DMC Global Inc. Q4 FY2020 Earnings Call

Good afternoon, everyone, and welcome to the DMC Global Fourth Quarter Earnings Call. It is now my pleasure to hand it over to your host, Geoff High, Vice President of Investor Relations. The floor is yours.

Hello, and welcome to DMC's fourth 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 turn the call over to Kevin Longe. Kevin?

Thank you, Geoff, and good afternoon everyone. The dedication and resiliency of our employees during 2020 enabled DMC to advance its strategy during an extremely challenging year. After our record financial performance in 2019, the pandemic hit and severely impacted demand in our core energy markets. We moved quickly to resize the company and aligned our activity-based expenses with much lower customer activity. Our efficient and highly variable cost structure and asset-light business model developed over the past several years enabled us to complete the restructuring process in two weeks and with only minimal restructuring expense. We reported full-year sales of $229 million, down 42% from a record $398 million in 2019. Adjusted EBITDA was $19.1 million versus $93.8 million in 2019. And adjusted diluted earnings per share was $0.07, down from $3.75 per share in 2019. We ended the year with a record cash position of $53.9 million, which included $25.7 million raised through our at-the-market equity program. We also have a $50 million undrawn revolving credit facility. Throughout the year, we maintained our investments in research and development and innovation, which is reflected in the 24 patents we were awarded and the 131 patent applications we filed. Both of our businesses introduced new products and applications that further strengthened their competitive positions and expanded their addressable markets. We achieved one of the strongest safety records in company history; both of our businesses completed the year without a single lost time accident. We also strengthened our market development teams, promoted a new Business President, and added two talented Board members. The entire DMC team should be proud of their accomplishments in 2020 as I am. It was a very difficult but productive year. During the fourth quarter, well completion activity in North America's unconventional oil and gas industry continued to improve, albeit off a low base. This led to increased demand for perforating systems from DynaEnergetics, our energy products business; system sales increased 21% sequentially versus the third quarter. DynaEnergetics reported a 24% sequential sales increase in its primary North American market during the fourth quarter. The increase offset an anticipated decline in international sales, which were down 55% sequentially. DynaEnergetics' international orders primarily address large conventional oil and gas projects and are typically of higher value than North American projects. Before last year's anticipated fourth quarter, international demand was strong and DynaEnergetics customers have stated they expect a significant recovery in project activity during this year's second half. DynaEnergetics introduced more new products in 2020 than in any prior year. Exploration and Production companies are providing positive feedback on several new offerings, including the DS Lonestar and DS NLine perforating systems as well as the DS MicroSet setting tool. DS Lonestar is a compact system equipped with next-generation high-performance chargers that deliver large, ultra-uniform entry holes and provide exceptional contact with the reservoir. In three recent field trials that utilized oriented Lonestar systems, 98% of the perforating tunnels delivered fluid and proppant into the formation. By comparison, the perforating efficiency of our competitors' best-performing systems is typically in a range of 80% to 85%. The technologically advanced E&P companies that performed these tests reported that the Lonestar system delivered consistent hydraulic fracturing treatment across the entire formation while also reducing the required pressure pumping horsepower by more than 20%. The trials were completed with no mis-runs or mis-fires illustrating the safety and performance benefits of our IS2 Intrinsically Safe initiating system, which is at the heart of all of our DS products. To date, DynaEnergetics has deployed more than $3 million IS2 systems without a single safety incident. The DS MicroSet setting tool has brought a step change improvement to a critical component on the perforating tool's strength. DS MicroSet is used to set the frac plug at the end of each stage in a multi-stage well, and it is by far the safest, most reliable, and most compact setting tool on the market. Similar to the shape charges in our DS perforating systems, DS MicroSet comes with the power charge pre-loaded. In addition, it does not require a firing head and is initiated by our wireless IS2 Intrinsically Safe ignitor. It is fully disposable, eliminating the dangerous redress process required by traditional selling tools. It also works seamlessly with our DS perforating systems and enables our customers to streamline their supply chains. Customer reaction to the performance of DS MicroSet has been very favorable. In the current environment, certain operators and service companies have taken a short-term view and are making decisions solely on price. Rather than focusing on safety, reliability, and total operating costs, these companies are deploying lower-cost older technologies or undifferentiated pre-wired perforating components from third-party manufacturers. DynaEnergetics is taking a longer view and is focused on educating the market about the comprehensive benefits of our factory assembled performance-assured systems. Customers deploying our DS systems are seeing improved synergies between their frac and wireline operations and are completing more stages per day with fewer people and less infrastructure. We believe several of the pre-wired components that have entered the market violate DynaEnergetics patents and we have initiated legal action against these component manufacturers. The COVID-19 pandemic led to a significant slowdown in economic activity, which in turn reduced energy demand and led to a steep drop in oil and gas prices. This created a very difficult environment for Exploration and Production companies and their service providers. DynaEnergetics supported its customers during the period of very weak activity and low pricing. We are optimistic that a swift vaccine rollout will aid the economic recovery, support higher energy prices, and improve demand for our solutions. As well completion activity continues to improve, we are taking steps to restore our profitability. DynaEnergetics recently announced a price increase that will take effect during the second quarter. NobelClad, our composite metals business, is forecasting a relatively slow start to the year, which reflects the late-cycle nature of its industrial end markets. NobelClad entered 2021 with a $40 million order backlog, which was approximately 25% higher than at the start of 2020. In addition, the blended contribution margin of the associated orders is a strong 44%. We remain confident that several large international orders delayed by the pandemic will be awarded to NobelClad in the coming quarters. We also believe the medium to long-range outlook for NobelClad remains very positive as the business continues to expand its addressable market with new composite metal applications. I'll now turn the call over to Mike for a review of our fourth quarter financial performance, and a look at first quarter guidance. Mike?

Thanks, Kevin. Fourth quarter sales were $57.1 million, up 3% sequentially and down 34% versus last year's fourth quarter. DynaEnergetics reported fourth quarter sales of $35.3 million, up 3% sequentially and a decline of 45% versus the same quarter last year. North American sales increased 24% sequentially, which more than offset soft international demand. Sales at NobelClad were $21.8 million, up 3% sequentially and flat versus last year's fourth quarter. Consolidated gross margin in the fourth quarter was 21%, down from 25% from the third quarter of 2020 and down from 35% in the fourth quarter of 2019. The decline from last year primarily relates to lower average selling prices at DynaEnergetics and a less favorable project mix at NobelClad. DynaEnergetics reported fourth quarter gross margin of 24% versus 24% in the third quarter of 2020 and 38% in last year's fourth quarter. NobelClad reported fourth quarter gross margin of 18% versus 26% in the third quarter and 27% in the year-ago fourth quarter. Looking at our fourth quarter expenses, consolidated SG&A of $12.5 million increased 8% versus the third quarter and declined 22% versus the year-ago fourth quarter. We reported a consolidated adjusted operating loss of $736,000, which excludes $82,000 in restructuring charges. Fourth quarter adjusted net loss was $825,000 or $0.05 per diluted share versus adjusted net income of $9.5 million or $0.65 per diluted share in last year's fourth quarter. Adjusted EBITDA was $3.6 million versus $17.6 million in last year's fourth quarter. DynaEnergetics reported fourth quarter adjusted EBITDA of $4.1 million, while NobelClad reported adjusted EBITDA of $1.9 million. We further strengthened our balance sheet during the fourth quarter and ended 2020 with cash and marketable securities of $53.9 million, including $25.7 million raised through our at-the-market equity program initiated during the fourth quarter of 2020. Looking at guidance, first quarter sales are expected to be in the range of $55 million to $62 million versus the $57.1 million reported in the 2020 fourth quarter. At the business level, DynaEnergetics is expected to report sales in a range of $37 million to $42 million versus the $35.3 million reported in the 2020 fourth quarter. The wide sales forecast range is due to the recent severe winter weather causing disruptions in Texas. NobelClad's sales are expected in a range of $18 million to $20 million versus the $21.8 million reported in the 2020 fourth quarter. Consolidated gross margin is expected in a range of 22% to 24% versus 21% in the fourth quarter. Fourth quarter selling, general and administrative expense is expected to be approximately $12.5 million to $13 million versus the $12.5 million reported last quarter, while amortization expense is expected to be approximately $325,000. Interest expense is expected in a range of $150,000. Adjusted EBITDA is expected in a range of $3.5 million to $5 million versus $3.6 million in the 2020 fourth quarter. Given the uncertainty regarding timing of the COVID-19 vaccination rollout, and its impact on economic activity and energy demand, we are not yet providing full-year sales and earnings guidance. We do expect 2021 capital expenditures will be in a range of $12 million to $15 million. In addition, full-year amortization expense is expected to be approximately $1.1 million versus the $1.4 million reported in 2020, and interest expense is expected to be approximately $425,000, down from the $731,000 reported in 2020. With that, I'll turn the call back over to Kevin.

