Not Your Father's Commodity Company - BOOM Q3 2008

I just finished taking notes on BOOM’s Q3 conference call and 10Q. Considering the tightness in the credit market, slowdown in the economy and precipitous drop in commodity prices (why has “precipitous drop” become my favorite phrase as of late?), I was pleasantly surprised by the results and guidance. Overall, results were better than expected and guidance was in-line with what was given on the Q2 conference call.

Not Your Father’s Commodity Company

BOOM is not your father’s commodity company….that’s because BOOM is not a commodity company. On the conference call, Yvon Cariou, BOOM’s CEO, made it a point to remind investors of this fact. BOOM is an advanced engineered materials company that manufactures high value components for large infrastructure projects. To this regard, BOOM’s margins are not as leveraged to commodity prices as – oh I don’t know – a commodity producer. Furthermore, BOOM’s cost structure is lower than that of commodity producer because BOOM harnesses the power of explosives to achieve what would otherwise require a great deal of capital equipment.

Despite the fact that BOOM is not a commodity company, it is important to keep in mind that the recent, by recent I mean over the last four years, demand for explosion clad has largely been driven by the infrastructure build-out of commodity businesses. While I firmly believe the bull market in commodities has a long ways to go and significant infrastructure development is required to alleviate the long-term supply and demand imbalances, a prolonged downturn in the economy along with an extended period of lower commodity prices could result in postponements and/or cancellations. If this is the case, I believe it will be a temporary phenomenon and ultimately there will be a continuation of the infrastructure build-out. And, any postponement of infrastructure projects will merely serve to prolong the commodities bull market.

Supply Chain Tightness and Pricing

BOOM’s supply chain remains tight but efforts to diversify its supplier network is starting to pay dividends. The situation in Europe is a little better than the U.S. mainly because, in the U.S., the Department of Defense (DoD) is able to “leapfrog” other customers to get PVQ* plates. As I have mentioned in the past, I am pretty certain the DoD uses PVQ plates for armoring MRAP vehicles.

On the call, Yvon made it clear that the supply chain and pricing for PVQ steel plates are different from that of other steel products. While pricing and demand for a lot of steel products have dropped, the same cannot be said for PVQ plates.

* PVQ: an acronym that stands for Pressure Vessel Quality. The Q3 call was the first time management used the acronym on a conference call to describe the carbon steel backer plates. The carbon steel backer plates are welded to the high alloy cladder plates. Throw this acronym around at cocktail parties and people will think you are an industry insider.

Bookings, Backlog and Demand

BOOM management has not seen any material postponements of projects on the “hot list” or cancellation of projects in the backlog. The “hotlist” is as robust as it has been at anytime in the past year and management is encouraged by customer activity.

The backlog was down 6% sequentially but up 28% from the year-ago quarter. Most ($4 million) of the sequential decrease in backlog was merely a function of a stronger USD relative to the Euro. Furthermore, a $5 million refinery order was booked on the first day of Q4 and not included in the backlog.

Competition

On the conference call, an analyst asked about competition from roll-bond and other traditional manufacturers of clad. Management acknowledged that traditional manufacturers of clad have been more present and have more capacity than they have been/have had in the past. I think this is probably true more so in Europe than in the U.S. and that is why the European operations will never have the same margins as the U.S. operations. It still sounds like traditional manufacturers are not able to compete in BOOM’s sweet spot, but BOOM is less apt to get spillover work from traditional manufacturers. Right now, my biggest concern is not competition from another explosion welding company but advances made by traditional cladding companies.

In particular, my concern is that traditional manufacturers will develop a technique that will produce a clad product capable of competing in BOOM’s sweet spot. I may be way off base on this but I think it is a possibility, and I have been on the lookout for any signs of this actually happening. I haven’t seen anything.

Explosion Clad

Clad sales in Q3 were up 6% from the year-ago quarter but down 19% from Q2. The sequential decline was fully expected. In fact, sales in the quarter were slightly better than expected. Despite lower sales in the quarter, the clad division managed to pull off an impressive gross margin of 32.5%, the highest level since the DYNA acquisition. The better than expected margin performance was a result of the disproportionately higher level of sales from the U.S. operations.

