DMC Global Inc. Q3 FY2020 Earnings Call

Good day, ladies and gentlemen, and welcome to your DMC Global Third Quarter Earnings Call. All lines have been placed on a listen-only mode and the floor will be open for your questions and comments following the presentation. At this time, it is my pleasure to turn the floor over to Geoff High, VP of Investor Relations. Sir, the floor is yours.

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 two 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?

Thank you, Geoff and good afternoon everyone. DMC reported third quarter sales that exceeded the high end of our guidance. The results were driven by improved customer demand at DynaEnergetics, our Oilfield Products business, as well as better than expected shipments at NobelClad, our Composite Metals business. Our performance also reflects the efforts of our employees around the world who have performed exceptionally well in the face of a global pandemic, a very challenging oil and gas market for DynaEnergetics, and project delays within a variety of end-use markets that pushed out orders at NobelClad. DynaEnergetics benefited from an improvement in North American well completions after a very weak second quarter and from strong third quarter international sales. The increase in activity in North America coupled with DynaEnergetics' efforts to align with leading operators and service companies led to a 122% sequential improvement in North American revenue, albeit off a very low second quarter base. DynaEnergetics' DS Factory-Assembled, Performance-Assured perforating systems, which we delivered just in time to the well site, are enabling North American customers to respond quickly to increasing demand. Tuesday evening of this week DynaEnergetics received a call from a service company that was in a jam using field-assembled components. The field-assembled guns were not meeting the needs of its E&P customer and the service company placed an emergency order for DS systems. The following morning, 400 of our DS systems were delivered to the customer's wellsite and have already been deployed. The E&P customer was pleased with the switch to our DS systems and has already committed to deploying several thousand more over the coming months, demonstrating the quality of our systems and just-in-time business model. DS systems require fewer people at the wellsite and less infrastructure and inventory. They enable customers to reduce the capital intensity of their operations and improve the returns on invested capital. In addition, the safety, performance and reliability of our systems improves the effectiveness of our customers' completion programs and the performance of their wells. We are cautiously optimistic that the bottom of the market is behind us and are encouraged by the modest improvement in well completions we saw during the third quarter. We believe this increase will be sustained through the end of the year. The activity improvement has accelerated the reduction of low-priced inventory in the market and the industry is closer to being back in balance. We expect the inventory overhang will be depleted during the first half of next year, and this should lead to improved demand for our DS systems. On the international front, we anticipate a seasonal sales decline during the fourth quarter and an improved order volume beginning early next year. NobelClad continues to deliver steady top-line results and improved profit margins despite the impact of several order delays related to the COVID-19 pandemic. NobelClad's unique know-how and composite metal production has helped it establish a loyal customer base within several large and stable end markets. This is particularly valuable given the inherent volatility in our core energy markets. NobelClad continues to invest in the development of new applications and is pursuing opportunities in a broad range of industrial processing, transportation, and alternative energy industries. During the third quarter, NobelClad shipped its first clad plates to a customer in the engineered wood industry. The plates are being used to reduce maintenance costs and extend the life of the customers' wood presses, which are exposed to high temperatures and corrosive glues and resins. This order resulted from two years of efforts by NobelClad and we are optimistic it will lead to additional opportunities in the global engineered wood industry. In July, Antoine Nobili was promoted to President of NobelClad. Antoine has developed strong application expertise and business acumen during his 25 years with NobelClad and he has been instrumental in expanding the global market for our composite metal plates. We further strengthened our balance sheet during the third quarter and ended the period with cash and cash equivalents of $24.6 million. Total debt at September 30 was $12 million and our $50 million revolving credit facility is undrawn and fully available. Earlier today we filed a prospectus supplement with the SEC to establish an at-the-market offering program. Under the program, we may from time to time sell shares of our common stock for aggregate proceeds of up to $75 million. We plan to use the proceeds for general corporate purposes, which may include working capital, debt repayment, and potential acquisitions or investments in businesses, products, or technologies. Details about the program are available in the prospectus supplement. I'll now turn the call over to Mike for a review of our third quarter financial performance. Mike?

Thanks, Kevin. Third quarter sales were $55.3 million, up 28% sequentially and down 45% versus last year's third quarter. DynaEnergetics reported third quarter sales of $34.2 million, up 45% sequentially and a decline of 56% versus the same quarter last year. As Kevin mentioned, North America sales increased 122% sequentially, which was partially offset by a decline in international sales due to order timing. Sales at NobelClad were $21.1 million, up 8% sequentially and down 7% versus last year's third quarter. Consolidated gross margin in the third quarter was 25%, up from 15% from the second quarter of 2020 and down from 36% in the third quarter of 2019. The decline from last year primarily relates to the year-over-year sales decline and lower average selling prices at DynaEnergetics. DynaEnergetics reported third quarter gross margin of 24% versus 8% in the 2020 second quarter and 39% in last year's third quarter. NobelClad reported third quarter gross margin of 26% versus 25% in the second quarter and 26% in the year-ago third quarter. Looking at our third quarter expenses, consolidated SG&A of $11.6 million declined 5% versus the second quarter and 32% versus the year-ago third quarter. We reported consolidated adjusted operating income of $1.6 million, which excludes $143,000 in restructuring charges. Third quarter adjusted net income was $1.2 million or $0.08 per diluted share versus adjusted net income of $13.4 million or $0.90 per diluted share in last year's third quarter. Adjusted EBITDA was $6 million versus $23.2 million in last year's third quarter. DynaEnergetics reported third quarter adjusted EBITDA of $4.2 million while NobelClad reported adjusted EBITDA of $3.4 million. We ended the third quarter with net cash of $12.6 million as compared with net cash of $4.5 million at the end of the second quarter. Looking at guidance, fourth quarter sales are expected to be in the range of $50 million to $55 million versus the $55.3 million reported in the 2020 third quarter. At the business level, DynaEnergetics is expected to report sales in the range of $30 million to $33 million versus the $34.2 million reported in the 2020 third quarter. We expect demand in North America to be modestly above third quarter demand. However, we anticipate a drop in international activity due to seasonality. We do expect international orders to pick back up in early 2021. NobelClad sales are expected in the range of $20 million to $22 million versus the $21.1 million reported in the 2020 third quarter. Consolidated gross margin is expected in the range of 20% to 23% versus 25% in the third quarter. We expect this sequential decline due to project mix at NobelClad and the decline in international orders at DynaEnergetics. Fourth quarter selling, general and administrative expense is expected to be approximately $12 million versus the $11.6 million reported last quarter while amortization expense is expected to be approximately $370,000. Interest expense is expected to be in the range of $150,000 to $200,000. Adjusted EBITDA is expected in the range of $2 million to $4 million versus $6 million in the 2020 third quarter. Fourth quarter capital expenditures are expected in the range of $2 million to $3 million. With that, I'll turn the call back over to Kevin.

Thanks, Mike. We have navigated the very difficult time in the industry and our businesses are well-positioned to capitalize on an expected improvement in demand. DynaEnergetics and NobelClad have established leadership positions in their respective industries and both have developed innovative products that generate true value for their customers. DMC is in a strong financial position enabling us to stay focused on our long-term strategy of building a diversified portfolio of innovative solutions that create value for our customers and superior returns for our shareholders. Our accomplishments are the outcome of the creativity and efforts of the entire DMC team and I want to again thank our employees for their hard work and dedication. With that, we are ready to take questions.

Thank you. We'll take our first question from Tommy Moll with Stephens. Please go ahead.

Good afternoon and thank you for taking my questions. Kevin, I would like to start by discussing the inventory challenges you mentioned regarding your DynaEnergetics business. Is it correct that we might need to wait up to three more quarters or until the middle of next year before seeing any improvement in the balance? If that is accurate, could you share any recent insights on the pricing situation? Has it worsened? Should we expect to maintain pricing and margins even as that inventory is depleted? What I'm trying to understand is that while the industry seems poised for improvement as we approach 2021, how does that align with your comments about the inventory still present in the market?

Yes, Tommy. I indicated that we believe it will take until the first half of 2021 before the inventory is consumed. There's a bit of an overhang currently. It will likely be more towards the middle of the first quarter, but this situation won't affect all companies in the same way. Some will be able to reduce their inventory more quickly, while others may take longer. The six-month timeframe likely represents the end of this process, but I anticipate that most of the inventory will be cleared in the first quarter. Regarding pricing, we think it has stabilized and we don't expect it to decrease from this point. It would be challenging for prices to fall. We do expect to see some improvement in pricing during the first quarter, provided that excess inventory in the market decreases and demand remains steady or ideally improves. We believe that pricing will begin to recover, although we are not providing guidance for 2021 yet. However, we expect recovery to begin between the second and third quarters of 2021 based on our current outlook.

Okay, thank you. That's helpful context and leads to the second point I wanted to ask about, which is on DynaEnergetics margins. You've done a phenomenal job through this downturn showing the resiliency of the margins there which to be sure have compressed. But they're still well into the positive territory and above what a lot of the peers would be able to show. So as we come into next year and let's just imagine a scenario where activity levels are improving through the first part of next year; how much of the cost that's been taken out this year comes back in or would you be able to frame for us the kind of incremental margin opportunity that's reasonable? Again assuming, we're in an industry environment that's improving as we work through the first part of next year.

Yes, Tommy, we were fortunate that many of the costs eliminated from our business were driven by activity. We operate with a high variable cost model and relatively low fixed costs, and I am very proud of our team. We restructured our business when the market was strong, and our restructurings this year, aside from the activity-driven costs, have been minimal compared to our competitors. As volume increases, we will reinstate the activity costs within our variable cost model. However, we do not anticipate adding back significant fixed costs, which should lead to an expansion in our margins. Our contribution margin for DynaEnergetics is not where we want it to be, but it remains strong in NobelClad even at lower volumes. Returning to the 2019 margin levels would mean absorbing about one-third of our overheads, including SG&A, and two-thirds would come from pricing.

That's helpful Kevin. Thank you. I'll turn it back.

And our next question comes from Taylor Zurcher with Tudor Pickering. Please go ahead.

Hey, thanks, and good afternoon. First question is on some of these new well designs out there. It seems like many E&Ps are looking to up space or elongate the distance between frac stages, it's really an effort to save costs. So one, are you seeing that? And then, are you seeing more clusters or perf shoots offset those potential reduced stage counts? So kind of summing it all up if stage count trends lower on the margin are you seeing gun count per well continue to increase on average?

We are observing an increase of approximately 20% this year. The closer spacing and longer laterals result in more perforation per completion or lateral, but do not necessarily increase the total amount. It does help save on the drilling aspect, but the significant impact on perforating comes from the closer spacing of the perforating guns and the charges.

Okay, got it. Okay. And then also at Dyna, the North American performance in Q3 was exceptionally strong. When we think about Q4, you're basically guiding towards the flattish quarter in North America for Dyna. Embedded in that guidance, are you contemplating any sort of sharp falloff in sales in North America towards the year-end like you saw last year and you've seen in years past, such that the first part of the quarter is much better than last or how should we think about that guidance for North America in Q4?

We don't expect a decline. The decline often seen in the fourth quarter is usually related to budget exhaustion and a slowdown during the holidays. However, most of those budgets were already reduced in the second quarter of this year, so we believe we won't experience the same budget exhaustion this year, and that the current activity will carry on into the fourth quarter.

Understood.

Yes.

Okay, got it. That's all I had. Thanks, guys.

Okay, thank you.

And our next question comes from Stephen Gengaro with Stifel. Please go ahead.

Thank you. Good afternoon, guys. So, just following up on the prior question, I assume, and maybe this is a wrong assumption. But I assume that throughout the third quarter, you saw monthly improvements and given the ramp, you talked about in North America it just feels like the fourth quarter is building in some conservatism or some seasonal fall. I just wanted to see if you could give us a little. I know you just responded but I was just trying to see if that thought process on the third quarter was correct? And if in fact, October was better than any months in the third quarter?

Yes, Stephen. This is Mike. That's correct. I mean, we're actually seeing our Americas business or North America up probably in the 10% range in the fourth quarter off of the third quarter and what you're seeing on the top line for DynaEnergetics is a seasonal downturn in the international business that we think will pick back up early on in 2021.

That makes sense. Regarding the third quarter, it seems that one of the challenges you faced earlier this year was a market share gain for components at the expense of integrated systems. I think you mentioned this in response to Tommy's question about the inventory situation and shared an anecdote about a customer. Can you give us an indication of whether you are seeing a shift in share back to integrated systems possibly sooner than you had anticipated, or would you consider that statement too strong at this time?

