Forum Energy Technologies, Inc.

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.

Thank you, Annie. Good morning, and welcome to Forum Energy Technologies' third quarter 2021 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 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. 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 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 backwater, 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 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, our revenue in the range of $145 to $155 million and EBITDA of $9 to $11 million. So revenue $145 to $155 million, EBITDA $9 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-like 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 de-lever 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. 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 lead 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 completion 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 or $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 non-cash items improved by $6 million sequentially. However, changes in networking 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 reduce 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 due August 2025, less the $50 million of cash on hand. Now let me turn the call over to Neil to further discuss our operating initiatives. Neil?

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 leak paths experienced with traditional high-pressure flow iron 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 replace flow iron more broadly in 2022 and beyond, the addressable market should be significant. We have an excellent growth opportunity ahead. Switching gears from U.S. 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. FEP 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 and preparation, construction, and maintenance. This product line is poised for growth in the coming energy transition. Additionally, our subsidy product line continues to serve the defense sector. During the quarter, we completed sea trials and final delivery of our LR-11 rescue submarines 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 subsidy 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 consumable and aftermarket product. 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 shipment 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 airframe the material to meet customer deadlines. Also, as Lyle mentioned, we are building strategic inventory 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 will 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 talents. 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 focused on providing well-side 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 SPD will begin marketing a new choke early next year that aligns with that goal. Importantly, our trim kits 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.

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 U.S. rig count. Pro forma for the business divestiture, our quarterly revenue is up $48 million compared with the third quarter of 2020, and our bookings have more than doubled. Over this same time period, 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?

Thank you, sir. Ladies and gentlemen, if you have a question at this time, please press star and then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, press the pound key. Our first question comes from the line of Ian McPherson from Piper Sandler. Your line is open. You may ask your question.

Hi. Good morning, everyone. Hey, Ian. Hey, Ian. So... I wanted to ask just a couple questions up front. 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. 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 normalized before we can get to better margins than what you're envisioning for Q4? Sure.

Ian, I'll start with the first part on bookings and the trajectory. you know, we continue to see, you know, strong inbound, you know, quoting activity for our key products. In the third quarter, we had some fairly large bookings come through, you know, with our ROVs and with our single line manifold systems. And so, you know, we think that, you know, those are pretty large ones, chunky. But I think our overall trend is continuing forward and, you know, It may or may not equal what we did in the Q3 with those large ones, but I think the overall momentum continues forward.

Yeah, demand is strong, Ian, as you can imagine with activity continuing to improve. So that relationship between higher activity, using RID count as the benchmark there, and our revenue and orders continues to hold. Now, 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 down hole and subsea segment, and pleased with the margin progression there, and they're doing well. Our completions business has also made very good 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. Within the production segment, I think they have been particularly impacted by the supply chain challenges. and that's really held back the margins there. A couple 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 devalves business with a long supply chain there, but also given our sourcing a lot from Asia, significant delays 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 VALS business and the forum overall. So I think those will be key elements to the higher margins going forward. We don't want to understate the potential for price improvement in many of our businesses.

Got it. Thank you very much, Chris and Neil. Appreciate the color. Great. Thanks, Ian.

Thank you, sir. Again, everyone, if you would like to ask a question, you will need to press star 1 on your touchtone telephone. We have another question from the line of Dan Pickering from Pickering Energy Partners. Your line is open. You may ask your question.

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 on the revenue side. I'm not sure if I heard an EBITDA implication. Do we think that, you know, we think that that 25%, 30% incremental margins would make sense, and so we would have had another $2 million or $3 million of EBITDA in Q3 if not for the supply chain?

Dan, I think you're on with that kind of a number. We definitely felt that 10 to 15 million with supply chain challenges and, you know, 25 to 30 percent 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 would 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 pickup 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.

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 for. That's right. Yep.

Well, we'll blame COVID for what looks like you would have probably exceeded your guidance, if not for those issues, and 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, you know, have you given any thought to sort of the, you know, any parameters around what you're going to implement that repo?

Yeah, 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, you know, there are rules about volume limitations and so forth, and of course we'll be abiding by those, but But we've got the resources and we've got the will to move forward with the plan.

Yeah. 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. Are you using a debt-to-cap measure or how are you thinking about, you know, 10 turning into 20 or why wasn't it 5? How do you think about sizing?

Yeah, 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?

Sure, sure. Last question. I usually ask ten. I'm only going to ask three this time. Energy transition – You talked about some new products there. You talked about, you know, 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?

Yeah, we're – We're starting to get these new opportunities and it's great to see them. I think with 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 you know, new territory here. But, yeah, I think it's a great opportunity, and I'm really pleased that we have so many shots on goal here.

Okay. So no need to buy your way into that market. You're getting acceptable profitability as is and maybe some margin upside.

Correct. No loss leaders there. That's right.

Okay. Thank you very much. Appreciate it, guys.

Well, Andy, 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.

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.