Mistras Group, Inc. - Quarter Report: 2014 February (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 February 28, 2014

 

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):

 

 

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 April 1, 2014, the registrant had 28,440,896 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 February 28, 2014 (unaudited) and May 31, 2013	1
				Unaudited Condensed Consolidated Statements of Income for the three and nine months ended February 28, 2014 and 2013	2
				Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended February 28, 2014 and 2013	3
				Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended February 28, 2014 and 2013	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	25
		ITEM 4.		Controls and Procedures	25
PART II—OTHER INFORMATION
		ITEM 1.	Legal Proceedings		27
		ITEM 1.A.	Risk Factors		27
		ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds		27
		ITEM 3.	Defaults Upon Senior Securities		27
		ITEM 4.	Mine Safety Disclosures		27
		ITEM 5.	Other Information		27
		ITEM 6.	Exhibits		27
SIGNATURES					29

 

i

Table of Contents

 

PART I—FINANCIAL INFORMATION

 

ITEM 1.                           Financial Statements

 

Mistras Group, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

 

		(unaudited)
		February 28, 2014			May 31, 2013
ASSETS
Current Assets
Cash and cash equivalents		$	9,950		$	7,802
Accounts receivable, net		126,304			108,554
Inventories		12,516			12,504
Deferred income taxes		3,029			2,621
Prepaid expenses and other current assets		14,637			8,156
Total current assets		166,436			139,637
Property, plant and equipment, net		74,428			68,419
Intangible assets, net		52,180			51,992
Goodwill		132,321			115,270
Other assets		1,352			1,342
Total assets		$	426,717		$	376,660
LIABILITIES AND EQUITY
Current Liabilities
Accounts payable		$	11,078		$	8,490
Accrued expenses and other current liabilities		48,212			47,839
Current portion of long-term debt		7,542			7,418
Current portion of capital lease obligations		7,147			6,766
Income taxes payable		1,485			1,703
Total current liabilities		75,464			72,216
Long-term debt, net of current portion		73,883			52,849
Obligations under capital leases, net of current portion		13,036			10,923
Deferred income taxes		13,862			11,614
Other long-term liabilities		19,152			18,778
Total liabilities		195,397			166,380
Commitments and contingencies
Equity
Preferred stock, 10,000,000 shares authorized		—			—
Common stock, $0.01 par value, 200,000,000 shares authorized		284			282
Additional paid-in capital		199,254			195,241
Retained earnings		35,081			18,982
Accumulated other comprehensive loss		(3,573		)	(4,452		)
Total Mistras Group, Inc. stockholders’ equity		231,046			210,053
Noncontrolling interests		274			227
Total equity		231,320			210,280
Total liabilities and equity		$	426,717		$	376,660

 

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

 

1

Table of Contents

 

Mistras Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

(in thousands, except per share data)

 

		Three months ended February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Revenues:
Services		$	142,967		$	124,510		$	414,448		$	351,466
Products and systems		8,760			9,151			29,872			33,311
Total revenues		151,727			133,661			444,320			384,777
Cost of revenues:
Cost of services		104,196			91,209			291,680			248,769
Cost of products and systems sold		3,702			3,527			12,965			13,022
Depreciation related to services		4,257			4,465			12,333			12,565
Depreciation related to products and systems		272			254			788			593
Total cost of revenues		112,427			99,455			317,766			274,949
Gross profit		39,300			34,206			126,554			109,828
Selling, general and administrative expenses		31,794			27,209			90,342			74,063
Research and engineering		757			754			2,186			1,801
Depreciation and amortization		2,771			2,473			7,729			6,535
Acquisition-related expense, net		978			(1,212		)	(1,530		)	(1,006		)
Income from operations		3,000			4,982			27,827			28,435
Interest expense		792			882			2,309			2,458
Income before provision for income taxes		2,208			4,100			25,518			25,977
Provision for income taxes		984			1,349			9,375			9,749
Net income		1,224			2,751			16,143			16,228
Less: net income attributable to noncontrolling interests, net of taxes		(23		)	—			(44		)	(33		)
Net income attributable to Mistras Group, Inc.		$	1,201		$	2,751		$	16,099		$	16,195
Earnings per common share
Basic		$	0.04		$	0.10		$	0.57		$	0.58
Diluted		$	0.04		$	0.09		$	0.55		$	0.56
Weighted average common shares outstanding:
Basic		28,396			28,175			28,338			28,121
Diluted		29,374			29,101			29,249			29,078

