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EX-21 - SUBSIDIARIES - MATRIX SERVICE COdex21.htm
EX-32.2 - CERTIFICATION PURSUANT TO SECTION 906 - CFO - MATRIX SERVICE COdex322.htm
EX-10.8 - FORM OF RESTRICTED STOCK UNIT AWARD AGREEMENT FOR NON-EMPLOYEE DIRECTORS - MATRIX SERVICE COdex108.htm
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 - CEO - MATRIX SERVICE COdex321.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 - CFO - MATRIX SERVICE COdex312.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 - CEO - MATRIX SERVICE COdex311.htm
EX-10.9 - FORM OF RESTRICTED STOCK UNIT AWARD AGREEMENT FOR EMPLOYEES - MATRIX SERVICE COdex109.htm
EX-10.10 - FORM OF RESTRICTED STOCK UNIT AWARD AGREEMENT FOR EXECUTIVE MANAGEMENT - MATRIX SERVICE COdex1010.htm
EX-10.22 - THIRD AMENDMENT TO SECOND AMENDED AND RESTATED CREDIT AGREEMENT - MATRIX SERVICE COdex1022.htm
EX-23 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - DELOITTE & TOUCHE LLP - MATRIX SERVICE COdex23.htm
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended June 30, 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 or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

5100 E. Skelly Drive, Suite 700

Tulsa, Oklahoma

  74135
(Address of Principal Executive Offices)   (Zip Code)

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

Securities Registered Pursuant to Section 12(b) of the Act:

(Title of class)

Common Stock, par value $0.01 per share

Securities Registered Pursuant to Section 12(g) of the Act: None

Name of Each Exchange on Which Registered: NASDAQ Global Select Market (common stock)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes  ¨    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes  ¨    No  þ

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  þ    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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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 definitions of “large accelerated filer”, ”accelerated filer” and “smaller reporting company” in Rule 12 b-2 of the Exchange Act.

Large accelerated filer  ¨            Accelerated filer  þ            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  þ

The aggregate market value of the registrant’s common stock held by non-affiliates computed by reference to the price at which the common stock was last sold as of the last business day of the registrant’s most recently completed second quarter was approximately $277 million.

The number of shares of the registrant’s common stock outstanding as of September 24, 2010 was 26,342,477 shares.

Documents Incorporated by Reference

Certain sections of the registrant’s definitive proxy statement relating to the registrant’s 2010 annual meeting of stockholders, which definitive proxy statement will be filed within 120 days of the end of the registrant’s fiscal year, are incorporated by reference into Part III of this Form 10-K.

 

 

 

 

     


Table of Contents

 

TABLE OF CONTENTS

 

          Page
   Part I   

Item 1.

   Business    2

Item 1A.

   Risk Factors    10

Item 1B.

   Unresolved Staff Comments    19

Item 2.

   Properties    20

Item 3.

   Legal Proceedings    20

Item 4.

   Reserved    20
   Part II   

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity     Securities    21

Item 6.

   Selected Financial Data    22

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    23

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    34

Item 8.

   Financial Statements and Supplementary Data    36

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    69

Item 9A.

   Controls and Procedures    69

Item 9B.

   Other Information    69
   Part III   

Item 10.

   Directors, Executive Officers and Corporate Governance    70

Item 11.

   Executive Compensation    70

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    70

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    70

Item 14.

   Principal Accountant Fees and Services    70
   Part IV   

Item 15.

   Exhibits and Financial Statement Schedules    71

 

     


Table of Contents

 

PART I

 

Item 1. Business

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K 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 Annual Report which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The word “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 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 Item 1A of this Annual Report 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 at their net realizable values;

 

   

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 Annual Report 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 or effects on 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.

BACKGROUND

Matrix Service Company was incorporated in the State of Delaware in 1989. We provide construction and repair and maintenance services primarily to the energy and energy related industries. As a full service industrial contractor, we strive to provide our clients a high degree of safety, quality and service utilizing our qualified professionals, technical expertise, skilled craftsmen, and overall project management expertise. To serve clients efficiently and effectively, Matrix Service maintains regional offices throughout the United States and Canada. We operate through separate union and merit subsidiaries, which allows us to serve customers on both a union and a merit basis.

We are licensed to operate in all 50 states and in four Canadian provinces. Our headquarters are in Tulsa, Oklahoma, and we have regional operating facilities in California, Delaware, Illinois, Michigan, Oklahoma, Pennsylvania, New Jersey,

 

       

 

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Texas and Washington in the United States and in Ontario, Alberta, and New Brunswick in Canada. Our principal executive offices are located at 5100 E. Skelly Drive, Suite 700, Tulsa, Oklahoma 74135. Our telephone number is (918) 838-8822. Unless the context otherwise requires, all references herein to “Matrix Service”, “Matrix Service Company”, the “Company” or to “we”, “our”, and “us” are to Matrix Service Company and its subsidiaries.

On July 30, 2009 the Company’s Board of Directors approved a change in the Company’s fiscal year end from May 31 to June 30, beginning July 1, 2009. As a result of the change, the Company had a transition period for the one month ended June 30, 2009 (“June Transition Period”). The Company’s financial information, including its business segment and geographical information for the 12 months ended June 30, 2010 (“fiscal 2010”), May 31, 2009 (“fiscal 2009”), May 31, 2008 (“fiscal 2008”) and for the June Transition Period is included in the financial statements and the notes thereto in “Financial Statements and Supplementary Data” in Part II, Item 8.

WEBSITE ACCESS TO REPORTS

Our public internet site is www.matrixservice.com. We make available free of charge through our internet site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

In addition, we currently make our annual reports to stockholders available on our internet site, www.matrixservice.com. Adobe Acrobat Reader software is required to view these documents, which are in PDF format. A link to Adobe Systems Incorporated’s Internet site, from which the software can be downloaded, is provided.

OPERATING SEGMENTS

We have two reportable segments, the Construction Services segment and the Repair and Maintenance Services segment. See Note 14—Segment Information, in the Notes to Consolidated Financial Statements for segment, geographic and market information. We also offer services to our customers where our two business segments work together to provide a combination of services. Customers utilize our services to construct or expand operating facilities, improve operating efficiencies, maintain existing facilities and to comply with environmental and safety regulations. Our projects range in duration from a few days to multiple years, which can be performed as one-time contracts or as part of long-term alliance agreements. We are able to provide services and respond to our customer’s requirements for both union and merit shop operations.

Construction Services

Our Construction Services segment provides turnkey and specialty construction to a wide range of industrial and energy sector clients. Our scope of services includes civil/structural, mechanical, piping, electrical, instrumentation, millwrighting, and fabrication. These services are provided for projects of varying complexities, schedule durations, and budgets. Our project experience includes retrofits, modifications and expansions to existing facilities as well as construction of new facilities.

Repair and Maintenance Services

Our Repair and Maintenance Services segment encompasses a wide range of routine, preventive, and emergency repair and maintenances services. Our ability to provide multiple services allows us to serve as a single source provider to our clients for their repair and maintenance needs.

MARKETS WITHIN OPERATING SEGMENTS

Within these two operating segments we serve four primary markets:

 

   

Aboveground Storage Tanks

 

   

Downstream Petroleum

 

   

Electrical and Instrumentation

 

   

Specialty

 

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Aboveground Storage Tanks

One of the cornerstones of our business has been, and continues to be, aboveground storage tanks (“AST”). We are one of the largest AST constructors in North America and offer complete engineering, procurement, and construction (“EPC”) services as well as fabrication services for the bulk storage, refining, petrochemical, pipeline and power industries. Our expertise includes cone roof tanks, dome roof tanks, open top floating roof tanks, geodesic domes, and specialty tanks. Our personnel are well versed in American Petroleum Institute (“API”) standards and American Society of Mechanical Engineers (“ASME”) code work in both atmospheric and pressure storage vessels.

Every AST project is designed in accordance with applicable industry standards, codes and regulations. With the teams that we have assembled, we have the knowledge and experience to comply with all applicable specifications to ensure that all requirements are met. In response to environmental requirements for control of vapor emissions and leak containment, we have developed many unique designs and devices such as floating roof seal systems, dike liners, and other products. Our product offerings include dikes and liners, steel internal floating roofs, tank double bottoms, and primary and secondary seals. Every product we offer is engineered to meet our customers’ specifications and industry standards.

One of our most significant areas of expertise is our turnkey tank and terminal construction service. Our tank design and EPC services allow our clients to be confident that the project will meet safety and quality objectives and be completed within time and budget constraints. As a general contractor, we offer a single point of contact, with the capability to perform the civil and site preparation, foundations, liners, mechanical, piping, structural, tank design, engineering, fabrication and construction.

Our tank repair and maintenance services are a key component of our core business. We are one of the largest tank repair and maintenance contractors in the United States with a reputation for quality, safety and reliability. AST repair and maintenance services include replacements/repairs to tank bottoms, shells, nozzles, roof structures, steel floating roofs, seals and manways for tanks of all sizes. We provide tank cleaning, foundation repair/replacement and complete tank relocation utilizing air lifting technology.

Downstream Petroleum

Our construction experience in the downstream petroleum market includes refineries, pipelines, petrochemical plants and gas facilities. This includes turnkey construction work for new or existing facilities, renovations, upgrades and expansion projects.

Repair and maintenance services for the downstream petroleum industry are typically classified as either refinery maintenance or turnarounds.

Plant maintenance contracts are agreements to provide outsourcing of maintenance management and the multiple crafts necessary to provide routine and preventive maintenance services for a facility. A typical maintenance contract includes planning and scheduling and active participation in or development of reliability programs, including the development of performance metrics. These services include safety implementation and quality assurance /quality control management.

Contracts for planned major maintenance activities are generally of short duration, but require detailed scheduling and advanced planning to assure the availability of qualified personnel and specialty equipment that are needed to complete the work in the shortest possible timeframe. We are committed to delivering all services on time, within budget and schedule constraints, and most importantly, in a safe manner.

Electrical and Instrumentation

Our product offerings include electrical construction, instrumentation, and control systems. Our experience spans a wide range of industries including power generation, refining, petrochemical and heavy industrial. In addition to ground-up construction, our management and technical teams perform expansion projects, critical path turnarounds, emergency response and staff augmentation services.

As part of our electrical capabilities, we have the experience and expertise to install complex instrumentation and control systems. This service includes instrument calibration and installation, loop checks, commissioning, and start-up.

Electrical and instrumentation repair and maintenance services include routine and preventive maintenance, emergency response, and outage support for various industries including power, petroleum and petrochemical.

 

       

 

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The acquisition of S.M. Electric Company, Inc. in fiscal 2009 significantly enhanced our electrical and instrumentation capabilities. This acquisition has enabled us to focus on supporting the expansion and modernization of the Mid-Atlantic and Southern New England transmission systems while allowing us to expand in our core markets of power generation, refinery, alternative energy, and industrial infrastructure.

Specialty

Liquefied Natural Gas/Industrial Gas Projects/Liquefied Petroleum Gas

Matrix Service engineers, fabricates and constructs refrigerated and cryogenic liquefied gas storage tanks for the storage of ammonia, butane, carbon dioxide, ethane, methane, argon, nitrogen, oxygen, propane and other products. We recently enhanced and expanded our capabilities though the acquisition of assets, technology and resources used for the design and construction of cryogenic storage tanks, including liquefied natural gas (“LNG”) tanks, liquid nitrogen/liquid oxygen (“LIN/LOX”) tanks and liquid petroleum (“LPG”) tanks. These tanks are utilized by our customers in the chemical, petrochemical and gas industries.

Specialty Tanks and Vessels

Our specialty tank and vessel expertise includes aerobic/anaerobic digesters, clarifiers, egg shaped digesters, spheres, petroleum scrubbers/absorbers, flare tips, thermal vacuum chambers and other pressure vessels. These tanks and vessels are used throughout the petroleum, chemical, power, aerospace and waste water industries.

Power Projects

Our construction service offerings for the power industry include stacks, stack liners, ducting, scrubbers, absorbers, and waste to energy facilities. Repair and maintenance services include providing repair, maintenance, and outage services for the power industry. Our onsite maintenance services include routine maintenance such as cleaning fans, changing lube oil coolers and maintaining gas turbines, heat recovery steam generators and other equipment. We also provide turbine disassembly, inspection and repair.

Fabrication

We provide large scale fabrication services to our operating units and customers throughout the United States and Canada. These facilities are staffed with qualified personnel and utilize sophisticated tooling and equipment. Our fabrication facilities specialize in steel plate, structural steel and vessel fabrication utilizing carbon steels, stainless steels and specialty alloy metals. Our largest fabrication facility is centrally located in the United States. This 227,900 sq. ft. facility in Oklahoma is located at the Port of Catoosa, the most inland port in the United States with barge, rail and truck access. The facility has the capacity to fabricate new tanks, new tank components and all maintenance, retrofit and repair parts, including fixed roofs, floating roofs, seal assemblies, shell plate and tank appurtenances. This facility is qualified to fabricate equipment in adherence to ASME codes and regulations including pressure vessels, stacks/stackliners, scrubbers, ducting, flare stacks and igniter tips.

Matrix Service was recently issued the ASME N Stamp (“N Stamp”). The N Stamp authorizes us to design, fabricate and construct certain nuclear quality components and structures. This achievement exemplifies our ongoing commitment to expanding our capabilities and to providing the U.S. power industry with another domestic source of certain nuclear plant components and construction. The N Stamp certification process involved a complete review of our quality control program to ensure that we meet the standards required to offer these services.

 

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OTHER BUSINESS MATTERS

Customers and Marketing

Matrix Service derives a significant portion of its revenues from performing services for major integrated oil companies, independent petroleum refiners, and pipeline, terminal and oil and gas marketing companies. In fiscal 2010 and the June Transition Period, these customer types accounted for 78% and 75% of consolidated revenues, respectively. The loss of significant work from any of these classes of customers or an overall decline in the petroleum industry would have a material adverse effect on the Company. Matrix Service also performs services for power companies, engineering firms, general contractors, and petrochemical and industrial gas companies. The Company provided services to approximately 420 customers in fiscal 2010 and 190 customers in the June Transition Period. The following tables provide a list of customers that accounted for greater than 10% of either our Construction Services or Repair and Maintenance Services revenue for fiscal 2010 and the June Transition Period:

 

     Revenue for the 12 Months Ended June 30, 2010  
     Construction Services     Repair and Maintenance
Services
    Total  
     (In thousands, except percentages)  

PSEG

   $ 48,740    15.2   $ 5,691    2.5   $ 54,431    9.9

BP PLC

     927    0.3     48,918    21.3     49,845    9.0

Chevron Corp

     10,773    3.4     24,348    10.6     35,121    6.4
                                       

Total

   $ 60,440    18.9   $ 78,957    34.4   $ 139,397    25.3
                                       
     Revenue for the One Month Ended June 30, 2009  
     Construction Services     Repair and Maintenance
Services
    Total  
     (In thousands, except percentages)  

BP PLC

   $ 1    —        $ 3,770    21.8   $ 3,771    8.2

Chevron Corp

     1,431    5.0     2,282    13.2     3,713    8.1
                                       

Total

   $ 1,432    5.0   $ 6,052    35.0   $ 7,484    16.3
                                       

The loss of any of these major customers could have a material adverse effect on the Company.

Matrix Service markets its services and products primarily through its marketing and business development personnel, senior professional staff and its operating management. The business development personnel concentrate on developing new customers and assisting management with existing customers. We competitively bid most of our projects. In addition, we have preferred provider relationships with customers who award us work through long-term agreements. Our projects have durations of a few days to multiple years.

Segment Financial Information

Financial information for our operating segments is provided in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Note 14—Segment Information of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data.

Competition

Matrix Service competes with local, regional and national contractors in both the Construction Services and Repair and Maintenance Services segments. Competitors generally vary with the markets we serve with few competitors competing in all of the markets we serve or for all of the services we provide. Contracts are generally awarded based on price, reputation for quality, customer satisfaction, safety record and programs, and schedule. We believe that our turnkey capabilities, expertise, experience and reputation for providing safe, timely, and quality services allow us to compete effectively in the markets that we serve.

 

       

 

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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 revenues recognized as of the reporting date.

Fiscal 2010

The following table provides a summary of changes in our backlog for fiscal 2010:

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Backlog as of June 30, 2009

   $ 224,260      $ 167,837      $ 392,097   

New backlog awarded

     312,907        217,264        530,171   

Backlog cancelled

     (18,238     —          (18,238

Revenue recognized on contracts in backlog

     (321,254     (229,560     (550,814
                        

Backlog as of June 30, 2010

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

At June 30, 2010 the Construction Services segment had a backlog of $197.7 million, as compared to a backlog of $224.3 million as of June 30, 2009. The decrease of $26.6 million is due to declines in Aboveground Storage Tank of $14.3 million, Downstream Petroleum of $17.7 million and Specialty of $8.6 million, partially offset by an increase in Electrical and Instrumentation of $14.0 million. Project cancellations totaling $18.2 million contributed to the backlog reductions with cancellations in Specialty totaling $10.1 million, Aboveground Storage Tank totaling $5.6 million, and Downstream Petroleum totaling $2.5 million. The backlog at June 30, 2010 and June 30, 2009 for the Repair and Maintenance Services segment was $155.5 million and $167.8 million, respectively. The decrease of $12.3 million is due to the decline in Aboveground Storage Tank of $28.7 million, partially offset by increases in Electrical and Instrumentation of $15.4 million and Downstream Petroleum of $1.0 million. Approximately 96% of our backlog at June 30, 2010 is expected to be completed in fiscal year 2011.

June Transition Period

The following table provides a summary of changes in our backlog in the June Transition Period:

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Backlog as of May 31, 2009

   $ 233,579      $ 167,494      $ 401,073   

New backlog awarded

     20,211        17,637        37,848   

Backlog cancelled

     (999     —          (999

Revenue recognized on contracts in backlog

     (28,531     (17,294     (45,825
                        

Backlog as of June 30, 2009

   $ 224,260      $ 167,837      $ 392,097   
                        

At June 30, 2009 the Construction Services segment had a backlog of $224.3 million, as compared to a backlog of $233.6 million as of May 31, 2009. The decrease of $9.3 million is due to declines in Downstream Petroleum of $6.7 million, Aboveground Storage Tank of $2.3 million and Specialty of $2.5 million, partially offset by an increase in Electrical and Instrumentation of $2.2 million. The backlog at June 30, 2009 and May 31, 2009 for the Repair and Maintenance Services segment was $167.8 million and $167.5 million, respectively. Electrical and Instrumentation increased $7.9 million, largely offset by decreases in Downstream Petroleum of $7.0 million and Aboveground Storage Tank of $0.6 million.

 

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Seasonality

Planned maintenance projects at customer facilities are typically scheduled in the spring and the fall when the demand for energy is lower. As a result, quarterly operating results in the Repair and Maintenance Services segment can fluctuate materially. The Construction Services segment typically has a lower level of operating activity during the winter months and early in the calendar year because many of our customers’ capital budgets have been spent or have not been finalized.

Raw Material Sources and Availability

Steel plate and steel pipe are the primary raw materials used by the Company. Supplies of these materials are available throughout the United States and globally from numerous sources. We anticipate that adequate amounts of these materials will be available in the foreseeable future, however, the price, quantity, and the delivery schedules of these materials could change rapidly due to various factors, including producer capacity, the level of foreign imports, worldwide demand, tariffs on imported steel and other market conditions.

Insurance

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 and provide for warranties for materials and workmanship. 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 performance and payment 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 contract.

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.

Employees

As of June 30, 2010, we had 2,477 employees of which 486 were employed in non-field positions and 1,991 were employed in field or shop positions. The number of employees varies significantly throughout the year because of the number, type and size of projects we have in progress at any particular time.

We maintain separate merit and union operations. In our union business, we operate under collective bargaining agreements with various unions representing different groups of our employees. Union agreements provide union employees with benefits including health and welfare, pension, training programs and compensation plans. We have not experienced any significant strikes or work stoppages in recent years. We maintain health and welfare, retirement and training programs for our merit craft employees and most administrative personnel.

Patents and Proprietary Technology

Matrix Service has several patents and patents pending, and continues to pursue new ideas and innovations to better serve our customers in all areas of our business. The Matrix Service patents under the Flex-A-Span® and Flex-A-Seal® trademarks are utilized to cover seals for floating roof tanks. Our patent of our ThermoStor® diffuser system is for a process that receives, stores and dispenses both chilled and warm water in and from the same storage tank. The patented RS 1000 Tank Mixer® controls sludge build-up in crude oil tanks through resuspension. The Valve Shield® patent relates to a flexible fluid containment system that captures and contains fluid leaking from pipe and valve connections. The patent for Spacerless or Geocomposite Double Bottom for Storage Tanks relates to a replacement bottom with leak detection and containment that allows for the retrofitting of an existing tank while minimizing the loss of capacity. The patent for the Training Tank for Personnel Entry, Exit and Rescue relates to a mobile device that can be used to train personnel on equipment that is made to simulate real world hazards.

 

       

 

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The Company acquired a perpetual license to use various patents and proprietary technologies of CB&I Inc. pursuant to a Technology Transfer Agreement dated December 20, 2008. These patents and technology relate to LNG storage tanks, LIN/LOX storage tanks, LPG storage tanks and thermal vacuum chambers. We believe that the ability to use these patents and technology will enable us to expand our presence in the markets for these products and will minimize the development costs typically associated with organic growth.

While we believe that continued product development and the protection of our patents are important to our business, we do not believe that these patents or purchased technology are essential to our success.

Regulation

Health and Safety Regulations

The operations of the Company are subject to the requirements of the United States Occupational Safety and Health Act (“OSHA”), comparable state laws and the Canadian Workers’ Compensation Board and its Workplace Health, Safety and Compensation Commission. Regulations promulgated by these agencies require employers and independent contractors to implement work practices, medical surveillance systems and personnel protection programs to protect employees from workplace hazards and exposure to hazardous chemicals and materials. In recognition of the potential for accidents within various scopes of work, these agencies have enacted strict and comprehensive safety regulations. The Company has established comprehensive programs for complying with health and safety regulations to protect the safety of its workers, subcontractors and customers. While the Company believes that it operates safely and prudently, there can be no assurance that accidents will not occur or that the Company will not incur substantial liability in connection with the operation of its business.

Environmental

The Company’s operations are subject to extensive and changing environmental laws and regulations in the United States and Canada. These laws and regulations relate primarily to air and water pollutants and the management and disposal of hazardous materials. The Company is exposed to potential liability for personal injury or property damage caused by any release, spill, exposure or other accident involving such pollutants, substances or hazardous materials.

In order to limit costs incurred as a result of environmental exposure, the Company has purchased contractor’s pollution liability insurance policies that cover liability we may incur as a result of accidental releases of hazardous materials at customer or operating locations, including our fabrication facilities in Oklahoma and California.

In April of 2010, the EPA alleged that the Company did not file the forms required by the Emergency Planning and Community Right to Know Act and assessed a penalty of $0.3 million. In September 2010, the Company settled all EPA allegations by paying an administrative penalty of $150,000. This item is discussed further in Note 8—Contingencies of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

The Company believes that it is currently in compliance, in all material aspects, with all other applicable environmental laws and regulations. The Company does not expect any material charges in subsequent periods relating to environmental conditions that currently exist and does not foresee any significant future capital spending relating to environmental matters.

 

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Item 1A. Risk Factors

The following risk factors should be considered with the other information included in this Annual Report on Form 10-K. As we operate in a continuously changing environment, other risk factors may emerge which could have material adverse effects on our results of operations, financial condition and cash flow.

Risk Factors Related to Our Business

Our reputation and our ability to do business may be impaired by the corrupt behavior of certain of our employees.

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 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 current and 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 a few customers resulting in an overbilling of $1.3 million, which will be refunded. The Company believes that the loss to the Company and the first $100,000 of costs incurred to conduct the investigation, is covered by the Company’s crime policy. The Company’s out-of-pocket costs, including the crime policy deductible and unreimbursable investigation costs, are expected to range from $300,000 to $600,000.

We intend to fully cooperate with law enforcement authorities with respect to this matter and are committed to conducting business in a legal and ethical manner. Many of our clients make compliance with applicable laws and ethical conduct a condition to their business relationships. The misconduct of these employees may cause us to be disqualified from some business opportunities with clients and others who require their business partners to maintain high ethical standards.

Unsatisfactory safety performance can affect customer relationships, result in higher operating costs, negatively impact employee morale and result in higher employee turnover.

Workplace safety is important to the Company, our employees, and our customers. As a result, we maintain comprehensive safety programs and training to all applicable employees throughout our organization. While we focus on protecting people and property, our work is performed at construction sites and in industrial facilities and our workers are subject to the normal hazards associated with providing these services. Even with proper safety precautions, these hazards can lead to personal injury, loss of life, damage to or destruction of property, plant and equipment, and environmental damage. We are intensely focused on maintaining a strong safety environment and reducing the risk of accidents to the lowest possible level. Poor safety performance may result in lost revenue and profitability or in lost customer relationships that could materially increase future insurance and other operating costs.

Demand for our products and services is cyclical and is vulnerable to the level of capital and maintenance spending of our customers and to downturns in the industries and markets we serve as well as conditions in the general economy. The lingering economic weakness has adversely impacted us and could continue to adversely impact us in the future.

The demand for our products and services depends upon the existence of construction and repair and maintenance projects in the downstream petroleum, power and other heavy industries in the United States and Canada. Therefore, it is likely that our business will continue to be cyclical in nature and vulnerable to general downturns in the United States, Canadian and world economies and declines in commodity prices, which could adversely affect the demand for our products and services.

Our Construction Services segment’s revenue and cash flow are dependent upon engineering and construction projects. The availability of these types of projects is dependent upon the economic condition of the oil, gas, and power industries, specifically, the level of capital expenditures of oil, gas and power companies on infrastructure. The current disruption in credit and capital markets, as well as a severe recession in North America have had and may continue to have an adverse impact on the level of capital expenditures of oil, gas and power companies and/or their ability to finance these expenditures. Our failure to obtain projects, the delay of project awards , the cancellation of projects or delays in the completion of contracts are factors that result in under-utilization of our resources, which adversely impact our revenue, operating results and cash flow. There are numerous factors beyond our control that influence the level of capital expenditures of oil, gas and power companies, including:

 

   

current or projected commodity prices, including oil, gas and power prices;

 

       

 

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refining margins;

 

   

the demand for oil, gas and electricity;

 

   

the ability of oil, gas and power companies to generate, access and deploy capital;

 

   

exploration, production and transportation costs;

 

   

tax incentives, including those for alternative energy projects such as wind generation;

 

   

regulatory restraints on the rates that power companies may charge their customers; and

 

   

local and international political and economic conditions.

Our Repair and Maintenance Services segment’s revenue and cash flow are dependent upon maintenance plans by the oil, gas and power industries. The lingering effect of a severe recession in North America continues to have an adverse impact on the level and timing of maintenance expenditures of oil, gas and power companies. Our failure to obtain projects, the delay in project awards, the cancellation of projects or project commencement delays are factors that result in under-utilization of our resources, which adversely impact on revenue, operating results and cash flow.

Our results of operations depend upon the award of new contracts and the timing of those awards.

Our revenues are derived primarily from contracts awarded on a project-by-project basis. Generally, it is difficult to predict whether and when we will be awarded a new contract due to lengthy and complex bidding and selection processes, changes in existing or forecasted market conditions, access to financing, governmental regulations, permitting and environmental matters. Because our revenues are derived primarily from contract awards, our results of operations and cash flows can fluctuate materially from period to period.

The uncertainty associated with the timing of contract awards may reduce our short-term profitability as we balance our current capacity with expectations of future contract awards. If an expected contract award is delayed or not received, we could incur costs to maintain an idle workforce that may have a material adverse effect on our results of operations. Alternatively, we may decide that our long-term interests are best served by reducing our workforce and incurring increased costs associated with severance and termination benefits which also could have a material adverse effect on our results of operations for the period when incurred. Reducing our workforce could also impact our results of operations if we are unable to adequately staff projects that are awarded subsequent to a workforce reduction.

Our credit facility imposes restrictions that may limit business alternatives.

Our senior revolving credit facility contains covenants that restrict or limit our ability to incur additional debt, acquire or dispose of assets, repurchase equity, or make certain distributions, including dividends. In addition, our credit facility requires that we comply with a number of financial covenants. These covenants and restrictions may impact our ability to effectively execute operating and strategic plans and our operating performance may not be sufficient to comply with the required covenants.

Our failure to comply with one or more of the covenants in our credit facility could result in an event of default. We can provide no assurance that a default could be remedied, or that our creditors would grant a waiver or amend the terms of the credit facility. If an event of default occurs, our lenders could elect to declare all amounts outstanding under the facility to be immediately due and payable, terminate all commitments, refuse to extend further credit, and require us to provide cash to collateralize any outstanding letters of credit. If an event of default occurs and the lenders under the credit facility accelerate the maturity of any loans or other debt outstanding, we may not have sufficient liquidity to repay amounts outstanding under the existing agreement.

In addition, due to our recent operating performance, we were prohibited from utilizing the entire amount of our credit facility at June 30, 2010. If the constraints on our ability to fully access the credit facility continue or worsen, it could limit our ability to fund working capital required for new projects, acquire additional capital assets or pursue our acquisition strategy.

We face substantial competition in each of our business segments, which may have a material adverse effect on our business.

We face competition in all areas of our business from regional, national and international competitors. Our competitors range from small family owned businesses to well-established, well-financed entities, both privately and publicly held,

 

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including many major equipment manufacturers, large engineering and construction companies, internal engineering departments and specialty contractors. The markets we serve require substantial resources and, in particular, highly skilled and experienced technical personnel. We compete primarily on the basis of price, customer satisfaction, safety performance and programs, quality of our products and services, and schedule. In particular, as a result of the continuing effects of the recent recession on capital and maintenance spending, we have and may continue to experience pressure on our operating margins.

Our backlog is subject to unexpected fluctuations, adjustments and cancellations and does not include the full value of our long-term maintenance contracts, and therefore, may not be a reliable indicator of our future earnings.

Backlog may not be a reliable indicator of our future performance. We cannot guarantee that the revenue projected in our backlog will be realized or profitable. Projects may remain in our backlog for an extended period of time. In addition, project cancellations or scope adjustments may occur from time to time with respect to contracts reflected in our backlog that could reduce the dollar amount of our backlog and the revenue and profits that we actually earn. Many of our contracts have termination rights, therefore, project terminations, suspensions or scope adjustments may occur from time to time with respect to contracts in our backlog.

The loss of one or more of our significant customers could adversely affect us.

One or more customers have in the past and may in the future contribute a material portion to our consolidated revenues in any one year. Because these significant customers generally contract with us for specific projects or for specific periods of time, we may lose these customers from year to year as the projects or maintenance contracts are completed. If we do not replace these projects or customers, our financial condition and results of operations could be materially adversely affected. The loss of business from any one of these customers could have a material adverse effect on our business or results of operations.

