Document
Table of Contents

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2017
 
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period to
 
Commission file number 001- 34481
 
 
Mistras Group, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
22-3341267
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
195 Clarksville Road
Princeton Junction, New Jersey
 
08550
(Address of principal executive offices)
 
(Zip Code)
 
(609) 716-4000

(Registrant’s telephone number, including area code) 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
ý Yes  o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
ý Yes  o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging Growth Company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes  ý No
 
As of August 2, 2017, the registrant had 28,250,751 shares of common stock outstanding and 1,055,759 shares of treasury stock.
 
 
 
 
 



Table of Contents

TABLE OF CONTENTS
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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Table of Contents

PART I—FINANCIAL INFORMATION
 
ITEM 1.                           Financial Statements
 


Mistras Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
 
(unaudited)
 
 
 
June 30, 2017
 
December 31, 2016
ASSETS
 

 
 

Current Assets
 

 
 

Cash and cash equivalents
$
26,784

 
$
19,154

Accounts receivable, net
129,221

 
130,852

Inventories
10,949

 
10,017

Deferred income taxes

 
6,230

Prepaid expenses and other current assets
16,526

 
16,399

Total current assets
183,480

 
182,652

Property, plant and equipment, net
76,218

 
73,149

Intangible assets, net
40,503

 
40,007

Goodwill
176,231

 
169,940

Deferred income taxes
2,085

 
1,086

Other assets
2,710

 
2,593

Total assets
$
481,227

 
$
469,427

LIABILITIES AND EQUITY
 

 
 

Current Liabilities
 

 
 

Accounts payable
$
9,342

 
$
6,805

Accrued expenses and other current liabilities
56,841

 
58,697

Current portion of long-term debt
2,116

 
1,379

Current portion of capital lease obligations
6,386

 
6,488

Income taxes payable
3,814

 
4,342

Total current liabilities
78,499

 
77,711

Long-term debt, net of current portion
99,544

 
85,917

Obligations under capital leases, net of current portion
8,919

 
9,682

Deferred income taxes
12,859

 
17,584

Other long-term liabilities
8,157

 
7,789

Total liabilities
207,978

 
198,683

Commitments and contingencies


 


Equity
 

 
 

Preferred stock, 10,000,000 shares authorized

 

Common stock, $0.01 par value, 200,000,000 shares authorized, 29,306,510 and 29,216,745 shares issued
293

 
292

Additional paid-in capital
220,305

 
217,211

Treasury stock, at cost, 960,882 and 420,258 shares
(21,000
)
 
(9,000
)
Retained earnings
95,712

 
91,803

Accumulated other comprehensive loss
(22,232
)
 
(29,724
)
Total Mistras Group, Inc. stockholders’ equity
273,078

 
270,582

Non-controlling interests
171

 
162

Total equity
273,249

 
270,744

Total liabilities and equity
$
481,227

 
$
469,427

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

Mistras Group, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
(in thousands, except per share data)
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
 

 
 

 
 
 
 
Revenue
$
170,439

 
$
178,340

 
$
333,757

 
$
345,795

Cost of revenue
118,825

 
121,044

 
233,828

 
239,273

Depreciation
5,271

 
5,761

 
10,433

 
11,017

Gross profit
46,343

 
51,535

 
89,496

 
95,505

Selling, general and administrative expenses
37,973

 
37,217

 
75,273

 
72,271

Research and engineering
552

 
623

 
1,195

 
1,285

Depreciation and amortization
2,613

 
2,865

 
5,116

 
5,627

Legal settlement

 
6,320

 

 
6,320

Acquisition-related expense (benefit), net
202

 
(330
)
 
(341
)
 
(483
)
Income from operations
5,003

 
4,840

 
8,253

 
10,485

Interest expense
1,015

 
340

 
2,033

 
1,440

Income before provision for income taxes
3,988

 
4,500

 
6,220

 
9,045

Provision for income taxes
1,770

 
1,737

 
2,304

 
2,825

Net income
2,218

 
2,763

 
3,916

 
6,220

Less: net income attributable to non-controlling interests, net of taxes
1

 
2

 
7

 
12

Net income attributable to Mistras Group, Inc.
$
2,217

 
$
2,761

 
$
3,909

 
$
6,208

Earnings per common share:
 

 
 

 
 
 
 
Basic
$
0.08

 
$
0.10

 
$
0.14

 
$
0.21

Diluted
$
0.07

 
$
0.09

 
$
0.13

 
$
0.21

Weighted average common shares outstanding:
 

 
 

 
 
 
 
Basic
28,437

 
28,932

 
28,562

 
28,924

Diluted
29,599

 
30,152

 
29,754

 
30,083

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

Mistras Group, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income
(in thousands)
 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
 
 
 
 
 
 
 
Net income
$
2,218

 
$
2,763

 
$
3,916

 
$
6,220

Other comprehensive income:
 

 
 

 
 
 
 
Foreign currency translation adjustments
6,042

 
2,220

 
7,492

 
4,607

Comprehensive income
8,260

 
4,983

 
11,408

 
10,827

Less: comprehensive income attributable to non-controlling interest
3

 
3

 
9

 
12

Comprehensive income attributable to Mistras Group, Inc.
$
8,257

 
$
4,980

 
$
11,399

 
$
10,815

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

Mistras Group, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands) 
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
 
 
 
Cash flows from operating activities
 

 
 

Net income
$
3,916

 
$
6,220

Adjustments to reconcile net income to net cash provided by operating activities
 

 
 

Depreciation and amortization
15,549

 
16,644

Deferred income taxes
308

 
(1,655
)
Share-based compensation expense
3,420

 
3,195

Bad debt provision for a customer bankruptcy
1,200

 

Fair value adjustments to contingent consideration
(632
)
 
(933
)
Other
282

 
(1,075
)
Changes in operating assets and liabilities, net of effect of acquisitions
 

 
 
Accounts receivable
2,703

 
7,930

Inventories
(815
)
 
237

Prepaid expenses and other assets
344

 
(449
)
Accounts payable
2,268

 
(1,271
)
Accrued expenses and other liabilities
(4,749
)
 
9,337

Income taxes payable
(822
)
 
(402
)
Net cash provided by operating activities
22,972

 
37,778

Cash flows from investing activities
 

 
 

Purchase of property, plant and equipment
(9,789
)
 
(6,787
)
Purchase of intangible assets
(688
)
 
(829
)
Acquisition of businesses, net of cash acquired
(4,500
)
 
(33
)
Proceeds from sale of equipment
759

 
281

Net cash used in investing activities
(14,218
)
 
(7,368
)
Cash flows from financing activities
 

 
 

Repayment of capital lease obligations
(3,300
)
 
(4,221
)
Proceeds from borrowings of long-term debt
3,784

 
648

Repayment of long-term debt
(1,032
)
 
(1,645
)
Proceeds from revolver
30,400

 
15,100

Repayment of revolver
(19,700
)
 
(30,100
)
Payment of contingent consideration for business acquisitions
(547
)
 
(2,123
)
Purchases of treasury stock
(12,000
)


Taxes paid related to net share settlement of share-based awards
(607
)
 
(62
)
Excess tax benefit from share-based compensation

 
129

Proceeds from exercise of stock options
276

 
323

Net cash used in financing activities
(2,726
)
 
(21,951
)
Effect of exchange rate changes on cash and cash equivalents
1,602

 
384

Net change in cash and cash equivalents
7,630

 
8,843

Cash and cash equivalents
 

 
 

Beginning of period
19,154

 
9,599

End of period
$
26,784

 
$
18,442

Supplemental disclosure of cash paid
 

 
 

Interest
$
2,023

 
$
1,484

Income taxes
$
2,463

 
$
4,502

Noncash investing and financing
 

 
 

Equipment acquired through capital lease obligations
$
2,199

 
$
6,229

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)








1.                                      Description of Business and Basis of Presentation
 
Description of Business
 
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), non-destructive testing (NDT) and mechanical 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.
 
Basis of Presentation
 
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 December 31, 2017 and 2016. 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 Transition Report on Form 10-K (“2016 Transition Report”) for the transition period ended December 31, 2016, as filed with the Securities and Exchange Commission on March 20, 2017.
 
Principles of Consolidation
 
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 non-controlling interests are reported in stockholders’ equity in the accompanying condensed consolidated balance sheets. The non-controlling interests in net income, net of tax, is classified separately in the accompanying condensed consolidated statements of income. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
On January 3, 2017, the Company's Board of Directors approved a change in the Company's fiscal year end from May 31 to December 31, effective December 31, 2016. The transition period was for the seven months ended December 31, 2016 ("the transition period"). Prior to this change, the Company's International segment was consolidated on a one month lag. Therefore, for this interim report, the condensed consolidated income statements include a one month lag for the International segment for the three and six months ended June 30, 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 statements do not include a one month lag for the International segment's results for the three and six months ended June 30, 2017.

Reclassification

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.

Customers


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Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






One customer, primarily generated from the Services segment, accounted for approximately 12% of our revenues for the three and six months ended June 30, 2017. This customer accounted for 11% of accounts receivable as of June 30, 2017. One customer accounted for 12% and 11% of our revenues for the three and six months ended June 30, 2016.

Significant Accounting Policies
 
The Company’s significant accounting policies are disclosed in Note 2 — Summary of Significant Accounting Policies in the Company's 2016 Transition Report. On an ongoing basis, the Company evaluates its estimates and assumptions, including among other things, those related to revenue recognition, valuations of accounts receivable, long-lived assets, goodwill, deferred tax assets and uncertain tax positions. Since the date of the 2016 Transition Report, there have been no material changes to the Company's significant accounting policies.

Recent Accounting Pronouncements

In August 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for all entities by one year. This update is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2014-09 will become effective for us beginning 2018, which is when we plan to adopt this standard. The ASU permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The ASU also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. We are still in the process of evaluating the effect of adoption on our condensed consolidated financial statements and are currently assessing our contracts with customers. We anticipate we will expand our condensed consolidated financial statement disclosures in order to comply with ASU 2014-09.

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This amendment will simplify the presentation of deferred tax assets and liabilities on the balance sheet and require all deferred tax assets and liabilities to be treated as non-current. ASU 2015-17 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance prospectively beginning in the first quarter of 2017, which did not have a material impact on the condensed consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This amendment supersedes previous accounting guidance (Topic 840) and requires all leases, with the exception of leases with a term of 12 months or less, to be recorded on the balance sheet as lease assets and lease liabilities. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2018, with early adoption permitted. The standard requires lessees and lessors to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Company is evaluating the effect that ASU 2016-02 will have on its condensed consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Stock Compensation (Topic 718). This amendment simplifies certain aspects of accounting for share-based payment transactions, which include accounting for income taxes and the related impact on the statement of cash flows, an option to account for forfeitures when they occur in addition to the existing guidance to estimate the forfeitures of awards, classification of awards as either equity or liabilities and classification on the statement of cash flows for employee taxes paid to tax authorities on shares withheld for vesting. ASU 2016-09 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance prospectively beginning in the first quarter of 2017, and accordingly, is recording excess tax benefits and tax deficiencies as a component of income tax expense.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). This amendment will provide guidance on the presentation and classification of specific cash flow items to improve consistency within the statement of cash flows. ASU 2016-15 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15,

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Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






2017, with early adoption permitted. The Company is evaluating the impact that ASU 2016-15 will have on its condensed consolidated financial statements and related disclosures.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230). This amendment will clarify the presentation of restricted cash on the statement of cash flows. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning and ending cash balances on the statement of cash flows. ASU 2016-18 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2017, with early adoption permitted. The Company does not expect that ASU 2016-18 will have a material impact on its condensed consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350). This amendment eliminates Step Two of the goodwill impairment test. Under the amendments in this update, entities should perform the annual goodwill impairment test by comparing the carrying value of its reporting units to their fair value. An entity should record an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. Tax deductibility of goodwill should be considered in evaluating any reporting unit's impairment loss to be taken. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is evaluating the impact that ASU 2017-04 will have on its condensed consolidated financial statements and related disclosures.

