Earnings Call Transcript - MTRX Q2 2024

Operator, Operator

Good morning and welcome to the Matrix Service Company Conference Call to discuss Results for the Second Quarter of Fiscal 2024. Currently, all participants are in a listen-only mode. As a reminder, this conference call is being recorded. I would now like to turn the conference over to today's host Ms. Kellie Smythe, Senior Director of Investor Relations for Matrix Service Company.

Kellie Smythe, Senior Director of Investor Relations

Thank you, Valarie. Good morning, and welcome to Matrix Service Company's second quarter fiscal 2024 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 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 because 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. Before I turn the call over to John Hewitt, I'd like to share that Matrix will be presenting at the upcoming Sidoti Small-Cap Virtual Conference on March 13th and 14th. If you'd like additional information on this event or would like to have a conversation with management, I invite you to contact me through Matrix Service Company Investor Relations website. I'll now turn the call over to John.

John Hewitt, President and CEO

Thank you, Kellie, and good morning, everyone. When we think about the safety risks present in the construction industry, we often think about the physical risks to people, but there are equally significant risks that have to do with mental health and well-being. Mental health issues arise from a variety of reasons, including loneliness, high pressure work environments, seasonal layoffs, loss of a family member or friend, and can manifest in different ways including loneliness, anxiety, depression, suicidal thoughts, and substance abuse. The construction industry has one of the highest suicide rates of any industry, and compared to all other construction fatalities, suicide occurs five times more often. This is why the construction industry is taking a collaborative approach to better understand mental health issues by providing research-based solutions. Through our participation in the Construction Industry Institute and Construction Safety Research Alliance, Matrix is directly involved in this effort. Matrix is also committed to doing all we can across our job sites and office locations through a cross-functional internal initiative called Matrix Cares. We believe that together, we can make a difference for our own employees and others across our industry, and I believe that the mental and physical safety of our employees as well as those visiting our offices or job sites is the most important thing we can do as coworkers and leaders. Now, let’s talk about business. I am proud to announce that with awards of $233 million in a quarter, we've achieved a record backlog for Matrix of $1.45 billion. This is an all-time high for the company in its 40-year history and is an achievement that is the result of the hard work of our people and our focused strategic approach in our core markets. We have transformed our organization to be more cost-efficient by ensuring our skills, expertise, and strong brand are aligned with our core markets. We are positioned to safely execute projects with improved operating processes while continuing to deliver best-in-class quality for our customers. As you will see when Kevin walks through our results, Matrix has resolved the primary issues that have plagued us the last few years. We have completed projects that were bid in a highly competitive pandemic environment, which resulted in limited margin opportunity. We also streamlined and refocused the company, restored our direct gross margins to our historical double-digit range, rebuilt our backlog to historic levels to support higher revenue volumes in the coming quarters, improved our liquidity position, and reduced our debt to zero. A dramatic improvement in both the volume and quality of the projects in our backlog positions us to expect revenue volume to grow and leverage our streamlined cost structure. Now I want to spend a few minutes on our work in the energy markets. Recently, President Biden paused pending and future permits to export LNG to non-free trade agreement countries. Generally, we do not expect this pause to impact our opportunity pipeline or backlog. The small to mid-scale LNG facilities we have won and are pursuing are domestic in nature, riding backup fuel supply, heat shaving, or ship bunkering. Any LNG tank projects related to large scale export facilities that might be associated with the current White House permit position are more of an opportunistic pursuit for Matrix. We have significant opportunities in the small-to-mid scale LNG market, as well as NGLs, ammonia, and hydrogen, and expect these opportunities to continue contributing to backlog. While the transition to a low carbon energy mix has been a focus of global energy policy, the world is still heavily dependent on fossil fuel and will be for the foreseeable future. At the same time, energy companies are actively at work developing longer-term, more sustainable energy solutions. For Matrix, our expertise in both traditional and emerging energy markets, together with our longstanding reputation for safe, quality delivery, positions us as a leading contractor across the entire industry and puts us in an advantageous position. Our opportunity pipeline remains steady at $5 billion, demonstrating the strength of our markets and our ability to continue our long-term trend of backlog growth. We remain a contractor of choice for work in traditional oil and gas, including the engineering and construction of crude storage tanks and terminals, ongoing maintenance repair work, refinery turnarounds, retrofitting for renewable fuels, and the installation of natural gas processing infrastructure. With the increasing use of LNG as a low carbon solution for ensuring reliable and affordable power for electricity, heating, cooling, and as an alternative fuel for high horsepower applications, Matrix has emerged as a leader in the design, construction, maintenance, and repair of LNG storage tanks and balance of plant facilities. Major energy companies also rely on us for NGL storage tanks and terminals, such as ethane, ethylene, propane, and butane that feed the global marketplace because of our country's vast, safe, and dependable natural gas availability. Looking forward, the transition to sustainable energy is a broad initiative and will include, among others, hydrogen. This is a market that, while not presently a significant revenue driver for us, will be as we assume a major leadership role in fulfilling the significant infrastructure needs that will evolve. This has created our strong market position in LNG, which is made possible because of our specialty vessel and cryogenic capabilities. The hydrogen market requires these same specialized skill sets. It is not a market that will develop overnight, nor is it one that any contractor can simply step into once it’s developed. The same is true for ammonia and methanol as energy carriers and a means of transporting hydrogen. Drawing on our extensive cryogenic engineering and construction expertise, Matrix is already at work laying the foundation needed to ensure we are at the forefront in providing the needed solutions in this space. For example, we have completed the construction of a hydrogen sphere in the southwestern U.S. and are beginning the engineering for a liquid hydrogen storage sphere for a client on the West Coast, which we will also construct. We're also actively working on a FEED study for a hydrogen production and distribution facility and conducting a feasibility study for a global energy company to develop large-scale liquid hydrogen storage solutions. With an increasing number of hydrogen and ammonia opportunities internationally, we are building strategic relationships with construction organizations, like that recently announced with Tissot Industries and other European partners, which provides the ability to offer complete EPC solutions across the European Union, United Kingdom, Norway, Switzerland, and elsewhere. As shared last quarter, we had communications with several of our long-standing clients, who are also part of the hydrogen hub teams identified to receive funding under the Bipartisan Infrastructure Law. Of course, we continue to be active in our other end markets with robust opportunities and growth potential across each of our reporting segments. As I've said before, our organization has been meaningfully transformed over the past few years, and that transformation is showing up in our performance. We continue to fine-tune the organization and are investing in the technology, systems, and personnel needed to execute our strategy and grow the business. I'll hand the call over to Kevin to review the results.

