Good day, ladies and gentlemen, and welcome to the DMC Global Second Quarter 2020 Earnings Conference Call. All lines have been placed on a listen-only mode and the floor will be open for your questions and comments following the presentation. At this time, it is my pleasure to turn the floor over to your host to Mr. Geoff High, VP of Investor Relations. Sir, the floor is yours.

Hello and welcome to DMC's second quarter conference call. Presenting today are President and CEO, Kevin Longe; and CFO, Mike Kuta. I'd like to remind everyone that matters discussed during this call may include forward-looking statements that are based on our estimates, projections and assumptions as of today's date and are subject to risks and uncertainties that are disclosed in our filings with the SEC. Our business is subject to certain risks that could cause actual results to differ materially from those anticipated in our forward-looking statements. DMC 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 dmcglobal.com after the call. In addition, the telephone replay will be available approximately two hours after the call. Details for listening to the replay are available in today's news release. And with that, I'll now turn the call over to Kevin Longe. Kevin?

Thank you, Geoff. The second quarter was marked by very challenging conditions in our primary energy markets. The COVID-19 pandemic led to a collapse in oil and gas demand and a corresponding slowdown in well completion activity. In the United States, completions dropped by 70% versus last year’s second quarter. This created a difficult environment for DynaEnergetics, our oilfield products business, which saw many customers stopped well completion activity altogether. Other companies used the slowdown to work through backlogs of undifferentiated perforating component inventory. The slowdown has been challenging. However, it is enabling DynaEnergetics to work more closely with several of the industry's leading operators and service companies. Many of which are transitioning from field assembled components to our factory-assembled, performance-assured perforating systems. Customers that have completed this transition are achieving significant improvements in operating efficiency, while also reducing their investments in assembly personnel and related infrastructure. They also benefit from just-in-time delivery of the industry's most reliable and best-performing perforating systems, while significantly reducing their investments in working capital. We continue to focus on DMC’s long-term business strategy, as exemplified by our sustained investments in innovation, technology and product development. These investments enabled DynaEnergetics to make several new additions to its product portfolio. These include a new generation of the IS2 Intrinsically Safe initiating system, which now enables deployment of up to 100 perforating systems in a single run. DS Echo, which is the first factory-assembled perforating system for the emerging re-frac market, and finally, the patent-pending DS MicroSet and DS Liberator, two products that expand our well completion product offering and increased DynaEnergetics’ addressable market by more than 20%. DS MicroSet is used to set the plug that isolates an individual stage in a well, while DS Liberator is a ballistic release tool that enables the service company…

Thanks, Kevin. Second quarter sales were $43.2 million, down 41% sequentially and down 61% versus last year's second quarter. DynaEnergetics reported second quarter sales of $23.6 million, down 56% sequentially and a decline of 73% versus the same quarter last year. As Kevin mentioned, the decline reflects an abrupt downturn in unconventional well completion activity in North America. Sales at NobelClad were $19.6 million, down 4% sequentially and down 12% versus last year's second quarter. Consolidated gross margin in the second quarter was 15%, down from 33% from the first quarter of 2020 and down from 38% in the second quarter of 2019. The decline primarily relates to the 73% year-over-year sales decline at DynaEnergetics, which was also impacted by lower selling prices and inventory reserves of $1.6 million. DynaEnergetics reported second quarter gross margin of 8% versus 37% in the 2020 first quarter and 41% in last year's second quarter. The magnitude of DynaEnergetics sales decline led to the significant underabsorption of fixed overhead and research and development expenses. Low capacity utilization of DynaEnergetics manufacturing facilities also resulted in an excess capacity charge of $2 million or $0.10 per diluted share. As mentioned, DynaEnergetics also recorded inventory reserves of $1.6 million or $0.09 per diluted share. NobelClad reported second quarter gross margin of 25% versus 25% in the first quarter and 26% in the year ago second quarter. Looking at our second quarter expenses, consolidated SG&A of $12.2 million, which includes $800,000 in bad debt expense, declined 27% versus both the first quarter and the year ago second quarter. We reported a consolidated adjusted operating loss of $5.9 million, which includes the $2 million in excess capacity charges, inventory reserves of $1.6 million and $800,000 in bad debt expense. The adjusted operating loss excludes $2 million in restructuring charges,…

Thank you. [Operator Instructions] We'll take our first question from Tommy Moll with Stephens. Your line is open. Please go ahead.

Good afternoon, and thanks for taking my questions.

Good afternoon, Tommy.

Kevin, you mentioned that management is currently in dialog with several operators and service companies in terms of they're seeking to transition away from field assembly and toward your platform. Could you tell us, are these current customers that are leaning into a pre-assembled opportunity that you might bring to them or are these new customers entirely? And how far along would you say, these – some of these discussions are?

Sure. Tommy, it's both, existing customers and new customers. There is a small group of customers who have moved to our business model completely and they're seeing the benefit of the just-in-time delivery of our complete factory-assembled systems. Some of the other people who did not transfer completely or are considering moving to our systems, one of the things that they're seeing in this downturn as they got trapped in investing in the assembly and inventory and operations to make perforating guns, which quite frankly, we can do better. And they don't want to be in that position again, particularly in a tight, volatile and short-cycled market. So we're getting a lot of interest from new companies that are people that we haven't done an extensive amount of work with in the past to move to our business model. And so while revenue is low, there is a significant amount of onboarding of new customers and going deeper with some existing customers.

That's very helpful, Kevin. And a related question, if we look at your third quarter guidance for the DynaEnergetics segment, it implies a significant sequential improvement. So I just – I wondered, if embedded in there is an assumption for some big conversions regarding the customers we just described or is that more just driven on the industry outlook or visibility you have elsewhere?

It's based on what we see in people that we're currently either selling to or onboarding. I will say, I think, one of the things that the market is experiencing is, first quarter of and in 2019, it was a 25% to 30% systems market. 70% of the market was component driven. And there is a lot of component inventory in the marketplace, particularly on metal parts and hardware that is currently the industry needs to work through. And our customers and potential new customers are working through kind of a mountain of existing inventory before they fully convert to the systems. We'd expect that inventory, it's going to take a quarter or two, probably two quarters at the current rate to work through. And so we really don't see a meaningful pickup until – into next year, but we are seeing a slight increase in activity in the third quarter.

Okay. Thank you very much. And if I could just sneak one final question in. On DynaEnergetics, this is a business that you have positioned to have a primarily variable cost structure. And since you completed the facility in Blum, this past couple – these past couple of quarters have really been the first big downdraft to stress that model, so to speak. So if we look at the decrementals in the second quarter, just as an example, you've got the inventory reserve and the excess capacity charge that are kind of noise in there. But if you pierce through those, would you characterize that the operation is performing as you expected when you built the facility in Blum and as you've positioned it over the past couple of years or is there still some more wood to chop in terms of streamlining the cost structure?

We're very pleased with the performance of that facility and business. Our cost structure and we have brought our cost structure in line over a five to seven year period of time in terms of our industrial footprint, if you will. And when this downturn hit in March really, beginning in March, we brought our activity cost structure into line, direct labor and indirect variable labor, but the efficiencies actually have improved at our Blum facility. And at this level of activity, we've actually in-sourced some components that we would have outsourced previously and that should give us an uplift to our margins as it is right now, although it's hard to see with all the noise, but it will continue to do that in the stronger market. But we're very pleased with the quality of our leadership team and the – our employees and what they've accomplished.

Thank you, Kevin. I will turn it back.

[Operator Instructions] We'll go next to Stephen Gengaro at Stifel. Your line is open.

Thanks. Good afternoon, gentlemen.

Good afternoon, Stephen.

I guess, two things. One, I just wanted to start with the DynaEnergetics business in the U.S. I mean, obviously, it was a pretty steep sequential drop. In your Q, you broke out kind of the U.S. piece and it looked pretty severe. When I think about the market share position and how you're sort of approaching that right now. And obviously, it seems like people are buying more components in the very short term, but how do you expect the – I mean, the market demand will do what it's going to do, but how do you expect your share to kind of evolve over the next two to six quarters, assuming we started to get a recovery in a market? And do you think you'll get back to kind of that sort of positive momentum on that front? Any kind of color you could add around that would be helpful.

Yes, I think, first of all, it's – in the second quarter – probably safe to say and it's expected on our part in a market that basically collapsed over a 45 day period of time from March to April and there is a significant amount of component inventory in suspension, if you will, in the market that – in a lot of the – either manufacturers or service companies – even though our systems performed better than a field-assembled system, it wasn't about performance and it wasn't about cost. It was about selling through the inventory that people had on their books to turn that inventory into cash and so with a market that had very little demand and a lot of people wanting to turn inventory into cash, pricing in the second quarter was very difficult – is very difficult, even going into the third quarter and we're not chasing that. And so in the down market with that kind of scenario, our market share of systems going down the well has declined, probably declined markedly and that's okay. We're focused on the medium to long-term. The prices at which those systems are being sold is not sustainable. You will see that in margins of companies as they begin to report. It won't be replenished and the value of our systems will really be seeing coming out of this downturn, because we – they're safer, they're more reliable, they perform better, they also require fewer people at a well site. There is going to be fewer people at a well site and it takes the working capital and costs of the service company and puts it on to our books. And so we have relatively high inventory for what demand is right now. And our inventory, we're not trying to turn into cash because of the strength of our balance sheet. And I guess, this is the first time in my career, I can say that we're saving that inventory for a sunny day and because they're good systems and they perform and we'll give on this quarter, we'll probably give on the next quarter or two as the inventory and suspension works its way through the industry. But the value proposition for our customers of Factory-Assembled, Performance-Assured systems has never been stronger. And it is – this downturn has highlighted that for people who have converted to our systems because they think it's – they're not stuck working through inventory but the just-in-time delivery model. So I think, we expect our margin to – I'd expect our market share to recover and actually go past where we were at the beginning of this downturn.

Okay. And then, when you mentioned component inventory, is that just a function of the normal component demand and just the overall activity just falling off a cliff and create, so even two quarters ago, there were components being sold, people are still summing at the well site and just because demand fell so fast, you had this inventory in a channel, is that what caused that?

Yes. In 2015, 2016, it took two years for the activity to decline 70% completions. This took 45 days and most companies had material-on-order, systems-on-order for a market that was different than the market that it turned out to be in the second quarter and for the balance of this year. And there's just a flywheel effect of that inventory coming in lower demand, it's going to take a while to work through. And so there is a lot of – there has been a lot of talk about systems but we are – have been the primary supplier of systems to the market. And the market has still been 70%, 70 plus percent a component business with field-assembly of perforating guns. And so there is a lot of cats and dogs, if you will, of manufacturers of hardware in the HEMP and just a small group of explosive manufacturers. And some of their product lines, systems that they've talked about weren't fully mature and market ready for this year. And so when this downturn happened, the hardware companies are scrambling to sell-through their inventory and some of our leading customers have backed off of the system focus and have been selling shaped charges and components into a declining price market. And quite frankly, that's probably put some of them further behind for coming out of the downturn, which again I'll go back to feeling pretty good about where we're going to be when the market starts to recover.

Thank you. Just the one more and I'll pass it on. Looking at your Q, there was a big spike in sales in India like $4.7 million versus almost zero in the last – as far back as I can see, is there a market opportunity there? What's driving that? Is it something I should be thinking about and we should be investigating a bit more?

There is a kind of an annual requirement in a tender that's put out by certain countries, in this case, India and we were awarded that project and that project shift in the Q2. It was more pronounced, you can see it now from a more pronounced standpoint, but it's been there on previous years. So it's a – I would view it as a kind of an annual event. Sometimes, we win it, sometimes we don't, but it just was more marked this year in terms of our performance.

And so does that mean that your baseline U.S. business probably rises at a faster percentage than your guidance suggest in the next quarter because that's not a recurring item?

Yes, it does. And it also means that our international business is very strong in the second quarter for DynaEnergetics and which would also highlight the faster drop-off in DynaEnergetics in the second quarter by choice, by design, because we're not chasing the low-price business.

Great, thank you. Thanks for your answers. I appreciate it.

[Operator Instructions] We will move next to Taylor Zurcher at Tudor, Pickering & Holt. Your line is open.

Hey, good afternoon, and thank you. Kevin, I wanted to peel back the onion a little bit more on Dyna and some of the moving pieces as it relates to sales in Q2 and what the Q3 guidance would imply. So if we take the midpoint for Q3, you're guiding basically a 20% sequential improvement at the top line and it sounds like some of these chunky or lumpy international pieces will fall off. So the inference is that the U.S. probably improves greater than the 20% and I wonder, what – do you have a view on what underlying completions activity in the U.S. might do sequentially in Q3 that's underpinning that guidance?

Yes, I think that there is probably a little bit of a stronger pickup there for us with some of the projects we're working on than the underlying completion activity, Taylor. We did see a pickup in – a slight pickup in June and a slight pickup in July over what April, May timeframe was. And so I think that part of it is a pickup in the third quarter versus the second and part of it is just a pickup with some of the customers that we're working with, that are – we're working with them a little bit deeper on some of their completion projects.

Okay, got it. My follow-up is related to cash flow over the back half. Working capital came back or as a source of cash here in Q2. As we think about the back half, I think most of the Q2 working capital was receivables collections but with Dyna starting to pick back up in the back half, I imagine the receivables collection dynamic is going to start reversing. At the same time you talked in one of the prior responses about how you still have a bunch of inventory on the balance sheet. So just curious how those two factors there will play in into whether you might get any cash out of working capital in the back half of the year.

Yes. I would expected in this role of you to point it out because I do expect the receivables to go up slightly, inventory to come down, because ours – our inventory is high but we'll sell-through some of these systems and are selling through them and we're hoping to be breakeven, if you will, or better at the income line, operating income line. And so we expect to be neutral from a cash standpoint for the quarter but, Mike, do you?

Yes. I mean, and really what it is as you – if you look at our cash neutral to slightly positive, Taylor. We're saying $1.5 million to $4 million in EBITDA and $2 million to $3 million in CapEx, so that pretty much gets us to a flattish working capital with receivables and inventory offsetting.

Okay, got it. That's all from me. Thanks for the answers.

Yes. Thanks, Taylor.

With no other questions holding, I would now like to turn the call back to DMC Global's CEO, Mr. Kevin Longe, for any additional or closing remarks.

Thank you, everybody. We appreciate your interest in the company. We have entered the second half of 2020 with a highly efficient operating structure, a portfolio of differentiated technologies and products, a strong balance sheet and a talented workforce. Our strategy is sound and I'm confident we will emerge from the downturn an even stronger company. I want to thank DMC's employees who have done an exceptional job during a very challenging period. Our teams around the world have worked hard to keep themselves and their co-workers safe, while also effectively addressing the needs of our customers. I sincerely appreciate their continued effort and dedication. Everybody, stay safe and we look forward to talking to you next after the end of the next quarter. Thank you.

Ladies and gentlemen that will conclude today’s call. We thank you for your participation. You may disconnect at this time, and have a great day.