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MATRIX SERVICE CO - Quarter Report: 2011 March (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 March 31, 2011

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 May 2, 2011 there were 27,888,217 shares of the Company’s common stock, $0.01 par value per share, issued and 26,438,116 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 Nine Months Ended March 31, 2011 and 2010

     1   
 

Condensed Consolidated Balance Sheets as of March 31, 2011 and June 30, 2010

     2   
 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2011 and 2010

     4   
 

Condensed Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Nine Months Ended March 31, 2011 and 2010

     6   
 

Notes to Condensed Consolidated Financial Statements

     7   

Item 2.

 

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

     16   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     26   

Item 4.

 

Controls and Procedures

     27   

PART II

  OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     28   

Item 1A.

 

Risk Factors

     28   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     28   

Item 3.

 

Defaults Upon Senior Securities

     29   

Item 4.

 

Reserved

     29   

Item 5.

 

Other Information

     29   

Item 6.

 

Exhibits

     29   

Signature

     29   


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     Nine Months Ended  
     March 31,
2011
    March 31,
2010
    March 31,
2011
    March 31,
2010
 

Revenues

   $ 136,333      $ 122,013      $ 463,423      $ 410,088   

Cost of revenues

     117,763        108,720        409,383        360,935   
                                

Gross profit

     18,570        13,293        54,040        49,153   

Selling, general and administrative expenses

     10,930        13,248        32,655        34,711   
                                

Operating income

     7,640        45        21,385        14,442   

Other income (expense):

        

Interest expense

     (227     (163     (594     (525

Interest income

     43        10        65        70   

Other

     485        208        595        752   
                                

Income before income tax expense

     7,941        100        21,451        14,739   

Provision for federal, state and foreign income taxes

     3,018        37        8,152        5,634   
                                

Net income

   $ 4,923      $ 63      $ 13,299      $ 9,105   
                                

Basic earnings per common share

   $ 0.19      $ 0.00      $ 0.50      $ 0.35   

Diluted earnings per common share

   $ 0.18      $ 0.00      $ 0.50      $ 0.34   

Weighted average common shares outstanding:

        

Basic

     26,425        26,307        26,389        26,258   

Diluted

     26,723        26,521        26,636        26,477   

See accompanying notes.

 

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Table of Contents

Matrix Service Company

Condensed Consolidated Balance Sheets

(In thousands)

(unaudited)

 

     March 31,
2011
    June 30,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 63,375      $ 50,899   

Accounts receivable, less allowances (March 31, 2011 - $1,553 and June 30, 2010 - $1,404)

     91,287        87,327   

Costs and estimated earnings in excess of billings on uncompleted contracts

     40,642        40,920   

Inventories

     2,596        3,451   

Income taxes receivable

     —          1,779   

Deferred income taxes

     5,872        8,073   

Other current assets

     2,752        6,076   
                

Total current assets

     206,524        198,525   

Property, plant and equipment at cost:

    

Land and buildings

     28,230        27,859   

Construction equipment

     54,754        52,086   

Transportation equipment

     19,703        19,192   

Office equipment and software

     14,876        14,358   

Construction in progress

     2,434        1,251   
                
     119,997        114,746   

Accumulated depreciation

     (67,410     (61,817
                
     52,587        52,929   

Goodwill

     27,460        27,216   

Other intangible assets

     3,973        4,141   

Other assets

     2,263        1,997   
                

Total assets

   $ 292,807      $ 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)

 

     March 31,
2011
    June 30,
2010
 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 28,767      $ 44,769   

Billings on uncompleted contracts in excess of costs and estimated earnings

     36,897        28,877   

Accrued insurance

     7,477        8,257   

Income taxes payable

     800        —     

Accrued wages and benefits

     18,173        13,538   

Current capital lease obligation

     401        772   

Other accrued expenses

     2,479        6,572   
                

Total current liabilities

     94,994        102,785   

Long-term capital lease obligation

     46        259   

Deferred income taxes

     4,478        4,179   
                

Total liabilities

     99,518        107,223   

Commitments and contingencies

     —          —     

Stockholders’ equity:

    

Common stock - $.01 par value; 60,000,000 shares authorized; 27,888,217 shares issued as of March 31, 2011, and June 30, 2010

     279        279   

Additional paid-in capital

     113,124        111,637   

Retained earnings

     94,548        81,252   

Accumulated other comprehensive income

     1,364        495   
                
     209,315        193,663   

Less: Treasury stock, at cost – 1,450,800 shares as of March 31, 2011, and 1,546,512 shares as of June 30, 2010

     (16,026     (16,078
                

Total stockholders’ equity

     193,289        177,585   
                

Total liabilities and stockholders’ equity

   $ 292,807      $ 284,808   
                

See accompanying notes.

 

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Matrix Service Company

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 

     Nine Months Ended  
     March 31,
2011
    March 31,
2010
 

Operating activities:

    

Net income

   $ 13,299      $ 9,105   

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

    

Depreciation and amortization

     8,250        8,880   

Deferred income tax

     2,191        256   

Loss on sale of property, plant and equipment

     7        26   

Allowance for uncollectible accounts

     321        2,838   

Stock-based compensation expense

     1,737        1,557   

Tax benefit deficiency from the vesting of deferred shares

     (139     (393

Other

     165        118   

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

    

Accounts receivable

     (4,281     26,388   

Costs and estimated earnings in excess of billings on uncompleted contracts

     278        (4,477

Inventories

     855        536   

Other assets

     3,066        2,821   

Accounts payable

     (16,045     (15,051

Billings on uncompleted contracts in excess of costs and estimated earnings

     8,020        (23,956

Accrued expenses

     (238     (1,347

Income tax receivable/payable

     2,579        (2,267
                

Net cash provided by operating activities

     20,065        5,034   

Investing activities:

    

Acquisition of property, plant and equipment

     (7,568     (4,059

Proceeds from asset sales

     112        87   
                

Net cash used by investing activities

   $ (7,456   $ (3,972

See accompanying notes.

 

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Matrix Service Company

Condensed Consolidated Statements of Cash Flows (continued)

(In thousands)

(unaudited)

 

     Nine Months Ended  
     March 31,
2011
    March 31,
2010
 

Financing activities:

    

Issuances of common stock

   $ 161      $ 67   

Capital lease payments

     (584     (829

Tax benefit of exercised stock options

     49        2   

Payment of debt amendment fees

     (216     —     

Purchase of treasury shares

     (272     (428
                

Net cash used by financing activities

     (862     (1,188

Effect of exchange rate changes on cash

     729        948   
                

Net increase in cash and cash equivalents

     12,476        822   

Cash and cash equivalents, beginning of period

     50,899        52,476   
                

Cash and cash equivalents, end of period

   $ 63,375      $ 53,298   
                

Supplemental disclosure of cash flow information:

    

Cash paid during the period for:

    

Income taxes

   $ 3,126      $ 7,810   
                

Interest

   $ 499      $ 400   
                

Non-cash investing and financing activities:

    

Equipment acquired through capital leases

   $ —        $ 236   
                

Purchases of property, plant and equipment on account

   $ 84      $ 100   
                

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

     —           —          13,299        —          —          13,299   

Other comprehensive income

     —           —          —          —          869        869   
                   

Comprehensive income

                14,168   

Exercise of stock options (31,000 shares)

     —           81        (3     83        —          161   

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

     —           (90     —          —          —          (90

Issuance of deferred shares (92,761 shares)

     —           (241     —          241        —          —     

Treasury share purchases (28,049 shares)

     —           —          —          (272     —          (272

Stock-based compensation expense

     —           1,737        —          —          —          1,737   
                                                 

Balances, March 31, 2011

   $ 279       $ 113,124      $ 94,548      $ (16,026   $ 1,364      $ 193,289   
                                                 

Balances, June 30, 2009

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

Net income

     —           —          9,105        —          —          9,105   

Other comprehensive income

     —           —          —          —          1,377        1,377   
                   

Comprehensive income

                10,482   

Exercise of stock options (11,500 shares)

     —           36        —          31        —          67   

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

     —           (391     —          —          —          (391

Issuance of deferred shares (147,488 shares)

     —           (403     —          403        —          —     

Treasury share purchases (44,904 shares)

     —           —          —          (428     —          (428

Stock-based compensation expense

     —           1,557        —          —          —          1,557   
                                                 

Balances, March 31, 2010

   $ 279       $ 111,295      $ 85,492      $ (16,140   $ 1,158      $ 182,084   
                                                 

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 attainment of 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:

 

     March 31,
2011
     June 30,
2010
 
     (in thousands)  

