Matrix Service Company
Q4 2016 Earnings Call Transcript

Published: 31 Aug 2016

[Operator:]

Good day, ladies and gentlemen and welcome to the conference call to discuss results for the Fourth Quarter and Fiscal Year ending June 30, 2016. [Operator Instructions] As a remainder, this conference call maybe recorded. I would now like to introduce your host for today’s conference, Mr. Kevin Cavanah, Vice President, Chief Financial Officer. Sir, you may begin.

[Kevin Cavanah:]

Thank you. I would now like to take a moment to read the following. Various remarks that the company may make about future expectations, plans and prospects for Matrix Service Company constitute forward-looking statements for 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 the company utilizes non-GAAP measures, the reconciliations will be provided in various press releases and on the company’s website. I will now turn the call over to John Hewitt, President and CEO of Matrix Service Company.

[John Hewitt:]

Thank you, Kevin, and welcome everybody. Good morning. First, a quick stage reminder for our call today. As we begin the school year, it’s a good time to take stock of our driving habits, especially around schools and school buses. According to the National Safety Council, most of the children who lose their lives in bus-related incidents are just 4 to 7 years old and are hit either by the bus or by a motorist illegally passing a stopped bus. Children walking, riding their bikes or being dropped off, and picked up by parents are also in danger. It’s important to slow down and pay attention when kids are present. Here are just a few tips offered by the National Safety Council

[Kevin Cavanah:]

Thank you, John. As John indicated, we are pleased with our fourth quarter results, which were in line with our expectations. Consolidated revenue for the quarter was $360 million, which compares to $364 million in the prior year and a 16% increase over the third quarter of fiscal 2016. Work on Dakota Access and the Napanee Generating Station continue to underpin the storage solutions and electrical infrastructure segments. Gross profit of $34.1 million for the quarter is down from $40.4 million in the prior year quarter. Consolidated gross margins were 9.5% and 11.1% for the same periods respectively. The decline in gross profit and margins was primary the result of continued headwinds in our electrical segment. On a segment basis, quarterly revenue for storage solutions was up 24% to $164 million. The increase is primarily associated with the Dakota Access Pipeline. Gross margins were 11% for the quarter, down from 13.6% a year ago that resulted from positive project closeouts and earned incentives. Margins for the segment were in line with our projected range of 11% to 13%. In our electrical infrastructure segment, revenue of $98 million represented the slight increase versus the prior year as construction progresses on TransCanada’s Napanee Generating Station. Gross margins of 10.4% were higher than 7.9% in the same period last fiscal year but were a little lower than the expected range of 11% to 13% due to under recovery caused by less than expected capital work in the U.S. Revenue for the oil, gas and chemical segment was $64 million in the quarter, they are down from $81 million in the prior year fourth quarter. The decline was due to lower level of capital work performed in the current period. Both quarters were negatively impacted by low turnaround volume. In fiscal 2015, we saw turnarounds deferred and in fiscal 2016, we experienced smaller than normal turnaround work scopes. Gross margins were 6.7% in the quarter versus 7.9% in the same period last year. Margins were low in the quarter due to under recovery of construction overhead costs as a result of low revenue volumes. A return to our long-term expected range of 10% to 12% is dependent upon a return to normal level of turnaround activity and capital work, the timing of which is uncertain. Moving on to the industrial segment, operating results improved over the third quarter of fiscal 2016. However, headwinds persist due to the weak outlook in the segment’s end markets. Revenue for the fourth quarter of fiscal 2016 was $33 million as compared to $55 million in the prior year. Gross margins were 4.7% compared to 15.2% for the same period in the prior year. Prior year gross margins were positively impacted by project closeouts while current year margins were negatively impacted by low volume. The outlook for the industrial segment remains difficult in the near-term and we continued to adjust the cost structure accordingly. Consolidated SG&A expenses decreased to $20 million for the fourth quarter of fiscal 2016 compared to $22 million in the same period last fiscal year. The cost decrease is the result of efficiency improvements and reduced incentive compensation. Earnings per share of $0.34 was in line with our expectations for the quarter due to strong performance in the electrical infrastructure and storage solutions segments. With regard to the 12 months results, revenue of $1.3 billion was essentially flat in the difficult market when compared to fiscal 2015. Strong revenue growth in both electrical infrastructure and storage solutions, which were up 35% and 12% respectively, over the prior fiscal year, were offset by declines in our other three segments. Gross margins of 9.6% for the year is up from 6.5% a year earlier, the latter of which was impacted by significant project charge during the year. Consolidated SG&A was flat year-over-year exclusive of a bad debt charge of $5.2 million incurred during the second quarter along with acquisition related costs of $1.2 million. Including these two items, actual SG&A expense was $85 million in the fiscal year. From an earnings perspective, the strong fourth quarter allowed us to complete fiscal 2016 with earnings per share of $1.07, which is within our previous guidance range of $1 to $1.10. During the year, we improved liquidity significantly while spending capital expenditures of $13.9 million, the acquisition of Baillie Tank Equipment for $13 million and repayment of $1.9 million of acquired debt. We also fully paid off the revolver under our senior credit facility, which has an $8.8 million balance at the beginning of the year. In addition, in the fourth quarter, the company repurchased $5 million worth of stock, bringing full year share repurchases to $10.5 million. Our cash balance of $72 million along with availability under our senior credit facility provides liquidity of over $230 million versus $175 million of liquidity at the end of fiscal 2015. This financial strength and liquidity continue to support our business objectives, which include executing on our strategic plans, funding working capital, funding capital expenditures, with a target below 1.5% of annual revenue, pursuing strategic acquisitions and opportunistic share repurchases. Moving on to guidance for fiscal 2017, we expect full year revenue between $1.3 billion and $1.45 billion and earnings of $1.10 to $1.40 per fully diluted share. We believe that this guidance reflects the quality of our backlog and the opportunity pipeline along with the current market uncertainty. I will now turn the call back to John for closing remarks.

[John Hewitt:]

Thank you, Kevin. Before we open the call up for questions, I would like to thank our employees for their dedication and commitment to our core values for delivering exceptional service to our customers and for producing a record safety year for our company. To each of you, I say thank you. To our shareholders, thank you for your continued trust in our management and our company. With that, we would like to open up the call for questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Matt Duncan of Stephens Incorporated. Your line is now open.

[Will Green:]

Hey, good morning guys. This is Will on the call for Matt.

[John Hewitt:]

Good morning.

[Will Green:]

Good morning. I appreciate the details on where construction stands on both of your large projects, but can you talk more about how you are tracking on the Dapple terminals and Napanee project relative to both budget and schedule?

[John Hewitt:]

No. I mean, we generally don’t give that kind of detailed information about any of our projects and I am not going to start now, both our clients are public companies and I don’t – we don’t – I don’t know what they are telling their stakeholders and so we don’t want to get cross purposes for what they have got going on. So, we wanted to give you guys a high level of progress on both of those jobs, which we did. But I think as a general rule of thumb, we have not in the past on really any size of our projects told you guys percent complete or how we are doing against the budget or anything else and I do not like to start.

[Kevin Cavanah:]

And Will, if you look at the margin performance in both those segments, there were good strong margins in the quarter reflecting the execution. Neither segment benefited this quarter from any unusual project closeouts that sometimes results in our margin pumping up a little higher. So, it’s just – they both just reflect good project execution.

[Will Green:]

Okay. And as we look at backlog spend steadily declining as you work off those large projects, but it sounds like you expect better bookings going forward. Do you expect backlog levels to grow from here by the end of calendar 2016 as well as by the end of fiscal ‘17 as you look at those bookings?

