ITEM 1.                          Financial Statements

 

 

 

1.                                     Description of Business and Basis of Presentation

 

 

Mistras Group, Inc. and subsidiaries ("the Company") is a leading “one source” global provider of technology-enabled asset protection solutions used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure. The Company combines industry-leading products and technologies, expertise in mechanical integrity (MI) and non-destructive testing (NDT) services and proprietary data analysis software to deliver a comprehensive portfolio of customized solutions, ranging from routine inspections to complex, plant-wide asset integrity assessments and management. These mission critical solutions enhance customers’ ability to extend the useful life of their assets, increase productivity, minimize repair costs, comply with governmental safety and environmental regulations, manage risk and avoid catastrophic disasters. The Company serves a global customer base of companies with asset-intensive infrastructure, including companies in the oil and gas, fossil and nuclear power, alternative and renewable energy, public infrastructure, chemicals, commercial aerospace and defense, transportation, primary metals and metalworking, pharmaceutical/biotechnology and food processing industries and research and engineering institutions.

 

 

The condensed consolidated financial statements contained in this report are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the results for the interim periods of the fiscal years ending MayDecember 31, 2017 and 2016. Reference to a fiscal year means the fiscal year ended May 31. Certain items included in these statements are based on management’s estimates. Actual results may differ from those estimates. The results of operations for any interim period are not necessarily indicative of the results expected for the year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to the audited consolidated financial statements contained in the Company’s AnnualTransition Report on Form 10-K (“2016 AnnualTransition Report”) for fiscalthe transition period ended December 31, 2016, as filed with the Securities and Exchange Commission on August 15, 2016.March 20, 2017.

 

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Mistras Group, Inc. and its wholly and majority-owned subsidiaries. For subsidiaries in which the Company’s ownership interest is less than 100%, the noncontrolling interests are reported in stockholders’ equity in the accompanying condensed consolidated balance sheets. The noncontrolling interests in net income, net of tax, is classified separately in the accompanying condensed consolidated statements of income.

On January 3, 2017, the Company's Board of Directors approved a change in the Company's fiscal yearsyear end onfrom May 31 exceptto December 31, effective December 31, 2016. The transition period was for the subsidiaries in seven months ended December 31, 2016 ("the transition period"). Prior to this change, the Company's International segment which end on April 30. Accordingly, the Company’s International segment subsidiaries arewas consolidated on a one month lag. Therefore, infor this interim report, the quarter and year of acquisition, results of acquired subsidiaries incondensed consolidated income statement includes a one month lag for the International segment are generally included in consolidated results for one less month than the actual number ofthree months from the acquisition date to the end of the reporting period.ended March 31, 2016. Management does not believe that any events occurred during the one-month lag period that would have a material effect on the Company’s condensed consolidated financial statements. The one month lag was removed with the change in the Company's fiscal year noted above, and accordingly, the condensed consolidated income statement does not include a one month lag for the International segment's results for the three months ended March 31, 2017.

Certain amounts in prior periods have been reclassified to conform to the current year presentation. Such reclassifications did not have a material effect on the Company's financial condition or results of operations as previously reported.

One customer accounted for approximately 14%11% of our revenues and 13%9% of accounts receivable in the first quarter of fiscal 2017, which primarily were generated from the Services segment. NoOne customer accounted for 10% or more of our revenues or accounts receivable in the first quarter of fiscal 2016.

 

The Company has share-based incentive awards outstanding to its eligible employees and non-employee directors under three equity incentive plans: (i) the 2007 Stock Option Plan (the 2007 Plan), (ii) the 2009 Long-Term Incentive Plan (the 2009 Plan) and (iii) the 2016 Long-Term Incentive Plan. No further awards may be granted under the 2007 and 2009 Plans, although awards granted under the 2007 and 2009 Plans remain outstanding in accordance with their terms. Awards granted under the 20092016 Plan may be in the form of stock options, restricted stock units and other forms of share-based incentives, including performance restricted stock units, stock appreciation rights and deferred stock rights.

 

 

For the three months ended AugustMarch 31, 2016,2017, the Company did not recognize any share-based compensation expense related to stock option awards. No unrecognized compensation costs remained related to stock option awards as of AugustMarch 31, 2016.2017.

For the three months ended AugustMarch 31, 2015,2016, the Company recognized share-based compensation expense related to stock option awards of less than $0.1 million.