Kevin Cavanah, Vice President and CFO

Thank you, John. The overall results for the second quarter were in line with our expectations. While revenue was a bit lower than expected, direct margin performance, cost management, bottom line performance, backlog, and liquidity were all at or above our expectations. We generated awards of $231 million, resulting in a book-to-bill ratio of 1.3, our 10th consecutive quarter at or above 1.0. With these awards, we have increased our backlog to $1.45 billion, the highest in company history. Backlog has increased 95% in the last year and 33% in the first half of fiscal 2024. Revenue of $175 million in the second quarter was on the lower side of our range of expectations. The decline compared to first quarter revenue of $198 million was primarily related to the normal timing of project execution on storage construction projects, with the first quarter benefiting from a high level of project procurement. As I mentioned last quarter, our backlog contains larger long-term construction projects. 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 between 3 and 6 months or longer. The contribution to revenue from these projects has been minimal thus far as each move through scope finalization, engineering, and planning stages at its own pace. We expect revenue from these projects to increase modestly in the third quarter and then pick up meaningfully in the fourth quarter and remain at elevated levels throughout fiscal 2025 and 2026. In the meantime, we are encouraged that direct gross margins have returned to historical double-digit levels in the first half of 2024. Project execution was strong once again, but was offset by under-recovered construction overhead resulting from the low revenue volume impacting gross margins by almost 500 basis points. The result was a gross margin of 6%, which was consistent with the first quarter. We expect to see improved overhead recovery in the third quarter and full recovery in the fourth quarter as a result of the revenue ramp we previously discussed. Organizational efficiencies achieved over the last several years continue to benefit our cost structure. Consolidated SG&A expenses were $15.7 million in the second quarter, which is the lowest level since the first quarter of fiscal 2014. This compares to $17.1 million in the first quarter. The decrease in the second quarter was primarily attributable to a reduction in expense associated with the variable accounting for cash settled stock compensation and lower project pursuit costs. The company will continue to control costs to leverage SG&A but expects to see modest targeted increases to support revenue growth as the year progresses. Other income during the second quarter included a gain of $2 million on a $2.7 million sale of a facility in Catoosa, Oklahoma. The facility was previously utilized for our industrial cleaning business, which was sold during the fourth quarter of fiscal 2023. This completes the divestiture and closure of non-core service offerings as part of our strategy to focus the business on our core markets. As expected, the effective tax rate was near 0 for the second quarter, and we expect the effective tax rate to be around 0 throughout the remainder of fiscal 2024. For the second quarter of fiscal 2024, we had a net loss of $2.9 million or $0.10 per fully diluted share, which was similar to the net loss of $3.2 million or $0.12 per share in the first quarter. Moving to the operating segments. In the Storage and Terminal Solutions segment, revenue was $62 million in the second quarter, compared to $90 million in the first quarter of fiscal 2024. First quarter revenues for this segment were positively impacted by the procurement of materials and components for construction projects awarded in the prior fiscal year. We did not have a similar level of procurement in the second quarter. We expect higher revenue volume as we move through the remainder of fiscal 2024 and into fiscal 2025 as large specialty storage project awards transition through contracting, project planning, and mobilization, and into field construction. Gross margin was 2.9% in the second quarter as strong project execution was negatively impacted by 770 basis points from the under recovery of construction overhead costs due to lower revenue. We have allocated additional resources to this segment to support recent awards, a significant opportunity proposal pipeline, and the related additional revenue that we expect in the coming quarters. With revenue increases in this segment, we expect to reach full recovery of construction overhead costs in the first quarter. In the utility and power infrastructure segment, revenue was $40 million in the second quarter compared to $32 million in the first quarter as revenue begins to benefit from peak shaver projects previously awarded. We expect LNG peak shaving revenue to continue to increase as we move through the second half of fiscal 2024. Gross margin was 3.5% in the second quarter of fiscal 2024 as good project execution in this segment was offset by almost 600 basis points from the under recovery of construction overhead costs. We've allocated additional resources to this segment as well to support recent awards, a strong bidding environment, and related anticipated revenue growth. As revenue continues to increase in this segment, we expect to reach full recovery of overhead costs in the fourth quarter of fiscal 2024. Finally, in the Process and Industrial Facility segment, second quarter revenue was $71 million, slightly lower than the $75 million in the first quarter. We expect revenue to remain at a similar level as we move through the remainder of fiscal 2024 and then increase in fiscal 2025 related to previously awarded construction work. The segment gross margin was 9.4% in the second quarter compared to 6.8% in the first quarter. With strong project execution in both quarters, we also reduced construction overhead costs in the second quarter by allocating resources to other segments, as I noted previously. Now let's discuss our financial position. Liquidity increased to $106 million, an improvement of $26 million in the quarter. Positive net cash inflows of $30 million from operations allowed the company to repay all outstanding borrowings on our credit facility of $10 million and increase our cash balance by $20 million. We expect to see cash and liquidity also improve in the second half of fiscal 2024. We'll continue to proactively manage the balance sheet to support the improving business and believe we have the liquidity to support our financial needs, including funding working capital for the normal spring peak and reimbursable work, funding construction projects that are in a prepaid position, and targeted capital expenditures to support operations. As we move forward and continue to strengthen our balance sheet, we will evaluate our approach to capital allocation to ensure we are creating value for our shareholders. That concludes my prepared comments, so I'll now turn the call back to John.

