Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended November 30, 2013

 

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.  x 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).  x Yes  o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting 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)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

 

As of January 1, 2014, the registrant had 28,382,851 shares of common stock outstanding.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

 

PAGE

PART I—FINANCIAL INFORMATION

 

 

 

 

 

 

ITEM 1.

Financial Statements

1

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of November 30, 2013 (unaudited) and May 31, 2013

1

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Income for the three and six months ended November 30, 2013 and 2012

2

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and six months ended November 30, 2013 and 2012

3

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended November 30, 2013 and 2012

4

 

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

5

 

 

 

 

 

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

 

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

27

 

 

 

 

 

ITEM 4.

Controls and Procedures

28

 

 

 

 

PART II—OTHER INFORMATION

 

 

 

 

 

 

ITEM 1.

Legal Proceedings

29

 

 

 

 

 

ITEM 1.A.

Risk Factors

29

 

 

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

29

 

 

 

 

 

ITEM 3.

Defaults Upon Senior Securities

29

 

 

 

 

 

ITEM 4.

Mine Safety Disclosures

29

 

 

 

 

 

ITEM 5.

Other Information

29

 

 

 

 

 

ITEM 6.

Exhibits

29

 

 

 

 

SIGNATURES

31

 

i



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)

 

 

 

 

 

November 30, 2013

 

May 31, 2013

 

ASSETS 

 

 

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

16,240

 

$

7,802

 

Accounts receivable, net

 

122,418

 

108,554

 

Inventories

 

12,828

 

12,504

 

Deferred income taxes

 

2,647

 

2,621

 

Prepaid expenses and other current assets

 

10,940

 

8,156

 

Total current assets

 

165,073

 

139,637

 

Property, plant and equipment, net

 

70,517

 

68,419

 

Acquisition-related deposit

 

11,000

 

 

Intangible assets, net

 

49,282

 

51,992

 

Goodwill

 

118,679

 

115,270

 

Other assets

 

1,315

 

1,342

 

Total assets

 

$

415,866

 

$

376,660

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Accounts payable

 

$

11,273

 

$

8,490

 

Accrued expenses and other current liabilities

 

46,967

 

47,839

 

Current portion of long-term debt

 

7,899

 

7,418

 

Current portion of capital lease obligations

 

6,760

 

6,766

 

Income taxes payable

 

1,198

 

1,703

 

Total current liabilities

 

74,097

 

72,216

 

Long-term debt, net of current portion

 

70,799

 

52,849

 

Obligations under capital leases, net of current portion

 

10,728

 

10,923

 

Deferred income taxes

 

12,629

 

11,614

 

Other long-term liabilities

 

17,760

 

18,778

 

Total liabilities

 

186,013

 

166,380

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

Preferred stock, 10,000,000 shares authorized

 

 

 

Common stock, $0.01 par value, 200,000,000 shares authorized, 28,382,851 and 28,210,862 shares issued and outstanding as of November 30, 2013 and May 31, 2013, respectively

 

283

 

282

 

Additional paid-in capital

 

197,462

 

195,241

 

Retained earnings

 

33,880

 

18,982

 

Accumulated other comprehensive loss

 

(2,020

)

(4,452

)

Total Mistras Group, Inc. stockholders’ equity

 

229,605

 

210,053

 

Noncontrolling interests

 

248

 

227

 

Total equity

 

229,853

 

210,280

 

Total liabilities and equity

 

$

415,866

 

$

376,660

 

 

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

 

1



Table of Contents

 

Mistras Group, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Income
(in thousands, except per share data)

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenues:

 

 

 

 

 

 

 

 

 

Services

 

$

143,139

 

$

127,731

 

$

271,481

 

$

226,956

 

Products and systems

 

13,616

 

9,998

 

21,112

 

24,160

 

Total revenues

 

156,755

 

137,729

 

292,593

 

251,116

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Cost of services

 

98,860

 

87,044

 

187,484

 

157,560

 

Cost of products and systems sold

 

5,634

 

4,485

 

9,263

 

9,495

 

Depreciation related to services

 

4,026

 

4,124

 

8,076

 

8,100

 

Depreciation related to products and systems

 

258

 

171

 

516

 

339

 

Total cost of revenues

 

108,778

 

95,824

 

205,339

 

175,494

 

Gross profit

 

47,977

 

41,905

 

87,254

 

75,622

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

29,849

 

23,362

 

58,548

 

46,854

 

Research and engineering

 

786

 

530

 

1,429

 

1,047

 

Depreciation and amortization

 

2,501

 

2,167

 

4,958

 

4,062

 

Acquisition-related expense, net

 

(411

)

99

 

(2,508

)

206

 

Income from operations

 

15,252

 

15,747

 

24,827

 

23,453

 

Interest expense

 

772

 

816

 

1,517

 

1,576

 

Income before provision for income taxes

 

14,480

 

14,931

 

23,310

 

21,877

 

Provision for income taxes

 

5,196

 

5,745

 

8,391

 

8,400

 

Net income

 

9,284

 

9,186

 

14,919

 

13,477

 

Less: net income attributable to noncontrolling interests, net of taxes

 

(27

)

(23

)

(21

)

(33

)

Net income attributable to Mistras Group, Inc.

 

$

9,257

 

$

9,163

 

$

14,898

 

$

13,444

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.33

 

$

0.33

 

$

0.53

 

$

0.48

 

Diluted

 

$

0.32

 

$

0.32

 

$

0.51

 

$

0.46

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

28,378

 

28,144

 

28,309

 

28,094

 

Diluted

 

29,102

 

29,008

 

29,147

 

29,036

 

 

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

 

2



Table of Contents

 

Mistras Group, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income

(in thousands)

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net income

 

$

9,284

 

$

9,186

 

$

14,919

 

$

13,477

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income(loss), net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

2,697

 

1,517

 

2,432

 

(514

)

Comprehensive income

 

11,981

 

10,703

 

17,351

 

12,963

 

less: comprehensive income attributable to noncontrolling interest

 

(27

)

(23

)

(21

)

(33

)

Comprehensive income attributable to Mistras Group, Inc.

