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MATRIX SERVICE CO - Quarter Report: 2010 December (Form 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended December 31, 2010

or

 

¨ Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from              to             

Commission File No. 1-15461

MATRIX SERVICE COMPANY

(Exact name of registrant as specified in its charter)

 

DELAWARE   73-1352174
(State of incorporation)   (I.R.S. Employer Identification No.)

5100 East Skelly Drive, Suite 700, Tulsa, Oklahoma 74135

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (918) 838-8822

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Inter Active Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of February 4, 2011 there were 27,888,217 shares of the Company’s common stock, $0.01 par value per share, issued and 26,420,517 shares outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         PAGE  

PART I

  FINANCIAL INFORMATION   

Item 1.

 

Financial Statements (Unaudited)

  
 

Condensed Consolidated Statements of Income for the Three and Six Months Ended December 31, 2010 and 2009

     1   
 

Condensed Consolidated Balance Sheets as of December 31, 2010 and June 30, 2010

     2   
 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2010 and 2009

     4   
 

Condensed Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Six Months Ended December 31, 2010 and 2009

     6   
 

Notes to Condensed Consolidated Financial Statements

     7   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     17   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     27   

Item 4.

 

Controls and Procedures

     28   

PART II

  OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     29   

Item 1A.

 

Risk Factors

     29   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     29   

Item 3.

 

Defaults Upon Senior Securities

     30   

Item 4.

 

Reserved

     30   

Item 5.

 

Other Information

     30   

Item 6.

 

Exhibits

     30   

Signature

     30   


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

Matrix Service Company

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(unaudited)

 

     Three Months Ended     Six Months Ended  
     December 31,
2010
    December 31,
2009
    December 31,
2010
    December 31,
2009
 

Revenues

   $ 175,252      $ 150,425      $ 327,090      $ 288,075   

Cost of revenues

     155,484        131,983        291,620        252,215   
                                

Gross profit

     19,768        18,442        35,470        35,860   

Selling, general and administrative expenses

     11,136        11,376        21,725        21,463   
                                

Operating income

     8,632        7,066        13,745        14,397   

Other income (expense):

        

Interest expense

     (197     (188     (367     (362

Interest income

     9        17        22        60   

Other

     83        461        110        544   
                                

Income before income tax expense

     8,527        7,356        13,510        14,639   

Provision for federal, state and foreign income taxes

     3,240        2,823        5,134        5,597   
                                

Net income

   $ 5,287      $ 4,533      $ 8,376      $ 9,042   
                                

Basic earnings per common share

   $ 0.20      $ 0.17      $ 0.32      $ 0.34   

Diluted earnings per common share

   $ 0.20      $ 0.17      $ 0.32      $ 0.34   

Weighted average common shares outstanding:

        

Basic

     26,400        26,273        26,372        26,234   

Diluted

     26,628        26,459        26,584        26,449   

See accompanying notes.

 

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Table of Contents

Matrix Service Company

Condensed Consolidated Balance Sheets

(In thousands)

(unaudited)

 

     December 31,
2010
    June 30,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 43,684      $ 50,899   

Accounts receivable, less allowances (December 31, 2010 - $1,574 and June 30, 2010 - $1,404)

     109,949        87,327   

Costs and estimated earnings in excess of billings on uncompleted contracts

     36,952        40,920   

Inventories

     2,401        3,451   

Income taxes receivable

     655        1,779   

Deferred income taxes

     5,648        8,073   

Prepaid expenses

     3,220        4,557   

Other current assets

     1,096        1,519   
                

Total current assets

     203,605        198,525   

Property, plant and equipment at cost:

    

Land and buildings

     27,801        27,859   

Construction equipment

     52,556        52,086   

Transportation equipment

     19,558        19,192   

Office equipment and software

     14,758        14,358   

Construction in progress

     4,292        1,251   
                
     118,965        114,746   

Accumulated depreciation

     (65,371     (61,817
                
     53,594        52,929   

Goodwill

     27,384        27,216   

Other intangible assets

     4,024        4,141   

Other assets

     2,338        1,997   
                

Total assets

   $ 290,945      $ 284,808   
                

See accompanying notes.

 

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Table of Contents

Matrix Service Company

Condensed Consolidated Balance Sheets

(In thousands, except share data)

(unaudited)

 

     December 31,
2010
    June 30,
2010
 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 35,804      $ 44,769   

Billings on uncompleted contracts in excess of costs and estimated earnings

     39,601        28,877   

Accrued insurance

     7,754        8,257   

Accrued wages and benefits

     12,786        13,538   

Current capital lease obligation

     522        772   

Other accrued expenses

     2,821        6,572   
                

Total current liabilities

     99,288        102,785   

Long-term capital lease obligation

     96        259   

Deferred income taxes

     4,150        4,179   
                

Total liabilities

     103,534        107,223   

Commitments and contingencies

     —          —     

Stockholders’ equity:

    

Common stock - $.01 par value; 60,000,000 shares authorized; 27,888,217 shares issued as of December 31, 2010, and June 30, 2010

     279        279   

Additional paid-in capital

     112,328        111,637   

Retained earnings

     89,625        81,252   

Accumulated other comprehensive income

     1,251        495   
                
     203,483        193,663   

Less: Treasury stock, at cost – 1,469,578 shares as of December 31, 2010, and 1,546,512 shares as of June 30, 2010

     (16,072     (16,078
                

Total stockholders’ equity

     187,411        177,585   
                

Total liabilities and stockholders’ equity

   $ 290,945      $ 284,808   
                

See accompanying notes.

 

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Matrix Service Company

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 

     Six Months Ended  
     December 31,
2010
    December 31,
2009
 

Operating activities:

    

Net income

   $ 8,376      $ 9,042   

Adjustments to reconcile net income to net cash provided (used) by operating activities:

    

Depreciation and amortization

     5,523        5,966   

Deferred income tax

     2,183        601   

Loss(gain) on sale of property, plant and equipment

     15        (27

Allowance for uncollectible accounts

     301        (28

Stock-based compensation expense

     1,031        992   

Tax benefit deficiency from the vesting of deferred shares

     (137     (387

Other

     96        79   

Changes in operating assets and liabilities increasing (decreasing) cash:

    

Accounts receivable

     (22,923     26,257   

Costs and estimated earnings in excess of billings on uncompleted contracts

     3,968        (1,133

Inventories

     1,050        731   

Prepaid expenses and other assets

     1,498        1,097   

Accounts payable

     (10,425     (6,895

Billings on uncompleted contracts in excess of costs and estimated earnings

     10,724        (16,820

Accrued expenses

     (5,006     (7,382

Income tax receivable

     1,124        (180
                

Net cash provided (used) by operating activities

     (2,602     11,913   

Investing activities:

    

Acquisition of property, plant and equipment

     (4,529     (2,849

Proceeds from asset sales

     84        82   
                

Net cash used by investing activities

   $ (4,445   $ (2,767

See accompanying notes.

 

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Matrix Service Company

Condensed Consolidated Statements of Cash Flows (continued)

(In thousands)

(unaudited)

 

     Six Months Ended  
     December 31,
2010
    December 31,
2009
 

Financing activities:

    

Issuances of common stock

   $ 44      $ 65   

Capital lease payments

     (413     (552

Tax benefit of exercised stock options

     25        2   

Payment of debt amendment fees

     (216     —     

Purchase of treasury shares

     (269     (422
                

Net cash used by financing activities

     (829     (907

Effect of exchange rate changes on cash

     661        652   
                

Net increase (decrease) in cash and cash equivalents

     (7,215     8,891   

Cash and cash equivalents, beginning of period

     50,899        52,476   
                

Cash and cash equivalents, end of period

   $ 43,684      $ 61,367   
                

Supplemental disclosure of cash flow information:

    

Cash paid during the period for:

    

Income taxes

   $ 1,695      $ 5,537   
                

Interest

   $ 281      $ 272   
                

Non-cash investing and financing activities:

    

Equipment acquired through capital leases

   $ —        $ 255   
                

Purchases of property, plant and equipment on account

   $ 1,501      $ 50   
                

See accompanying notes.

