NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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. Certain information and footnote disclosures, including critical and significant accounting policies normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted for this quarterly presentation. 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, 2022.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The Condensed Consolidated Financial Statements include the accounts of DMC Global Inc. (“DMC”, “we”, “us”, “our”, or the “Company”) and its controlled subsidiaries. Only subsidiaries in which controlling interests are maintained are consolidated. All intercompany accounts, profits, and transactions have been eliminated in consolidation.
Accounts Receivable
The Company measures expected credit losses for its accounts receivable using a current expected credit loss model, which is based on historical experience, adjusted for current conditions and reasonable and supportable forecasts. The Company has disaggregated pools of accounts receivable balances by business, geography and/or customer risk profile and has used history and other experience to establish an allowance for credit losses at the time the receivable is recognized. To measure expected credit losses, we have elected to pool trade receivables by business segment and analyze each segment’s accounts receivable balances as separate populations. Within each segment, receivables exhibit similar risk characteristics.
During the three months ended March 31, 2023, our expected loss rate reflects uncertainties in market conditions present in our businesses, including supply chain disruptions, rising interest rates, as well as global geopolitical and economic instability. In addition, we reviewed receivables outstanding, including aged balances, and in circumstances where we are aware of a specific customer’s inability to meet its financial obligation to us, we recorded a specific allowance against the amounts due, reducing the net receivable recognized to the amount we estimate will be collected. The offsetting expense for allowances recorded is charged to “Selling and distribution expenses” in our Condensed Consolidated Statements of Operations. During the three months ended March 31, 2023, net recoveries of $154 were recorded.
The following table summarizes year-to-date activity in the allowance for credit losses on receivables from customers in each of our business segments:
| | | | | | | | | | | | | | | | | | | | | | | |
| Arcadia | | DynaEnergetics | | NobelClad | | DMC Global Inc. |
Allowance for doubtful accounts, December 31, 2022 | $ | 244 | | | $ | 603 | | | $ | 78 | | | $ | 925 | |
| | | | | | | |
Current period provision for expected credit losses | — | | | 32 | | | — | | | 32 | |
| | | | | | | |
Recoveries of amounts previously reserved | (184) | | | (2) | | | — | | | (186) | |
Impacts of foreign currency exchange rates and other | — | | | 1 | | | — | | | 1 | |
Allowance for doubtful accounts, March 31, 2023 | $ | 60 | | | $ | 634 | | | $ | 78 | | | $ | 772 | |
Redeemable noncontrolling interest
On December 23, 2021, DMC completed the acquisition of 60% of the membership interests in Arcadia Products, LLC, a Colorado limited liability company resulting from the conversion of Arcadia, Inc. (collectively, “Arcadia”). The limited liability company operating agreement for Arcadia (the “Operating Agreement”) contains a right for the Company to purchase the remaining interest in Arcadia from the minority interest holder on or after the third anniversary of the acquisition closing date (“Call Option”). Similarly, the minority interest holder of Arcadia has the right to sell its remaining interest in Arcadia to the Company on or after the third anniversary of the acquisition closing date (“Put Option”). Both the Call Option and Put Option enable the respective holder to exercise their rights based upon a predefined calculation as included within the Operating Agreement.
The Company initially accounted for the noncontrolling interest at its acquisition date fair value. We determined that neither the Call Option nor the Put Option meet the definition of a derivative as the Operating Agreement does not allow for contractual net settlement, the options cannot be settled outside the Operating Agreement through a market mechanism, and the underlying shares are deemed illiquid as they are not publicly traded and thus not considered readily convertible to cash. Additionally, the settlement price for both options is based upon a predefined calculation tied to adjusted earnings rather than a fixed price, and the formula is based upon a multiple of Arcadia’s average adjusted earnings over a three-year period. As such, we have concluded that the Call Option and Put Option are embedded within the noncontrolling interest and therefore do not represent freestanding instruments.
Given that the noncontrolling interest is subject to possible redemption with redemption rights that are not entirely within the control of the Company, we have concluded that the noncontrolling interest should be accounted for in accordance with ASC 480 Distinguishing Liabilities from Equity ("ASC 480"). The noncontrolling interest is also probable of redemption, as the only criteria for the security to become redeemable is the passage of time. As such, the redeemable noncontrolling interest is classified in temporary equity, separate from the stockholders’ equity section, in the Condensed Consolidated Balance Sheets.
At each balance sheet date subsequent to acquisition, two separate calculations must be performed to determine the value of the redeemable noncontrolling interest. First, the redeemable noncontrolling interest must be accounted for in accordance with ASC 810 Consolidation (“ASC 810”) whereby income (loss) and cash distributions attributable to the redeemable noncontrolling interest holder are ascribed. After this occurs, applicable provisions of ASC 480 must be considered to determine whether any further adjustment is necessary to increase the carrying value of the redeemable noncontrolling interest. An adjustment would only be necessary if the estimated settlement amount of the redeemable noncontrolling interest, per the terms of the Operating Agreement, exceeds the carrying value calculated in accordance with ASC 810. If such adjustment is required, the impact is immediately recorded to retained earnings and therefore does not impact the Condensed Consolidated Statements of Operations or Comprehensive Income (Loss). As of March 31, 2023 and December 31, 2022, the redeemable noncontrolling interest is $187,522.
