Mark S. Traylor - Forum Energy Technologies, Inc. C. Christopher Gaut - Forum Energy Technologies, Inc. James W. Harris - Forum Energy Technologies, Inc. Prady Iyyanki - Forum Energy Technologies, Inc..

David Anderson - Barclays Capital, Inc. George O’Leary - Tudor, Pickering, Holt & Co. Securities, Inc. Jacob Lundberg - Credit Suisse Securities (USA) LLC (Broker) John Daniel - Simmons & Company International Blake Allen Hutchinson - Scotia Howard Weil Rob J. MacKenzie - IBERIA Capital Partners LLC Marc Bianchi - Cowen & Co.

LLC Bradley Philip Handler - Jefferies LLC Robin E. Shoemaker - KeyBanc Capital Markets, Inc. Sean C. Meakim - JPMorgan Securities LLC.

Good day, ladies and gentlemen, and welcome to the Third Quarter 2016 Forum Energy Technologies Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instruction] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Mark Traylor, Vice President of Investor Relations. Mr. Traylor, you may begin..

Thank you, Danielle. Good morning and welcome to Forum Energy Technologies Third Quarter 2016 Earnings Conference Call. With us to present the formal remarks are Cris Gaut, Forum's Chairman and Chief Executive Officer; as well as Prady Iyyanki, President and Chief Operating Officer; and Jim Harris, our Chief Financial Officer.

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 may include 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. Those risks include among other things matters that we have described 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 any 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. Management statements may include non-GAAP financial measures. For a reconciliation of these measures, please refer to our earnings release. This call is being recorded.

A replay of the call will be available on our website for two weeks following the call. I'm now pleased to turn the call over to Cris Gaut, our Chief Executive Officer..

Thanks, Mark, and good morning. I will begin with a summary of our third quarter performance, make some observations about the current market conditions and outlook and talk about our plan for Forum going forward.

Afterwards, I will turn it over to Jim who will discuss our financial results and liquidity position, and then Prady will address our preparedness for the recovery. The improvement in the North America drilling activity is marking the start of a recovery from the most significant downturn in decades. The average U.S.

rig count increased 14% in the third quarter and our U.S. revenue was up 17% sequentially on the improved U.S. land rig count. Our third quarter revenue was $138 million, a 3% decrease sequentially as the average oil price did not improve from the second quarter.

Despite the $5 million decline in revenue, our adjusted EBITDA increased $1 million and our net loss per share was $0.19 excluding special items which was the same as the second quarter. With the strengthening in oil prices towards the end of the quarter and improving confidence by the operators, we have seen an improvement in our inbound orders.

Excluding one order we received in 2015 for a large refinery project, we had the first increase in orders since the start of this downturn two years ago. Forum's total inbound orders during the third quarter were $145 million, a 13% increase from the level in the second quarter.

Setting aside our subsea product line and later cycle business, our new orders for the rest of Forum were up 29% sequentially. The third quarter book-to-bill ratio is 104% for the company as a whole, 91% for the drilling and subsea segment, 97% for the completion segment and 121% for the production and infrastructure segment.

Our short cycle North America upstream businesses, which represented almost half our total revenue, showed sequential growth well in excess of the increase in the U.S. rig count and had incremental margins of nearly 50%.

Our reduced cost structure, operational efficiencies and better manufacturing absorption drove these margins, and Prady will discuss more about these factors later in the call. Our late cycle businesses, subsea and drilling capital equipment, continue to work off their backlog and show declining revenue.

Our midstream and downstream businesses completed some large projects in the second quarter and have had some other awarded projects deferred until next year. However, new orders during the third quarter for our valves product line were up 26% sequentially.

Orders in our completion segment increased 17% as customer spending improved on downhole completion products and pressure pumping consumable equipment. This increased spending was driven by improved utilization of hydraulic fracturing equipment and more well construction activity.

Our domestic completions business is a build-to-stock sell-from-stock business, so it typically has a book-to-bill ratio of right around 100%. Orders in our drilling product line were up 48%, resulting in a book-to-bill ratio of 117% during the quarter, primarily on demand for rig consumable products and mud pump upgrade packages.

New orders in the subsea product line were down significantly and the book-to-bill ratio was 54% in Q3 as orders in this business are lumpy. However, I would note we have already received a very nice order in Q4 for subsea equipment for non-oil field use.

In our production equipment product line, orders were up 29% in the third quarter as operators made plans to complete more wells. We received an award from a large independent operator for 100 multi-phase hydrocarbon separation units to support their 2017 well completions program in the Permian and Eagle Ford Basins.

As we look ahead to the fourth quarter, we expect our orders to continue to increase. Taking into account the potential impacts of the holiday slowdowns to weather-related delays and instability in commodity prices, we expect our fourth quarter financial results to be in line with or slightly better than the third quarter level.