 

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

 

2

Table of Contents

 

Mistras Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Comprehensive (Loss)/Income

(in thousands)

 

		Three months ended February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Net income		$	1,224		$	2,751		$	16,143		$	16,228
Other comprehensive (loss)/income, net of tax:
Foreign currency translation adjustments		(1,553		)	1,633			879			1,119
Comprehensive (loss)/income		(329		)	4,384			17,022			17,347
less: comprehensive income attributable to noncontrolling interest		(23		)	—			(44		)	(33		)
Comprehensive (loss)/income attributable to Mistras Group, Inc.		$	(352	)	$	4,384		$	16,978		$	17,314

 

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

 

3

Table of Contents

 

Mistras Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

		Nine months ended February 28,
		2014			2013
Cash flows from operating activities
Net income		$	16,143		$	16,228
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		20,850			19,693
Deferred income taxes		1,987			1,530
Share-based compensation expense		4,013			4,749
Fair value adjustment to contingent consideration liabilities		(2,414		)	(2,256		)
Other		106			(197		)
Changes in operating assets and liabilities, net of effect of acquisitions of businesses:
Accounts receivable		(13,235		)	6,076
Inventories		(21		)	985
Prepaid expenses and other current assets		(6,273		)	(5,625		)
Other assets		(92		)	652
Accounts payable		2,419			(5,772		)
Accrued expenses and other current liabilities		(261		)	(7,772		)
Income taxes payable		(633		)	(743		)
Net cash provided by operating activities		22,589			27,548
Cash flows from investing activities
Purchase of property, plant and equipment		(11,661		)	(8,915		)
Purchase of intangible assets		(465		)	(897		)
Acquisition of businesses, net of cash acquired		(19,057		)	(33,601		)
Proceeds from sale of equipment		922			1,028
Net cash used in investing activities		(30,261		)	(42,385		)
Cash flows from financing activities
Repayment of capital lease obligations		(5,965		)	(5,054		)
Repayment of long-term debt		(7,938		)	(4,319		)
Net borrowings against revolver		26,063			26,008
Payment of contingent consideration for business acquisitions		(909		)	(1,887		)
Taxes paid related to net share settlement of share-based awards		(1,004		)	(806		)
Excess tax benefit from share-based compensation		292			455
Proceeds from the exercise of stock options		712			673
Net cash provided by financing activities		11,251			15,070
Effect of exchange rate changes on cash and cash equivalents		(1,431		)	260
Net change in cash and cash equivalents		2,148			493
Cash and cash equivalents
Beginning of period		7,802			8,410
End of period		$	9,950		$	8,903
Supplemental disclosure of cash paid
Interest		$	2,426		$	2,422
Income taxes		$	11,345		$	13,605
Noncash investing and financing
Equipment acquired through capital lease obligations		$	8,140		$	2,896
Issuance of notes payable and other debt obligations primarily related to acquisitions		$	—		$	7,715

 

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

 

4

Table of Contents

 

Mistras Group, Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

(tabular dollars in thousands, except per share data)

 

1.                                      Description of Business & Basis of Presentation

 

Description of Business

 

Mistras Group, Inc. (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 condensed consolidated balance sheets. The noncontrolling interests in operating results, net of tax, is classified separately in the accompanying condensed consolidated statements of income.

 

All significant intercompany accounts and transactions have been eliminated in consolidation. 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.

 

Significant Accounting Policies

 

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

 

5

Table of Contents

 

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

 

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 its 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 performance share units, stock appreciation rights and deferred stock rights.