 

$

11,954

 

$

10,680

 

$

17,330

 

$

12,930

 

 

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

 

3



Table of Contents

 

Mistras Group, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)

 

 

 

Six months ended November 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

14,919

 

$

13,477

 

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

 

 

 

 

 

Depreciation and amortization

 

13,550

 

12,501

 

Deferred income taxes

 

695

 

713

 

Share-based compensation expense

 

2,747

 

3,206

 

Fair value adjustment to contingent consideration liabilities

 

(2,976

)

(657

)

Other

 

211

 

162

 

Changes in operating assets and liabilities, net of effect of acquisitions of businesses:

 

 

 

 

 

Accounts receivable

 

(12,498

)

6,207

 

Inventories

 

(265

)

1,460

 

Prepaid expenses and other current assets

 

(2,802

)

(651

)

Other assets

 

(22

)

655

 

Accounts payable

 

2,524

 

(4,535

)

Accrued expenses and other current liabilities

 

124

 

(6,971

)

Income taxes payable

 

(573

)

1,829

 

Net cash provided by operating activities

 

15,634

 

27,396

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Purchase of property, plant and equipment

 

(8,189

)

(5,223

)

Purchase of intangible assets

 

(275

)

(482

)

Acquisition of businesses, net of cash acquired

 

(1,507

)

(27,033

)

Proceeds from sale of equipment

 

734

 

435

 

Acquisition-related deposit

 

(11,000

)

 

Net cash used in investing activities

 

(20,237

)

(32,303

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Repayment of capital lease obligations

 

(3,757

)

(3,381

)

Repayment of long-term debt

 

(4,105

)

(2,966

)

Net borrowings against revolver

 

22,013

 

12,349

 

Payment of contingent consideration for business acquisitions

 

(500

)

(1,295

)

Taxes paid related to net share settlement of share-based awards

 

(1,005

)

(807

)

Excess tax benefit from share-based compensation

 

122

 

393

 

Proceeds from the exercise of stock options

 

362

 

351

 

Net cash provided by financing activities

 

13,130

 

4,644

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(89

)

(162

)

Net change in cash and cash equivalents

 

8,438

 

(425

)

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

7,802

 

8,410

 

End of period

 

$

16,240

 

$

7,985

 

Supplemental disclosure of cash paid

 

 

 

 

 

Interest

 

$

1,666

 

$

1,361

 

Income taxes

 

$

7,570

 

$

4,673

 

Noncash investing and financing

 

 

 

 

 

Equipment acquired through capital lease obligations

 

$

3,443

 

$

2,460

 

Issuance of notes payable and other debt obligations primarily related to acquisitions

 

$

 

$

7,715

 

 

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

 

4



Table of Contents

 

Mistras Group, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements

(tabular dollars in thousands, except per share data)

 

1.                                      Description of Business & 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) services, destructive testing services, and proprietary data analysis software to deliver a comprehensive portfolio of customized solutions, ranging from routine inspections to complex, and plant-wide asset integrity assessments. 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, aerospace and defense, fossil and nuclear power, alternative and renewable energy, public infrastructure, chemicals, transportation, primary metals and metalworking, pharmaceuticals and food processing industries.

 

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 May 31, 2014 and 2013. 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 consolidated financial statements contained in the Company’s Annual Report on Form 10-K (“Annual Report”) for fiscal 2013, as filed with the Securities and Exchange Commission on August 14, 2013.

 

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 noncontrolling interests are reported in stockholders’ equity in the accompanying consolidated balance sheets. The noncontrolling interests in operating results, net of tax, is classified separately in the accompanying consolidated statements of income.

 

All significant intercompany accounts and transactions have been eliminated in consolidation. The fiscal year for Mistras Group, Inc. and its subsidiaries end on May 31, except for the companies in the International segment, which end on April 30. Accordingly, the Company’s International segment subsidiaries are consolidated on a one-month lag. Therefore, in the fiscal quarter and year of acquisition, results of acquired subsidiaries in the International segment are generally included in consolidated results for one less month than the actual number of months from the acquisition date to the end of the reporting period. Management does not believe that any events occurred during the one-month lag period that would have a material effect on the Company’s consolidated financial statements as of or for any period presented.

 

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. For the three and six months ended November 30, 2012, the Company reclassified $0.3 million and $0.5 million, respectively, related to interest accretion imputed on its acquisition related contingent consideration liabilities from interest expense to acquisition-related expense, net, which is a component of income from operations. See Note 4 — Acquisitions for further discussion with regards to acquisition-related expense, net.

 

5



Table of Contents

 

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

 

Significant Accounting Policies

 

Our significant accounting policies are disclosed in Note 2 — Summary of Significant Accounting Policies in our Annual Report. On an ongoing basis, we evaluate our 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 our Annual Report, there have been no material changes to our significant accounting policies.

 

Recent Accounting Pronouncements

 

In February 2013, the FASB issued Accounting Standard Update (ASU) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which expands the disclosure requirements for amounts reclassified out of accumulated other comprehensive income. The update does not change the current requirements for reporting net income or other comprehensive income in financial statements and is effective for annual and interim reporting periods beginning after December 15, 2012. The adoption of this pronouncement did not have a material impact on the Company’s consolidated financial statements. Other recently issued accounting pronouncements did not, or are not believed by management to likely have a material impact on the Company’s current or future consolidated financial statements.

 

2.                                      Share-Based Compensation

 

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

 

For the three months ended November 30, 2013 and 2012, the Company recognized share-based compensation expense related to stock option awards of less than $0.1 million and $0.8 million, respectively. For the six months ended November 30, 2013 and 2012, the Company recognized share-based compensation expense related to stock option awards of $0.7 and $1.6 million, respectively. As of November 30, 2013, there was less than $0.1 million of unrecognized compensation costs, net of estimated forfeitures, related to stock option awards, which are expected to be recognized over a remaining weighted average period of 1.9 years. Cash proceeds from, and the aggregate intrinsic value of, stock options exercised during the three and six months ended November 30, 2013 and 2012 were as follows:

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Cash proceeds from options exercised

 

$

59

 

$

252

 

$

362

 

$

351

 

Aggregate intrinsic value of options exercised

 

$

51

 

$

359

 

$

377

 

$

485

 

 

No stock options were granted during the six months ended November 30, 2013 and 2012.

 

The Company also recognized approximately $1.1 million and $0.8 million during the three months ended November 30, 2013 and 2012, respectively, in share-based compensation expense related to restricted stock unit awards. For the six months ended November 30, 2013 and 2012, the Company recognized share-based compensation expense related to restricted stock unit awards of $1.9 million and $1.6 million, respectively. As of November 30, 2013, there was approximately $10.5 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 2.8 years.

 

6



Table of Contents

 

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

 

During the first quarters of fiscal 2014 and 2013, the Company granted approximately 10,000 and 13,000 shares 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 approximately $0.2 million and $0.3 million, respectively, which was recorded as share-based compensation expense during the six months ended November 30, 2013 and 2012.

