Business Context and Reporting Period
Company: Matrix Service Company (Matrix Service)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended December 31, 2010 (Fiscal Year 2011, Q2)
Business Overview: Matrix Service provides construction and repair/maintenance services primarily for the downstream petroleum, power, and petrochemical industries. Operations are divided into two segments: Construction Services and Repair and Maintenance Services. The business is cyclical and dependent on the timing of major customer projects.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended Dec 31, 2010 | 6 Months Ended Dec 31, 2010 |
|---|---|---|
| Revenues | $175,252 | $327,090 |
| Gross Profit | $19,768 | $35,470 |
| Gross Margin | 11.3% | 10.8% |
| Operating Income | $8,632 | $13,745 |
| Net Income | $5,287 | $8,376 |
| Diluted EPS | $0.20 | $0.32 |
| Cash and Equivalents (Dec 31, 2010) | $43,684 | |
| Operating Cash Flow (6 Months) | $(2,602) | |
| Total Liquidity (Cash + Credit Availability) | $103,400 | |
| Backlog (Dec 31, 2010) | $365,967 |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 16.6% ($24.9 million) for the quarter and 13.5% ($39.0 million) for the six months compared to the prior year. This was driven primarily by a 31.0% increase in Construction Services revenues, specifically in Aboveground Storage Tanks and Electrical/Instrumentation sectors.
- Margin Compression: Despite revenue growth, gross margins declined to 11.3% (quarter) and 10.8% (six months) from 12.3% and 12.4% in the prior year periods, respectively. Management attributed this to lower direct margins, partially offset by improved recovery of construction overhead costs.
- Cash Flow: Operating cash flow turned negative at $(2.6) million for the six months ended Dec 31, 2010, compared to positive $11.9 million in the prior year. This was due to a $22.9 million increase in accounts receivable and a $10.4 million decrease in accounts payable, driven by increased business activity and timing of billings.
- Segment Performance: Repair and Maintenance Services revenues remained relatively flat for the quarter but declined 4.5% for the six months, primarily due to lower Downstream Petroleum activity.
Outlook, Risks, and Contingencies
Management Commentary and Outlook
Management expresses cautious optimism. The Aboveground Storage Tank market is strengthening due to Canadian oil sands development and U.S. storage capacity investments. The Electrical and Instrumentation market remains strong due to high-voltage overhauls. However, competition remains high, particularly in repair and maintenance, which is expected to pressure margins in the near term.
Legal Proceedings and Contingencies
- California Pay Practice Class Action: The company settled two class action lawsuits regarding overtime and wage violations. A cumulative charge of $6.1 million was recorded ($5.1 million in fiscal 2010). Final payments of $4.1 million were made in February 2011 following court approval in January 2011.
- Internal Investigation (Fraud): An investigation revealed collusion between a subcontractor and a former employee resulting in improper payments of approximately $1.7 million. The company recorded a $1.3 million liability for overbilling to customers and a $1.3 million receivable for expected insurance recovery. Investigation costs of $0.6 million were expensed in the first two quarters of fiscal 2011.
- Acquired Claims Receivable: The company holds $3.4 million in receivables from the 2009 acquisition of S.M. Electric Company, Inc. Collection may require litigation, and ultimate recovery could differ materially from the recorded amount.
Liquidity and Debt
The company maintains a $75.0 million senior revolving credit facility expiring November 30, 2012. As of December 31, 2010, availability was $59.7 million. The company is in compliance with all covenants, including a Senior Leverage Ratio covenant (max 2.5x EBITDA). Consolidated Funded Indebtedness was $9.0 million, consisting solely of letters of credit.
Investor Verification Checklist
- Working Capital Trends: Verify the sustainability of the $22.9 million increase in accounts receivable and its impact on future cash conversion cycles.
- Margin Recovery: Monitor whether the decline in direct margins is a temporary project-specific issue or a structural shift in the competitive landscape.
- Insurance Recovery: Confirm the status of the $1.3 million insurance claim related to the internal fraud investigation and the timing of collection.
- Backlog Conversion: Assess the quality of the $366 million backlog, specifically the mix of fixed-price vs. time-and-material contracts and the risk of unapproved change orders ($3.3 million included in backlog).
- Credit Covenant Compliance: Ensure continued compliance with the Senior Leverage Ratio and Fixed Charge Coverage Ratio, particularly given the recent amendment to the credit agreement regarding the class action lawsuit charges.