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) Scope of Modification Accounting. This amendment provides guidance concerning which changes to the terms or conditions of a share-based payment require an entity to apply modification accounting. Certain changes to stock awards, notably administrative changes, do not require modification accounting. There are three specific criteria that need to be met in order to prove that modification accounting is not required. ASU 2017-09 is effective for fiscal years, and interim period within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The Company is evaluating the impact that ASU 2017-09 will have on its condensed consolidated financial statements and related disclosures.


2.                                      Share-Based Compensation
 
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 2016 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.
 
Stock Options
 
For the three months ended June 30, 2017 and 2016, the Company did not recognize any share-based compensation expense related to stock option awards.

For the six months ended June 30, 2017 and 2016, the Company did not recognize any share-based compensation expense and recognized less than $0.1 million, respectively, related to stock option awards.

No unrecognized compensation costs remained related to stock option awards as of June 30, 2017.
 
No stock options were granted during the three and six months ended June 30, 2017 and June 30, 2016.

A summary of the stock option activity, weighted average exercise prices and options outstanding as of June 30, 2017 and 2016 is as follows:

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Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






 
For the six months ended June 30,
 
 
2017
 
2016
 
 
Common
Stock
Options
 
Weighted
Average
Exercise
Price
 
Common
Stock
Options
 
Weighted
Average
Exercise
Price
 
Outstanding at beginning of period:
2,167

 
$
13.33

 
2,265

 
$
13.16

 
Granted

 
$

 

 
$

 
Exercised
(37
)
 
$
7.39

 
(33
)
 
$
9.69

 
Expired or forfeited

 
$

 

 
$

 
Outstanding at end of period:
2,130

 
$
13.43

 
2,232

 
$
13.21

 
 
Restricted Stock Unit Awards
 
For the three months ended June 30, 2017 and June 30, 2016, the Company recognized share-based compensation expense related to restricted stock unit awards of $1.2 million and $1.0 million, respectively.

For the six months ended June 30, 2017 and June 30, 2016, the Company recognized share-based compensation expense related to restricted stock unit awards of $2.3 million and $2.2 million, respectively. As of June 30, 2017, there was $9.5 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 2.5 years.
 
During the first six months of 2017 and 2016, the Company granted approximately 9,000 and 12,000 shares, respectively, of fully-vested common stock to its five non-employee directors, as provided for under the Company's non-employee director compensation plan. These shares had grant date fair values of $0.2 million and $0.3 million, respectively, which was recorded as share-based compensation expense during the six months ended June 30, 2017 and June 30, 2016, respectively.
 
During the first six months of 2017 and 2016, approximately 8,000 restricted stock units vested for each period. The fair value of these units was $0.2 million 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, non-vested restricted share units is presented below:

 
For the six months ended June 30,
 
2017
 
2016
 
Units
 
Weighted
Average
Grant-Date
Fair Value
 
Units
 
Weighted
Average
Grant-Date
Fair Value
Outstanding at beginning of period:
569

 
$
20.81

 
595

 
$
18.89

Granted
124

 
$
21.21

 
1

 
$
23.11

Released
(8
)
 
$
21.99

 
(8
)
 
$
21.96

Forfeited
(11
)
 
$
21.05

 
(18
)
 
$
19.12

Outstanding at end of period:
674

 
$
20.87

 
570

 
$
18.85


 
Performance Restricted Stock Units

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 and (3) Revenue. There also is a discretionary portion of the PRSUs

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Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






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.

PRSUs are equity-classified and compensation costs are initially measured using the fair value of the underlying stock at the date of grant, assuming that the target performance conditions will be achieved. Compensation costs related to the PRSUs are subsequently adjusted for changes in the expected outcomes of the performance conditions.

Discretionary PRSUs are liability-classified and adjusted to fair value (with a corresponding adjustment to compensation expense) based upon the targeted number of shares to be awarded and the fair value of the underlying stock each reporting period until approved by the Compensation Committee, at which point they are classified as equity.

A summary of the Company's Performance Restricted Stock Unit activity is presented below:

 
For the six months ended June 30, 2017
 
 
Units
 
Weighted
Average
Grant-Date
Fair Value
 
Outstanding at beginning of period:
290

 
$
16.01

 
Granted
128

 
$
20.42

 
Performance condition adjustments
(60
)
 
$
20.57

 
Released
(64
)
 
$
14.87

 
Forfeited

 
$

 
Outstanding at end of period:
294

 
$
17.15

 
 
 
 
 
 
 
 
 
 
 


During the six months ended June 30, 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 six months ended June 30, 2017, the Compensation Committee approved these transition period PRSUs, which resulted in a reduction of approximately 3,000 units. There was a reduction of approximately 57,000 units to the awards granted in 2017 during the three months ended June 30, 2017.

As of June 30, 2017, the liability related to Discretionary PRSUs was less than $0.1 million and is classified within accrued expenses and other current liabilities on the condensed consolidated balance sheet.

For the three months ended June 30, 2017 and June 30, 2016, the Company recognized aggregate share-based compensation expense related to the awards described above of approximately $0.5 million and $0.4 million, respectively.
For the six months ended June 30, 2017 and June 30, 2016, the Company recognized aggregate share-based compensation expense related to the awards described above of approximately $0.9 million and $0.8 million, respectively.
At June 30, 2017, there was $3.2 million of total unrecognized compensation costs related to approximately 294,000 non-vested performance restricted stock units, which are expected to be recognized over a remaining weighted average period of 2.4 years.

