Forum Energy Technologies, Inc. (FET) Earnings Call Transcript & Summary

I am Jeff Robertson, Managing Director of Natural Resources at Water Tower Research. Before we begin, I would like to mention that today's discussion could include forward-looking statements as of today, May 21, 2024. FET's disclosures regarding such statements can be found under the Investor Relations tab of its corporate homepage. Neal and Lyle, I'd like to thank you for taking the time to join us today.

Thank you to be here, Jeff.

FET provides technology solutions to the oil, natural gas, industrial and renewable energy industries. The company's products are designed to help customers safely increase operational efficiency and reduce the environmental impact of their activities. Operational efficiency is really measured on an improved performance on their assets, which can result in lower costs and higher returns on investment. The company's product lines are segregated into 2 segments: Drilling and Completions and Artificial Lift and Downhole. FET served some of the largest oilfield services companies in the world with its drilling and completion segment and the E&P operators who own and process hydrocarbons with its artificial lift and downhole segment.

Neal, I'd like to begin, if we can just talk about the segments and the customers for FET's business. What drives revenue for those 2 segments? And how are they impacted each by capital spending cycles?

So Jeff, we recently adjusted our reporting segments in order to help ease the understanding of our business. And so, as we think about our customers and drivers, I'll start with our Drilling and Completions segment, which is just about 60% of our revenue. And in this segment, we sell the world's largest oilfield service companies. And so they utilize our products and solutions to drill and complete wells for oil and natural gas operators. So, this is generally highly engineered capital equipment and mission-critical consumable items and aftermarket services. This segment revenue is really driven by the level of activity of our service company customers. So specifically, we tend to look at global rig count and hydraulic fracture fleet count. And as these metrics increase, we sell incrementally more capital while also selling activity-based consumable items.

I think roughly 75% of FET's first quarter revenue came from activity-driven consumables. How do you differentiate between Drilling and Completion-related activity versus the production-related activity?

Again, it goes back to the customer base. So on the -- I just mentioned the drilling completions on the -- for that segment, I think we're -- what's important is that those activity-based consumables are usually big ticket items. So, their unit prices can be in the thousands, if not the hundreds of thousands of dollars. So much bigger than nuts and bolts and they need to be replaced every 3 to 6 months. For the Artificial Lift and Downhole segment, we generally sell our products to the operators directly. So there -- their metrics are how do they increase production, eliminate equipment damage and minimize costly workover. So, these activity-driven consumables that we sell in that segment are driven by well count, both newly completed and remediated wells and well complexity. So both segments, we are tied that generally tied to activity, more so on the Artificial Lift and Downhole segment, and we think that's a great place to be because it's generally more predictable, more stable.

So just to be clear, for my purposes, so Downhole - or Artificial Lift and Downhole really is over the life of the well. So that creates recurring revenue opportunities over the life of a producing well as opposed to technologies that are used for Drilling and Completion who's recurring revenue, I guess, is driven by the replacement cycle.

So I think -- yes, that's correct. So, I think a couple of caveats there. So as the wells are first drilled, the Artificial Lift and Downhole segment will consume our products there. Over time, as those wells are worked over or remediated then our products are used to get. And so, we have multiple bites at the apple in that segment. On the Drilling and Completion side, our products are generally not a per well but per multiple well consumption rates so that wireline, coiled tubing, for example, drilling consumables will be used over, let's call it, 10 or 20 wells and then they'll wear out. So, they wear out over time. And I think there, what's changing is the amount of time that these products wear out because of service intensity. What we're seeing is that our products are being utilized more and more per day as wells get longer, as hours pumped per day increases, as laterals get longer. And so they're wearing out more quickly over time. So that's where we see the benefit from service intensity.

You talk about the strategy in terms of a beat to market plan to gain share and drive growth. Can you really talk about what do you mean by beat the market? And how do you execute that strategy?