[Kevin Cavanah:]

Yes, I think what we are seeing in our pipeline and our bookings, there aren’t – there isn’t any one specific project that is the size of those two, where we added some pretty significant backlog as we talked about at the end of ‘15 with those two jobs. So, I don’t want to walk away from the call saying I was looking at a way to book another $200 million job, that’s not what we see in our pipeline. What we see in our pipeline are multiple projects of smaller size, many of which or couple of which that we have been selected, but have not been put in a position with that client to do a press release yet because of the timing of the situation. We have other projects that were either on the shortlist or we are negotiating terms and conditions for. So, I think – and we have talked about this earlier that we sort of felt like towards the end of 2016, our backlog will start to flatten out. And so I think based on what we are seeing in the pipeline and the potential for projects, I think that’s probably kind of where we are going to be. We are going to see backlog start to flatten out a little bit for the organization and start to move back in a positive direction in calendar ‘17.

[Will Green:]

Okay.

[Kevin Cavanah:]

But again, to reinforce what we said in our prepared remarks, the level, the current level of our backlog as a percentage of the anticipated revenue for fiscal ‘17 is not unusual for our business. It’s fairly - fact – it’s at the high end of the range of a backlog level that we entered the year with.

[Will Green:]

Right, okay. Then last thing for me, John, you are sitting on over $70 million in cash and no debt, so you have ample dry powder to grow the business. What kind of acquisitions are you looking at right now and what does the M&A funnel look like?

[John Hewitt:]

The M&A funnel looks fairly strong. Things that we are interested in is again, as we have mentioned we want to grow, expand our electrical infrastructure piece related to delivery with the high voltage work [T&D] [ph]. We have got a great, as we have said before, we have got a great brand position on the East Coast. We want to have that brand position in other areas of the country and so we are actively looking for that, for the right company to do that with. We also would like to continue to add more engineering services, more technical services, maybe some expanded process capabilities with other parts of our oil and gas segment and storage solutions segment. We feel very strongly that as the energy commodities get more into balance that there is going to be significant work terminals and tanks in both crude and LNG and natural gas – other natural gas liquids and we need to make sure we have got the capacity to be able to handle that. So, in general, those are the two of the biggest things right now that we are looking at. And so in the cash balance is great, but as Kevin has talked about on the call before, I mean, we can see some pretty wide swings in our working capital demands as we go through the year on all of these projects.

[Will Green:]

Thank you, guys. Congrats on the good quarter.

[John Hewitt:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of Bill Newby of Davidson. Your line is now open.

[William Newby:]

Good morning, guys. Bill on for John Rogers. Congrats on the good quarter.

[John Hewitt:]

Thank you.

[William Newby:]

First, I was just kind of hoping to follow-up on the bookings opportunities for the remainder of this year and into 2017, I was wondering – hoping you could provide some color on just where you are seeing the majority of those opportunities in terms of end market, any more commentary there would be great?

[John Hewitt:]

Where we are seeing the most of the opportunities will be in two segments, electrical infrastructure and in storage solutions, for the most part. While we have some – while we see some good opportunities, we think in oil gas & chemical, with some potential turnarounds maybe some larger – potential for some larger turnarounds in the back half of this fiscal year as well as some plant expansion opportunities, I would say the preponderance of those two opportunities and those two segments [indiscernible] I just talked about. Now, we do have a couple of things that would be industrial related, but they are a little bit – potentially a little further out, but there we are doing some feed work on some projects that we can’t totally talk about at the moment, but could convert themselves into EPC opportunities for us. Are we still on?

[Operator:]

Our next question comes from the line of Matt Tucker of KeyBanc Capital Markets. Your line is now open.

[Grier Buchanan:]

Hey, good morning guys. This is Grier Buchanan on for Matt. Congratulations on the quarter. A lot of my questions have been covered. I just wanted to follow-up on the guidance. Could you talk a little bit about your commodity price assumptions and maybe add some color on what you are – how you are thinking about commodity prices at the lower end [Brent] [ph] of that range? Thanks.

[John Hewitt:]

Yes. So, we don’t have mathematical connection between the price of crude and our guidance. I would think our market research and understanding believes that as we are – as we move through the end of this year that we think that and are hopeful that global oil prices will start to stabilize out in the mid to high 50s and we think that’s the level on high 50s to low 60s that’s going to kind of really open up a lot more opportunities for a lot of our clients. And so we are basically – really we look at the guidance based on where we got the backlog and what we see in the funnel today and how we handicap the go and the get percentage of what we see in the funnel. And certainly, a drop in the crude prices back down into the 30s wouldn’t be a good thing. But right now, I don’t think we see that. And the other thing that we are very, very active in right now is LNG for export. While we think many of these projects are second wave of the projects and they could be anywhere from a year to 2 years out before they get put – before they get contracted, but we are very busy with feed work and planning and budgeting for a number of clients related to LNG for export and storage.

[Grier Buchanan:]

That’s helpful, John. Thanks for that color. And then on the – moving to the oil and gas segment, on refinery turnarounds specifically, you guys have made a clear point about continued uncertainty around timing, you are expecting a pickup, I think in calendar – early calendar 2017 due to pent-up demand, has anything changed at all there in terms of your conversations with customers or is that just kind of the baseline assumption based on the delays to-date?

[John Hewitt:]

Yes. I think prior to the past 2 years we said its coming and it hasn’t, so like most people. I think this is based on our planned conversations, what we are hearing from our competitors, what we are hearing from actually equipment and part suppliers to the refiners. I think everybody is sort of pointing towards the back half of our fiscal year ‘17, which is the first – obviously, the first half of calendar ‘17. Whether that is going to be a huge turnaround season or not, I don’t know. But I think most people are feeling that it’s going to be bigger than what we are seeing probably over the past couple of years.

[Grier Buchanan:]

Yes, it makes sense. And then one more in the oil and gas, just curious on in the fiscal fourth quarter what drove the quarter-over-quarter improvement awards in revenues given that’s typically a seasonally lighter quarter?

[John Hewitt:]

In the oil, gas and chemical, our four quarters typically a little bit better. And I would say that we had a little bit more turnaround activity in the fourth quarter than the third, but it was still light.

[Grier Buchanan:]

Okay. Thanks guys. I will jump back in the queue.

[John Hewitt:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of Dan Mannes of Avondale Partners. Your line is now open.

[Dan Mannes:]

Thanks. Good morning everybody.

[John Hewitt:]

Good morning Dan.

[Dan Mannes:]

A couple of follow-ups here, I want to have first talk a little bit more on the guidance, I don’t want to say it’s a wide range, but obviously, what $150 million and $0.30, can you maybe just walk us through some of the key items that could swing this I don’t know for instance if the high end includes a pickup in turnaround business in early calendar ‘17 and the low end doesn’t, if you can maybe walk us through a couple of the swing factors, I think that would be helpful?

[John Hewitt:]

So I will give you a couple of my thoughts and Kevin can chime in here. There is still continues to be this uncertainty in the market and in our ability to be able to win and book work that in some of our segments, a competitive set contractors has gotten a little stiffer, so while we may win more work that could drive down the margins. What is going to take for us to win, what’s the outcome of the presidential race and who gets in office and how that’s going to affect our spending – spending patterns of our clients. I think it’s, so for us it’s this wide range – what you call wide range, which we don’t is that wide, but we will just call this wide range for us is we are trying to allow for the variability and our ability to fill up the rest of our backlog pipeline that we need to do. So again, we see projects out there in front of us. We have got projects that we see coming down the path that what we are going to win on. And what I think last year, or fiscal ‘16, we were caught a little unaware obviously by how quickly the awards and the opportunities were got delayed caught us by surprise and so we are just trying to give a bit of a buffer there for ourselves.

[Kevin Cavanah:]

Yes. So we are 60% booked or a little over 60% booked going into the year, which is normal. But it’s definitely been an uncertain environment for project awards. So I agree with John there. And what that can do is impact how well we recover our fixed cost structure. And so we tried to take that variability into the guidance. It does for the majority of that ranges SG&A is not going to be a very wide range as far as our expectations. And tax rate can have a little bit of variability depending upon the mix of work between U.S. and Canada. But we still don’t see a huge range there, so it’s mainly in the volume of revenues and a little bit in what’s ultimate gross margins we are able to achieve.

[John Hewitt:]

Right. And of course, project outcomes are always important, too. Whether there is anything whether the amount of the size of the project, the outcome of the project, obviously can have a positive or negative effect on our business.

[Dan Mannes:]

Let me ask it another way and your comments on coming in 6% booked is good for you guys and understand you guys have a lot to shorter term book and burn maintenance business and the inclusion of capital projects like Napanee is more of a newer phenomenon, when you think about your booking position in normal or “normal” levels of book and burn and shorter term work, can you get to the bottom end of your guidance range without any larger contract wins, I guess is my question?

[John Hewitt:]

Yes. I think so and as I said I mean, we don’t have an expectation right now of having $400 million project coming in. We think our bookings are going to be what we see coming down the future are going to be individually sub $150 million. And then our normal smaller projects that we do year-in, year-out, I will just say that normally as Kevin said coming into 60%, in a normal sort of environment, we feel really good about that. We would be less concerned about filling up the other 40%, but we are just – we are being a little cautious on the projects that we see that them happening in the timing that we are expecting. And we are going to be able to win those at a gross margin level that we would say is normal for our business.

[Dan Mannes:]

It makes sense. And my final question and somewhat related is, can you walk us through maybe the cadence of the year, because especially given the amount of revenue still to be complete for instance on Dakota Access and the visibility on Napanee, could this maybe a little bit different year, we have a lot more kind of first half visibility rather than second half or as maybe last year you are expecting more of a second half lift versus first, I don’t know if you can maybe give us a little more color on that?

[John Hewitt:]

Yes. So you are right there. I think we went into last year with expecting a much more robust second half of the year and then we saw the awards didn’t come and that didn’t happen. As we go into this year, we have talked about specifically the Dakota Access projects and we are hitting substantial completion in the second quarter. But definitely it puts a little bit higher volume into the first half than what you might see in the second half.

[Dan Mannes:]

Got it, that’s very helpful. Thank you.

[Operator:]

Thank you. And our next question comes from the line of John Franzreb of Sidoti & Company. Your line is now open.

[John Franzreb:]

Good morning guys.

[John Hewitt:]

Good morning.

[John Franzreb:]

John, you touched on the margin variability going forward and I was just wondering is some end markets pricing on the new jobs are tougher than others, can you just talk to that?

[John Hewitt:]

Yes. Well, I mean some of its mix of work, so if you look at our industrial segment, we are working iron and steel and copper. There is less work, some competition is falling away, but the work we are winning there has lower margins to it. It’s more of a mix of maintenance work and less capital works that’s driving those margins down. If you look at our tank business just itself, just tanks, where we are and this phenomenon happens to us. It seems on a cyclical basis what we are bidding just the tank-only projects, where there is multiple tanks associated with it, we have got four to six tanks, that presents a different competitor set than it would have been rather than a one-off tank. When you get a one-off tank, all of a sudden we are competing against a more of a mom-and-pop contractor that’s willing to take a job for a lot less margin just to keep food on the table. And so that can have a tendency, that mixed with the repair and maintenance work there can have a tendency to drive down some of the margins in that end. Oil, gas and chemical, again it’s really all about volume and our ability to recover our construction overheads there that we can’t just shut that off and because we need those people as that work comes back. When you are moving electrical infrastructure, electrical infrastructure I don’t think we are anticipating any real margin pressures there. It will be more about mix of work between when we had maintenance and capital work. That’s kind of my view on the world and Kevin has anything to add to that?

[Kevin Cavanah:]

No, I think you probably covered the big variability.

