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

Thank you, Stacy. Welcome, everyone, to Team's second quarter 2021 earnings conference call. With me on today's call are Amerino Gatti, our Chairman and Chief Executive Officer; and our Chief Financial Officer, Susan Ball.

This call is also being webcast and can be accessed through the audio link under the Investor Relations section of our website at teaminc.com. Information recorded on this call speaks only as of today, August 4, 2021.

Therefore, please be advised that any time sensitive information may no longer be accurate as of the date of any replay listening or transcript reading. There will be a replay of today's call, and it will be available via webcast by going to the company's website, teaminc.com. In addition, a telephonic replay will be available until August 11.

The information on how to access these replay features was provided in yesterday's earnings release.

Before we continue, I would like to remind you that this call contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities and Litigation Reform Act of 1995, including statements of expectations, future events or future financial performance.

Forward-looking statements involve inherent risks and uncertainties and we caution investors that a number of factors could cause actual results to differ materially from those contained in any forward-looking statements.

These factors and other risks and uncertainties are described in detail in the company's annual report on Form 10-K and in the company's other documents and reports filed or furnished with the Securities and Exchange Commission.

The company assumes no obligation to publicly update or revise any forward-looking statements, except as may be required by law. Amerino will begin by highlighting significant events in the second quarter and providing an update on our business. Susan will then detail our results.

And before we take your questions, Amerino will discuss the company's outlook. I would now like to turn the call over to Amerino..

Thank you, Kevin, and good morning, everyone. We remain cautiously optimistic on the strength of the global recovery. However, as the second quarter demonstrated, the recovery is proving to be uneven with disruptive stops and starts, both domestically and internationally.

Vaccine rollouts are gaining momentum and driving an overall increase in mobility and economic activity. Domestic petroleum demand has experienced a dramatic increase with recent levels that are in-line or above the comparable weeks in 2019. In fact, U.S.

gasoline demand recently set a record as motorists were eager to travel during the 4th of July holiday. Likewise, the TSA reported new post-pandemic records in domestic air travel. While the recent emergence of COVID variance is concerning and requires close monitoring, the overall pace of the domestic recovery is strong.

International is a different story. Business remains challenging with lower vaccination rates impacting Team's ability to travel and service our clients' assets. In these areas, the rebound in gasoline and air travel has been muted.

After more than a year of operating in a pandemic with reduced global mobility, we have seen a step change in consumption demand for travel as COVID-related restrictions were lifted, causing cost inflation in raw materials, transportation, and labor.

Team was not immune from the underlying inflationary pressures and higher costs associated with the ramp-up in overall economic activity. The second quarter started strong in April, with activity levels benefiting from several large turnaround projects.

May and June also realized improvements from increased economic activity with the easement of worldwide pandemic restrictions. Team was able to benefit from the backlog of delayed maintenance projects reporting consolidated revenue for the quarter at the upper end of our expectations.

Although second quarter revenue improved over 2020 levels, we continue to experience an uneven global recovery across segments with varying demand for our products and services. IHT and Quest are currently recovering at a faster pace than mechanical services.

Now, turning to our financial performance, consolidated revenue for the second quarter of 2021 was $238.9 million, up 26.2% from the same quarter in 2020, marking the first full year-over-year quarterly comparison to COVID impact. The revenue increase reflects the opening of the U.S. economy, as well as growth in select international markets.

Gross margin was 26.3%, below the prior year quarter of 30.3%. Gross margin was negatively impacted by underlying cost inflation associated with the ramp-up in economic activity and lingering COVID pricing concessions. Adjusted EBITDA for the quarter was $9.1 million or 3.8% margin.

There was a year-over-year margin decline, driven by the inflationary cost environment and the reinstatement of the 2020 temporary cost initiatives. We also increased our investment in training certifications, completing more than 35,000 training hours when compared to the second quarter of 2020, an increase of more than $1 million.

Turning to our segment overview. I will begin with Mechanical Services. Revenues were up 4.7% over 2020's depressed activity levels. MS completed work on several large turnarounds during the quarter, increasing revenue by 11.2% sequentially. MS continues to experience large project deferrals and a competitively priced market.

During the quarter, many large turnaround projects were delayed until later this year or pushed into 2022. MS margins were also negatively impacted by inflationary cost pressures. MS experienced year-over-year growth in the areas of fabrication, pulp and paper, power and utilities and renewable energy.

