Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Item 4. Controls and Procedures
Part II - Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Dynamic Materials Earnings 2019-09-30
BOOM 10Q Quarterly Report
10-Q 1 a0930201910q.htm DMC GLOBAL THIRD QUARTER 2019 10-Q Document
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
Commission file number 001-14775
DMC GLOBAL INC.
(Exact name of Registrant as Specified in its Charter)
(State of Incorporation or Organization)
(I.R.S. Employer Identification No.)
11800 Ridge Parkway, Suite 300, Broomfield, Colorado 80021
(Address of principal executive offices, including zip code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Act). Yes o No x
The number of shares of Common Stock outstanding was 14,645,752 as of October 23, 2019.
CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. We intend the forward-looking statements throughout this quarterly report on Form 10-Q to be covered by the safe harbor provisions for forward-looking statements. Statements contained in this report which are not historical facts are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from projected results. These statements can sometimes be identified by our use of forward-looking words such as “may,” “believe,” “plan,” “anticipate,” “estimate,” “expect,” “intend,” and other phrases of similar meaning. Such statements include projections, guidance and other statements regarding the expected impacts of new accounting standards and the timing of our implementation thereof, our business strategy, our expectations regarding additional restructuring expenses in the fourth quarter, the level of demand for our perforating products and factors affecting this demand, our expectations regarding commencement of commercial shipments of the DS TrinityTM 3.5 system, NobelClad’s demand outlook in the downstream and upstream energy sectors and our backlog. The forward-looking information is based on information available as of the date of this quarterly report and on numerous assumptions and developments that are not within our control. Although we believe that our expectations as expressed in these forward-looking statements are reasonable, we cannot assure you that our expectations will turn out to be correct. Factors that could cause actual results to differ materially include, but are not limited to, those factors referenced in our Annual Report on Form 10-K for the year ended December 31, 2018 and such things as the following: changes in global economic conditions; the ability to obtain new contracts at attractive prices; the size and timing of customer orders and shipments; product pricing and margins; our ability to realize sales from our backlog; fluctuations in customer demand; fluctuations in foreign currencies; competitive factors; the timely completion of contracts; the timing and size of expenditures; the timely receipt of government approvals and permits; the price and availability of metal and other raw material; fluctuations in tariffs or quotas; changes in laws and regulations; the adequacy of local labor supplies at our facilities; current or future limits on manufacturing capacity at our various operations; our ability to successfully integrate acquired businesses; the impact of pending or future litigation or regulatory matters; the availability and cost of funds; and general economic conditions, both domestic and foreign, impacting our business and the business of the end-market users we serve. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. We undertake no obligation to publicly release the results of any revision to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Thousands, Except Share and Per Share Data)
1. BASIS OF PRESENTATION
The information included in the condensed consolidated financial statements is unaudited but includes all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the interim periods presented. These condensed consolidated financial statements should be read in conjunction with the financial statements that are included in our Annual Report filed on Form 10-K for the year ended December 31, 2018.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The condensed consolidated financial statements include the accounts of DMC Global Inc. (“DMC”, “we”, “us”, “our”, or the “Company”) and its controlled subsidiaries. Only subsidiaries in which controlling interests are maintained are consolidated. All significant intercompany accounts, profits, and transactions have been eliminated in consolidation.
On January 1, 2018, the Company adopted a new accounting standard, as amended, regarding revenue from contracts with customers using the modified retrospective approach, which was applied to all contracts with customers. Under the new standard, an entity is required to recognize revenue to depict the transfer of promised goods to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods.
The Company’s revenues are primarily derived from consideration paid by customers for tangible goods. The Company analyzes its different goods by segment to determine the appropriate basis for revenue recognition. Revenue is not generated from sources other than contracts with customers and revenue is recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. There are no material upfront costs for operations that are incurred from contracts with customers.
Our rights to payments for goods transferred to customers arise when control is transferred at a point in time and not on any other criteria. Payment terms and conditions vary by contract, although terms generally include a requirement of payment within 30 to 60 days. In instances when we require customers to make advance payments prior to the shipment of their orders, we record a contract liability. We have determined that our contract liabilities do not include a significant financing component given the short duration between order initiation and order fulfillment within each of our segments. Please refer to Note 5 “Contract Liabilities” for further information on contract liabilities and Note 9 “Business Segments” for disaggregated revenue disclosures.
For the three months ended September 30, 2019 and 2018, we recorded $64 of bad debt expense and a $32 reversal of bad debt expense, respectively. For the nine months ended September 30, 2019 and 2018, we recorded $238 of bad debt expense and a $28 reversal of bad debt expense, respectively.
We recognize deferred tax assets and liabilities for the expected future income tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities. Any effects of changes in income tax rates or tax laws are included in the provision for income taxes in the period of enactment. The deferred income tax impact of tax credits is recognized as an immediate adjustment to income tax expense. We recognize deferred tax assets for the expected future effects of all deductible temporary differences to the extent we believe these assets will more likely than not be realized. We record a valuation allowance when, based on current circumstances, it is more likely than not that all or a portion of the deferred tax assets will not be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies, recent financial operations and their associated valuation allowances, if any.
We recognize the tax benefits from uncertain tax positions only when it is more likely than not, based on the technical merits of the position that it will be sustained upon examination, including the resolution of any related appeals or litigation.
The tax benefits recognized in the consolidated financial statements from such a position are measured as the largest benefit that is more likely than not to be realized upon ultimate resolution. We recognize interest and penalties related to uncertain tax positions in operating expense.
Earnings Per Share
The Company computes earnings per share (“EPS”) using a two-class method, which is an earnings allocation formula that determines EPS for (i) each class of common stock (the Company has a single class of common stock), and (ii) participating securities according to dividends declared and participation rights in undistributed earnings. Restricted stock awards are considered participating securities as they receive non-forfeitable rights to dividends similar to common stock.
Basic EPS is then calculated by dividing net income available to common stockholders of the Company by the weighted‑average number of shares of common stock outstanding during the period. Diluted EPS adjusts basic EPS for the effects of restricted stock awards, performance share units and other potentially dilutive financial instruments (dilutive securities), only in the periods in which such effect is dilutive. The effect of the dilutive securities is reflected in diluted EPS by application of the more dilutive of (1) the treasury stock method or (2) the two-class method assuming nonvested shares are not converted into shares of common stock. For the periods presented, diluted EPS using the treasury stock method was less dilutive than the two-class method; as such, only the two-class method has been included below.
Three months ended September 30,
Nine months ended September 30,
Net income as reported
Less: Distributed net income available to participating securities
Less: Undistributed net income available to participating securities
Numerator for basic net income per share:
Add: Undistributed net income allocated to participating securities
Less: Undistributed net income reallocated to participating securities
Numerator for diluted net income per share:
Weighted average shares outstanding for basic net income per share
Effect of dilutive securities
Weighted average shares outstanding for diluted net income per share
Net income per share:
The Company maintains a Non-Qualified Deferred Compensation Plan (the “Plan”) as part of its overall compensation package for certain employees. Participants are eligible to defer a portion of their annual salary, their annual incentive bonus, and their equity awards through the Plan on a tax-deferred basis. Deferrals into the Plan are not matched or subsidized by the Company, nor are they eligible for above-market or preferential earnings.
The Plan provides for deferred compensation obligations to be settled either by delivery of a fixed number of shares of DMC’s common stock or in cash, in accordance with participant contributions and elections. For deferred equity awards, subsequent to equity award vesting and after a period prescribed by the Plan, participants can elect to diversify contributions of equity awards into other investment options available to Plan participants.
During the second quarter of 2019, the Company established a grantor trust commonly known as a “rabbi trust” and set aside certain assets related to the Plan to satisfy the future obligations to participants in the Plan. These assets are subject to the Company’s general creditors. The assets held in the trust include unvested restricted stock awards (RSAs), vested company stock awards, and company-owned life insurance (“COLI”) on certain employees. Unvested RSAs and common stock held by the trust are reflected in the Condensed Consolidated Balance Sheet within “Treasury stock, at cost, and company stock held for deferred compensation, at par” at the par value of the common stock or unvested RSAs. These accounts are not adjusted for subsequent changes in the fair value of the common stock. COLI held by the trust is accounted for at fair value and is reflected in the Condensed Consolidated Balance Sheet within “Prepaid expenses and other,” and subsequent increases or decreases in the fair values of the assets are recorded as compensation expense or benefit, respectively, within “General and administrative expenses” in the Condensed Consolidated Statements of Operations.
Deferred compensation obligations that will be settled in cash are accounted for on an accrual basis in accordance with the terms of the Plan and are reflected in the Condensed Consolidated Balance Sheet within “Other long-term liabilities.” These obligations are adjusted based on changes in value of the underlying investment options chosen by Plan participants. Deferred compensation obligations that will be settled by delivery of a fixed number of shares of the Company’s common stock are reflected in the Condensed Consolidated Statements of Stockholders’ Equity within “Common stock” at the par value of the common stock or unvested RSAs. These accounts are not adjusted for subsequent changes in the fair value of the common stock.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We are required to use an established hierarchy for fair value measurements based upon the inputs to the valuation and the degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows:
Level 1 — Inputs to the valuation based upon quoted prices (unadjusted) for identical assets or liabilities in active markets that are accessible as of the measurement date.
Level 2 — Inputs to the valuation include quoted prices in either markets that are not active, or in active markets for similar assets or liabilities, inputs other than quoted prices that are observable, and inputs that are derived principally from or corroborated by observable market data.
Level 3 — Inputs to the valuation that are unobservable inputs for the asset or liability.
The highest priority is assigned to Level 1 inputs and the lowest priority to Level 3 inputs.
The carrying value of accounts receivable and payable, accrued expenses, revolving loans under our credit facility and borrowings under our capital expenditure facility approximate their fair value. Our revolving loans and borrowings under our capital expenditure facility reset each month at market rates. Our foreign currency forward contracts are valued using quoted market prices or are determined using a yield curve model based on current market rates. As a result, we classify these investments as Level 2 in the fair value hierarchy. The cash surrender value of COLI held to satisfy the future deferred compensation obligations is valued based upon the market values of underlying securities, and therefore we classify these assets as Level 2 in the fair value hierarchy.
We did not hold any Level 3 assets or liabilities as of September 30, 2019 or December 31, 2018.
Recently Adopted Accounting Standards
On January 1, 2019, the Company adopted a new accounting standard, as amended, that requires the Company to record assets and liabilities on the balance sheet for lease-related rights and obligations and disclose key information about its leasing arrangements. The Company elected the modified retrospective approach upon adoption and elected the package of practical expedients available under the new standard. This new standard establishes a right-of-use (“ROU”) model that requires the Company to recognize ROU assets and lease liabilities on the balance sheet for all leases with a term longer than 12 months at commencement of the lease.
Leases are classified as financing or operating, with classification affecting the pattern of expense recognition in the Statement of Operations. Refer to Note 6 “Leases” for further information.
In June 2016, the FASB issued a new accounting pronouncement regarding credit losses for financial instruments. The new standard requires entities to measure expected credit losses for certain financial assets held at the reporting date using a current expected credit loss model, which is based on historical experience, adjusted for current conditions and reasonable and supportable forecasts. The Company is required to adopt the new standard on January 1, 2020. Management is currently evaluating the potential impact that the adoption of this standard will have on the Company's financial position, results of operations, and related disclosures.
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value. Significant cost elements included in inventory are material, labor, freight, subcontract costs, and manufacturing overhead. As necessary, we adjust inventory to its net realizable value by recording provisions for excess, slow moving and obsolete inventory. We regularly review inventory quantities on hand and values, and compare them to estimates of future product demand, market conditions, production requirements and technological developments.
Inventories consisted of the following:
September 30, 2019
December 31, 2018
4. PURCHASED INTANGIBLE ASSETS
Our purchased intangible assets consisted of the following as of September 30, 2019:
Trademarks / Trade names
Total intangible assets
Our purchased intangible assets consisted of the following as of December 31, 2018:
Trademarks / Trade names
Total intangible assets
The change in the gross value of our purchased intangible assets from December 31, 2018 to September 30, 2019 was due to foreign currency translation and an adjustment due to the recognition of tax benefit of tax amortization previously applied to certain goodwill related to the NobelClad and DynaEnergetics reporting units. After the goodwill was written off at September 30, 2017 and December 31, 2015, respectively, the tax amortization reduces other noncurrent intangible assets related to the historical acquisition.
On occasion, we require customers to make advance payments prior to the shipment of goods in order to help finance our inventory investment on large orders or to keep customers’ credit limits at acceptable levels. Contract liabilities were as follows:
September 30, 2019
December 31, 2018
We expect to recognize the revenue associated with contract liabilities over a time period no longer than one year. Of the $1,140 recorded as contract liabilities at December 31, 2018, $799 was recorded to net sales during the nine months ended September 30, 2019.
The Company leases real properties for use in manufacturing and as administrative and sales offices, and leases automobiles and office equipment. Until the end of 2018, leases of property, plant and equipment were classified as operating leases. Payments made under operating leases were charged to the Condensed Consolidated Statement of Operations on a straight-line basis. Upon adoption of the new lease standard, the Company recognized ROU assets and lease liabilities in relation to leases which had previously been classified as operating leases.
The Company determines if a contract contains a lease arrangement at the inception of the contract. For leases in which the Company is the lessee, leases are classified as either finance or operating. ROU assets are initially measured at the present value of lease payments over the lease term plus initial direct costs, if any, with the classification affecting the pattern of expense recognition. If a lease does not provide a discount rate and the rate cannot be readily determined, an incremental borrowing rate is used to determine the future lease payments. Lease and non-lease components within the Company’s lease agreements are accounted for together. The Company has no material leases in which the Company is the lessor.
