U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to -------------------- Commission file number: 0-8328 DYNAMIC MATERIALS CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 84-0608431 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 551 ASPEN RIDGE DRIVE, LAFAYETTE 80026 (Address of principal executive office) (Zip Code) Issuer's telephone number, including Area Code (303) 665-5700 Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK, $.05 PAR VALUE (TITLE OF CLASS) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 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 - - ---- ----- State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 2,723,666 SHARES OF COMMON STOCK AS OF OCTOBER 31, 1998. ITEM 1. FINANCIAL STATEMENTS DYNAMIC MATERIALS CORPORATION CONDENSED BALANCE SHEETS (UNAUDITED)
September 30, December 31, 1998 1997 ASSETS ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ -- $ 53,809 Accounts receivable, net of allowance for doubtful accounts of $170,000 and $150,000, respectively 6,073,261 4,936,350 Inventories 3,587,387 4,029,559 Prepaid expenses and other 336,468 368,511 Deferred tax asset 200,000 200,000 Receivable from related party -- 221,274 ------------ ------------ Total current assets 10,197,116 9,809,503 ------------ ------------ PROPERTY, PLANT AND EQUIPMENT 10,581,141 5,831,687 Less- Accumulated depreciation (3,655,692) (2,988,807) ------------ ------------ Property, plant and equipment-net 6,925,449 2,842,880 ------------ ------------ INTANGIBLE ASSETS, net of accumulated amortization of $411,785 and $307,451, respectively 1,228,379 1,230,464 NOTE RECEIVABLE 280,000 -- RESTRICTED CASH AND SHORT TERM INVESTMENTS 6,461,015 -- OTHER ASSETS 383,905 522,962 ------------ ------------ TOTAL ASSETS $ 25,475,864 $ 14,405,809 ============ ============
SEE NOTES TO CONDENSED FINANCIAL STATEMENTS 1 DYNAMIC MATERIALS CORPORATION CONDENSED BALANCE SHEETS (UNAUDITED)
September 30, December 31, 1998 1997 ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Bank overdraft $ 82,536 $ -- Accounts payable 1,838,162 2,328,867 Accrued expenses 1,450,132 1,012,908 Current maturities of long-term debt and capital lease obligations 38,330 113,925 ------------ ------------ Total current liabilities 3,409,160 3,455,700 LINE OF CREDIT 2,785,000 -- INDUSTRIAL DEVELOPMENT REVENUE BONDS 6,850,000 -- LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS 62,730 76,832 DEFERRED TAX LIABILITY 13,800 13,800 ------------ ------------ Total liabilities 13,120,690 3,546,332 ------------ ------------ STOCKHOLDERS' EQUITY: Convertible preferred stock, $.05 par value; 4,000,000 shares authorized: no issued and outstanding shares -- -- Common stock, $.05 par value; 15,000,000 shares authorized; 2,723,666 and 2,718,708 shares issued and outstanding, respectively 136,184 135,936 Additional paid-in capital 6,686,940 6,587,911 Deferred compensation (59,062) -- Retained earnings 5,591,112 4,135,630 ------------ ------------ 12,355,174 10,859,477 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 25,475,864 $ 14,405,809 ============ ============
SEE NOTES TO CONDENSED FINANCIAL STATEMENTS 2 DYNAMIC MATERIALS CORPORATION CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (UNAUDITED)
Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 ------------ ------------ ------------ ------------ NET SALES $ 9,675,750 $ 7,803,059 $ 30,543,872 $ 25,462,599 COST OF PRODUCTS SOLD 7,554,313 6,059,108 24,042,453 19,809,451 ------------ ------------ ------------ ------------ Gross profit 2,121,437 1,743,951 6,501,419 5,653,148 ------------ ------------ ------------ ------------ COSTS AND EXPENSES: General and administrative expenses 1,070,726 558,785 2,401,618 1,654,089 Selling expenses 387,550 494,449 1,387,822 1,551,100 Start up costs related to new facility 86,036 -- 114,437 -- Research and development costs 2,369 10,495 28,963 27,624 ------------ ------------ ------------ ------------ 1,546,681 1,063,729 3,932,840 3,232,813 ------------ ------------ ------------ ------------ INCOME FROM OPERATIONS 574,756 680,222 2,568,579 2,420,335 OTHER INCOME (EXPENSE): Other income 141 257 5,625 23,763 Interest expense (75,166) (15,135) (198,811) (105,419) Interest income 9,006 14,720 11,089 21,807 ------------ ------------ ------------ ------------ Income before income tax provision 508,737 680,064 2,386,482 2,360,486 INCOME TAX PROVISION (199,000) (217,143) (931,000) (755,000) ------------ ------------ ------------ ------------ NET INCOME $ 309,737 $ 462,921 $ 1,455,482 $ 1,605,486 ============ ============ ============ ============ NET INCOME PER SHARE Basic $ 0.11 $ 0.17 $ 0.52 $ 0.60 ============ ============ ============ ============ Diluted $ 0.11 $ 0.16 $ 0.50 $ 0.56 ============ ============ ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING Basic 2,807,957 2,714,371 2,780,238 2,669,434 ============ ============ ============ ============ Diluted 2,881,317 2,880,891 2,889,732 2,879,216 ============ ============ ============ ============
SEE NOTES TO CONDENSED FINANCIAL STATEMENTS 3 DYNAMIC MATERIALS CORPORATION STATEMENT OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
Additional Common Stock Paid-In Deferred Retained Shares Amount Capital Compensation Earnings ----------- ----------- ----------- ----------- ----------- Balances, December 31, 1997 2,718,708 $ 135,936 $ 6,587,911 $ -- $ 4,135,630 Common stock issued for stock option exercises 34,365 1,718 75,629 -- -- Common stock issued in connection with the employee stock purchase plan 11,093 555 73,700 -- -- Shares issued in connection with the purchase of Spin Forge 50,000 2,500 447,300 -- -- Restricted stock grant related to the purchase of Spin Forge 7,500 375 67,125 (67,500) -- Amortization of deferred compensation 8,438 Shares repurchased from related party (98,000) (4,900) (564,725) -- -- Net income -- -- -- -- 1,455,482 ----------- ----------- ----------- ----------- ----------- Balances, September 30, 1998 2,723,666 $ 136,184 $ 6,686,940 $ (59,062) $ 5,591,112 =========== =========== =========== =========== ===========