As we reported yesterday, after three field tests, Team commercialized its new patent-pending SmartStop Isolation technology. The latest test was successfully completed on a 16-inch flare line at a refinery.

Team's proprietary SmartStop technology eliminates the need for complicated hydraulics or pivot points that are failure mechanisms in competitive line intervention tools. This new technology features a self-energized dual seal system within a single standard line stop fitting, reducing the number of pipe alterations required to perform in isolation.

SmartStop will increase operational safety, further strengthening our competitive advantages in the hot tapping market. Now turning to our Inspection & Heat Treating segment, IHT continues to perform well due to the run and maintain nature of the segment. Revenues were up 46% year-over-year.

Similar to MS, IHT also realized inflationary cost pressures when coupled with the COVID price concessions negatively impacted IHT's margins for the quarter. IHT experienced year-over-year growth in the areas of refining, chemical and petrochemical, pulp and paper, and power and utilities.

As the economy continues to open and plant utilizations rise, we have seen a steady increase in demand for our nested technicians. During the quarter, we were awarded two embedded contracts, one in a refinery and the other at a petrochemical plant. Our nested operations utilization is currently running at approximately 93% of pre-COVID levels.

In addition, Team was awarded a long-term asset integrity program with a large investment-grade mid-stream company. The scope of the project includes pipeline and facility mechanical integrity services.

We will partner with the client to develop and implement a structured approach to asset integrity, supporting safer and more reliable operations across the client's large distributed pipeline infrastructure. IHT continues to diversify its end markets.

As an example, we were recently awarded a nested contract to provide radiography and phased array ultrasonic testing for a private space flight company. Team has technicians on site providing services, and we expect the scope of the product to grow over time.

Quest Integrity's revenue realized strong sequential growth, up 50.7% over the first quarter and 51.4% increase over the comparable quarter in 2020. Due to Quest's visible project backlog, we began to more aggressively recruit globally in order to proactively manage the anticipated increase in demand.

Quest was recently awarded several large full-service pipeline inspection projects at domestic oil and gas production facilities, midstream assets and refineries. In addition, Quest won a unique multi-year contract in Australia, which upon successfully completing the inspections could open a new end market for Quest's Integrated Solution offerings.

Quest continues to see strong demand in the offshore subsea market. During the quarter, Quest successfully completed an offshore inspection project in West Africa. The client's pipeline had significant internal diameter changes, making the inspection extremely challenging.

Quest's proprietary high-resolution tools are uniquely capable of inspecting pipelines with these characteristics. Given Quest's success, we anticipate an increase in deepwater activity in this region.

From a geographic perspective, despite the COVID-related challenges that have limited our ability to travel to client work sites, we realized the year-over-year growth in the world.

In Canada, we experienced year-over-year growth and the focused efforts to improve workforce utilization and drive down indirect costs allowed us to expand gross margin and deliver a higher year-over-year adjusted EBITDA.

During the quarter, Canada was particularly affected by COVID outbreaks, forcing project delays in Western Canada that limited further revenue and margin expansion. As vaccine rates increase, Canada's economic activity will grow, which should bode well for our end markets.

Our Canadian team received the Alberta Boiler Safety Association approval for composite alterations. Team is uniquely positioned as the only full-service provider that has been awarded this certification. Many European countries also implemented COVID-related lockdowns through April and May before opening up in June.

Despite the challenging environment, Team's European operations realized incremental year-over-year revenue and adjusted EBITDA growth. The Middle East remains volatile as some countries have struggled with vaccine rollouts.

For example, UAE has the highest vaccination rates in the Middle East and one of the highest in the world, allowing for more robust economic recovery, while other countries still have imposed quarantine restrictions, limiting travel in and out of the country.

We were recently awarded a new five-year contract supporting onstream leak sealing call-out work with a large NOC client in Qatar. In addition, we were awarded a multi-year hot tapping service contract for a multi-national chemical manufacturing company in Saudi Arabia, helping build our market share in the Kingdom.

I will now turn it over to Susan for a more detailed financial review.

Susan?.

Thank you, Amerino, and good morning, everyone. I will review our second quarter financial performance and quarter-over-quarter comparisons.

As Amerino mentioned, our second quarter consolidated revenue of $238.9 million was up $49.6 million or a 26.2% increase from the second quarter of 2020, representing the first year-over-year comparable with the full three-month COVID impact.

