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Dynamic Materials Corporation

Q3 2010 Earnings Conference Call

October 28, 2010 5 PM ET

Executives

Geoff High – IR

Yvon Cariou – President and CEO

Rick Santa – SVP, CFO and Secretary

Analysts

Dan Whalen – Capstone Investments

Avinash Kant – D.A. Davidson

Phil Gibbs – KeyBanc Capital Markets

Gregory Macosko – Lord Abbett

Operator

Good afternoon. My name is Silima and I will be your conference operator today. At this time I would like to welcome everyone to the Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) I would now like to turn the call over to Geoff High of Pfeiffer High Investor Relations. Please go ahead.

Geoff High

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

I would like to remind everyone that 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 beginning approximately two hours after the conclusion of this call. Details for listening to today’s replay or webcast are available in today’s news release.

With that, I will now turn the call over to Yvon Cariou. Yvon?

Yvon Cariou

Thanks Geoff. Our third quarter financial performance reflects abilities of the diversified revenue stream we have established in recent years. While sluggish demand from the industrial processing sectors continue to restrain growth at our exclusive metalworking business, the broader economic recovery has led to much improved reserves at both our Oilfield products and AMK Welding segments.

We told you during our last call about increased quoting activity for our external welded plates and we have not seen any level in RFQs during the past three past three months. The sales teams at both our US and European quoting businesses continue to track several projects that are percolating in a variety of end markets. The most active of the sectors we participate in continue to be upstream oil and gas, power generation, aluminum and transportation, our US end market, as well as the chemical and petrochemical space.

On the operations front, consolidation of our Nitro Metall business in Sweden into our Dynaplat facilities in Germany is proceeding on plan. Our relocation of specialized production equipment will give Dynaplat important new cladding capabilities, and because we are redundant shooting capabilities with France and Germany, we believe our European operations we have more than adequate capacity for the foreseeable future. We expect that consolidation process will be complete by the end of next year’s first quarter, and we lead to enhance efficiency in the operating cost for our overall European cladding business.

As I mentioned, we experienced strong sales growth at our Oilfield product segment during the third quarter, accelerating exploration and production activity combined with wider use of horizontal drilling technologies has increased worldwide demand for our perforating gun systems and related products. In the third quarter sales from our legacy Oilfield products business increased 56% versus the third quarter of last year.

When you layer on the incremental revenue from our recent acquisitions in Canada, the United States and Russia, our year-over-year sales were 158% compared with the third quarter of last year. We think the financial and geographic benefits we are getting from this new operations clearly validates our recent acquisition problem. I should note that the two large international order prospects I told you about during our last call were both awarded to our Oilfield products business.

Customers in the Middle East and India placed the orders, and deliveries will take place over the next several quarter. Our AMK Welding business also had a very solid third quarter, delivering a 41% year-over-year improvement in sales and a 95% increase in operating income. In spite of the slow speed of recovery at our Explosion Welding business, we are very confident about this segment’s long-range prospects for growth. Clad metals were continued to play an essential role in the build out of the world’s industrial processing infrastructure.

As the global economy recovery gains steam, we fully expect demand for our flat sheet products will increase. For more on our third quarter financial performance I will now turn the call over to Rick.

Rick Santa

Thank you Yvon, good afternoon everyone. Sales during the third quarter 19% to $41.3 million versus the same period last year. Gross margin during the comparable quarters improved to 26% from 25%. Gross margin at our Explosive Welding business declined to 19% from 26% due to less favorable absorption of fixed manufacturing costs and a very competitive pricing environment. However, our Oilfield products business delivered significant expansion in gross margins which increased to 39% from 22% in the third quarter last year.

The improvement is attributable to the segment’s strong sales increase, favorable changes in product and customer mix and the incremental margin we have picked up on inter-company sales to distribution businesses we recently acquired. We are optimistic that over the long-term we will see improvements in consolidated gross margin as market conditions improve for the cladding industry.

Third quarter operating income improved 18% to $2.9 million from $2.5 million, while net income increased 21% to $1.3 million or $0.10 per diluted share from $1.1 million or $0.08 per diluted share in last year’s third quarter. Adjusted EBITDA was $6.7 million versus $6 million in the third quarter a year ago. As always please see the section in our news release regarding our use of adjusted EBITDA which is non-GAAP measure.

