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Edited Transcript of MG earnings conference call or presentation 6-Aug-19 1:00pm GMT

Q2 2019 Mistras Group Inc Earnings Call

PRINCETON Aug 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Mistras Group Inc earnings conference call or presentation Tuesday, August 6, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dennis M. Bertolotti

Mistras Group, Inc. - President, CEO & Director

* Edward J. Prajzner

Mistras Group, Inc. - Senior VP, CFO & Treasurer

* Jonathan H. Wolk

Mistras Group, Inc. - Senior EVP & COO

* Nestor S. Makarigakis

Mistras Group, Inc. - Group Director of Marketing Communications

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Conference Call Participants

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* Chip Moore

Canaccord Genuity Corp., Research Division - Senior Associate

* David Emerson Ridley-Lane

BofA Merrill Lynch, Research Division - VP

* Edward James Marshall

Sidoti & Company, LLC - Senior Equity Research Analyst

* Gerard J. Sweeney

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Tahira Afzal

KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. My name is Daniel, and I'll be your event manager today. We'll be accepting questions after management's prepared remarks.

I'll now pass the call over to MISTRAS Group Director of Marketing Communications. One moment while we connect.

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Nestor S. Makarigakis, Mistras Group, Inc. - Group Director of Marketing Communications [2]

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Welcome to the MISTRAS Group conference call for its second quarter of 2019. My name is Nestor Makarigakis. Participating on the call for MISTRAS will be Dennis Bertolotti, the company's President and Chief Executive Officer; Ed Prajzner, Senior Vice President, Chief Financial Officer and Treasurer; and Jon Wolk, Senior Executive Vice President and Chief Operating Officer.

I want to remind everyone that remarks made during this conference call will include forward-looking statements. The company's actual results could differ materially from those projected. Some of those factors that can cause actual results to differ are discussed in the company's most recent annual report on Form 10-K and other reports filed with the SEC.

The discussion in this conference call will also include certain financial measures that were not prepared in accordance with U.S. GAAP. Reconciliation of these non-U. S. GAAP financial measures to the most directly comparable U.S. GAAP financial measure can be found in the tables contained in yesterday's press release and in the company's related current report on Form 8-K. These reports are available at the company's website in the Investor Relations section and on the SEC's website.

I will now turn the conference over to Dennis Bertolotti. Dennis?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [3]

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Thank you, Nestor, and good morning, everyone. During today's call, we will give you an update on MISTRAS' business performance, financial results for the second quarter and first half of 2019 as well as provide our outlook for the remainder of the year.

Second quarter results were solid across the board from the top to the bottom line. Revenues, margins, net income, earning per share, cash flow and adjusted EBITDA all achieved our expectations with significant improvement both year-over-year and sequentially.

It is worth mentioning that our second quarter of 2018 was a very strong quarter for us, making our achievement this quarter even more noteworthy given the challenging comparable period. We maintained a strong momentum into the third quarter and we continue to feel good about where we are and our outlook for the year. Consequently, we are reiterating our existing fiscal 2019 guidance.

Our underlining business remains robust with revenues up almost 5% from a year ago, through a combination of both organic growth and expected contributions from our most recent acquisition.

On a constant currency basis, revenues were up almost 6.5%. Results were, once again, led by strong performance in the oil and gas market, which is primarily reflected in our Services segment where organic revenue growth was nearly 4% on a constant currency basis. Although we did get off to a slow start in the first quarter, the second quarter returned to a more normalized level of activity such that the overall market over the first half of the year puts us on track for the solid growth we anticipated for the full year 2019. Add in our recent wins in market share gains and we feel very confident in our outlook for this sector.

With nearly 50% of our oil and gas business being evergreen contracts and the addition of Onstream and the less cyclical midstream segment, we continue to structure our operations to better balance market risk.

While oil and gas was the largest contributor, it was complemented by growth in other verticals. For instance, Products and Systems recently won a $4 million bridge monitoring contract. We've also had several other new wins across multiple customers, spanning several of our end-market verticals. And we continue to bid on new opportunities on a global basis.

