DMC Global Inc. (BOOM) Q1 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the DMC Global 2018 First Quarter Earnings 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.

Hello, and welcome to DMC's first quarter conference call. Presenting today are President and CEO, Kevin Longe; and CFO, 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 we made available approximately 2 hours after the call. Details for listening to the replay are available in today's news release. And with that, I'll now turn the call over to Kevin Longe. Kevin, please go ahead.

Thanks, Geoff and hello, everyone. The new capacity investments we detailed during our last call coupled with strong execution by our operating teams led the first quarter financial results that exceeded our forecast. Consolidated first quarter sales were $67.3 million, a 24% sequential improvement over the fourth quarter and a 73% increase versus last year's first quarter. DynaEnergetics, our oilfield products business delivered record sales of $49.1 million and an improvement of 32% sequentially and 123% increase versus last year's first quarter. Improved pricing, strong customer demand and accelerated production were key drivers in DynaEnergetics better than expected result. The intrinsically safe DynaSelect detonator and the factory-assembled performance assured DynaStage system continued to generate very strong demand from both operators and service companies working in the onshore unconventional oil and gas industry. Sales at our NobelClad’s explosion welding business were $18.2 million, an increase of 5% sequentially, and 7% versus the 2017 first quarter. The business ended the first quarter with a trailing 12-month book-to-bill ratio of 1.04, in an order backlog of $35.6 million. Backlog declined approximately $2 million from the end of 2017. Consolidated gross margin was 34%, up from 33% in the fourth quarter and 27% in last year's first quarter. Improved pricing in a favorable product mix at it DynaEnergetics were the primary drivers of the increase. At the business level, DynaEnergetics reported gross margin of 40%, while NobelClad’s gross margin was 18%. Consolidated operating income was $5.3 million versus an operating loss of $2.3 million in last year's first quarter. Excluding $3.1 million in accrued anti-dumping penalties, at DynaEnergetics and $144,000 in restructuring expenses in NobelClad, the first quarter adjusted operating income of $8.6 million. DynaEnergetics reported adjusted operating income of $11.8 million, while NobelClad reported adjusted operating income of $132,000. Consolidated net income was $3.9 million, or $0.26 per diluted share, versus a net loss of $3 million, or $0.21 per diluted share, in the year-ago first quarter. Adjusted net income was $7.2 million, or $0.49 per diluted share. First quarter adjusted EBITDA was $11.6 million, up from $7.7 million in the fourth quarter and $930,000 in last year’s first quarter. At the business level, DynaEnergetics reported first quarter adjusted EBITDA of $13.4 million, while adjusted EBITDA of NobelClad was $948,000. DynaEnergetics global capacity expansion program are progressing on schedule and the 74,000 square foot manufacturing and assembly facility in Blum, Texas should be operational by the end of July. In the meantime, DynaEnergetics has effectively addressed a key bottleneck in its raw material supply chain, which has enabled the faster ramp up DynaStage production volumes than originally anticipated. Our NobelClad business also is making important progress on a number of operational and end market initiatives and we are confident the business is on a path toward sustainable growth. I'm very encouraged by our start to 2018 and by our prospects for healthy long-term financial growth. Our achievements would not be possible without the extraordinary efforts of our global workforce. I want to thank all of the DMC employees for their continued commitment to our success. With that, I'll turn the call over to Mike for some additional comments on our first quarter financial results and an update to our financial forecast. Mike?