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

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






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:
 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
 
 
 
 
 
 
 
Basic earnings per share:
 

 
 

 
 
 
 
Numerator:
 

 
 

 
 
 
 
Net income attributable to Mistras Group, Inc.
$
2,217

 
$
2,761

 
$
3,909

 
$
6,208

Denominator:
 

 
 

 
 

 
 

Weighted average common shares outstanding
28,437

 
28,932

 
28,562

 
28,924

Basic earnings per share
$
0.08

 
$
0.10

 
$
0.14

 
$
0.21

 
 
 
 
 
 
 
 
Diluted earnings per share:
 

 
 

 
 
 
 
Numerator:
 

 
 

 
 
 
 
Net income attributable to Mistras Group, Inc.
$
2,217

 
$
2,761

 
$
3,909

 
$
6,208

Denominator:
 

 
 

 
 

 
 

Weighted average common shares outstanding
28,437

 
28,932

 
28,562

 
28,924

Dilutive effect of stock options outstanding
802

 
833

 
841

 
807

Dilutive effect of restricted stock units outstanding
360

 
387

 
351

 
352

 
29,599

 
30,152

 
29,754

 
30,083

Diluted earnings per share
$
0.07

 
$
0.09

 
$
0.13

 
$
0.21

 

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Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






4.                                      Acquisitions

During the six months ended June 30, 2017, the Company completed one acquisition of a company located in the U.S. that provides NDT, chemical and special processing services.

In this acquisition, the Company acquired assets of the acquiree in exchange for aggregate consideration of $4.5 million in cash, and contingent consideration up to $3.5 million to be earned based upon the acquired business achieving specific performance metrics over the initial three years of operations from the acquisition date. The Company accounted for this transaction in accordance with the acquisition method of accounting for business combinations.

The assets and liabilities of the business acquired in 2017 were included in the Company's condensed consolidated balance sheet based upon their estimated fair values 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 acquired. The results of operations for this acquisition are included in the Services segment's results from the date of acquisition. Goodwill of $3.3 million primarily relates to expected synergies and assembled workforce and is generally deductible for tax purposes. Other intangible assets, primarily related to customer relationships and covenants not to compete, were $2.7 million.

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:

 
2017
Number of Entities
1

Consideration transferred:
 
Cash paid
$
4,500

Contingent consideration
2,508

Consideration transferred
$
7,008

 
 
Current assets
 
Property, plant and equipment
$
845

Intangible assets
2,742

Goodwill
3,326

Current liabilities

Long-term deferred tax asset
95

Net assets acquired
$
7,008


Revenues and operating income included in the condensed consolidated statement of operations for 2017 from this acquisition for the period subsequent to the closing of this transaction was approximately $2.0 million and $0.2 million, respectively. As this acquisition was immaterial to the Company's 2017 results, no unaudited pro forma financial information has been included in this report.

The Company is continuing its review of the fair value estimate of assets acquired and liabilities assumed for one entity 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 other intangible assets recorded for this entity totaled $2.9 million and $3.2 million, respectively. This measurement period will not exceed one year from acquisition date.


Acquisition-Related Expense 
 

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






In the course of its acquisition activities, the Company incurs costs in connection with due diligence, professional fees, and other expenses. Additionally, the Company adjusts the fair value of acquisition-related contingent consideration liabilities on a quarterly basis. These amounts are recorded as acquisition-related expense (benefit), net, on the condensed consolidated statements of income and were as follows for the three and six months ended June 30, 2017 and 2016:

 
Three months ended June 30,
 
Six months ended June 30,
 
2017
 
2016
 
2017
 
2016
Due diligence, professional fees and other transaction costs
$
209

 
$
445

 
$
291

 
$
549

Adjustments to fair value of contingent consideration liabilities
(7
)
 
(775
)
 
(632
)
 
(1,032
)
Acquisition-related expense (benefit), net
$
202

 
$
(330
)
 
$
(341
)
 
$
(483
)



5.                                      Accounts Receivable, net
 
Accounts receivable consisted of the following:
 
 
June 30, 2017
 
December 31, 2016
 
 
 
 
Trade accounts receivable
$
133,273

 
$
133,704

Allowance for doubtful accounts
(4,052
)
 
(2,852
)
Accounts receivable, net
$
129,221

 
$
130,852

 


6.                                      Property, Plant and Equipment, net
 
Property, plant and equipment consisted of the following:
 
 
Useful Life
(Years)
 
June 30, 2017
 
December 31, 2016
 
 
 
 
 
 
Land
 
 
$
1,893

 
$
1,714

Buildings and improvements
30-40
 
21,864

 
19,261

Office furniture and equipment
5-8
 
13,335

 
12,574

Machinery and equipment
5-7
 
176,173

 
166,423

 
 
 
213,265

 
199,972

Accumulated depreciation and amortization
 
 
(137,047
)
 
(126,823
)
Property, plant and equipment, net
 
 
$
76,218

 
$
73,149

 
Depreciation expense for the three months ended June 30, 2017 and June 30, 2016 was $5.6 million and $6.2 million, respectively.

Depreciation expense for the six months ended June 30, 2017 and June 30, 2016 was $11.1 million and $11.8 million, respectively.

 
7.     Goodwill
 

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






Changes in the carrying amount of goodwill by segment is shown below:
 
Services
 
International
 
Products and Systems
 
Total
Balance at December 31, 2016
$
123,392

 
$
33,351

 
$
13,197

 
$
169,940

Goodwill acquired during the period
3,326

 

 

 
3,326

Adjustments to preliminary purchase price allocations
(137
)
 

 

 
(137
)
Foreign currency translation
467

 
2,635

 

 
3,102

Balance at June 30, 2017
$
127,048

 
$
35,986

 
$
13,197

 
$
176,231

 
The Company reviews goodwill for impairment on a reporting unit basis on October 1 of each year and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. As of June 30, 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 June 30, 2017 and December 31, 2016 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:
 
 
 
 
June 30, 2017
 
December 31, 2016
 
Useful Life
(Years)
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
5-12
 
$
86,442

 
$
(54,366
)
 
$
32,076

 
$
81,559

 
$
(50,417
)
 
$
31,142

Software/Technology
3-15
 
18,902

 
(13,374
)
 
5,528

 
18,128

 
(12,577
)
 
5,551

Covenants not to compete
2-5
 
11,449

 
(10,020
)
 
1,429

 
11,143

 
(9,647
)
 
1,496

Other
2-5
 
7,385

 
(5,915
)
 
1,470

 
7,266

 
(5,448
)
 
1,818

Total
 
 
$
124,178

 
$
(83,675
)
 
$
40,503

 
$
118,096

 
$
(78,089
)
 
$
40,007

 
Amortization expense for the three months ended June 30, 2017 and June 30, 2016 was $2.3 million and $2.4 million, respectively.

