Mistras Group Inc (MG) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter three 2010 Mistras Group, Inc. earnings conference call. My name is Jeff and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will facilitate a question-and-answer session. (Operator Instructions).

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Dr. Sotirios Vahaviolos. Please proceed, sir.

Thank you very much, Jeff, and good morning to everyone. Welcome to the Mistras Group earnings conference call to discuss our recent company performance. Again, my name is Sotirios Vahaviolos. I am the founder, Chairman and Chief Executive Officer of Mistras.

Joining me today is Mr. Pete Peterik, the Company Chief Financial Officer. The purpose of today's conference call is to discuss our recently released financial results for this Company's third quarter that ended February 28, 2010. Our primary objective of this call is to provide you with a clear understanding of our performance and prospects. This discussion is intended to supplement our quarterly earnings release and our filings with the Securities and Exchange Commission.

Pete will begin with a brief disclaimer about the information we are providing today and a summary review of our financial results. I will then follow Pete with the few remarks and observations about our performance, marketing activity and prospects. We will then answer any questions you may have.

With that, Pete, let me turn it over to you.

Thank you, Sotirios. First, I want to remind everyone that our discussions during this conference call will include forward-looking statements. Actual results could differ materially from those projected and factors that could cause actual results to differ are discussed in the prospectus for our IPO, dated October 7, 2009, and our reports on Form 10-Q and Form 8-K.

Also, the discussions during this conference call will include certain financial measures that were not prepared in accordance with US generally accepted accounting principles. Reconciliations of these non-US GAAP financial measures to the most directly comparable US GAAP financial measures can be found in the Mistras Group, Inc.'s current report on Form 8-K dated April 7, 2010. These reports are available on our website at www.MistrasGroup.com in the investor's SEC filings and reports section and on the website of the Securities and Exchange Commission.

Now I would like to present summary financial results for our third quarter. As a reminder, we have a May 31 fiscal year-end and our third quarter ended February 28, 2010.

For the third quarter revenues, were $64.4 million compared to $47 million for the third quarter of fiscal 2009. The increase of $17.4 million or 36.9% was attributed to revenue increases in all of our segments, with our Services segment leading the way with a 40.7% growth rate.

For the first nine months of fiscal 2010, our consolidated revenues were $192.3 million, or 25.5% greater than the comparable period in fiscal 2009. Again, our Services segment had outstanding growth of 32.5%, while our other segments were even with the similar period last year.

Our gross profit was $17.6 million in our third quarter of fiscal 2010. This represents an increase of 34.5% from the third quarter of fiscal 2009. As a percentage of revenues, our overall gross profit margin was 27.4% and 27.9% for the third quarter of fiscal 2010 and 2009, respectively.

Our fiscal 2010 third-quarter operating income was $1.6 million as compared to a $0.3 million loss for the third quarter last year, which included $1.2 million for nonrecurring items. All of the costs after gross margin -- after gross profit used to determine operating income were 24.8% of revenues for the third quarter this fiscal year compared to 28.5% for the same quarter last year, an improvement of 370 basis points.

Selling, general and administrative expenses included in this determination of the quarter's income from operations were 21.9% of revenues as compared to 25.4% of revenues in the third quarter of fiscal 2009, an improvement of 350 basis points.

Net income attributed to Mistras Group, Inc. was $0.8 million in the current quarter compared to a net loss of $0.8 million in last year's third quarter.

Earnings per diluted share were $0.03 versus a negative $0.04 for last year's third quarter. Last year, we did not have the impact of the newly-issued shares of our public offering in this calculation.

We use adjusted EBITDA, a non-GAAP measurement, to evaluate our performance, as we believe this represents a better short-term metric, given our acquisition amortization, non-cash stock compensation expense and certain other nonrecurring items.

For the third quarter of fiscal 2010, our adjusted EBITDA was $6.5 million or 10.1% of revenues compared to $4.1 million or 8.7% of revenues (technical difficulty) 2009. This represents a 58.6% increase in adjusted EBITDA and a 140 basis point improvement in margin.

