Mistras Group, Inc. - Quarter Report: 2012 August (Form 10-Q)

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 August 31, 2012

 

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)

 

 

 

(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 October 1, 2012, the registrant had 28,133,982 shares of common stock outstanding.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

		PAGE
PART I—FINANCIAL INFORMATION
ITEM 1.	Financial Statements	1
	Unaudited Consolidated Balance Sheets as of August 31, 2012 and May 31, 2012	1
	Unaudited Consolidated Statements of Operations for the three months ended August 31, 2012 and 2011	2
	Unaudited Consolidated Statements of Comprehensive Income for the three months ended August 31, 2012 and 2011	3
	Unaudited Consolidated Statements of Stockholders’ Equity for the three months ended August 31, 2012 and 2011	4
	Unaudited Consolidated Statements of Cash Flows for the three months ended August 31, 2012 and 2011	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	26
ITEM 4.	Controls and Procedures	27
PART II—OTHER INFORMATION
ITEM 1.	Legal Proceedings	28
ITEM 1.A.	Risk Factors	28
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
ITEM 3.	Defaults Upon Senior Securities	29
ITEM 4.	Mine Safety Disclosures	29
ITEM 5.	Other Information	29
ITEM 6.	Exhibits	29
SIGNATURES		30

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1.     Financial Statements (unaudited)

 

Mistras Group, Inc. and Subsidiaries

Unaudited Consolidated Balance Sheets

(in thousands, except share and per share data)

 

		August 31, 2012			May 31, 2012
ASSETS
Current Assets
Cash and cash equivalents		$	7,329		$	8,410
Accounts receivable, net		87,627			104,515
Inventories, net		11,771			12,492
Deferred income taxes		1,860			1,885
Prepaid expenses and other current assets		5,190			6,321
Total current assets		113,777			133,623
Property, plant and equipment, net		62,181			63,527
Intangible assets, net		32,477			34,469
Goodwill		95,691			96,819
Other assets		697			1,378
Total assets		$	304,823		$	329,816
LIABILITIES, PREFERRED STOCK AND EQUITY
Current Liabilities
Current portion of long-term debt		$	5,589		$	5,971
Current portion of capital lease obligations		6,211			5,951
Accounts payable		7,998			11,944
Accrued expenses and other current liabilities		33,478			39,334
Income taxes payable		813			1,119
Total current liabilities		54,089			64,319
Long-term debt, net of current portion		18,087			34,258
Obligations under capital leases, net of current portion		12,644			13,094
Deferred income taxes		5,490			4,901
Other long-term liabilities		17,778			19,996
Total liabilities		108,088			136,568
Commitments and contingencies
Preferred stock, 10,000,000 shares authorized		—			—
Equity
Common stock, $0.01 par value, 200,000,000 shares authorized, 28,133,982 and 28,025,507 shares issued and outstanding as of August 31, 2012 and May 31, 2012, respectively		281			280
Additional paid-in capital		189,669			188,443
Retained earnings		11,617			7,336
Accumulated other comprehensive loss		(5,078		)	(3,047		)
Total Mistras Group, Inc. stockholders’ equity		196,489			193,012
Noncontrolling interest		246			236
Total equity		196,735			193,248
Total liabilities, preferred stock and equity		$	304,823		$	329,816

 

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

 

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Mistras Group, Inc. and Subsidiaries

Unaudited Consolidated Statements of Operations

(in thousands, except per share data)

 