Promissory Note
In order to equalize after-tax consideration to the redeemable noncontrolling interest holder relative to an alternative transaction structure, immediately following the closing of the acquisition, the Company loaned $24,902 to the redeemable noncontrolling interest holder. The loan was evidenced by an unsecured promissory note, and the loan will be repaid out of proceeds from the sale of the redeemable noncontrolling interest holder’s interests in Arcadia, whether received upon exercise of the Put Option, the Call Option or upon sales to third parties permitted under the terms of the Operating Agreement. The loan must be repaid in full by December 16, 2051 and has been recorded within “Other Assets” in the Condensed Consolidated Balance Sheets.
Revenue Recognition
The Company’s revenues are primarily derived from consideration paid by customers for tangible goods. The Company analyzes its different products by business segment to determine the appropriate basis for revenue recognition. Revenue is not generated from sources other than contracts with customers, and revenue is recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. There are no material upfront costs for operations that are incurred from contracts with customers.
Our rights to payments for goods transferred to customers within our DynaEnergetics and NobelClad business segments arise when control is transferred at a point in time and not on any other criteria. Our rights to payments for goods transferred to customers within our Arcadia business segment also generally arise when control is transferred at a point in time; however, at times, control of certain customized, project-based products passes to the customer over time. Payment terms and conditions vary by contract, although terms generally include a requirement of payment within 30 to 90 days across all of our segments. In
instances when we require customers to make advance payments prior to the shipment of their orders, we record a contract liability. We have determined that our contract liabilities do not include a significant financing component given the short duration between order initiation and order fulfillment within each of our segments. Refer to Note 9 "Business Segments" for disaggregated revenue disclosures.
See additional revenue recognition policy disclosures specific to each of our business segments within our Annual Report filed on Form 10-K for the year ended December 31, 2022.
Income Taxes
We recognize deferred tax assets and liabilities for the expected future income tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. Any effects of changes in income tax rates or tax laws are included in the provision for income taxes in the period of enactment. The deferred income tax impact of tax credits are recognized as an immediate adjustment to income tax expense. We recognize deferred tax assets for the expected future effects of all deductible temporary differences to the extent we believe these assets will more likely than not be realized. We record a valuation allowance when, based on current circumstances, it is more likely than not that all or a portion of the deferred tax assets will not be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies, recent financial operations and their associated valuation allowances, if any.
We recognize the tax benefits from uncertain tax positions only when it is more likely than not, based on the technical merits of the position, that the tax position will be sustained upon examination, including the resolution of any related appeals or litigation. The tax benefits recognized in the Condensed Consolidated Financial Statements from such a position are measured as the largest benefit that is more likely than not to be realized upon ultimate resolution. We recognize interest and penalties related to uncertain tax positions in operating expense.
Earnings Per Share
In periods with net income, the Company computes earnings per share (“EPS”) using a two-class method, which is an earnings allocation formula that determines EPS for (i) each class of common stock (the Company has a single class of common stock), and (ii) participating securities according to dividends declared and participation rights in undistributed earnings. Restricted stock awards are considered participating securities in periods of net income as they receive non-forfeitable rights to dividends as common stock. Restricted stock awards do not participate in net losses.
Basic EPS is calculated by dividing net income (loss) attributable to the Company’s stockholders after adjustment of redeemable noncontrolling interest by the weighted-average number of common shares outstanding during the period. Net income (loss) available to common shareholders of the Company includes any adjustment to the redeemable noncontrolling interest value as of the end of the period presented. Refer to "Redeemable noncontrolling interest" section above for further discussion of the calculation of the adjustment of the redeemable noncontrolling interest. Diluted EPS adjusts basic EPS for the effects of restricted stock awards, restricted stock units, performance share units and other potentially dilutive financial instruments (dilutive securities), only in the periods in which such effect is dilutive. The effect of the dilutive securities is reflected in diluted EPS by application of the more dilutive of (1) the treasury stock method or (2) the two-class method.
