ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
This Report on Form 10-K contains forward-looking statements regarding us and our business, financial condition, results of operations and prospects within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.
In some cases, you can identify forward-looking statements by terminology, such as “goals,” or “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “could,” “should,” “would,” “predicts,” “appears,” “projects,” or the negative of such terms or other similar expressions. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed elsewhere in this Report in Part I, Item 1A.
ITEM 1A. RISK FACTORS
This section describes the major risks to us, our business and our common stock. You should carefully read and consider the risks described below, together with the other information contained in this Annual Report, including our financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” before making an investment decision. The statements contained in this section constitute cautionary statements under the Private Securities Litigation Reform Act of 1995. If any of these risks actually occur, our business, financial condition, results of operations and future growth prospects may be adversely affected. As a result, the trading price of our common stock would likely decline, and you may lose all or part of your investment. You should understand that it is not possible to predict or identify all risk factors that could impact us. Accordingly, you should not consider the following to be a complete discussion of all risks and uncertainties.
Risks related to our business
Our operating results could be adversely affected by a reduction in business with our significant customers.
We derive a significant amount of revenues from a few customers. For instance, various divisions or business units of our largest customer, BP, were responsible for approximately 18%, 18% and 17% of our revenues for fiscal 2011, 2010 and 2009, respectively. Taken as a group, our top ten customers were responsible for approximately 44%, 45% and 36% of our revenues for fiscal 2011, 2010 and 2009, respectively. This concentration pertains almost exclusively to our Services segment, which accounted for more than 80% of our revenues for the last three fiscal years. Generally, our customers do not have an obligation to make purchases from us and may stop ordering our products and services or may terminate existing orders or contracts at any time with little or no financial penalty. The loss of any of our significant customers, any substantial decline in sales to these customers or any significant change in the timing or volume of purchases by our customers could result in lower revenues and could harm our business, financial condition or results of operations.
An accident or incident involving our asset protection solutions could expose us to claims, harm our reputation and adversely affect our ability to compete for business and, as a result, harm our operating performance.
We could be exposed to liabilities arising out of the solutions we provide. For instance, we furnish the results of our testing and inspections for use by our customers in their assessment of their assets, facilities, plants and other structures. If such results were to be incorrect or incomplete, whether as a result of poorly designed inspections, malfunctioning testing equipment or our employees’ failure to adequately test or properly record data, we could be subject to claims. Further, if an accident or incident involving a structure we are testing or have tested occurs and causes personal injuries to our personnel or third parties, or property damage, such as the collapse of a bridge or an explosion in a plant or facility, and particularly if these injuries or damages could have been prevented by our customers had we provided them with correct or complete results, we may face significant claims by injured persons or related parties and claims relating to any property damage or loss. Even if our results are correct and complete, we may face claims for such injuries or damage simply because we tested the structure or facility in question. While we do have insurance, our insurance coverage may not be adequate to cover the damages from any such claims, forcing us to bear these uninsured damages directly, which could harm our operating results and may result in additional expenses and possible loss of revenues. An accident or incident for which we are found partially or fully responsible, even if fully insured, may also result in negative publicity, which would harm our reputation among our customers and the public, cause us to lose existing and future contracts or make it more difficult for us to compete effectively, thereby significantly harming our operating performance. Such an accident or incident might also make it more expensive or impossible for us to insure against similar events in the future. Even unsuccessful claims relating to accidents could result in substantial costs, including litigation expenses, negative publicity and diversion of our management resources.
Many of our customers, particularly in the oil and gas and chemical industries, require their inspectors and other contractors working at their facilities to have good safety records. Safety records are impacted by the number and amount of workplace incidents involving a contractor’s employees. If our safety record is not within the levels required by our customers, or compares unfavorably to our competitors, we could lose business, be prevented from working at certain facilities or suffer other adverse consequences, all of which could negatively impact our business, revenues, reputation and profitability.
If we are unable to attract and retain a sufficient number of trained engineers, scientists and certified technicians at competitive wages, our operational performance may be harmed and our costs may increase.
We believe that our success depends, in part, upon our ability to attract, develop and retain a sufficient number of trained engineers, scientists and certified technicians at competitive wages. The demand for such employees is currently high, and we project that it will continue in the future. Accordingly, we have experienced increases in our labor costs, particularly in our Services segment, but also, to a lesser extent, in our International segment. Many of the companies with which we compete for
experienced personnel have comparatively greater name recognition and resources. The markets for our products and services also require us to use personnel trained and certified in accordance with standards set by domestic or international standard-setting bodies, such as the American Society of Non-Destructive Testing or the American Petroleum Institute. Because of the limited supply of these certified technicians, we expend substantial resources maintaining in-house training and certification programs. If we fail to attract sufficient new personnel or fail to motivate and retain our current personnel, our ability to perform under existing contracts and orders or to pursue new business may be harmed, causing us to lose customers and revenues, and the costs of performing such contracts and orders may increase, which would likely reduce our margins.
If we lose members of our senior management team upon whom we are dependent, we may not be able to manage our operations and achieve our strategic objectives.
Our future success depends to a considerable degree upon the availability, contributions, vision, skills, experience and effort of our senior management team. We do not maintain “key person” insurance on any of our employees other than Dr. Sotirios J. Vahaviolos, our Chairman, President and Chief Executive Officer. We currently have no employment agreements with members of our senior management team other than with Dr. Vahaviolos. Although we may enter into employment agreements with certain executive officers in the future, these agreements will likely not guarantee the services of the individual for a specified period of time. Although we do not have any reason to believe that we may lose the services of any of these persons in the foreseeable future, the loss of the services of any of these persons might impede our operations or the achievement of our strategic and financial objectives. The loss or interruption of the service of members of our senior management team could harm our business, financial condition and results of operations and could significantly reduce our ability to manage our operations and implement our strategy.
We operate in highly competitive markets and if we are unable to compete successfully, we could lose market share and revenues and our margins could decline.
We face strong competition from NDT and a variety of niche asset protection providers, both larger and smaller than we are. Many of our competitors have greater financial resources than we do and could focus their substantial financial resources to develop a competing business model or develop products or services that are more attractive to potential customers than what we offer. Some of our competitors are business units of companies substantially larger than us and have the ability to combine asset protection solutions into an integrated offering to customers who already purchase other types of products or services from them. Our competitors may offer asset protection solutions at prices below or without cost in order to improve their competitive positions. Smaller niche competitors with small customer bases may be very aggressive in their pricing in order to retain customers. These competitive factors could make it more difficult for us to attract and retain customers, or can cause us to lower our prices and accept lower margins in order to compete, the impact of any of which can reduce our market share, revenues and profits.
Due to our dependency on customers in the oil and gas industry, we are susceptible to prolonged negative trends relating to this industry that could adversely affect our operating results.
Our customers in the oil and gas industry (including the petrochemical market) have accounted for a substantial portion of our historical revenues. Specifically, they accounted for approximately 61%, 63% and 58% of our revenues for fiscal 2011, 2010 and 2009, respectively. While we make efforts to expand our customer base into industries other than the oil and gas industry, we may not be successful in doing so. Our services are vital to the operators of plants and refineries, however economic slow downs in the oil and gas industry can result in cut backs in contracts for our services. If the oil and gas industry were to suffer a prolonged or significant downturn, our revenues, profits and cash flows may be reduced. While we continue to seek to expand our market presence in the power generation and transmission, and chemical processing industries, among others, these markets too are cyclical in nature and as such, are subject to economic downturns.
Our growth strategy includes acquisitions. We may not be able to identify suitable acquisition candidates or integrate acquired businesses successfully, which may inhibit our rate of growth, and any acquisitions that we do complete may expose us to a number of unanticipated operational and financial risks.
Our historical growth has depended, and our future growth is likely to continue to depend, to a certain extent, on our ability to make acquisitions and successfully integrate acquired businesses. We intend to continue to seek additional acquisition opportunities, both to expand into new markets and to enhance our position in existing markets globally. We may not be able to successfully identify suitable candidates, negotiate appropriate acquisition terms, obtain necessary financing on acceptable terms, complete proposed acquisitions, successfully integrate acquired businesses into our current operations or expand into new markets. Once integrated,
acquired operations may not achieve levels of revenues, profitability or productivity comparable with those achieved by our current operations, or otherwise perform as expected.
Some of the risks associated with our acquisition strategy include:
· unexpected loss of key personnel and customers of the acquired company;
· making the acquired company’s financial and accounting standards consistent with our standards;
· assumption of liability for risks and exposures (including environmental-related costs), some of which we may not discover during our due diligence; and
· potential disruption of our ongoing business and distraction of management.
Our ability to undertake acquisitions is limited by covenants in our current credit agreement and our financial resources, including available cash and borrowing capacity. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of substantial additional indebtedness and other expenses, impairment expenses related to goodwill and impairment or amortization expenses related to other intangible assets, any of which could harm our financial condition and results of operations. Although management intends to: (i) evaluate the risks inherent in any particular transaction, (ii) assume only risks it believes to be acceptable, and (iii) develop plans to mitigate such risks, there are no assurances that we will properly ascertain or accurately assess the extent of all such risks. Difficulties encountered with acquisitions may harm our business, financial condition and results of operations.
Catastrophic events, such as natural disasters, industrial accidents, epidemics, war and acts of terrorism, could disrupt our business or the business of our customers, which could significantly harm our operations, financial results and cash flow.
Our operations and those of our customers are susceptible to the occurrence of catastrophic events outside our control, ranging from severe weather conditions to acts of war and terrorism. Any such events could cause a serious business disruption that reduces our customers’ ability to or interest in purchasing our asset protection solutions, and have in the past resulted in order cancellations and delays because customer equipment, facilities or operations have been damaged, or are not operational or available. For example, in April 2010, our largest customer, BP, suffered a catastrophic industrial accident in the Gulf of Mexico. Due to the scope of the accident, the possibility existed that BP would exit some of its refining operations or suffer liquidity problems, either of which could adversely affect our business. A large portion of our customer base has operations in the Gulf of Mexico, which is subject to hurricanes in the first and second quarters of our fiscal year. Hurricane-related disruptions to our customers operations have adversely affected our revenues in the past. Such events in the future may result in substantial delays in the provision of solutions to our customers and the loss of valuable equipment. Any cancellations, delays or losses due to a catastrophic event may significantly reduce our revenues and harm our operating performance.
The tsunami and earthquakes in Japan earlier this year, and resulting problems with the nuclear power plants in Japan’s Fukushima-1 nuclear plant has caused significant delays and other problems obtaining electronic parts and components from Japan. In addition, the radioactive exposure resulting from problems at the Fukushima-1 nuclear plant has raised concerns regarding the future of the nuclear energy industry. While the United States and other countries do not appear to be reducing the use of nuclear power, or halting construction of new nuclear power generation facilities, the situation in Japan could impact nuclear power generation business in the United States. Accordingly, our business could be adversely impacted by delays or increased costs to obtain electronic parts and components or by any regulatory action to suspend to halt construction of nuclear power generating facilities in the United States.
We face risks related to the current economic conditions.
The global economy continues to be fragile. Global financial markets continue to experience disruptions, including tight liquidity and credit availability, weak consumer confidence, modest economic growth, persistently high unemployment rates, volatility in interest and currency exchange rates and continued uncertainty about economic stability. There may be further deterioration and volatility in the global economy, the global financial markets and consumer confidence. We are unable to predict the likely duration and severity of the current global economic uncertainties or disruptions in the financial markets. The downturn has already resulted in certain of our customers canceling and delaying orders for our solutions, as well as some customers delaying payment for items billed. Although less frequent, we continue to experience pricing pressure on new contracts and renewals of existing contracts. We have also experienced a decline in our customers’ capital spending. In addition, current economic conditions have resulted in the reduced creditworthiness, inability to obtain sufficient financing, and bankruptcies of certain customers, increasing our potential exposure to bad debt. Further, with the recent uncertainty in the European financial markets, European governments have begun to consider significant austerity measures, which could lead to cancellations or delays of orders and thus, may reduce revenues and profitability.
If economic conditions deteriorate further, our business, financial condition and results of operations could be adversely affected. Although we believe we have adequate liquidity and capital resources to fund our operations as planned, in light of current market conditions, our inability to access the capital markets on favorable terms, or at all, may harm our financial performance. The inability
to obtain adequate financing from debt or capital sources could force us to self-fund strategic initiatives or even forgo certain opportunities, which in turn could potentially harm our financial performance.
We expect to continue expanding and our success depends on how effectively we manage our growth.
We expect to experience significant growth in the number of our employees and the scope of our operations. To effectively manage our anticipated future growth, we must continue to implement and improve our managerial, operational, financial and reporting systems, expand our facilities and continue to recruit and train additional qualified personnel. We expect that all of these measures will require significant expenditures and will demand the attention of management. Failure to manage our growth effectively could lead us to over or under-invest in technology and operations, result in weaknesses in our infrastructure, systems or controls, give rise to operational mistakes, loss of business opportunities, the loss of employees and reduced productivity among remaining employees. Our expected growth could require significant capital expenditures and may divert financial resources from other projects, such as the development of new solutions. If our management is unable to effectively manage our expected growth, our expenses may increase more than expected, our profit margins may suffer, our revenues could decline or may grow more slowly than expected and we may be unable to implement our business strategy.
The success of our businesses depends, in part, on our ability to develop new asset protection solutions and increase the functionality of our current offerings.
The market for asset protection solutions is impacted by technological change, uncertain product lifecycles, shifts in customer demands and evolving industry standards and regulations. We may not be able to successfully develop and market new asset protection solutions that comply with present or emerging industry regulations and technology standards. Also, new regulations or technology standards could increase our cost of doing business.
From time to time, our customers have requested greater functionality in our solutions. As part of our strategy to enhance our asset protection solutions and grow our business, we continue to make substantial investments in the research and development of new technologies. We believe our future success will depend, in part, on our ability to continue to design new, competitive asset protection solutions, enhance our current solutions and provide new, value-added services. Developing new solutions will require continued investment, and we may experience unforeseen technological or operational challenges. In addition, our asset protection software is complex and can be expensive to develop, and new software and software enhancements can require long development and testing periods. If we are unable to develop new asset protection solutions or enhancements that meet our customers’ needs on a timely basis, we will likely lose opportunities to earn revenues and to gain customers or access to markets, and our business and results of operations will be adversely affected.
If our software produces inaccurate information or is incompatible with the systems used by our customers and makes us unable to successfully provide our solutions, it could lead to a loss of revenues and customers.
Our software is complex and, accordingly, may contain undetected errors or failures. Software defects or inaccurate data may cause incorrect recording, reporting or display of information related to our asset protection solutions. Any such failures, defects and inaccurate data may prevent us from successfully providing our asset protection solutions, which would result in lost revenues. Software defects or inaccurate data may lead to customer dissatisfaction and our customers may seek to hold us liable for any damages incurred. As a result, we could lose customers, our reputation may be harmed and our financial condition and results of operations could be materially adversely affected.
We currently serve a commercial, industrial and governmental customer base that uses a wide variety of constantly changing hardware, software solutions and operating systems. Our asset protection solutions need to interface with these non-standard systems in order to gather and assess data. Our business depends on the following factors, among others:
· our ability to integrate our technology with new and existing hardware and software systems;
· our ability to anticipate and support new standards, especially Internet-based standards; and
· our ability to integrate additional software modules under development with our existing technology and operational processes.
If we are unable to adequately address any of these factors, our results of operations and prospects for growth and profitability would be harmed.
If we fail to successfully educate current and potential customers regarding the benefits of our asset protection solutions or the market for these solutions otherwise fails to develop, our ability to grow our business could be adversely impacted.
Our future success depends on continued and growing commercial acceptance of our asset protection solutions and our ability to obtain additional contracts. We anticipate that revenues related to our asset protection solutions will constitute a substantial portion of our revenues for the foreseeable future. If we are unable to educate our potential customers about the advantages our solutions have over competing products and services, or our current customers stop purchasing our asset protection solutions, our operating results could be significantly harmed. In addition, because the asset protection solutions industry is rapidly evolving, we could lose insight into trends that may be emerging, which would further harm our competitive position by making it difficult to predict and respond to customer needs. If the market for our asset protection solutions does not continue to develop, our ability to grow our business would be limited and we might not be able to maintain profitability.
The seasonal nature of our business reduces our revenues and profitability in our first and third fiscal quarters.
Our business is seasonal. This seasonality relates primarily to our Services segment. Our first and third fiscal quarter revenues for our Services segment are typically lower than our revenues in the second and fourth fiscal quarters because demand for our asset protection solutions from the oil and gas as well as the fossil and nuclear power industries increases during their non-peak production periods. For instance, U.S. refineries’ non-peak periods are generally in our second fiscal quarter, when they are retooling to produce more heating oil for winter, and in our fourth fiscal quarter, when they are retooling to produce more gasoline for summer. As a result of these trends, we generally have reduced cash flows in our second and fourth fiscal quarters, which may require us to borrow under our credit agreement or to discontinue or curtail some of our operations. In addition, most of our operating expenses, such as employee compensation and property rental expense, are relatively fixed over the short term. Moreover, our spending levels are based in part on our expectations regarding future revenues. As a result, if revenues for a particular quarter are below expectations, we may not be able to proportionately reduce operating expenses for that quarter. We expect that the impact of seasonality on our first and third fiscal quarter revenues and profitability and second and fourth fiscal quarter cash flows will continue.
Growth in revenues from our Services segment or traditional NDT services relative to revenues from our Products and Systems and International segments, may reduce our overall gross profit margin.
Our gross profit margin on revenues from our Services segment, particularly traditional NDT services, has historically been lower than our gross profit margin on revenues from our other segments because our services have higher labor-related costs. For instance, the gross profit margin in our Services segment for fiscal 2011 was approximately 28%, while our gross profit margin in our Products and Systems segment and in our International segment was approximately 51% and 35%, respectively. Our overall gross profit margin was approximately 31% during the same period. We expect to continue our efforts to increase the number of “evergreen” or “run and maintain” contracts at oil refineries. Often times, the services we provide at the beginning of these contracts are traditional NDT services. Until such time as we can understand the needs of each new “evergreen” plant and we can then make recommendations to provide our advanced NDT services, and thus improve our sales product mix, our margins may continue to decline. As a result, we expect our overall gross profit margin will be lower in periods when revenues from our services, and particularly from traditional NDT services, has increased as a percentage of total revenues and will be higher in periods when revenues from our advanced NDT services and our International or Products and Systems segments has increased as a percentage of total revenues. The Service segment revenue was approximately 84%, 84% and 80% of total revenues for fiscal years 2011, 2010 and 2009, respectively. We expect this trend to continue and to the extent is does, our margins may decrease or remain flat. Fluctuations in our gross profit margin may affect our level of profitability in any period, which may negatively affect the price of our common stock.
