did they destock in Q4? We think they might restock. How are you seeing kind of the January-February trends? And then tag-teamed with that, not just a production question, but is there any pricing? Have you seen any pricing in the system? across any of the business lines. And thanks again for letting me ask a bunch of questions.

Great, Dan. You know, on the production segment, both on the valve side and production equipment, there has been some destocking. On the valve side, we do sell to the big PDF distribution companies, and they have made a big point of trying to be more efficient from a working capital standpoint. And that's an effort that they have ongoing. And so that has had an impact on us. We work with them. They're good customers for us. And we also look at project work as well. which gets to the investment in the midstream and downstream, which hasn't been particularly strong here recently. And on the production equipment side, we do see larger operators tending to order in bulk and then work down their inventory of surface process equipment. and that was some of what we felt there. With the better oil and gas prices that we're seeing here currently, we do expect some pickup there, and we have seen some nice orders, so some improvement on that side we think is justified. From the VALS side, as we're focused on fewer VALS brands, we're hopeful that we can drive improved sales and that business through additional sales channels domestically and internationally. And then on pricing, Neil, you want to address that?

Yes. So we do see a little bit of pricing power in a few of our product lines, but I think overall there's still a lot of inventory capacity out in the market. However, we do see opportunities that as we – introduce new products that add value for our customers, that we can increase margins with the introduction of those products. So that's an area we're going to focus on.

Yeah, and serpent product, you know, that's an example, isn't it, Neil?

That's correct, where we're reducing the overall cost of ownership for our customer base and non-productive time in the field, that we can see an improvement in margins from products like that.

Flow water versus flux. Win-win. You know, better margins for us, but significant value for the customers.

All right. Thanks, Seth. Congrats again on getting through 2020. Thank you, Dan.

Thank you, Dan. Well, we appreciate the questions and the interest, and thank you all very much. Have a great day. Thank you, Angela.

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