This quarter's revenue reflects both increased turnaround activity and improved economic activity with the loosening of the COVID-19-related restrictions. For the quarter, all three segments had revenue growth over Q2 2020, with Quest having the largest overall percent increase at approximately 51%.

IHT followed with just over a 46% increase and also having the largest revenue dollar increase of approximately $37 million. Mechanical Services also showed a year-over-year revenue growth of 4.7%. Consolidated gross margin for the second quarter 2021 was $62.8 million, a 9.4% increase over the prior year quarter of $57.4 million.

Due to the direct cost inflation impacts and the reinstatement of the temporary cost actions that were fully in place in the second quarter of 2020, the consolidated gross margin percentage declined to 26.3%, compared to the prior year quarter of 30.3%, which was a record quarterly gross margin percentage.

The second quarter was impacted by significant cost inflation, particularly in raw materials, which increased roughly 50% or greater year-over-year. We also realized labor cost increases as the market for entry-level technicians is currently very tight.

These cost increases were compounded by the fact that we still had some lingering COVID-19 pricing concessions. The second quarter net loss was $17.5 million when compared to a net loss of $13.5 million in the prior year quarter. An increase in interest expense of $2.3 million drove the increased net loss versus the comparable quarter.

Adjusted net loss, a non-GAAP measure, was a negative $14.9 million or $0.48 adjusted net loss per diluted share for the second quarter of 2021, compared to an adjusted net loss of approximately $9.5 million or $0.31 adjusted net loss per diluted share for the same quarter in 2020.

Adjustments in the second quarter included approximately $2.3 million of professional and accrued legal fees and costs just over $300,000 of severance charges, which were primarily associated with the operating group reorganization. Consolidated adjusted EBITDA for the quarter was $9.1 million as compared to the prior year quarter of $12.7 million.

Our selling, general and administrative expenses for the second quarter of 2021 was $68.5 million, up $9.6 million from the prior year quarter.

The increase in SG&A reflects the impact of the reinstatement of the temporary cost reductions that were implemented at the inception of the pandemic, such as salary reductions, furloughs, training and travel. The majority of the cost reinstatements were fully in place at the beginning of April.

Additionally, we increased our investment in our sales force. As I mentioned on our prior call, more than half of the SG&A savings we realized in 2020 were permanent in nature. We expect our full year 2021 SG&A costs to be in the range of $270 million to $280 million.

We remain diligent in managing costs through the recovery with a focus on optimization of our SG&A cost structure. Interest expense was approximately $9.6 million, up $2.3 million, and we continue to expect that interest expense will be between $9 million and $10 million each quarter in 2021. Turning to our segment performance.

IHT reported second quarter revenue of $117.5 million, up 46% from the $80.5 million posted in the same period last year. The growth reflects an increase in turnaround projects and associated activity as well as increased hours associated with nested sites and technicians and, to a lesser degree, increases for call-out activities.

Second quarter adjusted EBITDA was $10.7 million, up $1.2 million over the prior year quarter. Adjusted EBITDA margin decreased this quarter to 9.1% as compared to 11.8% in the prior year quarter. Mechanical Services reported second quarter 2021 revenue of $97.2 million, up 4.7% from $92.8 million in the second quarter of 2020.

Adjusted EBITDA was $7.6 million in the second quarter of 2021, down from $16.9 million in the same period last year. Adjusted EBITDA margin decreased this quarter to 7.8% as compared to 18.2% in the prior year quarter. Quest Integrity revenue of $24.2 million was up 51.4% from the prior year period revenue of $16 million.

Second quarter adjusted EBITDA was $6.5 million, up from $1.7 million in the year ago period. Adjusted EBITDA margin was 26.6%, compared to the prior year quarter of 10.7% and has reached the normalized levels expected of around 25%. We ended the second quarter with $18.4 million of cash, borrowings under our ABL facility were $49.3 million.

We had total liquidity approximating $73.5 million at June 30. Cash interest for the year is expected to be approximately $26 million to $28 million. As expected during the second quarter 2021, cash flow from operations was down significantly as we funded the working capital demands associated with our revenue growth and increased activity levels.

Cash flow from operations for the quarter was a negative $17.6 million. Free cash flow was negative $23.4 million, which included $5.8 million in capital expenditures. Full-year 2021 CapEx forecast has now been reduced by $5 million, down to approximately $20 million.

As activity levels continue to grow, we will see increased working capital demand having an unfavorable lag effect on our cash flow generation. Although the variability of working capital change is difficult to forecast, we expect free cash flow positive for the full-year.