The terms of our contracts could expose us to unforeseen costs and costs not within our control, which may not be recoverable and could adversely affect our results of operations and financial condition.

In the current market, our customers are requiring that we bid more jobs on a fixed price basis. Under fixed-price contracts, we agree to perform the contract for a fixed-price and, as a result, can improve our expected profit by superior contract performance, productivity, worker safety and other factors resulting in cost savings. However, we could incur cost overruns above the approved contract price, which may not be recoverable. Under certain incentive fixed-price contracts, we may agree to share with a customer a portion of any savings we are able to generate while the customer agrees to bear a portion of any increased costs we may incur up to a negotiated ceiling. To the extent costs exceed the negotiated ceiling price, we may be required to absorb some or all of the cost overruns.

Fixed-price contract prices are established based largely upon estimates and assumptions relating to project scope and specifications, personnel, material needs, and site conditions. These estimates and assumptions may prove inaccurate or conditions may change due to factors out of our control, resulting in cost overruns, which we may be required to absorb and which could have a material adverse effect on our business, financial condition and results of our operations. In addition, our profits from these contracts could decrease and we could experience losses if we incur difficulties in performing the contracts or are unable to secure fixed-pricing commitments from our manufacturers, suppliers and subcontractors at the time we enter into fixed-price contracts with our customers.

Under cost-plus and time-and-material contracts, we perform our services in return for payment of our agreed upon reimbursable costs plus a profit. The profit component is typically expressed in the contract either as a percentage of the reimbursable costs we actually incur or is factored into the rates we charge for labor or for the cost of equipment and materials, if any, we are required to provide. Our profit could be negatively impacted if our actual costs exceed the estimated costs utilized to establish the billing rates included in the contracts.

Many of our fixed-price or cost-plus contracts require us to satisfy specified progress milestones or performance standards in order to receive a payment. Under these types of arrangements, we may incur significant costs for labor, equipment and supplies prior to receipt of payment. If the customer fails or refuses to pay us for any reason, there is no assurance we will be able to collect amounts due to us for costs previously incurred. In some cases, we may find it necessary to terminate subcontracts with suppliers engaged by us to assist in performing a contract and we may incur costs or penalties for canceling our commitments to them.

 

       

 

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If we are unable to collect amounts owed to us under our contracts, we may be required to record a charge against previously recognized earnings related to the project, and our liquidity, financial condition and results of operations could be adversely affected.

We may incur significant costs in providing services in excess of original project scope without having an approved change order.

After commencement of a contract, we may perform, without the benefit of an approved change order from the customer, additional services requested by the customer that were not contemplated in our contract price for various reasons, including customer changes or incomplete or inaccurate engineering, project specifications and other similar information provided to us by the customer. Our construction contracts generally require the customer to compensate us for additional work or expenses incurred under these circumstances.

A failure to obtain adequate compensation for these matters could require us to record in the current period an adjustment to revenue and profit recognized in prior periods under the percentage-of-completion accounting method. Any such adjustments, if substantial, could have a material adverse effect on our results of operations and financial condition, particularly for the period in which such adjustments are made. We cannot assure you that we will be successful in obtaining, through negotiation, arbitration, litigation or otherwise, approved change orders in an amount adequate to compensate us for our additional work or expenses.

Our profitability could be negatively impacted if we are not able to maintain adequate utilization of our workforce.

The costs of providing our services to customers, including the extent to which we utilize our workforce, affect our profitability. If we do not invest in building our business for the future, our long-term profitability will be negatively impacted. If we under-utilize our workforce, our project gross margins and overall profitability will suffer in the short-term. If we over utilize our workforce, we may negatively impact safety, employee satisfaction and project execution, which could result in a decline of future project awards. The utilization of our workforce is impacted by numerous factors including:

 

   

our estimate of the headcount requirements for our various operating units based upon our forecast of the demand for our products and services;

 

   

our ability to maintain our talent base and manage attrition;

 

   

our ability to schedule our portfolio of projects to efficiently utilize our employees and minimize downtime between project assignments; and

 

   

our need to invest time and resources into functions such as training, business development, employee recruiting, and sales that are not chargeable to customer projects.

Our use of percentage-of-completion accounting for fixed-price contracts and our reporting of profits for cost-plus contracts prior to contract completion could result in a reduction or elimination of previously reported profits.

Our revenues are recognized using the percentage-of-completion method of accounting. The percentage-of-completion accounting practices that we use result in our recognizing contract revenues and earnings ratably over the contract term based on the proportion of actual costs incurred to total estimated contract costs. In addition, some contracts contain penalty provisions for failure to achieve certain milestones, schedules or performance standards. We review our estimates of contract revenues, costs and profitability on a monthly basis. As a result, we may adjust our estimates on one or more occasions as a result of changes in cost estimates, change orders to the original contract, or claims against the customer for increased costs incurred by us due to customer-induced delays and other factors.

Contract losses are recognized in the fiscal period when the loss is determined. Contract profit estimates are also adjusted in the fiscal period in which it is determined that an adjustment is required. No restatements are made to prior periods. Further, a number of our contracts contain various cost and performance incentives and penalties that impact the earnings we realize from our contracts, and adjustments related to these incentives and penalties are recorded in the period when estimable.

As a result of the requirements of the percentage-of-completion method of accounting, the possibility exists, for example, that we could have estimated and reported a profit on a contract over several prior periods and later determine that all or a portion of such previously estimated and reported profits were overstated. If this occurs, the full aggregate amount of the overstatement will be reported for the period in which such determination is made.

 

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We are exposed to credit risk from customers. If we experience delays and/or defaults in customer payments, we could suffer liquidity problems or we could be unable to recover all expenditures.

Because of the nature of our contracts, at times we commit resources to customer projects prior to receiving payments from customers in amounts sufficient to cover expenditures on the customer projects as they are incurred. Delays in customer payments may require us to make a working capital investment. If customers default in making payments on projects, it could have an adverse effect on our financial position, results of operations and cash flows.

Actual results could differ from the estimates and assumptions that we use to prepare our financial statements.

To prepare financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions, as of the date of the financial statements, which affect the reported values of assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities. Areas requiring significant estimation by our management include:

 

   

contract costs and application of percentage-of-completion accounting;

 

   

provisions for uncollectible receivables from customers for invoiced amounts;

 

   

the amount and collectability of unapproved change orders and claims against customers;

 

   

provisions for income taxes and related valuation allowances;

 

   

recoverability of goodwill and intangible assets;

 

   

valuation of assets acquired and liabilities assumed in connection with business combinations; and

 

   

accruals for estimated liabilities, including litigation and insurance reserves.

Our actual results could materially differ from these estimates.

An inability to attract and retain qualified personnel, and in particular, engineers, project managers and skilled craft workers, could impact our ability to perform on our contracts, which could harm our business and impair our future revenues and profitability.

Our ability to attract and retain qualified engineers, project managers, skilled craftsmen and other experienced professionals in accordance with our needs is an important factor in our ability to maintain and increase profitability. The market for these professionals is competitive, particularly during periods of economic growth when the supply is limited. We cannot provide any assurance that we will be successful in our efforts to retain or attract qualified personnel when needed. Therefore, when we anticipate or experience growing demand for our services, we may incur additional cost to maintain a professional staff in excess of our current contract needs in an effort to have sufficient qualified personnel available to address this anticipated demand. If we do incur additional compensation and benefit costs, our customer contracts may not allow us to pass through these costs.

Competent and experienced engineers, project managers, and craft workers are especially critical to the profitable performance of our contracts, particularly on our fixed-price contracts where superior design and execution of the project can result in profits greater than originally estimated or where inferior design and project execution can reduce or eliminate estimated profits or even result in a loss.

Our project managers are involved in most aspects of contracting and contract execution including:

 

   

supervising the bidding process, including providing estimates of significant cost components, such as material and equipment needs, and the size and composition of the workforce;

 

   

negotiating contracts;

 

   

supervising contract performance, including performance by our employees, subcontractors and other third-party suppliers and vendors;

 

   

estimating costs for completion of contracts that is used by us to estimate amounts that can be reported as revenues and earnings on the contract under the percentage-of-completion method of accounting;

 

   

negotiating requests for change orders and the final terms of approved change orders; and

 

       

 

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determining and documenting claims by us for increased costs incurred due to the failure of customers, subcontractors and other third-party suppliers of equipment and materials to perform on a timely basis and in accordance with contract terms.

Work stoppages and other labor problems could adversely affect us.

Some of our employees are represented by labor unions. The Company has in excess of 50 collective bargaining agreements with various labor unions. The most significant agreements and the expiration dates include the following:

 

Trade

   Local #    Location    Expires

Boilermaker

   28    Bayonne, N.J.    12/31/2010

Boilermaker

   13    Philadelphia, PA.    9/30/2010

Electrician

   351    Winslow, N.J.    10/04/2010

National Travel Lodge

   All    National    10/31/2010

Electrician

   102    Parsippany, N.J.    5/31/2011

Electrician

   164    Paramus, N.J.    5/31/2011

The Company is also working under a number of other agreements that cover a smaller number of employees. These agreements expire within the next five years. For those agreements with upcoming expiration dates, the Company is currently negotiating renewals and expects that the renewals will be successfully completed. To date, the Company has not experienced any significant work stoppages or other significant labor problems in connection with its collective bargaining agreements. A lengthy strike or other work stoppage on any of our projects could have a material adverse effect on our business and results of operations due to an inability to complete contracted projects in a timely manner. From time to time, we have also experienced attempts to unionize certain of our merit employees. While these efforts have only achieved limited success to date, we cannot provide any assurance that we will not experience additional and more successful union activity in the future.

Future events, including those associated with our growth strategy, could negatively affect our liquidity position.

We can provide no assurance that we will have sufficient cash from operations or the credit capacity to meet all of our future cash needs should we encounter significant working capital requirements or incur significant acquisition costs. Insufficient cash from operations, significant working capital requirements, and contract disputes have in the past, and could in the future, reduce availability under our credit facility and impact our ability to comply with the terms of our credit agreement.

There are integration and consolidation risks associated with our acquisition strategy. Future acquisitions may result in significant transaction expenses, unexpected liabilities and risks associated with entering new markets, and we may be unable to profitably operate these businesses.

An aspect of our business strategy is to make strategic acquisitions in markets where we currently operate as well as in markets in which we have not previously operated. We may have difficulties identifying attractive acquisition candidates or we may be unable to acquire desired businesses on economically acceptable terms. Additionally, existing or future competitors may desire to compete with us for acquisition candidates that may have the effect of increasing acquisition costs or reducing the number of suitable acquisition candidates.

We may not have the financial resources necessary to consummate any acquisitions or the ability to obtain the necessary funds on satisfactory terms. We may not have sufficient management, financial and other resources to integrate future acquisitions. Any future acquisitions may result in significant transaction expenses, unexpected liabilities and risks associated with entering new markets in addition to the integration and consolidation risks. In the event we are unable to complete future strategic acquisitions, we may not grow in accordance with our expectations.

If we make any future acquisitions, we likely will have exposure to third parties for liabilities of the acquired business that may or may not be adequately covered by insurance or by indemnification, if any, from the former owners of the acquired business. Any of these unexpected liabilities could have a material adverse effect on our business.

We are involved, and are likely to continue to be involved in legal proceedings, which will increase our costs and, if adversely determined, could have a material effect on our financial condition and results of operations.

We are currently a defendant in legal proceedings arising from the operation of our business and it is reasonable to expect that we would be named in future actions. Many of the actions against us arise out of the normal course of performing

 

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services on project sites, and include claims for workers’ compensation, personal injury and property damage. From time to time, we are also named as a defendant for actions involving the violation of federal and state labor laws related to employment practices and wages and benefits and in contract disputes with customers relating to the timeliness and quality of the performance of our services and equipment, materials, design or other services provided by subcontractors and third-party suppliers. We also are, and are likely to continue to be, a plaintiff in legal proceedings against customers seeking to recover payment of contractual amounts due to us as well as claims for increased costs incurred by us resulting from, among other things, services performed by us at the request of a customer that are in excess of original project scope that are later disputed by the customer and customer-caused delays in our contract performance.

We maintain insurance against operating hazards in amounts that we believe are customary in our industry. However, our insurance has deductibles and exclusions of coverage so we cannot provide assurance that we are adequately insured against all types of risks that are associated with the conduct of our business. A successful claim brought against us in excess of, or outside of, our insurance coverage could have a material adverse effect on our financial condition and results of operations.

Litigation, regardless of its outcome, is expensive, typically diverts the efforts of our management away from operations for varying periods of time, and can disrupt or otherwise adversely impact our relationships with current or potential customers and suppliers. Payment and claim disputes with customers may also cause us to incur increased interest costs resulting from incurring indebtedness under our revolving line of credit or receiving less interest income resulting from fewer funds invested due to the failure to receive payment for disputed claims and accounts.

Our projects expose us to potential professional liability, product liability, warranty and other claims, which could be expensive, damage our reputation and harm our business. We may not be able to obtain or maintain adequate insurance to cover these claims.

We perform construction and maintenance services at large industrial facilities where accidents or system failures can be disastrous and costly. Any catastrophic occurrence in excess of our insurance limits at locations engineered or constructed by us or where our products are installed or services performed could result in significant professional liability, product liability, warranty and other claims against us by our customers, including claims for cost overruns and the failure of the project to meet contractually specified milestones or performance standards. Further, the rendering of our services on these projects could expose us to risks, and claims by, third parties and governmental agencies for personal injuries, property damage and environmental matters, among others. Any claim, regardless of its merit or eventual outcome, could result in substantial costs, divert management’s attention and create negative publicity, particularly for claims relating to environmental matters where the amount of the claim could be extremely large. Insurance coverage is increasingly expensive and we may not be able to or may choose not to obtain or maintain adequate protection against the types of claims described above. If we are unable to obtain insurance at an acceptable cost or otherwise protect against the claims described above, we will be exposed to significant liabilities, which may materially and adversely affect our financial condition and results of operations.

Employee, subcontractor or partner misconduct or our overall failure to comply with laws or regulations could harm our reputation, damage our relationships with customers, reduce our revenues and profits, and subject us to criminal and civil enforcement actions.

Misconduct, fraud, non-compliance with applicable laws and regulations, or other improper activities by one of our employees, subcontractors or partners could have a significant negative impact on our business and reputation. Such misconduct could include the failure to comply with safety standards, laws and regulations, customer requirements, regulations pertaining to the internal controls over financial reporting, environmental laws and any other applicable laws or regulations. The precautions we take to prevent and detect these activities may not be effective, since our internal controls are subject to inherent limitations, including human error, the possibility that controls could be circumvented or become inadequate because of changed conditions, and fraud.

Our failure to comply with applicable laws or regulations or acts of misconduct could subject us to fines and penalties, harm our reputation, damage our relationships with customers, reduce our revenues and profits and subject us to criminal and civil enforcement actions.

 

       

 

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We rely on internally and externally developed software applications and systems to support critical functions including project management, estimating, human resources, accounting, and financial reporting. Any sudden loss, disruption or unexpected costs to maintain these systems could significantly increase our operational expense as well as disrupt the management of our business operations.

We rely on various software systems to operate our critical operating and administrative functions. We depend on our software vendors to provide long-term software maintenance support for our information systems. Software vendors may decide to discontinue further development, integration or long-term software maintenance support for our information systems, in which case we may need to abandon one or more of our current information systems and migrate some or all of our project management, human resources, estimating, accounting and financial information to other systems, thus increasing our operational expense as well as disrupting the management of our business operations.

