ITEM 7.  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 included elsewhere in this annual report.

 

Unless stated otherwise, all dollar figures in this discussion are presented in thousands (000s).

Executive Overview

 

Our business is organized into two segments:  NobelClad and DynaEnergetics.  Prior to 2014, we were organized into three segments. At the beginning of 2014 management approved a change in operating structure whereby AMK would operate within and be managed as part of the Oilfield Products business segment. Consequently, we combined AMK and DynaEnergetics into one reportable business segment, Oilfield Products. AMK represented 3% of segment assets, 4% of consolidated sales and 2% of segment operating income as of and for the year then ended December 31, 2013. All prior periods segment disclosures have been restated to conform to the 2014 presentation.

On October 1, 2014 we completed the sale of our AMK business. We have reflected the results of AMK as discontinued operations in the consolidated statements of operations for all periods presented. Accordingly, historical consolidated statements of operations included in the Management's Discussion and Analysis of Financial Condition and Results of Operations have been restated to reflect the discontinued operation.

On October 23, 2014, we signed an agreement to purchase a manufacturing facility in the Siegerland region of Germany for €10,528.  The facility will significantly enhance NobelClad’s manufacturing capabilities and its ability to serve customers throughout Europe, the Middle East and Africa.  We expect the plant will be operational in the second quarter of 2015.

    

On October 27, 2014, management announced a plan to restructure its NobelClad European operations. Clad metal plate production will be shifted from facilities in both Rivesaltes, France and Wurgendorf, Germany to the new manufacturing facility in Germany. NobelClad's Rivesaltes plant will continue to produce transition joints with a reduced workforce while the Wurgendorf site will be closed and its workers will be transferred to the new facility. In the fourth quarter of 2014, we incurred restructuring charges related this plan of $6,781. The restructuring charges included severance of $2,466, non-cash impairment charges of $3,946 associated with the Wurgendorf facility and leasehold improvements at a leased facility in France, both of which are being closed under the consolidation program, and other exit costs of $369. We expect to incur additional restructuring charges of approximately $1,000 primarily related to equipment relocation in the first quarter of 2015.

In 2014, NobelClad accounted for 48% of our net sales and 13% of our income from operations before consideration of unallocated corporate expenses and stock-based compensation expense, which are not allocated to our business segments.  DynaEnergetics accounted for 52% and 87% of our 2014 net sales and income from operations, respectively. In 2013 and 2012, NobelClad accounted for 59% and 60% of our net sales, respectively, and 79% and 73% , respectively, of income from operations before unallocated corporate expenses and stock-based compensation expense. In 2013 and 2012, DynaEnergetics accounted for 41% and 40% of our net sales, respectively, and 21% and 27% , respectively, of income from operations before unallocated corporate expenses and stock-based compensation expense.

 

Our 2014 net sales increased by $501, or 0.2%, compared to 2013 net sales.  Sales increased $21,802 (26.1%) in our DynaEnergetics segment and decreased $21,301 (18.0%) in our NobelClad segment. Excluding the impact of restructuring expenses in 2014 of $6,781, our consolidated income from operations increased to $13,446 in 2014 compared to $10,978 in 2013. The $2,468 improvement in consolidated income from operations was due to a $9,973 increase in DynaEnergetics operating income and a $649 decrease in aggregate unallocated corporate expenses and stock-based compensation, offset by a $8,154 decline in NobelClad's operating income. The decrease in corporate expenses was driven by $2,965 of non-recurring expenses in the first quarter of 2013 associated with management retirements. Consolidated operating income for 2014 and 2013 includes amortization expense of $6,103 and $6,348, respectively. Net income was $2,567 for 2014 compared to net income of $6,459 for 2013.

 

Restatement of Previously-Issued Financial Statements

On March 5, 2015, we concluded to restate our financial statements and related disclosures to correct non-cash errors reported in our historical consolidated financial statements related to income tax expense and related deferred tax assets and liabilities at our business entities in Germany as well as other adjustments, which were immaterial. The effects of the restatement are reflected in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and no prior disclosures were modified or updated except those required to reflect the effects of the restatement. See the Explanatory Note

included in the front section of the annual report on Form 10-K and Note 3 "Restatement of Previously-Issued Financial Statements” contained in the Notes to Financial Statements for more information regarding the restatement and changes to previously issued financial statements.

