Mistras Group Inc (MG) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Mistras Group's earnings conference call for its second quarter ended November 30, 2015. My name is and Kat, I will be your event manager today. We will be accepting questions after Management's prepared remarks.

Participating on the call from Mistras Group will be Dr. Sotirios Vahaviolos, Chairman and CEO; Jon Wolk, Executive Vice President and CFO; and Dennis Bertolotti, EFP (sic - see Company website "EVP") and President of the Company's Service segment. As a reminder, this conference is being recorded. I will now hand the conference over to Dr. Vahaviolos. Please proceed.

Thanks very much, and good morning to all. In today's call, we will review Mistras Group's financial results for the second quarter of FY16 that ended on November 30, 2015, and discuss our prospects going forward.

I'm very pleased that Mistras followed up its record first quarter with a new earnings call record in the second quarter even though revenues were $12 million lower than in the prior year's second quarter, driven by a $9 million decline from foreign currency and dispositions. Our improved profitability reflects the actions that we took to reduce our cost and improve accountability across all of our business locations.

As in our first quarter, profit margins were substantially improved in the Products and Systems and International segments and in every country in which we operate. Services profit margin were in the line with prior year's Q2, despite revenues being down, as expected, by more than $10 million.

As in Q1, we gained strong bottom-line leverage. Mistras' EBITDA was in line with our previous year's second quarter despite the 6% revenue decline. Our adjusted EBITDA margin was nearly 15%, an improvement of 80 basis points over the prior year. For the first six months year to date, our adjusted EBITDA reached a new record of $51 million, an increase of nearly $9 million.

Approximately half of the business is in the oil and gas sector. That market has been significantly impacted by the oil price decline and by last winter's refinery labor strike. The oil price decline has affected organic growth, as oil and gas customers seek to reduce their spending. Overall turnaround volume has been similar to prior year but with different seasonality because of last year's refinery strike, and therefore, different comparisons to prior year's results.

For Mistras, Q1 was stronger, Q2 lighter, and Q3 looks to be somewhat stronger than prior year. Our results for the first half are strong validation of our focus on delivering profits and grow faster than revenues and are an example of actions that we have taken for several quarters. But rest assured, Mistras is still a growth Company. We're actively working on organic market share gains that will provide profitable growth.

The Mistras value proposition is now stronger than ever in an environment that is focusing companies to realize more value from their spending. For example, we have previously described our plan A and plan B focus in the Canadian oil sands region. I am pleased to advise that we are making good progress on both fronts and have been awarded both ongoing evergreen work and turnaround work, both of which will enable us to operate profitably with a sustainable platform in the region for years to come.

Jon will now explain our results in more detail, and then Dennis will provide more color in our operations. Afterwards, we will take questions. Jon.

Thank you, Sotirios. I remind everyone that remarks made during this conference call will include some forward-looking statements. The Company's actual results could differ materially from those projected. Some of the factors that could cause actual results to differ are discussed in the Company's most recent annual report on Form 10-K and in other reports filed with the SEC.

The discussion in this conference call will include certain financial measures that were not prepared in accordance with US GAAP. Reconciliations of those non-GAAP/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 financial results, and then I will comment on our initiatives to improve profit margins. Revenues for the second quarter FY16 were $194.8 million, 6% lower than the prior year's record second quarter. On a constant dollar basis, that 6% revenue decline would have been 2% had FX rates been unchanged from the prior year.

Services revenues declined by 6.5% from the prior year's record second quarter, driven by a mid-single-digit organic contraction and the weaker Canadian dollar, offset in part by a small amount of acquisition growth. International segment revenues declined by 6%, as high single-digit organic growth was more than offset by double-digit FX declines and the impact of dispositions. Products and Systems revenues had modest organic growth.

Despite the challenging revenue picture, the profit picture was much better. The Company's second-quarter gross profit margin improved to 29.2%, compared with the prior year's 28.5%, despite the $12 million revenue decline. Decremental margins on revenue declines are generally higher than incremental margins on revenue growth, so an improvement of this magnitude was notable. Company-wide SG&A costs were over $3 million lower than the prior year second quarter, resulting in a 120-basis point increase in the Company's operating margin to 10.0%, and a $1.4-million improvement in operating income.

Breaking this down by segment, Services gross and operating margins were in line with the prior-year second quarter, despite the expected 6.5% decline in revenues. Year-to-date Services gross margin improved by 80 basis points, and operating margin by 170 basis points, driven by sound execution in managing contracts, improved staff utilization, and better matching of changes in labor rates with changes in pricing.

International gross and operating margins improved by approximately 400 basis points in both the second quarter and for the six months year to date, driven by improved utilization of personnel, organic growth, and cost reductions made in the latter part of the prior fiscal year. However, international operating margins were 7.7% for the first six months of FY16, compared with 11.9% for Services, so there is still plenty of room for improvement.

Products and Systems gross margins improved by over 400 basis points in both Q2 and for the six months year to date. Operating profits were 13.5% of revenues, compared with breakeven in last year's first half, an operating income improvement of $2.2 million.

Company-wide operating expenses reflected significant improvement for the third consecutive quarter. Total operating expenses were $3.5 million lower than the prior year's second quarter, driven by headcount and other cost reductions that have continued into the current fiscal year. Operating expenses were favorable to prior year as a percentage of sales by approximately 50 basis points in the second quarter and by 100 basis points year to date.

The Company's adjusted EBITDA margin was 14.9% in second quarter, compared with 14.1% in the prior year. Year-to-date adjusted EBITDA margins were 13.7%, compared with 11.4% in the prior year.

Cash flow was yet another strong positive. Operating cash flow was $26.5 million year to date, compared with only $3.2 million in the prior year's first half. Free cash flow improved to positive $18.8 million, compared with negative $4.7 million in the prior year. Drivers to the approximately $23-million first-half improvement were the improved earnings as well as a five-day reduction in days sales outstanding that reduced working capital outlays.

Total capital expenditures, including non-cash capital lease outlays, were $9.3 million, or 2.5% of revenue, compared with 3.1% in the prior year's first half. Total debt and capital lease obligations net of cash was $108 million at November 30, 2015, and compared with $155 million one year ago. Net debt to adjusted EBITDA was 1.3 times at November 30, down from over 2 times last year. We did not buyback shares during the second quarter.

Our improved results have been driven by decisive actions and terrific execution by our entire Team in every country and in every line of business and have delivered despite the difficult market conditions. I have previously mentioned our key initiatives, which have been our game plan to achieve these improvements. These include contract operational reviews, focus on SG&A costs, reducing unbillable time, improving in the Canadian oil sands region, and pricing discussions with customers. The first three actions have measurably improved results to date, and we are on the cusp of seeing an improvement in the Canadian oil sands, as Sotirios mentioned in his remarks.

Now I will briefly update the Company's financial guidance. We continue to expect that revenues will be similar to those of prior year, in a range from $710 million to $725 million, inclusive of a combined $20-million-plus reduction due to foreign currency and dispositions.

Our adjusted EBITDA for the first half of FY16 has exceeded prior-year levels by nearly $9 million, or 21%. Although market conditions remain unfavorable, we are increasing our adjusted EBITDA guidance from our previously stated $72-million to $78-million range to a new range of from $79 million to $83 million. And with that, I turn this over to Dennis Bertolotti, our EVP and President of Services segment.

Thank, you Jon. I'll now provide updates on each of our business segments.

I'm proud of our Team and its resilience in a tough market. A plan is working in North America and in all of our key countries, as reflected in the performance numbers that Jon just shared with you. I'll provide some color and key developments in our business.

In our Services segment, the oil and gas market remained subdued. My team regularly meets and speaks to our customers, exploring ways to improve their productivity and gain even more value from our wide-ranging inspection services. Our partnership with existing customers is built upon a solid foundation of terrific value and flexibility that we provide to their operations.

Because the value that we deliver is obvious when compared to our competition, we are finding more and more companies open to learning more about Mistras and how we can help them. Sotirios already mentioned the important new customer that we recently gained in the Canadian oil sands. This new win is a multi-year evergreen on-site that will provide Mistras with both day-to-day inspection and enable additional turnaround and project work.

As Sotirios also mentioned, the timing of turnaround work caused services revenues to decline year over year in Q2, but margins held firm with last year's record Q2 because of improved operating disciplines that we have been installing. Q3 revenue should exceed those of the prior year, as increased turnaround work may be offset by weaker revenues from upstream customers.

Our International business has had terrific improvement, driven by an aggressive plan and strong execution to eliminate inefficiencies. Increasingly, our International subsidiaries are sharing technician resources and working together on business development opportunities to gain additional evergreen sales from flagship customers, even if they are located in different countries.

Our new CEO in France has driven both cost reductions and organic growth, which has greatly improved our utilization of service technicians and led to improved profits. Our UK subsidiary experienced organic growth primarily from its wind business, providing services and products to both offshore and onshore customers.