European sales were down as a result of summer vacations and some delayed shipments. I lived in Paris for a couple of years and the city would shut down for the month of August because everyone was on vacation. As such, the vacation bit doesn’t come as much of a surprise. The delayed shipments will get recognized as revenue in Q4. Based on the conference call, it sounds like BOOM was ready to ship the plates but they were waiting for the customer to perform certification and testing.

AMK

As far as I can tell, the $2.9 million in revenues on the quarter represents a record quarter for AMK, but the 37.9% gross margin is what caught my eye. Get this division some more business! I like the margin potential here.

Oilfield Products

The Oilfield Products division posted sales of $6.8 million, down 14.7% sequentially. Stronger margins helped make up for the lower sales. Gross margin in the quarter was 35.6% compared to 33.6% in the prior quarter. Operating margin was 12.9% compared to 7.4% in the prior quarter. Margin improvement was the result of product and customer mix.

Taxes

BOOM’s income tax provision was 7% on the quarter versus the 31-32% guidance given on the last call. An IRS examination and some 2007 “book-to-return” adjustments resulted in a $300,000 tax benefit and a $1.1 million tax adjustment, respectively.

Assuming a tax rate of 31.5% in Q3, BOOM’s tax provision would have been $5.3 million instead of $546,000, and EPS would have been 42c instead of 57c. Nonetheless, BOOM would still have beaten estimates of 36c.

For 2009, management expects a tax rate of 31-32%.

Debt/Capital Structure

At the end of the quarter, BOOM’s debt consisted of the following:

LOC current maturities: $4.785 million
LT debt current maturities: $7.741 million
Total current maturities: $12.256 million

LT LOC: $9.536 million
LT debt: $60.440 million
Total long-term maturities: $69.976

Total debt was down $7.1 million from the prior quarter.

Debt/Equity (total liabilities/stockholders’ equity): 1.13 (versus 1.40 at the end of 2007)

Of the long-term debt classified as current, $4.5 million in U.S. borrowings and $1.5 million in Euro borrowings, under the syndicated credit agreement, will be paid-off in November. Unless, additional working capital is needed to support an increase in business, management expects to pay-off some of the revolving line in the fourth quarter.

In the third quarter, BOOM generated over $12 million in EBITDA (not adjusted EBITDA, which excludes stock based compensation) and net interest expense was a little over $1.3 million. Even though the third quarter will likely represent the weakest quarter in terms of EBITDA, BOOM’s interest coverage (EBITDA/interest expense) was 9.1x, which is more than adequate. In Q4, BOOM should generate significantly more EBITDA and pay less in interest.

As a final note on debt, BOOM entered into a new two-year interest rate swap agreement on the U.S. borrowing of the syndicated credit agreement. The agreement, in effect, will convert the variable LIBOR rate to a fixed rate of 4.87% as of November 17, 2008. I have not seen anything on the pricing of the interest rate swap agreement.

Cash Flow/Free Cash Flow

In the third quarter, BOOM generated nearly $13.0 million in cash flow from operations, almost two times net income. Aside from the $2.6 million in add-backs for depreciation and amortization, receivables added over $6.4 million to cash. While BOOM utilized $4.5 million in cash for inventories, I believe this could be a positive sign that BOOM is getting a handle on the supply chain situation.

In his post, TMFBent mentioned that BOOM has cleared $17.5 million in free cash flow year-to-date. Out of curiosity, I went back to see what BOOM generated for free cash flow during the same period in 2007 – drum roll please – $5.4 million. Wow, that is a 224% improvement.

CapEx of $3.2 million was up pretty good from recent quarters. I was a little surprised this wasn’t brought-up on the conference call. When looking at BOOM’s recent capex, I think it is fair to say that a good chunk of spending has been expansionary as opposed to maintenance. At the same time, the breakdown between expansionary and maintenance might be a little more weighted towards maintenance this year than it was last year.

Guidance

I am going to put together another post on guidance that works through an EPS estimate for Q4 based on management guidance.

Management

About a month ago, I met with Yvon Cariou, CEO; Rick Santa, CFO; and, Geoff High, of Pfeiffer High Investor Relations. After about an hour, I left the meeting with some juicy information that everyone would probably like to hear. Are you ready for this? Management is passionate about the company, proud of its employees, confident about how they have positioned the company for the future, savvy in their decision making process and hungry to grow the business. I have always had faith in BOOM’s management, but I have to admit that I came away from this meeting with and even higher level of confidence.

I hope this all helps.

Tuff