Matrix Service Co (MTRX) Q3 2021 Earnings Call Transcript

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Matrix Service Co (MTRX -0.22%)
Q3 2021 Earnings Call
May 11, 2021, 10:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Matrix Service Company conference call to discuss the results for the Third Quarter Fiscal 2021. [Operator Instructions]. After the speaker presentation, there will be question-and-answer session. [Operator Instructions]. 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 -- Senior Director, Investor Relations

Thank you, Josh. Good morning, and welcome to Matrix Service Company's third quarter of fiscal 2021 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 and Presentations under the -- on the Investor Relations section of matrixservicecompany.com. Before we begin, please let me remind you that on today's call, the Company 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 annual report on Form 10-K for our fiscal year ended June 30th, 2020, and in subsequent filings made by the Company with the SEC. To the extent the Company utilizes non-GAAP measures, reconciliations will be provided in various press releases, periodic SEC filings and on the Company's website.

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

John R. Hewitt -- President and Chief Executive Officer

Thank you, Kellie. Good morning everyone and thanks for joining us. As we begin our call, I would once again like to open with a thank you to our employees for their continued focus on maintaining the safest possible working environment, which directly translates to a strong performance in the reduction of incidents and injuries. Even with the increased pressure and safety protocols demanded by COVID-19, our employees achieved a year to date consolidated total recordable incident rate of 0.25. This continued excellent performance is truly a testament to the strong leadership and focus on safety by our teams.

Turning now to our business discussion. I want to be very clear about the profound impact the COVID-19 pandemic has had on our business. The last 13 months have been extremely challenging to both Matrix and our customers as we managed through continued energy demand destruction, business uncertainty, and global economic conditions brought about by the pandemic. More specifically, in this extreme business climate, our customers, particularly those in oil and gas had continued to restrain capex spending and minimize all but routine maintenance, resulting in ongoing delays in project award starts and overall revenue volume.

We have been seriously impacted by not only these worldwide events, but the pandemic has affected overall decision making processes, efficiencies and productivity for our core customers. Many of them are like us, only just now returning en masse to the traditional office environments. This business environment has further contributed to an extended and unpredictable award cycle and drastically impacted our revenue volumes over the past four quarters.

The impact to our third quarter was severe as a third unanticipated wave of COVID-19 reached levels multiple times higher than previous peaks across North America, and severe weather outbreaks across the country from Texas to the East Coast, all served to enhance the disruption to many of our project sites and our operations.

As a reminder, low revenue volume impacts not only margins on missing revenue, but has a material impact on our ability to recover overheads. These overheads cover not only direct project resources and project management, controls, quality, safety etc, but also staff tied to estimating, planning and proposing on our robust project pipeline.

As it relates to operating results, positive and negative project outcomes as compared to the individual as-sold budgets are a natural part of our business and they generally offset each other to the positive over the course of the year. In this year and in our third quarter specifically, dramatically reduced revenues amplified the materiality of these outcomes. In spite of this, our overall portfolio of work is performing well.

Our earnings issues over the last 12 months are principally the result of reduced revenues and under recovery of construction overheads. That said, we believe that we have hit the bottom and expect the fourth quarter to be the highest revenue volume for the fiscal year. Book-to-bill in the quarter, albeit on depressed revenue volumes were nearly a 1.0 and while the opportunity pipeline across all segments is robust, and continues to strengthen, the timing of project awards which is dependent upon a return in market confidence for our customers will ultimately drive that outcome.

Over the past 18 months, we've made significant reductions in SG&A and construction overhead costs and we continue to look for ways to improve our efficiency and competitiveness without jeopardizing our ability to bid, win or support anticipated conversion of an extensive opportunity pipeline in the backlog.

Finding that balance between our right cost level and the human capital investment to prepare for the future opportunities that are right in front of us can at times see more like an art than science. We are first and foremost a people business and those people in this hyper competitive employment environment are critical to our emergence from this pandemic inspired downturn and successful execution of the opportunities that await us.

In our opinion, the timing of awards, this slide to the right, is right now a room to slide. We expect conversion to begin to occur at a faster rate and fully expect many of the opportunities to begin converting as we move through the first half of fiscal 2022. As our customers regain confidence in the markets, we believe our brand position and historical win rate will translate into improving backlog levels and revenue volume.

Finally, as you know, we have historically taken a very conservative approach to our balance sheet, a strategy we have employed to support the long-term health of the Company throughout business cycles. We have avoided debt where possible and always worked to maintain strong cash levels. In summary, COVID-19 has created unprecedented challenges in our business, but we have done what we always do: Adjust the business to the changes in the market; provide best in class solutions to our clients to maintain our leading position in key end markets and the strength of our brand; keep a focus on a strong balance sheet, and prepare the Company for the growth opportunities that are in front of us.

