Forum Energy Technologies, Inc. (NYSE:FET) Q4 2022 Earnings Call Transcript

Forum Energy Technologies, Inc. (NYSE:FET) Q4 2022 Earnings Call Transcript February 26, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Forum Energy Technologies Fourth Quarter 2022 Earnings Conference Call. My name is Gigi, and I will be your coordinator for today’s call. 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, Gigi. Good morning, everyone, and welcome to FET’s fourth quarter 2022 earnings conference call. With me today are Neal Lux, our President and Chief Executive Officer; and Lyle Williams, our Chief Financial Officer. We issued our earnings release yesterday, and it is 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 Form 10-K and our other SEC filings. Finally, management’s statements may include non-GAAP financial measures.

For a reconciliation of these measures, you may refer to our earnings release. During today’s call, all statements related to EBITDA refer to adjusted EBITDA. And unless otherwise noted, all comparisons are fourth quarter 2022 to third quarter 2022. I will now turn the call over to Neal.

Neal Lux: Thank you, Rob, and good morning, everyone. Reflecting on our 2022 achievement, I am pleased to say that we exceeded expectations. And as we will discuss during today’s call, I think FET is just getting started. Let’s begin with some key highlights from our annual and fourth quarter results and our debt conversion. Our teams delivered strong 2022 financial results. We ended the year with the highest backlog since 2018. Revenue and EBITDA grew by 29% and 194%, respectively, on a year-over-year basis. Also during the year, we increased our gross margins by 230 basis points and doubled our EBITDA margin to over 8%. This growth reflects our operating leverage and differentiated product portfolio. In the fourth quarter, we had robust bookings and revenue growth of 35% and 29%, respectively, year-over-year.

Demand for our products and solutions remained strong. EBITDA of $17 million was within our quarterly guidance range and up nearly 300% versus fourth quarter 2021. Finally, and most importantly, for the company’s future performance, we were able to significantly improve our balance sheet during the quarter with the conversion of our long-term debt to common stock. The conversion marks a significant milestone for a number of reasons. First, pro forma for the conversion, our year-end net debt was approximately $83 million or 1.4x full year 2022 adjusted EBITDA, FET’s credit rating was upgraded as a result of our significantly reduced leverage. Second, the conversion nearly doubled our market capitalization, and our daily trading volume has increased substantially.

Both of these factors have improved our investment profile. Third, the reduction in debt decreases FET’s annual cash interest payments by roughly $11 million, enhancing our free cash flow conversion. And finally, the balance of our long-term debt is now significantly below year-ending liquidity. This achievement opens up several strategic options, including share repurchases, further debt reductions and acquisitions. Lyle will discuss these options in greater detail during his remarks. In addition to strategic options, we have an incredible foundation for organic growth as a result of the attributes I listed during our earnings call in February 2022. One, our employees are key differentiators; two, industry fundamentals are expected to remain strong; three, FET is continuing to develop and launch innovative products and solutions; four, we have opportunities for significant margin expansion; and five, FET is positioned to access growing markets outside oil and gas.

And now we can add a sixth attribute, a solid balance sheet bolstered with meaningful positive free cash flow. Our colleagues at FET are dedicated and focused on delivering value to the customer and the company. And as we demonstrated with our impressive bookings in 2022, customers see the value we bring through technology, innovation and quality. Today, our customers are in a good financial position because industry fundamentals are solid. While commodity prices have recently moderated, some forecasters such as the International Energy Agency, expect oil demand to surpass supply in the second half of 2023. This should put a floor under activity now and provide incentives for a prolonged energy investment cycle. While increasing industry activity provides a tailwind for growth, we want FET to grow faster than the market.

To accomplish this goal, we are introducing products and technologies that our customers value. Our key components and consumable products enhance our customers’ long-life assets to make energy production safer, cleaner and more efficient. For example, we recently showcased our new FASTConnect, Frac Automated Switch Technology System at a Society of Petroleum Engineers technical conference. The FASTConnect System allows service companies to perform hydraulic frac operations without a traditional zipper manifold. Through automation, our solution increases the safety of field personnel and stages completed per day while eliminating a significant portion of a manifold operating expense. In addition, the FASTConnect System significantly improves the environmental impact of a frac fleet by eliminating the grease consumed.