Our financial position and liquidity remains strong and allow us to pursue disciplined acquisition and product development strategies. We are seeing an increase in acquisition activity as the recovery begins to unfold and we expect to benefit from this trend. Now let me ask Jim to take you through our results and financial position.

Jim?.

Thank you, Cris, and good morning, everyone. I will summarize our results for the quarter, comparing the third quarter 2016 with the second quarter 2016. Consolidated revenue of $138 million for the third quarter was down 3% sequentially, primarily on lower international activity levels, partially offset by higher activity in North America.

Our drilling and subsea segment revenue of $51 million was down 11% due to lower demand for drilling and subsea capital equipment, although we had increased sales of drilling and consumable products in North America.

The completion segment revenue of $34 million increased 37% sequentially due to higher well construction and completion activities in North America.

Our production and infrastructure segment revenue of $54 million was down 13% primarily due to the completion of an unusually large international refinery project in the prior quarter and softer demand for valves from the midstream gas transmission industry. However, our U.S. production equipment product line revenue increased 18% in the quarter.

The net loss for the third quarter was $18 million or $0.20 per diluted share. The quarter included special items on a pre-tax basis of $4 million for restructuring charges related to facility closures, partially offset by $3 million of foreign exchange gains.

The adjusted net loss excluding these items and the associated income taxes was $0.19 per diluted share. Our third quarter adjusted operating loss was $22 million excluding special items compared to an adjusted operating loss of $23 million from the second quarter.

Our operating margins improved even on the reduced revenue as we benefited from our cost reduction and efficiency initiatives. Our free cash flow after capital expenditures in the third quarter was negative $4 million.

While we successfully reduced inventories by $20 million during the quarter, we also reduced outstanding trade accounts payable by nearly an equal amount. Importantly, our customers delayed payments to us in the quarter, extending our average collection period by eight days.

That increase in days sales outstanding delayed about $12 million of expected free cash flow for the third quarter. While we have collected many of these larger accounts this month, year end collections could prove challenging making it difficult to bring our DSOs fully back to previous levels in the fourth quarter.

Considering that situation, we estimate free cash flow in the fourth quarter will be at least $10 million. Drilling and subsea recorded an adjusted operating loss of $10 million, completions $5 million and production and infrastructure broke even in the quarter.

We have staffed our operations to be in a position to take full advantage of the unfolding increase in North American drilling and completions activity. We remain confident that we can generate high incremental operating margins as we begin to see revenue increasing.

Our weighted average diluted share count for the third quarter was 90.9 million shares. Net debt at the end of the third quarter was $264 million, up $5 million, bringing our net debt-to-total capitalization ratio to 18.3%. Interest expense was $6.8 million in the third quarter.

Corporate expenses were $6.4 million and we expect corporate expenses to continue to be around $7 million per quarter. Capital expenditures were $3.4 million in the quarter and depreciation and amortization expense was $15.2 million.

Gross capital expenditures in the fourth quarter will be about $3.5 million bringing the full year total to about $17 million. Our effective tax rate on the third quarter loss was 39.6% and our estimated annual effective tax rate is now 38.4%. The higher effective tax rate is attributable to losses incurred in the U.S.

and benefited at a higher statutory rate, offset by earnings outside the U.S. taxed at lower rates. We will elect to carry the 2016 U.S. net operating loss back to earlier periods to claim a refund of taxes paid in those periods. Accordingly, we have reclassified the deferred tax benefit to other current assets on the balance sheet.

We anticipate receiving the refund which will be in excess of $30 million in the third quarter 2017. For more information about our financial results, please review the earnings release on our website. I will now turn the call over to Prady to update you on several of our initiatives.

Prady?.

Thanks, Jim. Good morning, everyone. I'll discuss our two top priority areas, positioning Forum to take advantage of a market recovery and maintaining focus on our cost structure and operational efficiencies. We've taken a hard look at our ability to respond to a swift recovery.

From a manufacturing standpoint, the three primary constraints for any company are capacity, supply chain and personnel. We are well prepared in each of these areas. Let me explain.

In terms of capacity, although we have achieved a 25% reduction in our global manufacturing footprint, we have maintained our peak level manufacturing capability by implementing lean manufacturing process in our existing facilities.

Our procurement function has been focused on accessing suppliers' ability to shorten lead times on critical items and secure capacity as we expect demand on our suppliers to accelerate. In addition, we have substantial levels of inventory that will allow us to meet customer demand early in the cycle.

From a people perspective, during the downturn, we maintained critical skill sets and applied lean process across all facilities. This means, we will need fewer additional people as we grow. In addition, many of our plants are on reduced work schedules, giving us the ability to increase manufacturing hours before adding significant head count.

Our main area of focus over the prior two years has been to reduce our cost structure and enhance operational efficiencies. As Cris mentioned, we are seeing the benefit of these initiatives as reflected in our high incremental operating margins in those areas where we have seen increased volumes.

Forum's overall operating margins will continue to see the positive impact as the recovery gains momentum. As we walk through our existing inventories and begin to plan more load on our manufacturing plant, our absorption of direct cost will improve significantly. In addition, we'll also see the benefit of our procurement savings.

Another area of focus has been on new product development and new market penetration. We've added about 20 new products this year and several new customers. Our emphasis has been on products which improve our customers' efficiency.

In that regard, we are developing several new completion products which extend the life of our customers' equipment as they drill longer laterals and use the equipment more intensively. Another recently introduced product that is gaining significant interest from our customers is our coiled tubing pipeline.

This new product reduces our customer installation time by approximately 15%, has significantly less connections per mile and we have received several new orders including the recent order for an offshore application in Latin America. Now I want to discuss our commercial efforts to take advantage of the recovery.

Similar to the commercial strategy we discussed for the Middle East, we have recently appointed a leader for the Permian Basin to represent all product lines. This enhances our ability to establish the Forum brand and fill across the whole company.

As the rig count increases and the pressure pumping equipment utilization continues to improve, we are strengthening our service teams in key basins and selectively adding commercial sales people to support the activity in North America. I'm pleased with the progress our team has made managing through the downturn and positioning us for the upturn.

Our team's determination to remain nimble, scalable and customer-centric affords Forum the opportunity to respond quickly to the growth in the industry. I will now turn the call back over to Cris for concluding remarks and to moderate Q&A.

Cris?.

Thanks, Prady. I believe our team at Forum has done a good job of working through the downturn and preparing for the market recovery. For my part, I much prefer talking about incrementals than decrementals on these conference calls.

We are very pleased to see the directional turn in our orders, driven by the improving trends in unconventional drilling and completion activity. As these trends gather pace with improved budgets in 2017, Forum is very well placed to benefit. Thank you for your interest. And at this point, we will open the line for questions.

Danielle, please take the first question..

Thank you. And our first question comes from David Anderson from Barclays. Your line is open..

Great. Thanks. Good morning, Cris..

Hey, David..

So, obviously, a lot of really positive stuff going on in North America land business here. You guided towards kind of flattish fourth quarter.

Can you just help us understand kind of what some of the moving parts are going on there? I would presume it's kind of your subsea side which is kind of a little bit of a lag and your North American business hasn't quite – isn't quite expected to ramp up yet.

Can you just kind of help us understand what's going on there?.

Yeah, we have the non-short cycle. The longer cycle capital equipment drilling business and the subsea business losing momentum, less sure of the timing of the midstream and downstream, although the orders are coming in – when we can deliver those products and when our customers will take delivery, we're less certain of.

But I think a very big factor is you look at the fourth quarter relative to the third quarter is just the available work days. What we've seen in recent years is that the holidays have become a very slow period, and particularly when our customers, the service companies and drilling contractors are really pushing to reduce their costs.

It's – we don't have a lot of confidence about how much they'll want to take delivery of things right at year end. So it's that fourth quarter effect that is a significant factor here, David..

Okay. And then obviously, the talk about the longer laterals, I mean, talking about it for a while but it seems to be really gaining a fever for this past quarter, you've talked to us in the past about kind of looking at footage drill, does a better kind of revenue proxy for your business.

Maybe can you just kind of talk to us a little bit how some of these trends are impacting your business? Coiled tubing seems to be kind of maybe one of the areas we weren't really thinking about and we saw kind of one of your bigger compares got a major order there.

Could you talk about some of the components of Forum that are linked to these longer lateral trends?.

Yeah. So, on a the drilling side, more time with the rotary table turning with more joints of piping handled and more hydraulic power needed to drive that drilling mud motor at the end of a long string in this 7,500 psi upgrades, all driving better consumable products in the drilling side.

Longer laterals driving, obviously, more completion stages, and the stages, more frac work, more consumables, more downhole and completion products in our completion's business. And as you point out, coiled tubing, there's a trend towards the larger diameter tubing, the long strings, higher value from our standpoint.

All those are positive trends that we're seeing in our business for the North America short cycle businesses..

Great. Thanks, Cris. Have a great weekend..

Thank you, David..

Thank you. And our next question comes from George O'Leary from TPH & Company. Your line is open..

Good morning, guys..

Hi, George..

Hi, George..

Impressive results especially on the completion side in the quarter with the 34% increase in sequential revenues. I guess is there any reason for us to think that, at least, that segment doesn't outpace the rig count, the U.S.

onshore rig count, from a revenue perspective? In the fourth quarter, is there some item on the international side that may drive that to lag? Just kind of curious how to frame expectations for the completions business in particular next quarter..

Yeah, well, that's a good question, George. I would say, from a North America standpoint, we do see our orders increasing again in the fourth quarter sequentially versus 3Q. The international activity is lagging behind the North America recovery.

