Matrix Service Company - Q3 2023

Transcript

Operator (participant)

Good morning, welcome to the Matrix Service Company conference call to discuss results for the Q3 of fiscal 2023. Currently, all participants are in 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. Kelly Smythe, Senior Director of Investor Relations of Matrix Service Company. Please go ahead.

Kellie Smythe (Senior Director of Investor Relations)

Good morning, and welcome to Matrix Service Company's Q3 fiscal 2023 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 as a result 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. I will now turn the call over to John Hewitt, President and CEO of Matrix Service Company.

John Hewitt (President and CEO)

Thank you, Kelly. Good morning, everyone, thank you for joining us. I'd like to open the call with a congratulations to our operations teams for being recognized for contract group safety achievement at 5 separate refineries by the American Fuel & Petrochemical Manufacturers. These safety recognitions represent the strong commitment and leadership our people bring to the workplace every day. Thanks to all our employees for making safety a critical part of your mission. On our business update, we continue to see very strong award momentum as reflected in total project awards of $309 million in the Q3. This resulted in a book-to-bill of 1.7 for our seventh consecutive quarter at or above 1.0. Year to date, we have been awarded $862 million in projects, up 35% over the same period in the prior fiscal year.

This has resulted in a book-to-bill of 1.3 or greater in each of our segments, and a consolidated book-to-bill of 1.5. We are seeing positive trends in our business as we win projects, build backlog, and execute with our transformed organization. Bidding activity remains robust across all segments. We're confident a strong award cycle will continue. At the end of the quarter, project backlog was $832 million, a 42% increase from the start of the fiscal year, with backlog up across each of our segments. Timing of awards aside, our proposal activity suggests that we will return to a more normalized backlog of more than $1 billion in the near term.

Keep in mind that many of the larger projects we're putting into backlog may take upwards of six months before they have a material impact on revenue, and in rare instances, perhaps longer. In any case, as this improved quality, size, and growing backlog flows more steadily through the business, financial results will improve along with higher, more stable revenues. From a segment perspective, in Storage and Terminal Solutions, our Q3 book-to-bill was 1.3 on awards of $66 million. This segment includes significant near-term opportunities for storage infrastructure projects related to LNG, ammonia, hydrogen, and NGLs. We believe specialty vessel and terminal projects in LNG and NGLs and hydrogen will be key growth drivers for this segment. In our Utility and Power Infrastructure segment, our book-to-bill was 0.7 on awards of $26 million, primarily comprised of power delivery maintenance and smaller capital projects.

Power delivery bidding is very active and the opportunities are expanding as we grow our core utility electrical business through market capture, client expansion, and geographic reach. For LNG peak shaving projects, also part of this segment, the market opportunities continue to be strong and our proposal teams are very busy. These projects have a long proposal process, are much larger in size on an individual basis and less frequent, but provide a much longer sustainable backlog for the segment. We expect to expand this part of the segment backlog in the next two quarters as we convert opportunities to live projects. Finally, in Process and Industrial Facilities, our book-to-bill was exceptionally strong at 2.2 on awards of $217 million, which include a large construction project to upgrade a natural gas compressor station.

Other construction projects of a similar size and nature are currently in the proposal process. We also continue to see demand for refinery maintenance and turnaround work, as well as increasing opportunities in mining and minerals, chemicals and renewables processing facilities. Over the past year, our project opportunity pipeline has stabilized and now consists of $5.6 billion in projects greater than $5 million. This pipeline does not include our normal day-to-day and recurring maintenance and small project activities, which represents approximately a third of our business revenue across all three segments. We continue to actively support and pursue work with our clients in the traditional energy and chemical space, which represents approximately 26% of our consolidated opportunity pipeline. We're also supporting many of these same clients as they invest in projects that deliver on or support the delivery of low carbon energy and industrial infrastructure.

