Earnings Call Transcript - MTRX Q2 2022

Operator, Operator

Good day and thank you for standing by and welcome to the Matrix Service Company's Conference Call to discuss results for the Second Quarter Fiscal 2022. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that this call is being recorded. I would now like to hand the conference over to your host today, Kellie Smythe, Senior Director of Investor Relations. You may go ahead.

Kellie Smythe, Senior Director of Investor Relations

Thank you, Justin. Good morning. And welcome to Matrix Service Company's Second Quarter of fiscal 2022 earnings call. Participants on today's call will include John Hewitt, President and Chief Executive Officer, and Kevin Cavanah, Vice President and Chief Finance Officer. The presentation materials we will be referring to during the webcast today can be found under Events and Presentations 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 annual report on Form 10-K for our fiscal year ended June 30th, 2021 and in subsequent filings made by the company with the SEC. To the extent that 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, President and CEO

Thank you, Kellie, and good morning, everyone, and thank you for joining us. I want to kick off today's call with a thank you to our employees across the business. Whether you're a trades person, an administrative team member on our project or in our office, or a member of our engineering team, we appreciate that the past two years have been challenging for you in both your personal and professional lives. At a company level, these challenges have been a catalyst to make us better. It's caused us to rethink strategies, markets, and structure, and we are changing the business, but one thing that will not change is our values. And while many difficult decisions have had to be made, we will always stay grounded by our values of integrity, caring, and stewardship, while delivering the best with a high level of quality and superior safety. Thanks to all of you, as we build a foundation for success and sustainability. Before I turn the call to Kevin to discuss our second quarter results, I want to briefly highlight how the recovery in our end markets is resulting in an acceleration in awards from our opportunity pipeline. As noted in our earnings release, this was our second consecutive quarter with a book-to-bill of over 1. Through the first half of our fiscal year, we achieved a book-to-bill of 1.4 on awards of $459 million. To put this into perspective, first half awards are more than twice as high as awards in the same period last year and already exceed total awards for the entire fiscal 2021. These awards come as we see further market recovery and returning confidence from our clients, whose infrastructure assets span North America and beyond. Positive market dynamics combined with a more focused total solutions approach by our centralized business development organization is resulting in the rebuilding of our backlog. Remember, however, there is an inherent lag between the time a project is awarded and when it begins to have a material impact on revenue. In some cases, this lag can be upwards of three months depending on the finalization of scopes, contracts, permits, and facility process requirements. Our growing backlog, which now stands at $592 million, will deliver sequential improvements in our quarterly results as we progress through the year and ultimately to profitability in our fourth fiscal quarter. I will discuss our market outlook and the progress we're making to take advantage of the opportunities in front of us shortly, but first, let me hand the call over to Kevin to discuss our segment and consolidated results.

Kevin Cavanah, Vice President and CFO

Thanks, John. I will start with consolidated results. Revenue was $162 million for the second quarter, which was in the range of our expectations. Gross margins were 2% in the quarter. The most significant impact to margins was the under-recovery of construction overhead costs, which negatively impacted gross margins over 500 basis points for all three segments. We expect this to improve as revenue volume increases through the last half of the fiscal year. Gross margins were also impacted by a lower than previously forecasted margin on repair projects. Consolidated SG&A expenses were $15.9 million in the three months ended December 31st, 2021, which is the lowest quarterly SG&A in over eight years. We also incurred $700,000 of restructuring costs in the quarter related to additional cost reduction efforts. One other item impacting earnings in the quarter was a $14.2 million non-cash valuation allowance placed on deferred tax assets comprised primarily of federal and state tax positions. Although the majority of these assets do not expire, and the company expects to utilize the assets when it returns to profitability, the valuation allowance was required by U.S. GAAP and impacted earnings per share by $0.53. Utilizing NOLs in future periods will have a positive impact on earnings by significantly lowering our effective tax rate. As a result, we now expect our effective tax rate to be in the single digits. For the three months ended December 31st, 2021, we recorded an adjusted net loss of $10.2 million and adjusted earnings per share of $0.38. Including the impact of the tax asset valuation allowance and restructuring costs, the quarterly net loss was $24.9 million, and the loss per share was $0.93. Moving to segment results, revenue for the Utility and Power Infrastructure segment was $55 million in the second quarter, producing a segment gross margin of a negative 0.9%. The segment gross margin was impacted by two issues: First, low volumes led to the under-recovery of construction overhead costs, and second, we are working through projects that were marked down in previous periods and projects that were bid competitively and therefore present lower-margin opportunities. We expect increased revenue volume and recovery of overhead costs as we move through the fiscal year to result in improved segment operating results. Revenue for the Process and Industrial Facilities segment was $50 million in the quarter. Revenue volume does not yet materially reflect the strong project awards won over the last two quarters. We expect to begin to see an improvement in the third quarter as a reminder, we have booked over $210 million of awards for this segment in the first two quarters of fiscal 2022, resulting in a book-to-bill of 2.2. These awards include some larger capital projects that are still in preliminary stages of engineering and design. The quarterly segment gross margin was 8.4%. Despite strong project execution, margin was impacted from the under-recovery of construction overhead costs caused by low revenue volume. The Storage and Terminal Solutions segment produced $57 million of revenue in the second quarter. The segment had a book-to-bill of 1.3 for the first half of the year and over $156 million of project awards. As a result, we will begin to see revenue volume benefit as recently awarded projects ramp up. The segment gross margin was a negative 0.3% in the second quarter due in part to the under-recovery of construction overhead costs. In addition, segment gross margin was impacted by lower than previously forecasted margins on a thermal energy storage repair project due to unforeseen changes in repair scope and associated scheduled delays, which reduced segment gross profit by $2.8 million. Overall, the biggest issue with our operating results for all three segments was revenue volume, which resulted in under-recovering overhead. The strong project awards in the last two quarters, as well as the current bidding environment, provide management confidence in an improving revenue outlook that will return the company to profitability within the fiscal year. Moving onto the Balance Sheet and cash flow. At the start of the quarter, the company had $62 million of cash, including $28 million of cash that was restricted. During the quarter, our total cash increased $31 million, to $93 million, including the same amount of restricted cash. The increase was primarily the result of cash generated from changes in working capital. Total liquidity increased $35 million in the quarter to $102 million. The quarter-end liquidity consists of $37 million of availability under our ABL credit facility and $65 million of unrestricted cash. The improved liquidity and our strengthened balance sheet provide the company with the financial capacity necessary to support increasing revenue during the remainder of Fiscal 2022 and into Fiscal 2023. I will now turn the call back to John.

John Hewitt, President and CEO

Thank you, Kevin. As I said earlier, the momentum in our business is growing and we're moving closer to that inflection point I spoke about during our last earnings call. This is a result of the recovery and evolution of our end markets and how we approach those markets as well as internal initiatives that have significantly decreased our cost structure and are expected to create further efficiencies going forward. In prior quarters, we spoke about both delays in capital project spending and how awards were shifting out in time due to the ebbs and flows of the pandemic. With that said, energy markets are stabilizing, demand is rising, and client spending plans have been re-established. Our sentiment has clearly shifted. This shift is evident in our business and our already strong opportunity pipeline that has increased by over 11% since the end of the first quarter due to increased activity across our diverse end markets and how we are approaching those markets. Bidding activity is extremely active across all of our segments, and we are adding resources to handle the increase in activity. Looking across our opportunity set, where I'm most excited about is the important role Matrix will play in the transition to clean energy and renewables while maintaining our strong market position in traditional energy markets. In our press release yesterday afternoon, we referenced recent notable awards, including the engineering, fabrication, and construction of seven renewable fuel storage tanks, upgrade projects at two separate refineries to allow processing of renewable diesel, and a capital project for a midstream gas processing plant. These are the types of capital projects entering our opportunity pipeline in greater numbers as compared to this time last year. Many of these projects are captured in our process and industrial facility segment, which has a book-to-bill of 2.2 through the first six months of our fiscal year and accounts for north of 40% of our backlog. There's been significant uptake in bidding in midstream gas processing and we expect to see capital investment in natural gas-related infrastructure to continue based on the growth in global demand and recent increases in gas prices. In addition, many of our clients are planning capital expenditures to upgrade their compression and processing stations to minimize the carbon footprints of those facilities and increase capacity. Several of these projects are in our proposal pipeline today. Natural gas has an extremely important role to play in the clean energy transition. Until other solutions are commercially viable and broadly available, natural gas will be needed to bridge the gap. In the same value chain, small-scale LNG peak-shaving opportunities remain strong. We are pricing multiple feed studies, maintenance repair, and capital projects for both new projects and several that had been on hold until recently. Extreme temperature conditions in some parts of the country and the sharp increase in natural gas prices over the last 12 months have driven further interest in peak shaving facilities by most utilities. These facilities offer our utility customers significant flexibility to meet peak demand for electricity and consumer gas supply while managing their exposure to fluctuations in natural gas spot prices. Opportunities across the Americas and the Caribbean in LNG, NGLs, and LNG bunkering facilities also continue to increase. Large capital investment projects aimed at carbon reduction and renewable fuels are also being announced in the refining sector. As these investments are made, we expect our extensive refinery expertise and brand position to result in a growing number of project awards. We are well-positioned to support the evolving needs of our customers through our broad capabilities and long-standing expertise in performing capital work, turnaround, maintenance, and repairs inside their facilities. Much of this work is being done under existing MSAs on a reimbursable basis. It is worth noting that over the past two years, we have grown our MSA-based nested maintenance operations from one to five refineries, thereby providing more stability and predictability to our refinery activities. This is an area of our business that we intend to grow further. Elsewhere in the clean energy value chain, we're continuing to make good progress in hydrogen. Our expertise in cryogenic storage and liquefaction combined with our relationship with Chart Industries is providing a strong point of entry in this same market, which has recently resulted in the award of a feed study that is expected to lead to multiple hydrogen processing-related projects with this client. We are also actively tracking or pursuing further opportunities in hydrogen, as well as ammonia which facilitates transport and storage of hydrogen, particularly as a bunkering fuel. And finally, we recently joined the Hydrogen Council, a global initiative of leading companies dedicated to advancing the use of hydrogen as a global energy source. Outside of clean energy and renewables, we continue to be active in traditional midstream crude oil infrastructure. As a brand leader in above ground storage, we expect continued work in crude tanks and terminals as well as their maintenance and repair. Bidding activity in this market has recently accelerated to pre-pandemic levels with near-term booking opportunities growing. In the mining sector, copper, precious metals, and rare-earth mineral prices are sustained at higher levels, increasing our customers' confidence to move forward with capital spending. We have recently won awards for several projects in the U.S. Southwest that are the types of projects that are often precursors for larger project work. Our chemical and petrochemical strategy is beginning to pay off with many chemical companies, both large and small, attracted to our comprehensive and diversified capabilities that include engineering, construction, and maintenance. We have been successful in getting master service agreements in place with some clients and winning small feed and engineering projects, including a new award with Komorze that was announced last month in aerospace. In addition to our first-quarter thermal vacuum chamber award, we mentioned in our last earnings call, we will be adding to our backlog in the third quarter another vacuum chamber project. We hope to announce both of these by press release soon. Bidding opportunities continue to be strong in this end market where Matrix has a strong position. Lastly, the interconnected world of electrical and renewable generation along with an aging infrastructure system creates organic potential for our electrical business currently operating in the Northeast, the Ohio Valley, and Mid Atlantic. This team is winning various project types, including greenfield substations and rebuilds, transmission and distribution, relay upgrades, and fiber installation. One example is a project we announced this morning for Talent Energy Corporation's subsidiary, Cumulus Data, at their Susquehanna data center. Our subsidiary, Matrix NAC, was selected to construct a greenfield substation, as well as associated transmission and distribution work. This project award was booked subsequent to the second quarter. In short, we are highly confident in the market backdrop and continue to take proactive steps to ensure Matrix has the right internal organizational footprint and resources to deliver against it. Since the start of the pandemic, we have streamlined the organization, taken out approximately $80 million in cost, one-third of which came out of SG&A. This was the outcome of a business improvement plan we began executing in 2020. As we move on to the next phase of this work, we remain focused on increasing the efficiency of the organization and are making strategic internal enhancements to that end. Specifically, we are taking steps to consolidate certain areas of the business to further improve our shared services structure for accounting, finance, and human resources. In addition, we're creating an Operational Center of Excellence that will initially focus on optimizing safety, quality, and procurement across the organization with the ultimate goal of including other operational support areas. We're also continuously evaluating opportunities across various end markets and strategically adding and allocating resources. We recently announced the hiring of several senior people to our business development team, and in addition, have been tactically building our operational project and technical teams to support the pursuit and execution of these opportunities and recently awarded projects. These people all have extensive backgrounds and relationships in the markets where we see the greatest growth opportunities for Matrix, specifically energy transition projects, LNG, renewables, hydrogen, midstream gas, and chemicals. The end result of our actions will be an optimized and efficient organization prepared to support the company's growth plan, aligned with the market opportunity and ultimately delivering better and consistent bottom-line results. With that, I'm now open the call for questions.

Operator, Operator

And thank you. As a reminder, Q&A roster. Our first question comes from John Franzreb from Sidoti & Company. Your line is now open.

John Franzreb, Analyst

Good morning, everybody. Thanks for taking my questions. I expect to start with the change in the cost structure from $70 million to $80 million. I guess, two questions there. 1. Does that change your break-even point? 2. Does it change your gross margin projections or targets in any particular segment?

Kevin Cavanah, Vice President and CFO

John, this is Kevin, I'll take that. First of all, in the gross margin targets, no, I don't think it changes those targets. I think the change just further makes us more capable of meeting those targets and enhances our earnings power. As far as what's the level of revenue we need to break even, the level of revenue we need to achieve full recovery of overheads, those targets of $200 million to break even and $220 or so to get full recovery, those are pretty much the same. And I think the reason I'm not changing those is just we've seen some, we talked about this last quarter, some of our markets that we bid in right now are pretty competitive. The gross margins are down a little bit in some of those, so that is offsetting that decrease in costs.

John Franzreb, Analyst

Can you discuss the $2.8 million that impacted the gross margin this quarter, including details about the project and its associated costs, as well as the potential for recovery?

John Hewitt, President and CEO

Without going into too much detail about the project, John, it was a thermal storage project. We encountered issues in scope development after the award. We have been working through these challenges with the client, which has led to increased costs and extended timelines for the project. We expect to be substantially complete by the end of April and believe we have accounted for the costs to complete at this stage. However, I cannot comment on any potential commercial opportunities moving forward.

John Franzreb, Analyst

Okay. And it's hard to believe almost anniversarying the one-year announcement of the short three minutes. But from a share value, it's a much different environment. Can you talk a little bit about how that agreement has progressed over the past year relative to your expectations and where do you see it on a going-forward basis?

John Hewitt, President and CEO

We are working on projects both with Chart and independently. While we wish everything could progress more quickly, that's not how things operate. We are looking at opportunities with them as well as on our own. We are also developing standardized design concepts and packages with them to provide uniform solutions to various clients. Recently, we secured a small feed award from a client planning to build hydrogen processing stations in North America, which we feel optimistic about regarding their financing capabilities. This project was a collaborative effort with Chart. We believe we are well-positioned to turn this feed study into a full project soon, likely within this calendar year.

John Franzreb, Analyst

Okay. And one more question I'll get back into queue, which is not being more aggressive in share repurchases at this level?

Kevin Cavanah, Vice President and CFO

Yeah. John will take that.

John Hewitt, President and CEO

Yeah, we had a good quarter on cash but the biggest driver was really related to working capital changes and the timing of billings and receipts on some of our capital projects. When we look out to the future, I think there's primary uses of cash. First of all, will be to fund those projects that are in a build-ahead position. Secondly, we've talked about that we expect the revenue volume to increase. Some of that will come from reimbursable type projects, and we will need to be in a position to fund that growth. And then finally, we've really decreased our capital spending in the last two plus years. And we're going to have to start increasing that a bit in the future, so that's our focal point right now with our priorities, with our cash.

John Franzreb, Analyst

Okay, Kevin. Thanks. Actually, I'm just going to get back to the queue.

Operator, Operator

And thank you. And our next question comes from Zane Karimi from D.A. Davidson. Your line is now open.

Zane Karimi, Analyst

Great. Thank you for that. And just to go off the cash flow a little bit into more detail. But how should we think about the cash flow dynamics as well as the working capital as you guys move forward with this work because you guys are having new ramping revenues and all of that?

Kevin Cavanah, Vice President and CFO

So, it varies and it's going to depend upon where the revenue increase comes from. So, if we have increased revenue in periods like when we have increased maintenance activity, that will be reimbursable. That work we're funding upfront and we're funding that for a couple of months. And so that's a usage of cash, especially in the fall and spring quarters is usually the period you see that the most. Then we're going to have capital projects, and we try to stay ahead from a cash perspective on those projects. There are times when we will lead to fund that, especially if the project gets well ahead on cash funding perspective. So as we're thinking about the rest of this fiscal year, I think we'll be able to maintain a pretty strong cash balance similar to what we've got right now. I think that the amount of availability under our credit facility will also increase a bit. So that will increase liquidity, I think we had $33 million outstanding at the end of the second quarter. That's down to just under $24 million today. So that increases availability $10 million just in January.

Zane Karimi, Analyst

Thank you for all that color. I'm going to change tracks a little bit here, but given the global pricing dynamics around gas, you mentioned how there is a significant uptick in bidding around infrastructure here. Can you talk a little bit more about the facility upgrades and the infrastructure in particular that you are bidding on and the industry's willingness to spend on carbon footprint minimization?

John Hewitt, President and CEO

There are several areas related to LNG. Many utilities are exploring peak shaving facilities and expanding storage for natural gas to LNG in order to safeguard their customers from substantial spikes in natural gas prices during extreme weather. We observe considerable opportunities in this space. In the first quarter, we added a storage tank to assist utilities in needing to store more gas. We are actively participating in various projects related to tax and infrastructure across the U.S., currently involved in bidding or have submitted proposals. Additionally, we are recognizing prospects for LNG in ship bunkering and small-scale exports to the Caribbean. We're also seeing opportunities in NGL-related projects in both the U.S. and Central America, including propane and ethane terminals. There is a significant amount of activity surrounding gas and gas liquids from a storage and terminal perspective. Furthermore, we have seen a notable increase in midstream gas processing work, with one project awarded and several in the proposal phase, more than we have encountered in the past three or four years, prior to the pandemic. One contributing factor to this is the challenges faced by some midstream clients attempting to implement new long-haul pipelines, which has prompted the need for cash flows to upgrade their existing systems for enhanced service capacity and reduction of their carbon footprint. There is a lot of activity happening, and we are quite enthusiastic about the prospects. Additionally, we have discussed a shift in our business development strategy, where we are now selling across the entire enterprise and all clients, rather than operating in a more siloed manner, which has broadened our opportunity pipeline across various energy markets.

Zane Karimi, Analyst

Thank you for that.

Operator, Operator

Thank you. Our next question comes from Noelle Dilts from Stifel. Your line is now open.

Noelle Dilts, Analyst

Good morning.

John Hewitt, President and CEO

Hi, Noelle.

Noelle Dilts, Analyst

Hi. I was hoping for us to chat a little bit about how we should think about the lag in terms of backlog translating into revenue. Are there any notable differences across the segments and do you think you could start to see benefit from some of the recent awards by the fourth quarter? Thanks.

John Hewitt, President and CEO

Yeah, I think it’s our expectation that we're going to start to see the awards in the first half of the year to start materially impacting late in the third quarter and dive more heavily into the fourth. Yeah, it is important to recognize that the timing of award to revenue is not necessarily a shot of adrenaline immediately as it happens. It takes some time. There may be some permitting issues that got to get finalized, or it could be the initial engineering work that gets done, which is a lighter percentage of actual revenue in the project before we can start procuring goods and services and start construction to move into the field. As we said in our prepared remarks, it can take upwards of three months from the time a project gets booked to the time it gets into a position where it's going to have a material impact on quarterly revenue. So that's where we see it. Our opportunity pipeline on awards cycle continues to be strong and growing. We expect to see strong awards to continue to happen as we move through the next couple of quarters and throughout the calendar year, so it's going to be a build-up of momentum from awards to revenue that we see moving out in time here. So, it won't be a quick spike. It's going to be a slow build, but we think we're building a very strong foundation of backlog across the business that is going to support continued revenue growth.

Kevin Cavanah, Vice President and CFO

And from a segment basis, the lag is going to happen more likely on capital projects, and we've got those throughout all three projects or all three segments. So it may be the same impact on all three of them.

Noelle Dilts, Analyst

Okay. Thanks for that, Cavanah. And then second, sorry if I missed this, but could you just discuss how labor cost inflation and some raw material inflation is impacting the business? Are you able to get those higher costs into current bids? If you could expand upon that, that'd be great. Thank you.

John Hewitt, President and CEO

We have some positive updates regarding the market conditions we've been navigating. The inflation surge in materials has affected us, but in the current bidding environment, we are managing to incorporate these price increases into our bids. Some projects that were delayed and bid before the pandemic are being revisited to update pricing for our clients. We are observing significant increases in material costs, especially for steel plates. However, we have largely handled this within our bidding strategy over the past six months. For ongoing projects in our backlog, we encountered material pricing challenges, but we were able to address most of these with our clients due to the pandemic's effects. On the labor front, as our project volume increases, we have been effective in sourcing labor nationwide and have established a strong reputation with both union and non-union labor. Although we haven’t faced severe difficulties in attracting labor, I anticipate it will become more difficult as our workloads increase and markets improve, and we will continue to address this issue.

Noelle Dilts, Analyst

Great. Thank you.

Operator, Operator

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

John Hewitt, President and CEO

I want to thank everybody for joining us on today's call. Hopefully, you heard throughout the call today that the management team is very upbeat on what we see for the organization, on return of the opportunity cycle, the awards cycle, the conversion of that into revenue, and the strong improvement in our bottom line as we move forward over the next couple of quarters. So again, thank you, everybody, for being part of the call, and a special thanks to all of our employees for their hard work, they do every day to make us successful.

Operator, Operator

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