Honestly, we expected the market conditions to recover at a faster pace and do not believe we are unique in that expectation. However, we do see a recovery on horizon and while we expect it to start in the third quarter, we'll begin in the fourth and slowly improve from there over the next fiscal year. The market that support our business will improve as vaccination rates climb, infection rates decline, energy demand increases, federal fiscal stimulus rollout and climate policy is codified.

The impacts of developing nations not yet getting their pandemic under control is a concern as to its ability to slow the improvement in the global economy and energy demand. However, at least domestically, these things are coming together, which in turn will begin to improve our results as well. The pent-up demand for maintenance in key energy and industrial infrastructure, as well as a strong move for a lower carbon future is real, and filling our opportunity pipeline.

In support of our clients, combined with improved COVID conditions in most of our locations and increases we see in future volumes caused by this pent-up demand, our administrative and engineering teams are returning in force to the majority of our office locations after 13 months of remote working which we enacted to protect their health and safety.

As I said earlier, we expect the fourth quarter of this fiscal year to be our strongest with a return to near breakeven. Kevin will give you an overview of the numbers and then I'll come back to talk about our outlook and strategy.

Kevin S. Cavanah -- Chief Financial Officer

Thanks, John. During the quarter, the most significant item that impacted our operating results is the low revenue volume of $148 million, as project awards continue to be delayed. We continue to see a healthy funnel of project opportunities throughout our business. The final project awards have taken longer than normal. As a result of the low revenue, we don't have the opportunity to earn gross margins on that work, and we incurred unrecovered overhead costs.

As a result of these prolonged award cycles, our quarterly revenue has trended down during the year. As John mentioned earlier, we believe we've hit the bottom of the cycle and are confident that in our fourth quarter, we will have significant improvement in our revenue volume and recovery of overheads.

This chart provides a revenue trend through the recently completed quarter as well as the anticipated improvement in our fourth quarter. Since the COVID-19 pandemic hit the United States, our revenue has significantly decreased. At the beginning of the pandemic, we understood that our business would be negatively impacted and implemented cost reductions based on our estimate of the impact. Accordingly, we implemented measures which reduced -- which resulted in an annual reduction to our overhead cost of over $60 million. And those efforts continue in a targeted manner today.

The biggest portion of those savings have reduced our construction overhead. In total, our quarterly construction overhead costs are down 30% -- are 30% lower today as compared to our pre-pandemic level. We have tried to balance between reducing the cost structure or lower revenue volume and being positioned to execute projects as the revenue volume improved. We will continue to look for areas to improve cost efficiency in underperforming niches of the business through the fourth quarter and into fiscal year 2022.

This chart demonstrates that the recovery of overheads is directly tied to revenue volume. While our cost reductions have been significant, they have not been sufficient to eliminate the under-recovery of overhead costs in these unexpectedly low revenue quarters. These under-recovered overheads, while painful in the short term, we consider as an investment in our future. We always manage the business based on our opportunity pipeline, taking into account the projects in the pipeline, historical win percentages and award timing.

Based on this information, we expect that the second quarter was going to be the low revenue point in the year and that revenue volumes will begin to improve sooner. But project awards have been delayed. We now believe the third quarter was the floor for revenue and expect a significant increase in the fourth quarter. As a result, we should move closer to full recovery of overheads in the fourth quarter and see a strong improvement in our gross margin.

Going into fiscal 2022, we believe business conditions will continue to improve and will provide sufficient volumes to fully recover our current overhead cost structure. I know I've spent a significant amount of time on overheads. But I believe this was warranted, given the significant impact to margins and profitability.

Now I'll continue with the overview of the quarterly numbers. Our gross profit was $1.6 million in the quarter and our quarterly gross margin was 1.1%. The most significant impact on our margin was the negative impact of under-recovered overheads in all three segments as a result of low revenue. We estimate the impact on third quarter gross margin related to the under recovery is about 450 basis points. We also incurred net unusual project items, which negatively impacted margins by 300 basis points.

The gross margins in the Utility and Power Infrastructure segment was a negative 10.5%. We incurred additional costs on a large capital project and overhead under-recovery, partially offset by strong project execution of electrical work. Process and Industrial Facilities project work produced a direct gross margin within our normal expectations during the quarter. However, significant under-recovery, combined with a one-time adjustment related to the estimated amount due on a completed project, resulted in the segment gross margin being reduced to negative 0.4%.