But the net impact on the completions of combination of North America and international, we do see the completion activity seeing more increased bookings in the fourth quarter versus third quarter.

Obviously, we do need to take into account, it depends on the holiday season how slow it is just a number of days, but the run rate would be significantly higher in the fourth quarter..

Okay. Great. That's helpful color. And then it was interesting to see you guys highlight the drilling consumables orders picking up, certainly a positive phenomenon for you guys despite capital order still lagging. It seemed like the commentary in recent quarters had been customers may have a decent bit of inventory in hand.

I guess, A, did that drilling consumable order level surprise you and then are there any products outside of the 7,500 psi mud pumps where you're seeing heavy orders on the consumables side?.

Yeah, I think there are two main parts to our drilling consumable products, George. And the part that we're – we've seen a significant ramp up so far is on the mud pump consumables, the hydraulic side of the rig. Where we haven't yet seen the destocking, and this is yet to come, is on the pipe handling consumables.

There still seems to be some destocking to go. I think we'll see that business really kick into gear during 2017..

Great, guys. That's it for me. Thanks..

Thank you. And our next question comes from Jacob Lundberg from Credit Suisse. Your line is open..

Hey, good morning, guys..

Hi, Jake..

And so, obviously, a very strong quarter in completions. I'm trying to get a sense for where incrementals could go over the next year relative to this quarter's 37%. So maybe we can go about this a couple of ways.

I guess, first, do you have any sense for the mix of revenues recorded in the quarter in terms of how much was sort of higher cost inventories that were sitting in your warehouse that were built before the operations had been streamlined over the past year or so implying higher COGS associated with the product versus how much was built kind of post-optimizing the manufacturing business, so would have been associated with lower COGS?.

So dividing the completions business into the two product lines there, on the pressure pumping consumables, we are still selling from stock there and probably will be for a while yet. So we're still burdened by unabsorbed manufacturing costs on that side.

And in fact, since under the manufacturing facility reorganization that Prady has been heading up and as we combine some facilities, we're making our pressure pumping consumables, some of them, in the same facility. We're making drilling products.

But actually with a higher revenue on the pressure pumping side, they're actually picking up more unabsorbed cost for that plant than the drilling side is.

So, when you look at incremental margins of completions versus drilling, it's a little bit of a difficulty there in that completions is actually picking up more than was it – what it was historic share of the unabsorbed manufacturing costs which depresses their incrementals a bit relative to drilling.

Now, when you shift over within completions to the other product line, downhole products, there, we have begun to ramp up producing new products to keep our stocks for all of our products at the right levels.

We, therefore, are moving into a period where we do have better absorption of our manufacturing costs and their incremental margins are more than 50% if that makes sense. And that's where we'll get.

Prady, you were talking about this, right?.

Yeah. Jacob, what I would say is at a very high level, if you look at our upstream product line, the mechanical production equipment for the upstream product line, the drilling consumables, stimulation and intervention and downhole product lines, at an average, our incrementals were about 50%, some higher and some lower.

The ones which were higher were the ones where we saw increased hours in the manufacturing shop. A good example of that is the downhole and the mechanical upstream which Cris was talking about. The ones which we saw lower incrementals, still high, but less than 50%, was the stimulation intervention primarily because we depleted the inventory.

There was no increased hours in the manufacturing shop. And I think that's the trend we would see throughout 2017 is at an average, we should see very high incrementals. It all depends how much volume of hours we see in the shop.

From an absorption standpoint and also as we stop putting more volume into the shop, we'll also start seeing the benefits of some of the operational things with, throughout the downturn, which is the lean, the procurement, the efficiency, all those things will kick in..

Okay. Understood. I guess in the same vein then. So, say, rig count in 2017 is up 25%, 30% something like that. When do you think you'd worked off those higher cost inventories. And you specifically mentioned simulation intervention.

When do you think those inventories would be worked off and then we'd sort of see average incremental margins come up to that, roughly 50% level associated with some of the other product lines where you're starting to add hours?.

Jacob, as you look across the company, I mean we obviously are at very low inventory turns today, about 1.2 turns. The company's target is to get back to three turns or better. And that represents about $200 million of inventory.

We don't see liquidating $200 million of inventory but what will happen is, as sales increase, we will start selling out of inventory and I'd say for us, a good quarter would be about a third of our sales would come out of inventory and two-thirds would be new items that we would produce.

So it'll take some time to work back to get to that three levels – three turns. I think we should be able to do that as we go through 2017 towards the end of the year..

So we said, I said in my remarks, Jake, that if you take the short cycle North America upstream businesses perform as a whole, we're already at that 15%. We – and that's pulled upwards by the businesses that are already through their inventory and ramping up production like downhole products, like the upstream production equipment.

But it will be probably 2017 before we get to that point with – for our pressure pumping consumables and for the pipe handling drilling products..