The significant majority of the Company’s leasing arrangements are classified as operating leases. As of September 30, 2019, the total ROU asset and lease liability for operating leases were $10,274 and $11,431, respectively. The ROU asset was included in “Other assets” while $1,944 of the lease liability was reported in “Other current liabilities” and $9,487 was reported in “Other long-term liabilities” on the Company’s Condensed Consolidated Balance Sheet. The Company’s financing leases were not material as of September 30, 2019. Cash paid for operating lease liabilities are recorded as cash flows from operating activities in the Company’s Condensed Consolidated Statements of Cash Flows. For the three and nine months ended September 30, 2019, operating lease costs were $784 and $2,220 which were included in the Company’s Condensed Consolidated Statements of Income. Short term and variable lease costs were not material for the three and nine months ended September 30, 2019.
Certain of the Company’s leases contain renewal options and options to extend the leases for up to five years, and a majority of these options are reflected in the calculation of the ROU asset and lease liability due to the likelihood of renewal.
The following table summarizes the weighted average lease terms and discount rates for operating lease liabilities:
September 30, 2019
Weighted average remaining lease term (in years)
Weighted average discount rate
The following table represents maturities of operating lease liabilities as of September 30, 2019:
Due within 1 year
Due after 1 year through 2 years
Due after 2 years through 3 years
Due after 3 years through 4 years
Due after 4 years through 5 years
Due after 5 years
Total future minimum lease payments
Less imputed interest
Outstanding borrowings consisted of the following:
September 30, 2019
December 31, 2018
Syndicated credit agreement:
U.S. Dollar revolving loan
Capital expenditure facility
Less: debt issuance costs
Less: current portion of long-term debt
Syndicated Credit Agreement
On March 8, 2018, we entered into a five-year $75,000 syndicated credit agreement (“credit facility”) which replaced in its entirety our prior syndicated credit facility entered into on February 23, 2015. The new credit facility allows for revolving loans of up to $50,000 with a $20,000 US dollar equivalent sublimit for alternative currency loans. In addition, the new agreement provides for a $25,000 Capital Expenditure Facility (“Capex Facility”) which was used to assist in financing our DynaEnergetics manufacturing expansion project in Blum, Texas. At the end of year one, the Capex Facility converted to a term loan which is amortizable at 12.5% of principal per year with a balloon payment for the outstanding balance upon the credit facility maturity date in year five. The new facility has a $100,000 accordion feature to increase the commitments under the revolving loan class and/or by adding a term loan subject to approval by applicable lenders. We entered into the credit facility with a syndicate of three banks, with KeyBank, N.A. acting as administrative agent. The syndicated credit facility is secured by the assets of DMC including accounts receivable, inventory, and fixed assets, as well as guarantees and share pledges by DMC and its subsidiaries.
Borrowings under the $50,000 revolving loan can be in the form of one, two, three, or six month London Interbank Offered Rate (“LIBOR”) loans. Additionally, US dollar borrowings on the revolving loan can be in the form of Base Rate loans (Base Rate borrowings are based on the greater of the administrative agent’s Prime rates, an adjusted Federal Funds rate or an adjusted LIBOR rate). LIBOR loans bear interest at the applicable LIBOR rate plus an applicable margin (varying from 1.50% to 3.00%). Base Rate loans bear interest at the defined Base rate plus an applicable margin (varying from 0.50% to 2.00%). All revolver loan borrowings and repayments have been in the form of one-month or two-month loans and are reported on a net basis in our Condensed Consolidated Statements of Cash Flows.
Borrowings under the $20,000 alternate currency sublimit can be in euros, Canadian dollars, pounds sterling, and in any other currency acceptable to the administrative agent. Alternative currency borrowings denominated in euros, pounds sterling, and any other currency that is dealt with on the London Interbank Deposit Market shall be comprised of LIBOR loans and bear interest at the LIBOR rate plus an applicable margin (varying from 1.50% to 3.00%).
The credit facility includes various covenants and restrictions, certain of which relate to the payment of dividends or other distributions to stockholders; redemption of capital stock; incurrence of additional indebtedness; mortgaging, pledging or disposition of major assets; and maintenance of specified ratios. As of September 30, 2019, we were in compliance with all financial covenants and other provisions of our debt agreements.
We also maintain a line of credit with a German bank for certain European operations. This line of credit provides a borrowing capacity of €4,000, of which €1,298 is available as of September 30, 2019 after considering outstanding letters of credit.
