Mistras Group, Inc.
Q4 2020 Earnings Call Transcript

Published: 17 Mar 2021

[Operator:]

Ladies and gentlemen, thank you for joining Mistras Group’s Conference Call for its Fourth Quarter and Year End 2020. My name is Towanda, and I’ll be your event manager today. We will be accepting questions after management’s prepared remarks. Participating on the call from Mistras will be Dennis Bertolotti, the company’s President and Chief Executive Officer; Ed Prajzner, Executive 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 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.

[Dennis Bertolotti:]

Thank you, Towanda. Good morning, everyone. We ended the year on a high note with strong performance across virtually every key performance metric, as well as with significant strengthening of our core financial condition. On the top line, it was our strongest revenue quarter of the year and a quarter that is not historically high on a relative basis due to seasonality revenues benefited from offshore mechanical, longer running turnarounds and growth in data services, particularly within PCMS and New Century Software. Gross profit margin was also up in the quarter to 30.7%, compared to 28.3% in the same quarter last year, continuing to favorable trend over the past several quarters. Most importantly, we have now expanded gross profit margin by 100 basis points or more on a full year basis for the third consecutive year. We also continue to drive down costs, which contributed to improvements broadly across our key profitability metrics with operating income in the quarter, nearly doubling over the year-year-over period and adjusted EBITDA up nearly 22%. And once again, we generated very strong cash flow with both operating and free cash flow exceeding adjusted EBITDA in the quarter, as well as on a full year basis. As a result, we actually generated more operating and free cash flow in 2020 than we did in 2019. This was quite an accomplishment given a significantly lower level of revenue in 2020. This was in part attributable to an improvement in working capital with more detail on later. The first priority remains using the free cash flow we generate the pay down debt and by the end of 2020, we have reduced our net debt position for nearly 19%, $200 million. This was all accomplished while continuing to assure the health and safety of our employees, customers, and vendors. In addition to paying down our debt, we also continued to invest in our sales and marketing infrastructure, as we felt it was important to be prepared for the markets return to a more normal level of activity. We have also been making great strides in our expanding Mistras proprietary IP, which will position us to have one of, if not the most comprehensive asset integrity service offering in the market for our customers.

[Ed Prajzner:]

Thank you, Dennis. We grew our key performance measures significantly in the fourth quarter. Once again, illustrating how our asset-light strategy consistently generates strong cash flows even in the most challenging times. Adjusted EBITDA was up nearly 22% to $17.6 million. Operating cash flow of $26 million was up approximately 40%, and free cash flow was up and even more impressive 55% to $21.2 million for the quarter. We converted over 100% of our adjusted EBITDA into free cash flow in the quarter and that’s quite a feat. For the year to date, we also converted over 100% of our adjusted EBITDA into free cash flow. Again, that’s rather remarkable and attributable in part to a reduction in trade receivables and benefit from the CARES Act, which allowed us to differ certain payroll taxes and a reduction in capital expenditures. Given our expectations for 2021 to be a growth year, we expect the cash conversion from adjusted EBITDA to trend back down to our historical norms of averaging about 50%, mostly due to working capital considerations as we invest in growth. In fact at the top line, the fourth quarter was our strongest revenue quarter of the year, with nearly 9% sequential growth from the third quarter of 2020. It was also the third consecutive quarter in which we met or exceeded our revenue guidance. As Dennis noted earlier, energy markets have been recovering and are currently stable. Longer running turnarounds supplemented our steady run-and-maintain business in the fourth quarter of 2020. While hours worked remain below the year ago levels, they did reflect sequential improvement over the third quarter. Revenues in the quarter also benefits from growth in alternative energy, such as wind turbines, in addition to gaining momentum in the private space market. Offsetting these improvements, where continued weakness in commercial aerospace, especially in Europe. However, international revenues in the quarter included improved turnaround volume in Germany, as well as favorable foreign currency translation. Products and systems also turned in a solid quarter as increased infrastructure spending is leading to growing demand for our sensors and related technology, primarily in the transportation infrastructure market.