We will continue to actively manage CapEx and discretionary spending accordingly to align the business throughout the year and adjust as necessary. We will maintain our focus on the discipline that enabled us to overcome the many challenges of the past 18 months.

This includes the focus on returns and cash flows, enhancing synergies and greater efficiencies across our segments. Working capital management and generating free cash flow to pay down debt remains our priority. That completes the financial review. I will now turn the call back to Amerino..

Thank you, Susan. Before we take your questions, I'll provide an overview of the macro market trends, an update on our technology and digital initiatives and our business and operational outlook.

Starting with the macro environment, as I mentioned earlier, we are in the middle of an uneven recovery and were faced with certain headwinds during the second quarter that have impeded global growth, including COVID-related restrictions, inflationary pressures and supply chain disruptions.

Despite these headwinds, the IMF is forecasting global economic growth rates of 6% this year and 4.9% in 2022. This has led to a historic increase in global petroleum demand, which is expected to increase from approximately 85 million barrels per day in the second quarter of 2020 to 100 million barrels per day by year-end.

Following the prolonged weather-related refinery shutdowns along the U.S. Gulf Coast in February that led to high drawdowns of petroleum product inventories, refining margins improved in the second quarter, which incentivized higher refinery utilizations. U.S.

refinery run rates are now back to pre-pandemic averages, but margins have since pulled back as the market awaits further demand increases in gasoline and jet fuel. Driven by strong demand for plastics, U.S. exports of ethylene to Asia and other parts of the world have increased significantly benefiting our petrochemical clients.

Ethylene prices reached a multi-year high in April when the Gulf Coast facilities ramped up following the winter storms. Ethylene prices are once again testing multiyear highs, driven by two Gulf Coast plants that are undergoing maintenance, reflecting a tight market.

We continue to monitor proposed government policies and spending plans and anticipate increased regulations in the energy sector with a renewed focus on the reduction of greenhouse gas emissions.

While the infrastructure bill is progressing through the Senate, the recently proposed clean energy standard plan would include provisions such as penalties for greenhouse gas emissions and larger tax breaks for wind and solar developers.

These government mandates can create opportunities for team to assist our clients in meeting their compliance-related and green energy goals. And now, an update on our technology and digital initiatives.

We remain focused on technology and innovation to improve our top quartile safety record and increase our product and service offerings to our clients. As we reported earlier this week, we entered into an agreement to become the exclusive provider of Credosoft Integrity Management platform in North America.

The software enhances Team's ability to monitor assets, ensure compliance and provide inspection and repair solutions. The Credosoft service offerings provides Team a stable subscription-based revenue profile. There are currently multiple clients utilizing the Credosoft platform for integrity monitoring services in North America.

Team is also making strong progress on scaling our digital job platform. This tablet-based solution allows our technicians at the work site to optimize data collection and documentation for the project, driving greater work efficiency, and time tools.

The software provides our clients scheduling and real-time information about the work being performed on their assets and standardizes invoicing and billing processes. Turning to our business and operational outlook.

Given the large number of aging assets and increasing regulatory requirements across the industry, the postponement of facility maintenance, deferrals of plant turnarounds and the delays of new capital projects, we expect global growth in our end markets over the next few years.

The depth and breadth of our operational and technical capabilities positions us well to support the client's asset performance optimization requirements. Furthermore, our balanced operating models, evenly split across nested, project and turnarounds and call-out, allows Team [the agility] to successfully compete in the current market environment.

Throughout the COVID pandemic, our global workforce management function allowed Team to flex our resources to match market activity and enable better forecasting and planning for our clients' future demands.

In addition, our decision to pay benefits and maintain training certifications during the pandemic has allowed for a more rapid and effective increase in skilled technicians. At our peak activity levels during the second quarter, we added over 1,200 field technicians versus the comparable quarter last year.

Team's industry-leading training and certification programs, together with our strong recruiting capabilities in the military, technical schools and colleges, will provide an opportunity to continue expanding our workforce to meet market demands. In the second quarter, we achieved workforce utilization rates greater than 90%.

As we look forward to the third quarter, we anticipate sequential top line improvements from higher activity levels as worldwide COVID-related restrictions ease.

However, like many other companies, Team faces an uncertain path related to the COVID recovery, which could potentially include additional government-mandated shutdowns regionally in the U.S. and internationally. We remain cautiously optimistic that our revenue for the remainder of the year will reflect increased economic growth.