| | | | | | | | | | | | | | | |
| Three months ended March 31, | | |
| 2023 | | 2022 | | | | |
Net income (loss) attributable to DMC Global Inc. stockholders, as reported | $ | 909 | | | $ | (3,288) | | | | | |
Adjustment of redeemable noncontrolling interest | (1,138) | | | (5,717) | | | | | |
| | | | | | | |
Less: Undistributed net income available to participating securities | — | | | — | | | | | |
Numerator for basic net loss per share: | (229) | | | (9,005) | | | | | |
Add: Undistributed net income allocated to participating securities | — | | | — | | | | | |
Less: Undistributed net income reallocated to participating securities | — | | | — | | | | | |
Numerator for diluted net loss per share: | (229) | | | (9,005) | | | | | |
Denominator: | | | | | | | |
Weighted average shares outstanding for basic net loss per share | 19,462,636 | | | 19,301,126 | | | | | |
Effect of dilutive securities (1) | — | | | — | | | | | |
Weighted average shares outstanding for diluted net loss per share | 19,462,636 | | | 19,301,126 | | | | | |
Net loss per share attributable to DMC Global Inc. stockholders | | | | | | |
Basic | $ | (0.01) | | | $ | (0.47) | | | | | |
Diluted | $ | (0.01) | | | $ | (0.47) | | | | | |
(1)Given we were in a net loss position after the adjustment of redeemable noncontrolling interest for the three months ended March 31, 2023 and 2022, all potentially dilutive shares were anti-dilutive and were therefore excluded from the determination of diluted EPS.
Deferred Compensation Plan
The Company maintains a Non-Qualified Deferred Compensation Plan (the “Plan”) as part of its overall compensation package for certain employees. Participants are eligible to defer a portion of their annual salary, their annual incentive bonus, and their equity awards through the Plan on a tax-deferred basis. Deferrals into the Plan are not matched or subsidized by the Company, nor are they eligible for above-market or preferential earnings.
The Plan provides for deferred compensation obligations to be settled either by delivery of a fixed number of shares of DMC’s common stock or in cash, in accordance with participant contributions and elections. For deferred equity awards, subsequent to equity award vesting and after a period prescribed by the Plan, participants can elect to diversify contributions of equity awards into other investment options available to Plan participants. Once diversified, such contributions will be settled by delivery of cash.
The Company has established a grantor trust commonly known as a “rabbi trust” and contributed certain assets to satisfy the future obligations to participants in the Plan. These assets are subject to potential claims of the Company’s general creditors. The assets held in the trust include unvested restricted stock awards (“RSAs”), vested company stock awards, company-owned life insurance (“COLI”) on certain employees, and money market and mutual funds. Unvested RSAs and common stock held by the trust are reflected in the Condensed Consolidated Balance Sheets within “Treasury stock, at cost, and company stock held for deferred compensation, at par” at the par value of the common stock or unvested RSAs. These accounts are not adjusted for subsequent changes in the fair value of the common stock. COLI is accounted for at the cash surrender value while money market and mutual funds held by the trust are accounted for at fair value.
Deferred compensation obligations that will be settled in cash are accounted for on an accrual basis in accordance with the terms of the Plan. These obligations are adjusted based on changes in value of the underlying investment options chosen by Plan participants. Deferred compensation obligations that will be settled by delivery of a fixed number of previously vested shares of the Company’s common stock are reflected in the Condensed Consolidated Statements of Stockholders’ Equity and Redeemable Noncontrolling Interest within “Common stock” at the par value of the common stock or unvested RSAs. These accounts are not adjusted for subsequent changes in the fair value of the common stock.
The balances related to the deferred compensation plan were as follows for the periods presented. The amount included within “Prepaid expenses and other” and “Other current liabilities” pertains to scheduled distributions per the terms of the Plan to our former Chief Executive Officer (“CEO”) that will occur within twelve months of March 31, 2023. Refer to Note 12 for additional information regarding the CEO transition.
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| | Balance Sheet location | | March 31, 2023 | | December 31, 2022 |
Deferred compensation assets | | Prepaid expenses and other | | $ | 5,798 | | | $ | — | |
Deferred compensation assets | | Other assets | | $ | 8,098 | | | $ | 13,566 | |
Deferred compensation obligations | | Other current liabilities | | $ | 5,798 | | | $ | — | |
Deferred compensation obligations | | Other long-term liabilities | | $ | 11,424 | | | $ | 15,292 | |
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Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We are required to use an established hierarchy for fair value measurements based upon the inputs to the valuation and the degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows:
•Level 1 — Inputs to the valuation based upon quoted prices (unadjusted) for identical assets or liabilities in active markets that are accessible as of the measurement date.
•Level 2 — Inputs to the valuation include quoted prices in either markets that are not active, or in active markets for similar assets or liabilities, inputs other than quoted prices that are observable, and inputs that are derived principally from or corroborated by observable market data.
•Level 3 — Inputs to the valuation that are unobservable inputs for the asset or liability.
The highest priority is assigned to Level 1 inputs and the lowest priority to Level 3 inputs.
The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate their fair value. The carrying value of our revolving loans and term loan under our credit facility, when outstanding, also approximate their fair value because of the variable interest rate associated with those instruments, which reset each month at market interest rates. All of these account balances are considered Level 1 assets and liabilities.