Thanks, Mike. We are encouraged by the improving strength of our end markets. We have entered 2021 with two very well-run businesses and the strongest balance sheet in company history. More importantly, we have an exceptionally talented team of innovative and determined employees. They have supported the company and each other during a very difficult year. And as I mentioned before, I am extremely grateful for their contributions. We are now ready to take any questions.

And the first question is coming from Stephen Gengaro. Stephen, your line is live. Please share your affiliation and ask your question.

So a couple of things, Kevin. If we could just start with the fourth quarter on the DynaEnergetics side, the gross margins and I was just, you had a really good third quarter. I think they were basically flat in the fourth quarter with a little higher revenue. Can you give us a little more color around that?

Yes, I mean they are basically flat quarter-to-quarter. We have a low fixed cost, high variable cost business. There is some absorption obviously when revenue picks up or volume picks up. But it was relatively minor and didn't offset some of the product and geographical mix that we have for the quarter. And so, but as you can see the gross margins have kind of flatlined at that 24% compared to where they were a year ago with 38% to 40%.

And Stephen, just to emphasize on the geographic mix in the third quarter, we had $9 million in international and $4 million in the fourth quarter. So we actually had unfavorable mix, fairly significant unfavorable mix there from a geographic standpoint than from 24% margins.

Okay, great. That helps. I was going to ask about international performance since the second quarter was really strong but the third quarter was weaker. How should we view this for 2021? Is the fourth quarter an outlier, or should we interpret international activity as a reflection of that business? Are there specific factors we should be aware of regarding international operations?

Yes, Stephen, it is very unpredictable and I think it will be weak in the first quarter. We anticipate it will improve after that, but in DynaEnergetics, that's a $30 million to $35 million business, where we only achieved $4 million in the fourth quarter, and it will again be weaker in the early part of the first quarter. We expect both businesses to see some improvement in the second quarter and beyond.

And we're expecting a sequential 2021 increase in international activity over 2020. So just emphasizing the quarter was an anomaly.

Great. Okay, and then just one final question. You mentioned the excess low-cost inventory in the channels, and it seems that activity has picked up quite well in the latter half of the year, continuing to be strong despite the short-term challenges in Texas. Can you update us on where we stand in this process, particularly with the announced price increase and how we are managing the low-cost inventory throughout the supply chain while looking at the potential for reaccelerating the integrated products?

We decided not to pursue a significant amount of business in the fourth quarter due to considerable low-priced selling of components, which exceeded that of systems. A competitor saw over a 60% increase in their Energetics and nearly 30% in their systems, yet their quarterly revenues were up only 18%. This indicates they were selling through inventory to gain market share at unsustainable prices, which negatively impact profit margins, our customers, and the industry, especially in an environment with elastic demand. We observed extensive discounting in the fourth quarter on already low prices. For instance, DynaEnergetics experienced a notable drop in the average selling price per gun in 2020 compared to 2019. However, we do not need to engage in price competition to win business; instead, we compete on technology and support our partner customers to maintain their competitiveness in challenging markets. So, while there was considerable inventory released in the fourth quarter, we expect some to carry over into the first quarter of this year. However, most of it should be resolved, and our planned price increase is aimed for the second quarter of 2021 when we anticipate improved activity from our partner customers in the industry.

