Greetings and welcome to the Team, Incorporated Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kevin Smith, Senior Director of Investor Relations. You may begin.

Thank you, Stacy. Welcome, everyone, to Team's second quarter 2021 earnings conference call. With me on today's call are Amerino Gatti, our Chairman and Chief Executive Officer; and our Chief Financial Officer, Susan Ball. This call is also being webcast and can be accessed through the audio link under the Investor Relations section of our website at teaminc.com. Information recorded on this call speaks only as of today, August 4, 2021. Therefore, please be advised that any time sensitive information may no longer be accurate as of the date of any replay listening or transcript reading. There will be a replay of today's call, and it will be available via webcast by going to the company's website, teaminc.com. In addition, a telephonic replay will be available until August 11. The information on how to access these replay features was provided in yesterday's earnings release. Before we continue, I would like to remind you that this call contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities and Litigation Reform Act of 1995, including statements of expectations, future events or future financial performance. Forward-looking statements involve inherent risks and uncertainties and we caution investors that a number of factors could cause actual results to differ materially from those contained in any forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's annual report on Form 10-K and in the company's other documents and reports filed or furnished with the Securities and Exchange Commission. The company assumes no obligation to publicly update or revise any forward-looking statements, except as may be required by law. Amerino will begin by highlighting significant events in the second quarter and providing an update on our business. Susan will then detail our results. And before we take your questions, Amerino will discuss the company's outlook. I would now like to turn the call over to Amerino.

Thank you, Kevin, and good morning, everyone. We remain cautiously optimistic on the strength of the global recovery. However, as the second quarter demonstrated, the recovery is proving to be uneven with disruptive stops and starts, both domestically and internationally. Vaccine rollouts are gaining momentum and driving an overall increase in mobility and economic activity. Domestic petroleum demand has experienced a dramatic increase with recent levels that are in-line or above the comparable weeks in 2019. In fact, U.S. gasoline demand recently set a record as motorists were eager to travel during the 4th of July holiday. Likewise, the TSA reported new post-pandemic records in domestic air travel. While the recent emergence of COVID variance is concerning and requires close monitoring, the overall pace of the domestic recovery is strong. International is a different story. Business remains challenging with lower vaccination rates impacting Team's ability to travel and service our clients' assets. In these areas, the rebound in gasoline and air travel has been muted. After more than a year of operating in a pandemic with reduced global mobility, we have seen a step change in consumption demand for travel as COVID-related restrictions were lifted, causing cost inflation in raw materials, transportation, and labor. Team was not immune from the underlying inflationary pressures and higher costs associated with the ramp-up in overall economic activity. The second quarter started strong in April, with activity levels benefiting from several large turnaround projects. May and June also realized improvements from increased economic activity with the easement of worldwide pandemic restrictions. Team was able to benefit from the backlog of delayed maintenance projects reporting consolidated revenue for the quarter at the upper end of our expectations. Although second quarter revenue improved over 2020 levels, we continue to experience an uneven global recovery across segments…

Thank you, Amerino, and good morning, everyone. I will review our second quarter financial performance and quarter-over-quarter comparisons. As Amerino mentioned, our second quarter consolidated revenue of $238.9 million was up $49.6 million or a 26.2% increase from the second quarter of 2020, representing the first year-over-year comparable with the full three-month COVID impact. This quarter's revenue reflects both increased turnaround activity and improved economic activity with the loosening of the COVID-19-related restrictions. For the quarter, all three segments had revenue growth over Q2 2020, with Quest having the largest overall percent increase at approximately 51%. IHT followed with just over a 46% increase and also having the largest revenue dollar increase of approximately $37 million. Mechanical Services also showed a year-over-year revenue growth of 4.7%. Consolidated gross margin for the second quarter 2021 was $62.8 million, a 9.4% increase over the prior year quarter of $57.4 million. Due to the direct cost inflation impacts and the reinstatement of the temporary cost actions that were fully in place in the second quarter of 2020, the consolidated gross margin percentage declined to 26.3%, compared to the prior year quarter of 30.3%, which was a record quarterly gross margin percentage. The second quarter was impacted by significant cost inflation, particularly in raw materials, which increased roughly 50% or greater year-over-year. We also realized labor cost increases as the market for entry-level technicians is currently very tight. These cost increases were compounded by the fact that we still had some lingering COVID-19 pricing concessions. The second quarter net loss was $17.5 million when compared to a net loss of $13.5 million in the prior year quarter. An increase in interest expense of $2.3 million drove the increased net loss versus the comparable quarter. Adjusted net loss, a non-GAAP measure, was a negative $14.9…

Thank you, Susan. Before we take your questions, I'll provide an overview of the macro market trends, an update on our technology and digital initiatives and our business and operational outlook. Starting with the macro environment, as I mentioned earlier, we are in the middle of an uneven recovery and were faced with certain headwinds during the second quarter that have impeded global growth, including COVID-related restrictions, inflationary pressures and supply chain disruptions. Despite these headwinds, the IMF is forecasting global economic growth rates of 6% this year and 4.9% in 2022. This has led to a historic increase in global petroleum demand, which is expected to increase from approximately 85 million barrels per day in the second quarter of 2020 to 100 million barrels per day by year-end. Following the prolonged weather-related refinery shutdowns along the U.S. Gulf Coast in February that led to high drawdowns of petroleum product inventories, refining margins improved in the second quarter, which incentivized higher refinery utilizations. U.S. refinery run rates are now back to pre-pandemic averages, but margins have since pulled back as the market awaits further demand increases in gasoline and jet fuel. Driven by strong demand for plastics, U.S. exports of ethylene to Asia and other parts of the world have increased significantly benefiting our petrochemical clients. Ethylene prices reached a multi-year high in April when the Gulf Coast facilities ramped up following the winter storms. Ethylene prices are once again testing multiyear highs, driven by two Gulf Coast plants that are undergoing maintenance, reflecting a tight market. We continue to monitor proposed government policies and spending plans and anticipate increased regulations in the energy sector with a renewed focus on the reduction of greenhouse gas emissions. While the infrastructure bill is progressing through the Senate, the recently proposed clean energy…

Thank you. [Operator Instructions] Your first question comes from Stefanos Crist with CJS Securities. Please go ahead.

Good morning.

Good morning.

Good morning.

First, can you just give us a little more detail on the inflationary pressures you're seeing and then how that's affected your gross margin and what you're expecting in those gross margins going forward in the second half?

Sure. Let me talk a little bit about the inflationary pressures, and then I'll let Susan touch on the gross margin. So, I think, you know overall, we've seen the raw materials impact on inflationary pressures, which has impacted our Mechanical Services segment the biggest because they have the most products in terms of manufactured goods. So from that standpoint, raw materials has had the largest increase, I think, as Susan mentioned in her prepared remarks. The freight logistics and just overall movement of goods and people was the second largest. And then we've seen an increase in labor costs. Those ones we expect to further increase as we go through the year as – even though we do expect some of the lower skilled available labor to become more available over the short-term as things change, especially in the U.S., we do see inflationary pressures tightening on the higher skilled labor as the market continues to tighten. So, it's starting with raw materials, followed by a lot of the freight, transport, logistics, and then labor cost increases. And Susan, maybe you want to touch on the gross margin?

Yes. With respect to the gross margin, as I've mentioned, for the quarter, it was about 26.3% on a six-month basis, 24.6%. And the increased, I would say, pressure with the inflationary costs and what we've seen in Q2, as we look forward to our gross margin on a full-year basis, we are anticipating improvements, obviously, in H2. But looking at it on a full-year basis, we're estimating it would be between 27% to 28%. So, probably closer to the lower end of that, but north of the 27%.

And maybe just to add a little bit of color on some of the reasons for the range. As Mechanical Services and Quest Integrity grow, obviously that will have a segment mix benefit to gross margin, as we're able to move pricing over the year, starting with COVID discounts, as I mentioned, and then price increases to offset some of that inflation that obviously has a factor. And then depending how those inflation increases or pressures continue throughout the year, we'll have a factor. So, I think there's a segment mix, pricing traction and then inflationary pressures are the three levers, if you will, that will impact gross margin for us.

Great. Thank you. And then you mentioned the outlook for fall turnarounds is positive. Could you maybe talk about what your visibility is there?

Sure. As you know, we track our turnarounds in half years. We are seeing – right now, clients obviously starting to man up in terms of labor requirements and equipment requirements for turnarounds that at this point, we expect we'll start later in September running through October. So, an impact in the latter part of Q3 and into the early part of Q4. We do see the turnaround market still being a little bit unstable in the sense that there are some projects moving that could potentially slide out of the year. But overall, we expect the second half of the year turnaround to be slightly stronger than the first half. We are seeing as well a lot more pit stop and smaller projects that are popping up as clients have delayed maintenance or turnarounds, some of them starting in 2019 because of the higher utilization rates, especially in refining and then because of COVID in 2020 and then cash management and CapEx in the first half, we are seeing that we're looking at a lot more pit stops to get them through the year, if you will, from a higher utilization and asset management standpoint. So, I think we anticipate a higher second half turnaround season overall and an increase in some of the smaller pit stops, which aren't as big of a benefit as large turnarounds, but they definitely are positive for us as you add up those pit stops there. They're a good impact for our activity in the second half.

Great. Thank you so much.

Thank you.

Your next question, Sean Eastman with KeyBanc Capital Markets.

Hi, team. Thanks for taking my questions. Good morning. So, just in light of the gross margin swing factors highlighted around the second half, maybe it would be helpful to just get a finer point on how that pricing traction and inflationary pressure trended exiting the second quarter? Just kind of where we're likely to fall out in 3Q based on what you've seen in the early part of the third quarter and kind of exiting the second quarter would be a helpful discussion. Is the inflation getting worse? Are you getting traction on the pricing programs? That type of thing would be really helpful to hear.

Sure. So, I think, first of all, on the inflation, Sean, some of the inflationary costs are transitionary. So, we – as we kind of shift through it, we expect some of that to level off and be more transitory. But I think raw materials is one of those that as the year goes on and supply chain improves, we expect that to level off or come back down a little bit. On the flip side, I think, as I mentioned earlier, as the labor market tightens, for higher skilled labor, maybe not as much on the entry level because I think that will open up after September. I think there will be inflationary pressures on labor on the higher end, higher skilled technicians from that perspective. So, I would say that we've made good progress on removing many of our COVID-related discounts. And we're in the final stages with a few clients for a few of those to come off later this year, but the majority have been removed. When it comes to pricing traction overall outside of COVID, the easiest move for us is call-out work because it's really quoted more on a job-by-job basis. We've increased transfer prices and implemented surcharges that was done over the latter couple of weeks. And time will tell how competitive the market is because that's obviously a quoting business, but we're being aggressive on moving there because that's step one. We have started negotiations with our top 25 clients, which I think will end up being more focused on the inflationary recovery and tying up resources as the market continues to tighten. So, I think as things tighten, we'll get more traction with our top 25. And some markets that maybe are less competitive on quoting, we've already seen some movement. Other markets like the Gulf regions right now, as an example, are still very competitive. And I expect that, that will take a little bit longer. On the flip side, we're doing a lot on the supply chain side to secure raw materials, look at our supply chain overall, look at our manufacturing capacity and also trying to bring down the cost to serve to the best of our ability. So, I think it's a little bit of a three-pronged approach. But overall, we expect to get pricing traction over the year, but it's going to be starting with call-out, I think, because that's the quickest to move followed by the contractual negotiations, which would come later in the year.

Okay. Thanks. And this Credosoft rollout, are we seeing any traction around these types of initiatives in terms of pricing, Amerino, and maybe differentiation? Has there been a good customer response to these types of things? Is there a, sort of a good pipeline of work out there that these types of initiatives can help you guys, kind of capture more share and get better pricing?

Well, good question. So, one of the reasons that we really felt and vice versa that it was a good partnership with Credosoft is they've got a few large IOC clients, especially international, where they've gotten very good traction on pipeline and mechanical integrity. And what they were really looking for and vice versa we were looking for was to partner in a large market, which is why we selected North America to be able to use our sales, some of our engineering support, their platform and expand their footprint into a new market. So, it was a good fit because of our size and scale. We've got, as I've talked about over the last few years, some very good digital tools working on efficiency and working on compliance and documentation. The clients have their own asset management systems, which a lot of them have in place. And what Credosoft allows us to do is really bridge our activities from inspection, some of the mechanical repair, etcetera into their asset management system. So, it's a very good bridge from our services into the clients' asset operating models. And what it does for us is it starts moving the needle, Sean, around risk-based inspection, more predictive inspection and utilizing data to start being more proactive. That starts with the inspection services. It also plugs in damage mechanisms like corrosion, for example, and the pull through, the benefit is really on the repair side. And so, we expect as the traction builds that we'll move more to risk-based type inspection and we'll get more pull-through for mechanical services, which is obviously one of the ambitions for us is to continue to grow mechanical services. The bridge that that provides and the partnership that they've got and the platform that they've got is subscription-based. So, we want to obviously be able to put it on and into our clients' facilities. We have currently five clients that are subscribed to the platform already. And again, using our strong client base, that's where we feel that there's going to be upside in terms of deployment and implementation.

Okay. Thanks a lot Amerino. I'll turn it over here.

Thank you.

Your next question, Martin Malloy with Johnson Rice.

Good morning. Kind of a similar question, except I wanted to ask about the SmartStop offering that you press released last night. And if you could maybe help us with try to quantify how important that is in terms of the market opportunity, addressable market and how meaningful the competitive advantage of that is?

Sure. First of all, when you look at the development, Marty, we've been working on this for about 2.5 years. So, there's been a lot of field testing, product development, including manufacturing, the materials, etcetera. The benefits really when you speak to a client, I think the first thing to put into context is it's an onstream repair. And our clients, as they want to obviously keep their utilizations up, either in plant environments or even more specifically, this addresses midstream and pipeline where you have flow in the lines more often, it's a big benefit. So, our system is able to only penetrate the pipe for the line once versus multiple penetrations, which, obviously, is beneficial. We can set it in low volume fluid movement versus a clean dry line, which is beneficial. We're able to monitor pressure between the two seals without having to make a second break in the line, which is beneficial. And really, when you look at it, it's mechanically, for the client, it's a lot more reliable. And our clients right now are focused on safety, focused a lot on reliability and turnaround time in terms of keeping their lines and their plants up. So, we're changing the commercial model instead of going strictly labor rate buildup and parts. We're doing this more at a project-based pricing level with project management. Materials and traceability is an advantage for us. So, leveraging some of the manufacturing investments we made over the last couple of years with our press cell. The whole package is what the clients like. I was at a client meeting last week where our client was one of the ones that did the field test on, and they very much like the fact that we don't have to: a, we can work on stream; b, it's a very reliable system; and c, is that they don't have to change their line in terms of two or three fittings to do their operations. So, I think there's a commercial model change for us. I think that the clients like the safety and operational part. And we've gone through pretty rigorous field testing and now we're expanding the sizes and the ability for us to deliver it starting in the U.S. and then moving it internationally.

Okay. Thank you. My next question, kind of bigger picture, but you're seeing a lot of the IOCs in the petrochemical companies have improved results and cash flows and the returning capital to shareholders, but they're in a much better position than they've been for the last couple of years. And it seems like for the past two years or so, there appears to be some underinvestment into the type of turnaround projects and maybe some of the maintenance being deferred that you would do. And then I don't know if you can maybe talk about as you look forward to 2022, when do those conversations with your customers start or if you've had any that might be indicative of how they're looking at maintenance lending going forward?

Sure. No, it's a very good question. And I would say a little bit of what I said what Sean applies. I think that the regulations, there's no doubt, be it emissions or overall regulations continue to tighten. There is no doubt that the run and maintain requirements in terms of regulatory inspections, either risk-based or annual-based and the use of ways for our clients to continue to monitor their assets to prevent environmental issues or maintain high utilization rates to maximize margin, stretch out their facilities and not invest big capital right now. All of those things, I think, we saw it in 2020 through cash conservation. We're seeing some of it in 2021. So, I think things like Credosoft, the fact that one-third of our revenue is run and maintain-based, and that's very regulatory-driven, the fact that our asset integrity and digital and Quest groups are focused on mechanical integrity and pipeline integrity. These are all regulatory-driven product and service lines. And we continue to feel that that is going to be a priority for our clients. We've built some good partnerships in our top 25 client base. We've had regular meetings with clients during COVID. And I can tell you that most of them are trying now to plan their CapEx planning for 2022. And they're going to do the pit stops. They're going to do the regulatory requirements, and they're going to do onstream repairs to get through the year. And then 2022 and 2023, as we look out either our own data, client data or third-party data, unit upgrades and CapEx investment, we expect that to kick-in. So, I think 2022 and 2023 looks strong, and I think it's going to be more capital investment. In the meantime, though, I think the drag on our Mechanical Services segment, we expect that if the utilizations remain up and generally, we've seen a one to two-quarter type of delay between inspection and Mechanical Services recovery, we expect that to be driven more by OpEx spend and call-out work. And because our clients right now, their margins are starting to improve, demand is increasing. We do expect call-out and OpEx spend to fill in the gap, if you will, between now and when CapEx starts to spend. I think most of our clients are planning their October, November CapEx plans, permitting and project planning for 2022 and 2023. Having said that, as I said earlier, we still expect our turnaround season in the second half to be solid, and we're planning labor and resources for it right now.

Great. Thank you very much.

Thank you.

Your next question comes from Adam Thalhimer with Thompson, Davis.

Thanks guys. Two quick questions. First, the guidance you gave for the back half of the year, does that imply EBITDA growth for the full-year? And second, Susan, on the free cash flow expectations, is that – when you say positive for the full-year, is that mostly driven by working capital swings in the back half?

So, yes, with respect to the EBITDA, we do expect H2 to be significantly improved over H1, and in line with what I said about gross margin with the inflationary pressures and other pricing with the results of Q2, we would expect that while our percentage and our margin would be up for EBITDA, it is going to be less than what we've been speaking to previously. So that's, again, up significantly from the first half of the year, but down from the prior expectations. What I would say is, expect it to be around probably just north of a 5% margin. And then as far as the free cash flow, as we mentioned, as the revenue is growing activity levels and expectations, that is obviously using working capital and we did expect that we wouldn't have positive free cash flow for the first half of the year. As we look to the second half of the year, that increase or that improvement is really going to be driven by the fact we are bringing down the working capital needs. We're collecting on the revenue levels that were generated in Q2 and those increasing levels in Q3 and Q4. So, it is a function of the improvements continuing to occur with really H1 being driven by – generally in the first half of the year, there's other cash costs that go out that we don't have in the second half of the year. We also will have a very focused effort on cash collections to be able to drive down our receivables to a much lower level.

Sounds good. Thanks.

Thank you.

[Operator Instructions] Your next question comes from Brian from Sidoti.

Stacy, are you still there?

Yes, hello.

Yes, hello. Can you hear me?

Hi, Brian. Good morning.

Hi, Brian Russo with Sidoti. If maybe you could talk about your gross margin a little bit more, you know the 400 – the 30% down to about 26%. Can you break that down possibly by what price concessions drove the margin lower versus raw material inflationary pressures versus labor cost pressure as well? Just trying to get a sense of the decrease in margin while you saw a nice top line growth, where we could see the recovery through the latter half of the year to get to your gross margin targets?

So, let me just start and I'll have Susan add a little bit of color, Brian. I think we're not providing the full color in terms of how much was pricing because obviously, there was COVID price discounts. But I'd say other than a few lingering ones going into H2, most of those have been removed. Inflationary pressures, as I mentioned earlier, around raw materials and logistics and labor, led by raw materials, as Susan said, over 50% increase had a factor. And then the third factor was the fact that we reinstated the temporary cost reductions, as we moved into the year, including trading, which we highlighted was 35,000 hours, actually above that and $1 million, which obviously goes into the gross margin impact as we recovered from the COVID period. So, you're right that it is inflationary, it is pricing, and it also is the fact that we've reinvested in things like training. The other factor is that our Mechanical business and our Quest business have strong gross margins as well. And as the mix of segments changes, it does impact things. So as we see Mechanical and Quest continue to grow into the second half of the year of year in 2022, that's where we'll get a positive mix as well because there is some different margin type performance from each of the groups. But I'll let Susan add a little bit more color around these.

