Mistras Group Inc

Thank you for joining Ms. Ross Group's conference call for its third quarter ended September 30th, 2022. My name is Andrea and I'll be your event manager today. We'll be accepting questions after management's prepared remarks. Participating on the call for Ms. Ross Group will be Dennis Bertolotti, the company's president and chief executive officer, Ed Prasner, executive vice president, chief financial officer and treasurer, and John Wolk, senior executive vice president and chief operating officer. I want to remind everyone the remarks made during this conference call will include forward-looking statements. the company's 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 U.S. GAAP. Reconciliation of these non-US 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 8K. These reports are available at the company's website and in the investor section on the SEC's website. I will now turn the conference over to Dennis Bertolatti.

All right. Thank you, Andrea. Good morning, everyone, and thank you for joining us today. NISTROS reported its ninth consecutive quarter of revenue growth. Our legacy operations continue to deliver improving performance, while the investments we are making and our strategic initiatives across renewable energy, data, and new markets are beginning to contribute to our overall success as well. Consequently, we believe the top line obscures the financial and fundamental growth of the business with both foreign translation and the continued under-realization of expectation in the downstream market masking what was otherwise a quarter of strong growth. On the bottom line, both net income and earnings per share were up more than 28% from a year ago, whereas adjusted EBITDA for the third quarter was essentially unchanged as both gross margin and overhead are battling a rising cost environment. We are addressing this by implementing price increases, and we are making progress breaking through customer resistance, primarily in the energy markets, where budgets do remain tight. However, there remains a significant lag between the time we increase our labor rate and the recovery time for the higher billing rate. We are also currently taking a hard look at all company-wide overhead to identify efficiency and productivity improvement that can better leverage our footprint, enabling us to focus more quickly on moving to our long-term goal of SG&A being 20% of revenue. Reflecting some of the rebound that we anticipated from the delays experienced in the second quarter, revenues were up 11% in upstream and 8% in the downstream. Year to date, our revenue across the overall oil and gas industry is up 6%. The typically more stable midstream business was a bit soft in the third quarter, other than our on-stream business, but we expect that sector to show steady performance over the longer term, driven by higher production levels and the corresponding increase in demand for inspection services across the transportation and distribution infrastructure. On-stream, again, had a record high revenue in the third quarter of 2022. And we expect its growth to benefit both our revenue top line as well as bottom line profitability. Business in our aerospace and defense industry remains strong. Recovery in commercial aerospace, growth in private space, and expansion into adjacent services continues to drive strong growth. We are increasing investment in this business as we believe we're building a strong foundation and a market where the demand for NET is large and growing. For instance, inspections for defense sectors, machining operations, cycle time reduction capabilities, and other services integral to inspections represent just some of the new markets we are seeing as powering strong growth in this vertical. All of these opportunities are in fast-growing markets, which carry a prospective gross margin higher than our current consolidated gross margin, and we look for significant contributions from these new verticals. Our renewables business also has us excited. It now appears that we will outpace our previous objectives and end the year with more turbine systems being delivered or already monitored than our originally anticipated numbers. While this market is in the early stages for monitoring solutions, it is a large and growing market with hundreds of thousands of wind turbines in operation globally and more being added every year. Every day, our installed technology is delivering further evidence of Sensoria's significant advantage relative to conventional inspection techniques, wherein we foresee an inflection point in the near future, resulting in faster market adoption and an acceleration in our growth trajectory. Importantly, once operators contact us for monitoring service, we expect to add incremental revenue for the repair and maintenance of any damage our sensors identify. Repair and maintenance services and revenue should be lucrative, along with higher margins and multiples for monitoring, adding to our already $15 million plus per year business in renewable wind. Our data solutions business continues to grow, destroying results at PCMS and en suite. We are constantly seeing new examples of how our data solutions are leading to stronger relationships and thus new opportunities with our customers. Customers that are looking for the best value for their spend represent an opportunity to rise above the competition and avoid commodity pricing. This continues to be a point of emphasis as we integrate data solutions across our organization. The new credit facility negotiated this quarter has not only added much greater liquidity, but is also freeing up financial resources that had previously been limited, allowing us to invest and build upon these strategic initiatives. Now, with additional financial flexibility, we are doubling down on our growth, which we expect to accelerate in 23 and beyond. Overall, it was a solid quarter at Mistrust. We are certainly confident in our future opportunities, but there are challenges. Exchange rates created an $11 million revenue headwind for the first nine months of 2022 with the related impact on margins. Tight budgets in our largest market and the lag being experienced in passing on the impact of our collectionary costs are also pressuring margins. Since the onset of the pandemic, our primary focus has been on actions that will enable us to weather the storm and emerge stronger and better equipped for a more normalized world. In 2020, when our two largest markets were virtually collapsing, we had one of our best years of cash flow, and we have reduced debt by $80 million over the past three years. And this year we negotiated a new bank facility that created much greater flexibility to invest in both organic and non-organic growth. Although our largest markets are improving, they're still below pre-pandemic levels while undergoing your own structural changes. This has certainly been a challenge for us, especially on the cost side, where we're experiencing labor cost pressures that lag and can be difficult to pass along to customers. While we see this as transitory, It is a near-term factor. With the worst of the pandemic behind us, we can now focus more of our resources on our goal to grow our strategic initiatives. We are making great strides building the new capabilities that will define our future as a greater mix of higher-value products that are more technologically sophisticated, predictive in nature, and compatible with the directive of energy markets, such as wind. Much has been accomplished, but there is more to do. I'm extremely honored to be leading Mistrust at this important and exciting time in our evolution, and I believe the future is very bright. I'll now turn the call over to Ed to give you more detail on our financial results for the third quarter and the first nine months of 2022.

Thank you, Dennis, and good morning, everyone. Revenue in the third quarter was up again, led by a record third quarter revenue performance in our services segment. consolidated revenue increased approximately 2.2% to 179 million, but was up 5.1%, excluding the impact of unfavorable foreign exchange. Revenue in our services segments, top two markets were up year over year in the third quarter, with overall oil and gas revenue exceeding that of the comparable pre-pandemic level in 2019. Our upstream sector was particularly strong, benefiting from strength in offshore Gulf and in the Alaska region. Downstream was also up from prior quarter as well, but it lagged our Q3 expectations and it lags behind the pre-pandemic level of activity. The midstream recovery took a pause in the third quarter, but is up year over year on a full year basis. Within midstream, OnStream's inline inspection testing business did have its best revenue and bottom line quarterly performance since inception. Aerospace and defense was also up significantly at 27% growth in the quarter year over year. Consequently, we believe the top line belies the fundamental growth of the business with both unfavorable effects and the continued weakness in some of our secondary end markets offsetting what was otherwise a quarter of solid growth in our two primary end markets. Gross profit for the quarter was approximately $54 million, up 3% from a year ago, with gross margin expanding 20 basis points to just over 30%. Gross margin in the quarter is illustrative of the benefit of faster growth in our aerospace and defense end market. In the near term, gross margin will primarily depend on the rate at which we can pass along price increases in line with inflationary cost pressures that we are experiencing. As we had noted during our second quarter earnings call, beginning this quarter, that is the third quarter, we are comparing against a year-ago quarter period in which almost all of the pandemic-related benefits had expired. So going forward, this comparability will help highlight the progress being achieved on gross margin, which trended higher from increased volumes, improved sales mix, and efficiency improvements. Selling general and administrative expenses in the third quarter were $41.6 million, up $2.4 million, or 6% from a year ago, in part due to expenses related to our bank refinancing of about $700,000 and an additional $600,000 of incremental cost-down actions, which were restored in the third quarter versus the same period last year, for a total of $1.3 million, or just over half of the overall increase. We are continually working to calibrate our overheads to match our level of revenue, and we are intensifying our actions in this important area. As Dennis stated earlier, despite ongoing inflationary cost pressures, we expect to reduce overhead from the current level as we exit 2022 heading into 2023, as it is one of the keys to leveraging our operating or increasing our operating leverage. Interest expense for the quarter was $2.7 million compared to $2.3 million in the same quarter of last year. This increase reflects the generally higher interest rate environment, as well as some temporary interim borrowings that increased our average outstanding debt for the quarter. For the third quarter, we reported net income of $4.4 million, or 14 cents per diluted share, which is increases of 29% and 27% respectively. Adjusted EBITDA for the quarter was $18.6 million, which was in line with a year ago. For modeling purposes, we would anticipate a prospective effective income tax rate of approximately 30% exclusive to any discrete items. Free cash flow for the quarter was 0.2 million compared to approximately 0.9 million negative a year ago. Operating cash flow in the third quarter was affected by a significant buildup in working capital, primarily attributable to September being our highest billing month of the year. We expect to see cashflow improve in the fourth quarter, not only from continued positive operating results, but also by a decrease in working capital. The fourth quarter has historically been one of our best cashflow quarters. In the fourth quarter, we do have a $4.5 million payment due for payroll taxes that had been deferred and accrued earlier under the CARES Act. That will satisfy all remaining CARES Act obligations. We additionally made a $2.4 million payment and early fourth quarter for final settlement of an accrued legal matter. Capital expenditures were $2.5 million for the quarter and $9.6 million for the first nine months of this year. We now expect total capital expenditures for the year to be less than our original $20 million budget and to be more likely in the range of $12 to $14 million. As of September 30, 2022, we had gross debt of approximately $201 million down from just under $203 million at the end of the year and net debt of $183.1 million compared to $178.5 million as of year end. Given that our primary use of residual free cash flow continues to be the reduction of outstanding debt, we believe our forecasted four-year free cash flow will enable us to pay down debt in the fourth quarter of 2022. Our goal remains to get below a three times leverage level even though our new credit facility provides quite a bit more flexibility. Once that level is achieved in 2023, we intend to evaluate our capital allocation strategy and use cash flow as a means to accelerate growth and build shareholder value. Keep in mind that under our new credit facility, maximum allowable total funded indebtedness to adjusted EBITDA is four times to the second quarter of 2023's measurement date, with a step down to 3.75 times for Q3 2023 measurement period and going forward for periods thereafter. We feel very comfortable operating under these terms. As noted in yesterday's release, we are updating our full year guidance to reflect our view on current market conditions. We now anticipate revenue between 683 to 693 million, adjusted EBITDA between 53 and 58 million, and free cash flow between $15 million and $18 million. Note that unfavorable foreign exchange is expected to lower revenue and adjusted EBITDA after translation into U.S. dollars by approximately $15 million and $2 million respectively on a full year basis for 2022 compared to our original outlook for the year. We expect both operating and free cash flow to improve in the fourth quarter of 2022 not only from continued positive operating results, but also due to an anticipated decrease in working capital from September 30, 2022. I will now turn the call back over to Dennis for his wrap-up before we move on to take your questions.