 

No stock options were granted during the three months ended AugustMarch 31, 20162017 and AugustMarch 31, 2015.2016.

A summary of the stock option activity, weighted average exercise prices and options outstanding as of AugustMarch 31, 20162017 and 20152016 is as follows:

 

 

For both the three months ended AugustMarch 31, 20162017 and AugustMarch 31, 2015,2016, the Company recognized share-based compensation expense related to restricted stock unit awards of $1.1 million. As of AugustMarch 31, 2016,2017, there was $11.2$8.3 million of unrecognized

compensation costs, net of estimated forfeitures, related to restricted stock unit awards, which are expected to be recognized over a remaining weighted average period of 2.92.5 years.

 

During the first three months of fiscal 2017 and 2016, the Company granted approximately 10,0009,000 and 15,00012,000 shares, respectively, of fully-vested common stock to its five non-employee directors, in connection with its non-employee director compensation plan. These shares had grant date fair values of $0.3$0.2 million and $0.2$0.3 million, respectively, which was recorded as share-based compensation expense during the three months ended AugustMarch 31, 20162017 and AugustMarch 31, 2015,2016, respectively.

 

During the first three months of fiscal 2017 and 2016, approximately 175,000 and 205,0005,000 restricted stock units respectively, vested.vested for each period. The fair value of these units was $4.4$0.1 million and $3.2 million, respectively.for each respective period. Upon vesting, restricted stock units are generally net share-settled to cover the required minimum withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.

A summary of the Company's outstanding, nonvested restricted share units is presented below:

The Company maintains Performance Restricted Stock Units (PRSUs) that have been granted to select executives and senior officers whose ultimate payout is based on the Company’s performance over a one-year period based on three metrics, as defined: (1) Operating Income, (2) Adjusted EBITDAS individual performance and (3) Revenue. There is a discretionary portion of the PRSUs based on individual performance, at the discretion of the Compensation Committee (Discretionary PRSUs). PRSUs and Discretionary PRSUs generally vest ratably on each of the first four anniversary dates upon completion of the performance period, for a total requisite service period of up to five years and have no dividend rights.

During the three months ended AugustMarch 31, 2017, the Compensation Committee modified the awards issued during the transition period ended December 31, 2016 from a one year performance period to a seven month performance period to align the awards with the change in the Company's fiscal year from May 31 to December 31. Accordingly, for the three months ended March 31, 2017, the Compensation Committee approved an additional 19,000 units pertaining to the 2016 Discretionary PRSUs. There was no adjustment to the fiscalthese transition period PRSU's, which resulted in a reduction of approximately 3,000 units.

As of March 31, 2017, awards duringall PRSU's were classified as equity.

 

3.                                     Earnings per Share

 

Basic earnings per share is computed by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the sum of (1) the weighted-average number of shares of common stock outstanding during the period, and (2) the dilutive effect of assumed conversion of equity awards using the treasury stock method. With respect to the number of weighted-average shares outstanding (denominator), diluted shares reflects: (i) the exercise of options to acquire common stock to the extent that the options’ exercise prices are less than the average market price of common shares during the period and (ii) the pro forma vesting of restricted stock units.

 

The following table sets forth the computations of basic and diluted earnings per share:

 

4.                                     Acquisitions

InDuring the first three months of fiscalended March 31, 2017, the Company completed two acquisitions. The Company purchased two companiesone acquisition of a company located in Canadathe U.S. that provideprovides NDT, chemical and special processing services.

In these acquisitions,this acquisition, the Company acquired 100%assets of the common stock of both acquireesacquiree in exchange for aggregate consideration of $1.2$4.5 million in cash, $0.3 million of notes payable and contingent consideration estimatedup to be $0.4$3.5 million to be earned based upon the acquired businessesbusiness achieving specific performance metrics over theirthe initial three years of operations from theirthe acquisition dates.date. The Company accounted for these transactionsthis transaction in accordance with the acquisition method of accounting for business combinations.

The Company is continuing its review of the fair value estimate of assets acquired and liabilities assumed for three entities acquired in the transition period ended December 31, 2016. This process will conclude as soon as the Company finalizes information regarding facts and circumstances that existed as of the acquisition date. Goodwill and intangibles for these three entities totaled $4.1 million and $3.4 million, respectively. This measurement period will not exceed one year from their respective acquisition dates.

The assets and liabilities of the businessesbusiness acquired in fiscal 2017 were included in the Company's condensed consolidated balance sheet based upon their estimated fair valuesvalue on the date of acquisition as determined in a preliminary purchase price allocation, using available information and making assumptions management believes are reasonable. The Company is still in the process of completing its valuation of the assets, both tangible and intangible and liabilities acquired. The results of operations for these acquisitionsthis acquisition are included in the Services segment's results from the date of acquisition. The goodwill of $3.3 million primarily relates to expected synergies and assembled workforce and is generally deductible for tax purposes.

The Company's preliminary purchase price allocations are included in the table below, summarizing the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

Revenues and operating income included in the condensed consolidated statement of operations for fiscal 2017 from these acquisitionsthis acquisition for the period subsequent to the closing of these transactions werethis transaction was approximately $0.4$0.3 million and $0.1 million, respectively. As these acquisitions are not significantthis acquisition was immaterial to the Company's 2017 results, no unaudited pro forma financial information has been included in this report.

TheDuring the three months ended March 31, 2016, the Company did not complete any acquisitions in the first three months of fiscal 2016.

In the course of its acquisition activities, the Company incurs costs in income from operationsconnection with due diligence, professional fees, and other expenses. Additionally, the Company adjusts the fair value of $(0.4) million and $0.9 million, for the three month periods ended August 31, 2016 and 2015, respectively. The Company’s aggregate acquisition-related contingent consideration liabilities were $2.0 million and $2.1 million as of August 31, 2016 and May 31, 2016, respectively.

5.                                     Accounts Receivable, net

 

Accounts receivable consisted of the following:

 

 

6.                                     Property, Plant and Equipment, net

 

Property, plant and equipment consisted of the following:

 

Depreciation expense for the three months ended AugustMarch 31, 2017 and March 31, 2016 and August 31, 2015 was $5.8$5.5 million and $5.6 million, respectively.

 

 

Changes in the carrying amount of goodwill by segment is shown below:

 

The Company reviews goodwill for impairment on a reporting unit basis on MarchOctober 1 of each year and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. As of AugustMarch 31, 2016,2017, the Company did not identify any changes in circumstances that would indicate the carrying value of goodwill may not be recoverable.

The Company's cumulative goodwill impairment as of AugustMarch 31, 2016, May2017 and December 31, 2016 and May 31, 2015 was $9.9 million, which is within its International segment.

8.                                     Intangible Assets

 

The gross amount, accumulated amortization and net carrying amount of intangible assets were as follows:

 

 

Amortization expense for the three months ended AugustMarch 31, 20162017 and AugustMarch 31, 20152016 was $2.2 million and $2.4 million, respectively.

 

9.                                     Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consisted of the following:

 

 

 

On October 31, 2014, the Company entered into a Third Amendment and Modification Agreement of its revolving line of credit, the Third Amended and Restated Credit Agreement (“Credit Agreement”), dated December 21, 2011, with its lending group. The Credit Agreement provides the Company with a $175.0 million revolving line of credit, which, under certain circumstances, the line of credit can be increased to $225.0 million. The Company may borrow up to $30.0 million in non-U.S. Dollar currencies and use up to $10.0 million of the credit limit for the issuance of letters of credit. The Credit Agreement has a maturity date of October 30, 2019. As of AugustMarch 31, 2016,2017, the Company had borrowings of $64.8$93.0 million and a total of $5.2$5.7 million of letters of credit outstanding under the Credit Agreement.

 

Loans under the Credit Agreement bear interest at LIBOR plus an applicable LIBOR margin ranging from 1% to 1.75%, or a base rate less a margin of 1.25% to 0.375%, at the option of the Company, based upon the Company’s Funded Debt Leverage Ratio. Funded Debt Leverage Ratio is generallydefined as the ratio of (1) all outstanding indebtedness for borrowed money and other interest-bearing indebtedness as of the date of determination to (2) EBITDA (which is (a) net income, less (b) income (or plus loss) from discontinued operations and extraordinary items, plus (c) income tax expenses, plus (d) interest expense, plus (e) depreciation, depletion, and amortization (including non-cash loss on retirement of assets), plus (f) stock compensation expense, less (g) cash expense related to stock compensation, plus or minus certain other adjustments) for the period of four consecutive fiscal quarters immediately preceding the date of determination. The Company has the benefit of the lowest margin if its Funded Debt Leverage Ratio is equal to or less than 0.5 to 1, and the margin increases as the ratio increases, to the maximum margin if the ratio is greater than 2.0 to 1. The Company will also bear additional costs for market disruption, regulatory changes effecting the lenders’ funding costs, and default pricing of an additional 2% interest rate margin on any amounts not paid when due. Amounts borrowed under the Credit Agreement are secured by liens on substantially all of the assets of the Company.

