Greetings and welcome to the DMC Global 2016 Fourth 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, Mr. Geoff High, VP of Investor Relations. Thank you, Mr. High. You may begin.

Hello and welcome to DMC's fourth quarter and year-end 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 be available at dmcglobal.com after the call. In addition, a telephone replay will be made 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. We noted during our last call that the steep two-year decline in drilling and well completion activity had finally reached bottom and was showing signs of recovery. While conditions remained very challenging during the fourth quarter, the turnaround did gain momentum and helped drive better than expected results at DynaEnergetics, our oilfield products business. Sales were also above forecast at NobelClad, our explosion welding business, which took advantage of raw material availability to deliver several orders ahead of schedule. Total sales during the fourth quarter were $40.2 million, a 10% sequential improvement and down 4% from the 2015 fourth quarter. Our original forecast was for a sales decline of 15% versus the prior year fourth quarter. DynaEnergetics reported sales of $17.3 million, which was up 7% sequentially after excluding the third quarter India tender order. Sales were down 7% versus the 2015 fourth quarter. Sales at NobelClad came in at $22.9 million, which was up 35% sequentially. Year-over-year, sales were down 2% from the 2015 fourth quarter. Consolidated gross margin of 25% was above our original forecast of 20% to 22%. The results were an improvement over third quarter gross margin of 23% and an adjusted gross margin of 23% in the fourth quarter of 2015. Our better than expected margin performance was due to strong sales of DynaEnergetics' intrinsically safe DynaSelect switch detonator, as well as a favorable project mix at NobelClad. At the business level, DynaEnergetics recorded gross margin of 27%, while NobelClad was 24%. Consolidated operating loss was $1.9 million versus an operating loss of $19.4 million in the 2015 fourth quarter. Last year's results included a non-cash goodwill impairment charge and reserves for potential anti-dumping duties. By business, DynaEnergetics reported a 2016 fourth quarter operating loss of $2.4 million, while NobelClad…

Thanks, Kevin, and good afternoon everyone. Starting with our fourth quarter expenses, SG&A was $10.9 million or 27% of sales versus $8.4 million or 20% of sales in last year's fourth quarter. The higher than expected general and administrative expense was driven primarily by increased outside legal fees associated with patent litigation and an anti-dumping case. Amortization expense was $1 million or 2% of sales. We ended fiscal 2016 with cash and cash equivalents of $6.4 million. Net debt at December 31 was $9.3 million, down 55% from the $20.5 million at the end of 2015. Fourth quarter operating cash flow was $359,000 versus $8 million in last year's fourth quarter. For the full fiscal year, operating cash flow was $18.2 million, up from $1.6 million in 2015. Growing demand in DynaEnergetics markets is requiring additional working capital. We therefore recently entered into an amended credit facility with our commercial banking syndicate, which relaxes potential near-term covenant constraints. Our new facility raises the maximum allowable leverage ratio and provides relief under our debt service coverage ratio through this year's third quarter. Our borrowing capacity under the facility moves to $35 million from the prior $75 million. However, the smaller capacity provides us with adequate liquidity to fund our expected working capital needs for the foreseeable future. The new facility also enables us to address certain financial obligations related to the previously mentioned anti-dumping case. We have provided an update on this and other legal matters in our Form 10-K, which we filed today with the SEC. Turning to guidance, we are forecasting that our full year 2017 sales would be up 10% to 15% from the $158.6 million reported last year. We expect DynaEnergetics sales will increase 30% to 35% from the $67.3 million we reported in 2016. NobelClad sales…

[Operator Instructions] Our first question comes from the line of Gerry Sweeney of ROTH Capital. Please proceed with your question. Gerry, your line is open. Please proceed with your question.

Sorry about that. I want to talk a little bit about guidance, specifically on DynaEnergetics. Maybe you can give us some of the variables that you take a look at when you're providing the guidance. Obviously there is I guess multiple service companies testing the technologies that are existing, guys using it, there is expanding budgets, and it just feels the tone of the market is much different than it was six months ago. So what I'm trying to I guess get a feel for is how you came up with your budget, are there any pressure points, are there other opportunities within that budget on a go forward basis?

First of all, what we are forecasting for the year is how we are operating in the first two months of the year. And over the downturn, the focus Gerry was on building our market share, continuing to invest in research and development and introduce new products. And when we look at 2017, we are really looking to hold our market share and benefit from the increase in the market as it comes out of the recovery, and hopefully experience better pricing and margin improvement. And so, our activity is really reflecting the market activity at this point.

Okay. And just on the market, I guess I mean in the past we have always kind of talked about the size of the market and market opportunity and something like maybe, and this may be my estimate, but say mid cycle, maybe it's $150 million in that sort of your 18% to 20% market share, and it kind of bounces back to $800 million market, but it seems like laterals are longer, there is less space between fracs, it seems like you're in a sweet spot in terms of having the right equipment, I guess a more intensive usage on a go forward basis. Is there potential for this market to be, for perforating to be maybe bigger this cycle than last cycle just because of the overall intensity?

