ITEM 1.                          Financial Statements

 

 

 

1.                                     Description of Business and Basis of Presentation

 

 

Mistras Group, Inc. and subsidiaries (the Company)("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, pharmaceutical/biotechnology and food processing 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 the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K (“2015 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 condensed consolidated balance sheets. The noncontrolling interests in net income, 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. 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 condensed 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 equity 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 and nine months ended February 29, 2016 and February 28, 2015, and 2014, the Company recognized share-based compensation expense related to stock option awards of less than $0.1 million for each period, respectively. For the nine months ended February 28, 2015 and 2014, the Company recognized share-based compensation expense related to stock option awards of less than $0.1 million and $0.7 million respectively. As of February 28, 2015,29, 2016, 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 1.0 year.less than 0.1 years.

 

No stock options were granted during the nine months ended February 29, 2016 and February 28, 2015 and 2014.2015.

 

 

For the three months ended February 29, 2016 and February 28, 2015, and 2014, the Company recognized share-based compensation expense related to restricted stock unit awards of $1.2$1.1 million and $1.0$1.2 million, respectively. For the nine months ended February 28, 2015 and 2014, the Company recognized share-based compensation expense related to restricted stock unit awards of $3.5 million and $2.9 million, respectively. As of February 28, 2015, there was $9.0 million of unrecognized compensation costs, net of

February 29, 2016 and February 28, 2015, the Company recognized share-based compensation expense related to restricted stock unit awards of $3.3 million and $3.5 million, respectively. As of February 29, 2016, there was $8.3 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 2.42.3 years.

 

During the first nine months of fiscal 20152016 and 2014,2015, the Company granted approximately 21,00028,000 and 19,00021,000 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 $0.5 million and $0.4 million, for each period respectively, which was recorded as share-based compensation expense during the nine months ended February 29, 2016 and February 28, 2015, and 2014.respectively.

 

During the first nine months of fiscal 2016 and 2015, approximately 220,000 and 2014, approximately 231,000 and 178,000 restricted stock units, respectively, vested. The fair value of these units was $5.2$3.5 million and $3.3$5.2 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 third quarter of fiscal 2014, the Company granted one-year, two-year and three-year performance restricted stock units to its executive officers and certain other senior officers. In the second quarter of fiscal 2015, the Company granted performance restricted stock units to its executive and certain other senior officers. In the first quarter of fiscal 2016, the Company modified its equity compensation program and granted 154,000 performance restricted stock units to its executive and certain other senior officers. As a condition for receiving any awards under the revised fiscal 2016 plan, the executive and senior officers surrendered and released all rights to receive any shares under the three-year 2014 awards and three-year 2015 awards with a performance or market condition. The Company has accounted for the fiscal 2016 awards as modifications in accordance with ASC 718, Compensation - Stock Compensation. These units have requisite service (vesting) periods of threefive years and have no dividend rights. For the three and nine months ended February 28, 2015, the Company recognized share-based compensation expense related to performance restricted stock units of $0.1 million and $0.2 million, respectively. At February 28, 2015, there was $1.6 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 2.5 years. The actual payout of these units will vary based on the Company’s performance over a three-yearone-year period (based on pre-established targets) and a market condition modifier based on three metrics related to the Company’s fiscal 2016 performance: (1) Operating Income, (2) Adjusted EBITDAS, which is consistent with Adjusted EBITDA as disclosed in the financial statements, which is net income before interest, taxes, depreciation, amortization, non-cash stock-based compensation expense, acquisition related items, and other non-routine items as determined by the Committee and (3) Revenue. There is also a discretionary portion based on individual performance. During the three months ended November 30, 2015, the Company evaluated the expected performance metrics and increased the estimated performance shares expected to be granted by 80,000 units to a total shareholder return (TSR) compared to an industry peer group. of 234,000 units. No adjustment was required during the three months ended February 29, 2016.