Storage and Terminal Solutions produced a gross margin of 10.6% in the quarter. Although this segment also incurred under-recovery, it was positively impacted by our assessment of recovery of change orders on a capital project following achievement of mechanical completion and site demobilization.

Moving down the income statement. SG&A was $17.2 million in the quarter as the Company continues to operate on a reduced cost structure. In the third quarter, we also incurred an additional $1.9 million in restructuring costs as we continued our efforts to streamline the business. For the quarter, we had a net loss of $12.9 million or $0.49 per share. Our adjusted EPS, which excludes restructuring, was a loss of $0.43 per share.

Moving to year-to-date results. Consolidated revenue was $498 million for the nine months ended March 31st, 2021, as our revenue has continued to be impacted by the current environment. On a segment basis, revenue decreased significantly in the Process and Industrial Facilities and Storage and Terminal Solutions segments while the Utility and Power Infrastructure segment experienced a small increase.

Consolidated gross profit through the third quarter was $31.2 million as good project execution has produced direct margins in our project work within our normal expectations. However, under-recovery has reduced the margin down about 400 basis points to 6.3%. Consolidated SG&A expenses were $52 million in the first nine months of fiscal 2021, which represents a 22% reduction when compared to the prior year as a result of cost reduction efforts. For the fiscal year, we have also incurred $6.6 million of restructuring costs. For the nine months, we produced a net loss of $20.5 million or $0.78 per fully diluted share. Excluding restructuring costs, our adjusted net loss per share was $0.59.

Moving to our balance sheet and liquidity. As a result of our conservative management, our balance sheet remained strong. We ended the third quarter with $74 million of cash and no debt. We believe our balance sheet is sufficient to support our business for the foreseeable future. During the year, we utilized $10 million to pay off all outstanding debt and limited capital expenditures to $4 million. Year-to-date, our capital expenditures are less than 1% of revenue and we expect to continue with this lower level of capital spending in the near-term. We utilized $4 million for restructuring activities in connection with our ongoing cost reduction efforts, and we utilized $9 million for operations, including additional working capital investment.

As a result of the Company's cost reduction efforts, our operations are near breakeven on a cash flow basis for the year-to-date despite the decreased revenue and earnings. Our conservative approach to managing the balance sheet is unchanged. However, based on our operating performance, we were required to amend our credit facility. The amendment eliminates certain financial covenants for the third quarter as well as the next three quarters. It restricts our ability to borrow and makes certain disbursements, including stock repurchases and acquisitions and limits capex. These provisions are generally consistent with our previously enacted management practices in this disruptive business environment.

We will also be required to maintain a strong cash balance and produce minimum amounts of EBITDA as defined in the credit agreement. We have included detailed disclosure, disclosures of the amendment in our Form 10-Q, which we filed yesterday with the Securities and Exchange Commission.

In summary, we have a strong history of effectively managing our balance sheet and are confident our liquidity is sufficient to support the business and revenue growth as it returns. During the quarter, we had project awards of $138 million, which is an improvement from the first two quarters with a book-to-bill of 0.9. Partially offsetting the project awards, the Company removed a project awarded nearly two years ago with a major energy company that initially had some unexpected regulatory delays followed by COVID-19-inspired offtake issues.

Our LNTP had a sunset date, which the customer did not renew. While we have been paid for the work executed under the LNTP to date, the balance of the backlog, approximately $74 million has been removed. The project itself has not been canceled but will require a rebid and refresh of the numbers, given the amount of time that has lapsed.

It is our understanding that this client still intends to move forward with this project once financial close has been achieved. Its removal reduced our quarter-end backlog to $538 million. This delayed project is one example of the uncertainty our customers have faced during the past year as they alter their previous spending plans. The regrowth of our backlog and revenue volume is critical to our ability to produce good operating results. We believe the third quarter was the floor of the cycle. And based upon the project funnel, we expect to begin regrowing that backlog and revenue in the fourth quarter.

In closing, if there's one thing you should take away from this financial discussion, it should be that our bottom line results have principally been impacted by a short-term volume problem, which is the result of being in an unpredictable environment. I will turn the call back to John to provide more color on our markets and opportunities as we move forward.

John R. Hewitt -- President and Chief Executive Officer

Thank you, Kevin. As mentioned earlier, fiscal 2021 has been extremely challenging, not only for Matrix but for our customers. During this period of unprecedented challenges, we continue to advance our growth initiatives and make strategic transitions in the business.

We have continued to provide our customers with flexible and innovative solutions. We have advanced our growth initiatives in the chemical and petrochemicals by signing MSAs that offer the opportunity for a significant level of future revenue generation for major blue-chip producers and our engineering teams, which will also lead to increased revenues for our fabrication and construction brands as well.