Our Brazilian subsidiary has made a remarkable improvement despite the continuing challenges presented by that economy. Our GM there has done a good job in changing our mix of work performed for Petrobras to be more mandatory and less discretionary, improving our utilization of people and reducing the risk of work stoppages. And the Germany, we have begun to receive more work from Airbus and other key customers, improving our sales mix and positioning us well for future growth. During the second quarter, we successfully performed our first turnaround locally for a large multinational customer.

As Jon, mentioned our Products and Systems business has also made a nice year-over-year improvement, earning over $2 million in operating income compared with last year's breakeven results. Contributors to this success have been a double-digit rise in sales combined with cost reductions to become more efficient. And now for Sotirios' closing remarks.

Thank you, Dennis. In closing, we are running the business assuming that the present oil price range will be the new normal for the foreseeable future. In this environment, we are focusing on operating as efficiently as possible, maximizing our stock utilization, and minimizing our capital outlays.

Our top priorities remain finding incremental value for both our existing customers and potential new customers and driving our profitability initiatives. Even though market conditions remain challenging, we are having a number of productive conversations with both existing and prospective customers. These efforts will enable the resumption of organic growth as early as the fourth quarter and into next fiscal year.

We have taken actions to reduce our cost base, and we will continue to be vigilant in doing what the market demand of us. In FY16, we have made some opportunities to grow our business, and we have an even bigger opportunity to improve our overall profitability. We are very focusing on achieving these goals.

In concluding our prepared remarks, we thank our loyal employees with their commitment to safety and quality and our loyal and valued customers and shareholders. We will now open the floor to questions.

(Operator Instructions)

Andrew Obin, Bank of America Merrill Lynch

Yes, good morning.

Good morning, Andrew.

Congratulations on a great quarter. Just couple of macro questions. How do you think the current pricing environment is changing the broader landscape, in particular, A the willingness of your customer base to outsource versus in-source, and the competitive environment versus your competitors?

Andrew, this is Dennis. I think the price is something that our customers have recognized is going to be in this range for a while, and like anybody else, they are going to watch the cost. So watching their cost is watching their expenses, which is their internal people as well.

So it's actually a good market for companies like us for outsourcing. While we know they're going to watch their total capital and total spend, we don't see them building up internally, so they're going to still have to get those jobs done, and companies like ourselves will be the one to provide them

And in terms of competitive landscape, what's your competition doing in terms of pricing trends to gain market share this environment?

I can't really speak for our competition. I know what we're doing, and we're trying to work with the customers and making sure that we provide the value and still give them the service, so I think that's the right thing. I would expect the competitors to do something similar, but can't speak to that.

Just a follow-up question. Your cash flow has been pretty good, but I understand a lot of your customers are strained in terms of free cash flow. Are you seeing any change in customer behavior and terms of payment terms, and how do you make sure that you get paid on time in this environment?

Andrew, it's Jon. We're not really seeing any differences in payment terms. If anything, our DSO has gone down by several days, and that's based on process enhancements that we're working on to continue to drive that, and we expect that to continue to improve. So I don't expect any degradation there.

Thank you very much

Thank you.

Matt Duncan, Stephens.

Good morning, guys, and great job in the quarter.

Thank you, Matt.

First question I've got is on the margin performance that you're seeing in both the International and the Products and Systems segments. Those were up substantially both sequentially and year over year. Obviously, you've been doing a lot of work to try and increase profitability across the business.

I'm curious, though. Is there anything that benefited either of those segments from a one-time-type nature? I know the pricing systems especially can have some lumpiness to it. Are we really just seeing the fruits of your hard labor to get the margins up in those businesses?

I'd answer that Matt. This is Jon. From an International perspective, I think that really these results are the result of the planning and execution that our Team has done that we have helped them with.

And there is nothing special in the second quarter. Seasonally, we get a little bit more work in the second quarter internationally as we do domestically, so that did help, but nothing unusual there.

From a Products and Systems perspective, our Products Team has done a very nice job reducing costs, taking appropriate steps to be in alignment with today's market. And we did get a little bit of a lift from sales in the first half of this year versus the first half of last year. And as you alluded, it can be a lumpy business, but we do believe we've made some good structural changes there that have improved margins.

Okay. So let me follow that up then with a question about the guidance. You had a really good first half, and it sounds like you think a lot of the work you've done to improve profitability is going to stick, but it looks like we have to assume that the margins are going to come down in all three segments for your EBITDA guidance to happen. If you keep up at the levels you've been, you would beat that EBITDA guidance.

So I'm trying to get a sense, are you just trying to layer in some conservatism here given the uncertainty in the market? Do you see reasons to believe that the margins will be lower? Just help us think about how you mentally put this guidance together given that it appears as though you are tracking to do better than that?

We're definitely tracking to do to better. From a revenue perspective, we're saying it's going to be roughly flat. The guidance range has maybe a 0% to 2% increase over prior year. So we're not really looking for revenue lift per se, although one could come.

If one doesn't come, I think that certainly the guidance range that we've got on the bottom line, we're effectively guiding for similar profitability as we had in last year's second half, and I think that there is a layer of conservatism built in there really based upon market conditions and uncertainties on turnarounds and customer timing and that sort of thing. If there are no disruptions, if there's no crazy weather event or some big cancellation of work, I think we would expect that there is a level of conservatism built into the bottom-line guidance.

Yes, because actually, it already has happened he last two or three years. In the fourth quarter sometimes turnarounds change. That's really what we are trying to base our opinions here.

Understood Sotirios. The last thing for me, the stock buyback plan you put in place, did you by any stock under that plan in the quarter?

No, we did not.

All right. Thanks guys.

Thank you.

Tahira Afzal, KeyBanc Capital Markets.

Hi, gentlemen. This is Sean on for Tahira today. Congrats on a great quarter.

Thank you.

So you guys touched on this a tiny bit in your last response, but just any more clarity you have on the spring turnaround outlook and what you are building into your guidance over there. Do you continue to be cautious for the outlook? Any update there would be very helpful.

Sean, this is Dennis. What we see is pretty much a normal year coming at us. We worry about the differences in the market, so that's why were not sure if things could change. But from what we see forecasted now, we see it to be similar to last year's Q3.

Okay, thanks. And you guys have talked about the abnormal seasonality we're going to see in the second half of the year. Could you give us an update on that? And secondly -- just how we are supposed to be thinking about the seasonal pattern for this year. And then secondly, do you have any more visibility on the offshore business for the second half of the year?

As far as seasonality goes, I think the year should look the same. There's probably going to be a little bit less capital work going on out there as customers will be retrenching back in the sands and other areas, but the maintenance and everything else we don't expect to be anything significantly different from where it was. The offshore could be challenged a little bit more by the price of $32 a barrel right now, so we know that part of the play, the actual upstream, could be challenged more than mid or downstream for sure.

Yes, but at this point -- I agree with what Dennis said, Sean, but in addition, I'd say that Q3 might be a little bit bigger than last year because we did have that turnaround that moved into Q3. Q4 is a little bit more of an open book at this point because things do move around in Q4 more than they do in the fall, but we're optimistic there at this point. In terms of the offshore, at least at this point in time, we're not aware of any material deferments.

Okay, that's very helpful. Thanks. Just one last quick one for me. You guys have done really well in Europe, but it seems like a lot of that is from some of the internal initiatives and some key new leadership you have in place, so could you just comment on business in Europe just from a more macro perspective?

I think one of the things we have concentrated is in getting new evergreens, and we already, for instance, did a turnaround in Germany that was for the first time on a very important customer of ours that we have it in other countries. So basically, I think in Europe, we're start implementing our USA model, and that's what you see the improvement.

Sean, it's Dennis. Europe, there's still a lot of room for growth for us there. I know the market is challenged, as is Canadian and some of the others, but there's still a lot of room for growth for us, so we're still optimistic.

All right. Thanks a lot for the responses, gentlemen.

Thank you.

Andy Wittmann, Robert W. Baird.

Thanks for taking my question. Sotirios, great to have you. The first question I had was about this large contract that you referenced I think at least three times in the script. That's telling me that it must be large. Can you give us any detail about the relative size potential of what that one could be and when it's slated to start up?

This is Dennis. I don't want to get an exact numbers. I can tell you, though, as far as magnitude, it's much larger than anything we have experienced --

In Canada.

In Canada, I'm sorry. In Canada, in that particular area of Canada. So it's really what we see as one of our first base-load contracts that can really keep us on a steady state. We push a lot of emphasis on that because we believe it's the type of work we've been looking for, for a while here.

Okay. Is that going to help you in the second half of this year? Is this more of a 2017 plan when that one phases in?

It's really a late Q3 into Q4.

Got you. And then my other question is something on the competitive environment, and Sotirios, we've seen from your competitors some fairly large-scale M&A where they are becoming large NDT inspection plays as well as maintenance plays. You talk about the impact as you see the environment seeing some level of consolidation, what that means for you if you feel compelled to offer some of those mechanical services, or if you feel like the NDT inspection is still the right strategy for your Company?

We still believe that the NDT is the right strategy for our Company. That's really what we believe, and we believe that [they're the one that] can be competitive, and basically, testing -- inspecting the valve and then repair it yourself has some conflicts in our opinion.

You're not seeing bundling of services or deeper customer intimacy from the competition to make the offering broader?

This is Dennis. I do see that our business, we have a lot of room for service line growth, be that additional NDT inspections or even getting into other things. It's not like we feel hampered at all, but yet, even though there's competitors doing other things, it doesn't make us want to have to jump into something we're not sure of. But we see a lot of room for growth. Our customers are very sound and behind us, and we think we could get into other markets with them and take --

Has to be something similar, Andy, to nature, where we really saw some new market and we saw that they would have also NDT. If we find something like this mechanical on a smaller scale, I think we would be interested.

Got it.

This is Jon. It was a good question because you got all three of us to chime in. I'd add my two cents, and that would be to the concern about are we getting crowded out of the market maybe because the other guys are bulking up or combining services. We are not seeing that at all.

If anything, we are so focused on providing superior value for our customers, we're having a greater number of conversations in this environment than we would have been at this time last year because there's more openness to the value proposition that we are providing. So we're not concerned about that.

Okay. I'll probably continue to take the temperature on that one as time evolves.

My last question, Jon, in the last two quarters, we've seen very good margin progression after maybe what was a bit of a slow start on some of the initiatives is coming through in full force. What's the runway look like?

Maybe the best way to ask this is, where we on the trajectory? Where do you think, as we look at adjusted EBITDA margins, where can we be in a couple of years? I think some of your commentary around that would be helpful for context.

Sure. And thank you for the comment. Year to date, we're up about 230 basis points for the first six months, and that's a nice improvement. It's certainly improvement that has, as you allude to, we've been -- had in the works now for a number of quarters, and we are grateful were starting to see it come through.

I think in terms of magnitude of improvement, that's probably about halfway of what we can realistically expect for us to achieve. I think there's probably another couple of hundred basis points out there to get. We're at this point really starting to lay the foundation to make what we've got sustainable and to grow it from here.

We're adding to our organization and increasing the level of administrative oversight, process discipline improvement, system upgrades, payroll, financial, what have you, nothing whole scale, nothing large and really impactful in that way, but incremental improvements that make it easier to do what we do and let us focus on the value that we add. I think we all to a Management Team member feel very confident that there's at least a couple hundred more basis points to get.

Exactly.

We agree.

Okay. Thank you very much.

Thank you.

(Operator Instructions)

Jeff Volshteyn, JPMorgan.

Good morning. Thank you for taking my question. Jon, just following up on your last comment, so the additional 200 basis points of margin, what would you say the timeline for that is?

(Laughter) I guess that one had to come. It's a great question, Jeff. As always with a question like that, it's a little bit hard to predict, and I think some of it will be interdependent with market conditions.

The improvements we've made so far have really been based on internal initiatives and strong execution, a good plan well executed, and commitment by our Team, our entire Team, to get it done. I think we still have more runway to go in terms of those initiatives, irrespective of the environment. So maybe half of it would be improvement we can drive, assuming the market doesn't deteriorate from here, and maybe the other half of that 200 would come about as market conditions improve.

Fair enough. Similar question in the line of the breakdown of your work from the type of work that you do and so, ongoing work that is more operations and maintenance versus project work, what I'm trying to understand is whether project work has increased and maybe the types of projects that you've been working on the last couple of quarters have changed either in scope or in size, does it move a needle on the project side?

Jeff, this is Dennis. Our project work never has been a huge percentage of our business. It's opportunistic, and when we get it, we can benefit from it, but we do really concentrate on the run and maintain and the things that those sites need to do to keep up day to day.

In this environment with the prices of oil and all that, project is going to be the one that's going to be the most challenged for return on investment and for customers who want to put their money down there. We're seeing that we're in a good spot because for us, the project work we have won't impact us that much either way. We do see some projects for us in certain areas that will benefit us going forward. That's what talking about possibly for the fourth quarter and such.

Okay. And last question for me, housekeeping. You mentioned improvement on the accounts receivable side. Is there anything else, any other moving parts that are important than the working capital that we should look out for in second and third quarter?

I think accounts receivable is by far the biggest component of the working capital movement, and that's the one I'd really look out for. Typically in Q3, because sales are lower, we get a cash inflow of a net reduction in receivables after a strong Q2, and I expect we'll have the same again. Q4 tends to be a little bit more neutral. I expect very good cash flow in the second half of the year following up on a very strong first half.

Thank you very much.

Thank you.

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

Okay. I would like to thank everyone for listening, and we wish you a great day in this difficult market environment today.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.