 

For the three months ended February 28, 2014 and 2013, 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 nine months ended February 28, 2014 and 2013, the Company recognized share-based compensation expense related to stock option awards of $0.7 million and $2.3 million, respectively. As of February 28, 2014, 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 2.0 years. Cash proceeds from, and the aggregate intrinsic value of, stock options exercised during the three and nine months ended February 28, 2014 and 2013 were as follows:

 

		Three months ended February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Cash proceeds from options exercised		$	349		$	321		$	712		$	673
Aggregate intrinsic value of options exercised		$	458		$	370		$	836		$	856

 

No stock options were granted during the nine months ended February 28, 2014 and 2013.

 

The Company also recognized approximately $1.0 million and $0.8 million during the three months ended February 28, 2014 and 2013, respectively, in share-based compensation expense related to restricted stock unit awards. For the nine months ended February 28, 2014 and 2013, the Company recognized share-based compensation expense related to restricted stock unit awards of $2.9 million and $2.1 million, respectively. As of February 28, 2014, there was approximately $9.8 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 2.6 years.

 

During the first nine months of fiscal 2014 and 2013, the Company granted approximately 19,000 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 $0.4 million and $0.3 million, respectively, which was recorded as share-based compensation expense during the nine months ended February 28, 2014 and 2013.

 

During the first nine 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 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 nine months of fiscal 2014 and 2013

 

6

Table of Contents

 

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

 

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 nine month periods ended February 28, 2014 and 2013 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 February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Basic earnings per share
Numerator:
Net income attributable to Mistras Group, Inc.		$	1,201		$	2,751		$	16,099		$	16,195
Denominator:
Weighted average common shares outstanding		28,396			28,175			28,338			28,121
Basic earnings per share		$	0.04		$	0.10		$	0.57		$	0.58
Diluted earnings per share:
Numerator:
Net income attributable to Mistras Group, Inc.		$	1,201		$	2,751		$	16,099		$	16,195
Denominator:
Weighted average common shares outstanding		28,396			28,175			28,338			28,121
Dilutive effect of stock options outstanding		849			815			750			806
Dilutive effect of restricted stock units outstanding		129			111			161			151
		29,374			29,101			29,249			29,078
Diluted earnings per share		$	0.04		$	0.09		$	0.55		$	0.56

 

4.                                      Acquisitions

 

In the third quarter of fiscal 2014, the Company completed the acquisitions of an asset protection business located in Texas and two businesses located in Canada to continue its market expansion strategy. The Company’s initial cash payments for these acquisitions was $17.8 million. In addition to the initial cash payment, the Company may pay up to $5.7 million in contingent consideration which may be earned based upon the acquired companies achieving specific performance metrics over specified periods ranging from 2 to 3 years. The Company is in the process of completing the preliminary purchase price allocations.

 

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.

 

7

Table of Contents

 

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

 

The assets and liabilities of the acquired businesses 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. The results of operations for these acquisitions are included in the Services segment’s results of operations from the dates of acquisition. The Company’s preliminary allocation of purchase price for these acquisitions is included in the table below, which summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

 

Number of Entities		4
Consideration transferred:
Cash paid		$	19,329
Contingent consideration		3,676
Consideration transferred		23,005
Current assets		2,731
Property, plant and equipment		1,695
Deferred tax asset		(938		)
Intangibles		5,758
Goodwill		15,982
Debt and other long-term liabilities		(2,223		)
Net assets acquired		$	23,005

 

The amortization period of intangible assets acquired ranges from 3 to 5 years. The Company recorded approximately $16.0 million of goodwill in connection with these acquisitions, reflecting the strategic fit and revenue and earnings growth potential of these businesses.

 

Revenues and operating income from these acquisitions for the periods subsequent to the closing of these transactions were approximately $7.2 million and $0.5 million, respectively, for the three and nine month periods ended February 28, 2014. These acquisitions are not significant and no pro forma financial information has been included in this report.

