September 9, 2005
United States Securities and Exchange Commission
Division of Corporation Finance
Washington. D.C. 20549-0510
Re: Dynamic Materials
Form 10-K for the year ended December 31, 2004
File No. 1-14775
Dear Mr. Cash:
We acknowledge receipt of your letter dated July 27, 2005, which included
additional comments that resulted from your review of our June 17, 2005 response
to the your initial May 4, 2005 comment letter relating to your review of the
above-referenced filing. We have carefully considered your additional comments
and provide you with the following revised response.
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2004
Financial Statements for the Year Ended December 31, 2004
Note 8 - Discontinued Operations, page 53
1. We note your response to comment 8 from our letter dated May 4, 2005.
Please refer to paragraph 42 of SFAS 144, which indicates that the
classification a component of an entity as discontinued operations is
only appropriate if that component has been disposed of or is
classified as held for sale, and if it meets the additional criteria
of having its operations and cash flows eliminated from your ongoing
operations and you have no significant continuing involvement in the
operations of the component. Please provide us with the following
additional information to help us understand how you have met the
criteria of this paragraph:
o It does not appear that you have disposed of your Spin Forge
Division since you retain the majority of the assets on your
books, and you are receiving rental income for leasing or
subleasing those assets to a third party. If you believe that
your lease and sublease of these assets constitutes a sale please
tell us the accounting guidance that you relied upon to make that
determination and provide us with any applicable analysis of how
you meet the criteria of such guidance. Specifically address in
your analysis the fact that the term of the lease for Spin
Forge's manufacturing equipment and tooling is less than three
years.
o We note that your sublease agreement with Aerojet offered them
the option to purchase your bargain purchase option on Spin
Forge's land. We further note that Aerojet's option expired on
August 1, 2005. Please tell us if Aerojet exercised this option.
If they did not exercise the option, please address your
retention of the bargain purchase option in an analysis that
supports your belief that you have disposed of Spin Forge's
assets.
o If you believe that your lease and sublease of Spin Forge's
assets meet the criteria of paragraph 30 of SFAS 144 to be held
for sale, please provide us with a detailed analysis of how these
leases meet each of the criteria. You should specifically address
the impact of the multiple-year lease terms on the criteria of
this paragraph.
o If you can demonstrate that Spin Forge's assets have either been
disposed of or can be classified as held for sale, then please
provide us with a detailed analysis of how this transaction meets
the criteria of paragraph 42(a) and 42(b). In this regard, we
note that you will continue to receive income from Spin Forge's
operations in the form of rental payments, and we note that you
retain legal title to the manufacturing equipment used by this
business.
Company Response
----------------
DMC acquired the Spin Forge manufacturing business in March of 1998.
At the time, Spin Forge was involved in two major defense programs,
the ATACM and Hawk missile motor case programs, and a third program
relating to the manufacture of titanium pressurant tanks for Boeing
launch vehicles. With all of these programs operating at normal volume
levels, Spin Forge generated good operating income and cash flow
during 1998 and 1999. However, significant volume cutbacks in the
Boeing tank and Hawk motor case programs beginning in 2000, and the
discontinuance of production of Boeing tanks in 2003 and Hawk motor
cases in 2004, resulted in Spin Forge reporting significant operating
losses during fiscal years 2000 through 2004. Of the three major
programs, only the ATACM program, with Aerojet as the customer, was
active at the time that we made a decision to divest of the Spin Forge
business in mid-2004. As stated in our initial response letter, if the
Company had not consummated the sale to Aerojet, Company management
and its Board of Directors was committed to the orderly shutdown of
the Spin Forge business operations.
Under an orderly shutdown scenario, DMC would have exercised its
option on the real estate and then sold the real estate to a third
party. We believe that such an orderly shutdown would have been
completed within approximately one year. However, continuation of the
ATACM program with minimal disruption was of critical importance to
Aerojet and its customer. Thus, Aerojet agreed to purchase the
business from DMC under the condition that DMC structure the
transaction with attractive financing terms. DMC was willing to
provide such financing to Aerojet because it believed that doing so
would result in the maximum recovery of the Company's investment in
Spin Forge operating assets, which were
comprised principally of work-in process inventories for the ATACM and
Hawk programs and manufacturing equipment and tooling.
As stated in our initial response letter of June 17, 2005, we believe
that the Spin Forge operating business rather than the manufacturing
equipment and tooling constitutes the long-lived asset or disposal
group. Perhaps the most critical assets of the Spin Forge business
(please refer to Exhibit A to this letter for excerpts from EITF 98-3
regarding the definition of a business), and those for which we
received no direct purchase price consideration, are the three
customer programs mentioned in the first paragraph of this response
and the technical knowledge and experience of the Spin Forge employees
with respect to the production requirements of these programs. All
Spin Forge employees became employees of Aerojet on the acquisition
date. The Spin Forge real estate option and sublease are not
considered material strategic assets of the Spin Forge operating
business as further discussed below. Accordingly, we applied the six
criteria of paragraph 30 of SFAS 144 to the Spin Forge business taken
as a whole and not to the equipment lease or sublease individually. We
believe that our initial response demonstrated that the Spin Forge
divestiture transaction met these six criteria and we continue to
believe this to be the case. We also believe that, when one views the
Spin Forge operating business as the long-lived asset or disposal
group, the Spin Forge operations are properly presented as
discontinued operations since we have effectively eliminated its
operations and cash flows from our ongoing operations and have no
significant continuing involvement in the operations of Spin Forge. We
have no day-to-day control over the operating assets of the business
and have no interaction with or the ability to influence customers,
suppliers and employees.
Strong support for our position to report Spin Forge as discontinued
operations can be found in EITF 3-13, which specifically addresses how
the conditions of paragraph 42 of SFAS 144 should be applied in
determining whether to report discontinued operations. EITF 3-13
contains a detailed discussion of two issues:
Issue 1 - How an ongoing entity should evaluate whether the
operations and cash flows of a disposed component have been or
will be eliminated from the ongoing operations of the entity; and
Issue 2- The types of continuing involvement that constitute
significant continuing involvement in the operations of the
disposed segment.
After reviewing the discussion of the foregoing issues and related
examples that are contained in EITF 3-13 and applying them to the Spin
Forge divestment transaction, we believe that the Spin Forge
transaction clearly satisfies guidance provided in EITF 3-13.
Specifically, with respect to Issue 1, EITF 3-13 paragraph 4 states
that "if all continuing cash flows are indirect, the cash flows are
considered to be eliminated and the component meets the paragraph 42a
criterion to be considered a discontinued operation". The only
remaining cash flows that DMC has with
respect to Spin Forge are the payments made and received under the
real estate lease, sublease and the equipment lease. These cash flows
are clearly indirect as they do not constitute the "revenue-producing"
or "cost-generating" activities of the Spin Forge operations. For
Issue 2, EITF 03-13 paragraph 9 indicates that "continuing involvement
in the operations of the disposed component provides the ongoing
entity with the ability to influence the operating and (or) financial
policies of the disposed component". Since DMC has no ability to
influence the Spin Forge operations, it is clear that it does not have
continuing involvement in the operations of Spin Forge as defined by
EITF 03-13. We also refer you to Exhibit A to this letter for excerpts
from Appendix A to SFAS 144 for examples that we believe further
support our position of accounting for Spin Forge as discontinued
operations.
Aerojet's option to acquire DMC's bargain purchase option on the Spin
Forge real estate was covered under the terms of a separate option
agreement between Aerojet and DMC. The terms of the option required
(a) the two parties to negotiate in good faith to reach agreement upon
the type and amount of the purchase consideration no later than
December 15, 2004 and (b) Aerojet to exercise its option on or before
August 1, 2005. If either of criteria was not satisfied by the
specified dates, the option agreement was to automatically terminate.
While the terms of the option agreement, sublease and equipment lease
were negotiated under the assumption that Aerojet would likely
exercise the option of the real estate, Aerojet made no effort to
negotiate the type and amount of purchase consideration prior to the
December 15 deadline. Consequently, the option agreement has been
terminated and DMC has engaged the services of a commercial real
estate broker to assist us in the marketing and sale of the Spin Forge
real estate. However, because the Aerojet sublease does not expire
until January 1, 2007, the terms of the option agreement between DMC
and the property owner were revised on the September 17, 2004 closing
of the Spin Forge divestiture transaction such that DMC cannot
exercise its option and close on the sale of the real estate to a
third party until the November 1, 2006 through January 31, 2007 time
period. Since DMC first made a decision to divest of the Spin Forge
business, it has been and remains our intent to either transfer our
real estate option to a third party or to exercise our bargain
purchase option at the earliest possible date and simultaneously sell
the real estate.
In your additional comments, you make the statement that "it does not
appear that you have disposed of your Spin Forge Division since you
retain the majority of the assets on your books". In making this
statement, the capital lease asset relating to the Spin Forge real
estate in the amount of $2,880,000 is included in the asset base. As
disclosed in Note 8, during 2004 the Company determined that the
accounting treatment of the Spin Forge real estate lease, which had
been accounted for as an operating lease since the inception of the
lease in March of 1998, should have been changed to capital lease
accounting in 2003 due to an increase in the value of the underlying
property which made the Company's purchase option a bargain purchase
option. Accordingly, we restated our
December 31, 2003 consolidated balance sheet to add a capital lease
asset of $2,880,000 and an offsetting capital lease obligation of the
same amount under assets of discontinued operations and liabilities of
discontinued operations, respectively. Thus, the net asset value of
the real estate is zero. It is important to note that the real estate
appraisal that we relied upon in determining that we held a bargain
purchase option determined that the highest and best use of the Spin
Forge property was as land held for redevelopment. The asset that DMC
holds is an option to purchase the real estate, not the real estate
itself, whose value can only be realized when the Spin Forge property
is vacated. We do not yet know the market value of our real estate
option, but the carrying value on our books is zero. We do not
consider the real estate option, lease and sublease to be material
operating assets of the Spin Forge business.
With respect to the equipment lease, we continue to view the lease as
a financing transaction. In order to continue future production on the
three principal Spin Forge programs, Aerojet will be required to
either purchase the leased manufacturing equipment and tooling or
replace the equipment and tooling. Aerojet has recently expressed an
interest in acquiring a major portion of the Spin Forge equipment and
tooling from DMC and has asked us if we are willing to finance such a
purchase. At the time that we sold the Spin Forge business to Aerojet
and entered into the lease agreement, we believed that Aerojet would
either (1) purchase all of the lease equipment and tooling as they
would be required to do if they exercised the real estate option, (2)
extend the lease for a full eight years allowing DMC to recover the
full value of its investment over this time period, or (3) purchase
the majority of the equipment and tooling and relocate such purchased
equipment to a new location. It is important to note that Aerojet is
responsible for all maintenance, taxes, insurance and other operating
costs of the leased assets and must replace any equipment and tooling
that should become inoperable or otherwise obsolete. To the extent
that Aerojet does not purchase any or certain of the leased assets,
DMC's plans would be to immediately liquidate such assets. DMC has no
intent or ability to operate any of the leased assets. In summary,
while formal title has not yet been transferred, it is our view that
Aerojet and not DMC is in control of the leased equipment and tooling,
as we have no right to control those assets so long as Aerojet makes
its payments to us. Accordingly, in recording the loss on the Spin
Forge sale, we recorded an impairment loss of $1,015,000 ($619,000,
net of tax) in our December 31, 2004 financial statements based upon
the difference between the then current carrying value of the
equipment and its estimated fair value, calculated as the present
value of the future minimum equipment lease payments from Aerojet plus
estimated liquidation proceeds at the end of the minimum lease term.
In summary, we believe that we have effectively eliminated the
operations and cash flows of Spin Forge from the ongoing operations of
the Company and that we have no significant continuing involvement in
the operations of the Spin Forge business as required by paragraph
42(a) and 42(b) of SFAS 144. Additionally, from a practical
standpoint, we view the financial statement presentation of the
divestiture of our Spin Forge Division as discontinued operations to
result in the most transparent and informative disclosures relative to
the Company's continuing operations. Inclusion of Spin Forge in DMC's
continuing operations would distort the true performance and trends of
our continuing operations by exaggerating the improvement in
operations from 2004 to 2005 and potentially mislead readers of our
historical and future consolidated financial statements.
* * *
We hope that our responses adequately address the additional comments
that you raised in your July 27, 2005 letter. Please let us know if
you require additional clarification with respect to our responses or
have any additional questions.
Sincerely,
Richard A. Santa
Vice President and Chief Financial Officer
EXHIBIT A
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Excerpt from Ernst & Young LLP Summary on FAS 141 - (shows that under EITF
98-3, Spin Forge constitutes a business, and DMC no longer controls any
aspects of this business)
What is a Business?
