DMC Global Inc. (BOOM) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to Dynamic Materials Corporations’ 2016 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Geoff High, Vice President of Investor Relations. Thank you, Mr. High. You may begin.

Hello, and welcome to DMC’s third 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 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 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 now turn the call over to Kevin Longe. Kevin, please go ahead.

Thanks, Geoff, and hello, everyone. During the third quarter, we saw indications that the two year collapse of well drilling and completion activity may have finally reached bottom. From peak to trough the downturn brought a roughly 80% reduction in the U.S. rig count, reduced the number of new wells initiated in the U.S. by more than 75%, cost the industry roughly 350,000 jobs worldwide and cut an estimated $1 trillion out of capital investments. Now, many companies in the oil field services industry are reporting that recovery may be taking hold. In a moment I’ll discuss the signals our DynaEnergetics business is seeing that support those reports. While our third quarter financial results still reflect difficult market conditions, we are confident the anticipated recovery will validate the investments we made during the downturn in new products and market development initiatives and the modernization of our global manufacturing facilities. DMCs consolidated sales for the third quarter was $36.6 million, down 7% from last year’s third quarter and 12% sequentially. The results were 2% below our forecast, due to the late deliveries by a sub-contractor to NobelClad, our explosion-welding business. These delays pushed $2.1 million in sales out of the third quarter. As a result third quarter sales in NobelClad declined 21% to $16.9 million versus last year’s third quarter and went down 36% sequentially. DynaEnergetics reported sales of $19.6 million, up 8% from last year’s third quarter and 32% sequentially. Included in DynaEnergetics third quarter sales results, is the impact of a recurring international which in 2015 shipped during the second quarter. Excluding this order, DynaEnergetics sales were down 12% versus the year ago third quarter and up 8% sequentially. This sequential increase resulted from record quarterly unit sales of a new generation of intrinsically safe 4 initiators. Consolidated gross margin was 23%, down from 26% in the third quarter last year and 24% in the second quarter. Gross margin was above our original forecast of 20% to 22% due to the strong DynaSelect sales. DynaEnergetics recorded gross margin of 28% for the quarter, up from 22% in the second quarter and down from 32% in last year's third quarter. NobelClad reported third quarter gross margin of 18%, down 25% in the second quarter and 21% in last year's third quarter. The decline was primarily due to a less favorable project mix, a warranty provision and reduced volumes. Consolidated operating loss was $2.4 million and included approximately $373,000 in restructuring expense related to a lease termination at DynaEnergetics. Operating loss in last year's third quarter was $941,000 and included $285,000 in restructuring charges. At the business level, DynaEnergetics reported an operating loss of $1 million, while NobelClad reported operating income of $700,000. Consolidated net loss was $3.1 million or $0.22 per diluted share versus the net loss of $4.2 million or $0.30 per diluted share in last year's third quarter. Adjusted EBITDA for the quarter was $1.2 million versus $2.5 million in the third quarter a year ago. At the business level adjusted EBITDA was $1.2 million at DynaEnergetics and $1.7 million at NobelClad. Like many in the oil field services industry, we expect the recovery and well completion activity will initially take hold in North America’s unconventional oil and gas basins. For DynaEnergetics, the recovery may already be underway. The DynaSelect initiator, which is primarily used in unconventional fields in the United States and Canada, saw 34% sequential increase in third quarter unit sales versus the second quarter and 19% increase versus the third quarter last year. These results primarily reflect the strong market penetration DynaSelect has achieved, since its introduction in 2013, as well as the general increase in customer activity. DynaEnergetics also saw a growing interest in DynaStage factory assembled perforating system, which also is designed for use in unconventional well completion. DynaStage is built around the DynaSelect initiator and a rise at the well site fully assembled. Two additional wireline companies began using the system during the third quarter, bringing to six the number of DynaStage customers operating in the U.S. and Canadian basins. During the downturn most wireline made substantial reductions to their field crews, including the highly trained workers who assemble on wire explosive perforating guns. As the market recovery gains momentum, we believe the DynaStage system will enable service companies to address customer demand without rehiring and training for perforating gun assembly teams. Several additional companies are evaluating DynaStage and given the increased efficiencies and reliability the system brings to the well completion process, we expect it will see broader adoption and through sales volumes as the recovery takes hold. The pickup in customer activity extent beyond North America, DynaEnergetics is reporting increased customer enquiries in several international markets, most notable the Middle-East. With our shaped charge plant in Tyumen, Siberia, now fully operational, we also believe DynaEnergetics will see a material improvement in sales from the Russian and CIS markets during the coming quarters. We’d noted in past calls that pricing pressure in DynaEnergetics markets has been a significant challenge during the downturn. Pricing adjustments naturally lag changes in sales volumes, so after recent improvement in demand is sustainable, we believe the current pricing environment will begin to improve during the first half of 2017. At NobelClad, order volume remained relatively weak during the quarter, although the business continued to receive steady enquiries from the chemical, petrochemical and middle markets. There are likely many reasons for the continued softness in customer spending activity, including general market uncertainty, cash constraints at large integrated energy companies and ongoing project modifications due to changing material costs. Regardless, many of the orders NobelClad is tracking are related to important industrial infrastructure projects that we believe will ultimately be built. As the industries only global explosion-welding company, NobelClad has established leading market share and production capabilities. We believe the business is well positioned to capture many of these orders when they’re ultimately released for construction. In the meantime, the business continues to advance its global sales and marketing initiatives and is pursuing a range of new applications for its explosion clad plates. During the downturn we’d made significant progress streamlining our businesses, lowering our cost structure and strengthening our balance sheet. These programs have enabled us to maintain aggressive investments in our manufacturing capabilities as well as new product technologies and market development programs. Collectively, we believe these initiatives have positioned DMC to deliver much improved financial performance as our markets recover. With that I’ll turn the call over to Mike for some additional comments on our financial results. Mike?