Our foreign currency forward contracts are valued using quoted market prices or are determined using a yield curve model based on current market rates. As a result, we classify these instruments as Level 2 in the fair value hierarchy. Money market funds and mutual funds of $8,625 as of March 31, 2023 and $8,444 as of December 31, 2022 held to satisfy future deferred compensation obligations are valued based upon the market values of underlying securities and are classified as Level 2 assets in the fair value hierarchy.
We did not hold any Level 3 assets or liabilities as of March 31, 2023 or December 31, 2022.
Recent Accounting Pronouncements
We have considered all recent accounting pronouncements issued, but not yet effective, and we do not expect any to have a material effect on the Company’s Condensed Consolidated Financial Statements.
3. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value. Significant cost elements included in inventory are material, labor, freight, subcontract costs, and manufacturing overhead. As necessary, we write down inventory to its net realizable value by recording provisions for excess, slow moving and obsolete inventory. We regularly review inventory quantities on hand and values, and compare them to estimates of future product demand, market conditions, production requirements and technological developments.
Inventories consisted of the following at March 31, 2023:
| | | | | | | | | | | | | | | | | | | | | | | |
| Arcadia | | DynaEnergetics | | NobelClad | | DMC Global Inc. |
Raw materials | $ | 10,233 | | | $ | 22,463 | | | $ | 9,806 | | | $ | 42,502 | |
Work-in-process | 13,006 | | | 30,914 | | | 12,460 | | | 56,380 | |
Finished goods | 53,978 | | | 26,418 | | | — | | | 80,396 | |
Supplies | — | | | — | | | 267 | | | 267 | |
Total inventories | $ | 77,217 | | | $ | 79,795 | | | $ | 22,533 | | | $ | 179,545 | |
Inventories consisted of the following at December 31, 2022: | | | | | | | | | | | | | | | | | | | | | | | |
| Arcadia | | DynaEnergetics | | NobelClad | | DMC Global Inc. |
Raw materials | $ | 11,099 | | | $ | 23,701 | | | $ | 8,926 | | | $ | 43,726 | |
Work-in-process | 11,468 | | | 21,198 | | | 7,587 | | | 40,253 | |
Finished goods | 55,074 | | | 16,802 | | | 456 | | | 72,332 | |
Supplies | — | | | — | | | 279 | | | 279 | |
Total inventories | $ | 77,641 | | | $ | 61,701 | | | $ | 17,248 | | | $ | 156,590 | |
4. PURCHASED INTANGIBLE ASSETS
Our purchased intangible assets consisted of the following at March 31, 2023: | | | | | | | | | | | | | | | | | |
| Gross | | Accumulated Amortization | | Net |
Core technology | $ | 14,257 | | | $ | (14,229) | | | $ | 28 | |
| | | | | |
Customer relationships | 244,980 | | | (52,880) | | | 192,100 | |
| | | | | |
Trademarks / Trade names | 23,940 | | | (3,810) | | | 20,130 | |
Total intangible assets | $ | 283,177 | | | $ | (70,919) | | | $ | 212,258 | |
Our purchased intangible assets consisted of the following at December 31, 2022: | | | | | | | | | | | | | | | | | |
| Gross | | Accumulated Amortization | | Net |
Core technology | $ | 14,063 | | | $ | (14,031) | | | $ | 32 | |
Customer backlog | 22,000 | | | (22,000) | | | — | |
Customer relationships | 244,650 | | | (47,254) | | | 197,396 | |
| | | | | |
Trademarks / Trade names | 23,914 | | | (3,417) | | | 20,497 | |
Total intangible assets | $ | 304,627 | | | $ | (86,702) | | | $ | 217,925 | |
The change in the gross value of our unamortized purchased intangible assets at March 31, 2023 from December 31, 2022 was due to foreign currency translation.
5. CONTRACT LIABILITIES
At times, 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. Contract liabilities were as follows for the periods presented: | | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
Arcadia | $ | 24,335 | | | $ | 27,634 | |
NobelClad | 5,293 | | | 3,661 | |
DynaEnergetics | 1,570 | | | 785 | |
Total contract liabilities | $ | 31,198 | | | $ | 32,080 | |
We generally expect to recognize the revenue associated with contract liabilities over a time period no longer than one year, but unforeseen circumstances can cause delays in shipments associated with contract liabilities, primarily supply chain delays and disruptions.
6. LEASES
The Company leases real properties for use in manufacturing and as administrative and sales offices, and leases automobiles and office equipment. The Company determines if a contract contains a lease arrangement at the inception of the contract. For leases in which the Company is the lessee, leases are classified as either finance or operating. Right-of-use (“ROU”) assets are initially measured at the present value of lease payments over the lease term plus initial direct costs, if any. If a lease does not provide a discount rate and the implicit rate cannot be readily determined, an incremental borrowing rate is used to determine the present value of future lease payments. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term within the Condensed Consolidated Statement of Operations. Lease and non-lease components within the Company’s lease agreements are accounted for together. Variable lease payments are recognized in the period in which the obligation is incurred. The Company has no leases in which the Company is the lessor.
