Mistras Group, Inc. 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following Management’s Discussion and Analysis (“MD&A”) provides a discussion of our results of operations and financial position for the three and nine months ended September 30, 2021 and 2020. The MD&A should be read together with our Unaudited Condensed Consolidated Financial Statements and related notes included in Item 1 in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission on March 16, 2021 (“2020 Annual Report”). Unless otherwise specified or the context otherwise requires, “Mistras,” “the Company,” “we,” “us” and “our” refer to Mistras Group, Inc. and its consolidated subsidiaries. The MD&A includes the following sections: • Forward-Looking Statements • Overview • Note about Non-GAAP Measures • Consolidated Results of Operations • Liquidity and Capital Resources • Critical Accounting Policies and Estimates Forward-Looking Statements This report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934 (“Exchange Act”). 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. 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, various risks, uncertainties or other factors known and unknown. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed in the “Business—Forward-Looking Statements,” and “Risk Factors” sections of our 2020 Annual Report as well as those discussed in this Quarterly Report on Form 10-Q and in our other filings with the SEC. At the time of this report, the COVID-19 pandemic is continuing to have a negative impact on us and our key markets and is causing ongoing economic disruption worldwide, although the Company has nevertheless begun approaching pre-pandemic levels of activity in certain end markets, particularly oil and gas. Our discussion below is qualified by the unknown impact that the COVID-19 pandemic will continue to have on our business and the economy in general, including the duration of the health risk the COVID-19 pandemic will cause and the resulting economic disruption. Overview The Company is a leading “one source” multinational provider of integrated technology-enabled asset protection solutions helping to maximize the safety and operational uptime for civilization's most critical industrial and civil assets. Backed by an innovative, data-driven asset protection portfolio, proprietary technologies, and decades-long legacy of industry leadership, the Company helps clients with asset-intensive infrastructure in the oil and gas, aerospace and defense, industrials, power generation and transmission (including alternative and renewable energy), other process industries and infrastructure, research and engineering and other industries towards achieving and maintaining operational excellence. By supporting these organizations that help fuel our vehicles and power our society; inspecting components that are trusted for commercial, defense, and space craft; and building real-time monitoring equipment to enable safe travel across bridges, the Company helps the world at large. 27 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) The Company enhances value for its clients by integrating asset protection throughout supply chains and centralizing integrity data through a suite of Industrial IoT-connected digital software and monitoring solutions, including OneSuite™, which serves as an ecosystem platform, pulling together all of the Company’s software and data services capabilities, for the benefit of its customers. The Company's core capabilities also include non-destructive testing (“NDT”) field inspections enhanced by advanced robotics, laboratory quality control and assurance testing, sensing technologies and NDT equipment, asset and mechanical integrity engineering services, and light mechanical maintenance and access services. Our operations consist of three reportable segments: Services, International, and Products and Systems. • Services provides asset protection solutions predominantly in North America, with the largest concentration in the United States, followed by Canada, consisting primarily of NDT, inspection, mechanical and engineering services that are used to evaluate the structural integrity and reliability of critical energy, industrial and public infrastructure and commercial aerospace components. Software, digital and data services are included in this segment. • International offers services, products and systems similar to those of the other segments to select markets within Europe, the Middle East, Africa, Asia and South America, but not to customers in China and South Korea, which are served by the Products and Systems segment. • Products and Systems designs, manufactures, sells, installs and services the Company’s asset protection products and systems, including equipment and instrumentation, predominantly in the United States. Given the role our solutions play in enhancing the safe and efficient operation of infrastructure, we have historically provided a majority of our solutions to our customers on a regular, recurring basis. We perform these services largely at our customers’ facilities, while primarily servicing our aerospace customers at our network of state-of-the-art, in-house laboratories. These solutions typically include NDT and inspection services, and can also include a wide range of mechanical services, including heat tracing, pre-inspection insulation stripping, coating applications, re-insulation, engineering assessments and long-term condition-monitoring. Under