Our business, and the industries we currently serve, are currently subject to governmental regulation, and may become subject to modified or new government regulation that may negatively impact our ability to market our asset protection solutions.
We incur substantial costs in complying with various government regulations and licensing requirements. For example, the transportation and overnight storage of radioactive materials used in providing certain of our asset protection solutions is subject to regulation under federal and state laws and licensing requirements. Our Services segment is currently licensed to handle radioactive materials by the U.S. Nuclear Regulatory Commission (NRC) and over 20 state regulatory agencies. If we allegedly fail to comply with these regulations, we may be investigated and incur significant legal expenses associated with such investigations, and if we are
found to have violated these regulations, we may be fined or lose one or more of our licenses to perform further projects. While we are investigated, we may be required to suspend work on the projects associated with our alleged noncompliance, resulting in loss of profits or customers, and damage to our reputation. Many of our customers have strict requirements concerning safety or loss time occurrences and if we are unable to meet these requirements it could result in lost revenues. An alleged violation of these types of regulations could also negatively impact our business. In the future, federal, state, provincial or local governmental agencies may seek to change current regulations or impose additional regulations on our business. Any modified or new government regulation applicable to our current or future asset protection solutions may negatively impact the marketing and provision of those solutions and increase our costs and the price of our solutions.
Additionally, greenhouse gases that result from human activities, including burning of fossil fuels, have been the focus of increased scientific and political scrutiny and are being subjected to various legal requirements. International agreements, national laws, state laws and various regulatory schemes limit or otherwise regulate emissions of greenhouse gases, and additional restrictions are under consideration by different governmental entities. We derive a significant amount of revenues and profits from such industries, including oil and gas, power generation and transmission, and chemicals processing. Such regulations could negatively impact our customers, which could negatively impact the market for the services and products we provide. This could materially adversely affect our business, financial condition, results of operations and cash flows.
We rely on certification of our NDT solutions by industry standards-setting bodies. We currently have International Organization for Standardization (ISO) 9001:2008 certifications for each of Mistras Services, Physical Acoustics Corporation (PAC), Physical Acoustics Limited, and Envirocoustics S.A. and we have ISO 14001:2004 certification for Mistras Services and Physical Acoustics South America. Physical Acoustics South America also has an OHSAS 18001:2007 certification. In addition, we currently have Nadcap (formerly National Aerospace and Defense Contractors Accreditation Program) certification for certain of our locations in California, Connecticut, Massachusetts, Ohio and Washington. We continually review our NDT solutions for compliance with the requirements of industry specification standards and the Nadcap special processes quality requirements. However, if we fail to maintain our ISO or Nadcap certifications, our business may be harmed because our customers generally require that we have ISO and Nadcap certification before they purchase our NDT solutions.
An inability to protect our intellectual property could negatively affect our business and results of operations.
Our ability to compete effectively depends in part upon the maintenance and protection of the intellectual property related to our asset protection solutions. Patent protection is unavailable for certain aspects of the technology and operational processes important to our business. Any patent held by us or to be issued to us, or any of our pending patent applications, could be unenforceable, challenged, invalidated or circumvented. Some of our trademarks that are not in use may become available to others. To date, we have relied principally on copyright, trademark and trade secrecy laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our intellectual property. However, we have not obtained confidentiality agreements from all of our customers and vendors. Although we have entered into confidentiality agreements with all of our employees in our Products and Systems segment and certain of our other employees involved in the development of our intellectual property, we cannot be certain that these agreements will be honored or enforceable. Some of our confidentiality agreements are not in writing, and some customers are subject to laws and regulations that require them to disclose information that we would otherwise seek to keep confidential. Although we do not transfer ownership of some of our more advanced asset protection products and systems and, instead, sell to our customers services using these products and systems, in part, in an effort to protect the intellectual property upon which they are based, this strategy may not be successful and our customers or third parties may reverse engineer or otherwise derive this intellectual property and use it without our authorization. Policing unauthorized use of our intellectual property is difficult and expensive. The steps that we have taken or may take might not prevent misappropriation of the intellectual property on which we rely. In addition, effective protection may be unavailable or limited in jurisdictions outside the United States, as the intellectual property laws of foreign countries sometimes offer less protection or have onerous filing requirements. From time to time, third parties may infringe our intellectual property rights. Litigation may be necessary to enforce or protect our rights or to determine the validity and scope of the rights of others. Any litigation could be unsuccessful, cause us to incur substantial costs, divert resources away from our daily operations and result in the impairment of our intellectual property. Failure to adequately enforce our rights could cause us to lose valuable rights in our intellectual property and may negatively affect our business.
We may be subject to damaging and disruptive intellectual property litigation related to allegations that our asset protection solutions infringe on the intellectual property of others, which could prevent us from offering those solutions.
Third-party patent applications, patents, copyrights and trademarks may be applicable to our asset protection solutions. As a result, third parties may in the future make infringement claims and other allegations that could subject us to intellectual property litigation
relating to our solutions. Such litigation would be time consuming and expensive, divert attention and resources away from our daily operations, impede or prevent delivery of our solutions and require us to pay significant royalties, licensing fees and damages. In addition, parties making infringement and other claims may be able to obtain injunctive or other equitable relief that could effectively block our ability to provide our solutions and could cause us to pay substantial damages if we are found to be infringing on others’ intellectual property rights. In the event of a successful claim of infringement, we may need to seek one or more licenses from third parties in order to continue to offer the related solution, which may not be available at a reasonable cost, or at all.
We may require additional capital to support business growth, which might not be available.
We intend to continue making investments to support our business growth and may require additional funds to respond to business challenges or opportunities, including the need to develop new, or enhance our current, asset protection solutions, enhance our operating infrastructure or acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our current stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.
Our credit agreement contains financial and operating restrictions that may limit our access to credit. If we fail to comply with financial or other covenants in our credit agreement, we may be required to repay indebtedness to our existing lenders, which may harm our liquidity.
Provisions in our current credit agreement impose restrictions on our ability to, among other things:
· create liens;
· make strategic acquisitions;
· make investments;
· incur more debt;
· merge or consolidate;
· make dispositions of property;
· pay dividends and make distributions;
· enter into a new line of business;
· enter into transactions with affiliates; and
· enter into burdensome agreements.
Our credit agreement also contains financial covenants that require us to maintain compliance with specified financial ratios. If we fail to comply with these covenants the lenders could prevent us from borrowing under our credit agreement, require us to pay all amounts outstanding and require that we cash collateralize letters of credit issued under the credit agreement. If the maturity of our indebtedness is accelerated, we then may not have sufficient funds available for repayment or the ability to borrow or obtain sufficient funds to replace the accelerated indebtedness on terms acceptable to us, or at all.
Our revenue cycle can be lengthy, unpredictable and require significant employee time and financial resources with no assurances that we will realize revenues.
Our sales cycles are often long and unpredictable. Many of our current and potential customers have extended budgeting and procurement processes. We believe that they also tend to be risk averse and follow industry trends rather than be the first to purchase new products or services, which can extend the lead time for or prevent acceptance of new products or services. Accordingly, they may take longer to reach a decision to purchase our solutions. This extended sales process, which often lasts between three and six months, requires the dedication of significant time and financial resources, with no certainty of success or recovery of our related expenses. It is not unusual for our current and potential customers to go through the entire sales process and not make any purchases.
Any real or perceived internal or external electronic security breaches in connection with the use of our asset protection solutions could harm our reputation, inhibit market acceptance of our solutions and cause us to lose customers.
We and our customers use our asset protection solutions to compile and analyze sensitive or confidential customer-related information. In addition, some of our asset protection solutions allow us to remotely control and store equipment at commercial, institutional and industrial locations. Our asset protection solutions rely on the secure electronic transmission of proprietary data over the Internet or other networks. The occurrence or perception of security breaches in connection with our asset protection solutions or our customers’ concerns about Internet security or the security of our solutions, whether warranted or not, would likely harm our reputation or business, inhibit market acceptance of our asset protection solutions and cause us to lose customers, any of which would harm our financial condition and results of operations.
We may come into contact with sensitive consumer information or data when we perform installation, maintenance or testing functions for our customers. Even the perception that we have improperly handled sensitive, confidential information would have a negative effect on our business. If, in handling this information, we fail to comply with privacy or security laws, we could incur civil liability to government agencies, customers and individuals whose privacy is compromised. In addition, third parties may attempt to breach our security or inappropriately harm our asset protection solutions through computer viruses, electronic break-ins and other disruptions. If a breach is successful, confidential information may be improperly obtained, for which we may be subject to lawsuits and other liabilities.
Our international operations are subject to risks relating to non-U.S. operations.
In fiscal 2011, 2010 and 2009, we generated approximately 15%, 14% and 18% of our revenues outside the United States, respectively. We expect to increase our international presence over time. Our primary operations outside the United States are in Europe, Canada, South America and Asia. There are numerous risks inherent in doing business in international markets, including:
· fluctuations in interest rates and currency exchange rates;
· varying regional and geopolitical business conditions and demands;
· compliance with applicable foreign regulations and licensing requirements, and U.S. regulation with respect to our business in other countries, including the Foreign Corrupt Practices Act;
· the cost and uncertainty of obtaining data and creating solutions that are relevant to particular geographic markets;
· the need to provide sufficient levels of technical support in different locations;
· the complexity of maintaining effective policies and procedures in locations around the world;
· the risks of divergent business expectations or difficulties in establishing joint ventures with foreign partners;
· political instability and civil unrest;
· restrictions or limitations on outsourcing contracts or services abroad;
· restrictions or limitations on the repatriation of funds; and
· potentially adverse tax consequences.
We are expanding our sales and marketing efforts in certain emerging markets, such as Brazil, Russia, India and China. Expanding our business into emerging markets may present additional risks beyond those associated with more developed international markets. For example, in China and Russia, we may encounter risks associated with the ongoing transition from state business ownership to privatization. In any emerging market, we may face the risks of working in cash-based economies, dealing with inconsistent government policies and encountering sudden currency revaluations.
Risks related to our common stock
We expect our quarterly revenues and operating results to fluctuate. If we fail to meet the expectations of market analysts or investors, the market price of our common stock could decline substantially.
Our quarterly operating results have fluctuated in the past and may do so in the future. Accordingly, we believe that period-to-period comparisons of our results of operations may be the best indicators of our business. You should not rely upon the results of one quarter as an indication of future performance. Our revenues and operating results may fall below the expectations of securities analysts or investors in any future period. Our failure to meet these expectations may cause the market price of our common stock to decline, perhaps substantially.
Our quarterly revenues and operating results may vary depending on a number of factors, including those listed previously under “Risks related to our business.”
In addition to the effect our operating results may have on the market price of our common stock, the market price of our common stock may also be influenced by many other factors, some of which are beyond our control, including:
· announcements by us or our competitors of significant contracts or acquisitions;
· liquidity of the market for our common stock;
· changes in financial estimates or recommendations by analysts;
· general economic and stock market conditions;
· quarterly or annual earnings of other companies in our industry;
· future sales of our common stock;
· changes in accounting standards, policies, guidance, interpretations or principles; and
· the other factors described in this Risk Factors section.
The stock markets have generally experienced extreme price and volume fluctuations. This volatility has had a significant impact on the market price of securities issued by many companies, including those in our industry. These changes frequently appear to occur without regard to the operating performance of these companies. The price of our common stock could fluctuate for reasons that have little or nothing to do with our company, and these fluctuations could materially reduce our stock price.
In the past, some companies that have had volatile market prices for their securities have been subject to class action or derivative lawsuits. The filing of a lawsuit against us, regardless of the outcome, could have a material adverse effect on our business, financial condition and results of operations, as it could result in substantial legal costs and a diversion of our management’s attention and resources.
A significant stockholder controls the direction of our business. The concentrated ownership of our common stock may prevent you and other stockholders from influencing significant corporate decisions.
Dr. Sotirios J. Vahaviolos, our Chairman, President and Chief Executive Officer, owns approximately 41% of our outstanding common stock. As a result, Dr. Vahaviolos effectively controls our Company and has the ability to exert substantial influence over all matters requiring approval by our shareholders, including the election and removal of directors, amendments to our certificate of
incorporation, and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. This concentration of ownership could be disadvantageous to other shareholders with differing interests from Dr. Vahaviolos.
We currently have no plans to pay dividends on our common stock.
We have not declared or paid any cash dividends on our common stock to date, and we do not anticipate declaring or paying any dividends on our common stock in the foreseeable future. We currently intend to retain all available funds and any future earnings for use in the development, operation and growth of our business. In addition, our credit agreement prohibits us from paying cash dividends and future loan agreements may also prohibit the payment of dividends. Any future determination relating to our dividend policy will be at the discretion of our board of directors and will depend on our results of operations, financial condition, capital requirements, business opportunities, contractual restrictions and other factors deemed relevant. To the extent we do not pay dividends on our common stock, investors must look solely to stock appreciation for a return on their investment.
Shares eligible for future sale may cause the market price for our common stock to decline even if our business is doing well.
Future sales by us or by our existing shareholders of substantial amounts of our common stock in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital in the future through the sale of our equity securities. Under our second amended and restated certificate of incorporation, we are authorized to issue up to 200,000,000 shares of common stock, of which approximately 27,671,000 shares of common stock are outstanding as of August 1, 2011. In addition, the Company has approximately 3,080,000 shares of common stock reserved for issuance related to stock options and restricted stock units that are outstanding as of August 1, 2011. We cannot predict the size of future issuances of our common stock or the effect, if any, that future sales and issuances of shares of our common stock, or the perception of such sales or issuances, would have on the market price of our common stock.
Provisions of our charter, bylaws and of Delaware law could discourage, delay or prevent a change of control of our company, which may adversely affect the market price of our common stock.
Certain provisions of our second amended and restated certificate of incorporation and amended and restated bylaws could discourage, delay or prevent a merger, acquisition, or other change of control that stockholders may consider favorable, including transactions in which our stockholders might otherwise receive a premium for your shares. These provisions also could limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. Stockholders who wish to participate in these transactions may not have the opportunity to do so. Furthermore, these provisions could prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions:
· allow the authorized number of directors to be changed only by resolution of our board of directors;
· require that vacancies on the board of directors, including newly created directorships, be filled only by a majority vote of directors then in office;
· authorize our board of directors to issue, without stockholder approval, preferred stock that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our board of directors;
· require that stockholder actions must be effected at a duly called stockholder meeting by prohibiting stockholder action by written consent;
· prohibit cumulative voting in the election of directors, which would otherwise allow holders of less than a plurality of stock to elect some directors; and
· establish advance notice requirements for stockholder nominations to our board of directors or for stockholder proposals that can be acted on at stockholder meetings and limit the right to call special meetings of stockholders to the Chairman of the Board, the Chief Executive Officer, the board of directors acting pursuant to a resolution adopted by a majority of directors or the Secretary upon the written request of stockholders entitled to cast not less than 35% of all the votes entitled to be cast at such meeting.
In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may, unless certain criteria are met, prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a prescribed period of time.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
As of May 31, 2011, we operated approximately 75 offices in 15 countries, with our corporate headquarters located in Princeton Junction, New Jersey. Our headquarters in Princeton Junction is our primary location, where our manufacturing and research and development are conducted. While we lease most of our facilities, as of May 31, 2011, we owned properties located in Olds, Alberta; Monroe, North Carolina; Trainer, Pennsylvania; Houston, Pasadena, and Deer Park, Texas; Burlington, Washington; and Gillette, Wyoming. These properties, as well as approximately 50 offices throughout North America (including Canada), are utilized by our Services segment. Our Products and Systems segment’s primary location is in our Princeton Junction facility. Our International segment has approximately 20 offices including locations in Brazil, United Kingdom, the Netherlands, France, Greece, Russia, Japan and India.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are subject to periodic lawsuits, investigations and claims that arise in the ordinary course of business. See “Litigation” in Note 14 to our audited consolidated financial statements contained in Item 8 of this report for a description of legal proceedings involving us and our business, which is incorporated herein by reference.
ITEM 4.
ITEM 4.
RESERVED
Executive Officers
The following are our executive officers and other key employees as of May 31, 2011 and their background and experience:
Sotirios J. Vahaviolos has been our Chairman, President and Chief Executive Officer since he founded Mistras in 1978 under the name Physical Acoustics Corporation. Prior to joining Mistras, Dr. Vahaviolos worked at AT&T Bell Laboratories. Dr. Vahaviolos received a B.S. in Electrical Engineering and graduated first in his engineering class from Fairleigh Dickinson University and received Masters degrees in Electrical Engineering and Philosophy and a Ph.D.(EE) from the Columbia University School of Engineering. During Dr. Vahaviolos’ career in non-destructive testing, he has been elected Fellow of The Institute of Electrical and Electronics Engineers, a member of The American Society for Nondestructive Testing (ASNT) where he served as its President from 1992-1993 and its Chairman from 1993-1994, a member of Acoustic Emission Working Group (AEWG) and an honorary life member of the International Committee for Nondestructive Testing. Additionally, he was the recipient of ASNT’s Gold Medal in 2001 and AEWG’s Gold Medal in 2005. He was also one of the six founders of NDT Academia International in 2008 headquartered in Brescia, Italy.
Dennis Bertolotti is the President and Chief Operating Officer, Services. Mr. Bertolotti has been with us since we acquired Conam Inspection Services in 2003, where Mr. Bertolotti was a Vice President at the time of the acquisition. Mr. Bertolotti has been in the NDT business for over 25 years, and previously held ASNT Level III certifications and various American Petroleum Institute, or API, certifications, and received his Associate of Science degree in NDT from Moraine Valley Community College in 1983. Mr. Bertolotti has also received a Bachelor of Science and MBA from Otterbein College.
