Matrix Service Company - Q1 2024

Transcript

Operator (participant)

Good morning, and welcome to the Matrix Service Company Conference Call to discuss results for the first quarter of fiscal 2024. Currently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. 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, the Senior Director of Investor Relations for Matrix Service Company.

Kellie Smythe (Senior Director of Investor Relations)

Thank you, Josh. Good morning, and welcome to Matrix Service Company's First 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. They 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 information about several upcoming investor conferences and corporate access opportunities. On November 14th, we will hold the Matrix Service Company Virtual Annual Stockholder Meeting. You can register to attend as instructed in the proxy or via the Events tab on our Investor Relations website.

We will present at and hold one-on-one meetings at the Sidoti MicroCap Virtual Conference planned for November 15th and 16th, and finally, we will hold a virtual non-deal roadshow hosted by Roth Company in December. If you'd like additional information on any of these events, I invite you to contact us through the Matrix Service Company Investor Relations website. I will now turn the call over to John.

John Hewitt (President and CEO)

Thank you, Kellie, and good morning, everyone. Here at Matrix, we continue to pursue and expect zero injuries across our platform. Broadly, our focus is around accountability, communication, and training to drive better outcomes. Each of us need to be accountable to ourselves and each other as we think about our behaviors, decision-making, and risk awareness, in not only our professional lives, but at home as well. We need to communicate our expectations, why safety is important, and support each other. As a learning organization, training is critical to improve awareness, decision-making, and ultimately, outcomes. Above all, each employee has the authority and the obligation to stop work when they see or feel uncomfortable with the task they or a coworker are about to perform. Three simple questions: What am I about to do? How can I get hurt? What am I gonna do about it?

Are key to keeping yourself and your coworkers safe. Turning to the quarter, we're pleased to update you on the continued momentum in our business and our end markets. We generated awards of $497 million in our fiscal first quarter, surpassing our fourth quarter of fiscal 2023 awards of $464 million. This is our highest project award total in 5 years. Project awards resulted in a book-to-bill ratio of 2.5. Our Storage and Terminal Solutions segment was the standout in the quarter, recording a book-to-bill of 4.6 on the back of a large capital project award. This award is a mid-size LNG liquefaction and storage facility in the eastern U.S., similar to previous small to mid-size LNG projects completed in the past.

This is a project for a client we've done a good deal of work for over the years, which is a testament to our ability to deliver complex projects safely, on time, and with high quality. In our last earnings call, we referenced another LNG project we were awarded in the fourth quarter of fiscal 2023, an LNG peak shaver in our Utility and Power Infrastructure segment. Together, these projects align with our strategy of leveraging our strong cryogenic storage brand and our capabilities in engineering, fabrication, procurement, and construction. Our strategy to offer complete solutions to the growing small to mid-size LNG facility market is creating awards and growth for the company as we expand our brand and capture market share. This market covers a range of uses, such as peak shaving units, backup power plant fuel supply, ship bunkering, rocket fueling, and export facilities.

Our teams have a great reputation executing these types of projects and have built strong client relationships over the years, made clear by continued awards like the most recent one I mentioned above. The pipeline for opportunities in the small to mid-scale LNG market remains strong with both new and repeat clients. Matrix capability to wrap the complete facility around the storage is unique in our markets and among our competition. Considering our current position in a robust market and with the numerous project proposals and bids in progress, as well as the ongoing FEED studies, we expect to keep adding similar projects to our backlog over time. Adjacent to this strong position in the small to mid-size LNG market, our strategy extends to other specialty vessels and facilities for ammonia, ethane, and other natural gas liquids.

In addition, our brand and skill sets extend to hydrogen storage facilities, as well as development of large-scale storage solutions for various clients. We have several clients that are part of the seven hydrogen hub teams recently selected by the Department of Energy to receive funding under the Bipartisan Infrastructure Law. We are in discussion with these clients on how we can assist them in these programs. We believe there will be significant opportunities for our company in not only these hubs, but also a variety of other projects that are taking advantage of the changing energy mix and federal clean energy funding and tax credits. As we look out into the future, we fully expect our backlog and specialty vessel storage and related facilities to continue to grow with a diversified mix of energy projects.

