Mistras Group, Inc.
Q1 2017 Earnings Call Transcript

Published: 10 May 2017

[Operator:]

Good morning, ladies and gentlemen, and welcome to Mistras Group's Earnings Conference Call for its first quarter ending March 31, 2017. My name is Liz, and I'll be your event manager today. [Operator Instructions] Participating on the call from Mistras Group will be Dr. Sotirios Vahaviolos, Chairman and CEO; Jon Wolk, Senior Executive Vice President and CFO; and Dennis Bertolotti, Mistras Group President and COO. I'll now hand the conference over to Dr. Vahaviolos. Please proceed.

[Sotirios Vahaviolos:]

Liz, thank you very much, and good morning to all. In today's call, we will review Mistras Group's financial results for the first quarter of our fiscal year 2017 that ended on March 31, 2017. For the last 2 years, I have been speaking about challenging market conditions imposed by low oil prices and the many actions we have taken in recognition of these challenges. We remain focused on 3 things

[Jon Wolk:]

Thank you, Sotirios. I remind everyone that remarks made during this conference call will include some forward-looking statements. The company's actual results could differ materially from those projected. Some of the factors that could cause actual results to differ are discussed in the company's most recent transition report on Form 10-K and in other reports filed with the SEC. The discussion in this conference call will include certain financial measures that were not prepared in accordance with U.S. GAAP. Reconciliations of those non-U. S. GAAP financial measures to the most directly comparable U.S. GAAP financial measures can be found in the tables contained in yesterday's press release and in our related current report on Form 8-K. These reports are available on the company's website in the Investors section and on the SEC website. Revenues for the first quarter of fiscal year 2017 were $163.3 million, 2% below the prior year's Q1. Services Q1 revenues declined 4% compared with prior year, driven by negative mid-single-digit organic growth, which resulted from shorter-duration turnarounds and a less-than-robust market for NDT spend. International segment Q1 revenues grew by 11% as mid-teens organic growth was slightly reduced by foreign currency. Products and Systems revenues had an organic contraction in Q1, driven by lower sales volume. The company's largest new construction customer in the nuclear industry declared bankruptcy at the end of our first quarter causing us to take a special $1.2 million pretax charge for potential loss on its pre-petitioned receivables. Inclusive of the special charge, the company's net income for Q1 2017 was $1.7 million or $0.06 per diluted share, and exclusive of this charge, net income was $2.5 million or $0.08 per diluted share compared with $0.11 per diluted share in the prior year's first quarter. Despite the revenue decline, the company's gross profit margin edged up slightly to 26.4% in the first quarter compared with 26.3% 1 year ago. Breaking this down by segment, Services segment results, excluding the special bad debt provision were as follows. Operating income declined by $2.8 million or 24% compared with the prior year's Q1 on a revenue decline of 4%. Q1 gross margins declined by 80 basis points compared with prior year, while operating margins declined by 180 basis points to 6.8% as operating expenses edged up compared with prior year due primarily to acquisitions. International gross margins improved by 250 basis points to 30.5% in Q1, while operating income grew to $3 million or 8.9% of revenues compared with results that were marginally above breakeven one year ago. This improvement was primarily driven by a growing Aerospace business, which led to double digit organic revenue growth and improved sales mix and improved utilization of personnel. Products and Systems had a challenging first quarter with sales down 16% and operating income declining by $0.3 million. Adjusted EBITDA for the total company was $13.3 million, down $1.7 million or 11% from the prior year's Q1. Operating cash flows for the first quarter of fiscal year 2017 were $13.4 million, while free cash flows were $9.6 million. Both amounts included a reduction for the payment of a $6.3 million legal settlement, which was accrued in 2016. Total capital expenditures in the first quarter of fiscal year 2017 included a non-included noncash capital lease outlays -- including noncash capital lease outlays were $4.5 million or 2.7% of revenue, well below the prior year's $6.8 million or 4.1% of revenue. We used our $9.6 million of free cash flows to repurchase $6 million of stock and fund one acquisition with $4.5 million of upfront cash. We repurchased approximately 256,000 shares of our stock during Q1 at an average price of approximately $23.41 per share. These shares were purchased at a discount to the company's weighted average stock price for Q1 pursuant to the company's previously announced agreement with Dr. Vahaviolos. As of March 31, 2017, the company had $35 million remaining on its share repurchase authorization. Total debt and capital lease obligations net of cash was $85.4 million at March 31, 2017. Net debt was approximately 1.1 times trailing 12-months adjusted EBITDA. I'll conclude my section with a brief discussion on our expectations of market performance and company specific guidance. Our tally of NDT inspection revenues generated by global public companies serving industrial customers revealed that year over year revenues declined at a double-digit rate during calendar 2016 led by lower spending in the Oil & Gas space. Our conversations with customers indicate that their inspection budgets for 2017 remain subdued and similar to 2016. While oil prices have compared positively to prior year levels so far year-to-date, the market still struggles with sub $50 per barrel oil, as this pricing does not encourage the types of operating or capital spending that is consistent with the significant increase in NDT inspection budgets. For example, one customer recently disclosed that it had a relatively high amount of turnaround activity in its first quarter, but unfortunately this activity did not require a great deal of NDT inspection. Of course, this dynamic can work both ways in that relatively lower levels of customer turnarounds can involve a disproportionately high amount of NDT inspection when conditions require and budgets allow this to occur. Our North American revenue performance in Q1 of 2017 reflects this market dynamic. Our expectations for Q2 are for a similar pattern, and we expect a lift in the second half based upon our knowledge of work schedules for the fall. Against this backdrop, we're reiterating our revenue profitability and cash flow guidance for calendar 2017. And with that, I turn this over to Dennis Bertolotti, President and Chief Operating Officer.

