Mistras Group, Inc. (MG) Q4 2013 Earnings Report, Transcript and Summary

Frank, good morning to you, ladies and gentlemen, and welcome to the Q4 2013 and Year-end Mistras Group Inc. Earnings Conference Call. My name is Gary, and I will be your event coordinator this morning. [Operator Instructions] I would now like to hand over to Sotirios. Over to you.

Gary, thank you very much, and good morning. Welcome to the Mistras Group Earnings Conference Call. This is Sotirios Vahaviolos, Founder, Chairman and Chief Executive Officer of Mistras Group. Also joining me today is Frank Joyce, our company's Chief Financial Officer. The purpose of today's call is to review our financial results for the company's fiscal 2013 fourth quarter and to discuss our prospect going forward. This discussion is intended to supplement our quarterly earnings release and our filings with the Securities and Exchange Commission. I would like to start off by saying that while we ended the year below our expectations, the year did, nonetheless, produced some notable increases over last year and the highest amounts ever for us in terms of revenue and advanced EBITDA. While the level of profitability did slip, the causes are all known to us and we have already begun to correct them. I will discuss that more later, but for now, let me turn it over to Frank, who will provide with more details about our financial results. Frank?

Thanks, Sotirios. First, I want to remind everybody that our discussions during this conference call will include forward-looking statements. Actual results could differ materially from those projected. Factors that could cause actual results to differ are discussed in our annual report on Form 10-K and in other reports filed with the SEC. Also, the discussions during this conference call will include certain financial measures that were not prepared in accordance with U.S. Generally Accepted Accounting Principles. Reconciliations of those non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures can be found in Mistras Group Inc.'s current report on Form 8-K dated August 7, 2013. These reports are available on our website in the Investors section and on the SEC website. Now I'm very pleased to present summary of financial results for the fourth quarter of fiscal 2013 and for the full year 2013. Revenues for the quarter, the fourth quarter rather of fiscal 2013 were $144.5 million, up 14% from $127.1 million reported in the prior year. Revenue growth in the quarter was achieved by acquisition growth of 16%, partially offset by a decline in organic revenues of nearly 2%. During the quarter, organic revenue growth of 6% in the services segment was offset by declines in the products and international segments, where a nonrecurring military order in products and the challenging economic conditions in Brazil and Europe contributed to the decline. Gross profit in the fourth quarter was $38.5 million, up from $37.5 million in Q4 '12. Gross margins were 26.7% in the current quarter versus 29.5% in Q4 last year. During the quarter, the services segment had a gross margin decline of about 135 basis points, which occurred across most service lines of the business. International gross margins declined by more than 10% in Q4 due to a combination of factors, including the challenging economic environments in Brazil and Europe and our recent acquisitions in Europe, where we added more services business in here primarily traditional NDT services to our mix, which previously was a products and advance services-based business. Furthermore, international incurred approximately $1.6 million in nonrecurring charges on the gross margin line in Q4, which were largely transition expenses related to recent acquisitions. Our products gross margin increased by 10% due to the mix in product shipped, including higher revenues from Acoustic Emission products. SG&A in Q4 '13 rose to $27.7 million versus $23.5 million in the prior year and consistent with prior quarters, the vast majority of the increase was due to acquisitions completed within the last 12 months. Acquisition-related expenses in the fourth quarter were a net benefit of $1.1 million and included a $2.1 million reversal of contingent consideration liabilities related to our Brazilian subsidiary. During the quarter, the company recorded a goodwill impairment charge of $9.9 million related to our investment in Brazil as economic conditions in that country helped reduce the fair value of our investment below book value. The charge, of course, is non-cash. And as many of you know, we invest for the long-term and take advantage of opportunities that become available to us. In Brazil, we're now the #2 player in NDT and nicely positioned for organic growth in the future. Operating income adjusted for acquisition-related expenses and the goodwill impairment was $7.9 million in the fourth quarter versus $12 million in Q4 '12. Adjusted net income declined to $4.7 million or $0.16 a share in the fourth quarter versus $7.3 million or $0.25 per share in Q4 of '12. Adjusted EBITDA declined to $16.5 million in Q4 '13 versus $19.3 million in the fourth quarter of the prior year. Our top 10 customers represented 37% of revenues during the fourth quarter versus 39% in the prior year quarter. In the current quarter, oil and gas revenues represented approximately 49% of total revenues versus 50% in Q4 of '12. Advance services revenues represented approximately 15% of the service segment revenues in the quarter versus 16% in the prior year quarter. I want to briefly summarize fiscal 2013 full year results, which include revenues of $529.3 million, up 21% versus $436.9 million in the prior year. The growth was achieved through a combination of 19% acquisition growth, 3% organic growth and the balance due to foreign exchange. Gross margins for the year were 28% versus 29.7% in the prior year. Adjusted net income was $20 million -- $20.2 million versus $22.2 million the prior year. Adjusted EBITDA was $68.3 million in fiscal '13 versus $65.2 million in the prior year. Adjusted EPS was $0.70 in the current year versus $0.77 in the prior year. And now a few comments on the company's balance sheet and cash flows. Cash provided by operating activities increased by 39% to $43.5 million in fiscal 2013 versus $31.4 million in fiscal 2012. In fiscal 2013, the company spent $12.5 million in cash on capital expenditures and leased another $3.9 million of capital equipment, bringing our total capital expenditure outlay for the 12-month period to $16.4 million or 3.1% of revenues. This compares to total capital expenditures of $19.1 million or 4.4% of revenues in fiscal 2012. Focusing on free cash flow for the moment. If you define free cash flow as cash from operations less total capital expenditures, Mistras generated $0.93 per share of free cash flow in fiscal 2013, significantly higher than the adjusted EPS number for the same period of $0.70. Our net debt declined to $70.2 million at year-end, down from $82.6 million at the end of the third quarter. During the fourth quarter, the company reduced its borrowings under its credit facility by more than $11 million and our net debt-to-EBITDA ratio declined to 1.0 versus 1.2 at the end of the third quarter. As of 05/31/13, the company had cash and cash equivalents of $7.8 million and undrawn revolver capacity of approximately $82 million. And with that, Sotirios, I'd like to turn it back to you.