this business model, many customers outsource their inspection to us on a “run and maintain” basis. We have established long-term relationships as a critical solutions provider to many of the leading companies with asset-intensive infrastructure in our target markets. These markets include companies in the oil and gas, aerospace and defense, industrials, power generation and transmission (including alternative and renewable energy), other process industries and infrastructure, research and engineering and other industries. We have focused on providing 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. We have made numerous acquisitions in an effort to grow our base of experienced, certified personnel, expand our service lines and technical capabilities, increase our geographical reach, complement our existing offerings, and leverage our fixed costs. 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 service lines, technologies, resources and customers which we believe will enhance our advantages over our competition. We believe long-term growth can be realized in all of our target markets. Our level of business and financial results are impacted by world-wide macro- and micro-economic conditions generally, as well as those within our target markets. Among other things, we expect the timing of our oil and gas customers inspection spend to be impacted by oil price fluctuations. We have continued providing our customers with innovative asset protection software ecosystem through our MISTRAS OneSuite platform. The software platform offers functions of MISTRAS' popular software and services brands as integrated apps on a cloud environment. OneSuite serves as a single access portal for customers' data activities and provides access to 50 plus applications being offered on one centralized platform. We have continued to develop new technologies to provide monitoring of wind blade integrity through our Sensoria™ tool. Sensoria helps provide real-time monitoring and damage detection of wind turbine blades and allows our customers to maximize uptime, performance and safety of wind turbine blades. This tool provides additional growth and expansion of our 28 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) capabilities to serve both new and existing wind turbines and greatly enhances our product offerings within the renewable energy industry. Recent Developments The COVID-19 coronavirus (COVID-19) pandemic has continued to cause disruption and volatility in domestic and international markets and conditions continue to improve during 2021 as compared to 2020. The Company's businesses have been classified as non-healthcare critical infrastructure as defined by the U.S. Centers for Disease Control and Prevention (CDC). Our facilities, and the Company's customers facilities as well, have remained open with staffing modifications and precautionary procedures taken as necessary. Overall, we have taken actions to help ensure the health and safety of our employees and those of our customers and suppliers; maintain business continuity and financial strength and stability; and serve our customers as they provide essential products and services to the world. The COVID-19 pandemic uncertainty, significant volatility in oil prices and decreased traffic in the aerospace industry have adversely affected our workforce and operations, as well as the operations of our customers, suppliers and contractors beginning in 2020. These negative factors continue to cause volatility and uncertainty in the markets in which we operate, although we have nevertheless begun approaching pre-pandemic levels of activity in certain end markets, particularly oil and gas where crude oil prices have exceeded pre-pandemic levels. While we cannot fully assess the impact that the COVID-19 pandemic or the significant volatility in oil prices will continue to have on our operations at this time, there are certain impacts that we have identified resulting in impairment charges in 2020. See Note 8- Goodwill, Note 9- Intangible Assets and Note 13- Leases to the Notes to the Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report for additional information. The Company has eliminated substantially all of the cost reduction initiatives undertaken in 2020, including re-installment of the savings plan employer match and increasing wages back to pre-pandemic amounts. Our cash position and liquidity remains strong. As of September 30, 2021, the cash balance was approximately $22.6 million. In April 2021, the Biden Administration announced aggressive initiatives to battle climate change, which includes a significant reduction in the use of fossil fuels and a transition to electric vehicles and increased use of alternative energy. Any legislation or regulations that may be adopted to implement these measures may negatively impact on our customers in the oil and gas market over the long-term, which presently is our largest market, although this initiative will likely benefit the alternative energy market, such as wind energy, for which we provide products and services. At this time, it is difficult to determine the magnitude and timing of the impact that climate change initiatives and legislation, if any, will have on these markets and the resulting impact on our business and operational results. We are currently unable to predict the overall impact that the COVID-19 pandemic uncertainty, volatility in oil prices and climate change initiatives to reduce the use of