Thanks, Kevin and good afternoon, everyone. Starting with our first quarter expenses, SG&A was $13.4 million or 20% of sales versus $11.7 million or 30% of sales in the first quarter last year. The increase resulted primarily from higher salaries and wages. First quarter amortization expense was $805,000 or 1% of sales. As Kevin mentioned, DynaEnergetics recorded a $3.1 million accrual related potential penalties on a previously reported anti-dumping and countervailing duties case brought in 2015. DynaEnergetics has initiated discussions with the U.S. Customs Department regarding the potential scope of penalties and intends to present arguments for relief and mitigation. Details of the case are available in today's 10-Q. Looking at our balance sheet, we ended the first quarter with cash and cash equivalents of $10.8 million. Net debt was $18.6 million, up from $9 million at the December 31. The increase primarily relates to increase working capital requirements associated with operational growth at DynaEnergetics as well as construction of DynaEnergetics new facilities in Blum, Texas. During the quarter, we use $3 million cash from operating activities. Turning to guidance, we anticipate second quarter sales will be in a range of $74 million to $76 million, versus the $47.2 million, we reported in last year's second quarter. DynaEnergetics sales should be in range of $54 million to $56 million, while NobleClad sales are expected to be approximately $20 million. We expect consolidated gross margin of between 33% and 34%, versus the 30% in last year's second quarter. SG&A should be in range of $14.5 million to $15 million, up from the $10.6 million in the 2017 second quarter. The increase relates to increase investments in headcount, higher salaries and wages, sales commissions and higher expected litigation expense of DynaEnergetics. Amortization expense is expected to be approximately $800,000, versus $1 million in the second quarter last year, while interest expense should be approximately $500,000. We expect second quarter adjusted EBITDA in a range of $12 million to $13 million, up from $6 million in last year’s second quarter. With respect to the full fiscal year, we are raising our sales forecast to a range of $290 million to $305 million, versus a prior forecast of $255 million to $270 million. The increase reflects growing confidence at DynaEnergetics that it’s capacity-expansion efforts and improvements in its supply chain will enable the business to more rapidly address customer demand. We expect DynaEnergetics’ sales to be in a range of $215 million to $225 million, versus our prior forecast of $180 million to $190 million. The forecast for NobelClad’s sales are unchanged at $75 million to $80 million. We anticipate full year gross margin in a range of 33% to 34%, versus our prior forecast of 31% to 32%. SG&A for 2018 is now expected to be approximately $55 million, up from our prior forecast of $50 million to $52 million. The adjustments reflects an increase in expected litigation expense at DynaEnergetics, which is scheduled to commence the patent infringement trial in October. Amortization expense is expected to be approximately $3 million and full year interest expense is expected in a range of $2 million to $2.25 million. Anticipated capital expenditures are unchanged at $30 million, $25 million of which relates to the capacity expansion at DynaEnergetics. The Company’s effective tax rate for 2018 is expected in a range of 28% to 30%. We anticipate full year earnings per diluted share in a range of $1.60 to $1.70. Excluding restructuring and accrued anti-dumping penalties, adjusted net income per share is expected in a range of $1.80 to $2.05. We now anticipate adjusted EBITDA in a range of $52 million to $56 million, up from a prior range of $39 million to $43 million. And with that, we're ready to take any questions. Operator?

At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question is with Gerry Sweeney with Roth Capital. Please proceed with your question.

Good afternoon, Kevin, Mike and Geoff. Congratulations on a great quarter. So obviously, great quarter, very positive guidance on the rest of the year. My question revolves around, where are we, in terms of – maybe within a demand type or how far could demand grow. I understand more investments are coming towards North America. There are some labor constraints that the DynaStage addresses. There's perforating cluster is getting I think – more intense, I think is on the 5% to 6% that maybe 15% in certain areas. So there's a lot of dynamics around that the end market, but maybe you could provide a little bit of your thoughts and view on how much to demand is out there where are we in a cycle potential where it could this go?

Well, if you look at total North American frac stages in the forecast and we use the IHS data. 2017 increase 65% over 2016. And the rate of increase is anticipated to slow down going forward, but it's still quite healthy averaging anywhere from 15% to 29% per year over the next three years. And so we feel that the current pickup in demand has some legs to it and we will continue for the foreseeable future.

Okay. That's helpful. Also what was the bottleneck in terms of the raw material? You didn’t mention it in particular or but is it a permanent fix any concern that bottleneck could arrive in the future. Maybe little bit on that one?

Well. There was such a dramatic increase in the second half of 2017 over first half as well as the prior year, that a lot of our outsourced materials were in short supply in terms of suppliers ramping as well as. As we mentioned, we're bringing on capacity with their investments that go primarily to our automated that line in Germany to our gun assembly and component manufacturers in Texas. So it's really across the board looking back and we took an aggressive stance last August, early September to try to get it out in front of capacity when we saw the pickup in market activity. And we began making investments last year that are starting to layer in this year as the year unfolds.

Got it. And then this maybe a little bit more for Mike. But obviously, it where for you Kevin as well actually, but the legal costs associated with – I think some of the packet is with one of your competitors. I thinking about when did the fourth quarter call? We estimated charge that the costs associated would be about $4 million for the rest of the share. It's appears to be taking another step up or it’s maybe $6 million, $7 million, $8 million. Is anything materially changing on that front or they becoming more aggressive? Or is it just the timing of the actual court dates slight closer into 2018 as opposed to next year?

It's the timing of the court dates and I believe what we're seeing is just the consistent stance from our competitor. And as you know, we're defending ourselves today with them, done it successfully and we intend on supporting that effort going forward. The legal expenses are significant. I don't want to underestimate that there in the $7 million to $8 million range for the year. And but when you're protecting your IP, it’s just one of those things that comes with being a technology driven company.

Okay. How many cases are or positions of the company your competitor have to go against you after this next court case? I mean, obviously, you had a great quarter, great guidance et cetera, but it lay on some of this – even with some of those expenses in place, you could be significantly better position going forward.