These represent 72% of our pipeline. The skills and expertise that Matrix offers as an engineering and construction contractor position us well to bid and win our fair share of this work, and more so, will provide us with a long, sustainable runway of quality projects. This runway is supported by key market drivers that provide strong tailwinds as client spending decisions are made based on concerns about energy security globally, aging infrastructure, energy reliability domestically, the clean energy transition, and the need for commodities to support these investments. As it relates to federal infrastructure investments, the Inflation Reduction Act is forecast to unlock $3 trillion of infrastructure investments over the next decade, with a large commitment from the government expected to bring springboard for private sector spending.

Dubbed the third great energy revolution, this will significantly accelerate upgrades to electrical infrastructure as well as growth across the hydrogen ecosystem in the U.S. and internationally. From a services and expertise perspective, Matrix has a significant role to play across nearly every aspect of these infrastructure investments, which impacts all 3 of our segments. With respect to hydrogen specifically, this is a mid to long-term opportunity given the market is effectively in the first innings of what will be a multi-decade investment cycle. While several companies in the U.S., including Matrix, have built cryogenic storage spheres for butane and propane, only 2, 1 of which is Matrix, have engineered and constructed cryogenic hydrogen spheres.

considering the massive investment to build out the hydrogen infrastructure both domestically and globally, today the bidding environment for hydrogen sphere storage is very active, and we expect it to be added to our backlog in the coming quarters. We are working on pre-FEED studies with several energy majors to help them develop hydrogen storage solutions both domestically and abroad. Additionally, in support of growing opportunities abroad, we have just signed an exclusive relationship with France-based Tissot Industrie to offer total engineering, procurement, and construction solutions for liquid hydrogen storage across the United Kingdom, Norway, Switzerland, and the European Union. Expect to see a press release about this relationship later today.

As I said earlier, we are in the early innings of an energy revolution, one that will occur globally. Matrix has positioned itself with technology and business partners, key employees, strong brand awareness, and blue chip clients to play a very active role in bringing these various projects to life. Overall, in both the short and long term, the market supports our vision for the future, a growing award and backlog position, and a return to normalized financial performance as this backlog flows through the business. I'll now turn the call over to Kevin to discuss our results. Then we'll open to questions.

Kevin Cavanah (VP and CFO)

Thanks, John. Overall, the operating results for the Q3 were in line with our expectations, except for some additional cost growth as we move towards completion and closeout of our midstream gas processing work. More on this shortly. Our Q3 revenue of $187 million was in line with our expectations as certain projects awarded in prior periods continue to work off, while the contribution to revenue of newly awarded projects is still limited as they progress through engineering and planning stages. We anticipate higher revenue volumes in the Q4 as the newly awarded projects enter the revenue stream. The added revenue of these newly added projects will also have a positive impact on our gross margins.

Our gross margin in the Q3 was 2.4% as a result of under recovery of construction overhead costs on lower revenue in some parts of the business. This impacted the gross margin by approximately 400 basis points. The company also incurred an additional $3.3 million in the quarter related to forecasted costs to complete and close out certain midstream gas processing work, which we expect to be mechanically complete by the beginning of July 2023. This additional cost negatively impacted the gross margin by 180 basis points. Gross margins for the remainder of our work improved as we move towards historical margins. The margin profile of our backlog also continues to improve as we book new projects in line with previously stated ranges.

Consolidated SG&A expenses were $16.9 million in the Q3, which is consistent with the first two quarters of the year. The company continued our focus on cost control and expects to leverage the cost structure as revenues improve beginning in the Q4. During the first two quarters of the year, our effective tax rate was 0. That continued in the Q3 with 1 positive exception. Interest of $400,000 received with tax refunds was recorded as a tax benefit in the quarter. We continue to place valuation analysis on newly generated deferred tax assets and will realize the benefit associated with the deferred tax assets as the company returns to profitability. For the 3 months ended March 31, 2023, we had a net loss of $12.7 million or $0.47 per fully diluted share.

On an adjusted basis, we had a net loss of $8.9 million or $0.33. The primary difference between unadjusted and adjusted earnings in the quarter relates to the valuation allowance placed on deferred tax assets. Turning to our segments, starting with Utility and Power Infrastructure. Revenue for the segment decreased to $35 million in the Q3 compared to $51 million in the Q2, following the completion of peak shaver work included in the first half of the year. Revenue from the awarded peak shaving project added in the Q2 will not begin to benefit revenue until late in the Q4 of fiscal 2023. Q3 gross margin was 8%. This margin was driven primarily by good execution on a mix of reimbursable power delivery work.

As the volume of LNG peak shaving work increases in this segment, we will be able to sustain and exceed this gross margin level. In Process and Industrial Facilities, revenues increased 23% to $100 million in the Q3 compared to $81 million in the Q2. The increase was primarily related to refinery turnarounds and maintenance. The Q3 gross margin of 3.2% was negatively impacted by increased forecasted cost to complete midstream gas processing work discussed previously, which reduced gross profit by $3.3 million for the quarter. Other work in the segment, including refinery turnaround maintenance, aerospace and mining and minerals, which amounted to approximately 80% of segment revenue, produced a gross margin of approximately 10% on strong project execution.

Finally, in Storage and Terminal Solutions, revenues decreased to $52 million in the Q3 as compared to $62 million in the Q2. While project awards have been strong for this segment, with a year-to-date book-to-bill of 1.6, these awards will not begin to generate additional revenue until the Q4. The Q3 gross margin for the segment was a negative 1.6%, as the low revenue volume resulted in substantial under-recovered construction overhead costs. The under-recovery impacted gross margins by 950 basis points. Revenue volume is expected to significantly increase in the Q4 as awarded work accelerates on projects that have a higher gross margin profile. This added revenue will virtually eliminate under-recovery of construction overhead costs for this segment. Now turning to liquidity.

During the Q3, our liquidity increased to $11.9 million as a result of expected decrease in working capital investment and the receipt of tax refunds. Liquidity of $92.4 million is comprised of $48.2 million of unrestricted cash and $44.2 million of borrowing availability. The company also has $25 million of restricted cash to support the credit facility and borrowings of $15 million. The company financial position is sufficient to support the needs of the business, impending growth that will come from the strong award activity achieved throughout fiscal 2023. I will now turn the call back to John.

John Hewitt (President and CEO)

Thanks, Kevin. Before we open up for questions, just some closing thoughts here. I wanna make sure that it's clear the business is making progress toward normalized levels of operations with many parts of the company on plan. While getting there has taken longer than we expected, and by the end of this fiscal year, we will have worked through substantially the lower margin projects that were awarded and impacted during the pandemic period. We've also transformed our organization to be better able to leverage our cost structure as revenues return, improve efficiency, competitiveness, and quality of our delivery.

We've strategically focused the company's business development approach and services platform on a narrower list of existing and new markets with opportunities for sustainable growth now and into the future. Significantly improved our project awards and backlog in terms of both size and margin profile, which we expect to continue. As we move into our Q4 of the fiscal year and toward fiscal 2024, we are positioned to continue our business improvement progress by reaching $1 billion plus in backlog, achieving our revenue expectations, and returning our margin profile to more historical ranges. With that, I'll open the call for questions.

Operator (participant)

Thank you. If you would like to ask a question, please press star 11 on your telephone. We ask as well that you wait for your name to be announced before you proceed with your question. One moment while we compile the Q&A roster for questions. The first question will be coming from John Franzreb of Sidoti. Your line is open.

John Franzreb (Senior Equity Analyst)

Good morning, guys, and thanks for taking the questions. I'd like to start with John, something that you just closed out with regarding the low margin business or unprofitable business that is still running through the P&L. Can you quantify how much that impacted Q3 results? If I heard you correctly, you expect that to be completely done by the Q4?

John Hewitt (President and CEO)

The one specific job, I think Kevin said in his notes, was a little impacted margins by around $3.2 million. That project we are focused on mechanical completion, probably sometime within the first two weeks of July. At which time in a couple weeks after that we'll be turning it over to the client. The material spending related to the project would be over in that timeframe.