 

During the first six months of fiscal 2014 and 2013 respectively, approximately 178,000 and 123,000 restricted stock units vested. The fair value of these units was $3.3 million and $1.9 million, respectively. 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. The restricted stock units that vested in the first six months of fiscal 2014 and 2013 were net-share settled such that the Company withheld approximately 55,000 and 37,000 shares, respectively, having value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The shares withheld were based on the value of the restricted stock units on their vesting date as determined by the Company’s closing stock price. Payments to taxing authorities for employees’ tax obligations for the six month periods ended November 30, 2013 and 2012 totaled $1.0 million and $0.8 million, respectively, and are reflected as a financing activity within the condensed consolidated statements of cash flows. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company.

 

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) only 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 November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income attributable to Mistras Group, Inc.

 

$

9,257

 

$

9,163

 

$

14,898

 

$

13,444

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

28,378

 

28,144

 

28,309

 

28,094

 

Basic earnings per share

 

$

0.33

 

$

0.33

 

$

0.53

 

$

0.48

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income attributable to Mistras Group, Inc.

 

$

9,257

 

$

9,163

 

$

14,898

 

$

13,444

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

28,378

 

28,144

 

28,309

 

28,094

 

Dilutive effect of stock options outstanding

 

697

 

789

 

702

 

798

 

Dilutive effect of restricted stock units outstanding

 

27

 

75

 

136

 

144

 

 

 

29,102

 

29,008

 

29,147

 

29,036

 

Diluted earnings per share

 

$

0.32

 

$

0.32

 

$

0.51

 

$

0.46

 

 

4.                                      Acquisitions

 

In the second quarter of fiscal 2014, the Company completed an acquisition of a professional engineering consulting and technical training services company serving the hydrocarbon processing and other energy-related industries. This company was acquired to complement service offerings within the Company’s Services segment and expand its technical capabilities. The Company acquired 100% of the common stock in exchange for $1.5 million in cash.

 

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Table of Contents

 

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

 

The assets and liabilities of the acquired business were included in the Company’s 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, both tangible and intangible, and liabilities acquired. This valuation and the related purchase price allocation is expected to be finalized prior to the end of fiscal 2014. The results of operations for this acquisition are included in the Services segment’s results of operations from the date of acquisition. The Company’s preliminary allocation of purchase price for this acquisition is included in the table below, which summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

 

Consideration transferred:

 

 

 

Cash paid

 

$

1,500

 

Consideration transferred

 

1,500

 

 

 

 

 

Current liabilities acquired

 

(174

)

Property, plant and equipment

 

5

 

Deferred tax asset

 

107

 

Intangibles

 

99

 

Goodwill

 

1,463

 

Net assets acquired

 

$

1,500

 

 

The amortization period of intangible assets acquired ranges from 3 to 5 years. The Company recorded approximately $1.5 million of goodwill in connection with this acquisition, reflecting the strategic fit and revenue and earnings growth potential of this business.

 

Revenues and operating income from this acquisition for the period subsequent to the closing of the transaction were approximately $0.5 million and $0.0 million, respectively, for the three and six month periods ended November 30, 2013. This acquisition is not significant and no pro forma financial information has been included in this report.

 

During the three and six month periods ended November 30, 2013, the Company incurred acquisition-related costs of $0.4 million and $0.5 million, respectively, in connection with due diligence, professional fees, and other expenses related to the completed acquisition as well as its other acquisition activity. Additionally, the Company adjusted the fair value of certain previously recorded acquisition-related contingent consideration liabilities. For the three and six month periods ended November 30, 2013, these adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of approximately $0.8 million and $3.0 million, respectively. The Company’s aggregate acquisition-related contingent consideration liabilities were approximately $12.0 million and $15.4 million as of November 30, 2013 and May 31, 2013, respectively.

 

During the three and six month periods ended November 30, 2012, the Company incurred acquisition-related costs of $0.2 million and $0.9 million in connection with due diligence, professional fees, and other expenses for its acquisition activity. Additionally, the Company adjusted the fair value of certain acquisition-related contingent consideration liabilities. For the three and six month periods ended November 30, 2012, these adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of approximately $0.1 million and $0.7 million, respectively.

 

The fair value adjustments to acquisition-related contingent consideration liabilities and the acquisition-related transaction costs have been classified as acquisition-related expense-net in the condensed consolidated statements of income for the three and six month periods ended November 30, 2013 and 2012.

 

5.                                      Accounts Receivable, net

 

Accounts receivable consist of the following:

 

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Table of Contents

 

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

 

 

 

November 30, 2013

 

May 31, 2013

 

 

 

 

 

 

 

Trade accounts receivable

 

$

124,623

 

$

110,438

 

Allowance for doubtful accounts

 

(2,205

)

(1,884

)

Total

 

$

122,418

 

$

108,554

 

 

6.                                      Inventories

 

Inventories consist of the following:

 

 

 

November 30, 2013

 

May 31, 2013

 

 

 

 

 

 

 

Raw materials

 

$

3,326

 

$

3,332

 

Work in process

 

2,206

 

2,310

 

Finished goods

 

4,039

 

4,355

 

Services-related consumable supplies

 

3,257

 

2,507

 

Total

 

$

12,828

 

$

12,504

 

 

7.                                      Property, Plant and Equipment, net

 

Property, plant and equipment consist of the following:

 

 

 

Useful Life
(Years)

 

November 30, 2013

 

May 31, 2013

 

Land

 

 

 

$

1,945

 

$

1,943

 

Buildings and improvements

 

30-40

 

22,458

 

20,973

 

Office furniture and equipment

 

5-8

 

6,625

 

5,543

 

Machinery and equipment

 

5-7

 

129,543

 

121,563

 

 

 

 

 

160,571

 

150,022

 

Accumulated depreciation and amortization

 

 

 

(90,054

)

(81,603

)

Property, plant and equipment, net

 

 

 

$

70,517

 

$

68,419

 

 

Depreciation expense for each of the three month periods ended November 30, 2013 and 2012 was approximately $4.6 million. Depreciation expense for the six months ended November 30, 2013 and 2012 was approximately $9.2 million and $9.0 million, respectively.

