Forum Energy Technologies, Inc. (NYSE:FET) Q3 2023 Earnings Call Transcript

Forum Energy Technologies, Inc. (NYSE:FET) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies Third Quarter 2023 Earnings Conference Call. My name is Giji, and I will be your coordinator for today’s call. There is a process for entering the question-and-answer queue. [Operator Instructions] A link with instructions can be found on the company’s Investor Relations website under the Events section. At this time, all participants are in a listen-only mode and all lines have been placed on mute to prevent any background noise. This conference call is being recorded for replay purposes and will be available on the company’s website. I will now turn the conference over to Rob Kukla, Director of Investor Relations. Please proceed, sir.

Rob Kukla: Thank you, Giji. Good morning, and welcome to FET’s third quarter 2023 earnings conference call. With me today are Neal Lux, our President and Chief Executive Officer; and Lyle Williams, our Chief Financial Officer. Yesterday, we issued our earnings release and announced FET’s acquisition of Variperm Energy Services. Both press releases are available on our website. Investor presentation slides relating to the Variperm acquisition are also available on our website. Please note that we are relying on the Safe Harbor protections afforded by federal law. Listeners are cautioned that our remarks today may contain information other than historical information. These remarks should be considered in the context of all factors that affect our business, including those disclosed in FET’s SEC filings, our earnings release, and Variperm acquisition announcement.

Management’s statements may include non-GAAP financial measures. For a reconciliation of these measures, you may refer to our earnings release and Variperm acquisition announcement. During today’s call, all statements related to EBITDA refer to adjusted EBITDA. And unless otherwise noted, references to FET’s standalone comparative financial results are third quarter 2023 to second quarter 2023. And finally, statements relating to FET and Variperm on a combined basis are trailing 12 months as of September 30, 2023. I will now turn the call over to Neal.

Neal Lux: Thank you, Rob, and good morning, everyone. As noted in yesterday’s press release, we are extremely pleased to announce the Variperm Energy Services acquisition. I want to welcome the Variperm employees to the FET family. We are excited to have you join our team and look forward to working together following closing in January. I also want to recognize the strong support we received from our syndicate of credit facility lenders. Before discussing our transformative acquisition, I would like to spend a few minutes on FET’s third quarter results and 2023 outlook. During the quarter, soft U.S. market conditions continued with rig count declining 10%. This was counter to the industry’s and our expectations at the time of our earnings call.

We also saw a rapid decline in activity based capital equipment demand from our pressure pumping customers, who passed orders in response to softening well completion activity. This led to a $14 million sequential revenue decline in our stimulation and intervention product line. Excluding this product line, FET’s revenues would have been up 6%, a significantly higher growth rate as compared to global rig count, which was effectively flat in the quarter. While revenue was down, we experienced an increase in bookings during the quarter, demonstrating the benefit of our global footprint. Our sales and marketing teams have been actively working with customers positioning FET as a key partner, and their efforts are paying off. We had another strong quarter of backlog growth supported with a 111% book-to-bill ratio.

In fact, all three segments posted a book-to-bill ratio greater than 100%. Overall, I am pleased with how well our teams executed this quarter and managed through market headwinds. We have successfully grown international revenues, which have mostly offset declining activity in the United States. Even though revenue declined slightly, gross profit and EBITDA remained steady. In general, we held our pricing firm and did not sacrifice margins for volume. Also, we managed expense as well through a combination of increased utilization and cost savings initiatives. These efforts allowed us to deliver EBITDA within our guidance range and generate $24 million in free cash flow this quarter. Looking ahead to the fourth quarter, indications are that the U.S. rig count may have finally bottomed.

The modest increases seen the past few weeks have been encouraging. However, we anticipate average rig and frac fleets counts will remain below third quarter levels. This is based on feedback from our customers that they anticipate a holiday slowdown due to budget exhaustion. Internationally, we expect activity to remain high with rig counts modestly increasing. Putting it together, we expect the operating environment for FET to be similar to the third quarter. Therefore, we are forecasting revenue and adjusted EBITDA to be flat compared to the third quarter, and we are confident in delivering $45 million to $55 million of free cash flow in the second half of 2023. Our ability to generate cash is an important part of our business and gives us flexibility to pursue strategic opportunities.

This leads us back to Variperm, a company we have been watching closely for a few years. We previously outlined our acquisition criteria, and this transaction checks all the boxes. It is expected to be highly accretive, transform FET’s financial metrics and increase free cash flow. The mix of cash and equity consideration allows us to maintain conservative net leverage and strong liquidity. This strategic acquisition demonstrates strong industrial logic, as various differentiated products and technologies complement our artificial lift product portfolio. From a financial perspective, the combination [ph] meaningfully increases the scale and profitability of FET. Putting the two companies together expands EBITDA to $121 million and increases EBITDA margins to 14%.

This elevates FET above many of our peers and improves our investment profile. Also, the transactions valuation and financing is highly accretive to earnings and cash flow metrics. If the free cash flow yield for the combined companies is similar to what FET has recently experienced, this acquisition would create significant value for shareholders. And the acquisition is a continuation of the value our management team has created over the past few years. For those unfamiliar with the FET story, we entered the COVID pandemic with around $400 million in total debt. We refinanced our senior notes in August of 2020 during a time of existential risk for the industry. In addition, we streamlined our business, eliminated significant fixed costs, and divested non-core assets.

From a base EBITDA of $20 million in 2021, we are on track to grow EBITDA by 250% in 2023. The combination of these steps drove our share price and helped us achieve mandatory conversion on nearly half of our outstanding long-term debt. Through free cash flow generation, asset sales and debt to equity conversion, we reduced our net leverage from 4.8 times in 2019 to 1.4 times EBITDA at the end of the third quarter. More importantly, these actions allowed us greater flexibility to generate shareholder value, including through strategic and accretive acquisitions and that is where we are today. With Variperm, we are acquiring a leading manufacturer of sand and flow control products for heavy oil production. They have a great customer base of large cap operators and have maintained long-term relationships in some cases over 25 years.

Variperm has four primary manufacturing locations and just under 300 employees. Their highly engineered and customized products are protected with patents and proprietary manufacturing techniques. As we think about longer-term growth prospects, Variperm has a clear path of increased customer adoption within Canada and upside from international and offshore markets using FET’s global distribution network. Also, this combination expands the total addressable market for FET’s artificial lift product family. Together, we are a formidable manufacturer of highly engineered products and solutions for the energy market. This is an exciting development for FET. I am going to turn the call over to Lyle for more detail on the acquisition and FET’s financial results.

Lyle Williams: Thank you, Neal. Good morning, everyone. As Neal mentioned, we are very excited about the Variperm acquisition. Let me hit some of the details of the transaction and financial highlights. This week we signed agreements to acquire the equity of Variperm for total consideration of 2 million shares of FET stock and $150 million of cash. As of signing, this equated to roughly $195 million of total consideration, or 3.7 times Variperm’s trailing 12 months of EBITDA. We expect the transaction to close in January following Canadian regulatory approval and satisfaction of other customary closing conditions. To give context to the regulatory review, FET and Variperm did not provide overlapping products or services. In addition, to avoid closing delays, all sources of cash have been secured and leave the combined company with a conservative amount of leverage and adequate liquidity to both manage future obligations and fund organic growth.

Cash consideration for the transaction will be funded through $90 million of cash from on hand balances and borrowings under our ABL credit facility and from the funding of a $60 million seller term loan. Prior to closing the Variperm acquisition, we will explore an alternative financing arrangement to the seller term loan. Following closing and without regard to any alternative financing arrangement, we expect net leverage to be 1.9 times EBITDA with liquidity of roughly $140 million. I am pleased to announce that in conjunction with the acquisition, FET lenders agree to amend our ABL credit facility to among other things, permit the Variperm acquisition, increase the aggregate revolving commitments from $179 million to $250 million and extend the maturity date to September 2028 and allow the seller term loan.

The amendment is conditioned upon the closing of the acquisition. Once finalized, the expansion of the revolver is advantageous to FET and allows us to increase our borrowing base by between $20 million and $25 million based on including Variperm working capital. We are thankful to our banking group for their continued support of our growth. These banks include Wells Fargo, JPMorgan, Bank of America and Amegy and we are pleased to welcome Goldman Sachs who has joined our credit facility as a lender. The seller term loan would mature in three years and is pre-payable at any time and without penalty. The interest rate of 11% is subject to escalation after the first anniversary of the loan. We structured the seller loan with longer maturity than a traditional bridge with terms that fit within our existing debt arrangements.

If we utilize the seller loan, we expect to be able to retire our remaining 9% senior secured notes in the third quarter 2024 without seeking any additional external funding. This structure puts our balance sheet in a strong position. Between the mix of stock and cash consideration, the seller term loan and the credit facility amendment, we believe we have the appropriate leverage, liquidity and visibility for us to move forward confidently with the acquisition of Variperm. Neal has already covered the industrial logic between Variperm and FET, which we are excited about. Let me provide a bit more color on the financial merits of the transaction before shifting to FET’s third quarter results. The transaction’s valuation at 3.7 times trailing 12 months EBITDA provides meaningful accretion for FET.