Costs incurred and estimated earnings recognized on uncompleted contracts

   $ 612,226       $ 630,342   

Billings on uncompleted contracts

     608,481         618,299   
                 
   $ 3,745       $ 12,043   
                 

Presented as:

     

Costs and estimated earnings in excess of billings on uncompleted contracts

   $ 40,642       $ 40,920   

Billings on uncompleted contracts in excess of costs and estimated earnings

     36,897         28,877   
                 
   $ 3,745       $ 12,043   
                 

Progress billings in accounts receivable at March 31, 2011 and June 30, 2010 included retentions to be collected within one year of $13.3 million and $13.2 million, respectively. Contract retentions collectible beyond one year totaled $1.5 million and $0.1 million at March 31, 2011 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

     —          244         244   
                         

Balance at March 31, 2011

       

Goodwill

     31,427        21,033         52,460   

Cumulative impairment loss

     (25,000     —           (25,000
                         
   $ 6,427      $ 21,033       $ 27,460   
                         

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 credit agreement, over the previous four quarters. For the four quarters ended June 30, 2010 Consolidated EBITDA was $25.2 million and resulted in a capacity reduction to the Credit Facility of $12.0 million at June 30, 2010. For the four quarters ended March 31, 2011, Consolidated EBITDA was $31.5 million and did not cause a reduction to the available capacity under the Credit Facility at March 31, 2011.

Availability under the senior credit facility is as follows:

 

     March 31,
2011
     June 30,
2010
 
     (In thousands)  

Credit Facility

   $ 75,000       $ 75,000   

Capacity constraint due to the Senior Leverage Ratio

     —           12,049   
                 

Capacity under the Credit Facility

     75,000         62,951   

Letters of credit outstanding

     7,484         11,622   
                 

Availability under senior credit facility

   $ 67,516       $ 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:

 

   

Our 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.

 

   

The Senior Leverage Ratio must not exceed 2.50 to 1.00.

 

   

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

 

   

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

 

   

Share repurchases are limited to $25.0 million in any calendar year.

 

   

Acquisitions are permitted 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 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.

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 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

 

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Matrix Service Company

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

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 have been made, which include $4.0 million deposited with the claim administrator in December 2010 and $0.1 million for applicable payroll taxes submitted in February 2011.

Unapproved Change Orders and Claims

As of March 31, 2011 and June 30, 2010, costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders of $4.8 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 March 31, 2011 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. The amounts ultimately realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings.

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 2009. The recorded value at March 31, 2011 of $2.4 million represents the Company’s best estimate of the amounts that will ultimately be collected. However, recovering these receivables will 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      Nine Months Ended  
     March 31,
2011
     March 31,
2010
     March 31,
2011
     March 31,
2010
 
     (In thousands)  

Net income

   $ 4,923       $ 63       $ 13,299       $ 9,105   

Other comprehensive income

     113         324         869         1,377   
                                   

Comprehensive income

   $ 5,036       $ 387       $ 14,168       $ 10,482   
                                   

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      Nine Months Ended  
     March 31,
2011
     March 31,
2010
     March 31,
2011
     March 31,
2010
 
     (In thousands, except per share data)  

Basic EPS:

           

Net income

   $ 4,923       $ 63       $ 13,299       $ 9,105   
                                   

Weighted average shares outstanding

     26,425         26,307         26,389         26,258   
                                   

Basic EPS

   $ 0.19       $ 0.00       $ 0.50       $ 0.35   
                                   

Diluted EPS:

           

Weighted average shares outstanding - basic

     26,425         26,307         26,389         26,258   

Dilutive stock options

     108         109         89         101   

Dilutive nonvested deferred shares

     190         105         158         118   
                                   

Diluted weighted average shares

     26,723         26,521         26,636         26,477   
                                   

Diluted EPS

   $ 0.18       $ 0.00       $ 0.50       $ 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      Nine Months Ended  
     March 31,
2011
     March 31,
2010
     March 31,
2011
     March 31,
2010
 
     (In thousands)  

Stock options

     —           106         105         123   

Nonvested deferred shares

     32         68         49         86   
                                   

Total antidilutive securities

     32         174         154         209   
                                   

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.