fossil fuels may have on our business, results of operations, liquidity or in other ways which we cannot yet determine. We will continue to monitor market conditions and respond accordingly. Refer to Item 1A. Risk Factors in Part I of our 2020 Annual Report. Note About Non-GAAP Measures The Company prepares its consolidated financial statements in accordance with U.S. GAAP. In this MD&A under the heading "Income (loss) from Operations", the non-GAAP financial performance measure "Income (loss) before special items” is used for each of our three operating segments, the Corporate segment and the "Total Company", with tables reconciling the measure to a financial measure under GAAP. This presentation excludes from "Income (loss) from Operations" (a) transaction expenses related to acquisitions, such as professional fees and due diligence costs, (b) the net changes in the fair value of acquisition-related contingent consideration liabilities, (c) impairment charges, (d) reorganization and other costs, which includes items such as severance, labor relations matters and asset and lease termination costs and (e) other special items. These adjustments have been excluded from the GAAP measure because these expenses and credits are not related to our or any individual segment's core business operations. The acquisition related costs and special items can be a net expense or credit in any given period. Our management uses this non-GAAP measure as a measure of operating performance and liquidity 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. We believe investors and other users of our financial 29 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) statements benefit from the presentation of this non-GAAP measure in evaluating our performance. Income (loss) before special items excludes the identified adjustments, which provides additional tools to compare our core business operating performance on a consistent basis and measure underlying trends and results in our business. Income (loss) before special items is not used to determine incentive compensation for executives or employees, nor is it a replacement for the reported GAAP financial performance and/or necessarily comparable to the non-GAAP financial measures of other companies. Results of Operations Condensed consolidated results of operations for the three and nine months ended September 30, 2021 and 2020 were as follows: Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Revenues $ 174,556 $ 147,894 $ 505,968 $ 431,794 Gross profit 52,216 47,384 147,553 129,186 Gross profit as a % of Revenue 29.9 % 32.0 % 29.2 % 29.9 % Income (loss) from operations 9,236 5,742 15,864 (105,869) Income (Loss) from Operations as a % of Revenue 5.3 % 3.9 % 3.1 % (24.5) % Income before provision (benefit) for income taxes 6,910 2,097 7,170 (115,279) Net income (loss) 3,397 1,553 3,983 (99,634) Net income (loss) attributable to Mistras Group, Inc. $ 3,380 $ 1,523 $ 3,955 $ (99,642) Revenue Revenue was $174.6 million for the three months ended September 30, 2021, an increase of $26.7 million, or 18.0%, compared with the three months ended September 30, 2020. Revenue for the nine months ended September 30, 2021 was $506.0 million, an increase of $74.2 million, or 17.2%, compared with the nine months ended September 30, 2020. Revenue by segment for the three and nine months ended September 30, 2021 and 2020 was as follows: Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Revenue Services $ 144,976 $ 119,721 $ 414,251 $ 349,271 International 29,100 26,477 88,699 76,887 Products and Systems 3,308 3,932 9,499 10,746 Corporate and eliminations (2,828) (2,236) (6,481) (5,110) $ 174,556 $ 147,894 $ 505,968 $ 431,794 Three Months In the three months ended September 30, 2021, total revenue increased 18.0% versus the comparable prior period. The increase was due to organic growth in our core business as our end markets recover from the effect of COVID-19. In addition, the Company realized low single-digit favorable revenue impact from foreign exchange rates. Services segment revenue increased 21.1% and International segment revenue increased 9.9%, due predominantly to recovery from the effect of COVID-19 and to single-digit favorable revenue impact from foreign exchange rates. Oil and gas customer revenue comprised approximately 56% and 55% of total revenue for the three months ended September 30, 2021 and 2020, respectively. Aerospace and defense customer revenue comprised approximately 10% and 10% of total revenue for the three months ended September 30, 2021 and 2020, respectively. The Company’s top ten customers comprised approximately 32% of total revenue for the three months ended September 30, 2021, as compared to 29% for the three months ended September 30, 2020, with no customer accounting for 10% or more of total revenue in either three-month period. For the 30 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) three months ended September 30, 2021, revenue in all our primary end market industries increased versus the comparable prior period, except for industrials which decreased slightly. Nine months In the nine months ended September 30, 2021, total revenue increased 17.2% versus the comparable prior period. The increase was due to organic growth in our core business as our end markets recover from the effect of COVID-19. In addition, the Company realized low single-digit favorable revenue impact from foreign exchange rates. Our Services segment revenue increased 18.5% due predominantly to recovery from the effect of COVID-19. International segment revenue increased 15.3% due to mid-single digit organic growth and mid-single digit favorable revenue impact from foreign exchange rates. Oil and gas customer revenue comprised approximately 58% and 56% of total revenue for the nine months ended September 30, 2021 and 2020, respectively. Aerospace and defense customer revenue comprised approximately 10% and 13% of total revenue for the nine months ended September 30, 2021 and 2020, respectively. The Company’s top ten customers comprised approximately 33% of total revenue for the nine months ended September 30, 2021, as compared to 31% for the nine months ended September 30, 2020, with no customer accounting for 10% or more of total revenue in either nine-month period. For the nine months ended September 30, 2021 revenue in all our primary end market industries increased versus the comparable prior period, except for aerospace and defense and industrial. Gross Profit Gross profit increased by $4.8 million, or 10.2%, in the three months ended September 30, 2021 versus the prior year comparable period, on an increase in revenue of 18.0%. Gross profit increased by $18.4 million, or 14.2%, in the nine months ended September 30, 2021 on an increase in revenue of 17.2%. Gross profit by segment for the three and nine months ended September 30, 2021 and 2020 was as follows: Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Gross profit Services $ 41,749 $ 37,603 $ 116,587 $ 103,780 % of segment revenue 28.8 % 31.4 % 28.1 % 29.7 % International 9,038 8,197 26,278 21,612 % of segment revenue 31.1 % 31.0 % 29.6 % 28.1 % Products and Systems 1,422 1,628 4,655 3,834 % of segment revenue 43.0 % 41.4 % 49.0 % 35.7 % Corporate and eliminations 7 (44) 33 (40) $ 52,216 $ 47,384 $ 147,553 $ 129,186 % of total revenue 29.9 % 32.0 % 29.2 % 29.9 % Three Months Gross profit margin was 29.9% and 32.0% for the three-month periods ended September 30, 2021 and 2020, respectively. Gross profit margin decreased primarily due to unfavorable sales mix and higher level of reimbursable travel costs in the Services segment partially offset by favorable sales mix and better utilization in the International and Products and Systems segments. Nine months Gross profit margin was 29.2% and 29.9% for the nine months ended September 30, 2021 and 2020, respectively. Gross profit margin remained flat primarily due to unfavorable sales mix and higher level of reimbursable travel costs in the Services segment offset by favorable sales mix and better utilization in the International and Products and Systems segments. 31 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) Operating Expenses Operating expenses for the three and nine months ended September 30, 2021 and 2020 was as follows: Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Operating Expenses Selling, general and administrative expenses $ 39,221 $ 37,473 $ 118,579 $ 116,638 Impairment charges — — — 106,062 Research and engineering 595 638 1,942 2,170 Depreciation and amortization 2,918 3,182 9,070 10,359 Legal settlement and litigation charges, net — (360) 1,030 (360) Acquisitions-related expense 246 709 1,068 186 Three Months Operating expenses increased $1.3 million, or 3%, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020. Selling, general and administrative expenses increased $1.7 million during the three months ended September 30, 2021 compared to the three months ended September 30, 2020, due to the Company reinstating several of the temporary cost reduction initiatives undertaken during 2020 in response to the COVID-19 pandemic, as further detailed in the Recent Developments section above. This increase was partially offset by foreign currency exchange losses. Acquisition-related expense decreased $(0.5) million for the three months ended September 30, 2021 compared to the three months ended September 30, 2020 due to remeasurement of acquisition related contingent consideration. Nine months Operating expenses decreased $103.4 million, or 44%, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, due predominantly to impairment charges of $106.1 million in 2020 as more fully described in Note 8– Goodwill and Note 9– Intangible Assets included in the Notes to the Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report. Excluding the 2020 impairment charges, operating expenses increased $2.7 million due to the Company reinstating several of the temporary cost reduction initiatives undertaken during 2020 in response to the COVID-19 pandemic, as further detailed in the Recent Developments section above, as well as a $1.2 million increase in net legal settlement and litigation charges primarily related to the Justin Price v. Mistras Group, Inc. matter more fully described in Note- 14 Commitments and Contingencies under the "Litigation and Commercial Claims" section to the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report. These increases were partially offset by foreign currency exchange losses. Depreciation and amortization decreased $1.3 million during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, due to the 2020 impairment charges reducing the net book value on certain of our intangible assets. Acquisition-related expense increased $0.9 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 due to remeasurement of acquisition related contingent consideration. 32 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) Income (loss) from Operations The following table shows a reconciliation of the income (loss) from operations to income (loss) before special items for each of our three segments, Corporate and Eliminations and the Company in total: Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Services: Income (loss) from operations (GAAP) $ 16,085 $ 13,599 $ 38,991 $ (57,058) Impairment charges — — — 86,200 Reorganization and other costs — 58 97 125 Legal settlement and litigation charges, net — (360) 1,650 (360) Acquisition-related expense, net 246 709 1,034 186 Income before special items (non-GAAP) $ 16,331 $ 14,006 $ 41,772 $ 29,093 International: Income (loss) from operations (GAAP) $ 1,169 $ (66) $ 2,158 $ (22,422) Impairment charges — — — 19,862 Reorganization and other costs (2) 21 124 313 Income (loss) before special items (non-GAAP) $ 1,167 $ (45) $ 2,282 $ (2,247) Products and Systems: Loss from operations (GAAP) $ (281) $ (160) $ (653) $ (1,936) Reorganization and other costs — 5 27 5 Loss before special items (non-GAAP) $ (281) $ (155) $ (626) $ (1,931) Corporate and Eliminations: Loss from operations (GAAP) $ (7,737) $ (7,631) $ (24,632) $ (24,453) Loss on debt modification — 278 645 Legal settlement and litigation charges, net — — (620) — Reorganization and other costs — 14 — 137 Acquisition-related expense, net — — 34 — Loss before special items (non-GAAP) $ (7,737) $ (7,617) $ (24,940) $ (23,671) Total Company: Income (loss) from operations (GAAP) $ 9,236 $ 5,742 $ 15,864 $ (105,869) Impairment charges — — — 106,062 Reorganization and other costs (2) 98 248 580 Loss on debt modification — — 278 645 Legal settlement and litigation charges, net — (360) 1,030 (360) Acquisition-related expense, net 246 709 1,068 186 Income before special items (non-GAAP) $ 9,480 $ 6,189 $ 18,488 $ 1,244 See section Note About Non-GAAP Measures in this report for an explanation of the use of non-GAAP measurements. 33 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) Three Months For the three months ended September 30, 2021, the income (loss) from operations (GAAP) increased $3.5 million, compared with the three months ended September 30, 2020, while income before special items (non-GAAP) increased $3.3 million. As a percentage of revenue, income before special items increased by 120 basis points to 5.4% in the three months ended September 30, 2021 from 4.2% in the three months ended September 30, 2020. Nine months For the nine months ended September 30, 2021, income (loss) from operations (GAAP) increased $121.7 million, compared with the nine months ended September 30, 2020, while income (loss) before special items (non-GAAP) increased $17.2 million. As a percentage of revenue, income (loss) before special items increased by 340 basis points to 3.7% in the nine months ended September 30, 2021 from 0.3% in the nine months ended September 30, 2020. During the nine months ended September 30, 2021, the Company experienced overall organic growth. Specifically, the Company has been recovering from the effect of COVID-19 which was more impactful to our financial results in 2020. During the nine months ended September 30, 2020, the COVID-19 initial outbreak and significant drop in oil prices had adversely affected our workforce and operations, as well as the operations of our customers, suppliers and contractors. Refer to Item 1A. Risk Factors in Part I of our 2020 Form 10-K, and the additional risk factors included in Part II, Item 1.A. of this Form 10-Q for further discussion. Interest Expense Interest expense was approximately $2.3 million and $3.6 million for the three months ended September 30, 2021 and 2020, respectively. Interest expense was approximately $8.7 million and $9.4 million for the nine months ended September 30, 2021 and 2020, respectively. The decrease was a result of a change in the effective interest rate, due to a lower leverage ratio and the elimination of the minimum LIBOR floor. An amendment in May 2021 to our Credit Agreement removed the LIBOR floor of 1.0%, which provided that if LIBOR is below 1.0%, the interest rate will be calculated as if LIBOR is 1.0%. Now the actual LIBOR rate is used to calculate interest, even if LIBOR is below 1.0%. This will reduce our interest rate, when LIBOR is below 1.0%. The terms of our Credit Agreement are described in Note 11- Long-Term Debt of the Notes to the Unaudited Condensed Consolidated Financial Statements, under the heading " Senior Credit Facility ". Income Taxes Our effective income tax rate was approximately 50.8% and 25.9% for the three months ended September 30, 2021 and 2020, respectively. Our effective income tax rate was approximately 44.4% and 13.6% for the nine months ended September 30, 2021 and 2020. The Company's effective income tax rate for the three months ended September 30, 2021 was higher than the statutory rate primarily due to a $1.2 million valuation allowance recorded during the period which was related to various state deferred tax assets and earnings in jurisdictions with higher income tax rates than the United States. The effective income tax rate for the three months ended September 30, 2020 approximated the statutory rate, as the favorable impact of the CARES Act was offset by the unfavorable impact of taxes in other jurisdictions and other permanent book to tax differences. The income tax rate for the nine months ended September 30, 2021 was higher than the statutory rate due to a $1.2 million valuation allowance recorded during the year related to various state deferred tax assets offset by the capitalization of certain non-US intercompany balances which resulted in a deductible foreign exchange loss in the US. The effective income tax rate for the nine months ended September 30, 2020 was lower than the statutory rate primarily due to impairments for which we did not realize income tax benefits, partially offset by income tax benefits of the CARES Act. On December 27, 2020, the United States enacted the Consolidated Appropriations Act, 2021, (the "Appropriations Act") an additional stimulus package providing financial relief for individuals and small business. The Appropriations Act contains a variety of tax provisions, including full expensing of business meals in 2021 and 2022, and expansion of the employee retention tax credit. We are currently evaluating the impact of this guidance on our consolidated financial position, results of operations, and cash flows, but does not expect it to have a material impact. 34 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) 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. It is also affected by discrete items that may occur in any given year but are not consistent from year to year. Our effective income tax rate may fluctuate 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. Liquidity and Capital Resources Cash flows are summarized in the table below: Nine months ended September 30, 2021 2020 Net cash provided by (used in): Operating activities $ 22,469 $ 41,791 Investing activities (15,494) (10,558) Financing activities (8,866) (25,077) Effect of exchange rate changes on cash (1,272) 944 Net change in cash and cash equivalents $ (3,163) $ 7,100 Cash Flows from Operating Activities During the nine months ended September 30, 2021, cash provided by operating activities was $22.5 million, representing a year-on-year decrease of $19.3 million, or 46%. The decrease was primarily attributable to increased usage of working capital. Additionally, revenue increased 17.2% versus the prior year comparable period due to organic growth. Specifically, the Company has been recovering from the effect of COVID-19 which was more impactful to our financial results in 2020. As we are increasing our work compared to the comparable prior period, our cash flows are lower in the current period as collections of receivables lag behind revenues. Cash Flows from Investing Activities During the nine months ended September 30, 2021, cash used in investing activities was $15.5 million primarily attributable to capital expenditures of $16.0 million compared to $11.0 million of capital expenditures in the prior period driven by increased operating activities. Cash Flows from Financing Activities Net cash used in financing activities was $8.9 million for the nine months ended September 30, 2021, compared to net cash used in financing activities of $25.1 million for the nine months ended September 30, 2020. During the nine months ended September 30, 2021, net borrowings of debt were approximately $15.5 million lower as compared to 2020 resulting in less debt paydown during the period as cash flows were used to support operating activities. Effect of Exchange Rate Changes on Cash and Cash Equivalents The effect of exchange rate changes on our cash and cash equivalents was a decrease of $1.3 million in the nine months ended September 30, 2021, compared to an increase of $0.9 million for the nine months ended September 30, 2020. Cash Balance and Credit Facility Borrowings As of September 30, 2021, we had cash and cash equivalents totaling $22.6 million and $22.2 million of unused commitments under our Credit Agreement with borrowings of $209.2 million and $4.3 million of letters of credit outstanding. We finance 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. 35 Table of Contents Mistras Group, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations (tabular dollars are in thousands) As of September 30, 2021, we were in compliance with the terms of the Credit Agreement and will continuously monitor our compliance with the covenants contained in the Credit Agreement. The May 2021 Amendment to our Credit Agreement also reduced the borrowing capacity on our revolving loan line of credit $155 million on September 30, 2021 which will be further reduced to $150 million on December 31, 2021. Additionally, quarterly payments on the term loan increased to $3.75 million through March 31, 2022, and to $5.0 million for each quarterly payment thereafter, with a final balloon payment at maturity. The terms of our Credit Agreement (as modified) are described in Note 11- Long-Term Debt of the Notes to the Unaudited Condensed Consolidated Financial Statements, under the heading " Senior Credit Facility ". Contractual Obligations There have been no significant changes in our contractual obligations and outstanding indebtedness as disclosed in the 2020 Annual Report. Off-balance Sheet Arrangements During the nine months ended September 30, 2021, 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. 36 Table of Contents Critical Accounting Policies and Estimates There have been no significant changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in the 2020 Annual Report. ITEM 3. Quantitative and Qualitative Disclosures about Market Risk There have been no significant changes to our quantitative and qualitative disclosures about market risk as discussed in Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk,” included in the 2020 Annual Report.