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, 2023 and 2022. 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, 2022, (“2022 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 2022 Annual Report as well as those discussed in this Quarterly Report on Form 10-Q and in our other filings with the SEC. In addition, there are various developments discussed below which could create risks and uncertainty about our business, results of operations or liquidity. 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 systems to help avoid catastrophic incidents, the Company helps the world at large. The Company enhances value for its clients by integrating asset protection throughout supply chains and centralizing integrity data through a suite of Industrial Internet of Things ("IoT")-connected digital software and monitoring solutions, including 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) 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, laboratory materials services, shop laboratory 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: North America (which we previously referred to as our Services segment), International, and Products and Systems. • North America 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 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 an 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 90 plus applications being offered on one centralized platform. Recent Developments The Russian-Ukrainian war is creating disruption in the oil and gas market and the supply chain in general, which is resulting in some disruption to our business operations primarily in Europe due to increased energy costs. 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) Earlier in 2022, the Company eliminated substantially all of the COVID related 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, 2023, the cash balance was approximately $12.8 million and our Credit Agreement provides us with significant liquidity. In April 2021, the Biden Administration announced aggressive initiatives to battle climate change, which includes potential plans for 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 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. The Company is currently unable to predict with certainty the overall impact that the factors discussed above and the effect of inflationary pressures may have on its business, results of operations or liquidity or in other ways which the Company cannot yet determine. The Company’s European operations are currently experiencing higher energy costs, among other increased costs, due in part to the Russian-Ukrainian war and an impairment was recorded during the quarter ended September 30, 2023 related to the Company's European reporting units. The Company will continue to monitor market conditions and respond accordingly. 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) from operations 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 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. Any measure that eliminates the foregoing items has material limitations as a performance or liquidity measure and should not be considered alternatives to net income (loss) or any other measures derived in accordance with GAAP. Because Income (loss) from operations before special items may not be calculated in the same manner by all companies, this measure may not be comparable to other similarly titled measures used by other companies. 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) Results of Operations Condensed consolidated results of operations for the three and nine months ended September 30, 2023 and 2022 were as follows: Three months ended September 30, Nine months ended September 30, 2023 2022 2023 2022 Revenues $ 179,354 $ 178,462 $ 523,399 $ 519,155 Gross profit 54,382 53,784 150,181 147,233 Gross profit as a % of Revenue 30.3 % 30.1 % 28.7 % 28.4 % Income from operations (4,682) 9,114 (2,618) 13,991 Income from Operations as a % of Revenue (2.6) % 5.1 % (0.5) % 2.7 % Income before provision (benefit) for income taxes (8,849) 6,379 (14,711) 7,201 Net Income (loss) (10,338) 4,394 (14,940) 3,707 Net Income (loss) attributable to Mistras Group, Inc. $ (10,298) $ 4,373 $ (14,947) $ 3,653 Revenue Revenue was $179.4 million for the three months ended September 30, 2023, an increase of $0.9 million, or 0.5%, compared with the three months ended September 30, 2022. Revenue for the nine months ended September 30, 2023 was $523.4 million, an increase of $4.2 million, or 0.8%, compared with the nine months ended September 30, 2022. Revenue by segment for the three and nine months ended September 30, 2023 and 2022 was as follows: Three months ended September 30, Nine months ended September 30, 2023 2022 2023 2022 Revenue North America $ 148,814 $ 152,778 $ 431,295 $ 435,251 International 30,980 25,693 90,664 83,441 Products and Systems 2,829 3,078 9,897 8,666 Corporate and eliminations (3,269) (3,087) (8,457) (8,203) $ 179,354 $ 178,462 $ 523,399 $ 519,155 Three Months In the three months ended September 30, 2023, total revenue increased 0.5% versus the prior year comparable period due predominantly to increased sales volume as compared to the prior period. North America segment revenue decreased 2.6% due to decreases in sales volume in our aerospace and defense and power generation & transmission end markets, amongst others. International segment revenue increased 20.6%, due predominantly to low double-digit organic growth and mid single-digit favorable foreign exchange rates impact. Products and Systems segment revenue decreased 8.1%, due to decreased sales volume as compared to the prior period. Oil and gas customer revenue comprised approximately 58% and 54% of total revenue for the three months ended September 30, 2023 and 2022, respectively. Aerospace and defense customer revenue comprised approximately 11% and 12% of total revenue for the three months ended September 30, 2023 and 2022, respectively. The Company’s top ten customers comprised approximately 36% of total revenue for the three months ended September 30, 2023, as compared to 32% for the three months ended September 30, 2022, with no customer accounting for 10% or more of total revenue in either three-month period. Nine months 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) In the nine months ended September 30, 2023, total revenue increased 0.8% versus the comparable prior period. The increase was due to organic growth in our core business, partially offset by an unfavorable revenue impact from foreign exchange rates. Our North America segment revenue decreased 0.9% due primarily to decreases in sales volume in our aerospace and defense and other process industries end markets which was partially offset by increased sales volume in our oil and gas end market. International segment revenue increased 8.7% due to mid single-digit organic growth and offset by low single-digit unfavorable revenue impact from foreign exchange rates. Products and Systems segment revenue increased by 14.2% due to increased sales volume within the power generation & transmission end market, as compared to the prior period. Oil and gas customer revenue comprised approximately 59% and 56% of total revenue for the nine months ended September 30, 2023 and 2022, respectively. Aerospace and defense customer revenue comprised approximately 11% and 12% of total revenue for the nine months ended September 30, 2023 and 2022, respectively. The Company’s top ten customers comprised approximately 35% of total revenue for the nine months ended September 30, 2023, as compared to 33% for the nine months ended September 30, 2022, with no customer accounting for 10% or more of total revenue in either nine-month period. The Company has retrospectively reclassified certain Oil and Gas sub-category revenues for each quarterly period in 2022 in order to conform the classification with the current year presentation. Total Oil and Gas sub-category revenues were unchanged in total in each quarterly period and for the full year ended December 31, 2022. The table below presents the reclassified balances for each quarterly period in the prior year. 2022 Quarterly Revenues Three months ended March 31, Three months ended June 30, Three months ended September 30, Three months ended December 31, Oil and Gas Revenue by sub-category Upstream $ 36,397 $ 38,051 $ 35,173 $ 36,435 Midstream 20,427 27,153 25,885 23,540 Downstream 37,399 36,061 35,973 35,258 Total $ 94,223 $ 101,265 $ 97,031 $ 95,233 Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Oil and Gas Revenue by sub-category Upstream $ 38,041 $ 35,173 $ 116,941 $ 109,621 Midstream 26,215 25,885 74,739 73,465 Downstream 38,996 35,973 116,361 109,433 Total $ 103,252 $ 97,031 $ 308,041 $ 292,519 Oil and gas upstream customer revenue increased approximately $7.3 million, or 7%, for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and $2.9 million, or 8%, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022 due to increased exploration operations and market share gains compared to the prior period. Midstream customer revenues increased approximately $1.3 million, or 2%, for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and $0.3 million, or 1%, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022 due to comparable pipe inspection services performed in both years. Downstream customer revenue increased $6.9 million, or 6%, for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and $3.0 million, or 8%, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022 due to increased sales volume at customer refineries and increased customer turnarounds. 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, Nine Months Ended September 30, 2023 2022 2023 2022 Revenue by type Field Services $ 122,717 $ 118,526 $ 348,501 $ 345,385 Shop Laboratories 14,840 12,528 42,216 35,533 Data Analytical Solutions 17,997 17,151 52,916 45,786 Other 23,800 30,257 79,766 92,451 Total $ 179,354 $ 178,462 $ 523,399 $ 519,155 Field Services revenues are comprised of revenue derived primarily by technicians performing asset inspections and maintenance services for our customers at locations other than Mistras properties. Field Services revenue increased by $3.1 million for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and increased $4.2 million, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. The increase in both periods was due to increased sales volume in our oil and gas end market for our North America and International segments. Shop Laboratory revenues are comprised of quality assurance inspections of components and materials at our Mistras in house laboratory facilities. Shop revenues increased by $6.7 million for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and increased $2.3 million for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. Shop revenues increased in both periods as compared to the prior year quarter due to increased sales volume related to our commercial aerospace and industrials end markets. Data Analytical Solutions revenues are comprised of revenue derived from data software sales & subscriptions, implementation services and analytics that offer insights and recommendations to improve asset integrity. Data Solutions revenue is derived from work performed by Mistras employees in our facilities, or at customer locations, using our proprietary portfolio of software applications. Data Solutions revenue increased by $7.1 million for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and increased $0.8 million, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022 due primarily to increased sales volume within PCMS, Onstream and other Data Solutions offerings within our North America segment. Other revenues are comprised of locations that perform both asset inspection services and testing of components and materials at in house Mistras laboratories. Other revenues decreased by $12.7 million for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, and decreased $6.5 million, for the three months ended September 30, 2023 as compared to the three months ended September 30, 2022. Other revenues decreased primarily due to decreased sales within the aerospace and defense sector and due to declines in our other end markets within the North America and International segments. Gross Profit Gross profit increased by $0.6 million, or 1.1%, in the three months ended September 30, 2023 versus the prior year comparable period, on an increase in revenue of 0.5%. Gross profit increased by $2.9 million, or 2.0%, in the nine months ended September 30, 2023 on an increase in revenue of 0.8%. Gross profit by segment for the three and nine months ended September 30, 2023 and 2022 was as follows: 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) 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, Nine months ended September 30, 2023 2022 2023 2022 Gross profit North America $ 44,773 $ 44,869 $ 121,088 $ 118,348 % of segment revenue 30.1 % 29.4 % 28.1 % 27.2 % International 8,481 7,694 24,247 25,324 % of segment revenue 27.4 % 29.9 % 26.7 % 30.3 % Products and Systems 1,096 1,189 4,773 3,514 % of segment revenue 38.7 % 38.6 % 48.2 % 40.5 % Corporate and eliminations 32 32 73 47 $ 54,382 $ 53,784 $ 150,181 $ 147,233 % of total revenue 30.3 % 30.1 % 28.7 % 28.4 % Three Months Gross profit margin was 30.3% and 30.1% for the three-month periods ended September 30, 2023 and 2022, respectively. North America segment realized an increase of 0.7% in gross profit margin to 30.1% during the three months ended September 30, 2023. This was primarily due to reduced overhead costs associated with lower revenues, as compared to the prior year period. International segment realized a decrease of (2.5)% in gross profit margin to 27.4% during the three months ended September 30, 2023 due primarily to increased inflationary costs as compared to the prior year period. Products and Systems segment realized an increase of 0.1% in gross profit margin to 38.7% during the three months ended September 30, 2023 due to favorable sales mix. Nine months Gross profit margin was 28.7% and 28.4% for the nine months ended September 30, 2023 and 2022, respectively. Gross profit margin increased due to favorable sales mix. 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, 2023 and 2022 was as follows: Three months ended September 30, Nine months ended September 30, 2023 2022 2023 2022 Operating Expenses Selling, general and administrative expenses $ 39,537 $ 40,767 $ 123,844 $ 123,545 Bad debt provision for troubled customers, net of recoveries — — — 289 Loss on debt modification — 693 — 693 Reorganization and other costs 2,702 130 6,017 65 Goodwill Impairment Charges 13,799 — 13,799 — Research and engineering 438 450 1,428 1,523 Depreciation and amortization 2,588 2,629 7,556 8,058 Legal settlement and insurance recoveries, net — — 150 (994) Acquisition-related expense, net — 1 5 63 $ 59,064 $ 44,670 $ 152,799 $ 133,242 % of total revenue 32.9 % 25.0 % 29.2 % 25.7 % Three months Total operating expenses increased $14.4 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due predominantly to impairment charges of $13.8 million incurred in the third quarter of 2023 as more fully described in Note 9- Goodwill of the Notes to the Unaudited Condensed Consolidated Financial Statements. Selling, general and administrative expenses decreased $1.2 million during the three months ended September 30, 2023 compared to the three months ended September 30, 2022, due mainly to favorable foreign currency exchange. Depreciation and amortization was flat during the three months ended September 30, 2023 compared to the three months ended September 30, 2022. During the three months ended September 30, 2023, $2.7 million of reorganization and other related costs were incurred, which were due to the Company's on-going efficiency and productivity initiatives. Nine months Operating expenses increased $19.6 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 due predominantly to impairment charges of $13.8 million incurred in the third quarter of 2023 as more fully described in Note 9- Goodwill of the Notes to the Unaudited Condensed Consolidated Financial Statements. Selling, general, and administrative expenses increased $0.3 million during the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 primarily due to favorable foreign currency exchange. Reorganization and other costs for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 increased $6.0 million due to professional fees and restructuring charges associated with changes in the Company's organizational structure. Depreciation and amortization decreased $0.5 million during the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Income (loss) from Operations 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 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, 2023 2022 2023 2022 North America: Income from operations (GAAP) $ 18,004 $ 16,700 $ 39,719 $ 35,315 Bad debt provision for troubled customers, net of recoveries — — — 289 Reorganization and other costs 35 12 574 40 Legal settlement and insurance recoveries, net — — 150 (841) Acquisition-related expense, net — — — 45 Income from operations before special items (non-GAAP) $ 18,039 $ 16,712 $ 40,443 $ 34,848 International: Income (loss) from operations (GAAP) $ (12,970) $ 814 $ (13,031) $ 2,678 Goodwill Impairment charges 13,799 — 13,799 — Reorganization and other costs, net 33 (15) 228 (114) Income from operations before special items (non-GAAP) $ 862 $ 799 $ 996 $ 2,564 Products and Systems: Loss from operations (GAAP) $ (557) $ (333) $ (78) $ (1,334) Reorganization and other costs 189 — 189 — Income (loss) from operations before special items (non-GAAP) $ (368) $ (333) $ 111 $ (1,334) Corporate and Eliminations: Loss from operations (GAAP) $ (9,159) $ (8,067) $ (29,228) $ (22,668) Loss on debt modification — 693 — 693 Reorganization and other costs 2,445 133 5,026 139 Acquisition-related expense, net — 1 5 19 Legal settlement and insurance recoveries, net — — — (153) Loss from operations before special items (non-GAAP) $ (6,714) $ (7,240) $ (24,197) $ (21,970) Total Company: Income (loss) from operations (GAAP) $ (4,682) $ 9,114 $ (2,618) $ 13,991 Bad debt provision for troubled customers, net of recoveries — — — 289 Goodwill Impairment charges 13,799 — 13,799 — Reorganization and other costs 2,702 130 6,017 65 Loss on debt modification — 693 — 693 Legal settlement and insurance recoveries, net — — 150 (994) Acquisition-related expense, net — 1 5 64 Income from operations before special items (non-GAAP) $ 11,819 $ 9,938 $ 17,353 $ 14,108 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) See section Note About Non-GAAP Measures in this Quarterly Report on Form 10-Q for an explanation of the use of non-GAAP measurements. Three Months For the three months ended September 30, 2023, income from operations (GAAP) decreased $13.8 million compared with the three months ended September 30, 2022, while income before special items (non-GAAP) increased $1.9 million for the three months ended September 30, 2023 compared with the three months ended September 30, 2022. As a percentage of revenue, income before special items increased by 100 basis points to 6.6% in the three months ended September 30, 2023 from 5.6% in the three months ended September 30, 2022. Nine months For the nine months ended September 30, 2023, income from operations (GAAP) decreased $16.6 million, compared with the nine months ended September 30, 2022, while income from operations before special items (non-GAAP) increased $3.2 million for the nine months ended September 30, 2023 compared with the nine months ended September 30, 2022. As a percentage of revenue, income from operations before special items increased by 60 basis points to 3.3% in the nine months ended September 30, 2023 from 2.7% in the nine months ended September 30, 2022. During the nine months ended September 30, 2023, the Company experienced overall organic growth offset by increased reorganization costs. Interest Expense Interest expense was approximately $4.2 million and $2.7 million for the three months ended September 30, 2023 and 2022, respectively. Interest expense was approximately $12.1 million and $6.8 million for the nine months ended September 30, 2023 and 2022, respectively. The increase in the three months ended September 30, 2023 was due to an increase in interest rates compared to the prior year period. The increase in interest expense for the nine months ended September 30, 2023 compared to the prior year period was due to an increase in the interest rates, partially offset by a decrease in outstanding borrowings. Income Taxes Our effective income tax rate was approximately (16.8)% and 31.1% for the three months ended September 30, 2023 and 2022, respectively. Our effective income tax rate was approximately (1.6)% and 48.5% for the nine months ended September 30, 2023 and 2022, respectively. The effective income tax rate for the three months ended September 30, 2023 was lower than the statutory rate primarily due to the impact of permanent tax adjustments related to executive compensation and goodwill impairment. The effective income tax rate for the three months ended September 30, 2022 was higher than the statutory rate primarily due to various permanent tax adjustments and a $0.1 million valuation allowance recorded on a foreign jurisdiction. The effective income tax rate for the nine months ended September 30, 2023 was lower than the statutory rate primarily due to the impact of permanent tax adjustments related to executive compensation and goodwill impairment. The effective income tax rate for the nine months ended September 30, 2022 was higher than the statutory rate due primarily to various permanent tax adjustments and a $0.9 million valuation allowance recorded during the period which was related to a foreign jurisdiction. 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. 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) Liquidity and Capital Resources Cash flows are summarized in the table below: Nine months ended September 30, 2023 2022 Net cash provided by (used in): Operating activities $ 10,684 $ 10,531 Investing activities (15,170) (8,877) Financing activities (1,839) (4,753) Effect of exchange rate changes on cash (1,411) (2,927) Net change in cash and cash equivalents $ (7,736) $ (6,026) Cash Flows from Operating Activities During the nine months ended September 30, 2023, cash provided by operating activities was $10.7 million, representing a year-on-year increase of $0.2 million, or 1%. The increase was primarily related to decreased days sales outstanding in the current year period and offset by an increase in prepaid expenses and other assets. Cash Flows from Investing Activities During the nine months ended September 30, 2023, cash used in investing activities was $15.2 million, compared to $8.9 million net cash used in investing activities for the nine months ended September 30, 2022. The change was primarily attributable to capital expenditures related to property, plant and equipment during the current period as compared to the prior period. Cash Flows from Financing Activities Net cash used in financing activities was $1.8 million for the nine months ended September 30, 2023, compared to net cash used in financing activities of $4.8 million for the nine months ended September 30, 2022. This was primarily due to during the nine months ended September 30, 2023, net repayments of debt were approximately $2.2 million higher as compared to 2022. 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 $1.4 million in the nine months ended September 30, 2023, compared to a decrease of $2.9 million for the nine months ended September 30, 2022. The primary driver of the change was foreign currency fluctuations related to the Euro and the US Dollar. Cash Balance and Credit Facility Borrowings As of September 30, 2023, we had cash and cash equivalents totaling $12.8 million and $114.2 million of unused commitments under our Credit Agreement with borrowings of $189.7 million and $2.9 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. As of September 30, 2023, 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 terms of our Credit Agreement are described in Note 12- Long-Term Debt of the Notes to the Unaudited Condensed Consolidated Financial Statements, under the heading " Senior Credit Facility ". Table of Contents Contractual Obligations There have been no significant increases in our contractual obligations and outstanding indebtedness as disclosed in the 2022 Annual Report. Off-balance Sheet Arrangements During the nine months ended September 30, 2023, 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 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 2022 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 2022 Annual Report.