Our recent acquisitions continued to perform well. West Penn had a good 2018 and this has continued into 2019.

Growth in the aerospace market is one of our corporate objectives and the outlook for the industry continues to be strong in 2019 and beyond.

Onstream, which was acquired in December 2018, is also having a good year. They are doing particularly well in the U.S., where we have been able to leverage existing MISTRAS midstream relationships. We are excited about the recent commercialization of their 20-inch tool and the progress being achieved with their larger 24-inch tool, which is expected to be ready later this year. Onstream will be a strong pillar of our overall growth strategy, focused on pipeline integrity. The greatest initiatives that we have undertaken from product divestitures to pricing discipline is leading to margins that have been consistently expanding over last several quarters. In the second quarter, we extended this trend with 120 basis points expansion of gross margins to 29.9% from 28.7%.

One of our key corporate initiatives is to achieve appropriate value for our services. And this year, our goal is to maintain gross margins at this level throughout the remainder of 2019.

The company has historically always generated attractive cash flow, and our cash flows from operations are on track so far in 2019, improving over the first half of last year to $21.1 million.

Free cash flow of $9.1 million is also up on a year-over-year basis. I will go through our detailed financial results in a few minutes, which evidence our strong execution thus far in 2019.

For the longer-term view, we have been steadily, albeit somewhat quietly, transforming MISTRAS to become the supplier of choice to position ourselves for additional wins in the future by maintaining our focus on the following: a, delivering value. We capture relevant data and quantify the value we deliver; b, meeting our promises, regardless of any hardships this might entail; c, working on the same side of the table as our customers, innovating to drive productivity for them. A great example is MISTRAS Digital, where we include customer feedback in developing a solution; and lastly, d, developing industry-leading productivity tools like our Advanced Radiographic Testing crawler with its innovative technology covered by IP protection.

Each of these areas are key differentiators enabling us to change the conversation with our customers, create demand and gain market share. Our core business is solid and growing organically. And this speaks volumes to our strong product offering and the demand for our services as fostered by our excellent industry relationships.

We are also investing and preparing for the future by developing technology-oriented growth channels. Onstream's Streamview data analytics facility, our PCMS software and more recent, field tablets are just some of the technology we are using to build a platform that anticipates the impending growth in the demand for more predictive analytics.

MISTRAS Digital is an important part of our long-term vision, and we are focused on building it both organically as well as through strategic acquisitions to complement our existing technology. We are on track with our expected progress for MISTRAS Digital. For the rest of 2019, we expect to keep standing up new data sites within our customer base as we ensure our customers are getting the information and value that they expect from the program.

In early 2020, we should be creating new full-time sites using our digital solution, and what will be an early version of the full benefits that can be achieved by utilizing real-time smart data tools.

I will now turn over the call to Ed for a detailed review of the financials for the quarter.

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Edward J. Prajzner, Mistras Group, Inc. - Senior VP, CFO & Treasurer [4]

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Thank you, Dennis. To reiterate Dennis' comments, second quarter results have us on pace to achieve our financial performance objectives for the full year, as reflected in our original outlook for 2019.

Looking at results for the second quarter. Consolidated revenues were up nearly 5% to $200.6 million but up closer to 6.5% on a constant currency basis. Organic growth was 2% with acquisitions contributing 5%, offset by an approximate 2% decline due to unfavorable currency translation.

Consolidated gross profit for the quarter was approximately $60 million, a 9% increase over the year ago quarter. Consolidated gross margins improved significantly to 29.9% for the second quarter compared with 28.7% in the prior year, an increase of 120 basis points.

Margin expansion reflects a more favorable service and product mix, which in turn reflects a more disciplined growth strategy, selective pruning of underperforming operations and contracts and an acquisition strategy focused on higher-margin businesses.

Operating income improved 50% for the second quarter to $15.4 million compared with $10.3 million in the comparable period last year. As Dennis mentioned, our second quarter last year was a strong period to compare against, making our performance this quarter all the more remarkable.

