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) and mechanical 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 December 31, 2017 and 2016. 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 Transition Report on Form 10-K (“2016 Transition Report”) for the transition period ended December 31, 2016, as filed with the Securities and Exchange Commission on March 20, 2017.

 

 

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 noncontrollingnon-controlling interests are reported in stockholders’ equity in the accompanying condensed consolidated balance sheets. The noncontrollingnon-controlling 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.

 

On January 3, 2017, the Company's Board of Directors approved a change in the Company's fiscal year end from May 31 to December 31, effective December 31, 2016. The transition period was for the seven months ended December 31, 2016 ("the transition period"). Prior to this change, the Company's International segment was consolidated on a one month lag. Therefore, for this interim report, the condensed consolidated income statement includesstatements include a one month lag for the International segment for the three and nine months ended March 31,September 30, 2016. 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. The oneone- month lag was removed with the change in the Company's fiscal year noted above, and accordingly, the condensed consolidated income statement doesstatements do not include a one month lag for the International segment's results for the three and nine months ended March 31,September 30, 2017.

Certain amounts in prior periods have been reclassified to conform to the current year presentation. Such reclassifications did not have a material effect on the Company's financial condition or results of operations as previously reported.

 

2.                                     Share-Based Compensation

 

The Company has share-based incentive awards outstanding to its eligible employees and non-employee directors under three equity incentive plans: (i) the 2007 Stock Option Plan (the 2007 Plan), (ii) the 2009 Long-Term Incentive Plan (the 2009 Plan) and (iii) the 2016 Long-Term Incentive Plan. No further awards may be granted under the 2007 and 2009 Plans, although awards granted under the 2007 and 2009 Plans remain outstanding in accordance with their terms. Awards granted under the 2016 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 March 31,September 30, 2017 and 2016, the Company did not recognize any share-based compensation expense related to stock option awards.

No unrecognized compensation costs remained related to stock option awards as of March 31,September 30, 2017.

 

No stock options were granted during the three and nine months ended March 31,September 30, 2017 and March 31,September 30, 2016.

A summary of the stock option activity, weighted average exercise prices and options outstanding as of March 31,September 30, 2017 and 2016 is as follows:

For the nine months ended September 30, 2017 and September 30, 2016, the Company recognized share-based compensation expense related to restricted stock unit awards of $3.4 million for each respective period. As of September 30, 2017, there was $8.1 million of unrecognized compensation costs, net of estimated forfeitures, related to restricted stock unit awards, which are expected to be recognized over a remaining weighted average period of 2.52.4 years.

 

During the first threenine months of 2017 and 2016, the Company granted approximately 9,00021,000 and 12,00022,000 shares, respectively, of fully-vested common stock to its five non-employee directors, in connection with itsas provided for under the Company's non-employee director compensation plan. These shares had grant date fair values of $0.2$0.4 million and $0.3$0.5 million, respectively, which was recorded as share-based compensation expense during the threenine months ended March 31,September 30, 2017 and March 31,September 30, 2016, respectively.

 

During the first threenine months of 2017 and 2016, approximately 5,000175,000 and 182,000 restricted stock units vested for each period. The fair value of these units was $0.1$3.2 million and $4.5 million for each respective period. 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.

A summary of the Company's outstanding, nonvestednon-vested restricted share units is presented below:

The Company maintains Performance Restricted Stock Units (PRSUs) that have been granted to select executives and senior officers whose ultimate payout is based on the Company’s performance over a one-year period based on three metrics, as defined: (1) Operating Income, (2) Adjusted EBITDAS and (3) Revenue. There also is a discretionary portion of the PRSUs

based on individual performance, at the discretion of the Compensation Committee (Discretionary PRSUs). PRSUs and Discretionary PRSUs generally vest ratably on each of the first four anniversary dates upon completion of the performance period, for a total requisite service period of up to five years and have no dividend rights.

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) 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:

 

4.                                     Acquisitions

During the threenine months ended March 31,September 30, 2017, the Company completed two acquisitions, one acquisition ofthat performs mechanical services at height, located in Canada, and a company located in the U.S. that provides NDT,primarily performs chemical and special processing services.specialty process services, primarily in the aerospace industry.

In this acquisition,these acquisitions, the Company acquired the assets of the U.S. acquiree and 100% of the common stock of the Canada acquiree in exchange for aggregate consideration of $4.5$8.5 million in cash, and contingent consideration up to $3.5$5.9 million to be earned based upon the acquired business achieving specific performance metrics over the initial three years of operations from the acquisition date.date and $1.6 million for working capital adjustments yet to be finalized. The Company accounted for this transactionthese transactions in accordance with the acquisition method of accounting for business combinations.

The Company is continuing its review of the fair value estimate of assets acquired and liabilities assumed for three entities acquired in the transition period ended December 31, 2016. This process will conclude as soon as the Company finalizes information regarding facts and circumstances that existed as of the acquisition date. Goodwill and intangibles for these three entities totaled $4.1 million and $3.4 million, respectively. This measurement period will not exceed one year from their respective acquisition dates.

The 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:

Revenues and operating income included in the condensed consolidated statement of operations for 2017 from this acquisitionthese acquisitions for the period subsequent to the closing of this transaction was approximately $0.3$9.1 million and $0.1$1.1 million, respectively. As this acquisition wasthese acquisitions were immaterial to the Company's 2017 results, no unaudited pro forma financial information has been included in this report.report for either acquisition.

DuringThe Company completed two acquisitions that provide NDT services, located in Canada, during the threenine months ended March 31, 2016,September 30, 2016. The Company acquired 100% of the Company did not complete any acquisitions.common stock of both acquirees in exchange for aggregate

Acquisition-Related Expense 

In the course of its acquisition activities, the Company incurs costs in connection with due diligence, professional fees, and other expenses. Additionally, the Company adjusts the fair value of acquisition-related contingent consideration liabilities on a quarterly basis. These amounts are recorded as acquisition-related expense (benefit) expense,, net, on the condensed consolidated statements of income and were as follows for the three and nine months ended March 31,September 30, 2017 and 2016:

5.                                     Accounts Receivable, net

 

Accounts receivable consisted of the following:

 

 

6.                                     Property, Plant and Equipment, net

 

Property, plant and equipment consisted of the following:

 

Depreciation expense for the three months ended March 31,September 30, 2017 and March 31,September 30, 2016 was $5.5$5.7 million and $5.6$5.8 million, respectively.

 

 

 

The Company reviews goodwill for impairment on a reporting unit basis on October 1 of each year and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable.

During the second quarter of 2017, there were pending contract bids which management assessed as having a reasonable chance of success. These contract bids were not awarded to the Company. As a result of March 31, 2017,this missed opportunity, the annual forecasting process was accelerated, resulting in lower future operating profits and cash flows. As such, there were indicators that the carrying amount of the goodwill for the Products and Systems reporting unit may not be recoverable due to the decline in the projected future cash flows.

The Company did not identifyperformed an analysis to determine any changesimpairment of long-lived assets (see Note 8) as well as an analysis to determine any impairment of goodwill. For the goodwill analysis, we used income and market approaches to estimate the fair value of the reporting unit, which requires significant judgment in circumstancesevaluation of economic and industry trends, estimated future cash flows, discount rates and other factors, and compared that would indicatefair value to the carrying value, and determined that the fair value of the reporting unit was less than the carrying value. The Company recorded an impairment charge of $13.2 million, based on the difference between the fair value and the carrying value of the reporting unit, which resulted in an impairment of the entire amount of goodwill may not be recoverable.for the Products and Systems reporting unit.

The Company's cumulative goodwill impairment as of March 31,September 30, 2017 was $23.1 million, of which $13.2 million related to the Products and Systems segment and $9.9 million related to the International segment. As of December 31, 2016, the cumulative goodwill impairment was $9.9 million, which is within its International segment.

8.                                     Intangible Assets

 

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

 

 

Amortization expense for the three months ended March 31,September 30, 2017 and March 31,September 30, 2016 was $2.2$2.4 million and $2.4$2.1 million, respectively.

 

 

On October 31, 2014, the Company entered into a Third Amendment and Modification Agreement of itsThe Company's revolving line of credit the Third Amended and Restated Credit Agreement (“Credit Agreement”), dated December 21, 2011,agreement with its lending group. The banking group ("Credit AgreementAgreement") provides the Company with a $175.0 million revolving line of credit, which, under certain circumstances, the line of credit can be increased to $225.0 million. The Company may borrow up to $30.0 million in non-U.S. Dollar currencies and use up to $10.0 million of the credit limit for the issuance of letters of credit. The Credit Agreement has a maturity date of October 30, 2019. As of March 31,September 30, 2017, the Company had borrowings of $93.0$95.1 million and a total of $5.7$5.0 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 defined as 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 3.25 to 1 and an Interest Coverage Ratio of at least 3.0 to 1. Interest Coverage Ratio is defined as 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 March 31,September 30, 2017, 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, the Company issued subordinated notes payable to the sellers. The maturity of the notes that remain outstanding are three years from the date of acquisition and bear interest at the prime rate for the Bank of Canada, currently 2.7%3.2% as of March 31,September 30, 2017. Interest expense is recorded in the condensed consolidated statements of income.

 

11.                              Fair Value Measurements

 

The fair value of contingent consideration liabilities classified as Level 3 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.

The following table represents the changes in the fair value of Level 3 contingent consideration:

 

 

 

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 issuances of debt.

 

12.                              Commitments and Contingencies

 

 

The Company is subject to periodic lawsuits, investigations and claims that arise in the ordinary course of business. The Company cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against it. Except possibly for certain of the matters described below, the Company does not believe that any currently pending legal proceeding to which the Company is a party will have a material adverse effect on its business, results of operations, cash flows or financial condition. The costs of defense and amounts that may be recovered against the Company may be covered by insurance for certain matters. The Company has accrued an aggregate of approximately $1.6 million for losses related to the matters described below, net of insurance, for which the Company has stated that an accrual has been established. This $1.6 million accrual does not include the California class action matter, described below, as to which the settlement amount has been fully paid.

 

 

13.                              Segment Disclosure

 

The Company’s three operating segments are:

Costs incurred for general corporate services, including finance, legal, and certain other costs 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.

 

Selected consolidated financial information by segment for the periods shown was as follows (intercompany transactions are eliminated in Corporate and eliminations):

 

 

 

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

 

 

Revenues by geographic area for the three and nine months ended March 31,September 30, 2017 and 2016, respectively, were as follows: