DMC Global Inc. (BOOM) Q4 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the DMC 2015 Fourth Quarter Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce you to Geoff High, Vice President of Investor Relations. Thank you. Mr. High, you may begin.

Hello, and welcome to DMC’s fourth quarter conference call. Presenting today are President and CEO, Kevin Longe and Chief Financial Officer, Mike Kuta. Kevin and Mike are joining us from our manufacturing facility in Liebenscheid, Germany. I would like to remind everyone that matters discussed during this call may include forward-looking statements that are based on our estimates, projections and assumptions as of today’s date and are subject to risks and uncertainties that are disclosed in our filings with the SEC. Our business is subject to certain risks that could cause actual results to differ materially from those anticipated in our forward-looking statements. DMC assumes no obligation to update forward-looking statements that become untrue because of subsequent events. A webcast replay of today’s call will be available at dmcglobal.com after the call. In addition, a telephone replay will be made available approximately 2 hours after the call. Details for listening to the replay are available in today’s news release. And so with that, I would like to turn the call over to Kevin. Kevin?

Thanks, Geoff and hello to everyone joining us today. The fourth quarter of 2015 was marked by deteriorating conditions in the global energy sector from which we derived more than two-thirds of our revenue. The industry saw deep sequential declines in crude prices, active drilling rigs and well completion activity. In light of this environment, most exploration and production companies were planning sharp cuts to their 2016 capital spending programs. Against this backdrop, we reported fourth quarter sales of $41.9 million, which was a 6% sequential improvement versus the third quarter. Sales were down 20% versus the 2014 fourth quarter or 15%, excluding the impact of foreign currency exchange translation. We have forecasted a year-over-year top line decline of 25% to 30% for the quarter, but sales at DynaEnergetics, our oilfield products business, were better than expected. DynaEnergetics reported fourth quarter sales of $18.6 million, which was up 2% sequentially and down 37% versus last year’s fourth quarter. Excluding foreign currency translation impact, sales declined 33% year-over-year. Growing demand for the DynaSelect switch detonator was the primary driver of the sales improvement. In the current environment, oil and gas service companies and their customers are seeking opportunities to lower costs and improve operating efficiencies. The DynaSelect detonator, which offers industry leading performance, reliability and safety is attracting new customers and generating an expanded use by existing users. Sales at our NobelClad, our explosive welding business, were $23.3 million. This was a 9% sequential improvement over the third quarter and a 3% increase versus the fourth quarter of 2014. Excluding the impact of foreign currency translation, NobelClad sales increased 8% year-over-year. Consolidated gross margin was 23%, excluding $6.2 million of accrued reserves for potential antidumping duties and a reserve adjustment of $1.3 million for the slow moving inventory of DynaEnergetics. As we had previously mentioned, DynaEnergetics has instituted an aggressive quantitative based policy towards slow moving and obsolete inventory. Given the industry downturn, a greater quantity of inventory was impacted by this policy during the fourth quarter, which led to the reserve adjustment. Gross margin was down from 26% in the third quarter and 32% in the 2014 fourth quarter. The decline in our fourth quarter gross margin, after excluding antidumping and inventory reserves, reflects pricing pressure in the oil and gas industry and a less favorable product mix at NobelClad. Fourth quarter gross margin at DynaEnergetics was 29%, excluding reserves for antidumping duties and slow moving inventory, while NobelClad reported gross margin of 18%. During the fourth quarter, we reported $19.6 million in special charges. These consist of the accrued antidumping duties and the inventory reserve adjustment as well as $670,000 in restructuring charges at DynaEnergetics. It also includes an $11.5 million non-cash goodwill impairment charge. In light of much weaker conditions in the oil and gas industry during the fourth quarter, we reported the charge to write-off the goodwill balance at DynaEnergetics. Excluding these special items, we reported fourth quarter income from operations of $190,000. At the business level, NobelClad reported operating income of $1.3 million, which included $144,000 in restructuring expense. DynaEnergetics reported a fourth quarter operating loss of $19 million, which included $19.4 million in special items. DMC’s fourth quarter adjusted EBITDA was $3.3 million. NobelClad reported adjusted EBITDA of $2.5 million, while DynaEnergetics reported $1.9 million in adjusted EBITDA. During the fourth quarter, DynaEnergetics was actively promoting the new DynaStage factory assembled perforating