More importantly, the combination creates a business with increased EBITDA, strong EBITDA margins and significant free cash flow. On a combined basis, the company’s revenue increases to $873 million, EBITDA increases to $121 million and EBITDA margin improves to 14%. Net of incremental interest combined free cash flow increases to $70 million. Shortly after closing, we will complete our purchase accounting analysis. Then we’ll have a more accurate approximation of pro forma net income, which we expect to be noteworthy. Let me provide directionality to our per share metrics. While share count will increase by just under 20%, EBITDA improves 77%, free cash flow increases 84% and net income improve substantially. The per share improvement in all of these metrics will be significant and this is another reason why we’re so excited about the transaction.

Now turning to third quarter FET results. Sequentially, our consolidated revenue decreased by $6 million. As Neal detailed earlier, the rapid decrease in U.S. completions activity drove our stimulation and intervention revenues down by $14 million. As pressure pumping customers idled fleets, they slowed purchases of consumable products and delayed demand for stimulation related capital equipment such as power ends, manifold trailers, hoses and radiators. Despite the decline in revenue, EBITDA fell by only $1 million. In the middle of the third quarter, realizing that U.S. market conditions had yet to bottom, our teams took action to control costs. In the quarter, we reduced expenses by over $1 million through headcount and variable cost reductions.

Highlighting international revenue, similar to the last quarter, FET’s international sales growth nearly offset softer U.S. market conditions. Revenue outside the U.S. increased by $10 million sequentially or roughly 15%, driven by a significant increase in shipments for coiled tubing and an increase in project revenues for our Forum process technology product family. Most of these increases were recognized in the Middle East region, where nearly all product lines saw revenue growth. And total revenue increased approximately 50%, benefiting from a strong international tailwind, non-U.S. revenues accounted for 42% of our total revenue. The Drilling & Downhole segment had revenue and EBITDA growth of $500,000. Drilling product line revenues declined with activity in the U.S. while Downhole and subsea revenues increased.

A more favorable mix of products and our aforementioned cost management actions supported EBITDA margins, which increased by 50 basis points. Segment book-to-bill ratio was 117% as we booked an order for four Perry XLX work class ROV systems. We remain excited about the continued strengthening outlook for international drilling and subsea opportunities as customers add capacity and upgrade equipment to support future oil and gas production and offshore wind farm development. Completion segment revenue and EBITDA were impacted this quarter as the dramatic decline in well completion activity slowed demand for our stimulation intervention products, where revenue declined by 30%. Our global tubing business provided the bright spot for the quarter.

Revenues jumped on international shipments and profit drop through in the business was strong as the team favorably managed costs in the quarter. Our segment book-to-bill ratio was 104%, slightly higher than we would expect for these activity based product lines. Our production segment continues to improve and provide consistent results. Segment book-to-bill ratio was 105%, driven by an improvement in orders for our Valve Solutions product line. Revenue increased sequentially and on a year-over-year basis and EBITDA margins continue to improve, reaching 6.8% this quarter, up nearly double from a year ago. Now, let me share with you our fourth quarter forecast. Neal discussed how we see the markets going forward. Our fourth quarter is in line with third quarter results, with revenue and EBITDA ranges of $170 million to $190 million and $15 million to $19 million, respectively.

With this forecast, our full year EBITDA is expected to be between $67 million and $71 million. This estimate for the full year, 2023 is lower than our forecast provided in last quarter’s call, driven by softer U.S. activity in both the third and fourth quarters. We remain confident in a long-term increasing market outlook as the world solves a structural shortfall in energy supply. Here are a few details for modeling purposes. In the fourth quarter, we anticipate corporate costs to be generally in line with the third quarter, interest expense to be $5 million and depreciation and amortization expense of roughly $9 million. For the full year, cash income taxes are expected to be around $8 million, primarily due to Canadian income. Capital expenditures for 2023 are expected to remain below $10 million.

Turning to cash and the balance sheet, we generated free cash flow of $24 million, driven by a decrease in net working capital from strong collections. Given the softness in the U.S. market, our teams continue to drive down working capital by tightening our supply chain and reducing the flow of inbound raw material to match market conditions, and we are working with our customers to achieve more appropriate collection timing. We are pleased with the turnaround in free cash flow in the second half of the year in line with our forecast. We ended the quarter with $37 million of cash on hand and $155 million of availability under our revolving credit facility for total liquidity of $192 million. As of September 30, our net debt was $97 million with a corresponding net leverage ratio of 1.4 times.

