Mistras Group, Inc. Q2 FY2022 Earnings Call

Good morning, ladies and gentlemen, and thank you for joining Mistras Group's Conference Call for the Second Quarter of Fiscal 2022. My name is Kurt Wright, and I will be your event manager today. We'll be accepting questions after management's prepared remarks. Participating on the call for Mistras 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 Operating Officer. I want to remind everyone that remarks made during the conference call will include forward-looking statements. The Company's actual results could differ materially from those projected. Some of those factors can result in actual results differing 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 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 in the Company's related current report on Form 8-K. These reports are available at the Company's website in the Investors section on the SEC's website. I will now turn over the conference to Dennis Bertolotti.

Thank you, Kurt. Good morning, everyone, and thank you for joining us today. I'm continually excited about the future of Mistras, and I want to thank our employees for their efforts as they continue to serve our customers and exceed their expectations. This quarter was extremely busy as we closed a new credit agreement. We experienced continued recovery in our end markets and expanded the growth of our strategic initiatives in data and digital solutions. Revenue this quarter was up year-over-year for the eighth consecutive quarter. We have continued to see strong demand in our key end markets, and we are optimistic for the second half of this year. Our aerospace and defense business was up nearly 33% in the second quarter as the commercial aerospace market surged forward as we had anticipated. This rebound in commercial aerospace, coupled with strong growth in both the private space and defense markets gives me confidence in this industry's ongoing recovery and expansion and validates our ability to meet and exceed customers' needs. I am also optimistic for strong third-quarter results, which would keep us in line with our full-year expectations. Adjusted EBITDA for the second quarter was $18.3 million, down from a year ago where a favorable sales mix was more than offset by gross margin pressure due to inflation. We expect gross margin to improve as we move through the remainder of the year, primarily by maintaining a favorable sales mix and taking proactive measures such as selective pricing adjustments in line with the inflationary cost pressures we have mostly been absorbing. Consequently, with the expectation of continued growth in the third quarter and confidence in strong fourth-quarter results, we reaffirm our '22 full-year guidance. While we are showing progress with our diversification initiatives, energy remains our dominant market. The second quarter got off to a good start with strong April results, but as we move through the quarter, we began to experience delays in deferrals concentrated once again in the downstream business where near-record crack spreads have refineries targeting high utilization rates. In our midstream business, downstream had record revenues in the second quarter, and we see this trend continuing into the latter half of '22 given market demand projections. In contrast to our downstream business, high production levels and the corresponding transportation and distribution activities are increasing demand for pipeline inspections. Consequently, we expect a strong recovery in our energy business in the third quarter and a return to historical patterns in the fourth. As I mentioned earlier and as we had anticipated, our aerospace and defense business has strengthened in the first half of '22 and in fact, it's up over 28%, and we expect this positive momentum to continue through the remainder of the year. Private space remains strong, and we believe our focus on reducing the production cycle time for parts will continue to drive faster growth in that market. While the supply chain remains a challenge to this industry, it has created an opportunity for Mistras to leverage the solutions business we developed by alleviating supply chain issues as we had done previously for our customer in France. We are quite excited that the expansion and installation of a new machining equipment and capabilities at our Georgia Aerospace facility is nearly complete. Now we can perform adjacent value-added services, such as machining for inspection procedures, saving cycle time and reducing transportation, thus reducing production time and costs for our customers. We are excited to get this operation running so that we can further leverage our capabilities in private space, aerospace and defense industries. As part of our aerospace and defense growth strategy, I'm very pleased to announce that the Honorable Jay M. Cohen has joined the Mistras team as an advanced technical solutions consultant. Retired Admiral Cohen will help Mistras expand its footprint in the military and defense, maritime and marine sectors, leveraging his extensive knowledge of the naval industry, catalog of high-level contracts and experience navigating government procurement procedures. In our renewables business, Sensoria continues to grow. Many of our ongoing pilots and demonstrations are quickly scaling up to full commercialization with approximately 50 wind turbines now being monitored. This puts us well on the way to achieving our goal of monitoring up to 100 wind turbines by the end of '22, with the prospect of greater growth in '23 as we rapidly expand our capacity. Our continued focus on renewables includes penetrating the wind farm market and building relationships with OEM manufacturers. Our attention remains on both large and small wind farms, including the market for massive offshore turbines. Finally, our data solutions business, especially PCMS and New Century Software had a strong quarter. OnSuite adoption continues to increase as the integrated applications now standing over 90 have been installed at nearly 40 unique customers spanning over 150 sites with close to 900 individual subscriptions. That is considerable growth in the last 90 days. OneSuite remains on track to double its revenue this year and enter 2023 with strong momentum for continued growth and expansion. The other process industries markets also had strong growth in the second quarter, which further illustrates the benefits being realized in our non-energy business and our push for greater diversification in our end markets. Continuing to increase revenue diversity should also benefit gross margin going forward as virtually all these industries carry an above corporate average gross margin. Ed will go through the details in a minute. The gross margin in our energy business should also begin to benefit from pricing actions we are taking due to rising labor costs. Recently, we have seen more acceptance from a market that has been historically resistant to price increases. As we continue to implement our pricing strategy, we expect to see this gradually increase our gross margin over the next few quarters. Also, I would note that overhead today is little changed from what it was three years ago in the pre-pandemic 2019. Despite current inflationary pressures, we believe we have a great opportunity to improve operating leverage and grow the bottom line faster than revenues. Additionally, I am pleased to announce a new credit facility, which provides us with much greater flexibility and liquidity to fund our growth initiatives, particularly our strategic initiatives and data solutions and renewable energy. It will enable us to enhance our organic growth initiatives as well as accelerate the pace at which we consummate strategic acquisitions, thereby creating value for our shareholders while investing in our employees and infrastructure. It also demonstrates the strong confidence in Mistras exhibited by a supportive consortium of seven strong financial institutions led by the two largest financial institutions in the U.S. Ed will provide additional details shortly. I'm looking forward to the second half of the year where we could have our strongest ever quarterly Services segment revenue in the third quarter, achieve a full year doubling of OneSuite revenues, moderate up to 100 wind turbines, benefit from an expected rapid recovery in the commercial aerospace market and launch our new supply chain service for the aerospace, defense, and private space industries, effectively transcending the lingering effects of the pandemic and energy market volatility. Inflation remains an ongoing challenge, but we are making progress on that front. Our improved financial flexibility, as Ed will discuss during his comments, the cost reduction initiatives we are initiating, and our pricing actions will help partially offset these impacts. As the year progresses, our new credit facility provides flexibility to increase our investment in both organic growth initiatives and more closely evaluate acquisitions that meet our strategic objectives. I'm optimistic about the prospects for growth in both our existing and new markets in '22 and beyond. I would now like to turn the call over to Ed to give you more detail on our financial results for the second quarter.