If our system was adopted on every zipper frac fleet, we estimate operators would eliminate 18 million pounds of grease from their well sites per year. The environmental improvement would be astounding. The total addressable market in the United States for this solution is between $300 million to $500 million. As an asset-light manufacturer with an international footprint, we address key markets around the world. A great example is a recent electrostatic desalter system award from one of the largest national oil companies in the world. The system will utilize FET’s edge desalting technology and for mix, our high-efficiency multiphase technology. The contract has a value of approximately $25 million, with potential for meaningful subsequent awards.

I’m extremely proud of everything we accomplished in 2022, but it’s time to focus on 2023. As I mentioned earlier, I’m excited about FET’s future. Long-term, market fundamentals remain strong. Supply and demand imbalances will continue to fuel the need for more investment. However, there are mixed views on where the U.S. rig count goes from here. We anticipate moderate rig count growth during the year with the trajectory to be determined. However, equipment utilization and service intensity will remain at high levels. Our customers are telling us they are sold out and have essentially no spare capacity. As their older equipment wears out, customers are upgrading and replacing it with more efficient and advanced capital items from our product catalogs.

As we demonstrated in 2022, increased demand for our differentiated products will enable us to further grow our EBITDA margin. The international markets are ramping up and FET will be there to participate in the growth. Historically, international revenue has been between 40% to 50% of total revenue. As international markets grow, so do we. And I believe that FET has a unique advantage with an optimized global footprint with a select number of manufacturing and distribution hubs that can strategically supply our customers with the products and solutions they need anywhere in the world. In addition, we can service nearly every oil and gas producing country without spending any additional capital or adding roofline. We can ship anywhere. The offshore market is also heating up.

Through 2022, the offshore drilling rig count has increased meaningfully. Service intensity of offshore operations exceeds land-based activity and drives additional demand for FET products. In the near term, this reactivation should benefit our drilling capital products for mud systems and tubular handling operations. Over the longer term, growing subsea activity should drive demand for our world-class and inspection ROVs and related products. With the opportunities we see in front of us, I am confident we can deliver revenue and EBITDA growth and generate strong free cash flow in 2023. We therefore expect EBITDA to be in the range of $80 million to $100 million and free cash flow of $20 million to $40 million. I will turn the call over to Lyle for more detail on fourth quarter results, outlook for the first quarter of 2023 and our capital deployment options.

Photo by Patrick Hendry on Unsplash

Lyle Williams: Thank you, Neal. Good morning, everyone. Overall, FET’s fourth quarter financial performance met or exceeded our expectations. Revenue of $191 million beat the top end of our guidance. At 5% growth, we outpaced the U.S. rig count as demand for our products and services remained strong. EBITDA of $17 million fell within our guidance, although our incremental profitability did not meet our expectations. During the quarter, two projects, one in our Subsea Technologies and one in our coil tubing product lines, generated unfavorable cost variances totaling over $2 million. Shifting to our operations. Each of our business segments posted increased revenue for the fourth quarter. Drilling and downhole segment revenue was $81 million, up 7%, led by higher demand for drilling handling tools and capital equipment.

Our drilling, downhole and subsea product lines all increased revenue. Drilling and downhole segment orders increased by 19%, with a book-to-bill of 108%, driven by strong demand for drilling capital, handling tools and bearings. This momentum should continue as global rig count grows, particularly outside the U.S. The segment currently generates roughly 50% of its revenue from international sales. Despite the revenue growth, segment EBITDA decreased $2 million compared with a strong third quarter. Subsea project costs and increased freight expenses partially offset the revenue growth. Unfavorable product mix and year-end production variances also impacted performance. Completions segment revenue was $74 million, a 3% increase with higher demand for pressure control equipment as well as radiators and power ends supporting pressure pumping activity.

Quality wireline revenue grew 7%, breaking the revenue record set last quarter. Bookings for the Completions segment were $81 million, up 3%, resulting in a book-to-bill ratio of 110%. We secured a number of Jumbotron radiator orders that will be paired with environmentally friendly dual gas blend engines for frac fleet upgrades. In addition, we received a sizable order for pressure control equipment destined for international markets. These awards were partially offset by lower orders for stimulation and coiled tubing products, following large project bookings we received in the third quarter. Completion segment EBITDA was $9 million, down $1 million. Higher revenues were offset by unexpected project costs in coiled tubing, unfavorable sales mix and higher freight costs.

