# Mistras Group, Inc. (MG) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Mistras Group, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1436126/000143612624000025/mg-20231231.htm
Accession: 0001436126-24-000025
Filing date: 2024-03-11
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/MG/
All MD&A years: /company/MG/mda/
Previous year: /company/MG/mda/fy2022/ (FY 2022)
Next year: /company/MG/mda/fy2024/ (FY 2024)

ITEM 7.                                                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis (this “MD&A”) provides a discussion of our results of operations and financial position for the year ended December 31, 2023. This section generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 are included in Part II–Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 filed with the SEC on March 15, 2023, which discussion is incorporated herein by reference. This MD&A should be read together with our audited consolidated financial statements and related notes included in Item 8 in this Annual Report. Unless otherwise specified or the context otherwise requires, “Mistras,” "MISTRAS," the "Company,” “we,” “us” and “our” refer to Mistras Group, Inc. and its consolidated subsidiaries. This MD&A includes the following sections:

•Forward-Looking Statements

•COVID-19 and Other Updates

•Overview

•Note about Non-GAAP Measures

•Consolidated Results of Operations

•Liquidity and Capital Resources

•Critical Accounting Estimates

•Recent Accounting Pronouncements

Forward-Looking Statements

This Annual Report on Form 10-K, including this MD&A, contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the 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. See “Forward-Looking Statements” at the beginning of Item 1 of this Annual Report.

COVID-19 and Other Updates

While our business and operations were negatively impacted the past several years by the COVID-19 pandemic, at the time of this Annual Report, the effects of the COVID-19 pandemic have subsided and our operations have normalized to pre-pandemic levels.

We are currently unable to predict with certainty the effects that inflationary pressures and the Russian-Ukrainian war may have on our business, results of operations or liquidity or in other ways which we cannot yet determine. To date, our European operations have experienced increased costs associated with higher energy costs, among others, due in part to the on-going war between Russia & Ukraine. We will continue to monitor market conditions and respond accordingly.

Overview

We are 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, strong commitment to Environmental, Social, and Governance ("ESG") initiatives, and a decades-long legacy of industry leadership, MISTRAS leads customers in the oil and gas, petrochemical, aerospace and defense, renewable and nonrenewable power, civil infrastructure, and manufacturing industries towards achieving operational and environmental excellence. By supporting these customers that help fuel our vehicles and power our society; inspecting components that are trusted for commercial, defense, and space craft; building real-time monitoring equipment to enable safe travel across bridges; and helping to propel sustainability, MISTRAS helps the world at large.

The Company enhances value for its customers by integrating asset protection throughout supply chains and centralizing integrity data through a suite of Industrial IoT-connected digital software and monitoring solutions. The Company’s core

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capabilities also include non-destructive testing ("NDT") field and in-line 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: North America (which we previously referred to as our Services segment), International, and Products and Systems.

•North America provides asset protection solutions 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. A majority of data analytical solutions revenues are generated by 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 the past 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 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 expenditures 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' 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.

2023 Developments

The Russian-Ukrainian war and the conflict in the Middle East between Israel and Hamas continue to create disruptions 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 in connection with the Russian-Ukrainian war.

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. At the time of this Annual Report, the effects of the COVID-19 pandemic have subsided, and our operations are continuing to normalize to pre-pandemic levels.

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Our cash position and liquidity remain strong. As of December 31, 2023, our cash and cash equivalents balance was approximately $17.6 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. During the third quarter of 2023, a triggering event was identified within the Company's reporting units within the International segment due to decreased gross margin in the current period as a result of inflationary pressures and rising energy costs. This resulted in goodwill impairment charges of $13.8 million within the International reporting units during the third quarter of 2023. The Company will continue to monitor market conditions and respond accordingly. Refer to Item 1A. Risk Factors in Part I of our 2023 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) 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.