 

The Credit Agreement contains financial covenants requiring that the Company maintain a Funded Debt Leverage Ratio of no greater than 3.25 to 1 and an Interest Coverage Ratio of at least 3.0 to 1. Interest Coverage Ratio meansis defined as the ratio, as of any date of determination, of (a) EBITDA for the 12 month period immediately preceding the date of determination, to (b) all interest, premium payments, debt discount, fees, charges and related expenses of the Company and its subsidiaries in connection with borrowed money (including capitalized interest) or in connection with the deferred purchase price of assets, in each case to the extent treated as interest in accordance with GAAP, paid during the 12 month period immediately preceding the date of determination. The Credit Agreement also limits the Company’s ability to, among other things, create liens, make investments, incur more indebtedness, merge or consolidate, make dispositions of property, pay dividends and make distributions to stockholders, enter into a new line of business, enter into transactions with affiliates and enter into burdensome agreements. The Credit Agreement does not limit the Company’s ability to acquire other businesses or companies except that the acquired business or company must be in the Company's line of business, the Company must be in compliance with the financial covenants on a pro forma basis after taking into account the acquisition, and, if the acquired business is a separate subsidiary, in certain circumstances the lenders will receive the benefit of a guaranty of the subsidiary and liens on its assets and a pledge of its stock.

 

As of AugustMarch 31, 2016,2017, the Company was in compliance with the terms of the Credit Agreement, and will continuously monitor its compliance with the covenants contained in its credit agreement.Credit Agreement.

In connection with certain of its acquisitions, the Company issued subordinated notes payable to the sellers. The maturity of the notes that remain outstanding are three years from the date of acquisition and bear interest at the prime rate for the Bank of Canada, currently 2.7% as of AugustMarch 31, 2016.2017. Interest expense is recorded in the condensed consolidated statements of income.

 

11.                              Fair Value Measurements

 

transfer a liability in an orderly transaction between market participants at the measurement date. It also establishes a three level hierarchy that prioritizes the inputs used to measure fair value. The three levels of the hierarchy are defined as follows:

The fair value of contingent consideration liabilities that was classified as Level 3 in the table above was estimated using a discounted cash flow technique with significant inputs that are not observable in the market and thus represents a Level 3 fair value measurement as defined in ASC 820. The significant inputs in the Level 3 measurement not supported by market activity include the probability assessments of expected future cash flows related to the acquisitions, appropriately discounted considering the uncertainties associated with the obligation, and as calculated in accordance with the terms of the applicable acquisition agreements.

 

12.                              Commitments and Contingencies

 

 

The Company is subject to periodic lawsuits, investigations and claims that arise in the ordinary course of business. The Company cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against it. Except possibly for certain of the matters described below, the Company does not believe that any currently pending legal proceeding to which the Company is a party will have a material adverse effect on its business, results of operations, cash flows or financial condition. The costs of defense and amounts that may be recovered against the Company may be covered by insurance for certain matters.

 

quality defects of the Company’s radiography images. No lawsuit has been filed at this time, but the Company received a demand forThe complaint alleges damages of approximately $6 million.  The Company is currently unable to determine the likely outcome or reasonably estimate the amount or range of potential liability related to this matter after consideration of its insurance coverage, and accordingly, has not established any reserves for this matter.

 

 

13.                              Segment Disclosure

 

The Company’s three operating segments are:

Costs incurred for general corporate services, including finance, legal, and certain other costs that are provided to the segments are reported within Corporate and eliminations. Sales to the International segment from the Products and Systems segment and subsequent sales by the International segment of the same items are recorded and reflected in the operating performance of both segments. Additionally, engineering charges and royalty fees charged to the Services and International segments by the Products and Systems segment are reflected in the operating performance of each segment. All such intersegment transactions are eliminated in the Company’s consolidated financial reporting.

