Thank you for joining Mistras Group's conference call for its third quarter ended September thirtieth, 2022. My name is Andrea, and I'll be your event manager today. We'll be accepting questions after management's prepared remarks. Participating on the call for Mistras Group 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 the remarks made during this conference call will include forward-looking statements. The company's actual results could differ materially from those projected. Some of those factors that can cause actual results to differ are discussed in the company's most recent annual report on Form 10-K and other reports filed with the SEC.
The discussion in 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 and in the investors section on the SEC's website. I will now turn the conference over to Dennis Bertolotti.
All right. Thank you, Andrea. Good morning, everyone, and thank you for joining us today. Mistras reported its ninth consecutive quarter of revenue growth. Our legacy operations continue to deliver improving performance, while the investments we are making in our strategic initiatives across renewable energy, data, and new markets are beginning to contribute to our overall success as well. Consequently, we believe the top line obscures the financial and fundamental growth of the business with both foreign translation and the continued under-realization of expectations in the downstream market, masking what was otherwise a quarter of strong growth. On the bottom line, both net income and earnings per share were up more than 28% from a year ago, whereas adjusted EBITDA for the third quarter was essentially unchanged, as both gross margin and overhead are battling a rising cost environment.
We are addressing this by implementing price increases, and we are making progress breaking through customer resistance, primarily in the energy markets, where budgets do remain tight. However, there remains a significant lag between the time we increase our labor rate and the recovery time for the higher billing rate. We are also currently taking a hard look at all company-wide overhead to identify efficiency and productivity improvements that can better leverage our footprint, enabling us to focus more quickly on moving to our long-term goal of SG&A being 20% of revenue. Reflecting some of the rebound that we anticipated from the delays experienced in the second quarter, revenues were up 11% in upstream and 8% in the downstream. Year to date, our revenue across the overall oil and gas industry is up 6%.
The typically more stable midstream business was a bit soft in the third quarter, other than our Onstream business, but we expect that sector to show steady performance over the longer term, driven by higher production levels and the corresponding increase in demand for inspection services across the transportation and distribution infrastructure. Onstream, again, had a record high revenue in the third quarter of 2022, and we expect its growth to benefit both our revenue top line as well as bottom-line profitability. Business in our aerospace and defense industry remains strong. Recovery in commercial aerospace, growth in private space, and expansion into adjacent services continues to drive strong growth. We are increasing investment in this business as we believe we're building a strong foundation in a market where the demand for NDT is large and growing.
For instance, inspections for defense sectors, machining operations, cycle time reduction capabilities, and other services integral to inspection represent just some of the new markets we are seeing as powering strong growth in this vertical. All of these opportunities are in fast-growing markets which carry a prospective gross margin higher than our current consolidated gross margin, and we look for significant contributions from these new verticals. Our renewables business also has us excited. It now appears that we will outpace our previous objectives and end the year with more turbine systems being delivered for early monitoring than our originally anticipated numbers. While this market is in the early stages for monitoring solutions, it is a large and growing market, with hundreds of thousands of wind turbines in operation globally and more being added every year.
Every day, our installed technology is delivering further evidence of Sensoria's significant advantage relative to conventional inspection techniques, wherein we foresee an inflection point in the near future resulting in faster market adoption and an acceleration in our growth trajectory. Importantly, once operators contact us for monitoring service, we expect to add incremental revenue for the repair and maintenance of any damage our sensors identify. Repair and maintenance services and revenue should be lucrative, along with higher margins and multiples for monitoring, adding to our already $50 million plus per year business in renewable wind. Our data solutions business continues to grow with strong results at PCMS and OneSuite. We are constantly seeing new examples of how our data solutions are leading to stronger relationships and thus new opportunities with our customers.
Customers that are looking for the best value for their spend represent an opportunity to rise above the competition and avoid commodity pricing. This continues to be a point of emphasis as we integrate data solutions across our organization. The new credit facility negotiated this quarter has not only added much greater liquidity but is also freeing up financial resources that had previously been limited. Allowing us to invest and build upon these strategic initiatives. Now with additional financial flexibility, we are doubling down on our growth, which we expect to accelerate in 2023 and beyond. Overall, it was a solid quarter at Mistras. We are certainly confident in our future opportunities, but there are challenges. Exchange rates created an $11 million revenue headwind for the first nine months of 2022, with the related impact on margins.