 

During the three and nine month periods ended February 28, 2014, the Company incurred acquisition-related costs of $0.4 million and $0.9 million, respectively, in connection with due diligence, professional fees, and other expenses related to the completed acquisitions 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 month period ended February 28, 2014, these adjustments resulted in a net increase of acquisition-related contingent consideration liabilities and a corresponding decrease in income from operations of approximately $0.6 million. For the nine month period ended February 28, 2014, these adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of approximately $2.4 million. The Company’s aggregate acquisition-related contingent consideration liabilities were approximately $15.5 million and $15.4 million as of February 28, 2014 and May 31, 2013, respectively.

 

During the three and nine month periods ended February 28, 2013, the Company incurred acquisition-related costs of $0.3 million and $1.2 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 nine month periods ended February 28, 2013, these adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of approximately $1.5 million and $2.2 million, respectively.

 

8

Table of Contents

 

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

 

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 nine month periods ended February 28, 2014 and 2013.

 

5.                                      Accounts Receivable, net

 

Accounts receivable consisted of the following:

 

		February 28, 2014			May 31, 2013
Trade accounts receivable		$	128,364		$	110,438
Allowance for doubtful accounts		(2,060		)	(1,884		)
Total		$	126,304		$	108,554

 

6.                                      Inventories

 

Inventories consisted of the following:

 

		February 28, 2014			May 31, 2013
Raw materials		$	3,409		$	3,332
Work in process		2,457			2,310
Finished goods		3,431			4,355
Services-related consumable supplies		3,219			2,507
Total		$	12,516		$	12,504

 

7.                                      Property, Plant and Equipment, net

 

Property, plant and equipment consisted of the following:

 

		Useful Life
		(Years)		February 28, 2014			May 31, 2013
Land				$	1,927		$	1,943
Buildings and improvements		30-40		22,704			20,973
Office furniture and equipment		5-8		6,804			5,543
Machinery and equipment		5-7		137,237			121,563
				168,672			150,022
Accumulated depreciation and amortization				(94,244		)	(81,603		)
Property, plant and equipment, net				$	74,428		$	68,419

 

Depreciation expense for the three months ended February 28, 2014 and 2013 was approximately $4.9 million and $5.0 million, respectively. Depreciation expense for the nine months ended February 28, 2014 and 2013 was approximately $14.1 million and $14.0 million, respectively.

 

8.                                      Intangible Assets

 

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

 

9

Table of Contents

 

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

 

				February 28, 2014									May 31, 2013
		Useful Life (Years)		Gross Amount			Accumulated Amortization			Net Carrying			Gross Amount			Accumulated Amortization			Net Carrying
Customer relationships		5-13		$	74,292		$	(32,466	)	$	41,826		$	69,901		$	(27,422	)	$	42,479
Software/Technology		3-15		14,969			(8,694		)	6,275			14,336			(7,629		)	6,707
Covenants not to compete		2-5		8,523			(7,724		)	799			8,069			(7,523		)	546
Other		2-5		6,743			(3,463		)	3,280			5,195			(2,935		)	2,260
				$	104,527		$	(52,347	)	$	52,180		$	97,501		$	(45,509	)	$	51,992

 

Amortization expense for the three months ended February 28, 2014 and 2013 was approximately $2.4 million and $2.2 million, respectively. Amortization expense for the nine months ended February 28, 2014 and 2013 was approximately $6.7 million and $5.7 million, respectively.

 

9.                                      Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consist of the following:

 

		February 28, 2014			May 31, 2013
Accrued salaries, wages and related employee benefits		$	23,581		$	23,662
Contingent consideration, current portion		3,314			5,144
Accrued workers’ compensation and health benefits		3,432			3,667
Deferred revenue		2,773			2,623
Other accrued expenses		15,112			12,743
Total		$	48,212		$	47,839

 

10.                               Long-Term Debt

 

Long-term debt consists of the following:

 

		February 28, 2014			May 31, 2013
Senior credit facility		$	65,631		$	39,567
Notes payable		10,537			15,740
Other		5,257			4,960
Total debt		81,425			60,267
Less: Current portion		(7,542		)	(7,418		)
Long-term debt, net of current portion		$	73,883		$	52,849

 

Senior Credit Facility

 

The Company has a credit agreement with a $125.0 million revolving line of credit, which, under certain circumstances, can be increased to $150.0 million, and 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 February 28, 2014, borrowings of $65.6 million and letters of credit of $3.6 million were outstanding under the credit agreement.