First of all these primarily relate to shaped charges, it doesn't relate to the book of our revenues, which are in our initiating systems and perforating systems. We have two more cases that will be tried by the end of this year, which were optimistic on.

Got it. And then final question revolves around guidance. Guidance were looks like, you took a big step up in the revenue this quarter than I think – I’d think about $75 million for the second quarter but guidance sort of implies – sort of a – maybe a steady state run in terms of revenue second, third, fourth quarter maybe with a little bit uptick. Is that the way to read it or – and how potential for our expansion the second half just this one to see how guidance with – I guess the belt that’s what…

Well. It's both demand pricing and capacity driven. It's important for us that we get the value for our technology. And our technology creates even greater value for our customers’ that's important for us. And so we're pursuing a market segment that values that technology and the first half is of this year is really capacity driven. The second half will start seeing more capacity layer in. However a lot of it depends on how the market evolves from that point on. And why we are very optimistic about the quarter-to-quarter in the year-to-year for the next three years. It's a very short cycle business and so we're confident with what we've forecasted in terms of our guidance for the year, but it is going to be fairly constant in the second half of the year.

Got it, great. I really appreciate it. Congrats again. I was great quarter for you. And I’ll jump back. Thank you.

Our next question is with Edward Marshall with Sidoti & Company. Please proceed with your question.

Hey guys, good afternoon.

Good afternoon, Ed.

So I wanted to touch on that last topic, you talked about capacity constraint versus capacity driven in the second half and another kind of look at that $12 million delta is sequentially, I know that you added some capacity in walking Q1. One of it to kind of get a sense from you, all that $12 million delta, how much was price and how much might have been volume in? And the specifically taking to DynaEnergetics?

Yes, exactly. So that delta is volume.

Well, volume.

Yes, primarily.

And Ed, I’ll add to that we’ve been aggressively increasing our prices which is layering in already in the first half of this year. And to restore our margins to where we believe that they should be and in the second half of the year is more volume related.

Okay, I confuse. So fourth quarter and first quarter than $12 million we driven by volume that increase but you're getting better pricing in the first half and less pricing – your losses?

What I'm saying on the delta is really our first half of 2018 versus second half. When you look at the fourth quarter delta of $12 million to the first quarter that’s a significant portion of that is price and price increases that we've put into the marketplace in 2018 being that we're adding your capacity which we were able to squeeze out a bit more in the first quarter more than we thought it. But that is primarily pricing, 2018 second half is primarily volume.

Got it. So I guess that the second part of my question. So when capacity come online and you’re not running all out that you are right now. What do you think happens to the pricing element of that equation they mean, is there going to be some with us – some progression and then ultimately what happens to the gross margin on that?

There will not be compression. We are very much focused on pricing the value and we're charging for that value today we're not pursuing the market on price. And so the customers who value the products that we offer – in the first half we’re going to be ours in the second half hopefully. But we're not out to try to built our capacity at any cost.

Got it. And then on the materials are you seeing any inflation across your materials?

Yes. I couldn’t, as I said here today tell you which materials and what – and the percentage, but we are seeing some inflation and some of the increases is definitely to cover cost increases as well as restore margins.

Got it. And is that across both businesses in NobleClad as well as DynaEnergetics and it had to find…

It is. I mean, I'm proud of the NobleClad is – as you know, it had a very difficult market for some time. They have been very, very good in fact strong at maintaining their contribution margin is really application driven and we've maintained our contribution margin over the decline in their market activity. And they are having also some material cost increases which are reflected in price increases. Their pricing is administered in a different way where DynaEnergetics has a standard product line and will put a price increase for certain products and usually goes across the board. NobleClad is a project driven business, and we target a contribution margin and then we're pricing real time in every project and so it's baked into the pricing on the projects of which we are working on.

So you’re saying, it’s just a pass through?

It’s a pass through.

If I look at backlog and how much of your backlog it was $35 million or so, is driven by price inflation materials that might be take into the projects?

Very little – if any to this point, we'll probably see more of that going forward.

And then while we're on NobelClad, I'm curious if you kind of talk about, I saw sequential decline yet still pretty much over the year-over-year pretty good growth in the backlog. I'm curious, if you kind of talk about maybe what’s going in that market generally should provide some more color about customer enquiries are related to your book et cetera that’s been kind of stall or it’s been picking up, as it’s slowdown anything…

I actually struck a sentence in our earnings release, that said that we're very optimistic with the increase in quoting activity. That is taking place. I feel that we've said that for such a long time we're kind of in the show me period and we feel as strong about that business as we ever have, but we need to demonstrate that to you and to our shareholders.