Tight budgets in our largest market and the lag being experienced in passing on the impact of our inflationary costs are also pressuring margins. Since the onset of the pandemic, our primary focus has been on actions that will enable us to weather the storm and emerge stronger and better equipped for a more normalized world. In 2020, when our two largest markets were virtually collapsing, we had one of our best years of cash flow, and we have reduced debt by $80 million over the past three years. This year, we negotiated a new bank facility that created much greater flexibility to invest in both organic and non-organic growth. Although our largest markets are improving, they are still below pre-pandemic levels while undergoing their own structural changes.
This has certainly been a challenge for us, especially on the cost side, where we're experiencing labor cost pressures that lag and can be difficult to pass along to customers. While we see this as transitory, it is a near-term factor. With the worst of the pandemic behind us, we can now focus more of our resources on our goal to grow our strategic initiatives. We are making great strides building the new capabilities that will define our future as a greater mix of higher value products that are more technologically sophisticated, predictive in nature, and compatible with the direction of energy markets such as wind. Much has been accomplished, but there is more to do. I'm extremely honored to be leading Mistras at this important and exciting time in our evolution, and I believe the future is very bright.
I will now turn the call over to Ed to give you more detail on our financial results for the third quarter and the first 9 months of 2022.
Thank you, Dennis, and good morning, everyone. Revenue in the third quarter was up again, led by a record third quarter revenue performance in our services segment. Consolidated revenue increased approximately 2.2% to $179 million, but was up 5.1% excluding the impact of unfavorable foreign exchange. Revenue in our services segment's top two markets were up year-over-year in the third quarter, with overall oil and gas revenue exceeding that of the comparable pre-pandemic level in 2019. Our upstream sector was particularly strong, benefiting from strength in offshore Gulf and in the Alaska region. Downstream was also up from prior quarter as well, but it lagged our Q3 expectations, and it lags behind the pre-pandemic level of activity. The midstream recovery took a pause in the third quarter, but is up year-over-year on a full year basis.
Within midstream, Onstream's in-line inspection testing business did have its best revenue and bottom-line quarterly performance since inception. Aerospace and defense was also up significantly at 27% growth in the quarter year-over-year. Consequently, we believe the top line belies the fundamental growth of the business with both unfavorable FX and the continued weakness in some of our secondary end markets offsetting what was otherwise a quarter of solid growth in our two primary end markets. Gross profit for the quarter was approximately $54 million, up 3% from a year ago, with gross margin expanding 20 basis points to just over 30%. Gross margin in the quarter is illustrative of the benefit of faster growth in our aerospace and defense end market.
In the near term, gross margin will primarily depend on the rate at which we can pass along price increases in line with inflationary cost pressures that we are experiencing. As we had noted during our second quarter earnings call, beginning this quarter, that is the third quarter, we are comparing against a year ago quarter period in which almost all of the pandemic-related benefits had expired. Going forward, this comparability will help highlight the progress being achieved on gross margin, which trended higher from increased volumes, improved sales mix, and efficiency improvements.
Selling, general, and administrative expenses in the third quarter were $41.6 million, up $2.4 million or 6% from a year ago, in part due to expenses related to our bank refinancing of about $700,000 and an additional $600,000 of incremental cost down actions which were restored in the third quarter versus same period last year, for a total of $1.3 million or just over half of the overall increase. We are continually working to calibrate our overheads to match our level of revenue, and we are intensifying our actions in this important area. As Dennis stated earlier, despite ongoing inflationary cost pressures, we expect to reduce overhead from the current level as we exit 2022 heading into 2023, as it is one of the keys to leveraging our operating or increasing our operating leverage.
Interest expense for the quarter was $2.7 million, compared to $2.3 million in the same quarter of last year. This increase reflects the generally higher interest rate environment, as well as some temporary interim borrowings that increased our average outstanding debt for the quarter. For the third quarter, we reported net income of $4.4 million or $0.14 per diluted share, which is increases of 29% and 27% respectively. Adjusted EBITDA for the quarter was $18.6 million, which was in line with a year ago. For modeling purposes, we would anticipate a prospective effective income tax rate of approximately 30% exclusive of any discrete items. Free cash flow for the quarter was $0.2 million compared to approximately -$0.9 million a year ago.