 

8.                                      Intangible Assets

 

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

 

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Table of Contents

 

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

 

 

 

 

 

November 30, 2013

 

May 31, 2013

 

 

 

Useful Life
(Years)

 

Gross
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

5-13

 

$

71,109

 

$

(30,861

)

$

40,248

 

$

69,901

 

$

(27,422

)

$

42,479

 

Software/Technology

 

3-15

 

14,852

 

(8,380

)

6,472

 

14,336

 

(7,629

)

6,707

 

Covenants not to compete

 

2-5

 

8,085

 

(7,643

)

442

 

8,069

 

(7,523

)

546

 

Other

 

2-5

 

5,357

 

(3,237

)

2,120

 

5,195

 

(2,935

)

2,260

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

99,403

 

$

(50,121

)

$

49,282

 

$

97,501

 

$

(45,509

)

$

51,992

 

 

Amortization expense for the three months ended November 30, 2013 and 2012 was approximately $2.2 million and $1.9 million, respectively. Amortization expense for the six months ended November 30, 2013 and 2012 was approximately $4.3 million and $3.5 million, respectively.

 

9.                                      Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consist of the following:

 

 

 

November 30, 2013

 

May 31, 2013

 

 

 

 

 

 

 

Accrued salaries, wages and related employee benefits

 

$

23,610

 

$

23,662

 

Contingent consideration, current portion

 

2,191

 

5,144

 

Accrued workers’ compensation and health benefits

 

3,823

 

3,667

 

Deferred revenue

 

1,836

 

2,623

 

Other accrued expenses

 

15,507

 

12,743

 

Total

 

$

46,967

 

$

47,839

 

 

10.                               Long-Term Debt

 

Long-term debt consists of the following:

 

 

 

November 30, 2013

 

May 31, 2013

 

 

 

 

 

 

 

Senior credit facility

 

$

61,581

 

$

39,567

 

Notes payable

 

11,210

 

15,740

 

Other

 

5,907

 

4,960

 

Total debt

 

78,698

 

60,267

 

Less: Current portion

 

(7,899

)

(7,418

)

Long-term debt, net of current portion

 

$

70,799

 

$

52,849

 

 

Senior Credit Facility

 

The Company’s credit agreement has a maturity date of December 20, 2016. The credit agreement provides the company with a $125.0 million revolving line of credit, which, under certain circumstances, can be increased to $150.0 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. As of November 30, 2013, there were outstanding borrowings of $61.6 million and a total of $3.6 million of outstanding letters of credit under the revolving credit facility.

 

Loans under the credit agreement bear interest at LIBOR plus an applicable LIBOR margin ranging from 1% to 2%, or a base rate less a margin of 0.25% to 1.25%, at the option of the Company, or based upon the Company’s Funded Debt

 

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Table of Contents

 

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

 

Leverage Ratio. Funded Debt Leverage Ratio is generally 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 defined in the agreement as (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) share-based compensation expense, less (g) cash expense related to share-based 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 2.5 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 if the Funded Debt Leverage Ratio exceeds 3.0 to 1. 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 less than 3.0 to 1 and an Interest Coverage Ratio of at least 3.0 to 1. Interest Coverage Ratio means 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 its 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 November 30, 2013, the Company was in compliance with the terms of the credit agreement, and it will continuously monitor its compliance with its covenants.

 

Notes Payable and Other

 

In connection with acquisitions through end of fiscal 2013, the Company issued subordinated notes payable to the sellers. The maturity of these notes range from three to five years from the date of acquisition, with stated interest rates ranging from 0% to 4%. The Company has discounted these obligations to reflect a 2% to 4% market interest rate. Unamortized discount on the notes was de minimis as of November 30, 2013 and May 31, 2013. Amortization is recorded as interest expense in the condensed consolidated statement of income.

 

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 issues of debt.

 

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. 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:

 

Level 1 — Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

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Table of Contents

 

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

 

Level 2 — Observable inputs other than quoted prices included in Level 1, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability and inputs derived principally from or corroborated by observable market data.

 

Level 3 — Unobservable inputs reflecting the Company’s own assumptions about inputs that market participants would use in pricing the asset or liability based on the best information available.

 

In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial liabilities that are required to be remeasured at fair value on a recurring basis:

 

 

 

November 30, 2013

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Contingent consideration

 

$

 

$

 

$

11,970

 

$

11,970

 

Total Liabilities

 

$

 

$

 

$

11,970

 

$

11,970

 

 

 

 

May 31, 2013

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Contingent consideration

 

$

 

$

 

$

15,438

 

$

15,438

 

Total Liabilities

 

$

 

$

 

$

15,438

 

$

15,438

 

 

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

 

Litigation

 

The Company is subject to lawsuits, investigations and claims that arise in the ordinary course of business. Although the Company cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against it, the Company believes that, except for the matters discussed below, the reasonably possible range of loss for all other pending legal proceeding to which the Company is a party in the aggregate is immaterial. The costs of defense and amounts that may be paid in such matters may be covered by insurance.

 

In January 2012, the Company received notice of a governmental investigation concerning an environmental incident which occurred in February 2011 outside of the premises of its Cudahy, California location. No human injury or property damage was reported or appears to have been caused as a result of this incident. While management cannot predict the ultimate outcome of this matter, based on its internal investigation to date, the Company does not believe the outcome will have a material effect on its financial condition or results of operations.

 

During fiscal 2013, the Company performed radiography work on the construction of a pipeline project in Georgia. The Company has received notice that the pipeline project owner contends that certain of the x-ray images the Company’s technicians prepared regarding

 

12



Table of Contents

 

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

 

the project did not meet the code quality interpretation standards required by API (American Petroleum Institute) 1104. The project owner is claiming damages as a result of the alleged quality defects of the Company’s x-ray images. No lawsuit has yet to be filed in this matter. At the present time, the Company is 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.

 

Acquisition-related contingencies

 

The Company is liable for contingent consideration in connection with certain of its acquisitions. Using information available as of November, 30 2013, estimated potential acquisition-related contingent consideration ranged from zero to approximately $25.6 million and would be payable upon the achievement of specific performance metrics by certain of the acquired companies over the next five years of operations. See Note 4 - Acquisitions and Note 10 — Long-Term Debt to these consolidated financial statements for further discussion of the Company’s acquisitions.

 

13.                               Subsequent Event

 

Subsequent to November 30, 2013, the Company completed the acquisition of an asset protection business located in Texas to continue its market expansion strategy. The Company’s initial cash payment for this acquisition was $11.0 million and is presented as acquisition-related deposit on the condensed consolidated balance sheet. In addition to the initial cash payment, the agreement provides for up to $4.0 million in contingent consideration which may be earned based upon the acquired company achieving specific performance metrics over the next three years of operation. The Company is in the process of completing the preliminary purchase price allocation. This acquisition is not significant and no pro forma financial information has been included in this report.

 

14.                               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 services that are used to evaluate 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.

