Mistras Group Inc (MG) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fiscal 2015 first-quarter Mistras Group Incorporated earnings conference call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I now like to turn the conference over to your host for today, Sotirios Vahaviolos, CEO. You may begin.

Francis, thank you very much and good morning to all. Welcome to the Mistras Group earnings conference call. This is Sotirios Vahaviolos, Founder, Chairman, and CEO of Mistras Group. Joining me today is Jon Wolk, the Company's Executive Vice President and CFO.

In today's call, we will review our Group's financial results for the first quarter of fiscal year 2015 that ended August 31 and discuss our prospects going forward. I will start by saying I am very pleased with our 23% revenue growth in the first quarter and with the strength of Mistras's service business and its continuous strong organic growth, but disappointed with the decline in our profitability and unfavorable leverage.

Our services segment had 10% organic revenue growth and our total Company had 9% organic growth in the first quarter. Most of this growth was driven by increased inspection requirements at new and existing customers.

We have spoken previously about our significant investments that we are making to strengthen our franchise for this year and beyond. Our investments in people, processes, and equipment are going as planned.

We are extremely pleased with our acquisition of NACHER Corporation and our interest in the important offshore market in an extremely credible way with world-class service capabilities. The addition of NACHER helps to uniquely position Mistras as a single-source solutions provider to our integrated energy customers for their downstream, midstream, and upstream operations in the Gulf and beyond.

Opening markets organically takes time, cost, and patience. These initiatives often take longer than expected. Because of key customers' demand, we expected our Canadian oil sands startup would get off to a quicker start.

Although this initiative is slower developing than planned, we remain excited about the significant growth opportunities and for gaining as first-time customers new major energy companies besides our original sponsor.

Our Canadian business development efforts are very promising and we have several indication the results will improve in the second half of our fiscal year, as we have previously stated.

The impact of these investments as well as impacts from market-based increases in labor costs and an adverse sales mix caused our margins to compress during the first quarter. Tighter market conditions in the Gulf led us to proactively increase annual wages at the start of the quarter to aid employee retention.

We chose to do this so that we could maintain our stocking levels for the upcoming fall turnaround season that looks to be busy, even though we had not obtained pricing adjustments from our customers. We are now engaged in a number of customer discussions to obtain pricing adjustments to offset these added costs.

While I am disappointed with our Q1 profitability, I am encouraged by our strong growth. We look forward to a healthy fall turnaround season, the impact of several initiatives that Jon will discuss, and the added contributions from NACHER acquisition that will enable us to meet our stated profit guidance.

And now I will turn it over to Jon, who will cover the Company's summary financial results. Jon?

Thank you, Sotirios. I remind everyone that the 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 annual report on Form 10-K and in other reports filed with the SEC. Also the discussions during this conference call will include certain financial measures that were not prepared in accordance with US GAAP.

Reconciliations of those non-US GAAP financial measures to the most directly comparable US GAAP financial measures can be found in the Company's current report on Form 8-K, filed yesterday.

These reports are available on the Company's website in the investor section and on the SEC website.

First I will summarize our first-quarter results and then I will comment on our initiatives to address our profit margins. Revenues for the first quarter of fiscal year 2015 grew 23% above prior year, driven by a strong 27% growth in our services segment, of which 10% of the services' growth was organic.

International revenues grew by 6%, driven primarily by FX, while products and systems' revenue was flat. Our first-quarter gross profit grew by 7% over prior year on a revenue gain of 23%.

Gross margins were 25.2% in the first quarter compared with 28.9% in prior year. The decline in growth profit percentage was due to our continued investment in Canada, the unreimbursed wage increases that Sotirios discussed, and a less robust sales mix, both in the services segment, where advanced services comprised 13% of revenues compared with 15% in the prior year's first quarter, and in the UK.

Operating expenses, excluding acquisition related costs, were in line with prior year as a percentage of revenues. Operating income, excluding acquisition-related items, declined to $2.7 million compared with $7.5 million in the prior year's first quarter.

Net income in the first quarter was $1.7 million or $0.06 per diluted share. Adjusted EBITDA in the first quarter was $13.1 million compared with $15.8 million in the prior year's first quarter.