We are susceptible to adverse weather conditions, which may harm our business and financial results.

Our business may be adversely affected by severe weather in areas where we have significant operations. Repercussions of severe weather conditions may include:

 

   

curtailment of services;

 

   

suspension of operations;

 

   

inability to meet performance schedules in accordance with contracts;

 

   

weather related damage to our facilities;

 

   

inability to receive machinery, equipment and materials at jobsites; and

 

   

loss of productivity.

Environmental factors and changes in laws and regulations could increase our costs and liabilities.

Our operations are subject to environmental laws and regulations, including those concerning emissions into the air; discharges into waterways; generation, storage, handling, treatment and disposal of hazardous material and wastes; and health and safety.

Our projects often involve highly regulated materials, including hazardous wastes. Environmental laws and regulations generally impose limitations and standards for regulated materials and require us to obtain permits and comply with various other requirements. The improper characterization, handling, or disposal of regulated materials or any other failure by us to comply with federal, state and local environmental laws and regulations or associated environmental permits could subject us to the assessment of administrative, civil and criminal penalties, the imposition of investigatory or remedial obligations, or the issuance of injunctions that could restrict or prevent our ability to operate our business and complete contracted projects.

In addition, under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”), and comparable state laws, we may be required to investigate and remediate regulated materials. CERCLA and the comparable state laws typically impose liability without regard to whether a company knew of or caused the release, and liability for the entire cost of clean-up can be imposed upon any responsible party.

We are subject to numerous other laws and regulations including those related to the environment, workplace, employment, health and safety. These laws and regulations are complex, change frequently and could become more stringent in the future. It is impossible to predict the effect on us of any future changes to these laws and regulations. We can provide no absolute assurance that our operations will continue to comply with future laws and regulations or that the costs to comply with these laws and regulations and/or a failure to comply with these laws will not significantly adversely affect our business, financial condition and results of operations.

Earnings for future periods may be affected by impairment charges.

Because we have grown in part through acquisitions, goodwill and other acquired intangible assets represent a substantial portion of our assets. We perform an annual goodwill impairment review in the fourth quarter of every fiscal year. In addition, we perform a goodwill impairment review whenever events or changes in circumstances indicate the carrying value may not be recoverable. At some future date, we may determine that an additional significant impairment has occurred in the value of our unamortized intangible assets, goodwill or fixed assets, which could require us to write off an additional portion of our assets and could adversely affect our financial condition or results of operations.

 

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Earnings for future periods may be negatively impacted by foreign currency exchange rates

We are exposed to financial risk as a result of changes in foreign currency exchange rates. The exposure relates to receivables, payables, and intercompany loans utilized to finance foreign subsidiaries in Canada. Future growth in foreign operations in Canada and other countries may expose the Company to additional risk. While we seek to minimize this risk through our contracting strategies and cash management, we may, depending on the magnitude of the risk, elect to utilize currency hedging. To the extent these risk mitigation strategies are ineffective, fluctuations in foreign currency exchange rates could negatively impact our operating results and financial condition.

We may need to raise additional capital in the future for working capital, capital expenditures and/or acquisitions, and we may not be able to do so on favorable terms or at all, which would impair our ability to operate our business or achieve our growth objectives.

To the extent that cash flow from operations, together with available borrowings under our credit facility, are insufficient to make future investments, make acquisitions or provide needed additional working capital, we may require additional financing from other sources. Our ability to obtain such additional financing in the future will depend in part upon prevailing capital market conditions, as well as conditions in our business and our operating results; and those factors may affect our efforts to arrange additional financing on terms that are satisfactory to us. If adequate funds are not available, or are not available on acceptable terms, we may not be able to make future investments, take advantage of acquisitions or other opportunities, or respond to competitive challenges.

Risk Factors Related to Our Common Stock

Our common stock, which is listed on the NASDAQ Global Market, has from time-to-time experienced significant price and volume fluctuations. These fluctuations are likely to continue in the future, and our stockholders may not be able to resell their shares of common stock at or above the purchase price paid.

The market price of our common stock may change significantly in response to various factors and events beyond our control, including the following:

 

   

the risk factors described in this Item 1A;

 

   

the significant concentration of ownership of our common stock in the hands of a small number of institutional investors;

 

   

a shortfall in operating revenue or net income from that expected by securities analysts and investors;

 

   

changes in securities analysts’ estimates of our financial performance or the financial performance of our competitors or companies in our industry;

 

   

general conditions in our customers’ industries; and

 

   

general conditions in the security markets.

Some companies that have volatile market prices for their securities have been subject to security class action suits filed against them. If a suit were to be filed against us, regardless of the outcome, it could result in substantial costs and a diversion of our management’s attention and resources. This could have a material adverse effect on our business, results of operations and financial condition.

Future sales of our common stock may depress our stock price.

Sales of a substantial number of shares of our common stock in the public market or otherwise, either by us, a member of management or a major stockholder, or the perception that these sales could occur, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.

We may issue additional equity securities, which would lead to dilution of our issued and outstanding stock.

The issuance of additional common stock or securities convertible into our common stock would result in dilution of the ownership interest in us held by existing stockholders. We are authorized to issue, without stockholder approval 5,000,000 shares of preferred stock, par value $0.01 per share, in one or more series, which may give other stockholders dividend,

 

       

 

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conversion, voting, and liquidation rights, among other rights, which may be superior to the rights of holders of our common stock. In addition, we are authorized to issue, without stockholder approval, a significant number of additional shares of our common stock and securities convertible into either common stock or preferred stock.

 

Item 1B. Unresolved Staff Comments

None

 

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Item 2. Properties

The principal properties of Matrix Service at June 30, 2010 were as follows:

 

Location

  

Description of Facility

  

Segment

  

Interest

Tulsa, Oklahoma    Corporate headquarters    Corporate    Leased
Alton, Illinois    Regional office and warehouse    Repair & Maintenance    Leased
Bellingham, Washington    Regional office and warehouse    Construction and Repair & Maintenance    Owned
Catoosa, Oklahoma    Fabrication facility, regional office and warehouse    Construction and Repair & Maintenance    Owned (1)
Cranbury, New Jersey    Sales office    Construction and Repair & Maintenance    Leased
Deer Park, Texas    Recruiting center    Construction and Repair & Maintenance    Leased
Eddystone, Pennsylvania    Regional office    Construction and Repair & Maintenance    Leased
Eddystone, Pennsylvania    Fabrication facility and warehouse    Construction and Repair & Maintenance    Leased
Houston, Texas    Regional office and warehouse    Construction and Repair & Maintenance    Owned
Houston, Texas    Regional office    Construction and Repair & Maintenance    Leased
Orange, California    Fabrication facility, regional office and warehouse    Construction and Repair & Maintenance    Owned
Newark, Delaware    Regional office and warehouse    Construction and Repair & Maintenance    Leased
Norwich, Connecticut    Sales office    Construction and Repair & Maintenance    Leased
Rahway, New Jersey    Regional office and warehouse    Construction and Repair & Maintenance    Leased
Sewickley, Pennsylvania    Regional office    Construction and Repair & Maintenance    Leased
Suisun City, California    Regional office and warehouse    Repair & Maintenance    Leased
Temperance, Michigan    Regional office and warehouse    Construction and Repair & Maintenance    Owned
Calgary, Alberta, Canada    Sales office    Construction and Repair & Maintenance    Leased
Leduc, Alberta, Canada    Regional office and warehouse    Construction and Repair & Maintenance    Leased
Saint John, New Brunswick, Canada    Regional office    Repair & Maintenance    Leased
Sarnia, Ontario, Canada    Regional office and warehouse    Repair & Maintenance    Owned

 

(1) Facilities were constructed by the Company in 2002 and 2003 on land acquired through the execution of a 15 year ground lease with renewal provisions for five additional terms of five years each.

In addition to the locations listed above, Matrix Service has temporary office facilities at numerous customer locations throughout the United States and Canada.

 

Item 3. Legal Proceedings

The information called for by this item is provided in Note 8—Contingencies, of the Notes to Consolidated Financial Statements included in Part II, Item 8., under the caption “Material Legal Proceedings” which information is incorporated by reference into this item.

 

Item 4. Reserved

None

 

       

 

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Part II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Price Range of Common Stock

Our common stock trades on the NASDAQ Global Select Market (“NASDAQ”) under the trading symbol “MTRX”. The following table sets forth the high and low sale prices for our common stock as reported by NASDAQ for the periods indicated:

 

     Fiscal 2010    Fiscal 2009
     High    Low    High    Low

First quarter

   $ 11.74    $ 9.59    $ 26.50    $ 18.56

Second quarter

     10.68      8.56      23.74      5.71

Third quarter

     12.20      9.43      8.91      5.10

Fourth quarter

     12.38      8.58      11.32      6.01

The high sales price of our common stock as reported by NASDAQ in the June Transition Period was $13.01 and the low sales price was $10.66.

As of August 31, 2010, there were 35 holders of record of our common stock. We believe that the number of beneficial owners of our common stock is substantially greater than the number of holders of record.

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.

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 fourth quarter of the fiscal year ended June 30, 2010.

 

     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

April 1 to April 30, 2010

           

Share Repurchase Program (A)

   —        —      —      3,000,000

Employee Transactions (B)

   2,100    $ 10.74    —      —  

May 1 to May 31, 2010

           

Share Repurchase Program (A)

   —        —      —      3,000,000

Employee Transactions (B)

   2,134    $ 10.60    —     

June 1 to June 30, 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 (“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.
(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.

 

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Item 6. Selected Financial Data

Selected Financial Data

(In thousands, except percentages and per share data)

 

     Twelve Months Ended     One
Month
Ended
 
     June 30,
2010
    May 31,
2009
    May 31,
2008
    May 31,
2007
    May 31,
2006
    June 30,
2009 (1)
 

Revenues

   $ 550,814      $ 689,720      $ 731,301      $ 639,846      $ 493,927      $ 45,825   

Gross profit

     52,922        94,323        75,117        65,886        47,079        5,149   

Gross profit %

     9.6     13.7     10.3     10.3     9.5     11.2

Operating income

     7,753        47,317        34,551        33,050        17,698        1,579   

Income before income taxes

     7,410        47,759        33,716        31,114        11,594        1,603   

Net income

     4,876        30,589        21,414        19,171        7,653        994   

Net income %

     0.9     4.4     2.9     3.0     1.5     2.2

Earnings per share-diluted

     0.18        1.16        0.80        0.74        0.35        0.04   

Equity per share-outstanding

     6.74        6.51        5.32        4.72        3.67        6.52   

Weighted average shares outstanding diluted

     26,499        26,390        26,875        26,752        25,742        26,434   

Working capital

     95,740        82,460        60,826        51,306        42,656        82,948   

Total assets

     284,808        303,451        274,593        242,909        188,276        299,961   

Long-term debt

     259        850        1,000        836        28,116        777   

Total debt

     1,031        1,889        2,153        4,301        30,330        1,828   

Capital expenditures

     5,302        9,983        18,302        13,120        5,614        348   

Stockholders’ equity

     177,585        170,389        138,700        125,576        76,399        170,797   

Total long-term debt to equity %

     0.1     0.5     0.7     0.7     36.8     0.5

Cash flow provided by operations

     4,399        38,624        45,596        11,358        35,880        18,906   

 

(1) On July 30, 2009 the Company’s Board of Directors approved a change in the Company’s fiscal year end from May 31 to June 30, beginning July 1, 2009. As a result of the change, the Company had a transition period for the one month ended June 30, 2009.

 

       

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). GAAP represents a comprehensive set of accounting and disclosure rules and requirements, the application of which requires management judgments and estimates including, in certain circumstances, choices between acceptable GAAP alternatives. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions. Note 1 of the Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K, contains a comprehensive summary of our significant accounting policies. The following is a discussion of our most critical accounting policies, estimates, judgments and uncertainties that are inherent in our application of GAAP.

CRITICAL ACCOUNTING ESTIMATES

Revenue Recognition

Matrix Service records profits on fixed-price contracts on a percentage-of-completion basis, primarily based on costs incurred to date compared to the total estimated contract cost. Matrix Service records revenue on reimbursable and time and material contracts on a proportional performance basis as costs are incurred. Contracts in process are valued at cost plus accrued profits less billings on uncompleted contracts. Contracts are generally considered substantially complete when field construction is completed. The elapsed time from award of a contract to completion of performance may be in excess of one year. Matrix Service includes pass-through revenue and costs on cost-plus contracts, which are customer-reimbursable materials, equipment and subcontractor costs, when Matrix Service determines that it is responsible for the procurement and management of such cost components.

Matrix Service has numerous contracts that are in various stages of completion which require estimates to determine the appropriate cost and revenue recognition. Matrix Service has a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs, and accordingly, does not believe significant fluctuations are likely to materialize. However, current estimates may be revised as additional information becomes available. If estimates of costs to complete fixed-price contracts indicate a loss, a provision is made through a contract write-down for the total loss anticipated. A number of our contracts contain various cost and performance incentives and penalties that impact the earnings we realize from our contracts. Adjustments related to these incentives and penalties are recorded in the period on a percentage of completion basis when estimable and probable.

Indirect costs (such as salaries and benefits, supplies and tools, equipment costs and insurance costs) are charged to projects based upon direct labor hours and overhead allocation rates per direct labor hour. Warranty costs are normally incurred prior to project completion and are charged to project costs as they are incurred. Warranty costs incurred subsequent to project completion were not material for the periods presented. Overhead allocation rates are established annually during the budgeting process and evaluated for accuracy throughout the year based upon actual direct labor hours and actual costs incurred.

Claims Recognition

Claims are amounts in excess of the agreed contract price (or amounts not included in the original contract price) that we seek to collect from customers or others for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes of anticipated additional costs incurred by us. Recognition of amounts as additional contract revenue related to claims is appropriate only if it is probable that the claims will result in additional contract revenue and if the amount can be reliably estimated. If all of the following requirements are met, revenue from a claim is recorded only to the extent that we have incurred costs relating to the claim. We must determine if:

 

   

there is a legal basis for the claim;

 

   

the additional costs were caused by circumstances that were unforeseen by the Company and are not the result of deficiencies in our performance;

 

   

the costs are identifiable or determinable and are reasonable in view of the work performed; and

 

   

the evidence supporting the claim is objective and verifiable.

 

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As of June 30, 2010 and May 31, 2009, costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders of $3.0 million and $0.5 million, respectively. There were no claims included in costs and estimated earnings in excess of billings on uncompleted contracts as of June 30, 2010 or May 31, 2009. Historically, our collections for unapproved change orders and other claims have approximated the amount of revenue recognized.

Loss Contingencies

Various legal actions, claims, and other contingencies arise in the normal course of our business. Contingencies are recorded in the consolidated financial statements, or are otherwise disclosed, in accordance with ASC 450-20, “Loss Contingencies”. Specific reserves are provided for loss contingencies to the extent we conclude their occurrence is both probable and estimable. We use a case-by-case evaluation of the underlying data and update our evaluation as further information becomes known. We believe that any amounts exceeding our recorded accruals should not materially affect our financial position, results of operations or liquidity. However, the results of litigation are inherently unpredictable and the possibility exists that the ultimate resolution of one or more of these matters could result in a material adverse effect on our financial position, results of operations or liquidity.

Legal costs are 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 June 30, 2010 and May 31, 2009, insurance reserves totaling $8.3 million and $7.6 million, respectively, are included on our balance sheet. These amounts represent our best estimate of our ultimate obligations for asserted claims, insurance premium obligations, and claims incurred but not yet reported at the balance sheet dates. 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 or losses that could be significant. A hypothetical ten percent unfavorable change in our claim reserves at June 30, 2010 would have reduced fiscal 2010 pretax income by $0.6 million.

