Amerino Gatti - Chief Executive Officer Susan Ball - Chief Financial Officer Don Bleasdell - Vice President of Finance

Good day ladies and gentlemen and welcome to the Team, Inc., second quarter 2019 earnings conference call. [Operator instructions] As a reminder, today's conference may be recorded. I'd now like to introduce your host for today's conference, Mr. Don Bleasdell, Vice President of Finance. Sir, please go ahead.

Thank you, Liz. Welcome everyone to Team’s second quarter fiscal year 2019 conference call. With me on today's call are Amerino Gatti, the company's 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 7, 2019. 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 15. Information on how to access these replay features was provided in yesterday's press release. Before we continue, I'd 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. These statements are 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 providing an update on our business. Susan will then detail our results, and before we take your questions, Amerino will highlight our OneTEAM progress and market outlook. I'd now like to turn the call over to Amerino. Amerino?

Thank you Don and good morning everyone; we appreciate you joining us today. We are pleased to share the following highlights driving Team's strong second quarter results: Strategic project selection and improved execution, optimized workforce management, continued pricing discipline, leveraging innovation and technology, enhanced margins despite slower top-line recovery, sustained cash flow improvement and the ongoing success of the OneTEAM integration and transformation program. Consolidated second quarter revenues of $316 million were up $46 million or 17% sequentially, but down approximately $28 million or 8.2% from a year ago. The current quarter activity was negatively impacted by continued softness in the Canadian market, exiting certain underperforming operations and some non-recurring projects. We are very pleased with the improvements in adjusted EBITDA, gross margin, SG&A and free cash flow. Second quarter adjusted EBITDA was $32.8 million or 10.4% margin, representing the highest level since 2016. The 10.4% adjusted EBITDA margin provides further support for our previously stated target of 10% to 12% adjusted EBITDA margin in 2020. Despite lower year-over-year quarterly revenues, our Q2 2019 gross margin was $94.6 million, up $28.6 million and 550 basis points sequentially. Gross margin percentage of 30% improved 170 basis points over last year, representing the strongest quarterly gross margin since 2015. Gross margin improvement was led by mechanical services and quest integrity segments, driven by strong execution in these businesses, ongoing strategic and operational initiatives and further implementation of our pricing plans. In addition, we successfully managed labor utilization and other associated costs. Second quarter SG&A of $81.6 million was the lowest since 2016. SG&A decreased $11.6 million or 12.4% from the prior year period and $600,000 sequentially. The year-over-year reduction in SG&A further reflects the successful implementation of our cost-savings plan within our OneTEAM transformation program. Typical of the second quarter, we were a net borrower on our credit facility. The first half free cash flow was negative $8.8 million, an improvement of approximately $21 million over the first half of 2018. We expect to generate more than $30 million of free cash flow in 2019, doubling the $15 million generated last year. Now I'll provide a high-level segment review. The inspection and heat treating segment reported revenues of $139 million and adjusted EBITDA of $13.9 million. While revenue and margin were lower year-over-year, both achieved sequential improvements of 9% and 120%, respectively. We attribute the declines in IHT's year-over-year performance primarily to the ongoing Canadian end market softness and to the underperforming businesses that were shuttered last year. More recently, IHT has also experienced some regional competitive pressures in the Gulf and West Coast divisions. The mechanical services segment delivered second quarter 2019 revenues of $145 million and adjusted EBITDA of $25.9 million or 17.9% margin. While revenues were slightly lower than prior year, adjusted EBITDA increased by 30%. The MS second quarter adjusted EBITDA represents the highest quarterly adjusted EBITDA since 2016. Our hot tap service line contributed to the strong second quarter performance. Previous technology and manufacturing investments in our hot tap and line stop fittings are driving growth and creating competitive advantages through improved quality and reduced delivery times. The quest integrity segment achieved record second quarter 2019 revenues of $32 million, a 23% increase when compared to last year. Adjusted EBITDA in the second quarter was $10.3 million or 53% higher than the prior year period. We are experiencing increased demand related to both further penetration into existing markets and growth into new markets for applications of a proprietary INVISTA technology enabling high-resolution ultrasonic inspections. Quest expanded margin despite the previously announced strategic growth investments in recruiting, training and tools. I will now provide highlights on our safety performance, technology and other updates. Safety is our number one core value. Our companywide focus on safety generated zero lost time cases in the second quarter. We improved our TRIR year-over-year by more than 40% and reduced recordable injuries. We remain committed to improving and achieving world class safety performance across our operations. I could not be more proud of our employees for their focus on safety and quality. Moving on to innovation and technology applications; as part of our ongoing, responsible, revenue enhancement initiative, we expanded our focus on the midstream market and our project management capacity for integrated solutions delivery in both the U.S. and Canada. Growing demand for hot tapping and line stop services, along with the continuing support of transmission pipeline projects provides a solid midstream backlog through 2019. In addition, we have seen an increasing volume of client requests and projects are being quoted for 2020. Quest Integrity continues its rapid growth and is on track for yet another record revenue year. Quest successfully expanded its smart cleaning solution, which includes decoking, inspection and condition plus process assessment into the Middle East and Latin America markets, working for several clients in each region. Quest remains the only company in the industry with combined process heater decoking, high-resolution ultrasonic inspection and comprehensive condition assessment. This fully integrated domain and critical asset specialized solution enables fitness for service, heater performance optimization and asset life extension, all of which are critical to our clients. And lastly, Team Digital, our proprietary platform that maximizes quality and efficiency through digitally enabled workflows continues to provide value for our clients. During the quarter, we implemented our mobile digital services for several repeat clients and are expecting our highest number of digital projects during the fall turnaround season. So far in 2019 we have completed 12% more digital turnarounds compared to the same period last year. I will now turn it over to Susan for a detailed financial review, and then I will share more about our OneTEAM progress and outlook. Susan?

Thank you, Amerino, and good morning everyone. Second quarter net income was $6.1 million, a $37.4 million increase over the second quarter of 2018. Second quarter consolidated revenues were $316 million, which was down 8.2% from second quarter 2018 due to approximately $5.6 million of underperforming operations that were shut down over the course of 2018. Additionally, foreign currency exchange negatively impacted revenues by $3.3 million. The Canadian market experienced better results sequentially that remained soft when compared to 2018 and contributed to over half the overall revenue decline year-over-year for the company. Quarterly revenues were up $46 million or 17% higher than the first quarter 2019 revenues of $270 million as refining utilization rates backed off the highs experienced earlier in the year. Consolidated gross margins improved significantly to 30%, an increase of 170 basis points when compared to the second quarter of 2018 of 28.3% despite the top-line decrease. We generated favorable fall-through and the highest quarterly gross margins since 2015, both primarily attributable to the ongoing success of our OneTEAM program, which includes the continued rigor and focus of workforce planning and the utilization process improvements. Quest Integrity gross margin increased 22% on a 23% revenue increase. IHT gross margin decreased 20% on an 18% revenue decrease. MS gross margin increased 3% on a 3% revenue decrease. The bulk of IHT margin changes for the result of the ongoing softness in the Canadian market, as well as volume impacts and associated fall-through. Consolidated adjusted EBITDA of $32.8 million in the second quarter of 2019 was up 7.7% from the second quarter of 2018. Adjusted EBITDA as a percentage of revenue increased 150 basis points to 10.4% from 8.8% in the second quarter of 2018. Now turning to our segment performance. The inspection and heat treating segment reported second quarter 2019 revenues of $139 million, an increase of 9% sequentially, however down 18% when compared to the same period last year. Second quarter adjusted EBITDA was $13.9 million, an increase of 120% sequentially, however down from $19 million in the second quarter of 2018. The mechanical services segment delivered second quarter 2019 revenues of $145 million, an increase of 19% sequentially, but slightly lower than $149 million in the second quarter of 2018. Adjusted EBITDA was $25.9 million or 17.9% margin, an increase of 134% sequentially and an increase of 30% when compared to the same period last year. The MS second quarter adjusted EBITDA represents the highest quarterly adjusted EBITDA since 2016. The quest integrity segment achieved record second quarter 2019 revenues of $32 million, a 23% increase when compared to last year. Adjusted EBITDA in the second quarter was $10.3 million or 53% higher than the prior year period. Moving now to SG&A, we continue to improve our SG&A spend through cost management actions, as well as the implementation of our OneTEAM program. Total SG&A for the second quarter 2019 was $81.6 million compared to $93.2 million in the second quarter of 2018, a decrease of $11.6 million or 12.4%. Sequentially, the $81.6 million was down from $82.3 million incurred in the first quarter of 2019. Due to our ongoing focus on improving costs and managing spend rigorously, second quarter 2019 SG&A was the lowest quarterly SG&A spend since 2016. Our effective income tax rate for the six months ended June 30, 2019, approximated 3.5%. The company has domestic federal tax net operating loss carry forwards of approximately $128 million as of December 31, 2018, which are available to offset our future taxable income. For the six month period ending June 30, Team generated $5.6 million of operating cash flow, representing an improvement of $23.3 million over the same six months in 2018. Capital expenditures were $14.4 million in the first half of 2019, slightly higher than the $12.1 million in the first half of 2018. First half 2019 free cash flow was a negative $8.8 million, representing a $21 million improvement when compared to the first half of 2018. We are also able to reaffirm our guidance for the full year capital spend to be in the range of $30 million to $33 million and remain on track for doubling our free cash flow from 2018 to more than $30 million in 2019. We ended the second quarter of 2019 with $12.8 million of cash and have available borrowing capacity under the credit facility of approximately $56 million with total liquidity approximating $69 million at June 30, 2019. As expected, we were a net borrower this quarter due to increased labor costs associated with the time lag of cash collections on increased sequential revenues, generating higher working capital requirements in the second quarter. We remain committed to paying down debt with any free cash flow generation. Our senior secured leverage ratio at June 30, 2019 was at 2.66x. Cash interest expense for the second quarter 2019 was approximately $5.8 million. Exiting the quarter, our focus continues to be on generating free cash flows and returns, being disciplined with our cash allocation, working capital management with continued expectations of receivable and inventory reductions in the second half of the year, and achieving additional cost control and associated reduction. In closing, I do want to provide an update on our senior credit facility. We currently are in active discussions regarding an extension on our credit facility that matures in July 2020. We believe extending the credit facility will ultimately provide us with the ability to obtain a more cost-effective and flexible long-term capital structure, with additional time that allows us to further execute and realize the continued benefits from the cost-savings reductions of the OneTEAM program, as well as to continue to demonstrate the overall improvement on the gross margin as we continue to responsibly manage revenue. That completes the financial review. I will now turn the call back over to Amerino.

Thank you, Susan. Before we take your questions, I want to review the progress of our OneTEAM program and provide a market outlook. We are in the second year of our OneTEAM transformation and integration program and remain on track to achieve annual run rate cost efficiencies of $35 million to $45 million by the end of 2020. The two cost pillars generated savings of $11.6 million in the first half of this year, and we expect to deliver the targeted $20 million to $22 million for the full year. Our focus on the revenue enhancement pillar has enabled us to realize operating leverage, de-emphasize lower-value contracts, and deliver sustained margin improvement. In the second quarter, gross margins expanded despite an overall revenue decline, driven by both the shift and mix to higher value projects and a lift from efficiencies and productivity improvements. Simultaneously, we have internalized the OneTEAM North America program, allowing us to reduce expenditures for some of our third-party advisors by bringing the expertise in-house. Now shifting to the market outlook. The latest global economic growth projection is approximately 3% for 2019. This is a reduction from earlier forecasts in the year due to a general decline in business confidence, the associated tightening of financial conditions and higher political and trade policy uncertainty across many economies. According to EIA data, the U.S. refinery utilization rate soared at January but backed off in late February through July. Q2 2019 utilization levels remained high at 90%, but were lower than prior year. The month of July had an average of 94% compared to 95% in 2018. A return to a slightly lower utilization will translate in the stronger demand for our services in the near to medium term. Over the long term higher utilizations will also benefit Team, due to the corrosive nature of the operating environment and additional asset wear and tear. The macroeconomic factors driving our end markets have enabled Team to begin capitalizing on shifting market trends, such as the integration of our inspection, heat treating and mechanical services operations to prepare for more on-stream, maintenance and remedial repair work. Meanwhile, inflationary pressures on labor, materials and logistics continue. In order to offset some of these headwinds, we have made strategic investments in manufacturing and engineering to be more competitive. On the labor front, our workforce management tools have been fully deployed, and we are benefiting from increased technician utilization. The depressed Canadian market continues to result in economic uncertainty due to regulatory hurdles and delays. Canadian turnaround activity has been significantly lower than last year, mainly impacting the IHT segment. This lower turnaround activity has led to aggressive project bidding by competitors. Despite this market environment, Canadian revenues and profitability increased sequentially, and we anticipate increased project activity in 2020. Before taking your questions, I will update some of our goals and objectives. First, from a revenue perspective, we expect 2019 to be an inverse of last year with the second half of 2019 being comparable to the first half of 2018. We are scheduling several off-cycle projects, mostly in the form of smaller pit stops that have not historically occurred. Additionally, due to recently high refinery utilization rates and delayed projects, we are experiencing increasing discovery activity. Second, we expect the IHT segment to improve its performance in the second half of the year, given higher planned activity from the refining, midstream and aerospace sectors. Third, we expect to deliver 180 to 200 basis point improvement in 2019 for adjusted EBITDA margins over the prior year. And finally, we expect to generate more than $30 million of free cash flow in 2019, doubling the $15 million generated last year. In closing, I would like to thank our clients, suppliers and shareholders for their support, and in particular Team's employees for their hard work and ongoing focus on safety, which is essential to creating value for all of our stakeholders. Our new structure is allowing us to be more agile, responsive and scalable, based on demand fluctuations in the market. At this point, we will be happy to take your questions.

[Operator instructions] Our first question comes from the line of Tahira Afzal with KeyBanc. Your line is now open.

Hi Amerino. Congrats on a good quarter.

Thank you, Tahira.

Amerino, I know you've talked about some macro uncertainty and clearly we're seeing it across the industrial space, so your comments seem to be aligned with what the environment is. I guess the EBITDA outlook for the margin improvement seems slightly nudged down perhaps. Would love to get color if that's in response to the macroclimate or whether it's something else on a company specific level.

So overall, our adjusted EBITDA is not projected to be down. We're still forecasting the 180 to 200 basis points improvement year-over-year. We're seeing a 2% to 3% market growth with the exception of Canada and our underperforming businesses, and we feel that the quarterly EBITDA delivery that we made this quarter will be in line in terms of reaching the target of that basis point improvement through the end of the year, Tahira.

Got it, Amerino, and you know how about next year as you see some of these uncertainties developing. Does it change your outlook for that sort of 10% to 12% sort of EBITDA margin into 2020 or is it too early to call?

Well, I think we're doing two things Tahira. Number one is, we are very focused on what we can control, which is the two cost pillars, and we're very confident that we are on pace to deliver the $35 million to $45 million. We are not stopping there. We are also now looking at our international operations in terms of a transformation, as well as further G&A consolidation and opportunities going into 2020 and beyond. So in terms of the effort, the focus that Susan talked about, we're clearly focused on those two pillars. On the revenue side, we've done some work there in terms of historically, the midstream, downstream and other sectors generally delay any shift in market by 12% to 18%, so – 12 to 18 months, I'm sorry. So even if there is a little bit of a slowdown, which we're not seeing yet, our business generally as utilizations comes down and the facilities age, we have the opportunity through that delay in the cycle to still grow and capture the growth and margins that we would need. So for us, right now looking into 2020, the 10% to 12% is strong in terms of where we expect to finish. We continue to focus on the two cost pillars. We do expect at least a 2% to 3% overall end market growth, even if there is a bit of a slowdown in some other sectors because of that delay, and we've still got opportunities to diversify our revenue base beyond refining. Aerospace is a good example. We've got two hubs: One in Europe, one in the U.S. We've gotten good support. I was just up in Cincinnati visiting one of our clients and opportunities to expand. So I think there's opportunity to also diversify that top line, as well as cross-sell.

Very helpful, and congrats again Amerino!

Thank you.

[Operator instructions] Our next question comes from the line of Adam Thalhimer with Thompson Davis. Your line is now open.

Hey, good morning. Congrats!

Thank you, Adam. Good morning!

Hey, when you talk about the back half of this year being similar to the first half of '18, are you talking about revenue or margins?

No, revenue. So from an activity standpoint [Cross Talk] From an activity standpoint, as we stated last quarter, our hours, our activity, our project plans, turnarounds, it's laying out that our revenue will be in line with H1 of 2018, which is where we're looking at the inverse model because of the high utilization rates in Q4 – Q3, Q4 of last year, Q1 and Q2 of this year. So it's a revenue with improved margin year-over-year to reach the 180 to 200 basis point improvement on margin.

Okay, but that math adds up to your best half of EBITDA in years, so I just want to make sure that's consistent.

No, no, that is consistent. Again, we had a very strong second quarter, but when you look into the third and fourth quarter with our increased activity levels and again, the reductions in our cost, no, you're right when you're looking at the math on that. I would say it's again the continuing ongoing process with cost reduction, workforce management improvement and overall looking at the contracts and revenue improvement.

So Adam, we went back to '16 obviously because of the acquisition time frame, right? So that's when we've combined Furmanite plus Team. The investments we've made in manufacturing and engineering over the last year and a half have contributed significantly to helping us be more competitive. We've also diversified our revenue stream in mechanical services, not only by product line, but also by sector as I talked about with more midstream growth, which in the midstream market it's allowing us to leverage some of our project management capabilities. A lot of our midstream clients want us to lead that project management exercise and bring all the pieces to the table when you are doing that type of work, and so between those two things and some pricing improvements, we've had obviously a good quarter. And mechanical services, with the shift in the macro market to more remedial repair on-stream, we're very confident that that's an area that we want to continue to invest into to improve the overall results of the company.

Alright, and then just one more and I'll hop back in queue, but curious what you are seeing in July and August in terms of demand. What gives you the confidence in that back-half revenue outlook? And then also, can you help us think about how much EBITDA we should put in Q3 versus Q4?

So in terms of the activity, right now we're seeing between a 6% to 8% improvement in terms of hours, activity hours, which is how we're forecasting H2 versus H1. We're expecting the second half turnaround season, as we stated to be a lot more similar to the first half turnaround season of last year. One of the benefits we're seeing right now is because of the high utilizations on the refining side, some of the project delays as I have stated are creating more pit stops, which are basically small, mini project turnarounds and more discovery work. So we're seeing a strong August and September play out right now, which the August and some of July is uncommon in terms of what happens, you know which happens historically, but we're seeing that because of the high utilization rates. And I think furthermore, we do expect Canada, although it's not going to – it's going to be lumpy for the rest of the year, their H2 will be stronger than H1, so that's a positive. And on the international front we're also seeing a stronger second half this year than we did last year. So overall, up in the activity side between those percentages that I just mentioned and then revenue in line with H1 of '19 – I'm sorry, H1 of '18. Thank you.

Okay, I got you. Thanks guys.

I'm showing no further questions in queue at this time. I'd like to turn the call back to Mr. Gatti for closing remark.

I think we have one more question.

We do have a follow-up from Tahira Afzal with KeyBanc; your line is now open.

Thanks a lot for squeezing me in. I guess you know when you are talking about revenues being the same Amerino, what's the profile of quest within that?

So quest will continue to grow in the second half of the year. We expect quest to be in the range of 12% to 13% year-over-year growth.

Okay, great. So when you are talking about being similar to the first half last year, it's more so for the other segments?

That's correct.

Okay, okay great. And then I guess you know when you are talking about and you've shown great success in terms of really generating free cash flow Amerino, am I getting a little ahead of myself? And Susan, correct me if I'm pushing my luck, but you know you’re doing more than $30 million this year. What could next year potentially look like once all these efforts you put in on the cost side are in place, you know your integrated sales model has had time to settle in?

I mean, we are forecasting and looking as we look into the future again with – in the future 2020 with cost reductions, you could see another $10 million up to $20 million more in free cash flow.

Very impressive! Okay, great. Thank you very much folks.

Thank you very much.

And I'm showing… [Cross Talk]

So I want to just – go ahead.

I'm just saying, I'm not showing any further questions.

Okay, thank you Liz. So once again, thank you for joining us on the call and for your continued interest in Team, and we look forward to speaking with you again next quarter.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone, have a great day!