Déjà Vu - A BOOM Review

I put together some quick thoughts on BOOM's Q2 results.

Guidance

In the first quarter earnings release, management said they expected to achieve full-year financial forecasts and the company’s financial performance during the second half of the year would be significantly stronger than that of the first. At the same time, management cautioned investors about uncertainty surrounding the future pricing and availability of carbon-steel backer plates. On the conference call, management described the carbon steel situation as “somewhat unprecedented” and admitted they were unsure of the potential near-term impact. Given the uncertainty, management qualified their expectations for the second half of the year as follows:

“…management expects that prior 2008 full-year financial forecasts will be achieved, provided expected customer orders are received under anticipated timeframes and metal supplies are adequate to meet 2008 production goals.”

After reviewing the Q2 earnings release, it was immediately clear why shares of BOOM were trading lower in afterhours. Longer lead times for carbon steel backer plates were going to have a significant impact on third quarter results and management revised their expectations for 2008 accordingly.

“…although year-to-date bookings have been strong, longer lead times on the delivery of carbon steel in the United States are expected to result in sales during the second half of 2008 that will be approximately 5% less than the first half of the year. Sales in the third quarter are expected to be up to 20% less than second quarter sales, while fourth quarter sales are expected to be equal to or above those of the second quarter.”

Sales

Sales guidance in the 10Q reads a little differently from the guidance in the earnings release. According to the 10Q, Q3 Explosive Metalworking sales are expected to be up to 20% less than Q2 (the press release makes it sound like overall sales). With sales of approximately $53.0 million in Q2, Explosive Metalworking sales could be as low as $42.4 million in the third quarter.

On the conference call, management said they expected the Oilfield Products division to report 30% higher sales in the second half of the year compared to the first half of the year. The 10Q gives a range of 20-30% higher. Furthermore, the 10Q indicates that most of the improvement is expected to occur in the fourth quarter. If I take sales in the first half of the year and multiply by 1.3 and then divide by two, I get average quarterly sales of just over $8.0 million for Q3 and Q4. If I assume all of the increase comes in the fourth quarter, I get Q3 sales of $6.2 million (Q3 sales = average quarterly sales in 1H). In my model, I will probably estimate Q3 sales of approximately $7 million, leaving about $9 million for Q4. While this approach is reflective of the information provided by management, my gut tells me Q3 sales will be similar to Q2 and sales in the second half will be better than 30% higher than the first half.

According to the 10Q, management expects AMK sales in the second half of the year to be comparable to or slightly better than the first half of the year. I was hoping to see more from AMK in the second half of the year, but current guidance would put 2008 sales at least 26.5% ahead of 2007. Keep in mind that a majority of AMK sales are tied to GE’s H System turbines. I have not seen any press releases announcing any new installations.

GE’s 7FB and 9FB turbines utilize similar materials as the H System. I can’t help but wonder if AMK does any work on the 7FB or 9FB turbines.

If I take the worse case scenario for Q3 (Explosive sales down 20%, Oilfield Products sales of $7 mil and AMK sales slightly higher), I calculate sales of approximately $51.7 million in Q3 compared to Q2 sales of $63.2 million and year-ago sales of $42.1 million.

Gross Margin

As a result of fixed costs being spread over lower sales, management expects Q3 gross margin to be 28- 29% compared to 30.15% in Q2. While I am not excited about expectations for lower gross margin in Q3, I am not overly concerned. I believe the supply chain issues will be short-lived (in terms of impact on BOOM), sales will move higher and BOOM’s gross margin will improve accordingly. In fact, management expects Q4’s gross margin to be comparable to the first two quarters based on the expectation that Q4 sales will be equal to or somewhat better than sales in the first two quarters.

Amortization and Interest Expense

At the current exchange rate, management expects 2008 amortization expense to total $7.7 million. To date, BOOM has recorded $4.3 million in amortization relating to the acquisition of DYNA. The remaining $2.9 million in amortization expense should be spread evenly over the next two quarters. Amortization will be lower in the second half of the year because the intangibles related to the backlog have been fully amortized.

Management expects pre-tax income to be impacted by $5.5 million in interest expense. To date, BOOM has recorded roughtly half of its expected 2008 interest. The expected interest expense is not net of interest income. Last quarter BOOM recorded just under $100,000 in interest income. Given the $10.8 million increase in cash on the quarter, interest income in Q3 should exceed Q2.

