Q4 2023 DMC Global Inc Earnings Call

Participants

Geoff High; Vice President - Investor Relations & Corporate Communications; DMC Global Inc

Michael Kuta; CEO & Director; DMC Global Inc

Eric Walter; Chief Financial Officer; DMC Global Inc

Ken Newman; Analyst; KeyBanc Capital Markets

Alec Scheibelhoffer; Analyst; Stifel, Nicolaus & Company, Inc.

Presentation

Operator

Greetings, welcome to the DMC Global fourth-quarter and full-year earnings call. (Operator Instructions) I'll now turn the conference over to your host, Geoff High, VP of Investor Relations. You may begin.

Geoff High

Hello and welcome to DMC's fourth-quarter conference call. Presenting today, our DMC CEO, Michael Kuta, and Chief Financial Officer, Eric Walter. 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.
Today's earnings release and related presentation on our fourth quarter performance are available on the Investors page of our website located at dmcglobal.com. A webcast replay of today's presentation will be available at our website shortly after the conclusion of this call. And with that, I'll now turn the call over to Michael Kuta. Mike.

Michael Kuta

Hello, and thank you for joining us for today's call. Our 2023 fourth quarter closed out a pivotal year for DMC. Full-year accomplishments included new records for several key financial metrics including sales, adjusted EBITDA, and free cash flow. We also made key additions to DMC's leadership team and Board of Directors.
We enhanced the operating strategies in our three business units while also reducing costs across the organization. And we initiated a detailed review of our portfolio strategy as we seek to unlock long-term value for DMC's stakeholders.
Looking at the fourth quarter, our manufacturing businesses reported varying conditions in their industrial end markets, Arcadia, which serves the commercial and high end residential building products. Market reported a 9% year-over-year sales decline, which is due principally to lower aluminum prices. During the quarter, Arcadia completed the first phase of a paint capacity expansion, a key strategic objective. A second expansion is planned for the back half of this year. Current market conditions have led to a soft start to the year at Arcadia, but we believe results will improve throughout the balance of 2020 for DynaEnergetics.
Our oilfield products business reported another strong quarter in its international markets. This solidified a new full year record for international sales, which were up 28% versus 2022. In Dana's North American market, fourth quarter unit sales of our flagship DynaStage system increased 4% sequentially. However, customer consolidation led to pricing pressure, reducing our overall EBITDA margins, 12.3%. Automation and operational excellence initiatives coming online in 2024 should improve Dana's profitability. In addition, we expect new premium product offerings will support our margin improvement efforts, Diners working to ramp up production of its new gravity 2.0 perforating system, which is the lightest most compact self orienting system on the market. It's generating strong end-user demand NobelClad, our composite metals business delivered another outstanding quarter. Sales were up 33% year over year, and adjusted EBITDA margins came in at approximately 25%, reflecting a very, very favorable project mix. Nobelclad continues to benefit from healthy activity in its global end markets, also capitalizing on strong demand and improved production capabilities for its Solyndra cryogenic transition joints. Last month, we formally announced our intent to simplify the DMC portfolio as part of a broader effort to enhance shareholder value. We are pursuing separate strategic alternatives for DynaEnergetics and NobelClad with the help of our financial advisers by streamlining our portfolio, we can sharpen our focus on the growth and profitability of Arcadia, which benefits from a strong brand, a differentiated business model and a larger addressable market. We've also strengthened our capital structure and improved our financial flexibility as we embark on a broad range of growth opportunities at Arcadia. I'm excited about the EMC's strategic direction and encouraged by our prospects for long-range growth. I'll now turn the call over to Eric for a closer look at our fourth-quarter financial results and a review of our guidance. Eric.

Eric Walter

Thanks, Mike. Our consolidated fourth quarter sales were $174 million, which is relatively flat with the fourth quarter last year. Gross consolidated gross margin was 26.1% of 30 basis points from our 2022 fourth quarter due to a more favorable project mix at NobelClad, combined with margin recovery at Arcadia. Our fourth quarter SG&A expense of $27 million was 15.6% of sales, down from 17.5% in the fourth quarter of last year. Driven mostly by lower litigation expenses and IT consulting fees at Dyna and Arcadia, respectively. It's important to note that our 2023 fourth quarter SG&A expense also includes $1 million of bad debt expense. Fourth quarter adjusted EBITDA attributable to DMC remained flat year over year at $20 million as improvements in NobelClad and Arcadia offset a decline at Dyna, inclusive of the Arcadia noncontrolling interest. Consolidated adjusted EBITDA was $23 million for 13.4% of sales, up 60 basis points versus the prior year quarter. At the business level, Arcadia reported fourth quarter adjusted EBITDA of $9 million, of which $5 million or 60% was attributable to DMC. Compared with the prior year. Arcadis adjusted EBITDA rose 29% and expanded 400 basis points. As a percentage of sales. Arcadis product pricing declined at a slower pace than the drop in aluminum costs, while SG&A also decline through lower ERP consulting fees and other miscellaneous costs.
Data reported fourth quarter adjusted EBITDA of $9 million or 12.3% of sales, less favorable customer mix and lower absorption of manufacturing overhead costs led to a sequential and year-over-year margin contraction. Nobelclad reported adjusted EBITDA of $8 million, which was 24.7% of sales and up 990 basis points compared to the fourth quarter of 2022. EBITDA margin improved due to a more favorable project mix and better absorption of fixed manufacturing overhead costs. Adjusted net income attributable to DMC was $5 million during the fourth quarter of 2023. Adjusted EPS attributable to DMC was $0.26, up 18% compared to last year's fourth quarter. During the quarter, DMC generated free cash flow of $15 million, which was an improvement of over 10% compared with the prior year quarter. We used fourth quarter free cash flow, primarily for principal payments on our long-term debt distributions to Arcadia joint venture partner and an investment in marketable securities. I should note that in this year's first quarter we used our investments in marketable securities or de-levering following the closing of our new $300 million senior secured credit facility.
In terms of liquidity, we ended the fourth quarter with cash and marketable securities of $44 million and had no amounts outstanding under our $50 million revolver. Our debt to adjusted EBITDA leverage ratio was 1.25 at the end of the fourth quarter, which was well below our covenant threshold of 3.0 on our pro forma net debt basis after subtracting cash and marketable securities Our leverage ratio was 0.78 at the end of the fourth quarter, which represents the eighth quarter in a row that we have de-levered.
Now turning to guidance for the first quarter of 2024. Consolidated sales are expected in a range of 168 to $178 million. As Mike mentioned, we expect market conditions in the first quarter to be soft in Arcadia as key markets, while the activity level in Donna's North American markets are expected to slightly improve first quarter adjusted EBITDA attributable to DMC is expected to be in a range of 15 to $20 million. Arcadia and NobelClad EBITDA margins are expected to moderate to levels similar to the prior year first quarter and Diana, where we believe sequential comparisons are more relevant, we anticipate EBITDA margins will improve versus the fourth quarter due to higher sales volumes and lower bad debt expense. With that, we're ready to take any questions from our analysts. Operator.

Question and Answer Session

Operator

(Operator Instructions) Ken Newman, KeyBanc Capital Markets.

Ken Newman

Hey, guys. I guess my first one will be just on the first quarter guide for Arcadia, and obviously, you're expecting that to be weaker here despite the prior year comps easing sequentially from 4Q to 1Q. Just curious, can you talk a little bit about how much of that is still the pricing drag? Is that completely all of it? Any color on just where volumes are within that business and how they're trending? And what are you seeing from an underlying activity outside of pricing within that business?

Michael Kuta

Yes, your pricing, so a bit of a drag with aluminum costs. We're also seeing in the first quarter I think it's it's abating now, but January was challenged with weather. So we had and severe rain and flooding on the West Coast, our core markets. So that impacted January for sure volume is relatively steady. We're seeing a bit of softness in our storefront business. But I think as we play out on the quarters, 2Q, 3Q, 4Q, we're going to see that strengthening. We're also seeing our project business and outlook there, strengthening quite a bit and improving. So it's a bit of a it's a bit of a mixed bag. We also see of RadiSys in a bit of a, I'd say, a valley, and we expect that to pick up throughout the year. So that's that's kind of the premise behind the I guess we'd call it 67 to 71 flattish with 4Q, Derek, anything else?
Okay.

Eric Walter

I think you hit on one.

Ken Newman

Okay. And you touched on it a little bit here. But the follow-up here is just that what is the confidence with the comfort that margins improve in Arcadia after the first quarter and obviously, the revenue copies is pretty significantly starting in the second quarter. Just hoping to dig on how much the benefit from capacity expansion and can can you quantify that benefit here in 2024? First is all the other moving pieces around maybe some stabilizing in pricing or expectations for something you expect some volume improvement as we move through the year?

Michael Kuta

Yes. I think the I think volume is going to help as we go throughout the year. I think Q2, some of the project business, again, that's there some good project mix in there. There's some unfavorable project mix in there. But I think what we're going to see is some revert back to historical 30%, low 30s, 30% plus margins in Arcadia. Again, it's a high variable cost business. So it's not entirely volume driven, but volume will help it as we step throughout the year and an increase in residential as well.