Items classified as “other” consist 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 March 31, 2011

          

Gross revenues

   $ 77,797       $ 60,923      $ —         $ 138,720   

Less: Inter-segment revenues

     2,114         273        —           2,387   
                                  

Consolidated revenues

     75,683         60,650        —           136,333   

Gross profit

     13,192         5,378        —           18,570   

Operating income

     6,886         754        —           7,640   

Segment assets

     125,275         99,261        68,271         292,807   

Capital expenditures

     2,300         562        177         3,039   

Depreciation and amortization expense

     1,547         1,180        —           2,727   

Three Months Ended March 31, 2010

          

Gross revenues

   $ 79,394       $ 45,701      $ —         $ 125,095   

Less: Inter-segment revenues

     3,073         9        —           3,082   
                                  

Consolidated revenues

     76,321         45,692        —           122,013   

Gross profit

     10,098         3,195        —           13,293   

Operating income (loss)

     880         (835     —           45   

Segment assets

     117,974         89,214        62,508         269,696   

Capital expenditures

     63         276        871         1,210   

Depreciation and amortization expense

     1,646         1,268        —           2,914   

Nine Months Ended March 31, 2011

          

Gross revenues

   $ 285,303       $ 185,209      $ —         $ 470,512   

Less: Inter-segment revenues

     6,502         587        —           7,089   
                                  

Consolidated revenues

     278,801         184,622        —           463,423   

Gross profit

     37,351         16,689        —           54,040   

Operating income

     17,809         3,576        —           21,385   

Segment assets

     125,275         99,261        68,271         292,807   

Capital expenditures

     4,458         893        2,217         7,568   

Depreciation and amortization expense

     4,612         3,638        —           8,250   

Nine Months Ended March 31, 2010

          

Gross revenues

   $ 244,484       $ 175,726      $ —         $ 420,210   

Less: Inter-segment revenues

     9,910         212        —           10,122   
                                  

Consolidated revenues

     234,574         175,514        —           410,088   

Gross profit

     33,088         16,065        —           49,153   

Operating income

     11,152         3,290        —           14,442   

Segment assets

     117,974         89,214        62,508         269,696   

Capital expenditures

     565         1,082        2,412         4,059   

Depreciation and amortization expense

     4,976         3,904        —           8,880   

 

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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 March 31, 2011

        

Aboveground Storage Tanks

   $ 40,120       $ 17,667       $ 57,787   

Downstream Petroleum

     13,974         25,464         39,438   

Electrical and Instrumentation

     14,493         17,519         32,012   

Specialty

     7,096         —           7,096   
                          

Total

   $ 75,683       $ 60,650       $ 136,333   
                          

Three Months Ended March 31, 2010

        

Aboveground Storage Tanks

   $ 28,305       $ 17,957       $ 46,262   

Downstream Petroleum

     24,286         22,086         46,372   

Electrical and Instrumentation

     18,251         5,649         23,900   

Specialty

     5,479         —           5,479   
                          

Total

   $ 76,321       $ 45,692       $ 122,013   
                          

Nine Months Ended March 31, 2011

        

Aboveground Storage Tanks

   $ 130,444       $ 60,766       $ 191,210   

Downstream Petroleum

     57,550         76,257         133,807   

Electrical and Instrumentation

     71,800         47,599         119,399   

Specialty

     19,007         —           19,007   
                          

Total

   $ 278,801       $ 184,622       $ 463,423   
                          

Nine Months Ended March 31, 2010

        

Aboveground Storage Tanks

   $ 95,736       $ 69,824       $ 165,560   

Downstream Petroleum

     69,250         89,293         158,543   

Electrical and Instrumentation

     47,726         16,397         64,123   

Specialty

     21,862         —           21,862   
                          

Total

   $ 234,574       $ 175,514       $ 410,088   
                          

 

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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 March 31, 2011 and June 30, 2010 costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders of $4.8 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 March 31, 2011 or June 30, 2010. The amounts ultimately realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings.

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 March 31, 2011 of $2.4 million represents the Company’s best estimate of the amounts that will ultimately be collected. However, recovering these receivables will 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 March 31, 2011 and June 30, 2010, the Company recorded insurance reserves totaling $7.5 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 estimated 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 March 31, 2011, 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 4.7% of revenues generated in Canada during the first nine 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 March 31, 2011 Compared to the Three Months Ended March 31, 2010

Consolidated

Consolidated revenues were $136.3 million for the three months ended March 31, 2011, an increase of $14.3 million, or 11.7%, from consolidated revenues of $122.0 million in the same period a year earlier. The increase in consolidated revenues was a result of a $14.9 million increase in Repair and Maintenance Services revenues while Construction Services revenues decreased $0.6 million.

Consolidated gross profit increased from $13.3 million in the three months ended March 31, 2010 to $18.6 million in the three months ended March 31, 2011. The increase of $5.3 million was due to higher revenues which increased $14.3 million and higher gross margins which increased to 13.6% in the three months ended March 31, 2011 compared to 10.9% in the same period a year earlier. The increase in gross margins was primarily due to the favorable effect of improved recovery of construction overhead costs in the three months ended March 31, 2011.

Selling, general and administrative expenses for the third quarter of fiscal 2011 were $10.9 million compared to $13.2 million in the third quarter of fiscal 2010. The third quarter of fiscal 2010 selling, general and administrative expenses included non-routine charges totaling $3.5 million related to acquired claim receivables. The third quarter of fiscal 2011 selling, general and administrative expenses included higher incentive compensation costs due to improved operating results when compared to the same period a year earlier. SG&A expense as a percentage of revenue decreased to 8.0% in the three months ended March 31, 2011 compared to 10.9% in the same period a year earlier.

Net interest expense was $0.2 million in the three months ended March 31, 2011 and 2010. 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 March 31, 2011 and 2010 was $0.5 million and $0.2 million, respectively, and related primarily to foreign currency transaction gains.

 

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The effective tax rates in the three months ended March 31, 2011 and 2010 were 38.0% and 37.0%, respectively.

Construction Services

Revenues for the Construction Services segment were $75.7 million in the three months ended March 31, 2011, compared with $76.3 million in the same period a year earlier. The decrease of $0.6 million, or 0.8%, was primarily due to lower Downstream Petroleum revenues which decreased to $14.0 million in the three months ended March 31, 2011 compared to $24.3 million in the same period a year earlier and lower Electrical and Instrumentation revenues, which decreased to $14.5 million in the three months ended March 31, 2011, versus $18.3 million in the same period a year earlier. These decreases were largely offset by higher Aboveground Storage Tank and Specialty revenues, which increased to $40.1 million and $7.1 million, respectively, in the three months ended March 31, 2011 compared to $28.3 million and $5.5 million, respectively, in the same period a year earlier.

Gross profit increased to $13.2 million in the three months ended March 31, 2011 from $10.1 million in the same period a year earlier. The increase in gross profit was due to higher gross margins which increased from 13.2% in the three months ended March 31, 2010 to 17.4% in the three months ended March 31, 2011. The increase in gross margins was due to strong project execution which led to the recognition of performance bonuses.

Repair and Maintenance Services

Revenues for the Repair and Maintenance Services segment were $60.6 million in the three months ended March 31, 2011 compared to $45.7 million in the same period a year earlier. The increase was due to higher Electrical and Instrumentation revenues, which increased to $17.5 million in the three months ended March 31, 2011, compared to $5.6 million in the same period a year earlier and higher Downstream Petroleum revenues, which increased to $25.5 million in the three months ended March 31, 2011 compared to $22.1 million in the same period a year earlier. Aboveground Storage Tank revenues were $17.7 million in the three months ended March 31, 2011 compared to $18.0 million in the same period a year earlier.

Gross profit increased from $3.2 million in the three months ended March 31, 2010 to $5.4 million in the three months ended March 31, 2011 due to higher revenues, which increased $14.9 million, and higher gross margins which increased to 8.9% in the three months ended March 31, 2011 compared to 7.0% 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.

Nine Months Ended March 31, 2011 Compared to the Nine Months Ended March 31, 2010

Consolidated

Consolidated revenues were $463.4 million in the nine months ended March 31, 2011, an increase of $53.3 million, or 13.0%, from consolidated revenues of $410.1 million in the same period a year earlier. The increase in consolidated revenues was a result of an increase of $44.2 million in Construction Services revenues and an increase of $9.1 million in Repair and Maintenance Services revenues.

Consolidated gross profit increased from $49.2 million in the nine months ended March 31, 2010 to $54.0 million in the nine months ended March 31, 2011. The increase of $4.8 million was largely due to the effect of higher revenues, partially offset by the effect of lower gross margins which decreased from 12.0% in the nine months ended March 31, 2010 to 11.7% in the nine months ended March 31, 2011. The change in gross margins was due to lower direct margins largely offset by the favorable effect of improved recovery of construction overhead costs.