Operating cash flow in the third quarter was affected by a significant buildup in working capital, primarily attributable to September being our highest billing month of the year. We expect to see cash flow improve in the fourth quarter, not only from continued positive operating results, but also by a decrease in working capital. The fourth quarter has historically been one of our best cash flow quarters. In the fourth quarter, we do have a $4.5 million payment due for payroll taxes that had been deferred and accrued earlier under the CARES Act. That will satisfy all remaining CARES Act obligations. We additionally made a $2.4 million payment in early fourth quarter for final settlement of an accrued legal matter. Capital expenditures were $2.5 million for the quarter and $9.6 million for the first nine months of this year.
We now expect total capital expenditures for the year to be less than our original $20 million budget and to be more likely in the range of $12 million to $14 million. As of September 30, 2022, we had gross debt of approximately $201 million, down from just under $203 million at the end of the year, and net debt of $183.1 million compared to $178.5 million as of year-end. Given that our primary use of residual free cash flow continues to be the reduction of outstanding debt, we believe our forecasted full year free cash flow will enable us to pay down debt in the fourth quarter of 2022.
Our goal remains to get below a 3x leverage level, even though our new credit facility provides quite a bit more flexibility. Once that level is achieved in 2023, we intend to evaluate our capital allocation strategy and use cash flow as a means to accelerate growth and build shareholder value. Keep in mind that under our new credit facility, maximum allowable total funded indebtedness to adjusted EBITDA is 4x through the second quarter of 2023's measurement date, with a step down to 3.75x for Q3 2023 measurement period and going forward for periods thereafter. We feel very comfortable operating under these terms. As noted in yesterday's release, we are updating our full year guidance to reflect our view on current market conditions.
We now anticipate revenue between $683 million and $693 million, adjusted EBITDA between $53 million and $58 million, and free cash flow between $15 million and $18 million. Note that unfavorable foreign exchange is expected to lower revenue and adjusted EBITDA after translation into U.S. dollars by approximately $15 million and $2 million dollars respectively on a full year basis for 2022 compared to our original outlook for the year. We expect both operating and free cash flow to improve in the fourth quarter of 2022, not only from continued positive operating results, but also due to an anticipated decrease in working capital from September 30, 2022. I will now turn the call back over to Dennis for his wrap-up before we move on to take your questions.
All right. Thanks, Ed. I am very optimistic about the potential for Mistras to capitalize on the technology development projects that we have been working on for the past few years. From the heightened activities with Sensoria, the customer acceptance of MISTRAS Digital, additional service lines with our aerospace to our corrosion under insulation crawlers, we are giving the market a new way to see and visualize value. Sorry. There is certainly no lack of initiatives at Mistras, excuse me, in creating differentiators for our offerings. After having operated for the past two and a half years in a violently disrupted end market and under an onerous financing facility, we now feel free to more aggressively implement the strategic growth initiatives that have been otherwise minimally resourced.
We are seeing the early results with increasing contributions from data and renewable energy and the ongoing expansion of our services in aerospace and defense industry. With greater freedom, we believe these initiatives will only further accelerate. At the same time, we are intently looking at expenses to make sure our cost profile calibrates with our revenue level. The ultimate goal is to get overhead to approximately 20% of revenues over time, which should significantly improve the operating leverage in our model. There are many macro factors that we believe provide a tailwind to our NDT market, including government compliance and safety standards, an aging infrastructure, evolving industries in need of new and innovative inspection solutions, and the growing complexity of the supply chain. These are all areas in which Mistras has an unmatched reputation. This is the long-term vision that is being strengthened every day.
before taking your questions, I would like to thank all Mistras employees for their continuing dedication to delivering a safe and superior product in this ever-changing environment we face on a daily basis. I am proud of our team and know that the financial results we are seeing is not reflective of the quality of our professionals or their expectations. Everyone that comes to work for Mistras expects to deliver a safe and conscientious product for our customers. By adopting our Caring Connects tenet, we provide a better workplace for the entire Mistras family and add to our legacy. Andrea, with that, please open up the lines for questions.
Thank you. At this time, we will conduct a question-and-answer session. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. Please stand by while we compile the Q&A roster. Our first question comes from Chris Sakai from Singular Research. Please go ahead.
Hi, good morning, Dennis and Ed.
Good morning.
I had a question on your price increases you say are expected to help with inflation. When are we supposed to expect these price increases to occur?
What's happening, Chris, it's a good question, is that they are occurring, but they're occurring behind the increases being given to the employees. As the market changes, so too does the pricing to the local employees. The skill sets go up at that customer, and then we start negotiating. We'll probably start before we pay it out, but what happens is you don't get the increases with the customer immediately. There's always a lag between getting the increases paid to us versus paying them out to the employees. With the inflationary thing we're in right now, this market's gonna keep us trailing that a little bit. We are getting increases, but as the inflation stays at this higher rate, normally you would do this on an annual basis.
We have COLAs built into our contracts, the cost of living allowance, that allows for these discussions to happen every year. Now, the timing is such that things just don't wait for the anniversary of the MSA or the contract, right? You gotta do them once or twice a year versus just one time at the MSA time. It causes a lot of continuous increases that you keep battling. For the most part, the customers are giving us the skill set increases. They don't do it across the board, but they do it for the sets that they see and recognize as what's going on. Cause you gotta recognize that it's just not NDT folks that are looking at this. All the customers going into those refineries and plants and everything else are battling the same problem.
Okay, thanks. With Sensoria and its recent deal with Bladena, can you sort of quantify what that will do for the top line?
Yeah. I mean, we've already been representing with them at conferences that they hold, and they are a major European and various markets of repair and maintenance on blade. They're promoting us as a very good way to get in front of understanding what's happening with your blades before they become very difficult to repair types of damage. We've already been in conferences with them and talking to some of their customers as well as us using it both ways. It's already helped us getting revenue. I wouldn't have the amount of dollars yet. It's still early on, but it's just another way to add our exposure and giving Sensoria credibility because you gotta remember, we're new to the market.
There's right now probably five or six competing technologies, none of which really measure the blade. They measure the effects the blade has on the wobble or the distortion on the shaft and other components that you could interpret are probably coming from a blade defect or taking a picture and hoping that it's at a surface level and things like that. We're still being run against other technologies, and we're being put on test beds currently with different owners and manufacturers to see how we hold up these other technologies. Having somebody with the reputation of Bladena helping us and saying that this is something they believe in, which they've seen a lot of other technologies and ideas as well, it really helps in that credibility part.
Okay, great. Last one from me. With the new credit facility, it's supposed to help inorganic and organic growth. Can you provide any color there as to what type of growth will this help?
Oh, hey, Chris. It's Ed Prajzner. I can.
Go ahead.
Yeah. Hey, Dennis.
Go on.
Hey, Chris. Yeah, essentially a couple things, Chris. It's number one, it gives us more liquidity. Number two, it gives us more leverage flexibility. So it just lets us. And thirdly, there's less required term loan amortization. So it just kind of is much more, you know, or less constrictive on the versus the prior credit agreement. We can flex into, you know, putting more of that capital to work. Again, job one is to still continue to pay down leverage, and we are doing that, but it gives us more upside. Again, more flexibility. It dropped the credit spread was lowered. You know, the availability was increased. Again, required amortization went down. It just gives us, let alone some affirmative negative covenants were all flexed back to pre-pandemic levels.
It just kind of uncuffs us to really use that credit, you know, for growth going forward. That's the benefits it gives us.
Chris, specifically things like machining for aerospace and space customers where we're getting new inspections because we're bringing on machining. We do the machining pre-inspection, and then we do the inspection. We're doing parts that we hadn't done the inspection on previously because the machining was located somewhere else and geographically was easier to get the inspection done somewhere else. Adding on more of these crawlers that we use for the corrosion under insulation, we call them ART, automated RT crawlers. Things like that under the old facility, we had to be more careful on how much money we were spending on things like that versus just keeping up the facility payments and all those constraints.
There's things that we're doing inside, and that's what we mean by we're adding into the renewables and other sectors, even building out more of these, buying more sensors, chips and everything for all these Sensoria components. You know, we're trying to build up for that to get ahead of and not have component problems as customers are making orders for more Sensoria blade as well.
Okay, thanks for the answers, Dennis.
Thank you. One moment for our next question. Our next question comes from Mitchell Pinheiro from Sturdivant & Co . Please go ahead.
Yeah. Hey, good morning.
Good morning, Mitch.
I wanna just look at guidance for a second. How much of the guidance decline relates to foreign currency?
It's a significant piece. On the revenue side, Mitchell, full year revenue impact of the FX is about $15 million in U.S. dollars. FX was $2 million on the EBITDA line were due to pure FX translation differentials. For the full year 2022.
For the full year. I mean, if I look at the midpoint of the fourth quarter, you know, it looks like it'll be somewhere around $170 million for fourth quarter revenue, which is maybe, you know, flat, maybe slightly down from a year ago. Is that? Is there anything beyond foreign currency that we need to understand?
From what we see for the fourth quarter, Mitch, we expect the third to be a little bit stronger for some of the push-offs into the third quarter. Third got started a little bit later. We're not sure how far and deep into the fourth quarter all these turnarounds and projects will go. Our guess on this is that from what we're seeing and what we're hearing right now is getting it maybe a little bit less than 2021. It was a strong quarter in Q4 for us in 2021. I think we'll be a little bit down. I think certainly you probably got another $4 million-$5 million in FX translation just in the quarter itself. That's gonna be part of it.
Yeah, I think it's just, is the customer gonna stay as long as they did in 2021 on these turnarounds and activities and how strong it will be into later this month? Probably you don't expect too much normally in December. It's more of just how late into November it all goes.
Okay. Okay. Midstream in the quarter, the third quarter was down. You had mentioned upstream was okay. What was the cause for the weakness in the other business?
You know, I think some of it was just timing of larger projects that didn't repeat from Q3 of 2021 to 2022. I didn't see anything there as far as loss of customers or major differences. I think it's just activity levels, you know, customer to customer, year to year on that.
Okay. As you look at your price increases, and I understand the lag, is the lag, are we talking? You may have mentioned this, and I might have missed it, but is this, you know, a quarter lag, or does it go beyond that? You know, I mean, how do you get pushback on price increases? Or are you getting pushback on any price increases? I mean, it's pretty evident the inflationary pressures. I would think that we would see, I don't want to say easy to get the price increases, but it's pretty much a foregone conclusion that you'll get them be, you know, a couple months out.
Right. I'll start with your second question. You're absolutely right. Everyone sees it and recognizes it. Customers just don't have the same urgency to recover it to us as fast as we have to pay it to the employees, right? We get it out as we see what's going on, and then while we're talking to customers, they say, "Yes, we understand it," but then they wanna see a document that's approving which one and why. They'll question, are all these needed? You know, you get into those kinds of granular parts of looking at the increase. Again, they don't generally fight you on it. They just delay it and take their time to, you know, cause I'm sure we're not the only ones coming at them.
It's probably a process that they're getting swamped with, and it just kind of makes it a slow reply in getting it back. The second half isn't so much that it's ununderstandable, it's just it doesn't come with the same sense of urgency that we have to pay it out. To your point on the increases, I mean, truthfully, you know how it is. You know, the increases can be the first day of the quarter or the last day of the quarter. They don't really fall neatly into the quarters and the month. What does happen, though, is it continuously happening, and it's still happening now. You pick a region, sometimes one region is faster or more aggressive than the other.
There's a lot of pressure out there. You get a lot of price increases from other folks that they're not controlling, and then the customer's having to keep up with it. What happens is we're constantly fighting this. The truth is, what we're trying to say is, as long as the inflation stays high like this, we're gonna always be dragging a little bit of this behind us. Once the inflation slows down, we'll catch up, we'll get back to a normal, and things will be there. We had a better gross margin quarter this quarter while still trying to drag these on, right? It's always keeping probably anywhere from 50-100 basis point pressure on our gross margin. Essentially, we're not trying to be cute about it.
