Mistras Group Q3 2024 Earnings Call Transcript

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Provided by Quartr
October 31, 2024

There are 6 speakers on the call.

Operator

Thank you for joining the MISTRAS Group's Conference Call for its Q3 Ended September 30, 2024. My name is Amber, and I will be your event manager today. We will be accepting questions after management's prepared remarks. Participating on the call for Ms. Strasse will be Manny Stomakos, the company's Chairman of the Board and Interim President and Chief Executive Officer, Ed Preissner Senior Executive Vice President and Chief Financial Officer.

Operator

I want to remind everyone that 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 cause actual results to differ are discussed in the company's most recent annual report on Form 10 ks and the other reports filed within the SEC. The discussion in the conference call will also include certain financial measures that were not prepared in accordance with US GAAP. Reconciliation of these non U.

Operator

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 the Form 8 ks. These reports are available at the company's website in the Investors section and on the SEC's website.

Operator

I would now like to turn the conference call over to Manny Stemitakis.

Speaker 1

Thank you, Amber. Good morning, everyone, and thank you for joining us today. The company's Q3 results were in line with our expectations, with the bottom line growing significantly faster than the top line, once again demonstrating the margin accretive actions and significant operating leverage improvements that we have instituted into our business model. Revenue was up nearly 2% during the quarter, led by continuing growth in the International segment for the 8th consecutive quarter, along with double digit revenue growth within the North American segment's Aerospace and Defense and Industrial Industries. Our consolidated oil and gas industry revenue decreased during the Q3, driven by decrease in downstream sub industry revenue as we had anticipated due to a relatively moderate fall turnaround season compared to a more robust spring turnaround season earlier this year.

Speaker 1

Our midstream sub industry revenue also decreased in the 3rd quarter due to timing of customer projects, whereas upstream sub industry revenue increased in the 3rd quarter due to strong customer demand. Adjusted EBITDA was up over 11% compared to the prior year quarter and up over 32% compared to the year to date period, reflecting significant improvements in our operating leverage. I'm also pleased with our 3rd consecutive quarter generating GAAP net income, which is a function of continued revenue growth, gross profit expansion and selling, general and administrative expense reductions. Selling, general and administrative expenses were down compared to both the year ago quarter and year to date periods. For the Q3 of 2024, SG and A was down 1.7% year over year to $38,900,000 SG and A was also down 5.1% sequentially from the Q2 of this year.

Speaker 1

I noted last quarter that both cash from operations and free cash flow performance along with debt level through mid year June 30 significantly lagged that of prior year and the company's expectations. I mentioned that management would be intently focused on improving this performance via prioritization and focus during the second half of twenty twenty four. I am pleased to report that we made significant progress on this front during the Q3, which Ed will cover later. A few additional comments on the Q3 are as follows. Revenue generated by our data analytical solutions category in the quarter was $17,900,000 which is essentially flat with the prior year as some scheduled jobs pushed out beyond the 3rd quarter and there were some unanticipated delays with new customer implementations.

Speaker 1

We expect revenue growth for this category to be a mid teens growth rate in 2025. Our global consolidated Aerospace and Defense revenue grew 9.1% in the 3rd quarter. In spite of unanticipated project push outs due to current market conditions. Nevertheless, assuming current market conditions don't materially change, we expect to finish up nearly 15% for the full year 2024. We additionally expect this key growth industry to continue with midteensrevenuegrowth in 2025.

Speaker 1

We will continue with our longer term strategy of increased investment in this industry and we'll continue to extend our service offerings to include more additive manufacturing and mechanical work beyond inspection testing. We will also continue to expand our scope of work in the private space industry as a result of robust demand for our services in this area. As such, we expect continued strong performance in this industry over the longer term. The search for a permanent CEO is on track and progressing well, and my goal is to announce our next CEO before the end of this year. Once in place, I will remain active as the Chairman of the Board and expect to work closely with the CEO, not just during a transitionary period, but on a recurring basis going forward to continue on the momentum and progress developed in 2024.

Speaker 1

And lastly, I once again want to note the renewed sense of commitment and dedication being demonstrated throughout the entire organization via an invigorated senior leadership team. Now I would like to turn the call over to Ed for a more detailed update on our recent results.

Speaker 2

Thank you, Manny, and good morning, everyone. As Manny mentioned, I am pleased to report that we did achieve significant progress in improving our cash from operations and free cash flow performance. We generated $19,400,000 of operating cash flow and $13,200,000 of free cash flow during the Q3 attributable to our improved results and operating leverage. We use this cash flow to pay down over $10,000,000 of borrowings during the Q3. Our gross debt as of September 30, 2024 is the lowest level it has been since our acquisition of Onstream in December 2018.

Speaker 2

And we have paid down over $100,000,000 of outstanding borrowings since that time. We are funding our organic growth initiatives with operating cash flow, which significantly improved in the Q3 of 2024. Although our second half of twenty twenty four free cash flow and debt pay downs are expected to achieve our original ambitions for the year, we will not make up the shortfall from the first half of twenty twenty four attributable to the earlier buildup of accounts receivable. Accordingly, we will revise our full year free cash flow outlook to a range of between $18,000,000 to $22,000,000 We will continue to fund our organic growth initiatives internally and the company's bottom line is growing significantly faster than the top line, once again demonstrating the margin accretive actions and significant operating leverage improvements that we have instituted into our business model. The Q3 of 2024 was our 5th consecutive quarter of both revenue and adjusted EBITDA growth versus the prior year comparable periods.

Speaker 2

Revenue in the Q3 was up only 2% year over year given the expected slowdown in the oil and gas industry, particularly in the downstream subcategory, which we had anticipated for the second half of this year. Our international segment revenue was up 8.7% in the quarter, continuing the strong trend they've experienced throughout 2024. Although overall North American segment revenue was essentially flat in the 3rd quarter, the Aerospace and Defense and Industrial Industry revenues were each up over double digits in the 3rd quarter as compared to the prior year. Our global consolidated Aerospace and Defense business revenue grew 9.1% in the 3rd quarter in spite of unanticipated project push outs due to current market conditions on the heels of having been up 17.5% in the 2nd quarter and 18.9% in the Q1 of 2024. Nevertheless, as Manny said earlier, assuming current market conditions don't materially change, we expect to finish up nearly 15% growth for the full year of 2024 in this industry.

Speaker 2

And we additionally expect this key growth industry to continue with mid teens revenue growth in 2025. Consolidated Industrials Industry revenue was up 17.2% and Power Generation and Transmission Industry revenue was up 19.7% respectively in the Q3 versus the prior year on the strength of demand in these industries. Although downstream revenue moderated in the Q3 as we had anticipated, upstream revenue continued to be strong in the 3rd quarter and was up 15.2% compared to the prior year Q3. Midstream revenue was down 17.8% in the quarter compared to the prior year, primarily due to a non recurring turnaround project, which occurred in the prior year quarter. Oil and Gas Industry revenue as a whole has been very resilient for the year to date in 2024, up 4.5% over the prior year for the 1st 9 months of the year.

Speaker 2

Gross profit dollars were up on a year to date basis for the 1st 9 months of 2024 across all segments as was operating income up for the same period. On a consolidated basis, operating income was $11,900,000 for the Q3 of 2024, a significant increase over the prior year period. As Manny mentioned, selling, general and administrative expenses were down both sequentially and year over year. For the Q3, our SG and A was 21.3 percent of revenue and was 21.7% of revenue for the 9 months ended September 30. On a full year basis, we anticipate 2024 SG and A of approximately 22 percent of revenue, which is down 160 basis points from full year 2023 SG and A in terms of revenue of 23.6%.

Speaker 2

The company's primary objective is to create shareholder value by improving our bottom line profitability. And in the Q3 of 2024, we continue to make significant progress on that front with GAAP net income of $6,400,000 or $0.20 dollars per diluted share. On a year to date basis for 9 months, our GAAP net income was $13,800,000 or $0.44 per diluted share. Interest expense was $4,300,000 for the 3rd quarter, up slightly from a year ago, but down sequentially from the 2nd quarter. We expect interest expense to reduce further in the 4th quarter and on an annual run rate basis in fiscal 2025 by first reducing leverage, which will lead to a lower credit margin spread and second, by decreasing the amount of our average outstanding borrowings.

Speaker 2

On a trailing 12 month bank defined leverage ratio on our credit rating on our credit facility rather was approximately 2.6 as of September 30. This is the lowest ratio lowest this ratio has been since the Q3 of 2018. Based on our current projections, we anticipate further reductions to our leverage ratio lower as of year end due to increasing our trailing EBITDA and reducing debt further. Our effective income tax rate was 29% in the 3rd quarter and was 22% for the 9 months ended September 30. We expect our effective income tax rate to be in the mid-twenty percent range for the full year of 2024.

Speaker 2

Note that there were several special items recorded during the Q3, including a $2,100,000 reauthorization and other cost charge, a $900,000 favorable legal settlement and a $1,500,000 non recurring other income benefit, which in aggregate essentially offset with only a very minimal impact to net income and no impact to diluted EPS. All in all, our efforts are resulting in improved performance. I am optimistic not only about this year, but about 2025 and beyond as we continue to implement initiatives that leverage the unparalleled excellence, talent, experience, capabilities and knowledge that have made MISTRAS a leader in this industry for over 40 years. We sincerely appreciate your continued support and expect to reward your patience with significantly improved results over full year 2024 and for the longer term future. At this time, I would like to turn the call back over to Manny for his closing remarks before we move on to answer your questions.

Speaker 1

Thanks, Ed. The 3rd quarter represented another sequential strong top and bottom line quarter for MISTRAS, providing evidence and confidence for our future performance given our new found disciplined processes and approach. While we are optimistic of our outlook, we know that there is nevertheless still work to be done to achieve our long term aspirations and goals. As I mentioned earlier, due to the short run underperformance in certain sectors due to current market conditions and project push outs, we are revising our 2024 guidance of full year revenue to between $725,000,000 $730,000,000 from $725,000,000 to $750,000,000 previously and adjusted EBITDA to between $80,000,000 $82,000,000 from $84,000,000 to $89,000,000 previously. And as Ed mentioned earlier, we are lowering our free cash flow guidance to between $18,000,000 $22,000,000 primarily related to an unanticipated buildup of accounts receivable.

Speaker 1

Despite these short term guidance impacts to our 2024 results, we are confident in our long term strategy and business model heading into 2025. As to our preliminary outlook for 2025, given the expected growth in our higher margin businesses and continued operating leverage improvements, we anticipate a meaningful improvement in our net income with low double digit expansion in adjusted EBITDA and low single digit organic revenue growth. I am encouraged with the progress being achieved by the collaboration between our commercial and operations functions, which is resulting in the successful renewal of long term agreements with a number of our largest customers. Our continued cost discipline, strategic partnerships with our valuable portfolio of clients and the company's long term vision have excited us for the prospect of continued profitable growth for MISTRAS. I am extremely proud of our nearly 5,000 employees who believe in our plan and are working hard every day to achieve our goals and objectives.

Speaker 1

You can feel that level of energy throughout the organization. And our customers are responding in kind as well with increasing levels of ROI recognition for the value that MISTRAS employees bring to the equation in delivering on our mission to maximize safety and operational uptime for our customers' vital assets. At this time, I would like to ask the operator to open the call to your questions.

Operator

Thank you. We will now conduct the question and answer session. Our first question comes from John Franzreb at Sidoti and Company. Your line is now open.

Speaker 3

Good morning everyone and thanks for taking the questions. I'd like to start out with the reduction in the cash flow projections. Could you just talk us through what changed today versus 3 months ago when you had the higher projections for the full year?

Speaker 2

Hey, John. Thanks. It's Ed. Yes, great question. We had a very good progress in Q3 and we'll continue that in Q4.

Speaker 2

It's just very simply our AR balance, it's billed and unbilled AR is still higher than we'd like it. It is elevated year over year. So we're still working to bring that back down. There's just not enough time to do that in the remainder 60 days of the year here to get back to the original aspirations, but it's really a function of just pulling the AR balance back down. It's how we get there.

Speaker 2

So again, we are making progress now. We just didn't get on it quickly enough in the year, so we're not digging out at this point from the shortfall earlier in the year during the first half. But otherwise, we're on course here and we'll have further improvements in Q4 as we saw in Q3.

Speaker 3

Are you making systematic changes so that this doesn't occur again?

Speaker 2

We are, yes, it's a focus Sean, it's an intensity, it's staying on WIP, it's the frequency of us meeting as a management team to get on top of the process, the schedule, having more frequent meetings, more intensity. We are making system changes. We are upgrading our ERP next year, a little more automation, a little more workflow to get late invoices out the door a little more rapidly, but it's more of a process of just making it the top priority for management is how we improve this. So we lost a little bit of our focus here more than anything else, but we are making some system improvements and we've intensified some of the timing and the process of how we're following up and pushing the envelope here. I think with higher interest rates now, some of our customers are probably a little less inclined to part with their money.

Speaker 2

So maybe it's got a little more challenging recently as well. I think that could be a part of it, but we are making it a top priority for management to lean in hard here, get the whip down, get invoice quickly and then preemptively call the customer and work hard to get the cash in the door. So we are working on this as a process and do expect it to get back on track here in 2025 and not make it the challenge that it's become here for 2024 for us.

Speaker 3

Okay. And looking back at the 3rd quarter, I didn't catch this if you mentioned it, but was there any revenue impact from price increases? And on the other flip side, was there any revenue impact from exiting unprofitable business lines?

Speaker 2

On your second question, no, definitely no exiting of work. On the pricing side, yes, same as we've seen throughout the year, there's been modest increase of pricing. That same couple of percent we're seeing, I would probably attribute much of the increase this quarter to pure pricing. Volume would have been flatter. But yes, our pricing strategies are still in place and very proactive and leading to improvement.

Speaker 2

But volume is what was off this quarter if you look at the sequential comparison. But yes, there was some pricing benefits during the Q3.

Speaker 1

And John, just to add to that. Sure. We are constantly evaluating the mix of the business we have and the profitability of the business. Our commercial team has done a really good job in working with our then we then we will not be walking away from any business. But if accounts are not profitable, we just can't continue to be in that space with that customer.

Speaker 3

Makes sense to me. One last question, I'll get back into queue. You highlighted that healthcare hit the gross margins. Can you kind of quantify how much that was of an impact in the quarter?

Speaker 2

I mean, it's we don't exactly quantify the amount, John, but it was not 100 of 1,000, but more like 1,000,000 plus enough to impact that gross margin dollar period over period. So again, just more of a claims experience impact there, nothing more structural than that.

Speaker 3

Okay. Fair enough. Thanks. I'll get back in the queue. Thank you for taking my questions.

Speaker 3

Thanks, Sean.

Operator

Thank you. One moment for our next question. Our next question comes from Chris Sakai at Singular Research. Your line is now open.

Speaker 4

Hi, good morning, Nanny and Ed. To get back to the higher healthcare claims expense, was this more of a one time thing? What happened there to really increase that?

Speaker 1

We had a couple of very high cost claimants. Today, high cost claimants are much more likely than they've been in the past. We had a couple of very high cost claimants and that did impact the overall claim activity. But when you remove those high cost claimants out of the equation, things are relatively normal.

Speaker 4

Okay, great. Can you talk about the power generation and transmission revenue increase, same with other process industries that seem to do pretty well this quarter, what are we to expect next quarter and 2025?

Speaker 2

Yes. Good question, Chris. That's a 2 of our smaller sectors across the board of industries we serve. But as we've seen all year, all of our sectors have been up nicely with good robust growth. I mean, a lot of just due to the general manufacturing level of activity out there across multiple industries.

Speaker 2

So yes, we should we expect to see decent growth, GDP plus kind of growth in some of those less pronounced sectors for us. So yes, we don't forecast necessarily at that level in our outlook. But yes, we do expect to see growth across a lot of those basic industrial and process oriented industries are all showing nice healthy level of activity. And we do expect that those kind of growth rates we've seen in 2024 to continue in 2025 for those sectors.

Speaker 4

Okay, great. And then, so far as downstream is concerned, do you anticipate an uptick in that next year?

Speaker 2

Yes, good question, Chris. As we said, our spring was rather robust. Our fall downstream was a little more moderate. Net net for the 2 combined, a pretty good year overall for that sector. We see the same thing next year.

Speaker 2

We're looking at now with our longer range planning on when turnarounds happen. And yes, we would expect to see a very similar year. Mike, could be the inverse next year. We can't quite control the timing of when our customers want turnarounds to happen. But you may see a little bit of a flip flop.

Speaker 2

But right now, it looks like the fall might be a little stronger than the spring. So you may have sort of the opposite effect next year. But we are still looking at that and locking that down for next year. But overall, we still we do expect to see a good year again in downstream next year. Just a question of which half ends up being a little stronger than the other, we were still working through that, but it should be a good year again for that sector next year.

Speaker 4

Okay, great. Thanks.

Speaker 2

Thank you.

Operator

One moment for our next question. Our next question comes from Mitchell Pinera at Studeban and Company. Your line is now open.

Speaker 5

Hey, good morning. Couple of questions for you. First on

Speaker 4

in the oil

Speaker 5

and gas segment, the midstream has been up and down and up and down. Any reason for the decline this particular quarter?

Speaker 2

Hey, Mitch, you said. Yes, it wasn't much of decline this quarter. There was a large recurring piece of work, turnaround work that does fall in midstream sometimes that occurred last year. So this year, by comparison looked off, but it was really last year was a little higher than normal due to some work that did not repeat in the current year, is what led to that differential in the midstream. Okay.

Speaker 5

And then with oil prices kind of falling, I'm curious, did that that didn't have any effect or did that have any effect in the for the quarter's results? And with like Brent at 70 or below, do you think that would have any sort of impact on the early next year's turnaround season?

Speaker 2

We don't think so, Mitch. No, that's still in what we would deem to be a fairly ordinary band of pricing for future crude prices. No, supply and demand matters more to them, capacity utilization matters more and crude prices, future prices do generally affect probably the downstream more than anybody. The midstream and upstream are not very sensitive to crude prices. So net net, the current price where it is and where it's expected to be pricing wise, no, we do not see that impacting anything at 25.

Speaker 2

That's within the normal range of what our customers were anticipating and planning for. So no, we do not expect current prices to have any impact on the short term here. No.

Speaker 5

Okay. And then you had 2 separate areas that sort of had delays or push outs on revenue, one being in the data analytics. I think, Manny, you talked about that. And then also aerospace, I guess, international aerospace, there were projects pushed out or you mentioned market conditions. Can you just give a little more color about what's happening in both data analytics and the aerospace project push outs?

Speaker 2

I'll address the second one and maybe Mandy might address the data one. On the aerospace side, that's just a function of that is our shop work where parts are coming to us. So we are at the mercy of the supply chain there. Again, that growth moderated slightly. International is a little flatter.

Speaker 2

So the Airbus platform is a little more distended maybe than the Boeing platform is in North America. North America was up nicely in the quarter and has been all year. The European platform is catching up a little bit. But that's just some of the ongoing in that sector. There is a lot of supply chain glitches.

Speaker 2

We're in a good one. Engine parts are still in short supply. That's a primary area where we do testing. So we believe the sector and niche that we serve is a little more robust, but there is, announcements and some strikes going on in the sector there on the final assembly side, which could be affecting us and may have slightly in the quarter even impacted us. But again, we're looking out longer term.

Speaker 2

It is a high growth sector for us. So we do expect to continue mid teen kind of revenue growth in that sector globally. Again, North America got back to COVID levels faster than international. International is still catching back up and lagging a little bit. But again, we're agnostic to the platforms there.

Speaker 2

We can equally serve them in the U. S. Versus Europe. So we believe that we'll continue to grow. Again, the pace might slow temporarily, but we feel very good about the long term prospects in aerospace and defense.