With respect to cost, the most notable changes versus last year’s third quarter are the 27% increase in general, administrative expense and the 38% increase in sovereign expense. Of course the primary driver of these increases was our previously mentioned acquisitions as new Oilfield products operations. Including the impact of these acquisitions, G&A expense increased $310,000 or 11% or fairly expensive decline by $425,000 or 19% versus last year’s third quarter.

During the third quarter, we recorded net other expense of $416,000 versus $633,000 in the same period of 2009. These expenses relate principally to realized and unrealized foreign exchange losses recognized by consolidated subsidiaries that prepare their financial statements and functional currencies other than the US dollar. There are some additional discussion of these expenses in the MD&A section of today’s Form 10-Q under the heading Other Income and Expense.

Through nine months, we generated operating cash flow of $10.3 million versus $23.4 million at the nine month mark last year. We ended the third quarter with a cash position of $11.1 million, and have working capital of approximately $40 million. Our long-term debt now stands at $23.5 million versus the $34.1 million we reported at the end of fiscal 2009.

Turning to guidance, we anticipate fourth quarter sales will be flat versus the third quarter and we expect gross margins will be in the range of 22% to 24%. We now anticipate 2010 sales will be down by roughly 8% versus fiscal 2009. This is slightly lower than the 5% decline we were anticipating at the end of the second quarter. The adjustment relates largely to reconversion rate of quotes to bookings. Full year gross margins are expected to come in at 24% which is at the high end of our prior forecast range.

We currently anticipate somewhat higher SG&A expense in the fourth quarter in light of the weakening of the dollar during Q3 and the impact of translating our Euro based business into US dollars. Based on the current exchange rate, we anticipate the impact to be approximately $300,000 in added expense during Q4. We’ve reduced our anticipated 2010 blended effective tax rate to a range of 22% to 23%. This below normal rate relates primarily to adjustments resulting from the Russian joint venture acquisitions and lower pretax income versus fiscal 2009. As previously noted, we expect to return to a blended effective tax rate of 33% to 35% in 2011.

With that we are now ready to take any questions, Silima?

Question-and-Answer Session

Operator

(Operator Instructions) your first question comes from the line of Dan Whalen.

Rick Santa

Hi Dan. Dan, are you there?

Operator

Mr. Whalen, your line is open sir.

Dan Whalen – Capstone Investments

Okay, can you hear?

Rick Santa

Yes.

Dan Whalen – Capstone Investments

Okay, great. Let’s turn the mute off. So you referenced two large orders that you’ve actually wrapped in. Can you just add any color in terms of size or scale or duration in terms of how long they’ll be completed?

Yvon Cariou

Sure, the sum of those two orders we are referring to in the Oilfield products is a one $7 million and delivery will go for most of 2011.

Dan Whalen – Capstone Investments

Okay, should we kind of spread that evenly or that’s – how is that kind of going to flow through the year?

Rick Santa

We expect more than $2 million to ship in the fourth quarter of this year.

Dan Whalen – Capstone Investments

Okay.

Rick Santa

A little bit less than $1 million carries over into 2012 and the rest of it, it’s largely Q2 and Q3 of 2011.

Dan Whalen – Capstone Investments

Okay, great. That’s helpful. And then just on the acquisition front, in terms of pipeline or whatever you want to call it. In terms of deals or potential deals, has the number changed dramatically versus – this quarter versus last quarter?

Yvon Cariou

I’m not sure Dan exactly what you refer to in terms of potential acquisitions we obviously we cannot talk about anything specific. We have indicated before we will achieve both in the clad space as well in Oilfield, whether its acquisition or other ways to grow those two businesses. We are acting clearly.

Dan Whalen – Capstone Investments

Okay, but in terms of the number of deals being presented hasn’t really changed meaningfully?

Yvon Cariou

I’m not sure what you refer, I don’t think we have presented on coming deals. We have realized in Oilfield products, three acquisitions between Q4 ‘09 and 2010 so far, right.

