Thank you for joining MISTRAS Group Conference Call for its Second Quarter Ended June 30, 2020. My name is Tequila, and I will be your event manager today. We'll be accepting questions after management's prepared remarks. Participating on the call for MISTRAS is -- will be Dennis Bertolotti, the company's President and Chief Executive Officer; Ed Prajzner, Executive Vice President, Chief Financial Officer and Treasurer; and Jon Wolk, Senior Executive Vice President and Chief Operate Officer. 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 can be caused -- 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 ordinance with 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 table 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.

Thank you, Tequila. Good morning, everyone. As anticipated, second quarter revenue was down 38% as compared to the year ago quarter. But thanks to our ability to quickly flex our organization in the face of rapidly deteriorating business conditions, and by flex I mean make extremely fast changes to our cost structure, we were able to maintain year-to-date gross profit margin and actually improve it in the second quarter. We also delivered significant improvements across a variety of additional key financial metrics. Cash from operations was more than double the year ago quarter, and free cash flow was up nearly 300% compared to the same period last year, which enabled us to reduce debt at a record pace. Gross margin was 33.1%, the best quarterly level in over five years despite the lower revenue. And over the first half of this year, gross margin was approximately the same as in the first half of last year despite a 25% revenue decline. We also drove overhead down by over 10% in the quarter. The success achieved this quarter demonstrates MISTRAS' strong ability to adjust and pivot to sustain positive cash flow during challenging economic circumstances, while maintaining the high level of service on which our franchise is built. Having succeeded one of the worst quarters in recent history, we are preparing for recovery in our end markets. We are also preparing to capitalize any opportunities being created by the sweeping changes in the way we all work, which has been accelerated by the global pandemic. A bright spot in these difficult times is pressure being put on our customers to condense their supply chains to get more value from their integrated partners, essentially, doing more with fewer, and we are quickly adapting to this change which we have anticipated for some…

Thank you, Dennis. Second quarter revenue was consistent with our revised outlook, coming in at slightly under $125 million, which was down 38% from the year ago quarter. We believe that the second quarter will be the low point of quarterly revenue this year, and we exited June at a run rate which was much higher than we entered April. And this trend has continued into July and early August. Hence, we believe that our third quarter revenue will improve progressively over the second quarter. For the six months ended June 30, 2020, our revenue was slightly over 75% of prior year revenue for the same period. This is evidence of the high level of recurring work from our run and maintain business despite the extreme turmoil in our key end markets. Additionally, despite a revenue decline of 22% sequentially in the second quarter from the first quarter, we generated second quarter gross profit of $41.2 million and a 33.1% gross profit margin, which represented an increase of approximately 760 basis points from the prior quarter. Our second quarter gross profit margin is the highest quarterly gross profit margin level that we have achieved over the past five years and is attributable to favorable sales mix and lower pass-through costs, such as travel, as well as temporary cost reductions and government subsidies being realized. On a year-to-date basis, we have maintained our gross profit margin at approximately 29% despite the significant decline in sales level. This is a function of our conscious effort to offset fixed costs under absorption with lower variable costs, demonstrating our ability to rapidly flex our organization, as Dennis mentioned earlier. Second quarter's selling, general and administrative expenses decreased by slightly over 10% as compared to the year ago quarter. This decrease is despite the addition…

Thanks, Ed. It's been proven many times that necessity is a driver for dramatic improvements and innovation. We believe the current pandemic is one of those periods where industrial companies will look at new and innovative ways of performing their work. MISTRAS has long been at the forefront of improving technology and creating new and better instruments, which can monitor important operational data generated by various equipments such as turbines, transformers and other critical machinery. With monitoring being done remotely, online and in real-time across more and more assets, much more data is being collected as well as being more thoroughly analyzed, thus providing owners with smarter and more intuitive information, which they can use to improve the efficiency and safety of their equipment. This is the path of the future. We believe that a crisis such as the current world pandemic can be a catalyst that significantly moves owners forward to adopt this transition much more rapidly as they will recognize that it will allow them to more efficiently manage their assets. MISTRAS believes that our customers will be looking for partners such as us with a more sophisticated approach to assisting them in condensing their vendor lists and searching for better business intelligence. This is our strategy, knowing that we can apply these tenets not only into our existing customer base, but also new customers or market segments we target in the future. Before taking your questions, I would also like to thank all the MISTRAS' employees once again for your dedicated customer service, dedication and attention to safety which you have shown in these extremely trying times. Your practicing of care and connect is working. Tequila, please open up the phone lines.