[Dennis Bertolotti:]

Thank you, Jon. I'll now provide updates on our business segments. In our Services segment, over 60% of services revenues are in the Oil & Gas sector. It's no secret that this market became progressively more challenged in 2016 and that thus far spending levels have remained muted in 2017. During our most recent call, which occurred less than 60 days ago, I told you that we were doing things that were within our control that will drive substantially better growth and profitability. These actions entail expanding our offering of related services with the focus on delivering even more value to our customers. On our last call, I explained our vision that builds upon our strong foundation as a leading NDT inspection provider and drives expansion of our services in three key areas

[Sotirios Vahaviolos:]

Thank you, Dennis. We continue to manage the business with the ultimate goal of delivering long-term value, building upon our foundation to always deliver strong results for our customers. (inaudible) our strategy of providing the best value, flexibility, productivity and safety through our diverse network of thousands of multi-certified technicians is the right one in good market and in challenged markets. Indeed, the market still remains challenging, but it feels like the direction will begin to change. We know there is lot of pent-up demand from deferred maintenance projects. We also feel there is upside from our new vision that we start to improve things as well. We have many reasons to be optimistic, including

[Operator:]

[Operator Instructions] Our first question comes from the line of Matt Duncan with Stephens.

[Will Steinwart:]

This is Will on the call for Matt. I wanted to start with the spring turnaround season and get your thoughts on why, in your opinion, you didn't experience a better season or see it out there when product distributors that sell into that market saw an improvement this spring.

[Sotirios Vahaviolos:]

Dennis will answer. Go ahead.

[Dennis Bertolotti:]

Well, I mean, I can't speak for the product guys themselves, not sure what they're selling into. But from the services side, there was still a decent amount of work we were thinking in the fall that there would be some pickup just by talking about their capital spend, but we've seen -- we've seen that the end of the quarter, March was a strong March for us, but it just didn't hold in January and February. So what we think happened is a lot of the areas in the winter that can be good in previous years, be it West or Gulf, they just didn't have as big a turnaround that they did in this year, so it just kind of weighted for a later spring on us.

[Will Steinwart:]

Okay. Then following on to that, March was strong. Can you talk about how you characterize the trends into April? I know May, it's very early, but any early indications there?

[Dennis Bertolotti:]

I mean, we can't really go forward with what that is, but the spring probably won't be what it was in previous years. We believed that fall in the second half is going to be better for us overall. But overall, just, when you look at January and February, whether it was a matter of planning or just capital, reduction of capital, the first 2 months were just weaker.

[Sotirios Vahaviolos:]

There was also the movement on turnaround. So okay.

[Will Steinwart:]

Right. Okay. And then, Jon, maybe one for you, on guidance. Can you talk about the cadence of revenues within each segment through the remainder of the year? I know it's back-half loaded primarily, but if you can speak to maybe each segment, that would be helpful.

[Jon Wolk:]

Yes. Sure. I think that International should have pretty good comps against prior year for really throughout the year. I think that Services will continue to show some weakness in the second quarter and as we get into the third and fourth quarter, particularly the fourth, I think, has got a pretty good opportunity to exceed prior year levels. I think products will have a relatively weaker first half, but given backlog, should have a better second half.

[Operator:]

Our next question comes from Edward Marshall with Sidoti.

[Edward Marshall:]

So as I look at input data coming up through April, input of crude into refineries. I mean, it looks like it might be the highest number ever, certainly in the last 4 years. I guess, that's what you're pointing to as far as kind of the spring turnaround season not looking, not look it's going to shape up well at all.

[Dennis Bertolotti:]

Yes. I mean, this is Dennis, again. I mean, what they are doing is they're trying to push a lot of products through, right, so that, that doesn't bode well for doing a lot of maintenance. So they are trying to keep themselves up under their utilization. And right now, they're just making sure that things are safe and operational. There is not a lot of outside of, the return on investment is still a little bit higher as it had been in 2016. So what they look at is for getting work done. It's still kind of a higher criteria.

[Edward Marshall:]

All right. Right. And so they are able to still operate at a high level without having the maintenance that's required? Or is this, is there something different with the equipment that's able to last longer?

[Dennis Bertolotti:]

No, it's not, there's not a difference in that. You can engineer out some equipment for a certain amount of time, but eventually, everything has to be opened up or looked at in some fashion. So what they can do is they can play with the market to maximize their profitability as well. So right now, we've seen the same thing. The refinery trends that are pushing out a lot of product, but eventually, they're going to have to catch up on that as well. So we don't think this is something that, steel still corrodes, erodes, all those things, crack and break. So you still have to get into it. It's just a matter of you can play a little bit with timing within a certain window, though. It can't last forever.

[Edward Marshall:]

Do you know how many refineries, just out of curiosity, have changed from, say, processing heavy crude to sweet crude?

[Dennis Bertolotti:]

No, I mean...

[Jon Wolk:]

I don't think we would have a metric on that.

[Dennis Bertolotti:]

Yes, we wish we did. I mean, it's got to, they played around a lot when the prices were really high, barrel prices and how much they're doing right now, we don't really track that well, to tell you the truth.

[Dennis Bertolotti:]

Got it. So as we look at the confidence that you talk about for the second half recovery and I put that with the tone of your cutting costs with some consolidation moving into the second quarter. And to right-size to the environment that you feel right now. And I mean, your guidance suggests a relatively strong pickup in the second half of the year, which assumes some turnaround activity but you're cutting costs in front of it. So I'm just kind of trying to parse those 2 together if you can help me out.

[Dennis Bertolotti:]

Yes. This is Dennis. I'll tell you, I mean, our philosophy is we'd rather miss $1 of revenue than try to hold on to $5 or $6 of cost and hope that it comes through. So we'd rather be a little bit cautious. We do really believe that the fall is going to be a good second half for us. But with that being said, I mean, when we talk about it, we, like any business, you have some that are really going good and some that are weaker. So what we're doing is also looking at the ones that are struggling a little bit more and maybe being little bit more focused on them than the ones that are still performing for us. So while we make that comment, it may not really be an across the board type of philosophy.

[Edward Marshall:]

Okay. And where did you say you were cutting those costs again? That's the last question.

[Jon Wolk:]

Several branches that we just don't see likely revenue growth.

[Edward Marshall:]

But what segment?

[Jon Wolk:]

Services. Thanks very much.

[Operator:]

Our next question comes from Tahira Afzal with KeyBanc Capital Markets.

[Tahira Afzal:]

So you guys have done a very commendable job of navigating through a soft environment. And Jon, you sort of highlighted that even last year that this might continue for a while. At that point, you'd mentioned something about maybe some permanent demand destruction as well. As you look a year up, on now, how do you see when that activity picks up, how notable do you expect the pickup to potentially be? Or is it tough to tell?

[Jon Wolk:]

That's a great question, Tahira. I think the answer is, it depends -- depends where we see it, depends in which segment, in which locations and from which customers. So I hate to answer a question with a question. But the reality is, I think we see that -- from a cost structure perspective, we think we're taking the right measures and we'll continue to take them as the calendar year goes on, but it's really -- I think will be very accretive, but it's hard to really quantify that right now.

[Tahira Afzal:]

Got it. Okay. And if I look at -- I keep reading about technology becoming a bigger part of this inspection, etcetera, in many different ways, including sort of tracking through putting different sensors on. Could you talk about whether you're seeing this in your business? And whether -- if you are, whether this is a positive benefit for yourself or is it going to be a bit of headwind?