SEE NOTES TO CONDENSED FINANCIAL STATEMENTS 4 DYNAMIC MATERIALS CORPORATION STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (UNAUDITED)
1998 1997 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,455,482 $ 1,605,486 Adjustments to reconcile net income to net cash from operating activities- Depreciation 666,885 435,667 Amortization 102,083 78,134 Amortization of deferred compensation 8,438 -- Decrease (increase) in- Accounts receivable, net (1,136,911) 438,569 Inventories 1,603,903 2,841,886 Prepaid expenses and other 113,109 (469,288) Increase (decrease) in- Bank overdraft 82,536 (743,471) Accounts payable (1,252,642) (723,008) Accrued expenses 373,838 224,913 ------------ ------------ Net cash flows from operating activities 2,016,721 3,688,888 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Investment of bond proceeds (6,461,015) -- Purchase of Spin Forge assets (2,615,691) -- Purchase of AMK assets (905,873) -- Cash paid in connection with the shares repurchased from related party (425,285) -- Loan to related party (280,000) -- Acquisition of property, plant and equipment (901,071) (205,477) Change in other noncurrent assets 26,628 22,846 ------------ ------------ Net cash flows used in investing activities (11,562,307) (182,631)
SEE NOTES TO CONDENSED FINANCIAL STATEMENTS 5 DYNAMIC MATERIALS CORPORATION STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (UNAUDITED)
1998 1997 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Industrial development revenue bond proceeds 6,850,000 -- Bond issue costs paid (171,151) -- Borrowings/(payments) on line of credit, net 2,785,000 (3,930,000) Finance charges paid in connection with the reducing revolver credit facility (33,977) -- Payments on long-term debt and capital lease obligations (89,697) (90,340) Net proceeds from issuance of common stock 151,602 320,661 ----------- ----------- Net cash flows from financing activities 9,491,777 (3,699,679) ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (53,809) (193,422) CASH AND CASH EQUIVALENTS, beginning of the period 53,809 209,650 ----------- ----------- CASH AND CASH EQUIVALENTS, end of the period $ -- $ 16,228 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: 1998 1997 ----------- ----------- Cash paid during the period for- Interest $ 192,893 $ 159,419 =========== =========== Income taxes $ 819,346 $ 1,238,242 =========== ===========
NONCASH INVESTING ACTIVITIES: $139,440 of the shares repurchased from a related party were in satisfaction of a receivable due from that party. SEE NOTES TO CONDENSED FINANCIAL STATEMENTS 6 DYNAMIC MATERIALS CORPORATION NOTES TO CONDENSED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The information included in the Condensed 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 Financial Statements should be read in conjunction with the financial statements that are included in the Company's Annual Report filed on Form 10-KSB for the year ended December 31, 1997. Certain prior period amounts have been reclassified to conform to the current period presentation. 2. ACQUISITION OF AMK AND SPIN FORGE BUSINESSES The Company has completed two separate business acquisitions since its December 31, 1997 fiscal year end. On January 5, 1998, the Company acquired certain assets of AMK Welding, Inc. (AMK) for a cash purchase price of approximately $940,000. Assets acquired consisted primarily of machinery and equipment, land and the building that houses AMK's operations. AMK supplies commercial aircraft and aerospace-related automatic and manual, gas tungsten and arc welding services. On March 18, 1998, the Company completed the acquisition of certain assets of Spin Forge, LLC (Spin Forge) for a purchase price of approximately $3,826,000 that was paid with a combination of approximately $2,616,000 in cash, assumption of approximately $760,000 in liabilities and 50,000 shares of DMC Common Stock valued at $449,800. The Company's management believes Spin Forge is one of the country's leading manufacturers of tactical missile motor cases and titanium pressure vessels for the commercial aerospace and defense industries. Principal assets acquired included machinery and equipment and inventories. The Company will lease land and buildings from Spin Forge and holds an option to purchase such property for approximately $2.9 million, subject to certain adjustments, exercisable under certain conditions through January 2002. The option may be extended beyond this date under specified conditions provided that the option price must be adjusted upwards in the event that the fair market value of the property at the time of exercise is higher than $2.9 million. The following unaudited pro forma results of operations of the Company for the three months ended September 30, 1997 and the nine months ended September 30, 1997 and 1998 assumes that the acquisition of AMK and Spin Forge had occurred on January 1, 1997. These pro forma results are not necessarily indicative of the actual results of operations that would have been achieved nor are they necessarily indicative of future results of operations. 7
Three Months Ended Nine Months Ended September 30, September 30, September 30, 1997 1998 1997 ---- ---- ---- Revenues $ 9,881,537 $ 31,805,157 $ 31,126,349 Net Income $ 549,435 $ 1,499,578 $ 1,679,484 Net Income Per Share -Basic $ 0.20 $ 0.53 $ 0.62 Net Income Per Share -Diluted $ 0.19 $ 0.51 $ 0.57
3. NEW ACCOUNTING PRINCIPLE The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), which requires that companies recognize all derivatives as either assets or liabilities in the balance sheet at fair value. Under SFAS 133, accounting for changes in fair value of a derivative depends on its intended use and designation. SFAS 133 is effective for fiscal years beginning after June 15, 1999. The Company is currently assessing the effect of this new standard. 4. INVENTORIES This caption on the Condensed Balance Sheet includes the following: September 30, December 31, 1998 1997 ---- ---- Raw Materials $1,427,670 $ 984,788 Work-in-Process 1,982,974 2,865,164 Supplies 176,743 179,607 ---------- ---------- $3,587,387 $4,029,559 ========== ========== 5. NET INCOME PER SHARE: The Company computes earnings per share (EPS) in accordance with Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share". Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted EPS recognizes the potential dilutive effects of dilutive securities. The following represents a reconciliation of the numerator and denominator used in the calculation of basic and diluted EPS: 8
FOR THE QUARTER ENDED SEPTEMBER 30, 1997 Per share Income Shares Amount ------ ------ --------- Net Income $ 462,921 ========== Basic earnings per share: Income available to common shareholders $ 462,921 2,714,371 $ 0.17 ======== Dilutive effect of options to purchase common stock -- 166,520 ---------- ---------- Dilutive earnings per share: Income available to common shareholders $ 462,921 2,880,891 $ 0.16 ========== ========== ======== FOR THE QUARTER ENDED SEPTEMBER 30, 1998 Per share Income Shares Amount ---------- ---------- -------- Net Income $ 309,737 ========== Basic earnings per share: Income available to common shareholders $ 309,737 2,807,957 $ 0.11 ======== Dilutive effect of options to purchase common stock -- 73,360 ---------- ---------- Dilutive earnings per share: Income available to common shareholders $ 309,737 2,881,317 $ 0.11 ========== ========== ======== FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 Per share Income Shares Amount ---------- ---------- -------- Net Income $1,605,486 ========== Basic earnings per share: Income available to common shareholders $1,605,486 2,669,434 $ 0.60 ======== Dilutive effect of options to purchase common stock -- 209,782 ---------- ---------- Dilutive earnings per share: Income available to common shareholders $1,605,486 2,879,216 $ 0.56 ========== ========== ========
9
For the nine months ended September 30, 1997 -------------------------------------------- Per share Income Shares Amount ------ ------ --------- Net Income $1,455,482 ========== Basic earnings per share: Income available to common shareholders $1,455,482 2,780,238 $ 0.52 ======== Dilutive effect of options to purchase common stock -- 109,494 ---------- --------- Dilutive earnings per share: Income available to common shareholders $1,455,482 2,889,732 $ 0.50 ========== ========= =========
In December, 1997 the Company adopted SFAS 128 and, as a result, the Company's reported earnings per share for the quarter and nine months ended September 30, 1997 were restated. The effect of this change on previously reported EPS data was as follows: Quarter Ended Nine Months Ended September 30, September 30, 1997 1997 ---- ---- Per share amounts Primary EPS as reported $0.16 $0.56 Effect of FAS 128 0.01 0.04 ----- ----- Basic EPS as restated $0.17 $0.60 ===== ===== Fully diluted EPS as reported $0.16 $0.56 Effect of FAS 128 -- -- ----- ----- Diluted EPS as restated $0.16 $0.56 ===== ===== 6. SIGNIFICANT CUSTOMER During the quarter ended September 30, 1998, two customers accounted for approximately 25% of net sales. No one customer accounted for more than 10% of net sales during the nine months ended September 30, 1998. Two customers accounted for approximately 24% of net sales during the quarter ended September 30, 1997 and one customer accounted for approximately 16% of net sales during the nine months ended September 30, 1997. International sales as a percent of net sales were 7% and 11% for the quarters ended September 30, 1998 and 1997, respectively. International sales as a percent of net sales were 16% and 28% for the nine months ended September 30, 1998 and 1997, respectively. Due to the fact that a significant portion of the Company's sales is derived from a relatively small number of customers, the loss of a customer, the failure to perform existing contracts on a timely basis, to receive payment for such services in a timely manner, or to enter into future contracts at projected volumes and profitability levels could adversely affect the Company's ability to meet its cash requirements exclusively through operating activities. 10 7. LONG-TERM DEBT During September 1998, the Company began construction on a new manufacturing facility in Fayette County, Pennsylvania. This project is being financed under a loan agreement in connection with industrial development revenue bonds issued by the Fayette County Industrial Development Authority. The Company closed on this financing arrangement on September 17, 1998. The principal balance outstanding at September 30, 1998 was $6,850,000. The loan bears interest at a variable rate which is set weekly based on the current weekly market rate for tax-exempt bonds. The interest rate at September 30, 1998 was 3.88%. The Company has established a bank letter of credit in the trustee's favor for the principal amount of $6,850,000 plus 98 days accrued interest on the bonds. The letter of credit is secured by the Company's accounts receivable, inventory, property plant and equipment and the bond proceeds not yet expended for construction. The portion of the borrowings not yet expended for construction was $6,461,015 as of September 30, 1998 and was classified as restricted cash and short term investments on the Company's balance sheet. The Company may redeem the bonds prior to maturity at an amount equal to the outstanding principal plus any accrued interest. The bonds mature on September 1, 2013 at which time all amounts become due and payable. On September 17, 1998, the Company entered into an interest rate swap agreement with a bank under which the Company converted the variable interest rate on the bonds to a rate that is largely fixed. Under the swap agreement, the Company has agreed to pay the bank a fixed interest rate of 4.41% over the life of the bonds and, in return, receive interest payments from the bank in an amount equal to 76% of the 30-day commercial paper rate. Since the current weekly tax-exempt rate (3.88% at September 30, 1998) is lower than 76% of the commercial paper rate (3.98% at September 30, 1998), the Company's effective rate is lower than the fixed rate of 4.41%. If the weekly tax-exempt rate should increase above 76% of the commercial paper rate in the future, the Company's effective interest rate would increase above the 4.41% fixed rate. 8. COMMITMENTS AND CONTINGENCIES LITIGATION The Company has been named as a defendant in a lawsuit filed by a French company who the Company had been in merger/acquisition discussions with during 1997, seeking damages of approximately $1.3 million. The Company plans to vigorously defend itself against such claim and management of the Company believes the ultimate outcome of such litigation will not have a material adverse effect on its financial condition or results of operations. No provision for liability with respect to this claim has been made in the accompanying statements of financial condition. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS The following discussion should be read in conjunction with the Condensed Financial Statements included elsewhere within this quarterly report. Fluctuations in annual and quarterly operating results may occur as a result of certain factors such as the size and timing of customer orders and competition. Due to such fluctuations, historical results and percentage relationships are not necessarily indicative of the results for any future period. Statements contained in this report that are 11 not historical facts are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from projected results. Factors that could cause actual results to differ materially include, but are not limited to, the ability to obtain new contracts at attractive prices; the size and timing of customer orders; fluctuations in customer demand; competitive factors; the timely completion of contracts; and general economic conditions, both domestically and abroad. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes 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. The Company further directs readers to the factors discussed in the Company's Form 10-KSB for the year ended December 31, 1997. GENERAL Dynamic Materials Corporation ("DMC" or the "Company") is a worldwide leader in the high energy metal working business. The high energy metal working business includes the use of explosives to perform both metallurgical bonding, or metal "cladding," and metal forming. The Company performs metal cladding using its proprietary Dynaclad(TM) and Detaclad(R) technologies and performs metal forming using its proprietary Dynaform(TM) technology. Historically, the Company has generated approximately 85% to 90% of its revenues from its metal cladding business and approximately 10% to 15% of its revenues from its metal forming and shock synthesis businesses. The Company expects revenues from its cladding business, as a proportion of total Company revenues, to decline as a result of the recent AMK and Spin Forge acquisitions. Metal Cladding. Clad metal products are used in manufacturing processes or environments that involve highly corrosive chemicals, high temperatures and/or high pressure conditions. For example, the Company fabricates clad metal tube sheets for heat exchangers. Heat exchangers are used in a variety of high temperature, high pressure, highly corrosive chemical processes, such as processing crude oil in the petrochemical industry and processing chemicals used in the manufacture of synthetic fibers. In addition, the Company has produced titanium clad plates used in the fabrication of metal autoclaves to replace autoclaves made of brick and lead for two customers in the mining industry. The Company believes that its clad metal products are an economical, high-performance alternative to the use of solid corrosion-resistant alloys. Metal Forming, Welding and Assembly. Formed metal products are made from sheet metal and forgings that are subsequently formed into precise, three-dimensional shapes that are held to tight tolerances. Metal forming is accomplished through both the use of explosives and traditional forming technologies, including spinning, machining, rolling and hydraulic expansion. DMC also performs welding services utilizing a variety of manual and automatic welding techniques that include electron beam and gas tungsten arc welding processes. The Company's forming and welding operations are often performed to support the manufacture of completed assemblies and sub-assemblies required by its customers. Assembly and fabrication services are performed utilizing the Company's close-tolerance machining, forming, welding, inspection and other special service capabilities. The Company's forming, welding and assembly operations serve a variety of product applications in the commercial aircraft, aerospace, defense and power generation industries. Product applications include torque box webs for jet engine nacelles, tactical and ballistic missile motor cases and titanium pressure tanks. The Company is continually working to generate solutions to the materials needs of customers in its target markets. Key elements of the Company's strategy include continual improvement of its 12 basic processes and product offerings, the internal development of new cladding and forming products and the acquisition of businesses that broaden or complement the Company's existing product lines. In July 1996, the Company completed its first strategic acquisition when it acquired the assets of the Detaclad(R) Division ("Detaclad") of E.I. du Pont de Nemours and Company ("DuPont"), a complementary explosion cladding business with expertise in cladding thin metals and heat exchanger components primarily for the chemical processing, power generation and petrochemical industries. The Company has completed two separate business acquisitions since its December 31, 1997 fiscal year end. On January 5, 1998, the Company acquired certain assets of AMK Welding, Inc. (AMK) for a cash purchase price of approximately $940,000. Assets acquired consisted primarily of machinery and equipment, land and the building that houses AMK's operations. AMK supplies commercial aircraft and aerospace-related automatic and manual, gas tungsten and arc welding services and generated sales of approximately $1.2 million in its most recent fiscal year that ended on July 31, 1997. On March 18, 1998, the Company completed the acquisition of certain assets of Spin Forge, LLC (Spin Forge) for a purchase price of approximately $3,826,000 that was paid with a combination of approximately $2,616,000 in cash, assumption of approximately $760,000 in liabilities and 50,000 shares of DMC Common Stock valued at $449,800. The Company's management believes Spin Forge is one of the country's leading manufacturers of tactical missile motor cases and titanium pressure vessels for the commercial aerospace and defense industries. Principal assets acquired included machinery and equipment and inventories. The Company will lease land and buildings from Spin Forge, LLC and holds an option to purchase such property for approximately $2.9 million, subject to certain adjustments, exercisable under certain conditions through January 2002. The option may be extended beyond this date under specified conditions provided that the option price must be adjusted upwards in the event that the fair market value of the property at the time of exercise is higher than $2.9 million. Spin Forge generated sales revenues of approximately $6.5 million for the year ended December 31, 1997. The Company has experienced and expects to continue to experience, quarterly fluctuations in operating results caused by various factors, including the timing and size of orders from major customers, customer inventory levels, shifts in product mix, the occurrence of acquisition-related costs and general economic conditions. In addition, the Company typically does not obtain long-term volume purchase contracts from its customers. Quarterly sales and operating results therefore depend on the volume and timing of backlog as well as bookings received during the quarter. A significant portion of the Company's operating expenses are fixed, and planned expenditures are based primarily on sales forecasts and product development programs. If sales do not meet the Company's expectations in any given period, the adverse impact on operating results may be magnified by the Company's inability to adjust operating expenses sufficiently or quickly enough to compensate for such a shortfall. In addition, the Company uses numerous suppliers of alloys, steels and other materials for its operations. The Company typically bears a short-term risk of alloy, steel and other component price increases, which could adversely affect the Company's gross profit margins. Although the Company will work with customers and suppliers to minimize the impact of any component shortages, component shortages have had, and are expected from time to time to have, short-term adverse effects on the Company's business. Results of operations in any period should not be considered indicative of the results to be expected for any future period. Fluctuations in operating results may also result in fluctuations in the price of the Company's Common Stock. The Year 2000 issue is the result of many computer programs being written such that they will malfunction when reading a year of "00." This problem could cause system failure or miscalculations 13 causing disruptions of business processes. For the past year, the Company has pursued a two-prong approach to the Year 2000 issue. The first prong has and continues to involve an internal evaluation of the Company's computer systems. The Company has completed a risk assessment to identify Year 2000 priorities by analyzing and determining whether the Year 2000 related risks were low, medium or high and whether the business impact would be marginal, manageable, critical or fatal for each system and device that may be affected by the Year 2000 issue. Based on this risk assessment, the Company determined that its first priority would be evaluating its MRP software. The Company found this software to be Year 2000 compliant as certified by the vendor and through internal testing. The Company continued this procedure for each of the areas identified during its risk assessment as follows. The Company's hardware was tested by advancing dates and checking for power-off date changes and power-on date changes as well as software and hardware operation at the advanced dates. Based upon those tests the Company believes its hardware to be Year 2000 compliant. The Company's network operating system will be Year 2000 compliant with the installation of a forthcoming patch from the vendor. The patch is expected to be released in the fourth quarter of 1998. The Company expects that its desktop applications will be Year 2000 compliant by mid 1999 with the announced patches that are forthcoming from various vendors. Finally, the Company has determined through testing that its various computer controlled manufacturing equipment is either Year 2000 compliant or will not have any adverse effects on manufacturing processes in the Year 2000. The second prong of the Company's approach, which the Company emphasized in the second and third quarter of 1998, is an integrated process of working with suppliers and customers to ensure that the flow of goods, services or payments will not be interrupted because of Year 2000 issues. To achieve this, the Company has been working to implement mechanical or manual workarounds even if Year 2000 problems arise. In many cases, such workarounds are already in place. Additionally, the Company is requesting that its suppliers and customers include language in their material subcontractor and consulting agreements that request these third parties to be "internally" Year 2000 capable. However, there can be no assurance that the failure of the Company's suppliers and customers to be Year 2000 compliant would not have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the Company may be adversely affected by disruptions in the operations of other companies with which the Company does business, from general widespread problems or an economic crisis resulting from noncompliant Year 2000 systems. The Company has not incurred any material historical Year 2000 costs to date. Management does not have an estimate of future Year 2000 project costs that may be incurred but expects such costs to be minimal since all Year 2000 compliance work is expected to be performed by Company employees. Management expects, but makes no assurance that, future Year 2000 project costs will not have a material adverse effect on its financial condition and results of operations. The Company has not formulated contingency plans in the event that systems are not Year 2000 compliant. While management does not believe there to be significant Year 2000 risks for the Company, manual workarounds will be developed as part of the Company's Year 2000 compliance program. There can be no assurance that the Company's systems will be Year 2000 compliant in time. 14 QUARTER ENDED SEPTEMBER 30, 1998 COMPARED TO SEPTEMBER 30, 1997 The following table sets forth for the periods indicated the percentage relationship to net sales of certain income statement data:
Percentage of Net Sales ----------------------- Three Months Ended September 30 Six Months Ended September 30, ------------------------------- ------------------------------ 1998 1997 1998 1997 ---- ---- ---- ---- Net Sales 100.0% 100.0% 100.0% 100.0% Cost of Products Sold 78.1% 77.7% 78.7% 77.8% ----- ----- ----- ----- Gross Margin 21.9% 22.3% 21.3% 22.2% General & Administrative 11.1% 7.2% 7.9% 6.5% Selling Expenses 4.0% 6.3% 4.5% 6.1% Start up Costs 0.9% 0.0% 0.4% 0.0% R & D 0.0% 0.1% 0.1% 0.1% Income from Operations 5.9% 8.7% 8.4% 9.5% Interest Expense 0.8% 0.2% 0.7% 0.4% Income Tax Provision 2.1% 2.8% 3.0% 3.0% Net Income 3.2% 5.9% 4.8% 6.3%
NET SALES. Net sales for the quarter ended September 30, 1998 increased 24.0% to $9,675,750 from $7,803,059 in the third quarter of 1997. Sales for the third quarter of 1998 included approximately $2,615,000 from the newly acquired Spin Forge and AMK businesses, with these sales accounting for the entire 1998 sales increase. For the nine months ended September 30, 1998, net sales increased 20.0% to $30,543,872 from $25,462,599 in the comparable period of 1997. Spin Forge and AMK sales of approximately $5,775,000 for the nine months ended September 30, 1998 accounted for the entire sales increase. GROSS PROFIT. As a result of the Company's increase in net sales, gross profit for the quarter ended September 30, 1998 increased by 21.6% to $ 2,121,437 from $1,743,951 in the third quarter of 1997. The gross profit margin for the quarter ended September 30, 1998 was 21.9%, representing a 2% decline from the gross profit margin of 22.3% for the third quarter of 1997. For the nine months ended September 30, 1998, gross profit increased 15.0% to $6,501,419 from $5,653,148 in the comparable period of 1997. The gross profit margin for the nine months ended September 30, 1998 was 21.3%, representing a 4% decline from the gross profit margin of 22.2% for the first nine months of 1997. The decreased gross margin rate for both the three and nine month periods is principally due to proportionately lower sales of explosively formed products. A customer that accounts for a major portion of the Company's sales of explosively-formed products has significantly reduced its 1998 order levels for explosively-formed parts and has informed the Company that it likely will no longer order such parts from the Company. For both the three and nine month periods, the resulting reduced 15 sales and gross profits from the Company's explosion forming business has been replaced by sales and gross profits generated by the recently acquired AMK Welding and Spin Forge operations. GENERAL AND ADMINISTRATIVE. General and administrative expenses for the quarter ended September 30, 1998 increased 91.6% to $1,070,726 from $558,785 in the third quarter of 1997. For the nine months ended September 30, 1998, general and administrative expenses increased 45.2% to $2,401,618 from $1,654,089 in the comparable period of 1997. These increases are primarily attributable to $262,524 in non-recurring expenses relating to the departure of the Company's former president and chief executive officer in the third quarter of 1998, and general and administrative expenses associated with the operations of AMK Welding and Spin Forge which were acquired on January 5, 1998 and March 18, 1998, respectively. Excluding the impact of non-recurring expenses, general and administrative expenses are expected to remain at the higher 1998 levels to support the acquired AMK and Spin Forge operations and other strategic business initiatives. After adjustment for non-recurring expenses related to the departure of the Company's former CEO, general and administrative expenses as a percentage of net sales increased from 7.2% in the third quarter of 1997 to 8.4% for the quarter ended September 30, 1998 and increased from 6.5% to 7.0% for the comparable nine month periods. SELLING EXPENSE. Selling expenses decreased by 21.6% to $387,550 for the quarter ended September 30, 1998 from $494,449 in the second quarter of 1997. For the six months ended September 30, 1998, selling expenses decreased 10.5% to $1,387,822 from $1,551,100 in the comparable period of 1997. These decreases reflect lower expense levels in a number of categories, including compensation and benefits, advertising and promotion, reserves for bad debts and travel and entertainment expenses. Selling expenses as a percentage of net sales decreased from 6.3% in the third quarter of 1997 to 4.0% for the quarter ended September 30, 1998, and from 6.1% for the nine months ended September 30, 1997 to 4.5% for the comparable period of 1998. These decreases reflect decreased spending levels combined with the higher sales volume achieved in 1998. START-UP COSTS. For the quarter and nine months ended September 30, 1998, the Company began to separately report the start-up costs associated with the construction of the new facility in Pennsylvania for the manufacture of clad metal plates. Start-up costs for the three and nine month periods of 1998 totaled $86,036 and $114,437, respectively, and include salaries, benefits and travel expenses for Company