Matrix Service Company (MTRX) Q2 2023 Earnings Call Transcript

Matrix Service Company (NASDAQ:MTRX) Q2 2023 Results Conference Call February 9, 2023 10:30 AM ET

Company Participants

Kellie Smythe – Senior Director of Investor Relations

John Hewitt – President, Chief Executive Officer

Kevin Cavanah – Vice President, Chief Financial Officer

Conference Call Participants

Brent Thielman – D.A. Davidson

John Franzreb – Sidoti

Operator

Good day, and thank you for standing by, and welcome to the Matrix Service Company conference call to discuss results for the second quarter fiscal 2023. At this time all participants are in a listen-only mode, [Operator Instructions]. Please be advised that today’s conference is being recorded.

I would now like to hand the conference over to your speaker today, Kellie Smythe, Senior Director of Investor Relations. Please go ahead.

Kellie Smythe

Thank you, Justin. Good morning, and welcome to Matrix Service Company’s second quarter fiscal 2023 earnings call. Participants on today’s call will include John Hewitt, President and Chief Executive Officer; and Kevin Cavanah, Vice President and Chief Financial Officer.

The presentation materials we will be referring to during the webcast today can be found under Events in presentation on the Investor Relations section of matrixservicecompany.com.

Before we begin, please let me remind you that on today’s call, we may make various remarks about future expectations, plans and prospects for Matrix Service Company that constitute forward-looking statements for the purposes of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various factors, including those discussed in our most recent annual report on Form 10-K and in subsequent filings made by the company with the SEC. To the extent we utilize non-GAAP measures, reconciliations will be provided in various press releases, periodic SEC filings and on our website.

I will now turn the call over to John Hewitt, President and CEO of Matrix Service Company.

John Hewitt

Thank you, Kellie, and good morning, everyone, and thank you for joining us. I’d like to open today’s call with a reminder that we are all accountable for safety. Responsibility for the safety of ourselves and each other does not stop when we work. We carry that responsibility into our personal lives as well.

This personal safety responsibility is about accountability, communication and training, or short ACT. We use this acronym to focus our leadership and drive a culture of safety across the organization. It reminds us to be accountable to ourselves and each other and live up to the leadership expectations we each carry.

It says we must communicate directly with purpose, the expectations and risk to execute better, and it reminds us that training improves outcomes, skills and leadership. Our road to zero injuries never ends at work or at home, and each of us have a personal role play in that journey.

Now for our business update. As we have discussed on previous calls, some projects that we took into backlog during the pandemic were lower in overall margins and were affected by the operating dynamics over the last several years. As noted previously, we have one of these midsized legacy projects left in the portfolio, which we are in the midst of completing. This project at midstream gas processing facility, which is in the Process and Industrial segment was awarded in calendar 2021.

Due to breakdown and commercial negotiations concerning the extensive scope changes that impacted our ability to progress the project work according to forecast as well as the impact of global supply chain issues and inflation, we have taken a charge of $9.6 million in the quarter related to the forecasted outcome. The project is expected to be mechanically complete in the fourth quarter of this fiscal year. We continue to manage our forecasted costs to complete and work with our clients to negotiate a reasonable outcome.

This project aside, we continue to see strong momentum, driven by the recovery in our end markets, our focused business development approach, a streamlined organization and our strong brand across the operating segments. In addition, our strong execution performance continues to create repeat business with several major energy and utility clients. Our momentum is clearly reflected by the ongoing increase in project awards that I spoke about on our last call.

This trend continued into our second fiscal quarter, with total awards of $319 million. This was our highest award total since the fiscal quarter — first fiscal quarter of 2020.

Second quarter awards resulted in a consolidated book-to-bill of 1.6, and we had a book-to-bill of 1.3 or greater in each of our segments. Year-to-date, we have received project awards totaling $553 million and achieved a book-to-bill of 1.0 or greater in each of our segments and a consolidated book-to-bill of 1.4. Bidding activity remained robust across all segments, and we’re confident the strong award cycle will continue for the balance of the year.

In Storage and Terminal Solutions, where we were seeing the largest individual opportunities, our second quarter book-to-bill was 1.8, on awards of $115 million. Included in these awards is another large ethane storage project, which is in addition to the enterprise products award we recently announced.