Nearly all of the Company’s leasing arrangements are classified as operating leases. ROU asset and lease liability balances were as follows for the periods presented:
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
ROU asset | $ | 46,912 | | | $ | 48,470 | |
| | | |
Current lease liability | 7,025 | | | 7,041 | |
Long-term lease liability | 41,580 | | | 43,001 | |
Total lease liability | $ | 48,605 | | | $ | 50,042 | |
| | | |
The ROU asset is reported in “Other assets” while the current lease liability is reported in “Other current liabilities” and the long-term lease liability is reported in “Other long-term liabilities” in the Company’s Condensed Consolidated Balance Sheets. Cash paid for operating lease liabilities are recorded as operating cash outflows in the Company’s Condensed Consolidated Statements of Cash Flows.
Arcadia leases certain office, manufacturing, distribution and warehouse facilities from entities affiliated with the redeemable noncontrolling interest holder and former president of Arcadia. There were eight related party leases in effect as of March 31, 2023, with expiration dates ranging from calendar years 2025 to 2031. As of March 31, 2023, the total ROU asset and related lease liability recognized for related party leases was $28,036 and $28,625, respectively.
For the three months ended March 31, 2023 and 2022, operating lease expense was $3,040 and $2,767, respectively. Related party lease expense for the three months ended March 31, 2023 and 2022 was $1,156 in each period and is included in total operating lease expense. Short term and variable lease costs were not significant for any period presented.
7. DEBT
Outstanding borrowings consisted of the following at:
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
Syndicated credit agreement: | | | |
U.S. Dollar revolving loan | $ | — | | | $ | — | |
Term loan | 128,750 | | | 135,000 | |
| | | |
| | | |
Commerzbank line of credit | — | | | — | |
Outstanding borrowings | 128,750 | | | 135,000 | |
Less: debt issuance costs | (2,064) | | | (2,202) | |
Total debt | 126,686 | | | 132,798 | |
Less: current portion of long-term debt | (15,000) | | | (15,000) | |
Long-term debt | $ | 111,686 | | | $ | 117,798 | |
Syndicated Credit Agreement
On December 23, 2021, we entered into a five-year $200,000 syndicated credit agreement (“credit facility”) which included a $150,000 Term Loan, which is amortizable at 10% of principal per year with a balloon payment for the outstanding balance upon the credit facility maturity date in 2026, and allows for revolving loans of up to $50,000. The credit facility has an accordion feature to increase the commitments by $100,000 under the revolving loan class and/or by adding a term loan subject to approval by applicable lenders. We entered into the credit facility with a syndicate of four banks, with KeyBank, N.A. acting as administrative agent. The credit facility is secured by the assets of DMC including accounts receivable, inventory, and fixed assets, including Arcadia and its subsidiary, as well as guarantees and share pledges by DMC and its subsidiaries.
Borrowings under the $150,000 Term Loan and $50,000 revolving loan limit can be in the form of Adjusted Daily Simple Secured Overnight Financing Rate ("SOFR") loans or one month Adjusted Term SOFR loans. Additionally, U.S. dollar borrowings on the revolving loan can be in the form of Base Rate loans (Base Rate borrowings are based on the greater of the administrative agent’s Prime rate, an adjusted Federal Funds rate or an adjusted SOFR rate). SOFR loans bear interest at the applicable SOFR rate plus an applicable margin (varying from 1.50% to 3.00%). Base Rate loans bear interest at the defined Base Rate plus an applicable margin (varying from 0.50% to 2.00%). As of March 31, 2023, no amounts were outstanding on the revolver.
The credit facility includes various covenants and restrictions, certain of which relate to the payment of dividends or other distributions to stockholders; redemption of capital stock; incurring additional indebtedness; mortgaging, pledging or disposition of major assets; and maintenance of specified ratios.
The leverage ratio is defined in the credit facility as the ratio of Consolidated Funded Indebtedness (as defined in the credit facility) on the last day of any trailing four quarter period to Consolidated Pro Forma EBITDA (as defined in the credit facility) for such period. The maximum leverage ratio permitted by our credit facility is 3.25 to 1.0 through the quarter ended March 31, 2023, and 3.0 to 1.0 from the quarter ended June 30, 2023 and thereafter.
The debt service coverage ratio is defined in the credit facility as the ratio of Consolidated Pro Forma EBITDA less the sum of capital distributions paid in cash (other than those made with respect to preferred stock issued under the Operating Agreement), Consolidated Unfunded Capital Expenditures (as defined in the credit facility), and net cash income taxes to the sum of cash interest expense, any dividends on the preferred stock paid in cash, and scheduled principal payments on funded indebtedness. Under our credit facility, the minimum debt service coverage ratio permitted is 1.35 to 1.0.