Amortization expense for the six months ended June 30, 2017 and June 30, 2016 was $4.4 million and $4.8 million, respectively.
 
9.                                      Accrued Expenses and Other Current Liabilities
 
Accrued expenses and other current liabilities consisted of the following:
 
 
June 30, 2017
 
December 31, 2016
 
 
 
 
Accrued salaries, wages and related employee benefits
$
25,956

 
$
23,442

Contingent consideration, current portion
2,716

 
1,826

Accrued workers’ compensation and health benefits
5,592

 
6,351

Deferred revenue
6,396

 
3,743

Legal settlement accrual

 
6,320

Other accrued expenses
16,181

 
17,015

Total accrued expenses and other liabilities
$
56,841

 
$
58,697

 

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






10.                               Long-Term Debt
 
Long-term debt consisted of the following:
 
June 30, 2017
 
December 31, 2016
 
 
 
 
Senior credit facility
$
93,904

 
$
82,776

Notes payable
259

 
320

Other
7,497

 
4,200

Total debt
101,660

 
87,296

Less: Current portion
(2,116
)
 
(1,379
)
Long-term debt, net of current portion
$
99,544

 
$
85,917

 
Senior Credit Facility
 
The Company's revolving credit agreement with its banking group ("Credit Agreement") provides the Company with a $175.0 million revolving line of credit, which, under certain circumstances, 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 June 30, 2017, the Company had borrowings of $93.9 million and a total of $5.6 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 defined 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 is 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 June 30, 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.
 
Notes Payable and Other
 

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






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 June 30, 2017. Interest expense is recorded in the condensed consolidated statements of income.
 

11.                               Fair Value Measurements
 
The Company performs fair value measurements in accordance with the guidance provided by ASC 820, Fair Value Measurements and Disclosures. ASC 820 defines fair value 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.

Financial instruments measured at fair value on a recurring basis

The fair value of contingent consideration liabilities 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.

The following table represents the changes in the fair value of Level 3 contingent consideration:
 
 
 
Six months ended
 
 
June 30, 2017
Beginning balance
 
$
3,094

Acquisitions
 
2,508

Payments
 
(547
)
Accretion of liability
 
148

Revaluation
 
(780
)
Foreign currency translation
 
22

Ending Balance
 
$
4,445

 
Financial instruments not measured at fair value on a recurring basis
 
The Company has evaluated current market conditions and borrower credit quality and has determined that the carrying value of its long-term debt approximates fair value. The fair value of the Company’s notes payable and capital lease obligations approximates their carrying amounts based on anticipated interest rates which management believes would currently be available to the Company for similar issuances of debt.

 
12.                               Commitments and Contingencies
 
Legal Proceedings and Government Investigations
 
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.

Litigation and Commercial Claims
 

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






The Company settled a consolidated purported class and collective action that resulted from the consolidation of two cases originally filed in California state court in April 2015. In connection with the settlement, the Company recorded a pre-tax charge of $6.3 million during the three months ended June 30, 2016 and paid the settlement in February 2017.
 
The Company is a defendant in the lawsuit AGL Services Company v. Mistras Group, Inc., pending in U.S. District Court for the Northern District of Georgia, filed November 2016. The case involves radiography work performed by the Company in 2013 on the construction of a pipeline project in the U.S. The owner of the pipeline project has claimed damages of approximately $6 million and contends that certain of the radiography images the Company’s technicians prepared regarding the project did not meet the code quality interpretation standards required by the American Petroleum Institute.  The Company is currently unable to determine the likely outcome or reasonably estimate the amount or range of potential liability related to this matter, and accordingly, has not established any reserves for this matter.

The Company’s subsidiary in France has been involved in a dispute with a former owner of a business purchased by the Company’s French subsidiary. The former owner received a judgment in his favor in the amount of approximately $0.4 million. The judgment is being appealed, but the Company recorded a reserve for the full amount of the judgment during the three months ended June 30, 2016.

The Company is a defendant in a lawsuit, Triumph Aerostructures, LLC d/b/a Triumph Aerostructures-Vought Aircraft Division v. Mistras Group, Inc., pending in Texas State district court, 193rd Judicial District, Dallas County, Texas, filed September 2016. The plaintiff alleges Mistras delivered a defective Ultrasonic inspection system in 2014 and is alleging damages of approximately $2.3 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, and accordingly, has not established any reserves for this matter.

Government Investigations

In May 2015, the Company received a notice from the U.S. Environmental Protection Agency (“EPA”) that it performed a preliminary assessment at a leased facility the Company operates in Cudahy, California. Based upon the preliminary assessment, the EPA is conducting an investigation of the site, which includes taking groundwater and soil samples. The purpose of the investigation is to determine whether any hazardous materials were released from the facility. The Company has been informed that certain hazardous materials and pollutants have been found in the ground water in the general vicinity of the site and the EPA is attempting to ascertain the origination or source of these materials and pollutants. Given the historic industrial use of the site, the EPA determined that the site of the Cudahy facility should be examined, along with numerous other sites in the vicinity. At this time, the Company is unable to determine whether it has any liability in connection with this matter and if so, the amount or range of any such liability, and accordingly, has not established any reserves for this matter.

Acquisition-related contingencies
 
The Company is liable for contingent consideration in connection with certain of its acquisitions. As of June 30, 2017, total potential acquisition-related contingent consideration ranged from zero to approximately $17.7 million and would be payable upon the achievement of specific performance metrics by certain of the acquired companies over the next 2.8 years of operations. See Note 4 - Acquisitions to these condensed consolidated financial statements for further discussion of the Company’s acquisitions.
 
13.                               Segment Disclosure
 
The Company’s three operating segments are:
 
Services. This segment provides asset protection solutions primarily in North America with the largest concentration in the United States and the Canadian services business, consisting primarily of non-destructive testing and inspection, mechanical and engineering services that are used to evaluate and maintain the structural integrity and reliability of critical energy, industrial and public infrastructure.
 
International. This segment offers services, products and systems similar to those of the Company’s other two segments to global markets, principally in Europe, the Middle East, Africa, Asia and South America, but not to customers in China and South Korea, which are served by the Products and Systems segment.
 

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






Products and Systems. This segment designs, manufactures, sells, installs and services the Company’s asset protection products and systems, including equipment and instrumentation, predominantly in the United States.
 
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):
 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
Revenues
 

 
 

 
 
 
 
Services
$
134,043

 
$
136,358

 
$
260,372

 
$
267,936

International
33,904

 
36,373

 
68,160

 
67,353

Products and Systems
5,107

 
6,467

 
10,657

 
13,148

Corporate and eliminations
(2,615
)
 
(858
)
 
(5,432
)
 
(2,642
)
 
$
170,439

 
$
178,340

 
$
333,757

 
$
345,795

 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
Gross profit
 

 
 

 
 
 
 
Services
$
35,490

 
$
36,490

 
$
65,703

 
$
68,948

International
8,828

 
11,867

 
19,288

 
20,540

Products and Systems
1,966

 
3,050

 
4,560

 
5,789

Corporate and eliminations
59

 
128

 
(55
)
 
228

 
$
46,343

 
$
51,535

 
$
89,496

 
$
95,505

 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
Income (loss) from operations
 

 
 

 
 
 
 
Services
$
12,132

 
$
7,372

 
$
19,513

 
$
18,711

International
(190
)
 
2,454

 
2,843

 
3,174

Products and Systems
(892
)
 
(114
)
 
(1,340
)
 
(246
)
Corporate and eliminations
(6,047
)
 
(4,872
)
 
(12,763
)
 
(11,154
)
 
$
5,003

 
$
4,840

 
$
8,253

 
$
10,485

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

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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)






 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
Depreciation and amortization
 

 
 

 
 

 
 

Services
$
5,468

 
$
6,084

 
$
10,787

 
$
11,708

International
1,888

 
2,043

 
3,732

 
3,922

Products and Systems
585

 
577

 
1,153

 
1,166

Corporate and eliminations
(57
)
 
(78
)
 
(123
)
 
(152
)
 
$
7,884

 
$
8,626

 
$
15,549

 
$
16,644

 
 
June 30, 2017
 
December 31, 2016
Intangible assets, net
 

 
 

Services
$
20,265

 
$
19,550

International
14,299

 
14,139

Products and Systems
5,123

 
5,482

Corporate and eliminations
816

 
836

 
$
40,503

 
$
40,007

 

 
June 30, 2017
 
December 31, 2016
Total assets
 

 
 

Services
$
295,731

 
$
291,539

International
144,303

 
130,427

Products and Systems
28,960

 
28,964

Corporate and eliminations
12,233

 
18,497

 
$
481,227

 
$
469,427

 
Revenues by geographic area for the three and six months ended June 30, 2017 and 2016, respectively, were as follows:
 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
Revenues
 

 
 

 
 
 
 
United States
$
119,029

 
$
123,664

 
$
230,560

 
$
244,935

Other Americas
17,895

 
17,105

 
33,368

 
31,888

Europe
30,706

 
32,891

 
61,366

 
60,138

Asia-Pacific
2,809

 
4,680

 
8,463

 
8,834

 
$
170,439

 
$
178,340

 
$
333,757

 
$
345,795



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Notes to Unaudited Condensed Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share data)







14. Repurchase of Common Stock

On October 7, 2015, the Company's Board of Directors approved a $50 million stock repurchase plan. As part of this plan, on
August 17, 2016, the Company entered into an agreement with its CEO, Dr. Sotirios Vahaviolos, to purchase up to 1 million of
his shares, commencing in October 2016. Pursuant to the agreement, in general, the Company will purchase from Dr.
Vahaviolos up to $2 million of shares each month, at a 2% discount to the average daily closing price of the Company's common stock for the preceding month. During the six months ended June 30, 2017, the Company purchased approximately 541,000 shares from Dr. Vahaviolos at an average price of $22.20 per share and an aggregate cost of $12.0 million. From the inception of the plan through June 30, 2017, the Company has purchased approximately 815,000 shares from Dr. Vahaviolos at an average price of $22.10 per share for an aggregate cost of $18.0 million and approximately 146,000 shares in the open market at an average price of $20.48 per share for an aggregate cost of approximately $3.0 million. All such repurchased shares are classified as Treasury Stock on the condensed consolidated balance sheet. As of June 30, 2017, approximately $29.0 million remained available to repurchase shares under the stock repurchase plan.

15. Subsequent Events

Subsequent to June 30, 2017, the Company completed an acquisition of a business, located in Canada, that provides maintenance and mechanical services via rope access to the industrial sector, for $3.9 million in cash upon closing. In addition to the cash consideration, the acquisition provides for possible contingent consideration of up to $2.3 million to be earned based upon the achievement of specific performance metrics over the next three years of operation. The Company is in the process of completing the preliminary purchase price allocation. The acquisition was not significant and no pro forma information has been included in this quarterly report on Form 10-Q.
 
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 and six months ended June 30, 2017 and June 30, 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 Transition Report on Form 10-K for the transition period ended December 31, 2016, filed March 20, 2017 (“2016 Transition Report”). Unless 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:
 
Forward-Looking Statements
Overview
Results of Operations
Liquidity and Capital Resources
Critical Accounting Policies and Estimates
 
Forward-Looking Statements
 
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

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Factors” sections of our 2016 Transition Report as well as those discussed this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission (“SEC”).
 
Overview
 
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), mechanical 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.
 