 

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Matrix Service Company

Condensed Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

(In thousands, except share data)

(unaudited)

 

     Common
Stock
     Additional
Paid-In
Capital
    Retained
Earnings
    Treasury
Stock
    Accumulated
Other
Comprehensive
Income(Loss)
    Total  

Balances, June 30, 2010

   $ 279       $ 111,637      $ 81,252      $ (16,078   $ 495      $ 177,585   

Net income

     —           —          8,376        —          —          8,376   

Other comprehensive income

     —           —          —          —          756        756   
                   

Comprehensive income

                9,132   

Exercise of stock options (12,900 shares)

     —           11        (3     36        —          44   

Tax effect of exercised stock options and the vesting of deferred shares

     —           (112     —          —          —          (112

Issuance of deferred shares (91,749 shares)

     —           (239     —          239        —          —     

Treasury share purchases (27,715 shares)

     —           —          —          (269     —          (269

Stock-based compensation expense

     —           1,031        —          —          —          1,031   
                                                 

Balances, December 31, 2010

   $ 279       $ 112,328      $ 89,625      $ (16,072   $ 1,251      $ 187,411   
                                                 

Balances, June 30, 2009

   $ 279       $ 110,496      $ 76,387      $ (16,146   $ (219   $ 170,797   

Net income

     —           —          9,042        —          —          9,042   

Other comprehensive income

     —           —          —          —          1,053        1,053   
                   

Comprehensive income

                10,095   

Exercise of stock options (11,000 shares)

     —           35        —          30        —          65   

Tax effect of exercised stock options and the vesting of deferred shares

     —           (385     —          —          —          (385

Issuance of deferred shares (145,638 shares)

     —           (398     —          398        —          —     

Treasury share purchases (44,334 shares)

     —           —          —          (422     —          (422

Stock-based compensation expense

     —           992        —          —          —          992   
                                                 

Balances, December 31, 2009

   $ 279       $ 110,740      $ 85,429      $ (16,140   $ 834      $ 181,142   
                                                 

See accompanying notes.

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1 – Basis of Presentation

The condensed consolidated financial statements include the accounts of Matrix Service Company (“Matrix Service”, “we”, “our”, “us” or the “Company”) and its subsidiaries, all of which are wholly owned. Intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X for interim financial statements required to be filed with the Securities and Exchange Commission and do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. However, the information furnished reflects all adjustments, consisting of normal recurring adjustments and other adjustments described herein that are, in the opinion of management, necessary for a fair statement of the results for the interim periods.

The accompanying condensed financial statements should be read in conjunction with the audited financial statements for the year ended June 30, 2010, included in the Company’s Annual Report on Form 10-K for the year then ended. The Company’s business is cyclical due to the scope and timing of projects released by its customer base. In addition, Matrix Service generates a significant portion of its revenues under a comparatively few major contracts, which often do not commence or terminate in the same period from one year to the next. Accordingly, results for any interim period may not necessarily be indicative of future operating results.

Note 2 – Uncompleted Contracts

Contract terms of the Company’s construction contracts generally provide for progress billings based on project milestones. The excess of costs incurred and estimated earnings over amounts billed on uncompleted contracts is reported as a current asset. The excess of amounts billed over costs incurred and estimated earnings recognized on uncompleted contracts is reported as a current liability. Gross and net amounts on uncompleted contracts are as follows:

 

     December 31,
2010
    June 30,
2010
 
     (in thousands)  

Costs incurred and estimated earnings recognized on uncompleted contracts

   $ 806,258      $ 630,342   

Billings on uncompleted contracts

     808,907        618,299   
                
   $ (2,649   $ 12,043   
                

Presented as:

    

Costs and estimated earnings in excess of billings on uncompleted contracts

   $ 36,952      $ 40,920   

Billings on uncompleted contracts in excess of costs and estimated earnings

     39,601        28,877   
                
   $ (2,649   $ 12,043   
                

Progress billings in accounts receivable at December 31, 2010 and June 30, 2010 included retentions to be collected within one year of $10.8 million and $13.2 million, respectively. Contract retentions collectible beyond one year totaled $1.5 million and $0.1 million at December 31, 2010 and June 30, 2010.

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 3 – Goodwill

The changes in the carrying value of goodwill by segment are as follows:

 

     Construction
Services
    Repair and
Maintenance
Services
     Total  
     (In thousands)  

Balance at July 1, 2010

       

Goodwill

   $ 31,427      $ 20,789       $ 52,216   

Cumulative impairment loss

     (25,000     —           (25,000
                         
     6,427        20,789         27,216   

Translation adjustment

     —          168         168   
                         

Balance at December 31, 2010

       

Goodwill

     31,427        20,957         52,384   

Cumulative impairment loss

     (25,000     —           (25,000
                         
   $ 6,427      $ 20,957       $ 27,384   
                         

Note 4 – Debt

The Company has a five-year, $75.0 million senior revolving credit facility (“Credit Facility”) that expires on November 30, 2012. The Credit Facility is guaranteed by substantially all of the Company’s subsidiaries and is secured by a lien on substantially all of the Company’s assets. The Credit Facility is primarily used for the issuance of letters of credit and to fund working capital.

The credit agreement was amended, effective September 24, 2010, to waive the Company’s non-compliance with the Fixed Charge Coverage Ratio covenant as of June 30, 2010, and to add back the charges related to the California Pay Practice Class Action Lawsuits discussed in Note 6 – Commitments and Contingencies, included in Part I, Item 1 of this report, to the calculation of Consolidated EBITDA. The amendment also modified the definition of the Fixed Charge Coverage Ratio.

The credit agreement includes a Senior Leverage Ratio covenant which provides that Consolidated Funded Indebtedness may not exceed 2.5 times Consolidated EBITDA, as defined in the September 24, 2010 amendment, over the previous four quarters. For the four quarters ended December 31, 2010, Consolidated EBITDA, as defined in the credit agreement, was $27.5 million. Accordingly, at December 31, 2010, Consolidated Funded Indebtedness in excess of $68.8 million would have violated the Senior Leverage Ratio covenant.

Availability under the senior credit facility is as follows:

 

     December 31,
2010
     June 30,
2010
 
     (In thousands)  

Credit Facility

   $ 75,000       $ 75,000   

Capacity constraint due to the Senior Leverage Ratio

     6,217         12,049   
                 

Capacity under the Credit Facility

     68,783         62,951   

Letters of credit outstanding

     9,034         11,622   
                 

Availability under senior credit facility

   $ 59,749       $ 51,329   
                 

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Interest rates and fees under the Credit Facility are as follows:

 

   

Amounts borrowed under the Credit Facility bear interest at LIBOR or an Alternate Base Rate, plus in each case, an additional margin based on the Senior Leverage Ratio.

 

   

The additional margin on the LIBOR-based loans is between 2.00% and 2.75% based on the Senior Leverage Ratio.

 

   

The additional margin on the Alternate Base Rate loans is between 1.00% and 1.75% based on the Senior Leverage Ratio.

 

   

The Alternate Base Rate is the greater of the Prime Rate, Federal Funds Effective Rate plus 0.50% or LIBOR plus 1.00%.

 

   

The Unused Revolving Credit Facility Fee is between 0.35% and 0.50% based on the Senior Leverage Ratio.

The credit agreement includes significant covenants and restrictions that include the following:

 

   

Tangible Net Worth must be an amount which is no less than the sum of $110.0 million, plus the net proceeds of any issuance of equity that occurs after November 30, 2008, plus 50% of all positive quarterly net income after November 30, 2008.

 

   

Senior Leverage Ratio must not exceed 2.50 to 1.00

 

   

Asset Coverage Ratio must be greater than or equal to 1.45 to 1.00

 

   

Fixed Charge Coverage Ratio must be greater than or equal to 1.25 to 1.00

 

   

Limits share repurchases to $25.0 million in any calendar year.

 

   

Permits acquisitions so long as the Company’s Senior Leverage Ratio on a pro forma basis as of the end of the fiscal quarter immediately preceding the acquisition is below 1.00 to 1.00 and availability under the Credit Facility is at or above 50% after consummation of the acquisition. If the Senior Leverage Ratio on a pro forma basis as of the end of the fiscal quarter immediately preceding the acquisition is over 1.00 to 1.00 but below 1.75 to 1.00, acquisitions will be limited to $25.0 million in a twelve month period, provided there is at least $25.0 million of availability under the Credit Facility after the consummation of the acquisition.

 

   

Other customary affirmative and negative covenants that place certain restrictions on the Company, including limits on new debt, operating and capital lease obligations, asset sales and certain distributions, including dividends.

The Company is in compliance with all affirmative, negative, and financial covenants under the credit agreement and is at the lowest margin tier for the LIBOR and Alternate Base Rate loans and the lowest tier for the Unused Revolving Credit Facility Fee.

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 5 – Income Taxes

The Company complies with ASC 740, “Income Taxes”. Deferred income taxes are computed using the liability method whereby deferred tax assets and liabilities are recognized based on temporary differences between the financial and tax basis of assets and liabilities using presently enacted tax rates. Valuation allowances are established against deferred tax assets to the extent management believes that it is not probable that the assets will be recovered.

The Company provides for income taxes regardless of whether it has received a tax assessment. Taxes are provided when it is considered probable that additional taxes will be due in excess of amounts included in the tax return. The Company continually reviews exposure to additional income taxes due, and as further information is known or events occur, adjustments may be recorded.

Note 6 – Commitments and Contingencies

Insurance Reserves

The Company maintains insurance coverage for various aspects of its operations. However, exposure to potential losses is retained through the use of deductibles, coverage limits and self-insured retentions.

Typically our contracts require us to indemnify our customers for injury, damage or loss arising from the performance of our services. The Company may also be required to name the customer as an additional insured up to the limits of insurance available, or we may be required to purchase special insurance policies or surety bonds for specific customers or provide letters of credit in lieu of bonds to satisfy performance and financial guarantees on some projects. Matrix Service maintains a bonding line sufficient to support the business. The Company generally requires its subcontractors to indemnify the Company and the Company’s customer and name the Company as an additional insured for activities arising out of the subcontractors’ work. We also require certain subcontractors to provide additional insurance policies, including surety bonds in favor of the Company, to secure the subcontractors’ work or as required by the subcontract.

There can be no assurance that our insurance and the additional insurance coverage provided by our subcontractors will fully protect us against a valid claim or loss under the contracts with our customers.

Material Legal Proceeding

California Pay Practice Class Action Lawsuits

On December 8, 2008 (“December 2008 Action”) a class action lawsuit was filed in the Superior Court of California, Los Angeles County alleging that the Company’s subsidiary, Matrix Service Inc. (“MSI”), and any subsidiary or affiliated company within the State of California had a consistent policy of failing to pay overtime wages in violation of California state wage and hour laws. Specifically, the lawsuit alleged that the Company was requiring employees to work more than 8 hours per day and failing to compensate at a rate of time and one-half, failing to pay double time for all hours worked in excess of twelve in one day, and not paying all wages due at termination. The class sought all unpaid overtime compensation, waiting time penalties, injunctive and equitable relief and reasonable attorneys’ fees and costs. The class included approximately 1,500 current and former employees.

On September 1, 2009 (“September 2009 Action”) a second class action lawsuit was filed in the Superior Court of California, Alameda County also alleging that MSI and Matrix Service Company failed to comply with California state wage and hour laws. The September 2009 Action included similar allegations to the December 2008 Action but also alleged that the Company did not provide second meal periods and third rest periods for employees who worked more than 10 hours in a day, complete and accurate itemized wage statements, compensation for all compensable travel time, and

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

did not take bonus payments into account when calculating the regular wage rate, leading to incorrect overtime rates. The class sought all allowable compensation, penalties for rest and meal periods not provided, restitution and restoration of sums owed, statutory penalties, declaratory and injunctive relief, and attorneys’ fees and costs. The plaintiffs then amended the September 2009 Action to assert damages under the Private Attorney General’s Act. The September 2009 Action increased the class to approximately 2,300 current and former employees.

The cases were coordinated in Alameda County. At the plaintiff’s request, mediation was held on September 7, 2010. In mediation, the parties executed a Memorandum of Understanding awarding the plaintiffs $4.0 million (“September Settlement”). The award was in addition to amounts previously paid to the class members of $1.9 million. The September Settlement was subject to court approval and resolved all class member claims included in the December 2008 Action and the September 2009 Action. The award was designated to pay the class member claims, an enhancement award to the three named plaintiffs, the cost of administration, and the class members’ attorneys’ fees and costs. As a result of these actions and the related settlement, the Company recorded a cumulative charge of $6.1 million, of which $5.1 million was recorded in fiscal 2010 and $1.0 million was recorded in fiscal 2009. The fiscal 2010 charge included an estimate of the cost that will be incurred by the Company for payroll taxes that will be paid in conjunction with the September Settlement.

On January 20, 2011 the Company received final court approval of the September Settlement. Final payments of $4.1 million, which include $4.0 million deposited with the claim administrator in December 2010 and $0.1 million for applicable payroll taxes, are expected to be made in February 2011.

Unapproved Change Orders and Claims

As of December 31, 2010 and June 30, 2010, costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders of $3.3 million and $3.0 million, respectively. There were no revenues related to claims included in costs and estimated earnings in excess of billings on uncompleted contracts at December 31, 2010 or June 30, 2010. Generally, collection of amounts related to unapproved change orders and claims is expected within twelve months. However, customers generally will not pay these amounts until final resolution of related claims, and accordingly, collection of these amounts may extend beyond one year.

Acquired Claims Receivable

The Company continues to pursue collection of the remaining claim receivables included in the purchase of S.M. Electric Company, Inc. in February of 2009. The recorded value at December 31, 2010 of $3.4 million represents the Company’s best estimate of the amounts that will ultimately be collected. However, recovering these receivables may require mediation, arbitration or litigation and the ultimate amounts realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings. All future collection costs will be expensed as incurred.

Other

The Company and its subsidiaries are named as defendants in various other legal actions and are vigorously defending each of them. It is the opinion of management that none of the known legal actions will have a material adverse impact on the Company’s financial position, results of operations or liquidity.

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 7 – Other Comprehensive Income

Other comprehensive income consisted of foreign currency translation adjustments.

 

     Three Months Ended     Six Months Ended  
     December 31,
2010
     December 31,
2009
    December 31,
2010
     December 31,
2009
 
     (In thousands)  

Net income

   $ 5,287       $ 4,533      $ 8,376       $ 9,042   

Other comprehensive income (loss)

     369         (20     756         1,053   
                                  

Comprehensive income

   $ 5,656       $ 4,513      $ 9,132       $ 10,095   
                                  

Note 8 – Earnings per Common Share

Basic earnings per share (“EPS”) is calculated based on the weighted average shares outstanding during the period. Diluted EPS includes the dilutive effect of employee and director stock options as well as the dilutive effect of nonvested deferred shares.

