Mistras Group Inc (MG) 2017 Q1 法說會逐字稿

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

I'll now hand the conference over to Dr. Vahaviolos. Please proceed.

Liz, thank you very much, and good morning to all. In today's call, we will review Mistras Group's financial results for the first quarter of our fiscal year 2017 that ended on March 31, 2017. For the last 2 years, I have been speaking about challenging market conditions imposed by low oil prices and the many actions we have taken in recognition of these challenges. We remain focused on 3 things: first, helping our existing customers realize great value for their inspection services spend; second, reducing our cost; and third, pursuing profitable organic revenue growth for both core entity services and for our expanded platform for mechanical services. Our performance in the first quarter of our fiscal year, calendar year 2017, was somewhat weaker than we expected in North America, but better than we expected internationally. Global revenues declined 2%, reflecting a mid-single digit organic services decline in weak North American market offset by double-digit organic growth in Germany and France. Our global gross profit margins improved slightly as international improvements offset North American weakness, and our cash flow remained strong.

Our long-term outlook remains very promising. Customer assets are aging inspection and maintenance needs are growing and projects that have been deferred cannot be deferred indefinitely. Our acquisition pipeline is promising, and our balance sheet provides us with many options for future growth. Although the market rebound has not yet occurred, Dennis will explain how we're using this time to make further adjustments to our cost structure and to enhance our competitive position by adding capabilities that will help our customers in new and exciting ways. We're actively quoting new business that will help to ignite our profitable growth in the fall of 2017 and for years to come. Jon will now explain our results and then Dennis will follow. Afterwards, I will close and we will take your 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 transition report on Form 10-K and in other reports filed with the SEC. The discussion in this conference call will include certain financial measures that were not prepared in accordance with U.S. GAAP. Reconciliations of those non-U. S. GAAP financial measures to the most directly comparable U.S. GAAP financial measures can be found in the tables contained in yesterday's press release and in our related current report on Form 8-K. These reports are available on the company's website in the Investors section and on the SEC website.

Revenues for the first quarter of fiscal year 2017 were $163.3 million, 2% below the prior year's Q1. Services Q1 revenues declined 4% compared with prior year, driven by negative mid-single-digit organic growth, which resulted from shorter-duration turnarounds and a less-than-robust market for NDT spend. International segment Q1 revenues grew by 11% as mid-teens organic growth was slightly reduced by foreign currency. Products and Systems revenues had an organic contraction in Q1, driven by lower sales volume. The company's largest new construction customer in the nuclear industry declared bankruptcy at the end of our first quarter causing us to take a special $1.2 million pretax charge for potential loss on its prepetitioned receivables. Inclusive of the special charge, the company's net income for Q1 2017 was $1.7 million or $0.06 per diluted share, and exclusive of this charge, net income was $2.5 million or $0.08 per diluted share compared with $0.11 per diluted share in the prior year's first quarter.

Despite the revenue decline, the company's gross profit margin edged up slightly to 26.4% in the first quarter compared with 26.3% 1 year ago. Breaking this down by segment, Services segment results, excluding the special bad debt provision were as follows: Operating income declined by $2.8 million or 24% compared with the prior year's Q1 on a revenue decline of 4%. Q1 gross margins declined by 80 basis points compared with prior year, while operating margins declined by 180 basis points to 6.8% as operating expenses edged up compared with prior year due primarily to acquisitions.

International gross margins improved by 250 basis points to 30.5% in Q1, while operating income grew to $3 million or 8.9% of revenues compared with results that were marginally above breakeven 1 year ago. This improvement was primarily driven by a growing Aerospace business, which led to double-digit organic revenue growth and improved sales mix and improved utilization of personnel. Products and Systems had a challenging first quarter with sales down 16% and operating income declining by $0.3 million. Adjusted EBITDA for the total company was $13.3 million, down $1.7 million or 11% from the prior year's Q1.

Operating cash flows for the first quarter of fiscal year 2017 were $13.4 million, while free cash flows were $9.6 million. Both amounts included a reduction for the payment of a $6.3 million legal settlement, which was accrued in 2016. Total capital expenditures in the first quarter of fiscal year 2017 included a non -- included noncash capital lease outlays -- including noncash capital lease outlays were $4.5 million or 2.7% of revenue, well below the prior year's $6.8 million or 4.1% of revenue. We used our $9.6 million of free cash flows to repurchase $6 million of stock and fund one acquisition with $4.5 million of upfront cash. We repurchased approximately 256,000 shares of our stock during Q1 at an average price of approximately $23.41 per share. These shares were purchased at a discount to the company's weighted average stock price for Q1 pursuant to the company's previously announced agreement with Dr. Vahaviolos. As of March 31, 2017, the company had $35 million remaining on its share repurchase authorization. Total debt and capital lease obligations net of cash was $85.4 million at March 31, 2017. Net debt was approximately 1.1x trailing 12-months adjusted EBITDA.

I'll conclude my section with a brief discussion on our expectations of market performance and company-specific guidance. Our tally of NDT inspection revenues generated by global public companies serving industrial customers revealed that year-over-year revenues declined at a double-digit rate during calendar 2016 led by lower spending in the Oil & Gas space. Our conversations with customers indicate that their inspection budgets for 2017 remain subdued and similar to 2016. While oil prices have compared positively to prior year levels so far year-to-date, the market still struggles with sub-$50 per barrel oil, as this pricing does not encourage the types of operating or capital spending that is consistent with the significant increase in NDT inspection budgets. For example, one customer recently disclosed that it had a relatively high amount of turnaround activity in its first quarter, but unfortunately this activity did not require a great deal of NDT inspection. Of course, this dynamic can work both ways in that relatively lower levels of customer turnarounds can involve a disproportionately high amount of NDT inspection when conditions require and budgets allow this to occur.

Our North American revenue performance in Q1 of 2017 reflects this market dynamic. Our expectations for Q2 are for a similar pattern, and we expect a lift in the second half based upon our knowledge of work schedules for the fall. Against this backdrop, we're reiterating our revenue profitability and cash flow guidance for calendar 2017.

And with that, I turn this over to Dennis Bertolotti, President and Chief Operating Officer.

Thank you, Jon. I'll now provide updates on our business segments. In our Services segment, over 60% of services revenues are in the Oil & Gas sector. It's no secret that this market became progressively more challenged in 2016 and that thus far spending levels have remained muted in 2017.

During our most recent call, which occurred less than 60 days ago, I told you that we were doing things that were within our control that will drive substantially better growth and profitability. These actions entail expanding our offering of related services with the focus on delivering even more value to our customers. On our last call, I explained our vision that builds upon our strong foundation as a leading NDT inspection provider and drives expansion of our services in 3 key areas: Mechanical services; Aerospace; and pipeline integrity. Although still early, I'm pleased to update you that there has been a great deal of company activity going on to build out these capabilities. Additionally, there are a number of bids that we are actively working to engage in this work. As a reminder, the mechanical service we're focused on include those that are complementary and adjacent to NDT inspection. Examples include removing and reapplying mechanical insulation, preparing surfaces and then reapplying either coating or painting or performing repair services. All these services can be performed both on the ground and at height. We believe we can earn a greater share of our customers’ spend, providing them with a strong, combined value proposition and new efficiencies that they cannot achieve with multiple vendors. And we continue to envision profit margins that are accretive.

In Aerospace, we completed an acquisition of a shop business that performs coating services that are complementary to NDT inspection, primarily for Aerospace customers. Our buildout to serve Safran for its fleet engine program remains on track with initial revenues expected to commence in our fourth quarter of this year, and market interest remains high among members of the European Aerospace supply chain. Pipeline integrity is a market that is poised to grow and is presently the most active market within Oil & Gas. We remain encouraged by the proposed FENSA regulations that will require pipeline owners to inspect, test, assess risk and document the condition of their entire pipeline networks. And we're actively seeking to expand our capabilities to service this important market. Because of the extended period of reduced market activity, we're also focused on driving cost reductions in our core business.

During the second quarter, we will consolidate several branch locations and eliminate approximately $2 million in annual costs. In addition, we're actively working on staffing levels at a handful of locations to better align cost to their lower level expected near-term activity. As Jon mentioned, our balance sheet is in great shape and our acquisition pipeline contains some very interesting companies, as we seek to further the scope of services that Mistras Group performs. And now for Sotirios' closing remarks.

Thank you, Dennis. We continue to manage the business with the ultimate goal of delivering long-term value, building upon our foundation to always deliver strong results for our customers. (inaudible) our strategy of providing the best value, flexibility, productivity and safety through our diverse network of thousands of multi-certified technicians is the right one in good market and in challenged markets. Indeed, the market still remains challenging, but it feels like the direction will begin to change. We know there is lot of pent-up demand from deferred maintenance projects. We also feel there is upside from our new vision that we start to improve things as well. We have many reasons to be optimistic, including: first, we have the best team in the industry with the most complete range of talent capabilities; second, we're delivering strong value to our customers, and this is the best way to both defend existing market share and to gain new others; third, our customers need our services for their aging network assets; fourth, we have the financial resources to continue to invest in building our base of value-added services; and fifth, at some point in the near future, the market will turn positive and enable us to realize significant revenue and growth. Our customers have big challenges, and we're the solution provider they can count in on to protect their assets. I extend my thanks to our management team, to our loyal employees, to our valued customers and to our shareholders. We'll now open the floor for questions. Liz?

(Operator Instructions) Our first question comes from the line of Matt Duncan with Stephens.

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

Dennis will answer. Go ahead.

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

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

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

There was also the movement on turnaround. So okay.

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

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

Our next question comes from Edward Marshall with Sidoti.

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

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

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

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

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

No, I mean...

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

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

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

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

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

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

(inaudible)

But what segment?

Services.

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

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

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

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

This is Dennis. We do see that customers are looking for value increases. We talk about mechanical, along with inspection things like that, so that you can put a combined crew versus 2 or 3 different vendors. That same kind of thinking, we also have a lot of progressive technology out there for online and all these other types of technology. And it sounds counterintuitive, but if we can help a customer put an online tool up there where it's hard to reach or it's a hazardous area and get the readings that they need on a continuous basis for something that need to be nursed or equipment that needs to be checked often as opposed to putting somebody in harm's way, it makes perfect sense for us as well as the customer. And being that we're positioned with the technology and the capability to do that, we believe as they go forward with this kind of thinking, that's going to walk right into what Mistras' strengths are.

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

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

That's right.

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

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

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

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

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

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

(Operator Instructions) Our next question comes from the line of Bobby Burleson with Canaccord.

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

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

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

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

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

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

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

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

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

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

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