We are pursuing a growing list of opportunities for our storage tank and terminal brand in international locations, such as the Caribbean, Mexico and Latin America, as these countries move to secure their sources of energy, reduce their carbon footprint through LNG and open up their countries following the significant impacts of COVID-19. We are further developing strategic partnerships with clients, technology providers and other contractors to address various business opportunities in growth markets such as LNG and hydrogen.

We continue to advance our domestic market position in LNG, NGLs and natural gas, which are critical energy, power and industrial feedstocks as well as bridging fuel to the future that support our customers' moves toward clean energy solutions. We have stayed focused on key sustainability issues important to our stakeholders and on telling our story on the progress we are making on ESG initiatives. We have maintained the talent necessary to support our customers as they begin to advance projects that have effectively been on pause across all of our segments.

As we look forward to fiscal 2022, we expect to see continued recovery and improvement in margins and overall results. Our opportunity pipeline is strong. And by remaining focused on our long-term strategy, we are well positioned for future opportunities. In mining and minerals, where commodity pricing has improved and there are significant demand for those commodities, clean energy initiatives and general infrastructure investments, we are prepared for what we believe will be a long-term aggressive spend by our clients.

The opportunity pipeline for thermal vacuum chambers used to test spacecraft, communication satellites and other high performance instruments in a simulated space environment remains robust. This is a niche market where we have extensive expertise, having designed more than 70 large vacuum chambers for aerospace companies and government research laboratories.

When we think about the growth of electrification across the United States, it includes the need to upgrade and improve the delivery system, the interconnectivity of renewable generation and the investments a federal infrastructure bill would support. These factors will create more opportunities for growth in our electrical delivery business.

One of the most significant areas of opportunity for Matrix, which will positively impact all three of our reporting segments is the world's move toward clean energy solutions. Supported by President Biden's recent pledge to slash U.S. carbon emissions by up to 52% by 2030 compared with 2005 levels, the move toward clean energy has also been embraced by many of our oil, gas and utility customers, who have previously set their own aggressive goals for achieving net zero emissions.

In the mid-term, getting there will require the use of bridging fuels, such as natural gas and LNG, and in the long term, renewable fuels such as hydrogen, along with more electrification overall, all of which will play a key role in decarbonization efforts and are areas where Matrix possesses extensive expertise.

Specifically in LNG, where Matrix enjoys a leading position in the EPC of small to mid-sized LNG terminals, U.S. Department of Energy has estimated the average annual consolidated capex spending for small scale liquefaction facilities supporting bunkering and peak shaving to be nearly $1 billion. This does not include the need for infrastructure to support the export and import of LNG into nearshore international locations, such as the Caribbean, Mexico and Latin America, all of which is currently a significant part of our opportunity pipeline. It does not include the continued build-out of large-scale export facilities for which we can support major EPC suppliers with the design, fabrication and construction of the storage elements.

Those areas where Matrix will play a leadership role will be in bunkering for transportation fuels for ships, where IMO regulations on sulfur will increase the number of LNG-powered ships in the fleet and where fueling infrastructure needs to be created. Matrix already plays a significant role in this investment as announced in the recent Pivotal LNG press release, which recognized us for our contribution to doubling of their LNG storage capacity at their JAX LNG facility in Jacksonville, Florida.

In LNG peak shaving, utilities are continuing to look toward infrastructure investments in remote or high-demand urban areas to assure supply during peak electrical demand, high gas demand for feeding or as a way to arbitrage gas supply costs for their rate base. In addition, utilities are considering the need for peak shaving to protect the supply and safety of its customer base when extreme weather events occur as we have recently seen in Texas. And we are fielding several opportunities directly as a result of this concern.

And again, the design, fabrication and installation of storage associated with the continued build-out of large scale LNG export terminals creates incremental growth opportunities to our normal small and medium-scale market focus. Matrix continues to have a strong position with these projects, competitive model and a world-class brand. Our opportunity and prospect pipeline is rich with projects. We expect additional growth in this area as the transition to cleaner energy, both domestically and internationally continues.

As countries and companies seek to reduce their greenhouse gas emissions, Hydrogen is emerging as a key solution for providing clean energy to businesses and consumers to meet their low carbon initiatives. Beating growing demand will require that hydrogen suppliers begin to plan for and build the significant infrastructure needed. This infrastructure, hydrogen liquefaction plants, plant expansions, storage expansion and other hydrogen-related facilities, such as marine bunkering and fueling stations, are all areas where Matrix is extremely well positioned to provide the EPC solutions needed.

Building on our more than 50 years of expertise in cryogenic storage, process integration, design, fabrication, construction and installation, we further strengthened our position in this quarter through our memorandum of understanding with Chart Industries to develop unique and cost-effective turnkey solutions for the North American hydrogen market.

According to the Hydrogen Council, overall global capex investment in hydrogen by 2030 is projected to be $300 billion, 11% of which the final investment decision has been made, another 13% is in the planning stages and 76% has been announced. Currently, our pipeline includes a growing number of opportunities, the majority of which is for green hydrogen and will require electrolyzers and liquefaction systems, storage piers, assemblies and related balance of plants.

Based on our analysis of our current hydrogen opportunity pipeline, we expect projects to begin entering our backlog near the end of calendar 2021 and into calendar 2022. Of interest is the fact that this demand is being driven by both suppliers as well as our end customers who are demanding green hydrogen as they pursue their own clean energy initiatives. In some cases, even though green hydrogen is currently more expensive to source than alternative fuels, it supports the end user's overall climate goals across their own portfolio.

In closing, while the impact of COVID-19 has been extremely challenging, we are optimistic that we are turning the corner and will also benefit in our position in the engineering and construction of clean energy solutions. We look forward to reporting improved results in our fourth quarter of fiscal 2021 and in subsequent fiscal years and remain confident in our long-term strategy and the opportunities we have for continued growth.

Now I would like to open up the call for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions]. Our first question comes from Zane Karimi with D.A. Davidson. You may proceed with your question.

Zane Karimi -- D.A. Davidson -- Analyst

Good morning, and thank you guys for taking my call.

John R. Hewitt -- President and Chief Executive Officer

Sure.

Zane Karimi -- D.A. Davidson -- Analyst

So first off, thanks for the color around the cost structure. And I was thinking about a little more in the ability you have to cut out both SG&A cost and construction overhead. So how much of that construction overhead looks to return with growing work and activity in the coming months? And how should we think about SG&A as a percent of revenue as this develops?

Kevin S. Cavanah -- Chief Financial Officer

So when we reduced our cost structure, we treat almost all of those reductions as permanent reductions. Now surely, as volume picks back up, there will be some costs that need to come back in. I mean, over the last year, for example, travel costs have been very minimal. It's important for us to be out in the field. And so that will be one cost that kind of comes back in a bit.

The other area that I'd expect to see cost would be primarily related to revenue producing positions. As our backlog grows, we'll have to make sure that we've got the adequate staff in-house to continue to execute the jobs that we've got. So overall, I'd say that, I don't know, 80% of the costs are probably more permanent reductions in nature would be my best estimate there.

And when you're thinking about SG&A as a percent of revenue, our goal is to get SG&A down 6% of revenue. So we'll begin approaching that when we pass $1 billion a year in revenue. It will take us a little bit of time to get there, but that is the goal we're striving to achieve.

Zane Karimi -- D.A. Davidson -- Analyst

Okay. Great. Thank you for that. And then as we look at a more robust return in demand, are there any segments that might require additional investments from here? How are you thinking about how best to utilize and take advantage of this return?

John R. Hewitt -- President and Chief Executive Officer

So, I think most of our segments right now, as we think about here and then over the next 12 months, most of the investments there are going to be people, I think to deal with the opportunity pipeline, improving -- increasing bench strength for people that are directly tied into projects. As Kevin mentioned, we don't see big increases pointing in to -- in SG&A. We've kept capex pretty low. So in our world, we're being capped [Phonetic] lot of our equipment.

And so as business starts to return and get a little stronger, we're going to be -- we'll be increasing the amount of money we spend on an annual basis on our capex. We're still looking for opportunities to expand our engineering capabilities into the Gulf Coast, each and every footprint rather into the Gulf Coast so that -- we're talking one of the near-term, if you're thinking about some acquisition, would be -- again the closest-term acquisition that we would be interested in, but that would be several quarters down.

Zane Karimi -- D.A. Davidson -- Analyst

Okay. Thank you very much for all this.

Operator

Thank you. [Operator Instructions]. And I'm not showing any further questions at this time. I would now like to turn the call back over to John Hewitt for any further remarks.

John R. Hewitt -- President and Chief Executive Officer

Now thank you everybody for joining us today. And, I appreciate you taking the time to be with us. I hope everybody stays healthy and safe as we continue to see improvements in all this pandemic environment. Thank you.

Operator

[Operator Closing Remarks].

Duration: 32 minutes

Call participants:

Kellie Smythe -- Senior Director, Investor Relations

John R. Hewitt -- President and Chief Executive Officer

Kevin S. Cavanah -- Chief Financial Officer

Zane Karimi -- D.A. Davidson -- Analyst

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