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Dynamic Materials 10-Q 2011
UNITED STATES 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 AND EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011
OR
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
DYNAMIC MATERIALS CORPORATION (Exact name of Registrant as Specified in its Charter)
5405 Spine Road, Boulder, Colorado 80301 (Address of principal executive offices, including zip code)
(303) 665-5700 (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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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 13,330,698 as of April 28, 2010.
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. In particular, we direct your attention to Part I, Item 1- Condensed Consolidated Financial Statements; Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations; Item 3 - Quantitative and Qualitative Disclosures About Market Risk; and Part II, Item 1A — Risk Factors. We intend the forward-looking statements throughout this quarterly report on Form 10-Q and the information incorporated by reference herein 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. All projections, guidance and other statements regarding our expected financial position and operating results, our business strategy, our financing plans and the outcome of any contingencies are forward-looking statements. 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. 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, the following: changes in global economic conditions; the ability to obtain new contracts at attractive prices; the size and timing of customer orders and shipment; 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; 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 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.
Part I - FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands, Except Share and Per Share Data)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (Dollars in Thousands, Except Share Data) (unaudited)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE THREE MONTHS ENDED MARCH 31, 2011 (Amounts in Thousands)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (Dollars in Thousands) (unaudited)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010 (Dollars in Thousands) (unaudited)
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
DYNAMIC MATERIALS CORPORATION & SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Currency Amounts in Thousands, Except Share and Per Share Data)
(unaudited)
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, 2010.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The Condensed Consolidated Financial Statements include the accounts of Dynamic Materials Corporation (“DMC”) and its controlled subsidiaries. Only subsidiaries in which controlling interests are maintained are consolidated. The equity method is used to account for our ownership in subsidiaries where we do not have a controlling interest. All significant intercompany accounts, profits, and transactions have been eliminated in consolidation.
Foreign Operations and Foreign Exchange Rate Risk
The functional currency for our foreign operations is the applicable local currency for each affiliate company. Assets and liabilities of foreign subsidiaries for which the functional currency is the local currency are translated at exchange rates in effect at period-end, and the statements of operations are translated at the average exchange rates during the period. Exchange rate fluctuations on translating foreign currency financial statements into U.S. dollars that result in unrealized gains or losses are referred to as translation adjustments. Cumulative translation adjustments are recorded as a separate component of stockholders’ equity and are included in other cumulative comprehensive income (loss). Transactions denominated in currencies other than the local currency are recorded based on exchange rates at the time such transactions arise. Subsequent changes in exchange rates result in transaction gains and losses, which are reflected in income as unrealized (based on period-end translations) or realized upon settlement of the transactions. Cash flows from our operations in foreign countries are translated at actual exchange rates when known, or at the average rate for the period. As a result, amounts related to assets and liabilities reported in the consolidated statements of cash flows will not agree to changes in the corresponding balances in the consolidated balance sheets. The effects of exchange rate changes on cash balances held in foreign currencies are reported as a separate line item below cash flows from financing activities.
In September 2010, our German subsidiary, DYNAenergetics, entered into a currency swap agreement with its bank to economically hedge the currency risk associated with a large U.S. dollar order ($2,700) that was awarded to it. Under the agreement, DYNAenergetics will exchange $2,700 for Euros at an exchange rate of 1.269 U.S. dollars per Euros between January 18, 2011 and April 30, 2011. We have not designated this derivative as a cash flow hedge for accounting purposes and as such, gains and losses related to changes in its valuation are recorded in the statement of operations. During the three months ended March 31, 2011, we recorded a gain
on this currency swap agreement of $50. The gain is classified as other income (expense), net in our statement of operations.
Revenue Recognition
Sales of clad metal products and welding services are generally based upon customer specifications set forth in customer purchase orders and require us to provide certifications relative to metals used, services performed, and the results of any non-destructive testing that the customer has requested be performed. All issues of conformity of the product to specifications are resolved before the product is shipped and billed. Products related to the oilfield products segment, which include detonating cords, detonators, bi-directional boosters, and shaped charges, as well as, seismic related explosives and accessories, are standard in nature. In all cases, revenue is recognized only when all four of the following criteria have been satisfied: persuasive evidence of an arrangement exists; the price is fixed or determinable; delivery has occurred; and collection is reasonably assured. For contracts that require multiple shipments, revenue is recorded only for the units included in each individual shipment. If, as a contract proceeds toward completion, projected total cost on an individual contract indicates a probable loss, we will account for such anticipated loss.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, trade accounts receivable and payable, and accrued expenses are considered to approximate fair value due to the short-term nature of these instruments. We estimate that a hypothetical 100 basis point decrease in our LIBOR/EURIBOR basis borrowing spread would increase the fair value of our long-term debt at March 31, 2011 by less than 2%.The majority of our debt was incurred in connection with the 2007 acquisition of DYNAenergetics.
Additionally, we have a foreign currency hedge agreement that we entered in September 2010 (see above), which is recorded at fair value. 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:
The highest priority is assigned to Level 1 inputs and the lowest priority to Level 3 inputs.
Our foreign currency hedge agreement is not exchange listed and is therefore valued with models that use Level 2 inputs. The degree to which our credit worthiness impacts the value requires management judgment, but as of March 31, 2011 and December 31, 2010, the impact of this assessment on the overall value of the derivatives was not significant and our valuation of the agreements is classified within Level 2 of the hierarchy.
We have recorded the fair value of our foreign currency hedge agreement as follows:
Related Party Transactions
Prior to acquiring the remaining outstanding interests in our unconsolidated joint ventures on April 30, 2010 (See Note 3), we had related party transactions with these joint ventures. A summary of related party transactions for the three months ended March 31, 2010 is summarized below:
Earnings Per Share
Unvested awards of share-based payments with rights to receive dividends or dividend equivalents, such as our restricted stock awards (“RSAs”), are considered participating securities for purposes of calculating earnings per share (“EPS”) and require the use of the two class method for calculating EPS. Under this method, a portion of net income is allocated to these participating securities and therefore is excluded from the calculation of EPS allocated to common stock, as shown in the table below.
Computation and reconciliation of earnings per common share are as follows:
3. ACQUISITIONS
Austin Explosives
On June 4, 2010, we completed our acquisition of Austin Explosives Company (“AECO”), which is now operating under the name DYNAenergetics US, Inc. This business is part of our Oilfield Products business segment. AECO had been a long-time distributor of DYNAenergetics shaped charges. This acquisition, along with the acquisition of the outstanding interests in our Russian joint ventures (discussed below), further expands our Oilfield Products business, and positions the segment to capitalize on the long-term demand from the oil and gas industry. From January 1, 2011 through March 31, 2011, DYNAenergetics US, Inc. contributed incremental net sales of $2,563 and an incremental net loss of $38 after the elimination of intercompany sales and the related gross profit. On a standalone basis, DYNAenergetics US, Inc. reported sales of $5,616 and net income of $280 for the same period.
The acquisition was structured as an asset purchase valued at $6,921 which was financed by (i) the payment of $3,620 in cash and (ii) the issuance of 222,445 shares of DMC common stock (valued at $3,301).
The purchase price of the acquisition was allocated to tangible and identifiable intangible assets based on their fair values as determined by appraisals performed as of the acquisition date. The allocation of the purchase price to the assets of AECO was as follows:
We acquired identifiable finite-lived intangible assets as a result of the acquisition of AECO. The finite-lived intangible assets acquired were classified as customer relationships and were valued at $4,773 which are being amortized over 11 years. These amounts are included in Purchased Intangible Assets and are further discussed in Note 7.
Russian Joint Ventures
On April 30, 2010, we purchased the outstanding minority-owned interests in our two Russian joint ventures that were previously majority-owned by our Oilfield Products business segment. These joint ventures include DYNAenergetics RUS, which is a Russian trading company that sells our oilfield products, and Perfoline, which is a Russian manufacturer of perforating gun systems. We paid a combined $2,065 for the respective 45% and 34.81% outstanding stakes in DYNAenergetics RUS and Perfoline. From January 1, 2011 through March 31, 2011, DYNAenergetics RUS and Perfoline contributed incremental net sales of $946 and an incremental net loss of $498 after the elimination of intercompany sales and the related gross profit. As
standalone companies, these two entities reported sales of $1,374 and a net loss of $267 for the same period.
Prior to the acquisition date, we accounted for our 55% and 65.19% interest in DYNAenergetics RUS and Perfoline, respectively, as equity-method investments (see Note 4).
Appraisals performed as of the acquisition date resulted in a new fair value of the combined entities of $5,598 which was allocated to our tangible and identifiable intangible assets as follows:
We acquired identifiable finite-lived intangible assets as a result of acquiring the remaining interests of DYNAenergetics RUS and Perfoline. The finite-lived intangible assets acquired were classified as customer relationships and were valued at $3,669 which are being amortized over 11 years. These amounts are included in Purchased Intangible Assets and are further discussed in Note 7.
Pro Forma Statement of Operations
The following table presents the pro-forma combined results of operations for the three months ended March 31, 2010 assuming (i) the acquisitions of AECO and the Russian joint ventures had occurred on January 1, 2010; (ii) pro-forma amortization expense of the purchased intangible assets; (iii) pro-forma depreciation expense of the fair value of purchased property, plant and equipment; (iv) elimination of intercompany sales; and (v) increase in interest expense for borrowing 1,500 Euros ($2,155 based on the January 1, 2010 exchange rate) to fund the acquisition of the Russian joint ventures:
The pro-forma results above are not necessarily indicative of the operating results that would have actually occurred if the acquisitions had been in effect on the dates indicated, nor are they necessarily indicative of future results of the combined companies.
4. INVESTMENT IN JOINT VENTURES
As discussed in Note 3, on April 30, 2010, we acquired the remaining minority-owned interests in two joint ventures that were previously majority-owned by our Oilfield Products business segment. Prior to the April 30, 2010 step acquisition, these investments, which include DYNAenergetics RUS and Perfoline, were accounted for under the equity method due to certain non-controlling interest veto rights that allowed the non-controlling interest shareholders to participate in the ordinary course of business decisions. Operating results from January 1, 2010 through April 30, 2010 include our proportionate share of income from these unconsolidated joint ventures and for the three months ended March 31, 2010 our results include equity in earnings of joint ventures of $169. As a result of the step acquisition, we now consolidate the financial statements of these entities.
Summarized unaudited financial information for the joint ventures accounted for under the equity method for the three months ended March 31, 2010 is as follows:
5. INVENTORY
The components of inventory are as follows at March 31, 2011 and December 31, 2010:
6. GOODWILL
The changes to the carrying amount of goodwill during the period are summarized below:
7. PURCHASED INTANGIBLE ASSETS
The following table presents details of our purchased intangible assets, other than goodwill, as of March 31, 2011:
The following table presents details of our purchased intangible assets, other than goodwill, as of December 31, 2010:
The change in the gross value of our purchased intangible assets from December 31, 2010 to March 31, 2011 is due solely to the impact of foreign currency translation adjustments.
8. CUSTOMER ADVANCES
On occasion, we require customers to make advance payments prior to the shipment of their orders in order to help finance our inventory investment on large orders or to keep customers’ credit limits at acceptable levels. As of March 31, 2011 and December 31, 2010, customer advances totaled $1,889 and $1,531 respectively, and originated from several customers.
9. DEBT
Lines of credit consisted of the following at March 31, 2011 and December 31, 2010:
Long-term debt consisted of the following at March 31, 2011 and December 31, 2010:
Loan Covenants and Restrictions
Our existing loan agreements include various covenants and restrictions, certain of which relate to the incurrence of additional indebtedness; mortgaging, pledging or disposition of major assets; limits on capital expenditures; and maintenance of specified financial ratios. On February 2, 2011, our credit facility was amended, retroactive to December 31, 2010, to revise the leverage ratios and fixed charge coverage ratios that we are required to satisfy on a quarterly basis throughout the remaining term of the credit facility. These revised ratios will ease our ability to
comply with certain covenants of the credit agreement. As of March 31, 2011, we were in compliance with all financial covenants and other provisions of our debt agreements.
10. BUSINESS SEGMENTS
Our business is organized in the following three segments: Explosive Metalworking, Oilfield Products, and AMK Welding. The Explosive Metalworking segment uses explosives to perform metal cladding and shock synthesis of industrial diamonds. The most significant product of this group is clad metal which is used in the fabrication of pressure vessels, heat exchangers, and transition joints for various industries, including upstream oil and gas, oil refinery, petrochemicals, hydrometallurgy, aluminum production, shipbuilding, power generation, industrial refrigeration, and similar industries. The Oilfield Products segment manufactures, markets and sells oilfield perforating equipment and explosives, including detonating cords, detonators, bi-directional boosters and shaped charges, and seismic related explosives and accessories. AMK Welding utilizes a number of welding technologies to weld components for manufacturers of jet engine and ground-based turbines.
The accounting policies of all the segments are the same as those described in the summary of significant accounting policies. 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.
Beginning in 2011, we changed our methodology of allocating corporate overhead to our business segments. In connection with this change we no longer allocate certain corporate expenses that do not directly benefit our business segments. The business segment disclosure for the three months ended March 31, 2010 presented below reflects our new allocation methodology.
Segment information is presented for the three months ended March 31, 2011 and 2010 as follows:
During the three months ended March 31, 2011 and 2010, no one customer accounted for more than 10% of total net sales.
11. COMPREHENSIVE INCOME (LOSS)
Our comprehensive income (loss) for the three months ended March 31, 2011 and 2010 was as follows:
Other cumulative comprehensive income (loss) as of March 31, 2011 and December 31, 2010 consisted entirely of currency translation adjustment.
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 are included in our Annual Report filed on Form 10-K for the year ended December 31, 2010.
Unless stated otherwise, all currency amounts in this discussion are presented in thousands (000’s).
Executive Overview
Our business is organized into three segments: Explosive Metalworking (which we also refer to as DMC Clad), Oilfield Products and AMK Welding. For the three months ended March 31, 2011, Explosive Metalworking accounted for 57% of our net sales and 53% of our income from operations before consideration of unallocated corporate expenses and stock-based compensation expense, which is not allocated to our business segments. Our Oilfield Products and AMK Welding segments accounted for 38% and 5%, respectively, of our first quarter 2011 net sales, and 31% and 16%, respectively, of our income from operations before unallocated corporate expenses and stock-based compensation expense.
Our net sales for the three months ended March 31, 2011 increased by $15,217, or 50.1%, compared to the same period of 2010. The year-to-year consolidated net sales increase reflects a sales increase of $4,768 (22.4%) for our Explosive Metalworking segment and sales increases of $10,050 (143.4%) for our Oilfield Products segment and $399 (19.5%) for AMK Welding. Excluding incremental sales of $3,509 from the acquisition of Austin Explosives on June 4, 2010 and the step acquisition of two Russian joint ventures that was completed on April 30, 2010, our Oilfield Products segment reported an increase of $6,541 or 93.4% from its first quarter 2010 net sales. Our consolidated income from operations increased to $1,496 for the three months ended March 31, 2011 from $245 in the same period of 2010. This $1,251 increase reflects increases of $1,384 and $208 in the operating income reported by our Oilfield Products and AMK Welding segments, respectively, which were partially offset by a decline in the operating income reported by our Explosive Metalworking segment of $284 and an increase in unallocated corporate expenses of $57. Reported consolidated operating income for the three month periods ended March 31, 2011 and 2010 includes amortization expense of $1,405 and $1,273, respectively, relating to purchased intangible assets associated with our acquisitions of DYNAenergetics, DYNAenergetics Canada, DYNAenergetics US, and the Russian joint ventures. We reported net income of $750 for the three months ended March 31, 2011 compared to a net loss of $412 for the same period of 2010.
Impact of Current Economic Situation on the Company
We were only minimally impacted in 2008 by the global economic slowdown. However, during 2009 and 2010, we experienced a significant slowdown in Explosive Metalworking sales to some of the markets we serve. The explosion-welded clad plate market is dependent upon sales of products for use by customers in a number of heavy industries, including oil and gas, alternative energy, chemicals and petrochemicals, hydrometallurgy, aluminum production, shipbuilding, power generation, and industrial refrigeration. These industries tend to be cyclical in nature and the current worldwide economic downturn has affected many of these markets. Despite the slowdown we have already seen in certain sectors, including chemical, petrochemical and hydrometallurgy, quoting activity in other end markets remains healthy, and we continue to track an extensive list of projects. While timing of new order inflow remains difficult to predict, we
believe that our Explosive Metalworking segment is well-positioned to benefit as global economic conditions improve.
Our Explosive Metalworking backlog, which totaled $97,247 at the end of 2008 before this business segment began to see a significant decline in booking activity, decreased to $41,154 at September 30, 2010 before rebounding to $56,539 at December 31, 2010 on strong fourth quarter 2010 booking activity and then increasing modestly to $58,530 at March 31, 2011. Based upon the improvement in our March 31, 2011 Explosive Metalworking backlog and expected year over year increases in 2011 sales for both our Oilfield and AMK Welding business segments, we believe that our 2011 consolidated net sales could increase by 24% to 28% from the $154,739 in consolidated net sales that we reported in 2010.
Net sales
Explosive Metalworking’s revenues are generated principally from sales of clad metal plates and sales of transition joints, which are made from clad plates, to customers that fabricate industrial equipment for various industries, including oil and gas, petrochemicals, alternative energy, hydrometallurgy, aluminum production, shipbuilding, power generation, industrial refrigeration, and similar industries. While a large portion of the demand for our clad metal products is driven by new plant construction and large plant expansion projects, maintenance and retrofit projects at existing chemical processing, petrochemical processing, oil refining, and aluminum smelting facilities also account for a significant portion of total demand.
Oilfield Products’ revenues are generated principally from sales of shaped charges, detonators and detonating cord, and bidirectional boosters and perforating guns to customers who perform the perforation of oil and gas wells and from sales of seismic products to customers involved in oil and gas exploration activities.
AMK Welding’s revenues are generated from welding, heat treatment, and inspection services that are provided with respect to customer-supplied parts for customers primarily involved in the power generation industry and aircraft engine markets.
A significant portion of our revenue is derived from a relatively small number of customers; therefore, the failure to complete 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 our ability to meet cash requirements exclusively through operating activities. We attempt to minimize the risk of losing customers or specific contracts by continually improving product quality, delivering product on time and competing aggressively on the basis of price.
Gross profit and cost of products sold
Cost of products sold for Explosive Metalworking includes the cost of metals and alloys used to manufacture clad metal plates, the cost of explosives, employee compensation and benefits, freight, outside processing costs, depreciation of manufacturing facilities and equipment, manufacturing supplies and other manufacturing overhead expenses.
Cost of products sold for Oilfield Products 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, depreciation of manufacturing facilities and equipment, manufacturing supplies and other manufacturing overhead expenses.
AMK Welding’s cost of products sold consists principally of employee compensation and benefits, welding supplies (wire and gas), depreciation of manufacturing facilities and equipment, outside services and other manufacturing overhead expenses.
Income taxes
Our effective income tax rate decreased to 16.7% for the three months ended March 31, 2011 from 27.8% for first quarter of 2010 and 17.7% for the full year 2010. Income tax provisions on the earnings of Nobelclad, Nitro Metall, Dynaplat, DYNAenergetics, DYNAenergetics Canada, DYNAenergetics RUS, Perfoline, and our German and Luxembourg holding companies have been provided based upon the respective French, Swedish, German, Canadian, Russian and Luxembourg statutory tax rates for the applicable years. Going forward, based upon existing tax regulations and current federal, state and foreign statutory tax rates, we expect our blended effective tax rate on our projected consolidated pre-tax income to range between 25% and 28% in 2011 before returning to normalized level of 28% to 30% in subsequent years.
Backlog
We use backlog as a primary means of measuring the immediate outlook for our Explosive Metalworking business. We define “backlog” at any given point in time as consisting of all firm, unfulfilled purchase orders and commitments at that time. Generally speaking, we expect to fill most backlog orders within the following 12 months. From experience, most firm purchase orders and commitments are realized.
Our backlog with respect to the Explosive Metalworking segment increased to $58,530 at March 31, 2011 from $56,539 at December 31, 2010 and $41,154 at September 30, 2010.
Three Months Ended March 31, 2011 Compared to Three Months Ended March 31, 2010
Net sales
Net sales for the first quarter of 2011 increased 50.1% to $45,574 from $30,357 for the first quarter of 2010. Explosive Metalworking sales increased 22.4% to $26,074 for the three months ended March 31, 2011 (57% of total sales) from $21,306 for the same period of 2010 (70% of total sales). The decrease in Explosive Metalworking’s proportionate contribution to consolidated net sales reflects a quicker recovery from the economic recession in our Oilfield Products business than in our core Explosive Metalworking business as well as the benefit of incremental 2011 sales for our Oilfield Products segment that resulted from 2010 acquisitions as further discussed below.
Oilfield Products contributed $17,056 to first quarter 2011 sales (38% of total sales), which represents a 143.4% increase from sales of $7,006 for the first quarter of 2010 (23% of total sales). Excluding incremental sales of $3,509 from our acquisition of Austin Explosives and step acquisition of two Russian joint ventures, the first quarter 2011 sales increase for Oilfield Products was $6,541 or 93.4%.
AMK Welding contributed $2,444 to first quarter 2011 sales (5% of total sales), versus sales of $2,045 for the first quarter of 2010 (7% of total sales), an increase of 19.5%.
Gross profit
Gross profit increased by 47.5% to $10,302 for the three months ended March 31, 2011 from $6,984 for the three months ended March 31, 2010. Our first quarter 2011 consolidated gross profit margin rate decreased to 22.6% from the 23.0% gross margin that we reported for the first quarter of 2010. The gross profit margin for Explosive Metalworking decreased from 21.9% in the first quarter of 2010 to 17.2% in the first quarter of 2011. Oilfield Products reported a gross margin of 30.2% in the first quarter of 2011 compared to a gross margin of 27.5% in the first quarter of 2010. The gross profit margin for AMK Welding increased to 29.7% in the first quarter of 2011 from 22.5% in the first quarter of 2010.
The decrease in the first quarter 2011 gross profit margin rate for our Explosive Metalworking segment relates principally to unfavorable changes in product mix as compared to the first quarter of 2010 and the negative impact that the extremely competitive pricing environment that existed during the last part of 2010 had on orders that shipped during the first quarter of 2011. Additionally, the gross margin performance in the first quarter of 2010 gross margin included the positive benefit of a sizeable order that shipped during the quarter and that involved customer-supplied metal. As has been the case historically, we expect to see continued fluctuations in Explosive Metalworking’s quarterly gross margin rates in the future that result from fluctuations in quarterly sales volume and change in product mix.
The increase in Oilfield Products’ first quarter 2011 gross margin relates principally to the significant sales increase discussed above, favorable changes in product/customer mix, and the incremental margin on intercompany sales to former distributors in the U.S. and Russia that were acquired during the second quarter of 2010 as these acquired entities sell products through to the end customers.
The increase in AMK Welding’s gross margin relates principally to the sales increase discussed above and associated more favorable absorption of fixed manufacturing overhead expenses.
Based upon the expected contribution to 2011 consolidated net sales by each of our three business segments, we expect our consolidated full year 2011 gross margin to be in a range of 24% to 26%.
General and administrative expenses
General and administrative expenses increased by $530, or 16.9%, to $3,675 for the three months ended March 31, 2011 from $3,145 for the same period of 2010. Excluding incremental general and administrative expenses of $372 that resulted from the acquisition of Austin Explosives and the Russian joint ventures, our general and administrative expenses increased by $158 or 5.0%. This increase includes an increase in outside service fees of $127, increases of $61
and $38 in salaries and accrued incentive compensation, respectively, and an increase of $40 in stock-based compensation. These increases were partially offset by a net decrease of $108 in all other expense categories that reflects tight controls over discretionary spending. As a percentage of net sales, general and administrative expenses decreased to 8.1% in the first quarter of 2011 from 10.4% in the first quarter of 2010.
Selling and distribution expenses
Selling and distribution expenses, which include sales commissions of $593 in the first quarter of 2011 and $298 in the first quarter of 2010, increased by 60.5% to $3,726 in the first quarter of 2011 from $2,321 in the first quarter of 2010. Excluding incremental selling and distribution expenses of $963 that resulted from the acquisitions of Austin Explosives and the Russian joint ventures, our selling and distribution expenses increased by $442 or 19.1%. This increase in our selling and distribution expenses includes increased selling and distribution expenses of $176 at our U.S. divisions and $267 at our foreign divisions.
The $176 increase in our U.S. selling and distribution expenses reflects increases of $132 and $88 for sales commissions and bad debt expense, respectively, and a net decrease of $44 in other spending categories. The $267 increase in our foreign divisions’ selling and distribution expenses reflects increases of $182 and $162 for salary expense and sales commissions, respectively, and a net decrease of $76 in other spending categories. As a percentage of net sales, selling and distribution expenses increased to 8.2% in the first quarter of 2011 from 7.6% in the first quarter of 2010. The increase in selling and distribution expenses as a percentage of sales relates largely to our Oilfield Products business and the need, particularly in North America, to maintain a number of strategically located distribution centers that are in close proximity to areas which contain a large concentration of oilfields and enjoy a high volume of related oil and gas drilling activities.
Amortization expenses
Amortization expense relates to the amortization of values assigned to intangible assets in connection with our November 15, 2007 acquisition of DYNAenergetics, our October 1, 2009 acquisition of LRI, our April 30, 2010 acquisition of the two Russian joint ventures and our June 4, 2010 acquisition of Austin Explosives. Amortization expense for the three months ended March 31, 2010 includes $1,064, $292, and $49 relating to values assigned to customer relationships, core technology, and trademarks/trade names, respectively. Amortization expense for the three months ended March 31, 2010 includes $883, $296 and $94 relating to values assigned to customer relationships, core technology, and trademarks/trade names, respectively. Amortization expense (as measured in Euros) associated with the DYNAenergetics acquisition is expected to approximate €3,490 in 2011, and 2011 amortization expense (as measured in Canadian dollars)
associated with the LRI acquisition is expected to approximate 80 CAD. Amortization expense (as measured in Euros) associated with the acquisition of the two Russian joint ventures is expected to approximate €235 in 2011, and 2011 amortization expense associated with the Austin Explosives acquisition is expected to approximate $435.
Operating income
Income from operations (“operating income”) increased by five-fold to $1,496 in the first quarter of 2011 from $245 in the first quarter of 2010.
Explosive Metalworking reported operating income of $1,554 in the first quarter of 2011 as compared to $1,838 in the first quarter of 2010. This 15.5% decrease is largely attributable to the 21.5% decline in the gross margin rate discussed above. Operating results of Explosive Metalworking for the three months ended March 31, 2011 and 2010 include $546 and $598, respectively, of amortization expense of purchased intangible assets.