Finally a few comments on the Company's balance sheet and cash flows. Mistras generated $14.5 million of operating cash flow during the first quarter of fiscal year 2015 compared with $11.5 million in the prior year's first quarter.

The Company used $3.8 million of cash for capital expenditures and also made non-cash outlays to lease $2 million of capital equipment. The Company's aggregate capital investment during the first quarter was $5.8 million or 3.5% of revenue.

The Company's free cash flow, defined as cash provided by operations less cash used by capital expenditures, was $10.7 million before the net use of cash for acquisitions of $36.8 million.

The Company's debt and capital lease obligations net of cash was $144.3 million at August 31, 2014, compared with $87.6 million at May 31, 2014, a ratio of 1.8 times forecasted adjusted EBITDA.

As of August 31, 2014, Mistras had an undrawn revolver balance of $23.4 million.

And now I will comment on the actions we have launched to address the contraction in our margins. Although we are excited about and committed to the investments we are making, we are not satisfied with our present profit margins or profit levels.

For this reason, we have launched several initiatives to improve margins during the current fiscal year 2015. These include: first, as Sotirios mentioned, we are already in pricing discussions with some of our largest customers and will expand this effort across our customer base.

Second: contract pricing reviews will become an ongoing process with executive oversight to ensure better contract execution and better alignment of pricing and labor costs going forward.

Third: we have commenced a worldwide review of operating cost on a region-by-region basis that is designed to identify savings opportunities and reduce costs. Fourth: reducing unbillable time in certain international countries.

And fifth: our ongoing business development efforts in Canada have generated a Plan B, which allows us to utilize the resources we have put in place to support Plan A when it eventually comes about, as we continue to believe it will.

I am confident that this plan will drive results in the second half of our present fiscal year. The management team is united in its common understanding of what is needed to be done. We have a shared purpose that is strongly supported by our CEO, a shared sense of urgency to execute on this plan, and as always, a mindset that we will work with our customers to achieve solutions that continue to provide them with superior value.

And with that, Sotirios, I turn it back over to you.

Thank you, Jon. I am very pleased of my team. They have recognized the opportunity in front of us and they have created a plan that I endorse to improve our results. I will comment more on this in a few moments, but first, I will update you on some key developments in our business.

First I will start with the services segment. Oil and gas chemical opportunities remain strong. Besides our evergreen run and maintain business, we were awarded two important capital projects during the quarter.

The first one we were awarded the NDT inspection services for the second phase of a major three to five year Gulf Coast LNG capital project. We previously provided prebuilt engineering services and advanced implementation software tools to this customer from our AIMS engineering group. This contract award is a terrific example of our single-source concept.

Second, we were awarded a multimillion dollar contract to perform NDT inspection services for a large propane dehydration capital project in the Gulf. In other business, we secured a multimillion dollar turnaround for a refinery in the Midwest owned by a major integrated energy company.

Also we won our first Utica shale regional midstream inspection project. For PCMS inspection data management software, we received additional orders from one of our nation's largest natural gas and crude oil pipeline companies as well as another major energy company that is targeting implementation at over 45 of their terminals nationwide.

In the power generation sector, we are extremely pleased that we have become the primary inspection provider for PSE&G nuclear fleet with a five-year agreement. We are also pleased to announce our multiyear new contract with Alliant Energy, where we will provide quality assurance and [reside] services for its major capital project in the Midwest.

Our recent teaming agreement with Altran NA has already produced five engineering and inspection contract awards. All told, Mistras engineering inspection services will service substantial fall projects and outages.

With our advanced inspection services, engineering service expansion, and proprietary online monitoring systems and products, Mistras continues to gain additional nuclear, fossil, alternative, and renewable power market share. Our products and systems segment continues -- profit levels were in line with prior year.

Our products and systems segment, besides providing proprietary technology to our services sector, continues to focus on improving its (inaudible) services in aerospace, automotive, power and chemical industry opportunities and on reducing its cost.

Sales of our newly released UT Tablet, portable PAC AE, and valve leak detection instrument, along with multiple orders for our online boiler tube monitoring surveillance systems, help to drive incremental gross margin, as did repeat orders for advanced inspection systems from leaders in the automotive and the industrial gas industries.

Moving to the international segment, our international segment continues to underperform as we finalize the integration of the companies we acquired the past two years. While there are signs of improvement in EMEA and South America, we expect profitability to return in the second quarter.