The computation of basic and diluted EPS is as follows:

 

     Three Months Ended      Six Months Ended  
     December 31,
2010
     December 31,
2009
     December 31,
2010
     December 31,
2009
 
     (In thousands, except per share data)  

Basic EPS:

           

Net income

   $ 5,287       $ 4,533       $ 8,376       $ 9,042   
                                   

Weighted average shares outstanding

     26,400         26,273         26,372         26,234   
                                   

Basic EPS

   $ 0.20       $ 0.17       $ 0.32       $ 0.34   
                                   

Diluted EPS:

           

Weighted average shares outstanding - basic

     26,400         26,273         26,372         26,234   

Dilutive stock options

     84         94         80         98   

Dilutive nonvested deferred shares

     144         92         132         117   
                                   

Diluted weighted average shares

     26,628         26,459         26,584         26,449   
                                   

Diluted EPS

   $ 0.20       $ 0.17       $ 0.32       $ 0.34   
                                   

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

The following securities are considered antidilutive and have been excluded from the calculation of diluted earnings per share:

 

     Three Months Ended      Six Months Ended  
     December 31,
2010
     December 31,
2009
     December 31,
2010
     December 31,
2009
 
     (In thousands)  

Stock options

     105         168         106         170   

Nonvested deferred shares

     54         266         128         231   
                                   

Total antidilutive securities

     159         434         234         401   
                                   

Note 9 – Segment Information

The Company has two reportable segments, the Construction Services segment and the Repair and Maintenance Services segment.

The primary services of our Construction Services segment are aboveground storage tanks for the bulk storage/terminal industry, capital construction for the downstream petroleum and power industries, specialty construction, and electrical and instrumentation services for various industries. These services, including civil/structural, mechanical, piping, electrical and instrumentation, millwrighting, and fabrication, are provided for projects of varying complexities, schedule durations, and budgets. Our project experience includes renovations, retrofits, modifications and expansions to existing facilities as well as construction of new facilities.

The primary services of our Repair and Maintenance Services segment are aboveground storage tank repair and maintenance services including tank inspection, cleaning and ASME code repairs, planned major and routine maintenance for the downstream petroleum industry and electrical and instrumentation repair and maintenance for various industries.

Other consists of certain corporate assets.

The Company evaluates performance and allocates resources based on operating income. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales and transfers are generally recorded at cost; therefore, no significant intercompany profit or loss is recognized. Segment assets consist primarily of accounts receivable, costs and estimated earnings in excess of billings on uncompleted contracts, property, plant and equipment and goodwill.

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Results of Operations

(in thousands)

     Construction
Services
     Repair and
Maintenance
Services
     Other      Total  

Three Months Ended December 31, 2010

           

Gross revenues

   $ 107,886       $ 69,855       $ —         $ 177,741   

Less: Inter-segment revenues

     2,282         207         —           2,489   
                                   

Consolidated revenues

     105,604         69,648         —           175,252   

Gross profit

     12,815         6,953         —           19,768   

Operating income

     6,144         2,488         —           8,632   

Segment assets

     141,477         101,964         47,504         290,945   

Capital expenditures

     1,286         93         891         2,270   

Depreciation and amortization expense

     1,516         1,209         —           2,725   

Three Months Ended December 31, 2009

           

Gross revenues

   $ 84,511       $ 69,849       $ —         $ 154,360   

Less: Inter-segment revenues

     3,929         6         —           3,935   
                                   

Consolidated revenues

     80,582         69,843         —           150,425   

Gross profit

     11,894         6,548         —           18,442   

Operating income

     5,006         2,060         —           7,066   

Segment assets

     120,697         88,760         68,806         278,263   

Capital expenditures

     234         719         863         1,816   

Depreciation and amortization expense

     1,647         1,300         —           2,947   

Six Months Ended December 31, 2010

           

Gross revenues

   $ 207,506       $ 124,286       $ —         $ 331,792   

Less: Inter-segment revenues

     4,388         314         —           4,702   
                                   

Consolidated revenues

     203,118         123,972         —           327,090   

Gross profit

     24,159         11,311         —           35,470   

Operating income

     10,923         2,822         —           13,745   

Segment assets

     141,477         101,964         47,504         290,945   

Capital expenditures

     2,158         331         2,040         4,529   

Depreciation and amortization expense

     3,065         2,458         —           5,523   

Six Months Ended December 31, 2009

           

Gross revenues

   $ 165,090       $ 130,025       $ —         $ 295,115   

Less: Inter-segment revenues

     6,837         203         —           7,040   
                                   

Consolidated revenues

     158,253         129,822         —           288,075   

Gross profit

     22,990         12,870         —           35,860   

Operating income

     10,272         4,125         —           14,397   

Segment assets

     120,697         88,760         68,806         278,263   

Capital expenditures

     502         806         1,541         2,849   

Depreciation and amortization expense

     3,330         2,636         —           5,966   

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Segment revenue from external customers by market is as follows:

 

     Construction
Services
     Repair and
Maintenance
Services
     Total  
     (In thousands)  

Three Months Ended December 31, 2010

        

Aboveground Storage Tanks

   $ 49,545       $ 21,868       $ 71,413   

Downstream Petroleum

     22,648         28,386         51,034   

Electrical and Instrumentation

     27,385         19,394         46,779   

Specialty

     6,026         —           6,026   
                          

Total

   $ 105,604       $ 69,648       $ 175,252   
                          

Three Months Ended December 31, 2009

        

Aboveground Storage Tanks

   $ 36,037       $ 25,076       $ 61,113   

Downstream Petroleum

     20,531         39,526         60,057   

Electrical and Instrumentation

     15,988         5,241         21,229   

Specialty

     8,026         —           8,026   
                          

Total

   $ 80,582       $ 69,843       $ 150,425   
                          

Six Months Ended December 31, 2010

        

Aboveground Storage Tanks

   $ 90,325       $ 43,100       $ 133,425   

Downstream Petroleum

     43,575         50,792         94,367   

Electrical and Instrumentation

     57,307         30,080         87,387   

Specialty

     11,911         —           11,911   
                          

Total

   $ 203,118       $ 123,972       $ 327,090   
                          

Six Months Ended December 31, 2009

        

Aboveground Storage Tanks

   $ 67,431       $ 51,867       $ 119,298   

Downstream Petroleum

     44,964         67,207         112,171   

Electrical and Instrumentation

     29,475         10,748         40,223   

Specialty

     16,383         —           16,383   
                          

Total

   $ 158,253       $ 129,822       $ 288,075   
                          

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 10 – Internal Investigation

In connection with a routine project review, the Company determined that a subcontractor and an employee of the Company in one operating location in the United States may have been in collusion to obtain improper payments from the Company. Consequently, the Company, with the assistance of internal audit, forensic accounting specialists and outside counsel, conducted an investigation into this matter which has led to the conclusion that the Company was improperly invoiced for a total of approximately $1.7 million by the subcontractor, a majority of which was in turn paid by the subcontractor to five former employees of the Company over the last four fiscal years. A portion of the improper payments were recorded as costs on cost reimbursable projects. These costs, along with the Company’s mark-up, were subsequently billed to certain customers resulting in an overbilling of $1.3 million, accordingly, the Company recorded a liability of $1.3 million in accounts payable at June 30, 2010. The Company paid $0.4 million in the second quarter of fiscal 2011 to partially settle this liability and expects to settle all refund liabilities in fiscal 2011. The Company believes that the loss to the Company and the first $100,000 of costs incurred to conduct the investigation are covered by the Company’s crime policy and recorded a receivable for the estimated probable loss recovery from insurance of $1.3 million in accounts receivable at June 30, 2010. The Company will submit a proof of claim to its insurer in the third quarter of fiscal 2011. No amounts have been collected as of December 31, 2010.

The Company recorded charges, which are included in selling, general and administrative expenses, of $0.5 million and $0.1 million in the first and second quarters of fiscal 2011 for the cost of the investigation. Since the internal investigation is complete and all significant costs have been identified, the Company does not believe this matter will significantly affect earnings in future periods.

The Company is fully cooperating with law enforcement authorities with respect to this matter.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CRITICAL ACCOUNTING ESTIMATES

There have been no material changes in our critical accounting policies from those reported in our fiscal 2010 Annual Report on Form 10-K filed with the SEC. For more information on our critical accounting policies, see Part II, Item 7 of our fiscal 2010 Annual Report on Form 10-K. The following section provides certain information with respect to our critical accounting estimates as of the close of our most recent quarterly period.

Unapproved Change Orders and Claims

As of December 31, 2010 and June 30, 2010 costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders of $3.3 million and $3.0 million, respectively. There were no revenues related to claims included in costs and estimated earnings in excess of billings on uncompleted contracts at December 31, 2010 or June 30, 2010.

Acquired Claims Receivable

The Company continues to pursue collection of the remaining claim receivables included in the purchase of S.M. Electric Company, Inc. in February of 2009. The recorded value at December 31, 2010 of $3.4 million represents the Company’s best estimate of the amounts that will ultimately be collected. However, recovering these receivables may require mediation, arbitration or litigation and the ultimate amounts realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings. All future collection costs will be expensed as incurred.

Insurance Reserves

We maintain insurance coverage for various aspects of our operations. However, we retain exposure to potential losses through the use of deductibles, coverage limits and self-insured retentions. As of December 31, 2010 and June 30, 2010, the Company recorded insurance reserves totaling $7.8 million, and $8.3 million, respectively. These amounts represent our best estimate of our ultimate obligations for asserted claims, insurance premium obligations and claims incurred but not yet reported. We establish reserves for claims using a combination of actuarially determined estimates and case-by-case evaluations of the underlying claim data and update our evaluations as further information becomes known. Judgments and assumptions, including the assumed losses for claims incurred but not reported, are inherent in our reserve accruals; as a result, changes in assumptions or claims experience could result in changes to these estimates in the future. If actual results of claim settlements are different than the amounts estimated, we may be exposed to gains and losses that could be significant.

Goodwill

The Company’s most recent annual goodwill impairment test, performed in the fourth quarter of fiscal 2010, indicated that the fair value of the Construction Services segment exceeded its carrying value by 75% and the estimated fair value of the Repair and Maintenance Services segment exceeded its carrying value by 61%. Based on the excess of estimated fair value over carrying value and the absence of any indicators of impairment at December 31, 2010, the Company does not currently anticipate recording a goodwill impairment charge for either of its operating units.

Recently Issued Accounting Standards

There are no recently issued accounting standards that we believe will have a material effect on our financial statements.

 

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RESULTS OF OPERATIONS

Overview

The Company has two reportable segments, Construction Services and Repair and Maintenance Services. The majority of the work for both segments is performed in the United States with 5.2% of revenues generated in Canada during the first six months of fiscal 2011.

The primary services of our Construction Services segment are aboveground storage tanks for the bulk storage/terminal industry, capital construction for the downstream petroleum and power industries, specialty construction, and electrical and instrumentation services for various industries. These services, including civil/structural, mechanical, piping, electrical and instrumentation, millwrighting, and fabrication, are provided for projects of varying complexities, schedule durations, and budgets. Our project experience includes renovations, retrofits, modifications and expansions to existing facilities as well as construction of new facilities.

The primary services of our Repair and Maintenance Services segment are aboveground storage tank repair and maintenance services, planned major and routine maintenance for the downstream petroleum industry, specialty repair and maintenance services and electrical and instrumentation repair and maintenance for various industries.

Significant fluctuations in revenues, gross profits and operating results are discussed below on a consolidated basis and for each segment. Revenues fluctuate due to many factors, including the changing product mix and project schedules, which are dependent on the level and timing of customer releases of new business.

Three Months Ended December 31, 2010 Compared to the Three Months Ended December 31, 2009

Consolidated

Consolidated revenues were $175.3 million for the three months ended December 31, 2010, an increase of $24.9 million, or 16.6%, from consolidated revenues of $150.4 million in the same period a year earlier. The improvement in consolidated revenues resulted from a $25.0 million increase in Construction Services revenues while Repair and Maintenance Services revenues were essentially unchanged.

Consolidated gross profit increased from $18.4 million in the three months ended December 31, 2009 to $19.8 million in the three months ended December 31, 2010. The increase of $1.4 million was due to higher revenues offset by lower gross margins which decreased to 11.3% in the three months ended December 31, 2010 compared to 12.3% a year earlier. The decrease in gross margins was due to lower direct margins partially offset by the favorable effect of improved recovery of construction overhead costs in the three months ended December 31, 2010.

Consolidated SG&A expenses were $11.1 million in the three months ended December 31, 2010 compared to $11.4 million in the same period a year earlier. SG&A expense as a percentage of revenue decreased to 6.4% in the three months ended December 31, 2010 compared to 7.6% in the same period a year earlier.

Net interest expense was $0.2 million in the three months ended December 31, 2010 and 2009. Net interest expense for both periods was primarily related to Unused Revolving Credit Facility fees, fees on letters of credit issued under the Credit Facility, amortization of Credit Facility deal and amendment fees partially offset by interest earned on invested cash.

Other income in the three months ended December 31, 2010 and 2009 was $0.1 million and $0.5 million, respectively, and related primarily to foreign currency transaction gains.

The effective tax rates in the three months ended December 31, 2010 and 2009 were 38.0% and 38.4%, respectively.

 

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Construction Services

Revenues for the Construction Services segment were $105.6 million in the three months ended December 31, 2010, compared with $80.6 million in the same period a year earlier. The increase of $25.0 million, or 31.0%, was primarily due to higher Aboveground Storage Tank revenues, which increased to $49.5 million in the three months ended December 31, 2010 compared to $36.0 million a year earlier, higher Electrical and Instrumentation revenues, which increased to $27.4 million in the three months ended December 31, 2010, versus $16.0 million in the same period a year earlier, and higher Downstream Petroleum revenues, which increased to $22.7 million in the three months ended December 31, 2010 compared to $20.5 million a year earlier. Partially offsetting these increases were lower Specialty revenues which decreased from $8.0 million in the three months ended December 31, 2009 to $6.0 million in the three months ended December 31, 2010.

Gross profit increased to $12.8 million in the three months ended December 31, 2010 from $11.9 million in the same period a year earlier due to higher revenues partially offset by lower gross margins which decreased from 14.8% in the three months ended December 31, 2009 to 12.1% in the three months ended December 31, 2010. The decline in gross margins was due to lower direct margins partially offset by improved recovery of construction overhead costs.

Repair and Maintenance Services

Revenues for the Repair and Maintenance Services segment were $69.7 million in the three months ended December 31, 2010 compared to $69.8 million in the same period a year earlier. The decline was due to lower Downstream Petroleum revenues, which decreased to $28.4 million in the three months ended December 31, 2010 compared to $39.5 million a year earlier, and lower Aboveground Storage Tank revenues, which decreased to $21.9 million in the three months ended December 31, 2010 compared to $25.1 million in the same period a year earlier. These declines were almost fully offset by higher Electrical and Instrumentation revenues, which increased to $19.4 million in the three months ended December 31, 2010, compared to $5.2 million a year earlier.

Gross profit increased from $6.5 million in the three months ended December 31, 2009 to $7.0 million in the three months ended December 31, 2010 due to higher gross margins which increased to 10.0% in the three months ended December 31, 2010 compared to 9.4% in the same period a year earlier. The gross margin increase was due to the favorable effect of improved recovery of construction overhead costs partially offset by lower direct margins.

Six Months Ended December 31, 2010 Compared to the Six Months Ended December 31, 2009

Consolidated

Consolidated revenues were $327.1 million in the six months ended December 31, 2010, an increase of $39.0 million, or 13.5%, from consolidated revenues of $288.1 million in the same period a year earlier. The increase in consolidated revenues resulted from an increase of $44.8 million in Construction Services revenues partially offset by a decrease of $5.8 million in Repair and Maintenance Services revenues.

Consolidated gross profit decreased from $35.9 million in the six months ended December 31, 2009 to $35.5 million in the six months ended December 31, 2010. The decrease of $0.4 million was due to lower gross margins which decreased to 10.8% in the six months ended December 31, 2010 compared to 12.4% a year earlier largely offset by the effect of higher revenues. The decrease in gross margins was due to lower direct margins partially offset by the favorable effect of improved recovery of construction overhead costs.

Consolidated SG&A expenses were $21.7 million in the six months ended December 31, 2010 compared to $21.5 million in the same period a year earlier. SG&A expense as a percentage of revenue decreased to 6.6% in the six months ended December 31, 2010 compared to 7.5% in the same period a year earlier.

Net interest expense was $0.3 million in the six months ended December 31, 2010 and 2009. Net interest expense for both periods was primarily related to Unused Revolving Credit Facility fees, fees on letters of

 

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credit issued under the Credit Facility, amortization of Credit Facility deal and amendment fees partially offset by interest earned on invested cash.

Other income in the six months ended December 31, 2010 and 2009 was $0.1 million and $0.5 million, respectively, and related primarily to foreign currency transaction gains.

The effective tax rates for the six months ended December 31, 2010 and 2009 were 38.0% and 38.2%, respectively.

Construction Services

Revenues for the Construction Services segment were $203.1 million in the six months ended December 31, 2010, compared with $158.3 million in the same period a year earlier. The increase of $44.8 million, or 28.3%, was primarily due to higher Electrical and Instrumentation revenues, which increased to $57.3 million in the six months ended December 31, 2010 compared to $29.5 million a year earlier, and higher Aboveground Storage Tank revenues, which increased to $90.3 million in the six months ended December 31, 2010, versus $67.4 million in the same period a year earlier. Partially offsetting these increases were lower Downstream Petroleum and Specialty revenues which decreased to $43.6 million and $11.9 million in the six months ended December 31, 2010, compared to $45.0 million and $16.4 million in the same period a year earlier.

Gross profit increased to $24.2 million in the six months ended December 31, 2010 from $23.0 million in the same period a year earlier due to higher revenues partially offset by lower gross margins which decreased from 14.5% in the six months ended December 31, 2009 to 11.9% in the six months ended December 31, 2010. The decline in gross margins was due to lower direct margins partially offset by the favorable effect of improved recovery of construction overhead costs in the six months ended December 31, 2010.

Repair and Maintenance Services

Revenues for the Repair and Maintenance Services segment were $124.0 million in the six months ended December 31, 2010 compared to $129.8 million in the same period a year earlier. The decline was due to lower Downstream Petroleum revenues, which decreased to $50.8 million in the six months ended December 31, 2010 compared to $67.2 million a year earlier, and lower Aboveground Storage Tank revenues, which decreased to $43.1 million in the six months ended December 31, 2010 compared to $51.9 million in the same period a year earlier. These declines were partially offset by higher Electrical and Instrumentation revenues, which increased to $30.1 million in the six months ended December 31, 2010, compared to $10.7 million a year earlier.

Gross profit decreased from $12.9 million in the six months ended December 31, 2009 to $11.3 million in the six months ended December 31, 2010 primarily due to lower gross margins which decreased to 9.1% in the six months ended December 31, 2010 compared to 9.9% in the same period a year earlier. The gross margin decrease was due to lower direct margins partially offset by the favorable effect of improved recovery of construction overhead costs.

Backlog

We define backlog as the total dollar amount of revenues that we expect to recognize as a result of performing work that has been awarded to us through a signed contract that we consider firm. The following contract types are considered firm:

 

   

fixed-price arrangements;

 

   

minimum customer commitments on cost plus arrangements; and

 

   

certain time and material contracts in which the estimated contract value is firm or can be estimated with a reasonable amount of certainty in both timing and amounts.

For long-term maintenance contracts we include only the amounts that we expect to recognize into revenue over the next 12 months. For all other arrangements, we calculate backlog as the estimated contract amount less the revenue recognized as of the reporting date.

 

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Three Months Ended December 31, 2010

The following table provides a summary of changes in our backlog for the three months ended December 31, 2010:

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Backlog as of September 30, 2010

   $ 224,964      $ 170,263      $ 395,227   

New backlog awarded

     85,108        60,884        145,992   

Revenue recognized on contracts in backlog

     (105,604     (69,648     (175,252
                        

Backlog as of December 31, 2010

   $ 204,468      $ 161,499      $ 365,967   
                        

At December 31, 2010 the Construction Services segment had a backlog of $204.5 million, as compared to a backlog of $225.0 million as of September 30, 2010. The decrease of $20.5 million is due to decreases in Downstream Petroleum of $10.9 million, Specialty of $4.8 million, Electrical and Instrumentation of $2.5 million and Aboveground Storage Tank of $2.3 million. The backlog at December 31, 2010 and September 30, 2010 for the Repair and Maintenance Services segment was $161.5 million and $170.3 million, respectively. The decrease of $8.8 million is due to decreases in Electrical and Instrumentation of $5.1 million and Aboveground Storage Tank of $4.6 million, partially offset by the increase in Downstream Petroleum of $0.9 million.

Six Months Ended December 31, 2010

The following table provides a summary of changes in our backlog for the six months ended December 31, 2010:

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Backlog as of June 30, 2010

   $ 197,675      $ 155,541      $ 353,216   

New backlog awarded

     209,911        129,930        339,841   

Revenue recognized on contracts in backlog

     (203,118     (123,972     (327,090
                        

Backlog as of December 31, 2010

   $ 204,468      $ 161,499      $ 365,967   
                        

At December 31, 2010 the Construction Services segment had a backlog of $204.5 million, as compared to a backlog of $197.7 million as of June 30, 2010. The increase of $6.8 million is due to an increase in Aboveground Storage Tank of $37.2 million, partially offset by decreases in Downstream Petroleum of $17.9 million, Electrical and Instrumentation of $10.0 million and Specialty of $2.5 million. The backlog at December 31, 2010 and June 30, 2010 for the Repair and Maintenance Services segment was $161.5 million and $155.5 million, respectively. The increase of $6.0 million is due to the increases in Aboveground Storage Tank of $4.7 million and Electrical and Instrumentation of $4.7 million, partially offset by a decrease in Downstream Petroleum of $3.4 million.

 

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Non-GAAP Financial Measure

EBITDA is a supplemental, non-GAAP financial measure. EBITDA is defined as earnings before interest expense, income taxes, depreciation and amortization. We have presented EBITDA because it is used by the financial community as a method of measuring our performance and of evaluating the market value of companies considered to be in similar businesses. We believe that the line item on our Consolidated Statements of Income entitled “Net income” is the most directly comparable GAAP measure to EBITDA. Since EBITDA is not a measure of performance calculated in accordance with GAAP, it should not be considered in isolation of, or as a substitute for, net earnings as an indicator of operating performance. EBITDA, as we calculate it, may not be comparable to similarly titled measures employed by other companies. In addition, this measure is not necessarily a measure of our ability to fund our cash needs. As EBITDA excludes certain financial information compared with net income, the most directly comparable GAAP financial measure, users of this financial information should consider the type of events and transactions that are excluded. Our non-GAAP performance measure, EBITDA, has certain material limitations as follows:

 

   

It does not include interest expense. Because we have borrowed money to finance our operations, pay commitment fees to maintain our Credit Facility, and incur fees to issue letters of credit under the Credit Facility, interest expense is a necessary and ongoing part of our costs and has assisted us in generating revenue. Therefore, any measure that excludes interest expense has material limitations.

 

   

It does not include income taxes. Because the payment of income taxes is a necessary and ongoing part of our operations, any measure that excludes income taxes has material limitations.

