DMC Global Inc. (BOOM) Q2 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the DMC Global 2017 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. [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.

Hello and welcome to DMC’s second quarter conference call. Presenting today are President and CEO, Kevin Longe and CFO, Mike Kuta. 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 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 second quarter sales of $47.2 million, which was a 21% sequential increase from the first quarter and a 14% increase versus the second quarter a year ago. The better than expected results were driven by strong demand at DynaEnergetics, our oilfield products business, which is benefiting from both increased well completion activity in North America’s unconventional sector and from a series of advanced product and technology introductions made during the downturn in the oil and gas industry. DynaEnergetics reported second quarter sales of $26.8 million, which was up 22% sequentially and 80% versus last year’s second quarter. Sales at NobelClad, our explosion welding business were up 20% sequentially to $20.4 million and were down 23% versus last year’s second quarter. NobelClad’s revenue stream generally includes a mix of both large projects and smaller maintenance and repair orders. Unlike last year’s second quarter which included deliveries on a $6.5 million order from the semiconductor capital equipment industry, this year’s second quarter did not include any large project shipments. This situation reflects the low level of end-market spending on major industrial projects during the last several quarters. As I will discuss in a moment, NobelClad is anticipating that several of the large projects it has been tracking are moving closer to the award and construction phase. Our second quarter gross margin improved to 30% from 27% in the first quarter and 24% in the second quarter a year ago. Higher average selling prices and a favorable product mix at DynaEnergetics drove the improvement. At the business level, DynaEnergetics’ second quarter gross margin was 34% and NobelClad’s was 25%. We reported consolidated operating income of $2 million, which included a $458,000 largely non-cash restructuring charge. The charge related to the closure of the DynaEnergetics sales and distribution center in Kazakhstan, where recent legislative changes increased the cost of operating the facility, which was taking only modest financial contributions to the company. In last year’s second quarter, we reported an operating loss of $822,000. At the business level, DynaEnergetics reported operating income of $2 million, including the $458,000 restructuring charge. NobelClad reported operating income of $2.3 million. We reported second quarter net income of $189,000 or $0.01 per diluted share versus a net loss of $766,000 or $0.05 per diluted share from last year’s second quarter. This year’s second quarter was negatively impacted by approximately $1 million in realized and unrealized foreign currency losses, which were primarily related to the strengthening euro against the U.S. dollar and Russian ruble. We reported second quarter adjusted EBITDA of $6 million, up from $930,000 in the first quarter and $3.3 million in the second quarter a year ago. DynaEnergetics reported adjusted EBITDA of $4.2 million, while NobelClad contributed $3.3 million. DynaEnergetics second quarter sales in North America were up approximately 30% sequentially outpacing the growth rate of the U.S. onshore rig count by 50% over the same period. The performance reflects DynaEnergetics successful efforts in recent years to capture a greater portion of the onshore unconventional completions market in the U.S. and Canada. Several top tier service companies incorporated DynaEnergetics’ high-value products and technologies during the downturn. And as completion activity accelerates in North America’s unconventional market, demand for those products is rapidly expanding. Second quarter unit sales of the intrinsically safe DynaSelect switch detonator were record levels for our fourth straight quarter and increased 35% sequentially versus this year’s first quarter. Unit sales of the factory assembled, performance assured DynaStage perforating system, were approximately 8 times higher in the second quarter than the first. Based on well completion data from HIS, we estimate that nearly 4% of the unconventional stages completed in North America during the second quarter were perforated with DynaStage. Customer feedback illustrates the tangible benefits DynaStage is delivering to customers. When a DynaEnergetics wireline customers is using DynaStage in three U.S. basins and has adopted to system to address the unique, fast-paced completion program, implemented by a leading exploration and production company in the DJ Basin. This program involves the deployment of gun string assemblies that are roughly 3 times longer than traditional strings. The customer reported that DynaStage has reduced the gun string assembly time by 80%. DynaStage also has enabled a reduction of the customer’s vendor count from 3 to 1 and reduced its working capital requirements. The system also has led to a substantial improvement in the overall reliability of the customers perforating operations. Another wireline company recently commented that the inherent safety of the DynaStage system gives us completion team’s greater peace of mind around the well site. Given the operational cost and safety benefit of the DynaStage system, we are confident demand will continue to grow. DynaEnergetics is running in two shifts at DynaStage assembly lines at its facilities in Texas and is continuing its initiatives to expand production and assembly capacity. We noted in our last call that DynaEnergetics implemented a series of price increases during the first quarter as part of its margin recovery efforts. Additional increases were put in place on select products during the second quarter and these efforts will continue during the second half of the year. At NobelClad, the list of large order opportunities we mentioned during our last call continued to expand during the second quarter. One of these opportunities resulted in the award of a $4 million order to NobelClad last week. The associated clad place will be used in the specialty chemical facility in Asia. The order will be reflected in NobelClad’s backlog at the end of the third quarter and we delivered during June 2018. We believe several of the projects including the perspective $9 million petrochemical order we mentioned last quarter are moving closer to the award phase and we believe NobelClad is well-positioned to benefit in 2018 and beyond. I am encouraged by our achievements during the first half of the year and very pleased with the performance of everyone across DMC’s global network of sales offices and manufacturing facilities. With that, I will turn the call over to Mike for some additional comments on our second quarter financial results. Mike?

Thanks, Kevin and good afternoon, everyone. Looking first at our second quarter expenses, SG&A was $10.6 million or 22% of sales versus $8.9 million or 22% of sales in the second quarter last year. The increase was due to the anticipated increase in outside legal expenses associated with our patent infringement defense as well as higher salaries and wages and higher stock-based compensation expense. Second quarter amortization expense was $1 million or 2% of sales. Turning to our balance sheet, we ended the quarter with cash and cash equivalents of $8.6 million. Net debt at June 30 was $15.3 million, up from $9.3 million at the end of fiscal 2016 and down from $16.9 million at the end of the first quarter. The increase versus the end of 2016 relates to the $3 million we tendered U.S. Customs in the first quarter pending the resolution of DynaEnergetics anti-dumping and countervailing duties case. Higher legal expenses and increased working capital requirements also drove the increase. During the second quarter we generated $2.1 million in cash from operating activities. Turning to guidance, we expect third quarter sales will increase 25% to 30% versus the $36.6 million we reported in last year’s third quarter. Gross margin is expected to be approximately 30%, up from the 23% in the year ago third quarter. SG&A activity is expected to be in a range of $10.5 to $11 million versus the $9.5 million in last year’s third quarter. Amortization expense should be approximately $1 million. We currently are maintaining our prior financial guidance for the full fiscal year. And now we are ready to take any questions. Operator?

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

Hey guys, how are you?

Fine Ed.

So I wanted to ask about the [Technical Difficulty] facility, I was curious if the Tyumen facility made that somewhat expandable for you guys?

Could you repeat your question, you broke up a little bit.

Yes. I am curious if Kazakhstan was suffering [Technical Difficulty] if that was made expandable by kind of some of the changes in Tyumen, etcetera?

It was and we can serve Kazakhstan from the Tyumen facility going forward.

And there were facilities in the surrounding East Asia that may need that means with the same kind of bill [ph]?

That, no that was the only add distribution centers that we have that would be served by the Tyumen facility.

When I look at DynaEnergetics I am curious if you kind of breakout from you get a little granular maybe talk about how much of the revenue is generated DynaSelect and how much is generated by the DynaStage system?

The DynaSelect is just the integrated switch detonator. The DynaStage is a full gun system. And we don’t get into the specific pricing of those products or systems. However, the DynaStage value would be in the range of four to one what a DynaSelect would be.

Right, I guess what I am asking is the percent of revenues, right, how to see that how grows over time?

Yes.

DynaEnergetics side, DynaSelect is about a quarter of our revenues.

And DynaStage?

It’s significantly less than half but certainly ramping – it’s ramping up.

And when I look at the cladding business, I am curious how much of the sales are booked and shipped in the quarter, what does that kind of go in backdrop?

Sorry, I do broke up there again.

I am curious how much of the cladding business is booked and shipped into quarter?

Okay. Most of what you seeing today is booked and shipped. And I believe the quarter that we just saw was almost one for one. And then these large projects take us above that level.

Could you provide guidance for 2Q or 3Q?

Yes. The guidance for 3Q?

For 3Q, yes?

Yes. For the third quarter we said revenue is going to be up 25% to 30%.

I am sorry, at the segment level?

At the segment level, we will see NobelClad in the $15 million to $16 million range and DynaEnergetics we expect in the $30 million range.

Significantly higher than 2Q and I guess for Dyna…?

Yes. We see DynaEnergetics grow in the third quarter.

And what’s particularly driving that do you think as more volume or more price?

It’s both and the prices are starting to kick in that we – the price increases that we instituted at the end of the first quarter and through the second quarter.

Got it. Thanks very much.

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

Hey, good afternoon Geoff, Kevin and Mike.

Yes. Hi Gerry.

I wanted to try and dig in a little bit on DynaEnergetics and forgive me I am going to trying to figure out how to do this and I think we spoke about it in past, obviously, DynaSelect is on roll, it’s doing great, we are starting again on DynaStage, you are up eight-fold and then you also mentioned I think DynaStage represented about 4% of I guess of stages fracked according to IHS, going forward and you have always want to talk about getting a 20% market share and obviously DynaStage is growing than your DynaSelect and you had your other sort of commoditized business that eventually it’s going to be pulled into DynaStage, how do we look at this growth on a go forward basis, I mean this DynaStage did 20,000 units, you had some production, I think bottleneck that you are increasing etcetera, just trying to figure out what the market opportunity is, maybe what the market sizes and are you sticking to that 20%, so it’s a little bit convoluted question, but I think it kind of gets the point for us is what we are trying to figure out?

Yes. First and foremost we feel that we have technology that creates value for our customers. And we want to try to capture that value in our pricing. We are focused on carving out in the marketplace a strong value added position. And our target is I should say would be 20% of the market, more for the technology driven aspect of the business around the safe and perforating and the performance of the perforation. The growth of DynaStage – excuse me DynaSelect the integrated switch detonator is a leading indicator of the opportunity for DynaStage. If somebody – if a wireline service company or end user likes the benefits and features of DynaSelect, the DynaStage is a factory assembled performance assumed perforating gun that we assemble and ship complete to the field. But the value proposition on the performances is behind DynaSelect as well as the assembly and quick assembly of these guns in the field. We are creating the market for the DynaSelect integrated switch detonator. DynaStage when we convert more of our component sales to system sales, we are somewhat cannibalizing previous sales of DynaEnergetics components, at the same time that we are expanding the market for complete systems. I don’t know if that gets to the….

Yes, I guess sort of maybe we can look at it, so it sounds like – what maybe we look at it how many units are you producing monthly or quarterly on DynaStage now as you saw 20,000 in the second quarter. And I did some channel checks and wrote them and you guys saw that, but I mean one of the comments was hey, we buy more, but we can’t get our hands on it, because demand is certainly outstripping supply. I am trying to figure out growth trajectory going forward obviously that $30 million in Q3 is going to be great, but where it can go going forward?

Yes, we estimated approximately 500,000 guns sold in the marketplace in the last quarter and we did approximately 20,000 in DynaStage. And so that’s the 4%. And so we feel that there is quite a growth opportunity for DynaStage.

Can you talk about how many you are producing today versus maybe what average was in the second quarter and where you want to take that production level?

We are producing that the second quarter – excuse me, the third quarter will be slightly greater than the second quarter. And right now, we are capacity constrained on assembly space.

Okay, got it. Okay, perfect. And then you said pricing was just kicking in, was that pricing – was that, you talked about a price increase I think on Q1. Is that the only – you don’t have done one price increase this year and it’s finally sort of gone through the system or has there been more than one?

There has been more than one. In March of Q1, we did across the board, but it varied by product line and through the second quarter, we have had a series of price increases on select products to bring the margins into what we feel are acceptable ranges.

And then on that front, I think completely in acceptable ranges or are you sort of 50% as to where you want to get it, 75%, 25% and this way we don’t – so we talk about prices per se, but how far along are sort of in that process of bringing pricing up?

We are expecting to see an improvement in our gross margin in the third and fourth quarter this year. We have made good progress this year, but we are still good 15% off of where we would like to be.

Did you say, I am sorry, 15%?

15%.

Got it. Thanks. Then jumping over to NobelClad obviously, I mean, there is little bit more granularity on the segment, tells us DynaStage – or DynaEnergetics great shaped, NobelClad obviously is going to be probably at least a rougher third quarter. And then are there any larger projects in the fourth quarter or you think this is all of them or 2018, obviously it also – it sounds like there is a lot of large projects in 2018 could be substantially better, but looking to maybe start with this year first?

Yes. Just to follow-on to Ed's question a lot of what we are seeing today is book and ship, replacement, repair kind of projects. The larger projects have a longer obviously gestation period, but they usually fall into our backlog and then they are shipped out over a 3 to 6-month period of time. And so the next month or two are critical for the booking of some of these larger projects for them to get into the 2017 revenue. And there is a strong – as each week goes by, there is a stronger likelihood that the project based business is going to fall into 2018. And we are quite optimistic with the projects that we are quoting. We believe they are going to land. They are harder to predict from a timing standpoint, because of the long gestation period that they have.

Those projects in the backlog, I mean there is certain type projects and certain sort of metal combination, but explosive welding is more pone to wind than others. Is there a way you can handicap those or some of these right in your ally, whether it’s the aluminum and titanium or terra plastic asset or whatever it is or are they a little bit more competitive versus real bond?