Note: A stronger dollar will have a somewhat favorable impact on amortization and interest expense.

Taxes

For fiscal 2008, management now expects a blended effective tax rate of 32-33%. In the first half of the year, BOOM’s effective tax rate was 34.33%. To be honest, I am not sure how or when the adjustment will occur to bring the overall effective tax rate down to 32-33%. Nonetheless, the effective tax rate in Q3 and/or Q4 should be below the 32-33% range.

Supply Chain Woes

Déjà vu

Just over a year-ago, when BOOM reported Q4 and full-year 2006 results, management warned that Q1 2007 would be negatively impacted by supply chain constraints. Given the tightness in the supply chain at the time, management guided for Q1 revenues of $26 million compared to Q4 revenues of $35.7 million. The market was not particularly fond of the guidance and sent shares of BOOM lower.

Ultimately, BOOM reported Q1 2007 revenues of $33.1 million, significantly better than expectations. On the Q1 2007 conference call, management said they received a shipment of materials late in the quarter and the Mt. Braddock team worked diligently to process orders before the end of the quarter. Sound familiar? As Q1 2007 results were significantly better than management’s expectations and BOOM was still working through its supply chain issues, management said Q2 revenues would approximate Q1 revenues. Once again, the market didn’t like the guidance and sent shares of BOOM lower.

On July 26, 2007, BOOM reported Q2 revenues that were slightly better than expected and earnings that were 16% better than Q1. In the earnings release, management said there was still tension in the supply chain for carbon-steel backer plates but they expected very strong results in the second half of the year.

BOOM delivered as expected on the second half of 2007. Despite the setbacks after BOOM reported Q1 and Q2 results, shares of BOOM were up over 100% in2007.

The Point

This isn’t the first time management has had to deal with supply chain constraints. In 2007 management dealt with the same issue by expanding their supplier network, bringing some of the finish work in-house and eventually re-aligning the timing of raw material shipments with the timing of orders. Having gone through this issue in the past and successfully working through it, management is in a better position to deal with it today.

The supply chain doesn’t have to improve in order for things to get better for BOOM; it only has to stabilize! There was still tension in the supply chain at the end of Q2 2007 and BOOM reported exceptional Q3 and Q4 results. As things stabilize management will once again re-align the timing of raw material shipments with the timing of orders. If you listen to the Q&A session of the most recent conference call, management tried making this point clear to one of the callers. Furthermore, management said that the tightness in the supply chain was probably past its peak, they didn’t expect it to get worse and their might be some modest, though not dramatic, improvement. Again, the situation only has to stabilize.

In 2007, tightness in the carbon-steel supply chain pushed some revenues from Q1 and Q2 into Q3 and Q4. I expect current tightness in the carbon-steel supply chain to shift some revenues from Q2 and Q3 into Q4 and Q1. To be honest, I am just not all that concerned about a modest shift in the timing of revenues. Demand for explosion clad remains strong, the outlook is positive and BOOM is well positioned for the future.

The Hidden Benefit

When supplies are tight and demand is high, prices go up. Given the strong demand and limited supply of carbon-steel backer plates, prices are high and have been moving up.

BOOM systematically passes down the cost of metals to its customers. When metal prices increase, typically there is no deterioration in BOOM’s gross margin (noted on CC). As such, pure gross profit dollars will increase with higher metal prices.

Note: BOOM has to be careful when carbon-steel prices are going up and clad metal prices are going down. Otherwise, the economics might push customers toward solid metal as opposed to explosion clad.

Orders, Backlog, Demand (Explosive Metalworking only)

By my calculations, BOOM booked $53.0 million in new orders in Q2 compared to $42.4 million in the prior quarter and $49.9 million in the year-ago quarter. In the year-ago quarter, BOOM booked a large, $8.3 million, order.

As a result of strong bookings in Q2, BOOM’s backlog increased to $104.9 million compared to $102.1 million in the prior quarter and $84.7 million in the year-ago quarter.

If Q3 revenues are 20% less than Q2 and Q3 booking are in-line with Q2 bookings, BOOM’s backlog will grow to over $118 million.

In reading the press release and listening to the conference call, management is very upbeat about the future prospects of the company. On the call management described its “hot list,” list of potential contracts, as being very robust and spanning a broad array of industries. Based on conversations with end-market customers and the pipeline of projects schedule scheduled for construction in coming years and beyond, management is “very optimistic” about BOOM’s long-term growth prospects.

Bookings in Q1 and Q2 were strong. Despite the strength, management had plenty to say about the timing of orders and how some projects have gone back for re-approval after increases in certain input costs. Call me crazy but I think there are a couple of good sized projects that management expects to book in the near future. I have noticed a number of large projects in BOOM's end-markets that are at or near the procurement phase. I made the same comment after last quarter and there were no large contract announcements. Nonetheless, I still think they are coming (sounds like I am waiting for aliens to land). Keep in mind that BOOM’s new unofficial threshold of significance is now $10 million.

New Markets

In his opening conference call remarks, Yvon Cariou, BOOM’s President and CEO, said the Explosive Metalworking division received a sizeable hydromet contract for processing gold and multiple orders from the solar sector for plates used in the production of highly purified silicon. During the Q&A session of the call, John Banker, BOOM’s VP of Sales & Marketing, provided some additional information on the two orders.

Unlike this contract, past hydromet contracts have been for HPAL nickel projects. According to Mr. Banker, a portion of the hydromet gold contract was for a new application for explosion clad. The other portion of the hydromet contract was for a POX autoclave. I don’t know if the autoclave portion of the contract was for the shell or internal components. I am guessing it was for the internal components but I honestly have no idea. I always thought POX autoclaves were constructed of acid brick lined steel and the internals were solid titanium. Either way, it seems to me that the autoclave portion of the contract would also be a new use. Again, I don’t know for sure.

The sum of the hydromet contracts was $8 million.

The solar sector contract was the second announced contract for this particular end-market. The last announced solar contract was an $11 million contract. The sum of the solar contracts discussed on the conferece call was $8 million. There are a few silicone expansion projects that I know of in the U.S., China and S. Korea. I have to look at the projects closer to see what project might have been responsible for the contract. On a side note, Hemlock Semiconductor is currently selecting a site for a good sized expansion projects.

In the Q&A session, management said they could have issued a press release announcing the gold and silicone contracts but decided against it. They decided against issuing a press release because they did not want to raise expectations beyond what they were. While it would have been nice to have seen a press release, I think management did the right thing.

Some Quick Notes on Financials

BOOM’s organice revenue growth was over 35%.

Gross profit margins were down as a result of product mix in the U.S, and lower margin contribution from DYNA. While gross margins are expected to be lower in Q3, margins are expected to increase with the expected increase in sales in Q4. In my opinion, there is plenty of room for gross margin improvement. As sales increase, BOOM will be in a better position to leverage its fixed cost. Additionally, I expect to see more favorable pricing in Europe over the course of the next year.

Inventories in the quarter were down 12.3%. The lower inventory levels at the end of the quarter are reflective of the supply chain situation discussed in detail above.

Receivables increased 12.3% over last quarter compared to an 8.2% increase in sales. The somewhat faster increase in receivables relative to sales is likely the result of the work done at the end of the quarter to process a shipment of materials received near the end of the quarter.

Cash flow from operations was $4.6 million in the quarter compared to net income of $4.6 million. At a quick glance, it looks like non-cash amortization and depreciation expense along with a reduction in inventories was offset by an increase in receivables, a reduction in notes payables and an increase in prepaid expenses.

For those concerned about BOOM’s debt load, BOOM has a principal payment, equivalent to 10% of the outstanding principal balance, due in November. Additionally, BOOM has a principal payment due after the end of the year that is based on a calculation of excess cash flow defined in financing agreements.

BOOM’s cash increased $10.8 million on the quarter compared to a $6.3 million increase in borrowing (LT and current portion of LT debt and LOC).

Conclusion

I am on page 7 of this post so I think I am done even though I have more to say. Q2 results were strong and better than expected. BOOM took a beating after reporting earnings because of the guidance for the second half of the year. While it is going to take some time to work through the supply chain issues, I think it is just a matter of time. Once management adjusts for the longer lead times, I expect things to improve significantly.

Regards,
Tuff

Disclosure
I own shares of BOOM and I have an open order to purchase additional shares.

Links

Q1 Earnings Release

Q1 Conference Call Transcript

Q2 Earnings Release

Q2 10Q

GE H System Turbine

GE 7FB and 9FB Turbines


(NASDAQ: BOOM)