Thanks Kevin and good afternoon, everyone. Beginning with our third quarter expenses, selling, general and administrative costs were $9.5 million or 26% of sales, down from $9.9 million or 25% of sales in last year’s third quarter, but above our original forecast of $9 million. Outside legal fees led to the higher than expected general and administrative expenses. Amortization expense was unchanged from last year at $1 million or 3% of sales. The $373,000 in the third quarter restructuring changes were related primarily to the termination of a lease in Austin, Texas as we have consolidated U.S. offices of DynaEnergetics into Huston. Turning to our balance sheet, we ended the third quarter with cash and cash equivalents of $7.5 million. We reduced our net debt during the quarter by $6.3 million or 47% versus the end of the second quarter. Third quarter operating cash flow was $9.4 million versus cash we used for operations of $1.7 million in last year’s third quarter. For the nine months period, operating cash flow was $17.8 million, an improvement of $24.2 million when compared to the cash we used for operations during the nine months period last year. Turning to guidance, we’re forecasting that our full year 2016 sales will be down 7% to 9% versus the $167 million we reported last year. Our prior forecast was for a decline of 5% to 7%. The revision relates to weaker than expected sales at NobelClad and an anticipated slower than normal holiday season at DynaEnergetics. Expectations for full year gross margin are unchanged at 22% to 24% versus the 25% reported in 2015. We expect our fourth quarter sales will be down 15% from the 2015 fourth quarter. Gross margin is expected in the range of 20% to 22% versus the 23% we reported in last year’s fourth quarter. SG&A is expected to total approximately $9.5 million, while amortization expense is anticipated at approximately $1 million. And now we’re ready to take any questions. Operator?

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Edward Marshall from Sidoti & Company. Please proceed with your question.

Hey guys, how are you doing today?

Yeah, fine Ed. How are you?

I’m doing pretty well. I guess I have quick - particular [ph] question on first signs on improving demand. Can you talk about maybe some of the signals that you said you saw, regarding some of those signals of improving demand within DynaEnergetics?

Primarily in our North American market, we saw increased demand over what we were expecting on our initiating systems and that probed through some take charge business also and gun business, but it’s primarily the initiating systems that was the leading indicator for us.

Okay and I think that’s coming off of particularly low base, can you talk about maybe what the percentage sales would be in DynaEnergetics as a whole?