 

·                  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.

 

Allocations for general corporate services, including accounting, audit, and contract management, 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.

 

The accounting policies of the reportable segments are the same as those described in Note 1 — Description of Business and Basis of Presentation. Segment income from operations is determined based on internal performance measures used by the Chief Executive Officer, who is the chief operating decision maker, to assess the performance of each business in a given period and to make decisions as to resource allocations. In connection with that assessment, the Chief Executive Officer may exclude matters such as charges for share-based compensation and certain other acquisition-related charges and balances, technology and product development costs, certain gains and losses from dispositions, and litigation settlements or other charges. Certain general and administrative costs such as human resources, information technology and training are allocated to the segments. Segment income from operations also excludes

 

13



Table of Contents

 

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

 

interest and other financial charges and income taxes. Corporate and other assets are comprised principally of cash, deposits, property, plant and equipment, domestic deferred taxes, deferred charges and other assets. Corporate loss from operations consists of depreciation on the corporate office facilities and equipment, administrative charges related to corporate personnel and other charges that cannot be readily identified for allocation to a particular segment.

 

Selected consolidated financial information by segment for the periods shown was as follows:

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenues

 

 

 

 

 

 

 

 

 

Services

 

$

108,862

 

$

105,213

 

$

204,672

 

$

187,610

 

International

 

43,209

 

26,777

 

80,968

 

51,206

 

Products and Systems

 

8,604

 

8,439

 

15,189

 

17,973

 

Corporate and eliminations

 

(3,920

)

(2,700

)

(8,236

)

(5,673

)

 

 

$

156,755

 

$

137,729

 

$

292,593

 

$

251,116

 

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Gross profit

 

 

 

 

 

 

 

 

 

Services

 

$

30,918

 

$

30,692

 

$

57,665

 

$

51,632

 

International

 

13,293

 

7,299

 

23,413

 

14,380

 

Products and Systems

 

3,718

 

3,975

 

6,102

 

9,220

 

Corporate and eliminations

 

48

 

(61

)

74

 

390

 

 

 

$

47,977

 

$

41,905

 

$

87,254

 

$

75,622

 

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Income from operations

 

 

 

 

 

 

 

 

 

Services

 

$

14,400

 

$

15,801

 

$

25,246

 

$

22,567

 

International

 

7,293

 

1,280

 

9,108

 

2,871

 

Products and Systems

 

469

 

1,703

 

1,060

 

4,783

 

Corporate and eliminations

 

(6,910

)

(3,037

)

(10,587

)

(6,768

)

 

 

$

15,252

 

$

15,747

 

$

24,827

 

$

23,453

 

 

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

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Depreciation and amortization

 

 

 

 

 

 

 

 

 

Services

 

$

4,156

 

$

4,579

 

$

8,391

 

$

9,103

 

International

 

1,983

 

1,412

 

3,905

 

2,459

 

Products and Systems

 

583

 

488

 

1,166

 

979

 

Corporate and eliminations

 

63

 

(17

)

88

 

(40

)

 

 

$

6,785

 

$

6,462

 

$

13,550

 

$

12,501

 

 

14



Table of Contents

 

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

 

 

 

November 30, 2013

 

May 31, 2013

 

Intangible assets, net

 

 

 

 

 

Services

 

$

12,563

 

$

14,527

 

International

 

27,487

 

27,520

 

Products and Systems

 

8,950

 

9,600

 

Corporate and eliminations

 

282

 

345

 

 

 

$

49,282

 

$

51,992

 

 

 

 

November 30, 2013

 

May 31, 2013

 

Total assets

 

 

 

 

 

Services

 

$

210,181

 

$

200,326

 

International

 

149,534

 

138,108

 

Products and Systems

 

37,221

 

37,948

 

Corporate and eliminations

 

18,930

 

278

 

 

 

$

415,866

 

$

376,660

 

 

 

 

November 30, 2013

 

May 31, 2013

 

Goodwill

 

 

 

 

 

Services

 

$

62,542

 

$

61,285

 

International

 

42,941

 

40,788

 

Products and Systems

 

13,196

 

13,197

 

 

 

$

118,679

 

$

115,270

 

 

Revenues by geographic area for the three and six months ended November 30, 2013 and 2012, respectively, were as follows:

 

 

 

Three months ended November 30,

 

Six months ended November 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenues

 

 

 

 

 

 

 

 

 

United States

 

$

99,497

 

$

95,560

 

$

182,654

 

$

171,835

 

Other Americas

 

13,752

 

16,141

 

27,172

 

27,929

 

Europe

 

37,399

 

22,231

 

72,805

 

38,908

 

Asia-Pacific

 

6,107

 

3,797

 

9,962

 

12,444

 

 

 

$

156,755

 

$

137,729

 

$

292,593

 

$

251,116

 

 

15



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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 November 30, 2013 and 2012. 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 Annual Report on Form 10-K for fiscal 2013 (“2013 Annual 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, 2014 is referred to as “fiscal 2014”), and 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

·                  Consolidated 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 (Securities Act), 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,” 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, unknown risks, uncertainties or other factors. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed elsewhere in this Report in Part II, Item 1A “Risk Factors” and in “Business—Forward-Looking Statements,” and “Risk Factors” sections of our 2013 Annual Report as well as those discussed in our other Securities and Exchange Commission (SEC) filings.

 

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) and predictive maintenance (PdM) services, proprietary data analysis and enterprise inspection warehousing software 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 primarily in North America with the largest concentration in the United States and a rapidly expanding Canadian services business, consisting primarily of non-destructive testing and inspection services that are used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure.

 

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·                  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 helping to ensure the safe and efficient operation of infrastructure, we have historically provided 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), aerospace and defense, fossil and nuclear power, alternative and renewable energy, public infrastructure, chemicals, transportation, primary metals and metalworking, pharmaceuticals and food processing industries.

 

For the last several years, 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. During this period, the demand for outsourced asset protection solutions, in general, has increased, creating demand from which our entire industry has benefited. We believe continued growth can be realized in all of our target markets. Concurrent with this growth, we have worked to build our infrastructure to profitably absorb additional growth and have made a number of acquisitions in an effort to leverage our fixed costs, grow our base of experienced, certified personnel, expand our product and technical capabilities and increase our geographical reach.

 

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.

 

The global economy has shown some signs of improvement, but continues to be fragile. Global financial markets continue to experience uncertainty, including tight liquidity and credit availability, relatively low consumer confidence, slow economic growth, high unemployment rates, volatile currency exchange rates and continued uncertainty about economic stability. However, we believe these conditions have allowed us to capitalize on an opportunity to selectively hire new talented individuals that otherwise might not have been available to us, to acquire and develop new technologies in order to aggressively expand our proprietary portfolio of customized solutions, and to make acquisitions of complementary businesses at reasonable valuations.

 

Consolidated Results of Operations

 

Three months ended November 30, 2013 compared to the three months ended November 30, 2012

 

Our consolidated results of operations for the three months ended November 30, 2013 and 2012 were as follows:

 

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Three months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

 

 

 

 

 

 

Revenues

 

$

156,755

 

$

137,729

 

Gross profit

 

47,977

 

41,905

 

Gross profit as a % of Revenue

 

31

%

30

%

Total operating expenses

 

32,725

 

26,158

 

Operating expenses as a % of Revenue

 

21

%

19

%

Income from operations

 

15,252

 

15,747

 

Income from Operations as a % of Revenue

 

10

%

11

%

Interest expense

 

772

 

816

 

Income before provision for income taxes

 

14,480

 

14,931

 

Provision for income taxes

 

5,196

 

5,745

 

Net income

 

9,284

 

9,186

 

Less: net income attributable to noncontrolling interests, net of taxes

 

(27

)

(23

)

Net income attributable to Mistras Group, Inc.

 

$

9,257

 

$

9,163

 

 

Our EBITDA and Adjusted EBITDA, non-GAAP measures explained below, for the three months ended November 30, 2013 and 2012 were as follows:

 

 

 

Three months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

EBITDA and Adjusted EBITDA data

 

 

 

 

 

Net income

 

$

9,284

 

$

9,186

 

Less: net income attributable to noncontrolling interests, net of taxes

 

(27

)

(23

)

Net income attributable to Mistras Group, Inc.

 

$

9,257

 

$

9,163

 

Interest expense

 

772

 

816

 

Provision for income taxes

 

5,196

 

5,745

 

Depreciation and amortization

 

6,785

 

6,462

 

EBITDA

 

$

22,010

 

$

22,186

 

Share-based compensation expense

 

1,040

 

1,572

 

Acquisition-related expense, net

 

(411

)

99

 

Adjusted EBITDA

 

$

22,639

 

$

23,857

 

 

Note About Non-GAAP Measures

 

EBITDA and Adjusted EBITDA are performance measures used by management that are not calculated in accordance with U.S. generally accepted accounting principles (GAAP). EBITDA is defined in this Quarterly Report as net income attributable to Mistras Group, Inc. plus: interest expense, provision for income taxes and depreciation and amortization. Adjusted EBITDA is defined in this Quarterly Report as net income attributable to Mistras Group, Inc. plus: interest expense, provision for income taxes, depreciation and amortization, share-based compensation expense, and, if applicable, certain acquisition-related expense (including adjustments to the fair value of contingent consideration) and certain non-recurring items (which items are in the reconciliation table above if applicable).

 

Our management uses EBITDA and Adjusted EBITDA as a measure of operating performance to assist in comparing performance from period to period on a consistent basis, as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations. Adjusted EBITDA is also used as a performance evaluation metric for our executive and employee incentive compensation programs.

 

Later in this report, the non-GAAP financial performance measures “Segment and Total Company Income from Operations before Acquisition-Related Expense (Benefit), net” is used, with tables reconciling the measures to financial measures under GAAP.  These non-GAAP measures exclude from the GAAP measures income from operations (a) transaction expenses related to acquisitions, such as professional fees and due diligence costs and (b) the net changes in the fair value of acquisition-related contingent consideration liabilities.  These items have been excluded from the GAAP measures because these expenses and credits are not related to the Company’s or Segment’s core business operations and are related solely to the Company’s or Segment’s acquisition activities.  Changes in the fair value of acquisition-related contingent consideration liabilities can be a net expense or credit in any given period, and fluctuate based upon the then current value of cash consideration the Company expects to pay in the future for prior acquisitions, without impacting cash generated from the Company’s business operations.

 

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We believe investors and other users of our financial statements benefit from the presentation of EBITDA, Adjusted EBITDA and “Segment and Total Company Income from Operations before Acquisition-Related Expense (Benefit), net” in evaluating our operating performance because it provides additional tools to compare our operating performance on a consistent basis and measure underlying trends and results in our business. EBITDA and Adjusted EBITDA remove the impact of certain items that management believes do not directly reflect our core operations. For instance, Adjusted EBITDA generally excludes interest expense, taxes and depreciation and amortization, each of which can vary substantially from company to company depending upon accounting methods and the book value and age of assets, capital structure, capital investment cycles and the method by which assets were acquired. It also eliminates share-based compensation, which is a non-cash expense and is excluded by management when evaluating the underlying performance of our business operations. Similarly, we believe that Segment and Total Company Income from Operations before Acquisition-Related Expense (Benefit), net, provides investors with useful information and more meaningful period over period comparisons by identifying and excluding these acquisition-related costs so that the performance of the core business operations can be identified and compared.

 

While Adjusted EBITDA is a term and financial measurement commonly used by investors and securities analysts, it has limitations. As a non-GAAP measurement, Adjusted EBITDA has no standard meaning and, therefore, may not be comparable with similar measurements for other companies. Adjusted EBITDA is generally limited as an analytical tool because it excludes charges and expenses we do incur as part of our operations. For example, Adjusted EBITDA excludes income taxes, but we generally incur significant U.S. federal, state and foreign income taxes each year and the provision for income taxes is a necessary cost. EBITDA and Adjusted EBITDA should not be considered in isolation or as a substitute for analyzing our results as reported under U.S. GAAP. In addition, acquisitions are a part of our growth strategy, and therefore acquisition-related items are a necessary cost of the Company’s business. Segment and Total Company Income from Operations before Acquisition-Related Expense (Benefit), net, are not metrics used to determine incentive compensation for executives or employees.