Now with respect to our balance sheet and cash flows, we continue to be pleased with our performance and related metrics. For the first nine months of fiscal 2010, our cash flow from operations was $12.3 million. For the first nine months of the fiscal year, cash used for capital expenditures was $1.7 million, and cash used for acquisitions were $14.4 million. Total capital expenditures, including equipment financed through lease finance (technical difficulty) leases, was $6.7 million or 3.5% of revenues.

As of February 28, 2010, our net debt was $15.4 million, including cash and cash equivalents of $13.7 million, and we have full availability under our $55 million revolver.

With that, Sotirios, I will turn it back to you.

Thanks, Pete. I am sure most of you saw the announcement last week that Pete is retiring. I would like to thank Pete personally for all he has done for Mistras in the past five years. Pete has been a major factor in the growth and development of the Company, and he has always been a great partner and colleague for me and everyone else on the Mistras management team. He was also a key member to our team for the success of our IPO last year.

As we noted in our release, Pete has agreed to remain with the Company until a successor is named. Pete, best wishes and good luck from all of us at Mistras.

Now I was like to add several observations and comments to Pete's remarks. First, I will start by reminding you that Mistras has a unique business model of technology-enabled asset protection solutions for the world's aging industrial and public infrastructure. Our model is to be that of a single-source provider, employing industry-leading products and services.

It begins with mechanical integrity review, which includes assessing and cataloging existing assets, recommending nondestructive inspection, either traditional or advanced, to inspect the customer's assets. We use our PCMS proprietary world-class data warehousing and analysis software for engineering computations and 24/7 online monitoring of critical assets, as well as determining compliance with standards, codes and regulations.

Overall, we are pleased with the third-quarter results, especially in light of the recent weakness in some of our end markets. While we were disappointed in our profitability margins this past quarter, we are focused on executing our plans to rapidly improve margins going forward.

Importantly, we believe the significant number of recent contract wins we have had provide the foundation for increased profitability, and are working aggressively to pursue additional high-margin opportunities. I strongly believe that downturns are ideal for gaining market share, especially when you can offer customers complete technology-based solutions.

Reflecting our market share gains, we set a new record for third-quarter revenues, with 37% growth over last year. All our segments had double-digit growth and the overall organic growth rate for the quarter was 24%. In the industrial markets which we serve, few customers or competitors are showing any growth, let alone the 26% overall and 14% organic growth that we have achieved in the first nine months of fiscal year '10.

In our Services segment, which has clearly paced our growth, we have won a significant number of new multi-year contracts, which, in addition to the ongoing recurring revenue, are the platform for expanding advanced services in the next six to 12 months.

During this quarter, our Asset Integrity Management software Center of Excellence won its first $1 million contract for implementing our enterprise PCMS software to create a well-managed inspection infrastructure for a key customer. We believe that this demonstrates that customers are recognizing the value of our advanced offerings to the industry.

Now, a couple of words about our segments. Our Services segment increased revenues in the quarter by 40.7% or $15.3 million to $52.9 million. The organic and acquisition growth rates in this segment were approximately 26% and 14%, respectively.

In the Products and Systems segment, our revenues for the quarter not only increased by 12%, but also delivered an improved gross margin of 860 basis points as compared to the same quarter last year.

Finally, our International segment revenues also had organic growth of approximately 19% and improved gross margin. These two larger segments, although representing approximately 18% of our revenues, contribute higher margins and, more importantly, together with the Services segment, provide the high technology that drives our overall growth.

We are very comfortable with our continued growth prospects. Importantly, we benefit from recurring maintenance-based inspection and engineering services, which are required by our customers on a daily basis, as opposed to revenues from capital-intensive projects. Currently, we have over 60 sites where we perform this necessary function of outsourced inspection that we refer to as evergreen accounts. Additionally, as our customers look to lower their costs by reducing their in-house resources, we can confidently fill their needs with our asset protection solutions and engineering services on as-needed basis.