Kevin Cavanah (VP and CFO)

John, as far as it goes, you know, on a consolidated basis, I'd say, we're probably in the 15%-20% of revenues at the lower margin type work in the Q3. That percentage should decrease in the Q4 and be, you know, down in the single digits, low single digits as we move into fiscal 2024.

John Franzreb (Senior Equity Analyst)

Okay, got it. Specifically on, let's call it the 2 weaker segments on the quarter, storage and utility. You indicated you expect storage to bounce back sizably by the Q4. Just walk us through what's going on in storage and utility that we should think about as the puts and takes as far as the revenue profile and for the balance of the year, fiscal year?

John Hewitt (President and CEO)

Some of the larger storage awards that we received in Q1 and Q2 just took more time than was usual to get those into a position where we could start spending, you know, more material money from those contracts. Each one had its own story involved with it. Some of them were some regulatory issues that our clients had to get through to allow us to start. Some of it was finalizing contract negotiations, some of the process around those facilities. Then there's engineering upfront for us in order for us to order materials and get ready to put the foundations in place. It's a low piece of the revenue with those.

We're on a couple of those awards, you know, our expectation is, and where our planning is going, we'll be moving into the field on those projects here and be busy in fabrication and construction. Those two things, those two projects alone will have an impact on revenues starting in the Q4. We've been pretty active with some other awards and bookings for various storage projects that are gonna get started in a more earnest fashion in the Q4. On the Utility and Power Infrastructure side, you know, again, I think we're finding, you know, it's very active on the power delivery side with our bidding environment.

We're expanding our client base and a little bit of our geography from an organic perspective. We are, our revenues in that space include more transmission work than they have historically for us. That's been helping to drive revenues and margins. We expect that trend to continue. We did put in a relatively smaller, peak shaving facility into backlog in the first, I think it was the Q1, Q2.

Q2. Again, that, you know, has some upfront engineering work and things that had to get done before we could start placing orders for equipment and move into the field. So that activities will start here later in the Q4.

John Franzreb (Senior Equity Analyst)

Got it. I guess one last question, and then I'll let somebody else take over. Regarding the bookings that you're doing today, how close are they to being back to you know, normal historic gross margin profile? If some businesses or segment are not up to that level yet, what's the resistance in getting there?

John Hewitt (President and CEO)

Kevin Cavanah here. I would say the majority of the larger project work that we've been booking here this fiscal year are in our historical gross margin profile and, with, I think the right risk profile associated with those. Those awards have been pretty well spread across all the segments. Probably UPI has probably got today's got the smallest volume, but it also has some of the largest opportunities out in the near term, to turn that around. I think those projects, you know, those projects that we've been putting in backlog, this year, all of them are in that historical profile.

Kevin Cavanah (VP and CFO)

Yeah. I'll just add on that the larger projects are definitely in that double-digit gross margin profile. That, you know, if you get to smaller projects, you know, a lot of times those are bid more competitively against, you know, more contractors and the margin opportunity on those projects may not be as high.

John Franzreb (Senior Equity Analyst)

Okay, guys. Thanks. I'll give back into queue. Thank you.

Operator (participant)

Thank you. One moment while we prepare for the next question. Our next question will be coming from Brent Thielman of D.A. Davidson. Brett, your line is open.

Brent Thielman (Managing Director and Senior Research Analyst)

Hey, great. Thanks, guys. John or Kevin, I guess with these Matrix multitude of large projects, I guess picking up here or ramping up, do you think you can get to that $1 billion kinda annual revenue run rate in the Q4? Hello?

Operator (participant)

One moment, please. Please stand by. One moment, Brett.

Can you hear us?

Brent Thielman (Managing Director and Senior Research Analyst)

Kelly, it's Brent Thielman. Can you hear me?

Operator (participant)

Hey, Brent.

Brent Thielman (Managing Director and Senior Research Analyst)

Yeah.

Operator (participant)

We can hear you. Can you hear us okay?

Brent Thielman (Managing Director and Senior Research Analyst)

I can hear you, yeah.

Operator (participant)

That's great.

Okay, great.

Brent Thielman (Managing Director and Senior Research Analyst)

Let me finish your question. The question was, you know, when will we get back into the billion-dollar kinda annual revenue run rate. Based on where we see the opportunities in front of us and the award timing, you know, that should be somewhere in the second or Q3 of 2024 is where we believe we'll be getting into that range.

John Hewitt (President and CEO)

Okay. Okay, I guess maybe off of that, do you still expect an acceleration from here? 'Cause I think there was some anticipation that might come this quarter.

Kevin Cavanah (VP and CFO)

Yeah, you're gonna see some acceleration in our revenues in the Q4 and into the Q1. You know, it's probably gonna be, if you look at it, you know, as a, as a graph, it's gonna be a rise, plateau, a rise, plateau. We think that's kind of a step process will occur as you move into fiscal 2024 and work through those quarters.

Brent Thielman (Managing Director and Senior Research Analyst)

Okay. John, I've heard some other companies talking about sort of future pipeline prospects associated with hydrogen kind of more beyond this year. You mentioned hydrogen storage projects as an opportunity. Is that something you see as early as this year or is some of these things a little further out than that?

Kevin Cavanah (VP and CFO)

Yeah, I mean, we're bidding, you know, the overall hydrogen infrastructure build-out. We, you know, think it's fairly early innings, but there is still a lot of opportunities domestically and internationally for individual hydrogen storage spheres into existing, you know, either industrial facilities or into some of the early regional hubs that are getting built. We're fielding a lot of those projects now. We're bidding a fair amount of them that are both domestically with this new relationship with Tissot we mentioned. We hope to start providing engineering and procurement services to support their efforts in Europe. Feel fairly confident in saying as we move into fiscal 2024, we should start adding more hydrogen projects into our backlog.

You know, right now we're, you know, we're doing some FEED work for some clients on some hydrogen facilities. We're doing some study work to upscale the size of hydrogen storage for a couple of energy majors. Those are not, certainly not big revenue dollars, but they position us very well for what we see to be a pretty large investment cycle moving out in time.

Brent Thielman (Managing Director and Senior Research Analyst)

Okay. Okay, then just, I mean, given the, you guys have sort of maintained, maybe even added the headcount the last few years in anticipation of a better market, which seems to be here now. Obviously pretty good bid pipeline in front of you. When you look at the sort of current position of the company, your overhead, I mean, what level of revenue are you prepared to take on an annual basis knowing that, you know, we're working our way back towards a $1 billion run rate here?

Kevin Cavanah (VP and CFO)

Yeah, good question. I think overall, I think our head count we've kept our head count pretty flat the last couple of years. We might have added a few positions as it relates to specific project needs, would be the only place we've really grown. We've probably decreased some head count administratively, offsetting that. You know, as we, as we look at the cost structure today, you know, it probably supports somewhere around $1 billion, $1.1 billion of annual revenue. There'll be some select positions we'll need to add, you know, depending on which projects make up that revenue stream.

You know, I think one of the important aspects of our financial improvement is, you know, we've talked about a lot on this call, revenue volume increasing, margins improving, but I think the third component is leverage of the cost structure. You know, eliminating the under-recovered construction overhead costs, getting our SG&A percentage down to a lower level. Those are important aspects. As a company, we're gonna be doing all we can to kind of hold the cost structure, while still having the infrastructure we need to execute on the projects. Now, as we return to profitability, there'll be some variable costs that come back in, but on an overall basis, we're planning on holding that cost structure to get the leverage.

Brent Thielman (Managing Director and Senior Research Analyst)

Okay. Very good. Thanks. Thanks all.

Operator (participant)

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

John Hewitt (President and CEO)

Thanks, thanks, everybody, for taking the time today to join us on the call. Wish everybody, be safe out there, and we look forward to speaking with you, on our next call.

Operator (participant)

Thank you all for participating in today's conference call. This concludes today's event. You may all disconnect. Everyone, enjoy the rest of your day.