[Dennis Bertolotti:]

Thanks, Ed. Let me conclude today’s prepared remarks with our outlook for 2021. Our business has been recovering over the past two quarters, from the low experienced in the second quarter of 2020, when the effect of COVID-19 was most impactful to our financial results. Although energy prices and demand are currently stable, the ongoing COVID-19 pandemic continues to impact our two largest markets. We expect annual revenue for this year to be higher than in 2020, however, first quarter 2021 revenues will decline modestly compared with those of the prior year, due to a full quarter’s impact of COVID-19 in 2021 as compared to a partial month in 2020. Moreover, first quarter 2021 revenue will be lower sequentially compared with the fourth quarter of 2020, due to typical seasonality patterns in the first quarter of any given year, not to mention the recent severe weather impacts of the Gulf region. We are optimistic that the revenue will continue to rebound once we reached the second quarter of fiscal 2021 and therefore we expect that revenue will commence year-on-year improvements beginning in the second quarter of 2021. Although, we expect that year-on-year adjusted EBITDA improvements will commence beginning in the first quarter of 2021. This outlook is contingent on continuing macroeconomic stability, including continuing stabilization in crude oil markets, timely and effective implementation of COVID-19 vaccinations in 2021 and no new or increased stay-in-place mandates resulting from an increased spread of COVID-19, which would impact our ability to work as a critical service provider. We believe that as we move deeper into 2021 market conditions will improve particularly in the oil and gas sector. But these are remaining as challenging times. Mistras continues to play offense by growing share and investing in our sales, marketing, and new technology initiatives, which provide the innovation that will drive Mistras and our industry forward. Our goal is to bring value to our customers, knowing their challenges, we will evolve – as safety and compliance standards continue to change with an evolving world view. And for new and emerging industries, such as alternative energy is a brand new world where they are relying on the experience and combined skills of trusted advisors, such as Mistras. The large layoffs seen in many of our customers and made them more dependent than ever on complex vendors, such as Mistras to operate efficiently, as always, Mistras’s goal is to remain at the forefront of the industry and to drive value for our shareholders. Before taking your questions, I like to thank all the Mistras’ employees, once again, for your understanding and leadership shown and helping us through this crisis, by continuing our solid reputation for safety, quality, and innovation all while providing outstanding customer service and dedication during these extremely trying times of this past year. Please continue to show the same concern for others and leadership you have shown to all of our stakeholders in the future. Caring Connects works. Towanda, please open up the phone line.

[Operator:]

Thank you. Our first question comes from the line of Sean Eastman with KeyBanc Capital Markets. Your line is open.

[Sean Eastman:]

Hi guys. Congrats on a really strong finish in the fourth quarter. It’s great work. I guess, first one for me, I’m just curious with the dialogue with customers is like, right now, I mean, are they mostly focused on making sure you guys are going to have the capacity to support them as these facilities start to run harder or is the dialogue more so focused on trying to do things differently in terms of driving efficiencies through sort of new technologies and data. That’d be an interesting dialogue.

[Dennis Bertolotti:]

