DMC Global Inc. (BOOM) Q1 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the DMC First Quarter 2016 Earnings Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host Geoff High, Vice President of Investor Relations for DMC. Thank you. Geoff, you may begin.

Hello, and welcome to DMC’s first quarter conference call. Presenting today are President and CEO, Kevin Longe and Chief Financial Officer, Mike Kuta. I’d 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 businesses 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 available approximately two hours after the call. Details for listening to the replay are available in today’s news release. And with that, I will turn the call over to Kevin Longe. Kevin?

Thanks, Geoff and hello everyone. DMC reported first quarter sales of $40.5 million, which was a 3% sequential decline versus the fourth quarter and 1% decline versus last year’s first quarter. Excluding the impact of foreign currency exchange translation, sales increased 1% versus the first quarter a year ago. We previously forecasted a first quarter sales decline of 8% to 12% versus the 2015 first quarter. However, our NobelClad explosion welding business took advantage of metal availability and accelerated production on several time sensitive orders. This effort led to a new single month production record in NobelClad’s U.S. manufacturing facility in Mt. Braddock, Pennsylvania. NobelClad’s first quarter sales were $25.1 million, a sequential improvement of 7% and 5% increase versus last year’s first quarter. Foreign currency exchange translation had minimal impact in NobelClad’s year-over-year results. Sales at DynaEnergetics, our oilfield products business were $15.5 million, a decline of 17% sequentially and down 8% from last year’s first quarter. Excluding the foreign currency impact, sales declined 6% year-over-year. DynaEnergetics continues to leverage the technical advantages of its product line to mitigate an unprecedented downturn in the energy industry. During the quarter in which the U.S. rig count dropped sequentially by more than 30%, unit sales of the intrinsic intrinsically safe DynaSelect integrated switch detonator reached record levels. DynaSelect’s unmatched performance is helping exploration and production companies and the service providers streamline the perforating process and reduce well completion costs. Consolidated first quarter gross margin was 26%, unchanged versus last year’s first quarter and up sequentially from 23% in the fourth quarter. DynaEnergetics’ gross margin was 42% which is a testament to the value its products are delivering to customers in this market. NobelClad reported first quarter gross margins of 16%. Consolidated first quarter operating loss was $85,000. Operating loss in last year’s first quarter was $3.2 million and included $2.9 million in restructuring charges and onetime expenses. At the business level, operating income was $1.5 million at NobelClad and $920,000 at DynaEnergetics. First quarter consolidated net loss was $413,000 or $0.03 per diluted share versus a net loss of $2.4 million or $0.17 per diluted share in last year’s first quarter. Adjusted EBITDA was $3 million which was 36% increase from $2.2 million in the 2015 first quarter. At the business level, NobelClad reported first quarter adjusted EBITDA of $2.4 million and DynaEnergetics delivered $2.5 million. During the first quarter, DynaEnergetics continued to invest in educating its market on the safety, reliability and lower completion costs available in its new factory assembled performance assurance DynaStage perforating system. Interest in DynaStage continues to grow. During the coming months, we expect to add additional distribution partners that can leverage the benefits of DynaStage to drive down the customers’ operating costs. While the contraction in capital spending has slowed the adoption of the system, we remain confident DynaStage will take hold in the market as spending rebounds and well completion activity improves. In the meantime, we are maintaining an active sales and marketing program throughout North America’s unconventional oil and gas regions and are expanding the DynaStage product line address a broader spectrum of well configurations. We recently noted that during the first quarter DynaEnergetics’ new manufacturing facility in Siberia obtained all necessary licenses to begin shape charge production. Our team in Siberia is working with regional operators to complete the required testing of the charges. And we expect commercial sales to the Russian and CIS market will commence by the end of June. In China, Dynamic’s DynaSlot well abandonment system is being tested as one of the world’s largest integrated energy company on a series of deep and complex gas wells. DynaSlot extends our systems approach to the plug and abandonment market and incorporates our intrinsically safe detonator technology with specialized shape charges designed specifically for the abandonment process. The DynaSlot system was tested on an initial well earlier this month and performed its design. These results will be validated on the second well during the next 30 to 45 days. The DynaSlot system is then expected to play a key role in a 35-well plug and abandonment program that customer is performing in China. This customer is also planning to use DynaSlot on its operations in Canada and is considering the system for a variety of other international well abandonment programs. Going forward, we believe the oil and gas industry will play much better emphasis on effective and environmental reform we decommissioning. We also believe DynaEnergetics is positioned to help drive this process and deliver industry leading plug and abandonment solutions. And NobelClad, production on a previously announced $6.3 million order from a large semiconductor capital equipment company is moving forward as our facility in Liebenscheid, Germany and should be largely complete by the end of the second quarter. Backlog at NobelClad was $40 million at the end of the first quarter, down from $42 million at the end of 2015. More than two-thirds of DMC’s revenues generated in the oil and gas industry for the global class in oil and gas prices that’s created a challenging environment for both of our businesses and DynaEnergetics in particular. The steep drop in drilling and well completion activity is created as its orderly market in which many in the oilfield products and services industry are competing almost exclusively on price. While DynaEnergetics has not been immune to these market pressures, it is taking a disciplined approach to pricing. The business is determined to capture an appropriate premium for the safety, reliability and lower completion costs as products are providing the market. Recent commentary from the exploration and production sector confirms our belief that the next two quarters will likely be very challenging for the oilfield products and services sector. Given the improved strength of our balance sheet and additional steps we’re taking to reduce operating costs, we will believe DMC is well-positioned to weather the downturn. We also believe the growing competitive advantage is in place at both NobelClad and DynaEnergetics position DMC to deliver long-term growth and improve shareholder value when our markets recover. With that I’ll 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, selling, general and administrative expense was $9.4 million or 23% of sales versus $10.9 million or 27% of sales in last year’s first quarter. Amortization expense was flat year-over-year at $1 million or 3% of sales. We reported first quarter income tax expense of $197,000. As we have explained previously, several of our business entities are in a cumulative loss position and we have reported valuation allowances against the associated prior tax benefits. When these businesses transition to profitability, we will reverse the allowances. Turning to our balance sheet, we ended the first quarter with cash and cash equivalents of $5.6 million. We reduced our net debt position by another 16% to $17.9 million from the end of the fourth quarter. We generated operating cash flow during the first quarter of $3.8 million, which represents a $7.6 million swing when compared with the $3.8 million of cash used in operations during last year’s first quarter. With respect to guidance, we’re maintaining the full year forecast we gave in March which anticipates sales will be flat versus the $166.9 million we reported in 2015. Gross margin is still expected in the range of 24% to 26% versus the 25%, we reported last year. There is considerable uncertainty regarding the timing and magnitude of a rebound in the energy sector, so we will modify our guidance at midyear point if appropriate. With respect to the second quarter, we expect sales will be flat versus the $44.7 million we reported in last year’s second quarter. Gross margin is expected in the range of 28% to 30% versus the 28% we recorded in the year ago quarter. Our second quarter results will include the previously announced $6.3 million order at NobelClad. Selling, general and administrative expenses are expected to be approximately $9.5 million and amortization expense is anticipated at approximately $1 million. Given the further deterioration of conditions in oil and gas industry, DynaEnergetics is making additional reductions to cost structure and expect to incur restructuring expenses of upto $1.5 million during the remainder of 2016. We anticipate annualized savings associated with restructuring will be approximately $750,000. And now, we’re 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 with Sidoti. Please go ahead.

So, I wanted to ask -- you gave some information on the DynaSelect products and in particular switch-detonator. You said it reached record levels. I am wondering first, if you can kind of quantify that in any way as far as what that either dollar amount or what type of growth that you’ve recognized in that business and then if you would do the same for the perforating guns as well?

We don’t break out the unit volumes but DynaSelect and DynaStage detonator is about a third of our revenues. And of course we mentioned -- and that’s true in both quarters, a little bit less than in the fourth quarter of 2015. And our overall volume has declined from the fourth quarter to the first quarter. So, the balance would be shape charges, gun, detonating cord and other associated products.

Got it, and you talked about pricing in the industry. Is that just on the particular products that you compete against or does that include DynaSelect products as well; are you seeing some erosion in price? I know there is no competing products for that, but are you having to reduce prices in order to kind of meet the market demand?

Yes. For the most product, we’ve been holding firm on the DynaSelect product line. There is not a direct competitive product to that and its operating benefits if you will exceed the cost or the cost premium that is charged for the product in actual application or use. Having said that an important part of both DynaSelect and DynaStage is getting the pull-through demand the E&P companies. And our overall business has been under continual price pressure at the service level. And so, we tried to differentiate our response to pricing and the products that are creating value. And when there is more of a like-to-like product, we will come down to our competition, if necessary. But we will not knowingly go below our competition.

Got it, and I guess finally, oils had a pretty decent move here and now it’s probably pretty mature, but I’m curious what are your customers kind of talking about the market and the energy market, as it turns around? And are you seeing any kind of pick up in volume demand at all?

I think what we’re feeling right now is kind of flywheel effect of the fourth quarter and the beginning of the first quarter and where oil was $27 or thereabouts in January, and there has been a continual slide in the rig count and ultimate E&P capital spending going into 2016 compared to 2015. And so, there is a little bit of disconnect right now with oil prices strengthening; there’s a lot of discussion in the industry with demand and supply coming in balance later in the year. But, the actual completion activity is still declining.

The next question comes from Gerry Sweeney of Roth Capital. Please go ahead.

Can I confirm something, did you say gross margin in DynaEnergetics in the quarter was 42%?

Yes.

So, can you help me reconcile? I didn’t -- I don’t know what they were in the fourth quarter off the top of my head but I thought they were probably in those mid to high 20s?

Yes. So, I’m sorry, Gerry. In the fourth quarter on an adjusted basis, we had the impact down the accrual [ph] and more significant inventory reserves; on an unadjusted basis, they were 26% or thereabouts.

And at the end of the day, you talked about -- Edward was just asking about I guess a little bit of product mix. And you said one-third of the revenue was DynaSelect and DynaStage and maybe a little bit less in the first quarter or maybe a little bit more DynaSelect in the first quarter. How did margins go from 26% to 42%? I mean that would seem as though there was a lot of DynaSelects being sold in Q1 versus fourth quarter?

Yes. It is, Gerry, product mix; we did so substantially more DynaSelect in the first quarter versus the fourth quarter; it’s also off the lower sales volume base, 15.5 million this quarter versus 18.6 million in the fourth quarter. We also sold a significant amount of our high performance DPEX shape charges, so that also contributed favorably to our product mix in the first quarter this year. I think when you look at the fourth quarter and the first quarter, I think the right answer is somewhere in between.

So, I think probably to look at that going out, is that what you are saying on a go forward basis, something in between?

Absolutely. Yes, Gerry.

Now, obviously it looks like we’re starting to see maybe some fruits of some of the restructuring et cetera on a go forward basis. And I understand that the market is still trending down, completions there are still decelerating. As you look all the restructuring is done and you’re looking out further, I am expecting this market to turn around at something. And use that carry 20% EBITDA margins in the I guess the DynaEnergetics. Is that potentially -- if we get back to a normalized market, is that still a potential to get back to those levels or is it still too early to tell?

We certainly believe so. And for that to happen, there’s product mix we need to continue selling our higher value added products. But as the volume comes back so will the pricing on some of the more standard products. And so, we’ll see the volume come back first and pricing probably come back second. So, we fully expect to hit those level of EBITDA margins in the future.

And then, would you say -- I mean if the market comes back, actually I think you were just talking about market share, I think a couple of years ago you were about 7% to 8%; I think recently you talked about being say 15% to 17%. Is that still fair assumption?

It depends -- it is, but it depends on the product line, the product family. We’ve invested quite heavily in research and development on the initiation systems, and that’s where we’re seeing the greatest growth.

Okay, got. I know I get one question and one follow-up, so I’m probably over the limit but I don’t take much chances and hope you don’t cut off and switch. It sounds like you pulled a little bit -- did you pull a little bit of business forward from 2Q into 1Q with that big production line in March?

Yes, just slightly. And that was the business doing it on its own as the materials came in. And so, it pulled it up couple of million dollars probably the difference in what our guidance was.

And was that any of that the semiconductor job or was that all…

It was all just everyday business; it wasn’t semiconductor at all, that’s mostly going in the second quarter.

And does that semiconductor carry higher gross margins because it looks like on the guidance the gross margin for [Multiple Speakers]

It does and it’s not just the end use application, but it’s really a very technical product and it’s a product that others cannot do or would have a very difficult time doing. And so, it’s truly a differentiated product on our part.

And then finally, this is my final, final question. We’ve talked about this probably a lot but just general chemical spending CapEx, there was probably a run a couple of years ago, it slowed down a little bit. And then, I think looking maybe to that derivative play of more specialty chemical, capital spending now that’s like the ethylene that’s been done, any thoughts on that?

Yes, I think what’s probably impacting NobelClad revenues more than the activity is the commodity pricing on the metals that they’re purchasing and then ultimately reselling. As far as overall activity levels, I’d say there is fairly constantly -- we’re not seeing the demand pick up as strong as we had hoped at this point. And we do think that some of the upstream issues are creating some downstream issues for some of the oil and gas people in that system. But we’re not seeing a real spike in activity yet.

The next question comes from Samir Patel, Askeladden Capital Management. Please go ahead.

I have three questions, I don’t know if can turn it seven but just three for right now, few are boring; few are interesting and we let you guys figure out which are which. So first one is I continue to be surprised by how well Dyna margins are holding out. And I know you guys have been talking about some pricing pressure and I guess the restructuring. But I am curious how are you coming out on optimizing for near term cash flow versus your ability to prosper if and when the energy markets recovering, can you maybe expand on the restructuring actions, exactly they entail? But I thought you’ve taken out a lot of the low hanging already, so this kind of into your product development roadmap or your engineering talent at all?

We have not cut back at all in our research and development, our product development or our market development activities. In fact our spending in those areas is greater today than it was at this time a year ago. And the costs that we have pulled out of the business are more the industrial footprint, consolidating our Edmonton facility into our -- with the Texas facility and also reducing the number of distribution centers that we had and building if you will, more of a super hub as we call it in our Blum, Texas location. And then the majority of the costs and headcount reductions have been in direct labor and indirect labor that supports the direct labor; that’s really activity base driven rather than the longer term investment decision, which is where the R&D, the product management and the market development stands. So, we have increased our spending quite a bit actually in that area.

Okay, just to make sure we’re on the same page, I was asking about the [Indiscernible] announced which last year was facility consolidation, so that sill applies to the cost reductions you’re taking right now in DynaEnergetics?

It does I mean there is a 17% drop if you will in activity, more than that in the industry relative to the fourth quarter of 2015 and our revenues and that’s primarily direct and indirect labor related on the manufacturing floor. We’re also consolidating an office and Boston, Texas into our Houston which is really the center of North American business.

Second question is on DynaStage. Can you elaborate on what exactly you’re hearing from customers? Is it that engineers are just reluctant to change or is that labor cost or lower write-down and companies aren’t just concerned about their investments and field assembly? And just trying to understand it seems like you have pretty good value proposition for you and so far helping breakdown well cost, but it feels like you’re not getting the same traction of DynaStage that you’re with DynaSelect?

We had head start at DynaSelect, and relatively to DynaStage, we’ve chosen to price that product according to the value that we think it creates for the marketplace. And there is a lot of more generic type products in the marketplace right now that are putting pressure under DynaStage and DynaSelect that we’re choosing not to play at the levels at which people are holding these prices. And the overall activity level and then pricing is the slow start. And there is also a lot of changes happening within the service sector, and there’s probably a greater focus on price than products right now and keeping some of their employees employed assembling guns rather than buying guns from us. We’re very excited about the product and we were confident of the value that it creates, not just for the E&P companies but the service companies as well. In fact, we’re actively chosen that you can’t have a market that has dropped as much as it has in volume, 60 to 70 plus percent and then have significant price reductions on top of that for the remaining business. And so, we’re trying to be a good steward of our business going forward.