Included in lines of credit are deferred debt issuance costs of $650 and $773 as of September 30, 2019 and December 31, 2018, respectively. Deferred debt issuance costs are being amortized over the remaining term of the credit facility which expires on March 8, 2023.
8. INCOME TAXES
The effective tax rate for each of the periods reported differs from the U.S. statutory rate primarily due to variation in contribution to consolidated pre-tax income from each jurisdiction for the respective periods, differences between the U.S. and foreign tax rates (which range from 20% to 34%), permanent differences between book and taxable income, and changes to valuation allowances on our deferred tax assets.
We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use existing deferred tax assets. Additionally, a three-year cumulative loss at a Consolidated Financial Statement level may be viewed as negative evidence impacting a jurisdiction that by itself is not in a three-year cumulative loss position. At March 31, 2019, the Company was no longer in a three-year cumulative loss position in the U.S. and we believe sufficient future taxable income will be generated to use existing deferred tax assets in that jurisdiction. Accordingly, during the three months ended March 31, 2019, we released valuation allowances of $368 in that jurisdiction and certain states. The Company will continue to monitor the realizability of deferred tax assets and the need for valuation allowances and will record adjustments in the periods in which facts support such adjustments.
The Tax Cuts and Jobs Act (“TCJA”) provides that foreign earnings generally can be repatriated to the U.S. without federal tax consequence. We have reassessed the assertion that cumulative earnings by our foreign subsidiaries are indefinitely reinvested. We continue to permanently reinvest the earnings of our international subsidiaries and therefore we do not provide for U.S. income taxes or withholding taxes that could result from the distribution of those earnings to the U.S. parent. If any such earnings were ultimately distributed to the U.S. in the form of dividends or otherwise, or if the shares of our international subsidiaries were sold or transferred, we could be subject to additional U.S. federal and state income taxes. Due to the multiple avenues in which earnings can be repatriated, and because a large portion of these earnings are not liquid, it is not practical to estimate the amount of additional taxes that might be payable on these amounts of undistributed foreign income.
During the fourth quarter, our German operating entities are expected to commence a tax audit for fiscal years 2015 through 2017. If any issues addressed in the audit are resolved in a manner not consistent with our expectations, the Company could be required to adjust its provision for income taxes in future periods.
9. BUSINESS SEGMENTS
Our business is organized into two segments: DynaEnergetics and NobelClad. DynaEnergetics designs, manufactures and distributes products utilized by the global oil and gas industry principally for the perforation of oil and gas wells. NobelClad is a global leader in the production of explosion-welded clad metal plates for use in the construction of corrosion resistant industrial processing equipment and specialized transition joints.
Our reportable segments are separately managed strategic business units that offer different products and services. Each segment’s products are marketed to different customer types and require different manufacturing processes and technologies.
The disaggregation of revenue earned from contracts with customers based on the geographic location of the customer is as follows.
Three months ended September 30,
Nine months ended September 30,
United Arab Emirates
Rest of the world
Three months ended September 30,
Nine months ended September 30,
United Arab Emirates
Rest of the world
During the three months ended September 30, 2019, no customer accounted for greater than 10% of consolidated net sales, while during the three months ended September 30, 2018, two customers accounted for greater than 10% of consolidated net sales. During the nine months ended September 30, 2019 and 2018, no customers were responsible for more than 10% of consolidated net sales.
We are exposed to foreign currency exchange risk resulting from fluctuations in exchange rates, primarily the U.S. dollar to euro, the U.S. dollar to Canadian dollar, and, to a lesser extent, other currencies, arising from inter-company and third-party transactions entered into by our subsidiaries that are denominated in currencies other than their functional currency. Changes in exchange rates with respect to these transactions result in unrealized gains or losses if such transactions are unsettled at the end of the reporting period or realized gains or losses at settlement of the transaction. We use foreign currency forward contracts to offset foreign exchange rate fluctuations on foreign currency denominated asset and liability positions. None of these contracts are designated as accounting hedges, and all changes in the fair value of the forward contracts are recognized in “Other income (expense), net” within our Condensed Consolidated Statements of Operations.
We execute derivatives with a specialized foreign exchange brokerage firm. The primary credit risk inherent in derivative agreements is the possibility that a loss may occur from the nonperformance of a counterparty to the agreements. We perform a review of the credit risk of our counterparties at the inception of the contract and on an ongoing basis. We anticipate that our counterparties will be able to fully satisfy their obligations under the agreements but will take action if doubt arises regarding the counterparties’ ability to perform.