Okay, Sean, I’ll take it and Jon will probably jump in. On capacity, the one thing that we didn’t do is, we didn’t cut into our business when 2020 first popped up with COVID. We didn’t cut back on our sales or marketing. We pushed in on that and we didn’t do anything on the technicians. We just modified the hours. Everyone worked according to the work that was out there and we took all appropriate cost cuts. So for the most part, we have all the bodies we had before this started, we just have a lot less work for them. We trend our hours every week, both in un-billable and billable hours. And we trend how many people we had out. We peak, Sean, at about 22% of our technicians that were billable in North America during the hike of the COVID late March and April. We’re down now to sub 2% or something like that. It’s minor. But the hours were always more than double whatever we were out in billable post. So what happened is our customers really try to get people back on as fast as possible. They didn’t want to lose as much as they could from the vendor base ourselves and any other vendors, but they really needed the amount of hours. So we have the ability to come back and handle whatever hours that we see coming at us even as we’re growing here into the spring. Our bodies are there. You always need some supplemental. Some people are specialty folks, but we do a good job of every week. We call every general manager. We get everyone on both the international and a domestic call. And we talk about resources and where we are short and where we’re long. And we have our internal recruiting folks doing nothing really, but moving bodies internally. So we feel very good about our capacity. To get to your second question on efficiency and technology, absolutely, they’re starting to think more and more about how do we do more? How do we predict more before the turnaround? How do we do online monitoring before the turnaround everything? How do we minimize everything? Especially in 2020, the turnarounds are really minimized by the hours, but there’s a lot customers are thinking about now about gaining efficiencies with our mobile solutions and just all the online capabilities. That’s why things like the wind turbines and there are new people still would go and look at a term and every five years or whatever their schedule was, the day after you inspected, something could happen and it needs repair again. With the new things that we’re working on, we can tell them when it happens immediately and go do the inspections on what is most in need of a repair. I don’t know. Jon, if you want to add anything to that?

[Jon Wolk:]

Yes, Dennis, I would, I think – I agree with everything you said, but in addition, I think, as you said in your prepared comments, we spend an awful lot of time during 2020 enhancing the capabilities that we have and being able to be in a position with customers to produce value that we’re being told by them. They’re not seeing from others. So things like the digital, the mobile solution, it’s a differentiator, the fact that you get the visibility, the productivity from our solution and our workforce does, in fact, we’ve even got other trades which customers have asked the other trades to use the Mistras digital mobile solutions, and they’re using it with good success to drive additional productivity. That’s just an example of the innovation that we’ve been bringing out to bear. So I think that that it’s really resonating with customers.

[Sean Eastman:]

Okay, interesting. And I’m just curious on the margin trajectory in the business. I mean, if we’re back at that 2019 revenue run rate in 2022, I mean, do you anticipate the margin profile to be similar as what you guys did in 2019 or better or worse? I’m just kind of curious how to think about that.

[Dennis Bertolotti:]

Yes, Sean, I will – Ed follow me up, but I’ll tell you, with the improvements we’re seeing on gross margin, maybe not all of them in 2020, because some of them are just the differences of pass-through and per diems and things like that. But we believe a good part of everything we’ve been doing in gross margin is sticky. It’s a reflection of what parts of the business we’re growing up and where we’re focusing and the customers and everything else. So we believe we’re not going to be slipping back to gross margins of the past. We’re going to get growing from where we are. Ed, is there anything else you want to add?

[Ed Prajzner:]

Yes. No, definitely. That’s true, absolutely. And again, the mix is very important. Again, the relative level of pass-through activity happening in a given period can absolutely start to affect your margins a little bit. Certainly, we’re going to keep the overhead cost control and calibrate cost of revenue going forward. Sean, we do believe the EBITDA rebounds a little quicker than the revenue does here in 2021. But yes, we definitely have aspirations to keep improving, but again, it’s not always linear. Every quarter is not going to move exactly in lock steps with the quarter before it, but no – but yes, we definitely feel that those margins are certainly attainable back in 91 and 90 rather than in going forward.

[Sean Eastman:]

Okay, great. And one last quick one from me. I mean, if we’re exiting 2021 at the 2019 revenue run rate, what does that assume around commercial aero?

[Dennis Bertolotti:]

Go ahead, Jon.

[Jon Wolk:]

I’ll start off there. Yes. So what we’re saying is, if you were to sort of annualize the fourth quarter of 2021, it’ll look a lot like 2019 levels. We have in all of our budgeting and forecasting and planning, we have aero lagging the oil and gas recovery and most people do. Commercial in particular might be lagging. We believe the defense and then the space might be moving a lot quicker and buffering some of the weakness in commercial, but we have aerospace lagging a little further along before it gets back to 90. We’re not suggesting that aerospace gets there in 2021, but versus oil and gas gets close. But aero will definitely lag a little bit into 2022 before it gets back to 2019 levels.