 

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 nine months of fiscal 2015, the Company completed four acquisitions. The Company purchased a company, located in Louisiana, a provider of maintenance and inspection services primarily on offshore platforms. This acquisition expandsexpanded 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 and an asset inspection business in Florida 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 aggregate consideration of approximately $35.7 million in cash and $20.5 million in notes payable issued as part of the acquisition and other liabilities assumed.acquisitions. The Company accounted for these transactions in accordance with the acquisition method of accounting for business combinations. In addition, the acquisitions in Quebec and Florida provideprovided for contingent consideration of up to $3.2 million to be earned based upon the acquired business achieving specific performance metrics over the nextinitial two to three years of operation. The Company is inoperation from the process of completing the purchase price allocations for these acquisitions.acquisition date.

The amortization period of intangible assets acquired in fiscal 2015 ranges from 3 to 10 years. The Company recorded $45.2 million of goodwill in connection with these acquisitions, reflecting the strategic fit and revenue and earnings growth potential of these business.businesses.

 

During the three and nine month periodperiods ended February 29, 2016, the Company incurred acquisition-related costs of $0.1 million and $0.2 million, respectively, 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 $1.3 million, for the three and nine month periods ended February 29, 2016, respectively. The Company’s aggregate acquisition-related contingent consideration liabilities were $3.8 million and $6.4 million as of February 29, 2016 and May 31, 2015, respectively.

During the three and nine month periods ended February 28, 2015, the Company incurred acquisition-related costs of $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 nine month periods ended February 28, 2015, these adjustments resulted in a net decrease of acquisition-related contingent consideration liabilities and a corresponding increase in income from operations of $1.7 million and $3.3 million, respectively. The Company’s aggregate acquisition-related contingent consideration liabilities were $8.8 million and $14.1 million as of February 28, 2015 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 nine month periods ended February 29, 2016 and February 28, 2015 and 2014.2015.

 

Depreciation expense for the three months ended February 29, 2016 and February 28, 2015 and 2014 was $5.4$5.5 million and $4.9$5.4 million, respectively. Depreciation expense for the nine months ended February 29, 2016 and February 28, 2015 and 2014 was $16.3$16.7 million and $14.1$16.3 million, respectively.

 

7.8.                                     Intangible Assets

 

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

 

 

Amortization expense for the three months ended February 29, 2016 and February 28, 2015 and 2014 was $2.7$2.4 million and $2.4$2.7 million, respectively. Amortization expense for the nine months ended February 29, 2016 and February 28, 2015 and 2014 was $8.5$7.2 million and $6.7$8.5 million, respectively.

 

8.9.                                     Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities consistconsisted of the following:

 

9.10.                              Long-Term Debt

 

Long-term debt consistsconsisted of the following:

 

 

On October 31, 2014, the Company entered into a Third Amendment and Modification Agreement, (the “Amendment”), to its revolving line of credit, the Third Amended and Restated Credit Agreement (“Credit Agreement”), dated December 21, 2011, with Bank of America, N.A., as agent for the lenders and a lender, and JPMorgan Chase Bank, N.A., Keybank, National Association and TD Bank, N.A., as lenders. The Amendment increasedCredit Agreement provides the Company’sCompany with a $175.0 million revolving line of credit, to from $125.0 million to $175.0 million and provides thatwhich, under certain circumstances, the line of credit can be increased to $225.0 million. The Company may continue to 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. The Amendment also extended the originalCredit Agreement has a maturity date of the Credit Agreement from December 20, 2016 to October 30, 2019. As of February 28, 2015,29, 2016, the Company had borrowings of $96.7$71.5 million and a total of $4.7$4.5 million of letters of credit outstanding under the Credit Agreement.

 

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, 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 amounts not paid when due. 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 no greater 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, 2015,29, 2016, 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 the 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 February 28, 201529, 2016 and May 31, 2014.2015. Amortization is recorded as interest expense in the condensed 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.

 

10.11.                              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:

 

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.

 

11.12.                              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.

 

 

 

 

12.13.                              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 nine months ended February 28,29, 2016 and 2015, and 2014, respectively, were as follows: