DMC Global Inc. quarterly report, Q3 FY2016

DMC Global Inc. (then Dynamic Materials Corporation) — Q3 2016 Form 10-Q

Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2016. The company operates NobelClad, which makes explosion-welded clad metal products, and DynaEnergetics, which manufactures oil-and-gas perforating products. Unless stated otherwise, financial amounts below are in thousands of U.S. dollars.

Financial performance and position

• At September 30, cash was $7,451; total assets were $166,935 and total liabilities were $48,255. Credit-facility borrowings were $15,250 before $551 of debt issuance costs (balance-sheet carrying amount $14,699). Net debt, as defined by management as borrowings less cash, was $7,248, down 65% from year-end 2015.
• Operating cash flow was $17,839 for the first nine months, versus cash used of $6,414 in 2015. The improvement primarily reflected working-capital movements, including lower receivables and inventory. Investing cash use was $4,008, mainly capital expenditures; financing cash use was $12,945, including $12,250 of net debt repayments and $861 of dividends. Cash ended the period at $7,451.
• The company reported $59,750 of available revolving credit capacity, subject to covenant compliance. It stated that it was in compliance with debt covenants at September 30. The $75,000 syndicated facility includes a $100,000 accordion feature subject to lender approval.
• Dividends declared were $0.02 per share in Q3 and $0.06 per share for the nine-month period, compared with $0.04 and $0.12, respectively, in 2015.

Material changes and operating drivers

• Q3 sales declined 7% year over year, and gross margin fell to 23.1% from 26.0%. NobelClad sales fell 21%, primarily because a subcontractor delay pushed a large shipment out of the quarter; lower gross profit also reflected warranty work and less favorable project mix. Management said the delayed shipment negatively affected Q3 revenue and gross profit.
• DynaEnergetics Q3 sales rose 8%, helped by the timing of an India project and higher DynaSelect initiator demand, but gross margin fell to 27.5% from 32.0% amid selling-price pressure and higher research and development spending. The prolonged downturn in oil-and-gas well completions continued to weigh on the segment.
• For the first nine months, sales declined 5% and gross margin fell to 24.3% from 26.8%. DynaEnergetics sales fell 14% and segment operating loss widened to $2,959 from $201; NobelClad sales rose 3% and operating income increased to $6,340 from $4,479. A large semiconductor-equipment project supported NobelClad’s year-to-date results.
• Year-to-date restructuring expense was $1,202, versus $3,397 in 2015, primarily related to DynaEnergetics headcount reductions and lease termination costs. Selling, general and administrative expenses totaled $27,874, down from $31,373.

Outlook, risks, contingencies and unusual items

• No specific earnings or revenue guidance was provided. Management said it believed operating cash flow and available credit would fund working capital, debt service, dividends and capital expenditure needs for the foreseeable future, while cautioning that weak energy markets, order intake, margins, backlog conversion and credit availability could affect liquidity.
• NobelClad backlog was $32,931 at September 30, down from $41,832 at December 31, 2015; management generally expects to fill most backlog within 12 months. Timing of orders and shipments is difficult to predict.
• The company had accrued approximately $6.4 million for potential anti-dumping and countervailing duties and related interest after a Commerce Department ruling on certain imported tubing. It appealed the ruling; additional legal costs and potential interest or penalties may arise. Potential penalties were not accrued because they were not considered probable or estimable.
• GeoDynamics brought two patent infringement cases, and one also alleges trademark infringement, concerning DynaEnergetics’ DPEX shaped charges. The company disputes the claims and had not accrued a loss; it stated it could not reasonably estimate a potential loss range. DynaEnergetics sought inter partes review of one patent, and summary-judgment motions in the first case were due December 2, 2016.
• A previously identified material weakness in deferred-tax accounting controls remained unremediated. Management concluded disclosure controls and procedures were not effective at the reasonable-assurance level as of September 30, 2016. Tax audits were ongoing in the United States and Germany.
• Other relevant uncertainties include foreign-currency movements, raw-material availability and pricing, customer demand, contract execution, and the company’s ability to integrate acquired businesses. Adjusted EBITDA is a non-GAAP measure and should be considered alongside GAAP results.

Investor facts to verify

1. Whether the delayed NobelClad shipment was completed and whether backlog and margins stabilized after quarter-end.
2. Whether DynaEnergetics’ pricing, demand, research and development costs, and operating losses improved as energy-market conditions changed.
3. Cash generation sustainability: Q3-period cash flow benefited materially from working-capital reductions, while sales were lower.
4. Borrowing capacity and covenant headroom, particularly in light of the tighter leverage limit effective October 1, 2016.
5. Developments in the anti-dumping appeal and GeoDynamics litigation, including any changes to accruals or potential exposure.
6. Progress remediating the deferred-tax accounting material weakness and the outcome of tax audits.