[Sean Eastman:]

Okay. Very helpful. Thanks for the time gentlemen.

[Operator:]

Thank you. Our next question comes from the line of Brian Russo with Sidoti. Your line is open.

[Brian Russo:]

Good morning. Ed, you mentioned your leverage ratio targets of three times by 2021. Could you just discuss the step downs in your interest expense and borrowing costs as leverage falls?

[Ed Prajzner:]

Sure, absolutely, Brian. So yes, so the biggest break in the pricing grid would be once we’re below a 3.75 leverage, which is two quarters from now, there’s a huge step down in interest from the current 5.15 down to a 3.5. So there’s a huge reduction. We won’t get there until the effectively that the fourth quarter of this year, the pricing grid goes into effect prospectively. After that the new leverage is achieved. So you’ll have fairly similar interests, slightly less debt, but similar interest rate for the next for three quarters of 2021, it’ll drop down in the fourth quarter. So you’ll have a modest reduction happening, but then from that point forward, you have a huge reduction going forward once you’re down to that next pricing grid. So there’s a big drop from 5.15 down to 3.5 later this year as we get below the 3.75 leverage.

[Brian Russo:]

Got it. Great. And then just your comments on the SG&A. Do you have any SG&A as percent of revenue targets, as revenue increases with the understanding that you’ve retained a lot of your sales and marketing, I think it’s in the mid 20% at year end 2020, is that – should the SG&A track revenues or should revenue growth exceed the SG&A growth?

[Ed Prajzner:]

It’s definitely the latter there. I mean, when we’re budgeting and forecasting, obviously, we want SG&A to grow at only a fraction of revenue in some periods it’s even – it should be growing a fraction a half or only a quarter of the revenue increase. See, right now, I think we ended Q4 SG&A is around 25% of revenue, approximately revenue will be scaling up next year. SG&A will not scale that much higher. I will look at it where that SG&A may stay flattish to creeping up slightly next year. Revenue will be outpacing that. So hopefully, as the year goes along, that number gets into a mid-20-ish percent. Our aspiration, as we’d love to see that get to a 20% or lower, but it’s going to take some – multiple cycles to get to that level. But the run rate is that now is a pretty good number. There’ll be some slight creep in that number as 2021 goes along. But again, as we’ve been saying for really all of 2020, we’ll continue to calibrate the cost footprint to the revenue level at hand. So as the contribution margin dollars come back and as the gross profit dollars come back in, and then we’ll continue to let some of the costs come back and grow, as we said on the call where we’ll invest in things, marketing and sales and whatnot. So we need to fuel that investment. And that’s going to come from top line. That’s why we’re pushing gross profit so much that allows us to invest in the business. But right now, it’s a pretty good indicator going forward. It’ll creep a little bit up, but it’s a pretty good range right now.

[Brian Russo:]

Okay, great. And the other comments on O&G to be below 50% of the sales mix over time, I think at year end 2020, it was at 57%, aerospace and defense was at about 12% and power and renewables somewhere in the mid-single-digit. How fast do you think that sales mix can evolve?

[Dennis Bertolotti:]

So Brian, it’s Dennis. As you know, that for us as our aspirational goals, that’s more of a three to five-year, I’m believing three to four years, we’ll have the balance of gas and oil under 50%. This is without acquisitions or anything else. It’s strictly organically and it’s by still growing gas and oil. But we believe the other markets in space, aerospace, renewables and energy and other things that we’re already in and can grow into like infrastructure. We believe that’ll start taking more and more of it. Those three primarily we’ll take more and more and chip away at that 50 some percent lead.

[Brian Russo:]

Okay, great. And then just lastly on the renewable, and the remote sensors on wind blades, have you been involved in the Texas market yet, or is that a market opportunity along with the Gulf and the South? And then if you could comment on what type of work you’re doing on the turbines as well.

[Dennis Bertolotti:]

Sure. I’ll throw it out to Jon. He’s more involved in it.

[Jon Wolk:]

Yes. Hi Brian, this is Jon. So absolutely, so we’ve been installed on a number of wind turbines primarily in the Southwest, including Texas during 2020 and through today. And so we were there as the – during the big freeze and we incidentally could hear what was happening on the blades during the big freeze and able to impart this information to customers. So absolutely it’s part of a global market that we’re looking to really serve. And in terms of what we’re doing is we’re monitoring primarily, but not exclusively wind turbine blades to really hear the effect of impact, damages, could be lightning strikes, it could be ice falling, it could be some other impact to the blades. And those impacts tend to cause damages almost immediately upon impact. And oftentimes, as Dennis said, those impacts of the resulting damage are undetected until the next inspection occurs. But the great thing about our technology is we can hear the impacts immediately, and we can hear the follow on effect of the impacts in terms of what’s happened to the blades in terms of what type of damage has occurred immediately and how that’s evolving over time. And we’re able to impart that knowledge to our customers so that they can use that data to determine if they can continue to run safely that certainly don’t want to run to failure, because that could be catastrophic in terms of cost and damage. And they can avoid those catastrophic costs by use of our technology and our know-how.

[Brian Russo:]

Got it, great. Very interesting. Thank you very much.

[Jon Wolk:]

Thank you.

[Dennis Bertolotti:]

Thank you, Brian.

[Operator:]

Thank you. Our next question comes from the line of Mitch Pinheiro with Sturdivant & Company. Your line is open.

[Mitch Pinheiro:]

Hi, good morning, so…

[Dennis Bertolotti:]

Good morning, Mitch.

[Mitch Pinheiro:]

I had a question, couple of questions here. Why wouldn’t the revenues start annualizing at 2019 levels earlier than the fourth quarter?

[Dennis Bertolotti:]

So the answer is, we believe it could happen as far as in the third. We don’t think it will – we know it won’t be at that rate in the first quarter and probably not in the second for 2019, but it’s – we believe it’s going to keep creeping up. It’s a function of vaccinations and people getting out and jumping back in their cars and demand on the inventory going down and power and everything else starting to get back to a normal. So it’s not so much us. It’s really just waiting for the energy and power in all those markets, just to get back to a normal consumption rate, which we don’t think is going to happen until sometime, I don’t know that’s June 1, July 1 or what the particular date is, but sometime by the time you’re getting to be mid or third quarter, we think we’ll be getting back to a more normal.

[Mitch Pinheiro:]

Okay. That was helpful. But this now how does – so how does the mix – revenue mix factor in, I mean aerospace particularly your international segments been weak? Is that – I mean are we going to see sort of a recovery across all segments equally? Or is this going to be fueled more by your – sort of your energy and customers and less so by aerospace as we get into the fourth quarter. Is there going to be an even sort of contribution or will there be less?

[Dennis Bertolotti:]

So I think – yes, I think you’re right in the second half. I think you’re going to see probably gas and oil getting back faster in aerospace, but like we say, we’re doing some things in aerospace where we believe on the non-commercial side on the military and in the space side, we believe there we’ve got a lot of great traction and that can help us offset what you see. Aerospace is going to be slowest internationally to catch up domestically. We’re seeing that we have some signs of the getting back to a normal, but it won’t be back there yet in 2021, one way or the other, but we’re – we also see that the things such as the wind and all the other parts of gas and oil and everything else catching up a little bit faster. So it won’t be a 2019 as far as the percentages go, but we’re going to hopefully have our revenue back to where it was in 2019 with just different percentages from the different industries as they come back online.

[Jon Wolk:]

Yes. And just to add to that on the international side, I mean we still have Europe in the midst of lockdowns, in fact, lockdowns are increasing in some countries right now. So it’s really hard to kind of model out when that’s going to relax. Vaccine rollout pace has been much slower in Europe than it has in America, for example. So I think those are some of the variables we’re trying to understand as well.

[Mitch Pinheiro:]

Okay, thank you. And then when it comes to digital, it’s right now, I mean can you talk a little bit about what percentage of your customers are using your digital services, and by what sort of end market they’re currently at and where you think it’ll head to?

[Dennis Bertolotti:]

So I’ll let Jon answer that one.

[Jon Wolk:]

Yes. So in terms of mobile deployment, really where we’re focused right now is oil and gas primarily, but we are looking to expand that. Within oil and gas, we’ve got some initially very good penetration across several major customers. And typically, it’s one or two sites within their fleet and looking to roll out beyond that as we get into 2021. I think 2020 was really a year of proving the technology works. I think 2021 will continue to be that with some of the customers that were going into their first sites, and demonstrating the strong productivity enhancement that we bring the strong visibility that we bring as well as, as I said earlier bringing the other trades on, so that visibility and productivity is multiplied not only across the NDT trade, but across those other trades as well. So I think the 2021 is really going to be a very exciting time in terms of a substantial rollout compared to where we have historically been. And then for Mistras Digital, we use that term kind of broadly, because it’s not just the mobile app, even though that’s substantial. You’ve also got yes, other applications for our in-house labs where we can track and trace parts status completion. And as we work multiple stages of different activities, different mechanical activities and help to achieve modification of those parts to customer specifications, we’ll be able to track that as well. That’s a new application that’s coming on soon.

[Dennis Bertolotti:]

Yes, Mitch, the only thing I’ll add is benefits. 2020 it was really tough to get onsite. Go see customers prove out the solution, or even just add any extra bodies to the site to be the SME subject matter experts to stand it up and get it running. So it kind of put a pause on it, but the funny thing was everyone wanted more data from where they were working. They just didn’t really want to spend the time effort or bring extra bodies on to do that. So we see 2021 as a good impetus to get that those kinds of things going.

[Ed Prajzner:]

And finally Mitch, just to add, you asked about relative size of this. I mean this is a huge opportunity that we’re all really excited about. If you add it together all of our current Mistras Digital, our software, our sensors, remote monitoring, you would probably barely get 10% of our current revenue, but it’s got an incredible upside to us and growth as you’re hearing, we’re really just getting started with it, incredible upside, its a very small piece of our business and we believe it will grow rather rapidly become a much bigger part going forward now that we’re past proof of concept and testing and demos and into real commercialization. It’s going to grow, it’s currently coming from a very small base, but we’re very excited about it.

[Mitch Pinheiro:]

Okay. Thank you. And then actually just one more question Dennis for you, where do you think CapEx is going to fall and is there going to be any seasonality to the CapEx?

[Dennis Bertolotti:]

So it’s a good question, because a lot of people wonder if we starve the business in any way, CapEx or somewhat that to get our cash flow. We really didn’t. I mean we moved CapEx along to parts of our business where we needed it. We were careful about buying new things, but we didn’t starve anything. So we don’t think there’s going to be a huge rebound. In fact, it’ll come off with its still going to be sub $20 million. I think that is what we’ve got planned for 2021. So it’s not going to be where we have this pent up demand for CapEx whatsoever in 2021.

[Mitch Pinheiro:]

Okay. Thank you for your time. Appreciate it.

[Dennis Bertolotti:]

You got it. Thanks, Mitch.

[Ed Prajzner:]

Thank you.

[Operator:]

Thank you. I’m showing no further questions in the queue. I will now like to turn the call back over to Dennis for closing remarks.

[Dennis Bertolotti:]

All right, everybody. Look, I appreciate the time everyone took to spend with us today. The whole Mistras team would like to thank you for joining our call today and wish everyone a safe, prosperous, and healthy future. Thank you again folks.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.