 

10

Table of Contents

 

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

 

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 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 the Company’s line of business, the Company must be in compliance with the financial covenants on a pro forma basis after taking into account the acquisition, and, if the acquired business is a separate subsidiary, in certain circumstances the lenders will receive the benefit of a guaranty of the subsidiary and liens on its assets and a pledge of its stock.

 

As of February 28, 2014, the Company was in compliance with the terms of the credit agreement. The Company continuously monitors its compliance with its covenants.

 

Several of the Company’s international subsidiaries have entered into a four million Euro facility agreement which enables each of them to borrow in Euros to finance the purchase of equipment. The Company has guaranteed the obligations of the subsidiaries under this facility agreement, and the interest rate charged on the loan balance is based upon the Company’s Funded Debt Leverage Ratio under the Company’s credit agreement. The facility agreement matures in October 2020.

 

Notes Payable and Other

 

In connection with some of its acquisitions made prior to the end of fiscal 2013, the Company issued subordinated notes payable to the sellers of the acquired businesses. 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 February 28, 2014 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.

 

11

Table of Contents

 

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

 

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

 

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

 

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

 

		February 28, 2014
		Level 1			Level 2			Level 3			Total
Liabilities:
Contingent consideration		$	—		$	—		$	15,463		$	15,463
Total Liabilities		$	—		$	—		$	15,463		$	15,463

 

		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.

 

12

Table of Contents

 

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

 

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 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. As of February 28, 2014, total potential acquisition-related contingent consideration ranged from zero to approximately $31.0 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 11 — Fair Value Measurements to these consolidated financial statements for further discussion of the Company’s acquisitions.

 

13.                               Subsequent Event

 

Subsequent to February 28, 2014, the Company completed the acquisition of an asset protection business located in Russia to continue its market expansion strategy.  The Company’s cash outlay for this acquisition was approximately $0.5 million. In addition, the Company will pay deferred consideration of approximately $0.3 million over the next three years. The Company is in the process of completing the preliminary purchase price allocation. This acquisition is not significant and no pro forma information has been included.

 

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

 

13

Table of Contents

 

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

 

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 February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Revenues
Services		$	109,122		$	90,537		$	313,794		$	278,147
International		38,064			37,516			119,032			88,722
Products and Systems		7,610			7,645			22,799			25,618
Corporate and eliminations		(3,069		)	(2,037		)	(11,305		)	(7,710		)
		$	151,727		$	133,661		$	444,320		$	384,777

 

		Three months ended February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Gross profit
Services		$	26,216		$	20,496		$	83,881		$	72,128
International		10,086			9,851			33,499			24,231
Products and Systems		3,674			3,790			9,776			13,010
Corporate and eliminations		(676		)	69			(602		)	459
		$	39,300		$	34,206		$	126,554		$	109,828

 

		Three months ended February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Income from operations
Services		$	7,452		$	6,293		$	32,698		$	28,597
International		84			586			9,192			3,457
Products and Systems		87			1,699			1,147			6,481
Corporate and eliminations		(4,623		)	(3,596		)	(15,210		)	(10,100		)
		$	3,000		$	4,982		$	27,827		$	28,435

 

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

 

		Three months ended February 28,						Nine months ended February 28,
		2014			2013			2014			2013
Depreciation and amortization
Services		$	4,591		$	4,660		$	12,982		$	13,763
International		2,053			1,941			5,958			4,400
Products and Systems		597			617			1,763			1,596
Corporate and eliminations		59			(26		)	147			(66		)
		$	7,300		$	7,192		$	20,850		$	19,693

 

14