Mistras Group Inc (MG) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Mistras Group Incorporated Q3 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) I would like to introduce your host for today's conference call, Mr. Sotirios Vahaviolos. You may begin.

Thank you very much, Kevin. In today's call, we will review Mistras Group's financial results for the third quarter of fiscal year 2015 that ended February 28, 2015, and discuss our prospects going forward.

As we described in the earnings release, in the middle of implementing our profitability improvement initiatives globally, three unexpected surprises occurred during our third quarter. First, we experienced the nation's first refinery strike in more than 25 years, and this has caused stocking changes and, in some cases, delays or deferrals of previously scheduled turnarounds and projects. Second, the price of West Texas intermediate crude fell 50% from its high of last summer. And third, the US dollar has strengthened substantially globally, and the European market has been softer than we expected.

The magnitude of these changes in a very short period of time has introduced an increased level of uncertainty. Expectations and predictions about the future price of oil vary widely. The refinery strike cost several customer delay and rescheduled some previously planned work. Both factors taken together have caused us to be a bit more conservative in our outlook for the next several months, as several of our customers have deferred previously scheduled turnarounds and projects.

But at the same time, this environment has also created new challenges for the oil and gas industry and all who serve it. Companies focused on servicing the upstream market have faced enormous challenges. Comparatively, companies like ours that primarily service the downstream refining market, and have run-and-maintain contracts with many of the major independent energy companies, have had much of easier time of it but also faced challenges in this, too.

We commence our third quarter feeling good after a record-setting second quarter. But market conditions change rapidly, and we experienced a great deal of transition during the third quarter as work scheduled shifted to accommodate both the refinery strike and deferrals of some previously scheduled projects. We strongly suggest that our third-quarter performance should be viewed within this context.

The biggest impact was borne by the services segment that delivered 11.7% revenue growth but experienced an organic decline of 0.9% for the quarter. But that was primarily strike and FX driven as compared with 22% growth in the second quarter. The big change was driven by the factors I have just described as well as sponsoring the anniversary of last year's large win in Alaska.

Our Canadian oil sands region start-up initiative continues to move forward, and we are seeing a pickup that began toward the end of the third quarter as we continue to improve throughout the year despite the oil price issues that affected the region. We have been very proactive in addressing these market conditions in an effort to stabilize our business and continue to maintain our market share while positioning ourselves for growth and, most importantly, profits, helped by our market diversification initiatives.

To improve profitability, we have continued to press forward on several operating initiatives that Jon will discuss. And as our team knows, these are my top priority. And now I will turn it over to Jon, who will cover the comments summary of 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 would 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 investors section and on the SEC website.

Now I will summarize our third-quarter financial results, and then I will comment on our initiatives to improve profit margins. Revenues for the third quarter of fiscal year 2015 were $163 million, 7.5% higher than in the prior year's Q3, driven by 12% growth in both our services and our products and systems segments. Total revenue growth would have exceeded 10% had FX rates been constant.

Our gains were offset in part by our international segment's 12% revenue decline, of which 10% was driven by FX. Products and systems' 12% growth was entirely organic, while services' 12% growth was entirely acquisition driven, as services experienced the impact of the strike as well as some adverse FX following the first half, which saw services achieve organic growth in the mid-teens, driven by the factors that Sotirios already discussed.

The international segment's double-digit revenue decline was driven primarily by the euro's double-digit decline. But international also experienced a slight organic decline for the third consecutive quarter. Markets such as Russia and Brazil continue to pose formidable challenges to revenue growth, while conditions in Europe remain soft.

Our third-quarter gross profit margin contracted by 215 basis points compared with the prior year's Q3. Services' gross margins contracted by 150 basis points, while international margins contracted by more than 500 basis points. The services gross margin contraction was driven by the refinery strike, which accounted for most of the decline.

Our NACHER acquisition had a quiet third quarter seasonally, which is typical, but did not produce incremental margins and earnings for the quarter, which also impacted our overall margins. The international gross margin decline was driven in part by a tough prior-year comp as well as by poor execution involving too much unbillable time in most countries. The largest decline was experienced in Brazil due to work stoppages connected with Petrobras.

To combat these difficulties, the Company initiated several actions to reduce operating expenses, which improved by 250 basis points of revenue compared with the prior year inclusive of acquisition-related items and by 90 basis points excluding acquisition-related items. Savings were achieved in the products and systems and services segments, driven by a combination of headcount and spending reductions, and additional reductions are planned. Operating income was slightly higher than in prior year but was below prior-year levels exclusive of acquisition-related items.

In addition to operating expenses, cash flow was another positive. Mistras generated $34.3 million of operating cash flow during the first nine months of fiscal year 2015, an increase of $11.6 million driven by collections of receivables. Free cash flow nearly doubled to $23.3 million, up from $11.8 million in the prior year. The Company's aggregate year-to-date capital expenditures including non-cash capital lease outlays were $16.4 million or 3.1% of revenue. Debt and capital lease obligations net of cash was $132.5 million at the end of February compared with $155.5 million three months ago, a ratio of 1.6 times forecast adjusted EBITDA.

And now I will comment on the actions we have launched to address the contraction in our margins. We continue to work on several initiatives that we are focused on to improve margins. These include pricing discussions with customers, contract operational reviews, a review of SG&A costs, reducing unbillable time in several of our international countries, and a plan B for the Canadian oil sands region. Good progress was made on each of these initiatives during the quarter. However, the difficult operational environment has complicated the first item considerably.

Pricing discussions and contract operational reviews are proceeding. Several cost initiatives have been taken, and more are planned given the current environment. Management changes continue to be implemented abroad; and, if anything, the current environment may help to improve our Canadian oil sands initiative.

For competitive reasons, I will refrain from quantifying customer-related discussions. The management team remains united in our common understanding of what is needed to be done and, in our shared sense of urgency, is supported by our CEO.

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

Thank you very much, Jon. I'm very proud of our team and its resilience in these diverse market conditions. They have recognized the opportunity in front of us and have created a plan that we are following to drive improved results.

And now I will update you on some key developments in our business.

In our services segment, we received new contract awards primarily in the specialty chemicals and power generation sectors, tied to our diversification efforts. We were chosen by a global specialty chemicals company headquartered in USA to provide mechanical integrity, reliability and predictive maintenance engineering, and consulting services. Our PCMS inspection data management software solution will serve as the new customer's database worldwide for warehousing and subsequent analysis.

In our growing power generation sector, we secured a multi-million-dollar contract to provide turbine overhaul inspection services. In addition, we also secured two multi-million-dollar contracts to provide quality assurance and site surveillance services for the construction of natural gas combined cycle plants.

In the oil and gas midstream sector, we were awarded a large contract to utilize our PCMS system to implement pipeline pressure equipment located in several regions at dozens of pipeline sites. Our products and systems segment continues to focus on improving its business pipeline of aerospace, automotive, power generation and chemical industry opportunities.

Specifically, within the power generation sector we received several important orders -- including, a major East Coast utility successfully tested and purchased our gas flange leak detection system that is intended to be deployed at more than a dozen sites. Second, the same utility purchased one of our 24/7 acoustic turbine online monitoring systems that has been successfully operated on gas, on GE gas turbines, and will now be applied to a different platform to identify a different potential component failure. This application could be deployed at dozens of sites and multiple power generation plants. The large electric utilities purchased our boiler tube leak detection 24/7 online monitoring systems with potential for additional deployment. And finally, we have receiving repeat orders for our advanced automotive airbag canister weld inspection system that has been deployed globally.

And now let's discuss the international progress. Our strategy for international is to, one, stabilize the revenue despite large FX impacts and aggressive global competition; two, finalize management changes, reduce unbillable labor and place more emphasis in profitability growth; and, three, opportunistically continue to pursue the implementation of the USA evergreen-based business model in EMEA and South America.

Revenue growth of our base business slowed during the quarter, due in part to lower capital equipment purchases and capital project services by our customers. Our French business was awarded three quarter-four turnarounds by an existing evergreen customer. The same customer also awarded us with with a multi-year contract to perform dock inspection at many of that customer's sites in several European countries. Also, in France we will be providing to another customer a complete solution including (inaudible) testing of composite panels for the aerospace industry.

In Germany, a global oil and gas client awarded us a mult-iyear evergreen contract for (inaudible) inspection in our geography and mechanical integrity. This contract will enable our advanced entity group to deploy its services and serve as a springboard for similar customers in Germany.

In our UK, our wind division will be 100% committed for the summer wind season while with significant projects in UK, Europe and the general EMEA territory maintenance contract, and support the year working -- the second year working for a major OEM on offshore platforms.

In Brazil, we have won several contracts, but the environment for the last several months did not allow continuous deployment of stock even with the cutbacks that we have made. With the extensive backlog we now have, we expect improvements in fourth quarter and next year.

And now for my closing remarks. As I mentioned earlier, the expectations for the future price of oil vary widely. We have chosen to assume that the present price environment will be the new normal for the foreseeable future. This requires us to operate more efficiently as possible. And it's assumed that little pricing capability will exist within the oil and gas sector. To this end, as Jon has mentioned, we continue to be proactive in managing costs and driving our profitability initiatives while navigating and adjusting to the dynamic market conditions.

But it's also important to keep in mind that the value divided by Mistras becomes even more compelling in an environment where companies are seeking to reduce their cost. Our Company has an incredible track record of saving its largest customers tens of millions of dollars per year by employing our wide range of complete and proprietary service solutions. In some cases, these savings approximate our customers' entire annual spend with us while at the same time ensuring safety and more comprehensive protecting them against the risk of asset failure than even before.

So while this environment provides new challenges, it also provides growth opportunities. Low-priced crude oil and natural gas feedstocks are generating downstream investments in chemical, petrochemical and power generation, where we are able to capitalize on those markets leveraging our services and product solutions.

So despite the increased uncertainty in the current global environment due to the significant drop in oil prices and the strong US dollars and continued weakness in Europe, we are confident in our ability to ride out this condition while continuing to grow our market position and be a leader in customer value creation.

We're excited about our opportunities in the spring quarter and continue to forecast growing markets in the macro environment. But in the short term and until we can have better insight of future oil and gas market conditions, we anticipate a less robust market environment. And accordingly, we have conservatively adjusted our performance expectations. We now expect revenue to come in at the lower end of the $720 million to $740 million range, and EBITDA may fall short of our guidance range of $78 million to $84 million.

In concluding this conference call, I thank our loyal employees for their commitment to safety and quality, and our loyal customers and valued shareholders. That concludes our prepared remarks, and we would like to open the floor for questions. Kevin?

(Operator Instructions) Matt Duncan, Stephens Inc.

So you called out three reasons that you fell short in the quarter. I'm curious if you can maybe tell us how you would weight those three in terms of the impact they had between the strike, FX and then uncertainty around the oil.

Well, definitely, Matt, I would put the strike on the top of the list. But Jon can give more detailed explanation.

Yes; the strike is the majority of it, Matt, for us. We had people who are reporting in for work at several sites that unfortunately couldn't do that. So there was a mismatch there between salary expense that we incurred for a time and revenue we were able to deploy.

Also, we had certain work that we were geared up to serve during the third quarter, and some projects had to get moved because customers told us that they were worried about their facility being subject to a strike. And so it just really wrought some havoc on our staffing capability to really be as efficiently as we ideally could have been. So I think the strike, first and foremost.

I think the price of oil, secondarily, comes into play because that may also, for a short time, just delay a project or two. But really, the strike and the lingering impact of the strike is what caused work to move, things to be deferred. And finally, FX became more meaningful as the quarter went on. It offset revenue increases by about 3% Companywide during the quarter in terms of a year-over-year impact. And there was some bottom-line impact of a few hundred-thousand dollars as well.

Okay. So with the strike effectively done now -- it did go on far enough in the turnaround season that I would assume it may impact the May quarter as well because it didn't really begin to wind down till later in March. How do you think that strike is going to impact the May quarter?

I think you are right; it could impact it a little bit. But work has been moved. For the first time we heard that there's going to be a summer turnaround, for instance, which is very unusual for our industry. So I think that it's a little bit unpredictable how things are going to move at this point. But I think our fourth quarter should be a good quarter. We anticipate it to be a good, healthy quarter. But there could be a little bit of impact; I think you are right about that.

Okay. And then last thing for me just on the guidance, you are pointing us to kind of the lower end of the revenue guide and saying that you may be below the EBITDA guidance. Can you help hone that in a little bit for us? The range is $78 million to $84 million. Are we talking you are going to be $70 million, $75 million? How far below the range do you think you might be on EBITDA?

I don't see us being way below the range. But if we miss, I think we could miss by $1 million or $2 million. And the concern there is just a little bit less visibility both here in the United States but also, as well, in Europe.

Okay.

We have taken, Matt, a very conservative approach because of the delays that we show, for instance, not only in America, but we saw the same delays because of Petrobras in Brazil, for instance. We saw the same delays in France also, where one turnaround moved into the fourth quarter for us.

Okay. All right, thanks for the color, guys.

Justin Hauke, Baird.

Just going back to the EBITDA guidance and gone below -- so if we do the math, it looks like -- and I know you are saying it could be below. But if you take $78 million as the EBITDA and you put that on the $720 million at the low end of the revenue, it's implying the margins for the fourth quarter are up meaningfully, like they would be at like 14%, which would be well above last year; it was closer to 11%. So why is it that you would assume margins would be up so materially in the fourth quarter? Is there anything that was one-time last year? What should we be thinking about?

Well, we have been working on lots of initiatives to take costs out, to improve contract profitability through acquisitions and so forth. There are a few differences in the Company's construction this year versus last year's fourth quarter. So I think that we are looking to some of those reasons, Justin, for why we might have margin increase in the fourth quarter.

Okay. And then on NACHER, you said it was a little bit weaker this quarter because of seasonality. Maybe just two questions -- can you give us the revenue and profit contribution for the quarter at NACHER? And then what are you seeing now that we blew past the seasonality? How is it playing out in the fourth quarter?

Well, first, we're not going to be breaking out NACHER separately. So for competitive reasons, we don't really think it's in our best interests to be providing that information in that kind of detail.

What I would say is that, yes, we've gotten past the slow winter season. And so we assume a better spring, certainly a very good summer for them. And that's the expectation.

It was basically exactly what was expected. December and January are not the good months, and it was really planned. At the same time, there were a few delays because of the price of oil. But that really now is over. And I think we are looking forward to and we are optimistic about the success of our NACHER company. Okay?

Can I -- just one more on there, too. I think this dovetails with it. The contingency liability reversal that you had, was that related to NACHER, or is that something else?

No, absolutely not.

There is no contention earn-out for NACHER, just to be clear on that. That related to a previous acquisition in Europe.

Great. Okay. Thank you very much.

Edward Marshall, Sidoti & Company.

So I wanted to just pick your brain for a second. I guess I wouldn't call them a competitor; I'd call them a peer. They reported yesterday. The tone of the commentary and outlook was much more positive, I'd say. And I don't want you to speak for them, but maybe you can talk about some of the specifics to your Company and maybe about what you are seeing. Is it cost-specific surrounding pricing heading into the cycle for you specifically? Or is there an outright conservatism on your part as you look at all the pieces that are coming together? Or did you have maybe more impact with the strike than maybe some of your competitors or peers might have seen? A lot of questions there, but could you help me out?

Okay. Before Jon really answers, I think we really have taken a conservative approach based on our experience from past years. Okay? So we are little bit nervous about what is happening. As I mentioned in my remarks, we feel that in the macro and even in the fourth quarter we are very optimistic, but we are going to be conservative in our guidance.

Yes, I think that's fair. Certainly, I can't speak to the other companies and what the impact is on them. I know that the strike has had a meaningful impact on us because it has caused us to not deploy work people in services companies as much as we anticipated. And with the work moving a bit, that does, again -- as I said earlier in my comments, it does provide for a little bit of disruption in terms of our plans.

So, having said that, we feel good about the fourth quarter. We feel good about the business. We've had a short-term, market-driven pick-up here, which is beyond anybody's control. But it doesn't change the trajectory we are on or how good we feel about our ability to service the market.

Everyone basically knows that downstream is still very strong. Okay? And the (inaudible) are going very strong. We all know that. But at the same time, we want to be a little bit more conservative because we have seen things shift like in turnarounds. And as Jon mentioned before, seeing a turnaround in the summer is very surprising to us.

So if I could summarize basically what I'm hearing, is it really just a function of being a seasonally weak quarter, seeing some signs maybe strike related, maybe some deferrals related -- some pricing issues and so forth? All summing up, giving you a muddy picture to look at forward, thinking that things should be good, but at the same time you are not really confident enough to really give that in the guidance? Is that a clear depiction of what you are really saying today?

I think that's a good summary, Ed, yes.

Okay. As we move on, I think about some of your cost initiatives. And maybe you talked to some of the progress around them. But I guess it sounds like pricing might be the hardest at this point to get through. Are you having any success in pricing discussions at all? Or are they basically just turning you away from the table and saying, work on your headcount and maybe some of your own structural cost issues?

Certainly, we are doing both. We are having excellent discussions with customers. So our relationship -- in virtually all of our sites, we have very strong relationships with customers. We are providing, and acknowledged to be providing, tremendous value. And we are really excited about what we're doing with our customers. So, considering those factors, the ability to have excellent discussions is very strong.

The market -- with the price of oil and so forth and, really, the uncertainty around that -- because, as Sotirios mentioned, from the end of our second quarter till today, the price of oil fell 30% in just three months after falling 50% before that. So it has been a real difficult time for them, I think, in predicting spending and so forth. And it's a tough environment, and we sympathize with them and we are working with them.

So it clouds, it complicates, but it absolutely does not stop our ability to have productive discussions along those lines.

Okay. And along the same lines, it looks like you are ahead of last year's pace on free cash flow, which is good to see, as being one of the initiatives that you set in place.

And I guess the question is, in your estimation are you having the success that you anticipated on maybe collectings? And I think you talked about some of the international customers. But are you having the success that you set out to? Or is this more of a function of the slowdown in revenue that allowed you to collect more receipts and therefore higher cash flows?

I think it's probably a little bit of both. There's an ebb and a flow in timing and collections of receivables that will happen. At the end of our second quarter, we had a very strong quarter, and a lot of the revenue occurred as the quarter went on. And so receivables built up. There was a little bit of a lag in revenues compared to what we might have expected at this time. So we did have a little bit of a catch-up there.

So I think that's a factor, but I also think equally as well is that we are focused on this. And we have an initiative here in place, and there's going to be a bunch of things rolling out to move things along further in the right direction. So it's a little bit of both.

That's good to hear. Last one, the currency targets that are implied in your guidance for the year -- and I know there's quite a few there. But I guess the big one is maybe Canada, euro, the European -- euro. What are implied in your guidance ranges there?

Well, what we are assuming at this point -- we are not really guiding on currency, actually. What we are assuming at this point is that currencies don't move from where they are at this point. They are just stable at the third-quarter levels.

And I assume there's a natural hedge with costs in the local currencies. But is there any chance for you to hedge from it financially?

There's always a chance to hedge. But the problem with doing a hedge is that you are making a bet that you can outthink the market. I don't like to do that, in general, unless I am really, really sure. And even if I'm really, really sure, I've done it in the past and most hedges don't seem to go the right way. If you talk to the banks who engineer the hedges, they are the first to acknowledge that most of the time they are receiving cash on these things rather than paying it out.

So we are not in a rush to do a hedge at this point. We think most of the move has occurred already. Certainly, there's a lot of draconian predictions of the euro going to $0.90 by some of the investment banks. But some of those might be driven by the impetus to try to get trading revenues out of us as opposed to a real live expectation.

And the natural hedge of your currency exposure, how much is naturally hedge costs versus revenue?

Well, the vast majority of it is. The biggest exposure we really face is where we have got balances between our subsidiaries that are denominated in the dollar. And then you've got a devaluation of the other side, and so you have got a transaction loss there for a short term of intercompany items.

Okay. Great. Thanks, guys.

Tahira Afzal, KeyBanc Capital Markets.

This is Sean on for Tahira today.

You sound different from Tahira.

I think that's a good thing. Most of my questions have been answered; there were some good ones ahead of me. What I'd just like to get your thoughts on the Shell and BG merger, and if you think there's any implications for MG. And in your experience, has M&A activity with your large customers impacted the Company at all?

Whenever you see transactions like this, there's maybe sometime some opportunities. But right now we really have no idea.

Okay. And in the past, can you characterize has there been any modulations as the companies go through these type of deals? Any comment there would be helpful.

The only thing, really, that happens is if you have two companies that are trying to transact and you are doing business with them, there's a delay of work. That's the only thing we have seen in the past. We are not really customers -- big customers of both of them. So therefore, there is little effect on us from past mergers. And soon there will be no effect here, either.

Okay. All right. Thanks very much, guys. That's all I have.

Jason [Borg, BLC].

Given the prices of oil were dropping during the fourth quarter, did you guys come up with low oil cost initiatives? The second question is how much is the Alaska BP job impacting you, given the bidding process you guys went through to win that work?

Well, regarding the first one, some of our customers are very impacted by the price of oil, but most aren't. The ones that are major and integrated and have upstream operations are obviously more effective than downstream customers who don't have upstream operations.

We don't have a price-of-oil initiative, per se, as much as we are just trying to do the initiatives that I've already spoken on. And with regard to -- the second part of your question was what, again?

Given, I guess, the nature of how you guys bid the job with the Alaska BP work, how much is that impacting your margins this year?

I'm not exactly sure what you are referring to there. But it's true that, yes, over a year ago we were in a competitive bidding process and we were awarded a bunch of work with BP in Alaska. We are very satisfied with that partnership that we have with BP, and we actively work to serve them. And things are going very well with that customer.

(Operator Instructions) Steven Howard, Morgan Stanley.

First question would be reading some of the industry publications, it seems that the Department of Transportation's Pipeline and Hazardous Materials Safety Administration issued a couple of proposals in terms of revamping pipeline maintenance standards. Are you guys following that in terms of maximum operating pressure and more regular testing? And I wanted to see what you thought about potential business opportunity there, should the regulations get a little bit more stringent.

I'm not going to report on the regulations be stringent or not. That's the UTM's solution. But from our point of view, yes, it has affected us. And I think I mentioned one contract that we got, a very recent contract.

Okay, good. And then the strike itself was well out of your hands. But I was interested in terms of the timing of the impact and whether or not it was all systems go for your customers. And then late in the quarter, there was more of a surprise -- oh, by the way, this is not going to go as well as we thought it was. I just wanted to get a sense of how the strike progressed from demand for your services.

Yes; it was essentially as you said. Things were going very well. And then really at the beginning of February, this hit, and it's still lingering at certain sites. There's still a potential for additional sites. You are just not sure how this is going to go. But we have worked directly with our customers to ensure that the staffing was in place. With every customer, it was a different scenario. At every site, it was a different scenario. But we've worked very closely with them to ensure that they were covered and that we could try to be as efficient as possible in servicing them.

And you have to keep in mind also we have more evergreens. We run and maintain contracts in these locations than any other of our competitors. Okay?

Okay. Thank you very much.

I'm not showing any further questions at this time. I'd like to turn the call back over to our hosts.

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

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.