system and those efforts have continued into 2016. A key element in the DynaStage rollout is a new mobile marketing trailer, which we will call Blum 1. The trailer features a fully assembled DynaStage system, which provides tangible evidence of the system’s features, functionality and cost benefits. Blum 1 also features many of DynaEnergetics’ other product offerings, including shape charges, detonators, cutting tools and the DynaSelect well abandonment product. Since October, the Blum 1 has traveled throughout Texas, Colorado, Louisiana and Oklahoma and DynaEnergetics sales group has met with completion engineers and management teams from 51 different exploration and production companies. Feedback in the DynaStage system has been encouraging and several additional operators have expressed interest in performing field trials. This is creating the expected pull-through from service providers and we are currently in discussions with multiple wireline companies about entering into DynaStage distribution partnerships. Meanwhile, Weatherford, our principal partner is deploying DynaStage into additional North American oil and gas basins. DynaStage sales volumes have been slow and below our original expectations, which reflects the seat decline in well completion activity. However, given the performance benefits of the system and the interest it is generating from operators, we are confident that sales will accelerate when well completion activity improves. DynaEnergetics’ new production facility in Tyumen, Siberia has received all permits for producing industrial explosives and we are about to begin test runs of the shape charge manufacturing line. This will be followed by internal quality checks and then field testing. We expect to complete this process by the second quarter and will then begin commercial sales into the CIS, which includes Kazakhstan and several other former Russian states. To-date, DynaEnergetics’ opportunity in this region has been limited by import restrictions. The Tyumen facility will enable DynaEnergetics to supply the CIS with the level of shape charge performance that is unavailable from current manufacturers. We think DynaEnergetics now has an opportunity to build a much larger presence in the region’s active oil and gas markets. During the fourth quarter, NobelClad began discussions with a semiconductor materials company in East Asia. The company was seeking specialized clad plates for a new type of production equipment. Our sales group in Asia and our production team here in Liebenscheid, Germany work closely with the company to establish project specifications and manufacturing strategy. Early in the first quarter, the customer awarded NobelClad a $6.3 million order for specialized plates, which are scheduled to ship during this year’s second quarter. The plates will be produced here in Liebenscheid where we were able to capitalize on the [indiscernible] during the project quoting process. This order is further validation of NobelClad’s objective to provide design and technical expertise directly to end users, which also allows the business to influence the material selection process. I should note that we would not have received this order without a visible presence in Asia. Our offices in South Korea and China have helped us to establish the level of customer intimacy in the region that did not previously exist. 2015 was a milestone year at DMC. In the face of a difficult market, we took a number of steps to strengthen the organization, improve operating efficiencies, launch new products and grow our markets. NobelClad consolidated most of its European explosion welding activity into the state-of-the-art manufacturing facility here in Germany. It also built stronger relationships with large industrial end users and made progress expanding its end markets and product applications. At DynaEnergetics, we consolidated a Canadian gun production facility into a larger manufacturing center in Texas. The business also opened a centralized distribution hub in Texas, which allows for the closure of 10 smaller facilities. Manufacturing and assembly infrastructure was established for the DynaStage gun system and the business implemented an aggressive sales and marketing programs for launching the product. At the corporate level, we streamlined the size of our executive team and reduced the number of Directors on our Board from nine to seven. I am confident our businesses are now properly structured to meet the current market demand. We will continue to closely monitor the energy and industrial infrastructure markets for a rebounded capital spending. In the meantime, our objective is to operate within our cash flow and deliver breakeven to positive operating income as we did during the fourth quarter. We will also continue to invest in new technologies, products and market development initiatives while holding the line on operational, administrative and capital investments. Our end markets do improve, I believe DMC will return to a position of strong growth and improve shareholder value. With that, I will turn things over to Mike for some additional detail on our financial results and a review of our guidance. Mike?