		Three months ended August 31,
		2012			2011
Revenues:
Services		$	99,225		$	82,902
Products		14,162			8,545
Total revenues		113,387			91,447
Cost of revenues:
Cost of services		70,516			56,887
Cost of products sold		5,010			3,640
Depreciation related to services		3,976			3,323
Depreciation related to products		168			177
Total cost of revenues		79,670			64,027
Gross profit		33,717			27,420
Selling, general and administrative expenses		23,492			19,381
Research and engineering		517			589
Depreciation and amortization		1,895			1,479
Acquisition-related costs		(179		)	—
Income from operations		7,992			5,971
Other expenses
Interest expense		1,046			661
Income before provision for income taxes		6,946			5,310
Provision for income taxes		2,655			2,116
Net income		4,291			3,194
Net (income) loss attributable to noncontrolling interests, net of taxes		(10		)	34
Net income attributable to Mistras Group, Inc.		$	4,281		$	3,228
Earnings per common share (see Note 4):
Basic		$	0.15		$	0.12
Diluted		$	0.15		$	0.11
Weighted average common shares outstanding:
Basic		28,045			27,677
Diluted		29,000			28,225

 

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

 

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Mistras Group, Inc. and Subsidiaries

Unaudited Consolidated Statements of Comprehensive Income

(in thousands)

 

		Three months ended August 31,
		2012			2011
Net income		$	4,291		$	3,194
Other comprehensive income, net of tax:
Foreign currency translation adjustments		(2,031		)	(313		)
Other comprehensive income		(2,031		)	(313		)
Comprehensive income		2,260			2,881
Comprehensive income (loss) attributable to noncontrolling interest		10			(37		)
Comprehensive income attributable to Mistras Group, Inc.		$	2,250		$	2,918

 

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

 

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Mistras Group, Inc. and Subsidiaries

Unaudited Consolidated Statements of Stockholders’ Equity

(in thousands)

 

		Common Stock					Additional paid-in			Retained earnings (accumulated			Accumulated other comprehensive			Total Mistras Group, Inc. Stockholders’			Noncontrolling
		Shares		Amount			capital			deficit)			income (loss)			Equity			Interest			Total Equity
Three months ended August 31, 2011:
Balance at May 31, 2011		27,667		$	277		$	180,594		$	(14,017	)	$	303		$	167,157		$	329		$	167,486
Net income		—		—			—			3,228			—			3,228			(34		)	3,194
Other comprehensive income, net of tax		—		—			—			—			(310		)	(310		)	(3		)	(313		)
Stock compensation		4		—			1,002			—			—			1,002			—			1,002
Net settlement on vesting of restricted stock units		36		—			(281		)	—			—			(281		)	—			(281		)
Excess tax benefit from stock compensation		—		—			151			—			—			151			—			151
Exercise of stock options		5		—			55			—			—			55			—			55
Balance at August 31, 2011		27,712		$	277		$	181,521		$	(10,789	)	$	(7	)	$	171,002		$	292		$	171,294
Three months ended August 31, 2012:
Balance at May 31, 2012		28,026		$	280		$	188,443		$	7,336		$	(3,047	)	$	193,012		$	236		$	193,248
Net income		—		—			—			4,281			—			4,281			10			4,291
Other comprehensive income, net of tax		—		—			—			—			(2,031		)	(2,031		)	—			(2,031		)
Stock compensation		13		—			1,634			—			—			1,634			—			1,634
Net settlement on vesting of restricted stock units		85		1			(807		)	—			—			(806		)	—			(806		)
Excess tax benefit from stock compensation		—		—			300			—			—			300			—			300
Exercise of stock options		10		—			99			—			—			99			—			99
Balance at August 31, 2012		28,134		$	281		$	189,669		$	11,617		$	(5,078	)	$	196,489		$	246		$	196,735

 

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

 

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Mistras Group, Inc. and Subsidiaries

Unaudited Consolidated Statements of Cash Flows

(in thousands)

 