I think the market is larger, the mid cycle market is larger than what you are indicating. With the movement to unconventional versus near-term investment in deep-sea, we are seeing land more conventional internationally and unconventional in North America, and those are more perforating intensive with longer laterals. And so, we do expect the market to be strong going forward. And as the mix moves more towards the unconventional, we benefit from that.

Okay. And then maybe this one might be a little bit more for Mike, but it sounds like on the credit facility, if I heard you right, it's a smaller facility, you amended it so it's smaller but it gives you more flexibility in terms of the actual credit ratios. Is that fair to say?

Correct, we get a three-quarter step-up in our leverage ratio.

And what are the exact step-ups ratio-wise?

So the step-up in the first quarter of 2017 is to 4x, it's 5x in the second quarter of 2017, 3.5x for the third quarter, and then steps back down to 3x for the fourth quarter.

Okay. And I mean you don't see any issues, I mean that's purely based on I guess your expected demand that would obviously flex with – working capital would flex if things sped up, slow down, et cetera, so you feel comfortable with that?

Absolutely. We don't believe – as we've said in the past, it's a balance sheet issue, it's a bit of a trailing earnings issue, as well some challenges in timing in the marketplace with NobelClad and first quarter order patterns.

Got it. Okay, I'll jump back in line and maybe come back with some more. Thanks.

[Operator Instructions] Our next question comes from the line of Edward Marshall of Sidoti & Company, LLC. Please proceed with your question.

So I guess the first question I had was regarding the growth that you are anticipating in DynaEnergetics, and I'm looking at specifically the embedded volume in the expectations for 2017. I assume it says I guess you shipped 20,000 fuses or charges, 20,000 units thus far since the advent of this program. I guess first, what are you looking for, for 2017 as far as unit production? And then also, can you kind of talk about what's embedded in the price for DynaEnergetics as we move forward, both volume and price?

We just announced price increases that range from 5% to 15% that are taking effect this month and we are pretty firm on those price increases. And so, the activity level that we're seeing is greater than the 35% to 40% that we forecasted for the year. And so, we are determined to hold our pricing and improve our margins as the year unfolds. And as far as the DynaSelect and DynaStage, we see both of those growing significantly. That's where we gained the greatest market share, is on the initiating systems. And what we see is, when we can make – not make, but when we develop applications based on the DynaSelect technology, it pulls along the DynaStage. So the DynaSelect is really the indicator of future DynaStage sales, which is a complete system.

So are you saying that you anticipate the volume increase of about is it 30% to 35% for 2017 and then the price increase is on top of that, or…? I'm trying to make heads or tails of that 30% to 35%.

It's a combination of both. We expect the market to be up more than the 30% to 35%. We are focused on maintaining the share that we've built in the initiating systems and protecting that market and moving more towards factory-assembled systems. And with that we'll see that 30% to 35% revenue growth, but that's a combination of units and pricing.

So the 5% to 15% price increase is on the legacy charge products I imagine? From my understanding, there has been a recent cut in the DynaSelect products in price.

There was a bringing down of the DynaSelect pricing in 2016 that matched quite frankly the cost coming down as we introduced a new circuit board into that product line. And so that product line is moving along its maturity curve and we're getting greater acceptance in the market and greater volume at a lower price, but we are maintaining our margin. And we are increasing prices in 2017 across the board and what's going up most is really the more generic products which are guns or hardware that is sold without charges.

Got it. When I think about the commentary about trial periods and certain customers, how I think about the margin in that particular product, because from what I understand you have given those trial periods away at cost? Is that still happening, and if I think about kind of the mix of business there as we move throughout the year, as we move from trial to say full production, should I assume a graduation of the operating margin and gross margins within that business? Maybe you can comment to that.

Yes, I think it's a blend but you'll see our incremental margins in that business exceed 40% going forward. That's our target.

Okay. And have you stepped back and looked at maybe the total investment that went into the DynaSelect and DynaStage products and move from the beginning of that to where we are today, because I think that it's taking you longer to recognize I think the revenue and the margin that you anticipated that product would take? So, kind of about a return on that particular investment, have you thought about kind of where that was when you started versus where it is today?

Actually it's a very good margin product and it's been a very good return on the research and development effort that we've put into it. This is more of a research and development type expenditure in order to come up with this technology. It's not capital intensive like guns or shaped charges would be. So the investment is different, and for a given dollar of margin, it's much lower on the initiating technology than it is on the other products.

Got it. Then you talked about NobelClad and I think in the comments you said that you pulled forward sales from the first quarter of 2017 into the fourth quarter. As I looked at the backlog, it did tick down just a hair because of that. I'm curious if that was a snapshot at year-end. I guess first, do you have the backlog as it stands today, and then how that affects I guess the first half ramp-up in NobelClad as we kind of think about that business going forward?

The slowest quarter of the year for that business is going to be the first quarter, which is somewhat correlated with the bookings for 2016 which were around $80 million for that business from a trailing 12-month basis. And the third quarter itself was a low booking month. And so, that translates into the first quarter of 2017 being low. But we expect to see the quarters build both from a booking and from a revenue standpoint from here on out, and we've got a number of larger projects that are more backend-loaded in the year that we see coming on also.