In addition to our storage market strategy, the vision for the rest of the business creates opportunity for growth, expansion, and sustainability and revenue. For example, our position for electrical infrastructure services, from substations to transmission and distribution and other industrial electrical work, presents a strong growth potential for the company in a market that has significant demand of expansion, upgrades, and repair across the country. We are working with technology providers on an increasing number of project opportunities across the country for carbon capture. We continue to be a leading contractor in traditional energy for refinery maintenance and repair, turnarounds, and projects, many of which are focused on lower-carbon process improvements, such as renewable fuel refining. We remain active in crude and refined product storage tanks and terminals, both new build and repair and maintenance.

And finally, midstream gas compression, mining and minerals, chemical and petrochemical, and aerospace projects on an E-only, C-only, or full EPC basis, leverage our engineering capabilities, project skills, and construction experience. These service lines, offerings, and skill sets complement each other and support the growth aspirations of the entire business, market capture, and geographic diversity of our operations. All these end markets continue to be supported by the strong tailwinds and macroeconomic drivers we have discussed before, which include global energy security, domestic energy supply assurance, clean energy transition goals, commodity demand to support renewables and infrastructure upgrades, and industrial reshoring of manufacturing, as well as federal infrastructure investments that will start to meaningfully flow into the project phase during calendar year 2024. I can confidently say that we're executing our strategy from a position of strength.

Our backlog has grown by 27% from the end of the fourth quarter of fiscal 2023, and 126% from a year ago. At $1.4 billion, our backlog is at its highest level since June 30, 2015. Even with $1.6 billion of awards these past 4 quarters, our opportunity pipeline remains steady between $5 billion-$6 billion, providing a strong indication of the potential in our markets and ability to continue our long-term trend of backlog growth. Organization has been meaningfully transformed over the past few years. We are focused on the end markets that present the best opportunity for us to leverage our decades of experience. We have restructured our organization to be more cost-efficient while maintaining our skills, expertise, and strong brand.

We are positioned to safely execute projects with improved operating processes while continuing to deliver best-in-class quality for our customers, and we continue to invest in digital solutions to improve our administrative and project execution performance. While the company is well-positioned with a high-quality backlog that contains larger long-term capital projects, it is important to note that our traditional small-cap projects and recurring repair and maintenance work, which is strategic to our overall portfolio, come in and out of backlog in a shorter time frame. This work has historically represented, on average, over 50% of our annual revenue.

So to be clear, our strategic market focus and positioning, the macroeconomic and industrial drivers, and the steady opportunity pipeline, combined with our transformed organization, will continue to build on our diversified backlog portfolio, which will lay the foundation for the business to grow and be sustainable well into the future. With that, I'll hand the call over to Kevin to review the results.

Kevin Cavanah (VP and CFO)

Thanks, John. Overall, the first quarter of fiscal 2024 was in line with our expectations, highlighted by the strong project awards John previously discussed. Revenue of $198 million during the first quarter was lower than the $206 million in the fiscal 2023 fourth quarter, primarily related to the decrease in the Process and Industrial Facilities segment, which I will discuss shortly, as well as seasonality in our business. The contribution of revenue of newly awarded projects is beginning to benefit the Storage and Terminal Solutions segment, but is still currently limited as the projects progress through engineering and planning stages. Gross margin was 6% in the first quarter of fiscal 2024, compared to a gross margin of 7.1% in the fourth quarter of fiscal 2023.