In our production segment, revenue was $36 million, up 5%, primarily led by higher demand for production equipment. Production segment bookings were $47 million for the quarter, comparable with the third quarter. The book-to-bill ratio remained strong at 130% as demand for our surface processing equipment and technology continues. Production segment EBITDA was $2 million, up $1 million primarily on increased volume, favorable sales mix and operating leverage in our production equipment product line. EBITDA margins at 4.7% continue a positive improvement trend, bettering the 3.5% in the third quarter. The segment will drive margin improvement through operating leverage, continued cost management and focusing on higher-margin, emission reduction and alternative energy applications in the longer term.

Inventory management has been a key focus area for us. In the first quarter 2022, we proactively built inventory to buffer our customers from the supply chain disruptions many companies faced. As the year progressed, we challenged our operations to normalize inventory levels and increase turns. Supply chain performance remains volatile, and in some cases, put a strain on our margins and ability to deliver. For example, due to the supply chain challenges in the fourth quarter, we expedited materials in support of commitments made to our customers. This accounted for most of the higher freight expenses I mentioned earlier. In addition, throughout 2022, steel price inflation and availability impacted margins in our coiled tubing and production equipment product lines.

We struggled to increase prices to offset this inflation due to competitive dynamics and in the case of production equipment due to the long lead time between our receipt of orders and ultimate shipment. We expect these steel and freight impacts to normalize through 2023. Free cash flow of $45 million was a highlight for the quarter. This result includes $32 million from our November 2022 sale-leaseback transaction. These proceeds are over 10x greater than the new annual lease commitments. This accretive transaction furthers our ability to improve returns. Excluding the leaseback proceeds, our quarterly free cash flow of $13 million was negatively impacted by large customers who delayed payments at year-end. In large part, because of this free cash flow generation, we ended the quarter with $51 million of cash on hand and $156 million of availability under our fully undrawn revolver.

Liquidity increased by $60 million from September to a total of $207 million. With this level of liquidity, we could retire our long-term debt today while leaving ample dry powder to fund operations. The strength of our balance sheet highlights the transformative nature of the debt conversion and our 2022 financial performance. We continue to believe FET shares are undervalued as we trade at a discount to other equipment manufacturing peers. Therefore, in the fourth quarter, we repurchased just over 100,000 shares at a discount to last Friday’s closing price. Comparing this price with our $80 million to $100 million 2023 guidance implies a valuation of 4.2x to 5.3x EBITDA, with many of our peers trading at 7x to 10x 2023 expectations. We believe our stock has compelling upside.

Now let me share with you our first quarter forecast. Neal discussed how we see the markets going forward and provided our 2023 EBITDA guidance earlier in the call. We anticipate modest growth progression in the U.S. and stronger international activity growth through the year. Thus far, 2023 U.S. rig activity has been relatively flat and international activity is in the process of ramping. Therefore, in the first quarter, we expect revenue of between $180 million to $200 million and EBITDA of between $16 million and $20 million, with these values increasing each quarter throughout the year. We expect first quarter free cash flow to be negative $20 million to $30 million. Expected payments of management cash incentives and property taxes as well as accrued interest related to converted notes will be partially offset by cash flow from EBITDA and net working capital improvements.

Let me provide a few details for modeling purposes. In the fourth quarter, corporate costs were flat with the third quarter coming in a little better than expected. In the first quarter, we expect corporate costs to be in line with the fourth quarter, interest expense to be $5 million and depreciation and amortization expense of roughly $8 million. We expect full year capital expenditures of approximately $15 million and cash income taxes of $5 million to $7 million. Let me shift my attention to our capital deployment alternatives. With a rightsized capital structure, ample liquidity and improving free cash flow, we are evaluating several options for deployment of our cash through a lens of improving our financial metrics and maximizing returns.