Net income improved in the second quarter and was up 24% and diluted earnings per share were up 30%, both on a GAAP basis. These increases substantially outpaced top line growth and are indicative of the leverage inherent in our model.

Second quarter results included a net bad debt recovery of $2.7 million on a pretax basis. This was comprised of a current period $1.7 million cash collection related to a customer originally reserved in 2017, and a $1 million partial reversal of a customer reserve recorded earlier in 2019.

Adjusted EBITDA was up 14% to $24 million for the second quarter of 2019 compared with $21.1 million in the same period last year. As a percentage of revenue, adjusted EBITDA expanded nearly a full point to 12% for the second quarter compared to same period last year, which demonstrates that our focus on both organic and acquisitive growth being margin accretive, is achievable.

As Dennis mentioned earlier, the company is a strong cash generator. Second quarter cash flows from operating activities were $12.9 million and free cash flow was $9.1 million. On a per share basis, free cash flow was $0.32 per share for the second quarter. We anticipate continued strengthening of our cash flow generation over the remainder of the year, attributable to our renewed focus on working capital management.

Looking more closely at our segments, Services revenue increased by 9% in the second quarter. Organic revenue grew 4% and Onstream incrementally added 6% to revenue growth. Unfavorable currency translation reduced Services revenue growth by approximately 1%.

The Services segment generated a gross profit margin of 29.3% for the quarter, a significant improvement of 210 basis points compared to the year ago period of 27.2%. Margin expansion is a key corporate strategy, and we were pleased to see our margins continue to expand in our largest segment driven by pruning lower-margin operations and growing higher-margin operations, including acquisitions such as West Penn and Onstream. There is strong operating leverage in this segment with significant contribution margins, wherein we could see a significant portion of incremental revenue drop straight to operating income. This is one reason we are confident we can sustain margins at the current level over the course of this year.

International revenues in the second quarter were down nearly 10% from a year ago, with about 6% of that attributable to unfavorable currency rates and 4% due primarily to the runoff of a low-margin German staff leasing business. For the second quarter, International reported a 29.8% gross margin compared to a 30.9% margin a year ago, largely due to lower labor utilization.

Products and Systems revenues were down $1.1 million in the second quarter, with this decline being largely attributable to the product line that was divested in 2018. Gross profit margin increased slightly for this segment at 43% compared with about 41% in the prior year. As Dennis mentioned, Products and Systems did win a $4 million project during the second quarter, which may partially benefit the fourth quarter of 2019.

SG&A was very well controlled in the second quarter of 2019 at approximately 21% of revenue, essentially flat with the first quarter and up only modestly over the same quarter prior year. Keep in mind that we achieved these results despite the inclusion of overhead assumed with Onstream and the ongoing investment we are making in sales and marketing as well as with developing and launching MISTRAS Digital. We are confident that the first half of 2019 spending level is a reasonable run rate for the full year.

We continue to review and rationalize our company-wide overheads for savings to make sure we maintain an efficient footprint to support and invest in our growing business. Operating income was up nearly 50% for the second quarter to $15.4 million compared to $10.3 million in the prior year.

Non-GAAP operating opening income was $13.5 million for the second quarter of 2019 compared to $10.5 million in the prior year. Net income was $7.4 million or $0.26 per diluted share for the second quarter of 2019 compared with $6 million or $0.20 per diluted share, respectively, in the same period last year.

Non-GAAP net income was $6.2 million or $0.22 per diluted share for the second quarter of 2019 compared with $6.1 million or $0.20 per diluted share for the prior period. This was a 10% increase in non-GAAP EPS.

Adjusted EBITDA was $24 million for the second quarter compared with $21.1 million in the same quarter last year, an increase of $2.9 million year-over-year. As a percentage of revenue, second quarter adjusted EBITDA was 12%, nearly 1 full point improvement over the same period in prior year. The company generated $12.9 million of cash flows from operating activities and $9.1 million of free cash flow for the second quarter of 2019 due to strong earnings, a positive reduction in working capital and better utilization of cash on hand.

The company's net debt, defined as total debt less cash and cash equivalents, was $257.9 million at June 30, 2019, compared to $265.1 million at December 31, 2018. The company paid down $17 million of debt during the second quarter of 2019 alone and has reduced total debt by over $20 million so far this year.

As defined in our credit agreement, our leverage ratio was approximately 3.75x as of June 30, 2019. It is our goal to reduce this ratio to around 3x leverage by the end of this fiscal year and to get below 3x leverage early in fiscal 2020.

Given our cash flow, annual interest expense and net debt, we believe our balance sheet is strong and will support the funding of both our organic growth objectives as well as any selective tuck-in acquisitions.

Our effective tax rate was 37% for the second quarter of 2019. We project our effective tax rate to be approximately 35% for the full fiscal year.

And with that, I will now turn the call back over to Dennis.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [5]

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Thank you, Ed. Heading into this year, we had anticipated a challenging first quarter, but a return to a more normalized level of activity beginning with the second quarter and extending through the balance of the year. And that outlook is proving out to be the case.

Recent organic wins, which together with some remaining opportunities, only strengthen our conviction about the full year outlook. Macro-level economic drivers also remain positive. So we are confident in maintaining our forward momentum and are reiterating our guidance for the full year of 2019, that being: total revenues are expected to be between $765 million to $785 million; adjusted EBITDA is expected to be between $90 million and $93 million; capital expenditures are expected to be up to $25 million; and free cash flow is expected to be between $42 million to $45 million.

The company is very pleased with the significant level of organic revenue wins that we have booked in 2019. We are successfully winning this new business due to a number of factors, including our solid reputation and brand, our consistently strong execution including our ability to quickly staff up with qualified, certified personnel to meet customer requirements and our ongoing investment in Digital and go-forward operating systems. We are focused on differentiating ourselves in the market, particularly through our expanding service lines, which solve for customer needs of reduced overall labor to accomplish a given project and evolving digital solutions, as I mentioned earlier.

We also remain firmly committed to maintaining our position at the forefront of leading development of advanced inspection tools utilizing proprietary technology. We add value and this enables us to price at market and generate solid operating profit with predictable, attractive cash flow. In the process, we serve our customers with an exceptional return on their investment by delivering top-quality results with superior economic value.

I'm confident that we are on the right path executing on our strategy and creating value over the short, mid and long term for MISTRAS shareholders.

We will now take your questions. Operator, please open up the phone lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tahira Afzal with KeyBanc.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [2]

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Dennis and your team, congrats on a great quarter. I guess first question, if I look at your top line guidance, essentially at the top end, it's assuming a flat revenue profile versus what you thought this quarter roughly. So I would love to get a sense of what could take you to the bottom end of your revenue guidance? And if -- that's with you being conservative?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [3]

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You're asking what's our bottom end of our revenue guidance, is what you're saying?

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [4]

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Well, the bottom end would assume that revenues fall off in the second half. So I was just trying to get an idea of what scenario would lead to that?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [5]

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Yes. The way I see it, we're not -- we don't believe we're going to hit the bottom end. But, I mean, we're still thinking we're coming closer to our midpoint. Right now, we had -- really the only thing we've got is just trying to make up for Q1. We believe Q3 and Q4 will be on track with what we thought. We had a late spring, there's possibility to have a late fall. But we believe by the time the year's done, we should be comfortably close to our midpoint.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [6]

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And then, Dennis, midpoint, would you, let's say, sort of a 3% to 4% revenue growth cadence and -- I guess is that what you see going out? I know it's still a little early to talk about next year. But assuming sort of a low to mid-single revenue growth line, some more margin expansion, it seems like you should be in a position to comfortably cross $100 million in EBITDA?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [7]

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Yes. No, I got it. We don't want to keep talking about the headwinds of the past, but we still do have for a full year the $11 million from the one big customer, and then we're losing the fall-off from the German portion of the manpower, which is full year is going to be somewhere around another EUR 15 million, so about $17 million or $18 million or more. So you're talking close to $30 million that we've got that we're still trying to put behind us. When you throw that into where we're at for a full year, that's another almost 3.5%. So you're talking mid-to-high single digits -- you're talking 6% or 7%. We believe we can outperform the market. We believe the market's in that 3% range. Maybe this year, we're closer to market. But next year, we believe we can beat that.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [8]

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Got it. Very helpful, Dennis. And last question and I think my site visit with yourself and your team -- and thank you for arranging for that -- really brought into sharper focus the importance of your digital initiative. Seems that the initial traction has been encouraging. How much do you expect tools to help as you look out a year or so, Dennis?

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [9]

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Tahira, it's Jon. Thanks for the question. So we're very excited about MISTRAS Digital. We have our first data site just converted to a paying customer in Q3. And they're talking to other refineries within their fleet. And it looks like we'll have a second order fairly soon within that same customer. We have a number of sites lined up in our queue. And right now, it's just a question of trying to logistically get through as many as we can in the second half of this year. So as we look out to next year, I think there's several million dollars in revenues that will be incremental to our top line. And we expect the margin profile to be pretty accretive.

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Operator [10]

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And our next question comes from Andrew Obin with Bank of America.

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David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [11]

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This is David Ridley-Lane on for Andrew Obin. Wondering how the bidding activity has been outside of the oil and gas sector in 2Q.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [12]

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Bidding activity meaning what the rest of the year will look like, you're saying?

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David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [13]

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New deal wins and just if you're seeing any hesitation from your clients?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [14]

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If I were to break it out by aerospace, I would say that's staying strong. We haven't seen any deflections but those are more on annualized programs. In the power sector for us, a lot of the power sector is based on wins. And while those things don't go as far out, we're still seeing the bids coming in. So it's a strong spring, and we'd expect the fall to be strong. But it's a little bit early for those kind of bids to be coming in but we haven't seen anything that would deflect a strong -- that portion of the power. And we have been getting some wins inside of traditional fossil and nuclear here in the U.S. as well. And I think that's just more of market share gains so much than differences in where the market is going for us. But it's a reflection of customers coming back to looking for stability in their provider.

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David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [15]

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Understood. And then on the labor -- continued labor market tightness here in the U.S. Have you seen any change in wage inflation for field staff? Any downtick in your retention rates for the staff? And any pressure -- is wage pressure a risk on your gross margin goals?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [16]

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Yes. That's a good question. I mean what we've been seeing is pretty consistent. There are areas in the West, in the Gulf and areas where the industrial is starting to grow quite a bit on their activity. Where they knew this was happening for a while, so those customers have been talking to us about cost of living increases that don't increase the margins, per se, but increases the spend so that it passes right through to make sure that they have enough skilled employees. Because it is not just any ticket, it's all the trades that are becoming an issue. And they've seen it long enough, particularly in the Gulf and West, where they planned and been talking to us for 6 months to 1 year in some cases about the large turnarounds they would have in 2019 and how to make sure they were staffed up. So the answer is we don't believe it will hurt gross margins. We believe it will bump a little bit of revenue but the bottom line margins will stay the same as well as the gross.

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Operator [17]

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And our next question comes from Chip Moore with Canaccord.

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Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [18]

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Jeff, maybe you could expand on Onstream a little bit, how things are going in the U.S. on some of those midstream relationships and then launch of a new tool, how reception's been.

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [19]

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Yes. Chip, it's Jon. We feel extremely positively about Onstream's uptick and introductions into the MISTRAS customer base in the United States. The great thing is that we have master service agreements with many of these midstream customers. And it's actually shortening the sales cycle for Onstream because typically there's a lengthy process just to get those master service agreements. Onstream has had nice traction. We have some of our U.S. customers on a limited basis so far. In this market, you have to earn your spurs. And as they like to say, land and expand. If you get that -- those first couple of runs, get great results and then keep going with those customers. Onstream enjoys many benefits in terms of service times, turnaround time, report turnaround time, et cetera. In terms of the new tools, great reception so far as the 20-inch tool and very shortly a 24-inch tool, as Dennis alluded to in his comments, we'll be launching as well. So far so good. We're very, very excited about it.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [20]

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And, Chip, it's Dennis, the other thing we really haven't gotten into yet is getting Onstream integrated with more of our other services, PCMS and some of the other things we can do. We feel there's still a lot there that can be done. We're working on it and then we think we'll see those benefits as the year progresses and into 2020 as well.

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Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [21]

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That's great. Good color. Maybe another one on -- more on the modeling side, on International, just remind us the exit of the German leasing business. Is that pretty much done now? And how do we think about that business in the back half -- that segment in the back half of the year?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [22]

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Yes. It's actually -- the anticipated start was for us in April and what surprised us a little bit is it started a little bit sooner. Employers are trying to get used to these new regulations so they're hiring and moving and moving bodies around more than we expected. It'll progress through the year, we anticipate maybe 90% of it being done by the end of 2019. There will be a little bit that flows through 2020, but it probably won't be enough that we really even have to mention it or talk about it. It's just a matter of how fast do these customers, these large employers, take on these folks because they've always been integral to their business and they knew they couldn't just let them go and start over and they're just trying to figure out when to bring them on and all that. And so it's -- that EUR 15 million, we believe, is a pretty number for the full year. So you're talking about somewhere in the next 2 quarters, somewhere around a $3.5 million or $4 million a year loss of revenue from that German segment. But we believe by the end of the year, it'll be behind us.

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Chip Moore, Canaccord Genuity Corp., Research Division - Senior Associate [23]

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Perfect. That's helpful. Appreciate it. Maybe a last one for me, just on the guidance in the back half, similarly sequential movement, anything to consider on seasonality or anything you're seeing in Q3 on how we should think about that trajectory?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [24]

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Yes. Like any year, there's seasonality, and 2 and 4 are always -- are typically our better quarters. One and 3 are the weaker of the 2. When we changed to calendar versus fiscal, it reduced that seasonality a little bit, but it's still there. So, I mean, there's always a potential for a late spring and a late fall and if that's the case, then 4 could pop out stronger than 3. But we expect them to both be pretty good this year, we're hoping that all of our customers stick to their schedules. If they move it a little bit and push off, Q4 could be a little bit stronger.

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Operator [25]

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And our next question comes from Gerry Sweeney with Roth Capital.

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Gerard J. Sweeney, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [26]

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Just a quick question and obviously getting up to speed a little bit here but what proportion of your oil and gas revenue is recurring? And then the follow-ups to that would be, any changes on that in the future? And then how much visibility do you have into potential changes, sort of customers changing some of their workflow?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [27]

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All right. Three questions. Let's see, oil and gas. I would say of our oil and gas revenue, we're probably in the 40% to 50% that's reoccurring, so that helps us to not be as much of a seasonality in 2 and 4. But you're always going to have growth in the various market sectors. Fortunately for us this year, a lot of our contracts were good contracts and they're in gas and oil. So while we try to diversify into the power contracts that we got in some of the aerospace, gas and oil is always bigger. So we're probably going to be still holding in that mid or high 50% range for the next couple of years as a percent of our total. But the percentage of the reoccurring, even like some of the contracts we got this year, were reoccurring type contracts. So we're trying to make that more and more part of what our profile is. Now I'm sorry, I didn't a get a chance to write it down, what was the third part of your question? I know it (inaudible).

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Gerard J. Sweeney, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [28]

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Oh. Sorry. I didn't mean to -- I was just making sure you stand on your toes towards the end of the call. But how much visibility, I mean, do you have into these changes? Obviously, there are contracts but are they staggered multiyear or one? So it sounds like recurring should become a higher percentage of revenue for the next several years? Is that what I'm hearing?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [29]

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Yes. You're right. I mean what we've gotten visibility is these RFIs and RFPs and all these things and they can go anywhere from a few months to 6 months to 12 months to complete the cycle. We don't have an idea of how many of those exactly we'll win or lose, but we can't -- what we can tell you is we're starting to see a lot more activity in those types of contracts. I think a lot of customers are looking for -- a couple of years ago, they were chasing after the lowest price regardless of consequence. And I think that's changed now that the oil market has changed for them and they've become more stable, they're looking for a more stable provider. So there's a lot of changes in all the contracts. So what we can say is, we're seeing a lot more bidding activity and a lot more things going on. What we can't say, though Gerry, is how many exactly we'll land. But we feel good about all the activity that's out there.

