So why are shares trading lower? Are you feeling a little confused or maybe a bit nervous? In this blog entry, I am going to briefly outline the facts of the report and subsequently provide my thoughts, notes and comments on some specific issues.
Q1 2007 Results
Sales (in millions)
| ---Q1 2007--- | ---Q1 2006--- | ---% Change--- | |
| Explosive Metalworking | $31.5 | $24.2 | +30.3% |
| AMK Welding | $ 1.6 | $ 1.0 | +60% |
| Overall | $33.1 | $25.2 | +31.5% |
DMC’s sales of $31.5 million for the first quarter of 2007 beat both analysts’ and managements’ estimates for the quarter. Late in the quarter, DMC received earlier than expected shipments of high alloy steel backer plates. The early shipment of backer plates along with the utilization of recently purchased equipment and the hard work of DMC’s employees contributed to the higher than expected revenues for the quarter.
In reviewing the 10Q filing it is evident that $5.4 million of the $8.7 million Ambatovy contract shipped in Q1, leaving $3.3 million to ship in Q2.
Gross Profit Margins
Gross profits margins for the quarter fell to 32.8% versus 36.9% in the year-ago quarter. Management attributed the lower gross margins to the normal quarterly fluctuations in gross margins, which are driven largely by product mix. Looking back at the quarterly reports over the past seven or eight quarters, gross margins have indeed fluctuated from quarter-to-quarter but the overall trend has been higher. I suspect gross margins for the year will be considerably higher than where they were in the first quarter, which is near the lower end of the range of the past eight quarters.
Operating expenses
Operating expenses as a percent of sales improved to 10.0% compared to 11.3% in the year-ago quarter. The lower operating expenses as a percent of sales were the result of higher sales spread over a relatively fixed cost structure.
Operating Income and Margins
Operating income for the quarter was up 17.3% to $7.5 million from $6.4 million in the year-ago quarter. Operating margins fell to 22.8% from 25.5% as a result of the lower gross margins offset somewhat by the lower operating expenses as a percent of sales.
Net Income and EPS
Net income from continuing operation was up 18% to $4.88 million from $4.13 million in the first quarter of 2006. As there has been close to no shareholder dilution in the last year, the percent increase in diluted EPS from continuing operations mirrored the percent increase in net income from continuing operations. DMC’s diluted EPS from continuing operations increased to $0.40 from $0.34 in the year-ago quarter. Note that in the first quarter of 2006, DMC recorded a one time gain of $0.11 per diluted share related to the sale of a real estate purchase option associated with its discontinued Spin Forge operation.
Balance Sheet
The balance sheet remained strong with nearly $20 million in cash and close to no long-term debt. Working capital increased 6.5% from the prior quarter and 52.7% from the year-ago quarter. Accounts receivables decreased a bit from the prior quarter and days-sales-outstanding was an impressive 47 days. I want to touch on inventories but I will save it for a little later in my post.
Cash Flow Statement
Cash flow from operations came in it $4.9 million, which closely mirrored net income. Aside from the $3.9 million in capital expenditures, there was nothing else worth noting on the cash flow statement.
Backlog
The backlog at the end of the quarter stood at $67.9 million, down slightly from the record high backlog of $68.8 million last quarter and up 60.5% from the $42.3 million backlog in the year-ago quarter.
Guidance
Unquestionably, it was managements’ guidance for Q2 that left some investors disappointed and sent shares lower in after-hours trading. Here is the quote from the Rick Santa, CFO:
"We previously indicated that the last three quarters of fiscal 2007 could be stronger than the first quarter, which we believed would be impacted by metal supply issues. Given our better-than-expected Q1 performance, we now believe that our second quarter results will likely be comparable to those of the first. For the full fiscal year, we are reiterating our forecast of year-over-yeartop-line growth in the 20 percent range."
My Thoughts, Comments, and Notes
Guidance
As the drop in share price since the release of earnings is seemingly attributable to management’s guidance for Q2, I want to begin my commentary with managements’ guidance. Look at guidance from this quarter and compare it with managements’ original guidance for 2007:
“With more than $68 million in our order backlog and an extensive range of contract opportunities on our hot list, we are looking to achieve revenue growth in the 20% range during fiscal 2007 …tightness in the supply chain is likely to lead to first quarter financial results that will approximate the average results we reported during the first three quarters of fiscal 2006. In light of our full- year growth expectations, we believe the average quarterly results during the balance of the fiscal year will be stronger than those of the first quarter. In addition, we believe that improvements in the supply situation could result in even better full-year financial growth than we are currently projecting."