Dan Whalen – Capstone Investments

Yes, I guess what I’m saying is people present deals and ideas to you guys to take a look at certain businesses or parts of businesses, has that…

Yvon Cariou

Yes, we would not comment how the deals come to us I guess than but just to say again, we are active in both space Clad and Oilfield products. That’s part of our global strategy.

Dan Whalen – Capstone Investments

All right, I’ll get back in queue. Thank you.

Operator

Your next question comes from the line of Avinash Kant.

Avinash Kant – D.A. Davidson

Good afternoon Rick and Yvon.

Rick Santa

Hi Avinash, how are you?

Yvon Cariou

Hi Avinash.

Avinash Kant – D.A. Davidson

Very good, very good. So a few questions, it looks like in the quarter your bookings started to improve at least quite a bit actually and could you give us some idea about where those bookings in the explosion clad side are coming from?

Yvon Cariou

What is good about the bookings, I things they come from a diversified markets, that’s one. And two, I think we’ve been stronger – seeing stronger activity from our European platform. And when I say European platform you need to remember that geographic territory attached to our platforms. For Europe, its Europe and the Middle East and India and Russia particularly, while for the US its North and South America, Australia and Asia, roughly. So again, Europe has made a stronger showing during the quarter in terms of bookings.

Avinash Kant – D.A. Davidson

Okay, and in terms of the traction on that, do you see – how do you see bookings trending in the current quarter? Do you think it will be improving from those levels meaningfully not any qualitative understanding that you can give us on bookings that will be great?

Yvon Cariou

Yes, it would be great Avinash, I wish I could be specific about it. All we can repeat is that we are very active in quoting worldwide in a number of markets. During my conference here I indicated the key markets remain upstream oil and gas power, aluminum and transportation now with some activity as well in chemical and petrochemical, in terms of being specific as to what’s coming to us, it’s very difficult game to play for us. We’re not in a position to be too specific.

Avinash Kant – D.A. Davidson

And a few things to check with Rick. In terms of the tax rate, do you mean that 22% to 23% tax rate for the full year ‘010 right, not just for the quarter?

Rick Santa

For the full year, yes, it will certainly be higher than that in Q4.

Avinash Kant – D.A. Davidson

Lower than that.

Rick Santa

No, the effect of tax rate will be higher than that in Q4 bringing the year-to-date rate from 18.4% up to the 22%, 23% level.

Avinash Kant – D.A. Davidson

So it’s been 18.4% this year, okay.

Rick Santa

That was the year-to-date effective tax rate.

Avinash Kant – D.A. Davidson

Effective tax rate, okay I see. I see, so it will be little bit higher than that in Q4, right?

Rick Santa

Right. And then we expect in Q – in 2011 that will return to a normal 33% to 35% level.

Avinash Kant – D.A. Davidson

Okay, so basically you’re kind of talking about down EPS on flattish revenues for Q4?

Rick Santa

Yes, that certainly would be consistent with sales remaining flat and the gross margin falling to the 22% to 24% range from the 26% plus that we enjoyed in Q3, and that has a lot to do with product mix and which locations are involved in shipping during the first – fourth quarter. For example, the US clad shipments will be weaker in Q4 than they were in Q3.

Avinash Kant – D.A. Davidson

All right. And how should we think of other income or interest expense going forward?

Rick Santa

The other expense did you say?

Avinash Kant – D.A. Davidson

Yes.

Rick Santa

If you can give me a crystal ball on the foreign exchange rates and what’s going to happen in Q4 and 2011, I would love it.

Avinash Kant – D.A. Davidson

All right.

Rick Santa

Because none of the experts seems to really understand what’s going on.

Avinash Kant – D.A. Davidson

Neither do I.

Rick Santa

The take on the US dollar is around 1.2 – the year-over-year dollar for 1.22 at the end of June to 1.38 at the end of September was certainly unanticipated.

Avinash Kant – D.A. Davidson

Right, but beyond…

Rick Santa

Well and that resulted in some of the losses, unrealized losses that we reported. On the interest expense, should go down because we have a $6.750 million principal payment due on the term loan in mid-November.

Avinash Kant – D.A. Davidson

So that’s what I was trying to understand that once you have paid that term loan in November, what should we look into interest expense of that, what will be the interest expense after that November payout?