Our concentration in run and maintain maintenance business and duplication of the US model is starting to show improvements abroad. In France, we were awarded two significant turnarounds for the fall and the spring of this year, all at our major evergreen client. We will deploy a complete range of services, including advancing the team.

Our French fatigue and fracture mechanics lab was awarded two projects to perform for components of the Airbus A320neo. Our lab was chosen for its ability to design tailor-made and complex destructive tests for our clients.

At another French in-house services NDT [line], we expect to see improved volume for the remainder of this year. During the quarter, we hired an experienced aerospace business manager to improve profits for our in-house activities in Europe for NDT and destructive testing.

During Q1, we also engaged with important training of our French GMs and project managers in contract management and overall profitability enhancement.

In Germany, we continue to expand our focus in advanced NDT solutions with several services projects at our key evergreen clients in the chemical industry. Slowly, our German operations are becoming strong players in the field of advanced NDT while also continuing to expand their unique relationships with key composite manufacturings in the field of destructive testing to fully support the ramp-up of the Airbus programs.

In the UK, we plan to be fully operational in Aberdeen in the third quarter to target the offshore market. Business for offshore North Sea wind turbines engineering services rope access is running well. And a framework agreement for Europe has been signed with a major European wind turbine OEM.

With continuing increased incentives between our European operations coupled with productivity and efficiency contract management, we are more optimistic about our future performance in EMEA.

Finally, in South America, we continue to downsize our operations and prepare ourselves with better contracts that will result in profitability in the third quarter of fiscal year 2015.

And now I will provide my closing remarks. We ended our fiscal year 2013 almost a year and a half ago with decline in organic growth. At that time, we emphasized our growth initiatives and our organic growth accelerated through fiscal year 2014 and into fiscal year 2015 as a result.

The strength of our market position affords us many opportunities to grow, but emphasis in profitability is now paramount. Of course, we are still committed to leveraging the power of our brand in the marketplace to continue to grow and be even more relevant to our customers.

We are committed to increasing profits at a faster rate than revenues. This has not always been our priority, but is now foremost in our minds. As I said earlier, I am proud of my team and their initiatives to improve our results. We expect the seasonality will significantly help to improve results in our second quarter. And as Jon stated, we expect these initiatives will begin to improve results in the second half of our present fiscal year 2015.

Also we expect that a healthy fall turnaround season as well as income earned by the NACHER acquisition will help to offset our Q1 shortfall. For this reasons, we increase our revenue guidance by $25 million to a range of from $705 million to $730 million and remain confident with our EBITDA guidance range of $78 million to $84 million.

As I conclude this conference call, let me thank our 5,800 loyal and safety-conscious employees, our loyal customers, and our valued shareholders.

That concludes our prepared remarks and would like now open the floor for questions. Francis?

(Operator Instructions)

Andrew Obin, Merrill Lynch.

Hi, Sotirios. Andrew Obin. Hi, how are you guys? Just a question on pricing. So when did you guys realize that labor pricing was an issue?

Andrew, I think we've been feeling these pressures now for a number of months. The question about when to actually go-to-market and talk to customers was really sort of an internal debate. And in the end, we opted to make sure that we could have the resources in place and the customers' discussions now have been following subsequent to that decision.

I completely appreciate that, but the question, then, when you guys provided guidance the last time around, it is sort of seems you were already aware of the fact there were these pricing pressures that were not addressed.

So I'm just wondering, you know, how did the process work that it seems that it's something we were aware of for a while, yet somehow, it's still a surprise in terms of the guidance. Where did the process go wrong?

I'm not sure the process went wrong. What we said is we are maintaining the guidance. The guidance has a fairly wide range in EBITDA; there is some additional incremental EBITDA that will come from the NACHER acquisition.

We are still within that range, so we didn't guide to a specific quarter, but we did say that the second half would be better than the first in terms of year-over-year measurement.

I guess the broader issue for me, in 2012, you guys had 436 -- $437 million in sales and you earned $0.76. You know, it's four years later and we are going to make over $700 million in sales and we are probably going to earn less money.

So I guess this is where I'm a little bit lost. It just seems -- I appreciate the message, but it just seems something is broken. I'm not quite sure what it is.

Well, there's been a lot of transition in the business model. There's been a lot of changes. And just to correct you, it's been three years later -- we are in the third year following that year.

We are taking a lot of action steps to address profit engine here and to get things on the right trajectory. There are factors that has been present in the marketplace, Andrew, since the date of those earnings.

I think most notably, I think there are different pricing dynamics in the market and different competitive dynamics within the customer base than we were encountering at that time. So the management team has been dealing with that and dealing with that reality and we have strategies in place to counteract what we are experiencing.

I appreciate it. And just a question on end markets. So what is your view -- I know you guys had a conservative view on the turnaround season in the US. Are you feeling any better about it? What does the energy prices mean for the turnaround season, if you could give us color on that? Thank you.

Yes, the turnaround season is a lot better than it was last year. We see a -- we are already busy and we think that this will be an outstanding fall season.

Terrific. Thank you very much.

Justin Hauke, Robert W. Baird.

Good morning, guys. Thanks for taking my questions here. Can I ask -- I know you guys have just talked about it a little bit in the past, but can you refresh us on just how your contracts are actually structured on these contracts? How does the negotiation work?

Because I think -- we are under the impression that most of what you do is under sort of a cost-plus structure, but maybe that's wrong. Can you just kind of talk a little bit about how the negotiation process works?

Yes, Justin, most of our contracts are on a time and materials basis.

I'm sorry -- that's what I meant.

Yes. Many of them are structured pursuant to master services agreements. So while pricing tends to be in place, virtually all of the contracts include provisions for us to seek increases to pass along additional costs as market conditions warrant.

So that process, though, if it's time and materials, does labor count as your materials? Is it a cost that the client realizes is variable and you invoice them based on what you are paying at that time or do they have a bandwidth? How does that work?

Well, Justin, labor would be time. Materials will be things like equipment and consumables -- supplies, most typically. So all the costs are subject to discussion and to the extent that market conditions are causing costs to increase, we have the capability to go back and have discussions with our customers on any one of a broad range of costs that we are incurring and to seek relief.

Also we have to consider the fact that [cost] is also negotiable in all of these contracts. So we have to go back and really show to the customer that as everybody else that the costs are really going up in the labor and [cola is the keys to there].

And just to add to that, [cola] is one thing, but it's incumbent upon us to demonstrate that we are providing added value to our clients. And we feel when our clients tell us we do a nice job, we are doing that.

Okay. That's helpful. I guess my next question is just in terms of the ramp in the Canadian projects, can you talk a little bit about your recruiting efforts in Canada and training and how that's developed and what you are doing there?

Yes, sure. It's a little bit chicken and egg. As we both mentioned, Sotirios and I in our prepared remarks, we certainly went into Canada with a definite Plan A in mind, but unfortunately for various reasons, Plan A hasn't materialized as expected.

So we are going with a Plan B -- still hoping Plan A can occur, but going with a Plan B. And as we get commitments from customers -- we recruit and we hire employees and we are able to service them.

Okay. And just the last one, it's a clarification and I apologize if you did quantify it in the prepared remarks -- I didn't hear it. But what was the margin impact of the unbilled labor expense specifically this quarter? Did you have a number?

Well, it's more than unbilled labor. You're right, we didn't quantify it, but it's more than unbilled labor. There's union costs versus nonunion costs when we made a conversion to facilitate our entry into this specific Canadian oil sands region.

There's additional overhead that we've taken on; there's additional salaried management team that we've taken on -- business development personnel and so forth. There's quite a lot of components to the ongoing investment that's incremental to at this point last year.

We didn't have those costs in last year's first quarter, as an example. But no, we didn't quantify that, but it was a similar drag as it was to -- we had in the second half of last year on a quarterly basis.

Okay. All right. Thank you very much, guys.

Matt Duncan, Stephens Inc.

Good morning, guys. So I wanted to dive into the margin pressure a little bit more. Jon, can you break down for us -- your gross margin was down 370 basis points year over year. Was that fairly evenly split among the three factors that you called out that were weighing on margins there?

Matt, it was roughly split among those three factors, yes. It was fairly evenly, but I don't want to get down to rounding differences and so forth.