Mark F. Carlos is our Group Executive Vice President, Products and Systems, having joined Mistras at its founding in 1978. Prior to joining Mistras, Mr. Carlos worked at AT&T Bell Laboratories. Mr. Carlos received a MBA from Rider University and a Masters in Electrical Engineering from Columbia University. Mr. Carlos is an elected Fellow of ASNT and AEWG, and currently serves as the Chairman of the American Society for Testing and Materials’ NDT Standards Writing Committee E-07 and was the recipient of its prestigious Charles W. Briggs Award in 2007.
Phillip T. Cole is Group Executive Vice President, International, and Managing Director of Mistras Group Limited (formerly Physical Acoustics Limited), our subsidiary based in England. Mr. Cole founded Dunegan UK in 1983, which was acquired by Mistras in 1986. Mr. Cole obtained a master’s degree in physics and electronic engineering from Loughborough University. Mr. Cole began his career at TI Research in the U.K. where he focused on NDT electromagnetic-acoustic devices.
Ralph L. Genesi is Group Executive Vice President, Marketing and Sales. He joined Mistras in March of 2009 with more than 25 years of executive management experience in marketing and sales as well as corporate profit and loss responsibility. Prior to joining Mistras, Mr. Genesi was President of Swantech Inc., a division of the Curtiss Wright Corporation from 2005 until 2009. From 2001 until 2005, Mr. Genesi was with Siemens AG, where he was Vice President and General Manager for the Siemens Power Generation Information Technology Business, responsible for energy trading, fleet operations and control solutions worldwide. Prior to that Mr. Genesi held positions as President-Americas Operations for Spectris Technologies Inc., a European holding company and Director, Global Market & Sales Development for Honeywell’s Industrial Automation & Controls business. Mr. Genesi has an Electrical Engineering degree from Fairleigh Dickinson University.
Francis T. Joyce joined us as our Executive Vice President, Chief Financial Officer and Treasurer in July 2010. Prior to join us, Mr. Joyce was the Chief Financial Officer from 2006 to 2008 of Macquarie Infrastructure Company LLC, a New York Stock Exchange infrastructure operation and investment company that provides services in the general aviation, bulk liquid storage, gas utility, district cooling and airport parking industries. Prior to his employment with Macquarie, Mr. Joyce served as Chief Financial Officer of IMAX Corporation, a NASDAQ company, from 2001 until 2006 and he was the Chief Financial Officer and Treasurer of TheGlobe.com from 1998 to 2001. Mr. Joyce started his career in public accounting at KPMG in New York. Frank graduated from the University of Scranton with a Bachelor of Science in Accounting and from Fordham University Graduate School of Business with an MBA in Finance. Mr. Joyce is a certified public accountant.
Michael C. Keefe is Executive Vice President, General Counsel and Secretary and also has responsibility for human resources, joining Mistras in December 2009. Most recently before Mistras, Mr. Keefe worked at International Fight League, a publicly-traded sports promotion company, from 2007 until 2009, initially as Executive Vice President, General Counsel and Corporate Secretary, then becoming the Chief Financial Officer, and eventually its President. From 1990 until 2006, Mr. Keefe served in various legal roles with Lucent Technologies and AT&T, the last four years as Vice President, Corporate and Securities Law and Assistant Secretary, and prior to that was in private practice at New Jersey’s largest law firm, McCarter & English, LLP. Before starting his legal career, Mr. Keefe was employed at PricewaterhouseCoopers LLP, and worked in accounting for seven years, becoming a certified public accountant. Mr. Keefe received a BS in Business Administration (Accounting) from Seton Hall University and a J.D. from Seton Hall University School of Law.
Michael J. Lange is Group Executive Vice President, Services having joined Mistras when we acquired Quality Services Laboratories in November 2000, and was elected a Director in 2003. Mr. Lange is a well recognized authority in Radiography and has held an ASNT Level III Certificate for almost 20 years. Mr. Lange received an Associate of Science degree in NDT from the Spartan School of Aeronautics in 1979.
Our executive officers are elected by, and serve at the discretion of, our board of directors. There are no family relationships among any of our directors or executive officers.
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES
Market for common stock
Our common stock currently trades on the New York Stock Exchange (NYSE) under the ticker symbol “MG”. The following table sets forth for the periods indicated the range of high and low sales prices of our common stock. Trading of our common stock commenced on October 8, 2009, the first trading day after our initial public offering.
Holders of record
As of August 1, 2011, there were approximately 20 holders of record of our Common Stock. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. The transfer agent of our common stock is American Stock Transfer & Trust Company, 6201 15th Avenue, Brooklyn, New York 11219.
Dividends
No cash dividends have been paid on our Common Stock to date. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following tables set forth our selected historical consolidated financial data for the periods indicated. The selected statement of operations and cash flow data for fiscal 2011, 2010 and 2009 and the selected balance sheet data as of May 31, 2011 and 2010 have been derived from our audited financial statements and related notes thereto included elsewhere in this Annual Report. The statement of operations and cash flow data for fiscal 2008 and fiscal 2007 and the selected balance sheet data as of May 31, 2009, 2008 and 2007 have been derived from our audited financial statements not included in this Annual Report. The information presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited financial statements and the notes thereto included elsewhere in this Annual Report.
(1) The following table provides a reconciliation of net income to EBITDA and adjusted EBITDA:
EBITDA and Adjusted EBITDA are performance measures used by management that are not calculated in accordance with U.S. generally accepted accounting principles (GAAP). EBITDA is defined in this Annual Report as net income attributable to Mistras Group, Inc. plus: interest expense, provision for income taxes and depreciation and amortization. Adjusted EBITDA is defined in this Annual Report as net income attributable to Mistras Group, Inc. plus: interest expense, provision for income taxes, depreciation and amortization, stock-based compensation expense, and, if applicable, certain acquisition related costs and certain one-time and generally non-recurring items (which items are described below or in the reconciliation table above).
Our management uses Adjusted EBITDA as a measure of operating performance to assist in comparing performance from period to period on a consistent basis, as a measure for planning and forecasting overall expectations and for evaluating actual results against such expectations. Adjusted EBITDA is also used as a performance evaluation metric of which to base executive and employee incentive compensation programs.
We believe investors and other users of our financial statements benefit from the presentation of Adjusted EBITDA in evaluating our operating performance because it provides an additional tool to compare our operating performance on a consistent basis and measure underlying trends and results in our business. Adjusted EBITDA removes the impact of certain items that management believes do not directly reflect our core operations. For instance, Adjusted EBITDA generally excludes interest expense, taxes and depreciation and amortization, each of which can vary substantially from company to company depending upon accounting methods and the book value and age of assets, capital structure, capital investment cycles and the method by which assets were acquired. It also eliminates stock-based compensation, which is a non-cash expense and is excluded by management when evaluating the underlying performance of our business operations.
While Adjusted EBITDA is a term and financial measurement commonly used by investors and securities analysts, it has limitations. As a non-GAAP measurement, Adjusted EBITDA has no standard meaning and, therefore, may not be comparable with similar measurements for other companies. Adjusted EBITDA is generally limited as an analytical tool because it excludes charges and expenses we do incur as part of our operations. For example, Adjusted EBITDA excludes income taxes, but we generally incur significant U.S. federal, state and foreign income taxes each year and the provision for income taxes is a necessary cost. Adjusted EBITDA should not be considered in isolation or as a substitute for analyzing our results as reported under U.S. generally accepted accounting principles.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” and the Financial Statements and related disclosures included elsewhere in this Report. The following discussion may contain forward-looking statements. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.
In some cases, you can identify forward-looking statements by terminology, such as “goals,” or “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or the negative of such terms or other similar expressions. You are urged not to place undue reliance on any such forward-looking statements, any of which may turn out to be wrong due to inaccurate assumptions, unknown risks, uncertainties or other factors. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed elsewhere in this Report in Part I, Item 1A “Risk Factors” and in Item 1 “Business-Forward-Looking Statements,” as well as those discussed in our other Securities and Exchange Commission (SEC) filings.
Overview
We are a leading global provider of technology-enabled asset protection solutions used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure. We combine 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 our 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. Given the role our services play in ensuring the safe and efficient operation of infrastructure, we have historically provided a majority of our services to our customers on a regular, recurring basis. We serve a global customer base of companies with asset-intensive infrastructure, including companies in the oil and gas, fossil and nuclear power, public infrastructure, chemicals, aerospace and defense, transportation, primary metals and metalworking, pharmaceuticals and food processing industries. During fiscal 2011, we provided our asset protection solutions to approximately 5,600 customers. As of May 31, 2011, we had approximately 2,700 employees, including approximately 30 Ph.D.’s and 100 other degreed engineers and, certified technicians, in approximately 75 offices across 15 countries. We have established long-term relationships as a critical solutions provider to many leading companies in our target markets. Our current principal market is the oil and gas industry, which accounted for approximately 61%, 63% and 58% of our revenues for fiscal 2011, 2010 and 2009, respectively.
For the last several years, we have focused on introducing our advanced asset protection solutions to our customers using proprietary, technology-enabled software and testing instruments, including those developed by our Products and Systems segment. During this period, the demand for outsourced asset protection solutions, in general, has increased, creating demand from which our entire industry has benefited. We have experienced a compounded annual growth rate (CAGR) for revenue of 31% over the last three fiscal years, including the impact of acquisitions and currency fluctuations. We believe further growth can be realized in all of our target markets. Concurrent with this growth, we have worked to build our infrastructure to profitably absorb additional growth and have made a number of small acquisitions in an effort to leverage our fixed costs, grow our base of experienced, certified personnel, expand our product and technical capabilities and increase our geographical reach.
We have increased our capabilities and the size of our customer base through the development of applied technologies and managed support services, organic growth and the integration of acquired companies. These acquisitions have provided us with additional products, technologies, resources and customers that we believe will enhance our competitive advantages over our competition.
The global economy continues to be fragile. Global financial markets continue to experience uncertainty, including tightened liquidity and credit availability, relatively low consumer confidence, slower economic growth, persistently high unemployment rates, volatile currency exchange rates and continued uncertainty about economic stability. However, we believe these conditions have allowed us to capitalize on an opportunity to selectively hire new talented individuals that otherwise might not have been available to us, to acquire and develop new technologies in order to aggressively expand our proprietary portfolio of customized solutions, and to make acquisitions of complementary businesses at reasonable valuations.
Basis of presentation
Consolidated results of operations
Our three segments are:
· Services. This segment provides asset protection solutions primarily in North America with the largest concentration in the United States, 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.
· Products and Systems. This segment designs, manufactures, sells, installs and services our asset protection products and systems, including equipment and instrumentation, predominantly in the United States.
· International. This segment offers services, products and systems similar to those of our other 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 our Products and Systems segment.
General corporate services, including accounting, audit, legal, payroll, information technology, human resources and contract management, are provided to the segments and are reported as intersegment transactions 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 corporate and eliminations.
The accounting policies of the reportable segments are the same as those described in the summary of our significant accounting policies in Note 2 to our audited consolidated financial statements included elsewhere in this Annual Report. Segment income from operations is evaluated based on internal performance measures used by the Chief Executive Officer, 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 items such as charges for stock-based compensation and certain other acquisition-related charges and balances, technology and product development costs, certain gains and losses from dispositions, and litigation settlements or other charges. Certain general and administrative costs such as human resources, information technology and training are allocated to the segments. Segment income from operations also excludes 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.
Statement of operations overview
The following describes certain line items in our statement of operations and some of the factors that affect our operating results.
Revenues
Our revenues are generated by sales of our services, products and systems. The majority of our revenues are derived under time-and-materials contracts for specified asset protection services on a project-by-project basis. The duration of our projects vary depending on their scope. Some of our projects last from a few weeks to a few months, but the more significant projects can last for more than a year and can require long-term deployment of substantial personnel, equipment and resources. The start date of our projects can be postponed or delayed and the duration of our projects can be shortened or increased due to a variety of factors beyond our control. In addition to the timing of these projects and the seasonality of our business, the amount and origination of our revenues often vary from period to period. A percentage of our revenues are usually attributable to recurring work from our existing customers. Although our top ten customers are responsible for a large percentage of our revenues, we generate our revenues from most of these customers by providing asset protection solutions to a number of their business locations. Decisions regarding the purchase of our solutions by these customers are made either on a corporate basis or on a location-by-location basis. Also included in our revenues are software license fees and product sales, as well as an estimate for potential sales returns and customer allowances. Revenues under our time-and-materials services contracts are based on the hours of service we provide our customers at negotiated rates, plus any actual costs of materials and other direct expenses that we incur on the project, which may include markups. Because these expenses, such as travel and lodging or subcontracted services, can change significantly from project to project, changes in our revenues may not be indicative of business trends.
Cost of revenues
Our cost of revenues includes our direct compensation and related benefits to support our sales, together with reimbursable costs, materials consumed or used in manufacturing our products and certain overhead costs, such as non-billable time, equipment rentals, fringe benefits and repair and maintenance.
Depreciation included in gross profit
Our depreciation represents the expense charge for our capitalized assets. Depending on the nature of the original item capitalized, these depreciation expenses are reported in one of two places in our statement of operations. Depreciation used in determining gross profit is directly related to our revenues and primarily relates to depreciation of equipment used for the delivery of our asset protection solutions and to a lesser extent depreciation of manufacturing equipment. We also have other depreciation primarily related to our corporate headquarters which is included in deriving our income from operations as discussed below.
Gross profit
Our gross profit equals our revenues less our cost of revenues and attributed depreciation. Our gross profit, both in absolute dollars and as a percentage of revenues, can vary based on our volume, sales mix, actual manufacturing costs and our utilization of labor. As a result, gross profit may vary from quarter to quarter. For instance, the seasonality of our business can cause our gross profit to decline during traditionally slower first and third quarters when we incur labor costs without any corresponding revenues. Under our time-and-materials contracts, we negotiate hourly billing rates and charge our clients based on the actual time that we expend on a project. Our profit margins on time-and-materials contracts fluctuate based on actual labor and overhead costs that we directly charge or allocate to contracts compared to negotiated billing rates.
In recent years, there has been an increasing demand for asset protection solutions and at times, a limited supply of certified technicians. Accordingly, we may experience increases in our cost of labor in our Services segment. The customers of our Services segment have been aware of these supply constraints and generally have, to some extent, accepted corresponding price increases for our services. However, in the current economic environment we have experienced certain pricing pressures from customers and we are uncertain whether our ability to increase prices for our services will continue. In our Products and Systems segment, our ability to increase prices for any product or system to offset associated cost increases is based principally on the extent to which it incorporates our proprietary technology. We believe our efforts to develop and offer our customer’s value-added proprietary solutions instead of commodity-type products help us, in part, to resist margin erosion. Our International segment offers services, products and systems similar to those of our other segments, so our ability to increase prices in this segment as costs increase is determined by the same factors affecting the pricing of our other segments, and the relative mix of services, products and systems it provides in the applicable period.
Selling, general and administrative expenses
Our selling, general and administrative (SG&A) expenses are comprised primarily of expenses of our sales and marketing operations, field location administrative costs and our corporate headquarters related to our executive, general management, finance, accounting and administrative functions and legal fees and expenses. These costs can vary based on our volume of business or as expenses are incurred to support corporate activities and initiatives such as training. The largest single category is salaries and related costs. In the near term, we expect these expenses to increase as we support the growth of our business and expand our sales and marketing efforts, improve our information processes and systems and implement the financial reporting, compliance and other infrastructure required for a public company. We also expect that our SG&A expenses will decline as a percentage of our revenues, particularly over the long-term.
Research and engineering
Research and engineering expense consists primarily of engineering salaries and personnel-related costs and the cost of products, materials and outside services used in our process and product development activities primarily in our Products and Systems segment. Other research and development is conducted in our Services segment by various billable personnel and our management on a collaborative basis. These costs are not separated and are included in cost of revenues. Specific development costs on software are capitalized and amortized in our depreciation and amortization included in our income from operations. From time-to-time, we receive minor grants or contracts for paid research which are recorded in our revenues with the related costs included in cost of revenues. We expect to continue our investment in research and engineering activities and anticipate that our associated expense will increase in absolute terms in the future as we hire additional personnel and increase research and engineering activity. However, as a percentage of revenues, we expect research and engineering expense to decline over the long term.
Depreciation and amortization included in income from operations
Our depreciation and amortization used in deriving our income from operations represents the expense charge for our capitalized assets, and primarily relates to buildings and improvements, including our corporate headquarters, office furniture, equipment, intangibles and other assets acquired as part of our acquisitions of other businesses. The intangible assets include, but are not limited to, non-competition agreements, customer lists and trade names, while the other assets acquired are primarily machinery and
equipment. To the extent we ascribe value to identifiable intangible assets that have finite lives, we amortize those values over the estimated useful lives of those assets. Fixed assets acquired are depreciated over their useful lives and charged to cost of revenues. Such depreciation and amortization expense, although non-cash, directly impacts our results of operations. It is difficult to predict with any precision the amount of expense we may record relating to acquired intangible and other assets.
Income from operations
Our income from operations is our gross profit less our SG&A expenses, research and engineering, depreciation and amortization, and reserve for legal settlements included in income from operations. We refer to our income from operations as a percentage of our revenues as our operating margin.
Interest expense
Our interest expense consists primarily of interest paid to our lenders under our credit agreement and our capital leases. Also included is the interest on subordinated notes issued as part of our acquisitions and interest incurred related to interest rate swap contracts, when applicable.
Income taxes
Income tax expense varies as a function of pre-tax income and the level of non-deductible expenses, such as certain amounts of meals and entertainment expense, valuation allowances and other permanent differences. As of May 31, 2011 we had approximately $1.1 million of net operating loss carry forwards (NOLs). available to offset state taxable income in future years. These state NOLs will expire, if not utilized, at varying dates beginning in 2015 depending on the laws of each state. At May 31, 2011, the Company has recorded a valuation allowance of less than $0.1 million against certain state deferred income tax assets based on its assessment that the respective deferred income tax assets would not be realized. Our effective income tax rate may fluctuate significantly over the next few years due to many variables including the amount and future geographic distribution of our pre-tax income, changes resulting from our acquisition strategy, and increases or decreases in our permanent differences.