Last question is for Kevin, really high level. As it relates to acquisition strategy, now it occurs to me that it’s actually been quite a while since you joined the Company, kind of four years now and that when oil was at 90 bucks a barrel and high yield was wide open; if you wanted to you could have gone and done a deal whether it’d be a bolt-on [indiscernible] or more material [Indiscernible] I mean certainly I look at plenty of your peers who are thrilled to go and sale four to five times on it. On the other hand, you’re pretty much dealing with platform company that would rather run at your leverage [indiscernible] You don’t seem to have any sense of urgency around deal making. And I am pretty sure I already know the answer but I’d be really interested Kevin your view now, and give an overview why you’ve taken the path you have and what that implies as far as goal post going forward as energy recover, if and when it happens?

Yes. But if you look at the last two to three years, we have felt that the better choice for our investments were in research and development and product development and we’re beginning to see the proofs of that at this time. So, we’ve really focused on organic load first and foremost. And because today the center of gravity on our revenues is really in a very cyclical market, we’ve chosen not to over leverage ourselves. We get actually uncomfortable when our leverage approaches 2x debt to EBITDA. And so, we want to keep our leverage down at the same time that we’ve been investing in infrastructure which is building out our facility in Russia, building out our facility in Blum, Texas and also consolidating facilities in Europe for the NobelClad business. And so the last two to three years, the investment has gone into the Company getting the infrastructure right, integrating what we did acquire previously and really investing in new product and new revenue growth opportunity such as DynaSelect, DynaStage and now DynaSlot. And then obviously the market collapsed over the last year to 18 months in particular. And so our balance sheet is not where we would like it be yet and our stock has been also not where we think it will be longer term. And so we really don’t have the currency, if you will or an acquisition, nor it’s in our focus. And so, our focus has really been on running our business in a very difficult environment and improving it for the long-term. And as the market recovers, as we improve our balance sheet, as our stock price starts reflecting the performance of the business, I think that you will see that our broader strategic thinking will be more in the forefront. But right now, we’re just really focused on our business today.

[Operator Instructions] There is a follow-up question from Edward Marshall with Sidoti. Please go ahead.

I just wanted to ask the follow-up to the DynaEnergetics gross margin. Was there an Indian tender in the fourth quarter, and if not, when did it hit last year and when it will hit this year?

There was not the India tender in the fourth -- that did not occur in the fourth quarter; that’s typically a second quarter or third quarter item. And this year I think most of it’s going to be recognized in the third quarter, I think some might ship in the second quarter but most of it is going to go in the third quarter.

I also wanted to give a you a chance to talk about maybe DynaSlot, and I understand that the rules in China and Canada and other regions are much different than they are in the U.S. How do you anticipate over the next year or two years the U.S. adapts some of the more conservative laws in China and Canada for the completion?

Yes, it varies not just quite country but by states and sometimes even counties within states as to plug and abandonment of wells. But I think our best perspective on it is that we believe that it will become more and more of the factor going forward how well they are abandoned. And we feel we have a good solution and one of the most economical solutions for that but also on the best performing. And so, it’s going to be slower growth longer time coming but there is a lot of rules and regulations, particularly in a downturn. And, but on a medium to longer term, we think that it’s going to increase the size of the market appreciably.

And how many of these other small projects DynaEnergetics kind of have in its arsenal? Because I know you increased R&D expense quite significantly once arriving. I was kind of curious as to think we’re seeing is this a roll out -- a new product roll out once a year or how do you see this playing out maybe over the next five years?