		Three months ended August 31,
		2012			2011
Cash flows from operating activities
Net income attributable to Mistras Group, Inc.		$	4,281		$	3,228
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		6,039			4,979
Deferred income taxes		694			146
Provision for doubtful accounts		(210		)	85
Loss (gain) on sale of assets		119			(12		)
Amortization of deferred financing costs		31			42
Stock compensation expense		1,634			1,002
Noncontrolling interest		10			(34		)
Foreign currency loss		95			5
Changes in operating assets and liabilities, net of effect of acquisitions of businesses
Accounts receivable		16,240			5,940
Inventories		613			(323		)
Prepaid expenses and other current assets		854			180
Other assets		677			144
Accounts payable		(2,762		)	(1,358		)
Income taxes payable		(276		)	(455		)
Accrued expenses and other current liabilities		(6,493		)	(770		)
Net cash provided by operating activities		21,546			12,799
Cash flows from investing activities
Purchase of property, plant and equipment		(2,714		)	(3,103		)
Purchase of intangible assets		(228		)	(130		)
Acquisition of businesses, net of cash acquired		—			(5,628		)
Proceeds from sale of equipment		325			68
Net cash used in investing activities		(2,617		)	(8,793		)
Cash flows from financing activities
Repayment of capital lease obligations		(1,644		)	(1,632		)
Repayment of long-term debt		(1,621		)	(2,047		)
Net repayments against current revolver		(15,000		)	—
Net repayments against former revolver		—			(3,850		)
Net repayments of other short-term borrowings		—			(1,014		)
Payment of contingent consideration for business acquisitions		(1,113		)	—
Taxes paid related to net share settlement of equity awards		(807		)	(281		)
Excess tax benefit from stock compensation		300			151
Proceeds from the exercise of stock options		99			55
Net cash used in financing activities		(19,786		)	(8,618		)
Effect of exchange rate changes on cash and cash equivalents		(224		)	224
Net change in cash and cash equivalents		(1,081		)	(4,388		)
Cash and cash equivalents
Beginning of period		8,410			10,879
End of period		$	7,329		$	6,491
Supplemental disclosure of cash paid
Interest		$	746		$	621
Income taxes		$	1,122		$	2,294
Noncash investing and financing
Equipment acquired through capital lease obligations		$	1,555		$	3,598

 

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 in thousands, except per share data)

 

1.                                      Description of Business & Basis of Presentation

 

Description of Business

 

Mistras Group, Inc., together with its subsidiaries (the Company), is a leading “one source” global provider of technology-enabled asset protection solutions used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure. The Company combines industry-leading products and technologies, expertise in mechanical integrity (MI) and non-destructive testing (NDT) services and proprietary data analysis software to deliver a comprehensive portfolio of customized solutions, ranging from routine inspections to complex, plant-wide asset integrity assessments and management. These mission critical solutions enhance customers’ ability to extend the useful life of their assets, increase productivity, minimize repair costs, comply with governmental safety and environmental regulations, manage risk and avoid catastrophic disasters. Given the role the services of the Company play in ensuring the safe and efficient operation of infrastructure, the Company has historically provided a majority of its services to its customers on a regular, recurring basis. 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, aerospace and defense, transportation, primary metals and metalworking, pharmaceuticals and food processing industries.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement have been included. Operating results for the three months ended August 31, 2012 are not necessarily indicative of the results that may be expected for the year ending May 31, 2013. The balance sheet at May 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. You should read these unaudited consolidated financial statements together with the historical consolidated financial statements of the Company as filed with the Securities and Exchange Commission.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of Mistras Group, Inc. and its wholly or majority-owned subsidiaries. Where 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 interest in net income, net of tax, is classified separately in the accompanying consolidated statements of operations.

 

All significant intercompany accounts and transactions have been eliminated in consolidation. Mistras Group, Inc.’s and its subsidiaries’ fiscal years end on May 31 except for the companies in the International segment, which end on April 30. The effect of this difference in timing of reporting foreign operations on the consolidated results of operations and consolidated financial position is not significant.

 

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.

 

2.                                      Summary of Significant Accounting Policies

 

Revenue Recognition

 

Revenue recognition policies for the various sources of revenues are as follows:

 

Services

 

The Company predominantly derives revenues by providing its services on a time and material basis and recognizes revenues when services are rendered. At the end of any reporting period, there may be earned but unbilled revenues that are accrued. Payments received in advance of revenue recognition are reflected as deferred revenues.