Despite generally strong project execution, gross margins in the first quarter experienced a 470 basis point impact from the underrecovery of construction overhead costs. Some of these construction overhead resources have been more actively involved in the pursuit and planning of future work. With the improved backlog, more resources will now shift to the execution of projects. On a consolidated basis, we expect to achieve full recovery of construction overhead costs on higher revenue volumes in the second half of fiscal 2024. Consolidated SG&A expenses were $17.1 million in the first quarter, compared to $17 million of SG&A expense in the fourth quarter of fiscal 2023. The first quarter expense includes an additional accrual of $1.6 million associated with the variable accounting for cash-settled stock-based compensation, which increased due to a significantly higher stock price.

The improved stock price is obviously a positive we have all been working to achieve, but it does increase expense related to certain to certain stock-based awards that are subject to variable accounting. This increase was offset by various other lower costs as we manage our cost structure, which includes our continued streamlining of the business, as well as delaying certain costs based on the timing of revenue. Other income during the first quarter included a gain of $2.5 million on the sale of a previously utilized facility, which was no longer strategic to the future of the business. This transaction is just one of many steps we have taken as we focus the business to its core offerings, improve efficiency, and manage our cost structure.

As expected, the effective tax rate for the first quarter was 0%, and we expect the effective tax rate to be around 0% throughout fiscal 2024. So for the first quarter of fiscal 2024, we had a net loss of $3.2 million, or $0.12 per share, compared to a net loss of $0.3 million, or $0.01, in the fourth quarter of fiscal 2023. Now, let me briefly discuss the operating segments. In the Storage and Terminal Solutions segment, revenue increased to $90 million in the first quarter, as compared to $64 million in the fourth quarter of fiscal 2023. Revenue for this segment was positively impacted in the first quarter by the procurement of materials and components for capital projects awarded in the prior fiscal year. We expect revenue to significantly improve in the second half of fiscal 2024.

Gross margin of 5.5% improved over the fourth quarter of fiscal 2023 due to strong project execution, but was still negatively impacted by the under recovery of construction overhead costs. We have allocated additional resources to this segment to support recent awards and additional revenue in the second half of fiscal 2024. As these revenues increase, we expect to eliminate the under-recovery of construction overhead costs in this segment. In the Utility and Power Infrastructure segment, revenue was $32 million in the first quarter, compared to $39 million in the fourth quarter, due to lower volumes of power delivery work during the summer months. LNG peak shaving work added to backlog over the past year is expected to positively impact revenue as we move through fiscal 2024.

Gross margin of 11.4% was positively impacted by strong project execution, which led to favorable project closeouts, as well as in LNG peak shaving projects, which have a better margin profile. In Process and Industrial Facilities segment, revenue decreased to $75 million in the first quarter of fiscal 2024, compared to $103 million in the fourth quarter of fiscal 2023, primarily due to the completion of certain gas processing work, lower refinery volumes during the summer months, and the sale of a non-core business during the fourth quarter of fiscal 2023. Despite generally strong project execution, first quarter gross margin of six, of 6.8% was negatively impacted by low revenue volumes, which led to the underrecovery of construction overhead cost. So now let's move to the balance sheet.

During the first quarter, we utilized $28 million of cash for working capital purposes. This was expected and primarily related to the timing of cash flows on projects. We ended the first quarter with total liquidity of $80 million and $10 million in debt. Our liquidity is comprised of $27 million of unrestricted cash and $53 million of borrowing availability under the credit facility. We also have $25 million of restricted cash to support the facility. We expect to see cash and liquidity increase as we move through the rest of the fiscal year. In fact, an event subsequent to the end of the first quarter also benefits our financial position. In October, we reached a favorable resolution on a long-standing legal dispute with an iron and steel customer that resulted in the receipt of $16.8 million.

The amount collected represented the full amount owed under a reimbursable contract, which the company had pursued for a number of years. Another subsequent event that warrants mention is that with the improving financial position of the company, we repaid all outstanding borrowings under the credit facility in early November. We will continue to proactively manage the balance sheet to support the improving business. On our last call, we provided an outlook for fiscal 2024, which is substantially unchanged. Overall, the results for the first quarter were in line with our expectations. We now expect revenue to be at a similar level in the second quarter and then show strong growth in the second half of the fiscal year as a result of the improved backlog. For the full year, this will create significant year-over-year revenue growth.

The bottom line results will follow a similar pattern as the revenue, with significantly stronger results in the second half of the fiscal year. We also anticipate accelerated movement toward the longer-term financial targets in the second half of the fiscal year. This concludes my prepared remarks, so I'll turn it back to Paul, to, John.

John Hewitt (President and CEO)

Thanks, Kevin. Before we open for questions, I'd just like to reiterate some key takeaways for today. First of all, our strategic approach to the energy and industrial end markets we serve is being validated, given the strength of our awards and ultimately backlog. This is supported by a steady opportunity pipeline across these markets. The timing and volume of project awards, or awards, will not be linear, and there will be some lighter award quarters. But overall, we believe our strategic approach will lead to further backlog growth and strong performance into the future. In the long term, the reshaping of global energy markets, energy supply security, push towards lower carbon activity, and industrial reshoring all create opportunities that we expect will drive our business for years to come. We are well positioned and structured to maximize our profitability and generate value and growth for stakeholders.

With that, I'd like to open the call up to questions.

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one one on your telephone. To withdraw your question, please press star one one again. One moment for questions. Our first question comes from Brent Thielman with D.A. Davidson. You may proceed.

Brent Thielman (Managing Director, Senior Research Analyst)

Hey, great. Thanks. Good morning, John, Kevin, Kellie. I guess, first off, John, wanted to get just your feel for, you know, look, higher cost to capital environment looks to be sustaining going forward. You're still booking work at an elevated pace. Maybe your customers' reaction to that, you know, how that might be impacting the overall kind of business or bookings pipeline. I imagine, you know, maybe the 50% of the business that's smaller project work could potentially be susceptible, but love to get your sense on that.

John Hewitt (President and CEO)

Probably two comments there. One is that we do hear from some customers that they're relooking at their portfolio of projects, capital projects that they're doing, based on the, you know, cost of debt. But I would say that's a pretty small percentage of our entire client base that we're kind of hearing those things from. And a lot of that may be mixed up with individual things that they've got going on within their organization of how they have spent or overspent their capital, you know, in the past year or two. So we're not hearing a lot of that. Two is that it's probably not a great market right now for a developer-led project because of the cost of capital.

But the majority of our clients and the clients where we're seeing a lot of our backlog and backlog growth from are more blue chip companies that they've got a heavy piece of their personal balance sheet and their own cash flows that are funding the projects. And those companies have a tendency to look much longer term on interest rates, the price of energy, demand in the market, and then appreciating that, you know, some of these larger projects take, you know, upwards of three years to get put in place. So currently, I would say we're not seeing a major effect on our business from on this award cycle.

Brent Thielman (Managing Director, Senior Research Analyst)

Great. That's encouraging. I guess second question was on LNG peak shaving projects. You've been really active there, and it sounds like the pipeline's pretty busy there with some, maybe some forthcoming opportunities as well. I think you mentioned the margin profile attached to these is pretty attractive. I was wondering if you could just kind of give us a sense what those look like, maybe relative to kind of the long-term averages you expect from the business from a gross profit perspective. Can these be sort of accretive beyond those targets as you kind of get deeper into execution on them?

John Hewitt (President and CEO)

Well, those projects certainly support our consolidated, long-range forecast for gross margins in the, as we've said in the past, in the 10%-12% range. I think one of the things that support that for those projects is it's a smaller competitive set for us, and the risk and margin profile embedded in the entirety of the project gives us an opportunity to deliver on the margins we need to support the consolidated margin profile of the business. So the levels of contingency and escalation, projects, you know, these projects are getting to be more, repetitive, so we're able to, you know, appreciate the risks better and to, manage the execution better, that we're able to deliver on those margins.