As of September 30, 2019 and 2018, the notional amounts of the forward currency contracts the Company held were $7,292 and $6,236, respectively. At September 30, 2019 and 2018, the fair values of outstanding foreign currency forward contracts were $0.
The following table presents the location and amount of net gains (losses) from hedging activities:
Three months ended September 30,
Nine months ended September 30,
Statements of Operations Location
Foreign currency contracts
Other income (expense), net
11. COMMITMENTS AND CONTINGENCIES
The Company records an accrual for contingent liabilities when a loss is both probable and reasonably estimable. If some amount within a range of loss appears to be a better estimate than any other amount within the range, that amount is accrued. When no amount within a range of loss appears to be a better estimate than any other amount, the lowest amount in the range is accrued.
Anti-dumping and Countervailing Duties
In June 2015, U.S. Customs and Border Protection (“U.S. Customs”) sent us a Notice of Action that proposed to classify certain of our imports as subject to anti-dumping duties pursuant to a 2010 anti-dumping duty (“AD”) order on Oil Country Tubular Goods (“OCTG”) from China. A companion countervailing duty (“CVD”) order on the same product is in effect as well. The Notice of Action covered one entry of certain raw material steel mechanical tubing made in China and imported into the U.S. from Canada by our DynaEnergetics segment during 2015 for use in manufacturing perforating guns.
In July 2015, we sent a response to U.S. Customs outlining the reasons our mechanical tubing imports do not fall within the scope of the AD order on OCTG from China and should not be subject to anti-dumping duties. U.S. Customs proposed to take similar action with respect to other entries of this product and requested an approximately $1,100 cash deposit or bond for AD/CVD.
In August 2015, we posted the bond of approximately $1,100 to U.S. Customs. Subsequently, U.S. Customs declined to conclude on the Company’s assertion that the mechanical tubing the Company has been importing is not within the scope of the AD order on OCTG from China. As a result, on September 25, 2015 the Company filed a request for a scope ruling with the U.S. Department of Commerce (“Commerce Department”).
On February 15, 2016, the Company received the Commerce Department’s scope ruling, which determined certain imports, primarily used for gun carrier tubing, are included in the scope of the AD/CVD orders on OCTG from China and thus are subject to AD/CVD. On March 11, 2016, the Company filed an appeal with the U.S. Court of International Trade (“CIT”) related to the Commerce Department’s scope ruling. On February 7, 2017, the CIT remanded the scope ruling to the Commerce Department to reconsider its determination. The Commerce Department filed its remand determination with the CIT on June 7, 2017 continuing to find that the Company’s imports at issue are within the scope of the AD/CVD orders on OCTG from China. On March 16, 2018, the CIT issued its decision on the appeal and sustained the Commerce Department’s scope ruling. The Company did not appeal this ruling.
On December 27, 2016, we received notice from U.S. Customs that it may pursue penalties against us related to the AD/CVD issue and demanding tender of alleged loss of AD/CVD in an amount of $3,049, which had previously been accrued for in our financial statements. We filed a response to the notice on February 6, 2017. On February 16, 2017, we received notice that U.S. Customs was seeking penalties in the amount of $14,783. U.S. Customs also reasserted its demand for tender of alleged loss of AD/CVD in the amount of $3,049. We tendered $3,049 in AD amounts on March 6, 2017 into a suspense account pending ultimate resolution of the AD/CVD case. We submitted a petition for relief and mitigation of penalties on May 17, 2017.
On March 27, 2018, we received notice from U.S. Customs Headquarters that it intended to move forward with its pursuit of penalties. The Company engaged in discussions with U.S. Customs Headquarters regarding the scope of penalties asserted and the arguments set forth in the Company’s petition for relief and mitigation of penalties. Based on these discussions and the Company’s assessment of the probable ultimate penalty rate, the Company accrued $3,103 in the first quarter of 2018.
On October 11, 2018, we received a decision from U.S. Customs Headquarters in which a mitigated amount of $8,000 in penalties was asserted. In its financial statements for the quarter ended September 30, 2018, the Company accrued an additional $4,897 of penalties. On December 7, 2018, we submitted a supplemental petition requesting a waiver of the penalty under the Small Business Regulatory Enforcement Act in lieu of tendering the penalty amount. On April 12, 2019, we received notice that our waiver request was denied and tendered the $8,000 during the second quarter of 2019.