In our Utility and Power Infrastructure segment, our book-to-bill was 1.9, on awards of $98 million, including an upgrade project for an existing LNG peak shaving facility. And finally, in Process and Industrial Facilities, our book-to-bill was 1.3, on awards of $105 million, which included a new fixed based maintenance contract and additional spring turnaround for our large refiner and a scope expansion of a previously awarded renewable fuels project.

At the end of the quarter, project backlog was $740 million, a 26% increase for the start of the fiscal year and backlog up across each of our segments.

Our capital projects opportunity pipeline, which is comprised of projects greater than $5 million, remains strong and includes $5.5 billion worth of quality opportunities. This pipeline does not include our normal day-to-day and recurring maintenance activities. Capital projects pipeline value can fluctuate from quarter-to-quarter given award progression, opportunity changes and our continuous evaluation of project quality. We expect the pipeline to remain healthy for the foreseeable future.

The vast majority of our opportunities are in clean energy and energy transition projects, in addition to the broader shift that is occurring in the energy markets. Client spending decisions are being driven by concerns about energy security globally, aging infrastructure and energy reliability domestically.

This is an exciting time for the company as we extend our expertise on the projects that support the development of the infrastructure needed to enable the transition to a lower carbon energy mix and energy security. In fact, about 70% of the projects in our pipeline support this transition with traditional energy, industrial and chemical projects making up the balance.

Over the years, Matrix brands have been synonymous with best-in-class storage solutions. Building storage tanks has been an important driver of our revenue. What’s well known to some investors is that our storage expertise extends far beyond the traditional flatline storage tanks used to store crude oil. The storage projects we are working on today are comprised of complex single and double wall cryogenic spears of tanks.

As an example, you may have seen a recent announcement that we were awarded the Greenfield engineering, procurement and construction of a 600,000-barrel cryogenic ethane storage tank for enterprise products along the Texas Gulf Coast.

We are fielding a growing number of downstream project opportunities, including those for both ethane and ethylene. These types of projects require a high degree of technical expertise and experience Matrix can offer. These specialty vessels, as we call them, are used for a variety of applications, including LNG, hydrogen, ammonia, ethane and other NGLs. In many applications, the storage tank is a critical construction path of an overall terminal project, thus giving us a competitive advantage to provide a complete facility to our energy clients.

With that said, before I hand the call over to Kevin to discuss our operating results for the quarter, I want to emphasize that the momentum in our business is not yet reflected in our operating results, nor did we expect that it would be. We expect that the larger projects will positively impact our results starting in our fourth fiscal quarter.

I’d like to express my gratitude to our shareholders and their patience they have shown as we’ve worked hard to optimize and protect our business following a rapid deterioration of our end markets during the first two years of the pandemic. We are seeing positive trends in our business as we win projects, build backlog and execute with our transformed organization.

As is normal in our business, the timing of awards and starts of projects can have an impact on our quarter-to-quarter operating performance. That being said, our expectation is that we will achieve a revenue level in the fourth quarter that returns the business to profitable performance with gross margins at or near our target range of 10% to 12%.

I’ll now turn the call over to Kevin to discuss our results, and then we will open for questions.

Kevin Cavanah

Thank you, John. The second quarter was shaping up to be in line with our expectations. As John discussed, project award activity was strong across all three segments. Our liquidity improved during the quarter, and operating results for the second quarter were similar to the first quarter with one exception.

Unfortunately, the outlook or change order recovery and an increase in the forecasted costs to complete a midstream gas processing project in the Process and Industrial Facilities segment changed significantly just prior to our original planned release of earnings. As a result of that change, we recorded a significant adjustment through the project forecast and put the project into a loss position. We recorded a quarterly charge of $9.6 million or approximately $0.36 per share.

The project is scheduled to be mechanically complete in the fourth fiscal quarter. We will continue efforts to manage the forecasted costs and negotiate a reasonable outcome of our claims with the client. This adjustment also triggered a goodwill impairment analysis for the impact of business unit in the Process and Industrial Facilities segment.

To be clear, the long-term prospects of the Process and Industrial Facilities segment are strong across multiple markets, completed thermal banking chambers, refining renewable fuels, chemicals and mining and minerals. However, our recent project performance and near-term prospects in the gas processing portion of this segment required us to reevaluate the fair value of the related goodwill.

Medium-term an impairment of goodwill was required for one of the business units serving this market and recorded a non-cash charge of $12.3 million or approximately $0.46 per share in the quarter.