Thanks Kevin and good afternoon everyone. Starting with our expenses, our efforts to streamline our cost structure during the past year to reduce selling, general and administrative expense by 25% versus last year’s fourth quarter, SG&A was $8.4 million or 20% of sales versus $11.2 million or 22% of sales in last year’s fourth quarter. Amortization expense was $1 million or 2% of sales versus $1.3 million or 3% of sales in last year’s fourth quarter. We reported a small income tax benefit from continuing operations relative to our pretax operating loss. We have mentioned previously that several of our business entities are in a cumulative loss position and we have recorded valuation allowances against the associated prior tax benefits. When these businesses transition to profitability, we will reverse the allowances. Looking at our balance sheet, we ended 2015 with cash and cash equivalents of $6.3 million. We ended the year with net debt of $21.2 million, which was down 23% from the end of the third quarter. In December 2015, we amended our revolving credit agreement with our bank syndicate. Modifications to our loan covenants have provided us with the addition financial flexibility during the period of challenging market conditions. For the full fiscal year, we generated cash from operations of $1.6 million. This represents an $8 million swing from the 2015 nine months period, during which we had used cash from operations of $6.4 million. With respect to guidance, there remains considerable uncertainty about the timing of a recovery in oil and gas industry, which is the primary end market of both of our businesses. However, we continue to anticipate the second half of the year will represent an improvement over the first. We currently expect sales for the full fiscal year will be comparable to the $166.9 million we reported in 2015. We expect full year gross margin in the range of 24% to 26% versus the 25% reported in 2015. For the first quarter, we anticipate sales will be down 8% to 12% versus the $40.8 million we reported in the 2015 first quarter. The expected decline relates to sharp capital spending cuts by most exploration and production companies, particularly in North America, which is our largest geographic market. First quarter gross margin is expected in the range of 22% to 24% versus the 31% reported in last year’s first quarter. The anticipated decline reflects the less favorable project mix at NobelClad and a lower proportion of higher margin sales from DynaEnergetics. Selling, general and administrative expenses are expected to be totaled $5 million for the first quarter, while amortization expense is expected to be approximately $1 million. And now we are ready to take any questions. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question comes from Edward Marshall of Sidoti & Company. Please go ahead. Ed, your line is open.

Good afternoon guys. So it’s Sidoti & Company, so you guys know. Listen, I am looking at the interest expense here and it’s relatively high in the quarter, I am wondering if there were some refinancing charges, it doesn’t look like it’s broken out in the one-time table, but I assume that’s probably what that’s related to, do you mind kind of addressing that?

Yes. Ed, this is Mike. Yes, we had amortization of our existing facility and when we did the refinancing in December and flip our facility down from – U.S. facility down from $90 million to $65 million, we took a pro rata charge for the reduction in the facility device that was originally entered into in February 2015.

Right. What was that charge?

The charge was roughly $0.5 million.

Okay. So if I look at next year, when we look at interest expense would you guys mind kind of walking me through what the interest expense will kind of look like for the full year of 2016?

Yes. I estimate interest expense in the range of $750,000.

For the full year?

Yes.

Okay. And is there any adjustment – is that assuming any kind of debt reduction?

It is assuming debt reduction.

To the tune of what?

The expected debt reduction for the full year of ‘16 is in the $4 million to $6 million range.

Okay. If we look at – you mentioned that the detonator was attracting new customers, you also mentioned that your discussions with multiple line customers – multiple wireline customers as well and I am wondering if there is any way to kind of – I know you are probably not willing to kind of discuss who the parties are, but maybe we can kind of quantify it by size, I mean what if it’s relatively large in the industry, we have already talked about that one, are you working with others the equivalent larger, smaller, can you kind of walk us through anything that you can regarding that kind of point and what kind of size we should expect from the size of these customers?

We are working with primarily customers of Weatherford size and smaller. And they would be the larger wireline companies in the industry outside of the big three, the core.