Goodwill

Goodwill is not amortized and is tested at least annually for impairment. We perform our annual analysis during the fourth quarter of each fiscal year and in any other period in which indicators of impairment warrant additional analysis. Goodwill represents the excess of the purchase price of acquisitions over the acquisition date fair value of the net assets acquired. Goodwill is evaluated for impairment by first comparing management’s estimate of the fair value of a reporting unit with its carrying value, including goodwill. Reporting units for purposes of goodwill impairment calculations are our reportable segments.

Management utilizes a discounted cash flow analysis to determine the estimated fair value of our reporting units. Significant judgments and assumptions including the discount rate, anticipated revenue growth rate and gross margins, estimated operating and interest expense, and capital expenditures are inherent in these fair value estimates which are based on our internal operating and capital budgets. As a result, actual results may differ from the estimates utilized in our discounted cash flow analysis. The use of alternate judgments and/or assumptions could result in a fair value that differs from our estimate and could result in the recognition of an impairment charge in the financial statements.

As a result of these uncertainties, we utilize multiple scenarios and assign probabilities to each of the scenarios in the discounted cash flow analysis. The results of the discounted cash flow analysis are then compared to the carrying value of the reporting unit. If the carrying value of a reporting unit exceeds its fair value, a computation of the implied fair value of goodwill is compared with its related carrying value. If the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in the amount of the excess. If an impairment charge is recorded, it would negatively impact our results of operations and financial position.

Although we do not anticipate a future impairment charge, certain events could occur that would adversely affect the reported value of goodwill. Such events could include, but are not limited to, a change in economic or competitive

 

       

 

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conditions, a significant change in the project plans of our customers, the economic condition of the customers and industries we serve, and a material negative change in the relationships with one or more of our significant customers. If our judgments and assumptions change as a result of the occurrence of any of these events or other events that we do not currently anticipate, our expectations as to future results and our estimate of the implied value of one or more of our reporting units also may change.

We performed our annual impairment test in the fourth quarter to determine whether an impairment existed and to determine the amount of headroom at May 31, 2010. Headroom is defined as the percentage difference between the carrying value of the goodwill and its fair value. At May 31, 2010, headroom for the Construction Services segment was 75% and headroom for the Repair and Maintenance Services segment was 61%.

Our significant assumptions, including revenue growth rates, gross margins, operating and interest expense and other factors, have been reasonably accurate in recent years, but are likely to change in light of the uncertain economic environment in which we operate. Assuming that all other components of our fair value estimate remain unchanged, a change in the following assumptions would have the following effect on headroom:

 

   

if the growth rate of estimated revenue decreases one percent from current estimates, headroom for the Construction Services segment would be reduced from 75% to 72% and headroom for the Repair and Maintenance Services segment would be reduced from 61% to 58%;

 

   

if our estimate of gross margins decreases one percent, headroom for the Construction Services segment would be reduced from 75% to 42% and headroom for the Repair and Maintenance Services segment would be reduced from 61% to 36%; and

 

   

if the applicable discount rate increases one percent, headroom for the Construction Services segment would be reduced from 75% to 62% and headroom for the Repair and Maintenance Services segment would be reduced from 61% to 50%.

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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Matrix Service Company

Results of Operations

(In thousands, except per share data)

 

     Construction
Services
    Repair and
Maintenance
Services
    (1)
Other
    Total  

Fiscal Year 2010

        

Consolidated revenues

   $ 321,254      $ 229,560      $ —        $ 550,814   

Gross profit

     34,374        18,548        —          52,922   

Operating income

     5,957        1,796        —          7,753   

Income before income tax expense

     5,582        1,828        —          7,410   

Net income

     3,673        1,203        —          4,876   

Earnings per share—diluted

           0.18   

Weighted average shares outstanding—diluted

           26,499   

Fiscal Year 2009

        

Consolidated revenues

   $ 395,240      $ 294,480      $ —        $ 689,720   

Gross profit

     50,959        43,364        —          94,323   

Operating income

     22,111        25,206        —          47,317   

Income before income tax expense

     21,973        25,786        —          47,759   

Net income

     14,207        16,382        —          30,589   

Earnings per share—diluted

           1.16   

Weighted average shares outstanding—diluted

           26,390   

Fiscal Year 2008

        

Consolidated revenues

   $ 455,887      $ 275,414      $ —        $ 731,301   

Gross profit

     33,081        42,036        —          75,117   

Operating income (loss)

     8,579        25,997        (25     34,551   

Income (loss) before income tax expense

     7,950        25,791        (25     33,716   

Net income (loss)

     5,483        15,946        (15     21,414   

Earnings per share—diluted

           0.80   

Weighted average shares outstanding—diluted

           26,875   

June Transition Period

        

Consolidated revenues

   $ 28,531      $ 17,294      $ —        $ 45,825   

Gross profit

     3,251        1,898        —          5,149   

Operating income

     1,141        438        —          1,579   

Income before income tax expense

     1,116        487        —          1,603   

Net income

     720        274        —          994   

Earnings per share—diluted

           0.04   

Weighted average shares outstanding—diluted

           26,434   

Variances 2010 to 2009

        

Consolidated revenues

   $ (73,986   $ (64,920   $ —        $ (138,906

Gross profit

     (16,585     (24,816     —          (41,401

Operating income (loss)

     (16,154     (23,410     —          (39,564

Income (loss) before income tax expense

     (16,391     (23,958     —          (40,349

Net income (loss)

     (10,534     (15,179     —          (25,713

Variances 2009 to 2008

        

Consolidated revenues

   $ (60,647   $ 19,066      $ —        $ (41,581

Gross profit

     17,878        1,328        —          19,206   

Operating income (loss)

     13,532        (791     25        12,766   

Income (loss) before income tax expense

     14,023        (5     25        14,043   

Net income (loss)

     8,724        436        15        9,175   

 

(1) Includes items associated with exited operations.

 

       

 

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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 5.8% of revenues generated in Canada during fiscal 2010 as compared to 3.1% in fiscal 2009 and 3.4% in the June Transition Period.

The primary services of our Construction Services segment are aboveground storage tanks for the bulk storage/terminal industry, capital construction for the downstream petroleum industry, specialty construction, and electrical/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.

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.

Change in Fiscal Year

On July 30, 2009, the Company’s Board of Directors approved a change in the Company’s fiscal year end from May 31 to June 30, beginning July 1, 2009. As a result of the change, the Company had a transition period for the one month ended June 30, 2009.

The Company’s results of operations for the 12 months ended June 30, 2010 (“fiscal 2010”), the 12 months ended May 31, 2009 (“fiscal 2009”), the 12 months ended May 31, 2008 (“fiscal 2008”), and the one month ended June 30, 2009 (“June Transition Period”) are discussed below.

Non-routine Charges

The Company’s fiscal 2010 results were affected by the following non-routine charges:

The California Pay Practices class action lawsuits – We recorded a pretax charge of $5.1 million in fiscal 2010 related to this matter. The charge was recorded as an increase to cost of revenues with $2.3 million allocated to the Construction Services Segment and $2.8 million charged to the Repair and Maintenance Services Segment. The charge is more fully discussed under the caption “Material Legal Proceedings” in Note 8—Contingencies of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report. This charge is referred to as the “charge on a legal matter” throughout our discussion of financial results in this Item 7.

Claims receivable write-down – We recorded pretax charges totaling $2.9 million in fiscal 2010 caused by a write-down of the value of claim receivables acquired in the February 2009 acquisition of S.M. Electric Company, Inc. (“SME”). Of the charge, $2.5 million was the result of the recorded value of a claim exceeding the arbitration award. The remaining $0.4 million charge related to a separate claim receivable and was recorded in conjunction with our on-going assessment of the recoverability of the recorded value of the claim receivables. These charges are collectively referred to as the “claims receivable write-off” in our discussion of financial results in this Item 7 and were recorded as an increase to selling, general and administrative (“SG&A”) expenses. This charge is more fully discussed in Note 3—Acquisitions of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

Claims receivable collection costs – Costs incurred to collect the claims acquired in the SME acquisition were higher than estimated and resulted in a pretax charge of $1.9 million in fiscal 2010. The charge is referred to as the “claims receivable excess collection costs” in our discussion of financial results in this Item 7 and was recorded as an increase to SG&A expense. This charge is more fully discussed in Note 3—Acquisitions of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

 

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Significant Loss on Projects

At June 30, 2010 estimated costs on a series of projects at a large complex in the Gulf Coast were well in excess of previous estimates resulting in a pretax charge of $5.4 million in fiscal 2010. The increased costs were primarily due to substantial weather delays and difficult working conditions at the site and poorly defined scopes of work which led to inefficiencies, rework and cost overruns. This charge was recorded as a reduction in gross profit in the Construction Services Segment. The charge is referred to as the loss on the “projects at a Gulf Coast site” throughout our discussion of financial results in this Item 7.

Fiscal 2010 Versus Fiscal 2009

Consolidated

Consolidated revenues were $550.8 million in fiscal 2010, a decrease of $138.9 million, or 20.1%, from consolidated revenues of $689.7 million in fiscal 2009. The decline in consolidated revenues was due to an overall decline in our level of business volume as our customers continue to be cautious in their short-term spending leading to short and long-term delays in project awards, downsizing of projects, and delays and reductions in maintenance spending. In addition, we did not experience the full effect of the recession in our core markets until the second half of fiscal 2009. Therefore, the comparable prior year revenues were only partially impacted by the effects of the recession.

Consolidated gross profit decreased from $94.3 million in fiscal 2009 to $52.9 million in fiscal 2010. The decrease of $41.4 million was due to lower business volume and lower gross margins which decreased to 9.6% in fiscal 2010 compared to 13.7% a year earlier. The lower gross margins were primarily due to a charge on a legal matter of $5.1 million and the loss of $5.4 million on the projects at a Gulf Coast site. Gross margins in fiscal 2010 and 2009 were negatively affected by a lower volume of business available to recover construction overhead costs, particularly in fiscal 2010.

Consolidated SG&A expenses were $45.2 million in fiscal 2010 compared to $47.0 million in the prior fiscal year. The net decrease of $1.8 million was the result of our on-going efforts to reduce our cost structure due to an unfavorable business environment and was partially offset by the claims receivable write-off of $2.9 million and claims receivable excess collection costs of $1.9 million. SG&A expense as a percentage of revenue increased to 8.2% in fiscal 2010 compared to 6.8% in the prior fiscal year primarily due to a lower level of revenues in fiscal 2010.

Net interest expense was $0.6 million in fiscal 2010 and $0.2 million in fiscal 2009. The increase in net interest expense in fiscal 2010 was due to lower interest rates earned on invested cash, higher Unused Revolving Credit Facility fees, higher rates on letters of credit issued under the Credit Facility and higher letter of credit balances.

Other income in fiscal 2010 was $0.3 million and related primarily to foreign currency transaction gains. Other income in fiscal 2009 was $0.7 million and related primarily to insurance proceeds received.

The effective tax rates for fiscal 2010 and fiscal 2009 were 34.2% and 36.0%, respectively. The fiscal 2010 effective tax rate was lower than the statutory rate due to a federal tax deduction relating to domestic production activities and state tax credits. In fiscal 2009, certain operating loss carryforwards previously reserved were utilized or deemed to be fully utilizable resulting in a benefit of $1.0 million.

Construction Services

Revenues for the Construction Services segment were $321.2 million in fiscal 2010, compared with $395.2 million in fiscal 2009. The decrease of $74.0 million, or 18.7%, was primarily due to continued delays in project awards and a decline in our customers’ capital spending. The lower spending led to declines in Downstream Petroleum, Aboveground Storage Tank and Specialty revenues which declined by $57.2 million, $41.9 million and $1.0 million, respectively. Partially offsetting these declines were higher Electrical and Instrumentation revenues, which increased to $72.0 million in fiscal 2010 compared to $45.9 million a year earlier. The increase in Electrical and Instrumentation revenues was primarily attributable to the inclusion of a full year of SME operations in fiscal 2010 compared to less than four months in fiscal 2009 due to the acquisition in February 2009.

Gross profit decreased from $51.0 million in fiscal 2009 to $34.4 million in fiscal 2010 due to the reduction in revenues and lower gross margins which decreased from 12.9% in fiscal 2009 to 10.8% in fiscal 2010. Fiscal 2010 margins were negatively affected by a lower volume of work which led to a lower recovery of construction overhead costs, the loss of $5.4 million on the projects at a Gulf Coast site, and the charge on a legal matter of $2.3 million.

 

       

 

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Repair and Maintenance Services

Revenues for the Repair and Maintenance Services segment were $229.6 million in fiscal 2010 compared to $294.5 million in fiscal 2009. The decline was due to a lower volume of recurring repair and maintenance work which has resulted in lower Aboveground Storage Tank revenues, which decreased 45.2% to $91.1 million in fiscal 2010 compared to $166.3 million a year earlier. This decline was partially offset by higher Downstream Petroleum and Electrical and Instrumentation revenues, which increased to $115.0 million and $23.5 million in fiscal 2010, compared to $106.2 million and $22.0 million a year earlier.

Gross profit decreased from $43.4 million in fiscal 2009 to $18.5 million in fiscal 2010 due to a reduction in revenues and lower gross margins. Gross margins were 8.1% in fiscal 2010 compared to 14.7% in fiscal 2009. The gross margin reduction was due to lower direct margins, the unfavorable impact of unrecovered construction overhead costs caused by a lower volume of business and the charge on a legal matter of $2.8 million.

Fiscal 2009 Versus Fiscal 2008

Consolidated

Consolidated revenues were $689.7 million in fiscal 2009, a decrease of $41.6 million, or 5.7%, from consolidated revenues of $731.3 million for fiscal 2008. The reduction in consolidated revenues was caused by a decrease of $60.7 million in Construction Services revenues partially offset by an increase of $19.1 million in Repair and Maintenance Services revenues.

Consolidated gross profit increased from $75.1 million in fiscal 2008 to $94.3 million in fiscal 2009. The improvement of $19.2 million or 25.6% was due primarily to an increase in gross profit caused by higher gross margins, which improved from 10.3% in fiscal 2008 to 13.7% in fiscal 2009. The gross margin improvement was due to higher margins in the Construction Services segment, where the gross margin increased to 12.9% in fiscal 2009 versus 7.3% in the prior fiscal year. Repair and Maintenance Services segment gross margins were 14.7% in fiscal 2009 compared to 15.3% in fiscal 2008.

Consolidated SG&A expenses increased $6.4 million, or 15.8%, in fiscal 2009 to $47.0 million from $40.6 million for fiscal 2008. The increase was primarily due to the costs relating to our expansion into Western Canada and the Gulf Coast Region, the acquisition of SME in February 2009, and higher employee related and facility costs incurred to build the infrastructure and sales forces necessary to support our long-term growth plan. SG&A expense as a percentage of revenue increased to 6.8% in fiscal 2009 compared to 5.6% in the prior fiscal year.

Net interest expense was $0.2 million in fiscal 2009 compared to $0.8 million in fiscal 2008. In fiscal 2009, the non-cash amortization of deal fees relating to the senior revolving credit facility and cash interest on our capital leases was partially offset by interest income generated from the investment of excess cash.

The prior year net interest expense was primarily related to the amortization of deal fees on the senior revolving credit facility and interest on short-term borrowings under the facility.