 

Revenues were $156.8 million for the three months ended November 30, 2013 compared to $137.7 million for the three months ended November 30, 2012. Revenues by segment for the second quarter of fiscal 2014 and 2013 were as follows:

 

 

 

Three months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Revenues

 

 

 

 

 

Services

 

$

108,862

 

$

105,213

 

International

 

43,209

 

26,777

 

Products and Systems

 

8,604

 

8,439

 

Corporate and eliminations

 

(3,920

)

(2,700

)

 

 

$

156,755

 

$

137,729

 

 

Our growth rates for the second quarter of fiscal 2014 and 2013 were as follows:

 

 

 

Three months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Revenue growth

 

$

19,026

 

$

23,509

 

% Growth over prior year

 

13.8%

 

20.6%

 

 

 

 

 

 

 

Comprised of:

 

 

 

 

 

% of organic growth

 

4.3%

 

1.6%

 

% of acquisition growth

 

9.4%

 

19.4%

 

% foreign exchange increase (decrease)

 

0.1%

 

(0.4)%

 

 

 

13.8%

 

20.6%

 

 

Revenues for the three months ended November 30, 2013 experienced year-on-year growth of $19.0 million, or 13.8%, fueled by growth from acquisitions of approximately 9% and organic growth of approximately 4%. Acquisitions contributed approximately 19% of the Company’s 20.6% year-on-year revenue growth generated in the second quarter of fiscal 2013, while organic growth contributed approximately 2%.

 

Revenue growth was experienced primarily in our International and Services segments. The Company’s 61% year-on-year

 

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growth in International revenue was driven primarily by acquisition, as the Company acquired its German subsidiary during the second quarter of the prior fiscal year. The remainder of the International increase was driven by organic growth of 17%. The 3.5% increase in Services segment revenues was driven by organic growth of 2.2% and acquisition growth of approximately 1%.

 

The Company continued to experience year-on-year growth in its key vertical markets during the second quarter of fiscal 2014. Oil and gas revenues grew by approximately 5% and remained the Company’s most significant vertical market, but saw its proportion decline to 48% of total Company revenues compared with 52% in the second quarter of fiscal 2013. This decline was driven primarily by acquisition-driven growth from the Company’s German subsidiary which was acquired during fiscal 2013 and has a high concentration of aerospace customers. The Company’s aerospace revenues increased to nearly 12% of total revenues, compared with approximately 6% in the prior year’s second quarter. The Company’s top ten customers comprised approximately 36% of total revenues in the second quarter of fiscal 2014 compared with 32% in the second quarter of the prior fiscal year.

 

Gross Profit increased by $6.1 million, or 14%, to $48.0 million in the second quarter of fiscal 2014, compared with $41.9 million in the second quarter of fiscal 2013. Gross profit by segment for the three months ended November 30, 2013 and 2012 was as follows:

 

 

 

Three months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Gross profit

 

 

 

 

 

Services

 

$

30,918

 

$

30,692

 

International

 

13,293

 

7,299

 

Products and Systems

 

3,718

 

3,975

 

Corporate and eliminations

 

48

 

(61

)

 

 

$

47,977

 

$

41,905

 

 

As a percentage of revenues, gross profit was 30.6% and 30.4% for the second quarters of fiscal 2014 and 2013, respectively. The increase in gross profit percentage was primarily attributable to improved margins in the International segment, which saw gross margins increase to 30.8% in the second quarter of fiscal 2014 compared with 27.3% in the prior year. The improvement in International margins was driven by an increase in higher margin product sales in the U.K., Russia and France, as well as an improvement in utilization of personnel performing services. Gross profit margin for the Services segment improved sequentially to 28.4% compared with 27.9% generated in the first quarter of fiscal 2014, but was lower than gross profit margin of 29.2% in the second quarter of fiscal 2013. The decline from prior year was primarily the result of additional costs incurred by the Company in anticipation of growth in its Canadian business, as well as the timing of fringe benefit costs incurred, including medical costs. As in the first quarter of fiscal 2014, the Products and Systems segment continued to experience lower gross margins due to an adverse sales mix compared with prior year.

 

Income from Operations

 

The following table shows a reconciliation of the segment and total Company income from operations before acquisition-related expense (benefit), net, to income from operations:

 

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Three months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Services:

 

 

 

 

 

Income from operations before acquisition-related expense, net

 

$

14,387

 

$

16,284

 

Acquisition-related expense (benefit), net

 

(13

)

483

 

Income from operations

 

14,400

 

15,801

 

 

 

 

 

 

 

International:

 

 

 

 

 

Income from operations before acquisition-related expense, net

 

$

3,992

 

$

1,343

 

Acquisition-related expense (benefit), net

 

(3,301

)

63

 

Income from operations

 

7,293

 

1,280

 

 

 

 

 

 

 

Products and Systems:

 

 

 

 

 

Income from operations before acquisition-related expense, net

 

$

450

 

$

1,088

 

Acquisition-related (benefit), net

 

(19

)

(615

)

Income from operations

 

469

 

1,703

 

 

 

 

 

 

 

Corporate and Eliminations:

 

 

 

 

 

Income from operations before acquisition-related (benefit), net

 

$

(3,988

)

$

(2,869

)

Acquisition-related expense, net

 

2,922

 

168

 

Income from operations

 

(6,910

)

(3,037

)

 

 

 

 

 

 

Total Company

 

 

 

 

 

Income from operations before acquisition-related expense, net

 

$

14,841

 

$

15,846

 

Acquisition-related expense (benefit), net

 

 

(411

)

 

99

 

Income from operations

 

 

15,252

 

 

15,747

 

 

Income from operations of $15.3 million for the second quarter of fiscal 2014 decreased $0.5 million, or approximately 3%, compared with the second quarter of fiscal 2013. As a percentage of revenues, income from operations was 9.7% and 11.4% for the second quarters of fiscal 2014 and fiscal 2013, respectively.

 

Operating expenses increased by $6.6 million, or 25%, compared with the prior year’s second quarter, and by $7.1 million, or 27%, excluding acquisition-related items. The primary driver to this increase was the impact from the acquisition of the Company’s German subsidiary in the second quarter of fiscal 2013, which added $3.2 million of year-on-year impact. The Services segment incurred a year-on-year operating expense increase of $2.1 million, or 15%, exclusive of acquisition-related charges, driven primarily by increases in headcount and facility-related costs incurred to grow its business in Canada and in the United States. Corporate operating expenses increased by $1.2 million, or 44%, exclusive of acquisition-related charges, compared to the prior year, driven primarily by the timing of insurance and recruiting costs.

 

Interest Expense. Interest expense was approximately $0.8 million for each of the second quarters of fiscal 2014 and 2013, respectively.

 

Income Taxes. The Company’s effective income tax rate was approximately 36% and 38% for the three months ended November 30, 2013 and November 30, 2012, respectively. The decrease was primarily due to the greater proportion of income from various foreign jurisdictions that carry lower tax rates.

