BOOM Q4 Earnings Release and Conference Call

Last Monday, I promised I would put together a few blog entries detailing my thoughts and analysis on Dynamic Materials Coporation’s (“BOOM”) recent earnings release and conference call. In the same blog entry, I went through the process of estimating BOOM’s Q4 financial results excluding the impact of its recent acquisition of DYNAenergetics (“DYNA”). Today, I will highlight and provide commentary on what I consider to be key takeaways from the earnings release and conference call. As I have already gone through the financial results and I intend to discuss guidance in another blog entry, I am going to focus on more general aspects of them both.

Backlog and Bookings

Please note that management reports backlog for its Explosive business only. As such, the discussion and calculations in this section are only applicable to the Explosive business segment.

BOOM reported a backlog of $100 million at the end of Q4. Excluding the $21.5 million contribution from the DYNA acquisition, BOOM’s core backlog was $78.5 million compared to $77.1 million at the end of Q3 and $68.8 million in the year-ago quarter.

On the conference call, Mr. James Bank, an Analyst with Sidoti & Company, questioned why, at a time when BOOM’s end-markets were incredibly strong, the core backlog was essentially flat compared to Q3. In response, Mr. Yvon Cariou, BOOM’s CEO, said quoting and booking activity remained significant but the lack of unusually large contracts and the expanded capacity resulted in a stable backlog.

BOOM’s capacity expansion project, substantially completed in Q3 2007, doubled the capacity of its U.S. operations and contributed to the 33% increase in sales from the first half of 2007 to the second half of 2007 (the 33% increase excludes the DYNA contribution in Q4). While the jump in sales resulted in some backlog contraction from Q2 to Q3, I was pleasantly surprised by the modest increase in core backlog from Q3 to Q4. I was expecting several quarters of contraction before seeing some stabilization. What was even more impressive was the fact that the backlog was stable without the contribution of any announced contracts.

With the increased capacity, I am focusing more on bookings, or new orders, rather than backlog. As management doesn’t report quarterly bookings, I will go over how I calculate quarterly bookings. Change in backlog from the beginning of a quarter to the end of a quarter is largely a function of sales relative to bookings during that quarter. If sales are less than bookings, the backlog will increase. If sales are greater than bookings, the backlog will decrease. In other words:

Beginning Backlog – Sales + Net Bookings = Ending Backlog

Using a little basic Algebra, I get:

Net Bookings = Ending Backlog – Beginning Backlog + Sales

If I apply the above to Q4 and exclude DYNA’s sales and backlog, I get:.

Net Bookings = $78.5 million – $77.1 million + $45.8 million = $47.2 million

The $47.2 million in new bookings in Q4 was substantially higher than the $32.7 million in Q3 and $34.3 million in the year-ago quarter. Looking at BOOM’s quarterly bookings over the past four years, Q4 bookings were well ahead of all the other quarters except for Q2 2007, which benefited from the $8.3 million alternative energy contract.

Don’t let the modest increase in backlog fool you. In order to assess demand, focus on bookings. Furthermore, don’t get carried away looking at bookings in just one quarter. Because the timing of contracts can distort booking activity from quarter-to-quarter, focus on the trend over several quarters.

Alternative Energy

In May of 2007, BOOM announced an $8.3 million alternative energy contract. This was the first alternative energy contract announced by management. On the Q4 conference call, management, for the first time, referenced alternative energy as a key market segment. Later in the call, a “private investor” requested additional information on the opportunities in this market segment. Mr. Cariou commented that the sector was developing and there were a lot of interesting opportunities. Furthermore, he specifically mentioned solar as a key application. He then turned the call over to Mr. John Banker, VP of Sales & Marketing, for comment. John went on to discuss the opportunities in the alternative energy sector that closely mirrored what was written in the 10K:

“Today's high oil and gas prices are driving significant demand for capital equipment in the alternative energy and non-traditional hydrocarbon sectors. Frequently, alternative energy technologies involve conditions which necessitate clad metals. Solar panels predominantly incorporate high purity silicon. Processes for manufacture of high purity silicon utilize a broad range of highly corrosion resistant clad alloys. Many geothermal fields are corrosive, requiring high alloy clad separators to clean the hot steam. Cellulosic ethanol technologies often require corrosion resistant metals such as titanium and zirconium. Many of the non-traditional hydrocarbon processes require equipment similar to the refinery and upstream oil and gas sectors. Coal gasification, tar sands production, and similar operations typically present corrosion issues necessitating clad equipment.”

