Mistras Group Inc

Ladies and gentlemen, thank you for joining Mistress Group conference call for its second quarter, end of June 30th, 2021. My name is Olivia, and I'll be your event manager today. We'll be accepting questions after management prepared remarks. Participating on the call for Mistress will be Dennis Batalati, the company's president and chief executive officer, Ed Preissner, executive vice president, chief financial officer and treasurer, and John Wolfe, Senior Executive Vice President, and Chief Operating Officer. I want to remind everyone that remarks made during this conference call will include forward-looking statements. The company actual results could differ materially from those projected. Some of those factors that can cause actual results to differ are discussed in the company's most recent annual report on Form 10-K and other reports filed with the SEC. The discussion in this conference call will also include certain financial measures that were not prepared in accordance with the U.S. GAAP. Reconciliation of these 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 the company's related current report on Form 8-K. These reports are available at the company's website, in the Investors section, and on the SEC's website. I will now turn the conference over to Dennis Bertolatti.

Thank you, Olivia. Good morning, everyone. Results in the second quarter were outstanding, consistent with our expectation that this quarter would mark an inflection point in our growth trajectory for 2021. Consolidated revenue was up nearly 43% in the quarter. We saw strength in our energy markets both domestically, including on stream, and in Europe. Actually, all of our end markets were up year over year in the second quarter, with the sole exception of aerospace and defense, although that market was up internationally. Consequently, we believe end markets are rebounding and will continue to do so over the balance of 2021. Together with a solid first quarter, results today have us excited about the momentum achieved over the first half of this year and leading into what we believe will be continued strength over the remainder of 2021. For the second quarter, gross profit margin increased over $14 million from last year, which is an increase of over 34%. Gross profit margin did decrease to 31.1% from 33.1% last year, which was anticipated as 2020 had a lower relative level of pass-through costs, such as travel and per diem, due to COVID lockdowns last year. On a year-to-date basis, gross profit margin is consistent with the first six months of 2020, both periods being at 28.8%. We remain very focused on improving gross profit dollars and gross profit margin through efficiency enhancement and better product mix. Selling general and administrative expenses were up in the second quarter over prior year quarter by $2.1 million. due primarily to restoring substantially all of the interim cost reduction measures that have been in place last year, most of which I am pleased to report have now been restored. Compared sequentially to the first quarter of 2021, SG&A is essentially flat, and SG&A is also essentially flat on a six-month basis with prior year, which is remarkable given the significant year-over-year revenue increase. but this is clear evidence of our keen focus on cost containment. Given our consistent gross profit margin and strong overhead controls, we had a strong improvement in operating income, which was $11.4 million for the second quarter of 2021. This drove an impressive $5.9 million of net income this quarter, or 20 cents per diluted share. Adjusted EBITDA was $22.5 million this quarter, an increase of nearly 100% over the prior year period, also being a five-year high as a percentage of revenue at 12.7%. In addition, adjusted EBITDA dollars were only 6% lower than our all-time high adjusted EBITDA as reported in the second quarter of 2019. This demonstrates a steady improvement in our productivity and efficiency, as well as the increased operating leverage we are creating with higher levels of volume. We also generated very strong cash flow this quarter, which enabled us to further reduce debt by $11.4 million in the second quarter. I am also very pleased with our revised credit agreement into this quarter, which significantly reduces our borrowing costs and enables increased investment in our growth initiatives, while also allowing us to continue to focus on reducing debt. Ed will walk you through the finer details But I want to emphasize that we would have been compliant with all financial covenants this quarter under the previous credit agreements requirements. I'm extremely pleased with the confidence our lending syndicate has shown in MISRUS and the support they are providing to fuel our growth. From virtually all perspectives, the second quarter of 2021 was a clear sign that we are well positioned to capitalize on a return to more normal economic conditions. Results demonstrate that we have implemented a solid growth strategy and increased operating leverage that is bringing more to the bottom line. And we substantially improved our financial condition, increasing our ability to further invest in our growth initiatives. Looking more closely at our various markets, last quarter we mentioned how a slow seasonal start and the Gulf storms looked like it was going to delay the turnarounds later into the spring. This ended up being exactly the case, and as a result, revenues in energy were strong again in the second quarter, as we captured the late spring start turnarounds for revenue, as well as the incremental revenue arising as turnarounds ran longer than usual into June. While turnarounds may be periodic and difficult to predict, they are indicative of the overall condition of energy markets, and right now we see the energy markets as rebounding. For instance, oil prices that were in the mid-60s per barrel at the time of our last call had more recently been hovering closer to 70 per barrel range. Energy remains our largest market, both traditional, fossil, and renewable. Consequently, over the near to intermediate term, we believe energy will continue to represent an attractive market for us. We have a multi-pronged strategy to succeed in energy. First, by continuing to take profitable market share. we believe we are growing share because owners are increasingly choosing partners that offer them an attractive value proposition which reduces their all-in cost. With our ruggedized tablets running MISROS Digital, PCMS, and other technological innovations, we are no longer competing exclusively on price. We are also expanding our scope of services by offering rope access, adjacent mechanical, and other capabilities that complement more traditional NDT services, which makes it easier to control our project costs. And finally, we can grow by introducing new products, such as data services via OneSuite, which we will be rolling out in the second half of 2021, and which represents a growing revenue stream for Mistrust. We also believe each of these strategies provides a point of differentiation, allowing Mistrust to become stickier with owners, which in turn should improve margins. As the energy market recovers, our on-stream business, which also serves a less volatile segment of the market, being midstream, is growing, both domestically and in Canada. For instance, the termination of the Keystone Pipeline has producers relying on their volumes through older existing pipelines. The aging infrastructure is creating demand to have these older pipelines inspected to not only determine if they can accommodate any increased demands, but also to ensure they comply with new more stringent safety regulations, including PIMSA. Onstream has also introduced new tools that can inspect larger diameter pipes, which is also opening up new, larger markets both in the United States and Canada. Today, about 70% on average of the revenue generated in our energy markets is from ongoing run-and-maintain business, which does not experience the dramatic peaks and valleys of capital budgets or periodic turnarounds. As we continue to implement our strategies, we believe we will become an increasingly valuable partner, growing in proportion of this less volatile, reoccurring revenue stream. In aerospace, there is anecdotal evidence suggesting that the commercial aerospace industry will bounce back sooner than previously thought, even in Europe, which has been particularly hard hit, although full recovery in aerospace is probably still not going to occur there until mid to later this next year. In fact, this quarter, aerospace was up in our international segment. Elsewhere, continued softness in the U.S. commercial aerospace sector is being offset by growth in the domestic defense and especially in the private space sectors, where revenue run rates are basically double that of a year ago. While it is still early on as we penetrate this market, growing both the materials we inspect and the operators for whom we work private spaceflight could become a very interesting sector, as could the closer-to-Earth business of privately maintaining satellites. Our renewable energy efforts are also continuing to make significant progress. Customers keep adding new blades and hubs to those we already are inspecting in the wind turbine sector. We are demonstrating how our proprietary acoustic emission technology, consisting of very sophisticated sensors and detection algorithms, can provide better information faster, than the inspection technologies currently used in the market today. While most of our active programs are on existing properties, we are also working with manufacturers who we believe can increase the value of their products by directly embedding our sensors into their new assets. But perhaps our most exciting initiative serving as a significant step in the digital transformation of asset protection is the introduction of Mistress OneSuite, our innovative, proprietary, an all-new asset protection software ecosystem, which we previously referred to as Project Kappa. The software platform offers functions of Mistrust's popular software and services brands as integrated apps on a cloud environment. One suite will ultimately serve as a single access portal for customers' data activities, while also providing opportunities for customers to discover Mistrust's breadth and depth in software and data insights from our current 50-plus applications being offered on one centralized platform. Just like any thriving ecosystem, apps within the OneSuite platform interact with each other, sharing critical information in real time. Put simply, MISRES OneSuite makes asset protection smarter and more digitally connected than ever before. Right now, we have nearly two dozen customers participating in the system's soft launch. Later in the year, we will have the official lunch suite launch, whereupon we will commence a more aggressive campaign. I am very enthusiastic about this very exciting area, which we will be speaking about in much greater depth in the future. I would now like to turn the call over to Ed to give you more detail on our financial results for the second quarter of 2021.

Thank you, Dennis, and good morning, everyone. It was truly an outstanding quarter, and it could be an inflection point And while some of the improvements over a year ago are attributable to the extreme effects on the year-ago quarter from the COVID-19 pandemic and other related macroeconomic factors, we nevertheless established new all-time records or near records in several key metrics. A five-year high adjusted EBITDA margin and the second-best all-time quarter of adjusted EBITDA puts the quarter's accomplishments in a more appropriate overall historical perspective. For the three-month end of June 30, 2021, total revenue increased 43% versus the prior year comparable period due predominantly to organic growth as well as the low single-digit favorable impact of foreign exchange. All land markets improved, again, with the sole exception of aerospace and defense market, which was down only modestly for the quarter and actually up in the international segment. The oil and gas market was 57.2% of revenue for the quarter, and is now 58.6% for the first half of 2021, which is up 140 basis points from last year. As Dennis mentioned, while we continue to invest in our growth initiatives, such as digital, private space, and renewable energy, the traditional oil and gas market will remain a large market for us, where we are having tremendous success gaining share while expanding our service offerings and thus growing revenue and earnings. Gross profit in the quarter increased over $14 million, or just over 34%. Gross profit margin was down from a year ago at 31.1% compared to 33.1%, but was consistent at 28.8% on a year-to-day basis for both the current and prior year. Keep in mind, as conditions normalize, our travel and related expense increases, and these costs are reimbursed by our customers as incurred, has the effect of reducing gross margin percentages although absolute gross profit dollars are up due to volume. We continue to constantly calibrate and then again recalibrate overhead costs with the current Revenue Monday. Compared to the first quarter, overhead was essentially flat, even though revenues were significantly higher, and we restored some of the costs that had been suspended last year. We are additionally restoring the remaining suspended temporary cost reductions, such as the company's 401 matching, and certain employee merit increases in the second half of 2021, which will modestly increase quarterly overhead in the third and fourth quarters of 2021. With the majority of pandemic-induced customer price concessions now restored, and hence the contribution margin and gross margin dollars recovered, we felt it was the right time to bring back the remaining temporary cost reductions that we instituted on the business back in April of 2020. Much of these reductions were imposed on employees, allowing the company to ensure its recovery. We are confident this recovery is underway, and now was the right time to bring these things back to normal, and we are very appreciative of our employees' contribution to Mishra's success. Our operating income improved dramatically to $11.4 million for the second quarter, compared to our small operating loss in the prior year period. Likewise, the bottom line we reported a tremendous increase in that income to $5.9 million, or $0.20 per diluted share, compared to a $2.7 million net loss, or negative $0.09 per diluted share, in the same period last year. As a result of this significant increase in gross profit and careful calibration of overhead, we had the second-best adjusted EBITDA quarter in the company's history, only $1.4 million, or 6% below, our best-ever quarter in Q2 of 2019, when sales were more than $22 million higher, and it was a five-year record for the highest quarterly adjusted EBITDA as percentage of revenue at 12.7%. This demonstrates our continued efforts to improve the operating leverage in our business model through both expanded gross margin and tight overhead expense control. Cash flow from operations in the quarter was $15 million, and pre-cash flow was $8.5 million. In contrast to last year, where there was a drop in revenue from the first quarter to the second quarter, we generated an increase in second quarter revenue this year. This required us to fund the corresponding increase in working capital, particularly accounts receivable, whereas a year ago, we harvested accounts receivable in the second quarter. Last quarter, we signaled that our growth was going to have this temporary dragging effect on cash flow. Accordingly, for the full year, we expect continuing positive free cash flow. However, the conversion rate as a percentage of adjusted EBITDA will be below our historical average of 50% of adjusted EBITDA. This is attributable to the effect of one-time items, such as through a payment of the CARES Act payable tax deferral, which is due later this year. Hence, our free cash flow conversion rate of approximately 25% for the first half of 2021 is a good estimate of what to expect for the full year of 2021. Capital expenditures are running a little ahead of last year, as expected, but we still anticipate total capital expenditures for the year to be in the $20 to $22 million range. Nevertheless, despite these increased uses of cash, we have reduced long-term debt by $11.4 million through the first six months of this year. At the end of June, net debt was down to $191.2 million, low below our targeted $200 million goal. Let me take a minute to further expand upon what Dennis mentioned earlier. what we consider to be a strong endorsement from our bank group, that is, our revised credit agreement executed in May 2021. This amendment included several significant improvements for us. First, the revised agreement removes the minimum 1 percent LIBOR floor. Instead, actual LIBOR will be used to calculate interest. And with the 30-day rate at 0.9 percent as of today, this represents a more than 90 basis point reduction in our borrowing rate relative to the previous 1 percent floor. Secondly, the LIBOR margin and base rate margins in the existing pricing grid were unchanged, but are now based on total consolidated debt leverage ratio to include junior debt, rather than the previous funded debt leverage ratio, which excluded junior debt. This is somewhat academic, since we don't currently have any junior debt, nor are we anticipating such. But more importantly, since we were below 3.75 leverage as of June 30, 2021, we moved to lower in the pricing grid, and therefore our all-in interest rate drops from LIBOR plus 4.15% to LIBOR plus 2.5% prospectively, commencing in the third quarter, which is an additional 165 basis point reduction in our effective interest rate. Coupled with the removal of the LIBOR floor, which actually commenced back in May, this lowers our all-in cost of borrowing from approximately 5.2% to 2.6%. At our current outstanding debt level, this represents a nearly $6 million annualized savings in interest expense. And thirdly, our allowable consolidated debt leverage ratio is now four times as of the end of each quarter due March 31 of 2022, dropping to 3.5 thereafter. At June 30, 2021, not only do we comply with the Disney leverage ratio, but we would have been in compliance under the old leverage test. So we have not and do not foresee any covenant compliance issues, nor do we perceive such as being a hindrance to executing on our business plan. Again, we estimate that the revised agreement coupled with our continued deleveraging will reduce interest expense by approximately $6 million over the next four quarters. When after tax basis at an assumed 30% tax rate, this will be approximately 14 cents per diluted share on an annualized basis. Consequently, this positive development frees up additional resources to invest in our growth initiatives through the reduced interest burden and more flexible terms. However, as Dennis stated earlier and I reiterate, these more favorable terms do not change our commitment to reducing debt. Actually, the revised agreement does require a slightly higher level of term loan amortization, although it is consistent with what our prior debt repayment plans would have otherwise been. Lastly, we did reduce the size of the revolver while maintaining required liquidity. This additionally saves us unused commitment fees. Turning to the tax rate, our consolidated effective tax rate was 27.7% for the second quarter of 2021. There were discrete benefits favorably impacting the rate thus far this year, so we anticipate an effective rate of closer to 30% for the second half of 2021. As Dennis mentioned, growth in our two largest segments, services and international, actually outpaced our consolidated growth In services, this generated a 69% increase in operating income, while we turned year-ago operating losses in both international and the products and systems segments into operating income this quarter. Revenues were also up in each of our end markets, except aerospace, with revenues from oil and gas up 52%, and now comprising 57% of total revenues in the quarter. We expect energy to remain strong throughout the balance of the year, with aerospace recovering somewhat more slowly except for the space sector, where revenues are growing robustly year over year. From all perspectives, it truly was an outstanding quarter. In addition, we are in a much stronger financial position with our revised credit agreement, which will provide additional resources to fund our growth initiatives. Regarding our outlook for the third quarter of 2021, our business has been recovering over the past four quarters from the low we experienced in the second quarter of 2020, when the effect of COVID-19 was most impactful to our financial results. Although energy prices and demand are currently stable, the ongoing COVID-19 pandemic continues to significantly impact our second largest market, that being aerospace. We expect revenue to increase in the low to mid-teens percentage in the third quarter of 2021 over the prior year quarter. Adjusted EBITDA is expected to be higher in the third quarter of 2021 than the prior year period, but lower sequentially than the second quarter of 2021 due to substantially all of the remaining temporary cost reduction measures from 2020 being restored during the third quarter of 2021. This outlook, of course, is contingent on continuing macroeconomic stability, including stabilization in crude oil markets, a timely and effective COVID-19 vaccine rollout throughout the remainder of 2021, as well as no new or increased stay-at-home mandates resulting from an increased spread of the COVID-19 variants, all of which could impact our ability to work as a critical service provider. Throughout the pandemic, and now as we cautiously rebound and recover, we have demonstrated Ms. Ross's ability to quickly adapt to a challenging market, and not just for immediate results, but also to set the stage to capitalize on emerging opportunities. As we look forward to the second half of 2021, we are highly confident that our business model is robust and sustainable, and we remain firmly committed to executing our plans by maintaining our intense focus on cost containment while continuing to prudently invest in the business. That is our strategy both today and over the long term, and it will continue to be a very exciting journey. And with that, I will now turn the call back over to Dennis for his wrap-up before we move on to take your questions.