Our forecast for the remainder of the year shows continued revenue growth opportunities not only in oil and gas, but also in power generation and transmission, chemical markets and infrastructure. Especially -- specifically, bridge integrity monitoring remains at the core of our business model. All the markets such as aerospace and industrial sectors have been soft this year, but we are cautiously optimistic of increased work in the latter part of calendar year '10.

In the near term, our growth prospects are advanced by strong -- I am sorry -- they are enhanced by a strong level of maintenance-based work in the fourth quarter. We would expect additional revenues, both traditional and expanded advanced services, for multi-year service contracts won this fiscal year. Further, we see a continued payback from our investment in our Centers of Excellence, which are the incubators of new technology and customer solutions, as well as exciting new projects in our other segments.

These include the delivery of an ultrasonic imaging system to inspect the composite materials for the Joint Strike Fighter, installations of systems to monitor bridges on a 24/7 basis, wind turbines and other structures. In addition, our significant research and development work, led by 30 Ph.D.s around the world, will also lead us into other applications for asset protection solutions.

The rapid growth in our Services segment presents a challenge, since much of the revenue increase came from new multi-year contracts where the initial customer services needs are traditional NDT, as opposed to higher-margin advanced offerings, which along with contract start-up costs produce lower margins. Combined with pricing pressures which are tied to the soft economy and other changes in the mix has led to lower profitability in our time and material billing. Although unbillable time decreased from the third quarter of 2009, it is still remains above our targeted levels.

In the third quarter this year, certain of our customers were managing project activity and turnarounds differently than in the past, which has created inefficiencies in the planning and poor utilization of labor. Although this practice is relatively new, we are adjusting our practices to more effectively manage these situations.

Our business model continues to provide predictable and consistent revenue, less vulnerability to more cyclical capital projects and is the base for leveraging our growth. As I have mentioned before, both private and public infrastructure continues to age, and needs to be assessed and monitored. We believe the solutions we offer are not optional, but critical. These trends should enable us to serve our customers more efficiently and have a positive impact on our profitability.

I would be remiss if not thanking our employees for their participation in our success and mention of the new safety awards presented to Mistras this quarter. We received the Sunoco Safety Award for the eighth consecutive year in Philadelphia area for the Services division's exceptional safety performance, and the seventh safety award while doing contract work at the Chevron Richmond Refinery in California. Our customers must trust that we can do the job of their inspection engineering departments, and being safe is a key factor in developing that trust.

Finally, as to our outlook for the last quarter of the year, we continue to see uncertain markets conditions in certain industries and geographic markets, but overall, are bullish about our own business prospects and continued improvement in profitability. As noted in our earnings release, we believe that our 2010 revenues will be at the high end of our previously announced range, while adjusted EBITDA will be closer to the lower end of our range.

Specifically, our current outlook calls for fiscal year 2010 revenues in the range of $266 million to $286 million -- $280 million, while our adjusted EBITDA will be in the range of $37 million to $41 million.

We have a clear path forward, with a proven and consistent business model to further improve our margins. Our goal is to be that unique global technology-enabled asset-protection solutions company, delivering strong returns to our shareholders through continued secular growth and improved profitability, while providing technology, productivity and value to our customers.

We look forward to our fourth quarter and to achieving most of our goals in fiscal 2011, but we should not forget that we are on our way to another 30% revenue growth and a robust 25%-plus adjusted EBITDA growth for our current fiscal year 2010.

That concludes our initial remarks. I will open it for questions.

(Operator Instructions) William Stein, Credit Suisse.

Sotirios, you are raising revenue guidance a little bit today for the full year. Just so we can model it, do we think of that as coming from Services, where the growth has been strong, or perhaps in one of the other segments?

It basically comes from a blend of business. We won a lot of new contracts, as well as some of the services that we tried to market for a while now really were sold to the customers. And one of that, as I have mentioned, basically was the Ames Project.