employees assigned to this project, field office expenses and other operating expenses directly associated with this project. The Company will continue to incur and separately report start-up costs in 1998 and 1999 until the new facility commences operations during the last half of 1999. RESEARCH AND DEVELOPMENT. Research and development expenses decreased to $2,369 for the quarter ended September 30, 1998 from $10,495 in the third quarter of 1997. For the nine months ended September 30, 1998, research and development expenses increased to $28,963 from $27,624 in the comparable period of 1997. The Company is currently utilizing its engineering resources to support current manufacturing activities, including plant design and equipment acquisition activities associated with a new manufacturing facility that is under construction in Pennsylvania, and does not expect to significantly increase spending on research and development projects in the near future. INCOME FROM OPERATIONS. Income from operations decreased by 15.5% to $574,756 for the quarter ended September 30, 1998 from $680,222 in the second quarter of 1997. This decrease is a direct result of non-recurring expenses in the amount of $262,524 relating to the departure of the Company's former president and chief executive officer and $86,036 in start-up costs discussed above. For the nine months ended September 30, 1998, income from operations increased 6.1% to $2,568,579 from 16 $2,420,335 in the comparable period of 1997. This increase is a direct result of the 20.0% increase in net sales and is less than expected due to the offsetting effect of the aforementioned non-recurring expenses and start-up costs. Income from operations as a percentage of net sales decreased to 5.9% for the three months ended September 30, 1998 from 8.7% in the comparable 1997 period and decreased to 8.4% for the nine months ended September 30, 1998 from 9.5% for the nine months ended September 30, 1997. INTEREST EXPENSE. Interest expense increased to $75,166 for the quarter ended September 30, 1998 from $15,135 in the third quarter of 1997. For the nine months ended September 30, 1998, interest expense increased to $198,811 from $105,419 in the comparable period of 1997. These increases are due to borrowings under the Company's revolving line of credit with KeyBank of Colorado that were required to finance the AMK Welding and Spin Forge acquisitions. INCOME TAX PROVISION. The Company's income tax provision decreased by 8.4% to $199,000 for the quarter ended September 30, 1998 from $217,143 in the third quarter of 1997. The income tax provision for the nine months ended September 30, 1998 increased 23.3% to $931,000 from $755,000 for the comparable period of 1997. For the quarter and nine months ended September 30, 1998, the effective tax rate was 39.1% and 39.0%, respectively, as compared to 31.9% and 32.0% for the respective comparable 1997 periods. The Company expects its effective tax rate to increase slightly in 1998 to 39.0% due to anticipated increases in state income taxes as a result of the AMK Welding and Spin Forge acquisitions. LIQUIDITY AND CAPITAL RESOURCES Historically, the Company has secured the major portion of its operational financing from operating activities and an asset-backed revolving credit facility. In connection with the Detaclad acquisition, the Company entered into a $7,500,000 asset-backed revolving credit facility with KeyBank National Association (KeyBank) in July of 1996. The credit facility had a seven-year term and was secured by substantially all of the Company's assets, including its accounts receivable, inventory and equipment. The maximum amount available under the line of credit was subject to borrowing base restrictions which were a function of defined balances in accounts receivable, inventory, real property and equipment. In connection with the Company's acquisition of Spin Forge on March 18, 1998 and resulting increase in the Company's asset base, the Company amended its revolving credit facility with KeyBank. Amendments included an increase in the total facility from $7.5 million to $10 million and separating $5 million of the total facility into a reducing revolving credit facility to be used principally for acquisition financing. The reducing revolving credit facility is secured by certain of the Company's assets, including those of the acquired AMK and Spin Forge businesses, and is not subject to borrowing base restrictions. Availability under this facility will be reduced at the rate of $1 million per year over its five-year term. The remaining $5 million of the revolving credit facility will continue under the same terms and conditions as described above for the original $7.5 million facility. The interest rate applicable to borrowings under both the revolving credit facility and reducing revolving credit facility is, at the Company's option, either the LIBOR Rate plus 1% to 1.5%, depending on certain conditions, or the Federal Funds Rate plus 2%. The Company's total borrowings under the KeyBank reducing revolving credit facility and revolving credit facility were $2,785,000 and zero, respectively, as of September 30, 1998 and 1997. 17 In March 1998, the Company's Board of Directors approved the Company's proposal to build a new manufacturing facility in Pennsylvania at a cost of approximately $6.8 million. The project is being financed with proceeds from $6,850,000 in industrial development revenue bonds issued by Fayette County Industrial Development Authority (IDA). The Company closed its loan agreement with Fayette County IDA on September 17, 1998 and has established a bank letter of credit in favor of the bond trustee for the principal amount of the bonds plus 98 days of accrued interest. In connection with the letter of credit, the reducing revolving credit facility with KeyBank was reduced from $5 million to $4 million. The letter of credit is secured by the Company's accounts receivable, inventory, property, plant and equipment, and bond proceeds not yet expended for construction of the facility and purchase of related equipment. Construction of the new facility began during the third quarter of 1998 and should be completed during the first half of 1999. The new facility should become fully operational during the second half of 1999. During the nine months ended September 30, 1998, the Company generated $2,016,721 in cash flows from operating activities as compared to generating $3,688,888 during the first nine months of 1997. The principal sources of cash flow from operations in the nine months ended September 30, 1998 were net income of $1,455,482, depreciation and amortization charges of $777,406, and a decrease in inventories of $1,603,903. These sources of operating cash flow were partially offset by a $1,136,911 increase in accounts receivable and a $878,804 decrease in accounts payable and accrued expenses. The large increase in accounts receivable relates to the build-up of Spin Forge accounts receivable subsequent to the March 18, 1998 acquisition of Spin Forge (outstanding accounts receivable on this date were not included among the assets purchased) and strong September sales in the Company's bonding business. The current ratio was 3.0 as of September 30, 1998 as compared to 2.8 at December 31, 1997. Investing activities in the nine months ended September 30, 1998 used $11,562,307 of cash, including $3,521,564 to fund the purchase of the Spin Forge and AMK assets, $901,071 to fund capital expenditures, and $6,461,015 to temporarily invest proceeds from the industrial development revenue bond issue. Financing activities for the nine months ended September 30, 1998 provided $9,491,777 of net cash. These cash flows included line of credit borrowings in the amount of $2,785,000 to finance the purchase of Spin Forge and AMK and $6,850,000 from the issuance of industrial development revenue bonds that will be used to finance construction of the Company's new manufacturing facility in Pennsylvania and the purchase of related equipment. The Company believes that its cash flow from operations, funds expected to be available under its amended credit facility, and proceeds from the industrial development revenue bond financing for the new Pennsylvania manufacturing facility will be sufficient to fund working capital and capital expenditure requirements of its current business operations, including those of the recently acquired AMK and Spin Forge businesses, for the foreseeable future. However, a significant portion of the Company's sales is derived from a relatively small number of customers; therefore, the failure to perform existing contracts on a timely basis, and to receive payment for such services in a timely manner, or to enter into future contracts at projected volumes and profitability levels could adversely affect the Company's ability to meet its cash requirements exclusively through operating activities. Consequently, any restriction on the availability of borrowing under the line of credit could negatively affect the Company's ability to meet its future cash requirements. The Company's expenditures for the Pennsylvania manufacturing facility could exceed its estimates due to construction delays, the delay in the receipt of any required government approvals and permits, labor shortages or other factors. In addition, the Company plans to grow both internally and through the acquisition of complementary businesses. Increased expenditures for the Pennsylvania manufacturing facility and/or a 18 significant acquisition may require the Company to secure additional debt or equity financing. While the Company believes it would be able to secure such additional financing at reasonable terms, there is no assurance that this would be the case. 19 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company has been named as a defendant in a lawsuit filed in France by a French company with which the Company had preliminary acquisition discussions during 1997. The Company plans to vigorously defend itself against such claim and the management of the Company believes that the ultimate outcome of such litigation will not have a material adverse effect on the Company's financial condition or results of operations. The Company is not party to any other legal proceedings, the adverse outcome of which would, in management's opinion, have a material adverse effect on the Company's business, operation results and financial condition. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 10 Material Contracts EXHIBIT NUMBER DESCRIPTION OF EXHIBIT 10.1 Loan Agreement dated as of September 1, 1998 by and between Fayette County Industrial Development and the Company. 10.2 Reimbursement Agreement dated as of September 1, 1998 by and between the Company and KeyBank National Association. 10.3 Master Agreement dated as of September 15, 1998 by and between KeyBank National Association and the Company. 10.4 Separation Agreement dated as of September 1, 1998 by and between Paul Lange and the Company. 27 Financial Data Schedule (b) A report on Form 8-K was filed on April 2, 1998 reporting the completion of the acquisition of certain assets of Spin Forge, LLC, which occurred on March 18, 1998. A report on Form 8-K/A was filed on June 1, 1998. This report amended the Form 8-K filed on April 2, 1998, to include audited financial information as of December 31, 1997 for the Spin Forge business, which the Company acquired on March 18, 1998. The report also included unaudited pro forma financial information as of March 31, 1998, and for the year ended December 31, 1997. A report on Form 8-K was filed on September 9, 1998 reporting the resignation of Paul Lange as president and chief executive officer of the Company, and the appointment of Joseph P. Allwein as the acting president and chief executive officer of the Company. Both events were effective as of September 2, 1998. 20 SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DYNAMIC MATERIALS CORPORATION (Registrant) Date: NOVEMBER 13, 1998 /s/ Richard A. Santa ----------------------------------- Richard A. Santa, Vice President of Finance and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) 21