And given the outlook for the second half of 2021, we maintain our full-year revenue expectations to be 10% to 15% higher than 2020. As previously mentioned, Team experienced an increase in operating costs resulting from the current inflationary environment. With this in mind, we began a proactive contracts review process to offset margin pressures.

First, we focused on rolling off the lingering COVID price concessions, then we started discussions with clients to progressively move prices to reflect the current market conditions and ultimately, improve margins. It is important that we offset cost increases related to inflationary pressures, tightening labor market and other higher cost to serve.

As reflected this quarter, there is typically a delay between recognizing increased costs and negotiating price improvements with clients. We anticipate second half 2021 and 2022 will allow Team to deliver margin improvement and solid free cash flow generation.

In closing, with the post-pandemic recovery upon us, our teams throughout the world are acting with a sense of urgency, focused on capturing available growth opportunities while driving profitability through disciplined pricing and cost management.

Team is committed to investing in our people, expanding our technology in digital portfolio and delivering execution excellence. Most importantly, we have not lost sight of our number one core value, safety first, and remain dedicated to top quartile performance by operating in a safe and reliable manner each and every day.

We will continue to demonstrate the same relentless discipline that helped guide us through 2020. Operator, I will now turn it back over to you for the question-and-answer session..

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

Good morning..

Good morning..

Good morning..

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

Sure. Let me talk a little bit about the inflationary pressures, and then I'll let Susan touch on the gross margin. So, I think, you know overall, we've seen the raw materials impact on inflationary pressures, which has impacted our Mechanical Services segment the biggest because they have the most products in terms of manufactured goods.

So from that standpoint, raw materials has had the largest increase, I think, as Susan mentioned in her prepared remarks. The freight logistics and just overall movement of goods and people was the second largest. And then we've seen an increase in labor costs.

Those ones we expect to further increase as we go through the year as – even though we do expect some of the lower skilled available labor to become more available over the short-term as things change, especially in the U.S., we do see inflationary pressures tightening on the higher skilled labor as the market continues to tighten.

So, it's starting with raw materials, followed by a lot of the freight, transport, logistics, and then labor cost increases.

And Susan, maybe you want to touch on the gross margin?.

Yes. With respect to the gross margin, as I've mentioned, for the quarter, it was about 26.3% on a six-month basis, 24.6%. And the increased, I would say, pressure with the inflationary costs and what we've seen in Q2, as we look forward to our gross margin on a full-year basis, we are anticipating improvements, obviously, in H2.

But looking at it on a full-year basis, we're estimating it would be between 27% to 28%. So, probably closer to the lower end of that, but north of the 27%..

And maybe just to add a little bit of color on some of the reasons for the range.

As Mechanical Services and Quest Integrity grow, obviously that will have a segment mix benefit to gross margin, as we're able to move pricing over the year, starting with COVID discounts, as I mentioned, and then price increases to offset some of that inflation that obviously has a factor.

And then depending how those inflation increases or pressures continue throughout the year, we'll have a factor. So, I think there's a segment mix, pricing traction and then inflationary pressures are the three levers, if you will, that will impact gross margin for us..

Great. Thank you. And then you mentioned the outlook for fall turnarounds is positive.

Could you maybe talk about what your visibility is there?.

Sure. As you know, we track our turnarounds in half years. We are seeing – right now, clients obviously starting to man up in terms of labor requirements and equipment requirements for turnarounds that at this point, we expect we'll start later in September running through October. So, an impact in the latter part of Q3 and into the early part of Q4.

We do see the turnaround market still being a little bit unstable in the sense that there are some projects moving that could potentially slide out of the year. But overall, we expect the second half of the year turnaround to be slightly stronger than the first half.

We are seeing as well a lot more pit stop and smaller projects that are popping up as clients have delayed maintenance or turnarounds, some of them starting in 2019 because of the higher utilization rates, especially in refining and then because of COVID in 2020 and then cash management and CapEx in the first half, we are seeing that we're looking at a lot more pit stops to get them through the year, if you will, from a higher utilization and asset management standpoint.

So, I think we anticipate a higher second half turnaround season overall and an increase in some of the smaller pit stops, which aren't as big of a benefit as large turnarounds, but they definitely are positive for us as you add up those pit stops there. They're a good impact for our activity in the second half..

Great. Thank you so much..

Thank you..

Your next question, Sean Eastman with KeyBanc Capital Markets..