 

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

 

Software

 

Revenues from the sale of perpetual licenses are recognized upon the delivery and acceptance of the software. Revenues from term licenses are recognized ratably over the period of the license. Revenues from maintenance, unspecified upgrades and technical support are recognized ratably over the period such items are delivered. For multiple-element arrangement software contracts that include non-software elements, and where the software is essential to the functionality of the non-software elements (collectively referred to as software multiple-element arrangements), the Company applies the rules as noted below.

 

Products

 

Revenues from product sales are recognized when risk of loss and title passes to the customer. The exceptions to this accounting treatment would be for multiple-element arrangements (described below) or those situations where specialized installation or customer acceptance is required. Payments received in advance of revenue recognition are reflected as deferred revenues.

 

Percentage of Completion

 

A portion of the Company’s revenues are generated from engineering and manufacturing of custom products under long-term contracts that may last from several months to several years, depending on the contract. Revenues from long-term contracts are recognized on the percentage-of-completion method of accounting. Under the percentage-of-completion method of accounting revenues are recognized as work is performed. The percentage of completion at any point in time is based on total costs or total labor dollars incurred to date in relation to the total estimated costs or total labor dollars estimated at completion. The percentage of completion is then applied to the total contract revenue to determine the amount of revenue to be recognized in the period. Application of the percentage-of-completion method of accounting requires the use of estimates of costs to be incurred for the performance of the contract. Contract costs include all direct materials, direct labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, and all costs associated with operation of equipment. The cost estimation process is based upon the professional knowledge and experience of the Company’s engineers, project managers and financial professionals. Factors that are considered in estimating the work to be completed include the availability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in project performance and the recoverability of any claims. Whenever revisions of estimated contract costs and contract values indicate that the contract costs will exceed estimated revenues, thus creating a loss, a provision for the total estimated loss is recorded in that period.

 

Multiple-element Arrangements

 

The Company occasionally enters into transactions that represent multiple-element arrangements, which may include any combination of services, software, and hardware. When a sales arrangement contains multiple elements, such as hardware and services and/or software products, the Company allocates revenue to each element based on a selling price hierarchy. The selling price for a deliverable is based on its vendor specific objective evidence (VSOE) if available, third party evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. The Company has historically utilized the VSOE due to the nature of its products. In multiple element arrangements where more-than-incidental software deliverables are included, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the accompanying consolidated financial statements. The more significant estimates include valuation of goodwill and intangible assets, useful lives of long-lived assets, allowances for doubtful accounts, inventory valuation, reserves for self-insured workers compensation and health benefits and provision for income taxes. Actual results could differ from those estimates.

 

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

 

Goodwill and Intangible Assets

 

Goodwill represents the excess of the purchase price over the fair market value of net assets of the acquired business at the date of acquisition. The Company tests for impairment annually, in its fiscal fourth quarter.  The most recent annual test for impairment performed for fiscal 2012 did not identify any instances of impairment and there were no events through August 31, 2012 that warranted a reconsideration of the impairment test results.

 

Intangible assets are recorded at cost. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. At times, cash deposits may exceed the limits insured by the Federal Deposit Insurance Corporation. The Company believes it is not exposed to any significant credit risk or risk of nonperformance of financial institutions.

 

The Company sells primarily to large companies, extends reasonably short collection terms, performs credit evaluations and does not require collateral. The Company maintains reserves for potential credit losses.