Services provides asset protection solutions predominantly in North America with the largest concentration in the United States, consisting primarily of NDT, inspection, mechanical and engineering services that are used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure.

International offers services, products and systems similar to those of the other segments to global markets, principally in Europe, the Middle East, Africa, Asia and South America, but not to customers in China and South Korea, which are served by the Products and Systems segment.
 
Products and Systems designs, manufactures, sells, installs and services the Company’s asset protection products and systems, including equipment and instrumentation, predominantly in the United States.
 
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 caused many of the Company’s customers to curtail spending for our services and products.
 
Results of Operations
 
Condensed consolidated results of operations for the three and six months ended June 30, 2017 and June 30, 2016 were as follows:

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Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
($ in thousands)
 
($ in thousands)
Revenues
$
170,439

 
$
178,340

 
$
333,757

 
$
345,795

Gross profit
46,343

 
51,535

 
89,496

 
95,505

Gross profit as a % of Revenue
27
%
 
29
%
 
27
%
 
28
%
Total operating expenses
41,340

 
46,695

 
81,243

 
85,020

Operating expenses as a % of Revenue
24
%
 
26
%
 
24
%
 
25
%
Income from operations
5,003

 
4,840

 
8,253

 
10,485

Income from Operations as a % of Revenue
3
%
 
3
%
 
2
%
 
3
%
Interest expense
1,015

 
340

 
2,033

 
1,440

Income before provision for income taxes
3,988

 
4,500

 
6,220

 
9,045

Provision for income taxes
1,770

 
1,737

 
2,304

 
2,825

Net income
2,218

 
2,763

 
3,916

 
6,220

Less: net income attributable to non-controlling interests, net of taxes
1

 
2

 
7

 
12

Net income attributable to Mistras Group, Inc.
$
2,217

 
$
2,761

 
$
3,909

 
$
6,208

 
Note About Non-GAAP Measures
 
In this MD&A under the heading "Income from Operations", the non-GAAP financial performance measure "Income before special items” is used for each of our three segments, the Corporate segment and the "Total Company", with tables reconciling the measure to a financial measure under GAAP. This non-GAAP measure excludes from the GAAP measure "Income from Operations" (a) transaction expenses related to acquisitions, such as professional fees and due diligence costs, (b) the net changes in the fair value of acquisition-related contingent consideration liabilities and (c) non-recurring items. These items have been excluded from the GAAP measure because these expenses and credits are not related to the Company’s or Segment’s core business operations. The acquisition related costs and special items can be a net expense or credit in any given period.

We believe investors and other users of our financial statements benefit from the presentation of "Income before special items" in evaluating our performance. Income before special items provides an additional tool to compare our core business operating performance on a consistent basis and measure underlying trends and results in our business. Income before special items is not used to determine incentive compensation for executives or employees.
 
Revenue
 
Revenues for the three months ended June 30, 2017 were $170.4 million, a decrease of $7.9 million, or 4%, compared with the three months ended June 30, 2016. Revenues for the six months ended June 30, 2017 were $333.8 million, a decrease of $12.0 million, or 3%, compared with the six months ended June 30, 2016.

Revenues by segment for the three and six months ended June 30, 2017 and June 30, 2016 were as follows:
 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
($ in thousands)
 
($ in thousands)
Revenues
 

 
 

 
 
 
 
Services
$
134,043

 
$
136,358

 
$
260,372

 
$
267,936

International
33,904

 
36,373

 
68,160

 
67,353

Products and Systems
5,107

 
6,467

 
10,657

 
13,148

Corporate and eliminations
(2,615
)
 
(858
)
 
(5,432
)
 
(2,642
)
 
$
170,439

 
$
178,340

 
$
333,757

 
$
345,795

 
Three Months

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In the three months ended June 30, 2017, Services segment revenues decreased 2% due to a combination of mid-single digit organic decline, offset by low single digit acquisition growth. International segment revenues decreased 7%, driven by low single digit organic and foreign exchange rate declines. Products and Systems segment revenues decreased by 21% driven by lower sales volume.

Oil and gas customer revenues were a primary driver for the decline in total revenues for the three months ended June 30, 2017 as compared with the three months ended June 30, 2016. Oil and gas customer revenues comprised approximately 57% of total Company revenues for both periods. The Company’s top ten customers comprised approximately 40% of total revenues for the three months ended June 30, 2017 from 38% for the three months ended June 30, 2016. One customer, BP plc., accounted for approximately 12% of total revenues for both the three months ended June 30, 2017 and three months ended June 30, 2016.

Six Months

In the six months ended June 30, 2017, Services segment revenues decreased 3%, as mid-single digit organic decline more than offset low single digit acquisition growth. International segment revenues increased 1%, as mid-single digit organic growth slightly more than offset a low single digit unfavorable impact of foreign exchange rates. Products segment revenues decreased 19% due to lower sales volume.

Oil and gas customer revenues were a primary driver for the decline in total revenues for the six months ended June 30, 2017 as compared with the six months ended June 30, 2016. Oil and gas revenues comprised approximately 58% of total Company revenues for both periods. The Company’s top ten customers comprised approximately 41% and 39% of total revenues for the six month periods ended June 30, 2017 and June 30, 2016, respectively. One customer, BP plc., accounted for approximately 12% of our total revenues for the six months ended June 30, 2017 and 11% for the six months ended June 30, 2016.

Gross Profit

Gross profit decreased by $5.2 million, or 10%, in the three months ended June 30, 2017, on a sales decline of 4%. During the six month period ended June 30, 2017, gross profit had a year-on-year decrease of $6.0 million, or 6%, on a sales decline of 3%.