 

Selected consolidated financial information by segment for the periods shown was as follows (intercompany transactions are eliminated in Corporate and eliminations):

 

 

 

Income (loss) by operating segment includes intercompany transactions, which are eliminated in Corporate and eliminations.

 

Revenues by geographic area for the three months ended AugustMarch 31, 20162017 and 2015,2016, respectively, were as follows:

 

ITEM 2.                                               Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following Management’s Discussion and Analysis (“MD&A”) includes a narrative explanation and analysis of our results of operations and financial condition for the three months ended AugustMarch 31, 20162017 and AugustMarch 31, 2015.2016. The MD&A should be read together with our condensed consolidated financial statements and related notes included in Item 1 in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes included in our AnnualTransition Report on Form 10-K for fiscalthe transition period ended December 31, 2016, filed August 15, 2016March 20, 2017 (“2016 AnnualTransition Report”). In this quarterly report, our fiscal years, which end on May 31, are identified according to the calendar year in which they end (e.g., the fiscal year ending May 31, 2017 is referred to as “fiscal 2017”), and unlessUnless otherwise specified or the context otherwise requires, “Mistras,” “the Company,” “we,” “us” and “our” refer to Mistras Group, Inc. and its consolidated subsidiaries. The MD&A includes disclosure in the following areas:

 

 

 

This 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 (“Exchange Act”). Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.

 

In some cases, you can identify forward-looking statements by terminology, such as “goals,” or “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “could,” “should,” “would,” “predicts,” “appears,” “projects,” or the negative of such terms or other similar expressions. You are urged not to place undue reliance on any such forward-looking statements, any of which may turn out to be wrong due to inaccurate assumptions, various risks, uncertainties or other factors known and unknown. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed in the “Business—Forward-Looking Statements,” and “Risk Factors” sections of our 2016 AnnualTransition Report as well as those discussed in our other filings with the Securities and Exchange Commission (“SEC”).

 

 

We offer our customers “one source for asset protection solutions”® and are a leading global provider of technology-enabled asset protection solutions used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure. We combine industry-leading products and technologies, expertise in mechanical integrity (MI), Non-Destructive Testing (NDT), Destructive Testing (DT) and predictive maintenance (PdM) services, process and fixed asset engineering and consulting services, proprietary data analysis and our world class enterprise inspection database management

and analysis software, PCMS, to deliver a comprehensive portfolio of customized solutions, ranging from routine inspections to complex, plant-wide asset integrity management and assessments. These mission critical solutions enhance our customers’ ability to comply with governmental safety and environmental regulations, extend the useful life of their assets, increase productivity, minimize repair costs, manage risk and avoid catastrophic disasters. Our operations consist of three reportable segments: Services, International and Products and Systems.

 

 

 

Given the role our solutions play in ensuring the safe and efficient operation of infrastructure, we provide a majority of our services to our customers on a regular, recurring basis. We serve a global customer base of companies with asset-intensive infrastructure, including companies in the oil and gas (downstream, midstream, upstream and petrochemical), power generation (natural gas, fossil, nuclear, alternative, renewable, and transmission and distribution), public infrastructure, chemicals, commercial aerospace and defense, transportation, primary metals and metalworking, pharmaceutical/biotechnology and food processing industries and research and engineering institutions. We have established long-term relationships as a critical solutions provider to many of the leading companies in our target markets.

We have focused on introducing our advanced asset protection solutions to our customers using proprietary, technology-enabled software and testing instruments, including those developed by our Products and Systems segment. We have made a number of acquisitions in an effort to grow our base of experienced, certified personnel, expand our product and technical capabilities, increase our geographical reach and leverage our fixed costs. We have increased our capabilities and the size of our customer base through the development of applied technologies and managed support services, organic growth and the integration of acquired companies. These acquisitions have provided us with additional products, technologies, resources and customers that we believe will enhance our advantages over our competition.

Demand for outsourced asset protection solutions has generally increased over the last ten years, creating demand from which our entire industry has benefited. We believe continued growth can be realized in all of our target markets. However, current market conditions are soft, driven by lower oil prices which have drivencaused many of the Company’s customers to curtail spending.

 

 

Condensed consolidated results of operations for the three months ended AugustMarch 31, 20162017 and AugustMarch 31, 20152016 were as follows: