Mistras Group, Inc. (NYSE:MG) Q3 2023 Earnings Call Transcript

Mistras Group, Inc. (NYSE:MG) Q3 2023 Earnings Call Transcript November 3, 2023

Mistras Group, Inc. beats earnings expectations. Reported EPS is $0.18, expectations were $0.16.

Operator: Thank you for joining Mistras Group’s Conference Call for its Third Quarter Ended September 30, 2023. My name is Michelle, and I will be your event manager today. We will be accepting questions after management’s prepared remarks. Participating on the call from Mistras Group will be Manny Stamatakis, the company’s Chairman of the Board and Interim President and Chief Executive Officer; Ed Prajzner, Senior Executive Vice President and Chief Financial 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 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 the conference call will also include certain financial measures that are not prepared in accordance 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 tables contained in yesterday’s press release and the company’s related current report on Form 8-K. These reports are available on the company’s website in the Investors section and on the SEC’s website. I will now turn the conference over to Manny Stamatakis.

Manny Stamatakis: Good morning, everyone, and thank you for joining us today. In my October call, I provided a broad overview of the Board’s strategic vision for Mistras. Today, in addition to sharing more about our financial performance, I want to talk about the future of Mistras as it relates to the status of Project Phoenix. Our results for the third quarter were in line with our expectations for revenue and adjusted EBITDA. Revenues were up, and I am particularly pleased with another quarter of growth in our commercial aerospace and Data Analytical Solutions businesses, which we believe are only beginning to blossom. Gross margin expanded while selling, general and administrative expenses contracted to help us achieve our adjusted EBITDA expectations for the quarter.

The improvements in gross margin and reduction in SG&A reflect the initial impact of Project Phoenix, which we expect to continue in 2024 and beyond. As also announced yesterday in a separate press release accompanying the earnings announcement, subsequent to September 30th, we completed additional actions associated with Project Phoenix that will further reduce overhead and improve sales efficiency. Ed will provide more details on that later. But first, I would like to take a moment to reflect on the year-to-date results of the company, which reflect low single-digit revenue growth, a slight gross profit margin increase, and nearly 10% EBITDA growth that the EBITDA growth was driven by savings associated with Project Phoenix. In 2023, the company decided to make changes to key senior management positions.

These changes were instituted by the board in conjunction with Project Phoenix to strengthen the organization and to enable us to better execute our Project Phoenix initiatives to help accelerate profitable growth by identifying meaningful margin improvement opportunities and steps to achieve sustained cost savings. The meaningful and timely contribution of Project Phoenix-related actions helped to offset softness in revenue and profitability experienced in 2023, and will also contribute a material sustained benefit to the company into 2024 and going forward. Project Phoenix’s overall target is to eliminate waste and redundancy and to improve efficiency with the goal to reduce SG&A to approximately 21% of total revenues by the end of 2024, primarily through a rationalization of the overhead workforce, including a targeted 15% reduction in administrative headcount, but without as adversely impacting the company’s technician base or ability to support operations and services to its customers.

Together with the other initiatives implemented, we expect total Project Phoenix savings and other benefits of approximately $30 million in fiscal 2024. These income from operations improvements initiatives should not be viewed as a reactive measures, as we are just as committed and plan to make more proactive, strategic, and robust investments into growth initiatives moving forward. While we plan to reinvest some of our Project Phoenix savings, we still expect fiscal 2024 adjusted EBITDA will be greater than our previous all-time high of $88 million. I am confident that these initiatives will accelerate profitable growth, as well as sustain cost controls and result in margin expansion going forward. Equally as important to the profitability of Project Phoenix is the behavioral discipline, accountability, and energy that this project has brought to the reshaped senior leadership team of the company.

I am pleased to be leading the company at this crucial juncture, supported by a highly skilled, motivated, and invigorated senior leadership team. Speaking on behalf of the board, I am optimistic for the future of the company and believe that the implementation of these initiatives will create real value for our shareholders. Now I’d like to turn the call over to Ed for his update on our recent results and a little more detail on Project Phoenix.

Ed Prajzner: Thank you, Manny, and good morning, everyone. It was another quarter of meaningful progress and significant change for Mistras. And Project Phoenix will fundamentally change our company and significantly increase shareholder value. But before highlighting these changes, let me provide some highlights for the quarter. For the third quarter of 2023, consolidated revenue was up slightly, primarily reflecting growth in oil and gas, in addition to continued strength in several of our key growth initiatives, particularly commercial aerospace and Data Analytical Solutions. I would also note that revenue in our International segment was up 21% in the quarter, driven primarily by a strong turnaround market and increased aerospace and defense volume.

Gross profit margin expanded 20 basis points as compared to the prior year quarter and was also up 210 basis points on a sequential basis, driven primarily by a favorable sales mix and lower healthcare expenses, somewhat offset by inflationary pressures, including rising energy costs and incremental subcontractor costs. Selling, general and administrative expenses were down 3% compared to the third quarter of 2022 and were also down 4.7% sequentially from the second quarter of 2023. As Manny mentioned earlier, this decrease largely reflects the impact of Project Phoenix and ongoing cost controls to achieve sustained overhead savings. Loss from operations was $4.7 million for the third quarter, yet income from operations before special items of $11.8 million on a non-GAAP basis when excluding the goodwill impairment charge and reorganization and other related costs associated with Project Phoenix.

The non-GAAP income from operations represents a 19% increase as compared to the prior year period. Net loss for the third quarter was $10.3 million, or negative $0.34 per diluted share, before adjusting for the same aforementioned items, while adjusted EBITDA in the quarter was up 12.5% to $20.9 million, meeting our expectations. The net loss in the quarter was largely attributable to a non-cash impairment charge of $13.8 million related to our International segment, related to macroeconomic factors in Europe, before consideration of the impact of any prospective Project Phoenix benefits. I will provide more detail on this item in a few minutes. Net income on a non-GAAP basis, excluding the aforementioned special items, was $5.6 million or $0.18 per diluted share for the quarter.

Our net cash provided by operating activities was $10.7 million for the first nine months of 2023 compared to $10.5 million in the prior year period. Free cash flow was negative $5.6 million for the first nine months of 2023 compared to positive $0.9 million in the prior year period. This decrease in cash flow, free cash flow, was primarily attributable to an increase in capital expenditures during the current year and higher than normal accounts receivable balances as of September 30th, due to the timing of projects in the third quarter. This $6.6 million increase in capital expenditures during the current year reflects investments in our shop laboratories and in Data Analytical Solutions offerings to foster future revenue growth. Gross debt increased by $10.2 million during the quarter ended September 30, from $183.7 million as of June 30, 2023 to $193.9 million as of September 30, primarily due to the aforementioned factors impacting cash flow.

Our trailing 12-month bank-defined leverage was just under 3.5 to 1 as of September 30. Accordingly, we are pushing back our timetable to achieve a leverage ratio of 3 to 1 or lower from our previous December 31, 2023 target to an expectation of that being achieved in early fiscal 2024. As I referenced earlier, we incurred a non-cash impairment charge of $13.8 million in the quarter due to decreased gross margin in the current period as a result of inflationary pressures and rising energy costs impacting our international reporting units operations. As a result, we performed an interim quantitative goodwill impairment test during the third quarter of 2023. This decreased gross margin, in addition to higher interest rates in the current period, contributed to an unfavorable decrease in this reporting unit value, which caused this impairment charge of $13.8 million, which was recorded within the International segment of our business.

Excluding this non-cash impairment charge, the International segment achieved positive non-GAAP operating income as well as positive EBITDA for both the three months and nine months ended September 30, 2023 and they’ve also experienced strong growth over the prior year comparable period. We are optimistic for continued growth in this business in 2024, and beyond despite this economic headwind caused by this non-cash impairment, we will also benefit from pricing and cost improvements as part of Project Phoenix initiatives, which will be implemented during Q4 for International. The reorganizational cost of $2.7 million recorded during the quarter relate to professional fees and certain restructuring charges associated with the changes made to our organizational structure.

