Below are my notes from Dynamic Material Corporation’s Q1 2008 conference call. It is probably more accurate to describe my notes as quotes but let’s stick with calling them notes.
I intended to save my commentary for a more detailed analysis that I was planning on posting later this week but I got a little carried away with my comments at the end of this post.
Opening Comments – Yvon Cariou, CEO and President
Order bookings at our Explosion Welding segment remained strong and this allowed us to raise our high watermark on our order backlog to $102 million
There is considerable demand within all primary end markets
Both refining and upstream oil & gas have been especially active sectors
Global investment activity in large capital equipment projects remains very active and this is evident in the broad range of orders we are booking into backlog
There are new prospect that are regularly appearing on our hot list
Higher energy and input costs have fueled significant price increases for high quality carbon steel. In addition, strong end-market demand is putting added tension on the carbon steel supply chain.
In recent years, we have been working to strengthen our relationship with suppliers and to broaden our sourcing network.
While pricing and supply issues are presenting our industry and our end markets with some renewed challenges, the underlying fundamentals remain very positive
Demand for our products is strong, diverse and global in nature
As the worldwide leader in the explosion welding industry, we remain very optimistic about our long-term prospects.
Financial Results – Rick Santa, CFO and Vice President
Sales for the quarter were $58.4 million for an increase of $25.3 million over Q1 last year. $15.2 million of the increase was attributable to the DYNA acquisition
Gross margins were lower as a result of: 1) the higher proportion of explosion welding revenue out of Europe, where margins have been historically lower than our U.S. operations; 2) lower margin sales contribution from our new Oilfield Products segment.
Most notable Q over Q changes in expense items were related to our DYNA acquisition
Amortization – There was no amortization or interest expense in last year’s Q1. This year Q1 included amortization expense related to the acquired intangible asses of $2.4 million or 4% of revenue.
Net Interest Expense– This Q1 was $1 million (the year-ago Q had positive net interest)
Adjusted EBITDA was up 66% ($13.5 million from $8.2 million last year)
Guidance – We expect Q2 sales and earnings results to be comparable to Q1. We expect we will meet the full year guidance we provided at the end of last quarter assuming we receive customer orders under anticipated timeframes and metal supplies are adequate to meet our 2008 production goals.
We obviously believe our results in the second half of fiscal 2008 will be significantly stronger than those of the first half.
Q&A – My notes from the Q&A includes all of the “A”s but none of the “Q”s. I have arranged the answers by topic and not by the order that they were given.
Supply Chain Constraints (Carbon Steel)
Renewed and increased tension on the supply chain
Suppliers have strong demand in their natural end markets and from other areas such as the DoD in the U.S. Also, with the USD situation, suppliers have more opportunity to export.
Early in this phase of tightness
Not sure if it will affect anything. All we are saying is that we sense new tightness on the capacity of steel suppliers
We have been and remain active in diversifying our steel providers. We have been diversifying our mix of sources from distributors to mills. Our teams have been very creative with this. We may be able to swell (?) with this as we have in the past but we just think it is fair to present (to shareholders) this added stress on our situation…”that is all.”
Higher Metal Prices (Carbon Steel)
Expecting more price increases
Price increases have not been a negative for us. Traditionally price increases have been more of an opportunity than a problem. We are just taken back by the magnitude.
It is structural….it is beyond supply and demand…it is a structural shift
The magnitude of price increases in the pipeline is uncharted territory
Not in a position today to have a definitive view on how the price increases will impact business
Price increases are not having an impact on quoting activity and we are not seeing things being delayed or pushed back
The total cost of steel in a large project is significant but not the major factor. Even if the price of steel was to double, I am not sure it would alter in a significant way how those projects would be executed. In a total project, the base material is minor.
Not protected against surcharges. There are some cases where previously committed fixed priced (contracts) are being revised unilaterally…so we are dealing with that. As far as going forward there will be surcharges so we are in the process of establishing our protocol there. In our business model we are blessed in the way that we pass-on ALL metal increases. Obviously we are going to try hard to continue that.
Margins and Expenses
Higher sales in the second half of 2008 should result in more efficient absorption of manufacturing overhead (= higher margins).
On the pricing side…once the DYNA backlog gets worked-off, we should see improved margins from the DYNAplat division of DYNAenergetics.
Don’t want to give any specific guidelines on the timing of “more disciplined pricing in Europe” because there are clients and accounts with a history and we don’t want to go in and do the wrong thing but certainly I would hope that by 2009 and 2010 there should be some movement there, but we are very active in spotting opportunities.
Newer equipment (see CapEx below) in Europe will translate into higher capacity and productivity
G&A expenses were at about 10% of sales. It is reasonable to use that % going forward but hopefully it will come down with the increase in revenue we expect in the second half of 2008.
Interest guidance of $5 million is just expense and not net of interest income. Interest income in Q1 was on the high side because they collected interest on a customer account (while the interest collected on the customer account is non-recurring, cash levels are higher now than they were at the beginning of the year).
“Other expenses” on the income statement relate to foreign exchange losses from European operations.
We give guidance for a tax rate of 36-37% because the proportion of sales between the U.S. vs. Europe as well as between Germany vs France or Sweden can fluctuate. We don’t expect the tax rate to fall below 36%.
Explosion Clad vs. Other
Rollbond, weld-overlay, and explosion clad are not interchangeable. They each have their own domains. When the various cladding methods compete it is on the bond areas of the domain. Most of the time when it is explosion welding it is going to stay that way.
(In other words, explosion clad is a viable substitute for roll-bond and weld-overlay but rollbond and weld-overlay are not normally a viable substitute for explosion clad.)
Guidance
Amortization – same amortization in Q2 as Q1. Amortization should fall off in second half (after BOOM works through the inherited backlog of DYNAplat). Amortization should be $2.3 million in Q2, which is adjusted upward for the higher foreign exchange rate.
There is no slowdown in number or level of quotes. Absolutely no slowdown. We remain optimistic that all of that quoting activity will transform into bookings.
The feel of quotations is extremely good.
The near-term project is of very good quality (This comments seems kind of strange. Was Mr. Cariou referring to a specific project? The comment was made at the 15:35 mark on the call. Have a listen and let me know what you think.)
We need the backlog to step-up by the end of Q2 in order to deliver the results we expect to deliver in the second half.
With the booking activity in April and the quoting activity that is on-going, we were comfortable (when we issued the Q1 press release) with the guidance that we provided at the end of last Q (as such, we are still standing by the full-year guidance).
CapEx and Capacity
$10 million CapEx budget for 2008 includes a lot of European divisions. There is some building expansions and replacement of older generation, large pieces of equipment with new generation (equipment) so that will translate into capacity and also productivity.
Mt. Braddock capacity utilization is probably somewhere around the mid 70% level
Acquisition
Not a lot of surprises from the acquisition. Very comfortable that the (DYNA) clad team is quickly embracing some of the DMC way of life (pricing, quoting, fast servicing customer, analyzing markets, bringing new things on a couple market applications that we didn’t know about). They have a couple of things in their operations related to explosives that we like very much.
We have a couple of interesting JVs that we are not in a position to talk about too much yet. Just to indicate, Canada and Russia is the location for those things. We’re trying to see how our general strategy can be fielded for that division
We would like to see more financial impact immediately but the fundamentals, the team, the operations, their potential, their markets….we feel rather encouraged by that.
Other Divisions
Oilfield Products - Sales from Oilfield Products division was slower than expected in Q1. That business is impacted by the general flow of orders and the timing of large orders, like our cladding business. Management at the Oilfield Products division is optimistic they can deliver against full-year expectations.
AMK – expect regular increases in sales over the year. The conditions seem to be in place for us to have a significant up-tick but we will see….we have been burned in the past. Certainly this level will stay or go up. We don’t anticipate it will slow down. Can it go up much faster, much higher…..it is too early to say.
Quick Thoughts
Countless times on the conference call management referenced the strength they are seeing in their end markets and that the level of quoting activity remains very strong. I recently started an inventory of projects in BOOM’s end markets that are likely to appear on BOOM’s “hot list.”. In looking at my inventory, I have no doubt BOOM is busy quoting not only a large number of projects but also some very large projects.
While there are some unknowns and risks associated with the rising price of carbon steel and the tightness in the supply chain, management continues to believe they will achieve their full-year guidance for 2008. Furthermore, BOOM has been working for the past year or more towards expanding their supplier network and bringing some of the prep work in-house. As for higher prices, Mr. Cariou said that rising metal prices has traditionally provided more of an opportunity than a problem. These risks should be kept in mind but also in perspective. Management has given no indication that these risks are in anyway impacting the level of activity that they are seeing in the market place and cannot say if they will have any impact going forward. Management merely felt it was reasonable to inform the investment community of what they are seeing in the marketplace.
If management is expecting a significant improvement in the second half of the year, does it really matter if Q2 results are similar to Q1? And, were Q1 results really that bad? After all, BOOM generated $7.3 million in operational cash flow, added about $8.5 million in cash to the balance sheet, and increased EBITDA 62% (I prefer to use EBITDA instead of Adjusted EBITDA, which increased 66 %.).
BOOM is the worldwide leader in explosion clad. BOOM recently acquired its only significant competitor in Europe and the only competition that remains is from a company in Japan that mostly operates and competes locally. I encourage any investor interested in BOOM to look at BOOM’s end markets and consider the number and size of some of the projects that are planned for the next 5 years or more.
The most recent earnings report does not change my expectations for BOOM in the long-term. Sure my investment is worth a little less today than it was last Thursday but I am already looking to the first half of next year. Management is expecting the second half of 2008 to be significantly stronger than the first half of 2008 and I would be willing to bet that trend continues into the first half of 2009. When we get into the first half of 2009, the year-over-year comparisons should be impressive.
If you are a long-term investor, forget about the analysts that can only focus on one quarter at a time. Forget about the analysts that call into the conference calls looking for management to build-out their models for next quarter. Look at the big picture and you will see a strong management team that is preparing BOOM, the market leader in explosion welding technology, for the growth that lies ahead.
Well, that is the end of my little pep talk. I intended on making only a few quick comments…so much for that idea. For fun let’s see when the analysts start telling us to get back into the BOOM. Something tells me it will be at a higher price than what they told us to get out at. Although, I have to admit, Sidoti made a good call prior to earnings.
I hoped this helped. I have to go through the 10Q in more detail tomorrow.
Regards,
Tuff
Links
Q1 Earnings Report
Q1 Conference Call
Monday, May 5, 2008
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