 

The Company has one customer, BP plc. (BP), which accounted for 12% and 16% of revenues for the three months ended August 31, 2012 and August 31, 2011, respectively.  Accounts receivable from this customer were approximately 9% of total accounts receivable, net as of August 31, 2012 and May 31, 2012. The relationship with BP is comprised of separate contracts for non-destructive testing and inspection services with multiple affiliated entities within the broad BP organization.  The Company conducts business with various divisions or affiliates of the BP organization through numerous contracts covering many segments of BP’s business including downstream (refinery), midstream (pipelines) and upstream (exploration).  These contracts are typically negotiated locally with the specific BP division or affiliate, are of varying lengths, have different start and end dates and differ in terms of the scope of work and nature of services provided.  Most contracts are based on time and materials.

 

Equity-based Compensation

 

The Company measures the cost of employee services received in exchange for an award of equity instruments based upon the grant-date fair value of the award. The Company uses the “straight-line” attribution method for allocating compensation costs and recognizes the fair value of each equity award on a straight-line basis over the vesting period of the related awards.

 

The Company uses the Black-Scholes option-pricing model to estimate the fair value of the stock option awards as of the grant date. The Black-Scholes model, by its design, is highly complex and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are the expected term of stock option awards and the estimated volatility of the Company’s common stock price. The Black-Scholes model is sensitive to changes in these two variables.  Since the Company’s initial public offering (IPO), the expected term of the Company’s stock options is generally determined using the mid-point between the vesting period and the end of the contractual term. Expected stock price volatility is typically based on the daily historical trading data for a period equal to the expected term. Because the Company’s historical trading data only dates back to October 8, 2009, the first trading date after its IPO, the Company has estimated expected volatility using an analysis of the stock price volatility of comparable peer companies.  Prior to the Company’s IPO, the exercise price equaled the estimated fair market value of the Company’s common stock, as determined by its board of directors. Since the Company’s IPO, the exercise price of stock option grants is determined using the closing market price of the Company’s common stock on the date of grant.

 

Recent Accounting Pronouncements

 

In July 2012, the FASB issued ASU 2012-02, Intangibles — Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, that is intended to reduce the cost and complexity of the impairment test for indefinite-lived intangible assets by providing an entity with the option to first assess qualitatively whether it is necessary to perform the impairment test that is currently in place. An entity would not be required to quantitatively calculate the fair value of an indefinite-lived intangible asset unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. ASU 2012-02 is effective for annual and interim impairment test beginning after September 15, 2012.

 

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

 

Early adoption is permitted. The Company does not expect that the adoption of this pronouncement will have a material impact on the Company’s consolidated financial statements.

 

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 allows an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This authoritative guidance eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income, or the Company’s option to present components of other comprehensive income either net of related tax effects or before related tax effects, nor does it affect how earnings per share is calculated or presented.  Effective June 1, 2012, the Company adopted the provisions of this updated accounting standard related to comprehensive income. The adoption of this pronouncement did not have a material impact on the Company’s consolidated financial statements.

 

3.                                      Capitalization

 

Common Stock

 

Dividends on common stock will be paid when, and if, declared by the board of directors. Each holder of common stock is entitled to vote on all matters and is entitled to one vote for each share held.

 

Equity Awards

 

In September 2009, the Company’s board of directors and shareholders adopted and approved the 2009 Long-Term Incentive Plan (the 2009 Plan), which became effective upon the closing of the IPO. Awards may be in the form of stock options, restricted stock units and other forms of stock-based incentives, including stock appreciation rights and deferred stock rights. The term of each incentive and non-qualified stock option is ten years. Vesting generally occurs over a period of four years, the expense for which is recorded on a straight-line basis over the requisite service period. The 2009 Plan allows for the grant of awards of up to approximately 2,286,000 shares of common stock, of which 1,444,000 shares were available for future grants as of August 31, 2012. Prior to the Company’s IPO in October 2009, the Company had two stock option plans: (i) the 1995 Incentive Stock Option and Restricted Stock Purchase Plan (the 1995 Plan), and (ii) the 2007 Stock Option Plan (the 2007 Plan). No additional awards may be granted from these two plans. As of August 31, 2012, there was an aggregate of approximately 2,539,000 stock options outstanding and approximately 562,000 unvested restricted stock units outstanding under the 2009 Plan, the 2007 Plan, and the 1995 Plan.

