Mistras Group, Inc. (NYSE:MG) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Thank you for joining Mistras Group’s Conference Call for its First Quarter Ended March 31, 2023. My name is Jada and I’ll be your event manager today. We’ll be accepting questions after management’s prepared remarks. Participating on the call for Mistras will be Dennis Bertolotti, the company’s President and Chief Executive Officer; and Ed Prajzner, Senior Executive Vice President and Chief Financial Officer. I’d like 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 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.

This discussion in this conference call will also include certain financial measures that were not prepared in accordance with US GAAP. Reconciliation of these non-US GAAP financial measures to the most directly comparable US 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 Bertolotti.

Dennis Bertolotti : Thank you, Jada. Good morning, everyone, and thanks for joining us today. We continue to make significant progress capitalizing on our strong market position and innovative new technologies to grow Mistras and improve profitability. As evidence of this, in the first quarter, our revenue grew 5.5% in constant currency. Our gross margin expanded 270 basis points and we drove SG&A as a percentage of revenue down by over 40 basis points, resulting in an adjusted EBITDA of 88% increase. These financial results were in line with our most recent outlook for the full year, which we are reaffirming today. And our overall financial condition also continued to improve, with our bank defined leverage ratio reduced to just under 3.25 as of quarter end, and we’re well on our way to achieving our goal of being below 3.0 by year-end.

We saw strength in our energy business in Q1, which is benefiting from the rapid growth of our data solution revenues. The organic growth in our business, in addition to lower health care expenses in the quarter, helped boost our gross profit margin by 270 basis points from the year ago quarter. While reported SG&A was up on an absolute basis due to a few infrequent items during the quarter, we are working hard in making progress in fundamentally lowering our overhead towards our longer-term aspirational target of 20% of revenue. The first quarter represented a very solid start to a year in which we expect to drive growth, improve profitability and continue to invest across the organization to unlock the hidden value of our strong brand, products, service line capabilities and innovation.

I’m particularly pleased with the growth of data solutions, which you can now see in the supplemental schedules included in our earnings release. Data Solutions includes our flagship OneSuite, PCMS, New Century, online monitoring and the majority of our Onstream business, along with various other data monitoring services, including Sensoria. We were early to invest in this exciting area and data solutions permeates throughout all Mistras’ geographies and industries. Data Solutions revenue grew by over 35% in the quarter and now represents 10% of our total revenue as compared to about 7.7% of our total consolidated revenue for the first quarter of 2022. We believe that Data Solutions will grow quicker than the other service offerings during ’23 and over the longer term.

Note that Data Solutions revenue is higher than we previously described it, which is due to the current inclusion of Onstream’s customer reporting via its Streamview software within the data solutions roll-up. Nevertheless, the growth level of data solutions add credence to and is a substantial reason why we are confident that we can achieve the significant bottom line increases we are expecting in our full year guidance. We are continuing to see customers recognize the need to integrate data more fully to optimize their performance. Whether that involves getting data quicker or benefiting from the insights of data analytics, the markets have continued to increase their need to better capture and utilize the data generated by our facilities in order for them to stay competitive.

Expect to see us continuing our investment in this area, responding to market demand and creating new growth opportunities by expanding within customers as well as new and existing customers. Similarly, our strategy to take on more of the machine, branding and other activities complementary to our testing and inspection services, particularly in Aerospace, is driving growth. As we address online customer needs, supply chain issues continue to challenge the industry, forcing customers to seek new ways to move faster and to simplify their logistics. For instance, in the Aerospace market, we are opening a new 20,000 square foot facility adjacent to our Heath, Ohio operations to accommodate the increased demand for our solutions. In addition, other customers are supporting the installation of 4 new CNC machines in our Georgia location to expand capacity and increase the throughput for their products.

We believe our continued ability to provide unique solutions will help alleviate some of the supply chain issues that our customers face, enabling us to grow and expand our solutions in Aerospace as well as other end markets. Note, there are still some isolated project delays in the Defense sector, which offset the progress being achieved in our overall Aerospace and Defense vertical. Nevertheless, we believe Defense is a large and growing opportunity over the long term, and we are aggressively seeking market share gains in this industry via our established relationships, utilizing our technical solutions consultants. Our Onstream in-line inspection testing business has continued its record growth of 2022 into the first quarter of ’23. Onstream generates a considerable portion of its revenues from data solutions, and it serves both the upstream and Midstream markets.

This versatility is helping to generate robust growth and margins, which we expect to continue in ’23. There was also a significant progress achieved during the quarter, preparing for future growth towards improving operating leverage and profitability, such as investing in technology to digitize and standardize our processes. Finally, I would like to emphasize that our financial condition continues to improve with our leverage ratio at the lowest level since immediately prior to the Onstream acquisition in December of 2018. I would now like to turn the call over to Ed to give you more detail on our financial results for the first quarter.