Thank you. And the next question is coming from Tommy Moll. Tommy, your line is live. Please announce your affiliation and pose your question.

Yes, same. So coming out of the last downturn, Kevin, you took significant market share on the DynaEnergetics side and I think a lot of that was driven on your ability to nudge the industry toward a systems-type orientation, at least for a chunk of the market where you were the leader, are the leader. I wonder, in this current context, at least as far as Q4 goes maybe you lost some share, but it was more just liquidating inventories at the competitors, it was a driver more than any kind of shift in real customer preference on system versus component. So I'm trying to peer in the crystal ball here, and think about as we go into this year. If there is another big share gain opportunity in front of you, or have you seen anything in terms of customer preference where you ought to be able to capture a lot of that back or maybe you can go beyond where you were the last time.

We experienced a slight loss of market share in 2020, but we largely held on to it. Our partners continued to rely on our systems, which offer a strong value proposition. Our product is distinct, and to put it in context, the cost of perforating systems is less than 2% of the total completion job for E&P companies. However, when we consider the technologically advanced companies using our systems, we've seen a 35% to 40% year-over-year increase in the number of stages they can achieve per frac spread. This improvement, while not the sole reason, is partly due to the deployment of our systems. The value our systems provide in completions far surpasses their cost, and even the modest margin increases we're aiming for represent only a small fraction of the overall completion expense. Given the minimal cost coupled with leading technology that enhances completion efficiency, we anticipate our market share will either stabilize or grow based on the performance of our guns and the efficiency of the operation overall. Our pricing aligns with the market; we’re not significantly above it. We offer differentiated products compared to undifferentiated ones. Thus, we expect to gain market share while also concentrating on key customers who value the comprehensive benefits our systems bring to their operations rather than just focusing on the lowest price.

Thank you, Kevin. That's helpful context. I have a quick follow-up on Dyna before we switch topics. I want to revisit the international dynamic in comparison to North America, as there has been a noticeable divergence between the two. In your guidance for the first quarter, there is a significant shift for North America, which makes sense given the current ongoing disruptions. Leaving North America aside for a moment, can you provide some clarity on the international side? Does it appear that the sequential trends for the first quarter are not significantly different from the fourth quarter, and that the second quarter is similar to the first quarter, but then you expect a pickup in the third and fourth quarters? Or would you describe it differently?

We think the second half of the year will be stronger than the first, but we expect a stronger second quarter than we do the first quarter.

And the first quarter they look like the fourth quarter and that's baked into our guidance.

Yes. And our guidance reflects the unfortunate situation happening in Texas right now, and we wish everybody there all the best during a very difficult time. And as we previously mentioned, an odd quarter from an international standpoint for DynaEnergetics and just a soft quarter for NobelClad also. But we expect both businesses to show incremental growth year-over-year and a little bit stronger in the back half than the first half.

Thank you, Kevin. I would like to shift the focus to mergers and acquisitions, which have been a central part of our strategy for a while. I am interested in understanding the status of the full-year pipeline and how active your discussions are at the moment. Any insights you can share about which markets you are looking to expand into or your presence in, even if you can't provide too much detail, would be appreciated. Additionally, I need to ask whether we should view your substantial cash and marketable securities position as a potential priority for M&A, or if there is another focus for those resources.

It is a likely priority but it's longer term rather than near term. And our pipeline is one that I need to say that we use a rifle not a shotgun and we're very selective on companies entering that pipeline and how far we go down with that. And I think that we like the markets that we're in and we're going to continue to support those and look at bolt-on opportunities when it makes sense when it's a product that can expand the total available market or improve our competitive position but we're also not opposed to markets outside of our two markets today. And we look at technology-driven companies with advanced manufacturing, which is what we done or created in our existing markets and that's led to the differentiation and stronger shareholder returns over time.