Okay.

And I guess following up on that, I mean can you get any more specific with where in 2017 you might expect that, if sort of the market plays out as we're kind of expecting? So for – I mean, should we expect that like first or second quarter or most second half event?.

Boy, that's still a tough one. We're just getting started on this recovery, and the shape of that curve, man, if you and I knew that one, Jake, we ought to do something different..

Fair enough. Fair enough. And a follow-up if I could.

Just trying to get a sense for your confidence in your ability to hold on to some of these cost savings that you've implemented over the past couple years? And in the same vein, so one, what's your confidence around that? And then secondly, any color you could provide in terms of you're seeing cost inflation from some of your suppliers already, in particular, thinking on the pressure pumping consumables side?.

Yeah, no, Jacob, I think it's a great question. And I think we are pretty confident we are going to hold on to our cost savings. If you look at last quarter, our decrementals were 13%. If you look at this quarter, even though our revenue was down 3%, our EBITDA and our operating income was sequentially higher than last quarter.

And then, on a move forward basis too, we expect our incrementals to be very high which is what we saw also in the third quarter.

I think as we start seeing more volume into the manufacturing shops, I think it will be – there will be an impact, not only on the absorption but also more importantly the impact of lean and efficiency and also the procurement savings will start kicking in. Now on the inflation side from suppliers, we've done a few things, right.

There's – we have put some contracts in place to protect us on the – from an inflation standpoint. At this point of time, we don't see an inflation on the commodities of steel or whatsoever, but we have put some contracts in place to protect us from that standpoint.

I know there is some discussion on the frac pad that they're seeing some inflation on a – from a sand standpoint. But we are not seeing an inflation on the material standpoint at this point..

All right. Understood. Thanks a lot, guys. Thanks a lot for the insight, guys. I appreciate it..

Yeah, good..

Thank you. And our next question comes from John Daniel from Simmons & Company. Your line is open..

Thank you..

Hi, John..

Hey, guys. Just a couple of questions here. First on the M&A opportunities.

Can you speak to where you're seeing the most acquisition opportunities? And then which areas would you actually like to consolidate, just seeing if they're different?.

Yeah, John, as you know, there are acquisitions that we can kind of put into two buckets, the things that you're proactively going out and hunting for but then you also have to be prepared to respond to opportunities that develop. I think I'm pleased with the pipeline that we have, and that things are beginning to move in that pipeline.

We're getting close to concluding a deal, I think, that hopefully we can talk about here shortly. Now to answer, what kinds of things are in that proactive side....

Yeah..

...expanding our product offering in the completions space is clearly a priority for us. Also, a priority for us is improving our balance and our offering in the midstream process industry side as well. But we also, historically, a significant portion of our acquisitions have come from opportunities that develop.

So we're going to be prepared there as well. But I think we will be more active, John..

Okay. Thank you. Just a final one for me. This 7,500 psi system is getting a lot of discussion this quarter with – most of the land drillers are talking about the desire to pursue further upgrades which is good for you.

My question is what, I hope you can answer this, what is your annual manufacturing capacity for these systems? Or if you don't want to speak about just one, what's your view on the total industry capacity?.

Yeah, another great question. We are the top two suppliers for the 7,500 psi upgrades. We don't have any capacity constraints as such. We have – and then again, if you look at from a manufacturing standpoint, on the rooftop is not a constraint, equipment is not a constraint.

We have been working very hard for the last 12 months on the supply chain to get additional suppliers onboard where we have single sources just to diversify the source base and people, right. I mean, on the people side, we are still working on a reduced work schedule.

And by the time we get to the over time, that gives us enough time to go get the people onboard. So we don't have any capacity constraints at this point of time. Just from a data standpoint, we think about 70% of the current fleet, which is operational, does have the psi upgrades.

On a move forward basis, we expect to at least secure 40% plus of the market share..

Yeah, and I think some other land drillers have had their conference calls are saying that they think what, maybe a third to half of the way through on the Tier 1 rigs to get this 7,500 psi upgrade.

Clearly, that's becoming more and more of a requirement by the operators, so they can get that high rate of penetration with the drilling mud motors on these long laterals..

Right. I guess and maybe I think the number was 300 that Patterson alluded to that could be potentially upgraded, that was their call. And if I'm wrong and I'm not sure one of my colleagues or peers will correct me.

But let's assume that it is 300, do you think that the industry, the OEMs such as yourself, can meet that in one year's, two years? I'm just trying to see where we might have headwinds on the land drillers in terms of their ability to upgrade – or just how much can be done on an annual basis..

Yeah. I think it's 300 for that Tier 1 group..

Yeah..

If you look behind that, I would – as the rig count – if the rig count improves beyond that, and the Tier 2 rigs begin to go back to work....

Right..

...they're going to want these higher pressure mud systems as well, I would think. So, yeah, can we, as an industry, do that, do 300 systems in a year? Yeah, I think we probably can..