Noncontrolling interest, net of taxes
The noncontrolling interest represents the ownership interests of other stockholders in our international subsidiaries, where 100% ownership is not permitted or de minimis local ownership is helpful for business purposes.
Consolidated results of operations
Fiscal 2011, 2010 and 2009
Our revenues, gross profit, income from operations and net income for fiscal 2011, 2010 and 2009 were as follows:
Our growth rates for fiscal 2011, 2010 and 2009, respectively, were as follows:
Fiscal 2011 compared to fiscal 2010
Revenues. Our revenues, by segment for fiscal 2011, 2010 and 2009, were as follows:
(1) Revenues by operating segment include intercompany transactions, which are eliminated in corporate and eliminations.
Revenues increased $66.5 million, or 24%, in fiscal 2011 compared to fiscal 2010 as a result of growth in all our segments. For fiscal 2011 and fiscal 2010, we estimate that our organic growth rate, as compared to growth driven by acquisitions, was approximately 16% and 18%, respectively. In fiscal 2011, we estimate that organic growth by segment was approximately 19% for our Products and Systems segment, 16% for our Services segment and 11% for our International segment. This organic growth was driven by an increase in demand for our inspection services coupled with an increase in seasonal turn-around maintenance activity from our “run and maintain” or “evergreen” contracts at oil refineries. In fiscal 2011, we estimate that growth from acquisitions was $19.0 million, or approximately 8%, compared to $25.8 million, or 12%, in fiscal 2010. We completed five acquisitions in fiscal 2011 compared to three acquisitions in fiscal 2010 and five acquisitions in fiscal 2009, increasing our capabilities and adding to our base of qualified technicians.
We continued to experience growth in many of our target markets in fiscal 2011 as compared to fiscal 2010. The largest dollar increase was attributable to customers in the global oil and gas market on several new and existing projects, including an increase in our portfolio of “run and maintain” contracts and new work obtained due to our acquisitions. Overall, our revenues from the oil and gas market grew approximately 20% in fiscal 2011 and provided approximately 61% and 63% of our total revenues for fiscal 2011 and 2010, respectively, with the largest increase coming from the petrochemical section of the oil and gas industry. In addition, we also experienced high growth in several of our other target markets outside of oil and gas, including industrial, and aerospace and defense markets. Taken as a group, all target markets other than oil and gas grew approximately 32% over the prior year. Our top ten customers represented approximately 44% of our revenues for fiscal 2011 compared to 45% in fiscal 2010. Our largest customer, BP, accounted for approximately 18% of our revenues in both fiscal 2011 and 2010. No other customer accounted for more than 8% of our revenues in fiscal 2011.
Gross profit. As a percentage of revenues, our gross profit in total and its components for fiscal 2011, 2010 and 2009, were as follows:
Our gross profit, by segment for fiscal 2011, 2010 and 2009, was as follows:
Our gross profit increased $20.3 million, or 24%, in fiscal 2011 compared to fiscal 2010. As a percentage of revenues, our gross profit was approximately 31% in fiscal 2011 and 2010. Cost of revenues, excluding depreciation, as a percentage of revenues was approximately 66% in fiscal 2011 and 2010. Depreciation expense included in the determination of gross profit was $13.2 million and $10.5 million for fiscal 2011 and 2010, respectively. Also included in cost of revenues is an increase to our provision for slow moving inventory of $0.7 million in fiscal 2011 compared to fiscal 2010.
Despite the increase in our fiscal 2011 revenues, our gross profit as a percentage of revenues remained at approximately 31%. This is primarily attributable to a change in the mix of revenues generated during the year, as well as better utilization of direct labor. For example, revenues from the oil and gas industry increased approximately 20% during fiscal 2011 and represented approximately 61% of total revenues. The revenue from this industry often has lower gross margins than other industries because these contracts tend to be longer and have a high concentration of traditional NDT services. As a result of these lower margins revenue growth in this category tends to decrease overall gross margins. Offsetting the impact of higher revenues from the oil and gas industry was revenue growth in all other industries of approximately 32% in fiscal 2011. Advanced NDT services, which have higher margins than traditional NDT services, increased more than 30% during fiscal 2011 and now represents approximately 15% of our Services segment revenues compared to approximately 14% in fiscal 2010. Our revenue growth is also attributable to sales from new contracts, which drive market share growth but are competitive from a pricing perspective in the short term. While these competitive pricing contracts remain a focus of many of our new and existing Services segment customers, we were able to improve our gross profit as a percentage of revenues by focusing on utilization rates of our service technicians and other controllable costs of revenues. These costs, as a percentage of revenues, decreased to approximately 13% during fiscal 2011 from approximately 14% during fiscal 2010. Historically, by introducing more advanced NDT tools to our Services segment customers, margin enhancement follows.
Another contributing factor for the decreases in fiscal 2011 and 2010 compared to 2009 was the continued economic downturn in fiscal 2010 and 2011. We experienced revenue declines in shop work and industrial markets, which have higher margins than our traditional NDT services. During fiscal 2010, certain of our customers managed project activity and turnarounds differently than in the past, stopping or changing planned work schedules more abruptly. This created
inefficiencies in the planning and utilization of labor. In fiscal 2011 we continued to develop several new specialties within our asset protection solutions by hiring and training new employees and creating “centers of excellence”, including centers for industrial tube and off-shore oil rig platform inspections and new pipeline construction. This investment in our technicians to gain future market share, however, contributes to non-billable labor until these markets develop.
Income from operations. Our income from operations, by segment for fiscal 2011, 2010 and 2009, was as follows:
Our income from operations of $29.6 million for fiscal 2011 increased $8.7 million, or 42%, compared to fiscal 2010. As a percentage of revenues, our income from operations increased to approximately 9% in fiscal 2011 compared to approximately 8% in fiscal 2010.
As a percentage of revenues, SG&A expenses were approximately 20% in fiscal 2011 and fiscal 2010. Our SG&A expenses for fiscal 2011 increased $10.5 million, or 19%, from $55.5 million in fiscal 2010 to $66.0 million in fiscal 2011. The increase in expense was primarily due to the cost of additional salary and other infrastructure costs to support our growth in revenues, including the addition of new locations and personnel in connection with our acquisitions. Overall, our SG&A expenses included higher compensation and benefit expenses of $6.7 million over the prior year attributed to normal compensation increases, including incentive compensation, as well as our investment in additional management and corporate staff to support our growth (including support of the development of new and existing centers of excellence). Our recent acquisitions accounted for approximately $2.5 million of the total increase in SG&A expenses. Other increases in SG&A expenses included stock compensation costs of approximately $1.1 million, professional service and consulting costs of approximately $1.2 million, and a decrease in foreign currency transaction gains of approximately $1.0 million. These increases were offset by a decrease in our provision for bad debts of approximately $0.3 million. Income from operations was also negatively impacted by a legal provision of $0.3 million in fiscal 2011 as compared to a reversal of a legal provision of $0.3 million in fiscal 2010. Depreciation and amortization included in the determination of income from operations for fiscal 2011 and fiscal 2010 was $5.4 million and $4.7 million, respectively, each being 2% of revenues.
Interest expense. Interest expense was $2.8 million and $3.5 million for fiscal 2011 and fiscal 2010, respectively. The $0.8 million decrease in fiscal 2011 interest expense related primarily to the maturity of our interest rate swap agreement in November 2010.
Net loss (income) attributable to noncontrolling interests, net of taxes. The net loss attributable to noncontrolling interests for fiscal 2011 relates primarily to a net loss from Diapac, our subsidiary in Russia, offset by an increase in net income of our Brazilian subsidiary, PASA. In fiscal 2010, net income attributable to noncontrolling interests was primarily attributable to net income from Diapac and PASA.
Income taxes. Our effective income tax rate was approximately 39% for fiscal 2011 compared to approximately 38% for fiscal 2010. The increase was primarily due to the impact of permanent tax differences and higher foreign taxes offset by a decrease in state taxes and a decrease relating to our reserve for uncertain tax positions.
Net income attributable to Mistras Group, Inc. Net income attributable to Mistras Group, Inc. for fiscal 2011 was $16.4 million, or approximately 5% of revenues, an increase of $6.0 million over net income attributable to Mistras Group, Inc. for fiscal 2010, which was $10.4 million, or approximately 4% of revenues. The increase in net income was primarily the result of our revenue growth, and lower interest and research and engineering expenses, offset by higher SG&A expenses and increases to our legal provision and provision for income taxes.
Net income attributable to common shareholders. Net income attributable to common shareholders for fiscal 2011 was $16.4 million, or approximately 5% of revenues, a decrease of $0.5 million when compared to fiscal 2010, which was $16.9 million, or approximately 6% of revenues. In fiscal 2010, net income attributable to common shareholders included a fair market value
adjustment of $6.5 million to reduce the preferred stock value to the benefit of common shareholders. All of the preferred shares outstanding as of our IPO in October 2009 converted to common stock. Offsetting the impact of the fair market value adjustment in fiscal 2010 was an overall increase in net income attributable to Mistras Group, Inc. of $6.0 million in fiscal 2011.
Fiscal 2010 compared to fiscal 2009
Revenues. Revenues increased $63.0 million, or 30%, for fiscal 2010 compared to fiscal 2009 as a result of growth in all our segments. For fiscal 2010 and fiscal 2009, we estimate that our organic growth rate, as compared to growth driven by acquisitions, was approximately 18% and 16%, respectively. In fiscal 2010, we estimate that organic growth by segment was 20% for our Services segment, 9% for our Products and Systems segment and 7% for our International segment. This organic growth was the result of continued demand for our asset protection solutions, including growth from new and existing customers. In fiscal 2010, we estimate that growth from acquisitions was $25.8 million, or 12%, compared to $33.6 million, or 23%, in fiscal 2009. We completed three acquisitions in fiscal 2010 compared to five acquisitions in fiscal 2009, and seven acquisitions in fiscal 2008, increasing our capabilities and adding to our base of qualified technicians.
Despite the prolonged downturn in the global economy, we continued to experience growth in many of our target markets in fiscal 2010 as compared to fiscal 2009. The largest dollar increase was attributable to customers in the global oil and gas market on several new and existing projects, including an increase in our portfolio of “run and maintain” contracts and new work obtained due to our acquisitions. Overall the oil and gas market provided approximately 63% and 58% of our total revenues for fiscal 2010 and 2009, respectively. Within this market, we provide services to refineries, as well as midstream and upstream customers, petrochemical and other industry segments. Refineries are currently the largest area of this market and represent approximately 39% of our total revenues. As of May 31, 2010 and 2009, we serviced approximately 30% and 20%, respectively, of the U.S. refineries and 43% and 36%, respectively, of refineries producing 100,000 or more barrels per day, but this only represents approximately 6% of the world’s refineries. We also experienced high growth in several of our other target markets, including chemical, fossil and nuclear power. These increases were partially offset by declines in capital projects, turnaround work and reduced pipeline, aerospace and industrial parts inspection activity and the completion of certain projects as compared to fiscal 2009. Our top ten customers represented approximately 45% of our revenues for fiscal 2010 compared to 36% in fiscal 2009. Our largest customer accounted for approximately 18% and 17% of our revenues in fiscal 2010 and 2009, respectively. No other customer accounted for more than 7% of our revenues in fiscal 2010.
Gross Profit. Our gross profit increased $13.9 million, or 20%, in fiscal 2010 compared to fiscal 2009. As a percentage of revenues, our gross profit was approximately 31% and 33% in fiscal 2010 and fiscal 2009, respectively. Cost of revenues, excluding depreciation, as a percentage of revenues increased to approximately 66% in fiscal 2010 from approximately 63% in fiscal 2009. Depreciation expense included in determining gross profit for fiscal years 2010 and 2009 was $10.5 million and $8.7 million, respectively, each being 4% of revenues.
Despite the increase in our fiscal 2010 revenues, our gross profit as a percentage of revenues declined to approximately 30% in fiscal 2010 from approximately 33% in fiscal 2009. This decrease was primarily attributable to a lower margin product mix of sales for our Services segment. The Services segment generated the largest portion of the revenue increase and our gross margins on revenues from our Services segment are generally lower than that of our other segments. In addition, we increased our market share through new customer contracts and through acquisitions, which often leads to lower margins in the near term until such time as we can fully integrate these acquisitions into our business model and deliver a stronger mix of advanced asset protection solutions to our customers, which generally carry higher margins.
Income from operations. Our income from operations of $20.9 million for fiscal 2010 increased $6.1 million, or 41%, compared to fiscal 2009. As a percentage of revenues, our income from operations increased to approximately 8 % compared to approximately 7% in fiscal 2009.
As a percentage of revenues, SG&A expenses for fiscal 2010 were approximately 20% compared to approximately 22% for fiscal 2009. Our SG&A expenses for fiscal 2010 increased $9.0 million, or 19%, over fiscal 2009. The increase in expense is primarily due to the cost of additional salary and other infrastructure costs to support our growth in revenues, including the addition of new locations and personnel in connection with our acquisitions. Our recent acquisitions accounted for approximately $4.2 million of total increase in SG&A expenses. Stock compensation costs increased approximately $2.5 million in fiscal 2010 over fiscal 2009. In addition, we increased our allowance for doubtful accounts by $0.4 million, net of estimated recoveries, related to the bankruptcy of one of our customers. Other increases in our SG&A expenses included higher compensation and benefit expenses over the previous year attributed to normal salary increases as well as our investment in additional management and corporate staff. A significant portion of
these increases (as well as other increases in cost of revenues) supported our development of additional centers of excellence. Our professional fees also increased in fiscal 2010, which related primarily to increased costs associated with operating as a publicly traded company, including our continued efforts to comply with the Sarbanes-Oxley Act, as well as certain costs associated with our initial public offering in October 2009. Depreciation and amortization included in the determination of income from operations for fiscal 2010 and fiscal 2009 was $4.7 million and $3.9 million, respectively, each being 2% of revenues.
Interest expense. Interest expense was $3.5 million and $4.6 million for fiscal 2010 and fiscal 2009, respectively. The $1.1 million decrease in fiscal 2010 interest expense was primarily attributable to a decrease in average borrowings outstanding during the year. Just prior to our IPO in October 2009, we had outstanding borrowings under our revolving credit facility of approximately $66.4 million, which was subsequently repaid with the proceeds of the offering. Additionally, we incurred expense related to the market rate adjustments to our interest rate swaps, as the fixed rate on these swaps was higher than market rates during both annual periods. The total interest expense adjustments for these swap arrangements for fiscal 2010 and fiscal 2009 was approximately $0.5 million and $0.2 million, respectively.
Net income attributable to noncontrolling interests, net of taxes. The net income attributable to noncontrolling interests related primarily to an increase in net income of our Brazilian subsidiary, PASA, offset by a decrease in net income from Diapac, our subsidiary in Russia. In fiscal 2009, net income attributable to noncontrolling interests was primarily attributable to an increase in net income from Diapac.
Income taxes. Our effective income tax rate was approximately 38% for fiscal 2010 compared to approximately 45% for fiscal 2009. The decrease was primarily due to the impact of permanent tax differences and an adjustment to our liabilities related to uncertain tax provisions offset by higher state taxes.
Net income attributable to Mistras Group, Inc. Net income attributable to Mistras Group, Inc. for fiscal 2010 was $10.4 million, or 4% of revenues, an increase of $5.0 million over net income attributable to Mistras Group, Inc. for fiscal 2009, which was $5.5 million, or 3% of revenues. The increase in net income was primarily the result of our revenue growth and lower interest expense, offset by higher SG&A expenses and research and engineering expenses and an increase to our provision for income taxes. Net income attributable to Mistras Group, Inc. was also positively impacted by the reversal of a legal provision of $0.3 in fiscal 2010 compared to a legal provision of $2.1 million in fiscal 2009 related to the settlement of a lawsuit.
Net income (loss) attributable to common shareholders. Net income attributable to common shareholders for fiscal 2010 was $16.9 million, an increase of $38.6 million when compared to fiscal 2009 which was a net loss of $21.6 million. This increase is primarily attributable to the conversion of all of our preferred shares outstanding to common stock, $27.1 million, as a result of our IPO in October 2009.
Segment results for fiscal 2011, 2010 and 2009
Segment discussions that follow provide supplemental information regarding the significant factors contributing to the changes in results for each of our business segments.
Services segment
Selected financial information for the Services segment was as follows for fiscal 2011, 2010 and 2009:
Revenues. Over the last three years, the largest increase in our total revenues was from our Services segment. Our Services segment revenues had a CAGR of 35% during this period with annual increases in fiscal 2011, 2010 and 2009 of $55.4 million, $60.2 million and $51.5 million, respectively. As a percentage of prior year segment revenues, these increases were approximately 24%, 36% and 44%, respectively. In fiscal 2011, our Services revenues increased $55.4 million, or 24%, compared to fiscal 2010. The increase was attributable to organic growth of approximately 16%, and growth from acquisitions of approximately 8%. The increased sales activity was driven by base growth in manpower requirements, turn-around activities inside our evergreen contracts and several new multi-year contracts we entered into this year. The industries contributing to this growth were oil and gas, chemical and power generation with the largest growth in dollars coming from the oil and gas industry, in both the downstream and midstream segments. Customers in the oil and gas industry accounted for approximately 67% and 69% of our Services segment revenues in fiscal 2011 and 2010, respectively. The three-year CAGR from this target market has been approximately 40%. We also have experienced double digit CAGRs in most of our other target markets due to strong demand, the addition of new customers and increasing revenues from existing customers. We increased our revenues to existing customers by increasing our penetration on existing service offerings and providing different types of asset protection solutions. Our top ten customers accounted for approximately 52%, 53% and 44% of our Services segment revenues during fiscal 2011, 2010 and 2009, respectively. One customer, BP, represented approximately 21% of revenues for our Services segment in fiscal 2011, 2010 and 2009. Revenues from BP, as well as most of our larger oil and gas customers, are generated from numerous contracts and at multiple sites.