The errors arose from incorrect income tax accounting at our operations in Germany. In November 15, 2007 we acquired DynaEnergetics under Holding Co, a newly created German subsidiary. Subsequent to the acquisition we recognized income tax expense or benefits for German federal and local income tax purposes and paid cash taxes accordingly. However, we incorrectly had been deferring the recognition of the income tax expense or benefit in our calculation of net income for purposes of U.S. GAAP reporting.

The non-cash impact of the restatement and other adjustments decreased income from continuing operations by $1,036 in 2013 and $919 in 2012. The cumulative effect of the errors increased shareholders’ equity by $237 as of December 31, 2013. The restatement only impacted the income tax provision (benefit) line item in our consolidated statements of operations for the years ended December 31, 2013 and 2012, respectively. The restatement had no impact on the Company’s revenues, do not affect the Company’s cash balances and have no effect on the Company’s future operations.

We have not amended our previously-filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by the restatement. The financial information that has been previously filed or otherwise reported for these periods is superseded by the information in this Form 10-K, and the financial statements and related financial information contained in such previously-filed reports should no longer be relied upon.

Net sales

 

NobelClad'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. These industries tend to be cyclical in nature and timing of new order inflow remains difficult to predict; however, we believe that our NobelClad segment is well-positioned in the marketplace.

 

Dynaenergetics markets and sells 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.

 

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 of products sold for NobelClad includes the cost of metals and alloys used to manufacture clad metal plates, the cost of explosives, employee compensation and benefits, freight, outside processing costs, depreciation of manufacturing facilities and equipment, manufacturing supplies and other manufacturing overhead expenses.

 

Cost of products sold for DynaEnergetics includes the cost of metals, explosives and other raw materials used to manufacture shaped charges, detonating products and perforating guns as well as employee compensation and benefits, depreciation of manufacturing facilities and equipment, manufacturing supplies and other manufacturing overhead expenses.

NobelClad Backlog

 

We use backlog as a primary means to measure the immediate outlook for our NobelClad business.  We define “backlog” at any given point in time as all firm, unfulfilled purchase orders and commitments at that time.  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 NobelClad backlog increased to $41,244 at December 31, 2014 from $36,930 at December 31, 2013 .

 

Forward-Looking Statements

 

This annual report and the documents incorporated by reference into it contain certain forward-looking statements within the safe harbor provisions of the Private Securities Litigations Reform Act of 1995.  These statements include information with respect to our anticipated future financial condition and results of operations and businesses.  Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will,” “continue,” “project,” “forecast,” and similar expressions, as well as statements in the future tense, identify forward-looking statements.

 

These forward-looking statements are not guarantees of our future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements.  These risks and uncertainties include:

• The ability to obtain new contracts at attractive prices;

• The size and timing of customer orders;

• Fluctuations in customer demand;

• General economic conditions, both domestically and abroad, and their effect on us and our customers;

• Competitive factors;

• The timely completion of contracts;

• The timing and size of expenditures;

• The timely receipt of government approvals and permits;

• The adequacy of local labor supplies at our facilities;

• The availability and cost of funds; and

• Fluctuations in foreign currencies.

 The effects of these factors are difficult to predict.  New factors emerge from time to time and we cannot assess the potential impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement.  Any forward-looking statement speaks only as of the date of this annual report, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of such statement or to reflect the occurrence of unanticipated events.  In addition, see “Risk Factors” for a discussion of these and other factors.

 

Year ended December 31, 2014 compared to Year Ended December 31, 2013

 

 

Net sales for 2014 increased 0.2% to $202,561 from $202,060 in 2013 .

 

NobelClad sales decreased 18.0% to $97,108 in 2014 ( 48% of total sales) from $118,409 in 2013 ( 59% of total sales).  The decrease in Nobelclad sales this period relates primarily to the lower backlog and timing of shipments out of backlog.

 

DynaEnergetics contributed $105,453 to sales in 2014 ( 52% of total sales) compared to $83,651 in 2013 ( 41% of total sales), which represents a sales increase of 26.1% .  The increase in Oilfield products sales was driven by increased demand and favorable product and customer mix primarily from sales of our DynaSelect selective perforating detonator switch.

 

Gross profit increased by 5.7% to $61,419 in 2014 from $58,134 in 2013 .  Our 2014 consolidated gross profit margin rate increased to 30.3% from 28.8% in 2013 primarily from a higher proportion of sales in DynaEnergetics, which has higher gross profit margins than NobelClad. 