Two things I will note from all this. First, I think it is clear that the $8.3 million alternative energy contract was for a silicone manufacturing facility. Second, the solution to the global energy crisis needs to encompass traditional hydrocarbon, non-traditional hydrocarbon and alternative energy sources. BOOM, as the leading manufacturer of explosion clad metal plates, is in a strong position to benefit from all aspect of the solution.

As a refresher, BOOM’s key market segments include:

oil and gas;
petrochemicals and chemicals;
alternative energy;
hydrometallurgy;
power generation
aluminum production;
ship building; and,
industrial refrigeration.

Size Matters

It is always exciting when BOOM issues a press release announcing a large contract. Not that I am counting but BOOM hasn’t announced a large contract in 293 days. If BOOM’s end markets are so strong, why hasn’t management announced any new big contracts? For starters, management has an informal threshold range for contract announcements. As revenues have increased, so has the threshold for contract announcements. Second, the price of cladder metals, in particular nickel, went through a correction in 2007. As such, there were some contracts that would have been above the threshold range but were not because of the lower prices for cladder metal. It is important to point out that fluctuations in metal prices don’t have an impact on a contracts contribution to the bottom line (re-confirmed by Mr. Cariou on the conference call). Finally, large contracts are very much a matter of timing. I have no doubt that there are a number of large contracts in the works and they will eventually result in contract announcements. While we haven’t had a contract announcement in 293 days, there could just as easily be several announcements in a short period of time.

Based on management’s comments in the press release and conference call, I expect to see at least one large contract announcements in the near future. While, each member of the management team had a comment about mid to large-sized projects coming down the pipeline, Mr. Banker, as the VP of Sales & Marketing, is probably the best one for me to quote:

“There are quite a number of relatively large projects sitting out there that seem to be cuing up to come through the shoot as we move forward.”

One last note before moving on….management always stresses the importance of the $1 to $5 million contracts that don’t get announced because they would be issuing press releases on a regular basis. Even though there have been no contract announcements in several months, BOOM’s quarterly bookings have been very strong and the backlog has increased. The increase in backlog has come in the face of increased capacity, record sales and the shipment of large contracts already in the backlog. We can thank the smaller contracts for maintaining the high backlog.

Actions Speak Louder than Words

Over the last two years, BOOM has doubled the capacity of its U.S. cladding business, expanded its AMK welding facility, undertaken a modernization program at its European operations, and acquired one of its two major competitors. Capital spending in 2007 was about $14 million and management plans to spend another $10 million in 2008 plus a couple million from what was leftover from the 2007 budget. The majority of the 2008 capital expenditures will be spent on the expansion of its European manufacturing operations (building and equipment additions).

On conference calls, management responsibly exhibits conservative optimism when giving general and specific guidance about the future. Without over-hyping the underlying market fundamentals, management speaks favorably about the high level of booking activity, growing “hot list”, and expectation for continued capital spending from its end markets. In the most recent earnings release, Mr. Cariou said that current explosion-welding quoting volume and end-market activity suggests the robust capital spending taking place across most of DMC's end markets will continue during 2008.

While management’s words give me the warm and fuzzies, it is management’s actions, in the form of market positioning through capital spending and the recent acquisition, that gives me the confidence I need as an investor.

Competition

Competition was addressed briefly on the conference call but I will go into a little more detail as it will not only highlight BOOM’s favorable position in the marketplace but also possible opportunities for acquisitions.

Asahi-Kasei Corporation, a Japanese holding company, has a division that manufactures explosion clad metal plates. Asahi-Kasei’s explosion clad division has been mostly regionally focused. While benefiting from the overall strength in demand for explosion clad, Asahi-Kasei’s explosion clad division has not added significantly to capacity, if at all.

There are several small companies in China that manufacture a less sophisticated, low-end explosion clad product that is intended to compete more with roll bond than explosion clad. There is no evidence that these companies are developing the sophisticated cladding product manufactured by BOOM.

Aside from the division of Asahi-Kasei and with the acquisition of DYNA, BOOM is the only significant provider of explosion clad metal plates in the world. At the same time, BOOM’s explosion clad competes with other cladding processes such as rollbond and weld overlay. Nonetheless, rollbond, weld overlay and explosion clad seem to have their own niches within the overall clad market and most of the time they don’t compete in the same space.

Another Acquisition?

Is another acquisition in the cards for DMC? In the earnings release, Mr. Cariou said:

“From a geographic perspective, activity in our U.S. and European home markets remains strong. We also are seeing considerable demand from global markets such as India, China, Russia and the Middle East. We therefore, will continue to explore opportunities to expand our global presence.”