Rick Santa

I think our long-term, our long-term – we have some revolving credit debt at the end of the quarter, but that was largely offset by cash that was related to our European operations where some large payments came into more of quarter end and they didn’t have time to pay down the revolvers. So if you just focus on the long-term debt.

Avinash Kant – D.A. Davidson

Right.

Rick Santa

It should be down to $23 million to $24 million.

Avinash Kant – D.A. Davidson

Right.

Rick Santa

After we make that payment. And on the biggest piece of that debt our effective rate continues to be, I think 6.37% plus the amortization of some of the deferred debt issuance costs. So it’s probably in effective rate that’s close to the 7.5%, 8% when you factor in the amortization.

Avinash Kant – D.A. Davidson

7.5%.

Rick Santa

Yes, I think somewhere in that range, I haven’t computed what it is with the non-cash amortization of deferred debt issuance cost being built in.

Avinash Kant – D.A. Davidson

So roughly 200k, no I might – it should be roughly 400k or 450 roughly in the third quarter?

Rick Santa

I think the 450 probably sounds close to that.

Avinash Kant – D.A. Davidson

Right.

Rick Santa

For the right number.

Avinash Kant – D.A. Davidson

Okay, and final question. In terms of the visibility, of course you’ve not made any comments thus far and historically you have talked about growth rates in the explosion clad side of kind of around long-term growth rates of I think 15% to 20%. Do you still believe that the asset growth rate that is achievable once we come to some normalcy in the business?

Yvon Cariou

I’m not sure I’m going to, given the past couple of years, to talk about long-term growth rate Avinash, but I think what we can say is that we see opportunities to grow in the world for our clad business. And we certainly have great team in place and great platforms and we’ll take advantage of those opportunities. Long-term, I think clad is a growing business. I would not put a number on it today.

Avinash Kant – D.A. Davidson

Okay, I’ll come back with more later on. Thank you.

Operator

There is a question from the line of Phil Gibbs.

Phil Gibbs – KeyBanc Capital Markets

Hi gentlemen, good evening. How are you?

Rick Santa

Good, how about you?

Yvon Cariou

Phil, how are you?

Phil Gibbs – KeyBanc Capital Markets

Doing okay. I had a question regarding the strength in your Oilfield products and if that’s an area relative to outlook you may have had three or four months ago, if that surprises you and really what’s driving that business, is it just the direction on drilling and the trend toward more of that because we’ve certainly seen that shift occurring over the last several years?

Yvon Cariou

What’s interesting in that business concurrent to clad is that you have a number of metrics which are published by the industry. And the weekly rig counts in the US and in the world definitely is increasing, and I cannot say we are surprised, I think we were expecting that growth, we saw it coming and we also knew that we have in place a team that is in place and therefore is pursuing all opportunities. So growth is not a surprise.

Phil Gibbs – KeyBanc Capital Markets

Now are there any cross-selling opportunities ever in there potentially between the explosive metalworking and the Oilfield products businesses?

Yvon Cariou

Honestly I don’t think so, there could be a few things but they are really different businesses, one hand you have a capital equipments for process activities. On the other hand it’s a consumable into the drilling of wells. So we have opportunity with clad I’m sure in the oil space, maybe beyond what we do today, certainly upstream oil and gas is getting us – upstream is getting us closer to the Oilfield so to speak.

Phil Gibbs – KeyBanc Capital Markets

Okay.

Yvon Cariou

But those businesses are essentially quite different.

Phil Gibbs – KeyBanc Capital Markets

Okay. Now is explosion clad involved in any desalination projects, because we see one of – a big project coming on in the Middle East, that may not be something that you would participate in but that part of the world certainly seems like its growing a bit further and that would support what you’re saying about the European business?

Yvon Cariou

Yes, in general it is not a big driver for our business. In general you talk about pretty thin type of material, although it is all of the alloys that we are dealing with in the standard steel are nickel alloys, but in general desalination has not been a segment for explosion welding.

Phil Gibbs – KeyBanc Capital Markets

Okay. And my last question is very general. Have you seen the global financing metrics improve for some of the projects that you may have on your radar and how does the financing availability or the willingness to commit to new projects compared to maybe how it may have been three months ago, six months ago. Just trying to gage the financing side of the equation for some of these projects.