So when I look at – I imagine you spoke to a lot of customers as of late and everybody is feeling somewhat elated with the relief that they have seen in the price of the commodities. I'm kind of curious if maybe you've taken gauges as to what the new breakeven points would be, and I know from region to region it differs, but if you can kind of step back, I mean now seeing oil off the last couple of days until today, just kind of give a sense as to what breakeven means for these different wells and maybe your thought process on that?

I think we look at the overall market and where it's going. The last couple of days, quite frankly, it's trading that deviates from what we think are the longer-term supply and demand, with supply falling short from demand on a longer-term basis as the production comes down. And so, we are sticking pretty much as we did through the downturn to our strategy and we're fairly confident that the market is going to enable us to deliver through both unit pricing and volume that 30% to 35% growth in DynaEnergetics this year. And that comes from various basins. We are not getting into the specifics on the basins itself.

Got it. So the breakeven for oil pretty much for the different regions, what would you say based on the conversations you've had with customers?

We are not – those aren't the type of conversations that we are having. We are mostly dealing with the service businesses and it's anywhere from $40 to $70 depending on the basin, is what we understand.

Got it. And then the new leverage ratios that you have on the debt, and I guess this is for Mike, how do I think about, is it pro forma estimates of EBITDA or is that – and by the way, when you calculate EBITDA, do they add stock compensation back or how I think about just a pure apples-to-apples comparison to what the covenants look at versus what we might typically look at?

It's adjusted EBITDA as defined in our 10-K and as you see in our press release.

Got it. Great. Thanks guys.

In the trailing 12 months.

It's trailing 12 months, and it does add back stock compensation.

And is there an interest coverage ratio component or anything like that?

Yes, there is a debt service coverage ratio.

Got it, okay. Thanks guys.

We have a follow-up question from the line of Gerry Sweeney of ROTH Capital. Please proceed with your follow-up.

Wanted to talk a little bit, the other products and Tyumen, the Tyumen facility, so you have DynaSlot, you have the Tyumen facility coming onboard, how does – let me take a step back actually. We are always focusing on here North American unconventional, but you do have the DynaSlot out there, you have the Tyumen facility that's just starting to ramp up, the HaloFrac, et cetera. I mean, I don't want to lose sight of that, but how does that fit into the portfolio of products you sell and the opportunity longer-term for you guys? Just want to get some thoughts on that.

Gerry, we spend a lot of time talking about the initiation systems, the DynaSelect, DynaStage, where we take the initiating system and put it into a perforating gun. We also have to be a leader in the perforating technology itself depending on the rock formation and the type of application that our customers are going into. And so, we have a full suite of shaped charges as well as different gun lengths and sizes and configurations, and our efforts are all driven towards increasing the number of barrels of oil that come from using our perforating systems and/or lowering the cost. And so, we talk a lot about DynaSelect/DynaStage but it really is a full suite of products, and we have as broad or broader suite of shaped charges and gun configurations. In fact, I believe we have the broadest in the marketplace. And so, all these things are complementary to one another. Regarding Tyumen, Tyumen is a market, the CIS market, and we have leading shaped charge technology in that market, particularly as it relates to the domestic manufacturers. And we spent the last five years building a greenfield facility and getting the appropriate licenses and regulations that we needed to have in order to produce shaped charges. We are now producing shaped charges and trialling and sampling a whole host of customers in that marketplace, and we expect to see that business move from a development market from a construction standpoint into a development market from a market development standpoint, and that will be a more significant contributor to DynaEnergetics performance going forward for that region. Having said that, I will note that there was quite a drop in the ruble a couple of years ago and that reduced the dollar size of that market from what it was originally anticipated to be.

Got you. And then just wanted to – two other quick ones – you said I think earlier, I don't want to get the cart before the horse, but you said, I think you said a series of price increases. And from the sounds of it, the one on March 1st was first one and you're going to keep a pretty tight eye on the market and I guess go back with another potential increase if appropriate?

Yes. I mean we need to price for our technology and our technology is generating the returns for our customers, and to support the investments that we're making we need to see much more attractive contribution margins than what we are operating today.

Got it. And on the NobelClad, the second half potential projects, there always seems to be some projects on the horizon in NobelClad and it sounds like you might be a little bit more confident on that market on a go forward, or in the second half. Just I want to gauge your confidence level in NobelClad's ability to start ramping back up or at least bookings start to accelerate.

Yes, I think what we have guided for 2017 is a flat year over 2016. 2016 was what we believe is the bottoming of that business relative to capital spending and we expect to start seeing growth from here on out. It does slow down later and recover later compared to our more consumable product business in DynaEnergetics. And so, we think the back half of 2017 into 2018-2019 is where this business is really finding its stride. But for 2017 itself, it's flat over 2016.

Got it, okay. I appreciate it. Thanks guys.

[Operator Instructions] There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to the President and CEO, Mr. Kevin Longe.

Thank you everybody for joining us and we look forward to speaking with you again after the end of our first quarter when we are announcing our first quarter results. Thank you.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your night.