In fiscal 2010, our Services revenues increased $60.2 million, or 36%, compared to fiscal 2009. We estimate $25.8 million of the increase in revenues are from acquisitions compared to $33.6 million in the prior year. The balance of the growth came from several new multi-year contracts, particularly in the form of “evergreen” accounts. Also contributing to our revenue growth was an increase in turnaround projects and other large-scale projects that had been postponed in the third and fourth quarters of fiscal 2009. In several of our non-energy related markets, we did experience slowing in our revenue growth because of the continuation of the economic downturn. Across all markets, we experienced pricing pressure, especially on new business and existing contract renewals.
Gross profit. Our Services segment gross profit for fiscal 2011 was $77.9 million, or 28% of Services revenues, an increase of $15.9 million over fiscal 2010, which was $62.0 million, or 27% of revenues. The modest growth in gross margin, an increase of 0.3% from the previous year, is considered positive due to the pricing pressure from large master service agreements with larger oil and gas customers that drive our base revenues up while being awarded at competitive pricing. While competitive pricing contracts remain a focus of many of our Services segment customers, we were able to improve our gross profit as a percentage of revenues by focusing on utilization rates of our service technicians and other controllable costs of revenues. In fiscal 2011 our unbilled labor expense, as a percentage of segment revenues, decreased approximately 70 basis points compared to fiscal 2010. Cost of revenues, excluding depreciation, as a percentage of revenues was 68% and 69% in fiscal 2011 and 2010, respectively. For fiscal 2011 and 2010 depreciation expense included in gross profit was $11.6 million and $8.8 million respectively, each representing approximately 4% of revenues. We continued to invest in
additional field test equipment and fleet vehicles, which generate depreciation expense, to support our growth and reduce other operating costs, such as repairs and maintenance.
Our Services gross profit for fiscal 2010 was $62.0 million, or 27% as a percentage of segment revenues, an increase of $13.5 million over fiscal 2009. The decrease in gross profit percentage in fiscal 2010 however, relates to an increase in revenues from new multi-year contracts that often start with providing traditional NDT services, which generally produce lower margins, until such time as we are engaged in a stronger mix of advanced asset protection solutions, which carry higher margins. This was coupled with an expansion of our new centers of excellence and training which represents our continued investment in our technicians and our ability to provide new NDT solutions, but contributes to non-billable time. In fiscal 2010, depreciation expense included gross profit increased $1.6 million, a 22% increase, representing both new assets acquired and increased depreciation from our acquired businesses. During fiscal 2010, certain of our customers managed project activity and turnarounds differently than in the past, stopping or changing planned work schedules more abruptly or frequently than in the past, creating inefficiencies in the planning and utilization of labor. Compared to fiscal 2009, our number of certified technicians and related fringe benefit costs, particularly healthcare costs, increased.
Income from operations. Our income from operations from our Services segment was $31.9 million in fiscal 2011, an increase of $9.2 million or 41% compared to fiscal 2010. As a percentage of segment revenues, our income from operations increased to approximately 11% in fiscal 2011 compared to approximately 10% in fiscal 2010. SG&A expenses in our Services segment increased $6.5 million to $41.4 million in fiscal 2011 from $34.9 million in fiscal 2010, each representing approximately 15% of segment revenues. The Services segment SG&A expenses included higher compensation and benefit expenses of $4.5 million over the prior year attributed to normal compensation increases, including incentive compensation, and the cost of additional salary to support our growth in revenues, including the addition of new locations and personnel in connection with our acquisitions. Our acquisitions in fiscal 2011 accounted for approximately $1.7 million of our SG&A expenses. Other increases in SG&A expenses in fiscal 2011 included professional service and consulting costs of approximately $0.7 million. The year over year decrease in SG&A expenses as a percentage of sales, approximately 0.5%, reflects the benefit of increased leverage of our cost base resulting from higher sales volumes. Depreciation and amortization expense used in determining income from operations was approximately $4.4 million and $4.0 million in fiscal 2011 fiscal 2010, respectively, each being 2% of revenues.
In fiscal 2010, significantly higher segment revenues, coupled with decreases in legal settlement costs and bad debt expense were the primary drivers for the increase in our operating margin. SG&A expenses in our Services segment for fiscal 2010 compared to fiscal 2009 increased $5.8 million, or 20%. This increase primarily related to higher operating costs of $5.4 million (primarily payroll expense and a corresponding increase in occupancy costs for rents and utilities) to support our acquisitions and overall growth. In addition, we continued our investment in new training, safety and quality programs to support new customer offerings and infrastructure. These increases were offset by a net decrease of $1.5 million in our provision for bad debt relating primarily to a large customer filing for bankruptcy in fiscal 2009. Depreciation and amortization expense used in determining income from operations was $4.0 million and $3.3 million for fiscal 2010 and fiscal 2009, respectively, each being 2% of revenues.
Products and Systems segment
Selected financial information for the Products and Systems segment was as follows for fiscal 2011, 2010 and 2009:
Revenues. The Products and Systems segment also experienced growth in revenues over the last three years. Revenues were $26.1 million, $18.9 million and $17.3 million for fiscal 2011, 2010 and 2009, respectively. In fiscal 2011, 2010 and 2009, the Products and Systems segment revenue growth was approximately 38%, 9%, and 4%, respectively. The largest customer for this segment is our International segment, which distributes these products primarily to our European, and Asian and North African markets, or, to a lesser extent, uses the products in their field testing and engineering services. Other larger markets representing approximately 55% of total segment revenues have been research and test laboratories, nuclear and fossil power, and industrial and aerospace companies.
Our Products and Systems revenue increase of $7.2 million in fiscal 2011 compared to fiscal 2010 resulted primarily from an acquisition completed in fiscal 2011, which accounted for $3.7 million, or 51%, of the increase. Revenues also increased by an aggregate of $4.4 million in our Acoustic Emission, Vibrametrics and engineering product lines, offset by a $0.8 million decrease in our NDT product line.
In fiscal 2010, our Products and Systems revenues increased $1.6 million compared to fiscal 2009 due to an increase in acoustic emission revenues and several large NDT orders received during fiscal 2010. We also continued our expansion of our sales distribution channels by hiring additional industry-focused sales representatives to continue to drive sales growth. Offsetting these increases in revenues were decreases in our Vibrametrics and customer service product lines.
Gross profit. Our Products and Systems segment gross profit increased $3.3 million, or 34%, in fiscal 2011 compared to fiscal 2010. As a percentage of segment revenues, our gross profit was approximately 51% and 53%, in fiscal 2011 and 2010, respectively. Our recent acquisition contributed $2.2 million in gross profit for fiscal 2011. Depreciation expense used in determining gross profit for fiscal 2011 and 2010 was $0.6 million, or 2% of segment revenues, and $0.7 million, or 4% of segment revenues, respectively. Overall, the gross margin percentage decreased by 2% in fiscal 2011 as a result of an increase to our provision for slow-moving inventory of approximately $0.7 million. Excluding this increase in the inventory reserve, the gross profit percentage for fiscal 2011 would have reflected a margin of approximately 53% of revenues. The gross profit in our Products and Systems segment can fluctuate depending on volume and product mix. For example, our ultrasonic NDT solutions require custom product engineering to automatically inspect a wide range of parts varying in size and shape. This may include a small part from a jet engine to a major component of a Boeing 787 jet. The inspection of these large components requires the fabrication of large structures to facilitate testing, for which we generally use subcontractors and procure large, expensive components. The utilization of subcontractors and high cost parts for this work often yields lower gross margins.
For fiscal 2010 our Products and Systems segment gross profit of $9.9 million increased $1.4 million, or 17%, compared to fiscal 2009. Our segment gross profit as a percentage of revenues for fiscal 2010 and 2009 was 53% and 49%, respectively. Depreciation expense used in determining gross profit for fiscal 2010 and 2009 was $0.7 million, or 4% of segment revenues, and $0.8 million, or 5% of segment revenues, respectively. The improvement in gross profit percentage was attributable to sales of higher margin products and several costs cutting initiatives implemented during the year.
Income from operations. Our income from operations from our Products and Systems segment of $5.1 million for fiscal 2011 increased $2.6 million, or 99%, compared to fiscal 2010. As a percentage of Products and Systems segment revenues, our operating
income increased to approximately 20% in fiscal 2011 compared to approximately 14% in fiscal 2010. The improvement in gross profit was the principal driver of the operating income improvement. Our recent acquisition contributed $1.5 million of income from operations in the fiscal year 2011. Depreciation and amortization expense in determining segment income from operations was approximately $0.5 million, or 2% of revenues, and $0.2 million, or 1% of revenues, in fiscal 2011 and 2010, respectively. Segment SG&A expenses, which after gross profit, are the largest determinant of our income from operations in fiscal 2011 and 2010 were $5.5 million, or 21% of segment revenues, and $4.9 million, or 26% of segment revenues, respectively. The largest increase in these costs can be attributed to our recent acquisition, which accounted for $0.4 million of fiscal 2011 SG&A expenses. Our research and engineering expenses decreased 8% to $2.1 million in fiscal 2011 compared to $2.3 million in fiscal 2010. This was due to an adjustment to software capitalization in fiscal 2010 of $0.3 million. Research and engineering expenses were $2.1 million, $2.3 million and $1.9 million in fiscal 2011, 2010 and 2009, respectively. As a percentage of our Products and Systems segment sales, these costs have represented 8%, 12% and 11% for the three years, respectively.
Our Products and Systems segment income from operations was $2.6 million, or 14% of revenues, and $1.7 million, or 10% of revenues, in fiscal 2010 and 2009, respectively. The improvement in gross profit was the principal driver of the operating income improvement. Our SG&A expenses in fiscal 2010 were 26% of segment revenues compared to 27% of revenues in fiscal 2009. Depreciation and amortization expense in determining segment income from operations was approximately 1% in fiscal 2010 and 2009, respectively. Segment selling, general and administrative expenses in fiscal 2010 and 2009 were $4.9 million, or 26% of segment revenues, and $4.7 million, or 27% of segment revenues, respectively. The largest increase in these costs can be attributed to increases in our sales force to better capture market opportunities in our target markets. Similarly, our research and engineering expenses have increased as a result of new hires, and were $2.3 million and $1.9 million in fiscal 2010 and 2009, respectively. As a percentage of our Products and Systems segment revenues, these costs have represented approximately 12% and 11% for the same period.
International segment
Selected financial information for our International segment was as follows for fiscal 2011, 2010 and 2009:
Revenues. Our International segment revenues increased $5.9 million, or 19%, to $36.8 million in fiscal 2011 compared to $30.9 million in fiscal 2010. The increase is primarily attributable to organic growth of approximately 11% and acquisition growth of approximately 8%. For the last three fiscal years, the International segment revenues, including currency fluctuations, had a CAGR of 16%, with annual increases of $5.9 million, $1.8 million and $5.4 million during fiscal 2011, 2010 and 2009, respectively. Revenues from customers in the oil and gas and chemicals markets have comprised approximately 47%, 50% and 57% of our International segment revenues during fiscal 2011, 2010 and 2009, respectively. Most of this business is centered in major oil refineries in Europe and South America. Other revenues are more widely distributed including infrastructure, industrial, manufacturing and other testing companies, research centers and universities.
Our International segment contributed $1.8 million to our revenue growth for fiscal 2010 compared to fiscal 2009. For fiscal 2010, we estimate the organic segment growth was approximately 7%. In fiscal 2010, we had no segment growth attributable to acquisitions. Currency fluctuations in fiscal 2010 caused by the strengthening of the U.S. dollar resulted in $0.3 million in lower revenues, most of this variance occurring in the last half of fiscal 2010. $2.0 million of our overall segment growth was from services we provided to a major oil and gas customer in Brazil and an aggregate of $1.5 million was from the United Kingdom, the Netherlands and India, offset by $1.0 million decrease in revenue from a large contract in Russia and a $0.7 million decrease in revenues in France.
Gross profit. Our segment gross profit for fiscal 2011 was $12.9 million, or 35% of segment revenues, an increase of $1.3 million when compared to fiscal 2010 which was $11.7 million, or 38% of segment revenues. The decrease in gross profit margin is a result of fewer overall acoustic emission product sales, which have a higher margin profile, an increase in more traditional NDT services, which carry lower margins, and an increase in reimbursable expenses, for which we receive only modest margins. Our segment gross profit for fiscal 2010 was $11.7 million, or 38% of segment revenues, a decrease of $0.9 million when compared to fiscal 2009 which was $12.6 million, or 43% of segment revenues.
Income from operations. Our income from operations from our International segment of $3.5 million for fiscal 2011 increased $0.5 million, or 18%, when compared to fiscal 2010. As a percentage of segment revenues, our income from operations remained at 10% from fiscal 2010 to fiscal 2011. Depreciation and amortization expense in determining segment income from operations was $0.4 million and $0.3 million, or approximately 1% of revenues, in fiscal 2011 and 2010, respectively. Segment SG&A expenses, which after gross profit, are the largest determinant of our income from operations in fiscal 2011 and 2010 were $8.9 million, or 24% of segment revenues, and $8.3 million, or 27% of segment revenues, respectively. The largest increase in these costs can be attributed to our fiscal 2011 acquisition, which accounted for $0.4 million of fiscal 2011 SG&A expenses. Foreign currency transaction gains included in income from operations were $0.5 million, $0.4 million and $0.2 million in fiscal 2011, 2010 and 2009, respectively.
Our income from operations from our International segment for fiscal 2010 was $3.0 million compared to $4.1 million for fiscal 2009. As a percentage of segment revenues, our income from operations was 10% and 14% in fiscal 2010 and 2009, respectively. Our SG&A expenses for fiscal 2010 and 2009 were $8.3 million, or 27% of segment revenues, and $8.0 million, or 28% of segment revenues, respectively. The overall decrease in our operating income from fiscal 2009 is primarily attributable to lower profitability at our Russian and French subsidiaries.
Corporate and eliminations
The elimination in revenues and cost of revenues primarily relates to the elimination in consolidation of revenues from sales of our Products and Systems segment to the International segment. The other major item in the corporate and eliminations grouping are the general and administrative costs not allocated to the other segments. These costs primarily include those for non-segment management, accounting and auditing, acquisition transactional costs, stock compensation expense and certain other costs. As a percentage of our total revenues, these costs have generally remained constant over the last three fiscal years, consisting of 3%, 3% and 2% of total revenues for fiscal 2011, 2010 and 2009, respectively. The increase in operating expenses in 2011 and 2010 primarily related to higher compensation and additional staff, audit and accounting fees and other general increases in expense at our corporate offices.
Liquidity and capital resources
Overview
We have primarily funded our operations through cash provided from operations, bank borrowings, stock offerings and capital lease financing transactions. We have used these proceeds to fund our operations, develop our technology, expand our sales and marketing efforts to new markets and acquire small companies or assets, primarily to add certified technicians and enhance our capabilities and geographic reach. In October 2009, we raised approximately $74.0 million in net proceeds through our IPO, which we subsequently used to repay our bank borrowings under our credit facility and to increase our cash and cash equivalents. In May 2011, we raised approximately $14.7 million in net proceeds through a secondary offering of our common stock, which we used to repay our bank borrowings and
fund working capital. We believe that our existing cash and cash equivalents, our anticipated cash flows from operating activities, and our available borrowings under our credit agreement will be sufficient to meet our anticipated cash needs over the next 12 months.
Cash flows table
The following table summarizes our cash flows for fiscal 2011, 2010 and 2009:
Cash flows from operating activities
Cash provided by our operating activities in fiscal 2011 was $25.3 million, an increase of $6.3 million over the prior fiscal year. Positive operating cash flow was primarily attributable to higher net income excluding depreciation, amortization and other non-cash items of $40.4 million. The $6.3 million year over year increase was also impacted by an increase in working capital in fiscal 2011 compared to fiscal 2010. We used $15.1 million to fund an increase in our working capital during fiscal 2011 compared to $9.8 million in fiscal 2010.
Cash provided by our operating activities in fiscal 2010 was $19.9 million, an increase of $6.3 million over the prior fiscal year. Positive operating cash flow was primarily attributable to higher net income excluding depreciation, amortization and other non-cash items of $28.8 million. The $6.3 million year over year increase was also impacted by an increase in working capital in fiscal 2010 compared to fiscal 2009. We used $9.8 million to fund an increase in our working capital during fiscal 2010 compared to $8.2 million in fiscal 2009.
Cash flows from investing activities
Cash used in investing activities for fiscal 2011 was $36.5 million, an increase of $20.0 million from fiscal 2010. Cash used in investing activities included the acquisition of five asset protection businesses for cash payments aggregating $26.2 million. Cash purchases of property, plant and equipment were $10.1 million and included $4.5 million to fund a land purchase and construction costs for a new operations and training facility in Houston, Texas.
Cash used in investing activities for fiscal 2010 was $16.5 million, an increase of $0.6 million from fiscal 2009. Cash purchases of property, plant and equipment were $1.9 million and were primarily related to equipment used by our technicians. Cash used in investing activities also included our acquisition of three asset protection businesses for cash payments aggregating $14.7 million.
Cash flows from financing activities
For fiscal 2011, net cash provided by financing activities was $5.3 million, a decrease of $2.7 million from fiscal 2010. In May 2011, we completed a secondary offering of 3,754,061 shares of our common stock at a price of $16.00 share. The Company sold 989,660 shares and 2,764,401 shares were sold by a selling stockholder. The Company received net proceeds of approximately $14.7 million from the offering. For fiscal 2011, net cash provided by financing activities primarily consisted of net proceeds from the secondary stock offering of approximately $14.7 million, and net borrowings under our credit facility of $3.9 million. These proceeds were offset by repayments of $13.4 million related to our capital lease obligations and other long-term debt.
For fiscal 2010, net cash provided by financing activities was $8.1 million, an increase of $3.2 million from fiscal 2009. In October 2009, we completed the sale of 6,700,000 shares of common stock at a price of $12.50 per share, providing net proceeds to the Company of approximately $74.0 million after deducting underwriters’ commissions and other expenses. We used approximately $66.6 million of the net proceeds to repay the outstanding principal balance of the term loan ($25.0 million), outstanding balance of the revolver ($41.4 million) and accrued interest thereon ($0.1 million). We made capital lease payments of $6.1 million during fiscal 2010.
Effect of exchange rate on changes in cash
For fiscal 2011, 2010 and 2009, exchange rate changes increased (decreased) our cash by $0.7 million, ($0.2) million and $0.4 million, respectively.
Cash balance and credit facility borrowings
As of May 31, 2011, we had cash and cash equivalents totaling $10.9 million and available borrowing capacity of $51.1 million under our current revolving credit facility. Our outstanding borrowings under our revolving credit facility were $3.9 million as of May 31, 2011. We finance our operations primarily through our existing cash balances, cash collected from operations, bank borrowings and capital lease financing. We believe these sources are sufficient to fund our operations for the foreseeable future.
On July 22, 2009, we entered into a credit agreement with Bank of America, N.A., JPMorgan Chase Bank, N.A., TD Bank, N.A. and Capital One, N.A., which provided for a $25.0 million term loan and a $55.0 million secured revolving credit facility. Borrowings under the agreement were used to repay the outstanding indebtedness from our former credit facility and to fund acquisitions.
In October 2009, we repaid the outstanding principal balance of the term loan and the outstanding balance of the revolving credit facility using the proceeds from our IPO. Credit extended under the term loan may not be re-borrowed under the current credit agreement. Credit extended under the revolving credit facility may re-borrowed at any time. Borrowings made under the revolving credit facility are payable on July 21, 2012. In December 2009, we signed an amendment to our current credit agreement that, among other things, adjusted certain affirmative and negative covenants including delivery of financial statements, the minimum consolidated debt service coverage ratio, the procedures for obtaining lender approval in acquisitions and the removal of the minimum EBITDA requirement.
Under the amended agreement, borrowings under the credit agreement bear interest at the LIBOR or base rate, at our option, plus an applicable LIBOR margin ranging from 1.75% to 3.25%, or base rate margin ranging from -0.50% to 0.50%, and a market disruption increase of between 0.0% and 1.0%, if the lenders determine it applicable. As of May 31, 2011, the interest rate for the borrowings under our revolving credit facility was 2.75%.
The credit agreement also contains financial and other covenants limiting our ability to, among other things, create liens, make investments and certain capital expenditures, incur more indebtedness, merge or consolidate, acquire other companies, 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 agreement’s financial covenants require us to maintain a minimum debt service coverage ratio, and a funded debt leverage ratio, all as defined in the credit agreement. There is a provision in the credit facility that requires us to repay 25% of the immediately preceding fiscal year’s “free cash flow” if our ratio of “funded debt” to EBITDA, as defined in the credit agreement, is greater than a specified amount on or before October 1 each year.
As of May 31, 2011, we were in compliance with the terms of the credit agreement, which we continuously monitor.
Liquidity and capital resources outlook
Future sources of cash
We expect our future sources of cash to include cash flow from operations, cash borrowed under our revolving credit facility and cash borrowed from leasing companies to purchase equipment and fleet service vehicles. Our revolving credit facility is available for cash advances required for working capital and for letters of credit to support our operations. To meet our short-and long-term liquidity requirements, we expect primarily to rely on cash generated from our operating activities. We are currently funding our acquisitions through our available cash, borrowings under our revolving credit facility and seller notes. We have an effective shelf registration statement with the SEC for the issuance of up to approximately $64.2 million of securities, including shares of common stock and preferred stock, debt securities, warrants and units. Accordingly, we may also obtain capital through the issuance of debt or equity securities, or a combination of both. As of August 1, 2011, there were no outstanding borrowings under the existing revolving credit facility.
Future uses of cash
We expect our future uses of cash will primarily be for acquisitions, international expansion, purchases or manufacture of field testing equipment to support growth, additional investments in technology and software products and the replacement of existing assets and equipment used in our operations. We often make purchases to support new sources of revenues, particularly in our Services segment. In addition, we have certain equipment replacement needs, including our fleet vehicles. We historically spend approximately 3% to 4% of our total revenues on capital expenditures, excluding acquisitions, and expect to fund these expenditures through a combination of cash and lease financing. Our cash capital expenditures, excluding acquisitions, for fiscal 2011, 2010 and 2009 were approximately 3%, 1% and 3% of revenues, respectively. In October 2010, we entered into an agreement for the construction of a new operations and training facility that will consolidate our presence in the Houston, Texas metro area. This facility will serve as our Gulf Region headquarters and is expected to be completed by the end of the first quarter of fiscal 2012. Total costs, including construction and land, are expected to be approximately $4.5 million.
Our anticipated acquisitions may also require capital. For example, subsequent to May 31, 2011, we made three acquisitions with an initial cash outlay of approximately $5.7 million. In some cases, additional equipment will be needed to upgrade the capabilities of these acquired companies. In addition, our future acquisition and capital spending may increase as we aggressively pursue growth opportunities. Other investments in infrastructure, training and software may also be required to match our growth, but we plan to continue using a disciplined approach to building our business. In addition, we will use cash to fund our operating leases, capital leases and long-term debt repayment and various other obligations, including the commitments discussed in the table below, as they arise.
We also expect to use cash to support our working capital requirements for our operations, particularly in the event of further growth and due to the impacts of seasonality on our business. Our future working capital requirements will depend on many factors, including the rate of our revenue growth, our introduction of new solutions and enhancements to existing solutions and our expansion of sales and marketing and product development activities. To the extent that our cash and cash equivalents and future cash flows from operating activities are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or public or private equity or debt financings. We also may need to raise additional funds in the event we determine in the future to effect one or more acquisitions of businesses, technologies or products that will complement our existing operations. In the event additional funding is required, we may not be able to obtain bank credit arrangements or effect an equity or debt financing on terms acceptable to us or at all.
Contractual obligations
We generally do not enter into long-term minimum purchase commitments. Our principal commitments, in addition to those related to our long-term debt discussed below, consist of obligations under facility leases for office space and equipment leases.
The following table summarizes our outstanding contractual obligations as of May 31, 2011:
(1) Includes estimated cash interest to be paid over the remaining terms of the leases.
Long-term debt listed in the table above consists primarily of seller notes payable in connection with our acquisitions.
In addition to the above, we have certain acquisition-related contingent payments that may become payable if certain financial measures, as defined in each respective agreement, are achieved.
Off-balance sheet arrangements
During fiscal 2011, 2010 and 2009, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical accounting policies and estimates
The preparation of financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenues and expenses during the reporting period. Our more significant estimates include: the valuation of goodwill and intangible assets; the impairment of long-lived assets, allowances for doubtful accounts, reserves for inventory obsolescence, and reserves for self-insured workers compensation and health benefits. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates under different assumptions or conditions. There have been no material changes to these estimates for the periods presented in this Annual Report.
We believe that of our significant accounting policies, which are described below and in Note 2 to our audited consolidated financial statements included in this Item 8 of this Annual Report, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
Revenue recognition
Revenue recognition policies for the various sources of revenues are as follows:
Services
The Company predominantly derives revenues by providing its services on a time and material basis and recognizes revenues when services are rendered. At the end of any reporting period, there may be earned but unbilled revenues that are accrued. Payments received in advance of revenue recognition are reflected as deferred revenues.
Software
Revenues from the sale of perpetual licenses are recognized upon the delivery and acceptance of the software. Revenues from term licenses are recognized ratably over the period of the license. Revenues from maintenance, unspecified upgrades and technical support are recognized ratably over the period such items are delivered. For multiple-element arrangement software contracts that include non-software elements, and where the software is essential to the functionality of the non-software elements (collectively referred to as software multiple-element arrangements), the Company applies the rules as noted below.
Products
Revenues from product sales are recognized when risk of loss and title passes to the customer, which is generally upon product delivery. The exceptions to this accounting treatment would be for multiple-element arrangements (described below) or those situations where specialized installation or customer acceptance is required. Payments received in advance of revenue recognition are reflected as deferred revenues.
Percentage of completion
A portion of the Company’s revenues are generated from engineering and manufacturing of custom products under long-term contracts that may last from several months to several years, depending on the contract. Revenues from long-term contracts are recognized on the percentage-of-completion method of accounting. Under the percentage-of-completion method of accounting revenues are recognized as work is performed. The percentage of completion at any point in time is based on total costs or total labor dollars incurred to date in relation to the total estimated costs or total labor dollars estimated at completion. The percentage of completion is then applied to the total contract revenue to determine the amount of revenue to be recognized in the period. Application of the percentage-of-completion method of accounting requires the use of estimates of costs to be incurred for the performance of the contract. Contract costs include all direct materials, direct labor costs and those indirect costs related to contract performance, such as
indirect labor, supplies, tools, repairs, and all costs associated with operation of equipment. The cost estimation process is based upon the professional knowledge and experience of the Company’s engineers, project managers and financial professionals. Factors that are considered in estimating the work to be completed include the availability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in our project performance and the recoverability of any claims. Whenever revisions of estimated contract costs and contract values indicate that the contract costs will exceed estimated revenues, thus creating a loss, a provision for the total estimated loss is recorded in that period.
Multiple-element arrangements
The Company occasionally enters into transactions that represent multiple-element arrangements, which may include any combination of services, software, and hardware. Under current Financial Accounting Standards Board (FASB) guidance, the Company utilizes vendor-specific objective evidence to determine whether the multiple elements can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if: (1) the delivered item has value on a standalone basis; and (2) there is objective and reliable evidence of the fair value of the undelivered items, if the delivery or performance of the undelivered items is probable and in the control of the Company.
If these criteria are not met, then revenues are deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value. Effective June 1, 2012, the Company will adopt updated guidance from the FASB that will require the allocation of revenue in multiple-element arrangements to separate units of accounting based on an element’s estimated selling price if vendor-specific or other first party evidence is not available; see “Recent Accounting Pronouncements”.
Goodwill and intangible assets
Goodwill represents the excess of the purchase price over the fair market value of net assets of the acquired business at the date of acquisition. We test goodwill for impairment annually in our fiscal fourth quarter using a two-step process. The first step identifies potential impairment by comparing the fair value of our reporting units to their carrying value. If the fair value is less than the carrying value, the second step measures the amount of impairment, if any. The impairment loss is the amount by which the carrying amount of goodwill exceeds the implied fair value of that goodwill. For purposes of our goodwill impairment testing, we have identified our reporting units as our operating segments. All of our segments have goodwill. The fair value of the reporting unit is determined using a market approach valuation model, specifically the quoted price method, and an income approach valuation model, specifically discounted cash flows. Our discounted cash flow analysis incorporates the following key assumptions: growth projections, our weighted average costs of capital, future capital expenditures and tax rates. There have been no significant changes in the assumptions and methodologies used for valuing goodwill since the prior year. There was $64.1 million and $44.3 million of goodwill at May 31, 2011 and 2010, respectively. The fair value of our reporting units significantly exceeds the carrying value of these reporting units for fiscal 2011 and 2010. Accordingly, there have been no impairments of goodwill. There were no impairment indicators present in the reporting units in fiscal 2011. A material negative change in our key assumptions would need to occur for our step one tests to indicate an impairment. Intangible assets are recorded at cost, with finite lives and are amortized on a straight-line basis over their estimated useful lives. We review intangible assets subject to amortization periodically to determine if any adverse condition exists or change in circumstances has occurred that would indicate impairment or change in useful life. If impairment exists, and it is determined that there is no recoverability, an impairment charge is recorded.
Impairment of long-lived assets
We perform a review of long-lived assets for impairment when events or changes in circumstances indicate the carrying value of such assets may not be recoverable. If an indication of impairment is present, the Company compares the estimated undiscounted future cash flows to be generated by the asset to its carrying amount. If the undiscounted future cash flows are less than the carrying amount of the asset, the Company records an impairment loss equal to the excess of the asset’s carrying amount over its fair value. The fair value is determined based on valuation techniques such as a discounted cash flow analysis or a comparison to fair values of similar assets. We had $49.2 million and $40.0 million in net property, plant and equipment as of May 31, 2011 and 2010, respectively, and did not record any impairment charges in the two fiscal years ended on those dates.
Long-lived assets, net outside of the U.S. totaled $13.2 million and $11.2 million as of May 31, 2011 and 2010, respectively.
Income taxes
Income taxes are accounted for under the asset and liability method. This process requires that we assess temporary differences between the book and tax basis of assets resulting from differing treatment between book and tax of certain items, such as depreciation. Deferred income tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided if it is more likely than not that some or all of the deferred income tax assets will not be realized. We consider all available evidence, both positive and negative, to determine whether, based on the weight of the evidence, a valuation allowance is needed. Evidence used includes information about our current financial position and our results of operations for the current and preceding years, as well as all currently available information about future years, including our anticipated future performance, the reversal of deferred tax liabilities and tax planning strategies. As of May 31, 2011 and 2010, we had net deferred income tax expense of $1.8 million and $0.9 million, respectively. With the exception of certain state and foreign deferred tax assets, we believe that it is more likely than not that we will have sufficient future taxable income to allow us to realize the benefits of the net deferred tax assets. We currently do not believe there are other outcomes that are reasonably likely to occur with regard to income taxes that would have a material impact on our fiscal 2011 and 2010 financial statements.
Recent accounting pronouncements
In October 2009, the FASB issued Accounting Standards Update (ASU) ASU 2009-13, which amends ASC 605, “Revenue Recognition”, to require companies to allocate the overall consideration in multiple-element arrangements to each deliverable by using a best estimate of the selling price of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price. This guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We do not expect a significant impact on our financial statements when the guidance is adopted in fiscal 2012.
In April 2010, the FASB issued Accounting Standards Updates (ASU) 2010-17, which amends ASC 605, “Revenue Recognition”. ASU 2010-17 provides guidance on applying the milestone method to milestone payments for achieving specified performance measure when those payments are related to uncertain future events limited to transactions involving research and development. Entities can make an accounting policy election to recognize arrangement consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met. This guidance is effective prospectively for milestones achieved in fiscal years beginning on or after June 15, 2010. We do not expect a significant impact on our financial statements when the guidance is adopted in fiscal 2012.
ITEM 7A.
ITEM 7A. Quantitative and qualitative disclosures about market risk
Interest rate sensitivity
We had cash and cash equivalents of $10.9 million at May 31, 2011. These amounts are held for working capital purposes and were invested primarily in bank deposits, money market funds and short-term, interest-bearing, investment-grade securities. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, will reduce future investment income. If overall interest rates had fallen by 10% in fiscal 2011, our interest income would not have been materially affected.
Foreign currency risk
We have foreign currency exposure related to our operations in foreign locations. This foreign currency exposure, particularly the Euro, British Pound Sterling, Brazilian Real, Russian Ruble, Japanese Yen, Canadian Dollar and the Indian Rupee, arises primarily from the translation of our foreign subsidiaries’ financial statements into U.S. dollars. For example, a portion of our annual sales and operating costs are denominated in British pound sterling and we have exposure related to sales and operating costs increasing or decreasing based on changes in currency exchange rates. If the U.S. dollar increases in value against these foreign currencies, the value in U.S. dollars of the assets and liabilities originally recorded in these foreign currencies will decrease. Conversely, if the U.S. dollar decreases in value against these foreign currencies, the value in U.S. dollars of the assets and liabilities originally recorded in these foreign currencies will increase. Thus, increases and decreases in the value of the U.S. dollar relative to these foreign currencies have a direct impact on the value in U.S. dollars of our foreign currency denominated assets and liabilities, even if the value of these
items has not changed in their original currency. We do not currently enter into forward exchange contracts to hedge exposures denominated in foreign currencies. A 10% change in the average U.S. Dollar exchange rates for fiscal 2011 would cause a change in consolidated operating income of approximately $0.4 million. We may consider entering into hedging or forward exchange contracts in the future.
Fair value of financial instruments
We do not have material exposure to market risk with respect to investments, as our investments consist primarily of highly liquid investments purchased with a remaining maturity of three months or less. We do not use derivative financial instruments for speculative or trading purposes; however, this does not preclude our adoption of specific hedging strategies in the future.
Effects of inflation and changing prices
Our results of operations and financial condition have not been significantly affected by inflation and changing prices.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Mistras Group, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows present fairly, in all material respects, the financial position of Mistras Group, Inc. and its subsidiaries at May 31, 2011 and May 31, 2010, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 2011 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of May 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report On Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our audits (which was an integrated audit in 2011). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
August 12, 2011
Mistras Group, Inc. and Subsidiaries
Consolidated Balance Sheets
May 31, 2011 and 2010
(in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
Mistras Group, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended May 31, 2011, 2010 and 2009
(in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
Mistras Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity (deficit)
Years ended May 31, 2011, 2010 and 2009
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Mistras Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Fiscal Years Ended May 31, 2011, 2010 and 2009
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
1. Description of business and basis of presentation
Description of business
Mistras Group, Inc. and subsidiaries (the Company) is a leading “one source” global provider of technology-enabled asset protection solutions used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure. The Company combines industry-leading products and technologies, expertise in mechanical integrity (MI) 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. Given the role our services play in ensuring the safe and efficient operation of infrastructure, the Company has historically provided a majority of its services to its customers on a regular, recurring basis. 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, aerospace and defense, transportation, primary metals and metalworking, pharmaceuticals and food processing industries.
Principles of consolidation
The accompanying consolidated financial statements include the accounts of Mistras Group, Inc. and its wholly or majority-owned subsidiaries. Where 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 interest in net income, net of tax, is classified separately in the accompanying consolidated statements of operations.
All significant intercompany accounts and transactions have been eliminated in consolidation. All foreign subsidiaries’ fiscal years end on April 30, while Mistras Group, Inc. and the domestic subsidiaries’ fiscal years end on May 31. The effect of this difference in timing of reporting foreign operations on the consolidated results of operations and consolidated financial position is not significant.
Reclassification
Certain amounts previously reported for prior periods have been reclassified to conform to the current year presentation in the accompanying consolidated financial statements. Such reclassifications did not have a material effect on the Company’s financial condition or results of operations as previously reported.
2. Summary of significant accounting policies
Revenue recognition
Revenue recognition policies for the various sources of revenues are as follows:
Services
The Company predominantly derives revenues by providing its services on a time and material basis and recognizes revenues when services are rendered. At the end of any reporting period, there may be earned but unbilled revenues that are accrued. The Company had $2.9 million and $1.6 million of unbilled revenues accrued for fiscal 2011 and 2010, respectively. Payments received in advance of revenue recognition are reflected as deferred revenues.
Software
Revenues from the sale of perpetual licenses are recognized upon the delivery and acceptance of the software. Revenues from term licenses are recognized ratably over the period of the license. Revenues from maintenance, unspecified upgrades and technical support are recognized ratably over the period such items are delivered. For multiple-element arrangement software contracts that include non-
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
software elements, and where the software is essential to the functionality of the non-software elements (collectively referred to as software multiple-element arrangements), the Company applies the rules as noted below.
Products
Revenues from product sales are recognized when risk of loss and title passes to the customer. The exceptions to this accounting treatment would be for multiple-element arrangements (described below) or those situations where specialized installation or customer acceptance is required. Payments received in advance of revenue recognition are reflected as deferred revenues.
Percentage of completion
A portion of the Company’s revenues are generated from engineering and manufacturing of custom products under long-term contracts that may last from several months to several years, depending on the contract. Revenues from long-term contracts are recognized on the percentage-of-completion method of accounting. Under the percentage-of-completion method of accounting revenues are recognized as work is performed. The percentage of completion at any point in time is based on total costs or total labor dollars incurred to date in relation to the total estimated costs or total labor dollars estimated at completion. The percentage of completion is then applied to the total contract revenue to determine the amount of revenue to be recognized in the period. Application of the percentage-of-completion method of accounting requires the use of estimates of costs to be incurred for the performance of the contract. Contract costs include all direct materials, direct labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs, and all costs associated with operation of equipment. The cost estimation process is based upon the professional knowledge and experience of the Company’s engineers, project managers and financial professionals. Factors that are considered in estimating the work to be completed include the availability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in our project performance and the recoverability of any claims. Whenever revisions of estimated contract costs and contract values indicate that the contract costs will exceed estimated revenues, thus creating a loss, a provision for the total estimated loss is recorded in that period.
Multiple-element arrangements
The Company occasionally enters into transactions that represent multiple-element arrangements, which may include any combination of services, software, and hardware. Under current Financial Accounting Standards Board (FASB) guidance, the Company utilizes vendor-specific objective evidence to determine whether the multiple elements can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if: (1) the delivered item has value on a standalone basis; and (2) there is objective and reliable evidence of the fair value of the undelivered items, if the delivery or performance of the undelivered items is probable and in the control of the Company.
If these criteria are not met, then revenues are deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value. Effective June 1, 2012, the Company will adopt updated guidance from the FASB that will require the allocation of revenue in multiple-element arrangements to separate units of accounting based on an element’s estimated selling price if vendor-specific or other first party evidence is not available; see “Recent Accounting Pronouncements”.
Use of estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the accompanying consolidated financial statements. The more significant estimates include valuation of goodwill and intangible assets, useful lives of long-lived assets, allowances for doubtful accounts, inventory valuation, reserves for self-insured workers compensation and health benefits and provision for income taxes. Actual results could differ from those estimates.
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
Cash and cash equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Accounts receivable
Accounts receivable are stated net of an allowance for doubtful accounts and sales allowances. Outstanding accounts receivable balances are reviewed periodically, and allowances are provided at such time that management believes it is probable that such balances will not be collected within a reasonable period of time. The Company extends credit to its customers based upon credit evaluations in the normal course of business, primarily with 30-day terms. Bad debts are provided for based on historical experience and management’s evaluation of outstanding accounts receivable. Accounts are written off when they are deemed uncollectible.
Inventories
Inventories are stated at the lower of cost, as determined by using the first-in, first-out method, or market. Work in process and finished goods inventory include material, direct labor, variable costs and overhead.
Software costs
Costs that are related to the conceptual formulation and design of licensed programs are expensed as research and engineering. For programs the Company licenses to customers, the Company capitalizes costs that are incurred to produce the finished product after technological feasibility has been established. The capitalized amounts are amortized using the straight-line basis over three years, which is the estimated life of the related software. The Company performs periodic reviews to ensure that unamortized program costs remain recoverable from future revenues. Costs to support or service these licensed programs are expensed as the costs are incurred.
The Company capitalizes certain costs that are incurred to purchase or to create and implement internal-use software, which includes software coding, installation, testing and data conversion. Capitalized costs are amortized on a straight-line basis over three years.
Property, plant and equipment
Property, plant and equipment are recorded at cost. Depreciation of property, plant and equipment is computed utilizing the straight-line method over the estimated useful lives of the assets. Amortization of leasehold improvements is computed utilizing the straight-line method over the shorter of the remaining lease term or estimated useful life. The cost and accumulated depreciation and amortization applicable to assets retired or otherwise disposed of are removed from the asset accounts and any gain or loss is included in the consolidated statement of operations. Repairs and maintenance costs are expensed as incurred.
Goodwill and intangible assets
Goodwill represents the excess of the purchase price over the fair value of net assets of the acquired business at the date of acquisition. The Company tests goodwill for impairment annually, in its fiscal fourth quarter, using a two-step process. The first step identifies potential impairment by comparing the fair value of the Company’s reporting units to its carrying value. If the fair value is less than the carrying value, the second step measures the amount of impairment, if any. The impairment loss is the amount by which the carrying amount of goodwill exceeds the implied fair value of that goodwill. There was no impairment of goodwill for the years ended May 31, 2011, 2010 and 2009.
Intangible assets are recorded at cost. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives.
Impairment of long-lived assets
The Company reviews the recoverability of its long-lived assets on a periodic basis in order to identify business conditions which may indicate a possible impairment. The assessment for potential impairment is based primarily on the Company’s ability to recover the
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
carrying value of its long-lived assets from expected future undiscounted cash flows. If the total expected future undiscounted cash flows are less than the carrying amount of the assets, a loss is recognized for the difference between fair value (computed based upon the expected future discounted cash flows) and the carrying value of the assets.
Shipping and handling costs
Shipping and handling costs are included in cost of revenues.
Taxes collected from customers
Taxes collected from customers and remitted to governmental authorities are presented in the consolidated statements of operations on a net basis.
Research and engineering
Research and product development costs are expensed as incurred.
Advertising, promotions and marketing
The costs for advertising, promotion and marketing programs are expensed as incurred and are included in selling, general and administrative expenses. Advertising expense was approximately $0.8 million, $0.8 million and $0.5 million for fiscal 2011, 2010 and 2009, respectively.
Fair value of financial instruments
The Company includes disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate that fair value. The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and other current assets and liabilities approximate fair value based on the short-term nature of the accounts. The fair value of the Company’s debt and capital lease obligations at May 31, 2011 was approximately $1.6 million lower than carrying value. The Company estimated fair value using a discounted cash flow analysis using pricing for similar debt arrangements in an active market.
Foreign currency translation
The financial position and results of operations of the Company’s foreign subsidiaries are measured using their functional currency, which in all cases presently, is the local currency. Assets and liabilities of the foreign subsidiaries are translated into the U.S. dollar at the exchange rates in effect at the balance sheet date. Income and expenses are translated at the average exchange rate during the year. Translation gains and losses are reported as a component of other comprehensive income for the period and included in accumulated other comprehensive income within stockholders’ equity. Foreign currency translation gains are included in net income and were approximately $0.3 million, $1.3 million and $0.2 million in fiscal 2011, 2010 and 2009 respectively.
Derivative financial instruments
The Company recognizes its derivatives as either assets or liabilities, measures those instruments at fair value and recognizes the changes in fair value of the derivative in net income or other comprehensive income, as appropriate. In the past, the Company has hedged a portion of the variable rate interest payments on debt using interest rate swap contracts to convert variable payments into fixed payments. The Company does not apply hedge accounting to its interest rate swap contracts. Changes in the fair value of these instruments are reported as a component of interest expense. As of May 31, 2011, the Company had no outstanding interest rate swap contracts.
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
Concentration of credit risks
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. At times, cash deposits may exceed the limits insured by the Federal Deposit Insurance Corporation. The Company believes it is not exposed to any significant credit risk or risk of nonperformance of financial institutions.
The Company sells primarily to large companies, extends reasonably short collection terms, performs credit evaluations and does not require collateral. The Company maintains reserves for potential credit losses.
We have one customer, BP, which accounted for 18%, 18% and 17% of revenues for fiscal 2011, 2010 and 2009, respectively. Accounts receivable from this customer was approximately 15% and 10% of total accounts receivable, net at May 31, 2011 and 2010, respectively. Our relationship with BP is comprised of separate contracts for non-destructive testing and inspection services with multiple affiliated entities within the broad BP organization. We conduct business with various divisions or affiliates of the BP organization through numerous contracts covering many segments of BP’s business including downstream (refinery), midstream (pipelines) and upstream (exploration). These contracts are typically negotiated locally with the specific location, are of varying lengths, have different start and end dates and differ in terms of the scope of work and nature of services provided. Most contracts are based on time and materials.
Self insurance
The Company is self-insured for certain losses relating to workers compensation and health benefits claims. The Company maintains third-party excess insurance coverage for all workers compensation and health benefit claims in excess of approximately $0.3 million to reduce its exposure from such claims. Self-insured losses are accrued when it is probable that an uninsured claim has been incurred but not reported and the amount of the loss can be reasonably estimated at the balance sheet date. Management monitors and reviews all claims and their related liabilities on an ongoing basis.
Stock-based compensation
The Company measures the cost of employee services received in exchange for an award of equity instruments based upon the grant-date fair value of the award. The Company uses the “straight-line” attribution method for allocating compensation costs and recognizes the fair value of each stock option on a straight-line basis over the vesting period of the related awards.
The Company uses the Black-Scholes option-pricing model to estimate the fair value of the stock option awards as of the grant date. The Black-Scholes model, by its design, is highly complex and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are the expected term of stock option awards and the estimated volatility of the Company’s common stock price. The Black-Scholes model is sensitive to changes in these two variables. Since the Company’s initial public offering (IPO), the expected term of the Company’s stock options is generally determined using the mid-point between the vesting period and the end of the contractual term. Expected stock price volatility is typically based on the daily historical trading data for a period equal to the expected term. Because the Company’s historical trading data only dates back to October 8, 2009, the first trading date after its IPO, the Company has estimated expected volatility using an analysis of the stock price volatility of comparable peer companies. Prior to the Company’s IPO, the exercise price equaled the estimated fair market value of the Company’s common stock, as determined by its board of directors. Since the Company’s IPO, the exercise price of stock option grants is determined using the closing market price of the Company’s common stock on the date of grant.
The fair value of stock option awards was estimated at the date of grant using the Black-Scholes option-pricing model with the following range of assumptions:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
Income taxes
Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carry-forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided if it is more likely than not that some or all of the deferred income tax asset will not be realized.
Income tax accounting standards prescribe a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. These standards also provide guidance on de-recognition, measurement, and classification of amounts relating to uncertain tax positions, accounting for and disclosure of interest and penalties, accounting in interim periods and disclosures required. Interest and penalties are recognized as incurred within “provision for income taxes” in the consolidated statements of operations.
Comprehensive income
Comprehensive income is defined to include all changes in equity, except those resulting from investments by stockholders and distribution to stockholders, and is reported in the statement of stockholders’ equity (deficit). Included in the Company’s comprehensive income are net income and foreign currency translation adjustments.
Recent accounting pronouncements
In October 2009, the FASB issued Accounting Standards Update (ASU) ASU 2009-13, which amends ASC 605, “Revenue Recognition”, to require companies to allocate the overall consideration in multiple-element arrangements to each deliverable by using a best estimate of the selling price of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price. This guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company does not expect a significant impact on the financial statements of the Company when the guidance is adopted in fiscal 2012.
In April 2010, the FASB issued Accounting Standards Updates (ASU) 2010-17, which amends ASC 605, “Revenue Recognition”. ASU 2010-17 provides guidance on applying the milestone method to milestone payments for achieving specified performance measure when those payments are related to uncertain future events limited to transactions involving research and development. Entities can make an accounting policy election to recognize arrangement consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met. This guidance is effective prospectively for milestones achieved in fiscal years beginning on or after June 15, 2010. The Company does not expect a significant impact on the financial statements of the Company when the guidance is adopted in fiscal 2012.
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. For the fiscal year ended May 31, 2010, the amount of net income (numerator) used in the computation of diluted earnings per share did not include preferred stock accretion as such accretion provided an anti-dilutive effect. 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 (loss) per share:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
The following weighted-average common shares and equivalents related to options outstanding under the Company’s stock option plans and the conversion of its outstanding preferred stock conversion were excluded from the computation of diluted earnings (loss) per share as the effect would have been anti-dilutive:
4. Accounts receivable and allowance for doubtful accounts
An allowance for doubtful accounts is provided against accounts receivable for amounts management believes may be uncollectible. Changes in the allowance for doubtful accounts are represented by the following:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
In January 2009, a customer filed to reorganize under Chapter 11 of the U.S Bankruptcy Code. Total pre-petition accounts receivable from this customer as of May 31, 2010 was approximately $2.3 million. During fiscal 2010, the Company wrote off approximately $2.0 million, or 84% of the pre-petition balance. This customer emerged from Chapter 11 during the Company’s fiscal year ending 2011.
5. Inventories
Inventories consist of the following at May 31, 2011 and 2010:
Inventories are net of reserves for slow-moving and obsolete inventory of approximately $1.0 million and $0.9 million at May 31, 2011 and 2010, respectively.
6. Property, plant and equipment, net
Property, plant and equipment consist of the following at May 31, 2011 and 2010:
Depreciation expense was approximately $13.5 million, $10.9 million and $8.8 million for the years ended May 31, 2011, 2010 and 2009, respectively.
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
7. Goodwill
The changes in the carrying amount of goodwill at May 31, 2011 and 2010 are as follows:
8. Acquisitions
The Company made five acquisitions during fiscal 2011 for strategic market expansion. These acquisitions were asset protection companies specializing in in-house aerospace component inspection; rope access; imaging, data mining and archiving; and advanced ultrasonic inspection. These companies were acquired to complement our service and product offerings within our Services, Products and Systems, and International segments. Four of the acquisitions were asset purchases, but which met the definition of “acquisitions of businesses” under the provision FASB Accounting Standards Codification (ASC) 805-10-20. In the remaining acquisition, we acquired 80% of the common stock of the acquiree. The holders of the remaining 20% interest can require the Company to purchase the noncontrolling interest at any time for a price based upon EBITDA of the acquiree’s operations. The estimated fair value of the minority holders’ put option was de minimis as of May 31, 2011. The 20% minority interest is reflected as noncontrolling interest in stockholders’ equity. In addition to the cash and debt consideration, the Company also accrued a liability of approximately $4.6 million as of May 31, 2011, which represents the estimated fair value of contingent consideration expected to be payable in the event that certain of the acquired companies achieve specific performance metrics over the next four years of operations. In fiscal 2011, there were no changes to the initial estimated fair value of contingent consideration. The potential contingent consideration ranges from zero to $9.2 million and would be payable annually based upon operational performance for the fiscal years ended May 31, 2012 through 2015.
Assets and liabilities of the acquired businesses were included in the consolidated balance sheets as of May 31, 2011 based on their estimated fair value on the date of acquisition as determined in a purchase price allocation, using available information and making assumptions management believes are reasonable. Results of operations for the period from acquisition date are reported in each respective operating segment’s statement of operations. The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
The amortization period of intangible assets acquired ranges from one to fifteen years. The Company recorded approximately $19.4 million of goodwill in connection with our fiscal 2011 acquisitions, reflecting the strategic fit and revenue and earnings growth potential of these businesses. Substantially all of the goodwill recognized is expected to be deductible for tax purposes.
Revenues and income from operations included in the Consolidated Statement of Operations for fiscal 2011 from these acquisitions for the period subsequent to the closing of each transaction was approximately $19.0 million and $2.5 million, respectively.
The unaudited pro forma information for the periods set forth below gives effect to the fiscal 2011 acquisitions as if they had occurred at the beginning of the annual period presented. The pro forma information is present for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisitions been consummated as of that time (unaudited, in thousands):
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
9. Intangible assets
The gross carrying amount and accumulated amortization of intangible assets at May 31, 2011 and 2010 are as follows:
Amortization expense for the years ended May 31, 2011, 2010 and 2009 was approximately $5.0 million, $4.2 million and $3.8 million, respectively, including amortization of software for the years ended May 31, 2011, 2010 and 2009 of $0.4 million, $0.5 million and $0.7 million, respectively.
The following is the approximate amount of amortization expense in each of the years ending subsequent to May 31, 2011:
Amortization expense years ending May 31,
10. Accrued expenses and other current liabilities
Accrued expenses and other current liabilities consist of the following at May 31, 2011 and 2010:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
11. Long-term debt
Long-term debt consists of the following at May 31, 2011 and 2010:
Senior credit facility
On July 22, 2009, the Company entered into its current credit agreement with Bank of America, N.A., JPMorgan Chase Bank, N.A., TD Bank, N.A. and Capital One, N.A., which provided for a $25.0 million term loan and a $55.0 million secured revolving credit facility. The proceeds from this transaction were used to repay the outstanding indebtedness of the former credit facility and to fund acquisitions.
The outstanding principal balance of the term loan was subsequently repaid in October 2009 in connection with the Company’s IPO and may not be re-borrowed under the current credit agreement. The Company also repaid the outstanding balance of the revolving credit facility but may re-borrow the revolving credit facility at any time during the term of the agreement. Borrowings made under the revolving credit facility are payable on July 21, 2012. In December 2009, the Company signed an amendment to its current credit agreement that, among other things, adjusted certain affirmative and negative covenants including delivery of financial statements, the minimum consolidated debt service coverage ratio, the procedures for obtaining lender approval for acquisitions and the removal of the minimum EBITDA requirement.
Under the amended agreement, borrowings under the credit agreement bear interest at the LIBOR or base rate, at the Company’s option, plus an applicable LIBOR margin ranging from 1.75% to 3.25%, or base rate margin ranging from -0.50% to 0.50%, and a market disruption increase of between 0% and 1.0%, if the lenders determine it is applicable.
Notes payable and other
In connection with acquisitions through fiscal 2011, the Company issued subordinated notes payable to the sellers. The maturity of these notes range from three to five years from the date of acquisition with interest rates ranging from 0% to 7%. The Company has discounted these obligations to reflect a 3.5% to 10.0% imputed interest. Unamortized discount on the notes was approximately $0.1 million and $0.3 million as of May 31, 2011 and 2010, respectively. Amortization is recorded as interest expense in the Consolidated Statements of Operations.
Scheduled principal payments due under all borrowing agreements in each of the five years and thereafter subsequent to May 31, 2011 are as follows:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
12. Financial instruments
In calendar 2010, the Company hedged a portion of the variable rate interest payments on its debt using an interest rate swap contract to convert variable payments into fixed payments. The Company did not apply hedge accounting to its interest rate swap contracts. Changes in the fair value of this instrument were reported as a component of interest expense. The interest rate swap contract matured in November 2010 and had a notional amount of $8.0 million. The following outlines the significant terms of the contract and the fair value of the contract as of May 31, 2010.
The Company classifies its interest rate swaps at fair value in the following categories:
Level 1-Quoted prices in active markets for identical assets or liabilities.
Level 2-Inputs other than quoted market prices in active markets that are observable for the asset or liability, either directly or indirectly, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data by correlation or other means.
Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The fair value of the Company’s interest rate swap liability, approximately $0.2 million at May 31, 2010, was determined using quoted prices in an active market and was classified as a Level 1 liability within the fair value hierarchy.
13. Obligations under capital leases
The Company leases certain office space, including its headquarters, and service equipment under capital leases, requiring monthly payments ranging from $1 thousand to $66 thousand, including effective interest rates that range from approximately 3% to 15% expiring through May 2016. The net book value of assets under capital lease obligations was $14.4 million and $14.0 million at May 31, 2011 and 2010, respectively.
Scheduled future minimum lease payments subsequent to May 31, 2011 are as follows:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
14. Commitments and contingencies
Operating leases
The Company is party to various noncancelable lease agreements, primarily for its international and domestic office and lab space. Minimum future lease payments under noncancelable operating leases in each of the five years subsequent to May 31, 2011 are as follows:
Total rent expense was $4.2 million, $3.2 million and $3.1 million for the years ended May 31, 2011, 2010 and 2009, respectively.
Litigation
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. The costs of defense and amounts that may be recovered in such matters may be covered by insurance.
The Company is a defendant in two related class action lawsuits in California, based upon alleged violations of California labor and employment law: Quiroz v. Mistras Group, Inc., et al, U.S. District Court, Central District of California (Case No. CV09-7146 PSG), filed in September 2009, and Ballard v. Mistras Group, Inc., et al, U.S. District Court, Central District of California (Case No. 2:10-cv-03186 (PSG)), filed in March 2010. Both of these cases were brought on behalf of existing and former California employees of the Company and its subsidiaries for alleged violation of various labor and employment laws, primarily for failure to pay wages timely and for having defective wage statements, as well as other claims, and sought penalties under the California Private Attorneys General
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
Act. The Ballard case was filed shortly after the plaintiff’s request to certify the Quiroz case as a class action suit was denied by the same attorney representing the plaintiff in the Quiroz case.
The Company and counsel for the plaintiffs in both the Quiroz and Ballard cases have agreed upon a combined settlement, which received final court approval on August 1, 2011. The Company has reserved approximately $0.2 million in connection with this settlement, the charges for which were taken in fiscal 2011. This reserve represents the Company’s estimate of its total liability related to the approved settlement of these cases, net of insurance reimbursements.
Acquisition related
The Company is liable for contingent consideration in connection with its acquisitions (See Note 8).
15. Employee benefit plans
The Company provides a 401(k) savings plan for eligible U.S. based employees. Employee contributions are discretionary up to the IRS limits each year and catch up contributions are allowed for employees 50 years of age or older. Under the 401(k) plan, employees become eligible to participate on the first day of the month after six months of continuous service. Under this plan, the Company matches 50% of the employee’s contributions up to 6% of the employee’s annual compensation, as defined by the plan. There is a five-year vesting schedule for the Company match. The Company’s contribution to the plan was approximately $1.9 million, $1.4 million and $1.0 million for the years ended May 31, 2011, 2010 and 2009, respectively.
The Company participates with other employers in contributing to a union plan, which covers certain U.S. based union employees. The plan is not administered by the Company and contributions are determined in accordance with provisions of a collective bargaining agreement. The Company’s contributions to the plan were approximately $1.0 million, $0.5 million, and $0.3 million for the years ended May 31, 2011, 2010 and 2009, respectively. The Company has benefit plans covering certain employees in selected foreign countries. Amounts charged to expense under these plans were not significant in any year.
16. Income taxes
Income before provision for income taxes is as follows:
The provision for income taxes consists of the following:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
The provision for income taxes differs from the amount computed by applying the statutory federal tax rate to income tax as follows:
Deferred income tax attributes resulting from differences between financial accounting amounts and income tax basis of assets and liabilities at May 31 are as follows:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
At May 31, 2011, the Company has recorded a valuation allowance against certain state and foreign deferred income tax assets based on its assessment that the respective deferred income tax assets would not be realized. As of May 31, 2011, the Company has available state net operating losses of approximately $1.1 million with expiration dates starting in 2015.
The following table summarizes the changes in the Company’s gross unrecognized tax benefits, excluding interest and penalties:
The Company has recorded the unrecognized tax benefits in Other Long-Term Liabilities in the consolidated balance sheets as of May 31, 2011, 2010 and 2009. As of May 31, 2011, 2010 and 2009, there were approximately $0.4 million, $0.6 million, and $0.7 million of unrecognized tax benefits, respectively, including penalties and interest that if recognized would favorably affect the effective tax rate. Interest and penalties related to unrecognized tax benefits are recorded in income tax expense and are not
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
significant for the years ending May 31, 2011, 2010 and 2009. The Company does not anticipate material changes to its unrecognized tax benefits within the next year.
The Company has not recognized U.S. tax expense on its undistributed international earnings of approximately $2.9 million and $1.8 million for fiscal 2011 and 2010, respectively, since it intends to reinvest the earnings outside the United States. Any additional U.S. income taxes incurred would be reduced by available foreign tax credits. If the earnings of such foreign subsidiaries were not indefinitely reinvested, a deferred tax liability may have been required.
17. Capitalization
Common Stock
In October 2009, the Company completed its initial public offering of 10,000,000 shares of common stock at a price of $12.50 per share. The Company sold 6,700,000 shares and received net proceeds of approximately $74.0 million from the offering. The Company used approximately $68.0 million of the net proceeds to repay the outstanding principal balance of the term loan ($25.0 million), outstanding balance of the revolver ($41.4 million) and accrued interest thereon ($0.1 million) in October 2009, as well as approximately $1.5 million to pay costs and expenses related to the offering. The remaining proceeds of approximately $6.0 million was used in connections with acquisitions the Company has made and for working capital purposes.
In May 2011, the Company completed a secondary offering of 3,754,061 shares of common stock at a price of $16.00 share. The Company sold 989,660 shares and 2,764,401 shares were sold by a selling stockholder. The Company received net proceeds of approximately $14.7 million from the offering. The Company intends to use the net proceeds for general corporate purposes including the reduction of outstanding indebtedness, acquisitions, capital expenditures and working capital.
Dividends on common stock will be paid when, and if declared by the board of directors. Each holder of common stock is entitled to vote on all matters and is entitled to one vote for each share held.
Preferred stock
Prior to its IPO in October 2009, the Company completed several private placements of its Class A and Class B preferred stock. These preferred shares included various redemption and conversion features and were reported outside the equity section and adjusted to fair value, which represented their redemption value at each reporting date. Effective upon the closing of the IPO, all of the preferred shares outstanding as of the offering were converted to common stock.
Equity awards
In September 2009, the Company’s board of directors and shareholders adopted and approved the 2009 Long-Term Incentive Plan (the 2009 Plan), which became effective upon the closing of the IPO. Awards may be in the form of stock options, restricted stock units and other forms of stock-based incentives, including stock appreciation rights and deferred stock rights. The term of each incentive and non-qualified stock option is ten years. Vesting generally occurs over a period of four years, the expense for which is recorded on a straight-line basis over the requisite service period. The 2009 Plan allows for the grant of awards of up to approximately 2,286,000 shares of common stock, of which 1,997,000 shares were available for future grants as of May 31, 2011. Prior to the Company’s IPO in October 2009, the Company had two stock option plans: (i) the 1995 Incentive Stock Option and Restricted Stock Purchase Plan (the 1995 Plan), and (ii) the 2007 Stock Option Plan (the 2007 Plan). No additional awards may be granted from these two plans. As of May, 2011, there were stock options for a total of approximately 2,867,000 shares of common stock and approximately 213,000 unvested restricted stock units outstanding under the 2009 Plan, the 2007 Plan, and the 1995 Plan.
For the fiscal year ended May 31, 2011, 2010 and 2009, the Company recognized stock-based compensation expense related to stock option awards of approximately $3.3 million, $2.7 million and $0.2 million, respectively. Cash proceeds from and the aggregate intrinsic value of stock options exercised during the years ended May 31, 2011, 2010 and 2009 were as follows:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
A summary of the stock option activity, weighted average exercise prices, options outstanding and exercisable as of May 31, 2011 is as follows (in thousands, except per share amounts):
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
The Company also recognized approximately $0.5 million in stock-based compensation expense related to restricted stock unit awards during the fiscal year ended May 31, 2011. There was no such expense incurred in fiscal 2010 and 2009. As of May 31, 2011, there was approximately $1.7 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 3.2 years.
18. Related party transactions
The Company leases its headquarters under a capital lease (Note 13) from a shareholder and officer of the Company requiring monthly payments through October 2014. Total rent payments made during fiscal 2011 were approximately $0.8 million.
The Company has a lease for office space located in France, which is partly owned by a shareholder and officer, requiring monthly payment through January 2016. Total rent payment made during fiscal 2011 were approximately $0.2 million.
19. Segment disclosure
The Company’s three segments are:
· Services. This segment provides asset protection solutions primarily in North America with the largest concentration in the United States, 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.
· 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.
· International. This segment offers services, products and systems similar to those of our other 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 our Products and Systems segment.
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 the summary of significant accounting policies in Note 2. 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 stock-based compensation and certain other acquisition-related charges and balances, technology and product development costs, certain gains and losses from dispositions, and litigation settlements or other charges. Certain general and administrative costs such as human resources, information technology and training are allocated to the segments. Segment income from operations also excludes 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 financial information by segment for the periods shown was as follows:
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
(1) Revenues by operating segment include intercompany transactions, which are eliminated in corporate and eliminations. The Services segment had sales to other operating segments of $1.4 million, $0.5 million and $0.1 million for fiscal 2011, 2010 and 2009, respectively. The Products and Systems segment had sales to other operating segments of $4.4 million, $4.4 million and $3.9 million for fiscal 2011, 2010 and 2009, respectively. The International segment had sales to other operating segments of $0.3 million, $0.6 million and $0.3 million for fiscal 2011, 2010 and 2009, respectively.
Operating income by operating segment includes intercompany transactions, which are eliminated in corporate and eliminations.
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
Revenues by geographic area
Net revenues by geographic area for the fiscal years ended May 31, 2011, 2010 and 2009 were as follows:
No individual foreign country’s revenues or long-lived assets were material for disclosure purposes.
20. Subsequent event
Subsequent to fiscal 2011, the Company acquired three asset protection businesses for approximately $5.7 million in cash. In addition to the cash consideration, the agreement allows for contingent consideration to be earned based upon certain of the acquired companies reaching specific performance metrics over the next four years of operation. The Company is in the process of completing the preliminary purchase price allocation. These acquisitions were not individually significant and no pro forma information has been included.
Mistras Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(continued)
(tabular dollars in thousands, except per share data)
21. Selected quarterly financial information (unaudited)
The following is a summary of the quarterly results of operations for the years ended May 31, 2011 and 2010 (in thousands, except per share amounts):
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Pursuant to Rule 13a-15(b) under the Exchange Act, our management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer along with our Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls (as defined in Rule 13a-15(e) of the Exchange Act) and procedures. Based upon that evaluation, our Chief Executive Officer along with our Executive Vice President and Chief Financial Officer concluded that as of the end of our fiscal year ended May 31, 2011, our disclosure controls and procedures were effective.
Management’s Report On Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended (the Exchange Act). Our internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer along with our Executive Vice President and Chief Financial Officer, or persons performing similar functions, and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of May 31, 2011. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on that assessment, our management concluded that, as of May 31, 2011, our internal control over financial reporting was effective.
The effectiveness of the Company’s internal control over financial reporting as of May 31, 2011 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during our fourth fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The information required by Item 10 is incorporated herein by reference to the information contained in our definitive proxy statement related to the 2011 annual shareholders meeting. The information concerning our executive officers required by this Item 10 is provided under the caption “Executive Officers of the Registrant” in Part I hereof.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to the information contained in our definitive proxy statement related to the 2011 annual shareholders meeting.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 regarding Security Ownership of Certain Beneficial Owners and Management and Related Stockholders is incorporated by reference to the information contained in our definitive proxy statement related to the 2011 annual meeting of shareholders.
Equity Compensation Plan Information
The following table provides certain information as of May 31, 2011 concerning the shares of our common stock that may be issued under existing equity compensation plans.
(1) Includes all the Company’s plans: 1995 Incentive Stock Option and Restricted Stock Plan, 2007 Stock Option Plan and 2009 Long-Term Incentive Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is incorporated by reference to the information contained in our definitive proxy statement related to the 2011 annual shareholders meeting.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated by reference to the information contained in our definitive proxy statement related to the 2011 annual shareholders meeting.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1) The following financial statements are filed herewith in Item 8 of Part II above:
Page
Report of independent registered public accounting firm
Consolidated financial statements
Balance sheets as of May 31, 2011 and May 31, 2010
Statements of operations for the years ended May 31, 2011, 2010 and 2009
Statements of stockholders’ equity (deficit) for the years ended May 31, 2011, 2010 and 2009
Statements of cash flows for the years ended May 31, 2011, 2010 and 2009
Notes to consolidated financial statements
(2) Financial Statement Schedules
All other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.
(3) Exhibits
Exhibit No.
Description
3.1
Second Amended and Restated Certificate of Incorporation (filed as exhibit 3.1 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
3.2
Amended and Restated Bylaws (filed as exhibit 3.2 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
4.1
Specimen certificate evidencing shares of common stock (filed as exhibit 4.1 to Registration Statement on Form S-1 (Amendment No. 5) filed on September 23, 2009 (Registration No. 333-151559) and incorporated herein by reference.
10.1
Form of Indemnification Agreement for directors and officers (filed as exhibit 10.1 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
10.2
Second Amended and Restated Credit Agreement dated as of July 22, 2009 (filed as exhibit 10.3 to Registration Statement on Form S-1 (Amendment No. 6) filed on October 6, 2009 (Registration No. 333-151559) and incorporated herein by reference)
10.3
Amendment dated as of December 14, 2009, to the Second Amended and Restated Credit Agreement (filed as exhibit 10.1 to Current Report on Form 8-K filed December 18, 2009 and incorporated herein by reference)
10.4
Employment Agreement between the Company and Sotirios J. Vahaviolos (filed as exhibit 10.4 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
10.5
Amendment to Employment Agreement, dated July 14, 2010, between the Company and Sotirios J. Vahaviolos (filed as exhibit 10.1 to Quarterly Report on Form 10-Q filed on October 14, 2010 and incorporated herein by reference)
10.6
1995 Incentive Stock Option and Restricted Stock Purchase Plan (filed as exhibit 99.1 to the Registration Statement on Form S-8 filed on February 3, 2010 (Registration No. 333-164688) and incorporated herein by reference)
10.7
2007 Stock Option Plan and form of Stock Option Agreement (filed as exhibit 10.5 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
10.8
2009 Long-Term Incentive Plan (filed as exhibit 10.6 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference).
10.9
Form of 2009 Long-Term Incentive Plan Stock Option Agreement (filed as exhibit 10.7 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
10.10
Form of 2009 Long-Term Incentive Plan Restricted Stock Agreement (filed as exhibit 10.8 to Registration Statement on Form S-1 (Amendment No. 4) filed on September 21, 2009 (Registration No. 333-151559) and incorporated herein by reference)
10.11
Form of Restricted Stock Unit Certificate for awards under 2009 Long-Term Incentive Plan (filed as exhibit 10.1 to Quarterly Report on Form 10-Q filed on January 13, 2011 and incorporated herein by reference)
10.12
Compensation Plan for Non-Employee Directors (July 2010) (filed as exhibit 10.2 to Quarterly Report on Form 10-Q filed on October 14, 2010 and incorporated herein by reference)
10.13*
Compensation Plan for Non-Employee Directors (June 2011)
21.1*
Subsidiaries of the Registrant
23.1*
Consent of PricewaterhouseCoopers LLP
24.1*
Power of Attorney (included as part of the signature page to this report)
31.1*
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2*
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1*
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 Indicates a management contract or any compensatory plan, contract, or arrangement.
* Filed herewith.
** Furnished herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: August 12, 2011
We, the undersigned directors and officers of Mistras Group, Inc., hereby severally constitute Sotirios J. Vahaviolos, Francis T. Joyce and Michael C. Keefe, and each of them singly, as our true and lawful attorneys with full power to each of them to sign for us, in our names in the capacities indicated below, any and all amendments to this Annual Report on Form 10-K filed with the Securities and Exchange Commission.
This power of attorney may only be revoked by a written document executed by the under signed that expressly revokes this power by referring to the date and subject hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/Sotirios J. Vahaviolos
Chairman, President and Chief Executive
August 12, 2011
Sotirios J. Vahaviolos
Officer (Principal Executive Officer)
and Director
/s/ Francis T. Joyce
Executive Vice President, Chief Financial
August 12, 2011
Francis T. Joyce
Officer and Treasurer (Principal Financial and
Accounting Officer)
/s/Daniel M. Dickinson
Director
August 12, 2011
Daniel M. Dickinson
/s/ James J. Forese
Director
August 12, 2011
James J. Forese
/s/ Richard H. Glanton
Director
August 12, 2011
Richard H. Glanton
/s/Ellen T. Ruff
Director
August 12, 2011
Ellen T. Ruff
/s/ Michael J. Lange
Director
August 12, 2011
Michael J. Lange
/s/Manuel N. Stamatakis
Director
August 12, 2011
Manuel N. Stamatakis