Our second quarter revenue was $194 million compared to $208 million in the first quarter. Consolidated gross profit decreased to a loss of $1.3 million in the quarter, including the project adjustment. Excluding the adjustment, our gross profit was $8.3 million in the quarter and our gross margin was plus 4.3%, which was somewhat lower than our expectations due to under-recovered overhead costs at this revenue level, which impacted gross margins by 230 basis points. We expect under recovery to improve as revenue levels increased in the fourth quarter.

Consolidated SG&A expenses were $17.5 million in the second quarter compared to $16.8 million in the first quarter. The increase is primarily related to project Symcox [ph] as we continue our efforts to increase our backlog quality projects.

We also incurred $1.3 million of restructuring costs in the second quarter, primarily related to closing and underperforming office.

Our effective tax rate for the second quarter was 0 as expected. We will continue to place valuation allowances on newly generated deferred tax assets and we’ll realize the benefit associated with the reserve deferred tax assets when the company returns to profitable performance later in this year.

For the three months ended December 31, 2022, we had a net loss of $32.8 million or $1.22 per fully diluted share. On an adjusted basis, we had a net loss of $14.4 million or an adjusted loss of $0.53 per fully diluted share, of which $0.36 related to the previously mentioned project loss.

Now turning to our segments, starting with Utility and Power Infrastructure. Revenue from the Utility and Power Infrastructure segment increased to $51 million in the second quarter compared to $45 million in the first quarter, a higher revenue volume related to increased power delivery work. The company is substantially complete with the previous peak shaver projects, and the newly awarding peak shaver project will not begin to positively impact revenue until the end of the fiscal year.

The segment gross margin was 4.8% in the second quarter of fiscal 2023 compared to 3.8% in the first quarter. The margin increase was related to improved overhead recovery. While margins are improving, the segment continued to be impacted by work on projects with previously produced gross margins and projects that were bid in a highly competitive environment.

In Process and Industrial Facilities, revenue was $81 million in the second quarter compared to $87 million in the first quarter. The decrease was primarily related to the project adjustment previously discussed. Gross margin was a loss of 6.4%, excluding the $9.6 million adjustment on the cash processing project. The segment gross margin was a positive 5.6%, which improved modestly over the first quarter gross margin of 5%.

The segment continued to incur under-recovered overhead costs in the second quarter, which impacted gross margins by 250 basis points at this revenue level.

And finally, in Storage and Thermal Solutions. Revenue decreased to $63 million in the second quarter as compared to $77 million in the first quarter. The revenue volume was lower than expected as the award of a large storage project was delayed, and that project was previously expected to begin generating revenue in the second quarter.

While the ultimate award of that project is not known, the company has successfully captured other storage project awards as evidence by 1.8 book-to-bill for the first six months of the year. These award projects will generate additional revenue that have a later start date than the affirmation project.

As a result of the decline in quarterly revenue for the Storage segment is temporary, and we expect to see a substantial increase in the fourth quarter.

The segment gross margin was 2.6% from the second quarter, which was impacted by two issues, lower revenue volume negatively impacted overhead recovery, which had a 460 basis point impact in the quarter and increased forecasted costs to complete a smaller capital storage project had a 260 basis point impact in the quarter. That project was awarded, and a competitive environment is scheduled to be completed in the fiscal year.

Now turning to liquidity. As of December 31, 2022, we had total liquidity of $80.5 million, an increase of $23.9 million during the quarter. Liquidity improved primarily as a result of an expected decrease in working capital investment, resulting from the timing of cash flows on projects. Liquidity is comprised of $31.5 million of unrestricted cash and $49 million of borrowing availability. The company also has $25 million of restricted cash to support the credit facility and borrowings of $15 million.

We expect our liquidity position to continue to improve for several reasons, including expected improved operating results in the fourth quarter, the receipt of approximately $13 million of tax refunds in the third fiscal quarter and positive cash flow from newly awarded capital projects.

Overall, the operating results for the second quarter were disappointing. However, the latency projects that negatively impacted our results will be completed within the fiscal year and many of the headwinds we have been facing are abating.

In addition, a number of our businesses are generating improved operating performance, with margins out of the near targeted ranges. Combined with the strong award activity and the strength of the project funnel, we are confident that our revenue will increase.

Gross margins and overhead recovery will improve, resulting in significantly improved operating results and a return to profitability.

We’ll now open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our next question comes from Brent Thielman from D.A. Davidson. Your line is now open.