Well, it’s part of the -- I think the discipline and what I’m very proud of the skills and the research and development of product management team of DynaEnergetics is -- they really are very knowledgeable, very skilled people and also very disciplined in terms of having technology roadmaps that turn into product roadmaps that are now beginning to turn into market development roadmaps and then both on introducing new products but it’s also a continual improvement of the products that we have, whether it’s a shape charge performance or whether it’s the initiating technology. And so, we actually -- I’m pretty excited about the roadmaps that they have in place. And quite frankly, it was easy to get behind the team because they knew what they wanted to accomplish and it’s really funding them properly and then I think quite frankly, I wish we could fund more than we’re doing right now.

And I guess the number of projects respectively for year; I mean is it -- should we expect one a year, should we expect to ramp two to three year? I know it’s a difficult question but just give us some perspective. I won’t hold you to the answer.

Probably a handful of things every year in terms of incremental improvements and then once every year or two probably a step change in terms of overall performance. And so, I think we’ve had a step change in DynaSelect. DynaStage is really DynaSelect in a factory assembled performance assured package where we’ve chosen to go from selling components to selling systems. And that’s an innovation that is as much on the product -- it is on the product in terms of how it’s put together, but it’s also on the business model. And because we feel that we could do better in terms of the quality and cost and reliability than how it’s being done in the field. And so, the innovation is happening, not just at the product level but also at the business model level as well as how we do things on the shop floor.

And then lastly, I guess looking at CapEx for the year. I don’t even know if you’ll make 2 million in CapEx this year. What the plan’s for cash as the year progresses? And listening to your call, it sounds like it earmarks for debt. But I just kind of curious what we think and do you have guidance for CapEx for 2016?

Our CapEx is in the $3 million to $4 million for the year, there is some carryover projects from ‘15 that have come into ‘16.

So, the run rate will pick up I guess?

Yes. And primarily probably in the third quarter. But it’s an interesting question that when we step back and look at it, DMC has spent a lot of money on CapEx over the recent past with acquiring our Liebenscheid facility in Germany to consolidate NobelClad, putting in the distribution center in Blum Texas, consolidating Edmonton into Texas and the two Greenfield facilities Blum, Texas and Tyumen, Siberia. And as we look forward, there is less what I would call infrastructure spending. And so, our CapEx is going to come down more in line with depreciation. And a lot of the expenditures that we’re looking at today are really in business processes and systems. And so, if I were to model out forward, it would be more around depreciation than it would around how CapEx has been spent in the recent past. And so, our EBITDA will exceed our depreciation and then that will be used for reducing our debt and hopefully beginning to building up a cash balance.

There are no further questions at this time. I would like to turn the floor back over to Kevin Longe for any closing remarks.

I would just like to thank everybody for [multiple speakers]. Yes, one last question from Samir.

Yes, exactly. Samir Patel has just returned with a follow-up question, Askeladden Capital Management. Please go ahead.

Just one follow-up guys on going back to DynaStage, you talked about the need to have pull through demand if you will from the actual workers in the field, and it seems like your service company partner is in a bit of a catch [ph] situation where obviously they want to sell the product and have that technological differentiation but also with around employees that work. How do you break that down, how do you actually generate demand, people in the field for DynaStage and kind of start pulling through? And is that in right way for that question?

Yes, first of all, our marketing efforts to the E&P companies on DynaSelect, DynaStage, it’s the same technology and DynaSelect that’s included in DynaStage. It’s helping to create a pull through demand. For the product itself, this is one where patience is a virtue and the merits of the product will sell itself, not just for the E&P company but for the service company. A lot of the service companies that’s been dealing with a very-very difficult situation in terms of a drop of inactivity and probably most likely even a greater drop in selling prices than what we’ve seen on the products side of it. And so, a lot of these service companies are looking at alternatives that maybe they were moving away from when the pricing was stronger. And we quite frankly think sacrificing a little bit on safety and ultimate performance more further the cost. And as the market gets strong, these dynamics are going to change and it will fall back into more of a performance in addition to an economic analysis. And this is just patience on our front.

Got it. Thanks.

Thank you everybody for joining us today and as always we appreciate your interest and we look forward to speaking with you again at the end of the second quarter.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for participating and have a pleasant day.