Yeah, regarding the initiating systems, first of all we had a record quarter and the year-to-date is up 16%, 17% over the prior year. And as mentioned in the call that’s with the backdrop of rigs dropping over 80% and so we feel very good about how our initiating systems are taking hold in the market and primarily picking up share. And we saw the quarter pick up even over our own internal forecasts as some of the customers that we were working with which - their activity itself picked up, which was what drove the increase in our initiating systems. And so that’s what we’re seeing.

Yeah, but I guess the question is though, what is the percentage of the sales that DynaEnergetics - I mean a couple of million dollars going to say $3.5 million, just give me order of magnitude here so I can kind of think about, how to put the percentage of year-over-year into perspective.

Those sales in the quarter were approaching 25% of our revenues for the initiating systems.

Initiating systems, 25% of DynaEnergetics revenue?

Yes.

Got it, perfect. Okay and is there anything more behind that, is there one particular customer that might be stocking in here or is this something that is a broad based kind of customer related?

It’s a broad based, yeah. We have sold, as an example, over 100,000 of those initiating systems year-to-date.

How many did you say, 10,000?

Over 100,000.

100,000 perfect. Thanks guys very much, I appreciate it.

Our next question is from Gerry Sweeney from ROTH Capital. Please proceed with your question.

Hey, good afternoon Jeff, Kevin and Mike, how are you guys doing?

Fine Gerry, how are you?

Curious as the wireline guys were coming to you, are they coming to you - I mean you’ve gone from one to four to six companies now, is it - it’s a lead off - hey, we want to talk about DynaSelect and DynaStage or - just curious that what is driving the uptick in wireline companies participation?

The DynaSelect and integrated switch detonator and DynaStage, they use the same DynaSelect technology. And so when we are marketing this out to wireline service companies and to E&P companies, we’re leading with DynaSelect from a safe and selective initiating system which basically improves the reliability and the operating performance or the cost of completing a well. The DynaStage itself is driven with that technology, but also with - it’s a factory assembled system, so it requires no field wiring. And essentially we end up taking responsibility for the performance of the gun system and also taking working capital on to our balance sheet and also of our customers and that’s really what’s driving that.

Got it, I was just curious. I mean I’m assuming that it was the DynaEnergetics, DynaSelect and DynaStage [ph] they’re coming to you for that product and I guess there are six companies signed up now.

Yeah.

How big are they versus the potential customer base that’s out there? I mean it’s a great product, there’s a lot of value add across the board, we know that. You’re gaining traction, trying to figure out how much opportunities are out there? We have already talked about you may be gaining 20% market of the sort of enlightened wireline companies. With that in my mind, how big is this opportunity, is it gaining a little bit more stand on your thought or is it sort of on track just trying to navigate the velocity of the pickup.

Yeah and if I could answer that in two questions, regarding DynaStage the fleet assembled perforating guns. We are working with six people - six companies, one of those is a major wireline service company, the others are medium size. But I would like to highlight that that’s a small percentage right now of our overall DynaSelect initiating systems, which really go across the market including to more than one of the large major service companies. And so the market in general has bought into and is using the DynaSelect technology and we expect the DynaStage to pick up significantly as the market begins to recover because of it being a factory assembled system.

And I mean, is that assumption or is that expectation, I assume because you can talk in terms of seeing the merits of the DynaStage and you start to see buy in at least when you’re sitting at the table discussing a product.

Very much so.

Okay, got it. And then shifting gears a little bit, over to Tyumen, how do we look at this? Now, that I believe it is up and running, it gives you an opportunity to sell into the Russian market, but does this initially sort of shift production and shift sales from I guess your facility in Germany or does this give you an opportunity to sell more into Russia and that occurs overtime, just wondering how that market develops say in ‘17, ‘18.

Yeah, the facility - the official opening was just this past quarter, but we received our license in the second quarter. And it was built - I mean, we started the approval process I want to say four and a half, five years ago for this facility and so it’s quite gratifying to finally complete it. But it was built with the intention of serving the Russian and CIS markets. We are capable of exporting out of there and particularly with the drop in the Ruble that could be something that we do going forward, but right now we’re targeting the Russian market with that facility.

So can you tell - drive additional sales because you’re there or it was planned four t to five years ago or is it now - I don’t if it cannibalizes, but maybe take some sales away from the German facility?

We were limited with how much we could export into the Russian and the CIS markets or set another way limited to how much they could import. And so making shaped charges locally will increase the available market for us significantly and we believe and understand that our technology is significantly more advanced than what’s been used locally. And so we should see a shift over to our shaped charges which are going to increase the overall available market or sales for us going forward. We’re targeting less than 30% of that market though and so I think that’s important because part of that market that we cannot reach, whether we go to market, but we view this being a significant region for us going forward and it’s a very modern and an advanced facility that can serve export markets also if we choose to export from there, from Russia.

How big is the Russia, CIS markets as you mention it?

I don’t have the figures in front of me, but it’s 10 plus percent of the overall world market, plus or minus I would say.

Got it and then a sort of housekeeping question, how much restructuring do you think is left. When we see the restructuring charges, I think they’ve been declining through the year. Is there still some restructuring going on into the fourth quarter and does it end sort of - when does it end or would be a small consistent sort of process improvement.

We’re not expecting any more restructuring for this calendar year and based on our current and announced plans, we’re not forecasting restructurings going forward.

Got it and then real quick - I’ll jump back with DynaEnergetics this [indiscernible]. The amount that - the wireline companies have ordered, obviously it was a big quarter. I mean, are they ordering on like a quarterly basis, say halfway through the third quarter they stocked up for the rest of the year, what are ordering patterns like in that business? How do they sort of the supply chain management side?

That market does not operate with a backlog. It’s pretty much a very, very short turnaround business basined in weeks, not even months.

But you know how much they - I mean, they order a couple of weeks’ worth of supplies, we ship it out and they sort of manage internally. I know the DynaStage is different, but I mean in particular the DynaSelect.

No, it’s very short, five to ten day kind of window.

Okay, so orders are consistent, you can see what’s happening today?

Yeah.

Got it, perfect. That’s it for me. I appreciate it.

Our next question is Samir Patel from Askeladden Capital Management. Please proceed with your question.

How are you guys, how is it going?

Fine Samir, how are you?

I’m doing pretty well. Okay, so a couple of questions here, one is - sorry for just being stupid here, but you guided down your fourth quarter basically by almost 10% kind of relative to your previous expectations. And yeah, you’re talking about the market strengthening and getting better, can you just kind of reconcile how that works?

Yeah, the market’s getting better, we also have - on the DynaEnergetics side of it, we were anticipating the market getting better. We also have holiday season in the North American market, which we think is going to soften the fourth quarter and we had a slowdown in NobelClad. And so a combination of these things are what’s causing us to guide lower into the fourth quarter.

Okay, got it. As far as on the pricing side, I mean kind of similar question. You guys talked about you’re expecting pricing to strengthen kind of in the early parts of ‘17, it’s still weakening. Schlumberger kind of tried to draw that line in the sand in the summer and say, okay, we’re going to push for pricing now and there’s oil pricing decline or at least not increased [ph]. What gives you the confidence that you’re going to have that snapback from customers? What kind of gives you - what gives you that leverage when you’re having those negations next year that you haven’t had this year?

I like to say it’s going to snapback. I think we need to see utilization and volume increase first before the price levels come back second. When it comes to negotiating our selling prices, we are not trying to gain shares through lower price. We were gaining our share based on our value add and our technology and so it varies by product line, where we have a high degree of differentiation in our initiating systems. We have fairly stable pricing and where we’re seeing the majority of competitive pricing pressures in the market are on pipe and the gun systems themselves, which have much differentiation and that’s really one where the overall volume in the market needs to pick up before we start seeing more rational pricing in the market place.

Got you, okay. One for Mike, I know that one of your focuses this year was getting the working capital kind of optimize. You’ve done a really good job on that, obviously a larger cash flow has come from that. Can you help me demensionalize as you go forward presuming there is a recovery at some point, how much of the working capital improvement is sort of been a stick, right, how much of it struck or versus how much it shows. You’re doing lots - volume and so therefore you need lots and receive [ph] both in inventory.

Yeah, Samir I think some of our decline and favorable improvements in working capital and receivables have come down as volume has come down. So I think we’re not at a normalized receivable level. I will say though that we still have inventory to work through as well and probably as volume comes back we probably got 5 million or so in inventory that we can work though. So I think if you - as we experience a market improvement, we’ll see some offsetting factors there, so we should have a significant working capital drag going the other way.