[Dennis Bertolotti:]

We do see that customers are looking for value increases. We talk about mechanical, along with inspection things like that, so that you can put a combined crew versus two or three different vendors. That same kind of thinking, we also have a lot of progressive technology out there for online and all these other types of technology. And it sounds counterintuitive, but if we can help a customer put an online tool up there where it's hard to reach or it's a hazardous area and get the readings that they need on a continuous basis for something that need to be nursed or equipment that needs to be checked often as opposed to putting somebody in harm's way, it makes perfect sense for us as well as the customer. And being that we're positioned with the technology and the capability to do that, we believe as they go forward with this kind of thinking, that's going to walk right into what Mistras' strengths are.

[Jon Wolk:]

And we have some R&D activity going on along those lines.

[Sotirios Vahaviolos:]

Which is really related more and more to the online monitoring.

[Jon Wolk:]

That's right.

[Tahira Afzal:]

Absolutely. I mean, wouldn't that be cutting edge for yourselves as a consequence? You guys are already there in a sense, aren't you?

[Dennis Bertolotti:]

Yes. We're trying to mix that with our strong base of engineering and our software for knowing where the data is and where to go look. So it's not so much about going around and just hunting for corrosion, it's going knowing where to look for it and putting a team on that exact location. So we believe we have those capabilities where the customer isn't just spending money recklessly to get the information they need.

[Tahira Afzal:]

Okay. And I guess, last question is more on in terms of this year's numbers. Do you need the turnaround season to develop as per plan and what you're seeing and what you're hopeful of to meet the upper end of your guidance range? Or can you guys be nimble around enough around cost if you see that it's not coming?

[Jon Wolk:]

For the upper end of the revenue guidance range, we absolutely do need that. I would say for the upper end of the proper range at this point, certainly, that would be the leading driver. On the cost, as Dennis mentioned in his commentary, we're going to be pretty active not only in the actions that we're contemplating for Q2, but potentially additional actions if the market just doesn't fulfill what we've been told it should realize in the fall. But yes, we would need turnaround activity would absolutely help us reach the upper end, yes.

[Tahira Afzal:]

And I mean, the reason I'm asking, Jon, is a couple of years ago when the market was still challenged, you guys were able to drive a lot of profitability by realigning, restructuring. Is a lot of that low-hanging fruit kind of done away with now?

[Jon Wolk:]

I think a chunk of it's been picked, but there's still more that we're in the process of realizing. So it's not over with. No.

[Operator:]

[Operator Instructions] Our next question comes from the line of Bobby Burleson with Canaccord.

[Bobby Burleson:]

Just curious on, yes, the developments this year, you're pursuing in mechanical services. Is there any update kind of on an expansion in Canada or anywhere else where you are building out that capability?

[Dennis Bertolotti:]

Bobby, this is Dennis. We do have a couple of market areas where we think we're strongest and importantly, the customers are willing to look at that. There are some areas of the country be it North America, Canada and, or U.S. where they encourage and other areas where they don't, just like any technology trend. So we've got a couple of areas that we're focused on pretty heavy where we think the mechanical will be a leading edge for us to drive value. And surprisingly, there is a lot of customers who are actually looking at proposals that are willing to bring in mechanical and NDT at the same time. So it's been a very encouraging reception on their part as well.

[Bobby Burleson:]

Okay. Great. And then in terms of an earlier question about product distributors seeing a little bit better demand. Have you guys gone back and kind of looked at the relationship of your services versus what may be the broader kind of product distribution sees in terms of seasonality, their leading indicator for what you see in the services side? Or do they overlap with you guys, typically?

[Jon Wolk:]

Bobby, I'm not sure that we've really drawn a real correlation there. Sometimes, we'll have a customer who keeps us really busy for weeks on end beyond what our expectation was, and you won't necessarily see that from anybody else in the products range and vice versa. So I would say that we don't really have an excellent correlation as we speak.

[Bobby Burleson:]

Okay. And in terms of mechanical services margins, are you guys still thinking about those being kind of similar to corporate average? Or any kind of update in your thoughts regarding margins there?

[Jon Wolk:]

Yes. It's early, but we do see them in line or slightly exceeding. Well, it depends on the project.

[Bobby Burleson:]

Okay. Great. And some of these opportunities, NDT with mechanical. Customers are interested and looking at that. How long does it take really to get -- something like that going from a proposal to real revenue?

[Jon Wolk:]

It's a great question. It's one that we're wrestling with right now. We have several proposals out there, and I think we're awaiting some answers. So we're hoping that before the year's out, we'll start to be seeing some of those and have them moving the needle a little bit.

[Operator:]

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

[Sotirios Vahaviolos:]

Okay. I would like to thank everyone for listening, and we wish you a great day. Thank you very much, Liz.

[Operator:]

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