I appreciate your comments. Thanks very much.

[Operator Instructions] Our next question is with Jim McIlree with Chardan Capital. Please proceed with your question.

Yes, thank you and good afternoon. I'd like to understand a little bit about your gross margin expectations and DynaEnergetics. It seems like just working through the math that you're kind of assuming the gross margins are flat from this 40% level for the rest of the year. Is my math correct or my assumptions correct?

Yes, yes.

Okay. And so Kevin when you talked about getting margins back to where they should be this is kind of where they should be in your view is that right?

They should be, I'd actually like to see them higher than that. One of the kind of the anomalies of our financial statements, as we include in our cost of goods sold research and development. And so why the gross margin is relatively constant for the balance of this year for NobelClad, we have to step up a significant step up in research and development spending, that is coming out of our – that's included in our cost of goods sold in reducing that gross margin. And those are really investments for future revenues and so as that is more normalized ideally we'd like to see the gross margin in the 42% to 44% range for that business. But this year we’ve got – we're focusing on 40%.

Can you size or range the amount of R&D as a percent of DynaEnergetics sales?

3% to 4%. That would be included in the cost of goods sold. There's also an intellectual property investment that is carried in SG&A and there are some of those – there are some employees included in SG&A, but it would be in the 3% to 4% range. And that's been – that's a lower percentage than what we've been running because of the pickup in revenues.

Right, Okay. You had – it looks like a fairly significant working capital investment this quarter. And the question is what your expectation is on the current guidance, what you think your working capital needs are for the rest of the year?

Mike you want to steal that?

Yes. So you can see that we had a $9.7 million unfavorable change in working capital and previous guidance after year end. We said that we've probably cap out around $40 million are top out $40 billion in debt we’ve accelerated in terms of our growth a little bit more faster then what we thought. So maybe we could take above that a little bit, but no substantial change there and I didn't feel the need to, to change guidance on where our debt working capital requirements would be.

Okay, great. And then on the restructuring and the anti-dumping. I know it's very difficult to predict what those might be for the rest of the year for next year, but can you just take a wide stand at it?

On the – I mean start of the restructuring. I think we've – we're expecting about $1.5 million total for the year and restructuring and that will be to finalize closure of manufacturing in our French operations to NobelClad. And then we did it through what we feel like for the reserved for anti-dumping penalties of $3.1 million in the first quarter with Mike to note that we feel that we've got good arguments against the anti-dumping penalties and we're at a negotiation phase with the customs group and so we'll see where that goes, that we've got or hopeful that we can farewell there and not incur any additional accruals.

So the current balance sheet amounts for the anti-dumping is about $6.7 million and so that's what you – that's your best guess of your liability. If it goes against year you just decide say well let's stop this and move on. Would that be a cash amount due immediately or that be not payable over time?

So there's a couple pieces of that, what you're seeing on the balance sheet is the remaining prior underlying anti-dumping duties that we had accrued. So that $6.7 million, $3.6 million of that is prior anti-dumping duties that will we will pay. And then the $3.1 million Delta is the penalties which we may or may not pay depending on outcome of negotiations with customs.

Okay. Is that something – and that's something that's likely to be finalized this year or in the next 12 months?

Yes, we expect that. It could push into 2000 – it could push into 2019, but we're hopeful we can resolve it this year.

Yes, the important thing that I would like to add to that is that we feel that we're fully accrued for what we see today. And tariffs and the duties themselves have been accrued in this quarter we've recognized the penalty portion of it.

Right, okay. A prior questionnaire with asking about the phase of second half DynaEnergetics sales versus the first half and the math looks out to be like the second half by quarter is about equal to the second quarter level. So topping out at let's call it this $55-ish million revenues. And just a little confused by that with the removal of the bottlenecks in the increase in capacity. Why is it just flattish, why wouldn't you see at least some pickup in second half revenues versus the first half – excuse me versus the second quarter?

Yes. We're talking about DynaEnergetics here and what I'm showing is in our guidance $104 million in first half and at the midpoint, so it's about $105-ish million in the first half and $115 million to $120 million in the second half. So we're showing $10 million, $15 million a growth in the second half and we're just – we've got to get the capacity online in the third quarter, we’ve had bottleneck issues we think we've worked through those, but those things can [indiscernible]. We want to deliver and provide you with guidance that we feel good about and that we believe strongly that we can deliver on.

Okay, that’s fair. Thank you very much I appreciate that. I think that will do it for me. Thanks a lot and good luck with everything.

Thank you.

Ladies and gentlemen, we have received end of our question-and-answer session. And I would like to turn the call back over to Kevin Longe, Chief Executive Officer for closing remarks.