So what has changed? Nothing! While some revenue shifted from Q2 to Q1, actual results for the first half of the year and the full year are panning out as expected by management. By shifting some revenue from Q2 to Q1, DMC is actually in a better position to potentially move ahead of expectations starting in Q2. In my original post covering DMC, I said that I expected results to exceed managements’ expectations. I made this statement largely expecting the first half of the year to be in-line with management expectations with the second half of the year exceeding expectations. With the natural gas contract shipping in the third quarter of 2007, I believe the higher margins and efficiencies associated with that contract to provide a nice boost to third quarter results especially when compared to the year-ago results.
Based on managements’ guidance for the full year, management is expecting revenues of roughly $136 million. If I subtract actual revenues for Q1 and expected revenues for Q2 from the full year estimate, I am left with an average of $35 million in revenues for Q3 and Q4, which is only a modest increase in revenues from the first half of the year. When I listen to the conference call and consider the various factors playing into the expected weakness in the first half of the year relative to the second half of the year, I am increasingly convinced that the average quarterly revenue in the second half of the year will exceed $35 million.
To those taking notes at home, on three other occasions management has issued negative near-term guidance that resulted in a decline in or a ceiling on DMC’s share price. The negative guidance on each occasion followed exceptionally strong earnings results. On two of the three occasions, results in the subsequent quarter were significantly better than expected. I am not saying anyone should ignore guidance. All I am saying is that management tends to be conservative in its outlook and that certain events may occur in any given quarter that may result in a more favorable outcome. While I find managements’ seemingly conservative commentary to be frustrating at times, I think management does a reasonable job of managing investors’ expectations. In my opinion, a negative surprise would result in far greater losses to individual investors relative to a pullback on conservative guidance.
Supply Chain
Does anyone remember DMC’s third quarter 2006 conference call when management fielded a number of questions relating to the supply chain? At the time, the supply chain was tight because a supplier experienced a significant equipment failure. I am not 100% certain but I believe it was a supplier of clad metal as opposed to backer metal. During that call, management mentioned that its provider of backer plates in the U.S. received a sizeable order from the Department of Defense (DoD) for the same type of plates utilized by DMC. As a result of this order, management expected further tightness in the supply chain during the first half of 2007. Assuming that the DoD order will be largely complete by the end of the second quarter, there will be at least some level of relief in the supply chain going into the second half of the year. Unfortunately, this issue was not discussed on the last conference call and I was unavailable for the live event to ask about it myself.
Based on comments in the conference call management is confident that the tightness in the supply chain will improve over time. I am not sure if management made this comment in relation to the completion of DoD order or if it was just a general comment. My guess is that it was a combination of both. Despite managements’ expectations for improvements in the supply situation, they are taking steps to stay ahead of the issue by handling more of the finishing work in-house and by expanding their supplier network to include some smaller suppliers of high alloy steel. Presumably these efforts should yield some dividends in the near future. Furthermore, management has taken steps to better monitor the supply chain and suppliers are working hard to meet demand. Based on management comments, I believe management is seeing some evidence of improvements in the supply chain but they are unwilling not make any overly optimistic comments to this regard until the improvement is evident or at the very least imminent.
On the conference call there was some discussion regarding inventory. Inventories increased by nearly $2.5 million in the quarter and inventory turns were down modestly. Management indicated that they were not overly concerned with inventory levels because everything in inventory relates to a specific order. With every order, DMC has to have a backer plate and a clad plate. Instead of trying to time the orders of the different metals to coincide with each other, DMC requests suppliers to ship the metals as soon as possible. As such, it is reasonable to assume that DMC has an inventory of clad plates waiting for its corresponding backer plate. This being the case, DMC is in a position to capitalize once again on earlier than expected shipments of backer plates.