And are you – is this specifically to region or – and I think we have talked about this in the past or is this kind of broad coverage base for them? And I guess importantly, does it damage any of the agreements that you have with Weatherford already, considering they are using this for particular market share gains in the period growing against – if you are selling into their customer line, I thought that was against what you had originally thought. So maybe if you can walk me through that to jump over question, but I think you know what I am going at?

Yes. I mean, there is one or two that we hopefully will bring on that cover a broader geographical territory. And we have priced the product such that the size of the customer and their ability to compete effectively against one another is fair. And actually by having more than one potential supplier of the equipment actually helps the revenue. Otherwise, the E&P companies would feel that they have less choice, if you will.

Got it. Okay, thanks very much.

The next question comes from Gerard Sweeney of ROTH Capital. Please go ahead.

Hey, Geoff, Kevin and Mike, thanks for taking my call.

Yes, hi, Gerry.

I apologize, I jumped on a little bit late just dealing with a couple of things and I caught some of the guidance. I have caught a little bit of the commentaries here and there. And looking at the DynaEnergetics, the system, it sounds like there is a lot of interest in there, but you are quoting some really large headwinds on the, what to say, rig count and just capital spending on the oil side of the equation. As you bring material out and checking things out, I mean, how are you seeing pricing? Is it degrading? Is it – I mean, people are interested in the products? How does that jive with current market conditions and general uptake across the board?

Yes. The product has generated quite a bit of interest. And in fact, we are very pleased with the reception that it’s receiving. Having said that, we have chosen not to compete on price with DynaStage. The value that DynaStage brings to an E&P company really is significant relative to the price of the perforating system itself. And we would rather – in fact, we have chosen to grow comparison to this year, if you will, by not getting down into the gutter with some of the pricing that we are seeing from less disciplined competitors. And so I would say in order of magnitude, the completion activity first and foremost is impacting the potential opportunity. And within that opportunity our sticking to pricing on value is also hurting the immediate sales of that product line.

Okay.

And I will answer that, our approach is really to – that’s why the Blum 1 is so important to us is a further education to the market to the operational and safety benefits of DynaStage and DynaSelect.

Got it. So, I mean speaking of completion activity, I mean, you are talking to your customers and others speak things like backlog. I would imagine when a little bit of activity comes back it’s going to come back maybe with some of this backlog on the completion side. Is that the right way to look at it? Are you getting some insight into that with your customers, more just in the tone, tenure, how things are playing out? There is probably some people better positioned than others and just looking to see if you have any sort of incremental view on the industry on a go-forward basis?

Yes, I can’t say that we have seen it start to come back yet, if you will. We think that the first quarter is going to be a very difficult quarter for us as well as for the industry. And our thoughts is – and time will tell that we believe that the market will come back a little bit slower than it went down that this was going to be an interesting year from E&P companies to wireline service companies to manufacture the products that those who do not have a strong balance sheet, I think we are starting to get late into a downturn and we would expect to see the industry changing as it goes forward and in the stronger companies, which we believe we are one coming out of it with a better market position.

Got it. And then switching over to NobelClad, again I apologize I didn’t get the chance to go through everything and I saw – I heard the $6 million order from Southeast Asia. How is backlog and how are things on that side in terms of we always look an opportunity in the U.S. in terms of cheap natural gas, free refinery CapEx, things like that? Any thoughts comments on that side?

Yes. As far as the backlog is holding fairly constant and we are very excited about this order that we received, which we will be shipping in, in the – primarily in the second quarter of this year. However, with this order, we are not – it doesn’t change our guidance for the year and we see it more steady this year than accelerating. Part of that is the currency translation from our European sales to the U.S. The other part of it is that commodity prices, metal prices are still quite low, which makes up part of our – significant part of our cost basis and also impacts our revenues.

Got it. Okay, I really appreciate it. Thank you.

[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to Kevin Longe for closing comments.

Yes. First of all, I would like to thank everybody for their interest in Dynamic Materials and we look forward to keeping you apprised of our progress in 2016 and talking to you after we finished the first quarter. So thank you for joining us.

This concludes today’s teleconference.