ITEM 1.                          Financial Statements

 

 

 

1.                                     Description of Business and Basis of Presentation

 

 

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) and non-destructive testing (NDT) services and proprietary data analysis software to deliver a comprehensive portfolio of customized solutions, ranging from routine inspections to complex, plant-wide asset integrity assessments and management. These mission critical solutions enhance customers’ ability to extend the useful life of their assets, increase productivity, minimize repair costs, comply with governmental safety and environmental regulations, manage risk and avoid catastrophic disasters. The Company serves a global customer base of companies with asset-intensive infrastructure, including companies in the oil and gas, fossil and nuclear power, alternative and renewable energy, public infrastructure, chemicals, commercial aerospace and defense, transportation, primary metals and metalworking, pharmaceuticalspharmaceutical/biotechnology and food processing industries.industries and research and engineering institutions.

 

 

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, 20152016 and 2014.2015. 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 2014,2015, as filed with the Securities and Exchange Commission on August 8, 2014.12, 2015.

 

 

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 net income, net of tax, is classified separately in the accompanying consolidated statements of income.

 

All significant intercompany accounts and transactions have been eliminated in consolidation. Mistras Group, Inc.’s and its subsidiaries’ fiscal years end on May 31 except for the subsidiaries 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 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.

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’sCompany's financial condition or results of operations as previously reported.

 

 

2.                                     Share-Based Compensation

 

The Company has share-based incentive awards outstanding to its eligible employees and Directors under two employee stock ownershipequity incentive 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 restricted stock units, stock appreciation rights and deferred stock rights.

 

 

For the three months ended November 30, 20142015 and 2013,2014, the Company recognized share-based compensation expense related to stock option awards of less than $0.1 million and $0.1 million,for each period respectively. For the six months ended November 30, 20142015 and 2013,2014, the Company recognized share-based compensation expense related to stock option awards of less than $0.1 million and $0.7 millionfor each period respectively. As of November 30, 2014,2015, 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 1.30.3 years.

 

No stock options were granted during the six months ended November 30, 20142015 and 2013.2014.

 

 

For each of the three months ended November 30, 20142015 and 2013,2014, the Company recognized share-based compensation expense related to restricted stock unit awards of $1.2$1.1 million and $1.1$1.2 million, respectively. For the six months ended November 30, 20142015 and 2013,2014, the Company recognized share-based compensation expense related to restricted stock unit awards of $2.3$2.2 million and $1.9$2.3 million, respectively. As of November 30, 2014,2015, there was $10.2$9.5 million of unrecognized compensation costs, net of estimated forfeitures, related to restricted stock unit awards, which are expected to be recognized over a remaining weighted average period of 2.6 years.

 

During the first quartersix months of fiscal 20152016 and 2014,2015, the Company granted approximately 15,000 and 10,000 shares, respectively, 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 $0.2 million for each period respectively, which was recorded as share-based compensation expense during the six months ended November 30, 20142015 and 2013.2014.

 

During the first halfsix months of fiscal 2016 and 2015, approximately 217,000 and 2014, approximately 226,000 and 175,000 restricted stock units, respectively, vested. The fair value of these units was $4.9$3.4 million and $3.2$4.9 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.

In the second quarter of fiscal 2015, the companyCompany granted performance restricted stock units to its executive and certain other senior officers. These units have requisite service (vesting) periodswere surrendered as part of three years and have no dividend rights.the revised fiscal 2016 plan as discussed above. For the three and six months ended November 30, 2015, there was $0 and $0.2 million of compensation expense recognized, respectively. For the three and six months ended November 30, 2014, the Company recognized share-based compensation expense related to performance restricted stock units of $0.1 million. At November 30, 2014, there was $1.8 million of total unrecognized compensation costs related to approximately 115,000 non-vested performance restricted stock units. These costs are expected to be recognized over a weighted-average period of approximately 2.8 years. The actual payout of these units will vary based on the Company’s performance over a three -year period (based on pre-established targets) and a market condition modifier based on total shareholder return (TSR) compared to an industry peer group. Compensation cost is initially measured assuming that the target performance condition will be achieved. However, compensation cost related to the performance condition is adjusted for subsequent changes in the expected outcome of the performance condition. Compensation cost related to the TSR condition is fixed at the measurement date, and not subsequently adjusted.$0.1 million, respectively.

In the secondthird quarter of fiscal 2014, the companyCompany granted one-year, two-year and three-year performance restricted stock units to its executive officers and certain other senior officers. TheseThe three-year performance restricted stock units have requisite service (vesting) periodswere surrendered as part of three years and have no dividend rights.

 

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:

 

In the first half of fiscal 2015,2016, the Company completed three acquisitions.one acquisition. The Company purchased The NACHER Corporation, located in Louisiana, a provider of maintenancecompany that provides unmanned aerial systems and inspectionNDT services, primarily on offshore platforms. This acquisition expands the service offerings within the Services segment, allowing the Company to provide services to the upstream operations of its customers. The Company also purchased a group of asset protection businesses located in Quebec, Canada to continue its market expansion strategy. The Company’s International Segment completed an acquisition of an asset inspection business located in the United Kingdom.U.S.

In these acquisitions,this acquisition, the Company acquired 100% of the common stock or certain assets of eachthe acquiree in exchange for aggregate consideration of approximately $33.7$1.8 million in cash and $20.5 million in notes payable issued as part of the acquisition and other liabilities assumed. The Company accounted for these transactions in accordance with the acquisition method of accounting for business combinations. In addition, the acquisition in Quebec provides for contingent consideration of upestimated to $2.7be $0.9 million to be earned based upon the acquired business achieving specific performance metrics over the next threeinitial four years of operation. The Company is in the process of completing the preliminary purchase price allocations.