[Operator Instructions] Your first question comes from the line of David Ridley-Lane with Bank of America.

Good morning. This is David Ridley-Lane on for Andrew. What were the achieved cost reductions in the second quarter? And how do you plan on sort of potentially using furloughs and other temporary measures in the third quarter as you balance supply and demand?

David, this is Ed here. I'll take this one. We're -- I mean, Q3 is going to look a lot like Q2 in terms of the cost outs. We're continuing to calibrate the cost footprint to the revenue at hand. So it's going to scale with the revenue. Travel is a good example. If we're not traveling, that goes away naturally. As the work comes back, that comes back. But we've got essentially a very similar estimate in there for Q3 from Q4. And it's a decent-sized number, the 10% of SG&A that's being taken out due to the cost-out measures we have in place currently.

Got it. And a quick follow-up. With better visibility into clients' plans, what would you say -- what would you estimate the portion of planned turnarounds did shift from the first half into the second half? And what portion perhaps shifted out into 2021?

Jon, do you want to grab that one? Jon, you might still be on mute.

Yes, sorry. Sorry about that. It's been interesting time as we've been planning, working directly with every customer in every region. Some turnarounds have just been deferred into 2021, some have been deferred into the second half and some have been ongoing, but they've been ongoing without travelers. They've been elongated. They've been extended. And so it's been probably the weirdest turnaround season that we've seen in many years. I'd say it's sort of a mixed bag. It's tough to give a precise quantification. It's probably a 50-50 in terms of what got deferred into the rest of this year. And then the question will be at what scale and scope, and those are open questions as well.

David, I'll add a little color to that. The turnarounds that we have seen continuing so far, to John's point, they've been going on at a very much reduced hourly impact. Typically, a turnaround is six or seven days a week, and it's 10 or 12-hour days. They've been going five days a week. They've been going eight hours. Some are doing 10. We've had one that did overtime, but that's really been the uncommon one. The bulk of them are taking their turnaround schedule and doubling it. And we've even had a few customers approach us and ask us to do fitness for service on the equipment where we actually look at the major components that they have coming up for their turnarounds in the fall, and they've asked us if they had to delay it past the fall because of COVID, what would be the impact and could they rightfully take a look at extending it based on what we can do for online, on stream inspection as well as just the quickness for service calculations. So customers are looking in case the impact affect them more in a quarter. But to John's point, right now, I believe it's a -- it's most of what we've seen in Q2 got pushed into the second half, a small percentage got pushed into '21 and only one or two that we see actually get pushed out further than that.

Next question comes from the line of Sean Eastman with KeyBanc Capital.

Hi guys, This is Alex Dwyer on for Sean. Congrats on the strong results. Maybe just back off to last question. As we look on to next year, 2021, with the revenue deferrals you've seen this year, I guess I just wanted to get a sense on what your outlook is for the potential for growth next year. And then what are the big swing factors you would call out next year and maybe what should we be tracking, whether it be like customer Capex budgets or Opex budgets or even some general economy metrics? Thank you.

Okay. So I'll take the first and then let throw it to the other guys on the rest. But as far as 2021, we haven't set our budget yet. We're going to be working at much sooner than normal just because of the way the year has been. Truthfully, we recalibrate our forecast almost monthly just to try to get a good idea of where we are from manpower and other resources. But what we're hoping to do is make '21 approximate 2019 as close as we can. We don't know about the seasonality and how it will happen yet. The way it's trending, we see the hours creeping up. We see the bodies coming back. We track the amount of bodies that were taken out for COVID, and we track the amount of billable hours week-over-week versus the previous year. They're on the rise. They're not coming back as fast as you'd want, but that's just part of everyone being careful about the safety practices that COVID has imposed on them, and let's face it, some of the spend reductions as well. We think that the turnarounds in the fall should be very close to what they had planned. There's no certainty that they will go to full length. Some customers may try to save a couple of dollars. But right now, what we see is the fall is going to get us, at best, better. And then hopefully, we're going to look at more of a 2019 relook. But we -- again, we haven't gone that far. Ed or Jon, if you want to add on that?

Yes. Jon, here. Dennis, thanks. I'll tag on to that and just say, look, we believe the second half will be higher than the first half of this year. As Dennis was saying, as you go into next year, assuming a pattern that's at least fairly close to what 2019 was, you're going to see some pretty significant growth off of a very low '20 baseline, particularly in Q2.

Yes, that's very helpful. And my next question is regarding the competitive environment. Can you talk about some of the regions or sectors that gain share, or see the opportunity to gain share? And is there a point at which smaller competitors become the stress market positioning becomes incrementally better?

Yes. I'll take the first shot on that. There's definitely -- it's caused a lot of stress on business like ours, much, much bigger businesses and certainly, smaller ones, and you hear about it in the communities of small restaurants, bars and everything else. Small business are having a hard time getting through this. I think not only is there going to be stress on smaller customers of ours, the smaller competitor of ours, I also think to my point of talking about the technology, I think there's going to be a difference of what types of vendors customers are going to be looking forward. They're going to be looking certainly for financially stable and ones that they can give a three- or five-year contract to knowing they'll be there through this. But they're going to look at ones that can take on more types of complex situations and take on more and more of the work. Because let's face it, you can only take away so much from an hourly rate or so much from a fixed rate. At some point, you just got to do it more effectively, smarter and a lot of times, that means a lot less vendors trying to do all these different steps and having more and more doing one of these steps or one whole project. So I think it's actually going to be changing the way people are looking and customers are looking at their vendor base.

Your next question comes from the line of Brian Russo with Sidoti.

So, the up to 20% sequential increase in the third quarter versus the second quarter, it still kind of implies a decrease of about 22% from the third quarter a year ago. Just curious to know what's driving the decrease? Is it what you referred to earlier, the delays in the turnarounds? Or is it cancellation of projects? I just want to get a little bit more color on the year-over-year revenue driver.

Yes. I'll take first, and I'm sure Jon can back me up. But you're right. We're talking sequentially now because the truth is there's very few companies in our space, and I think that would compare 2020 to 2019 in these months. We're hoping to get closer to the run rate. Like I say, next year, I don't know if it'll be a flat repeat of 2019, but we're hoping to approximate it. But we haven't even gotten the budget yet. So when we see it, truly, Brian, right now, aerospace in Europe got hit early and quick. It's going to stay a decrease for aerospace in Europe. We're starting to see a little bit more of that in the United States. We can definitely change our load in aerospace and hold our margins, but you're going to be on a lower revenue. The gas and oil spend right now for the rest of the year, customers, like I say, the turnarounds are being done at reduced levels. They may be being done at even just bare minimum. Sometimes, they'll make sure that the safety and compliance and what they need done. They may or may not spend their whole budget on the complete turnaround. So we're being cautious when we give guidance because we know those things could happen. And the truth is our folks in the Gulf are looking at these high contact rates and all the COVID, and they worry about it if customers will start to impose stricter mandates. And what happens is, you can only take the people that are local. You're not going to bring subject matter experts that we have around the country and bring them into those locations. The customers are not going to want to travel them. So they do things for reduction. So we worry about that as well.

Okay. Great. And just to clarify, the cost cuts in the second quarter, I think you said that can also be leveraged in the third quarter. Does that equate to similar type gross margins?

No. Brian, it's Ed here. I would say that your year-to-date gross profit margin, the 29%, that's more what I would expect going forward. As one example, some of these cost out, such as travel, they're passed through with really very little or no margin on. So yes, we don't expect this quarter's 33% to keep continuing. As revenue comes back, some of your pass-throughs come back. So we believe the 29% through six months, that's more what you should be looking to expect in the back end of the year.

Okay. Great. And then one more question on the oil and gas contract that you mentioned earlier. Can you provide any details on that? Is that midstream, downstream or any other subsector of oil and gas?

Yes. We're being a little cagey about it because it's still not fully up and running, but we could say it's more of a, what you call it, downstream -- or actually upstream, I'm sorry, the other way around. It's not typical, just a refinery sector. It's a little bit different than that.

And it looks like just your Services segment that looks like it perform better on a gross margin basis than the other two, the International and the other sector. Just what -- can you just differentiate between Services in terms of higher-margin product offerings or ability to cut incremental costs there versus elsewhere?

I'll let Jon explain, but I think the quick easy answer, Brian, is the difference in the way the countries handle the pandemic. We have the ability in the United States and to a large degree inside Canada where Services get this revenue from, to be able to quickly take our utilization and fix it with the resource level very quickly. In Europe, as you know, it's handled a little bit thinly. So there is -- the way they handled it, everyone stayed on employment in the various countries and inside our facilities. And then we were getting the money back very quickly. In five, six days after filing for recovery, we'd get the money back very quickly. So it made it easier in that respect. But your pass-through, it's almost becoming like a pass-through kind of thing because all this money is just trading dollars. You're paying $1 off for employee or $1 back or sometimes a little bit less in the country. So it's money kind of almost being washed. You know what I mean. So your margin is going to go down just because of that. Jon, if you want to add anything to that?

Yes. I'd agree with Dennis. We have more flexibility in terms of being able to reduce hours in the United States and to reduce headcount, the cost of making those reductions and so forth. We have a lot more flexibility. The other thing is that we had in the United States and Canada, a very good sales mix. During Q2, the mix toward higher-margin pipeline work and aerospace tilted more in that favor. So that helped as well in a relative sense. And as Ed alluded to earlier, much less out-of-pocket cost, traveling costs associated with typically busy turnaround season. We certainly missed that work. But on the other hand, it did help margins by 1% or 2%.

Okay. Great. One last question, if you don't mind. Just bigger picture, MISTRAS Digital and the industrial Internet of Things. I mean, at what point does this become a revenue driver? You referenced tangible versus intangible right now. Just curious what your bigger picture and outlook is for that kind of industry innovation?

Yes. John's running it, but I'll say one quick thing on that, Brian. I mean, we're actually looking at that as being more of a market driver for us than revenue. Certainly, it will bring some revenue with. But especially in the days of COVID right now, trying to show a customer how you're going to save them money by charging them upfront has been a problem. Their budgets are slashed, and they have very little flexibility to spend outside of a reduced number. So for us, we believe that we have this technology that can really show a difference in how we get work done for our customers. So we see that the most important aspect is going to be the ability to retain and grow our market. But there always is going to be some revenue in there but truthfully, it's not our main goal. Jon, if you want to add on?

Yes. Thanks, Ed. I totally agree. I'd say the two biggest benefits to customers are the enhanced visibility they get in terms of the status of what's going on in their plants and also the productivity they get, both on their resource base and in ours. And I think that longer term, the streamlining of work is what drives a better experience for them, for our employees and drives more market share for us. That's really what we're -- how we're trying to win at this.

Your next question comes from the line of Mitch Pinheiro with Sturdivant.

Yes, hi, good morning. I apologize if anything I ask is repeat. I lost my phone battery charge in the call. In terms of your business in this quarter, what percentage of this quarter was like a run and maintain revenue versus like Capex revenue? And where do you see revenues in the second half?

Yes, it's Jon. I'll take it. I'll start. I mean, we don't typically break out those. And sometimes it's a little bit hard to tell. But I would say that anecdotally, there was a lot more typical run and maintain work than there was project work just because projects being discretionary in timing, many customers were just not looking to spend on projects during Q2. So the revenues that we did have were much more run and maintain base than they would have been typically.

Yes. Mitch, that's actually one of our strengths is that having as many sites as we do, we're near triple digits or at triple digits where we have more than a handful up to hundreds at a site. That's a big part of why we got through this a little bit less speedup than people would expect or others may have just because we're not as capital dependent on that. So our ability to have folks. Now albeit that said, they've reduced the number of folks at the site. They've reduce the number of hours at the site. So I mean you still had sites up and running. They just weren't doing the spend like Jon was saying that you would have seen in a typical year.