Yvon Cariou

Yes, I suppose the fact that for several quarters we talk about the fact that our quotation activity are pretty strong, pretty healthy diversified. That’s a good sign. On the other hand, we’ve used probably the word sluggish too many times and as a conversion into bookings has not been there. So does that mean that the boards of those projects are not releasing the funds or they – that’s a maybe a fair assumption that some people are sitting there, waiting to make sure make sure that the economy is really growing before releasing.

Phil Gibbs – KeyBanc Capital Markets

But if I understand a lot of companies are cash rich, it’s not a cash or financing problem, it’s just a question when are they going to feel comfortable pushing the button and I think that relates more to the their view of how the global economies will perform in the coming years.

Yvon Cariou

Yes, it’s a good point. Its they need to confirmation that their return of investment, ROI anticipated is probable.

Rick Santa

Yes, just not hearing from our sales people that financing of the projects is an issue.

Phil Gibbs – KeyBanc Capital Markets

Okay, so it’s more of willingness.

Rick Santa

That’s our read on things.

Phil Gibbs – KeyBanc Capital Markets

Okay, perfect. Thanks guys, I appreciate it.

Operator

(Operator Instructions). There is a question from the line of Gregory Macosko.

Gregory Macosko – Lord Abbett

Yes, thank you. Just a follow-up on the question about the quoting etcetera. Are – you said you’ve done a lot of quotes and that is just sluggish whatever, are they – are the jobs that you’ve quoted, have they said we’re just not doing the job or they just don’t get back to you. What is the character of those that business out there that’s relative to the quotes?

Yvon Cariou

The quotation is of course when we do daily and they have a life of their own. You have budget quotations typically on a given project you go through a number of iterations many like 10, 15. And then when a project gets closer to being awarded you see an acceleration, a more precision in the description of the project. And so when we talk about quotations, we talk about some of all the quotations we do and again a metric I have given a few times here for our company in clad where we are between $150 million, $200 million of sales a year, we quote into billions of dollars. And we track all of that arithmetic all of that volume.

And in size that mix of quotes you have again budget quotes and some that are mature and its very complex diversified world. We may really well be quoting one project to different fabricators. And it takes a little bit of a detective work sometimes to recognize it quotation A is actually the same as quotation B. So it’s a complex work, but we know we get there reasonably well I think.

Gregory Macosko – Lord Abbett

Okay, and but do you ever get them to say its cancelled, don’t bother, we’re done or just sort of gets away if they have the quote just gets away the project just disappears and nobody talks about it.

Yvon Cariou

Yes, sometimes the project disappears. We never say we never give up, we always respond. We always send a quotation to whomever and we tie to piece together whatever intelligence we can capture about that market or that application.

Gregory Macosko – Lord Abbett

Okay, now with regard to the Oilfield and the welding business. Those two clearly are growing nicely with regard to the core business, even before you consider acquisition. Will there be – will you be required to add additional SG&A or costs to cover that growth, or are you pretty well in place, I mean you have two projects in I guess in India or wherever and that you’ve one, do you need to add overhead and the like?

Yvon Cariou

Yes, it is fair question. I don’t believe that we need to do add. We – in buying those acquisitions over the past few months, we have generated a number of good employees and managers. And I think the Oilfield team is pretty well set to take advantage of the market opportunities. So I don’t think we should see a Delta increase in SG&A in those businesses.

Gregory Macosko – Lord Abbett

Okay and the same for welding?

Yvon Cariou

Same for welding.

Gregory Macosko – Lord Abbett

Okay, all right. Thank you very much.

Yvon Cariou

You’re welcome.

Operator

(Operator Instructions) There are no further questions.

Yvon Cariou

Okay, well thanks all of you. Thank you again for joining us today and for your continued interest in the company. We remain bullish on the long-term future of our business and clad in particular. We have built what we think is a best team in our industry and we have the support of a very strong Board of Directors. We look forward to continue this conversation with you at the end of the fourth quarter. Thank you again.

Operator

This will conclude today’s conference. You may now disconnect your line.

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