 

NobelClad's gross profit margin decreased from 25.4% in 2013 to 22.3% in 2014. The decrease in gross margin rate relates principally to lower sales volume and unfavorable manufacturing overhead absorption compared with 2013.

 

DynaEnergetics' gross profit margin increased to 38.0% in 2014 from 33.9% in 2013. The full year gross profit margin improved due to favorable price and mix including DynaSelect sales.

 

 

General and administrative expenses decreased by $906 , or 3.7% , to $23,766 in 2014 from $24,672 in 2012.  Excluding the impacts in 2013 of $2,965 in non-recurring expenses associated with management retirements and a $756 asset impairment charge related to an information system project in Russia, our general and administrative expenses increased by $2,815 or 13.4% from an aggregate increase in salaries, benefits and payroll taxes of $1,093, a $976 increase in stock-based compensation expense and a $327 increase in professional services. The increases were driven by year-over-year headcount additions to support business development initiatives, corporate branding and recruiting expenses. Excluding the impact of non-recurring management retirement and asset impairment expenses, general and administrative expenses, as a percentage of net sales, increased to 11.7% in 2014 from 10.4% in 2013.

 

Selling and distribution expenses increased by 12.2% to $18,104 in 2014 from $16,136 in 2013.  The increase was primarily due to a $1,000 aggregate increase in salaries, benefits and payroll taxes, a $436 increase in bad debt expense mostly from favorable adjustments in the third quarter of 2013 and an increase of $100 in stock-based compensation expense. As a percentage of net sales, selling and distribution expenses increased to 8.9% in 2014 compared to 8.0% in 2013.

Our 2014 consolidated selling and distribution expenses include $5,928 and $11,892 for our NobelClad and DynaEnergetics business segments, respectively. Our 2013 consolidated selling and distribution expenses include $5,574 and $10,378 for our NobelClad and DynaEnergetics business segments, respectively. The higher level of selling and distribution expenses for our DynaEnergetics segment relative to its contribution to our consolidated net sales reflects the strategy, particularly in North America, maintaining 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 expense relates to the amortization of values assigned to intangible assets in connection with our prior years acquisitions of DYNAenergetics, LRI, the two Russian joint ventures, Austin Explosives and our January 3, 2012 acquisition of TRX, all part of our DynaEnergetics business segment.  The $245 decrease in 2014 amortization expenses reflects the impact of foreign currency translation effects and a slight decrease in Q4 2014 amortization expense associated with the DYNAenergetics acquisition based on the amortization schedule. Amortization expense for 2014 includes $4,777 , $1,135 , and $191 relating to values assigned to customer relationships, core technology, and trademarks/trade names, respectively.  Amortization expense for 2013 includes $5,021 , $1,136 , and $191 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 and the acquisition of the two Russian joint ventures is expected to approximate €2,235 and €145, respectively, in 2015.  Our 2015 amortization expense associated with the Austin Explosives acquisition and the acquisition of TRX is expected to approximate $435 and $895, respectively, and  our 2015 amortization expense (as measured in Canadian dollars) associated with the LRI acquisition is expected to approximate 80 CAD.

 

Restructuring expenses relate to our decision in the fourth quarter of 2014 to consolidate our NobelClad European operations. Clad metal plate production will be shifted from facilities in both Rivesaltes, France and Wurgendorf, Germany to a new manufacturing facility in Germany. NobelClad's Rivesaltes plant will continue to produce transition joints with a reduced workforce while the Wurgendorf site will be closed and its workers will be transferred to the new facility. The restructuring charges of $6,781 included severance of $2,466, non-cash impairment charges of $3,946 associated with the Wurgendorf facility and leasehold improvements at a leased facility in France, both of which are being closed under the consolidation program, and other exit costs of $369.

 

Income from operations (“operating income”) decreased by 39.3% to $6,665 in 2014 from $10,978 in 2013. Excluding the impact of restructuring expenses, our consolidated operating income for 2014 was $13,446, an increase of $2,468 or 22.5% over 2013. The above consolidated operating income totals for 2014 and 2013 include $6,381 and $7,217 , respectively, of unallocated corporate expenses and $3,588 and $3,401 , respectively, of stock-based compensation expense.  These expenses are not allocated to our business segments and thus are not included in the below 2014 and 2013 operating income totals for NobelClad and DynaEnergetics.