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Edited Transcript of MG earnings conference call or presentation 7-May-19 1:00pm GMT

Q1 2019 Mistras Group Inc Earnings Call

PRINCETON May 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Mistras Group Inc earnings conference call or presentation Tuesday, May 7, 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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* Edward James Marshall

Sidoti & Company, LLC - Senior Equity 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 Liz, 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 the first quarter ended March 31, 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; as well as Dr. Sotirios Vahaviolos, Executive Chairman; 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 Investors 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's business performance, financial results for the first quarter of 2019 as well as give you our outlook for the remainder of the year.

First quarter results were relatively low as previously announced and marginally weaker than we had initially thought, which we will elaborate more on during this call. More importantly, with the strong momentum generated exiting the quarter, the pickup in the turnarounds and coupled with the recent organic wins, we continue to feel good about where we are and are consequently reiterating our guidance for the full year. Despite the softer-than-expected first quarter, our underlying business remains robust, both domestically and internationally, in oil and gas and in all other verticals. And despite a turnaround market that had got off to a considerably slower start than a year ago, we continue to expand gross margins, leverage our industry-leading reputation to gain share and build out our midstream and technology-oriented growth channels so that we remain bullish not just on the year but over the long term.

As stated in our last call with you, first quarter 2019 revenues were down from a year ago. Exclusive of a 2% adverse effect from unfavorable foreign exchange and looking past the large contract nonrenewal, comparable revenues were flat with last year. Acquisitions incrementally added 3.1% growth to the top line in the first quarter of 2019.

Our gross margin performance was strong in the first quarter of 2019, improving 190 basis points to 27.6% from 25.7%. This has been a favorable trend over the past year and is a corporate initiative reflective of our strategy focused on achieving value for our customers.

For the first quarter of 2019, gross margin improvement was attributable to a favorable sales mix, all the more impressive considering it was achieved at a lower level of volume. We anticipate that gross margin will improve further throughout the remainder of 2019.

The company has historically always generated attractive cash flow, and our cash flow from operations are on track so far in 2019, improving over 40% from the first quarter of 2018.

Ed will go through the financial details in a few minutes, but we had 2 charges during the first quarter to fully resolve non-operational matters that we previously identified, neither of which will be a factor affecting ongoing operations. Nevertheless, the core business is strong. Over the last trailing 12 months, we were able to earn back half of the $40 million reduction in annual revenues resulting from last April's nonrenewal. This speaks volumes to our strong product offering and industry relationships as well as clearly illustrates that our services remain in demand.

As further evidence to this, I am pleased to announce that so far this year, our Services segment has already been awarded $15 million of annualized new business, which is expected to generate revenues of approximately $15 million over the remainder of this year. This new business is across multiple customers and spans several of our end-market verticals. Again, we continue to build on new, unplanned opportunities on a global basis.

The wins to date were additive to our budget. We have quietly been transforming MISTRAS to become the supplier of choice to position ourselves for these wins by maintaining our focus on the following.

Delivering value. This includes the innovative ways that we identify key performance indicators with our customers and things they tell us will save them money. We capture relevant data and quantify the value they feel we deliver.

Meeting our promises. If we say we will staff a turnaround, then we do it. We don't leave our customers hanging just weeks before the work is to commence as some of our competitors have been known to do.

Working on the same side of the table as our customers.

Innovating to drive productivity for them. A great example is MISTRAS Digital. We have been thoughtful and include their feedback in developing a solution that we believe will lead the industry in providing transparency and visibility as well as productivity improvements.

And lastly, developing industry-leading productivity tools, like our advanced Radiographic Testing crawler, which has IP protection because of its innovative ways to move and scan for critically important data that indicates corrosion under insulation as well as strong productivity. Each of these areas are key differentiators, enable us to change the conversation with customers and create demand and market share gains for MISTRAS.

Beyond priming and restarting our organic growth engine, our recent acquisitions are also performing well. West Penn met our expectations for its first full year in 2018 and has continued performing well into 2019. We are leveraging the strong relationships across our other East Coast-based laboratories focused on aerospace. We have also been building a collaborative partnership between West Penn and our Le Creusot facility in France serving Safran. 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 off to a good start in 2019. Although they had a slow January and February, they ramped up nicely in March. Their U.S. business is doing particularly well, and this was the primary area in which we had expected them to grow. We are excited about the recent commercialization of their 20-inch tool and 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.

We also recently formed a Pipeline Center of Excellence focused on inspections of new construction pipeline and other midstream facilities as well as supporting the development of our growing pipeline integrity solutions.

In addition to pipeline integrity, our new digital initiatives lever technology to improve performance and quality, while reducing our costs. From tablets in the field, to Onstream's centralized data analytics facility, we are finding ways to leverage technology to provide our customers with more value in a more rapid manner. This is one of many areas facilitating our growth as well as recent contract wins.