 

No stock options were granted during the three months ended August 31, 2012 or August 31, 2011.

 

The Company recognized stock-based compensation expense related to stock option awards of approximately $0.8 million for each of the three month periods ended August 31, 2012 and 2011. As of August 31, 2012, there was approximately $3.0 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 1.0 year.  Cash proceeds from and the aggregate intrinsic value of stock options exercised during the three months ended August 31, 2012 and 2011 were as follows:

 

		Three months ended August 31,
		2012			2011
Cash proceeds from options exercised		$	99		$	55
Aggregate intrinsic value of options exercised		$	126		$	34

 

The Company also recognized approximately $0.6 million and $0.2 million in stock-based compensation expense related to restricted stock unit awards during the three months ended August 31, 2012 and 2011, respectively.  As of August 31, 2012, there was approximately $10.1 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 3.2 years.

 

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

 

In June 2012, the Company granted approximately 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 a grant date fair value of approximately $0.3 million, which was recorded as stock-based compensation expense during the quarter ended August 31, 2012.

 

During the first quarter of fiscal 2013 and 2012, approximately 123,000 and 52,000 restricted stock units vested.  The fair value of these units was $1.9 million and $0.5 million, respectively.  Upon vesting, restricted stock units are generally net share-settled to cover the required 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 quarter of fiscal 2013 and 2012 were net-share settled such that the Company withheld shares with 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 Company withheld approximately 37,000 and 16,000 shares in the first quarter of fiscal 2013 and 2012, respectively.  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. Total payments for the employees’ tax obligations to the taxing authorities were $0.8 million and $0.3 million and are reflected as a financing activity within the consolidated statements of cash flows for the three months ended August 31, 2012 and 2011, respectively. 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.

 

4.                                      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 August 31,
		2012			2011
Basic earnings per share
Numerator:
Net income attributable to Mistras Group, Inc.		$	4,281		$	3,228
Denominator:
Weighted average common shares outstanding		28,045			27,677
Basic earnings per share		$	0.15		$	0.12
Diluted earnings per share:
Numerator:
Net income attributable to Mistras Group, Inc.		$	4,281		$	3,228
Denominator:
Weighted average common shares outstanding		28,045			27,677
Dilutive effect of stock options outstanding		806			477
Dilutive effect of restricted stock units outstanding		149			71
		29,000			28,225
Diluted earnings per share		$	0.15		$	0.11

 

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

 

5.                                      Acquisitions

 

Assets and liabilities of acquired businesses were included in the consolidated balance sheets as of August 31, 2012 based on their estimated fair value on the date of acquisition as determined in a purchase price allocation, using available information and making assumptions management believes are reasonable. The Company did not complete any acquisitions during the three months ended August 31, 2012.  However, the Company is still in the process of completing its valuations of the intangible assets for certain of its acquisitions completed in fiscal 2012. These valuations and purchase price allocations are expected to be finalized prior to the end of the second fiscal quarter ending November 30, 2012. The results of operations of each of the acquisitions are reported in each respective operating segment’s statement of operations from the date of acquisition.

 

During the three months ended August 31, 2012, the Company incurred acquisition-related costs of $0.6 million in connection with due diligence, professional fees, and other expenses for its fiscal 2013 acquisition activity.  Additionally, the Company adjusted the fair value of certain acquisition-related contingent consideration liabilities. For the three months ended August 31, 2012, the adjustments resulted in a net decrease of approximately $0.8 million to the Company’s acquisition-related contingent consideration liabilities, which were approximately $11.6 million as of August 31, 2012 and recorded on the balance sheet in accrued expenses and other liabilities. These adjustments also resulted in a corresponding net increase to income from operations of approximately $0.2 million for the three months ended August 31, 2012. Both the fair value adjustments to acquisition-related contingent consideration liabilities and the acquisition-related expenses have been classified as acquisition-related costs in the statement of operations for the three months ended August 31, 2012. Acquisition-related costs for the Company’s fiscal 2012 acquisition activity were insignificant for the three months ended August 31, 2011.

 

The unaudited pro forma information for the periods set forth below gives effect to the Company’s fiscal 2012 acquisitions as if they had occurred at the beginning of each period presented. The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisitions been consummated as of that time (unaudited, in thousands):

 

		Three months ended August 31,
		2012			2011
Revenues		$	113,387		$	107,504
Income from operations		$	7,992		$	4,798

 

6.                                      Accounts Receivable, net

 

Accounts receivable consist of the following:

 

		As of August 31, 2012			As of May 31, 2012
Trade accounts receivable		$	89,699		$	106,821
Allowance for doubtful accounts		(2,072		)	(2,306		)
Total		$	87,627		$	104,515

 

7.                                      Inventories, net

 

Inventories consist of the following:

 

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

 

		As of August 31, 2012			As of May 31, 2012
Raw materials		$	3,100		$	3,054
Work in process		2,528			2,232
Finished goods		3,582			4,287
Supplies		2,561			2,919
Total		$	11,771		$	12,492

 

Inventories are net of reserves for slow-moving and obsolete inventory of approximately $1.3 million and $1.2 million as of August 31, 2012 and May 31, 2012, respectively.

 

8.                                      Property, Plant and Equipment, net

 

Property, plant and equipment consist of the following:

 

		Useful Life		As of August 31, 2012			As of May 31, 2012
		(Years)
Land				$	1,907		$	1,892
Building and improvements		30-40		14,181			16,950
Office furniture and equipment		5-8		10,023			6,760
Machinery and equipment		5-7		106,924			105,096
				133,035			130,698
Accumulated depreciation and amortization				(70,854		)	(67,171		)
Property, plant and equipment, net				$	62,181		$	63,527

 

Depreciation expense for the three months ended August 31, 2012 and 2011 was approximately $4.4 million and $3.6 million, respectively.

 

9.                                      Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consist of the following:

 

		As of August 31, 2012			As of May 31, 2012
Accrued salaries, wages and related employee benefits		$	13,786		$	17,195
Contingent consideration, current portion		3,315			2,371
Accrued worker compensation and health benefits		3,660			3,678
Deferred revenues		3,212			5,390
Other accrued expenses		9,505			10,700
Total		$	33,478		$	39,334

 

10.                               Long-Term Debt

 

Long-term debt consists of the following:

 

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

 

		As of August 31, 2012			As of May 31, 2012
Senior credit facility:
Revolver		$	10,000		$	25,000
Notes payable		11,161			12,532
Other		2,515			2,697
		23,676			40,229
Less: Current maturities		(5,589		)	(5,971		)
Long-term debt, net of current maturities		$	18,087		$	34,258

 

Senior Credit Facility

 

In December 2011, the Company entered into a Third Amended and Restated Credit Agreement (Credit Agreement) with Bank of America, N.A., as agent for the lenders and a lender, and JPMorgan Chase Bank, N.A., Keybank National Association and TD Bank, N.A., as lenders.  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 Credit Agreement has a maturity date of December 20, 2016.  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 August 31, 2012, there were outstanding borrowings of $10.0 million and a total of $3.0 million of outstanding letters of credit under the current revolving credit facility.

 

Loans under the Credit Agreement bear interest, at the option of the Company, at LIBOR, plus an applicable margin ranging from 1% to 2%, or base rate less a margin ranging from 1.25% to .25%, based upon its Funded Debt 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 (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 2.5 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 August 31, 2012, the Company was in compliance with the terms of the credit agreement, and it will continuously monitor its compliance with the covenants contained in the new credit agreement.