When I listened to the conference call, the above quote stuck in my mind and I listened for potential clues as to how management might address this growing demand.

Asahi-Kasei’s cladding division would seemingly be the only business worth acquiring. Mr. Cariou referred to Asahi-Kasei’s explosive division as “our Japanese friends” and called them a good competitor of high quality. I think it was the Q2 2007 conference call that Mr. Cariou had similar comments about “our European friends.” Also, there was a funny pause by Mr. Rick Santa, BOOM’s CFO, when he was answering a question from Mr. Bank about primary uses of cash. When I first listened to the call, I thought there was something behind the pause like Mr. Santa was debating what to say and what not to say. When I listened to the call a second time, I wasn’t so sure and thought maybe he was just formulating his response in his head or had just taken a sip of water or something. Have a listen and let me know what you think (minute 19:53 into the call).

If management is not going to address demand outside of its home markets by acquiring Asahi-Kasei, they might also consider an expansion of its sales network or an in-house initiative to create a manufacturing facility in a strategic location. Another possibility might be an acquisition of one of the Chinese explosion cladding companies mentioned above. This approach would alleviate some of the barriers to establishing a physical presence in China and BOOM would provide the acquired company with the technical know how and equipment to produce the same type of explosion clad plates as those produced by BOOM.

Supply Chain

Supply chain constraints have been a concern for both BOOM management and investors for over a year. The issue originated with the availability of cladder plates and once that issue resolved itself there were issues with the availability of high-alloy steel backer plates.

At the end of 2006, management guided 2007 revenue growth in the 20% range, which was seemingly below what most investors were anticipating. Supply chain constraints were probably the most significant reason for management's conservative estimate for top-line growth in 2007. Over the course of 2007, analysts and investors sought details from management on the status of the supply chain. In an effort to relieve some of the pressure, management discussed how they were seeking to expand its supplier network and increase the amount of finishing work done in-house. Unfortunately, there are a limited number of suppliers of the specific type of backer plate used by BOOM. While the situation remained tight throughout the year, the overall impact was not that significant and BOOM reported over 39% organic revenue growth.

On the latest conference call, an analyst asked about the supply chain. Mr. Cariou described the situation as tight, stable and a little more relaxed. Mr. Banker echoed Mr. Carious comments and also suggested that lead times for cladding metals were shortening.

For now, I think the supply chain issues are mostly behind us and not the primary business constraint. I think the most significant constraint at this point is the availability of qualified engineers to work on the vast number of projects that are coming down the pipeline. Engineering and procurement firms have accumulated massive backlogs that are growing every quarter. The backlog of projects will eventually trickle down to BOOM but it will probably take a little more time than it would have otherwise.

Credit Market Turmoil

In light of what has been going-on in the markets as of late, I thought it would be worthwhile to note management’s response to a question about how the turmoil in the credit markets are affecting BOOM (coincidently, Mr. Carious quote also highlights what I wrote in the previous section). Mr. Cariou responded:

“We are not seeing directly any of the effects of the credit crunch you are referring to. We are not seeing that. We are seeing a list of projects that remain healthy. We do hear from the industry that it is difficult to find professional talents to execute the designs, the manufacturing, and the exploration of a number of projects. We do hear about some boards looking at the situation and there has been some inflation in the cost of projects. Although, we have heard about that, we have not seen any direct impacts and our list of project agreements remains very healthy. Maybe I will give the call over to John Banker. He can comment on that. What do you think John?”

To that Mr. Banker replied:

“We are certainly not seeing any evidence in their project list of things being cancelled or slowing down of new things showing up on the list. We are tracking things that are relatively close to purchase. We are generally are looking things forward only four to six months in great detail, but again no evidence of any trends at present.”

AMK

AMK only represents a small portion of BOOM’s overall revenues and, as a result, takes a back seat to the Explosive segment. Nonetheless, AMK increased revenues 48% over the year-ago quarter and management expects improved revenue contribution from AMK over the course of the 2008.

What’s Next

In the time I started writing this post and now, BOOM filed its 10K. I will review the report and write another blog entry if there is something worthwhile to talk about outside of what I have already discussed. Finally, I plan to go through management’s guidance for Q1 2008 and 2007 and put together some estimates.

Disclosure

I have owned shares of BOOM for several years. Last week I added to my BOOM position for the first time in about 22 months.

Good luck,
Tuff