Okay..

Now, if everyone decides they want to upgrade 1,000 rigs, that would be – that's different. But I don't – I'm not worried about that one..

Okay..

I agree with that. I think 300 to 400, I think the industry can handle that..

Okay..

Within 12 months..

I appreciate that. Thanks, guys..

Thank you and our next question comes from Blake Hutchinson from Howard Well. Your line is open..

Good morning..

Hi, Blake..

Just wanted to make sure we're getting the right read with where we're going here in the valves business. Obviously, 3Q, well, it's getting such a stabilizing factor up until this point, obviously, 3Q you faced a though comparison.

So you noted that orders were up 26% sequentially, but also noted that you've seen some deferred midstream and downstream order flow.

What should we make of this? Is the upstream business starting to take over from midstream, downstream and you would said that is still going to be a fairly stable business or do we may be have a little bit more of a pocket of weakness before you see some of those larger projects hit in perhaps 2017? And I guess you could let us know if you still think the green light is on there and it's just delays truly..

Yeah, so, yeah, we're in a little soft spot here on the midstream side, some big projects completing and not being replaced at the moment by the same scale of new ones. But it is also true that orders are picking up for the upstream valves. So that will be helpful.

And gosh, clearly, there are still midstream constraints in the system and that work will be done. So I think we will see a return to stability in the valves business at a better level than in Q3, but it's a soft patch at the moment..

Okay. So....

If I could add to that....

Yeah, go ahead please, please. Yeah..

If I could add to that, David, I would say, for our product portfolio, we see the valve market flattish on a move forward basis. As Cris said, the midstream liquids are slow. The gap is stable and CapEx is moving to the right. On the downstream side, this is the MRO seasonal activities, so a lot of bids out there. We'll participate in all of them.

However, the CapEx is slow and the petrochemical investments are slowing down, but the upstream is up. So the net impact for that, for us, is the market is flattish, but there are a lot of market share opportunities as a result what you saw in third quarter was our orders were up 26% sequentially, but we also had a low second quarter in valve.

So, on a move forward basis, we do expect the valve business to be stable..

Okay. And I guess, Prady, that would be more of kind of a year-over-year type of purview and perhaps maybe we should still think of that as a bit of a headwind into 4Q in the results..

Actually, the 4Q dividend, as I said at the MRO seasonal activity, the seasonal activity, right, as you know this time of the year, they shut the refineries down. But at the same time, they are doing the upgrades. A lot of bids out there. We'll participate on those. And the upstream part of the activity is up, so we're going to see some activity there.

So we expect the fourth quarter to be stable..

Okay. Okay. Excellent. So that's more of a go-forward from 3Q then. So, Cris, just kind of switching gears a little bit, I guess one thing addressing another area, it's been a bit weak, just the rig drilling capital equipment markets and even consumables, I guess ex mud pumps. A lot of chatter over a conference call season about newbuild and upgrade.

Up until now the dialogue from you has been it's been pretty quiet in terms of specking in any of your equipment ex-mud pumps to those.

Are you seeing any increase in dialogue with customers about new – any newbuild activity or any signs that there's something pending here on the rig capital equipment business?.

The one area, Blake, where there is significant chatter about newbuild rig activity is in the Middle East. A number of NOCs there are talking about more high capability rigs, also, in India too. So – and away from that, the capital equipment that – orders that we're seeing in drilling are catwalks for rigs that don't have them.

So they're as efficient as they could be, both on workover rigs and land rigs. And on our iron roughnecks, we do have a nice order for iron roughnecks for an offshore driller.

That's a situation where they're looking to reduce their maintenance cost with the complex system that they have for jack-up rigs in this time when their pricing is under significant pressure, and they're looking for lower operating expense, sometimes going with less complex, easier to maintain systems have some advantage..

Great. Thanks for the time, guys. I'll turn it back..

Yeah..

Thank you. And our next question comes from Rob MacKenzie from IBERIA Capital. Your line is open..

Thank you, guys. Cris, I wanted to come back to the acquisition question from a slightly different angle.

I know when you guys were smaller, acquisitions were an integral part of your growth strategy, but it seems like and maybe I'm wrong that would be all the talk about the market share opportunities and growth and the opportunities you face in your existing business that, perhaps acquisitions will take a smaller role going forward in terms of your overall growth form.

Is that accurate or not? And where do you see that playing out the next year or so?.

Well, we were younger. I don't know that we were smaller then. We've gotten – no, acquisitions are clearly a part of our strategy just as they have been.

I think the difficulty over the past two years has been that during a significant downdraft, the bid-ask spreads just get really wide and it's been, for the whole industry, a really difficult time to get deals done.

When we had the most success in deals here in my history with Forum has been in the early stages of an upturn, and I think that we're entering a period like that again. And so I'm hopeful that we can be as active and successful with the acquisitions and as we enter this upturn as we were in 2010, 2011 and 2012..

Great. And I appreciate your answer earlier on what you thought was the most interesting relative to your existing verticals.

Any interest in new verticals or things to tack on that you're not currently doing today?.

No, I think we've got enough verticals. So we're – our strategy is to – and we like the completions business. We like our mix of being in completions and drilling and production.

And so what we're after is kind of filling in our product offering using our distribution channels, using our supply chain, but putting more products to the existing customer base through those channels..

Makes sense. Thank you. I'll turn it back..

Thanks..

Thank you. And our next question comes from Marc Bianchi from Cowen. Your line is open..

Thank you. I was hoping you guys could offer some detail on the mix of sort of short cycle and non-short cycle business that you had in the third quarter.

How would you break down those proportions?.

So the short cycle upstream businesses, as I mentioned, were nearly 50% of our revenue, right. And roughly equally the remainder, roughly equally split between our midstream, downstream process industry exposure on one hand, and on the other, our drilling capital equipment in subsea business..

Okay. Okay. That's helpful. So, as I think about the outlook for the fourth quarter, it's about 50%. Is that sort of short cycle upstream and then the remainder has a pretty good midstream proportion. We've got a forecast for D&C spending to be up 20% in the fourth quarter. And I think that the short cycle business is very levered to that..

Yeah..

It just seems kind of tough for the rest of it to be down – would have to be down 20% to kind of be flat. So maybe if you could offer some more commentary on kind of what's showing up there. Maybe perhaps there was something in the third quarter that was one-time that doesn't recur. Just curious for any color..

So you're asking about the fourth quarter guidance and why it's not better? Is that what you're saying?.

Pretty much..

Yes, so....

But under those moving parts..

Yeah, so I would refer again to my comments. And I agree with the trends that you are outlying. I agree with the trend. The fourth quarter, it just has fewer work days. There's 13 weeks in the fourth quarter.

If we're down two of those weeks for holidays, furloughs at our customers or whatever is going on out there or just reluctance to spend, in the past two years, it's been two to three weeks. So it's just essentially a shorter quarter..

Okay.

And nothing that happened in third quarter that was maybe non-recurring in any of the businesses to think about as we go from third to fourth?.

No, nothing that – we – right. No. In the second quarter, we completed some big projects as we pointed out in the downstream and midstream that we didn't have that kind of big lumpy projects in Q3 if that's what you're asking..

Yeah, yeah, that is. Okay. Thanks. And then maybe just another one on the acquisitions you've done, you guys did a few that were sort of towards the tail end of the prior upcycle, speaking of kind of Quality Wireline and then J-Mac and Team during the downturn.

Can you kind of update us on where you are on those and maybe give us a perspective of what kind of revenue those businesses were doing prior to the downturn and sort of what you think the potential is given whatever you've done to increase the earnings power in the next upcycle?.

Yeah. So, Team, we've just did this year and that is ramping up and will be, I think, more significant for us in 2017. We're beginning the production to add to the inventory that we acquired and it's on track with what we assumed when we bought the company. Quality Wireline, gosh, that was 2013 that we bought that and grew nicely.

It makes the e-line for the wireline service companies for perforating charges. Obviously, a good business, ramped up significantly after we bought it, and then obviously as a consumable product, went down in the downturn. But that's one business that we've seen a very nice improvement.

Prady will comment on the cost side and what we've been able to do there. And then J-Mac, which rounded out our offering in pressure pumping aftermarket products, very pleased with that offering now and has brought very good cross-selling opportunities with our preexisting products in the flow iron and fluid ends side..

I think what Forum has done from an integration standpoint to your question is, out of the two, probably two fronts, the top two fronts is one is on the product side. We've made several investments in new products. A good example is if we look at on the pressure pumping side, we have a 3,000-horsepower pump.

But more importantly, we are coming up with a new pump system with an innovative fluid end system with a lot of features which improves the longer life in harsher environment and being more used intensively, lighter weight, fits into the 2,400-horsepower space.

And we've developed a raised tracker manifold which distributes the sand evenly to the cylinders and plugs, just to give you an example, right. So we have come up with a lot of products to position ourselves to take the advantage of the downturn. Another good example is the wireline.

So the same thing applies to some of the other acquisitions, too, is we worked on lean and efficiency on the procurement front and even though the business is down, for example, the wireline business significantly, their operating margins are pretty high just because of the operational things we've done..

Okay. Thanks for that, Prady. I'll turn it back..

Thanks..

Thank you. And our next question comes from Brad Handler from Jefferies. Your line is open..

Thanks. Good morning, guys..

Hi, Brad..

I think I've really just got one left related to your production equipment business and I guess the nice order you had for the 100 systems.

Can you remind us or just give us some perspective on – back in the upcycle when you were having – when you were contracting with the large customers that you were dealing with, how many systems were being contemplated in an order? What kind of perspective is the 100 relative to kind of the orders and the visibility you had in better times?.

This is pretty big, pretty big. It's a sizable order. But at the same time, I think this time of the year, third quarter and fourth quarter, some of our customers start planning for the 2017. And this order in specific is – we see a little bit in the fourth quarter, but most of that is for the 2017 program..

And there's an element of operators wanting to lock in at this point, right..

Correct..

Sure..

The price levels too. So....

Right. I guess that was a question as well, but let me just clarify.

So, in other words, this is a consistent type of order for what you might have seen back in 2013?.

This is a little bigger than we usually – we normally get. I think the order size is a little bigger..

Okay..

And an example of an operator going long here..

Right. Interesting.

And, yes, if you don't mind, I'm just curious where – maybe you can answer it a little bit more generally, but what kind of pricing discount for some of these types of steel heavy capital equipment items are is the market driving today versus the peak?.

Yeah, I mean we're sensitive from a competitive issue to talk about pricing..

Sure..

But, yes, pricing's come down. But on the other hand, we've driven down our costs significantly. So we're happy but not thrilled with the margin on this contract..

But building the backlog for 2017, having a good base load in the manufacturing shops also gives us the opportunity to take the benefit of some of the operational things we've done..

Of course, of course. Well, thanks. I appreciate the perspective. I'll turn it back..

Right..

Thank you. And our next question comes from Robin Shoemaker from KeyBanc Capital Markets. Your line is open..

Thank you. Cris, I just wanted to ask about this delayed payment issue that you brought up, and everybody from Schlumberger on down is complaining about this. So you have two categories of customers, E&P and oil service. I was wondering if they're both guilty of this.

And what is it that gives you leverage on the collection of receivables that would allow you to bring DSOs back down? Or is there any change that this is the new normal?.

So, Robin, the – we did a very good job, I would say, up until this quarter holding line on DSOs. We had seen some extension, but for most of the downturn, we had been right around that 65 days. So this came as an unusual quarter for us. I wouldn't say that we'd expect now to just give up those eight days and won't – we won't get them back.

I do think it'll be a challenge to get it all back in the fourth quarter just given what the year end priorities for our customers. But all companies are being pressured to generate free cash flow and preserve liquidity and that's manifesting itself in the payment of invoices later.

And to answer your question specifically, it cuts across the customer base. So it's not any distinct set of customers that are extending the payment terms. I will note that the extension is a one-time hit. So, if we're unsuccessful in the fourth quarter getting those days back, it won't be another hit to the fourth quarter.

It will just be a missed opportunity. Hence, our confidence that we should still be able to generate even with our interest payment, our semi-annual interest payment in the fourth quarter, we're still confident that we'll be able to generate an excess of $10 million of free cash flow. But we are very focused on the terms that we extend.

The second part of your question on leverage. Admittedly, with the bigger customers, whether it's the E&P operators or service companies, we have less leverage although we have a lot of dialogue with those companies.

On the smaller companies and those that maybe a little stretched on their credit capacity, the leverage that we have used is to not deliver additional equipment or not take additional orders until we see our receivable balances in a little healthier state. So we will use that leverage in order to improve our collections.

But this market has been very difficult for everybody and all the companies are very focused on improving their cash flows..

And to be fair, there were some large payments that we were hopeful of receiving before quarter end that came in just after quarter end which would have helped all this. I would also note though that those companies who complain a lot here about light payments from operators have no compunction about passing that on..

I fully expected that. Okay. Well that's the only question I had. Thank you..

Danielle, let's take one more question please..

Perfect. And our last question comes from Sean Meakim from JPMorgan. Your line is open..

Hi. Good morning. Thanks for having me here..

Hi, Sean..

I guess I'll keep it brief and just one question. We talked a bit about M&A. Your strategies have been well articulated I think and well executed as well.

So, if adding new verticals doesn't have a lot of appeal, perhaps we're at the trough of the cycle, line of sight to recovery getting better, is there any potential in larger mergers of equals or things like that where perhaps there are opportunities to pair up with another competitor with different types of scope, et cetera, where you can come out of the – come in to the next cycle even stronger and more formidable?.

Well, there's no mileage in talking about mergers or acquisitions at any time. So that's a difficult subject to address. I think that in our acquisition strategy, we have, I believe, had good success in the bolt-on kinds of deals. I think we've developed a good process for integration and being able to leverage – I hate the word synergy.

But we do look for ways we can add the product but leverage our manufacturing capability, which clearly, underutilized and our distribution system. So that's where we think we can add the most value at this point in the company's life cycle..

Okay. Fair enough. I appreciate it. Thanks..

Very good, Sean..

Well, thank you all for your interest and your time and we look forward to doing the same thing in three months. Take care. Bye..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day..