Brent Thielman

Hey great. Good morning, John, Kevin. I guess just one question on the revenue volume. Just kind of wanted to gauge your temperature. I mean are you surprised by the time it’s taking to kind of get some of these new awards moving forward? Kind of anything unusual behind that? And then I just kind of want to get your confidence what you’re seeing happen with some of these awards, again, gives you confidence around pickup in the fourth quarter as you’ve laid out?

Kevin Cavanah

Yes. So if you look at the revenues for the quarter, they were pretty much in line with our expectations. I’d say the only exception to that was the volume within storage internal solutions was a little bit lower than we originally expected. And that’s the result of, as I mentioned in my comments, a large storage project that — we expect it to be awarded in and we would have started during the second quarter, it would have had a pretty decent amount of revenue in the quarter.

That project is still not awarded, and the timing of when it will be awarded don’t know that. But the good news is that the segment had a bunch of other projects that we have awarded the last six months. And so the prospects for the increased revenue secular are still there. It just start a little later than the projects that didn’t get awarded. So we’re — that’s the only variance from the revenue standpoint.

The timing of some of these projects that we were pulling into backlog, the work on — generally on some of them takes — could take up to two quarters before we get any kind of heavy revenue. There’s some — there’ll be some upfront engineering. Some of the projects or a little bit more complex, so there’s more time taken to negotiate contracts. Those are making us some final permits to get in place.

So usually, as we said in our comments, it can take a quarter or two for those things that really start impacting our revenue.

Brent Thielman

And John, is that just because these are kind of more of the larger capital projects? Is that fair?

John Hewitt

Yes. I mean — even I mean larger capital projects, but even projects that are in — sometimes are in the, say, $30 million to $50 million kind of range, depending on who the client is and how their processes work after they select a contractor. We can be selected and we could be able to put it in the backlog, but it could take a couple of months before we’re really going to start putting money into it.

So, it’s just kind of sort of the nature of the business. And as we return our revenue levels, it’s a little bit more impactful to the business on a quarter-over-quarter basis until we get back up to a revenue run rate that’s foundational for the company.

Brent Thielman

Okay. That’s helpful. And then just on the midstream gas processing project. Just sort of curious why negotiations didn’t sort of translate to the outcome you’d anticipated? And I think the bigger question here is probably just — are there others of this magnitude, you’re in negotiations with customers where maybe there’s risk of a similar outcome or is this sort of truly unusual to you?

John Hewitt

Yes. No, I think this is sort of an unusual situation. This is — as we said and we spent before in other calls, this is probably the last of our larger, what I’d call, our COVID contracts. And so, I would say we’re not completed with our clients discussing through some of the commercial issues, but we felt at the time of the filing here that we needed to take a position that we’ve taken.

Brent Thielman

Understood. And I guess, John or Kevin, I mean, any context for what sort of revenues left for that job as we work through the kind of fiscal second half?

Kevin Cavanah

Yes, so $25 million to $30 million. And a lot of that will be out in the third quarter.

Brent Thielman

Okay. And John, I mean, John. It sounds like you’re pretty confident. Book-to-bill is going to be pretty strong here over the next couple of quarters? I mean, any kind of highlighted sectors you want to point to, you’re really seeing a lot of activity?

John Hewitt

Yes, I think whole thing storage. So, there’s a lot of — and there are obviously two words on the bigger projects are, but a lot of activity in storage around LNG, ammonia, ethane, propane, hydrogen, we continue to work in that sector. Those opportunities continue to keep flowing in on pre-feed work and hydrogen opportunities, both domestically and internationally. And so, we’re continuing to work in that market.

And so, I think what we see out in front of us, the opportunities for LNG shaving facilities, LNG plants related to ship on grain and export is pretty big. And so, we feel very comfortable where we are, and we’re going to continue to see good awards and positive bookings as we move out over the next several quarters.

And let is normal, our business and timing of all that, when we can take it into backlog that can move month-to-month. And — but as we’ve said before, the trend in backlog growth for us is what’s important work cycle. And I think what we see out of the future is a very positive trend in awards and building our backlog.

Brent Thielman

Okay, great. Appreciate that’s all. Best of luck.

Operator

[Operator Instructions] And our next question comes from John Franzreb from Sidoti. Your line is now open.

John Franzreb

Hey John, Kevin. Thanks for taking my question. Just to circle back to the midstream processing project. Was there anything unique about this contract that you didn’t have to engage in before?