Hi, team. Thanks for taking my questions. Good morning.

So, just in light of the gross margin swing factors highlighted around the second half, maybe it would be helpful to just get a finer point on how that pricing traction and inflationary pressure trended exiting the second quarter? Just kind of where we're likely to fall out in 3Q based on what you've seen in the early part of the third quarter and kind of exiting the second quarter would be a helpful discussion.

Is the inflation getting worse? Are you getting traction on the pricing programs? That type of thing would be really helpful to hear..

Sure. So, I think, first of all, on the inflation, Sean, some of the inflationary costs are transitionary. So, we – as we kind of shift through it, we expect some of that to level off and be more transitory.

But I think raw materials is one of those that as the year goes on and supply chain improves, we expect that to level off or come back down a little bit. On the flip side, I think, as I mentioned earlier, as the labor market tightens, for higher skilled labor, maybe not as much on the entry level because I think that will open up after September.

I think there will be inflationary pressures on labor on the higher end, higher skilled technicians from that perspective. So, I would say that we've made good progress on removing many of our COVID-related discounts. And we're in the final stages with a few clients for a few of those to come off later this year, but the majority have been removed.

When it comes to pricing traction overall outside of COVID, the easiest move for us is call-out work because it's really quoted more on a job-by-job basis. We've increased transfer prices and implemented surcharges that was done over the latter couple of weeks.

And time will tell how competitive the market is because that's obviously a quoting business, but we're being aggressive on moving there because that's step one. We have started negotiations with our top 25 clients, which I think will end up being more focused on the inflationary recovery and tying up resources as the market continues to tighten.

So, I think as things tighten, we'll get more traction with our top 25. And some markets that maybe are less competitive on quoting, we've already seen some movement. Other markets like the Gulf regions right now, as an example, are still very competitive. And I expect that, that will take a little bit longer.

On the flip side, we're doing a lot on the supply chain side to secure raw materials, look at our supply chain overall, look at our manufacturing capacity and also trying to bring down the cost to serve to the best of our ability. So, I think it's a little bit of a three-pronged approach.

But overall, we expect to get pricing traction over the year, but it's going to be starting with call-out, I think, because that's the quickest to move followed by the contractual negotiations, which would come later in the year..

Okay. Thanks.

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

Well, good question. So, one of the reasons that we really felt and vice versa that it was a good partnership with Credosoft is they've got a few large IOC clients, especially international, where they've gotten very good traction on pipeline and mechanical integrity.

And what they were really looking for and vice versa we were looking for was to partner in a large market, which is why we selected North America to be able to use our sales, some of our engineering support, their platform and expand their footprint into a new market. So, it was a good fit because of our size and scale.

We've got, as I've talked about over the last few years, some very good digital tools working on efficiency and working on compliance and documentation. The clients have their own asset management systems, which a lot of them have in place.

And what Credosoft allows us to do is really bridge our activities from inspection, some of the mechanical repair, etcetera into their asset management system. So, it's a very good bridge from our services into the clients' asset operating models.

And what it does for us is it starts moving the needle, Sean, around risk-based inspection, more predictive inspection and utilizing data to start being more proactive. That starts with the inspection services. It also plugs in damage mechanisms like corrosion, for example, and the pull through, the benefit is really on the repair side.

And so, we expect as the traction builds that we'll move more to risk-based type inspection and we'll get more pull-through for mechanical services, which is obviously one of the ambitions for us is to continue to grow mechanical services.

The bridge that that provides and the partnership that they've got and the platform that they've got is subscription-based. So, we want to obviously be able to put it on and into our clients' facilities. We have currently five clients that are subscribed to the platform already.

And again, using our strong client base, that's where we feel that there's going to be upside in terms of deployment and implementation..

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

Thank you..

Your next question, Martin Malloy with Johnson Rice..

Good morning. Kind of a similar question, except I wanted to ask about the SmartStop offering that you press released last night.

And if you could maybe help us with try to quantify how important that is in terms of the market opportunity, addressable market and how meaningful the competitive advantage of that is?.

a, we can work on stream; b, it's a very reliable system; and c, is that they don't have to change their line in terms of two or three fittings to do their operations. So, I think there's a commercial model change for us. I think that the clients like the safety and operational part.

And we've gone through pretty rigorous field testing and now we're expanding the sizes and the ability for us to deliver it starting in the U.S. and then moving it internationally..

Okay. Thank you. My next question, kind of bigger picture, but you're seeing a lot of the IOCs in the petrochemical companies have improved results and cash flows and the returning capital to shareholders, but they're in a much better position than they've been for the last couple of years.

And it seems like for the past two years or so, there appears to be some underinvestment into the type of turnaround projects and maybe some of the maintenance being deferred that you would do.

And then I don't know if you can maybe talk about as you look forward to 2022, when do those conversations with your customers start or if you've had any that might be indicative of how they're looking at maintenance lending going forward?.

Sure. No, it's a very good question. And I would say a little bit of what I said what Sean applies. I think that the regulations, there's no doubt, be it emissions or overall regulations continue to tighten.

There is no doubt that the run and maintain requirements in terms of regulatory inspections, either risk-based or annual-based and the use of ways for our clients to continue to monitor their assets to prevent environmental issues or maintain high utilization rates to maximize margin, stretch out their facilities and not invest big capital right now.

All of those things, I think, we saw it in 2020 through cash conservation. We're seeing some of it in 2021.

So, I think things like Credosoft, the fact that one-third of our revenue is run and maintain-based, and that's very regulatory-driven, the fact that our asset integrity and digital and Quest groups are focused on mechanical integrity and pipeline integrity. These are all regulatory-driven product and service lines.

And we continue to feel that that is going to be a priority for our clients. We've built some good partnerships in our top 25 client base. We've had regular meetings with clients during COVID. And I can tell you that most of them are trying now to plan their CapEx planning for 2022. And they're going to do the pit stops.

They're going to do the regulatory requirements, and they're going to do onstream repairs to get through the year. And then 2022 and 2023, as we look out either our own data, client data or third-party data, unit upgrades and CapEx investment, we expect that to kick-in.

So, I think 2022 and 2023 looks strong, and I think it's going to be more capital investment.

In the meantime, though, I think the drag on our Mechanical Services segment, we expect that if the utilizations remain up and generally, we've seen a one to two-quarter type of delay between inspection and Mechanical Services recovery, we expect that to be driven more by OpEx spend and call-out work.

And because our clients right now, their margins are starting to improve, demand is increasing. We do expect call-out and OpEx spend to fill in the gap, if you will, between now and when CapEx starts to spend. I think most of our clients are planning their October, November CapEx plans, permitting and project planning for 2022 and 2023.

Having said that, as I said earlier, we still expect our turnaround season in the second half to be solid, and we're planning labor and resources for it right now..

Great. Thank you very much..

Thank you..

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

Thanks guys. Two quick questions.

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

So, yes, with respect to the EBITDA, we do expect H2 to be significantly improved over H1, and in line with what I said about gross margin with the inflationary pressures and other pricing with the results of Q2, we would expect that while our percentage and our margin would be up for EBITDA, it is going to be less than what we've been speaking to previously.

So that's, again, up significantly from the first half of the year, but down from the prior expectations. What I would say is, expect it to be around probably just north of a 5% margin.

And then as far as the free cash flow, as we mentioned, as the revenue is growing activity levels and expectations, that is obviously using working capital and we did expect that we wouldn't have positive free cash flow for the first half of the year.

As we look to the second half of the year, that increase or that improvement is really going to be driven by the fact we are bringing down the working capital needs. We're collecting on the revenue levels that were generated in Q2 and those increasing levels in Q3 and Q4.

So, it is a function of the improvements continuing to occur with really H1 being driven by – generally in the first half of the year, there's other cash costs that go out that we don't have in the second half of the year. We also will have a very focused effort on cash collections to be able to drive down our receivables to a much lower level..

Sounds good. Thanks..

Thank you..

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

Stacy, are you still there?.

Yes, hello..

Yes, hello.

Can you hear me?.

Hi, Brian. Good morning..

Hi, Brian Russo with Sidoti. If maybe you could talk about your gross margin a little bit more, you know the 400 – the 30% down to about 26%.

Can you break that down possibly by what price concessions drove the margin lower versus raw material inflationary pressures versus labor cost pressure as well? Just trying to get a sense of the decrease in margin while you saw a nice top line growth, where we could see the recovery through the latter half of the year to get to your gross margin targets?.

So, let me just start and I'll have Susan add a little bit of color, Brian. I think we're not providing the full color in terms of how much was pricing because obviously, there was COVID price discounts. But I'd say other than a few lingering ones going into H2, most of those have been removed.

Inflationary pressures, as I mentioned earlier, around raw materials and logistics and labor, led by raw materials, as Susan said, over 50% increase had a factor.