Thank you. And the next question is coming from George O'Leary. George, your line is live. Please announce your affiliation and pose your question.

Just curious obviously being done here in Houston, I can see it on a daily basis and we've had heating power water issues down here. Just given your facility in Blum, Texas, I wondered if you could talk logistically about what are issues, what are issues, kind of just describe the situation a bit and then maybe to the extent you can and I realize the situation is very much still fluid, but how much that has factored in those issues have factored into the Q1 '21 guidance.

We have essentially lost a week of production in Texas because we decided not to have employees come in due to bad road conditions and other circumstances. However, even if we had remained in production, we would have faced challenges since many of our customers have experienced a slowdown at their well sites. We anticipate that operations will begin to normalize next week, and we believe we can quickly catch up on product sales more rapidly than some of our customers can resume well completions. Therefore, we are confident in our ability to meet customer demand, depending largely on their success in coming back online.

Great.

Regarding the question, Mike, what is it? 5% to 7% maybe or? Yes, we look at it as a couple of million dollars that could get pushed out into the second quarter. So we've adjusted our guidance to reflect a bit of a wider range to see we might get those orders out, but again as orders might go up in Q2.

And again it's good that our customers get up to speed.

Got it. Thank you, guys, both for that. And then just back on the DynaEnergetics margins, just as we think about maybe, we have taken some of this noise out that we're seeing right now and some of the noise in the fourth quarter with regard to mix. As we think about Q2 '20 plus, is there an incremental margins range that you would push us to or what would you expect normalized incremental margins to be in the back half of the year? Maybe any framing there would be helpful.

Yes, we are reluctant to provide guidance on revenue and margins for the latter half of the year due to numerous factors. This is primarily influenced by the vaccine, economic activity, its effect on oil and gas, and our market demand. We anticipate that our market share will remain stable or improve. We have announced an initial price increase, but there is still a considerable amount of time before it goes into effect. Therefore, it is challenging to forecast margins beyond the first quarter.

Do you expect higher margins as we progress through the year regardless of magnitude?

Without a doubt.

Perfect. I have one more question, driven more by curiosity than anything else. In your press release and prepared remarks, you discussed the Lonestar system and Lonestar shaped charges, which I find fascinating. I'm wondering if the tunnel is reaching the desired location and if the rubblization caused by the shaped charges is what results in a 20% reduction in frac horsepower based on the field trials you've conducted, or if there's something else at play. I'm just curious if you could elaborate a bit more on that. I thought it was very interesting.

Yes, it's both the alignment and the type of channels that these shaped charges are making that are improving the performance. And the combination of the proprietary shaped charge and the size of that charge and the alignment, and the accuracy of that alignment is what's really creating the increased performance of our products.

Thank you. And the next question is coming from Gerry Sweeney. Gerry, your line is live. Please announce your affiliation and pose your question.

Similar question to Tommy, but maybe a little bit different. Last market cycle, I think it was more about DMC introducing the systems, proving their effectiveness coming into this cycle of new products. Now you have data on improved operations, you're less shy of putting the data out there, than I think you were several quarters ago, plus a highlighted synergies. What are the discussions with potential new customers in terms of getting them over the hump and buying from the product? I know there's nuances even internally with some of your clients, but and E&P versus services. But curious as to how that's developing especially with some of this data that you are putting now in terms of cost improvements.

Yes, first of all, we're not trying to cater to everyone; we are focusing on a select group of companies in the market that recognize the technological and business model advantages. Our aim is to create total value for their customers through reduced time, increased efficiency, and improved results in barrels of oil per day. This involves educating them about the total value proposition, both for exploration and production companies and their service company partners, who we hope will also collaborate with us. The process requires both parties to understand the implications for safety, reliability, and operational efficiency of the completion, as well as the significant business model benefits for service companies, such as reduced personnel, facilities, and working capital. It's essential that they become comfortable with our story, the supporting data, and our commitment as true partners looking out for both our interests and theirs. Our focus is on medium to long-term benefits rather than short-term gains, which fosters meaningful dialogue and partnerships with leading industry figures.