Gross profit by segment for the three and six months ended June 30, 2017 and June 30, 2016 was as follows:
 
 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
($ in thousands)
 
($ in thousands)
Gross profit
 

 
 

 
 
 
 
Services
$
35,490

 
$
36,490

 
$
65,703

 
$
68,948

   % of segment revenue
26.5
%
 
26.8
%
 
25.2
%
 
25.7
%
International
8,828

 
11,867

 
19,288

 
20,540

   % of segment revenue
26.0
%
 
32.6
%
 
28.3
%
 
30.5
%
Products and Systems
1,966

 
3,050

 
4,560

 
5,789

   % of segment revenue
38.5
%
 
47.2
%
 
42.8
%
 
44.0
%
Corporate and eliminations
59

 
128

 
(55
)
 
228

 
$
46,343

 
$
51,535

 
$
89,496

 
$
95,505

   % of total revenue
27.2
%
 
28.9
%
 
26.8
%
 
27.6
%

Three months

As a percentage of revenues, gross profit was 27.2% and 28.9% for the three month periods ended June 30, 2017 and 2016, respectively. Services segment gross profit margins decreased to 26.5% in the three months ended June 30, 2017 compared to 26.8% in the three months ended June 30, 2016. The 30 basis point decrease was primarily driven by lower sales levels. International segment gross margins decreased to 26.0% in the three months ended June 30, 2017 compared with 32.6% in the three months ended June 30, 2016. The 660 basis point decrease was driven by lower utilization of technical labor and overhead as well as a less favorable sales mix. Products and Systems segment gross margin declined by 870 basis points for

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the three months ended June 30, 2017 to 38.5% compared with 47.2% in the three months ended June 30, 2016, driven by lower sales volumes.

Six months

As a percentage of revenues, gross profit was 26.8% and 27.6% for the six months ended June 30, 2017 and 2016, respectively. Services segment gross profit margins decreased to 25.2% in the six months ended June 30, 2017 compared to 25.7% in the six months ended June 30, 2016. The 50 basis point decrease was primarily driven by lower sales levels and a less favorable sales mix. International segment gross margins decreased to 28.3% in the six months ended June 30, 2017 compared to 30.5% in the six months ended June 30, 2016. The 220 basis point decrease was primarily driven by lower utilization of technical labor and overhead, as well as a less favorable sales mix. Products and Systems segment gross margin decreased by 120 basis points for the six months ended June 30, 2017 to 42.8% compared with 44.0% in the six months ended June 30, 2016, driven by lower sales volumes.


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Income from Operations

The following table shows a reconciliation of the income from operations to income before special items for each of the Company's three segments and for the Company in total:

 
Three months ended
 
Six months ended
 
June 30, 2017
 
June 30, 2016
 
June 30, 2017
 
June 30, 2016
 
($ in thousands)
 
($ in thousands)
Services:
 

 
 

 
 
 
 
Income from operations
$
12,132

 
$
7,372

 
$
19,513

 
$
18,711

Legal settlement

 
6,320

 

 
6,320

Bad debt provision for a customer bankruptcy

 

 
1,200

 

Severance costs
314

 

 
330

 

Asset write-offs and lease terminations
123

 

 
123

 

Acquisition-related expense (benefit), net
201

 
(295
)
 
78

 
(468
)
Income before special items
12,770

 
13,397

 
21,244

 
24,563

International:
 

 
 

 
 

 
 

(Loss) income from operations
(190
)
 
2,454

 
2,843

 
3,174

Severance costs
63

 
645

 
76

 
710

Acquisition-related expense (benefit), net

 
(83
)
 
(501
)
 
(63
)
(Loss) income before special items
(127
)
 
3,016

 
2,418

 
3,821

Products and Systems:
 

 
 

 
 

 
 

Loss from operations
(892
)
 
(114
)
 
(1,340
)
 
(246
)
Severance costs

 
28

 

 
17

Acquisition-related expense (benefit), net

 

 

 

Loss before special items
(892
)
 
(86
)
 
(1,340
)
 
(229
)
Corporate and Eliminations:
 

 
 

 
 

 
 

Loss from operations
(6,047
)
 
(4,872
)
 
(12,763
)
 
(11,154
)
Acquisition-related expense (benefit), net
1

 
48

 
82

 
48

Loss before special items
(6,046
)
 
(4,824
)
 
(12,681
)
 
(11,106
)
Total Company
 

 
 

 
 

 
 

Income from operations
$
5,003

 
$
4,840

 
$
8,253

 
$
10,485

Legal settlement

 
6,320

 

 
6,320

Bad debt provision for a customer bankruptcy

 

 
1,200

 

Severance costs
377

 
673

 
406

 
727

Asset write-offs and lease terminations
123

 

 
123

 

Acquisition-related expense (benefit), net
202

 
(330
)
 
(341
)
 
(483
)
Income before special items
$
5,705

 
$
11,503

 
$
9,641

 
$
17,049

 

Three months
For the three months ended June 30, 2017, income from operations (GAAP) increased $0.2 million, or 3%, compared with the three months ended June 30, 2016, while income before special items (non-GAAP) decreased $5.8 million, or 50%. As a percentage of revenues, income before special items declined by 320 basis points to 3.3% in the three months ended June 30, 2017 from 6.5% in the three months ended June 30, 2016.
 
Operating expenses decreased $5.4 million during the three months ended June 30, 2017, driven primarily by the absence of a $6.3 million legal settlement that occurred during the three months ended June 30, 2016 (See Note 12).


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Six months
For the six months ended June 30, 2017, income from operations (GAAP) decreased $2.2 million, or 21% compared with the prior year, and income before special items (non-GAAP) decreased $7.4 million, or 43%. As a percentage of revenues, income before special items decreased by 200 basis points to 2.9% in the six months ended June 30, 2017 from 4.9% in the six months ended June 30, 2016.

Operating expenses decreased $3.8 million during the six months ended June 30, 2017, driven primarily by the absence of a $6.3 million legal settlement that occurred during the six months ended June 30, 2016 (See Note 12), offset in part by $1.5 million of additional operating expenses pertaining to Services segment acquisitions, and $1.3 million of Corporate segment expenses, primarily professional fees.

Interest Expense
 
Interest expense was approximately $1.0 million and $0.3 million for the three months ended June 30, 2017 and 2016, respectively, and $2.0 million and $1.4 million for the six months ended June 30, 2017 and 2016. The increase was due to borrowings from the Company's revolving line of credit under its Credit Agreement.