Okay, great. You mentioned a moment ago that some customers are managing turnarounds differently today. Can you give us a little bit more detail in what way? Is it just applying a little bit more pricing pressure on your business or is it something more complex?

Well, in my 35 years of experience in the NDT industry, we never had shutdowns that -- we started with 40 to 45 days, we planned for 40 or 45 days, and the customer at the last moment, while we were working on the shutdown, cut it to 10 days. That automatically does a lot of inefficiencies for us. And of course, the amortization of our hard work of training those employees that we bring on the shutdown was amortized over 10 days rather than 45 days. So that created inefficiencies and of course losses for us.

That is helpful to understand that. Just one other quick one and then I will get back in line. The new EBITDA guidance suggests a bigger than I would expect quarter-over-quarter ramp from fiscal Q3 to Q4. So are we expecting somewhat of a rebound in the Services segment or are the others improving more?

I think it is really consistent with our fourth quarter. I think it is very consistent and I think it will be in line with past fourth quarters.

Got it. Thanks very much.

(multiple speakers), but that is what it is, okay. Because our businesses, as we have said before, is really cyclical.

Jack Atkins, Stephens, Incorporated.

Good morning, guys. This is Jack on the call for Matt Duncan. My first question, Sotirios, is to your comments on your efforts to improve gross margins. I guess could you go into some more detail on your strategy to improve your gross margins?

Well, first of all, Jack, pricing pressures have slowed down since the start of 2010. We didn't really have any customers to come in and asking for reduction on their prices. That was the first good sign.

The other thing is higher revenue will drive higher profitability. Okay? We also see something very interesting to us. Upward trends and the depressed industries such as aerospace, heavy industry. This was really the mainstay for us in the in-house work, which is really the traditional NDT that is very profitable for us. That we see really a change.

We also are aggressively looking to match our available manpower capabilities to our ever-changing demands. We are very careful more to make sure that we have enough people rather than have too many for our future work.

Okay.

And of course, as always in our business, is the blend of traditional to the advanced NDT. We see more and more advanced NDT, especially in the fourth quarter.

Okay, great. That is very helpful. And then just shifting gears here and looking at the acquisition environment, could you talk a bit about that? And also, could you maybe address sort of the desire on the part of potential acquisition targets with regard to price? Are they being more reasonable about price? Are you still seeing the bid/ask spread between what you're willing to pay and what targets are willing to take?

Our strategy is that if we don't get an acquisition on our price, we are going to walk away. We have walked as much away from many companies as we have acquired. So our strategy is we will pay what we think is reasonable, and if the seller is looking for more, we are going to walk away.

Okay, that is very helpful, guys. Thanks for your comments.

Scott Levine, JPMorgan.

Good morning, guys. It is actually Rodney Clayton here. So first of all, can you talk a little bit more generally about your expectations for the turnaround season here? I guess you touched on it a little bit -- with describing how some of your customers are handling turnarounds differently more recently.

But generally, as we kind of head into the summer season here, as the refiners get ready for driving season and refinery margins remaining under pressure, generally what are you expecting relative to what we have seen, I guess, over the past couple of years?

Basically, we have always said that June, July and December are the worst months, the lowest in revenues months of the year. So from our situation, we see also some shifting of the shutdown or at least -- or maintenance work into the summer this year, which I think will be beneficial to us.

Because a lot of the refineries, as you know -- you mentioned refineries -- but there is a lot of other work that we do on the upstream and midstream in the oil and gas industry. A lot of the work, the maintenance especially work, has to be done, and you cannot delay it forever. Because if you delay it, you are going to have accidents, as some of you already are aware of.

Okay, that is helpful. Secondly, are there any drivers on the legislative or regulatory side that you see that might be beneficial to you going forward? I know there is proposals for some pretty major pieces of legislation -- a climate bill, potentially a highway transportation bill. Do you see any potential benefit from that type of legislation?

Well, if they put money for monitoring and rehabilitating bridges, we will see a lot more going our way. As a matter of fact right now, we are doing more bridges in the United Kingdom than we do in America.