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Edward J. Prajzner, Mistras Group, Inc. - Senior VP, CFO & Treasurer [30]

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Yes. Jerry, just to add to Dennis' answer, that's really one of the key reasons why we're focused on some of the things that Dennis alluded to in the call, with MISTRAS Digital and with the ART crawler. If anything, those 2 additions to the portfolio really generate a lot of interest within the existing customer base and within prospects out there. So as Dennis talks about increasing the amount of recurring revenue, those 2 will be kind of the anchors that we use to make that increase occur.

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Operator [31]

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(Operator Instructions) Our next question comes from Edward Marshall with Sidoti.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [32]

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So I wanted to ask you if we could drill down on the Services margin just a bit and I wanted to get a sense from you as much of that improvement was maybe top line volume driven, maybe the acquisition of Onstream as that pulls through, price-driven wage inflation and then the cost initiatives. If you kind of parse out what kind of occurred in Q2 with Services.

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Edward J. Prajzner, Mistras Group, Inc. - Senior VP, CFO & Treasurer [33]

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Yes. Let me just tell you. We got a combination of factors helping us there. Certainly, the sales mix is helping, the contribution of Onstream being higher than the base average certainly helps. There's efficiencies in our base business definitely helping. As Dennis said, the cost structures on labor are kind of a push, we're getting some passthrough, so maybe that may be flattish or potentially even flattening out the margin a little bit. But you've got a combination from all fronts there. Sequentially you have good leverage, good contribution margin dropping down from what you saw in Q1 versus what's in Q2 now. So you really have kind of all levels contributing there, bringing us up to that pretty close to 30-ish percent gross margin and then expanding on out to the operating margin line. So we've kind of gotten all components you mentioned there sort of helping the case.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [34]

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This is Dennis. I really believe it's kind of our -- our plan is coming together. Some quarters a little better than others but we've been trying to push to get good contracts, we've been trying to push to get acquisitions and customers that see the value in us and not just trying to go after revenues. And I think what you're seeing is a reflection of that in our margins going up from contribution through gross, down to operating and EBITDA. So I think what you're seeing is hopefully a trend that we will keep pushing quarter-after-quarter. Obviously, there's going to be some variation quarter-over-quarter, but we believe that we can keep pushing the margins up and keep growing our business, getting some organic growth, getting acquisitive growth, while maintaining margin growth as well. We believe this is part of what we can do as our future.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [35]

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It's good to hear. We've -- you've talked about Onstream a bit in the call. I'm curious if you can talk about maybe the contribution in revenue and profits and confirm for me that you said that you saw very little in the U.S. right now that -- so that would have been a Canadian-driven kind of revenue component.

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [36]

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Yes, Ed, it's Jon. The -- when Ed quoted the increases in revenue related to acquisition, that was really the Onstream impact. And I think that was about...

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Edward J. Prajzner, Mistras Group, Inc. - Senior VP, CFO & Treasurer [37]

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5%.

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [38]

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5% of growth year-over-year, so -- or 5% of total, I'm sorry. In terms of the -- it's primarily a Canadian story so far because that's really where they started. And that's where the lion's share of their revenues are. But the growth that they've seen this year has been in the United States primarily. And we expect that to continue in the future.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [39]

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Now if I just think through whole -- the holistic view of trial runs with customers, my sense is your seeing a minor drag on the profitability of that business especially in the United States. Is that measurable? I mean is that something that -- when I look at your Services business we could see upside from here in the future, as you kind of build that segment out, go from a -- maybe a cost-even revenue to cost-even kind of scenario to maybe a more profitable scenario that Onstream could normally run? I'm just trying to think that through as you're investing in that -- both geographic and product market within the United States.

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [40]

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Absolutely, there's upside. The great thing about the line of business that Onstream is in, is that there are very few competitors who do what they do. And so margins tend to be healthier than what we have in our typical NDT business because there's just fewer competitors, there's a high-technology content to what they do, high software and intelligence content with what they do. So their margins on their incremental revenue are very nice, and even in the trial runs that we're doing now, those tend to be [thin]. But to your point, it's really utilization story. So as the more runs that we can get, the more share of customers that we can gain and add value to, the better for us and better for the bottom line.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [41]

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So since you brought it up, could you kind of talk about the incremental margin in that business, maybe the contribution margin?

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Edward J. Prajzner, Mistras Group, Inc. - Senior VP, CFO & Treasurer [42]

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Well, for competitive purposes, we'd rather not go into that kind of depth about any particular product line but it's positive.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [43]

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I thought so. We look into the fall and the impact from IMO 2020, I mean do you get a sense there might have been a pull forward in maybe maintenance and inspection into the spring period versus kind of what would have been anticipated into the fall? And so I'm just trying to get a sense about Q2 versus the balance of the year? And how that might play out ahead of IMO 2020?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [44]

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Yes. I mean we get this question asked a lot, and truth is we don't track what the turnarounds are caused by, but I've yet to see one based on just trying to do the sulfur content change for the diesel. So what we're seeing is, whether coming down for a cat cracker catalyst change or something, or whatever the nature is, we know that there is some portion of the contract that's in there and part of the work that's in there is for this. But we don't track particularly to what part of it is for that. Our Gulf locations, our west coast locations might be seeing a little bit more of that. Obviously, our Midwestern and all of those aren't seeing it, but we haven't seen one area getting more turnaround so much more than the other based on -- just for IMO. I've seen it a little bit in Europe, we've seen it a little bit in the Gulf, but we haven't -- like I say, we don't track it specifically to those reasons for extending a term or [causing] them.

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Operator [45]

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And our next question comes from Tahira Afzal with KeyBanc.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [46]

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I guess just had one question and that is in regards to your business on the aerospace side. Can you talk a bit about whether there have been some positive trickle-throughs now that we are a little far away from Boeing having had its issues?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [47]

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Tahira, what we've seen is -- immediately right now, no, we haven't seen any changes, but what -- and again, the problem's with the macro, more software. But what the bigger problem was that we see is Boeing is having some issues from government oversight and how much is internal versus external inspection. So if anything, I think in the long run, there is a possibility that more of these inspections, regardless of what type of material you're talking about, are going to go to third-party companies. If something like that changes, we absolutely see that being an upside for us because our locations that we have, have a very high amount of certification and other things that prohibit other people from jumping into it. So if the market does see an infection from third-party inspections going out there, companies like MISTRAS would definitely benefit. But in this quarter, no, there hasn't been any immediate impact.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - MD, Associate Director of Equity Research, and Equity Research Analyst [48]

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Got it. Okay. And then this might be a long shot, but we've been watching all the developments with NASA and the Lunar program, any thoughts around how you could leverage your expertise? Or do you feel that's not an area of focus or potential opportunities for yourself?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [49]

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It's a great question. Absolutely, I think probably more on the private side than on the government side because you've got a lot of private companies doing that And they're sending up rockets and satellites and all of that on a very regular basis. So we definitely are looking at that and we're working with those companies as well. And we see as they ramp up their amount of liftoffs and all that has to do with reinspections, all that has to do with new material going through. So we absolutely do see that as a potential for us and for the market as a whole.

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Operator [50]

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And I'm not showing any further questions at this time. I would now like to turn the call back over to Dennis Bertolotti for any further remarks.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [51]

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Okay. I'd like to say that we appreciate everyone's interest in MISTRAS. We look forward to updating you on our next scheduled call. And I'd like to thank everyone for listening to today's call. Have a safe, productive day.

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Operator [52]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program and you may all disconnect. Everyone, have a wonderful day.