Mistras Group, Inc. quarterly report, Q1 FY2019

Mistras Group, Inc. — Q1 2019 Form 10-Q

Reporting period: Three months ended March 31, 2019; unaudited. Comparisons are with the three months ended March 31, 2018 unless otherwise noted. Mistras provides technology-enabled asset inspection, testing, maintenance and related products to energy, industrial, aerospace and infrastructure customers through Services, International, and Products and Systems segments. Dollar amounts below are in millions unless stated otherwise.

Financial performance and liquidity

Metric	Q1 2019	Q1 2018
Revenue	$176.8	$187.6
Gross profit / margin	$48.9 / 27.6%	$48.1 / 25.7%
Operating income (loss) / margin	$(4.4) / (2.5)%	$6.4 / 3.4%
Net income (loss) attributable to Mistras	$(5.3); $(0.19) per diluted share	$2.9; $0.10 per diluted share
Operating cash flow	$8.2	$5.8
Capital expenditures	$5.6	$5.2

• Revenue fell 6%. Management attributed the decline to mid-single-digit organic contraction, including about $10 million from a contract that ended after Q1 2018, and a low-single-digit foreign-exchange headwind; acquisition growth partly offset the decline.
• Gross profit increased 2% despite lower revenue. Gross margin improved 190 basis points, led by more favorable mix in Services and improved utilization and mix in International. Products and Systems margin fell to 36.1% from 46.7%, principally reflecting lower sales.
• Operating expenses were $53.3 million versus $41.7 million. The reported operating loss included a $5.5 million net provision for troubled customers, $0.5 million of pension withdrawal expense, and $0.5 million of acquisition-related expense. Non-GAAP income before special items was $2.3 million, down from $5.5 million; the filing cautions that this measure is not a substitute for GAAP results.
• Interest expense rose to $3.5 million from $1.8 million, primarily due to acquisition-related borrowing and, to a lesser extent, higher base rates. The effective tax rate was approximately 33%, compared with 37%.
• Operating cash flow increased by $2.4 million, mainly due to working-capital timing, including receivable collections. Investing cash use was $5.0 million; financing cash use was $3.9 million. Cash declined $0.9 million to $24.6 million.
• Total debt was $287.7 million at quarter-end. The company reported $279.2 million borrowed under its credit agreement, $5.4 million of letters of credit, and $114.1 million of available borrowing capacity.
• Current assets were $197.7 million and current liabilities were $107.4 million. Adoption of the new lease standard added approximately $38 million of operating-lease assets and liabilities at January 1, 2019; operating-lease liabilities were $37.0 million at March 31.

Material changes and segment trends

• Services revenue declined 4% to $140.3 million; operating income fell to $4.1 million from $12.3 million. Its gross margin improved to 26.6% from 23.8%.
• International revenue declined 9% to $35.2 million, reflecting foreign exchange and a modest organic decline. The segment recorded an operating loss of $0.2 million, versus income of $0.9 million; gross margin improved to 29.5% from 27.8%.
• Products and Systems revenue declined 45% to $3.4 million, reflecting lower core sales and the 2018 sale of a subsidiary. The segment reported an operating loss of $1.3 million, versus income of $0.3 million.
• Oil and gas generated approximately 57% of revenue, down from 60%; aerospace and defense contributed approximately 14%, down from 15%. No customer represented 10% or more of revenue.
• Onstream, acquired in December 2018, contributed to acquisition growth and added inline-inspection and digital capabilities. Related Q1 operating expenses were approximately $3.2 million, including $1.3 million of depreciation and amortization.

Outlook, risks and unusual items

• Management expected relatively stable oil and gas inspection spending for the remainder of 2019, with maintenance shutdown spending expected to remain steady with 2018. It cited oil prices having recovered to year-ago levels and anticipated that the prevailing range would persist. The filing provides no specific revenue or earnings guidance.
• Debt covenant: Mistras did not meet its maximum funded-debt leverage ratio of 4.00:1 for the rolling 12 months ended March 31, 2019, but obtained a waiver. It was compliant with the fixed-charge coverage covenant. Management warned that future compliance is not assured; another breach could require repayment and harm liquidity. The company stated that available funding sources were sufficient for the foreseeable future.
• A renewable-energy customer entered insolvency proceedings on April 9, 2019. Mistras recorded an additional $5.7 million reserve in Q1 to fully reserve its exposure, partly offset by a $0.2 million recovery on an unrelated prior provision.
• A multi-employer pension withdrawal liability remained estimated at approximately $4.9 million, net of $1.5 million in payments. German labor-leasing changes contributed to estimated severance obligations of approximately $1.6 million.
• The company disclosed an unresolved EPA investigation concerning possible hazardous materials at a leased California site; it could not estimate potential liability and recorded no accrual. It also noted a vehicle-accident lawsuit, for which it believes insurance is sufficient but cannot assure coverage will meet all claims.
• The board terminated the share repurchase plan effective April 1, 2019. No shares were repurchased under the plan during Q1.

Important facts for investors to verify

• Whether Mistras maintains leverage-covenant compliance in subsequent quarters and the terms or availability of any further waiver.
• The renewable-energy customer exposure, actual recoveries, and the adequacy of the bad-debt reserve.
• Revenue trends after the ended contract, including organic performance, foreign-exchange effects, and the contribution and costs of Onstream.
• Progress and cash-payment timing for pension withdrawal and German severance obligations, as well as developments in the EPA investigation and accident litigation.
• Liquidity, borrowing availability, and the effect of debt service and lease obligations on future cash generation.