DMC Global Inc. (BOOM) Q3 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the DMC Global 2017 Third Quarter Earnings 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 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 Jeff and hello everyone. Third quarter sales were $52.2 million, which was 11% sequential increase versus the second quarter and a 43% improvement over last year's third quarter. The results exceeded our forecast and reflect better than expected sales at DynaEnergetics, our oilfield products business which set a new single quarter record for sales, operating income and adjusted EBITDA. Despite a slowdown in the growth of the US onshore rig count, the unconventional well completion sector remained very active during the quarter reflecting increased completion intensity and longer lateral. This fueled strong demand for DynaEnergetics intrinsically safe perforating products, which include a DynaSelect detonator and the factory-assembled, performance assured DynaStage system. Approximately 65% of DynaEnergetics third quarter sales were generated by these highly differentiated product line. DynaEnergetics reported third quarter sales of $35.3 million, which was a 32% sequential improvement versus the second quarter and 80% increase versus last year’s third quarter. The results exceeded DynaEnergetics prior quarterly sales record by approximately 20%. At NobleClad, our explosion welding business, third quarter sales were $16.8 million which was a 17% decline from the second quarter and flat versus last year's third quarter. NobleClad’s financial results during 2017 reflects a lengthy down cycle in global industrial infrastructure spending. This situation has curtailed NobleClad large project bookings and led to a recent decline in smaller repair and maintenance orders from the downstream energy industry. Following an analysis of conditions in NobleClad’s end markets and the corresponding decline in the financial performance, w recorded a non-cash $17.6 million impairment charge related to NobleClad’s goodwill balance. The discussion of the impairment charge is available in our third quarter Form 10-Q which was filed earlier today. In a moment I will discuss recent developments that indicate NobleClad financial performance should begin to improve during 2018. Third quarter consolidated gross margin improved to 33% from 30% in the second quarter and 23% in the third quarter year ago. The increase was driven by higher average selling prices and a more favorable product mix. At the business level, DynaEnergetics supported gross margin of 39% and NobleClad reported gross margin of 21%. Excluding non-cash impairment charge, our consolidated third quarter operating income increased to $5.1 million versus adjusted operating loss of $2.1 million in last year's third quarter. DynaEnergetics operating income was $6.9 million and NobleClad reported adjusted operating income of $554,000. Third quarter adjusted net income was $3.2 million or $0.22 per diluted share versus an adjusted net loss of $2.8 million or $0.19 per diluted share in the comparable year ago quarter. Third quarter adjusted EBITDA was $8.6 million, up sequentially from $6 million in the second quarter and $1.2 million in last year’s third quarter. DynaEnergetics reported EBITDA of $8.6 million, while adjusted EBITDA at NobleClad was $1.5 million. DynaEnergetics advanced perforating technology continues to drive material improvements in the performance of its customers well completion program. During the third quarter, a DynaEnergetics customer operating in the DJ Basin deployed approximately 8,500 DynaStage systems consecutively without a perforating miss-run. The customer also reported that the factory assembled DynaStage system enabled the company to improve efficiency and complete nearly 50% more stages per day then when using conventional field assembled guns. Customers using the DynaStage system achieve a level of reliability and efficiency that is not possible when using a mixed bag of components assembled in the field. This operational efficiency is driving a continued expansion of DynaEnergetics customer base. To address accelerating demand DynaEnergetics is expanding its production capacity. The business announced during the third quarter will construct 40,000 square foot manufacturing and assembly center in Blum, Texas, which will be operational by next year's third quarter. The business has ordered a second automated DynaSelect assembly line for its facility in Germany and is more than doubling its shaped charge production capacity in Blum. DynaEnergetics also is reopening it’s DynaStage assembly facility in Mt. Braddock, Pennsylvania which will improve access to customers in the Marcellus and Utica Shale region. A planned second base of the Blum expansion is scheduled for 2019 and will include 30,000 square foot hardware manufacturing facility. DynaEnergetics is budgeting approximately $25 million over the next three years for the capacity expansion which will be funded from operating cash flow. As I mentioned earlier, we're expecting NobleClad’s financial performance to improve beginning in 2018. The business has been pursuing several large projects during the past several quarters and some of those opportunities have recently materialized it’s orders. In addition to the $4 million petrochemical order announced early in the third quarter, NobleClad has secured a $1.7 million order for five plays that will be used to fabricate mining related metal processing equipment. This order represents a new applications for the businesses explosion welded plates and illustrate the positive impact on NobleClad’s market development initiative. After the close of the third quarter, NobleClad received a $7.4 million purchase order related to a petrochemical project in Asia. The order will be reflected in NobleClad’s fourth quarter backlog and is the largest project booked by the business in more than four years. Each of these projects is expected to ship during 2018 and we are optimistic they are the first of several additional large orders that will be booked for delivery next year. While the recovery in DynaEnergetics and NobleClad’s end markets has been uneven, I'm very encouraged by the fundamental strength of both businesses and the leadership positions they have established in their industry. I’m also extremely pleased with the performance and commitment of everyone across DMC Global network of manufacturing and sales facilities. With that I’ll turn the call over to Mike for some additional comments on our third quarter financial results. Mike?

Thanks Kevin, and good afternoon everyone. Starting with our third quarter expenses, SG&A was $11 million or 21% of sales versus $9.5 million or 26% of sales in the third quarter last year. The increase was principally due to higher salaries and wages as well as increased outside legal expense associated with ongoing patent infringement litigation. Third quarter amortization expense was $1 million or 2% of sales. Looking at our balance sheet, we ended the third quarter with cash and cash equivalents of $8.9 million. Net debt at September 30 was $13.1 million, up from $9.3 million at the end of fiscal 2016 and down from $15.3 million at the end of the second quarter. During the third quarter, we generated $3.7 million in cash from operating activities. Turning to guidance, we expect fourth quarter sales will increase approximately 30% versus the $40.2 million we reported in last year's fourth quarter. Gross margin is expected to be approximately 30%, up from 25% in the year ago fourth quarter and down from 33% in the third quarter. The anticipated sequential decreases principally related to lower sales volumes on fixed overhead at NobleClad and regional sales shifts at DynaEnergetics. SG&A is expected in a range of $12 million to $12.5 million versus the $10.9 million reported in last year's fourth quarter. The anticipated increase relates to higher legal costs associated with ongoing pattern litigation at DynaEnergetics and increased investments in growth resources at both DynaEnergetics and NobleClad. Amortization expense should be approximately $1 million. Fourth quarter adjusted EBITDA is expected to be approximately $6 million, up from $1.5 million in last year's fourth quarter. And now we are ready to take any questions. Operator?

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

I wanted to talk about, I guess when I look at the numbers here and I kind of do the math, it doesn't seem to add up. It looks like you're looking at 2.5 million, 2.8 million in the operating income for fourth quarter, but you’re saying 6 million in EBITDA. So I’m just trying to back into those numbers, just trying to get a sense as to what you're expecting for the fourth quarter.

So I think you're pretty close at on the operating income and so for the fourth quarter if you take into account D&A and non-cash stock compensation and just our normal run rate should get you to about that 6 million range bridging operating income to adjust EBITDA.

Got you, so you’re including stock-based comp too, how much you run a quarter just remind me.

It’s in the 700,000 range, 700,000 to 800,000.

When I think about the guidance on the gross margin 30% seems low after 3Q result. Can you talk to me about is the mix in the individual businesses, maybe you can also talk about the top line of both Dyna and Noble in the expectation there on the individual basis.

In terms of starting with topline, I mean we expect to be flattish with Q3 and that's about 36, 37-ish million on our Dyna business in sales, roughly 15 or slightly above that 15 to 16 million in our NobleClad business. As far as margins as you see, NobleClad, this will be the - fourth quarter will be the softest quarter for NobleClad to get the impact of overhead absorption there, their margins are going to be significantly softer in the fourth quarter. Dyna is going to be slightly - DynaEnergetics is going to be just slightly below third quarter just due to product mix. But the key driver there is NobleClad.

So NobleClad soft sales and I guess you’re seeing a little bit of mix in DynaEnergetics.

And on DynaEnergetics, some of it earlier in the year contracts were fulfilling at, we've raised prices there. So it's a little bit of a flywheel effect.

And I guess looking at maybe the longer term outlook here and you have a lot of demand, lots of investments as well and that's going to be puts and takes to kind of the output on the bottom line. You kind of narrowed down potential ranges for us as to what your think this business can earn over a period of time because there seems to be a lot going on in each individual business. And I just want to get your sense as to what that might look like.

Hi, this is Kevin. I believe that the margins that you're seeing in the third and fourth quarter are sustainable margins for that business. And we will continue to grow with the market as the market recovers. So that's basically driven by the speed of the market recovery. And we expect it to continue at a reasonably good pace into ’18 and ‘19. And the investments that we're making are longer term investments in facilities and equipment that we expect to get a decent return on invested capital from and to enable that capacity growth. And they will be funded out of operative cash flow with discipline that we're putting on both of our two businesses.

With the growth in Blum, rather than expansion in Blum, the expansion in Germany and I guess the discussion around Mt. Braddock. This is all wound up, what does capacity look like then versus where it is today?

The capacity that we're adding in Germany is the addition of the second automated detonator line for DynaSelect products as well as some other products. It's a highly automated production line that is necessary at the volumes that we're operating at from a technology standpoint. However that's also the smaller part of the investment, the largest part of the investment is happening in Blum, which is a new building and that's mostly floor space. But we should see more than a doubling of our capacity from our current operating rates for both assembly of guns and gun systems as well as out initiating systems on the DynaSelect side of things.

So that's that discussion we've already had announced, so just to be clear, is that capacity will have bottlenecks and other supplies going into that that can be freed up over time. And so without major investments such as a detonating line in Germany, you can actually see an expansion of what capacity the bigger chunk of the capacity that you're putting into Blum in the…

The detonating line will not be a bottleneck and we're also taking advantage of our global footprint particularly as it relates to shaped charges and in making those available in North America from our other locations. We will operate on a longer term basis within our depreciation and amortization for both businesses. And so we're fairly comfortable with the rate at which we're spending. And the capacity won't be a limiting factor in ’18, it will be both demand and demand relative to the price expectations that we have for our technology.

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

So I think what some of us were trying to get at is, great quarter, I'm sure you probably want to get away from some specifics because I imagine you're shaking up some of your competitors and taking market share et cetera. But I've always looked at this sort of, how big the market is and how fast its growing and what percentage of the market you want. And it seems like that number is getting bigger and changing all the time. Is there any way you can maybe frame out what you think the market was a couple of quarters ago versus today, what it could be next year. And just to get a sense of how big it is.

It's evolving if you will, the North American onshore has been growing much faster than any part of the market, the geographical markets over the last several quarters. However it is still down from - the global market is still down from its peak in 2014, with the growth in the North American market probably returning to similar level as ‘14. We expect the growth to continue into ’18 and ’19 however at a slower increase over what we've seen ’17 versus ‘16. The international we hope to start picking up on a longer term basis. Net-net, the market is somewhere up 40% to 50% year-to-date over the prior year and we're recognizing that growth in our revenues as well as some pickup in share on our initiating systems.

Are you guys sold out in the third quarter, meaning, I mean there's different components, right, so there's the five components and then you have DynaSelect and DynaStage. And obviously it sounds like DynaStage was sold out, but what about other areas.

We're close to capacity on our - the majority of our DynaEnergetics business.

And then, sorry, go ahead.

Yeah, which is quite frankly a pricing opportunity and we're changing the mix more to systems versus components. And so our overall objective is to maintain the more technical and higher margin part of the market with part. And so we're interested in working with customers who understand the value of our systems and how that can improve their bottom line.

So right now sold out - you’re approaching capacity, there's a pricing opportunity. You talked about upwards of sometimes 50% more wells frac and of traditional equipment. How much - and a loaded question I know, but how much pricing opportunity do you have. I mean, you listen to [indiscernible] they're all saying people are going to pay out for product and services that increase efficiencies. Do you know how much opportunity there is.

Yeah, well I think that they’ll pay for increased efficiencies that's got to show up in their bottom line and they're willing to pay for that equipment, which is what we're seeing with the demand for our initiating systems. We are a product company versus a service company and we take a more of a longer term view on our product pricing. And so, the pricing that we put in place is more consistent from week to week, month to month, quarter to quarter. It's really dependent upon the product type and the customer mix. And so we'll see more stability there and margins that -- we were pleased with the margins that we saw from DynaEnergetics in the third quarter and that really represents our longer term average for DynaEnergetics.

And then, international, there's definitely some more talk about international bottoming last quarter, this quarter and starting to see some acceleration, potentially starting to see some acceleration. How much of an impact could international have on the business? I mean, certainly, the intensity isn't quite the same as, completion intensity isn't quite the same, but certainly, I guess the shaped charges that may not get as much press as DynaSelect and DynaStage, you have had some good additions in that category as well?

Yeah. I think our land based on conventional or DynaSelect, DynaStage systems are primarily benefiting from the unconventional business in North America. Internationally, we're seeing more traditional kind of perforating systems, but we're gaining penetration with our higher performing shaped charges and so we're seeing the market value of the higher performing shaped charges more than the initiating systems that we see in North America. And we expect that market to be north of 25% of DynaEnergetics business on a long term basis.

I know I made a lot of questions. Switching gears a little bit, NobelClad, you'd certainly highlighted new business and I think the mining and segment and I know for the last couple of years, you’ve sort of been trying to broaden out the addressable market. How large of a sort of adjacent market is that mining business and I think you've -- there's other areas you're trying to expand in and maybe just trying to gauge how much it adds to the addressable market on NobelClad, maybe some of these initiatives you’re working on.

Yeah. I think the story with NobelClad is that when we united the cladding businesses under the single brand name, NobelClad three, four years ago, at the same time, we put in place a global application engineering group that is working on a number of end use applications from, whether it's metal refining and semiconductor type applications to cladded pipe and different components within piping systems. And we’re just beginning to see the benefits of the investments in the application engineering and that business and marketplace. Last year, we received a large order in Asia for a semiconductor application. This year, as you mentioned in this quarter, we got this autoclave for a metal processing application. We're starting to see more and more quotes being made, but I can't necessarily put a number yet to the size of the market that that's going to create because these are all developing applications and –

But certainly additive to the addressable market.

Additive to the addressable market. Partially offsetting a decline in metal prices from several years ago and also, downstream oil and gas market over the last couple of years.

And then sorry, final, final, I got to -- not to jump around, I want to jump back to DynaEnergetics, targeted 20% market share before, I got to imagine that you can expand that target.

Yeah. I mean, we were operating with a very small market share and historically, it's been growing quite nicely. That targeting of 20% that, it's as much a message to our sales team as it is to our investors and that we are not out after trying to corner the market and perforating systems. We want to get at a healthy share of the market, get it based on technology, not on price and create a good return for our shareholders. And so, it's a message to ourselves that we're focused on the premium part of the business where we can support it from a technology standpoint. We're seeking our market share in initiating systems drift up and that's pulling along some of the other products. But, we're not going to go after market share with price and we’ll right it up with our technology as the demand for that technology exists.

Sure. My sense is the tone of the market is also changing. A little bit more focus on returns, cash flow, et cetera and working within those and that's as opposed to maybe the last cycle, which tends me to believe that value added services are potentially could be a larger portion of the market to just go around.

They have to be. If you're not creating value for your customers, you're not going to win at this game if you will and the benefit of DynaSelect and DynaStage and the perforating charges that DynaEnergetics has developed is that they all create value for our customers greater than the price that we're charging for the products. And so as long as that case exists, the demand is going to be strong and with healthy margin expectations on our, so that we can keep investing in technology, it should be a good situation for DynaEnergetics over the next several quarters.

[Operator Instructions] Our next question is from Edward Marshall, Sidoti & Company.

Kevin, I was just wondering that 65% of the intrinsically safe products that you shipped in the quarter, how much of that was detonator, how much of that was systems?

The systems -- we're not breaking out going forward, Ed, the individual products sales. But the system sales were consistent with what we gave guidance for at the end of the second quarter and if that helps.

Yes. It does. How do you – you’ve created great products. The opportunity in the market is the right time. There are consumables. How do you lock in the market share you're gaining, so that some of the competitors that probably have better capital situations, maybe more money to spend on R&D, how do you go about sending the share, so this is a short-term cash flow shot in the arm if you will.

That's a good question to ask. And we actually feel very comfortable with our ability to compete in the marketplace against any size competitor. With our – from an R&D standpoint. We have very well defined technology, product and market development road maps that go out three to five years from today that there's a pipeline of technology and products that exists. This is not a one trick pony. We're 6, 7, 8 generations down on our DynaSelect technology, we’re 3, 4 generations down in the road on our DynaStage system design, even though, it's just getting started in the marketplace and we've got a number of products, coming behind these products. And the interesting thing about ingenuity is it's less about scale and more about efficiency and thought processes. And, we do not feel disadvantaged at all against any of our larger competitors.

And then I did want to ask a question because I haven't yet really on NobelClad and I wanted to, looking at what our competitor -- one of your competitors -- customers had said yesterday about pricing specifically and I guess downstream energy and saying it's not rational. And, far more comments about other parts of the market and also talked about their desire to seek out which looks like you have alternative markets. Do you see the same kind of not rational market, not rational pricing in say refinery, et cetera versus what you're seeing in maybe petrochemical and I guess now mining and pharmaceutical, et cetera.

I think the key for pricing is we need, we want our customers to be profitable and what our customers are profitable and their business is strong, they're updating and maintaining their facilities and they're improving their production lines and their capacity. And so the key to margins for us is to make sure that our end markets are strong. And, we all know how the downstream oil and gas market has been the last couple of years and that's curtailed some of our, both volume opportunities. To a lesser extent, pricing opportunities on NobelClad. We've actually maintained a healthy contribution margin for what we're selling, our gross margin has come down because of absorption. We maintain a fairly healthy pricing for the technology. But there's just less spending when our customers are not making as much money as they once did. So, oil and gas, we're optimistic that that's going to be a stronger market going forward, because this business is a long cycle. We expect to see the business start picking up in ’18 and ‘19 and continue. And then the other markets themselves have their own cycles to them and right now, the metal processing is starting to improve, semiconductor has been strong. The chemical market is really GDP driven and we're seeing hopefully a decent market there over the next couple of years.

Next question is from Jim Brilliant, Century Management.

Kevin, in the past, you guys have talked about the number of new clients for DynaEnergetics, did you mention that earlier today, I didn't -- if you did, I didn't?

No, we didn’t. And I think we typically mentioned those according to either DynaSelect or DynaStage and right now, we've got 15, 16 leading service companies that are using the DynaStage system with more looking at it and hoping to come online.

So within -- as you've got the service companies and E&P guys adopting it, early on, you kind of marketed as because of the safety inherent, safety benefits, but equal to that and not to discount safety, because obviously it's important, but the productivity enhancement that your customers are getting as you, I think, you highlighted with the example earlier today, how would you kind of characterize the, maybe the change in adoption or the adoption rate based on the productivity. And I mean the characterization of your E&P guys, in other words, you highlighted in one your presentations one of the -- probably the most, one of the E&P guys with one of the most successful reputations for driving productivity throughout their organization and is that catching on more so than the safety, are they grasping the productivity gains that they're getting? Or is it one-off by customer?

Well, it's interesting. I mean the heart of the initiating system is save and selective and how it operates. However, what's really driving the quick adoption of it is the -- it's what you're mentioning, it's eliminating misruns, the higher operating efficiency down the well. The assurance that you get in terms of the performance of the product itself and how fast and easy it goes down the well and can keep up with the pace that they're running these laterals out today. And coupled with that is because it's factory assembled, we eliminate the supply chain challenges for our customers as well as we reduced the crews that they need in the field in order to assemble products and so it really is hitting on many levels. Certain customers focus on different aspects of it, but when you take it all together, you get all the benefits in the system, regardless of what you choose to focus on.

What I'm getting at is within the different basins, take the Bakken and the Eagle Ford, estimates are that we've already drilled 80% of the tier 1 acreage there and as you go to tier 2, tier 3, it just costs you more and they're just naturally not as productive, so I'm wondering if you're getting more activity with those types of well characteristics that were acreage where it's tier 1, tier 2 in the Bakken and the Eagle Ford, because they're having a difficulty keeping production levels up at, for the same dollar invested in other words. Do you know where, in other words, are you getting an increased penetration in the tier 2, tier 3 acreage or is it across the basin and it doesn't matter for you.

It's across the basins, because the operating efficiency you get applies to each of the different basins.

Yeah. I imagine – yeah, it certainly applies to it, but I would think as they -- especially those in the Eagle Ford and Bakken struggle to get economic returns at the current oil price. Anything that [indiscernible] productivity is going to be a premium.

And the time savings, the operating efficiencies, the reduced crews, it just increases the application of the system across the board.

Okay. Do you have any data to determine whether you’re, what acreage, tier 1, tier 2, 3 characteristics you sell into.

Yeah. We know where they're deployed obviously. I don't have that information in front of me, but I can – we’ll prepare that for our next call.

Okay. And then on the NobelClad side, how much of the increase in SG&A in the fourth quarter is just year-end seasonality stuff and how much of it is other issues?

Mike, I think you may have the information, but there's a pickup in the SG&A in the fourth quarter related to legal expenses for DynaEnergetics primarily.

Okay. And how much is that?

The increase there, so our run rate has been around 11 million. We're forecasting 12 million to 12.5 million, so about 1 million in spend stand there. And then there is some seasonality, some other spending, but the primary driver is the legal expense.

And when do you guys get through all this legal stuff?

We’re working through them all. Go ahead, Kevin.

As soon as our competitor becomes rational.

Well, that can be a long time? I mean, I'm just joking. You had success in the courts already with this particular competitor, correct?

Correct. And the unfortunate thing is when -- it's easy to be sued. And when you are, you have to defend yourselves and we're defending ourselves vigorously because we're competent in our technology and our position and so we didn't choose the fight, but we’ll fight it to the end.

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.

Thank you, everybody. We appreciate your interest -- continued interest in the company and we look forward to talking with you at the end of Q4. With that, have a good evening. Thank you

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