Other income in fiscal 2009 was $0.7 million and related primarily to insurance proceeds received. In comparison, we did not report any other income in fiscal 2008.

The effective tax rate for fiscal 2009 was 36.0% compared to 36.5% in fiscal 2008. In fiscal 2009, certain operating loss carryforwards previously reserved were utilized or deemed to be fully utilizable resulting in a tax benefit of $1.0 million. The prior fiscal year included a $0.7 million tax benefit resulting from the assessment of the realizability of state investment tax credits and other miscellaneous deductions.

Construction Services

Revenues for the Construction Services segment were $395.2 million, compared with $455.9 million in the same period a year earlier. The decrease of $60.7 million was due to lower Specialty revenues, which decreased $50.8 million as the construction of the tanks on a Gulf Coast LNG project was completed in the fourth quarter of fiscal 2008. In addition, Aboveground Storage Tank revenues decreased 11.7% to $177.8 million in fiscal 2009, versus $201.4 million in fiscal 2008, and Downstream Petroleum revenues, decreased 7.8% to $144.2 million in fiscal 2009, versus $156.4 million a year earlier. Partially offsetting these declines were higher Electrical and Instrumentation revenues, which increased $25.9 million to $45.9 million in fiscal 2009, compared to $20.0 million a year earlier. This increase is primarily attributable to the acquisition of SME in February 2009.

 

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At May 31, 2009, the Construction Services segment had a backlog of $233.6 million, as compared to a backlog of $325.3 million as of May 31, 2008. The decrease of $91.7 million is due to declines in Aboveground Storage Tank, Downstream Petroleum and Electrical and Instrumentation of $79.5 million, $11.5 million and $6.6 million, respectively. Partially offsetting these declines was an increase in Specialty of $5.9 million. Project cancellations totaling $19.0 million and $29.5 million contributed to the backlog reductions in Aboveground Storage Tank and Downstream Petroleum, respectively.

Gross profit increased from $33.1 million in fiscal 2008 to $51.0 million in fiscal 2009. The increase in gross profit was due to improved direct gross margins primarily because fiscal 2008 results included $20.8 million in pretax charges for cost overruns on a Gulf Coast LNG project. In addition the Company experienced improved project execution in fiscal 2009 helping to offset the negative impact of unrecovered construction overhead costs due to lower than expected revenues during the year.

Repair and Maintenance Services

Revenues for Repair and Maintenance Services were $294.5 million in fiscal 2009 versus $275.4 million in fiscal 2008. The $19.1 million improvement was due to higher Downstream Petroleum revenues, which increased $17.2 million to $106.2 million in fiscal 2009, compared to $89.0 million in the prior fiscal year and higher Electrical and Instrumentation revenues, which increased $3.6 million to $22.0 million in fiscal 2009, compared to $18.4 million in the prior fiscal year. These increases were partially offset by lower Aboveground Storage Tank revenues, which decreased $1.7 million to $166.3 million in fiscal 2009 from $168.0 million during fiscal 2008.

Backlog at May 31, 2009 and May 31, 2008 for the Repair and Maintenance Services segment was $167.5 million and $142.0 million, respectively. The increase of $25.5 million was due to increases in Downstream Petroleum of $16.4 million and Electrical and Instrumentation of $15.6 million, partially offset by a decline in Aboveground Storage Tank of $6.5 million. Included in Aboveground Storage Tank’s backlog decline were cancelled projects totaling $2.7 million.

Gross profit increased from $42.0 million in fiscal 2008 to $43.4 million in fiscal 2009 due to an increase in revenues partially offset by a decline in gross margins, which were 14.7% in fiscal 2009 versus 15.3% in fiscal 2008.

One Month Ended June 30, 2009 Compared to One Month Ended June 30, 2008

Revenues declined $14.2 million, or 23.7%, from $60.0 million in the prior period to $45.8 million in the one month ended June 30, 2009. The decline was due to lower Construction Services revenues, which decreased $7.8 million from $36.3 million in the prior period to $28.5 million in the one month ended June 30, 2009, and lower Repair and Maintenance Services revenues, which decreased $6.4 million from $23.7 million in the prior period to $17.3 million in the one month ended June 30, 2009.

Gross profit decreased $4.7 million to $5.1 million in the one month ended June 30, 2009 compared to $9.8 million a year earlier. The decline in gross profit was due to lower revenues, which decreased 23.7%, and lower gross margins which decreased from 16.3% in the prior period to 11.2% in the one month ended June 30, 2009. The decline in gross margins was due to lower margins in the Construction Services segment which decreased from 15.4% to 11.4% and lower margins in the Repair and Maintenance Services segment which decreased to 11.0% compared to 17.6% a year earlier. Gross margins in both segments were negatively affected by a lower volume of business available to recover construction overhead costs in the one month ended June 30, 2009.

Income before income taxes decreased $4.5 million, from $6.1 million in the prior period to $1.6 million in the current fiscal year. The decline was due to lower gross profit, which decreased $4.7 million, partially offset by lower SG&A expenses.

Non-GAAP Financial Measure

EBITDA is a supplemental, non-GAAP financial measure. EBITDA is defined as earnings before interest, 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

 

       

 

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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, which 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.

 

     Reconciliation of EBITDA to Net Income
     (In thousands)
     Twelve Months Ended    One Month
Ended
     June 30,
2010
   May 31,
2009
   May 31,
2008
   June 30,
2009

Net income

   $ 4,876    $ 30,589    $ 21,414    $ 994

Interest expense (1)

     672      563      808      91

Provision for income taxes

     2,534      17,170      12,302      609

Depreciation and amortization

     11,751      10,760      8,373      994
                           

EBITDA

   $ 19,833    $ 59,082    $ 42,897    $ 2,688
                           

 

(1) Interest expense for the 12 months ended May 31, 2008 is presented net of interest income.

Outlook

We are beginning to experience improvements in many of our markets, led by Aboveground Storage Tank and Electrical and Instrumentation. 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 energy trading companies looking to add storage capacity. Additionally, many projects that were delayed are now moving forward as market conditions have improved. We expect the Electrical and Instrumentation market to continue to be strong due to the continuing high voltage overhaul occurring in the United States. The Repair and Maintenance Services segment remains relatively soft with only modest increases in bid volume and continued downward pressure on gross margins. With regard to turnaround activity, fiscal 2011 is shaping up to be similar to fiscal 2010 with many announced shutdowns being delayed into calendar year 2011. We also expect our focus in the Gulf Coast, Western Canada and Latin America to begin to produce significant opportunities in fiscal 2011.

FINANCIAL CONDITION AND LIQUIDITY

Overview

We define liquidity as the ability to pay our liabilities as they become due, fund business operations and meet all monetary contractual obligations. Our primary source of liquidity in fiscal 2010 was cash on hand at the beginning of the year. Cash on hand at June 30, 2010 totaled $50.9 million and availability under the senior revolving credit facility totaled $51.3 million, resulting in total liquidity of $102.2 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.

 

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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 resulting from the failure of a significant customer

 

   

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

In fiscal 2009, we funded the acquisitions of SME and the purchase of certain assets, technology and resources for the design and construction of specialty cryogenic tanks with cash on hand. However, 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 Flows from Operating Activities

Operations provided $4.4 million of cash in fiscal 2010. Major components of cash flows from operating activities are as follows:

 

Cash Flow from Operations

(In thousands)

 
    

Net income

   $ 4,876   

Non-cash expense

     17,179   

Loss on disposition of property, plant and equipment

     209   

Cash effect of changes in operating assets and liabilities

     (17,865
        

Cash flow from operations

   $ 4,399   
        

Cash Flows from Investing Activities

Investing activities used $5.1 million of cash in fiscal 2010 due to capital expenditures of $5.3 million, partially offset by proceeds from asset sales of $0.2 million. Fiscal 2010 capital expenditures included $1.4 million for the purchase of construction equipment, $1.7 million for transportation equipment, $1.7 million for furniture and fixtures, and $0.5 million for land and buildings. Assets acquired through capital leases totaled $0.3 million in fiscal 2010 and are reported as non-cash additions to property, plant and equipment in the Consolidated Statement of Cash Flows.

At June 30, 2010 expected spending to complete in-progress capital projects totaled $1.2 million. The completion of these projects will be funded with cash on hand.

Cash Flows from Financing Activities

Financing activities used $1.4 million of cash in fiscal 2010 primarily due to capital lease payments of $1.1 million and treasury share purchases of $0.5 million. Partially offsetting these payments were proceeds from the exercise of stock options outstanding under our stock based incentive plans of $0.1 million and the related tax benefit of $0.1 million.

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. Our ability to incur short-term borrowings or to access the Credit Facility for letters of credit is limited by the Senior Leverage Ratio, which

 

       

 

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provides that Consolidated Funded Indebtedness may not exceed 2.5 times Consolidated EBITDA over the previous four quarters, as defined in the credit agreement. Due to the operating results in the second half of fiscal 2010, Consolidated EBITDA totaled $25.2 million for the four quarters ended June 30, 2010, reducing the capacity of the Credit Facility to $62.9 million. There were $11.6 million of letters of credit outstanding at year end reducing the remaining availability to $51.3 million at June 30, 2010. The operating results also caused a violation of the Fixed Charge Coverage Ratio covenant. The Fixed Charge Coverage Ratio at June 30, 2010 was 0.83 to 1.00 which was less than the minimum requirement of 1.25 to 1.00.

The Company received a waiver of the Fixed Charge Coverage Ratio covenant violation on September 24, 2010. The credit agreement was also amended, effective September 24, 2010, to add back the $5.1 million charge on a legal matter to the calculation of Consolidated EBITDA which will improve our ability to comply with the Fixed Charge Coverage Ratio covenant and increase availability under the Credit Facility. If the amendment had been effective June 30, 2010 we would have had access to the full capacity of the Credit Facility.

Based on our current budget projections and the amendment discussed above, we believe that access to the capacity of the Credit Facility will be limited in the first half of fiscal 2011. However, given our strong cash position, we do not expect this decreased capacity to affect the day-to-day operations of the business but further reductions in availability could limit our ability to make strategic acquisitions.

The credit agreement, as currently amended, includes the following:

 

   

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.

 

   

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 financial covenants 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; and,

 

   

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

The Company has received a waiver for the June 30, 2010 Fixed Charge Coverage Ratio covenant violation and is in compliance with all other 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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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 did not purchase any common shares under the February 2009 Program in fiscal 2010. 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 49,138 shares in fiscal 2010 to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares.

The Company has 1,546,512 treasury shares as of June 30, 2010 and intends to utilize these treasury shares solely in connection with equity awards under the Company’s stock incentive plans.

Commitments

As of June 30, 2010, the following commitments were in place to support our ordinary course obligations:

 

     Commitments by Expiration Period
     Less than 1
Year
   1–3 Years    3–5 Years    More than 5
Years
   Total
     (In thousands)

Letters of credit (1)

   $ 2,697    $ 8,925    $ —      $ —      $ 11,622

Surety bonds

     45,242      412      10      —        45,664
                                  

Total commitments

   $ 47,939    $ 9,337    $ 10    $ —      $ 57,286
                                  

 

(1) All letters of credit issued under our Credit Facility are in support of our workers’ compensation insurance programs or certain construction contracts. The letters of credit that support our workers’ compensation programs are expected to renew annually through the term of the Credit Facility; therefore, they are reported in the same period that the Credit Facility expires. The letters of credit that support construction contracts will expire when the related work is completed and the warranty period has passed; therefore, these letters of credit are reported in the period that we expect the warranty period to end.

Contractual obligations at June 30, 2010 are summarized below:

 

     Contractual Obligations by Expiration Period
     Less than
1 Year
   1-3 Years    3-5 Years    More than 5
Years
   Total
     (In thousands)

Operating leases

   $ 3,003    $ 5,118    $ 3,173    $ 499    $ 11,793

Capital lease obligations

     781      315      —        —        1,096

Purchase obligations (1)

     —        —        —        —        —  
                                  

Total contractual obligations

   $ 3,784    $ 5,433    $ 3,173    $ 499    $ 12,889
                                  

 

(1) We enter into purchase commitments in the ordinary course of business to satisfy our requirements for materials and supplies under contracts that we have been awarded. The commitments, which are recoverable from our clients, are short-term and are generally settled in less than one year. We do not enter into long-term purchase obligations on a speculative basis for fixed or minimum quantities.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Our interest rate risk results primarily from our variable rate indebtedness under our senior credit facility, which is influenced by movements in short-term rates. Borrowings under our $75.0 million revolving credit facility are based on an alternate base rate or LIBOR as elected by the Company plus an additional margin based on our Senior Leverage Ratio. Although there were no amounts outstanding under the facility at June 30, 2010 and we did not borrow under the facility in

 

       

 

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fiscal 2010, we have in the past and may in the future borrow against our revolving credit line to fund short-term working capital needs. We do not currently utilize interest rate swaps to hedge our interest rate risk; therefore, short-term interest rates could have an impact on future interest expense.

Financial instruments with interest rate risk at June 30, 2010 were as follows:

 

     Maturity by Fiscal Year    Fair Value as
of June 30,
2010
     2011    2012    2013    2014    2015    Total   
     (In thousands)     

Long-term debt:

                    

Variable rate debt (1)

   $ —      $ —      $ —      $ —      $ —      $ —      $ —  

 

(1) There were no outstanding borrowings under our senior credit facility at June 30, 2010 nor were any amounts borrowed in fiscal 2010. At the Company’s option, amounts borrowed under the revolving credit facility will bear interest at LIBOR or an Alternate Base Rate, plus in each case, an additional margin based on the Senior Leverage Ratio. The Alternate Base Rate is the greater of the Prime Rate, the Federal Funds Effective Rate plus 0.5% or LIBOR plus 1.00%. The additional margin ranges from 1.00% to 1.75% on Alternate Base Rate borrowings and from 2.00% to 2.75% on LIBOR-based borrowings. The Senior Leverage Ratio for the year ended June 30, 2010 placed the Company in the lowest interest rate tier, resulting in LIBOR and Alternate Base Rate margins of 2.00% and 1.00%, respectively.

Financial instruments with interest rate risk at May 31, 2009 were as follows:

 

     Maturity by Fiscal Year    Fair Value as
of May 31,
2009
     2010    2011    2012    2013    2014    Total   
     (In thousands)

Long-term debt:

                    

Variable rate debt (1)

   $ —      $ —      $ —      $ —      $ —      $ —      $ —  

 

(1) There were no outstanding borrowings under our senior credit facility at May 31, 2009 nor were any amounts borrowed in fiscal 2009. At the Company’s option, amounts borrowed under the revolving credit facility will bear interest at LIBOR or an Alternate Base Rate, plus in each case, an additional margin based on the Senior Leverage Ratio. The Alternate Base Rate is the greater of the Prime Rate, the Federal Funds Effective Rate plus 0.5% or LIBOR plus 1.00%. The additional margin ranges from 1.00% to 1.75% on Alternate Base Rate borrowings and from 2.00% to 2.75% on LIBOR-based borrowings. The Senior Leverage Ratio for the year ended May 31, 2009 placed the Company in the lowest interest rate tier, resulting in LIBOR and Alternate Base Rate margins of 2.00% and 1.00%, respectively.

Foreign Currency Risk

Matrix Service has subsidiaries with operations in Canada with the Canadian dollar as their functional currency. Historically, movements in the foreign currency exchange rate have not significantly impacted results. However, growth in our Canadian operations or expansions to other counties and fluctuations in currency exchange rates could impact the Company’s financial results in the future. Management has not entered into derivative instruments to hedge foreign currency risk, but periodically evaluates the materiality of our foreign currency exposure. A 10% change in the Canadian dollar against the U. S. dollar would not have had a material impact on the financial results of the Company for the fiscal year ended June 30, 2010.

Commodity Risk

Steel plate and steel pipe are the primary raw materials used by the Company. Supplies of these materials are available throughout the United States and worldwide. We anticipate that adequate amounts of these materials will be available in the foreseeable future, however, the price, quantity, and delivery schedules of these materials could change rapidly due to various factors, including producer capacity, the level of foreign imports, worldwide demand, the imposition or removal of tariffs on imported steel and other market conditions. We mitigate these risks by including standard language in our contracts, which passes the risk of increases in steel prices or unavailability of steel to our customers.

 

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Item 8. Financial Statements and Supplementary Data

 

Financial Statements of the Company   

Management’s Report on Internal Control Over Financial Reporting

   37

Reports of Independent Registered Public Accounting Firm

   38

Consolidated Balance Sheets as of June 30, 2010 and May 31, 2009

   40

Consolidated Statements of Income for the Years Ended June 30, 2010, May 31, 2009, May  31, 2008 and the One Month Ended June 30, 2009

   42

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the Years Ended June 30, 2010, May 31, 2009, May 31, 2008 and the One Month Ended June 30, 2009

   43

Consolidated Statements of Cash Flows for the Years Ended June 30, 2010, May  31, 2009, May 31, 2008 and the One Month Ended June 30, 2009

   45

Notes to Consolidated Financial Statements

   47

Quarterly Financial Data (Unaudited)

   67

Schedule II—Valuation and Qualifying Accounts

   68

Financial Statement Schedules

The financial statement schedule is filed as a part of this report under Schedule II—Valuation and Qualifying Accounts for the three fiscal years ended June 30, 2010, May 31, 2009 and May 31, 2008 and the One Month Ended June 30, 2009 immediately following Quarterly Financial Data (Unaudited). All other schedules are omitted because they are not applicable or the required information is shown in the financial statements, or notes thereto, included herein.

 

       

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Matrix Service Company (the “Company”) and its wholly-owned subsidiaries are responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

All internal control systems, no matter how well designed, have inherent limitations and cannot provide absolute assurance that all objectives will be met. Internal control over financial reporting is a process that involves diligence and is subject to lapses in judgment and human error. Internal control over financial reporting can also be circumvented by collusion or management override of controls. Because of these limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2010. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework.

Management’s assessment included an evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, overall control environment and information systems control environment. Based on this assessment, the Company’s management has concluded that the Company’s internal control over financial reporting as of June 30, 2010 was effective.

Deloitte & Touche LLP, an independent registered public accounting firm, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of June 30, 2010. Deloitte & Touche LLP’s report on the Company’s internal control over financial reporting is included herein.

 

 

/s/ Michael J. Bradley

------------------------------------------------------------------------

   

 

/s/ Thomas E. Long

----------------------------------------------------------------------

Michael J. Bradley     Thomas E. Long
President and Chief Executive Officer     Vice President and Chief Financial Officer

September 28, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Matrix Service Company:

We have audited the internal control over financial reporting of Matrix Service Company and subsidiaries (“the Company”) as of June 30, 2010 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended June 30, 2010 of the Company and our report dated September 28, 2010 expressed an unqualified opinion on those financial statements and financial statement schedule.

 

 

/s/ Deloitte & Touche LLP

---------------------------------------------------------------

Tulsa, Oklahoma

September 28, 2010

 

       

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Matrix Service Company:

We have audited the accompanying consolidated balance sheets of Matrix Service Company and subsidiaries (the “Company”) as of June 30, 2010 and May 31, 2009, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the year ended June 30, 2010, the one month ended June 30, 2009 and the years ended May 31, 2009 and 2008. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and the financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Matrix Service Company and subsidiaries as of June 30, 2010 and May 31, 2009, and the results of their operations and their cash flows for the year ended June 30, 2010, the one month ended June 30, 2009 and the years ended May 31, 2009 and 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of June 30, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated September 28, 2010 expressed an unqualified opinion on the Company's internal control over financial reporting.

 

 

/s/ Deloitte & Touche LLP

---------------------------------------------------------------

Tulsa, Oklahoma

September 28, 2010

 

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Matrix Service Company

Consolidated Balance Sheets

(In thousands)

 

     June 30,
2010
    May 31,
2009
 
Assets     

Current assets:

    

Cash and cash equivalents

   $ 50,899      $ 34,553   

Accounts receivable, less allowances (2010—$1,404; 2009—$710)

     87,327        122,283   

Costs and estimated earnings in excess of billings on uncompleted contracts

     40,920        35,619   

Inventories

     3,451        4,926   

Income tax receivable

     1,779        647   

Deferred income taxes

     8,073        4,843   

Prepaid expenses

     4,557        3,935   

Other current assets

     1,519        3,044   
                

Total current assets

     198,525        209,850   

Property, plant and equipment, at cost:

    

Land and buildings

     27,859        27,319   

Construction equipment

     52,086        53,925   

Transportation equipment

     19,192        17,971   

Furniture and fixtures

     14,358        14,527   

Construction in progress

     1,251        812   
                
     114,746        114,554   

Accumulated depreciation

     (61,817     (55,745
                
     52,929        58,809   

Goodwill

     27,216        25,768   

Other intangible assets

     4,141        4,571   

Other assets

     1,997        4,453   
                

Total assets

   $ 284,808      $ 303,451   
                

 

 

See accompanying notes.

 

       

 

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Matrix Service Company

Consolidated Balance Sheets (continued)

(In thousands, except share data)

 

     June 30,
2010
    May 31,
2009
 
Liabilities and stockholders’ equity     

Current liabilities:

    

Accounts payable

   $ 44,769      $ 48,668   

Billings on uncompleted contracts in excess of costs and estimated earnings

     28,877        51,305   

Accrued insurance

     8,257        7,612   

Accrued wages and benefits

     13,538        16,566   

Current capital lease obligation

     772        1,039   

Other accrued expenses

     6,572        2,200   
                

Total current liabilities

     102,785        127,390   

Long-term capital lease obligation

     259        850   

Deferred income taxes

     4,179        4,822   

Commitments and contingencies

     —          —     

Stockholders’ equity:

    

Common stock—$.01 par value; 60,000,000 shares authorized; 27,888,217 shares issued as of June 30, 2010 and May 31, 2009

     279        279   

Additional paid-in capital

     111,637        110,272   

Retained earnings

     81,252        75,393   

Accumulated other comprehensive income

     495        596   
                
     193,663        186,540   

Less treasury stock, at cost —1,546,512 and 1,696,517 shares as of June 30, 2010 and
May 31, 2009

     (16,078     (16,151
                

Total stockholders’ equity

     177,585        170,389   
                

Total liabilities and stockholders’ equity

   $ 284,808      $ 303,451   
                

 

 

See accompanying notes.

 

41

 

     


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Matrix Service Company

Consolidated Statements of Income

(In thousands, except per share data)

 

     Twelve Months Ended     One Month
Ended
 
     June 30,
2010
    May 31,
2009
    May 31,
2008
    June 30,
2009
 

Revenues

   $ 550,814      $ 689,720      $ 731,301      $ 45,825   

Cost of revenues

     497,892        595,397        656,184        40,676   
                                

Gross profit

     52,922        94,323        75,117        5,149   

Selling, general and administrative expenses

     45,169        47,006        40,566        3,570   
                                

Operating income

     7,753        47,317        34,551        1,579   

Other income (expense):

        

Interest expense

     (672     (563     (890     (91

Interest income

     79        330        82        17   

Other

     250        675        (27     98   
                                

Income before income tax expense

     7,410        47,759        33,716        1,603   

Provision for federal, state and foreign income taxes

     2,534        17,170        12,302        609   
                                

Net income

   $ 4,876      $ 30,589      $ 21,414      $ 994   
                                

Basic earnings per common share

   $ 0.19      $ 1.17      $ 0.81      $ 0.04   
                                

Diluted earnings per common share

   $ 0.18      $ 1.16      $ 0.80      $ 0.04   
                                

Weighted average common shares outstanding:

        

Basic

     26,275        26,121        26,427        26,192   

Diluted

     26,499        26,390        26,875        26,434   

 

 

See accompanying notes.

 

       

 

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Matrix Service Company

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

(In thousands, except share data)

 

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

Balances, May 31, 2007

  $ 279   $ 104,408      $ 23,422      $ (3,500   $ 967      $ 125,576   

Net income

    —       —          21,414        —          —          21,414   

Other comprehensive income (Note 10)

    —       —          —          —          617        617   

Comprehensive income

              22,031   

Exercise of stock options (165,450 shares)

    —       574        (27     494        —          1,041   

Tax effect of exercised stock options

    —       721        —          —          —          721   

Stock-based compensation expense

    —       2,874        —          —          —          2,874   

Issuance of deferred shares (59,590 shares)

    —       (175     —          175        —          —     

Open market purchase of treasury shares (729,982 shares)

    —       —          —          (12,843     —          (12,843

Other treasury share purchases (23,192 shares)

    —       —          —          (700     —          (700
                                             

Balances, May 31, 2008

    279     108,402        44,809        (16,374     1,584        138,700   

Net income

    —       —          30,589        —          —          30,589   

Other comprehensive loss (Note 10)

    —       —          —          —          (988     (988
                 

Comprehensive income

              29,601   

Exercise of stock options (62,950 shares)

    —       108        (5     169        —          272   

Tax effect of exercised stock options and vesting of deferred shares

    —       (220     —          —          —          (220

Stock-based compensation expense

    —       2,206        —          —          —          2,206   

Issuance of deferred shares (83,370 shares)

    —       (224     —          224        —          —     

Treasury share purchases (17,237 shares)

    —       —          —          (170     —          (170
                                             

Balances, May 31, 2009

  $ 279   $ 110,272      $ 75,393      $ (16,151   $ 596      $ 170,389   
                                             

 

 

See accompanying notes.

 

43

 

     


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Matrix Service Company

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (continued)

(In thousands, except share data)

 

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

Balances, May 31, 2009

   $ 279    $ 110,272      $ 75,393      $ (16,151   $ 596      $ 170,389   

Net income

     —        —          994        —          —          994   

Other comprehensive loss (Note 10)

     —        —          —          —          (815     (815
                   

Comprehensive income

                179   

Tax effect from the vesting of deferred shares

     —        (9     —          —          —          (9

Stock-based compensation expense

     —        238        —          —          —          238   

Issuance of deferred shares (1,952 shares)

     —        (5     —          5        —          —     
                                               

Balances, June 30, 2009

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

Net income

     —        —          4,876        —          —          4,876   

Other comprehensive income (Note 10)

     —        —          —          —          714        714   
                   

Comprehensive income

                5,590   

Exercise of stock options (31,900 shares)

     —        38        (11     88        —          115   

Tax effect of exercised stock options and vesting of deferred shares

     —        (496     —          —          —          (496

Stock-based compensation expense

     —        2,052        —          —          —          2,052   

Issuance of deferred shares (165,291 shares)

     —        (453     —          453        —          —     

Treasury share purchases (49,138 shares)

     —        —          —          (473     —          (473
                                               

Balances, June 30, 2010

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

 

 

See accompanying notes.

 

       

 

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Matrix Service Company

Consolidated Statements of Cash Flows

(In thousands)

 

     Twelve Months Ended     One Month
Ended
 
     June 30,
2010
    May 31,
2009
    May 31,
2008
    June 30,
2009
 

Operating activities:

        

Net income

   $ 4,876      $ 30,589      $ 21,414      $ 994   

Adjustments to reconcile net income to net cash provided by operating activities, net of effects of acquisitions (Note 3):

        

Depreciation and amortization

     11,751        10,760        8,373        994   

(Gain) loss on disposition of property, plant and equipment

     209        250        (6     (19

Provision for uncollectible accounts

     2,892        441        1,161        66   

Stock-based compensation expense

     2,052        2,206        2,874        238   

Other

     484        123        260        4   

Inventory lower of cost or market write-down

     —          1,157        —          —     

Deferred income tax

     (3,556     (88     1,484        (411

Tax benefit deficiency from vesting of deferred shares

     (578     (347     —          —     

Changes in operating assets and liabilities increasing (decreasing) cash, net of effects from acquisitions (Note 3):

        

Accounts receivable

     12,003        9,838        (2,748     22,214   

Costs and estimated earnings in excess of billings on uncompleted contracts

     (5,724     16,928        (4,306     (722

Inventories

     1,238        (1,828     636        (89

Prepaid expenses and other assets

     615        (749     (1,530     (1,171

Accounts payable

     1,693        (25,063     963        (5,676

Billings on uncompleted contracts in excess of costs and estimated earnings

     (22,816     (3,411     14,466        1,054   

Accrued expenses

     1,231        494        1,265        591   

Income tax receivable/payable

     (1,971     (2,676     1,290        839   
                                

Net cash provided by operating activities

     4,399        38,624        45,596        18,906   

Investing activities:

        

Acquisition of property, plant and equipment

     (5,302     (9,983     (18,302     (348

Proceeds from asset sales

     218        1,002        452        21   

Acquisitions, net of cash acquired

     —          (15,337     —          —     
                                

Net cash used by investing activities

   $ (5,084   $ (24,318   $ (17,850   $ (327

See accompanying notes.

 

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Matrix Service Company

Consolidated Statements of Cash Flows (continued)

(In thousands)

 

     Twelve Months Ended     One Month
Ended
 
     June 30,
2010
    May 31,
2009
    May 31,
2008
    June 30,
2009
 

Financing activities:

        

Exercise of stock options

   $ 115      $ 272      $ 1,041      $ —     

Advances under bank credit facility

     —          —          183,810        —     

Repayments of bank credit facility

     —          —          (183,810     —     

Payment of debt amendment fees

     —          (244     —          —     

Capital lease payments

     (1,077     (1,137     (775     (87

Repayment of other notes

     —          —          (2,709     —     

Tax benefit of exercised stock options and vesting of deferred shares

     82        127        721        —     

Open market purchase of treasury shares

     —          —          (12,843     —     

Other treasury share purchases

     (473     (170     (700     —     
                                

Net cash used by financing activities

     (1,353     (1,152     (15,265     (87

Effect of exchange rate changes on cash

     461        (590     361        (569
                                

Net increase (decrease) in cash and cash equivalents

     (1,577     12,564        12,842        17,923   

Cash and cash equivalents, beginning of period

     52,476        21,989        9,147        34,553   
                                

Cash and cash equivalents, end of period

   $ 50,899      $ 34,553      $ 21,989      $ 52,476   
                                

Supplemental disclosure of cash flow information

        

Cash paid during the period for:

        

Income taxes

   $ 8,641      $ 20,134      $ 8,750      $ 247   
                                

Interest

   $ 530      $ 396      $ 529      $ 142   
                                

Non-cash investing and financing activities:

        

Equipment acquired through capital leases

   $ 280      $ 877      $ 1,220      $ 26   
                                

Purchases of property, plant and equipment on account

   $ 41      $ 49      $ 484      $ 112   
                                

 

See accompanying notes.

 

       

 

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Table of Contents

 

Matrix Service Company

Notes to Consolidated Financial Statements

Note 1—Summary of Significant Accounting Policies

Organization and Basis of Presentation

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

The Company operates primarily in the United States and has operations in Canada. The Company’s reportable segments are Construction Services and Repair and Maintenance Services.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We believe the most significant estimates and judgments are associated with revenue recognition, the recoverability tests that must be periodically performed with respect to our goodwill and other intangible assets, valuation reserves on our accounts receivable and deferred tax assets, and the estimation of loss contingencies, including liabilities associated with litigation and with the self insured retentions on our insurance programs. Actual results could differ from those estimates.