The projects that we are talking about particularly the large PPA project, if it goes, it’s going explosion clad, yes and NobelClad.

Got it. I think I will jump back in queue. I think that’s it from me, but thanks, guys. I really appreciate and congrats obviously DynaEnergetics is it’s there, so. Thanks.

Thanks, Gerry.

Our next question is from Jim McIlree of Chardan. Please proceed with your question.

Thank you and good afternoon.

Yes, good afternoon Jim.

Can you talk about the second shift in Texas, was that – did you have the second shift in Texas for Q2 or is that just starting now in Q3?

We had it for Q2.

Okay. So you are kind of – so how do you – what’s your next step for capacity additions, does that require a new facility or do you add on to the Texas facility or how do you increase capacity going forward?

Yes, we are currently engineering an expansion of that facility from a shaped charge capacity standpoint and also floor space for assembly it is because we are handling explosives and lot of industries you can go out and lease space nearby that our facility in Blum has DOT and ATF approval for assembling explosives. And so we are adding floor space is what we are doing at the existing location.

And when is it expected that you have additional floor space?

Well, we are moving some things around to on an interim basis to accommodate assembly and moving off of that site of things that do not require the explosive certification for the manufacturing and we are planning and the availability of new manufacturing additional manufacturing space in 2018.

So, is it fair to say that the capacity additions for the rest of this year would be relatively modest and it’s really next year that you can see a significant jump in capacity?

Significant jump, yes, would be next year. However, we feel that we can double the size of our current capacity for gun assembly from where we are today this year, this quarter.

Okay, you said you could, but does that mean that you are planning to do that?

We are planning to do that. We are doing that.

Planning to. Okay, that’s great. And can you refresh my memory about how high gross margins can get in the DynaEnergetics business and I know there is a lot of moving parts with the capacity additions and the product mix changes. And I know there is a lot of things going on, but you can maybe bracket what you think gross margins can get to for DynaEnergetics?

Our near-term target is north of 38% gross margin. And I would like to have a caveat that the way that we account for our R&D than our cost of goods sold. And so that’s net of our R&D expenditures.

And a mid-term or a long-term target?

I think we would like to see it above 40 consistently.

Okay. Yes, that’s all I have. Thanks a lot and congratulations, really impressive quarter.

Thank you.

[Operator Instructions] Our next question is from Edward Marshall of Sidoti & Company. Please proceed with your question.

A quick follow-up the DynaStage system was 4% of the market and you sort of – will you anticipate that will be in Q3?

We expect – obviously we expected the increase. But I don’t think that – we normally don’t project on a product line basis what the revenues are going to be.

Is it fair to say that it won’t necessarily be materially higher or you anticipate it’s going to be materially higher?

We would expect it be materially higher.

Okay. So, let’s say, its double where it is today I mean your capacity constraint is still like a long way to go to get 20% of the market, so what type of investment will you need to kind of capture that extra percent of market share?

Okay. It’s actually a very, it’s not equipment driven or process equipment driven. It’s just floor space and facilities for employees. And so it’s a very simple capacity to add. And we are currently working on the engineering part of the facility right now and we would expect to have that available in the first half of next year.

What the dollar value for that would cost?

In the $7 million range for next year’s investment for this facility.

And that’s [Technical Difficulty] add on additionally for that?

No.

I am sorry no it was 20% or…?

From assembly space for DynaStage that would be enough floor space for assembly. We may need other process equipment to satisfy that market. Part of this and let me back up, part of it has to do with an estimate of what the market size is next year, so it’s not just the market share growth, it’s the market size. And we can handle both the market share and the market size growth that we are anticipating with that $7 million into – investment into done into DynaStage manufacturing floor space. As the market grows further, we would expect to need certain process equipment, but that will fall in our normalized CapEx spending.

And just refresh my memory what did you expect free cash flow to be in 2017?

Yes. We haven’t guided on that yet.

Okay. But I mean I guess my point is you haven’t generated cash from the first six months of the year, do you anticipate the back half of the year to be a strong cash flow performance?

I think to be slightly stronger we are going to have our working capital pool from increasing demand in DynaEnergetics. But we expected to be slightly stronger than the first half.

Okay. So just let me just clear, you are kind of you are constrained by the EBITDA growth in the business I think you have to kind of think about your covenants kind of how that flows through, etcetera to kind of think about [Technical Difficulty] is that a fair thought process?

I am not necessarily concerned with covenants at this point in time the way we serve forecast playing out in our EBITDA, if you look at our guidance.

Right. So EBITDA is going to recover first for you just spend money I guess that was…

As it should.

Yes, correct.

Okay. Thanks guys.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Kevin Longe for closing remarks.