The assets and liabilities of the businessesbusiness acquired in fiscal 20152016 were included in the Company’sCompany'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 arethis acquisition is included in each respective operating segment’sthe Services segment's results of operations from the date of acquisition. For acquisitionsThe Company's preliminary purchase price allocations are included in the table below, summarizing the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

In the first half of fiscal 2015, the Company completed three acquisitions. The Company purchased a company, located in Louisiana, a provider of maintenance and 2014inspection services primarily on offshore platforms. This acquisition expanded the service offerings within the Services segment, allowing the Company to provide services to the upstream operations of its customers. The Company also purchased a group of asset protection businesses located in Quebec, Canada to complement service offerings within the Company’s Services segment and continue its market expansion strategy. The Company’s International Segment completed an acquisition of an asset inspection business located in the United Kingdom.

In these acquisitions, the Company acquired 100% of the common stock or certain assets of each acquiree in exchange for whichaggregate consideration of approximately $34.0 million in cash and $22.7 million in notes payable issued as part of the final purchaseacquisitions and other liabilities assumed. The Company accounted for these transactions in accordance with the acquisition method of accounting has yetfor business combinations. In addition, the acquisition in Quebec provided for contingent consideration of up to $2.7 million to be completed,earned based upon the Company’sacquired business achieving specific performance metrics over the initial three years of operation from the acquisition date.

 

During the three and operating income from these acquisitions for the period subsequent to the closing of these transactions were $25.9 million and $2.7 million, respectively, for the six month periodperiods ended November 30, 2014. No unaudited pro forma financial information is required2015, the Company incurred acquisition-related costs of less than $0.1 million in connection with due diligence, professional fees, and other expenses for its acquisition activities. Additionally, the Company adjusted the fair value of certain previously recorded acquisition-related contingent consideration liabilities. These adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of $0.2 million and $1.1 million, for the three and six month periods ended November 30, 2015, respectively. The Company’s aggregate acquisition-related contingent consideration liabilities were $5.7 million and $6.4 million as these acquisitions are not significant to the Company.of November 30, 2015 and May 31, 2015, respectively.

 

During the three and six month periods ended November 30, 2014, the Company incurred acquisition-related costs of less than $0.2 million in connection with due diligence, professional fees, and other expenses related tofor its acquisition activity.activities. 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, 2014, these adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of $0.6 million and $1.6 million, respectively. The Company’s aggregate acquisition-related contingent consideration liabilities were $12.5 million and $14.1 million as of November 30, 2014 and May 31, 2014, 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, 20142015 and 2013.2014.

 

5.                                     Accounts Receivable, net

 

Accounts receivable consisted of the following:

 

 

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

 

 

 

Loans under the Credit Agreement bear interest at LIBOR plus an applicable LIBOR margin ranging from 1% to 1.75%, or a base rate less a margin of 1.25% to 0.375%, at the option of the Company, 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 (a) net income, less (b) income (or plus loss) from discontinued operations and extraordinary items, plus (c) income tax expenses, plus (d) interest expense, plus (e) depreciation, depletion, and amortization (including non-cash loss on retirement of assets), plus (f) stock compensation expense, less (g) cash expense related to stock compensation, plus or minus certain other adjustments) for the period of four consecutive fiscal quarters immediately preceding the date of determination. The Company has the benefit of the lowest margin if its Funded Debt Leverage Ratio is equal to or less than 0.5 to 1, and the margin increases as the ratio increases, to the maximum margin if the ratio is greater than 2.0 to 1. The Company will also bear additional costs for market disruption, regulatory changes effecting the lenders’ funding costs, and default pricing of an additional 2% interest rate margin on any

 

The Credit Agreement contains financial covenants requiring that the Company maintain a Funded Debt Leverage Ratio of no greater than 3.03.25 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 itsthe 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 November 30, 2014,2015, the Company was in compliance with the terms of the Credit Agreement, and will continuously monitor its compliance with the covenants contained in its credit agreement.

 

 

In connection with certain of its acquisitions through fiscal 2015, the Company issued subordinated notes payable to the sellers. The maturity of thesethe notes that remain outstanding range from two 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. Unamortized discount on the notes was de minimis as of November 30, 20142015 and May 31, 2014.2015. Amortization is recorded as interest expense in the consolidated statements 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 issuesissuances of debt.

 

11.10.                              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:

 

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:

 

 

 

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.

 

12.11.                              Commitments and Contingencies

 

 

The Company is subject to periodic lawsuits, investigations and claims that arise in the ordinary course of business. Although the Company cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against it, the Company does not believe that any currently pending legal proceeding to which the Company is a party will have a material adverse effect on its business, results of operations, cash flows or financial condition.condition, except for the proceedings described below for which the Company is currently unable to determine the likely outcome or reasonably estimate the amount or range of potential liability estimate. The costs of defense and amounts that may be recovered against the Company in such matters may be covered by insurance.insurance, except that the primary claims set forth in the purported class action case in California is excluded from insurance coverage.

 

During fiscal 2012 and 2013, the Company performed radiography work on the construction of pipeline projects in Georgia.the U.S. The Company has received notice that the owner of the pipeline projects contends that certain of the x-ray images the Company’s technicians prepared regarding the projects did not meet the code quality interpretation standards required by API (American Petroleum Institute) 1104.1103. The projects' owner of the projects is claiming damages as a result of the alleged quality defects of the Company’s x-ray images. No lawsuit has been filed at this time. The Company is currently unable to determine the likely outcome or reasonably estimate the amount or range of potential liability related to this matter, and accordingly, has not established any reserves for this matter.

 

 

 

 

13.12.                              Segment Disclosure

 

The Company’s three operating segments are:

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.

 

 

 

 

Revenues by geographic area for the three and six months ended November 30, 20142015 and 2013,2014, respectively, were as follows: