Matrix Service Co Q3 FY2021 Earnings Call

Thank you all for being here today, and welcome to the Matrix Service Company conference call to discuss the results for the third quarter of fiscal 2021. I will now turn the conference over to Kellie Smythe, Senior Director of Investor Relations. Please proceed.

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 & Presentations 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 30, 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.

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 that the COVID-19 pandemic has had on our business. The last 13 months have been extremely challenging for both Matrix and our customers as we've managed through continued energy demand disruption, 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, have 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, like us, are 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 have made significant reductions in SG&A, 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 a right cost level and a human capital investment to prepare for the future opportunities that are right in front of us can at times seem 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 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 work 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 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 the horizon. And what we expected to start in the third quarter will begin in the fourth and slowly improve from there over the next fiscal year. The markets that support our business will improve as vaccination rates climb, infection rates decline, energy demand increases, federal fiscal stimulus is rolled out and climate policy is codified. The impact 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 and key energy and industrial infrastructure as well as a strong move to 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 will come back to talk about our outlook and strategy.

Thank you, John. During the quarter, a key factor affecting our operating results was the low revenue of $148 million due to delays in project awards. Although we have a healthy pipeline of project opportunities, final awards have taken longer than usual. This low revenue means we can't earn gross margins on that work and have incurred unrecovered overhead costs. Consequently, our quarterly revenue has declined throughout the year. As John mentioned, we believe we have reached the lowest point in this cycle and are confident that our revenue volume will show significant improvement in the fourth quarter, alongside a recovery of overheads. This chart illustrates the revenue trend from the recently concluded quarter and the expected improvement in the fourth quarter. Our revenue has significantly decreased since the COVID-19 pandemic began in the United States. We anticipated the pandemic would negatively impact our business and implemented cost reductions based on our estimates. We have successfully achieved over $60 million in annual overhead cost reductions, which continue today in a targeted manner. The largest portion of these savings has come from reductions in construction overhead. Overall, our quarterly construction overhead costs are currently 30% lower compared to pre-pandemic levels. We have aimed to balance reducing our cost structure in response to lower revenue while positioning ourselves to execute projects as revenue improves. We will keep looking for ways to enhance cost efficiency in underperforming areas of the business through the fourth quarter and into fiscal year 2022. This chart shows that the recovery of overheads is directly related to revenue volume. While our cost reductions have been significant, they have not been enough to fully eliminate the under-recovery of overhead costs during these unexpectedly low revenue quarters. We view these under-recovered overheads, though challenging in the short term, as an investment in our future. We manage the business based on our opportunity pipeline, considering the projects in the pipeline, historical win rates, and award timing. As per this information, we expected the second quarter to be the lowest revenue point of the year, anticipating revenue to start improving sooner. However, project awards have been delayed. We now see the third quarter as the bottom for revenue and expect a significant increase in the fourth quarter, which should bring us closer to a full recovery of overheads and a strong improvement in our gross margin. Looking ahead to fiscal 2022, we believe conditions will continue to improve, providing enough volume to fully recover our current overhead costs. I understand I've focused extensively on overheads. However, this was necessary given their significant impact on margins and profitability. Now, let's continue with the quarterly overview. Our gross profit for the quarter was $1.6 million, resulting in a gross margin of 1.1%. The most substantial impact on our margin was the negative effect of under-recovered overheads across all three segments due to low revenue. We estimate the effect on third quarter gross margin related to under-recovery to be about 450 basis points. Additionally, we encountered net unusual project items that adversely affected margins by 300 basis points. The gross margins for the Utility and Power Infrastructure segment was negative 10.5%. Higher costs on a large capital project and overhead under-recovery were partially offset by strong execution of electrical work. In the Process and Industrial Facilities segment, project work yielded a direct gross margin within our normal expectations during the quarter. However, significant under-recovery, coupled with a one-time adjustment for the estimated amount due on a completed project, reduced the segment gross margin to negative 0.4%. The Storage and Terminal Solutions segment achieved a gross margin of 10.6% for the quarter. Although this segment also faced under-recovery, it benefited from our assessment of recovery from change orders on a capital project after completing mechanical work and site demobilization. Looking further down the income statement, SG&A expenses were $17.2 million for the quarter as we continued to operate with a reduced cost structure. In the third quarter, we incurred an additional $1.9 million in restructuring costs while streamlining the business. For the quarter, we recorded a net loss of $12.9 million, or $0.49 per share. Our adjusted EPS, excluding restructuring, amounted to a loss of $0.43 per share. Moving on to year-to-date results, consolidated revenue reached $498 million for the nine months ending March 31, 2021, continuing to be impacted by the current environment. On a segment basis, we saw significant revenue decreases in the Process and Industrial Facilities and Storage and Terminal Solutions segments, whereas the Utility and Power Infrastructure segment experienced a slight increase. For the third quarter, consolidated gross profit stood at $31.2 million, supported by good project execution leading to direct margins within our normal expectations. However, under-recovery decreased the margin by about 400 basis points to 6.3%. Consolidated SG&A expenses for the first nine months of fiscal 2021 were $52 million, reflecting a 22% reduction compared to the previous year due to cost-cutting efforts. For the fiscal year, we've incurred a total of $6.6 million in restructuring costs. For the nine-month period, we posted 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. Now, let's discuss our balance sheet and liquidity. Thanks to our prudent management, our balance sheet remains solid. We ended the third quarter with $74 million in cash and no debt. We believe this balance sheet will be enough to sustain our business for the foreseeable future. Over the year, we used $10 million to eliminate all outstanding debt and limited capital expenditures to $4 million. Year-to-date capital expenditures have accounted for less than 1% of revenue, and we plan to maintain this lower level of spending in the near term. We allocated $4 million towards restructuring activities as part of our ongoing cost reduction strategy, along with $9 million for operations, including additional investment for working capital. Due to our cost-saving measures, our operations are nearly breakeven on a cash flow basis year-to-date, despite lower revenue and earnings. Our conservative approach to balance sheet management remains intact. However, in light of our operating results, we had to amend our credit facility. This amendment suspends certain financial covenants for the third quarter and the next three quarters. It also limits our borrowing capacity and certain expenditures, including stock repurchases and acquisitions, and restricts capital expenditures. These provisions are generally consistent with our existing management practices in this volatile business climate. We will also need to maintain a strong cash balance and generate minimum amounts of EBITDA as defined in the credit agreement. We've provided detailed information about the amendment in our Form 10-Q, which we submitted yesterday to the Securities and Exchange Commission. In summary, we have a proven track record of managing our balance sheet effectively and are confident our liquidity is adequate to support the business and its growth as revenue rebounds. In the quarter, we secured project awards totaling $138 million, an improvement over the first two quarters, resulting in a book-to-bill ratio of 0.9. However, we removed a project awarded nearly two years ago with a major energy company that faced regulatory delays followed by COVID-19 related issues. Our LNTP had a sunset date that the customer did not renew. While we have been compensated for the work done under the LNTP, the remaining backlog of approximately $74 million has been removed. While the project itself hasn't been canceled, it will need to be rebid and refreshed due to the time elapsed. We understand that the client intends to proceed with this project once financial close is achieved. This removal decreased our quarter-end backlog to $538 million. This delayed project illustrates the uncertainty faced by our customers during the past year as they revise their spending plans. The growth of our backlog and revenue volume is vital for producing strong operating results. We view the third quarter as the low point in the cycle and expect to start rebuilding our backlog and revenue in the fourth quarter. In conclusion, the key takeaway from this financial discussion is that our bottom-line results have been primarily affected by a short-term volume issue caused by the unpredictable environment we are in.

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 towards 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 demands 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, the 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 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.

Our first question comes from Zane Karimi with D.A. Davidson.

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 the growing work and activity in the coming months? And how should we think about SG&A as a percent of revenue as this develops?

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 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. 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.

Okay. Great. 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?

Most of our segments are focusing on investments in personnel over the next 12 months to manage the opportunity pipeline and strengthen our team for ongoing projects. As Kevin mentioned, we are not anticipating significant increases in SG&A, and we have kept CapEx relatively low. In our industry, we rely heavily on our equipment investments. As business conditions improve, we plan to increase our annual CapEx spending. We are also exploring opportunities to enhance our engineering capabilities in the Gulf Coast region. One potential near-term acquisition we are considering would be relevant several quarters from now.

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.

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 this pandemic environment. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.