In the third quarter of 2023, these charges included severance costs associated with the transformation of our Products and Systems segment as announced back on October 2nd. Before providing additional data and details on Project Phoenix, I would like to highlight that our Data Analytical Solutions revenue, which has experienced growth of nearly 16% for the year, is experiencing strong growth throughout all of 2023, and we believe this provides customers with a significant benefit being achieved through data analytical procedures, which in turn turns the data into actionable information, which our facility operators and our customer can use to maximize safety, enhance their productivity and optimize their budgets. But now let me provide a little more detail on Project Phoenix.

A brief overview of actions taken thus far are as follows. First is strategic pricing, wherein we have developed and will further enhance a proactive structural price strategy to address inflationary costs being experienced within our business. This is the commercial function of Project Phoenix, which we mentioned earlier. Secondly, this reduction to overhead, our goal is to reduce overhead, as Manny said, to approximately 21% of total revenue by the end of 2024, primarily through a rationalization of the overhead workforce, including a targeted 15% reduction in administrative headcount without impacting the company’s technician workforce base or our ability to support operations and service our customers. And finally, the new leadership as a part of our transformation plan to improve shareholder value by lowering SG&A overheads, improving free cash flow, and accelerated growth, the board made recent changes to senior leadership within the company to further strengthen the organization and enhance the execution of the various initiatives comprising Project Phoenix.

We anticipate the new commercial focus, which emerged from Project Phoenix, will help drive organic revenue growth in 2024, leading to a record adjusted EBITDA of greater than $88 million, primarily attributable to a significant increase in operating leverage arising from a meaningful reduction in overhead combined with profitable growth. More immediately, however, we are lowering our guidance ranges for fiscal 2023 with full-year revenue now expected to be between $695 million to $705 million from a previous $710 million to $720 million range, and adjusted EBITDA is now expected to be between $65 million and $68 million from a previous $68 million to $71 million range. The reduction in revenue and EBITDA are due to lower than previously forecasted fourth quarter results.

Free cash flow guidance is also being lowered to between $7 million to $10 million from previously $23 million to $25 million range, which had excluded certain cash expenses being incurred to achieve the cost savings of Project Phoenix. This reduction in free cash flow guidance was due to an adverse day sales outstanding and buildup of AR and the incurrence of these cash expenses to achieve the Project Phoenix cost savings, and to a lesser extent, the increased capital expenditures to foster revenue growth. We anticipate a modest single-digit revenue growth in 2024, yet a significant expansion in adjusted EBITDA attributable to operating leverage and the ongoing benefits of Project Phoenix. Accordingly, we expect to generate an all-time adjusted EBITDA in fiscal 2024.

This outlook includes approximately $20 million of incremental benefit from Project Phoenix in 2024, and this detail was delineated in a separate press release issued yesterday, which accompanied the earnings release, as Manny alluded to. Project Phoenix provides a roadmap for sustained cost savings and increased profitable growth with the ultimate goal of driving bottom-line improvement and increasing shareholder value. After thorough planning, we are now implementing or have implemented many of its initiatives, which are yielding immediate benefits. We appreciate your continued support and expect to reward your patients with significantly improved results in 2024. At this time, I would like to turn the call back over to Manny for his closing remarks before we move on to take your questions.

Manny Stamatakis: Thanks, Ed. The successful implementation of Project Phoenix will stabilize our core business and allow us to expand and achieve further successes in our growth areas, and I am confident that management will achieve these objectives. Specifically, I anticipate that Project Phoenix will lead to the following results. Stabilization of our legacy oil and gas business, wherein we can maintain if not gain market share in an otherwise mature market, while yielding better economics return through a combination of strategic pricing actions, a lower-cost footprint, and a comprehensive productivity and efficiency improvement plan. In addition, in 2024, the company will be making increased investments in our key growth initiatives.

We will be targeting investments in our Data Analytical Solutions and in-line pipeline inspection offerings, as well as our aerospace and defense. We already have a significant presence and are rapidly expanding in all of these markets. Through organic growth strategies, we intend to invest in each of these markets to capitalize on the growing demand for better and more efficient technology. Our data analytical proprietary software is currently analyzing over 1 million assets in over 500 plants. Our target is to increase our revenue in this sector of higher margin business by 15% to 20% CAGR over the next three years. These solutions will enable our customers to better pinpoint when and what actions should be taken to protect and preserve their assets, resulting in meaningful cost savings.

I’m very pleased to be serving Mistras at one of the most pivotal junctures in the company’s history, and I am confident in the decisions the Board has made and the actions that management will execute on. I believe this will lead to significantly improved results. We hope this, in turn, will restore investors’ confidence in Mistras’ proven ability to create shareholder value. Finally, as I indicated previously, one of my key focuses for 2024 will be to identify and engage the right individual with the right leadership and skill sets to lead our reinvigorated company forward. We plan to engage a leading executive search firm in the near future to assist us with this most important objective. At this time, I would like to ask the operator to open the call up to your questions.

Operator: Thank you. [Operator Instructions] And our first question is going to come from the line of Chris Sakai with Singular Research. Your line is open. Please go ahead.

Chris Sakai: Hi, good morning. I wanted to ask about Power Generation & Transmission and Other Process Industries. It looks like there was a decline there in both of those segments for the quarter one year ago. I wanted to ask what was going on there and why was there a decline there?

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Q&A Session

Ed Prajzner: Sure. I’ll take that one, Chris. That’s a drop off of a long-term recurring contract, new construction bills happening that’s dropping off. So that was expected. We’ve been envisioning that. That was actually a delayed exit. But, yes, we’ll be replacing that with new contract work we’re going after, but that’s a sun setting of a long-term project in that – in those particular sectors, actually.

Chris Sakai: Okay. And there was an increase in accounts receivable. What was going on there?

Ed Prajzner: A little bit of that timing is, Chris, at the end of the quarter, we built up the third month of the quarter was heavier on the invoicing side. So a lot of that timing of projects and when the invoicing took place with the customer, we maybe took our eye a little bit off the working capital. So we will tighten that up in the fourth quarter to improve that. No real issues there other than we need to tighten back up on the working capital and bring that back down in the fourth quarter and I anticipate that we will do that. But that was largely the timing of when the invoicing happened late in the quarter. Again, we’ll tie that back down during Q4.

Chris Sakai: Okay. Sounds good. And then last one for me. It looks like – was there – can you comment on oil and gas? What were your – what was the major improvements for upstream?

Ed Prajzner: Yes, all three sectors actually, Chris, had a good quarter. It’s just that there is a good flow of product. I mean, there is good demand. That upstream is probably the least volatile of the three for us, but just good level of business there across the board, North America and Europe. Just steady state business there, a lot of volume flowing. So the upstream is not as nearly cyclical as the other sectors, but that’s a strong one. I mean, that’s largely where our onstream business plays. They had another record quarter, so they would fall into that sector there in the quarter that – the connecting capillary lines off of the drilling back to the Midstream. So onstream would have helped that sector of the upstream for us. But, no, it’s just a nice solid piece of the business for us. All three were actually very solid, but we do like that upstream piece in particular.

Chris Sakai: Okay, great. Thanks for the answers.

Ed Prajzner: Thank you.

Operator: Thank you and one moment as we move on to our next question. And our next question is going to come from the line of Mitchell Pinheiro with Sturdivant & Co. Your line is open. Please go ahead.

Mitchell Pinheiro: Yes, hi. Good morning.

Manny Stamatakis: Good morning, Mitch.

Mitchell Pinheiro: So, hey – Manny, this is a question, I guess, for you. You’ve been on the board now for 20 years. And I’m sort of curious – I mean, obviously, I mean, the results at Mistras has been a little bumpy over the last several years for a lot of obvious reasons, including COVID. And I’m curious why now is Project Phoenix happening, and maybe why wasn’t it five years ago? What’s happened? Is it just that there’s a little more sense of urgency for – because of the stock price or is there changes in the business that made Project Phoenix more relevant now than five years ago, let’s say?

