Mistras Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Financial statements are unaudited. Amounts below are in millions unless stated otherwise. The company changed its fiscal year-end to December 31 in 2016; 2016 International results included a one-month reporting lag that was removed in 2017, which may affect comparability.
Business context
Mistras provides asset-protection services, products and systems, including nondestructive testing and inspection, for energy, industrial and public infrastructure customers. Its reportable segments are Services, International, and Products and Systems. Management cited soft market conditions, with lower oil prices prompting customers to curtail spending. Oil and gas customers generated approximately 57% of Q2 revenue and 58% of first-half revenue.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $170.4 | $178.3 | $333.8 | $345.8 |
| Gross profit | $46.3 | $51.5 | $89.5 | $95.5 |
| Gross margin | 27.2% | 28.9% | 26.8% | 27.6% |
| Operating income | $5.0 | $4.8 | $8.3 | $10.5 |
| Net income attributable to Mistras | $2.2 | $2.8 | $3.9 | $6.2 |
| Diluted EPS | $0.07 | $0.09 | $0.13 | $0.21 |
- Revenue fell 4% in Q2 and 3% in the first half year over year. Q2 declines were 2% in Services, 7% in International and 21% in Products and Systems. First-half revenue rose 1% in International but fell 3% in Services and 19% in Products and Systems.
- Gross profit declined 10% in Q2 and 6% in the first half. Q2 gross margin fell 170 basis points; International and Products and Systems margins weakened notably, due respectively to lower utilization and less favorable mix, and lower sales volume.
- Q2 GAAP operating income rose slightly, but first-half operating income fell 21%. Management’s non-GAAP “income before special items” was $5.7 million in Q2, down 50%, and $9.6 million for the first half, down 43%. The prior-year comparison included a $6.3 million legal-settlement charge; excluding special items, underlying operating performance was weaker.
- Interest expense increased to $1.0 million in Q2 and $2.0 million in the first half, primarily due to revolver borrowings. Effective tax rates were approximately 44% for Q2 and 37% for the first half, up from 39% and 31%, respectively, largely due to discrete items.
Cash flow, liquidity and debt
- First-half operating cash flow was $23.0 million, down 39% from $37.8 million. Management attributed the decrease primarily to working-capital movements, including payment of the prior-year legal settlement and collection timing.
- Investing cash outflow was $14.2 million, including $9.8 million of property and equipment purchases and $4.5 million for an acquisition. Financing cash outflow was $2.7 million and included $12.0 million of share repurchases.
- Cash was $26.8 million at June 30, 2017, versus $19.2 million at December 31, 2016. Total debt was $101.7 million, compared with $87.3 million at year-end; capital lease obligations were another $15.3 million. Revolver borrowings were $93.9 million, and $5.6 million of letters of credit were outstanding.
- The company reported $75.5 million of available borrowing capacity and compliance with its credit-facility covenants. The $175 million revolving facility matures October 30, 2019; financial covenants include maximum funded-debt leverage of 3.25:1 and minimum interest coverage of 3.0:1. Management said available cash, operating cash flow, borrowing and lease financing should fund operations for the foreseeable future.
- Accounts receivable, net, was $129.2 million. The allowance for doubtful accounts rose to $4.1 million from $2.9 million, including a $1.2 million provision related to a customer bankruptcy.
Material changes, outlook and notable items
- Management provided no quantified revenue or earnings guidance in the supplied filing text. It described current markets as soft and said it believed growth could continue across target markets, while noting customer spending pressure associated with lower oil prices.
- The company acquired a U.S. NDT, chemical and special-processing services business for $4.5 million cash, plus up to $3.5 million contingent consideration. Since acquisition, it contributed approximately $2.0 million revenue and $0.2 million operating income. A subsequent Canadian mechanical-services acquisition closed for $3.9 million cash, with up to $2.3 million additional contingent consideration.
- Potential acquisition-related contingent consideration ranged from zero to approximately $17.7 million. A $50 million repurchase authorization had approximately $29 million remaining; the company repurchased about 541,000 shares for $12.0 million in the first half.
- Goodwill was $176.2 million. Management reported no impairment indicators overall, but specifically assessed reduced profitability in Products and Systems and concluded its reporting unit’s fair value was not more likely than not below carrying value, citing pending contract bids and expected profitability.
- Legal matters include a pipeline radiography claim seeking approximately $6 million and an alleged defective inspection-system claim seeking approximately $2.3 million; the company said it could not estimate likely outcomes or potential liabilities and had recorded no reserves for these matters. An EPA investigation of a California leased facility also remained unresolved, with no reserve recorded because potential company liability was unclear. The prior-year $6.3 million class-action settlement was paid in February 2017.
- One customer represented approximately 12% of Q2 and first-half revenue; the same customer accounted for 11% of receivables at June 30. The top ten customers represented about 40% of Q2 revenue and 41% of first-half revenue.
- The company adopted deferred-tax balance-sheet classification guidance and stock-compensation guidance in 2017; management reported no material effect from the deferred-tax change. It planned to adopt the new revenue-recognition standard in 2018 and was still assessing its effects.
Important facts for investors to verify
- Whether revenue and segment margins stabilize, particularly in Products and Systems and International, and whether pending bids translate into contracts.
- Whether operating cash flow recovers and receivables remain collectible given the customer bankruptcy provision and customer concentration.
- Debt, interest costs, covenant headroom and liquidity after acquisitions and share repurchases.
- Final acquisition purchase-price allocations and performance-based contingent consideration; the new acquisitions’ contribution to results.
- Developments and possible exposure in the pipeline, inspection-system and EPA matters, for which the filing provides no reliable estimate of liability.
- Products and Systems goodwill impairment assumptions and the impact of adopting the revenue-recognition standard.