What it is it's gonna be there until the inflation slows down a little bit. We'll be keeping up with it, but always a little bit behind it, right?
Okay. Just a couple other questions. With your company-wide overhead goal, you still got a little ways to go. What kind of things are you working on? Where do you see the opportunity to get that down to 20%?
Yeah, Ed, I'll let you take that if you want.
Sure, Dennis. Yeah. Mitch, yeah, it's more just focusing on our productivity, our efficiency, you know, making sure we're getting the best spend of our investment. I mean, we're looking at how do we automate things? How do we get more process throughput, you know, on the footprint we have and leverage that? You know, we're looking at all SG&A items, you know, even some of the overheads up in the COGS line, just making sure we're getting the best return there, you know, being as efficient as we can and, you know, kinda looking internally at how we can maximize that. It's really just an efficiency, productivity review of all things we're doing, you know, kind of zero-based budget things and make sure that there is true value in what you do there.
Does the customer appreciate it? Do they let us bill them for that and pass this through as valuable activity? Obviously, all that stays. We're not trying to affect the top line growth. We wanna keep doing those investments. If it's not mission critical, not value add, you know, it's fair game, and that's the kind of things we're looking at. We do it, you know, we always do it. It's just we're doing it more urgently now, where that top line's not where we want it to be. We're obviously taking a much harder look at this as we, you know, get deep into our budget cycle.
That's where we are, you know, and we're just taking a much harder look at things as, you know, as we kind of roll the budget together here shortly in the next couple months here.
Do you expect to see? I mean, I know you're not giving guidance for next year, but do you expect to see productivity improvement in 2023?
Yeah. In fact, we said that just minutes ago in the script. Yeah, absolutely. As we exit the year and look into next year, we absolutely see this being able to help productivity and profitability next year. Yeah, we're looking at this at a very holistic level. Yeah, we do expect some.
Okay.
You know, immediate benefits here, and it's something we look at all the time. Yeah, we are looking at it very, you know, in a very immediate term. Absolutely.
Okay. What drives the CapEx lower this year?
Again, that's just one of those things we look at intently. I mean, it's driven by volume a little bit, but it's really just challenging the need for that and, hey, can you go a little longer on the existing asset to preserve that capital? Again, we do focus very intently on it and, you know, there's a controllable level there. It is scaling to revenue to a certain extent. It's just looking at every item there and just, you know, doubling down on the return, making sure it's something we really wanna do now is what it is. We've just really clamped down and going to just the essentials there and, you know, letting the existing assets go a little longer.
As long as there's no risk there, we, you know, we do that. That's just kind of a whole bunch of little things there in the CapEx bucket is what we controlled. That's, you know, that's just a part of the same studying the asset base here we need to get our jobs done, making sure we're being very efficient with it.
If there's always.
Just to be clear, I'll just say we are still feeding opportunities. We haven't-
Sure.
You know, slowed down the growth of the business. We're making sure we're doing it. You know, we're just.
Right.
Looking at it and saying, "Okay, because we spent X last couple years, does it still need to be?" We, you know, the things that we're doing for aerospace and machining and crawlers and, you know, building into the software and all that, we're still feeding opportunities and still trying to plan for the future. It's just, you know, we wanna make sure if we are putting some in the CapEx, is because they're really needed. We're not slowing down any of the growth that way at all.
Okay. I mean, I've seen the model, like, you know, the CapEx would be about 3% of revenue. Is that still something fair to look out in the out years? Or is this or maybe is it a little lower than that these days?
Three would be a high side. If we do, as Dennis is describing, investing more in our internal labs, you know, any given period, it might drift up a little higher, closer to a 3%. More historically, it's been averaging closer to 2.5%. Yeah, in a high year, could be slightly higher than that. Two, 2.5% of revenue is a pretty good approximation for long-term CapEx requirements for us. Again, as Dennis said, we will be leaning into our labs a little bit, trying to grow them a little faster, not organically, but 2.5% is a good number for CapEx modeling.
Okay. Just last question. Just Dennis, what should I or maybe Ed, what should I from an interest rate perspective on your debt in the fourth quarter, what do you think the rate I should model?
The interest rate, I mean, we're gonna be pushing, you know, 5 and a fraction probably %. Yeah, so you're, you know, all in with all the uncommitted pieces, maybe closer to 5.75. Yeah, in that range.
Okay. All right. Thank you much.
All right, sir. Thank you.
Thank you. One moment for the next question. Our next question comes from Brian Russo with Sidoti & Company. Please go ahead.
Hi, good morning.
Morning, Brian.
Morning.
Hey, you know, so just looking at, you know, the revenue breakdown by industry, third quarter 2022 versus the year ago quarter, you know, it looks like you're seeing a nice recovery in, you know, oil and gas and aerospace and defense, you know, but clearly not showing up, you know, in the top line, first of all. Do you attribute all of that to the negative sensitivity to the strong dollar? Or is there something fundamental that might be going on in this third quarter and/or maybe this fourth quarter, that, you know, had you moderate the top line of the guidance?
You know, I don't think so. I'll throw it to Jon in one second. I mean, it's. The sectors that we expected to be growing aerospace and some of the other recovery are there. I will say there is a little bit of chunkiness, like in aerospace as far as the whole supply chain. Our customers are complaining they're trying to get more through and they just can't get to it. So I think there's a want to get more through in aerospace. The demand is there. They just haven't found a way to get it out yet. So that's gonna come up a little bit slower than you expect. There are some things like that are just structural, but I don't see anything else major. Jon, I don't know if you've got any thoughts on that.
Yeah, thank you, Dennis, and thanks for the question, Brian. I think supply chain, believe it or not, is still wreaking havoc, you know. We've got some customers, for instance, that we're testing raw materials for that they just can't get the material. That's been an ongoing challenge, you know, kind of as the years rolled on. They were good earlier in the year, and as the years rolled on, they haven't had material available to test. I think that's one of these realities that it's hard to plan on. When you give guidance, you don't anticipate those kind of things that are outside of your control, but they're real factors too.
Okay, got it. Remind me, and I apologize if you conveyed this earlier, but you mentioned what the full year FX impact is on revenue. What was it year to date? Then, you know, to follow on a prior question that just backing into the fourth quarter relative to year to date and full year, fourth quarter's basically flat versus a year ago. I'm curious if there is a headwind on FX, you know, that may be masking, you know, some of the overall improvement in your end markets and your business model.
Hey, Brian. It's a little bit, yeah. The full year effect on revenue is expected to be about $15 million. Through nine months, it was about $11 million. You know, you have another $4 million or so headwind hitting us here expected in Q4 on the revenue line due to FX.
Okay, got it. What was the leverage ratio as of September 30?
We're right just under a 375, 337-ish or so.
Okay, that's including what was a relatively weak first quarter, right? It looks like you're well on your way to under 3 times. I'm just curious how much of that's gonna be, you know, debt reduction, absolute debt reduction versus, improvement in EBITDA or a combination of both. Maybe tie that into what are your debt amortization payments, on a quarterly basis, and are you looking to exceed that with your free cash flow?
Yeah, a good question, Brian. Yeah. Well, two things. A combination of higher trailing EBITDA and lower funded debt will move both numerator and denominator in our favor. Q4 is routinely a very good strong free cash flow period for us. It was last year. We expect to have the same thing this year, that will certainly help in our favor there, you know, driving that downward. Amortization is very low right now. The new credit agreement effective August pushed amortization down from 20% to 2.5%. Modest level of amortization now. As we said on the call in the prepared remarks, we're not gonna, you know, do anything other than keep paying leverage down now.
We'll pay beyond the required amortization to get leverage down to, you know, below a 3. I believe that happens sometime before next year is over. We'll keep doing that in the interim, taking that residual free cash flow well beyond what the required term loan, you know, necessitates. Again, to Dennis's earlier point, we have optionality now. We've got some flexibility. If we see a great organic growth capability to grow a revenue stream, we can do that and will do that, but it's not gonna affect our otherwise step down in leverage, you know, to the 3.0. That will continue.