I think those are, you know, a couple of the reasons that help us drive the overall business to this more of a consolidated margin profile.

Kevin Cavanah (VP and CFO)

Yeah, and I think what's key here is the consolidated margin profile. You know, as John said, these projects have good margins, but one of the other added benefits is that, you know, we've talked about under recovery of construction overhead has been a big driver toward our margins not being where we want them to be. And so the volume from these projects will benefit us on that recovery of overhead.

Brent Thielman (Managing Director, Senior Research Analyst)

Great. I appreciate that. I guess the last one, I'll get back in queue. Kevin, I think you sort of indicated, look, as you start ramping up on these projects, you should see increase in cash generation potential. You know, you're essentially debt-free at this point. Seems like you could be building some cash on the balance sheet. I guess two-part question would be, you know, what do you start to think about doing with that cash, John or Kevin? And two, how do we think about kinda the conversion to cash or cash conversion as, you know, again, you start ramping up on these projects, just to get a feel for the cash potential this year?

Kevin Cavanah (VP and CFO)

Yeah. So I do believe that our balance sheet position is gonna improve as we move through the rest of the year. I think that's gonna come from a couple of places. Number one is the improved financial results. Just producing positive earnings is gonna produce positive cash. Secondly, if you look at the mix of work we're gonna do, you know, certainly, there'll be increases in repair and maintenance work that's reimbursable, that we'll have to fund. But I think that'll be more than offset by just the timing of cash flows on the capital projects. So I think that we'll be able to build cash, and our--

I think our initial focus on the use of that cash is gonna be more internal, making sure that we've we've got the right equipment needed for that to support that business. You know, as we've said before, we've been focused on really returning the company to profitability before we get too aggressive on either any other actions, such as M&A, stock buyback, dividend, any of that stuff. Those will be things we consider in the future, but focus this year is really about you know, rebuilding the company's profitability, getting back to the financial targets that we've set.

Brent Thielman (Managing Director, Senior Research Analyst)

Okay, great. Thank you.

Operator (participant)

Thank you. One moment for questions. Our next question comes from John Franzreb with Sidoti. You may proceed.

John Franzreb (Senior Equity Analyst)

Good morning, everyone, and thanks for taking the questions.

Kevin Cavanah (VP and CFO)

John-

John Franzreb (Senior Equity Analyst)

John, congratulations on another great bookings quarter. I wanna start right there. You mentioned in your prepared remarks that you reallocated resources from procurement to execution. Does that kind of suggest that we should think that the incoming booking profile will be a little bit more muted in the next quarter or two as you move to execution? Especially in light of the fact that you also mentioned there's some large projects out there you think that are certainly near-term opportunities.

Kevin Cavanah (VP and CFO)

Yeah, I don't think we have not taken our foot off the gas pedal as it relates to continuing to book projects and awards. You know, these things have a tendency to come in like waves on the ocean, and we've certainly had a strong wave here the past couple of quarters. And we've seen it coming, right? So we appreciate the timing of when our clients are gonna be making decisions on some of these larger projects. And so we're, you know, we're like, we're not taking our foot off that gas pedal, right? We're continuing to pursue projects to build backlog. We're looking out into the future, how we're gonna continue to take a bigger share of that market related to, you know, our storage brand and position in that market.

But you know, we you know, we to effectively chase some of that work, we do engage our project teams, and to you know, not only to help plan and create the estimates and the budgets for that work, but also to you know, talk to our clients, our potential client, you know, about the projects, about how we're gonna execute it. You know, very important for us to put our project and field management in front of our clients. But yes, then they are starting to transition over into the execution phases.

You know, we continue to have proposal-specific people, that's what they do for the organization. And so you know, that doesn't change. And so they will, combined with our business development teams, are continuing to pursue projects to build backlog out in the future.

John Franzreb (Senior Equity Analyst)

Got it. Thanks for the clarity there. Clearly, the under absorption issue has been a problem for some time. Kevin certainly said that the second half of the year is where we'll probably migrate to a much better situation. It seems to me that's largely gonna be led by storage and to a lesser extent, the utility business, but the process will be lagging a bit. Can you kind of review the outlook on the process side? When do you expect that business maybe to turn the corner? I know the expectation is for it to be down this year, but what's the depth and duration of that?

Kevin Cavanah (VP and CFO)

Yeah. So first thing, I think we'll see pretty good growth in both Storage and the Utility segments. For Process Industrial Facilities, you know, we've got a number of things that are impacting the top line for that segment. You know, we've completed some work that we previously have been, you know, trying to get done, but that was pretty significant for the company, an important step. We did sell a non-core business that in the fourth quarter of last year, that impacts that segment. But we've also had some good bookings in that segment. If you go back to, I think it was the third quarter of fiscal 2023, we booked a large capital project. Now that project's a little unique.

There's a longer runway before we really start seeing revenues on that project. It won't really start benefiting us till the first quarter of fiscal 2025. So we have visibility to seeing that these revenues increase, but most of that will happen in the very first part of fiscal 2024, 2025.

John Franzreb (Senior Equity Analyst)

Got it. In regards to your, your long-term financial targets, excuse me. I'm most interested in the 4.5% operating margin, target. What kind of, revenue profile and gross margin profile are you using to get that 4.5%, op margin target? It's certainly better than what I was expecting by the end of next year.

Kevin Cavanah (VP and CFO)

There's a number of things that will go into us getting to that target. We need to get revenue volume up. We've talked previously that to get to where we're fully recovering our construction overheads, we probably need at least $250 million of quarterly revenue to get there. But we also wanna get the SG&A percentage down to 6.5% or lower. In order for that to happen, we probably need that revenue to be even higher than that, get it up to $275 million or so in a quarter. Those are two big drivers.

And then the third one is just, you know, what's the margin opportunity in the full backlog of the business, you know, between the capital part projects and the repair and maintenance projects? And that needs to be north of 10%. So the combination of those three things are what's gonna get us to the 4.5%. And as I said in my comments, all three of those areas are gonna improve and be helping us move toward that make a significant step toward those some financial targets as we complete the fiscal year.

John Franzreb (Senior Equity Analyst)

Great, Kevin. Thanks. Thanks for that. And I guess one last pesky question, regarding the tax rate. You mentioned that you expect it to be approaching zero this year. How does that look in 2025? What's the step function up?

Kevin Cavanah (VP and CFO)

Yeah. So I think it'll be near zero this year. I mean, there's always unique tax issues that could, you know, adjust that, so it could be 0%-5% somewhere this year. Next year, we'll still be utilizing a lot of reserved tax assets, so I'm currently, back of the envelope, projecting that to be somewhere around 10% next year. That's my best guess at this point.

John Franzreb (Senior Equity Analyst)

Okay. That's fair enough. Thank you, everybody, and congratulations again on that strong bookings number.

Kevin Cavanah (VP and CFO)

Thanks, John.

Operator (participant)

Thank you. I would now like to turn the call over to John Hewitt for any closing remarks.

John Hewitt (President and CEO)

Well, a couple things real quickly. First of all, I wanna thank all of our employees for your hard work, for your dedication to quality, and to teamwork that's gone into delivering not only on the strong awards, but also to our execution strategy and improving in the business overall. Certainly want to thank our shareholders for your support through this period. And would leave everybody, again, with a reminder on your personal safety awareness, to ask those three questions: What am I about to do? How can I get hurt? And what am I gonna do about it? And to remember, for our employees, that you do have the authority to stop work, and you have the obligation to do that as well if you see something or feel something, and is unsafe.

So other than that, glad to have spent time with everybody today, and look forward to seeing you in future conferences and calls.

Operator (participant)

Thank you. This concludes today's conference call. We thank you for your participation. You may now disconnect.