Okay, understood. One more, if I may. And there may be an obvious answer to this question, but obviously there have been some pretty high profile mining accidents recently. And realizing that a lot of times those incidents are caused by gas explosions and things of that nature, is that an area of potential for you going forward at all?

In that area, we have what we call predictive maintenance. People really, when they dig and they create the mines, they use vibration technology to monitor that. As of today, the only thing I can tell you is we sell accelerometers to them. But I will also mention to you that we sell more to Australia than we sell in this country.

Okay, understood. Thanks a lot, guys, nice quarter.

(Operator Instructions) Richard Eastman, Robert W. Baird.

Good morning, Pete and Sotirios. Just a question. Sotirios, I wanted to circle back for a minute or two on the gross margin on the Services side. Given what you are seeing in the marketplace today -- so we are seeing smaller, kind of abbreviated projects -- we have locked down some business contractually, some new business.

How should we think that your margins will improve -- kind of what would be the timeline that we should think about your margins on the Services side being able to improve, given that some of this contract work will certainly proceed through the fourth quarter into next year. What would be a pace that we could see some improvement there on the margin side?

I would assume that will be very gradual. It's not going to be really instant; [it continues], but it will be gradual. Of course in the second quarter and the fourth quarter, you always have the margins that you are looking for. But in the first and the third quarter, it will be gradual.

So your gross margin on the Service side can improve in the fourth quarter -- how? I mean is it utilization or is it the types of services that would be fourth-quarter versus third-quarter?

Basically, as I said, on the second and the fourth quarter is when you have not only shutdowns, but you also have maintenance work. That is where you really find some of the problems that you don't see on a day-to-day basis. That is when you are bringing in advanced technologies to really characterize them a lot better than you did before.

That automatically drives our advanced technologies in these areas. And so that is really how -- you typically, for instance, you don't have as many crews of (inaudible) technology on the third quarter or the first quarter as you do on the second and on the fourth quarter, and these are very high-margin areas.

Okay, so the mix can shift. Because I would think from a pricing standpoint, you already locked in on the pricing side, right -- for the next three to six months?

Well, you're not always -- it depends on the company. You may be locked on your evergreen accounts, but you are not locked on everybody else.

Okay. And then the other question I've had was when I look at your total operating expense number, is there anything in that number in the third quarter that goes away in the fourth quarter? In other words, does any of your underutilization show up in the OpEx number versus the gross margin number?

That number tends to be pretty consistent and pretty flat. The operating expense portion. Things that would certainly impact it to a certain extent might be a little bit of administrative overtime, etc. -- what is going on with the provision for doubtful accounts. But there is really nothing in there that moves a whole lot, so that is why in periods of higher volume, we bring more to the bottom line.

So our operating expenses in dollars from the third quarter to the fourth quarter should change little?

Very little, yes.

Yes.

Okay. And then just on this utilization issue, if one of my technicians is underutilized and spends some of his time training or bid proposal or prospecting, does that hour or two of his time, does that show up in OpEx or does that show up, again, still as a cost of goods sold?

That shows up as a cost of goods sold, and that shows up as a component of the gross margin.

Okay, okay. So underutilization will show up in that cost of goods sold number; it never switches over to the OpEx number.

As well, Rick, as will higher vacation periods, holiday periods, et cetera. So again, in the fourth quarter, we don't have those periods, so the margins will improve.

That is really what affects the December timeframe, Rick.

Okay. Very good, thank you.

(Operator Instructions) William Stein, Credit Suisse.

Thanks. Guys, I think you mentioned that fixed capital expenditures including capital leases was, I think, 3.5% of revenue. I think historically it has been a bit higher. Can you comment as to what we should think about that, how we should think about modeling fixed capital expenditures going forward?

I think directionally where we are year-to-date is kind of an approximation. We are certainly down from previous years because we have invested a lot of capital in the past and we have the equipment at our disposal, so I would expect that trend to continue, Will.

So something below -- I think historically it has been around 4.5%, so think a bit more like 4%, 3.5%, something like that?