Oilfield Products reported operating income of $924 in the first quarter of 2011 as compared to an operating loss of $460 in the first quarter of 2010. The significant improvement in operating results for our Oilfield Products segment is attributable to the significant increases in sales and gross profit as discussed above that reflect the incremental sales and gross profit from the acquisitions of Austin Explosives and the Russian joint ventures as well as an increase in global oil and gas drilling activities, particularly in North America. Operating results of Oilfield Products for the three months ended March 31, 2011 and 2010 include $859 and $675, respectively, of amortization expense of purchased intangible assets.
AMK Welding reported operating income of $468 in the first quarter of 2011, an increase of 80.0% from the $260 that it reported in the first quarter of 2010. The improvement in AMK’s operating income is largely attributable to the 19.5% sales increase and the 32.1% increase in the gross margin rate discussed above.
Our consolidated operating income for the three months ended March 31, 2011 and 2010 includes $658 and $601, respectively, of unallocated corporate expenses and $792 in each period of stock-based compensation expense. These expenses are not allocated to our business segments and thus are not included in the above first quarter operating income or loss totals for our Explosive Metalworking, Oilfield Products, and AMK Welding business segments.
Other income (expense), net
We reported net other expense of $203 in the first quarter of 2011 compared to net other income of $141 in the first quarter of 2010. Our 2011 net other expense of $203 includes net realized and unrealized foreign exchange losses of $311, offset by a gain of $50 on our currency swap agreement and net other income items aggregating $58. Our 2010 net other income of $141 relates principally to realized and unrealized foreign exchange gains recorded by our Swedish and German subsidiaries.
Interest income (expense), net
We recorded net interest expense of $407 in the first quarter of 2011 compared to net interest expense of $1,109 in the first quarter of 2010. Our first quarter 2010 interest expense included a non-recurring, non-cash charge of $251 related to the write-off of unamortized debt issuance costs associated with the March prepayment, in the amount of $12,498 (9,020 Euros), of the remaining balance of the Euro term loan that was outstanding under our bank syndicate credit facility. This Euro term loan was scheduled to mature on November 16, 2012. The decrease in our first quarter 2011 interest expense is attributable to a significant reduction in average outstanding borrowings that resulted from scheduled term loan payments and the March 2010 prepayment of the Euro term loan.
Income tax provision (benefit)
We recorded an income tax provision of $148 in the first quarter of 2011 compared to an income tax benefit of $154 in the first quarter of 2010. The effective tax rate decreased to 16.7% in the first quarter of 2011 from 27.8% in the first quarter of 2010 and 17.7% for the full year 2010. Our consolidated income tax provision for the three months ended March 31, 2011 and 2010 included $476 and $386, respectively, related to U.S. taxes, with the remainder relating to net foreign tax benefits of $328 and $540 for the three months ended March 31, 2011 and 2010, respectively, associated with our foreign operations and holding companies.
We expect our blended effective tax rate for 2011 to range from 25% to 28% based on projected pre-tax income.
Adjusted EBITDA
Adjusted EBITDA is a non-GAAP measure that we believe provides an important indicator of our ongoing operating performance. Our aggregate non-cash depreciation, amortization and stock-based compensation expense for the three months ended March 31, 2011 and 2010 was $3,553 and $3,219, respectively, and represents a significant percentage of the consolidated operating income that we reported for these periods. We use non-GAAP EBITDA and Adjusted EBITDA in our operational and financial decision-making and believe that these non-GAAP measures are a reliable indicator of our ability to generate cash flow from operations and facilitate a more meaningful comparison of the operating performance of our three business segments than do certain GAAP measures. Research analysts, investment bankers and lenders also use EBITDA
and Adjusted EBITDA to assess operating performance. The following is a reconciliation of the most directly comparable GAAP measure to Adjusted EBIDTA.
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