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Dynamic Materials Corporation (NASDAQ:BOOM)

Q3 2008 Earnings Call

October 30, 2008 5:00 pm ET

Executives

Geoff High - Investor Relations, Pfeiffer High

Yvon Cariou - President, Chief Executive Officer, Director

Richard Santa - Vice President, Chief Financial Officer and Secretary

Analysts

Avinash Kant - D.A. Davidson & Co.

James Bank - Sidoti & Company

Mark Parr - Keybanc Capital Markets

Bob Johnson - Satuit Capital

Avinash Kant - D.A. Davidson & Co.

Operator

Good afternoon. My name is Tasha and I will be your conference operator today. At this time, I would like to welcome everyone to the Dynamic Materials Corporation’s third quarter earnings conference call. All lines have been placed on mute to prevent any backgrounds noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions). Thank you. I would now like to turn the call over to Mr. Geoff High of Pfeiffer High Investor Relations. Please go ahead, sir.

Geoff High

Thank you, Tasha. Good afternoon and welcome to Dynamic Materials third quarter conference call. Presenting on behalf of the Company will be President and Chief Executive Officer, Yvon Cariou, and Senior Vice President and Chief Financial Officer, Rick Santa.

I would like to remind everyone that the matters discussed during this call may include forward-looking statements that are based on management's estimates, projections, and assumptions as of today's date and are subject to risks and uncertainties that are disclosed in Dynamic Materials’ filings with the Securities and Exchange Commission.

The Company's business is subject to certain risks that could cause actual results to differ materially from those anticipated in its forward-looking statements. Dynamic Materials assumes no obligation to update forward-looking statements that become untrue because of subsequent events.

A webcast replay of today's call will be available at Dynamicmaterials.com after the call. In addition, a telephone replay will be made available for 48 hours beginning approximately two hours after the conclusion of this call. Details for listening to today’s call and webcast are available on today’s news release.

With that, I will now turn the call over to Yvon Cariou. Yvon, please go ahead.

Yvon Cariou

Thanks, Geoff and welcome to everyone joining us for today's call. As you know, there has been extreme volatility throughout the commodities markets and this has created a challenging environment for many companies in these sectors. For those of you new to the DMC story, I want to reiterate something that we have stated on past calls. Dynamic Materials is not a commodities business, rather, we are an advanced and general materials Company that provides high-value components for large infrastructure projects. While most commodities businesses require major capital investments to operate our cost structure is by comparison very low. This is because we used the power of exclusion to achieve what would also wise take a good deal of capital equipment.

Finally, our margins do not as nearly the exposure to pricing swings as commodity-based businesses. As you read in today’s news release, our third quarter earnings performance came in better than expected. We benefited from strong results at our Oilfield products and AMK Welding segments, which helped offset the anticipated sequential reduction in third quarter sales at our explosive metalworking business. This dip in clad metal sales was primarily due to the limited availability of PVQ or pressure-vessel quality steel, which serves as the backing components in our explosion welded plates.

I am pleased to report that our efforts to mitigate our supply challenges are beginning to pay off. Although supplies are still tight, we have made solid progress in diversifying our domestic sourcing network for this specialized metal. In spite of tenuous economy climate, bookings during the third quarter remained steady. The slight sequential [3.47] order backlog was largely related to changes in foreign currencies.

On the first day of the third quarter we booked an additional $5 million into backlog when we received a sizeable order for plates to be used in a large refinery project. We continue to monitor our very active hot list of prospective orders. In fact, during August and September the totaled pool of projects on the list was higher than that anytime in the past year.

We have not experienced any material project postponements and our backlog has not been impacted by other cancellations. As Rick will discuss in a moment, we are maintaining our prior guidance for the fourth quarter. While the current economic conditions make it difficult to forecast 2009, we are encouraged by the level of activity in our end markets and I am confident in our ability to address these opportunities. We have established a solid industrial platform and outstanding global sales growth and a strong balance sheet; in short, we believe DMC’s well positioned for a long term growth.

I will now turn the call over to Rick, who will discuss the highlights of our third quarter financial performance. Rick?

Richard Santa

Thank you, Yvon. Good afternoon, everyone. We report our third quarter sales of $52.4 million, which was slightly better than our forecast and represented a 24% increase over the last year’s third quarter. But the year-to-date period sales were $174 million up 58% versus the nine-month period of 2007. It is worth noting that through the first three quarters approximately 18% of our revenue increase was from organic operation. So if you strip out the impact of our acquisition you can see that the growth in our core business has remained very respectable.

Third quarter gross margin was 33%, down slightly from 34% in last year’s third quarter but well above our forecasted range of 28% to 29%. The improvement over forecast was the result of a favorable product mix at out Oilfield product segment, strong growth at AMK and higher than expected proportionate sales by our US explosion welding business.

We reported a sharp drop in our effective tax rate for the quarter, which came at 7% versus our forecasted full year effective tax rate range of 32% to 33%. The third quarter completion of an IRS examination allowed us to record approximately $300,000 in unrecognized tax benefits. On top of that certain adjustments identified during the preparation our 2007 federal and state tax returns positively impacted our Q3 tax provision by approximately $1.1 million.

Third quarter amortization expense related to acquire intangible assets was $1.4 million and net interest expense was $1.3 million. Q3 adjusted EBITDA increased to $12.8 million from $11.5 million in the third quarter last year. For the year-to-date period adjusted EBITDA was up 41% to $41.1 million versus $29.2 million last year. Since adjusted EBITDA is a non-GAAP disclosure, we encourage you to read the section in our news release regarding our use of such measures.

Third quarter net income came at $7.2 million or $0.57 per diluted share. Our net income was relatively flat versus our third quarter last year. It was well above our forecast for the quarter. Thanks to our better than expected gross margin and lower tax rate. Year-to-date net income was $18.7 million or $1.49 per diluted share versus net income of $17.7 million or $1.44 per diluted share last year.

As we stated in our last call, we expect fourth quarter sales to rebound to a level comparable with our second quarter sales of $63.2 million.

We anticipate gross margin also will be comparable to the second quarter level of 30%. Fourth quarter operating income will be impacted by approximately $1.2 million of amortization expense associated with the DYNA energetics acquisition, while pre-tax income will be impacted by approximately $1.2 million of interest expense, in light of the third quarter tax provision adjustments, we expect our full year 2008 from the effective tax rate will be approximately 27% and it should increase to a range of 31% to 32% in fiscal 2009.

We are now ready to take your questions. Tasha?

Question-and-answer session

Operator

(Operator instructions).Your first question comes from Avinash Kant – D.A. Davidson & Co.

Avinash Kant – D.A. Davidson & Co.

Good afternoon Yvon and Rick. A quick question in the guidance that you have maintained for the fourth quarter, what is the mix that we are looking at in terms of explosion clad and other businesses? Would it also be similar to Q2 levels?

Yvon Cariou

Yes, somewhat similar, AMK had a very strong quarter and we could see a small drop off at AMK welding. Oilfield should do very well and as the guidance indicates and we expect a good rebound in our explosion welding business from the third quarter.

Avinash Kant – D.A. Davidson & Co.

Okay. From the commentary that you have put in the press release, it looks like, up until now you have not seen any impact from the decline in oil prices and also the credit situation that is around in terms of projects being delayed or pushed out.

Yvon Cariou

We have not seen direct link to the projects we have been tracking now.

Avinash Kant – D.A. Davidson & Co.

Okay. And then as the food chain on the materials side it starts to get better. Do you think…, what gives you comfort that the same situation, what happened in the third quarter would not happen again or could it happen if you saw a lump in orders?

Yvon Cariou

Yes, what you have to read in there is that the supply chain remained tight for the kind of steel that we need. But our efforts to diversify our sources are now we can see it is starting to bail us. So we should be in the better position in the future. Some of that is also depending on the product mix, but we have clearly made a gain on strengthening the supply chain there. The time situation at some of the mills that we talked about before are still there because they are busy for the same reason we are busy. And there is still some of that Defense Department procurement jumping in front of the queue. But we have managed to get away from that a little bit somewhat by diversifying the chain.

Avinash Kant – D.A. Davidson & Co.

And one final question if I may. I know you are not talking about ’09 at this point. You have seen strong bookings and everything else. But qualitative, do you think ’09 will be a positive year? It will be up sequentially or not?

Yvon Cariou

It was too early for us to cast a judgment on ’09. We do not see as we indicated the negative sign at this juncture, but we do not know how the global economy drastically it will be affected and when, for the stuff we are involved with.

Avinash Kant – D.A. Davidson & Co.

Okay. Thank you.

Yvon Cariou

And what we have today in the projects we monitor, everything looks pretty steady.

Avinash Kant – D.A. Davidson & Co.

Thanks.

Operator

Your next question comes from James Bank with Sidoti & Company.

James Bank – Sidoti & Company

Hi, good afternoon. If I could get into the tax a little bit more. Rick, could you help me understand this on a per-share basis, it was $300,000 and $1.1 million?

Richard Santa

Yes. The best way to go through that analysis and I kind of did it my self. If you look at the 31% to 32% that we estimated would be our effective tax rate last year. And now if you assume that our full year effective tax rate is 27% for the year. If you apply that 27% tax rate to Q3 and your Q4 forecasts that will help you qualify how much is the improvement in Q3 related to operating results versus the tax adjustment.

James Bank – Sidoti & Company

Did you do the homework for me?

Richard Santa

I think if you use $0.27 then I think your earns will come out to about 45. Twenty seven percent, I think you will get 45% and if you use 32%, which is no longer valid for the full year, it would be $0.42.

James Bank – Sidoti & Company

Okay.

Richard Santa

But right in that range that is we call and the work’s in front of me.

James Bank – Sidoti & Company

Alright, okay. So, what I am trying to get at and I hate to do this to you guys. It just seems is that every quarter we step into, there is definitely a heightened prudence and I think we are kind of stepping into it again for the year and I think on the last conference call an investor brought up the notion that those seems like you guys can pull it off in the last inning. And you certainly have done it again. It seems like you are going to do in the fourth quarter. But I guess with the supply chain as tight as it is. We have to assume that there has not been any slowdown with the projects and what is going on out there. So I think it must be reasonable to assume that there is growth on the out year. Are you able to comment on that?

Yvon Cariou

Potentially there is growth. If you look at the projects, it is about the backlog again of the engineering and construction companies. Somebody noted not long ago, based on that we should have significant growth. But we do not know if some of those projects or when they will be affected or postponed. So, certainly, we do not want to guess the judgment. We are well positioned and ready to go.

Richard Santa

Yes, I think you add to that our long term outlook for the next few years are still very positive. It is hard call 2009 right now with what is going on the global economy. But I do not think to make a long term fundamental to our business will be changed by what is going on today and that is a very long duration.

James Bank – Sidoti & Company

Okay. It sounds good to me. Could I have the gross profit breakdown per segment? Just on a margin basis?

Yvon Cariou

I guess it is noted. It goes into our 10-Q but it is not in the release.

James Bank – Sidoti & Company

Okay.

Yvon Cariou

But it was very strong in excess of 35% for Oilfield slightly in excess of 35% for Oilfield. I think at a range of 38% for AMK welding and clad was, I think a little bit shy of 31%, somewhere between 30% and 31% for the explosion welding. Let me just double check that quickly.

James Bank – Sidoti & Company

Okay. So that is very helpful. And now the tax in ’09, so we are assuming 31% to 32%, is just kind of the norm going forward?

Richard Santa

Thirty one percent to 32% is we estimate for 2009 and at this point I would assume that would be the rate, rate beyond that as well.

James Bank – Sidoti & Company

Okay.

Yvon Cariou

We do not have better information at this point.

James Bank – Sidoti & Company

And with the debt, it looks like you took some out here in the quarter. Any help in and where you might be at the end of the year with your debts just trying to think of where the interest expense should go.

Richard Santa

Yes, we have strong cash balance at the end of the quarter. We have some debt principal repayment that is scheduled in Q4, $4.5 million on the US term loan and 1.4 million euros on the European term loan.

James Bank – Sidoti & Company

Okay.

Richard Santa

And I would also anticipate that we will pay down some of revolve in credit cash. But in business it is a little bit stronger in the fourth quarter we could see some cash uses to support high levels of working capital than what we had at the end of Q3. And I need to correct that the gross margins for the explosive metalworking, James, were 31.9% in Q3.

James Bank – Sidoti & Company

Well, okay.

Richard Santa

Which includes a stronger than anticipated weighting of US clad which as we have indicated before, has stronger margins than our European explosion welding divisions.

James Bank – Sidoti & Company

Okay. Alright, that is great. Thank you very. That is all I have.

Operator

Your next question comes from Mark Parr – Keybanc Capital Markets.

Mark Parr – Keybanc Capital Markets

I have a question as far as seasonal impacts in the European clad business. It is looks like about $3 million drop off in revenue sequentially. Is that predominantly due to seasonal impacts, or are you seeing anything in particular there as to why it dropped off that precipitously sequentially?

Richard Santa

There is couple of things and at this $3 million, it is an [inaudible] number because that is what they fell short and it was made up for by the US doing a little bit better than we anticipated. So the quarter came out right on our forecast.

Mark Parr – Keybanc Capital Markets

Okay.

Richard Santa

And I think a couple of things, you have an impact a little bit in Europe because of the summer time vacation and I think there was also some delays right around quarter end and shipments that required customer testing and certification before shipments from our facilities, so some of that just gets carried over into the early part of the fourth quarter.

Mark Parr – Keybanc Capital Markets

Yes. There was a bottleneck there.

Richard Santa

There was a little bit of a bottleneck right at quarter end at both the French division and the German division.

Mark Parr – Keybanc Capital Markets

Okay.

Richard Santa

So we expect stronger fourth quarter.

Mark Parr – Keybanc Capital Markets

Getting back to the tax rate in the quarter, we are you trying to say that the impact as far as the benefit was concerned was about $1.4 million to the quarter? With $300,000…

Richard Santa

Yes, there might have been a couple of other smaller fine what is going on, but those were the two big things. So again, if you take the 24% rate, which is our new full year rate, you can kind of isolate the Q3 impact of the adjustment. Just do the 7% versus the 24 and it should be pretty close. Do not have my calculator handy right now. It should be pretty close to that $1.4 million or might be a little bit higher than that.

Mark Parr – Keybanc Capital Markets

You are talking about 27, is that right Rick?

Richard Santa

Yes. Excuse me, 27, yes. Twenty seven versus 7% excuse me.

Mark Parr – Keybanc Capital Markets

Okay. Yes. It looks like you benefited from mix, too. You kind of alluded to that earlier as far as doing more of the clad business domestically instead of Europe.

Richard Santa

The lower gross margin guidance for the fourth quarter relates the fact that we expect a higher proportion of US shipment in Q4 to be export orders that typically have lower margins.

Mark Parr – Keybanc Capital Markets

Okay. Would you expect DYNA clad to rebound from the quarters as well?

Richard Santa

…Asia or elsewhere in the world?

Mark Parr – Keybanc Capital Markets

Would you expect DYNA clad to rebound from the third quarter level as well?

Richard Santa

Yes, they have shown steady improvements throughout the year.

Yvon Cariou

We manage Europe as one entity in our release. So with the concept of one division behavior we are going to fade into an assembly of the three European companies.

Mark Parr – Keybanc Capital Markets

So we should be more or less viewing the business closer to its entirety at this point.

Yvon Cariou

Yes, definitely the integration is achieved and they work as one sales force and although there are three plants, it is like one virtual plant if you want.

Mark Parr – Keybanc Capital Markets

Fair enough. Thanks you for the color guys.

Operator

(Operator Instructions) Your next question comes from Bob Johnson – Satuit Capital.

Bob Johnson – Satuit Capital

Good afternoon. A couple of questions, first, with regards to the sourcing of material we have seen in terms of general comments about the steel industry some dramatic lessening of activity in the last, whatever, four, five, six weeks. Is your material that you purchase so specialize that that is immune to the weakening that we are seeing?

Yvon Cariou

Yes, I do not know if it is immune but certainly it is not affected like the rest of the discussion regarding steel, in general, prices are remaining steady, not going down and availability is tight which is a good indicator also from our business as some of what they do has to do with CapEx and large infrastructure. So, we are in a sector that is very different from the supply chain point of view.

Bob Johnson – Satuit Capital

Okay. And then is that same tightness evident in Europe as compared with the US?

Yvon Cariou

Yes, it is evident. It has not been as tight. One reason is that we have DOD here in the US who with a strong customer for armoring materials that use the same kind of best steel and they do not have that situation. And it is a little easier in Europe, but it is still tight.

Bob Johnson – Satuit Capital

Okay. And then on a separate question, I can understand your reluctance to show any real enthusiasm about the outlook going forward except to say that things look promising. On the last conference call, I recall a comment that the potential bookings or the potential project or the potential of quotes that are outstanding were in the billions, with a B of dollars. Can you give us an update on that amount?

Yvon Cariou

No. The comments, they are to do with the volume of quotations that we produce here.

Bob Johnson – Satuit Capital

Alright.

Yvon Cariou

And it is in the billions, number of those report are repetitive, they start at a budget level and re-budget and re-budget. And when it gets down to what we call the hot list, it is a much, much smaller number. Still significant, of course, for us but that is the way we work from. The 2 billion was to indicate there was a volume of quotation which for a business of $200 million a year or so.