12. RESTRUCTURING AND ASSET IMPAIRMENTS
During the third quarter of 2019, DynaEnergetics completed a series of capacity expansion initiatives at its plants in North America and Germany. The new capacity improved DynaEnergetics’ operating efficiencies and enabled the business to more effectively serve its global customer base. Capitalizing on its more efficient manufacturing footprint, DynaEnergetics ceased its operations in Tyumen, Siberia in September 2019. In conjunction with shutting down operations, DynaEnergetics recorded a non-cash asset impairment charge of $4,620 within “Restructuring expenses, net and asset impairments”, which was calculated by comparing the estimated fair value less costs to sell to the carrying value of the assets. DynaEnergetics also recorded $1,260 in severance charges within “Restructuring expenses, net and asset impairments” and a non-cash inventory write down of $630 recorded within “Cost of products sold” associated with the decision to cease operations in Siberia.
As of September 30, 2019, total DynaEnergetics Siberia’s assets classified as held for sale was $4,534. As necessary, we will continue to assess remaining Siberian assets for impairment in the fourth quarter of 2019. Once the entity is substantially liquidated, we will incur additional restructuring expenses related to the reclassification of cumulative currency translation losses, which approximated $8 million as of September 30, 2019.
During the fourth quarter of 2017, NobelClad announced plans to consolidate its European production facilities by closing manufacturing operations in France. During the third quarter of 2018, final approval of the proposed measures was granted by the local workers council, in accordance with applicable French law. NobelClad completed the closure of the Rivesaltes production facility in the fourth quarter of 2018 but is maintaining its sales and administrative office in France. During the second quarter of 2019, NobelClad sold its production facility and related assets and recognized a gain of $519. NobelClad also recorded an additional accrual of $712 for known and probable severance liabilities related to employees terminated as part of closing the manufacturing operations in France. The additional severance accrual was recorded based, in part, on a successful appeal of severance benefits by some terminated employees during the second quarter of 2019.
Total restructuring and impairment charges incurred for these programs are as follows and are reported in the “Restructuring expenses, net and asset impairments” line item in our Condensed Consolidated Statements of Operations:
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our historical consolidated financial statements and notes, as well as the selected historical consolidated financial data that is included in our Annual Report filed on Form 10-K for the year ended December 31, 2018.
Unless stated otherwise, all currency amounts are presented in thousands of U.S. dollars (000s).
DMC Global Inc. (“DMC”) operates two technical product and process business segments serving the energy, industrial and infrastructure markets. These segments, DynaEnergetics and NobelClad, operate globally through an international network of manufacturing, distribution and sales facilities.
Our diversified segments each provide a suite of unique technical products to niche sectors of the global energy, industrial and infrastructure markets, and each has established a strong or leading position in the markets in which it participates. With an underlying focus on generating free cash flow, our objective is to sustain and grow the market share of our businesses through increased market penetration, development of new applications, and research and development of new and adjacent products that can be sold across our global network of sales and distribution facilities. We routinely explore acquisitions of related businesses that could strengthen or add to our existing product portfolios, or expand our geographic footprint and market presence. We also seek acquisition opportunities outside our current markets that would complement our existing businesses and enable us to build a stronger and more diverse company.
DynaEnergetics designs, manufactures and distributes products utilized by the global oil and gas industry principally for the perforation of oil and gas wells. These products are sold to oilfield service companies in the U.S., Europe, Canada, South America, Africa, the Middle East, Russia, and Asia. DynaEnergetics also sells directly to end-users. The market for perforating products, which are used during the well completion process, generally corresponds with oil and gas exploration and production activity. Exploration activity over the last several years has led to increasingly complex well completion operations, which in turn, has increased the demand for high quality and technically advanced perforating products.
Cost of products sold for DynaEnergetics includes the cost of metals, explosives and other raw materials used to manufacture shaped charges, detonating products and perforating guns as well as employee compensation and benefits, freight in, depreciation of manufacturing facilities and equipment, manufacturing supplies and other manufacturing overhead expenses.
During the third quarter of 2019, DynaEnergetics announced that sales of its DynaStage® (DS) systems had exceeded one million units. We believe the milestone was the result of a widespread transition by operators and service companies to our Factory-Assembled, Performance-Assured perforating systems.
Additionally, DynaEnergetics continues to introduce new products and technologies within its DS product family. In the first quarter of 2019, it introduced DS TrinityTM 4.0, a compact product that features three charges on a single radial plane. Field trials of the DS Trinity 3.5, a smaller diameter version of the DS Trinity 4.0, were completed in early October 2019 and commercial shipments of the system will commence at the end of October 2019. DS NLineTM , which enables the user to align the charges at surface and then orient the gun in the wellbore, has also been adopted by several operators and service companies.
