MTRX

Business Context and Reporting Period

Company: Matrix Service Company (Matrix Service)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010 (First Quarter of Fiscal 2011)
Business Overview: Matrix Service provides construction and repair/maintenance services, primarily for the oil and gas, petrochemical, and power industries. Operations are divided into two segments: Construction Services and Repair and Maintenance Services.

Key Financial Metrics

Note: Total liquidity includes $43.3 million in cash and $55.2 million in availability under the senior revolving credit facility.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 10.2% year-over-year, driven by a 25.5% increase in Construction Services revenues ($97.5M vs $77.7M). This was partially offset by a 9.4% decline in Repair and Maintenance Services revenues ($54.3M vs $60.0M).
• Margin Compression: Gross margins declined from 12.7% to 10.3% due to lower direct margins, despite favorable effects from reduced unrecovered construction overhead costs.
• Profitability Decline: Net income decreased 31.5% to $3.1 million. Operating income fell 30.3% to $5.1 million.
• Cash Flow Reversal: Operating activities used $5.3 million in cash compared to providing $4.5 million in the prior year. This was primarily due to increased working capital requirements (higher accounts receivable and costs in excess of billings) and a decrease in accounts payable.
• Segment Performance:
  • Construction Services: Revenues rose due to growth in Electrical and Instrumentation ($29.9M vs $13.5M) and Aboveground Storage Tanks ($40.8M vs $31.4M).
  • Repair and Maintenance: Revenues declined due to lower volume in recurring work, specifically in Aboveground Storage Tanks and Downstream Petroleum.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

Management anticipates continued improvements in the Aboveground Storage Tank and Electrical and Instrumentation markets, driven by Canadian oil sands development and U.S. high voltage overhauls. Conversely, the Repair and Maintenance segment remains soft with downward pressure on margins. Turnaround activity for fiscal 2011 is expected to be average to slightly below average. The company is pursuing international expansion opportunities in Latin America.

Unusual Items and Contingencies

• Internal Investigation: The company recorded a $0.5 million charge in SG&A expenses related to an internal investigation into collusion between a subcontractor and employees, resulting in improper payments of approximately $1.7 million. A liability of $1.3 million was recorded for overbilling to customers, with an offsetting receivable for insurance recovery.
• Legal Settlements: A $4.0 million settlement was reached regarding California Pay Practice Class Action Lawsuits (in addition to $1.9 million previously paid). A cumulative charge of $6.1 million has been recorded for these actions ($5.1M in fiscal 2010, $1.0M in fiscal 2009).
• EPA Penalty: The company paid a $150,000 administrative penalty to settle allegations of non-compliance with reporting requirements.
• Acquired Claims: The company holds $3.4 million in acquired claims receivables from the S.M. Electric acquisition, collection of which may require litigation and could result in material adjustments to future earnings.

Risks and Liquidity

The company operates under a $75.0 million senior revolving credit facility. While currently in compliance with all covenants, management noted that Consolidated EBITDA for the four quarters ended September 30, 2010, was $26.7 million. They expect EBITDA for the four quarters ending December 31, 2010, to be less than $30 million, which may limit the ability to maintain funded indebtedness levels under the Senior Leverage Ratio covenant.

Investor Verification Checklist

• Covenant Compliance: Verify the company's ability to maintain the Senior Leverage Ratio covenant given the projected decline in EBITDA for the trailing four quarters ending December 31, 2010.
• Working Capital Trends: Monitor the sustainability of the $5.3 million cash outflow from operations and the trend in accounts receivable and unbilled costs.
• Legal Exposure: Confirm the final court approval of the $4.0 million California wage settlement and the status of the $1.3 million insurance recovery related to the internal investigation.
• Margin Recovery: Assess whether the decline in gross margins (10.3%) is a temporary anomaly or a structural shift in the Repair and Maintenance segment.
• Claims Collection: Evaluate the collectability of the $3.4 million in acquired claims receivables and the $3.6 million in unapproved change orders included in revenue.