Demand and Backlog
Moving away from the supply chain, demand remains strong and the backlog is near record levels despite considerably higher shipments in the last two quarters. On the conference call, management said that most of the backlog would ship by the end of the year. With a backlog of $67.9 million and $103 million in additional sales required to meet the 20% guidance, management has visibility on 66% of the remaining revenue, which is very promising.
What was most impressive with regards to the backlog at the end of the quarter was the fact that the backlog remained near record levels reported at the end of Q4 2006 despite the high level of shipments in Q1 and the fact that no order in the quarter exceeded $2 million. As this was the first real insight with regards to the volume of smaller orders that DMC is dealing with on a regular basis, I was surprised by this fact.
While there were no large orders announced in the first quarter, both the CFO and CEO indicated that they were quoting a number of large projects and they were “reasonably confident” they would be reporting on a large order “soon”. Depending on the timing of that order and other factors relating to the order, revenues from that order may or may not be included in 2007. Nonetheless, DMC will be completing shipment on Ambatovy in Q2 and commencing shipments on the natural gas contract in Q3. If management is able to book the large order noted above sometime in the second quarter with the expectation of shipping at least a portion of that order sometime in the fourth quarter, managements’ guidance for 20% revenue growth will be out the window. Please keep in mind that there are no guarantees that DMC will get this order or that DMC will be able to ship at least portions of this order by the end of the year.
In responding to one caller’s question, management emphatically stated that they are not seeing any slowdown in activity in the U.S. or abroad. Furthermore, management said they are seeing continued global strength across all of it market segments.
Capacity
DMC is still receiving shipments on some of the equipment related to the Mt. Braddock expansion but the expansion project is nearly complete. The only delay relates to a large press that will be delivered sometime in Q3. If this is the only delay, management deserves credit for completing this project largely on-time and within budget. The Mt. Braddock expansion is not only on scheduled but it also played a key role in the better than expected results in Q1. The modernization projects in both France and Sweden are progressing nicely and the AMK construction project is nearly complete. According to management, DMC is the only player in its industry making significant investments in new capacity. Management expects their capital projects to help them maintain their position as a global leader (34-40% global market share) in explosion welded metals.
Gross Margins
As mentioned earlier, gross margins for the quarter were at the low end of the recent range. Management attributed the lower gross margins in the quarter to product mix. Gross margins have fluctuated from quarter-to-quarter but the overall trend has been higher. I expect gross margins to continue to fluctuate but I expect the trend to remain positive with the opportunity for noticeable improvement in 2008 as the company is able to sell into the additional capacity.
As a side note, I crunched some numbers based on the Q1 results and the recent range of gross margins. If I substitute the actual gross margins in Q1 with the highest gross margin percentage in recent history (36.87% in Q1 2006), excluding the abnormally high gross margin in Q4 of 2007, while holding all other factors constant, I get an EPS of $0.47 per diluted share. If I substitute the gross margins from Q1 with the average gross margin in the first three quarters of 2006 (35.37%), again excluding the abnormally high gross margins in Q4 of 2006, I get an EPS of $0.44 per diluted share. My point in this exercise is to demonstrate that DMC can still expand earnings from Q1 to Q2 even if revenues are flat, as expected by management.
Conclusion
DMC reported better than expected top and bottom line results in the first quarter of 2007. While management expects second quarter revenue to be in-line with first quarter revenues, the first half of the year is playing-out largely as expected. As indicated earlier, I have been expecting and continue to expect any surprise to the upside to come in the second half of the year. Nonetheless, DMC’s increased capacity and inventory of clad plates puts it in a position to capitalize in the event of an earlier than expected shipment of backer plates once again in Q2. Demand is strong across all segments and additional capacity is now available, with additional capacity coming on-line in the quarter. Tightness in the supply chain remains the biggest issue and I expect this situation to steadily improve over time. Again, nothing has changed since the last earnings report.
Regards,
Tuff
If a conference call transcript is not made available in the next week or so, I will post my conference call notes.
Dynamic Materials Corporation (Public, NASDAQ:BOOM)
Sources
10Q Filing
Press Release
Conference Call
1 comment:
Thanks for the analysis. I have been following the company for a while, although I do not (yet) own any shares. I did not understand the market's reaction to the quarterly report, which I saw as positive. Your discussion helps me move toward a decision.
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