Got it. Are sales moving more toward exploration and production or are they being specified in? Obviously, again, we are seeing cost savings and you are a very well-known entity now.

So we sell exclusively through our service partners, we don't sell direct to the E&P. But we are seeing an increase in specifications coming from E&Ps where they're asking their service companies to consider using our products. But it's very important that we are interested in the health of our customer partner service companies as well as our own suppliers and that the ecosystem is from us to the service company and the service company to the E&P.

Okay. A couple more shorter questions here. Market size, I want to say the last cycle $1 billion, and $1.5 billion obviously, you also introduced the MicroSet tool, which I think increased the market opportunity. Do you think the market size gets back to that $1.5 billion this cycle, and with or without MicroSet?

I believe MicroSet plays a significant role in our future with a comprehensive energy solution. Our target market is both important and substantial in the oil and gas sector. We're seeing a significant rise in gas usage, especially in power applications, although oil consumption may see a decline. While the market may become smaller, it remains attractive, and we anticipate returning to revenue levels equal to or exceeding those of 2019. We focus on generating revenue through unique products that deliver real value to our customers instead of competing on price. This strategy is reflected in the patents we've secured over the past year and their applications. We expect the market in 2023 to be moderately sized, potentially smaller but also tighter and more profitable for both our partners and our company.

Got it. One last question. This is about the international side. The Indian tender was something that always came up, not so much recently, but is it part of the international push that could occasionally bring in significant revenue?

There are various tenders in the Middle East and India markets, so it has been somewhat inconsistent. There has been some delay, but we expect, as Kevin mentioned, that this business is strong with solid margins, and we anticipate it will be on track this year despite a slow start in the first quarter. We are not concerned.

The next question is coming from Matthew Galinko. Matthew, your line is live. I mean there is, Yes, it's various tenders in the Middle East, India markets, so Yes it has been lumpy. There's been some push out there, but again we expect, as Kevin said, for this business, it's a strong business with very strong margins and we expect it to be on track this year just slow out of the gate in the first quarter. So we're not worried.

Hi, thanks. Good afternoon. I appreciate you taking my questions. First, you mentioned pursuing legal action against competitors who may be infringing on your intellectual property. If you're willing to share, what kinds of outcomes are you aiming for? Are you considering extracting licensing fees for the technology used, or are you focusing on strengthening your position? I have a follow-up question as well.

Yes, our approach does not involve licensing, and we want to protect the technology we have heavily invested in developing. We aim for our customers to gain a return on the technology they implement, just as we need to see a return on what we create. There are no free rides, and we simply want others to develop their own technology rather than copying ours.

Got it. Okay. That makes sense. And then it sounds like you had a little bit of deal slippage on the cloud side of the business just expand on that a little bit and talk about your confidence on those deals staying with you and what kind of delays and push outs, are you anticipating?

Yes, we've seen push-outs from anywhere from a quarter to two quarters for the most part. I think it is important to highlight that our backlog was up and going into 2021 versus going into 2020 and so we are seeing good activity and we'd expect that to pick up later in the year also. Just because of the uncertainty that exists until economies get back to more of a normal times, we have seen delays in construction projects and particularly the larger projects that the NobelClad would get involved with.

Thank you. There are no other questions in queue at this time. I'd now like to hand the call back over to Kevin Longe for any closing remarks.

We appreciate everybody's interest in our company and the work that we are doing. We look forward to working with you and talking with you again as the year unfolds. We certainly hope that everybody stays safe from the pandemic and difficult weather, especially our Texas friends and family. And we look forward to the next call and hopefully a stronger back half of this year as we get some of the difficult situations in the world behind all of us. But thank you for your interest in our company.