I will now turn the call over to Ed for a detailed review of the financials for the first 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, the first quarter results coupled with our recent organic wins 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 quarter. Consolidated revenues were down 6% to $176.8 million but down only 4% on a constant-currency basis. The majority of the year-over-year difference is the $10 million of revenue from the contract vacated March 31 last year. So this is the last quarter that contract will distort our underlying performance. Again, after adjusting for this anomaly and using a constant foreign exchange rate, our revenues for the first quarter were essentially flat year-over-year. Consolidated gross profit for the quarter was $48.9 million, slightly higher than the year ago quarter despite the lower sales volume.

Consolidated gross margins improved significantly, however, to 27.6% for the first quarter compared with 25.7% in the prior year, an increase of 190 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.

As Dennis mentioned, we recorded 2 items during the first quarter of 2019, totaling $6 million, to resolve nonoperational matters that were previously identified, neither of which will be a factor affecting ongoing operations. These items were comprised of the following. First, we recorded an additional bad debt provision of $5.5 million net of recoveries. This related to an earlier item in the fourth quarter of 2018 wherein we recorded a reserve of $700,000 for a renewable energy industry customer within the company's Services division, based in part on available information about the financial difficulties of this customer. This customer filed for a voluntary insolvency proceeding on April 9, 2019, at which time payments under the previously agreed to payment plan ceased. As a result, during the first quarter of 2019, we recorded an additional charge of $5.7 million to fully reserve the exposure related to this customer.

During the first quarter of 2019, we additionally recorded a net $200,000 recovery of an unrelated bad debt, for which we had recorded a reserve during the second quarter of 2017.

Secondly, we recorded an additional $500,000 provision related to the pension withdrawal expense that we initially recorded during the third quarter of 2018. We believe this matter is fully reserved for as of March 31, 2019.

Adjusted EBITDA was $12.7 million for the first quarter of 2019. Since gross profit dollars in the quarter were essentially flat with prior year, albeit on lower revenues, the lower EBITDA is primarily due to our slightly higher selling, general and administrative expenses this year.

The company is a strong cash flow generator. In the first quarter of 2019, cash flows from operating activities were $8.2 million, a 41% increase compared to $5.8 million in the year ago quarter aided by working capital reductions. We foresee continued cash flow improvements throughout 2019.

Looking more closely at our segments. Services revenue decreased by 3.6% in the quarter. After adjusting for the large contract nonrenewal effective April 1, 2018, that anniversaried this quarter, Services was essentially flat with last year. Onstream incrementally added 4% revenue growth to the Services segment. The Services segment generated a gross profit margin of 26.6% for the quarter, a significant improvement of 280 basis points compared to the year ago period. Margin expansion is a key corporate strategy, and we are pleased to see margins continue to expand, driven by pruning lower-margin operations and growing higher-margin operations, including acquisitions, such as West Penn and Onstream.

International revenues in the first quarter were down 8.6% from a year ago. The decrease is primarily due to unfavorable foreign exchange rates since revenues were down less than 1% in local currencies. For the first quarter, International reported 29.5% gross margin, which is up 170 basis points from a year ago. This improvement is attributable to better manpower utilization and improved sales mix. As mentioned last quarter, the winding down of the German staff leasing business will present a revenue headwind this year, and we saw that beginning in the first quarter. However, we don't expect the wind-down to have a material impact on this segment's profitability.

Products and Systems revenues were down $2.7 million in the first quarter with about $1.1 million of that attributable to the product line divested in 2018. SG&A as a percentage of revenue was approximately 23.6% in the first quarter, down sequentially from 24.4% last quarter but up from 20.8% in the first quarter of 2018. As mentioned last quarter, some of the increase reflects a deliberate commitment to increase our sales and marketing investment as a strategy to accelerate growth.

Last quarter, we indicated that outside of some nominal growth in sales and marketing, which is paying off as evidenced by our recent organic revenue wins as well as increased investment in research and development, we did not expect any significant increase in overhead spending in fiscal 2019.

Given overhead was down sequentially from the fourth quarter, despite the first quarter included some costs that are unique to beginning of the year, we are confident the first quarter spending is a reasonable run rate for the year. We are, however, reviewing and rationalizing our overall company-wide overheads for savings to make sure we maintain an efficient footprint to support our growing business.

GAAP operating loss was $4.4 million attributable to the items that I mentioned earlier. Non-GAAP operating income was $2.3 million for the first quarter of 2019. GAAP net loss was $5.3 million or $0.19 loss per diluted share for the first quarter of 2019. Non-GAAP net loss was $800,000 or $0.03 loss per diluted share. The company generated $8.2 million of cash flows from operating activities and $2.5 million of free cash flow for the first quarter of 2019, in part due to a positive reduction in working capital. This was a significant improvement over the first quarter of last year.