I mean, does -- so -- I mean do we have to be [Technical difficulty] I mean if you can -- if they can reduce the number of bodies and hours on a run and maintain basis, is that going to play through down the road where we'll see a permanent reduction in on-site keeping up hours, et cetera, is that a headwind? Or does this come back to normal?

Mitch, I'll take the first shot on that. So for the most part, what you're doing is you're just deferring costs, right? They're -- like Jon was saying, they're not spending on the Capex and they're reducing on that. So for the most part, what you're doing is you're taking maintenance and you're prioritizing as to what is most urgent related to safety and operation, and you're deferring the rest of it. Now to the extent that we can show them how to operate more effectively and efficiently with digital and things like that, we're going to take on different services and everything to support it and maybe do a little bit less of each one service and get more done that way. So customers are going to be looking for how do you benefit it. But you can't really benefit by not doing the maintenance. It eventually comes back. And even when I -- in my first answer, we're telling customers how they could use engineering and online inspection and maintenance to prolong a turnaround, you still got to get it done. It's just you're pushing it down the road a little bit.

Great. Yes. And then, I guess, when you look at 2021, I know you're not giving guidance, and I'm just sort of trying to get a view into maybe how customers are looking at 2021, but a lot of the other deferrals, are they all going to have to happen in 2021? Can we keep -- is there a level of spend that is going to be eliminated or all these projects, they have to happen at some point? I mean, where do you think your customers are in that thinking?

Jon, do you want to take first shot?

Yes, sure. Mitch, it feels like, as Dennis was saying, if work is getting deferred now, and many customers have gotten waivers in terms of having to comply with typical OSHA levels of inspection and so forth. So the customers have obtained deferrals temporarily because of COVID, but those are not indefinite. So to Dennis' point, you're deferring work now, but you're going to have to catch up on that work. So there is pent-up demand that is building because of the dynamic that we're in right now. From a longer-term perspective, as Dennis was saying, in terms of digital, there is some amount of efficiency that's going to be coming and continue to come on an ongoing basis, where we can help customers reduce non-value-added work. You're not going to reduce the amount of inspection that needs to happen, but you can reduce the amount of administrative work around that inspection. So in the net, I think there's the net deferral of work that's to come should more than outpace and should -- has to lead to growth next year.

Okay. In terms of like SG&A, excellent job in the quarter, cutting costs. Is that -- is this a sustainable level? Or have we reached the right fighting rate here?

I mean, some -- yes, I mean, this -- you have to go back about three years ago to find the level we're at now. So I mean there is certainly some temporary cost outs which will snap back when volume comes back. But we're continuing to look at the overheads, the fixed overheads and recalibrate what we need. This is a sustainable level. We will be subtracting, not adding to the fixed overheads right now going forward. So we are taking a hard look at that as we see volumes recover. And kind of continue to recalibrate that footprint. But we are very comfortable that it certainly doesn't need to grow. We can keep it at the level it is now and reduce it further and still support the business. So we are taking a hard look at that. But to answer your question, it's very sustainable at the level we're at now going forward.

Thank you. And there are no further questions at this time.

Okay. So you turn it back to me then? Okay. Thank you. Okay. I'd like to close up by saying that our results thus far this year demonstrate our ability to quickly flex our cost footprint to maintain our gross profit margin, while we generate strong cash flow to fund our operations and deleverage our balance sheet. We will believe there will be a market recovery in the second half of 2020 with resumed revenue growth and adjusted EBITDA expansion. We are prepared to capitalize on the opportunities being created by the sweeping changes in the way we all work, which has been accelerated by the global pandemic, specifically the transition of value-added services where we believe we are ideally positioned to help customers consolidate their supply chain while generating better business intelligence. And we are bringing more and more intelligence to our customers under the MISTRAS' digital umbrella. Necessity is the driver for dramatic improvement and innovation, and we plan to stay at the forefront of leadership in our industry, pursuing growth opportunities where we can leverage our unique technology into markets which have tremendous potential. As always, I remain firmly resolved to the success of MISTRAS, and I am extremely confident and optimistic in our long-term prospect of increasing shareholder value. On behalf of the whole MISTRAS' team, I would like to thank everyone for joining the call today, and we wish everyone a safe, prosperous and healthy future. Thank you.

Thank you for your participation. This does conclude today's call. You may now disconnect.