Again, we've got a little more flexibility if we wanna, you know, do something in the interim, on a little bit on the growth side where there's a high ROI. But no, we're in a good place there. We'll keep knocking that down. I think the combination of the leverage and the EBITDA going up, and bringing the funded debt down. Both of those combined to continue to bring the leverage down, you know, as we go into next year and beyond.
Okay. Just lastly, you know, when we look forward to 2023 with the understanding that you don't have guidance, but it seems as if oil and gas has normalized, and, you know, maybe we're still seeing an aerospace and defense recovery, but, you know, where does the growth in your core end markets, you know, come from post-2022? You know, is it gaining market share from the digital offerings or is it from, you know, top-line diversification through some of these emerging markets like wind remote sensing, et cetera?
Yeah, I'll take that and throw it to Jon to answer. Thanks, Brian. Oil and gas is recovering. I wouldn't say it's quite there in the downstream. There's still a lot of hesitancy to spend some of the money that they had pre-pandemic. I talk to customers all the time that are just amazed on how much lighter they're running their run and maintain than they had been. I don't know. Something will probably force them to change that over time, you would expect. I think part of 2023's recovery is oil and gas still has a way to go. I think inside the aerospace and defense, I put a little bit lighter than Jon did. He's right. I mean, the
Some of our markets, we got customers waiting for material and you know, the spend is much less than everyone anticipated because the material just isn't there to fabricate. We have some of that we believe is gonna continue getting better. Things like that are out of our control, so we're not so sure how fast and how much, but we are doing the things like you were talking about with Sensoria and doing that. With the MISTRAS Digital, we're starting to push digital a different way to try to get through faster and get our customers and employees to understand it. We're making initiatives there too. There's a lot of things that we're doing with the crawler and everything else.
We're not waiting for the market to come back to us, but I do think both of those, the defense aerospace and in the oil and gas, they are coming back. You know, it's just probably never as fast as you want it. With everything else that we're working on, we feel good about getting some of these things in place and keeping ourselves stickier and showing value with the digital and all that. While it's small, we got signs in many, many places that the digital is not only helping us get stickier, but bringing work in where customers are talking about looking at doing more and more locations with us because they really are starting to see the advantage of getting this data centralized and getting in one place.
I guess my answer to it is a little bit of everything to what you asked, Brian. I don't know if it's. I wouldn't put my finger on any one of them as being the major contributor. Certainly, the supply chain gets itself figured out, and oil and gas starts spending more. We still got a ways to go in our recovery. We've got our shop businesses in aero that are starting to hit months that haven't been seen before. We anticipate that keep going, but at the same time we know there's some additional demand that they just can't get through and get it to us, right? It's just a function of all these things getting back a little bit more normal.
We don't really see anything as too far out of our control that we don't. You know, we will come out later with a 2023 guidance, but we don't see anything out there that's really gonna be structurally in our way right now. Even the inflation right now is definitely a drag on the margin, but we don't see it right now changing our customer habits or spend unless something dramatic, probably more on the healthcare side than the inflation really would hurt us there.
Okay, got it. One more on the free cash flow conversion. Historically, you were averaging about 50%, obviously a lot lower than that in 2022, you know, due to some you know, one-time you know, payroll CARES-type repayments and another discrete item you mentioned. You know, when we look forward over the next several years, is that historical 50% cash conversion you know, still kind of achievable?
I think Brian said absolutely. In fact, it's been trickling up ever so slightly that average as well. Yeah, you're right. Couple discrete items this year knocking that down. Our AR, which is, you know, accounts receivable and WIP deferred costs on the balance sheet, you know, that number is up significantly, almost $132 million at the end of September. That number will come back down. You know, there is just a delay in the collection side this year that's a little bit slower. No, 50% plus a little progress in our favor. I believe very achievable.
All right, great. Thank you very much.
Thanks, Brian.
Thank you.
Thank you. I'm showing no further questions at this time. I'd now like to turn it back to Dennis Bertolotti for closing remarks.
All right, Andrea. Thank you. I'd like to thank everyone for joining the call today, and we look forward to updating you on our progress and our various initiatives. Have a great day. Thank you, folks.
Thank you for your participation in today's conference. This concludes the program. You may now disconnect.