Speaker 2

And it's not just commercial aerospace. Yes, they may have a little more of the volatility at the moment, but that same sector also includes private space, which is very strong right now and defense in there as well and other very stable sector and we can balance the load amongst the 3 to a certain extent as well. Do you want to address the data side, Manny, or I can explain that one too?

Speaker 1

Look, the data business is a little bit flat this year, primarily due to unanticipated delays with some implementations, but primarily due to push outs by our customers extending when they want to start the various projects. But we're very confident and comfortable that next year, we'll be back into the mid teen growth rates in 2025 in this high margin business. So this is a temporary situation. It's more of a timing issue, and we're comfortable that next year we'll be back on track. I mean,

Speaker 5

so just hearing push outs and then seeing the account receivable stay stubbornly high. This isn't a function of your customers having any, I don't want to say financial difficulties, but just starting to see some pressure on their own cash flows. Is there any of that happening? Or is it very just some random and audit and push outs that just sort of all have come together here over the last quarter or 2?

Speaker 2

Yes, I would not connect those, Mitch. No, our customers are all blue chip, good payers. We've had virtually no write offs, knock on wood for quite some time. So it's not their ability to pay, it's just their desire to pay, which we have to get better at pushing and driving. As I said on the I think that speaking of interest rates, I do think that's relevant.

Speaker 2

The last couple of years, you get a real yield on overnight money. That was not the case the couple of years before that. So I think that's a factor, but that's on us. We have to work harder to pull that money in. But no, there's no cause and effect there.

Speaker 2

There's no issues on our customer side. It's just their desire to pay. It is not their ability to pay. There's not a credit concern that you should be implying there whatsoever. That's not the issue.

Speaker 5

Okay, fantastic. And then a couple of other questions. So as you looked at the 2024 outlook, the bottom end of your revenue range remains at $725,000,000 but you did lower the bottom end of the adjusted EBITDA range by $4,000,000 down to the $80,000,000 mark. Is that a function of maybe higher margin just is that a function of like higher margin aerospace revenue being delayed? Why would the bottom end of that adjusted EBITDA fall at the same revenue level?

Speaker 2

It's exactly that, Mitch. And as Manny said, the data business is also a little more flat year over year. Your 2 high flyers with higher margin profiles attached to them are lighter in the mix there. So you have an unfavorable sales mix affecting you there on the EBITDA side, where the EBITDA gap opened up a little more than the revenue side because you lost the more attractive piece of the portfolio there underperformed. So that's why that EBITDA number is a little lower in impact there when we lowered the scale of revenue.

Speaker 5

Okay. That's helpful. And then I guess like I guess final question here for Manny and so your reorganizational costs continue to be there. I think it's I can't remember, dollars 5,000,000 year to date and you did about $12,000,000 last year. When do we see the reorg costs stop?

Speaker 5

And what has the current reorg costs been centered around? And where are we in your in the reorganization efforts? Are we in the 8th inning, 9th inning? If you could talk about that, that would be helpful.

Speaker 1

I can tell you that we are constantly evaluating where we are and where we should be. And we'll continue to make changes that are necessary. I wouldn't say we're in the 9th inning, but maybe the 6th or 7th inning because we have plans for 2025 beyond to continue to improve where we are, how we operate and how efficient we are. We have areas that we've identified for 2025 that we're going to be looking at to improve profitability. And in some of those cases, we will have to make some investments and there will be some costs associated to them.

Speaker 1

But the return on those investments will be more than adequate to justify the cost expense.

Speaker 5

Okay. All right. Well, that's all I have. Thanks for the time.

Speaker 2

Thanks, Mitch.

Operator

Thank you. I am now showing no further questions at this time. I would like to turn the conference back to Manny Stamatakis for closing remarks.

Speaker 1

Thank you, operator, and thank you everyone for joining this important call today and also for your continued interest in MISTRAS. We look forward to providing you with an update on our business and progress achieved towards our ongoing initiatives on our next call. Everyone, please have a safe and prosperous day.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.

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