Sure. Fair enough. And then on the wage inflation side, was this more the market dictating that you had to go ahead and do this if you were going to keep people? Had you started to lose technicians to other people that were taking them at higher wages? And was it more of a reactionary move or was it more proactive?

Matt, we tried to really put a common increase at the beginning of the year for everyone, so people really got their raises sometimes earlier than normal, but we had to do that standpoint to make sure that we have the people available for the fall turn around, because we have commitments with customers for turnarounds and we had to provide the people. We made sure that that really happened.

And then in terms of the pricing discussions that you are having with customers, where are you in that process? How long do you think it's going to take to get enough price improvement to be able to make up the margin pressure you are getting from wage inflation? When do the two cancel each other out?

Well it's early in the process at this stage, Matt. But the discussions have commenced. And as I said, we are starting with the larger customers first and going to migrate really throughout the entire customer base.

So I think that probably in the second half of the year, we will start to see benefit not only from this initiative, but from several of the others.

Okay. So in other words, there are still going to be some margin pressure here in the second quarter, but obviously, you get the benefit of what sounds like a pretty healthy turnaround season. So you are going to see a nice sequential improvement in margins, but year over year, there's still going to be a decent bit of gross margin headwind, is that the right way to think about it?

Probably, but it remains to be seen how much of a headwind we will have. We will see the net effect of the two factors. It's hard to say right now.

Okay. And then last thing from me on the NACHER acquisition, just hoping you could talk a little bit more about the market opportunity in the offshore market for you guys?

Well, Matt, basically we are talking about almost 4,000 platforms in the Gulf and we are only working at about maybe less than 20 of them, okay? So we think there's a great opportunity.

But what is more importantly is really combining the type of work that they do with the NDT. Of course, NDT and engineering services is really the most exciting part for this acquisition.

Okay. So Sotirios, is there any way to put a dollar market size on that offshore platform market? There's 4,000 platforms -- what's the revenue opportunity per platform?

Well, we are in 5% -- 5% of the platforms, so there is tremendous --

Just to interrupt for a second -- they are not all created equal.

Yes, of course.

So the platforms in the deep shelf are more of a revenue opportunity than not, so it's hard to just answer that question with, well, here is the number. But as Sotirios says, we think this is an exciting opportunity. This is a huge expansion potential for us for both sets of services.

Okay. Thanks.

(Operator Instructions)

Tahira Afzal, KeyBanc.

Good morning, Sotirios and Jon. First question is on the macro side. We've seen oil prices come under pressure in the past -- really hasn't had much of an impact on your business. And of course, there's some concerns about Europe.

I would love to get your thoughts on how you are thinking about those two macro factors as you plan ahead.

Right now, Tahira, as you realize, most of our work -- and we mentioned today a couple of capital projects -- but the majority of our work is really in maintenance. We see sometimes, as we saw in 2008, 2009, a decrease in maintenance, but it really was nothing like, let's say, a capital project.

So there might be some weaknesses, but the opportunities for us is a lot more than that. So we believe that it might affect us, but looking at the turnaround season in the fall and in the spring, we cannot forecast a slowdown.

Got it. Okay. And second question more on the micro side, you know in the past quarter, you talked about some interesting and I think positive changes you are making in terms of the incentive structure within your employee base and then really some integration in your offices in terms of how you view information. Would love to get an update on both of those, if possible.

Well, the compensation structure was changed, so that's been implemented. With regard to the infrastructure side and the development of middleware and installation of that middleware, we are in the process of going out to our first lab with some of that solution during the upcoming quarter. So we feel very positive about those initiatives.

Great. And Jon, if I look at all the initiatives that you have announced today on margin improvement, does that -- do you need to further change or think of the incentive structure to really sort of help implement and make those initiatives effective or is the incentive structure really already taking that into account?

Well, I think compensation structures are all always works in progress and we tweak them over time, depending upon the working and operating dynamics that we face. So I think we made a really good step this year and we feel very positively about those changes, but on an as-needed basis, I'm sure we will tweak them going forward, as anybody does.

Got it. Thank you.

At this time, we have no other questions in the queue. I like to turn to call back over to Mr. Sotirios Vahaviolos for your closing remarks.

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

And ladies and gentlemen, this concludes your presentation. You may now disconnect. Enjoy your