Thank you, Dennis, and good morning, everyone. Revenue in the second quarter was up year-over-year for the eighth consecutive quarter as we continue to extend our record of consistent growth. Results were once again a mix of strength in key markets that continue to recover from the pandemic, offset by the continuing challenges in the energy market, which is operating at peak capacity utilization. Our efforts to diversify away from an energy concentration have been progressing. And as Dennis just mentioned, many of our new growth initiatives are meeting expectations. Turning to results for the second quarter. Consolidated revenue increased approximately 3% on a constant currency basis to $179 million. Normally, revenue was up approximately 1% with growth driven primarily by strong performance in oil and gas, aerospace and defense, and other process industries. Oil and gas was up overall on the strength of upstream and midstream. However, as the quarter progressed, we experienced pushouts and deferrals in our downstream business. It's clear these were mostly deferrals as we've already seen a rebound early in the third quarter in our Services segment. Hence, as Dennis said, we anticipate a strong third quarter, and we expect to be on pace to achieve our original 2022 revenue growth projections. Gross profit for the quarter was approximately $54 million, with gross margin 29.9% compared to 31.1% a year ago. Gross margin continues to reflect higher health care costs in North America and the lag in price increases in response to inflationary cost increases. In addition, gross margin in the year-ago quarter benefited from pandemic-triggered Canadian wage subsidies, which have since expired. Beginning in the third quarter, we will be comparing against the year-ago quarter in which almost all pandemic-related benefits had expired. So we will have a truer, cleaner apples-to-apples comparison for all future periods. This will more clearly demonstrate the progress being achieved on gross margin, which we expect to trend significantly higher over the balance of the year from increased volumes, improved sales mix, efficiency improvements, and pricing increases. Selling, general and administrative expenses in the second quarter were $40.7 million, which is down sequentially from $42 million in the first quarter, although up by 2.4% from a year ago, much of which relates to inflationary pressures. Despite these ongoing pressures, we expect to maintain overhead at the current level over the remaining quarters of this year, and it's also one of our keys to increasing operating leverage. Interest expense for the quarter was $2.1 million, down from $3.2 million in the same quarter of last year as we have reduced both our operating debt and our outstanding debt balances as well as the associated interest rate via improved leverage and strong free cash flow generation. Under our new credit agreement, we expect quarterly interest expense to remain in the same range. For the quarter, we reported net income of $4.7 million or $0.15 per diluted share. Adjusted EBIT for the quarter was $18.3 million. For modeling purposes, we would anticipate an effective income tax rate of approximately 30% for the remainder of 2022, exclusive of any discrete items. Free cash flow for the quarter was $9.3 million, up from $8.5 million a year ago and in line with our typical free cash flow conversion of approximately 50% of adjusted EBITDA. We expect free cash flow for the year to approximate 50% of our adjusted EBITDA, except for the payment by the end of the year of $4.5 million in payroll taxes that had been deferred earlier under the CARES Act. This payment will be the second and final installment associated with this CARES Act benefit. Capital expenditures were $3.9 million for the quarter and $7.1 million for the first half of this year. We expect capital expenditures to be in line with our expectations and to be under $20 million for the full year. As of June 30, '22, we had gross debt of approximately $200 million, down from just under $203 million at the end of the year and net debt of $181.8 million compared to $178.5 million of net debt as of year-end. Given that our primary use of cash flow continues to be the reduction of outstanding debt, we believe our forecasted full year free cash flows will enable us at the end of the year to be at or below our targeted leverage ratio of being equal to or less than 3x, which remains our goal, even though our new credit facility provides quite a bit more flexibility. Once that level is achieved, we intend to evaluate our use of cash flow as a means to accelerate growth and build shareholder value. Let me quickly recap the highlights of our new credit facility that was announced under a separate release earlier this week. The new credit facility consists of $315 million of aggregate credit, including a funded $125 million five-year Term Loan A and a committed $190 million five-year revolving facility. The new credit agreement matures on July 30, 2027. This facility significantly expands the unused yet available revolving credit by almost $100 million at closing. The arrangement also includes significant reductions in required term loan amortization, specifically decreasing the required payments to $1.6 million per quarter for year one and two, replacing a facility that had been requiring $5 million per quarter, improving available cash by nearly $15 million per year. The amortization schedule does increase in years three through five, but remains well below the level of the prior facility. The new facility also provides leverage flexibility by increasing the maximum allowable total funded debt to 4x adjusted EBITDA from the third quarter of '22 through the second quarter of 2023 measurement periods with a step down to 3.75x for the Q2 '23 measure period and for all periods thereafter. This compares to the prior allowable fund debt level of up to 3.5x for the June '22 period and all measuring periods going forward. The Company has also retained a $75 million uncommitted accordion. This indication of the facility was oversubscribed by $100 million and includes seven banks, all of which are included within the top 35 financial institutions in the United States. Since upsizing our credit facility in December 2018 to finance the Onstream acquisition, we have repaid nearly $80 million of debt over a period of unprecedented weakness in two of our largest markets. This new credit agreement provides us with ample liquidity to fund our growth initiatives as well as the flexibility to more immediately consider strategic acquisition possibilities. Despite rising rates and overall credit concerns, this facility clearly illustrates the confidence of the financial markets in our strategy, recovery plans, and in management. As Dennis mentioned earlier, we expect a strong recovery in our energy business in the third quarter and a return to historical patterns in the fourth quarter. Consequently, with the expectation of continued growth in the third quarter and confidence in strong fourth-quarter results, we reaffirm our previously announced outlook for the full year 2022, that being revenue between $695 million and $715 million, adjusted EBITDA between $65 million and $69 million, and free cash flow between $27 million and $30 million. While the second quarter results were below our expectations, we are confident in the level of work expected for the second half of 2022, given strong energy markets, improving commercial aerospace demand, robust industrial manufacturing, and a rapidly developing data solutions offering. And with that, I will now turn the call back over to Dennis for his wrap-up before we move on to take your questions.

Thanks, Ed. As we move into the second half of the year, I'm optimistic that we will improve our gross and operating margins by implementing higher prices in partnership with our customers to offset the increased cost of our business. This recovery of labor cost increases has been dragging on our results due to the lagging impact of increasing our prices. We will also continue to look at all overheads and constantly calibrate our cost footprint with our current revenue level to help ensure that we can maximize our returns as revenue continues to rebound. We are focused on optimizing our efficiency, improving the operating leverage in our business, and generating increased shareholder returns. As our newer growth areas such as wind, private space, and digital take hold, we will improve our results and gain market share. Our core legacy markets are certainly recovering, most notably, the commercial aerospace market, and we believe this is a transformative year for all our growth initiatives. We expect to exit the year with a strong foundation of renewable energy growth via Sensoria, which will create monitoring as well as inspection and repair opportunities, along with our continued commercial aerospace recovery, our private space growth, and last but certainly not least, with data solutions expansion via OneSuite. Government entities continue to impose new and more restrictive compliance and safety standards in both North America and Europe. Thus, there has been significant public interest and investment in much of today's critical industrial infrastructure to ensure they operate at peak efficiency. When coupled with global supply chain issues that demand new innovative thinking, a strong market offers many opportunities that will support long-term growth. Our crossover mechanical offerings are very well positioned to serve this niche. Our focus remains on developing new and innovative solutions that help our customers meet these challenges and improve their productivity. We're finding success in serving more customers with what we believe is the best digital offering available. Before taking your questions, I'd like to thank all Mistras employees for their continuing dedication to constantly evolving customer needs. I'm proud of the team and the way we've executed on our strategic plans for the future while continuing to focus on serving our customers in the present. Your focus on caring for the safety and well-being of everyone that we interact with is at the core of Mistras' vision. By sticking to the tenets of our Caring Connects initiative, we provide a better workplace not only for the current Mistras family, but for all those who will join us in the future to add to our legacy. Kurt, please open up to phone lines.

Our first question comes from Brian Russo of Sidoti.

Just on the project delays in the downstream end market of energy. Clearly, that kind of triangulates with some of the relatively historically high utilization rates. But what types of projects are being delayed? And what gives you the confidence that the third quarter could be your highest quarter historically in that sector, even though the third quarter tends to be a period where refineries run at the highest utilization rates given that it's a heavy air and ground travel season and demand for the byproducts?

Absolutely. You raise a valid point regarding the summer driving season impacting utilization. To address your initial question, the delays occurred during the capital turnarounds in the spring. Back in late 2021, when we were preparing our budget, we anticipated a very aggressive spring, as historically, this season has been stronger. However, as the year progressed into January and February, we started to learn that a couple of projects were being postponed to later in the year. While only one or two actually shifted out of 2022, most were rescheduled, and many had their timelines shortened. This led to a slight reduction in the start dates, and what we expected to be the peak period was also moved earlier, with earlier end dates. This was largely influenced by historically high crack spreads, which are around 50% above what we've observed in the past four decades. Customers have indicated that there aren't significant mechanical issues, but rather, they are attempting to take advantage of the current situation. Additionally, they are facing pressure to meet demand due to rising gas prices and the limited number of refineries available. Consequently, many projects have been pushed into the third quarter. In response to your second question, while unforeseen events like hurricanes could alter plans, we haven't encountered significant delays from the current discussions. Since it is still early August, we expect to see peak activity by late August and into September and October. Typically, if changes are going to occur, we would have started hearing about them soon. So far, plans remain on track, with only a minor number of turnarounds possibly extending into 2023.

Okay. Got it. Great. And then switching to aerospace and defense. To just summarize your comments, you're starting to see true evidence of the commercial aerospace recovery while the defense side has been strong all along. And so the 2Q revenue of $22 million, that gets you pretty close to that $90-plus million pre-pandemic run rate in 2019. And I'm just curious how soon do you think you'll get there given the latest developments in the space?

The $90 million you mentioned for the aerospace run rate? Yes, from what we see, the demand is present. The supply chain poses some challenges. It's not primarily on our side; we are doing our best to navigate the middle, but much of the issue stems from castings and forgings and the speed of deliveries. We are still encountering some problems there, and they are facing more quality issues than usual. We are working to manage the steps between the initial material going out and the final product to reduce trucking and wait times nationwide, which saves time and money. Therefore, I believe we are improving in that area. Regarding whether '22 will reach the same run rate, no, it will not; we are in the process of catching up. We expect '23 to align more closely with that as long as raw materials can keep pace. The only significant issues we see are in one of our facilities that focuses heavily on composite work, particularly for wide-body aircraft, which require more composites to reduce weight. We haven't seen demand return in that segment yet. However, for the standard structures and especially for engine components, we anticipate a return to normalcy in '23.

Okay. Great. Regarding Sensoria, is the rollout meeting or surpassing expectations? I assume that renewable type monitoring and maintenance work is still under 5% of the overall revenue mix. When do you anticipate seeing an acceleration in this area, considering your 100 turbines of capacity to monitor in 2023?

I'll provide one comment and then hand it over to Jon. It's important for us to recognize that while monitoring is key, it also enables us to conduct inspections and repairs. Therefore, the revenue we anticipate isn't solely from an increase in monitoring but is intrinsically linked to it. We aim to be proactive partners in helping our clients maintain their power and energy assets, assisting them in planning for turnarounds and addressing critical issues. Now, I'll let Jon expand on that idea.

Yes, Brian. Thanks, Dennis. I think Dennis is right. We routinely inspect and repair several thousand wind turbines per year. And so monitoring 50 to 100 obviously doesn't sound very much in comparison. But the exciting thing is that we're in a lot of discussions with customers and trialing with a number of customers and receiving very encouraging feedback. We're very enthused about the results of those trials, and I think our customers are enthused as well. So the volume of conversations is increasing, and we're looking for a higher range of turbines that we'll be talking about in 2023 than we are in 2022. To your question about when will that sector be 5% of revenues, that's a great question. I think we've got a bit of ways to go until we hit that. But we're very excited about the progress of where the wind turbine monitoring and the wind turbine business in general for us is heading.

But I will be a little cautious on that data, but we expect it to get to 5% for sure.

Okay. Great. And then just a bigger picture, you guys are generating a lot of cash. You've got more financial flexibility with the new credit facility and leverage seems to be declining quicker than originally anticipated, like you said, below 3x by the end of this year, I believe. So despite the MAX that you have under the new credit facility, I mean, how comfortable are you with increasing leverage for acquisitions? And how do you balance that with maybe utilizing cash to buy back stock?

At this point, we believe our best use of cash is to continue investing in growth. Our goal is to reach or stay below a leverage ratio of 3.0 by 2022. We are currently exploring options in the market but will not make any commitments until 2023 when we are below that threshold. I prefer to maintain a leverage ratio below 3.0, whether for acquisitions or otherwise. Initially, our acquisitions won't be too large, but they can enhance our diversity and strengthen our offerings, similar to recent acquisitions that improved our capabilities across all labs with IT and other solutions. We expect to pursue more opportunities, especially in machining for aerospace, while also prioritizing debt reduction to stay under 3.0. After achieving that, we aim to focus on strategies that will positively impact our entire business. I want to keep leverage below three as a general guideline, as many investors perceive small caps above 3% as a higher risk than they are willing to accept.

I just had a question. I know you're saying gross margins will improve in the second half. Can you give us an idea as to the level of improvement?

I'll let Ed answer that. However, I want to mention that we've always aimed for a gross margin of 30% or more. Currently, we are close to that target; in the second quarter, we achieved 29.9%. We anticipate exceeding 30% in the third quarter and will see how the fourth quarter performs. Nevertheless, we do not expect to reach that 30% mark for the entire year. Our goal is to work towards that target moving forward. Ed, I'll pass it to you.

Yes, that's about correct, Dennis. The first half was 27.5%. The second half could be 200 basis points higher than that. It's significant with the mix benefits offsetting some inflationary pressures, which definitely helps. So yes, we expect Q3 to be higher than Q4. We anticipate a substantial increase in the second half.

Okay. And then can you shed some light on revenue? And from your downstream section, it looks like it's in a little decline, but can you shed some light on how that is and why?

Jon, if you want, you could add. Yes, this is Jon. So that's exactly where the turnarounds that Dennis was referencing earlier were getting pushed out. So we expect it to be busier in the first half of the year, but in particular, the second quarter based on the original schedules that were our customers made us aware of. And because the work got pushed because refineries had more uptime than they were with the record crack spreads, I think they seemed to have moved to more of a second half, in particular Q3. There's still a turnaround or two that may be on the bubble in terms of are they Q3 or Q4, but that's really what's going on there.

Okay. And then lastly, are you seeing any signs of recession on your end? What are you seeing there?

I can tell you that right now, our bigger fight, Chris, is just keeping up with the inflation on some of the skill sets. It's certain areas, there's a high amount of pressure on some of the skills and people are able to get increases. So right now, our fight is we're going back not so much a fight, but our issue is we're going back to the customers and getting increases from them maybe a little delayed from the time you got to pass out the difference for the hourly rates to the folks. But we haven't seen anything in recession. Our markets. We're strong in aerospace, we're strong in gas and oil, and to everyone's comments, everyone's still out there driving and everyone's flying. So as long as those things are happening, I think, we're going to be outside of some of the things that you're seeing in some of the other sectors. I mean if it got really bad, it's definitely going to affect us at some point. But right now, the simple answer to your question is no, we haven't seen anything necessarily yet.

Yes. Just to add on to what Dennis is saying, we are in discussions with several customers on pricing. And the focus is not so much that we are trying to keep gross margin at some certain level. Our focus is really on making sure that our technician pool feels like we and our customers have their back from an inflationary perspective because so many people, including all of us on the phone are experiencing the effects of the inflationary environment. So we're really just trying to make sure that these technicians are supported. And so with our customers trying to work together to provide increases to make them feel that way. So that's really the effect of that. In terms of demand, demand is not waiting for our services at all; if anything, if we had more employees that were on the rolls right now, we'd be able to handle the work.

Yes. Can you hear me?

I can hear you, Mitch. Yes. We can.

I joined the call late while managing several other calls. I'm interested to know if you could discuss any differences between upstream, midstream, and downstream for the second half. I just heard your response about expecting stronger demand due to some turnarounds in the second half. Are there any unusual factors, either positive or negative, in upstream or midstream that might affect revenue generation in the second half?

I’ll pass it over to Jon. In our discussions about upstream, we're primarily focused on larger land-based facilities. We have a small investment in fracking, but it's not significant. We're noticing an increase in fracking, although we're not experiencing the extreme volatility seen with barrel prices at $140 or $100. Our land-based upstream operations, which include regions like Canada and Alaska, are performing relatively well, and there is some activity in the Gulf of Mexico along with the North Sea, but our main focus remains on land-based projects in California, which have been stable. The midstream sector tends to be somewhat insulated from price fluctuations; companies are generally focused on managing their costs when prices are lower and on maximizing profit when prices are higher. This is where we see significant volatility. However, with gas prices decreasing for about 50 consecutive days, we expect our downstream sector to move toward normalcy. While this can change unexpectedly, currently, we're anticipating that all three segments—upstream, midstream, and downstream—will operate more consistently in the second half compared to the first half, where we were primarily seeing stability in two out of three areas. Jon, do you have any additional insights on this?

Dennis, I agree with everything you just said in terms of yes, the downstream is where we'll be busier in the second half compared to the first half. But upstream and midstream, I think, will be essentially what we saw in the first half. In fact, mid might even get a little bit better for us.

Can you remind me about the size of downstream relative to upstream and midstream in a typical environment?

It's a great question. We always talked about the segments as being 54% most recently. And I'm not sure if we have the numbers for Q2, but as of Q1, we were 19, 18, 17, downstream. So they're very close, right, to create that 54%. 19 was the downstream, the largest segment, and I believe it was up and then midstream for 18 and 17. So when you look at it as a whole, they're big numbers, but when you break them out, we're starting to break them out because people might think we're all of one and nothing on the others. We're pretty well balanced between the three.

How is the $29 million run rate performing this quarter? Where did that figure stand three to four years ago? What average quarterly revenue do you expect from downstream? What revenue opportunities do you foresee?

In recent years, spring has generally been our strongest quarter because in the fall, companies realize they have overspent their budgets and start looking for cost savings. Therefore, it was unusual for us to experience this level of cost-saving efforts in the spring. Jon or Ed, do you have any figures that could provide Mitchell with more insights on that?

I don't have the specific numbers available, but I believe the spring has been the busiest time over the last several years. Regarding Mitch's question, our spending levels have not yet returned to pre-COVID levels generally, but this year it seems like we might be starting to recover. We anticipate that Q3 will reflect this progress. Go ahead, Ed.

Sorry, Jon. To add to that, Mitch, we started disclosing the bifurcation of upstream, downstream, and midstream only this year. Previously, we only did it annually through the end of 2021. This year, we're doing it quarterly for the first time. Looking at the third quarter, as mentioned in the press release on Page 11, the downstream sector is the smallest of the three this quarter. Historically, it would typically be the largest in this quarter. So, it is currently significantly below expectations, which contributes to our confidence in Q3. All three sectors are performing solidly, but downstream is notably lagging. I don’t have the exact numbers readily available, but we can gather that information. In previous quarters, particularly in Q2 and earlier, downstream would have been considerably higher than the other two sectors.

Well, I'm not sure it helps me understand anything more, but I do appreciate the quarterly breakdown of the three subsegments there. So much appreciated disclosure probably can confuse things sometimes. But I had a question for Dennis also. You talked about your confidence sort of in the second half. And at the same time, you mentioned digital solutions service offerings, which will be a driver. Can you explain that?

Yes, I think we may not have communicated effectively. Some people viewed digital as a completely separate area from our existing operations. We've discussed the 90 different applications we currently offer, and you'll see that number increase each quarter. We're not creating as many new applications; instead, we're focusing on highlighting and enhancing existing ones, which mainly originated from our legacy businesses and acquisitions, especially within gas and oil sectors. Our goal is to provide a more robust data message to our customers that responds more quickly compared to traditional paper reports. We offer digital solutions that deliver real-time readings, transforming these into actionable items. We're using color-coded reports to show asset conditions, as analyzing hundreds of readings individually doesn't yield meaningful trends. We are also incorporating our engineering calculations and standards to provide specific recommendations for improving asset conditions. The data solutions we're developing are enhancing our existing offerings, and they are driving innovations in areas such as renewable energy and monitoring technologies that we have utilized for years. This technology is now applied in new contexts, like monitoring turbine blades, creating new market opportunities for us. The data applications we offer make us more relevant, efficient, and valuable to our existing customers in various sectors, including upstream, midstream, and downstream in oil and gas, as well as in power and aerospace. Initially, these developments will strengthen our position with current customers before helping us reach new ones. Does that clarify things for you?

Yes, it does. I was reviewing the data regarding the third quarter, and you mentioned that digital solutions are driving your rapid growth. I'm curious if these digital solutions are helping you acquire new customers who will be online in the third quarter. Why do you believe digital solutions will be a key driver for the third quarter? Have they been a significant contributor to your business? I'm interested in any specific details you can share about this.

It's a good question because of what we're doing within PCMS. We're noticing significant growth in the chemical industry as many customers face pressure to implement mechanical integrity programs. These programs offer a formal way to assess their assets and their aging, providing insights on how to manage them. While these customers have had various programs in place, the mechanical integrity and risk-based inspection programs represent an advancement. We're seeing increasing numbers of chemical customers adopting this approach. The initiatives within OneSuite leverage many aspects of the PCMS applications. However, not every customer opts for or has the capability to use PCMS, often relying on different systems. In the past, we would face challenges if a customer used another system alongside PCMS. Now, we're integrating the key features of PCMS into OneSuite, which allows us to provide enhanced data even if clients are utilizing homegrown or competitive systems. This means we're consistently delivering more actionable insights. We anticipate that OneSuite revenue, starting from lower levels, will double and continue to grow. Currently, the data is showing mid-single-digit growth, and we expect to accelerate that. Ultimately, this will help us distinguish ourselves in a market focused on finding the best value rather than just the lowest cost. By providing customers with faster data and demonstrating how we can help them reduce expenses and accomplish more, we find value even in reducing non-destructive testing costs while expanding our involvement in their projects. This approach works to everyone's advantage, as it allows us to increase our share of their overall project needs while saving them money. We are confident that the data will be a key driver of our growth in the market.

Okay, good. My last question relates to acquisitions. I understand your answer about getting below 3x leverage and why that's important. From an acquisition perspective, considering your infrastructure, digital solutions, and the growing share of customer opportunities, can't you simply grow by hiring more technicians as demand increases? Is there a specific need for new capabilities through acquisitions? Given your standing in the industry, you should be an attractive employer since you're growing and gaining market share among large, reputable accounts. Technicians would likely feel secure working for a company that knows how to manage cash effectively during tough times. I would assume that you could achieve growth on your own, especially as you become a leading thought and innovation leader in the industry. Why is acquisition necessary for your growth when you have such strong free cash flow and a capital-light model?

I understand your points, and I appreciate your feedback on our current position and future direction. I believe we do not need to purchase growth. However, as you mentioned earlier, we want to accelerate our diversification across industries. Currently, our potential contracts in the gas and oil sector significantly outweigh those in other sectors. Some investors express concern that having over 50% in gas and oil is excessive, which is part of our diversification strategy. We've been involved in data management for refineries for an extended period, having acquired our data management company in 1991. They had already been operating for a decade before that, so we have a long-standing presence in this area. There are IT-centric opportunities we can explore that could enhance our core markets and help us penetrate new ones. For instance, with our acquisition of New Century, while we recognized their contributions, they had a 25-year head start in that market, building relationships and expertise. When entering a new market, it's essential to consider how to accelerate our capabilities. We believe we can grow without acquisitions, but staying ahead in evolving IT is crucial. What seems effective today may change tomorrow. We must continually seek innovation to maintain our competitive edge. Thank you for participating in our call today.

That will be our last question. I am turning it back over to Dennis Bertolotti for our closing.

Great. Thanks, Kurt. So thank you to everyone for your continued interest in Mistras and for joining our conference call today. Please have a safe, productive day, and we look forward to updating you on our next earnings call. Have a good day.

Thank you all for your participation in today's conference. This concludes the program. You may now disconnect. Thank you.