Yes. Brian, as Amerino mentioned, we're really not providing the specific details to it. But I would say that it's more the increasing costs that we're seeing impacting the gross margin for the first half of the year. And as Amerino mentioned, while we rolled in the cost reductions of the temporary costs from 2020 by the beginning of this quarter, the second quarter, April, there are additional costs that do ramp up that you don't have throughout the year, Amerino mentioned, the training and other type I mentioned previously in the gross margin and free cash flow, additional costs that hit Q1, Q2 that really kind of get reduced for the second half of the year. So again, I would say it's more closer to the cost increases that really impacted it. But the mix, as Amerino mentioned, between the segments will is what we're looking at as an improvement as Quest has sequentially improved and significantly. That base of their fixed costs – and they are covered by a lot more fixed cost, that base of fixed cost does help elevate that gross margin as we see the growth for them.

Okay. Got it. That's helpful. And just on Mechanical Services, obviously, you saw quite a bit of year-over-year top line growth at IHT and Quest, but it just seems the revenue for the Mechanical Services is only 4%, given the 2Q of last year. It just seems surprisingly low. Is that what you're referring to earlier on project delays and turnarounds being delayed? Or why wasn't that more in line with the other segments, given the year-over-year comp?

Yes. Good question. And a couple of things I would highlight for Q2. You're right in terms of some of the project delays that I referenced in the prepared remarks. We are seeing more competitive pricing pressures in Mechanical Services than we are at this time in the other two segments. And I referenced a little bit earlier the Gulf divisions, for example. So, we are being, I would say, revenue growth mindful that we do it profitably. So, we're not chasing every quote. We're trying to be, I would say, calculated, if you will, right now as we get through the recovery phases. So, call-out was impacted due to competitive pressures. Also, mechanical has a bigger footprint, Brian, international and into Canada. And we had some further COVID restrictions in some of the non-U.S. areas that impacted the growth rate. They still did well in those areas, but they didn't know as well as they could have had COVID restrictions not limited our ability to travel in and out of countries. Their footprint is much broader than IHT, for example, when it comes to geographical coverage. So, those are the big three. Historically, MS has generally lagged on a recovery, the IHT for regulatory type-driven reasons where clients have to meet their regulatory requirements, for example, inspection versus more call-out on mechanical. But what we're seeing now is some good movement on leak repair. We're seeing some good movement on call-out, hot tapping, both pipeline and plant-based. So, we expect that to catch up, but those are the reasons that we're seeing a bit more of a lag on MS versus the other two.

Okay. Got it. And then just clearly, the energy industry is recovering, but it seems that aerospace is lagging. Any comments on that end market, which, I believe, is your second largest market?

Yes. So, I would say that we are seeing things being pushed in the aerospace for large engine teardowns, large type projects. We are seeing some improvement in terms of inspecting new parts and working with some new clients. But overall, yes, I would say, it's lagging the recovery, if you compare it to refining and petrochemical, which is one of the reasons we talked about last quarter is making our investments in our facilities and some of our expansion plans because we want to hit it on the upswing, which we expect would be 2022. So, it is lagging. We're making some headway with new clients, but not recovering at the same speed, obviously, as you would expect to refining right now in petrochemical.

Alright, great. Thank you very much.

Thank you.

Thank you.

Thank you. I would like to turn the floor over to Amerino for closing remarks.

Thank you, Stacy. We remain optimistic about our outlook and Teams’ opportunities to grow in the current environment as our clients place increased emphasis on asset performance optimization and reducing their carbon footprint. I'd like to thank all of our employees for their dedication to operational excellence and health and safety. We remain excited about our growth opportunities in 2021 and beyond. Thank you for joining us on this call and your continued interest in Team, and we look forward to speaking with you again next quarter.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.