FET remains well positioned to fund operations with ample liquidity and a strong balance sheet. Let me turn the call back to Neal for closing remarks.

Neal Lux: Thank you, Lyle. We believe the Variperm acquisition is transformational. However, it does not change who we are. We remain a manufacturer of highly engineered and differentiated products, operating in niche markets where we have competitive advantages. We are a global company whose solutions are utilized around the world, making our customers’ operations safer, more efficient and environmentally friendly. We believe demand for energy and the investment required to supply it will continue to grow FET revenue. We have a long-term tailwind. And we can grow faster than the market through the introduction of new products while remaining committed to our capital light business model. Adding a great business like Variperm makes the FET story even more compelling for existing shareholders and new ones. Giji, please take the first question.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of John Daniel from Daniel Energy Partners.

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Q&A Session

John Daniel: Hey, guys. Congratulations on the acquisition. Hopefully, you can hear me okay.

Neal Lux: Yeah. Thanks, John.

John Daniel: Okay, good. Sorry. Just driving here. I know you mentioned there’s not necessarily a product overlap per se with the transaction. But I’m curious, is there an opportunity where the person you’re selling to within the customer base might be the same person. I’m not trying to get to like a bundling concept, but just where you’re bringing more to the table, if you will, the same buyer. Does that make sense?

Neal Lux: That does, John. Yes, I think there’s a great opportunity for our multi-lift product family. If you think about the wells where Variperm’s products are being utilized, generally, there’s an ESP involved on the production well. And we think that’s a great opportunity to cross sell or utilize. I think Variperm’s great success with their customers. We also share some of the – from our other parts of our production segment, where we sell through distribution partners. Many of the end users are the same customers that Variperm sells to today. So I think we have some. But I think this is a great opportunity to expand that as we integrate and get to know each other even better.

John Daniel: Right. Okay. And I know everybody wants to talk international, so I’ll let my – the next people ask that question, but on the U.S. land side, coiled tubing, I don’t know if you saw some pretty impressive announcements by the coiled tubing providers in terms of the total distance they’ve been achieving, in terms of the wells. What are you guys seeing right now on not just the demand for the coil itself, but any changes in designs as these laterals keep going longer?

Neal Lux: Yes, absolutely, John. That’s a key focus for our teams. I think as you may have known over the years, we’ve spent a lot of time hiring engineers, specifically in our coil that have experience in the field and developing specific designs to get to longer laterals. And we believe with the designs and kind of proprietary approach that we take, just by utilizing our product versus a competitor’s, you can give more reach and more weight on bit with products from Global Tubing.

John Daniel: Okay. Is there a theoretical maximum that you guys see in terms of how far it will actually go out? It seems to keep getting longer.

Neal Lux: Yes. I think it really comes down to our customers’ equipment and ability to move it. But I think what I’ve seen and I’ve been involved in the business now for many years, is that our customers always seem to find a way to overcome challenges, whether it’s the transportation or amount of pipe they can get on a reel. So I think as long as our customers and service companies remain creative, I think we have the product that can allow them to do the job.

John Daniel: Okay. That’s all I got. Thank you for including me.

Neal Lux: Thanks, John.

Lyle Williams: Thanks, John.

Operator: Thank you. [Operator Instructions] Our next question comes from the line of Jeff Robertson from Water Tower Research.

Jeff Robertson: Thank you. Good morning.

Neal Lux: Good morning, Jeff.

Jeff Robertson: You all talked, Neal, about your fourth quarter outlook. Can you add any color on the kind of conversations you’re having with customers as there’s – based on how they’re thinking about 2024.

Neal Lux: Yes. I think it’s a – depending on which part of the completion side or drilling side that they sit, you can kind of get a little bit of different color. But I think the general view is that the second – sorry, the first half of next year will be stronger than the first. I think it’s second half of this year. So I think the – really the idea is how fast do we start out of the gate? Do we have a quick first quarter ramp up as the E&P companies utilize their budgets or not? So I think that would be that focus on U.S. land. Now, internationally, we just had a great show in early October, and I think that show set again record attendance. And I think that reflects the sentiment that we’re seeing internationally.

Jeff Robertson: When you think about the Variperm offering suite, you mentioned international. If you take some of those products to international markets, places like the Middle East, is there some sort of an adoption process that they would have to go through to be certified?