DMC Global Inc (BOOM) 2017 Q3 法說會逐字稿

Greetings, and welcome to the DMC Global 2017 Third Quarter Earnings Conference Call.

(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 Third 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 be 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 turn the call over to Kevin Longe.

Kevin?

Thanks, Geoff, and hello, everyone.

Third quarter sales were $52.2 million, which was an 11% sequential increase versus the second quarter.

And a 43% improvement over last year's quarter third quarter.

The results exceeded our forecast and reflect better than expected sales at DynaEnergetics, our oilfield products business.

We've set a new single quarter record for sales, operating income and adjusted EBITDA.

Despite a slowdown in the growth of the U.S. onshore rig count, the unconventional well-completion sector remained very active during the quarter, reflecting increased completion intensity and longer laterals.

This fueled strong demand for DynaEnergetics' intrinsically safe perforated products, which includes the DynaSelect detonator and the Factory-assembled, Performance-assured DynaStage system.

Approximately 65% of DynaEnergetics third quarter sales were generated by these highly differentiated product lines.

DynaEnergetics reported third quarter sales of $35.3 million, which was a 32% sequential improvement versus the second quarter and an 80% increase versus last year's third quarter.

The results exceeded DynaEnergetics' prior quarterly sales record by approximately 20%.

At NobelClad, 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.

NobelClad's financial results during 2017 reflects a lengthy down cycle in global industrial infrastructure spending.

This situation has curtailed NobelClad's large project bookings and led to a recent decline in smaller repair maintenance orders from the downstream energy industry.

Following an analysis of conditions in NobelClad's end markets and the corresponding decline in the financial performance, we recorded a noncash $17.6 million impairment charge related to NobelClad's goodwill balance.

A 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 NobelClad's 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 a year ago.

The increase was driven by higher average selling prices and a more favorable product mix.

At the business level, DynaEnergetics reported gross margin of 39% and NobelClad reported gross margin of 21%.

Excluding the noncash impairment charge, our consolidated third quarter operating income increased to $5.1 million versus an adjusted operating loss of $2.1 million in last year's third quarter.

DynaEnergetics' operating income was $6.9 million, and NobelClad 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 on 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 of NobelClad was $1.5 million.

DynaEnergetics' advanced perforating technologies continued to drive material improvement in the performance of its customers' well-completion programs.

During the third quarter, a DynaEnergetics' customer, operating in the D-J Basin deployed approximately 8,500 DynaStage systems consecutively without a perforating misrun.

The customer also reported that the Factory-assembled DynaStage system enabled the company to improve efficiency and complete nearly 50% more stages per day than 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 that it'll construct a 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 its DynaStage assembly facility in Mt.

Braddock, Pennsylvania, which will improve access to customers in the Marcellus and Utica shale regions.

A planned second phase of the Blum expansion is scheduled for 2019 and will include a 30,000-square-foot hardware manufacturing facility.

DynaEnergetics is budgeting approximately $25 million over the next 3 years for the capacity expansion, which will be funded from operating cash flow.

As I mentioned earlier, we're expecting NobelClad'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 as orders.

In addition to the $4 million petrochemical order announced early in the third quarter, NobelClad has secured a $1.7 million order for clad plates that will be used to fabricate mining related metal processing equipment.

This order represents a new application for the business' explosion-welded plates and illustrates the positive impact of NobelClad's market development initiative.

After the close of the third quarter, NobelClad received a $7.4 million purchase order, related to a petrochemical project in Asia.

The order will be reflected in NobelClad's fourth quarter backlog and is the largest project booked by the business in more than 4 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.

Though the recovery in DynaEnergetics and NobelClad'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 industries.

And we are also extremely pleased with the performance and commitment of everyone across the DMC's 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 decrease is principally related to lower sales volumes on fixed overhead at NobelClad and regional sales shifts at DynaEnergetics.

SG&A is expected in the 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 patent litigation at DynaEnergetics and increased investments in growth resources of both DynaEnergetics and NobelClad.

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.

I wanted to talk about -- I guess when I look at the numbers and I kind of do the math, it doesn't seem to add up, looks like you're looking at $2.5 million, $2.8 million in operating income for fourth quarter, but you're saying $6 million in EBITDA.

So just trying to look back into those numbers, just trying to get a sense as to what you're expecting for the fourth quarter?

Yes.

So I think you're pretty close, Ed, on the operating income.

And so for the fourth quarter, if you take into account D&A and noncash stock compensation and just our normal run rates you should get you to about that $6 million range, bridging operating income to adjusted EBITDA.

Got you.

So you're including stock-based comp, too.

How much did that run a quarter, remind me?

It's in the $700,000 range -- $700,000 to $800,000.

Okay.

Okay.

When I think about the guidance on the gross margin, 30% seems low after the 3Q result.

Can you talk to me about is it the mix in individual businesses, and maybe you can also talk about the top line at both Dyna and Nobel and the expectations there on the individual basis?

Yes.

So in terms of starting with top line, I mean, we expect to be flattish with Q3 and that's about $36 million, $37-ish million on our Dyna business in sales, roughly $15 million or slightly above that $15 million to $16 million on our NobelClad business.

As far as margins, as you see, NobelClad, this will be the -- fourth quarter will be the softest quarter for NobelClads.

We've got the impact of overhead absorption there.

Their margins are going to be significantly softer in the fourth quarter.

Dyna's 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 NobelClad.

So NobelClad's soft sales, and I guess you're saying a little bit of mix in DynaEnergetics...

Yes.

And on DynaEnergetics, some of it's earlier in the year contracts were fulfilling and we've raised prices there.

So it's a little bit of a flywheel effect.

Got it, got it.

And I guess looking at -- I guess looking at 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 narrow down potential ranges for us as to what you 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?

Yes, Ed, it's 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.

And 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 are 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 operating cash flow with the discipline that we're putting on both of our 2 businesses.

Okay.

With the growth in Blum, rather the expansion in Blum, the expansion in Germany and I guess the discussion around Mt.

Braddock, if 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 a second automated detonator line for our 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 our initiating systems on the DynaSlot side of things.

So that's the discussion we already have announced.

So just to be clear, is that capacity will have bottlenecks and other supplies going into that, that could be freed up over time, and so will that major investments such as the 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...

Yes, the detonating line will not be a bottleneck and we are also taking advantage of our global footprint, particularly, as it relates to shaped charges and making those available in North America from our other locations.

I -- we will operate on longer-term basis within our depreciation and amortization for both businesses.

And so yes, 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 from Gerry Sweeney, Roth Capital.

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, we've batted around how big the market is and how fast it's 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 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.

And, 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 levels 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 in -- meaning -- I mean there's different components, right?

So there's the 5 components and then you have DynaSelect and DynaStage, but -- and obviously, it sounds like DynaStage was sold out, but what about other areas?

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

Okay.

Again sorry, go ahead.

Yes, 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 (inaudible) 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.

Got it.

So right now, sold out or you're approaching capacity.

There's a pricing opportunity.

You talked about upward of sometimes 50% more wells fracked than a traditional equipment.

How much -- loaded question I know, but how much pricing opportunity do you have?

I mean, you listen to Schlumberger, Halliburton and Core Labs they're all saying people are going to pay up for products and services that increase efficiencies.

Do you know how much opportunity there is?

Yes.

Well, I think that they'll pay up for increased efficiencies.

It's got to show up in their bottom line.

And they are 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 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 in 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.

Okay.

Okay.

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 shape charges that may not get as much press as DynaSelect and DynaStage for a start you have some good addition to -- in that category as well?

Yes.

I think that the -- our land-based unconventional, our 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, 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.

Got it.

I know, a lot of questions.

Switching gears, a little bit NobelClad, you certainly highlighted new business in, I think, the mining end segment.

And I know for last couple of years, you're sort of been trying to broaden out the addressable market.

How much -- how large of a, sort of, adjacent market is that mining business?

And I think you've -- there is 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 that you're working on?

Yes, I think the story with NobelClad is that when we united the cladding businesses under the single brand-name NobelClad 3, 4 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 claded pipe and different components within piping systems.

And we're just beginning to see the benefits of the investments in the application engineering, in 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 a soft downstream oil and gas market over the last couple of years.

Got it.

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?

Yes.

We were operating with a very small market share and historically, it's been growing quite nicely.

The targeting of 20% that -- it's as much a message to our sales team as it is to our investors in that we are not out after trying to corner the market in perforating systems.

We want to get a healthy share of the market, get it based on technology, not on price and to 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, the price, and we'll ride it up with our technology as the demand for those technologies exists.

And we can get...

Sure.

But my sense is the tone in 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 to me believe that value-added services are -- potentially could be a larger portion of the market this go around?

They have to be.

Yes, if you're not creating value for our customers, you're not going to win at this game if you will.

And in the benefit of the DynaSelect, 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 was going to be strong.

And with healthy margin expectations on our deals 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?

And how much that was systems?

The systems, we're not breaking out going forward, Ed, the individual product 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 you -- you've created great products, the opportunity in the market, it's the right time, the consumables.

How do you lock in the market share you're gaining so that some of the competitors that probably have better capital situations, they need more money to spend on R&D.

How do you go about extending the share, so this isn't 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 sized competitor.

With our -- from an R&D standpoint.

We have very well-defined technology product and market development road maps, that go out 3 to 5 years from today.

There's also 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 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 projects.

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.

Got it.

And then, I did want to ask a question because I haven't yet really on NobelClad.

And I wanted to -- looking at what are competitors -- 1 of your competitors -- or customer had said yesterday about pricing, specifically, and I guess downstream energy and saying it's not rational.

And how do you -- former 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 when our customers are profitable, and their business is strong, they're updating and maintaining their facilities and they are 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 in 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 maintained 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, semiconductors 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.

Our next question is from Jim Brilliant, Century Management.

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

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 but with more looking at it and hoping to come online.

So within the -- as you've got the service companies and the E&P guys adopting it.

Early on, you kind of marketed it as because of the safety inherit -- 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 1 of your presentations, 1 of the -- probably the most -- 1 of the E&P guys with 1 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 are getting?

Or is it one-off by customer?

Well, it's interesting.

I mean, the heart of the initiating system is safe and selective and how it operates from.

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 at today.

And coupled with that, is because it's factory assembled, we eliminate the supply-chain challenges for our customers as well as we reduce the crews that they need in the field in order to assemble products.

And so it really is hitting on many levels and certain customers focus on different aspects of it, but when you take it altogether, 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 are getting more activity with those types of well characteristics so we are at 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.

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.

Yes, imagine it -- yes, 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 (inaudible) activity 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.

Are you -- do you have any data to determine whether you're -- what acreage Tier 1, Tier 2, Tier 3 characteristics you sell in to?

Yes.

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.

Correct.

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 there.

And then, there's 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.

No, 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 confident in our technology and our position.

And so we didn't choose to 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.