Mistras Group, Inc. - Quarter Report: 2013 November (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

For the quarterly period ended November 30, 2013

 

Or

 

 

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):

 

 

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

 

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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.

 

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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.

 

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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.

 

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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.

 

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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. 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.

 

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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.

 

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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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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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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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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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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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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

 

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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 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

 

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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

 

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