John Hewitt, President and CEO

Thank you, Kevin. Before we open for questions, I'd like to reiterate some key takeaways for today. First, with record high backlog, we expect to see a marked improvement in revenue volumes in the near term. Those higher revenue volumes will provide for better construction overhead absorption, leverage of SG&A, and improved bottom line performance. But it's difficult in our business to accurately predict the timing of awards, starts, and backlog conversion to revenue, and we are highly confident in this outlook. Second, we believe our strategic approach to our strong end markets, clients, and services will help us maintain a sizable opportunity pipeline and lead to further backlog growth and strong performance well into the future. Third, organizationally, we are leaner and more efficient. We'll continue to invest in the processes, systems, and people needed to drive performance improvement and deliver strong project execution. In conclusion, there is a lot of positive momentum in the business, and we are well positioned to maximize our profitability and generate value and growth for our stakeholders. I'd like to open the call for questions and then come back to you for some closing thoughts.

Operator, Operator

Thank you. Our first question comes from John Franzreb of Sidoti & Company. Your line is open.

John Franzreb, Analyst

Good morning, everyone, and thanks for taking the questions. I'd like to start with the gross margin profile in the second quarter. Considering how much revenue was down and when you look at it versus a year ago, was sizably better. How much reflects the absence of unprofitable jobs and how much reflects new jobs priced appropriately in that mix? Can you give us a sense of what drove the margin in the quarter?

Kevin Cavanah, Vice President and CFO

As I talked about on the call, the direct gross margins in the quarter were strong in the double-digit area that we've been striving to reach. That's the result of the quality of bookings we've had over the last year and a half. If you look at the same period last year, the direct margins were extremely low – low single digits. That was due to the combination of still working off the COVID backlog while continuing on projects that were very difficult for us to complete profitably. So when you look at the margin performance quarter-over-quarter, it's an extremely big improvement. I don't have to split between what's related to new projects versus the old, but suffice to say the margin performance is where we need it to be on these projects. Now what's left is to get revenue volume up to where we want it so we can fully recover our construction overhead.

John Franzreb, Analyst

And Kevin, just for clarity's sake, what's your definition of direct gross margins?

Kevin Cavanah, Vice President and CFO

So I think about direct gross margins as the actual margin that I'm earning on each individual job. When I think about gross margin, it's the combination of those direct margins on jobs, combined with the recovery of our construction overhead pool of costs that we utilize to manage all those projects. So when we have a period where we've got the right volume and are fully recovering those overheads, then the direct gross margins are fairly equal to the gross margin. In a period where our revenue volume is low, and we're not fully recovering that overhead, the under-recovery can have a very significant impact on our margins, which it did this quarter, by almost 600 basis points. That is something that's extremely important for us to manage, and it's the one item that John noted in his comments that we've still got to get completed. We completed everything else. We just need to convert the strong backlog we've booked the last year plus to revenue, which we think is coming.

John Franzreb, Analyst

And, John, regarding the awards cycle, what innings do you think you're in? Is it unreasonable to assume that you can persist at the current rate of awards?

John Hewitt, President and CEO

No, I don't think that's unreasonable. Timing is everything, and whether it will be above 1 quarter after quarter, but certainly I think we're in a position to exit the year with a book-to-bill over one and projects that are in our pipeline of a variety of sizes. We believe we are still in early innings in our ability to continue adding good projects to backlog and grow the business.

John Franzreb, Analyst

Okay. Got it. That sounds great. And one last question. If I heard correctly in the prepared remarks, it sounded like the revenue outlook is strong through fiscal 2026 based on the current bookings profile that doesn't assume any incremental new awards. Is that the proper understanding?

Kevin Cavanah, Vice President and CFO

We always have a portion of our revenue that's what we call book and burn, which will get awarded and burned off in the next quarter or two and then we have the larger projects that have a two and a half to three-year construction period. When we make comments like that, with these larger projects we've added to backlog, we've got much better visibility into the total revenue stream for 2025 and 2026, which gives us the confidence to make that statement.

John Hewitt, President and CEO

If I add on to that, I would say the backlog in place now helps us lay a foundation for the future. Overlaying what we see in the opportunity pipeline gives us confidence that we will be able to have a strong revenue stream in the next couple of years.

John Franzreb, Analyst

Great. That's great, John. I appreciate it. I'll get back in the queue and let somebody else go. Thank you.

Operator, Operator

Our next question comes from the line of Brent Thielman of D.A. Davidson. Your line is open.

Brent Thielman, Analyst

Hi. This is Jean Ramirez for Brent Thielman. D.A. Davidson. I'll start with the revenue question. Should we see some revenue progression from the second fiscal quarter to the third? It seems like this should be sort of a trough for revenue given the sizable backlog today.

Kevin Cavanah, Vice President and CFO

Yeah. We would agree with that. I think this will be the low point of the fiscal year. You'll see some decent growth here in the third quarter and then should be higher growth in the fourth.

Brent Thielman, Analyst

Okay. Thank you. Just a follow-up on the refinery turnaround season and activities you performed there. Just wanted to see if it's better or worse relative to the past few years.

Kevin Cavanah, Vice President and CFO

We're entering our refinery turnaround cycle now. Majority of our refinery turnaround work is located in the Pacific Northwest. I don't foresee anything unusual this year compared to last year. I would say it's been an average turnaround cycle for us in those facilities.

Brent Thielman, Analyst

Thank you. And one more question. You mentioned favorable direct margins. Are those continuing to get better with the work awarded in New York, or in other words, do the bid margins keep moving higher because the market's so busy right now?

John Hewitt, President and CEO

When we look at the margin performance in the first half of fiscal 2024, we've had some good project closeouts that have helped move that margin up. I'm really pleased with the overall strong execution by our field, which has also contributed. I think that will be replaced by the quality backlog we've got. Those projects should lend themselves to a similar level of margin. We strive to maximize direct margin performance but I wouldn't expect direct margins to go significantly higher than the 10% to 12% range we've discussed as the normal range for the business. You also need to remember that 30% to 40% of our business is reimbursable and a lot of maintenance activities, which leads to a lower margin profile. So instead of a double-digit margin, we’re in the high single digits for that type of work.

Brent Thielman, Analyst

Perfect. I appreciate the color. I'll hop back in and let someone else ask some questions.

Operator, Operator

Looks like we have a question from John Franzreb of Sidoti & Company. Your line is open.

John Franzreb, Analyst

Thank you. John, just back to the hydrogen discussion, I might have missed this. You said it was small, but put it in context how much business you do in the hydrogen market. What do you think maybe the potential is and the timeline for realizing that kind of potential?

John Hewitt, President and CEO

It's about how fast the U.S. transitions to a higher percentage of hydrogen in the energy mix. We feel comfortable long term that hydrogen will take a larger position in the U.S. energy mix, whether that's for industrial processes, transportation fuel, or some kind of blending for power generation. We're laying the foundation for that future, spending time on marketing and providing feasibility and FEED studies to various clients. We're picking up occasional storage sphere or smaller hydrogen processing facility projects. I expect this to continue to grow for us over the next years, but we're probably a couple of years away from it having a material impact on our backlog and revenues from hydrogen. That said, I anticipate we will continue to add small hydrogen-related projects into our backlog over the next 12 to 18 months, which should continue to grow subsequently.

John Franzreb, Analyst

Understood. And just a little about the leverage discussion. Kevin, you suggested that the second quarter SG&A was artificially low due to the timing of bonus accruals and other items. However, you also said that you expect to leverage the SG&A line rather significantly in the year ahead. How should we think about SG&A on a go-forward basis? Similar to maybe the first quarter? A marginal increase? Any color on that line would be helpful?

Kevin Cavanah, Vice President and CFO

I think the second half SG&A will probably be higher than the first half. Variable accounting on cash settled stock-based compensation will have a higher expense. We also anticipate project pursuit costs will increase as we continue working to build the backlog, along with other targeted increases needed for the added revenue volume. We're trying to get SG&A to 6.5%, and I think we'll make significant progress towards that, especially in the fourth quarter. I'm not sure if we'll get all the way there, but I believe we can get close—hopefully to 7% or lower—and then achieve that target in fiscal 2025.

John Franzreb, Analyst

And when you talked about asset relocations, just about moving personnel from process into utility and storage, not adding additional personnel. Am I understanding that properly?

Kevin Cavanah, Vice President and CFO

Yes. There are really two aspects of the construction overhead. First, when we talk about reallocating resources, our staff can work in multiple segments. Given the volume of revenue that was flowing through the process and industrial facility segment last year, the percentage of completion was definitely higher. As that work completed, we're reallocating those resources to the other segments. Those resources—project management, quality, safety—are being more focused on the other two segments in the second half of the year compared to the prior year.

John Franzreb, Analyst

Okay. And just lastly, on the long-term financial targets, any kind of update on when we would expect to realize those targets? Is that by the end of fiscal 2025? What are your thoughts there?

Kevin Cavanah, Vice President and CFO

You can see significant movement toward those targets at the end of the fourth quarter. Will we get all the way there? I'm not sure about that, but I do believe those are achievable in fiscal 2025.

John Franzreb, Analyst

Great, guys. Thank you for taking my follow-ups.

Operator, Operator

It looks like we have follow-up questions from the line of Brent Thielman of D.A. Davidson. Your line is open.

Brent Thielman, Analyst

Hi. Just thinking about CapEx. Can you give us a sense of how we should be modeling CapEx for the year or the next couple of years? Should we think of it tied to revenue growth? There are some costs to support all of this growth, right?

Kevin Cavanah, Vice President and CFO

It is tied to revenue growth, and as we've controlled costs in the last few years, we've held our capital spending pretty low. I'd expect it to increase. Our long-term target is around 1.5% of revenue. I'd predict we’ll be around that level for the second half of the year or potentially a little higher as we ramp up some of that CapEx corresponding to the increase in revenue volumes. I don’t have a fiscal 2025 CapEx budget yet, but I expect we will be at least at the 1.5% level next year, possibly a little higher.

Brent Thielman, Analyst

And for fiscal year 2025, when you say a little higher, is that compared to the second half of fiscal year 2024 or just in general, a little higher than 1.5%?

Kevin Cavanah, Vice President and CFO

I'm talking about a little higher as a percentage of revenue. So when I mention the 1.5%, it could be around 1.8% or 2%. However, I don't have a developed CapEx forecast yet; I'm just anticipating needs for the parts of the business that are growing.

Brent Thielman, Analyst

Perfect. Makes sense. I appreciate the follow-up. Thank you so much.

Operator, Operator

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to John Hewitt for any closing remarks.

John Hewitt, President and CEO

I want to thank everybody for being on the call today. I hope it's clear that there are a lot of great things happening in the business and that we are positioned for significantly improved bottom line profitability as you look out into the short term. Thank you very much for your time today, and everybody, please be safe.

Operator, Operator

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to John Hewitt for any closing remarks. I want to thank everybody for being on the call today. I hope it's clear that there are a lot of great things happening in the business and that we are positioned for significantly improved bottom line profitability in the short term. Thank you very much for your time today, and everybody, please be safe.