Bob Johnson – Satuit Capital

Okay. You said 2 billion.

Yvon Cariou

Yes.

Bob Johnson – Satuit Capital

Okay. And then last question, given that you are now saying that the integration is essentially complete of the metalworking operations. The big issue for some of us has been when the margins on the European business begun to approach those of the US. Given the strong demand that still exist for the product, have you reached what you think are acceptable levels of margins from Europe compared with the US? And I will make comment that it sounded when this question got raised in the past, as though you were being somewhat deferential to longer-term customers over there. And I guess some of us would like to see you be a little less deferential and a little more beneficial through the bottom line.

Yvon Cariou

Yes. Actually, it is a good question. We certainly plan to see that margin improve as we go. It is an exercise that takes time and though we will not achieve it in one exercise. It will take a couple of years and it will probably never reach the kind of level we enjoy in the US for competitive reasons. Some of the other technology use in your par armor [inaudible] and we do not have as much room to maneuver, so definitely it is in our agenda. It is not such energy this size. Having said that we have made progress and we will of course push out to try to do more.

Bob Johnson – Satuit Capital

Okay, fine. And if I could, just one more, Rick, when does the amortization begin to be the moderator or safe? Is it this quarter?

Richard Santa

No, yes. But in Q3 we dropped off the amortization that showed up in Q1, in Q2 for the order backlog that was acquired, so except for foreign exchange effects it should be steady for the next three years.

Bob Johnson – Satuit Capital

Steady at that $1.4 million.

Richard Satan

Yes, at that $1.4 million, I think we said it becomes closer to $1.3 million and it could even be a little bit below that based on where exchange rates are today. Because all of the amortization is euro based from the DYNA energetics acquisition.

Bob Johnson – Satuit Capital

Okay, fine. Thank you very much.

Operator

Your next question is a follow from Avinash Kant – D.A. Davidson & Co.

Avinash Kant – D.A. Davidson & Co.

Hi, Rick. A quickly question for you, should we expect much change in the depreciation numbers going forward?

Richard Santa

I do not think there is should be a significant adjustment. You may have some items that where depreciation starts in Q4 but that would be principally in Europe and I think the average exchange rate will probably offset that, the lower average exchange rate.

Avinash Kant – D.A. Davidson & Co.

Okay.

Richard Santa

Or I would say it will be pretty flat in the quarter.

Avinash Kant – D.A. Davidson & Co.

Another question I had was that in terms of your, the competitive processes that are out there not explosion clad, but I am talking roll bond and other processes. Given what is happening in the pricing environment or have you seen any pressure from that side?

Yvon Cariou

Worldwide it looks like those guys have no capacity, we hear more about them. They have, as you know, traditional applications which have nothing to do with what we do. And some of them are increased capacity, so we do, yes, I think it is safe to say that they are more present than they have been.

Avinash Kant – D.A. Davidson & Co.

Alright, and could that have a pricing impact on you or could they…?

Yvon Cariou

Good in some instances. It is good in some instances.

Avinash Kant – D.A. Davidson & Co.

And if it were to be in which regions would that be predominant?

Yvon Cariou

I think it is more project driven than region driven, but maybe more in the, what we call the export areas, like the Middle East or the Far East.

Avinash Kant – D.A. Davidson & Co.

Okay. And one final thing, of course, one more time and we have asked this a few times so will just to clarify it a little bit. The tax impact, so simply said if I take out the $1.4 million in tax impact from you, your operating EPS would have been $0.46 so that was roughly like $0.11 impact?

Richard Santa

When I use the 27% rate, I think you came to $0.45 then I do not have it in front of me. I might have rounded up to $0.46 but $0.45 to $0.46 would have been the earnings had we use the 27% rate in Q3.

Avinash Kant – D.A. Davidson & Co.

And that is how we should look at it. So I think that 27% would be roughly, yes, $0.45. So that is the way to look at it right?

Richard Santa

Yes.

Avinash Kant – D.A. Davidson & Co.

Okay. Thank you so much.

Operator

There are no questions at this time. You may continue with your presentation or closing remark.

Yvon Cariou

Thank you, Tasha. Thank you all for joining us for today’s call. We continue to make great progress in positioning DMC for long terms success and we thank you for your support at the Company. I also want to thank the entire of DMC team as well as our Board or Directors for their hard work and dedication.

We look forward to speaking with you again soon. Goodbye.

Operator

This concludes today’s conference call. You may now disconnect.

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