John Hewitt

I don’t think it’s anything — as far as the process, the design, the fabrication, the erection of the facility, I would say it’s not — we do more complex things.

John Franzreb

So, what was — what’s the unusual part that the customer pushback on the changes in scope?

John Hewitt

Well, I really don’t want to debate that in public. So, we’re trying to give you guys a perspective of the challenges on the project. Certainly, the supply chain issues that I think the planet has felt over the last 18 months [indiscernible 0:27:24.5] had an impact from and both from us, from a delivery timeframe and inflationary pressure. And as we noted in the release, the job had want to changes in scope from the client. And when there’s a significant amount of changes that can also impact our ability to perform as we had planned. And so those are things that we’re working through with our clients, and we’re continuing to do that.

John Franzreb

So, John, do you feel there’s any — in hindsight, I guess, any operational changes that you should make in order to prevent this kind of incidence to happen again?

John Hewitt

I mean we’ll do what we normally do. We will do a lessons learned, and we will do a lessons learned with the client. If that’s supported to us when we’re done and to talk about how we interact with. There’s continues to be possibility for future work with this client and certainly, that would be an outcome that that we would like.

We have a lot of clients. We build complex projects with over and over and over again. And so, we’re — they’re obviously happy with our performance. And so, I would say this is still a bit of a unique situation. But we’re always honest with ourselves, and we’ll look at the areas where we think we could have done something differently or better, and we’ll make those adjustments.

John Franzreb

Okay. And it sounded like during the quarters, you made some minor structural change, closed down an office. It makes me wonder if the breakeven point for the company has changed at all, either positively or negatively in light of recent operating environment?

Kevin Cavanah

So, I don’t think it’s changed significantly from what we talked about in the last quarter. 1.5 years ago, we were talking about $200 million was kind of a quarterly breakeven, and that’s gone up a bit to probably 215, 220 based on inflation. So — but there’s not a big change in what we need to either fully recover or breakeven.

John Franzreb

Okay. And the revenue that was pushed out of storage, you said you expected it to close and be working on it in the quarter. That job hasn’t closed. Is there any expectation it will close by year? Or do you think it’s firmly pushed out for now?

John Hewitt

Yes, we’ve sort of taken the position here that this project will not be in this fiscal year as we look at our forecasting going forward. And so, it was a fairly sizable storage-related project, but the owner has had issues getting to financial close and permitting.

So, we’ve kind of taken the position, and we’re sort of — we’ve been working with them for a while doing some fieldwork and that we were working towards converting that into a full contract. We’re kind of out of that process right now until they get their situations together and straight on to make a decision on how to proceed with the project.

So, we fundamentally taken it out and so came out of the — in the middle of the second quarter, basically. And so that’s why you’ve had this impact in the second quarter.

John Franzreb

Got it. And John, you said that the jobs in the backlog are closer to historic norms on the gross margin side. How far away, I don’t know, across the whole business profile, do you think you’re often getting normalized gross margins? And what kind of timing do you see on realizing that?

John Hewitt

So, we’re driving the average is up in the backlog. One of the — some of these newer projects that are in this $300-plus million of awards in the quarter are in that range. So, they’re driving those averages — the averages for the organization back up into that range, plus the opportunity that average range from a historical perspective might be on the low side, but we generally had good performance across our projects on a quarter-to-quarter basis.

We’re able to upsize our direct margins because we’re either underrun our costs, we’re able to convert other contingencies and things that are built into the projects to the bottom line. So that’s — our historical operating environment is that we’ve got more opportunities to drive the margins up than to drive the margins down. And — so that also contributes to keeping those margins in that range.

John Franzreb

Okay. And I guess one last question, and I’ll jump back in. There was once a time you talked about exiting fiscal 2023 with a $1 billion backlog. Is that number still on the table? Or has that been pushed to the left or right, either way?

John Hewitt

That’s still on the table for me.

John Franzreb

Okay. Thanks a lot.

Operator

And thank you. And I am showing no further questions. I would now like to turn the call back over to John Hewitt, President and CEO, for closing remarks.

John Hewitt

So, thank you, everybody, for joining us today. Certainly, a challenging quarter for us, but we are making progress with the organization, all the things that we’ve done and we’ve invested in, and we feel very strongly about the direction of the organization and where we’re going and going to continue to build backlog and we’re going to continue to improve operating results here over the next couple of quarters.

So, we look forward to speaking with everybody in May.

Operator

Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.