As of March 31, 2023, we were in compliance with all financial covenants and other provisions of our debt agreements.
We also maintain a line of credit with a German bank with a borrowing capacity of €7,000 for certain European operations. This line of credit is also used to issue bank guarantees to customers to secure advance payments made by them. As of March 31, 2023 and December 31, 2022, we had no outstanding borrowings under this line of credit and bank guarantees of €2,023 and €2,221, respectively, were secured by the line of credit. The line of credit has open-ended terms and can be canceled by the bank at any time.
Included in “Long-term debt” are deferred debt issuance costs of $2,064 and $2,202 as of March 31, 2023 and December 31, 2022, respectively. Deferred debt issuance costs are being amortized over the remaining term of the credit facility, which expires on December 23, 2026.
8. INCOME TAXES
The effective tax rate for each of the periods reported differs from the U.S. statutory rate primarily due to variation in contribution to consolidated pre-tax income from each jurisdiction for the respective periods, differences between the U.S. and foreign tax rates (which range from 20% to 33%), permanent differences between book and taxable income, and income or loss attributable to the redeemable noncontrolling interest holder.
Arcadia is treated as a partnership for U.S. tax purposes. With the exception of certain state taxes, income or loss flows through to the shareholders and is taxed at the shareholder level. Tax impacts related to income or loss from Arcadia that are included in consolidated pretax results but are attributable to the redeemable noncontrolling interest holder are not included in the consolidated income tax provision.
We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use existing deferred tax assets. Additionally, a three-year cumulative loss at a consolidated financial statement level may be viewed as negative evidence impacting a jurisdiction that by itself is not in a three-year cumulative loss position. During the three months ended March 31, 2023 and March 31, 2022, we did not record any adjustments to previously established valuation allowances, except for corresponding adjustments related to changes in deferred tax asset balances. These adjustments had no impact on the Condensed Consolidated Statements of Operations. The Company will continue to monitor the realizability of deferred tax assets and the need for valuation allowances and will record adjustments in the periods in which facts support such changes.
The Tax Cuts and Jobs Act (“TCJA”) provides that foreign earnings generally can be repatriated to the U.S. without federal tax consequence. We have assessed the assertion that cumulative earnings by our foreign subsidiaries are indefinitely reinvested. We continue to permanently reinvest the earnings of our international subsidiaries and therefore we do not provide for U.S. income taxes or withholding taxes that could result from the distribution of those earnings to the U.S. parent. If any such earnings were ultimately distributed to the U.S. in the form of dividends or otherwise, or if the shares of our international subsidiaries were sold or transferred, we could be subject to additional U.S. federal and state income taxes. Due to the multiple avenues in which earnings can be repatriated, and because a large portion of these earnings are not liquid, it is not practical to estimate the amount of additional taxes that might be payable on these amounts of undistributed foreign income.
9. BUSINESS SEGMENTS
Our business is organized into three segments: Arcadia, DynaEnergetics and NobelClad. In December 2021, DMC acquired a 60% controlling interest in Arcadia. Arcadia supplies architectural building products, including exterior and interior framing systems, curtain walls, windows, doors, and interior partitions to the commercial construction market; it also supplies customized windows and doors to the high-end residential construction market. DynaEnergetics designs, manufactures and distributes highly engineered products utilized by the global oil and gas industry principally for the perforation of oil and gas wells. NobelClad is a leader in the production of explosion-welded clad metal plates for use in the construction of corrosion resistant industrial processing equipment, as well as specialized transition joints for use in construction of commuter rail cars, ships, and liquified natural gas (LNG) processing equipment.
Our reportable segments are separately managed, strategic business units that offer different products and services, and each segment has separate financial information available that is evaluated regularly by the Chief Operating Decision Maker ("CODM") in allocating resources and assessing performance. Each segment’s products are marketed to different customer types and require different manufacturing processes and technologies.
Segment information is as follows:
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| Three months ended March 31, | | |
| 2023 | | 2022 | | | | |
Net sales: | | | | | | | |
Arcadia | $ | 80,338 | | | $ | 67,968 | | | | | |
DynaEnergetics | 81,968 | | | 48,887 | | | | | |
NobelClad | 22,035 | | | 21,861 | | | | | |
Net sales | $ | 184,341 | | | $ | 138,716 | | | | | |
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| Three months ended March 31, | | |
| 2023 | | 2022 | | | | |
Income (loss) before income taxes: | | | | | | | |
Arcadia | $ | 3,133 | | | $ | (2,443) | | | | | |
DynaEnergetics | 13,168 | | | 3,298 | | | | | |
NobelClad | 2,621 | | | 705 | | | | | |
Segment operating income | 18,922 | | | 1,560 | | | | | |
| | | | | | | |
Unallocated corporate expenses | (7,254) | | | (3,368) | | | | | |
Unallocated stock-based compensation* | (4,448) | | | (2,102) | | | | | |
Other expense, net | (200) | | | (209) | | | | | |
Interest expense, net | (2,381) | | | (1,024) | | | | | |
Income (loss) before income taxes | $ | 4,639 | | | $ | (5,143) | | | | | |
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| Three months ended March 31, | | |
| 2023 | | 2022 | | | | |
Depreciation and amortization: | | | | | | | |
Arcadia | $ | 6,469 | | | $ | 13,349 | | | | | |
DynaEnergetics | 1,787 | | | 1,984 | | | | | |
NobelClad | 740 | | | 915 | | | | | |
Segment depreciation and amortization | 8,996 | | | 16,248 | | | | | |
Corporate and other | 71 | | | 87 | | | | | |
Consolidated depreciation and amortization | $ | 9,067 | | | $ | 16,335 | | | | | |
* Stock-based compensation is not allocated to wholly owned segments DynaEnergetics and NobelClad. Stock-based compensation is allocated to the Arcadia segment as 60% of such expense is attributable to the Company, whereas the remaining 40% is attributable to the redeemable noncontrolling interest holder.
In the tables below, net sales for Arcadia have been presented consistent with United States regional definitions as provided by the American Institute of Architects. The geographic distribution of net sales for DynaEnergetics and NobelClad is based on the customer location.
Arcadia
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| Three months ended March 31, | | | | |
| 2023 | | 2022 | | | | |
West | $ | 62,282 | | | $ | 56,204 | | | | | |
South | 8,553 | | | 5,839 | | | | | |
Northeast | 6,853 | | | 3,217 | | | | | |
Midwest | 2,650 | | | 2,708 | | | | | |
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Total Arcadia | $ | 80,338 | | | $ | 67,968 | | | | | |
DynaEnergetics
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| Three months ended March 31, | | |
| 2023 | | 2022 | | | | |
United States | $ | 64,649 | | | $ | 38,743 | | | | | |
Canada | 7,040 | | | 4,749 | | | | | |
United Arab Emirates | 1,788 | | | 1,213 | | | | | |
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Oman | 1,747 | | | 928 | | | | | |
Kuwait | 1,357 | | | 542 | | | | | |
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Indonesia | 704 | | | 342 | | | | | |
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India | 623 | | | 230 | | | | | |
Rest of the world(1) | 4,060 | | | 2,140 | | | | | |
Total DynaEnergetics | $ | 81,968 | | | $ | 48,887 | | | | | |
(1) Rest of the world does not include any individual country comprising sales greater than 2% of total DynaEnergetics revenue.
NobelClad
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| Three months ended March 31, | | |
| 2023 | | 2022 | | | | |
United States | $ | 9,119 | | | $ | 9,155 | | | | | |
China | 2,206 | | | 2,357 | | | | | |
United Arab Emirates | 1,860 | | | 998 | | | | | |
Canada | 1,855 | | | 1,438 | | | | | |
Germany | 1,271 | | | 587 | | | | | |
United Kingdom | 796 | | | 49 | | | | | |
| | | | | | | |
Italy | 671 | | | 413 | | | | | |
France | 558 | | | 351 | | | | | |
Sweden | 497 | | | — | | | | | |
Belgium | 466 | | | 276 | | | | | |
South Africa | 430 | | | 843 | | | | | |
Norway | 365 | | | 234 | | | | | |
Netherlands | 353 | | | 491 | | | | | |
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Spain | 295 | | | 199 | | | | | |
India | 2 | | | 2,325 | | | | | |
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Rest of the world | 1,291 | | | 2,145 | | | | | |
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Total NobelClad | $ | 22,035 | | | $ | 21,861 | | | | | |
(1) Rest of the world does not include any individual country comprising sales greater than 2% of total NobelClad revenue.
During the three months ended March 31, 2023, one DynaEnergetics customer accounted for approximately 10% of consolidated net sales. The same DynaEnergetics customer accounted for approximately 15% of consolidated accounts receivable as of March 31, 2023 and December 31, 2022. During the three months ended March 31, 2022, no single customer accounted for approximately 10% of consolidated net sales.
10. DERIVATIVE INSTRUMENTS
We are exposed to foreign currency exchange risk resulting from fluctuations in exchange rates, primarily the U.S. dollar to the euro, the U.S. dollar to the Canadian dollar and, to a lesser extent, other currencies, arising from intercompany and third-party transactions entered into by our subsidiaries that are denominated in currencies other than their functional currency. Changes in exchange rates with respect to these transactions result in unrealized gains or losses if such transactions are unsettled at the end of the reporting period or realized gains or losses at settlement of the transaction. We use foreign currency forward contracts to offset foreign exchange rate fluctuations on foreign currency denominated asset and liability positions. None of these contracts are designated as accounting hedges, and all changes in the fair value of the forward contracts are recognized in “Other expense, net” within our Condensed Consolidated Statements of Operations.
We execute derivatives with a specialized foreign exchange brokerage firm as well as other large financial institutions. The primary credit risk inherent in derivative agreements is the possibility that a loss may occur from the nonperformance of a counterparty to the agreements. We perform a review of the credit risk of our counterparties at the inception of the contract and on an ongoing basis. We anticipate that our counterparties will be able to fully satisfy their obligations under the agreements but will take action if doubt arises regarding the counterparties’ ability to perform.
As of March 31, 2023 and December 31, 2022, the net notional amounts of the forward contracts the Company held were $28,335 and $21,907, respectively. At March 31, 2023 and December 31, 2022, the fair value of outstanding forward contracts was $0.
The following table presents the location and amount of net gains (losses) from hedging activities, which offset foreign currency gains and losses recorded in the normal course of business that are not presented below, for the periods presented.
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| | Three months ended March 31, | | |
Derivative | Statements of Operations Location | 2023 | | 2022 | | | | |
Foreign currency contracts | Other expense, net | $ | 171 | | | $ | (127) | | | | | |
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11. COMMITMENTS AND CONTINGENCIES
Contingent Liabilities
The Company records an accrual for contingent liabilities when a loss is both probable and reasonably estimable. If some amount within a range of loss appears to be a better estimate than any other amount within the range, that amount is accrued. When no amount within a range of loss appears to be a better estimate than any other amount, the lowest amount in the range is accrued.
Legal Proceedings
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results except as set forth below:
Wage and Hour Matters
Felipe v. Arcadia, Inc. and One Stop Employment Services, Inc. (“One Stop”). This complaint was filed on October 22, 2021 in Los Angeles Superior Court and purports to allege a class action on behalf of all non-exempt California employees who worked on behalf of One Stop or Arcadia at any time during the four years preceding the date of the complaint. One Stop is a staffing agency which provides temporary workers, including to Arcadia. The complaint states claims under California’s labor laws and under its general Unfair Business Practices Act, California Business & Professions Code section 17200. The plaintiff has subsequently dismissed the class action claims without prejudice, acknowledging that Arcadia’s arbitration agreement likely bars such class claims. The plaintiff also filed a separate action under California’s Private Attorneys General Act (“PAGA”) alleging essentially the same wage and hour violations. This action included other Arcadia employees. In Viking River Cruises,
Inc. versus Moriana, the U.S. Supreme Court concluded that arbitration agreements may bar representative PAGA claims. However, Viking River left open certain state law issues, which the California Supreme Court has agreed to address. Currently, Felipe’s PAGA representative claims are stayed, and will likely remain stayed until a California Supreme Court ruling. The plaintiff has however commenced arbitration on individual claims, though no dates have yet been set in that arbitration.
Mayorga v. Arcadia, Inc. This complaint was filed on November 15, 2021 in Los Angeles Superior Court. It purported to allege a class action on behalf of all of the Company’s non-exempt California employees who worked at the Company within four years before the date the complaint was filed. It asserts claims substantially similar to those asserted in the Felipe case but does not include One Stop as a defendant. The plaintiff amended his complaint to delete class action claims and any individual non-PAGA claims. Accordingly, plaintiff’s complaint is now limited to PAGA collective action claims. As in Felipe, those PAGA representative claims are currently stayed and will likely remain stayed until the California Supreme Court addresses the state law issues left open by the U.S. Supreme Court’s decision in Viking River Cruises, Inc. versus Moriana. The plaintiff has however commenced arbitration on a solely individual basis of his wage and hour claims. The arbitral body has appointed an arbitrator to adjudicate those claims and a hearing has been set for 2024. The remaining Mayorga PAGA representative claims have now been assigned to the same judge as the Felipe case.
We have agreed to mediate the Felipe claims in May 2023, and in any settlement arising out of this process, we would intend to resolve the claims in both Mayorga and Felipe to the extent asserted on behalf of other employees.
Arcadia intends to vigorously defend against the Felipe and Mayorga actions. Due to the nature of these matters and inherent uncertainties, it is not possible to provide an evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss, if any. Further, under the Equity Purchase Agreement, certain amounts have been placed in escrow pending resolution of these matters.
12. CHIEF EXECUTIVE OFFICER TRANSITION
During the first quarter of 2023, the Company and its former CEO entered into a separation agreement pursuant to which the former CEO received certain severance benefits consistent with his pre-existing employment agreement with the Company. These severance benefits include 18 months of salary, a lump sum cash payment, and accelerated vesting of outstanding equity awards. During the three months ended March 31, 2023, the Company recognized $1,621 of severance related expense and $3,040 of stock-based compensation expense related to the accelerated vesting of outstanding equity awards. These expenses were recognized in “General and administrative expenses” in the Condensed Consolidated Statements of Operations.