Selling, general and administrative expenses for the nine months ended March 31, 2011 were $32.7 million compared to $34.7 million for the nine months ended March 31, 2010. Selling, general and administrative expenses for the nine months ended March 31, 2010 included non-routine charges totaling $4.4 million related to acquired claim receivables. Selling, general and administrative expenses in the nine months ended March 31, 2011 included non-routine charges of $0.6 million related to an internal fraud investigation previously discussed in our filings with the Securities and Exchange Commission, and

 

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higher incentive compensation costs due to improved operating results when compared to the same period a year earlier. SG&A expense as a percentage of revenue decreased to 7.0% in the nine months ended March 31, 2011 compared to 8.5% in the same period a year earlier.

Net interest expense was $0.5 million in the nine months ended March 31, 2011 and 2010. 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 nine months ended March 31, 2011 was $0.6 million and related primarily to foreign currency transaction gains partially offset by costs relating to the relocation of a regional operating facility. Other income in the nine months ended March 31, 2010 totaled $0.8 million and related primarily to foreign currency transaction gains.

The effective tax rates for the nine months ended March 31, 2011 and 2010 were 38.0% and 38.2%, respectively.

Construction Services

Revenues for the Construction Services segment were $278.8 million in the nine months ended March 31, 2011, compared with $234.6 million in the same period a year earlier. The increase of $44.2 million, or 18.8%, was primarily due to higher Aboveground Storage Tank revenues, which increased to $130.4 million in the nine months ended March 31, 2011, versus $95.7 million in the same period a year earlier and higher Electrical and Instrumentation revenues, which increased to $71.8 million in the nine months ended March 31, 2011 compared to $47.7 million in the same period a year earlier. Partially offsetting these increases were lower Downstream Petroleum and Specialty revenues which decreased to $57.6 million and $19.0 million, respectively, in the nine months ended March 31, 2011, compared to $69.3 million and $21.9 million, respectively, in the same period a year earlier.

Gross profit increased to $37.4 million in the nine months ended March 31, 2011 from $33.1 million in the same period a year earlier due to higher revenues, partially offset by lower gross margins which decreased from 14.1% in the nine months ended March 31, 2010 to 13.4% in the nine months ended March 31, 2011. 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 nine months ended March 31, 2011.

Repair and Maintenance Services

Revenues for the Repair and Maintenance Services segment were $184.6 million in the nine months ended March 31, 2011 compared to $175.5 million in the same period a year earlier. The increase was due to higher Electrical and Instrumentation revenues, which increased to $47.6 million in the nine months ended March 31, 2011, compared to $16.4 million in the same period a year earlier partially offset by lower Downstream Petroleum revenues, which decreased to $76.3 million in the nine months ended March 31, 2011 compared to $89.3 million in the same period a year earlier, and lower Aboveground Storage Tank revenues, which decreased to $60.8 million in the nine months ended March 31, 2011 compared to $69.8 million in the same period a year earlier.

Gross profit increased from $16.1 million in the nine months ended March 31, 2010 to $16.7 million in the nine months ended March 31, 2011 primarily due to higher revenues, which increased $9.1 million, largely offset by the effect of lower gross margins which decreased to 9.0% in the nine months ended March 31, 2011 compared to 9.2% in the same period a year earlier. The gross margin decrease was due to lower direct margins largely offset by the favorable effect of improved recovery of construction overhead costs.

 

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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.

Three Months Ended March 31, 2011

The following table provides a summary of changes in our backlog for the three months ended March 31, 2011:

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Backlog as of December 31, 2010

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

New awards

     78,709        75,539        154,248   

Revenue recognized

     (75,683     (60,650     (136,333
                        

Backlog as of March 31, 2011

   $ 207,494      $ 176,388      $ 383,882   
                        

At March 31, 2011, the Construction Services segment had a backlog of $207.5 million, as compared to a backlog of $204.5 million as of December 31, 2010. The increase of $3.0 million is due to increases in Downstream Petroleum of $8.0 million and Specialty of $2.1 million, partially offset by decreases in Aboveground Storage Tank of $3.8 million and Electrical and Instrumentation of $3.3 million. The backlog at March 31, 2011 and December 31, 2010 for the Repair and Maintenance Services segment was $176.4 million and $161.5 million, respectively. The increase of $14.9 million is due to increases in Downstream Petroleum of $12.5 million and Electrical and Instrumentation of $6.1 million, partially offset by the decrease in Aboveground Storage Tank of $3.7 million.

Nine Months Ended March 31, 2011

The following table provides a summary of changes in our backlog for the nine months ended March 31, 2011:

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Backlog as of June 30, 2010

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

New awards

     288,620        205,469        494,089   

Revenue recognized

     (278,801     (184,622     (463,423
                        

Backlog as of March 31, 2011

   $ 207,494      $ 176,388      $ 383,882   
                        

At March 31, 2011 the Construction Services segment had a backlog of $207.5 million, as compared to a backlog of $197.7 million as of June 30, 2010. The increase of $9.8 million is due to an increase in Aboveground Storage Tank of $33.4 million, partially offset by decreases in Electrical and Instrumentation of $13.4 million, Downstream Petroleum of $9.9 million, and Specialty of $0.3 million. The backlog at March 31, 2011 and June 30, 2010 for the Repair and Maintenance Services segment was $176.4 million and $155.5 million, respectively. The increase of $20.9 million is due to increases in Electrical and Instrumentation of $10.7 million, Downstream Petroleum of $9.2 million, and Aboveground Storage Tank of $1.0 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 present 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      Nine Months Ended  
     March 31,
2011
     March 31,
2010
     March 31,
2011
     March 31,
2010
 
     (In thousands)  

Net income

   $ 4,923       $ 63       $ 13,299       $ 9,105   

Interest expense

     227         163         594         525   

Provision for income taxes

     3,018         37         8,152         5,634   

Depreciation and amortization

     2,727         2,914         8,250         8,880   
                                   

EBITDA

   $ 10,895       $ 3,177       $ 30,295       $ 24,144   
                                   

 

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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 nine months ended March 31, 2011 was cash on hand at the beginning of the year and operational cash flows. Cash on hand at March 31, 2011 totaled $63.4 million and availability under the senior revolving credit facility totaled $67.5 million resulting in total liquidity at March 31, 2011 of $130.9 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 attainment of 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 Nine Months Ended March 31, 2011

Cash Flows from Operating Activities

Cash flow from operations for the nine months ended March 31, 2011 totaled $20.1 million and was primarily due to cash generated from profitable operating results, partially offset by an increase in working capital. The cash effect of significant changes in working capital include the following:

 

   

Accounts payable decreased by $16.0 million. The decrease was primarily due to a large steel purchase late in the prior fiscal year related to a significant Aboveground Storage Tank project.

 

   

Accounts receivable increased by $4.3 million. The accounts receivable balance fluctuates from period to period based on many factors including, but not limited to, the volume of business and the rate of collections. We consider the $4.3 million increase in accounts receivable to be a normal fluctuation. In addition, we consider both the aging and the amount of the March 31, 2011 accounts receivable balance to be normal based on historical trends.

 

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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 $8.3 million. This change was primarily attributable to advanced billings on Aboveground Storage Tank contracts in the Construction Services segment.

 

   

Other assets decreased by $3.1 million and is primarily attributable to certain insurance deposit refunds received.

 

   

Income taxes receivable/payable decreased by $2.6 million due to the timing of income tax payments.

 

   

Accrued expenses decreased by $0.2 million. The decrease was primarily the result of payments totaling $4.1 million to settle the California Pay Practice Class Action Lawsuits offset in part by higher accrued wages at March 31, 2011. The settlement and payments for the California Pay Practice Class Action Lawsuits 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.

Cash Flows from Investing Activities

Investing activities used $7.5 million of cash in the nine months ended March 31, 2011 due to capital expenditures of $7.6 million partially offset by proceeds from asset dispositions of $0.1 million. Capital expenditures included $3.7 million for the purchase of construction equipment, $2.0 million for transportation equipment, $1.4 million for office equipment and software and $0.5 million for land and buildings.

Cash Flows from Financing Activities

Financing activities used $0.9 million of cash in the nine months ended March 31, 2011 primarily due to capital lease payments of $0.6 million, treasury stock purchases of $0.3 million and payment of $0.2 million in fees associated with the September 2010 amendment to the senior revolving credit facility, 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 credit agreement, over the previous four quarters. For the four quarters ended June 30, 2010 Consolidated EBITDA was $25.2 million and resulted in a capacity reduction to the Credit Facility of $12.0 million at June 30, 2010. For the four quarters ended March 31, 2011, Consolidated EBITDA was $31.5 million and did not cause a reduction to the available capacity under the Credit Facility at March 31, 2011. At March 31, 2011 our Consolidated Funded Indebtedness was $7.5 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.