Thank you, Frank. I would like to make a few comments on our fiscal 2013 full year results. While we did not meet our expectations, fiscal 2013 was a year with good profits and plenty of positives. Our cash generation capabilities continues to be strong and as Frank mentioned, we generated $0.93 per share of free cash flow in the 2013, significantly higher than our adjusted EPS of $0.70. We're paying down debt, digesting our acquisitions and positioning each of our business units for future organic growth and profitability. Fiscal 2013 was a transition year for Mistras, a year when we made both structural changes and organizational changes to the company. As a result of these changes, I am confident that fiscal 2014 would be a strong year for Mistras. And now, I would like to provide you with some exciting projects and opportunities that our worldwide team developed in the quarter that go beyond fiscal 2014. Our services division captured a number of key strategic projects in the quarter specifically within the midstream and downstream segments of oil and gas, chemical and power generation. Within the downstream refining segment, we're seeing a move towards unit level turnarounds versus the traditional multiunit type turnarounds. We're seeing refineries looking to take advantage of the favorable crack spreads and therefore, want the flexibility to manufacture high-yielding end products without shutting down the entire refinery for traditionally planned scheduled maintenance. For our other green[ph]customers who are looking to this option, Mistras is providing them with the most comprehensive set of solutions in our industry including upfront engineering, turnaround planning, proprietary software and advance services available. This unprecedented innovation gives our customers the confidence to plan a turnaround, large or small, knowing they can achieve maximum savings. At the same time, we experienced an increase in the traditional run and maintain services performing process assessments and reach base inspections. These services help our customers target and prioritize their inspection requirements of these evergreens in support of large-scale, preventative maintenance activities. We're being proactive in the way we approach our customers knowing that they are under pressure to reduce cost without compromising safety. Activity levels remain high in our midstream business segment with 2 new projects awards for leading pipeline -- from leading pipeline energy firms. We're encouraged by the growth prospects in the area, specifically driven by the $22 billion of pipeline project schedule to kick off in the next 12 months. We're also seeing plans for the massive petrochemical, chemical and LNG plant capital expansion projects in the Gulf beginning to develop. Industry sources attracting more than 700 major capital projects valued at $179 billion. The scheduled for construction in the Gulf region alone between 2013 and 2018, that's up from 564 anticipated projects in Q1 '13. We were awarded a significant inspection services contract by one of the chemical companies that is planning one of these major capital projects for inspection at its existing manufacturing facilities in the Gulf. Our Canadian business continues its strong growth all outside the Oil Sands. Pipelines constitute 50% of our business, while the other half remains very diverse in such markets as refining, mining, power generation, aerospace and infrastructure. We're also very pleased by the significant progress that our power generation initiative has produced in the quarter with awards for 2 large nuclear power -- nuclear plant projects, a gas combined cycle project, an integrated gasification combined cycle project and being the successful bidder for multistage, multiplant master agreement with a major U.S. electric utility. Looking forward, we are continuing opportunities and growth developing in the segment with our value-based portfolio of solutions. Turning to products and systems. Our domestic group sales were impacted by the delay in end-user delivery acceptance mainly for overseas, online installations of large systems preventing revenue recognition in the quarter. Although capital spending, especially in the defense segment, remains down and causing delays in purchasing. We're encouraged by the increasing quotation activity and expect to see the release of funding for some of the largest scale of systems in the coming quarters. In power generation, we're excited to announce that through a tailor collaboration project between Mistras, the Electric Power Research Institute, EPRI and Dynergy [ph] Energy Center, our successful triple 5 AMS coal-fired boiler oil line leak detection system is now being adopted for use on gas fired, Heat Recovery Steam Generators or HRSGs to help avoid forced planned outages. This is significant because there are more than 2,200 HRSGs in operation in the U.S. alone because of turbines being used in coal generation and combined cycle configurations driven by the economics of cheap gas and the reduced emission footprint of these operating units. On the international segment, we completed factory acceptance testing and the shipment of a large Acoustic Emission base online monitoring system to be installed at a grassroots chemical polypropylene plant located in Russia. The system will be remotely monitoring several critical reactor vessels used in the processes and is configured with special alarm criteria to alert control room operators in the event of a process upset. We plan on offering similar systems to existing polypropylene plants worldwide due to the volatile nature of the processes and the need for safe operations. In power generation, specifically in alternative energy, we received a 7-figure order for an Acoustic Emission Systems, based monitoring system to be installed on several offshore wind turbines that will be remotely monitoring for structural integrity of the units. We also received a repeated, multimillion dollar order for a major wind turbine OEM utilizing our international robotics organization for blade-related maintenance services and upgrades at multiple wind farm locations in Europe. In addition, we received a multimillion dollar order for 4 of our nuclear leak detection systems to be installed at the new nuclear facilities in the Middle East. This order confirms our leadership position for safety control systems for new nuclear power plants as this represents our third OEM client. Also happening in the power segment, we're in final negotiations with leading electricity producer in Europe for an 8-year entity inspection services contract. This is a key achievement since it now alleviates and recognizes Mistras as a prime contractor in the region. In our oil and gas segment, we had a major breakthrough and were awarded a significant, multimillion euro, multi-evergreen contract with a major French-based energy company in addition to awards for turnarounds in multiple refinery locations in the region. I'm also pleased to report that our German acquisition, GMA, has been accepted and has begun providing energy services for our network of U.S. base, multinational energy customers within the region. As reported in past earnings calls, building a strong international business, especially for run and maintain evergreen business in only 2 years, is a monumental task. We're delighted with the recent wins in Europe due to our small but influential acquisitions leveraging the experience of Mistras with our outstanding global customer base. Notwithstanding the difficult current market conditions in Europe, the need for daily evergreen work continues to exist and we are proud that our diverse management teams are collaborating to execute on our strategic plans. As for Brazil, we did struggle this year. And as Frank mentioned, we had $9.9 million write-down of goodwill in our business there. However, we remain confident of our investments we have made and believe we are currently well positioned as the #2 energy company in Brazil. In summary, we are very encouraged by the level of new activity, both domestically and internationally, that we're experiencing and our ability to attract and capture these significant projects. Assuming the avoidance of un-forecasted delays in turnarounds and in large online product installations, coupled with establishment or new refinery evergreens in Europe, we're building toward an improved organic growth rate in fiscal year '14 and beyond. And now, I would like to spend a minute on the company's outlook for fiscal 2014. Consistent with our -- the guidance range we gave in late June, the company expects fiscal year '14 revenues to be in the range of $570 million to $600 million and [indiscernible] to be in the range of $74 million to $80 million. Consistent with prior years, we do not give guidance for individual quarters, but we'll update annual guidance at least quarterly. In closing, the opportunities are there for us. Although we did not meet our expectations in 2013, we have made the organizational changes and have taken steps for better execution in 2014 and beyond. I am very positive about the future of Mistras and our ability to penetrate our existing and new global markets. That concludes my remarks, and I would like to open the floor to questions, Gary.

[Operator Instructions] We have our first audio question coming from the line of Tahira Afzal of KeyBanc.

This is Shu Stateron [ph] for Tahira. First off, you talked about your different product or project opportunities, you talked about opportunities in the U.S. and internationally. First question really on organic growth, can you kind of walk us through your different segments, products, international services, and kind of walk us to where you see better growth opportunities organically now versus maybe what you saw 3 months ago? So really trying to look at change in visibility.

Yes. Let me -- first of all, let me give you the statistics for 2013. Our service organization did 6% organic growth and our international organic growth is 2.3%. What were down really were in products and systems. I don't know if you have anything else to add, Frank.

Yes. Services was a steady 6% both in the quarter and full year. I think in the quarter, our organic growth rate in total was down 2%. But there's a couple of factors, I think, that are important to note in there. As Sotirios mentioned, both international and products were down in the quarter. And in products, there was one very significant order of about $3.6 million, military order for last year that did not recur. And that's the second quarter in the row we've had that as a bad comp. So that was a bit of a headwind. In the fourth quarter, as well as the third quarter, in international, particularly in Brazil, was a very soft quarter for international. And as I think we mentioned earlier, the project work was slow to develop. Product sales were slow. So those are the 2 that have given us trouble. In products, I think, one, we're going to be modest of the bad comp going forward. That's an important thing to note. And then I think, I would like to think that we're near the bottom for both international and that the way those -- and to the extent that, that starts to pick up, we won't have a drag on organic growth as it was in this quarter. So I think you'll see some improvement both in international and product.

And service will continue with the growth, the organic growth.

And then one follow-up on the inorganic side. Can you just give us an update on the acquisition market? What you're seeing in terms of pricing? What you're seeing in terms of opportunities on the bit pipe and just on the acquisition pipeline?

First of all, you touched a very sensitive subject encased. The acquisition opportunities are all there okay? The pricing depends really if it is strategic or basically private equity. Private equities pay a lot more than the Strategic Partners pay. And that's all I can say at this time.

Next question comes from the line of Rich Wesolowski of Sidoti & Company. Richard Wesolowski - Sidoti & Company, LLC: Frank, could you detail how much revenue from acquisitions already completed as included in fiscal '14 guidance?

Fiscal '14 is around $30 million to $32 million. Somewhere in that range. Richard Wesolowski - Sidoti & Company, LLC: Okay, and just briefly, another catch up. Would you repeat the amount of the earn out reversal in the quarter and confirm where that was on the income statement?

Yes. It's about $2.1 million related to Brazil and that was an acquisition-related cost. Richard Wesolowski - Sidoti & Company, LLC: Okay. Sotirios, that was a long and impressive rundown of the recent awards, a lot of which I like to see outside of the energy patch. Would you remind relaying a few details of your plan to revive the advanced service sales growth outside of oil and gas?

Well, basically Rich, we started it about a couple of years ago. And really, we're delighted with oil and gas because of the continues to give us a growth that we're looking for. But at the same time, when we acquired GMA, we acquired also a lot of aerospace industry and that grows also in America. The chemical -- there's no secret in the chemical industry. It's really a big market for us. There's no secret again that the pipeline industry is very affected. But as you probably realize in our case, we're trying to concentrate also toward the run, the evergreen type, the run and maintain evergreen contracts. And we're delighted with our wins in France, okay, on that particular sector. Richard Wesolowski - Sidoti & Company, LLC: When you mentioned the midstream areas in a lot of the pipeline work, I was under the impression that at least some of the radiography work for the new gathering lines was very heavily competed, discounted on price. Is that an area that's becoming too competitive for Mistras to deal in or is it still a good market?

Not really, not really. Because I think we just offer more than just basically radiography, okay, doing the work. We offer a lot more services and that's what I try to address. I try to address here and saying that Mistras with our evergreens and any customer that we have, we just don't offer only the inspection. We offer asset protection solutions. We basically -- there's a lot of other services we provide, but just keep in mind also, that there are shortages and the demand is very high in that area. So pricing factors plays into this. But in our situation, basically, we're going to walk away if it is really on price or bad pricing. Richard Wesolowski - Sidoti & Company, LLC: All right. And then last one, I'm wondering are we now through the pocket of time where the evergreen renewals in the U.S. are mainly on the contracts where Mistras is the incumbent and maybe discuss just the pace of evergreen renewal potential over the course of the year.

Well, because of the multiple evergreens that we have, this will always be repeated. You always see evergreens turning around, okay. And last year as you probably realize, is that the refineries that change hands in America, the big refineries that change hands in America was our own evergreens. And so people do not spend the money that they typically spent when they such changes.

Next question comes from the line of Andrew Wittmann of Baird. Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division: So in your prepared remarks, Sotirios, you talked about some of the organizational and structural changes that you've put in place and maybe will be putting in place. Can you just give us a little bit more detail specifically on what some of those are and how you expect them to deliver some results?

Well, first of all basically, we try to take more control on the pricing, okay? Pricing. Because that's, if you notice, that was one of our problems, okay? The other thing is that we really -- basically hire -- the acquisitions in Europe, we hire the appropriate people to really match them with the ones that we had in order for us to really have people that can run a bigger business than we had before, okay? In the case of Brazil for instance, we made all the changes internally. We have a very strong company now and that organizational report directly to the United States, the service organization, because basically, that will be America. America will be one basically management, okay? In the case of Europe, we basically selected, promoted a Vice President for business development that will really -- are not going to worry only about 1 country, will worry about the whole Europe, okay? And a lot more cost controls within the company. And that's really as far as I can go, I would prefer not to discuss anymore. Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division: Got you. So when it comes to utilization of your people in the fourth quarter and so far what you're seeing in the first quarter, can you talk about how utilization is trending and the impact that you might see ...

Well, basically, in our case, what we trend is really be un-billable as we've discussed before. We've seen absolutely 0 change for the un-billable. And as we said in the last time, it was really more on the margin, it was really the margin question. Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division: Got it. So do you still see -- so do you still feel like utilization is where it needs to be or is it unchanged...

It's exactly where it needs. I mean, we always like less but I don't think we can do better than what we're doing now. Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division: Got it. And then, you kind of talked on the update call about your expectations for the fall turnaround, is there any change in what you're seeing there if customers come to you and sort of planning a little bit more, a little bit less from what you've expected in June?

Andrew, what we discussed even before that we see the fall to basically be flat, something that we have similar to what we had last year. There's a lot of -- as we probably realize, there's a lot of what I call noise in the system where everybody believes that the spring will be very, very large. It will be a very big turnarounds. I've been in this industry for 40 years. I have never seen the changes that I saw last year and the delays. So I hope that it will be in the spring, but that's all I can say for now. We're really are not -- our numbers are really based not on plan issues turnarounds.

Next question is from the line of Tristan Richardson of D. A. Davidson. Tristan Richardson - D.A. Davidson & Co., Research Division: Just to follow-up on Brazil. I mean, I know that, that market has been soft at least in the fourth quarter. I'm sort of curious, longer term it's a big market. It seems like a big opportunity. I'm just curious does that market remain spotty? Or do you look at '14 and see sort of a pickup? I just love to hear your outlook on Brazil.

Well, the outlook in Brazil basically is that we like to really come out of the negatives that we have now and going to the positive. But we're not really looking -- we're looking to really -- in a company it's very stable as we have now because we reduced the staff as you realized in bringing them to the exact size. And we're looking at the third and the fourth quarter for better numbers.

And next question comes from the line of Tom Hayes.

Just a couple of quick questions. Most of them have been answered, but was the goodwill write-off driven through the reported margin line for international business?

It did not go through margins. It went -- it's a separate line item on the P&L. If that's your question.

Yes. I'm just wondering if the margin report for international is x the goodwill write-off. Sounds like it was. Then just 2 kind of quick questions. What stock comp and kind of CapEx plans are for next year?

Stock comp is around 5 for next year and what was the other one?

CapEx.

CapEx should be about 3.5% of revenue so yes, whatever that math is.

[Operator Instructions] Okay, and we do have a question again from Rich. Richard Wesolowski - Sidoti & Company, LLC: We've seen -- I'm sure you've seen scattered signals that other firms are entering deeper into the advanced service realm, which is to be expected. I'm wondering if there's any service lines that you once considered advanced that you might consider not traditional but more commoditized in that realm.

Well, surely you will see basically the computer radiography and things like this that would be really not advanced, okay? But, areas like Acoustic Emission, areas like phase array, will always remain advanced and always will require a lot of training. Richard Wesolowski - Sidoti & Company, LLC: Okay. I understand the make up of your revenue is different today than it was in '07 and '08 the last time the downstream oil and gas business went bananas. But it's possible as you mentioned we're heading to a period where there's too few of companies like Mistras to perform the work around the chemical, the pipeline and the refineries. As you look out past this year, 2, 3 years out, do you have a target for the company's gross or operating margin? Is it a lot higher than it is today?

Well, there's no shrivel [ph]. We always talk about the operating margins to be in the 30% range, okay? That's what we prefer. And as far as the growth potential, we like to be -- the organic growth we like to be on the upper teens, I'm sorry, on the upper...

Single digits.

Single digits. Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division: So as you look at the targets that are high single-digit organic growth and gross margins, a couple of hundred basis points above where they are today.

We hope so because I think we have the technology and keep in mind that we have more online systems. We have more software, we have more things than anybody else has to offer. And we like the compliment that now everybody wants to be in the advanced services.

I think, Rich, on gross margins for the next year, when we look at revenues of 570 to 600 I think the implicit gross margins in that range are on the low point of about 28.6% to -- and a high point to about 28.8%. So just to give you that range for fiscal '14 guidance.

Next question is from the line of Stephen Ragard of Stephens Inc.

Just a follow up, I guess, on the last comment you made, about 28.6% to 28.8% gross margin next year embedded in the EBITDA guidance. Can you sort of just walk us through, is that coming from a rebound in both international and services or both? Can you just kind of talk about that a little bit?

Stephen, before basically Frank answers the question, keep in mind that Richard comment was on the long run. So when I said 30%, I didn't mean for next year. I meant for the long run.

That's fine. I think it will be both international and services. That's where I would see it. I think international where adjustments to direct labor are more difficult, higher revenues tend to boost margins quicker. I think just in services and just looking around the organization, there's been a number of structural and management changes there that I think would push margins up a bit too. It's very competitive environment out there but those are the 2. So I think net-net were talking about 0.6 or 0.8 increase from where we ended this year.

Okay. That's helpful. I guess, more housekeeping just to make sure I heard you guys correctly. Frank, did you call it $1.6 million in transition cost in the quarter?

Yes, $1.6 million in the gross margin, line across a sales in the fourth quarter and international.

Okay. And then some note on the tax loan. So 38% still what we should be using going forward?

Yes. That's a good question. 38% is a good number.

Okay. We have no further questions. I just like to hand back to Sotirios for the closing comments.

Okay. I would like to thank everyone for listening in on our call and hope that you have a great day.