 

Six months ended November 30, 2013 compared to the six months ended November 30, 2012

 

Our consolidated results of operations for the six months ended November 30, 2013 and 2012 were as follows:

 

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Six months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

 

 

 

 

 

 

Revenues

 

$

292,593

 

$

251,116

 

Gross profit

 

87,254

 

75,622

 

Gross profit as a % of Revenue

 

30

%

30

%

Total operating expenses

 

62,427

 

52,169

 

Operating expenses as a % of Revenue

 

21

%

21

%

Income from operations

 

24,827

 

23,453

 

Income from Operations as a % of Revenue

 

8

%

9

%

Interest expense

 

1,517

 

1,576

 

Income before provision for income taxes

 

23,310

 

21,877

 

Provision for income taxes

 

8,391

 

8,400

 

Net income

 

14,919

 

13,477

 

Less: net income attributable to noncontrolling interests, net of taxes

 

(21

)

(33

)

Net income attributable to Mistras Group, Inc.

 

$

14,898

 

$

13,444

 

 

Our EBITDA and Adjusted EBITDA (non-GAAP measures explained earlier under the consolidated results of operations for the three months ended November 30, 2013 and 2012), for the six months ended November 30, 2013 and 2012, were as follows:

 

 

 

Six months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

EBITDA and Adjusted EBITDA data

 

 

 

 

 

Net income

 

$

14,919

 

$

13,477

 

Less: net income attributable to noncontrolling interests, net of taxes

 

(21

)

(33

)

Net income attributable to Mistras Group, Inc.

 

$

14,898

 

$

13,444

 

Interest expense

 

1,517

 

1,576

 

Provision for income taxes

 

8,391

 

8,400

 

Depreciation and amortization

 

13,550

 

12,501

 

EBITDA

 

$

38,356

 

$

35,921

 

Share-based compensation expense

 

2,747

 

3,206

 

Acquisition-related expense, net

 

(2,508

)

206

 

Adjusted EBITDA

 

$

38,595

 

$

39,333

 

 

Revenues were $292.6 million for the six months ended November 30, 2013 compared to $251.1 million for the six months ended November 30, 2012. Revenues by segment for the six months ended November 30, 2013 and 2012 were as follows:

 

 

 

Six months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Revenues

 

 

 

 

 

Services

 

$

204,672

 

$

187,610

 

International

 

80,968

 

51,206

 

Products and Systems

 

15,189

 

17,973

 

Corporate and eliminations

 

(8,236

)

(5,673

)

 

 

$

292,593

 

$

251,116

 

 

We estimate our growth rates for the six months ended November 30, 2013 and 2012, respectively, were as follows:

 

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Six months ended November 30,

 

 

2013

 

2012

 

 

($ in thousands)

Revenue growth

 

$

41,477

 

$

45,449

% Growth over prior year

 

16.5%

 

22.1%

 

 

 

 

 

Comprised of:

 

 

 

 

% of organic growth

 

4.4%

 

4.8%

% of acquisition growth

 

12.2%

 

18.2%

% foreign exchange (decrease)

 

(0.1)%

 

(0.9)%

 

 

16.5%

 

22.1%

 

Revenues for the first half of fiscal 2014 experienced year-on-year growth of $41.5 million, or 16.5%, fueled by growth from acquisitions of approximately 12% and organic growth of approximately 4%. Acquisitions contributed approximately 18% of the Company’s 22.1% year-on-year revenue growth generated in first half of fiscal 2013, while organic growth contributed approximately 5%, with foreign exchange reducing that rate of increase by nearly 1%.

 

Revenue growth for the first half was experienced primarily in our International and Services segments. The Company’s 58% year-on-year growth in International revenue was driven primarily by acquisition, as the Company acquired its German subsidiary during the second quarter of fiscal 2013. The remainder of the International increase was driven by organic growth of 2.5%. The 9% increase in Services segment revenues was driven by organic growth of 8.1% and acquisition growth of approximately 1%.

 

The Company continued to experience year-on-year growth in its key vertical markets during the first half of fiscal 2014. Oil and gas revenues grew by approximately 12% and remained the Company’s most significant vertical market, but saw its proportion decline to 48% of total Company revenues compared with 50% in the first half of fiscal 2013. This decline was driven primarily by acquisition-driven growth from the Company’s German subsidiary which was acquired during fiscal 2013 and has a high concentration of aerospace customers. The Company’s aerospace revenues increased to 12% of total revenues, compared with approximately 6% in the prior year’s first half. The Company’s top ten customers comprised approximately 35% of total revenues in the first half of fiscal 2014 compared with 31% in the first half of the prior fiscal year.

 

Gross Profit increased by $11.6 million, or approximately 15%, to $87.3 million during the first half of fiscal 2014, compared with $75.6 million in the first half of fiscal 2013. Gross profit by segment for the six months ended November 30, 2013 and 2012 were as follows:

 

 

 

Six months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Gross profit

 

 

 

 

 

Services

 

$

57,665

 

$

51,632

 

International

 

23,413

 

14,380

 

Products and Systems

 

6,102

 

9,220

 

Corporate and eliminations

 

74

 

390

 

 

 

$

87,254

 

$

75,622

 

 

As a percentage of revenues, gross profit was 29.8% and 30.1% for the six month periods ended November 30, 2013 and 2012, respectively. The slight reduction in gross profit percentage was primarily attributable to improved margins in both the Services and International segments that was more than offset by the Products and Systems segment’s reduction. Gross profit margin for the Services segment improved to 28.2% in the first half of fiscal 2014 compared with 27.5% in the first half of the prior fiscal year, driven by operational efficiencies. Gross profit margin for the International segment improved to 28.9% in the first half of fiscal 2014 compared with 28.1% in the first half of the prior fiscal year, driven by higher margin product sales in the U.K., Russia and France, as well as improved utilization of personnel performing services. These gains were offset by the Products and Systems segment’s decline in gross margin to 40.2% from 51.3% in the prior fiscal year’s first half. The decline in Products and Systems segment gross margin was due to lower sales levels and an adverse sales mix compared with prior year.

 

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Income from Operations

 

The following table shows a reconciliation of the segment and total Company income from operations before acquisition-related expense (benefit), net, to income from operations:

 

 

 

Six months ended November 30,

 

 

 

2013

 

2012

 

 

 

($ in thousands)

 

Services:

 

 

 

 

 

Income from operations before acquisition-related expense, net

 

$

25,402

 

$

23,260

 

Acquisition-related expense, net

 

156

 

693

 

Income from operations

 

25,246

 

22,567

 

 

 

 

 

 

 

International:

 

 

 

 

 

Income from operations before acquisition-related expense, net

 

$

5,337

 

$

3,052

 

Acquisition-related expense (benefit), net

 

(3,771

)

181