No, it's not too strong of a statement. Looking at the second quarter, we chose not to pursue the low-price segment of the business, and we accepted a reduction in market share to ensure that our pricing was responsible and maintained value for our shareholders. We did reduce our prices to support our service customers who transitioned their operations to our systems and need to compete effectively in the market. The successes we experienced in the third quarter, which are continuing into the fourth, are primarily attributed to our integrated systems. These systems provide the advantage of components designed to work together, factory assembled, eliminating field wiring, making it easier and faster to operate in the field. Although we haven’t dropped our prices in the third or fourth quarter, we are witnessing discontent stemming from the older model where operations required buyers to assemble components in the field, which is labor-intensive and capital-intensive. In a market where having fewer personnel and less capital locked in perforating operations is advantageous, we are noticing a shift. Customers are increasingly focused on the overall ecosystem cost of building perforating guns rather than just the transactional price of individual components. As a result, we are regaining market share due to the superior quality of our system and the reduced capital intensity associated with our products.

Great. That's very helpful commentary. Thank you.

And we'll move next to Gerry Sweeney with ROTH Capital. Please go ahead.

Hey, good afternoon, Mike, Kevin, Geoff. Thanks for taking my call. I wanted to talk a little about some of the newer products. I see DS Trinity, NLine that built upon the original DynaStage. Just curious as to how much sort of market uptake you're seeing on that? And are they driving new adoption, new customers or are they bringing some older DynaStage customers along to a new level? What I'm trying to get at obviously longer term is you've been prolific in investing in new technology. You're keeping the pedal down, I assume on the marketing, etc. How does this all translate into market share as we look a little bit further out in the curve?

We're seeing an increase in directional perforating if you will, and our NLine has been a very successful product line in the third quarter. There seems to be greater focus on the orientation of the perforations and also the accuracy and the consistency of the perforations and we excel in both accuracy, consistency and also the channel that's being created. So the NLine, we've seen being very well embraced and adopted in the marketplace. The order that I mentioned earlier this week, where we were able to respond quickly, we are able to use our Trinity system and the feedback from the E&P to the service company has been what we would expect and very complementary and so Trinity is probably a little slower in the quarter relative to NLine, but we just saw a recent pickup in it.

Regarding the mining applications, if I recall correctly, there was collaboration with Newcrest and potential for significant orders over an extended period. Additionally, there are opportunities in other mining applications, likely with attractive margins. Do you have any updates on that front or insights into how we are approaching it?

It's still in the very early stages of being adopted by our customer, and we're moving at the pace of their mining operations. This is a relatively new product that operates at very high temperatures in the mining industry, making it a niche application within that sector. However, we believe it has the potential for a significant application with strong margins. So far, you've only seen a small impact from it in the NobelClad results for the third quarter. It's not the main driver for NobelClad yet, but we expect to see stronger performance from it in 2021 and 2022.

Got it. Okay, that's it from me. I appreciate it. Thank you.

And we have a follow-up question from Matt Galinko with Sidoti. Please go ahead.

Hi, good afternoon. Thanks for taking my question. I guess, just curious about how you think about timing on market development and engineered wood for NobelClad. It sounds like you got an initial order. But how do you think about follow-on and sort of building from that?

The engineered wood marketplace is significant, with a market size in the tens of billions, potentially around $40 billion in product revenue. There are about 50 companies worldwide producing engineered wood. We have developed applications that enhance operational efficiency by reducing maintenance and service needs for presses and plates. We are at the early stages, receiving orders from a client we have previously collaborated with, and we are actively reaching out to other companies with a compelling value proposition. We anticipate increasing momentum in 2021 and 2022 to support the current state of the industry.

And we have a follow-up question from Stephen Gengaro with Stifel. Please go ahead.

Thanks. Kevin, one more thing I want to just address. Do you see any opportunity with the Liberty One spin transaction and my sense would be that Schlumberger with somebody who is more up to be internally developed in a system and the release. You're kind of a truly a leader on the technology side, in the press business but I'm not so sure they're doing much on the integrated perf guns. Is that something that has come up? Is that a potential opportunity with Schlumberger maybe getting out of the game a little bit as we think about the competitive landscape?

Well, I don't know if Schlumberger is getting out of perforating. I think they've moved or will move one of their business units over to Liberty. And so we view it as from a supply standpoint, market neutral and we would be focused on both Schlumberger and Liberty like we would the broader market for selling our systems.

And we do have a question from Jim Brilliant with Century. Please go ahead.

Afternoon, guys. How are you?

Yes. Hi, Jim.

Kevin, if we look at kind of roll the calendar back a little bit in the '18 and '19 as you developed new products and more offerings. You certainly separated yourself from the pack with the integrated system. Now we got a downturn and there is this excess inventory in the market that we've got to get through. But how would you characterize the market going forward from a competitive front and not just from the perforating side, but also from the E&P side and the service side? What do you see different going forward than maybe what we had in the past?

Well, what we're witnessing and I think the market is witnessing right now is consolidation at the E&P level, and we would expect there to be consolidation and attrition at the service and the equipment level particularly for the lower technology component kind of companies. The lower capital intensity and the lower people intensity of integrated system is just too compelling for I think a service company or an E&P company to ignore. And so I would think that it's going to mostly impact the smaller component manufacturers from the equipment side and it doesn't make sense to be a vertically integrated wireline service company assembling components that you don't have basic or manufacturing capabilities.

The fact that you picked up a lot of business from a competitor that was having problems in the field is kind of interesting to me in that it's a relatively slow time in the industry. Yes, they're having problems with field assembly. Was that a product issue or is it a labor issue? And I guess what I'm getting at is, not to get overly excited about the eventual ramp, but how is the field assembled industry going to ramp if they can't do it in a slow time? What are the dynamics that are causing problems now in that field assembled?

Yes. Well, there are a lot of people coming out of the industry and expertise and so assembling perforating guns in the field with components that aren't necessarily designed to go together is kind of a difficult process. It requires more people and it also requires a coordination of the supply chain for all the different products and capacity in this particular case for the size of the projects that were being considered. And so for all of that to come together in a market where there is consolidation, attrition, and reduction in force is very difficult. And so we just feel that we were benefited because of our business model and the integration of our products.

So is there something different now in this downturn than say 2016, because there were still those same things, people are coming out of the market and all that? But nonetheless, when the industry ramped up you still had field assembled people ramping up and they got back to business. Is there something different that you think changes that?

Yes. Margins are lower. And so you can be inefficient when margins are higher and the savings may at first appear to be lower, but when you get down to this kind of environment where volume is down, margins are down, and every completion is a critical completion, you really have to be good at what you do and I think that that's going to favor DynaEnergetics and some of its larger competitors that are also working on integrated systems.

Okay. And then in terms of product roadmap, you've been introducing several new products in various degrees and various areas. Are you contemplating moving beyond perforating guns and energetics? Are there other things that you're looking at?

We introduced several new products in late Q2 and early Q3, with two additional product lines set to launch in Q4. The majority of our new products focus on perforating and expanding our product portfolio, allowing us to offer a perforating system suited for different types of completions. While these introductions do not significantly impact market size, they strengthen our product offerings. One notable release is a ballistic released tool that is new for us, along with a setting tool that has undergone extensive testing in Q3. This setting tool is expected to increase our total available market by about 20% and incorporates many safety and performance advantages of our perforating systems. We are experiencing strong interest and anticipate quick adoption of the setting tool in the market. Additionally, we are concentrating on lower completions and related products, focusing only on those that can bring added value for our customers and enhance our value proposition, which are few and far between.

Okay. And then one last question, I know, it may be early for budgeting next year. But what's your CapEx look like for next year? And is there anything particularly planned along the way of increased efficiency?

Yes, we're just in the early stages of budgeting for next year. We would expect our CapEx spending to be modest in the range that we're spending this year until we see demand and margins start to improve dramatically.

Okay, thanks guys. I appreciate it.

With that, there appear to be no further questions. So I'll turn it back over to Kevin Longe for any concluding remarks.

Just would like to thank everybody for joining the call today and we hope you and your families and colleagues are doing well in this very difficult environment. And I'm pleased to say that I think the next time that we'll have an earnings conference call will be in 2021 and it will be nice to put 2020 in the record books. And look forward to talking with you in February. Thank you.

And that does conclude today's conference call. We appreciate your attendance. Please disconnect your lines at this time and have a great day.