NobelClad is a global leader in the production of explosion-welded clad metal plates for use in the construction of corrosion resistant industrial processing equipment and specialized transition joints. While a significant portion of the demand for our clad metal products is driven by maintenance and retrofit projects at existing chemical processing, petrochemical processing, oil refining, and aluminum smelting facilities, new plant construction and large plant expansion projects also account for a significant portion of total demand. These industries tend to be cyclical in nature and timing of new order inflow remains difficult to predict. We use backlog as a primary means to measure the immediate outlook for our NobelClad business. We define “backlog” at any given point in time as all firm, unfulfilled purchase orders and commitments at that
time. Most firm purchase orders and commitments are realized, and we expect to fill most backlog orders within the following 12 months. NobelClad’s backlog increased to $33,241 at September 30, 2019 from $29,879 at December 31, 2018.
Cost of products sold for NobelClad includes the cost of metals and alloys used to manufacture clad metal plates, the cost of explosives, employee compensation and benefits, freight in, outside processing costs, depreciation of manufacturing facilities and equipment, manufacturing supplies and other manufacturing overhead expenses.
NobelClad is experiencing consistent demand from the downstream energy sector and also is bidding on a number of international upstream energy sector projects. Also, new composite-metal applications are generating increased customer interest within a variety of industrial processing sectors.
Factors Affecting Results
DynaEnergetics sales of $77,356 in the third quarter of 2019 increased 17% compared with the third quarter of 2018 due to higher well-completions in the U.S. unconventional oil and gas market and adding several new customers for its intrinsically safe initiating systems (IS2™) and its family of DynaStage® (DS) Factory-Assembled, Performance-Assured™ perforating systems. Sales decreased 13% sequentially versus the second quarter of 2019 due to lower well-completions in the U.S. unconventional oil and gas market principally due to an anticipated slowdown in well completion activity within North America’s unconventional oil and gas industry.
NobelClad’s sales of $22,738 in the third quarter of 2019 increased 2% versus the second quarter of 2019 and increased 5% compared with the third quarter of 2018 due to higher project volume.
Consolidated gross profit of 36.2% in the third quarter of 2019 increased from 33.8% in the third quarter of 2018. The improvement primarily was due to a higher proportion of DynaEnergetics sales relative to NobelClad sales, favorable product mix and productivity improvements in DynaEnergetics, improved project mix in NobelClad and the favorable impact of higher volume on fixed manufacturing overhead expenses.
Consolidated selling, general and administrative expenses were $17,111 in the third quarter of 2019 compared with $15,050 in the third quarter of 2018. The increase primarily was due to headcount additions and merit raises, as well as higher stock-based compensation, and increased variable incentive compensation.
Restructuring expenses and asset impairments of $5,880 were recorded in the third quarter of 2019 related to severance and asset impairments associated with the shutdown of DynaEnergetics’ operations in Tyumen, Siberia. Additionally, $630 of restructuring-related inventory write downs were recorded in “Cost of products sold” in the third quarter of 2019. As of September 30, 2019, the total DynaEnergetics Siberia’s assets classified as held for sale was $4,534. As necessary, we will continue to asses remaining Siberian assets for impairment in the fourth quarter of 2019. Once the entity is substantially liquidated, we will incur additional restructuring expenses related to the reclassification of cumulative currency translation losses, which approximated $8 million as of September 30, 2019.
Net debt of $15,952 decreased $12,028 from $27,980 at December 31, 2018. Net debt is a non-GAAP measure calculated as total debt ($28,135 at September 30, 2019) less cash and cash equivalents ($12,183 at September 30, 2019)
Use of Non-GAAP Financial Measures
Adjusted EBITDA is a non-GAAP (generally accepted accounting principles) measure that we believe provides an important indicator of our ongoing operating performance and that we use in operational and financial decision-making. We define EBITDA as net income plus or minus net interest, taxes, depreciation and amortization. Adjusted EBITDA excludes from EBITDA stock-based compensation, restructuring and impairment charges and, when appropriate, other items that management does not utilize in assessing DMC’s operating performance (as further described in the tables below). As a result, internal management reports used during monthly operating reviews feature Adjusted EBITDA and certain management incentive awards are based, in part, on the amount of Adjusted EBITDA achieved during the year.
Net debt is a non-GAAP measure we use to supplement information in our Condensed Consolidated Financial Statements. We define net debt as total debt less cash and cash equivalents. In addition to conventional measures prepared in accordance with GAAP, the Company uses this information to evaluate its performance, and we believe that certain investors may do the same.
The presence of non-GAAP financial measures in this report is not intended to be considered in isolation or as a substitute for, or superior to, DMC’s GAAP information, and investors are cautioned that the non-GAAP financial measures are
limited in their usefulness. Because not all companies use identical calculations, DMC’s presentation of non-GAAP financial measures may not be comparable to other similarly titled measures of other companies.