One option is to repay our long-term debt or repurchase additional shares. Relative to other alternatives, debt repayment yields a modest return. Share repurchases are more attractive at current levels. However, we are limited by our indenture to an additional $5.9 million of share repurchases. Another option is funding for organic growth. Our plan for 2023 includes significant organic growth driven by market share gains and new product introduction. Funding for this growth is already included in our healthy free cash flow forecast. We will continue to seek and evaluate additional organic investment opportunities to generate outsized returns. Finally, as another option, accretive M&A transactions could further transform our product portfolio.

The market for transactions has improved, with many sellers exploring strategic alternatives. We look for transactions with good industrial logic and that are accretive to our earnings. Importantly, we are committed to maintaining reasonable net leverage, and we’ll use an appropriate mix of cash and equity to achieve this goal. In short, the conversion of our debt not only enhances our story today, but it also opens a number of investment opportunities to gain greater rates of return. I will now turn the call back over to Neal. Neal?

Neal Lux: Thank you, Lyle. 2022 was a transformative year for FET. We executed at a high level and achieved what we set out to do. So to the FET team, thank you, and job well done. The markets remain tight, equipment utilization and service intensity are at high levels and significant investment will be needed over the coming years. FET will be there to provide our customers with the technology and solutions they need to operate in this up cycle. Similar to last year, we have set high expectations that I am confident our people will deliver on. We are excited about what we can do in 2023. Gigi, please take the first question.

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Q&A Session

Operator: Our first question comes from the line of John Daniel from Daniel Energy Partners.

John Daniel: Good morning. Thank you for squeezing me in. Just two questions for you. The first is on your prepared remarks, you talked about opportunities with conversions, and I missed part of this, so I apologize. But is that just the radiators or is there other content that you all are participating in? And then is it – color around whether it’s accelerating, steady, just near-term thoughts.

Neal Lux: Sure. Good question, John. Good morning. On the upgrades that we’re seeing, the radiators are a big part of that. Just nearly every new engine will put a new radiator. And generally, they’re choosing to go with the GHT Jumbotron option, which is, again, one of the best radiators in the business. In addition to that, there’s opportunities for power ends that we are supplying as well. And then finally, as the upgrades continue, we are seeing more and more customers utilize our flexible hose and manifold solutions. So those are going hand in hand. I think our acceleration or speed is really dependent on upstream of what’s going on in supply chain of us from deliveries of engines to the packagers that put everything together. So bookings are there, and I think it will just go through the year to see how well the supply chain delivers. But we’re prepared, we’re ready on that side to deliver.

John Daniel: Okay. And then one final one for me, and I’ll let others in. On the M&A, would you characterize your looking – are these tuck-in opportunities? Or would you look to do something more transformative? And then are you casting a wide net, if you will? Or are you trying to – is there certain one or two product services that you’re keen on bringing in the portfolio? Just a little bit more color on that.

Neal Lux: Yes. Great question. I’ll start, and I’m sure Lyle will add in. For those who followed FET, we’ve always been an M&A company. We’ve always looked at different opportunities. And we’re open to both a tuck-in acquisition or a transformative acquisition if it can meet our criteria. And really the key there is, it has to be accretive and be a good strategic fit. So areas that we really like are those in artificial lift or areas where we can consolidate with existing product lines like controlling our completions. Also, we want to have acquisitions that improve our financial metrics, improve our EBITDA margins, free cash flow profile. And then finally, we want to maintain and reduce our net leverage. So if we can get the right deal done with cash or look to an appropriate mix of cash and stock. And again, we’re open to using equity. We think our stock is undervalued, but we need to have a partner that sees the same value as well.

John Daniel: Okay, fair enough. Thank you all very much.

Neal Lux: Thanks, John.

Operator: Thank you One moment for our next question. Our next question comes from the line of .

Neal Lux: Good morning, Eric.

Unidentified Analyst: Good morning. Congrats on another good quarter. Just a couple of quick questions. So are the sale leaseback proceeds required to go to the debt similar to what happened on 12/31/2020 with the valves business?

Neal Lux: Good. Okay. I understand your question. Good question. And no, they’re not. There are carve-outs within the indenture that allow us to use that cash kind of on a per transaction basis. So we’ve got some good cover there, and we do not have a requirement to return that cash back to bondholders.