Forum Energy Technologies, Inc. (FET) Q4 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen and welcome to the Forum Energy Technologies Earnings Release Conference Call for the Fourth Quarter 2012. My name is Shanelle, and I will be your coordinator for today's call. At this time all participants are in listen-only mode. And all lines have been placed on mute to prevent any background noise. We will be facilitating a question-and-answer session after the speakers' remarks. As a reminder this conference call is being recorded for replay purposes. After the speakers' remarks today I'll instruct you on procedures for asking questions. I will turn the conference over to Mark Traylor, Vice President, Investor Relations & Planning. Please proceed, sir.

Thank you, Shanelle. Good morning, and welcome to Forum Energy Technologies Quarterly Earnings Conference Call for the Fourth Quarter 2012. With us today to present formal remarks are Cris Gaut, Forum's Chairman and Chief Executive Officer and Jim Harris, Senior Vice President and Chief Financial Officer. Also with us today are Forum's two division presidents, Charlie Jones, President of Drilling and Subsea Division, and Wendell Brooks, President of our Production and Infrastructure Division. We issued our earnings release last night and it is available on our website. The statements made during this conference call, including the answers to your questions, include information that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements involve risks and uncertainties that may cause actual results or events to differ materially from those expressed or implied in such statements. These risks include, among other things, matters that we describe in our earnings release and in our filings with the Securities and Exchange Commission. We do not undertake any ongoing obligation, other than that imposed by law to publicly update or revise our forward-looking statements to reflect future events, information, or circumstances that arise after this call. In addition this conference call contains time-sensitive information that reflects management's best judgment only as of the date of the live call. This call is being recorded and replay of the call will be available on our website for 30 days following the call. Management statements may include non-GAAP financial measures. For reconciliation of these measures, refer to our earnings release available on our website. I am now pleased to turn over the call to Chris Gaut.

Thanks, Mark and good morning. I will start with some highlights from the quarter and the full and offer a few thoughts and the outlook for our business and then I will turn it over to Jim who will provide greater detail on our financial performance. Our fourth quarter, diluted earnings per share were $0.26, but this includes $0.02 of charges for acquisition transactions, severance and foreign currency expenses. During the fourth quarter oil and gas operators reduced their spending resulting in a declining U.S. rig count. This lack of spending in activity especially in the latter part of the quarter affected our sales of consumable products and we also saw some customers defer the acceptance of capital goods they already had on order from us. This lower level of activity caused us to have an under absorption of manufacturing costs, which depressed our operating margins in the fourth quarter across many of our product lines. Total customer orders during the fourth quarter were $335 million. The fourth quarter book-to-bill ratio was 101% for the company as a whole for Drilling & Subsea division in with 99% and for Production and Infrastructure division was 105%. On a sequential basis, we had a 6% decrease in orders from the third quarter on lower orders for Drilling, Subsea and Valve product lines. Production equipment orders although down from the third quarter as well, remained at a very high level and we have recently received a number of large orders from modular equipment from major operators. We also saw an increase in orders for Flow equipment and we believe this business has now begun to improve. The outlook for our Subsea Technologies product line looks good. And based on recent customer discussions we expect strong demand for our remotely operated vehicles our ROVs…

Thank you, Chris, and good morning, everyone. Consolidated revenues of $330 million for the fourth quarter are down 2% year-over-year. We had good year-over-year revenue growth in Valve Solutions at 23% and Production Equipment improved 8%. These gains were offset by the challenges faced in Drilling Technologies with the North American rig count down over 11% at the end of the year compared to a year earlier. These declines in activity drove our Drilling Products revenue down 7%. We have discussed in earlier calls the market for our Flow Equipment products but our customers continued destocking in the fourth quarter 2012 and this resulted in a year-over-year decline of 34% from the very strong results achieved by Flow Equipment in the fourth quarter 2011. Sequentially, our consolidated revenue declined 5%, mostly attributable to Drilling Technologies 16% reduction, so that product line has been working down the portion of its backlog with near-term delivery commitments. Despite the strong headwinds in the year, Drilling technologies achieved record revenue for the full year 2012. We had good sequential revenue gains coming from our downhole product line, up 11% in the fourth quarter and the demand for those products remains consistently elevated above our current production capacity. Our net income for the fourth quarter 2012 was $24 million, a decrease of $8 million or 25% compared to the same 2011 period. Fully diluted earnings per share for the quarter of $0.26 includes $0.2 and charges for transaction fees related to the four acquisitions, severance costs and foreign exchange translation losses. The adjusted $0.28 represents a decrease of $0.15 or 35% from $0.43 reported in the fourth quarter 2011. However, approximately $0.8 or over half of that decrease year-over-year is attributable to the dilutive impact of the shares issued in the IPO and concurrent private…

Thanks, Jim. I think Forum had a fairly successful year during 2012. We delivered record annual revenue of $1.4 billion, grew revenue 25% year-over-year, with each of our six product lines contributing to the growth, unfortunately completing our IPO and concurrent private replacements in April and closed four acquisitions in the fourth quarter. We welcome the addition of Dynacon and Merrimac to the Forum product family and we see good potential for other attractive acquisitions that will further expand our offering within our existing product lines. Let me finish with some comments on 2013. We expect sequential improvement throughout 2013 in our results and a good contribution from our recent acquisitions. Although our Drilling Product line continues to face headwinds, our other businesses are seeing growing demands and good prospects. We are seeing an increase in orders which will drive an improvement in our results over the course of 2013 we believe. I'm pleased with the progress Forum has made, and I want to recognize and thank our employees for their good work. Thank you for your interest. And at this point, we will open the line for questions.

(Operator Instructions). Our first question comes from the line of Jonathan Sisto of Credit Suisse.

Good morning, gentlemen.

Good morning, Jonathan.

Chris, if you may, as we look into '13, how much of your cash flow will go to acquisitions and how much will go to organic growth? And then, I guess, secondarily, do you expect to lever up in any way to accelerate the growth in '13?

So, as Jim said Jonathan, our capital spending program in 2013 about $65 million, we made a significant investment in working capital for growth throughout 2012 and we think we will be able to leverage that working capital balance we have with minimal increase, as we grow revenue from here organically. So, that will leave a significant amount of free cash flow that we can devote to acquisitions. As you know and you can see from the balance sheet attached to the press release, we have an underleveraged balance sheet. If we are very successful on acquisitions, its potential, it is possible that we would increase our debt percentage of our capital structure somewhat in 2013, Jonathan, but I do not see us levering up the company so to speak, correct. But we feel we got the resources to fund our growth both organically and continue our acquisitions program which we see is having good prospects.

On the prospects, how many prospects are out there in kind of the $25 million to $100 million range?

Well, we don’t want to for obvious reasons be too specific there, but we’re looking at, as we always do, a number of acquisitions and they tend to be more naturally in the smaller end of that range, but we also have some bigger things that we’re investigating as well. It’s very hard to predict or plan or budget acquisitions, but it is an area that gets significant effort for us. But I don’t want that to take away from what we see as our growth opportunities in the number of our businesses, the prospects in the subsea business look good. We noticed the demand out there for our downhole products that we’d like to get on with addressing, continued strong demand in Production Equipment and Valves and even Flow Equipment having turned the corner, we don’t expect a rapid improvement there but a gradual one during 2013 now that the destocking is behind us.

Chris, I appreciate the color. I’ll turn it back.

Thank you.

Our next question comes from Brad Handler, Jefferies & Company. Brad Handler - Jefferies & Company: Thanks. Good morning, guys.

Good morning, Brad. Brad Handler - Jefferies & Company: Could you please fill in a little bit for us with respect to your '13 guidance I guess, perhaps may be the $1.80 to $1.90 range, is the real swing factor there Drilling Technologies and the strength of the recovery, and perhaps you could fill that answer in with -- you know with the bottom of the range a flat year-on-year in Drilling Technologies for example?

Yeah, I think that’s a one way to think about it Brad, yes. I think the rate of improvement or the level of improvement in Drilling Technologies that being our largest product line business swing factor for us. When we think about the improvement over the course of the year, it is the combination of course revenue growth but also margin improvement. Brad Handler - Jefferies & Company: Okay, fair enough. Is that may be make sense then to try to get a sense for your rig count forecast implicit in the range or your sense of activity if you want to express it in some other way, what are you assuming and then specifically how strong does it have to be in the back of the year to get there?

Right, so from year end '11 to year end '12 if the U.S. rig count came down 10% to 12% and we think we might get may be by the end of ‘13, may be half of that back but that still implies that year-over-year the rig count would be down 5%, right. So some improvement from year end '12, but our planning is not significant in the rig count improvement. On the other hand, we think Brad with the greater level of drilling efficiency, uncompleted wells and so on that the number of wells that will be completed will be at a significantly higher rate and that -- with that that is meaningful for Forum because more of our businesses are tied to the well count than to the rig count. If maybe 25% of our revenue base is tied to the rig count, 40% is tied to the well count. And so with that higher well count, I think that explains part of our growth expectations for number of businesses, including Downhole Technologies, Production Equipment, Flow Equipment and to some extent Valves and our well servicing products and equipment that we sell even within the Drilling Technology Group. Brad Handler - Jefferies & Company: That will make sense. No, that all makes a lot of sense. If I may, may be just one more quick one and then I will turn it back. In your Q1 guidance, what are you expecting revenues or perhaps what’s the range of revenues?

Brad, this is Jim Harris. We don’t typically give revenue guidance, but with the acquisitions, I will say that it will be up from the fourth quarter. Yes, so we said $100 million for the year and you know so that’s a starting point, but I think we have indicated that we do see some other growth in a number of our product lines. We expect revenue to be up across the board in Production and Infrastructure Group hoping for improvement in downhole and in subsea drilling is the question mark as you pointed out at the outside of your question. Brad Handler - Jefferies & Company: Okay, all very helpful. Thanks, guys.

Thanks.

Our next question comes from Doug Becker, Bank of America.

Thanks.

Good morning, Doug.

Good morning. Just help me a little more order of magnitude of the factors that impacted fourth quarters, certainly the under absorption has been mentioned, lower spending in Drilling Technologies, some of the deferral capital equipment. Just to better calibrate the recovery in '13, can we get a sense of your order of magnitude of some of these larger factors?

Yeah, Doug, so about -- I’d say about half of the decline or maybe less than half was attributable to the absorption issue and the manufacturing inefficiencies and then a little less than half would be attributable to these systems implementations. Over the last 18 months we have implemented close to 20 new ERP systems in our businesses and as you know, a pretty knows and is disruptive and there tends to be a period of adjusting to those systems after their end. And we still have several more that we intend to implement this year and that has driven some of the inefficiencies. And then keep in mind also the $0.02 that we called out from the earnings per share, those factors do also impact the EBITDA margins that would have contributed and then the balance would have been with the mix and the customer delays that we talked about the deliveries.

Right, so you are speaking of the kind of EBITDA margins and the breakdown in the margin percentages there among those items, which I think is good color, but you know going to revenue if that’s part of your question as well Doug, obviously that the revenue reduction sequentially was all in the Drilling Subsea Group and that was primarily in the drilling area. Is that responsive?

No, that makes a lot of sense. Have you seen capital equipment cancellations or is it really just referrals that we’re seen?

No, we have not seen cancellation, so it was truly operators who had because of the greater drilling efficiencies used up their budgets and were really in a position to say, gosh, we are just going to not -- we don’t need to do anything in the rest of the year, we are not going to do anything rest in the rest of the year until we get our budgets refreshed. I think in some cases they were also looking possibly at some of their contracts or services with us but with our customers, turning over to more attractive rates with the operators at the beginning of the year, a lack of urgency [did work]. And for example if I mentioned not getting well sites prepare to accept delivery, but even in the subsea space, we saw some delays taking what we expected would be delivery of some capital equipment there into the first quarter.

And one last one on just downhole mention that was exceeding demand was exceeding the bearable capacity with this reframe is it machines from in fracturing and help within this be addressed?

So with the working on that for some time Doug and you know its challenge both on the process on and you know the culture side and I think we are making progress, we know the potential is there and revenue was up fourth quarter or the third quarter and we are looking for continued improvement you know I guess that good lease out of this is we are more confident that the potential exist. Right Charles?

Absolutely.

Okay, thanks very much.

Thanks, Doug.

Our next question comes from Blake Hutchinson, Howard Weil.

Good morning guys.

Hi, Blake.

Chris you made some comments about word of flow in the fourth quarter and I just wanted and also cited some early quarter success in both production equipment and flow equipment. Wanted to get your feel for first quarter order flow are you suggesting it maybe we're starting the year definitely better than 4Q or kind of tracking that at [330] or just kind of maybe your thoughts around what you're seeing?

On the production infrastructure side, yeah I think we are definitely starting the year stronger from an order flow there, right Wendell?

Yeah.

Across the board, in drilling and Subsea space you know drilling is in a different category that’s going to be slow until the recount turns around on the other hand we just talk about downhole and the strong demand out there is the matter how much in the way orders we can accept and deliver on time. Subsea space we are saying that we expect an increase in orders there just recently Charlie and I were talking this morning we hadn't received an order for a trencher in Asia. I think today we also just gotten another order for [ore class] vehicle in both of those associated with that. So demonstrate the advantage of that other combination there. So we certainly need for the quarter but the discussions we are having with customers indicate to us that the demand is out there.

So P&I definitely with that drilling in site it’s going to be a little tougher drilling such a piece of that division?

Yeah, I mean we do think the orders will be up over Q4.

Okay, great.

Yeah.

And just following about you talked about the Subsea segment, I guess because of the fairly well documented success and lot of with lot of spicing that it flat understanding its won’t be its there a you know projection in terms of where will be delivering some of these longer lead items, where we should expect an uptick in revenue, should we be more concentrated to second and third quarter or do you see a nice uptick in first quarter? Can you help us out with lumpiness of that business a bit?

Yeah right so we some time receive orders for equipment for delivery you know year from now but we don’t begin recognizing revenue on that and to we substantially closer to delivery could doesn’t take as that long to build it. So revenue increase in Q1 will be driven by near term orders I think this trencher for Asia is a near-term more as this work pass or we I just mention we are seeing good demand for observation ROVs and some of the orders that are under discussion are not yet booked would be for nearer term delivery.

Okay that’s good color and just housekeeping Merrimac is going to go all in the drilling segment correct it’s not split between drilling and flow equipment?

Correct.

And would you suggest, you gave a little color as to revenue run rate, can we enter these immediately 20% op margin in terms of or should we build that over the year?

A couple of deals, I think a consistent margin over the course of the year should use most assumptions like--

Great. Thanks. I'll turn it back.

Our next question comes from the line of Jeff Tillery, Tudor, Pickering

Hey good morning.

Good morning, Jeff.

Both, the Downhole Tools business you talked about demanding there in excess of which you feel comfortable being able to take -- take the orders and be comfortably you can deliver them, is there capacity milestones we need to be watching this year, is there some kind of light switch date which we need to be aware of, or we see an inflection there, or is it more gradual?

It's a gradual improvement in our capabilities, but we are clearly working on. We are taking number of steps that gradually will improve our capacity. And we think there's the potential for some larger orders out there that we'll be working towards. And that would be -- once we take those on and make some announcement that will be big step forward.

And I think an add on, Chris, that I think the thing that you need to understand, Jeff, as well there is no step function and it is going to be gradual as Chris said, but we are looking at some longer term deals. So that's why we're trying to take our time and position ourselves to be able to address this in the longer term form the capacity perspective.

Longer term large deals.

Right.

I guess, mechanically how would that working -- would you book that all in one period of time, now we'll we see that, and we see the visibility around that coming or that it would be more of a frame agreement type of --

It would be a frame agreement, right, these are not capital goods right. So there would be orders for certain volume of equipment over a period of time.

Yeah, we can't position ourselves.

And we would book that and recognize the revenue as those product ship.

That's makes, sense. And the production and infrastructure segment with revenues that were pretty flattish sequentially I guess I was surprised to see the 500 basis point gross margin decline was that -- how much was a mix issue versus just efficiency issues, or can you just provide a little bit more color on that, Jim?

Yeah, it was - Wendell do you want to address that.

Sure, Jeff. Biggest problem for us in the fourth quarter, were the delayed shipments, which led to a lot of inefficiency in our plants that was about, probably 300 basis points. We also had about 100 basis point of product mix, the client mix in the and fourth quarter shifted. And we had some inefficiencies in the few jobs, the primary problem for us were [delayed] shipments coming into the end of the year.

And so we have labor cost and it didn't make sense for us to lay off or reduce hours for people in December knowing that this is a business that was seeing strong demand and when we're trying to bail them, trying to build and retain capable work force. So we have (Inaudible) costs.

I guess, looking at it another way, that those revenue was flat sequentially, coming into the quarter, given what you've now and you would have thought revenue been up quite a bit, and so that's why those costs were still in place? Is that's fair?

We thought that those products would ship, that we have on order yeah.

Alright, should we thing -- thank you guys very much.

If that puts in the Q1, but doesn't mean we're going to have some kind of windfall Q1 of the stuff that's slipped plus, a normal level of Q1, it's more likely that the whole scheduled to shipped out, right.

Okay, that makes sense. Thank you.

Our next question comes from Robin Shoemaker, Citi.

Thank you. Good morning, Chris. Wanted to ask you, if could just give us an overview of the international business. I think that's now 40% of your revenue roughly. And where do you see the most opportunities for growth internationally across all your product lines. And are there any new international markets that you're targeting?

So, our subsea business we clearly see its growth all of that is international, our customers are tend to non-US companies and so we recognize that all international even if we sell some subsea equipment that might, that goes on, a vessel that might be working in the Gulf of Mexico from time to time right, does that make sense? Other areas that are driving international opportunities for us in the downhole space international demand opportunities look good. And a number of it was related to where the active rig counts are whether that be Brazil and the Middle East and Asia. And in drilling we see opportunities that we're working on in Asia for some capital equipments in Middle East. And we think that recent acquisition of Merrimac on the consumable side has really good international opportunities that we can grow into, it will not happen once, but it's something we're ramping up.

Okay. Good. Just one other [smallest] question. In your previous earning releases you had disclose gross profit and SG&A by in terms of both division drilling and subsea and production and infrastructure. And in this press release you disclosed operating income and EBITDA, which you'd previously. But, is this new the new format going forward or that's just for modeling purposes?

Yes. Robin, we'll have full disclosures in the K, the reason that we cut back if you'll note in the MD&A in each of the quarters, where we've discussed results we talked about operating income margins as suppose breaking it out between gross margins and SG&A and it was kind on and we only having schedule in there, so what we've done is gone to a format that's consistent with what other companies report that are in our space and we would expect continue to have the earning released on that basis.

Okay. Got it. Thank you.

Our next question comes from the line of Mike Urban with Deutsche Bank.

Hey. Good morning guys.

Hey, Mike.

Chris, I appreciate the breakdown on the percentage of the business coming from rig count versus well count or consumables, but I wanted to dig a little bit further into the drilling business, since that's I guess, you have the least visibility and then we're maybe is the weakest right now. I guess first question I mean how much if any visibility do you have into a recovery at this point or its still wait and see right now?

So, there's two parts right, the consumable part and the capital equipment side. On the capital equipment side, that's going to be down, right? Most of our capital equipment is sold to land rig operators. And there's less new building of land rigs and upgrading going on there. We are offsetting that with our initiative on the international side. And U.S. rig upgrades haven't gone away they just -- they're just on the lower level, so that's where we are on the capital equipment side and it will be a bit lower until either we can attract more international upgrade. And association with new builds for capital goods or the U.S. market picks up. On the consumable side, there's the initial destocking that goes on when rigs are stacked, and the rig count is on its way down, that runs its course. And we feel that we're that that destocking is possibly getting to an inflection point, right, Charlie?

Yes.

Not ready to call the bottom, but we think we may see it on the horizon there. So, we don't -- what are we signaling is we don't expect consumable business to continue to fall right, and that's possible in the near term we could seen an inflection point.

Okay, got you. And then digging in more specifically on the capital equipment piece given what we seen and continue to see in terms rig efficiency improvements. Is that business that can return to the previous level of growth that you've had in the past and then if so, what drives that? Is that as you said the international coming through is that the gas coming back in U.S., is that attrition? How should we think about that business structurally given the ongoing improvements in the [efficiency] and the fact that we have significantly recapitalized the U.S. fleet at this point.

Mike, I think there are a number of potential drivers there like one is new rigs internationally, both land rigs and jackup rigs, that we can be associated with. Second, is on the international side, I think growing desire by rig contractors to do some of the upgrades that have been done to rigs here in the U.S. And then thirdly, in North America with this drilling efficiency trend, there is a real push to have highly efficient rigs and operating that equipment and some mechanical rigs are certainly going to be retired but other SCR rigs and so on will be upgraded. And I think there is a potential with more cash flow to the drilling contractors, as their cash flow improves for them then to begin to invest as their utilization opportunities improve for them to do more upgrades there again.

Okay, great. Thank you.

Thanks, Mike.

Thanks, Mike. We'll take one more question, Shannelle?

Yes. Our final question comes from Josh Lingsch of Simmons & Company. Josh Lingsch - Simmons & Company: Good morning, gentlemen.

Good morning, Josh. Josh Lingsch - Simmons & Company: Chris, a couple of questions for you. You mentioned revenue for flow equipment increased 4% in Q4 due to increased consumable orders was that primarily fluid ends?

It was not. It was that flow including our - and there were some fluid end orders that we have begun to see and we are getting more orders for fluid ends, but it was again most of our sales are of flow lines (Inaudible), valves and so on. That would be the larger portion of the mix of our business. Josh Lingsch - Simmons & Company: Okay great thanks. And then second could you provide us with your thoughts on the wear and tear of the U.S. frac fleet and when do you see the need for increased fleet remanufacturing and when does that effort actually materialize?

Okay. So what we largely produce in the flow line and at consumable parts, the high pressure components there, high use areas are by their nature equipment, that needs to be inspected, serviced and replaced on an ongoing basis. And I think, we have a number of different currents in the pressure pumping market today, we may not, in many basins be press -- pumping, as higher pressure as we were in say Haynesville. But on the other hand as we move to basins where there are more stages and possibly, more pad sites where the equipment can stay on one location longer and be pumping more stages for months with fewer moves, obviously that's more up time on the equipment and more pumping. So, we think that now this the stocking has largely run its course to the level of demand will be driven by the activity and there we expect with -- there is good amount of pumping activity going on and that will drive demand for these consumable products. Josh Lingsch - Simmons & Company: Okay.

And that destocking process--

And question about demand for new equipment, I think that goes to how much equipment, pressure pumping equipment remains stacked, what the utilization rates and when that, when those utilization rates go back up. And that is not a market that we track as much as what the activity is in and what the demand for these consumable products are. But clearly there is still a significant amount, I don't know what it is 30% pressure pumping spreads that are stacked. If they get back to work that's that much more [shooting iron we'd need to set]. Josh Lingsch - Simmons & Company: Thank you very much.

Very good, josh. Well we thank you all for your interest and good questions. And we look forward to talking with you again next quarter and hopefully seeing you in the interim. Thanks, Shannelle?

Thank you. Ladies and gentlemen that concludes the presentation thank you for your participation, you may now disconnect have a great day.