Okay, got it. And with that inventory, I mean there’s no concern about a write down or kind of like you had with the line pipe - or not line pipe, gun - the carriers [indiscernible].

No. Not at this point.

Okay and then - sorry, just one more little small one. Have you filled the NobelClad position yet or is that still open?

We haven’t. In offer that’s been accepted and we hope to have an announcement within the next week or so, once the individual starts at the company.

Okay, cool. Good to hear. Well, thanks. That’s all for me.

Thank you.

[Operator Instructions] Our next question is a follow up from Edward Marshall from Sidoti.

Just a quick follow up, I looked at the DynaEnergetics business and the mix we think that now being a significant amount of the initiating systems relative to historic levels and I know that pricing is down on the shaped charges. Firstly, I would like to ask to quantify the amount of price degradation that’s still there and maybe what it was on a sequential basis. But I wanted to note that we’re still operating at an operating loss in that segment and with the initiating devices becoming a much stronger piece of the business there. I kind of I want you to walk through maybe profitability as we kind of dagger [ph] ourselves out of this - in this still where we are in the cycle. A lot of questions there I guess.

First of all the initiating systems are at a healthy margin, although we have had to adjust price in order to compete successfully with alternatives, not direct alternatives but indirect alternatives. But we just are in the process of introducing the next generation DynaSelect initiator, which is actually going to improve our competitiveness at the current prices and you’ll see the margins start coming up on that product line. When it comes to shaped charges and guns, shaped charges are stickier from a price standpoint, particularly depending on which shaped charges we’re selling. Some have more embedded technology than others and guns are the most competitive product line that we have out there. And so it’s really a mix bag when it comes to projecting the price increase in the margin going forward on those product lines.

Ed, I would also add, when you look at our results from quarter-to-quarter, we were breakeven on the operating income line in the first two quarters of the year in that sense, just north of 49 in sales, so that’s sort of our breakeven point when you think about operating income and generating positive operating income.

Are you suggesting that it’s volume driven and not price driven by what’s going on in the shaped charges market?

It’s volume and price and our incremental margin has come down year-over-year about 10%, the majority of the margin has come down through volume.

Okay, I talked to others - my concern I guess is that, I’ve talked to others about service providers and they’ve mentioned the discussion around price. And the question that is getting close especially from the investors to me is once we get that price up, we get it back [ph]. And I think that’s the big concern out there, have you seen any signs at the place - the sign from the new products, I understand what’s going on in DynaStage, but in the old existing products, does that price come back once you’ve actually sacrificed it?

We did these projects - as I mentioned earlier there’s no backlog for this business, so it really is based on the activity at the time that we’re selling and the technology and we’re moving more towards initiating systems, complete gun systems and higher performing shaped charges. We believe that our incremental margins will be back to - very, very quickly back to the levels that we saw in ‘14.

But you’re referring to the new products, not the legacy products, is that correct?

The new products are important in terms of maintaining a healthy incremental margin and that’s the case in this year and it’ll be the case in every year going forward, which is why we have significantly stepped up our research and development in both initiating systems and shaped charges and pricing powers directly related to new product introduction. And we’re designing this business for a higher incremental margin than where we are today and we’re going to get there through the new product introduction and the return of a reasonable volume. We don’t have to get back to the volume in ‘14 to get to the incremental margins in ‘14 because of the new products that we’re introducing.

Got it, thanks. And the last question I have is on the push-ups, do you anticipate that picking up in Q4? Recovering those sales in Q4 or is that something that’s going to happen over multiple periods?

The push-out on NobelClad - we believe that 75% of that will fall into Q4.

And that’s in your guidance?

Yeah.

Got it. Okay, thanks very much. I appreciate it guys, have a great evening.

Ladies and gentlemen, we’ve reached the end of the question-and-answer session and I’d like to turn the call back to Kevin Longe, CEO for closing remarks.

I just like to thank everybody for joining us today and we appreciate your continued interest in the company and look forward to speaking with you again at the end of this year and getting this year into the record books. Thank you very much.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.