So as we think to create value over the long term, we need to exceed the rate of growth of our market drivers. So global rig count is really at the FET level, our main driver. And the focus we want to have is we want to grow faster than that rate of growth of that global rig count. And we do that a few ways. First, we want to grow profitable market share. So this is done by aligning our product portfolio to activity. So, we've talked about that here just a second ago. We also focused on niche markets where we have fewer competitors and higher margins, and we leverage our globally recognized brands. Second, approach is we want to continue to develop differentiated products and technologies that allow our customers to be safer and more efficient. And we combine that with our global manufacturing and distribution footprint, where we ship our solutions around the world wherever energy is produced. And then the final leg of this beat to market strategy is energy transition. As a manufacturer of engineered solutions, we have a lot of different ways of participating in that opportunity. And so when we put it all together, our strategy to beat the market is an approach that we think is paying off today and will pay off even more in the future.

You talked about the business model being asset-light in the past. How does the asset-light business model fit in with the manufacturing and distribution company to really position FET to capitalize on margin opportunities?

So I think as a manufacturer, for us, we can deliver our products wherever energy is produced without having to invest in facilities or basis. So, if we want to ship our -- and we want to sell in the West Africa, we just put our products on a boat and have them delivered. We don't have to invest in local facilities there. It also allows us to pivot where we need to go. So globally, we can shift from the U.S. to Canada to Latin America to Asia and the Middle East, and we can do it without adding a lot of incremental capital expenditures. So, we believe that we can grow our revenues organically by 50% from our current levels without a meaningful change in our level of capital expenditures. This is what we mean by capital-light. We have a business with really strong operating leverage that does not require a lot of capital investment to grow revenue.

Lyle if we can just touch on the balance sheet, I know we'll talk about Variperm the acquisition, which closed in January here in a few minutes. But from a big picture standpoint, how do you think about managing the balance sheet to maintain FET's flexibility and be able to adapt to changing market conditions in the different parts of the world in which the company operates?

Yes, good question, Jeff, and thanks for hosting us today. Neal mentioned operating leverage. And that's a key -- something that's very interesting, I believe, from our investment thesis and operating leverage specifically stems from our capital-light business that Neal talked about. That means that we can grow considerably without more CapEx. And also from our ability to grow top line without having to add a lot of other fixed costs. So as we grow, we ought to be able to expand our margins. We believe firmly that a company like ours that has a lot of operating leverage should not have a lot of financial leverage. So the last several years, we've done a lot of work to fix the balance sheet. First, since 2020, we've reduced our net debt position from $400 million or so to roughly $100 million, a level that's less than the accounts receivable on our balance sheet. So, a lot of de levering of the business. Last year, we upsized our asset-backed revolving credit facility, our ABL to $250 million. So, as we grow and we need to grow working capital, that facility will grow along with us, gives us dry powder. Then finally, in January, you mentioned Variperm, but we did complete the Variperm acquisition, really dramatically increasing our scale, profitability and drop-through of cash from that profitability. So with that new scale and profitability, we're able to generate a lot more free cash flow. So right now, I think we have the right financial structure to weather ups and downs in the market. If there's softer times in the market, we can service our debt by monetizing working capital as times of stronger growth, we can leverage our ABL to fund those requirements and cash needs.

Neal, I'd like to go back to the correlation of revenue with global rig down as we talked about, that really revenue is driven by activity levels. But in the U.S., an unconventional basin, the laterals are getting longer, as we mentioned, completed -- that requires more intense stimulation which puts more wear and tear on the type of capital equipment products that FET provides for Drilling and Completion work. So, if you think about revenue on a per rig basis in a stagnant rig count, is it -- is there an opportunity still to grow revenue because of the shorter replacement cycle for a lot of the products that FET provides?

Yes, Jeff, absolutely. So the first and most direct way we benefit from the unconventional growth of lateral length and other completion intensity is greater demand for our products. So, the more footage drilled, the longer lateral length, more stages per well, more pumping hours per day that as those metrics you mentioned earlier, increase, the more our products are consumed in the year. So, this is really a secular driver related to service intensity. And a great example of that is our wireline cable business. So, with more stages per well and more pumping hours per day, our cables are going to help the operator enable more production for that well, which is great for that operator. But for the service companies, they're going to need to replace our cable more often because it's working more. And so, this is service intensity that drives demand and more revenue for FET.

Really to gain share and to increase FET's total addressable market requires the company to provide technology solutions that really meet those changing needs of the customers that you talk about. How do you -- what's the engineering and design process to identify solutions to where FET can supply its customers with innovative products to capitalize on those types of trends?

So again, we look at those trends. And we key our product development a couple of different ways. We want to develop products and solutions that last longer, again, so that they see more value per dollar they spend that reach farther that go longer on the lateral, that reduce downtime. And especially the service intensity increases, the value of our products that increase efficiency, they go up as well. So, we utilize our market-facing employees who are really experts in their market niches and who understand how to capture value so that we develop the right way to develop products to separate ourselves from our competition. And as we look at key markets, we want to -- when we want to innovate, we want to earn a great return. We want to generate higher margins, and we've had success doing that, especially with our newest products like the FR120 Iron Roughneck and our latest iteration Enviro-Lite Greaseless Cable.

You all, I think, developed some new pump -- pressure pump in [indiscernible] which also have been shown so far to pretty dramatically increase operational efficiency. Neal, what's the -- what's the adoption time line on some of the innovative products that you design look like? And how do you drive adoption within -- among the customer base?

That's a great question. And it varies. So we do innovation in a couple of ways here. So there's really kind of what's called the iteration where every quarter, every 6 months, every year, we make our existing products better. We see that great examples is in our wireline business, our Coiled Tubing businesses, our multi-list pump business where we're just making the existing products we have incrementally better year-over-year. And again, that separates us from new entrants and makes it makes it hard for a competitor to get into the market. That adoption rate is generally very quick. So that happens more quickly. On new products that are disruptive, and I think the FASTConnect is a great example of that. It takes longer time. Service companies, operators, everyone likes to be the second first user of your products. So what we need to do is to get our product in the field as early as we can. And so what we do is early stages of product development as we're analyzing the market that we are targeting, we are listening to the voice of the customer. That's critical. So that when we are ready for our first field deployment, we have a customer we've convinced, who's worked with us, who's ready to adopt. Then when we get in the field, we gather data. We want to ensure that we are indeed solving the problem that we've set out to solve. And when we were successful, we create white papers. We present at industry events, and we utilize targeted marketing to develop leads and opportunities. And we are in a relatively small industry. There's fewer and fewer operators. There's fewer and fewer service companies. So, any time you have success with a leading customer, you will get a lot of adoption more quickly just by having success and word of mouth.

Neal, it sounds like there's a lot of collaboration then between FET and your customers on what they need and how you all can best provide. Is that also true in your Coiled Tubing line of products. As companies say, these are the types of wells we need to be able to drill and can you design a Coiled Tubing string to allow us to be safe and efficient?

Absolutely. I think the Coiled Tubing example is one that we see across the company. But we have multiple engineers working for us today that in their previous parts of their career had been engineers for the service companies, utilizing Coiled Tubing in the field. And we've brought that expertise in-house, and they work on a daily basis, looking at well designs, different types of casing, different types of wells, depending on the severity and the tortuosity where they will make specialized and custom designs for our customers to enable them to have the most productive Coiled Tubing string utilized in their operation. And then what we combine that with is our manufacturing and supply chain so that we can be as flexible as possible and customized as possible, but do it in extremely friendly way for working capital so we can turn our inventory and move quickly to the manufacturing process. So we've spent a lot of time putting all those phases together. And I think it's led to a lot of our success, especially in the completion side of the business.

FET acquired Variperm Energy Services, a Canadian local services company, which specialized in flow control products, primarily for the oil sands market in Canada in January of this year. What role the acquisitions play in the beat the market strategy? I know FET has really executed a series of transactions, which since the company was formed.

So for us, beat the market is a combination of organic and inorganic approaches. So when we do look at acquisitions, we won acquisitions that have strong industrial logic that can increase our margins, that have products that are differentiated and ideally protected with IP or industrial know-how and can be accretive specifically with Variperm, which is a great example. They increased our total addressable market by adding sand and flow control products to our Downhole portfolio. Their products are used globally in complex well formations. But adding Variperm also gave us access to the Canadian oil sands, which is one of the largest and most stable oil basins in the world. And then I think at a time when energy security dominates political calculus participating in the Canadian oil sands is a great place to be.

You talked a little bit about margin accretion, but Variperm's margin accretion in Artificial Lift and Downhole segment was very evident in first quarter 2024 results. Adjusted EBITDA margin was 21.6%, which was more than 500 basis points higher than first quarter '23 with nearly a full quarter contribution from Variperm. Why are there solutions so accretive to FET's overall margins?