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Consolidated Results of Operations

Year ended December 31, 2023 vs. Year ended December 31, 2022

The following table summarizes our Consolidated Statements of Income (Loss) for the years ended December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","For the year ended December 31,"],["","2023","","2022"],["","($ in thousands)"],["Revenue","$","705,473","","","$","687,373"],["Gross profit","203,807","","","198,173"],["Gross profit as a % of Revenue","28.9","%","","28.8","%"],["Income (loss) from operations","(1,904)","","","19,799"],["Income from operations as a % of Revenue","(0.3)","%","","2.9","%"],["Income (loss) before provision for income taxes","(18,665)","","","9,294"],["Net income (loss)","(17,445)","","","6,574"],["Net income (loss) attributable to Mistras Group, Inc.","$","(17,453)","","","$","6,499"]]
[[/GREPCENT_TABLE]]

Revenues

Revenues by segment for the years ended December 31, 2023 and 2022 were as follows:

[[GREPCENT_TABLE]]
[["","For the year ended December 31,"],["","2023","","2022"],["","($ in thousands)"],["Revenue"],["North America","$","579,330","","","$","573,336"],["International","124,414","","","112,425"],["Products and Systems","12,986","","","12,727"],["Corporate and eliminations","(11,257)","","","(11,115)"],["","$","705,473","","","$","687,373"]]
[[/GREPCENT_TABLE]]

Revenue was $705.5 million for the year ended December 31, 2023, an increase of $18.1 million, or 2.6%, compared with the year ended December 31, 2022. The increase was driven by the North America segment, which experienced a revenue increase of $6.0 million, or 1.0%, driven by single-digit organic growth in certain end markets. The International segment revenues increased by $12.0 million, or 10.7%, due predominantly to low single-digit favorable impact of foreign exchange rates and by mid single-digit organic growth. The Products and Systems segment increased by $0.3 million, or 2.0%, driven by higher sales volume.

Oil and gas customer revenue comprised approximately 59% and 56% of total revenue for the years ended December 31, 2023 and 2022, respectively. Aerospace and defense customer revenue comprised approximately 11% and 12% of total revenue for the years ended December 31, 2023 and 2022, respectively. Our top ten customers comprised approximately 35% of total revenue for the years ended December 31, 2023 and 2022, with no customer accounting for 10% or more of total revenue in either period.

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[[GREPCENT_TABLE]]
[["","","","For the year ended December 31,"],["","","","","","2023","","2022"],["","","","","","($ in thousands)"],["Oil and Gas Revenue by sub-category"],["Upstream","","","","","$","157,828","","","$","146,056"],["Midstream","","","","","101,278","","","97,005"],["Downstream","","","","","156,889","","","144,691"],["Total","","","","","$","415,995","","","$","387,752"]]
[[/GREPCENT_TABLE]]

Oil and gas upstream customer revenue increased approximately $11.8 million, or 8%, for the year ended December 31, 2023 compared to the year ended December 31, 2022, due to continued market share gains and expanded exploration operations, as compared to the prior year period.

Midstream customer revenues increased approximately $4.3 million, or 4%, for the year ended December 31, 2023 compared to the year ended December 31, 2022, due to increased pipe inspection services.

Downstream customer revenue increased $12.2 million, or 8%, for the year ended December 31, 2023 compared to the year ended December 31, 2022, due to increased sales volume at customer refineries and increased customer turnarounds.

The following table presents revenue by type, explained directly below the table.

[[GREPCENT_TABLE]]
[["","","","For the year ended December 31,"],["","","","","","2023","","2022"],["","","","","","($ in thousands)"],["Revenue by type"],["Field Services","","","","","$","470,433","","","$","455,051"],["Shop Laboratories","","","","","58,188","","","48,809"],["Data Analytical Solutions","","","","","72,458","","","62,410"],["Other","","","","","104,394","","","121,103"],["Total","","","","","$","705,473","","","$","687,373"]]
[[/GREPCENT_TABLE]]

In presenting the allocation of revenues by type in the table above, management makes certain assumptions in its allocation of revenues from laboratories that provide more than one type of service. The allocation methodology and assumptions made are consistent for the years presented.

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 $15.4 million, or 3.4%, for the twelve months ended December 31, 2023 as compared to the twelve months ended December 31, 2022. The increase 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 $9.4 million, or 19.2%, for the twelve months ended December 31, 2023 as compared to the twelve months ended December 31, 2022. The increase was 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 Analytical 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 Analytical Solutions revenue increased $10.0 million, or 16.1%, for the twelve months ended December 31, 2023 as compared to the twelve months ended December 31, 2022. The increase was due primarily to increased sales volume within PCMS, Onstream and other Data Analytical Solutions offerings within our North America segment.