Ken Newman

Got it. Maybe one more before I jump back in the queue, the free cash flow expectation with volumes being or with sales kind of being a little bit lighter here in the first quarter to start the year how do you think about working capital benefit? Then any sense on how you think about free cash flow conversion beyond the first quarter here?

Eric Walter

Jim, this is Eric. So for 2023, we had a free cash flow conversion of 40% to 45%. And this year, we're aiming to get that up into the, call it low 50% low to mid 50% level. We do think that there's going to be some tailwinds from working capital. We think that the working capital actually was slightly higher in a couple of the businesses in 2023 than maybe what they needed. So as we go forward in 2024, we think we're going to be able to unwind some of that and you get a benefit the free cash flow line.

Operator

Alec Scheibelhoffer, Stifel.

Alec Scheibelhoffer

Thanks and good afternoon, everyone, and thanks for taking my question. So just to start to software, I was wondering if you could provide just an update on the competitive landscape in the perforating business. Any kind of color you can provide on how pricing is trending, given some of the consolidation we've seen in the market in North America yes, just some color around that would be great.

Michael Kuta

So we've seen some pricing pressure from consolidation in the market so that that's been a driver to margins. I think where we're seeing that. And that's that's ahead of some of the initiatives we have on margin improvement. So we're putting in a lot of automation here in the first and second quarter that's going to drive better margins and quite frankly, better performance of our perf gun systems.
We've also got quite a bit of CSI operational excellence initiatives, cost out that we're implementing this year. That's going to drive margins. And quite frankly, also some new tech in our gun systems, improved product mix. And that is also going to come, I think, are going to drive improvements there as well. So I think we're seeing a pretty good market out of the gate here in January and in the first quarter. And so we expect improvements off of 4Q, and we should see a better a much better profile as we go throughout the year.

Alec Scheibelhoffer

Thank you for that. And then just shifting gears to our Katy I was just wondering if you could provide some additional color on the outlook for the business. I'm just curious in the past, you've mentioned kind of going after some low-hanging fruit and growing the business organically nicely. A CapEx, if I'm looking correctly for 24 is up a little bit sequentially. I'm wondering if that's just speaking to some of that organic growth if there's any inorganic that you're going after as well?

Michael Kuta

Yes. I'd start on the organic side. I mean, some of some of it's SG&A and people investment. We've got to pull through more are on our commercial interiors business and Arcadia custom business, which is the luxury residential side of our business. You know that the predominant business in Arcadia is a commercial exteriors, low rise storefront. And so I think that's going to be part of that. I think on the CapEx side, some additional investments in paint as well as anodizing are going to drive both volume as well as margin as we outsource some of our anodizing now.

Geoff High

Got it.

Alec Scheibelhoffer

That's great. And actually, if I could squeeze one more in shifting back to Diana. I would just I know you mentioned some automation, some other initiatives you have on the margin front. I was just curious for that business. Are you factoring any kind of growth in the business in the US, if activity is relatively flat? Or how should we kind of think about that on a margin standpoint?

Michael Kuta

Yes. So I think what we're expecting is a fairly sizable growth in the international business. So we exited 2023 record international sales. We have a record backlog internationally, so we'll see growth there as North America. We didn't provide full year guidance, but it's off to a good start, I'd say. But I wouldn't I wouldn't have put a bunch of growth into the North America side probably more on the flatter side.

Alec Scheibelhoffer

Eric, would you?

Eric Walter

Yes, I think you just said augment what Mike was saying. I think as you think about the the revenue trajectory of that business. I think it's going to be relatively flattish kind of going forward. But when you peel it back and look at the domestic versus international components, there's going to be a bit of a mix there. Like Mike said, the international piece, we're feel pretty confident about and they're showing a lot of upward some growth there. But the North American market is probably going to be a bit flattish to us, maybe a little bit more sluggish than in years past.

Michael Kuta

And again, the international piece is also part of what's driving the margins as well. So and that's a business that should outperform for us in 2024.

Alec Scheibelhoffer

Got it. That's great color.

Michael Kuta

We've got.

Alec Scheibelhoffer

I'll turn it back.

Operator

Thank you.
Thank you. And just as a reminder, if anyone has any questions, you may press star one on your telephone keypad to join the question and answer you. And in this section we have reached the end of the question-and-answer session. And I'll now turn the call back over to Michael Kuta for closing remarks.

Michael Kuta

Thank you again for joining today's call. We appreciate your interest in DMC and look forward to updating you in May following our first quarter.

Operator

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.