And then the third factor was the fact that we reinstated the temporary cost reductions, as we moved into the year, including trading, which we highlighted was 35,000 hours, actually above that and $1 million, which obviously goes into the gross margin impact as we recovered from the COVID period.

So, you're right that it is inflationary, it is pricing, and it also is the fact that we've reinvested in things like training. The other factor is that our Mechanical business and our Quest business have strong gross margins as well. And as the mix of segments changes, it does impact things.

So as we see Mechanical and Quest continue to grow into the second half of the year of year in 2022, that's where we'll get a positive mix as well because there is some different margin type performance from each of the groups. But I'll let Susan add a little bit more color around these..

Yes. Brian, as Amerino mentioned, we're really not providing the specific details to it. But I would say that it's more the increasing costs that we're seeing impacting the gross margin for the first half of the year.

And as Amerino mentioned, while we rolled in the cost reductions of the temporary costs from 2020 by the beginning of this quarter, the second quarter, April, there are additional costs that do ramp up that you don't have throughout the year, Amerino mentioned, the training and other type I mentioned previously in the gross margin and free cash flow, additional costs that hit Q1, Q2 that really kind of get reduced for the second half of the year.

So again, I would say it's more closer to the cost increases that really impacted it. But the mix, as Amerino mentioned, between the segments will is what we're looking at as an improvement as Quest has sequentially improved and significantly.

That base of their fixed costs – and they are covered by a lot more fixed cost, that base of fixed cost does help elevate that gross margin as we see the growth for them..

Okay. Got it. That's helpful. And just on Mechanical Services, obviously, you saw quite a bit of year-over-year top line growth at IHT and Quest, but it just seems the revenue for the Mechanical Services is only 4%, given the 2Q of last year. It just seems surprisingly low.

Is that what you're referring to earlier on project delays and turnarounds being delayed? Or why wasn't that more in line with the other segments, given the year-over-year comp?.

Yes. Good question. And a couple of things I would highlight for Q2. You're right in terms of some of the project delays that I referenced in the prepared remarks. We are seeing more competitive pricing pressures in Mechanical Services than we are at this time in the other two segments.

And I referenced a little bit earlier the Gulf divisions, for example. So, we are being, I would say, revenue growth mindful that we do it profitably. So, we're not chasing every quote. We're trying to be, I would say, calculated, if you will, right now as we get through the recovery phases. So, call-out was impacted due to competitive pressures.

Also, mechanical has a bigger footprint, Brian, international and into Canada. And we had some further COVID restrictions in some of the non-U.S. areas that impacted the growth rate. They still did well in those areas, but they didn't know as well as they could have had COVID restrictions not limited our ability to travel in and out of countries.

Their footprint is much broader than IHT, for example, when it comes to geographical coverage. So, those are the big three. Historically, MS has generally lagged on a recovery, the IHT for regulatory type-driven reasons where clients have to meet their regulatory requirements, for example, inspection versus more call-out on mechanical.

But what we're seeing now is some good movement on leak repair. We're seeing some good movement on call-out, hot tapping, both pipeline and plant-based. So, we expect that to catch up, but those are the reasons that we're seeing a bit more of a lag on MS versus the other two..

Okay. Got it. And then just clearly, the energy industry is recovering, but it seems that aerospace is lagging.

Any comments on that end market, which, I believe, is your second largest market?.

Yes. So, I would say that we are seeing things being pushed in the aerospace for large engine teardowns, large type projects. We are seeing some improvement in terms of inspecting new parts and working with some new clients.

But overall, yes, I would say, it's lagging the recovery, if you compare it to refining and petrochemical, which is one of the reasons we talked about last quarter is making our investments in our facilities and some of our expansion plans because we want to hit it on the upswing, which we expect would be 2022. So, it is lagging.

We're making some headway with new clients, but not recovering at the same speed, obviously, as you would expect to refining right now in petrochemical..

Alright, great. Thank you very much..

Thank you..

Thank you..

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

Thank you, Stacy. We remain optimistic about our outlook and Teams’ opportunities to grow in the current environment as our clients place increased emphasis on asset performance optimization and reducing their carbon footprint. I'd like to thank all of our employees for their dedication to operational excellence and health and safety.

We remain excited about our growth opportunities in 2021 and beyond. Thank you for joining us on this call and your continued interest in Team, and we look forward to speaking with you again next quarter..

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