[John Franzreb:]

Okay, good. And recently, there was an announced proposed merger in the fertilizer market, how does that play into your expectations of a recovery in the industrial side of your business next year?

[John Hewitt:]

So was that the Orascom, CF Industries?

[John Franzreb:]

Agrium and Potash…?

[John Hewitt:]

Yes. I am afraid I don’t have any intelligence there to comment on. I know that for a while, CF Industries was going to buy Orascom’s fertilizer business which eventually fell apart. And – but most of what we are seeing in the fertilizer business, there is a lot of projects out there on the planning stage, but they are getting the financial close has been difficult. Some of that, we believe has been driven by the major cost overruns that Orascom has had on their Greenfield facility and schedule problems they had on their facility in the that we – as we mentioned in our prepared notes, essentially completed our work there, which was we are going very well for us. But their overall project, which is a multi-billion dollar project they have had a lot of problems on. And I think to some extent is shaking up the financial markets a little bit on the ability for these developers to actually put – to meet their financial performance based on what is the cost of building.

[John Franzreb:]

Right. And one last question, what kind of timing you are thinking about adding a follow-on project to Napanee in the power gen market?

[John Hewitt:]

So what we are seeing and what is clear in our prepared remarks is that the market has been shifting on us where there is going to be less projects that are similar to a Napanee where your client is going to play general contractor and they are going to hire an engineer, buy the $4 million of pieces of equipment and hire a contractor. We are seeing more of demand for full EPC solutions. Many of the EPC contractors out there that fit that model which we don’t, because we do not have the internal engineering resources and is difficult for us to find an engineering partner that’s willing to line up with the risks associated with that. So we are going to find ourselves more looking to partner with some of the bigger EPC firms to provide specific packages of work. So, we are – our pipeline now actually is pretty full with projects where we maybe doing centerline erection, which is all the turbine work and the heat recovery steam generator installations or could be all the electrical work and switchyards or could be some of the other mechanical pieces and piping and high energy piping and some of those things. So, we are strategically trying to stay flexible there. So, I would say it’s unlikely that you are going to see us put a major power generation project in our backlog at least for the next couple of years. There are going to be these smaller packages. Now, these smaller packages can be anywhere from $50 million to $150 million each. But our ability to be able to do that, especially in areas of the country where we have got a very strong presence in the union markets, which in general provides some uncertainty for some of the big EPC firms put us in a very good differentiated position, where hopefully we will be able to have multiple of these smaller projects going sort of simultaneously or in a sequential sort of order. And we will provide a much more study flow of backlog and revenue in and out of the company. It was that sort of a good thing and as obviously smaller project like that more defined scope presents less risk for the company.

[John Franzreb:]

Great, great. That’s perfect color. Thank you very much.

[John Hewitt:]

You are welcome.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Matt Duncan of Stephens Incorporated.

[Will Green:]

Hi, guys. Just a quick follow-up for me. Kevin, you kind of hit on it a little bit with your guidance commentary, but I was wondering how about how we should think about quarterly SG&A costs going forward?

[Kevin Cavanah:]

So, I don’t think you are going to see a big variability in quarterly SG&A. The biggest variability in SG&A is just the incentive compensation aspect of SG&A follows how profitable a quarter is. So, our people are earning higher incentives when we are making more money and lower incentives when we are not. So, that’s the biggest piece of viability. I think overall you shouldn’t see much variability and you shouldn’t expect that the huge escalation was really focused on trying to control our overhead cost both the construction overhead and SG&A and to lever those where we can. So, we have still got to go to keep that or get that SG&A percentage as a lower percentage of revenue. We have talked about that in the past this year. We were still around 6%. We would like to get below that and that’s still a goal of ours.

[Will Green:]

Okay, great. Thank you guys.

[Operator:]

Thank you. And I am showing no further questions at this time. I would now like to turn the call over to John Hewitt for closing remarks.

[John Hewitt:]

So, thank you everybody for a good call. Great questions today. And we look forward to talking to you again in the end of the next quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.