Interest expense for the quarter was $3.5 million, which is consistent with the $12 million to $14 million of interest expense we anticipated for fiscal '19.

The company's net debt that being total debt less cash and cash equivalents was $263 million at March 31, 2019, down marginally from the end of the year as we used some of our free cash flow to pay down debt.

Given our cash flow, annual cash interest expense and net debt, we believe our balance sheet is strong and will support the funding of both our organic and acquisition growth objectives. Our effective tax rate was 33.3% for the first quarter of 2019, including a few discrete items, which increased the rate by 1.5%. We project our effective income tax rate to be in the range of 32% to 35% for the full 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 been anticipating a challenging first quarter, including a later-than-usual start to the turnaround season, so our results to date in 2019 have not altered our view for the year. And our recent organic wins and remaining opportunities only strengthen our conviction about the full year outlook. Macro-level economic drivers also remain positive, and we are confident in maintaining our forward momentum.

So the company is reiterating its guidance for the full year 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, free cash flow is expected to be between $42 million to $45 million.

As I mentioned earlier, 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 an 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 evolving digital solutions as well as our 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 with us by delivering top-quality results with superior economic value.

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

We will now take your questions. Operator, please open 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 the line of 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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Okay, I guess, the first question is we see these push-outs we have for a very long time on and off. What gives you confidence around the ones that had been pushed out that they will come back later on in the year? From my experience, sometimes, the length of time and duration on when some of these turnarounds come back can be much longer.

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

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Tahira, it's Dennis. Are you speaking to push-outs for revenue?

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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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Yes.

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

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Yes. I mean, the way we've seen it, it wasn't so much surprise to us. On the first quarter, we've seen that in previous years, especially when they are trying to pick back up from a reduction of work due to the oil price, they had busier January and February. So we just didn't see that in our customers and many others. So we've just seen a slower spring for us. March was good. It's gone into a good April and May, but it wasn't that projects got canceled or changed so much. They just didn't really have as much planned for early January, February.

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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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Got it. Is there a way you guys can track that better because it seems the disconnect was less about things getting pushed out than just the ability and the visibility around what's going to move with certainty.

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [7]

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Tahira, it's Jon. I think really we're trying to be as responsive as possible to our customer schedules. And as Dennis indicated, we originally guided lower for Q1 than prior year revenues because of our understanding of those schedules. Conversely, as Dennis just indicated, we feel good about Q2 and especially good about the second half of the year, again, with knowledge of those same schedules.

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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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Okay. Great. And then just as a follow-up on the margin side. You guys are very good at giving us sort of an idea on the segment margins and how they will ramp up. Any update over there? Because it seems obviously things are a little more back-end loaded now.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [9]

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I think we see some additional expansion this year, as we saw throughout last year, in the margins across the segments, not maybe quite the improvement you saw last year. But we are driving on the gross margin line, and with the volume recovery, that will trickle down to the OI line.

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Operator [10]

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(Operator Instructions) Our next question comes from the line of Edward Marshall with Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [11]

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So I wanted to ask about Onstream. First, correct my math if I'm wrong, but it looks like roughly $6 million of revenue in the quarter from that business. Is that what you kind of said with 4% growth in Services?

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

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That's about right, yes.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [13]

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Okay. So looking at last year's -- looking at the announcement of the release, it was around $27 million. And I just wanted to kind of parse out -- that was an annualized run rate in '17. Just want to parse out -- that looks like a $7 million quarterly run rate. Is there a lot of seasonality in this business? I guess, considering their geography, I guess, there would be. Can we talk about maybe that and maybe the confidence that you have? Is this embedded in the growth rates in the revenue that you're looking for, for the remainder of the year?

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [14]

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Yes. Ed, this is Jon. It is quite a seasonal business. Q2 and Q3 tend to be the best seasons for Onstream given weather and accessibility to pipelines, et cetera. We feel very good about their forecast for the year, and it is definitely baked in Q1 will be a lowest quarter for them. They'll pick up sequentially from here.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [15]

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And typically on that -- it's Dennis -- typically on that, as you get more work in the U.S., their seasonality will diminish a little bit. When you're talking about still a Canadian-specific market, there's going to be -- just based on the weather, there is a little bit more seasonality there. And as you know that's the growth plan for us is more in the Southern portion of the U.S. So that's going to be helpful as well for that seasonality impact.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [16]

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Got it. I mean, that's what got me a little confused because looking at that growth rate, talking about the growth that you're now starting to see in The United States, and then not seeing the true-up to the growth rates of 7 -- or the revenue of '17, it got me a little confused. So if we look at the investment that you've made, the wider-diameter systems and the focus on The United States, can you talk about -- you mentioned a little bit of the penetration, but can you talk about the penetration that you're seeing kind of in The United States and maybe some of the growth that you're seeing, share this year versus share last year, et cetera, if you would like to elaborate?