 

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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 financial covenants and restrictions that include the following:

 

   

Our 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.

 

   

The Senior Leverage Ratio must not exceed 2.50 to 1.00.

 

   

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

 

   

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

 

   

Share repurchases are limited to $25.0 million in any calendar year.

 

   

Acquisitions are permitted 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 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

The Company has never paid cash dividends on its common stock, and the terms of our credit agreement limit the amount of cash dividends that can be paid. 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 28,049 shares in the nine months ended March 31, 2011 to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares.

The Company has 1,450,800 treasury shares as of March 31, 2011 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

The Company continues to experience generally improving market conditions and strong bid volume in both the Construction Services and Repair and Maintenance Services segments. Our outlook remains positive and we continue to see attractive project opportunities across our core markets.

The aboveground storage tank (“AST”) business continues to gain momentum with a number of projects planned in Cushing, Oklahoma and other terminal facilities in North America. The development of the Canadian oil sands and related pipelines to transport crude oil to the Gulf Coast continues to be a key driver for the AST market. Recent research reports have highlighted the excess crude inflow capacity into Cushing compared to the smaller outflow capacity to the Gulf Coast as a key driver for additional storage capacity over the next several quarters. This, combined with improving economics for terminal operators, is expected to support additional investments in storage assets. The AST repair and maintenance business has improved somewhat in recent months and we continue to pursue opportunities in the U.S. and Canada. The level of competition in the repair and maintenance market remains high, which is keeping margins below historical levels.

The electrical and instrumentation business continues to be a significant part of our growth strategy. We are targeting opportunities in the power delivery, power generation, downstream petroleum and renewable energy markets, which we believe will allow us to expand our market share in the Northeast corridor, Mid-Atlantic States and in other growth areas throughout North America. We have added equipment, tools and personnel to position the Company to capture a significant amount of work required to construct and upgrade power systems. We are also expanding beyond our traditional substation business to include transmission and distribution construction and maintenance as we see a growing market for capital expansion and maintenance to the high voltage infrastructure required by many of our utility customers.

The calendar year 2011 outlook for the downstream petroleum market is positive based on refinery utilization rates and improving crack spreads. This trend also bodes well for improved construction activity in this market segment. Turnaround activity in the third fiscal quarter was higher compared to the prior year and we expect turnaround activity in the fourth fiscal quarter to be strong as well. However, the timing of future awards continues to be uncertain. In addition, it will be difficult to achieve attractive margins given the high level of competition in the downstream petroleum market.

 

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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

Other than noted below, 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.

Japan is a major producer of steel, and the earthquake and resulting tsunami that occurred in Japan on March 11, 2011 has caused or may cause Japanese companies to curtail some of their steel exports due to reduced manufacturing capacity, increased Japanese demand, or other factors. We purchase our

 

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steel from domestic sources, and the events in Japan have not had a material short-term effect on our steel supply. However, supply disruptions originating in Japan could affect domestic supply or steel prices in the United States. We continue to believe that our contracting strategy of passing the risk of steel price increases and availability on to our customers mitigates our risk related to these events. However, we cannot predict and will continue to assess what affect, if any, a long-term reduction in Japanese imports may have on the United States steel market in terms of both pricing and availability of our steel supplies.

 

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 through 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 March 31, 2011. 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 March 31, 2011.

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 March 31, 2011.

While we believe our control environment is effective, as a result of the fraud that allegedly occurred and has been discussed in our previous filings with the Securities and Exchange Commission, the Company is in the process of enhancing certain internal control processes and procedures in order to improve the existing internal controls.

 

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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 third 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
 

January 1 to January 31, 2011

           

Share Repurchase Program (A)

     —           —           —           3,000,000   

Employee Transactions (B)

     334       $ 11.79         —        

February 1 to February 28, 2011

           

Share Repurchase Program (A)

     —           —           —           3,000,000   

Employee Transactions (B)

      $           —        

March 1 to March 31, 2011

           

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

The Company has never paid cash dividends on its common stock, and the terms of our credit agreement limit the amount of cash dividends that can be paid. 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 10:    Fourth Amendment to Second Amended and Restated Credit Agreement.
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: May 3, 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 10:    Fourth Amendment to Second Amended and Restated Credit Agreement.
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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