I would assume basically 3% to 4% is more realistic, and it always by the way goes hand in hand with new centers of excellence we create. That is where we put a lot of money sometimes, for the new centers of excellence, especially advanced centers of excellence.

I mentioned before (inaudible). That is where you put a lot of money on, for capital equipment.

One other one, I am just realizing looking through my model that taxes were quite a bit lower this quarter than they had been in the past. How should I think about that in Q4 and then going forward?

We, in Q3, included an adjustment of our ETR, or effective tax rate, to reflect updated estimates to the distribution of where the taxable income was going to come from. It also included -- reflected our just-filed fiscal 2009 tax return, and some 1018 adjustments. But at the end of the day, our effective tax rate currently is estimated to be approximately 42%. And this compares to 45% last fiscal year.

And 42% going forward or does that continue to ratchet down?

42% certainly for the foreseeable future, and then that gets adjusted based on the timing differences and everything else in the tax provision as we go forward.

Okay. Thanks.

Richard Eastman, Robert W. Baird.

Pete, was there any impact on the International business from currency here -- sales impact?

In the third quarter, there was a bit of a positive impact for currency, year over year. Quarter over quarter, about 2.5% of the total growth in revenues were impacted based on a weaker dollar. And again, you have to be careful, because we are really comparing quarters, not sequential quarters there.

Yes, that is year-over-year, and that is just the international, 2.5%?

No, 2.5% would be the total impact across all of the segments.

Okay. All right. Sotirios, you had mentioned in your statements the gross margin on the Products and Systems side, are we kind of sustainably up in the mid-50s or is that going to continue to bounce around?

Basically, in the Products, we will be in the 50 to 55 range. It's not going to go below 50, it's not going to go above 55. But that is the range that we are really --.

At the same time you have to remember, Rick, you have to have a certain volume, okay? In the products, you are looking for the breakeven, and if you are exceeding the breakeven, our margins are very high.

Yes. And is there any pricing pressure on the product side?

Not really. It is more application-related. And of course, last year, don't forget you had a terrible capital market. Capital -- basically -- in the capital, everything was slowed down, everything was slowed down. We won a lot of these awards, like I mentioned of the JSF, because it was a military project. Okay?

The industry is just opening up right now. It was really the industry -- the capital purchases were very closed from the industry before. And it is really we are very encouraged also that it was really better for us in Europe and abroad. That was really -- last year was almost dead.

I just want to flip one more question on this. I just want to go back to this gross margin on the Services side one more time. When you talk about your customers -- and you had commented about a typical project would be you plan for 40 to 45 days; now they are more like 10 days. And that is the customer downsizing the scale of the project?

Well, I think basically the customer spends their money, because it is not only us during the shutdown. There are the mechanical contractors; there are many, many contractors. And they have very limited budgets, and when they find something that is more related to mechanical, they spend their money there. And that really is what has happened.

And the impact on your business is that, again, your guys aren't utilized for 40 to 45 days; they are utilized for 10, and you then need to reschedule them. Or is it an overtime issue?

It is really an issue of really rescheduling them to other areas. And at the same time, when you put 40, 50 people, as we typically do on a shutdown, you are really -- you are spending one weeks of training for safety and other issues, that now that cost, you amortize over 10 days rather than 45 days.

Okay, interesting. Okay. And you don't have to pick up -- is there any shift in the per diem costs or anything? Are they assuming you will pick that up or are you still able to pass that through?

Per diem is always an expense, but in different areas is different kind of numbers. Different companies look at per diem differently, but we always get per diem when we shift people -- when we bring, let's say, people in California from Texas, we will charge a per diem.

Okay, and they are still paying that?

They are still paying it.

Okay. All right, thank you.

Okay, ladies and gentlemen, this is going to conclude the Q&A portion of this call. I would now like to turn it back over to Mr. Vahaviolos for closing remarks.

Thank you very much for attending our session and we hope to do better in the future.

Ladies and gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect. Have a great day.