Manny Stamatakis: That’s a good question, Mitch. The board felt it was time to reassess where we were. Probably should have done it five years ago, but we didn’t. And as – when COVID came, I think the whole world changed. We had hoped that we would come out of COVID better. We always had some concerns about our expenses. Our SG&A wasn’t performing at the level we had hoped it would. And we just felt that we were now at a point, look 2022 was not a good year for this company. And had it been a better year, we might have attacked things differently, but I think, the combination of our coming out of COVID, the results in 2022, we decided that it was time, it was time to bring in some people to look at what we were doing, it was time to identify opportunities that we could save money in.

It had not been done on an ongoing basis. So we decided that 2023 was going to be our rebuilding year and that’s exactly what we’ve done in 2023. We’re examining a lot of things, we’re making changes, we’re very optimistic about 2024.

Mitchell Pinheiro: So, you are going to get a new CEO, and you talked about finding the right person with the right skill set, so a) I am curious to know, like, what are those skill sets; b) it’s sort of – so here is this person that’ll be coming in and Project Phoenix is well underway. Sometimes you would think that the new CEO would have been the one embarking on Project Phoenix, but now that the new CEO is going to be the one, I guess, executing Project Phoenix. So, what kind of skill sets do you want? And are the skill sets for the new CEO, does it involve different things beyond what we’ve seen in the Project Phoenix initiatives?

Manny Stamatakis: We are looking for someone that has leadership skills and experience, somebody that knows how to delegate, understands accountability, knows how to build a cohesive, strong management team, and to profitably grow the company. We want our next CEO to be responsive, a good listener, a strategic thinker that has the experience to navigate the public company arena and importantly, a passion to get things done. In simpler terms, our next CEO must have affability, availability, and ability. We are confident we are going to find that person, we are going to work hard to do that. We think that bringing the – when we bring the right person in, it will not matter whether we started Project Phoenix before he got here or she got here or after. So that’s our thinking, that’s our plan, that’s what we’re looking for, and we’re going to invest a lot of time and effort to try to identify that individual and engage him.

Mitchell Pinheiro: Okay. And then just a couple other things related to Project Phoenix. One, is you talk about pricing strategy. Generally, pricing is sort of dictated by the market. So what is it – I mean, are you going to be raising prices, I don’t say across the board, but where you can? And I guess are you willing to lose business that does not opt for higher pricing? I would love to hear your answer on that.

Ed Prajzner: Yes, I am sure you would. Look, the past year to year and a half, the world has changed again, inflation is up, interest rates are up, our labor shortages have not changed, and it costs us more for good talent. We need to make sure that as we develop our pricing that we are accounting for all of that. It does us no good to have business that we are losing money on. We just – nobody can operate in margins where you are losing money. We believe our customers are fair and reasonable, and we hope that we can work with them to, at a minimum, make sure that we are covering our costs, the incurred costs that we have, we do so in a strategic way and we believe that because we have now undertaken an initiative to lower our SG&A, we can still be competitive.

Mitchell Pinheiro: So – okay. And then also related to Project Phoenix, and maybe this is for Ed. From SG&A, when I was looking at the separate press release where you are updating on Project Phoenix, you talk about $21 million of cost savings, estimated cost savings for SG&A, which would be, I guess, a relative, maybe, what is that, looks like $12 million of incremental SG&A savings. Did I read that correctly, number one? And number two, what are the investment – what are the dollars that are going to be spent – on a free cash flow basis, what are the dollars that will offset a lot of these improvements? Do you have a cash investment figure that you can share?

Ed Prajzner: Yes, but certainly. And you read those numbers correctly. The $21 million is the run rate in 2024, of which we have $9 million achieved in 2023. So, that is incremental $12 million benefit SG&A year over year. That’s before COGS benefits and revenue uplifts. The effort to do this is largely behind us. I mean, the actions have been taken here in 2023. The cost has been incurred. So, incrementally in 2024, there is not additional investment needed to do that. This 15% back office overhead reduction we alluded to on the call, that’s largely behind us now. So, there is cost to achieve that taking place in 2023, but there really will not be a whole lot of incremental cost in 2024 to achieve this. We are otherwise automating things, looking for workflow and automation, we do that all the time to be more efficient.