Statement 141 refers to EITF 98-3 for the definition of a business. EITF
98-3 defines a business as a self-sustaining integrated set of activities
and assets conducted and managed for the purpose of providing a return to
investors. A business consists of (a) inputs, (b) processes applied to
those inputs, and (c) resulting outputs that are used to generate revenues.
EITF 98-3 refers to these as "elements" of the set of activities and
assets. For an acquired set of activities and assets to be a business, it
must contain all of the inputs and processes necessary for it to continue
to conduct normal operations after the acquired set is separated from the
seller, including the ability to sustain a revenue stream by providing its
outputs to customers.
Determining whether an acquired set of assets and activities is a business
is a three-step process. These steps include:
1. Identify the elements included in the acquired set.
2. Compare the identified elements in the acquired set to the complete set
of elements necessary for the acquired set to conduct normal operations in
order to identify any missing elements.
3. Make an assessment as to whether the missing elements are significant
enough to conclude that the acquired set is not a business. The elements
necessary for an acquired set to continue to conduct normal operations will
vary by industry and by the operating strategies of the acquired set. An
evaluation of the necessary elements should consider:
1. Inputs:
a. Long-lived assets, including intangible assets, or rights to the use of
long-lived assets.
b. Intellectual property.
c. The ability to obtain access to necessary materials or rights.
d. Employees.
2. Processes: The existence of systems, standards, protocols, conventions,
and rules that act to define the processes necessary for normal,
self-sustaining operations, such as strategic management processes,
operational processes, and resource management processes.
3. Outputs: The ability to obtain access to the customers that purchase the
outputs of the acquired set.
Excerpt from SFAS 144 Appendix A - examples 12 and 13:
------------------------------------------------------
Example 12
FAS144, Par. A25
A25. An entity that manufactures and sells consumer products has several
product groups, each with different product lines and brands. For that
entity, a product group is the lowest level at which the operations and
cash flows can be clearly distinguished, operationally and for financial
reporting purposes, from the rest of the entity. Therefore, each product
group is a component of the entity.
FAS144, Par. A26
A26. The entity has experienced losses associated with certain brands in
its beauty care products group.
a. The entity decides to exit the beauty care business and commits to a
plan to sell the product group with its operations. The product group is
classified as held for sale at that date. The operations and cash flows of
the product group will be eliminated from the ongoing operations of the
entity as a result of the sale transaction, and the entity will not have
any continuing involvement in the operations of the product group after it
is sold. In that situation, the conditions in paragraph 42 for reporting in
discontinued operations the operations of the product group while it is
classified as held for sale would be met.
b. The entity decides to remain in the beauty care business but will
discontinue the brands with which the losses are associated. Because the
brands are part of a larger cash-flow-generating product group and, in the
aggregate, do not represent a group that on its own is a component of the
entity, the conditions in paragraph 42 for reporting in discontinued
operations the losses associated with the brands that are discontinued
would not be met.
Example 13
FAS144, Par. A27
A27. An entity that is a franchiser in the quick-service restaurant
business also operates company-owned restaurants. For that entity, an
individual company-owned restaurant is the lowest level at which the
operations and cash flows can be clearly distinguished, operationally and
for financial reporting purposes, from the rest of the entity. Therefore,
each company-owned restaurant is a component of the entity.
a. The entity has experienced losses on its company-owned restaurants in
one region. The entity decides to exit the quick-service restaurant
business in that region and commits to a plan to sell the restaurants in
that region. The restaurants are classified as held for sale at that date.
The operations and cash flows of the restaurants in that region will be
eliminated from the ongoing operations of the entity as a result of the
sale transaction, and the entity will not have any
continuing involvement in the operations of the restaurants after they are
sold. In that situation, the conditions in paragraph 42 for reporting in
discontinued operations the operations of the restaurants while they are
classified as held for sale would be met.
b. Based on its evaluation of the ownership mix of its system-wide
restaurants in certain markets, the entity commits to a plan to sell its
company-owned restaurants in one region to an existing franchisee. The
restaurants are classified as held for sale at that date. Although each
company-owned restaurant, on its own, is a component of the entity, through
the franchise agreement, the entity will (1) receive franchise fees
determined, in part, based on the future revenues of the restaurants and
(2) have significant continuing involvement in the operations of the
restaurants after they are sold. In that situation, the conditions in
paragraph 42 for reporting in discontinued operations the operations of the
restaurants would not be met.