 

   

It does not include depreciation or amortization expense. Because we use capital and intangible assets to generate revenue, depreciation and amortization expense is a necessary element of our cost structure. Therefore, any measure that excludes depreciation or amortization expense has material limitations.

A reconciliation of EBITDA to net income follows:

 

     Three Months Ended      Six Months Ended  
     December 31,
2010
     December 31,
2009
     December 31,
2010
     December 31,
2009
 
     (In thousands)  

Net income

   $ 5,287       $ 4,533       $ 8,376       $ 9,042   

Interest expense

     197         188         367         362   

Provision for income taxes

     3,240         2,823         5,134         5,597   

Depreciation and amortization

     2,725         2,947         5,523         5,966   
                                   

EBITDA

   $ 11,449       $ 10,491       $ 19,400       $ 20,967   
                                   

 

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FINANCIAL CONDITION AND LIQUIDITY

Overview

We define liquidity as the ongoing ability to pay our liabilities as they become due, fund business operations and meet all monetary contractual obligations. Our primary sources of liquidity for the six months ended December 31, 2010 was cash on hand at the beginning of the year and operational cash flows. Cash on hand at December 31, 2010 totaled $43.7 million and availability under the senior revolving credit facility totaled $59.7 million resulting in total liquidity at December 31, 2010 of $103.4 million.

Factors that routinely impact our short-term liquidity and that may impact our long-term liquidity include, but are not limited to:

 

   

Changes in working capital

 

   

Contract terms that determine the timing of billings to customers and the collection of those billings

 

   

Some cost plus and fixed price customer contracts are billed based on milestones which may require us to incur significant expenditures prior to collections from our customers.

 

   

Time and material contracts are normally billed in arrears. Therefore, we are routinely required to carry these costs until they can be billed and collected.

 

   

Some of our large construction projects may require significant retentions or security in the form of letters of credit.

 

   

Capital expenditures

Other factors that may impact both short and long-term liquidity include:

 

   

Acquisitions of new businesses

 

   

Strategic investments in new operations

 

   

Purchases of shares under our stock buyback program

 

   

Contract disputes or collection issues

 

   

Maintaining full capacity under our senior revolving credit facility and remaining in compliance with all covenants contained in the credit agreement

In the future we may elect to raise additional capital by issuing common or preferred stock, convertible notes, term debt or increase the amount of our revolving credit facility as necessary to fund our operations or to fund the acquisition of other businesses. We will continue to evaluate our working capital requirements and other factors to maintain sufficient liquidity.

Cash Flow in the Six Months Ended December 31, 2010

Cash Flows from Operating Activities

Increased business activity in the six months ended December 31, 2010 led to higher balances in certain working capital accounts which caused operations to use $2.6 million in cash. Working capital changes in the six months ended December 31, 2010 that significantly affected the cash balance at December 31, 2010 include the following:

 

   

Accounts receivable increased by $22.9 million. The increase was caused primarily by increased business activity.

 

   

Accounts payable decreased by $10.4 million. The decrease was due to a large steel purchase late in the prior fiscal year.

 

   

Accrued expenses decreased by $5.0 million. The decrease was primarily the result of a payment of $4.0 million in December 2010 to settle the California Pay Practice Class Action

 

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Lawsuits. The settlement and payment are discussed in Note 6 of the Notes to Condensed Financial Statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

   

The net change in the combined balances of costs and estimated earnings in excess of billings on uncompleted contracts and billings on uncompleted contracts in excess of costs and estimated earnings caused a decrease in working capital and an increase to cash of $14.7 million. This change was primarily attributable to advance billings on Aboveground Storage Tank contracts in the Construction Services Segment.

Cash Flows from Investing Activities

Investing activities used $4.4 million of cash in the six months ended December 31, 2010 primarily due to capital expenditures of $4.5 million partially offset by proceeds received from asset dispositions of $0.1 million. Capital expenditures included $1.8 million for the purchase of transportation equipment, $1.3 million for office equipment and software, $1.1 million for construction equipment and $0.3 million for land and buildings.

Cash Flows from Financing Activities

Financing activities used $0.8 million of cash in the six months ended December 31, 2010 primarily due to capital lease payments of $0.4 million, payment of $0.2 million in fees associated with the September 2010 amendment to the senior revolving credit facility and treasury stock purchases of $0.3 million partially offset by cash received from the issuance of common stock associated with the exercise of incentive stock options and the related tax benefit.

Senior Revolving Credit Facility

The Company has a five-year, $75.0 million senior revolving credit facility (“Credit Facility”) that expires on November 30, 2012. The Credit Facility is guaranteed by substantially all of the Company’s subsidiaries and is secured by a lien on substantially all of the Company’s assets. The Credit Facility is primarily used for the issuance of letters of credit and to fund working capital.

The credit agreement was amended, effective September 24, 2010, to waive the Company’s non-compliance with the Fixed Charge Coverage Ratio covenant as of June 30, 2010, and to add back the charges related to the California Pay Practice Class Action Lawsuits discussed in Note 6 – Commitments and Contingencies, included in Part I, Item 1 of this report, to the calculation of Consolidated EBITDA. The amendment also modified the definition of the Fixed Charge Coverage Ratio.

The credit agreement includes a Senior Leverage Ratio covenant which provides that Consolidated Funded Indebtedness may not exceed 2.5 times Consolidated EBITDA, as defined in the September 24, 2010 amendment, over the previous four quarters. For the four quarters ended December 31, 2010, Consolidated EBITDA, as defined in the credit agreement, was $27.5 million. Accordingly, at December 31, 2010, Consolidated Funded Indebtedness in excess of $68.8 million would have violated the Senior Leverage Ratio covenant. At December 31, 2010 our Consolidated Funded Indebtedness was $9.0 million and related solely to letters of credit.

Interest rates and fees under the Credit Facility are as follows:

 

   

Amounts borrowed under the Credit Facility bear interest at LIBOR or an Alternate Base Rate, plus in each case, an additional margin based on the Senior Leverage Ratio.

 

   

The additional margin on the LIBOR-based loans is between 2.00% and 2.75% based on the Senior Leverage Ratio.

 

   

The additional margin on the Alternate Base Rate loans is between 1.00% and 1.75% based on the Senior Leverage Ratio.

 

   

The Alternate Base Rate is the greater of the Prime Rate, Federal Funds Effective Rate plus 0.50% or LIBOR plus 1.00%.

 

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The Unused Revolving Credit Facility Fee is between 0.35% and 0.50% based on the Senior Leverage Ratio.

The credit agreement includes significant financial covenants and restrictions that include the following:

 

   

Tangible Net Worth must be an amount which is no less than the sum of $110.0 million, plus the net proceeds of any issuance of equity that occurs after November 30, 2008, plus 50% of all positive quarterly net income after November 30, 2008.

 

   

Senior Leverage Ratio must not exceed 2.50 to 1.00

 

   

Asset Coverage Ratio must be greater than or equal to 1.45 to 1.00

 

   

Fixed Charge Coverage Ratio must be greater than or equal to 1.25 to 1.00

 

   

Limits share repurchases to $25.0 million in any calendar year.

 

   

Permits acquisitions so long as the Company’s Senior Leverage Ratio on a pro forma basis as of the end of the fiscal quarter immediately preceding the acquisition is below 1.00 to 1.00 and availability under the Credit Facility is at or above 50% after consummation of the acquisition. If the Senior Leverage Ratio on a pro forma basis as of the end of the fiscal quarter immediately preceding the acquisition is over 1.00 to 1.00 but below 1.75 to 1.00, acquisitions will be limited to $25.0 million in a twelve month period, provided there is at least $25.0 million of availability under the Credit Facility after the consummation of the acquisition.

 

   

Other customary affirmative and negative covenants that place certain restrictions on the Company, including limits on new debt, operating and capital lease obligations, asset sales and certain distributions, including dividends.

The Company is in compliance with all affirmative, negative, and financial covenants under the credit agreement and is at the lowest margin tier for the LIBOR and Alternate Base Rate loans and the lowest tier for the Unused Revolving Credit Facility Fee.

Dividend Policy

We have never paid cash dividends on our common stock, and the terms of our credit agreement limit the amount of cash dividends we can pay. We currently intend to retain earnings to finance the growth of our business. Any future dividend payments will depend on our financial condition, capital requirements and earnings as well as other factors the Board of Directors may deem relevant.

 

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Stock Repurchase Program and Treasury Shares

Treasury Shares

On February 4, 2009 our Board of Directors authorized a stock buyback program (“February 2009 Program”) that allows the Company to purchase up to 3,000,000 shares of common stock provided that such purchases do not exceed $25.0 million in any calendar year commencing in calendar year 2009 and continuing through calendar year 2012. The Company has not purchased any common shares under the February 2009 Program since its inception. Matrix Service may purchase shares in future periods if sufficient liquidity exists and the Company believes that it is in the best interest of the stockholders.

In addition to any stock buyback program that may be in effect, the Company may withhold shares of common stock to satisfy the tax withholding obligations upon vesting of an employee’s deferred shares. Matrix Service withheld 27,715 shares in the six months ended December 31, 2010 to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares.

The Company has 1,469,578 treasury shares as of December 31, 2010 and intends to utilize these treasury shares in connection with equity awards under the Company’s stock incentive plans and for share issuances under a recently adopted employee stock purchase plan.

Outlook

We are encouraged by the improving outlook in many of our businesses as we see a number of attractive opportunities across our core markets. The strengthening of new construction in the Aboveground Storage Tank market is being led by the continued development of the Canadian oil sands and increasing investment from companies looking to add storage capacity in the United States. The AST repair and maintenance business is also showing some signs of improvement both in the United States and Canada; however, the level of competition remains high which we expect will result in reduced margins in the near term. We expect the Electrical and Instrumentation market to continue to be strong due to the high voltage overhaul occurring in the Northeastern corridor of the United States and strong demand for maintenance services. The recent upward trend in refinery utilization rates and improving crack spreads suggest an improving Downstream Petroleum market. However, our outlook remains cautious as the level of competition continues to make it difficult to capture work at attractive margins.

 

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FORWARD-LOOKING STATEMENTS

This Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Form 10-Q which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts” and similar expressions are also intended to identify forward-looking statements.

These forward-looking statements include, among others, such things as:

 

   

amounts and nature of future revenues and margins from our Construction Services and Repair and Maintenance Services segments;

 

   

the likely impact of new or existing regulations or market forces on the demand for our services;

 

   

expansion and other development trends of the industries we serve;

 

   

our ability to generate sufficient cash from operations or to raise cash in order to meet our short and long-term capital requirements; and

 

   

our ability to continue to comply with the covenants in our credit agreement.

These statements are based on certain assumptions and analyses we made in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate. However, whether actual results and developments will conform to our expectations and predictions is subject to a number of risks and uncertainties which could cause actual results to differ materially from our expectations, including:

 

   

the risk factors discussed in our Form 10-K for the fiscal year ended June 30, 2010 and listed from time to time in our filings with the Securities and Exchange Commission;

 

   

the inherently uncertain outcome of current and future litigation and, in particular, our ability to recover the claim receivables acquired in a recent acquisition;

 

   

the adequacy of our reserves for contingencies;

 

   

economic, market or business conditions in general and in the oil and gas, power and petrochemical industries in particular;

 

   

changes in laws or regulations; and

 

   

other factors, many of which are beyond our control.

Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to or effects on us or our business operations. We assume no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events or otherwise.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in market risk faced by us from those reported in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010, filed with the Securities and Exchange Commission. For more information on market risk, see Part II, Item 7A in our fiscal 2010 Annual Report on Form 10-K.

 

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Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chairman of the Board of Directors, who is currently acting in the capacity of our Chief Executive Officer, and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e).

The disclosure controls and procedures are designed to provide reasonable, not absolute, assurance of achieving the desired control objectives. The Company’s management, including the Chairman of the Board of Directors and the Chief Financial Officer, do not expect that the disclosure controls and procedures or our internal controls over financial reporting will prevent or detect all errors or fraud. The design of our internal control system takes into account the fact that there are resource constraints and the benefits of controls must be weighed against the costs. Additionally, controls can be circumvented by the acts of key individuals, collusion or management override.

We carried out an evaluation, under the supervision and with the participation of our management, including our Chairman of the Board of Directors and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2010. Based on the foregoing, our Chairman of the Board of Directors and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level at December 31, 2010.

There have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting during the quarter ended December 31, 2010.

While we believe our control environment is effective, as a result of the alleged fraud that is discussed in Note 10 – Internal Investigation included in this Quarterly Report on Form 10-Q, the Company is in the process of enhancing certain internal control processes and procedures in order to improve its ability to deter and detect any recurrence of such conduct and expects to be substantially complete with the control enhancements by the end of fiscal year 2011.

 

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PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

For information regarding legal proceedings, see the discussion under the caption “Material Legal Proceeding” in Note 6 in Item 1 of Part 1 of this Quarterly Report on Form 10-Q, which information is incorporated by reference into this Part II, Item 1.

 

Item 1A. Risk Factors

There were no material changes in our Risk Factors from those reported in Item IA of Part I of our Annual Report on Form 10-K for the fiscal year ended June 30, 2010.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The table below sets forth the information with respect to purchases made by the Company of its common stock during the second quarter of fiscal year 2011.

 

     Total Number
of Shares
Purchased
     Average Price
Paid

Per Share
     Total Number
of Shares
Purchased as
Part of

Publicly
Announced
Plans or
Programs
     Maximum
Number of
Shares That

May Yet Be
Purchased
Under the

Plans
or Programs
 

October 1 to October 31, 2010

           

Share Repurchase Program (A)

     —           —           —           3,000,000   

Employee Transactions (B)

     18,431       $ 9.41         —        

November 1 to November 30, 2010

           

Share Repurchase Program (A)

     —           —           —           3,000,000   

Employee Transactions (B)

     8,822       $ 10.25         —        

December 1 to December 31, 2010

           

Share Repurchase Program (A)

     —           —           —           3,000,000   

Employee Transactions (B)

     —         $ —           —        

 

(A) On February 4, 2009 our Board of Directors authorized a stock buyback program that allows the Company to purchase up to 3,000,000 shares of common stock provided that such purchases do not exceed $25.0 million in any calendar year commencing in calendar year 2009 and continuing through calendar year 2012.
(B) Represents shares withheld to satisfy the employee’s tax withholding obligation that is incurred upon the vesting of deferred shares granted under the Company’s stock incentive plans.

Dividend Policy

We have never paid cash dividends on our common stock, and the terms of our credit agreement limits the amount of cash dividends we can pay. We currently intend to retain earnings to finance the growth of our business. Any payment of cash dividends in the future will depend upon our financial condition, capital requirements and earnings as well as other factors the Board of Directors may deem relevant.

 

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Item 3. Defaults Upon Senior Securities

None

 

Item 4. Reserved

 

Item 5. Other Information

None

 

Item 6. Exhibits:

 

Exhibit 31.1:    Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – CEO.
Exhibit 31.2:    Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – CFO.
Exhibit 32.1:    Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – CEO.
Exhibit 32.2:    Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – CFO.

Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

        MATRIX SERVICE COMPANY

Date: February 7, 2011

    By:  

/s/    KEVIN S. CAVANAH        

     

Kevin S. Cavanah,

Vice President and

Chief Financial Officer signing on behalf of the registrant and

as the registrant’s principal financial officer

 

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EXHIBIT INDEX

 

Exhibit 31.1:    Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – CEO.
Exhibit 31.2:    Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – CFO.
Exhibit 32.1:    Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – CEO.
Exhibit 32.2:    Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – CFO.

 

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