Edward Prajzner : Thank you, Dennis, and good morning, everyone. Results for the quarter met or exceeded our financial expectations. We continue to string together a record of consistent growth despite operating markets that continue to closely approach but have not yet fully returned to prepandemic levels while also working through significant foreign currency headwinds. Revenue growth was 5.5% on a constant currency basis in the quarter. This is a result of a combination of a stable and resilient oil and gas market, improving demand in commercial Aerospace and strong growth in private space in addition to significant growth of data solutions results across all markets. We are also benefiting from pricing actions initiated last year, which are now balanced with employee wage rate increases whereas we had been lagging last year with a more pronounced inflationary pressure than we anticipate this year.

Gross profit margin for the quarter increased 270 basis points compared to the prior year, primarily due to lower health care expenses and an improved sales mix, specifically data solutions. Selling, general and administrative expenses in the first quarter were up $900,000 as compared to the prior year period due to a few infrequent items, but more importantly, down 40 basis points as a percentage of revenue. Cost containment remains a focus and is one of the main reasons we are confident that we can increase the operating leverage in our business model. Our North American segment, which was formerly called Services, generated significant operating income in the first quarter of $9.4 million, up from $3.8 million a year ago, with the operating margin expanding 400 basis points.

As Dennis mentioned earlier, in addition to the absolute revenue growth, North America’s operating margin is also benefiting from the rapid growth in data solutions. Adjusted EBITDA for the quarter was $10.4 million compared to $5.5 million a year ago, an increase of 88% due to the aforementioned gross profit expansion, and this was consistent with our most recent expectations. Our effective income tax rate actually a benefit for the quarter was 15.6%. For modeling purposes, we would anticipate an effective income tax rate of approximately 30% for the full year 2023. In an encouraging change from our historical trends, we saw a positive operating cash flow in the first quarter, primarily due to an improvement in DSO. Free cash flow was essentially flat in Q1 compared to a negative $8.6 million in the prior year period, which was a significant improvement year-over-year, despite incremental CapEx spending of $1.5 million for new projects commencing in the year.

For the full year, we still expect CapEx of less than $20 million. We paid down almost $2 million of debt during the first quarter, lowering gross debt to $189.3 million with net debt of $172.6 million. As Dennis stated earlier, this is a milestone event as we haven’t been operating cash flow positive or paid down debt in the first quarter since pre-pandemic levels, specifically back to Q1 of 2019. Keep in mind as well that our bank group consists of some of the largest U.S. banks. This provides us comfort regarding both availability and access to liquidity, and we have ample access under our existing credit agreement, which does not mature until July of 2027. Despite the recent increase in reference rates, we still expect total interest expense of around $13 million for the full year due to the recent step down in leverage and continuing deleveraging throughout the remainder of the year.

Given the solid results in the first quarter, we are reaffirming guidance for the full year 2023, that being revenue of between $710 million and $740 million, adjusted EBITDA between $70 million to $75 million and free cash flow between $30 million to $35 million. Given stable and resilient energy markets, improving Aerospace demand and continued data solutions growth, we are confident in achieving our outlook projections. Our business model is robust and sustainable through extremes of economic cycles, and we remain firmly committed to executing our plans, while maintaining our intense focus on cost containment while continuing to prudently invest in our business. That is our strategy, both today and over the long term. 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.

Dennis Bertolotti : Okay. Thanks, Ed. To summarize, we had a strong first quarter to kick off the year, and we continue to be optimistic about Mistras’ future in ’23 and beyond. Data Solutions now represents 10% of our business, and this will continue to provide top and bottom line growth. We’re making tremendous progress preparing Mistras to improve productivity and efficiency to better leverage our inherent strength to capitalize in the sectors of our markets that are the fastest growing, so we can serve our customers in this ever-changing environment. Before taking your questions, I would like to sincerely thank all the talented dedicated Mistras’ employees out there for their continued focus on delivering a safe and superior service offering while meeting our customers’ highest demands. And with that, Jada, please open up the lines for questions.

Q&A Session

Operator: Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from Chris Sakai of Singular Research.

Operator: One moment, while we look for our next question. Our next question comes from Mitchell Pinheiro from Sturdivant & Company.

Operator: One moment for our next question, please. Our next question comes from Brian Russo of Sidoti.

Operator: I will now like to pass it back to Dennis Bertolotti for closing remarks.

Dennis Bertolotti : All right. Thanks, Jada. I’d like to thank everyone for joining the call today and for your continued interest in Mistras. Everyone, please have a safe and prosperous day. Thank you.

Operator: Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.