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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 $16.7 million, or 13.8%, for the twelve months ended December 31, 2023 as compared to the twelve months ended December 31, 2022. Other revenues in 2023 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 as compared to the prior year period.

Gross Profit (Loss)

Gross profit (loss) by segment for the years ended December 31, 2023 and 2022 were as follows:

[[GREPCENT_TABLE]]
[["","For the year ended December 31,"],["","2023","","2022"],["","($ in thousands)"],["Gross profit (loss)"],["North America","$","163,960","","","$","159,049"],["% of segment revenue","28.3","%","","27.7","%"],["International","33,610","","","33,591"],["% of segment revenue","27.0","%","","29.9","%"],["Products and Systems","6,457","","","5,490"],["% of segment revenue","49.7","%","","43.1","%"],["Corporate and eliminations","(220)","","","43"],["","$","203,807","","","$","198,173"],["% of total revenue","28.9","%","","28.8","%"]]
[[/GREPCENT_TABLE]]

Gross profit increased $5.6 million, or 2.8%, for the year ended December 31, 2023 compared to the year ended December 31, 2022, with a sales increase of $18.1 million, or 2.6%. Gross profit margin was 28.9% and 28.8% for the years ended December 31, 2023 and 2022, respectively, due to favorable sales mix. North America segment gross profit margins had a year-on-year increase of 60 basis points to 28.3% for the year ended December 31, 2023, due primarily to favorable sales mix. International segment gross margins had a year-on-year decrease of 290 basis points to 27.0% for the year ended December 31, 2023, due primarily to increased inflationary pressures. Products and Systems segment gross margins increased by 660 basis points for the year ended December 31, 2023 to 49.7%, driven by favorable sales mix.

Operating Expenses

Operating expenses for the years ended December 31, 2023 and 2022 was as follows:

[[GREPCENT_TABLE]]
[["","For the year ended December 31,"],["","2023","","2022"],["","($ in thousands)"],["Operating Expenses"],["Selling, general and administrative expenses","$","166,749","","","$","166,400"],["Goodwill Impairment charges","13,799","","","\u2014"],["Bad debt provision for troubled customers, net of recoveries","\u2014","","","42"],["Reorganization and other costs","12,269","","","195"],["Research and engineering","1,723","","","1,994"],["Depreciation and amortization","10,104","","","10,661"],["Acquisition-related expense, net","9","","","76"],["Legal settlement and litigation charges (benefit), net","1,058","","","(994)"],["","$","205,711","","","$","178,374"],["% of total revenue","29.2","%","","26.0","%"]]
[[/GREPCENT_TABLE]]

Operating expenses increased $27.3 million, or 15.3%, for the year ended December 31, 2023 compared to the year ended December 31, 2022 due primarily to impairment charges and reorganization charges recorded in the current period that were not

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in the prior period. Selling, general and administrative expenses increased $0.3 million, or 0.2% for the year ended December 31, 2023 compared to the year ended December 31, 2022 primarily due to unfavorable foreign currency exchange.

Income (Loss) from Operations

The following table shows a reconciliation of segment income (loss) from operations to income (loss) before special items (unaudited) for the years ended December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","For the year ended December 31,"],["","2023","","2022"],["","($ in thousands)"],["North America:"],["Income from operations (GAAP)","$","55,170","","","$","49,616"],["Bad debt provision for troubled customers, net of recoveries","\u2014","","","42"],["Reorganization and other costs","960","","","99"],["Legal settlement and insurance (recoveries) charges, net","1,058","","","(841)"],["Acquisition-related expense, net","\u2014","","","45"],["Income before special items (non-GAAP)","$","57,188","","","$","48,961"],["International:"],["Income (loss) from operations (GAAP)","$","(12,229)","","","$","3,566"],["Goodwill Impairment charges","13,799","","","\u2014"],["Reorganization and other costs","351","","","(43)"],["Income before special items (non-GAAP)","$","1,921","","","$","3,523"],["Products and Systems:"],["Income (loss) from operations (GAAP)","$","267","","","$","(992)"],["Reorganization and other costs","382","","","\u2014"],["Income (loss) before special items (non-GAAP)","$","649","","","$","(992)"],["Corporate and Eliminations:"],["Loss from operations (GAAP)","$","(45,112)","","","$","(32,391)"],["Legal settlement and insurance (recoveries) charges, net","\u2014","","","(153)"],["Loss on debt modification","\u2014","","","693"],["Reorganization and other costs","10,576","","","139"],["Acquisition-related expense, net","9","","","31"],["Loss before special items (non-GAAP)","$","(34,527)","","","$","(31,681)"],["Total Company:"],["Income (loss) from operations (GAAP)","$","(1,904)","","","$","19,799"],["Goodwill Impairment charges","13,799","","","\u2014"],["Bad debt provision for troubled customers, net of recoveries","\u2014","","","42"],["Legal settlement and insurance (recoveries) charges, net","1,058","","","(994)"],["Loss on debt modification","\u2014","","","693"],["Reorganization and other costs","12,269","","","195"],["Acquisition-related expense, net","9","","","76"],["Income before special items (non-GAAP)","$","25,231","","","$","19,811"]]
[[/GREPCENT_TABLE]]

See "Note about Non-GAAP Measures" in this Annual Report for an explanation of our use of non-GAAP measures.

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Total Company income from operations (GAAP) decreased by $21.7 million, or 109.6% compared to the year ended December 31, 2022. Total company income before special items (non-GAAP) increased by $5.4 million or 27.4% compared with the year ended December 31, 2022. Operating expenses, excluding special items (non-GAAP), as a percentage of revenue, was 25.3% for the year ended December 31, 2023 compared to 25.9% for the year ended December 31, 2022. The primary driver for the increase in total company income before special items was increased sales in 2023 compared to 2022. Income before special items as a percentage of revenue increased by 70 basis points to 3.6% for the year ended December 31, 2023 from 2.9% for the year ended December 31, 2022. Our discussion below is qualified by the unknown impact that the Russia - Ukraine war will continue to have on our business and the economy in general, including the resulting economic disruption. Refer to Item 1A. Risk Factors in Part I of this Annual Report for further discussion.

Interest Expense

Interest expense was $16.8 million and $10.5 million for the years ended December 31, 2023 and December 31, 2022, respectively. The increase was due to increased interest rates in the current period.

Income Taxes

Our effective income tax rate was approximately 6.5% for the year ended December 31, 2023, compared to 29.3% for the year ended December 31, 2022. The decrease in effective tax rate was primarily driven by a $1.7 million US R&D tax credit benefit in 2022, partially offset by the recording of a $1.1 million valuation allowance recorded in 2022 which was related to certain Canadian entities.

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.

Further in response to the COVID-19 pandemic, the American Rescue Plan Act was signed into law on March 11, 2021. This act, among other things, provides economic relief provisions to individuals and funding to certain businesses and programs. The Company does not expect this act to have a material impact.

On August 19, 2022, the United States enacted the Inflation Reduction Act, (the "Inflation Act"), a package intended to reduce inflation. The Inflation Act contains a variety of tax provisions, including a 15% corporate minimum tax, a tax on stock repurchases, and various tax credit opportunities. We evaluated the impact of this guidance on our consolidated financial position, results of operations, and cash flows, and do not expect it to have a material impact.

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

Overview

We have funded our operations from cash provided from operations, bank borrowings and lease financings. Management believes that our existing cash and cash equivalents, anticipated cash flows from operating activities, and available borrowings under our New Credit Agreement will be more than sufficient to meet anticipated cash needs over the next 12 months and for the foreseeable future. We generated operating cash flows of $26.7 million and $26.4 million for the years ended December 31, 2023 and 2022, respectively. Capital expenditures for the purchase of property, plant and equipment and of intangible assets was $23.6 million and $13.4 million for the years ended December 31, 2023 and 2022, respectively.

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Cash Flows Table

The following table summarizes our cash flows for the years ended December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","For the year ended December 31,"],["($ in thousands)","2023","","2022"],["Net cash provided by (used in):"],["Operating activities","$","26,748","","","$","26,406"],["Investing activities","(22,133)","","","(12,238)"],["Financing activities","(7,706)","","","(16,323)"],["Effect of exchange rate changes on cash and cash equivalents","249","","","(1,467)"],["Net change in cash and cash equivalents","$","(2,842)","","","$","(3,622)"]]
[[/GREPCENT_TABLE]]

Cash Flows from Operating Activities

Cash provided by operating activities for the year ended December 31, 2023 was $26.7 million, an increase of $0.3 million from the prior year period. The increase was mainly attributable to movements in working capital driven primarily by an increase in net accounts receivable collections, an increase in accrued expenses and other liabilities, and an increase in accounts payable in the current year as compared to the prior year.

Cash Flows from Investing Activities

Net cash used in investing activities for the year ended December 31, 2023 was $22.1 million, an increase of $9.9 million used in investing activities from the prior year period. The Company used $10.2 million more cash for purchases of property, plant and equipment and intangible assets in 2023 compared to 2022.

Cash Flows from Financing Activities

Net cash used in financing activities for the year ended December 31, 2023 was $7.7 million, compared to $16.3 million for the year ended December 31, 2022. During the year ended December 31, 2022, we entered into the New Credit Agreement which replaced our prior credit agreement, as detailed more in Note 11-Long-Term Debt. As part of the New Credit Agreement, the prior revolving credit facility and term loan were repaid in full. Net repayment of debt and revolver was approximately $9.6 million higher compared to 2022. In addition, for the year ended December 31, 2023, we incurred approximately $0.6 million more taxes paid related to net share settlement of share-based awards.

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 $0.2 million for the year ended December 31, 2023, compared to a decrease of $1.5 million for the year ended December 31, 2022. The primary driver of the change was foreign currency fluctuations during the year related to the Euro and the US Dollar.

Cash Balance and Credit Facility Borrowings

The terms of our New Credit Agreement are described in Note 11-Long-Term Debt of the Notes to Consolidated Financial Statements in this Annual Report, under the heading "Senior Credit Facility", the provisions of which are incorporated herein.

As of December 31, 2023, we had cash and cash equivalents totaling $17.6 million and available borrowing capacity of up to $116.0 million under our New Credit Agreement. Borrowings of $186.4 million and letters of credit of $2.9 million were outstanding under the New Credit Agreement at December 31, 2023. We finance our operations primarily through our existing cash balances, cash collected from operations, bank borrowings and lease financing. We believe these sources are sufficient to fund our operations for the foreseeable future. As of December 31, 2023, we were in compliance with the terms of the New Credit Agreement and will continuously monitor our compliance with the covenants contained in the New Credit Agreement. See Note 11-Long-Term Debt of the notes to the consolidated financial statements for additional information.

Liquidity and Capital Resources Outlook

Future Sources of Cash

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We expect our future sources of cash to include cash flow generated from our operating activities and borrowings under our New Credit Agreement. Our revolving credit facility is available for cash advances required for working capital and for letters of credit to support our operations. Acquisitions, if any, are funded through available cash and borrowings under the New Credit Agreement.

Future Uses of Cash

We expect our future uses of cash will primarily be for repayment of debt, 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 North America segment. In addition, we annually fund a certain amount of replacement equipment, including a portion of our fleet vehicles. We historically spend approximately 2% to 3% 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 each of the years ended December 31, 2023 and 2022 were approximately 3.4% and 2.0% of revenues, respectively. We continue to take steps to reduce spending and preserve cash.

Our New Credit Agreement does not limit the Company’s ability to acquire other businesses or companies except for certain provisions as described within Note 11-Long-Term Debt. Our future capital spending may increase as we pursue growth opportunities and acquire additional equipment to meet or pursue business 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, finance leases, long-term debt repayments and various other obligations as they arise as noted within Note 11-Long-Term Debt and Note 17- Leases.

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 acceptable terms.

Off-Balance Sheet Arrangements

During the years ended December 31, 2023 and 2022, 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 in accordance with U.S. GAAP 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. We have established policies and control procedures intended to ensure that estimation methods, including any judgments made as part of such methods, are well-controlled, independently reviewed and applied consistently from period to period. The accounting policies that we believe require more significant estimates and assumptions include revenue recognition, acquisitions, long-lived assets and goodwill. We base our estimates and assumptions on historical experience, known or expected trends and various other assumptions that we believe to be reasonable. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates, which may cause our future results to be significantly affected.

We believe that the following critical accounting policies comprise the more significant estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

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The majority of our revenues are derived from providing services on a time and material basis and are short-term in nature. We account for revenue in accordance with Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of our contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and is, therefore, not distinct. We provide highly integrated and bundled inspection services to our customers. Some of our contracts have multiple performance obligations, most commonly due to the contract providing both goods and services. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is a relative selling price based on price lists.

Contract modifications are not routine in the performance of our contracts. Generally, when contracts are modified, the modification is to account for changes in scope to the goods and services that are provided. In most instances, contract modifications are for goods or services that are distinct, and, therefore, are accounted for as a separate contract.

Our performance obligations are satisfied over time as work progresses or at a point in time. The majority of our revenue recognized over time as work progresses is related to our service deliverables, which includes providing testing, inspection and mechanical services to our customers. Revenue is recognized over time based on time and material incurred to date which best portrays the transfer of control to the customer. We also utilize an available practical expedient that provides for revenue to be recognized in an amount that corresponds directly with the value to the customer of the entity’s performance completed to date. Fixed fee arrangements are determined based on expected labor, material and overhead to be consumed on fulfillment of such services. Revenue is recognized on a cost-to-cost method tracked on an input basis.

The majority of our revenue recognized at a point in time is related to product sales when the customer obtains control of the asset, which is generally upon shipment to the customer. Contract costs include labor, material and overhead.

We expect any significant remaining performance obligations to be satisfied within one year.

Contract Estimates

The majority of our revenues are short-term in nature. We have many Master Service Agreements ("MSAs") that specify an overall framework and contract terms, where we and our customers agree upon services or products to be provided. The actual contracting to provide services or furnish products are triggered by a work order, purchase order, or some similar document issued pursuant to an MSA which sets forth the scope of services and/or identifies the products to be provided. From time to time, we may enter into long-term contracts, which can range from several months to several years. Revenue on such long-term contracts is recognized as work is performed based on total costs incurred to date in relation to the total estimated costs for the performance of the contract at completion. This includes contract estimates of costs to be incurred for the performance of the contract. Cost estimation is based upon the professional knowledge and experience of our project managers, engineers and financial professionals. Factors that are considered in estimating the work to be completed include the availability of materials, the effect of any delays in our project performance and the recoverability of any claims. Whenever revisions of estimates, contract costs and/or 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.

Long-Lived Assets

We perform a review of long-lived assets (or asset groups) 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, we compare the estimated undiscounted future net cash flows to be generated by the asset (or asset group) to its carrying amount. If the undiscounted future net cash flows are less than the carrying amount of the asset (or asset group), we record an impairment loss equal to the excess of the asset’s carrying amount over its fair value. We estimate fair value based on valuation techniques such as a discounted cash flow analysis or a comparison to fair values of similar assets. As of December 31, 2023 and December 31, 2022, we had $81.0 million and $77.6 million in net property, plant and equipment, respectively, and $44.0 million and $49.0 million in intangible assets, net, respectively.

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Goodwill

Goodwill represents the excess purchase price of acquired businesses over the fair values attributed to underlying net tangible assets and identifiable intangible assets. We test goodwill for impairment at a “reporting unit” level (which for us is represented by (i) our North America segment, (ii) our Products and Systems segment, (iii) the European component of our International segment and (iv) the Brazilian component of our International segment). Our annual impairment test is conducted on the first day of our fourth quarter, which is October 1. Goodwill is also tested for impairment whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

In testing for goodwill impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing a quantitative impairment test is not necessary. If we conclude otherwise, we are required to perform a quantitative impairment test.

An impairment will be recorded in the amount that the fair value is less than the carrying value. We consider the income and market approaches to estimating the fair value of our reporting units, which requires significant judgment in evaluation of economic and industry trends, estimated future cash flows, discount rates and other factors. Sustained declines in our stock price and related market capitalization could impact key assumptions in the overall estimated fair values of our reporting units and could result in non-cash impairment charges that could be material to our consolidated balance sheet or results of operations.

During the third quarter of 2023, a triggering event was identified within the Company's reporting units within the International segment due to decreased gross margin in the current period as a result of inflationary pressures and rising energy costs impacting the International reporting units' operations. As a result, the Company performed an interim quantitative goodwill impairment test.

In performing the interim quantitative goodwill impairment test and consistent with prior practice, the Company determined the fair value of each of the reporting units using a combination of the income approach and the market approach by assessing each of these valuation methodologies based upon availability and relevance of comparable company data and determining the appropriate weighting.

Under the income approach, the fair value for each of the reporting units was determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. The Company used internal forecasts, updated for recent events, to estimate future cash flows estimated using a terminal value calculation, which incorporates historical and forecasted trends, including an estimate of long-term future growth rates, based on the Company’s most recent views of the long-term outlook for each reporting unit. The internal forecasts include assumptions about future profitability, including the expected demand for the Company’s goods and services. Due to the inherent uncertainties involved in making estimates and assumptions, actual results may differ from those assumed in the forecasts. The Company derived the discount rates using a capital asset pricing model and analyzing published rates for industries relevant to the reporting units to estimate the cost of equity financing. The Company used discount rates that are commensurate with the risks and uncertainties inherent in the respective businesses and in the internally developed forecasts, updated for recent events. Increased interest rates in the current period increased the discount rate associated with the reporting units which contributed in an unfavorable decrease in the reporting units value.

The market approach valuation was derived from metrics of publicly traded companies or historically completed transactions of comparable businesses. The selection of comparable businesses was based on the markets in which the reporting units operate, considering risk profiles, size, geography, and diversity of products and services.

Based upon the results of the interim quantitative goodwill impairment test, the Company recorded an impairment charge of $13.8 million within the International reporting units. The impairment was calculated based on the difference between the estimated fair value and the carrying value of the reporting units and is included in Goodwill impairment charges on the condensed consolidated statements of income (loss) for the three and nine months ended September 30, 2023. Any significant adverse changes in future periods to the Company’s internal forecasts or the external market conditions, if any, could reasonably be expected to negatively affect its key assumptions and may result in future goodwill impairment charges which could be material.

We elected to perform a quantitative assessment of goodwill on October 1, 2023. Our quantitative assessment considered relevant events and circumstances occurring since our interim quantitative goodwill impairment test performed as of September

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30, 2023. Specifically, we considered changes in macroeconomic conditions, industry and market conditions, our internal forecasts of future revenue and expenses, our stock price, any significant events affecting the Company and actual changes in the carrying values of our net assets. After considering all positive and negative evidence for the assessment as of September 30, 2023, we concluded that it was not more likely than not that our carrying values exceeded fair values and as such, no additional impairment was indicated.

Additionally, as of December 31, 2023, there are no indicators of an impairment. See Note 8-Goodwill of the notes to the consolidated financial statements for additional information.

Acquisitions

We allocate the purchase price of acquired businesses to their identifiable tangible assets and liabilities as well as identifiable intangible assets, such as customer relationships, technology, non-compete agreements and trade names. Allocations are based on estimated fair values of assets and liabilities, which reflects assumptions that would be made by typical market participants if they were to buy or sell each asset on an individual asset basis. Certain estimates and judgments are required in the application of the fair value techniques, including estimates of the respective acquisitions' future performance and related cash flows, selection of a discount rate and economic lives, and use of Level 3 measurements as defined in ASC 820 Fair Value Measurements and Disclosure. Deferred taxes are recorded for any differences between the assigned values and tax bases of assets and liabilities. We typically engage third-party valuation experts to assist in determining the fair values for both identifiable tangible and intangible assets. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, could materially impact our results of operations. See Note 7-Acquisitions to the consolidated financial statements for additional information.

Recent Accounting Pronouncements

For information about recent accounting pronouncements, see Note 1-Summary of Significant Accounting Policies and Practices of the notes to the consolidated financial statements.