 

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

 

Notes Payable and Other

 

In connection with certain of the acquisitions the Company has completed, it has, at various times, issued subordinated notes payable to the sellers. The maturity of these notes range from three to five years from the date of acquisition with interest rates ranging from 0% to 7%. The Company has discounted these obligations to reflect a 3.5% to 10% imputed interest rate. Unamortized discount on these notes totaled approximately $0.1 million as of August 31, 2012 and May 31, 2012. Amortization is recorded as interest expense in the consolidated statement of operations. The Company also has payment obligations to the sellers or the shareholders of the sellers pursuant to non-compete agreements which require the sellers and shareholders of the sellers not to compete with the Company.  The payment obligations under these agreements range from 3 to 5 years.

 

The carrying value of the Company’s long-term debt approximates fair value as it amended its credit agreement on December 21, 2011, bringing the Company’s interest rate to current market rates. 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.

 

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:

 

		August 31, 2012
		Level 1			Level 2			Level 3			Total
Liabilities:
Contingent consideration		$	—		$	—		$	11,613		$	11,613
Total Liabilities		$	—		$	—		$	11,613		$	11,613
		May 31, 2012
		Level 1			Level 2			Level 3			Total
Liabilities:
Contingent consideration		$	—		$	—		$	13,063		$	13,063
Total Liabilities		$	—		$	—		$	13,063		$	13,063

 

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

 

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 acquisition agreements.

 

12.                               Commitments and Contingencies

 

Litigation

 

The Company is subject to periodic 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 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 in such matters may be covered by insurance.

 

Acquisition-related contingencies

 

The Company is liable for contingent consideration in connection with certain of its acquisitions. As of August 31, 2012, total potential acquisition-related contingent consideration ranged from zero to $17.7 million and would be payable upon the achievement of specific performance metrics by certain of the acquired companies over the next four years of operations. See Note 5 to these consolidated financial statements for further discussion of the Company’s acquisitions.

 

13.                               Subsequent Event

 

In September 2012, the Company’s German subsidiary acquired all of the shares of an inspection and asset protection company headquartered in Germany for approximately $36.0 million, comprised of $28.3 million in cash and $7.7 million of subordinated notes, which are payable over three years.  In addition to the cash and debt consideration, the share purchase agreement provides for the potential payment to the sellers of contingent consideration that may be earned based upon the acquired company reaching specific performance metrics over the next five years of operation.  The Company is in the process of completing the preliminary purchase price allocation.

 

14.                               Segment Disclosure

 

The Company’s three segments are:

 

Services. This segment provides asset protection solutions primarily in North America with the largest concentration in the United States, 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.

 

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.

 

International. This segment 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.

 

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.

 

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

 

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 stock-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 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 August 31,
		2012			2011
Revenues
Services		$	82,397		$	75,689
Products and Systems		9,534			7,513
International		24,429			9,773
Corporate and eliminations		(2,973		)	(1,528		)
		$	113,387		$	91,447

 

Revenues by operating segment include intercompany transactions, which are eliminated in Corporate and eliminations.  The Services segment had sales to other operating segments of $1.1 million and $0.1 million for the three months ended August 31, 2012 and 2011, respectively. The Products and Systems segment had sales to other operating segments of $1.7 million and $1.3 million for the three months ended August 31, 2012 and 2011, respectively. The International segment had sales to other operating segments of $0.1 million for each of the three month periods ended August 31, 2012 and 2011.

 

		Three months ended August 31,
		2012			2011
Gross profit
Services		$	20,940		$	20,308
Products and Systems		5,245			3,751
International		7,081			3,431
Corporate and eliminations		451			(70		)
		$	33,717		$	27,420

 

		Three months ended August 31,
		2012			2011
Income from operations
Services		$	6,823		$	7,160
Products and Systems		3,165			1,011
International		1,595			736
Corporate and eliminations		(3,591		)	(2,936		)
		$	7,992		$	5,971

 

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