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [17]

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Yes. Thanks, Ed. This is Jon, again. We're seeing quite a lot of exciting sales cycles in The United States. Canadian business is steady, but The United States is where we're going to see the bulk of our growth with Onstream in 2019, and we feel very good about the uptake. It's off of a low base. So almost everything is incremental in the U.S., but feeling very strong about it.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [18]

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Is that a similar margin to the Canadian business? And a follow-up to that. Are you still offering kind of trial runs? Or are these now kind of going to purchase orders and -- or however you would quantify them?

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

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Well, the margin profile is similar, yes. The pricing profile is similar across North America. But what we're finding is that we're certainly getting purchase orders and revenue and paying runs. As you alluded to the wider dimension tools, the 20-inch, the 24-inch tools that Dennis spoke of in the prepared script, those are -- tend to be -- the initial runs tend to be on a trial basis. The initial results have been extremely favorable, and so purchase orders come pretty quickly on the heels of those initial runs.

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

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And the 16-inch is already in field and getting revenue because that was being proved out actually just prior to our acquisition. The 20 and 24 are in the stages of one that's been out there, proved out a lot more versus the 24 is. Still, like Jon is saying, that one is actually just getting its first runs.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [21]

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And I just wanted to ask one more on this if I could. When I think about trial runs and I think about your margin, is it meaningfully impacting the margin within your Services business, to do these trial runs? I mean, I'm assuming you're offering them at almost free to cost. I know there's purchase orders following it, but that seems to probably be on a lag. Is it material to the margin in that segment?

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [22]

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I wouldn't call it material for the Services segment margins, no. It is a little bit dilutive to Onstream's results in the quarter that they occur but not to Services as a whole, no.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [23]

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Got it. We talk -- looking at the revenue guide for the remainder of the year, if I just take the midpoint and do some simple math, it looks like there is a 13% increase from the first quarter on average for the balance of the year. That puts you at about $200 million almost a quarter. And I know that there is some seasonality in your numbers. But as I think that through, between Onstream, West Penn, the increase in the turnaround business, is there anything else that I'm kind of missing here? Or are you baking in some acquisitions into this target? So I can kind of get a sense. Or is this all organic?

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [24]

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Ed, that's all organic. Again, as Dennis said, we ended March strong, that's continuing into April. So that's organic. There is no acquisitions factored into that guidance for the year nor the new contracts we talked about on the prepared remarks. Neither is that factored in at this time.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [25]

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Are those contracts for Services this year? Or does that leak into next year?

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Jonathan H. Wolk, Mistras Group, Inc. - Senior EVP & COO [26]

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That was $15 million of annualized, Services. That will be incremental to the back end of this year.

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

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By coincidence, there are some onetime ones that make it $15 million additional that we already got for 2019. So the numbers are $15 million both ways, but that's just coincidence. We had a couple of large, onetime ones, but annualized is $15 million that we have in hand and with what we're doing and working in the market or looking at there's potential for more coming in. And so we feel really good about -- you're right about the math. It's got to be close to $200 million for the next three quarters, but we feel good that we've got there.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [28]

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Got it. And the final one from me. I'm looking at the turnaround comments regarding picked up late in the quarter, and that's what the data -- the industry data would have suggested. What's your impact into April? I think you mentioned that you saw that service -- that turnaround continue. Wondering if you could potentially quantify that for me, say, April last year versus April this year on a percentage terms just to give us some confidence as we look at that pretty good ramp through the remainder of the year?

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

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Yes. We feel confident that in Q2, 3 and 4, we will beat the previous year's numbers. Q1 was the only one that we thought we were going to have some problems with because of the falloff of a large customer and all that. I mean, you're talking single digit, but probably mid-single-digit types of growth throughout the year. I mean, we're anticipating roughly and to have mid-single digit for the full year even with the setback of what we got for Q1. So some quarters will be little bit harder than that to bring the average up.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [30]

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You refer to EPS or revenue when you say numbers?

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [31]

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Revenue, I'm sorry.

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Operator [32]

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I'm showing no further questions in queue at this time. I'd like to turn the call back to Dennis Bertolotti for closing remarks.

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Dennis M. Bertolotti, Mistras Group, Inc. - President, CEO & Director [33]

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All right, folks. We appreciate your interest in MISTRAS, and we look forward to welcoming you and talking to you on our next call. Have a safe and productive day. Thank you.

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Operator [34]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.