Revenue Recognition

Matrix Service records profits on fixed-price contracts on a percentage-of-completion basis, primarily based on costs incurred to date compared to the total estimated contract cost. Matrix Service records revenue on reimbursable and time and material contracts on a proportional performance basis as costs are incurred. Contracts in process are valued at cost plus accrued profits less billings on uncompleted contracts. Contracts are generally considered substantially complete when field construction is completed. The elapsed time from award of a contract to completion of performance may be in excess of one year. Matrix Service includes pass-through revenue and costs on cost-plus contracts, which are customer-reimbursable materials, equipment and subcontractor costs, when Matrix Service determines that it is responsible for the procurement and management of such cost components.

Matrix Service has numerous contracts that are in various stages of completion which require estimates to determine the appropriate cost and revenue recognition. Matrix Service has a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs, and accordingly, does not believe significant fluctuations are likely to materialize. However, current estimates may be revised as additional information becomes available. If estimates of costs to complete fixed-price contracts indicate a loss, provision is made through a contract write-down for the total loss anticipated. A number of our contracts contain various cost and performance incentives and penalties that impact the earnings we realize from our contracts, and adjustments related to these incentives and penalties are recorded in the period, on a percentage-of-completion basis, when estimable and probable.

Indirect costs (such as salaries and benefits, supplies and tools, equipment costs and insurance costs) are charged to projects based upon direct labor hours and overhead allocation rates per direct labor hour. Warranty costs are normally incurred prior to project completion and are charged to project costs as they are incurred. Warranty costs incurred subsequent to project completion were not material for the periods presented. Overhead allocation rates are established annually during the budgeting process and evaluated for accuracy throughout the year based upon actual direct labor hours and actual costs incurred.

Precontract Costs

Precontract costs are charged to earnings as incurred.

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

Claims Recognition

Claims are amounts in excess of the agreed contract price (or amounts not included in the original contract price) that we seek to collect from customers or others for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes of anticipated additional costs incurred by us. Recognition of amounts as additional contract revenue related to claims is appropriate only if it is probable that the claims will result in additional contract revenue and if the amount can be reliably estimated. If all of the following requirements are met, revenue from a claim is recorded only to the extent that we have incurred costs relating to the claim. We must determine if:

 

   

there is a legal basis for the claim;

 

   

the additional costs were caused by circumstances that were unforeseen by the Company and are not the result of deficiencies in our performance;

 

   

the costs are identifiable or determinable and are reasonable in view of the work performed; and

 

   

the evidence supporting the claim is objective and verifiable.

Unapproved change orders and claims are more fully discussed in Note 8—Contingencies.

Cash Equivalents

The Company includes as cash equivalents all investments with original maturities of three months or less which are readily convertible into cash. Approximately $0.3 million of cash as of June 30, 2010 and May 31, 2009 is classified as Other Assets as it is restricted for use under an alliance agreement with a customer.

Accounts Receivable

Accounts receivable are carried on a gross basis, less the allowance for uncollectible accounts. The Company’s customers consist primarily of major integrated oil companies, independent refiners and marketers, power companies, petrochemical companies, pipeline companies, contractors and engineering firms. The Company is exposed to the risk of individual customer defaults or depressed cycles in our customers’ industries. To mitigate this risk many of our contracts require payment as projects progress or advance payment in some circumstances. In addition, in most cases the Company can place liens against the property, plant or equipment constructed or terminate the contract if a material contract default occurs. Management estimates the allowance for uncollectible accounts based on existing economic conditions, the financial condition of its customers and the amount and age of past due accounts. Accounts are written off against the allowance for uncollectible accounts only after all collection attempts have been exhausted.

Loss Contingencies

Various legal actions, claims and other contingencies arise in the normal course of our business. Contingencies are recorded in the consolidated financial statements, or are otherwise disclosed, in accordance with ASC 450-20, “Loss Contingencies”. Specific reserves are provided for loss contingencies to the extent we conclude their occurrence is both probable and estimable. We use a case-by-case evaluation of the underlying data and update our evaluation as further information becomes known. We believe that any amounts exceeding our recorded accruals should not materially affect our financial position, results of operations or liquidity. However, the results of litigation are inherently unpredictable and the possibility exists that the ultimate resolution of one or more of these matters could result in a material adverse effect on our financial position, results of operations or liquidity.

Legal costs are expensed as incurred.

Inventories

Inventories consist primarily of raw materials and are stated at the lower of cost or net realizable value. Cost is determined primarily using the average cost method. As a result of a decline in the market value of steel, which is a major component of the raw material cost, the Company recorded a charge of $1.2 million in fiscal 2009 as an increase to cost of revenues.

 

       

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

Depreciation

Depreciation is computed using the straight-line method over the estimated useful lives of the depreciable assets. Depreciable lives are as follows: buildings—40 years, construction equipment—3 to 15 years, transportation equipment—3 to 5 years, and furniture and fixtures—3 to 10 years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the lease term.

Impairment of Long-Lived Assets

The Company evaluates long-lived assets for impairment when events or changes in circumstances indicate, in management’s judgment, that the carrying value of such assets used in operations may not be recoverable. The determination of whether an impairment has occurred is based on management’s estimate of undiscounted future cash flows attributable to the assets as compared to the carrying value of the assets. If an impairment has occurred, the amount of the impairment recognized is determined by estimating the fair value of the assets and, to the extent the carrying value exceeds the fair value of the assets, recording a loss provision.

For assets identified to be disposed of in the future, the carrying value of the assets are compared to the estimated fair value less the cost of disposal to determine if an impairment has occurred. Until the assets are disposed of, an estimate of the fair value is redetermined when related events or circumstances change.

Goodwill

Goodwill is not amortized and is tested at least annually for impairment. Goodwill represents the excess of the purchase price of acquisitions over the acquisition date fair value of the identifiable net assets acquired. Goodwill is evaluated for impairment by first comparing management’s estimate of the fair value of a reporting unit with its carrying value, including goodwill. Reporting units for purposes of goodwill impairment calculations are our reportable segments.

Management utilizes a discounted cash flow analysis to determine the estimated fair value of our reporting units. Judgments and assumptions related to revenue, gross margins, operating expenses, interest, capital expenditures, cash flow and market assumptions are inherent in these estimates. As a result, use of alternate judgments and/or assumptions could result in a fair value that differs from our estimate and ultimately result in the recognition of impairment charges in the financial statements. We utilize various scenarios and assign probabilities to each of these scenarios in our discounted cash flow analysis. The results of the discounted cash flow analysis are then compared to the carrying value of the reporting unit.

If the carrying value of a reporting unit exceeds its fair value, a computation of the implied fair value of goodwill is compared with its related carrying value. If the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in the amount of the excess. If an impairment charge is incurred, it would negatively impact our results of operations and financial position. We perform our annual analysis during the fourth quarter of each fiscal year and in any other period in which indicators of impairment warrant an additional analysis.

Other Intangible Assets

Intangible assets that have finite useful lives are amortized by the straight-line method over their useful lives ranging from 1 to 15 years. Intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment. Each reporting period, we evaluate the remaining useful lives of intangible assets not being amortized to determine whether facts and circumstances continue to support an indefinite useful life. Intangible assets are considered impaired if the fair value of the intangible asset is less than its net book value. If quoted market prices are not available, the fair values of the intangible assets are determined based on present values of expected future cash flows using discount rates commensurate with the risks involved.

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 June 30, 2010 and May 31, 2009, insurance reserves totaling $8.3 million and $7.6 million, respectively, are included on our consolidated balance sheet. These amounts

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

represent our best estimate of our ultimate obligations for asserted claims, insurance premium obligations and claims incurred but not yet reported at the balance sheet dates. 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 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 future gains and losses that could be material.

Stock-Based Compensation

The fair value of stock-based awards is calculated at grant date. The fair value of stock options is determined using a Black Scholes valuation model. The fair value of performance and time-based nonvested deferred shares is generally the value of the Company’s common stock at the grant date. The fair value of market-based nonvested deferred shares is based on several factors, including the probability that the market condition specified in the grant will be achieved.

For all stock-based awards expense is recognized over the requisite service period, net of estimated forfeitures. The expense related to performance based shares is recognized only if management believes it is probable that the performance targets specified in the awards will be achieved.

The expense for stock based awards that settle in cash is recognized over the requisite service period. The estimated liability is marked to market each reporting period with changes to the liability recorded as compensation expense if the payout of the award is considered probable.

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 statement 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 we consider it probable that additional taxes will be due in excess of the amounts included in our tax returns. We continually review our exposure to additional income taxes due, and as further information is known or events occur, adjustments may be recorded.

Foreign Currency

The functional currency of the Company’s operations in Canada is the Canadian dollar. The assets and liabilities are translated at the year end exchange rate and the income statement accounts are translated at average exchange rates throughout the year. Translation gains and losses are reported in Accumulated Other Comprehensive Income (Loss) in the Statement of Changes in Stockholders’ Equity and Comprehensive Income. Transaction gains and losses are reported as a component of Other income (expense) in the Statement of Income.

Recently Issued Accounting Standards

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

Note 2—Change in Fiscal Year

On July 30, 2009 the Company’s Board of Directors approved a change in the Company’s fiscal year end from May 31 to June 30, beginning July 1, 2009. As a result of the change, the Company had a transition period for the one month ended June 30, 2009 (“June Transition Period”).

Included in this report is the Company’s consolidated balance sheets as of June 30, 2010 and May 31, 2009 and the consolidated statements of income, comprehensive income, cash flows and changes in stockholders’ equity for the 12 months ended June 30, 2010 (“fiscal 2010”), May 31, 2009 (“fiscal 2009”), and May 31, 2008 (“fiscal 2008”) and for the one month ended June 30, 2009.

 

       

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

Note 3—Acquisitions

Purchase of Engineering and Construction Assets and Technology

On December 20, 2008, the Company acquired engineering and construction resources and technology used to design, engineer and construct single and full containment LNG storage tanks, LIN/LOX storage tanks, LPG storage tanks and thermal vacuum chambers from CB&I Inc., a subsidiary of Chicago Bridge & Iron Company N.V. (“CB&I”). The purchase included approximately 70 engineering and construction personnel, along with tools, equipment, and a perpetual license to use CB&I’s technology necessary to design, engineer and construct LNG storage tanks, LIN/LOX storage tanks, LPG storage tanks and thermal vacuum chambers.

Purchase of S.M. Electric Company, Inc.

On February 5, 2009 the Company acquired S.M. Electric Company, Inc. (“SME”). The purchase price consisted primarily of the repayment of SME’s bank indebtedness and the repayment of certain indebtedness to SME’s former owners. SME, located in Rahway, New Jersey, provides electrical and contracting services to industrial and utility customers in the Northeastern United States. SME has contracts and performs work in both the Repair and Maintenance and Construction Services segments. SME’s financial results are included in both operating segments from February 5, 2009.

Summarized Combined Purchase Price

The purchase prices were allocated to the major categories of assets and liabilities based on their estimated fair values at their respective acquisition dates. The following table summarizes the final purchase price allocation.

 

Current assets

   $ 32,087

Property, plant and equipment

     2,280

Tax deductible goodwill

     4,712

Other intangible assets

     4,721

Other non-current assets

     541
      

Total assets acquired

     44,341

Current liabilities

     28,871

Non-current liabilities

     75
      

Net assets acquired

     15,395

Cash acquired

     58
      

Net purchase price

   $ 15,337
      

The operating and proforma data related to the SME acquisition was not material. Both acquisitions were funded with cash on hand.

SME Claim Receivables

Included in the SME acquisition were certain claim receivables which were recorded at their net realizable values, which included an allowance for estimated collection costs. In fiscal 2010, the cumulative collection costs exceeded the original estimate of the allowance for collection costs resulting in a pretax SG&A charge of $1.9 million.

Additionally, in fiscal 2010 the Company was awarded $0.5 million through arbitration on one of the claims. The award was less than the claim’s recorded value and resulted in a pretax SG&A charge of $2.5 million. Finally, as a part of the Company’s ongoing assessment of the recoverability of the remaining uncollected balances the Company recorded a pretax SG&A charge of $0.4 million. The recorded amount of these claims was $6.1 million at May 31, 2009 and $3.4 million at June 30, 2010.

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

Note 4—Customer 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 on uncompleted contracts is reported as a current liability. Gross and net amounts on uncompleted contracts are as follows:

 

     June 30,
2010
   May 31,
2009
 
     (In thousands)  

Costs incurred and estimated earnings recognized on uncompleted contracts

   $ 630,342    $ 1,071,904   

Billings on uncompleted contracts

     618,299      1,087,590   
               
   $ 12,043    $ (15,686
               

Shown on balance sheet as:

     

Costs and estimated earnings in excess of billings on uncompleted contracts

   $ 40,920    $ 35,619   

Billings on uncompleted contracts in excess of costs and estimated earnings

     28,877      51,305   
               
   $ 12,043    $ (15,686
               

Accounts receivable at June 30, 2010 and May 31, 2009 included retentions to be collected within one year of $13.2 million and $15.2 million, respectively. Contract retentions collectible beyond one year are included in Other Assets on the Consolidated Balance Sheets and totaled $0.1 million at June 30, 2010 and $2.8 million at May 31, 2009.

Note 5—Goodwill and Other Intangible Assets

Goodwill

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

 

     Construction
Services
    Repair and
Maintenance
Services
    Total  
     (In thousands)  

Balance at May 31, 2008

   $ 4,052      $ 19,277      $ 23,329   

Purchase price adjustment

     (452     (194     (646

Translation adjustment

     —          (240     (240

Acquisition of business (Note 3)

     1,995        1,330        3,325   
                        

Balance at May 31, 2009

     5,595        20,173        25,768   

Purchase price adjustment (Note 3)

     315        210        525   

Translation adjustment

     —          (150     (150
                        

Balance at June 30, 2009

     5,910        20,233        26,143   

Purchase price adjustment (Note 3)

     517        345        862   

Translation adjustment

     —          211        211   
                        

Balance at June 30, 2010

   $ 6,427      $ 20,789      $ 27,216   
                        

The translation adjustments relate to goodwill recorded as a part of a Canadian acquisition. A deferred tax asset valuation allowance relating to an acquisition was reversed that resulted in the goodwill adjustment in fiscal 2009. The June Transition Period and fiscal 2010 adjustments were recorded when finalizing the purchase price allocation of the Company’s fiscal 2009 SME acquisition.

 

       

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

The Company adopted SFAS 141(R), Business Combinations (codified as ASC 805) effective June 1, 2009. Beginning with the effective date of SFAS 141(R), ASC 805 requires that entities disclose the gross amount of goodwill and the accumulated impairment losses as of the beginning and end of each fiscal year in which a statement of financial position is presented. The required information for the periods indicated below is as follows:

 

     Goodwill (gross)    Accumulated
Impairment

Losses
    Goodwill (net)
     (In thousands)

June 1, 2009

   $ 50,768    $ (25,000   $ 25,768

June 30, 2009

     51,143      (25,000     26,143

June 30, 2010

     52,216      (25,000     27,216

Other Intangible Assets

Information on the carrying value of other intangible assets is as follows:

 

          At June 30, 2010
     Useful Life    Gross
Carrying
Amount
   Accumulated
Amortization
    Net
Carrying Amount
     (Years)    (In thousands)

Intellectual property

   6 to 12      $ 2,460    $ (251   $ 2,209

Customer based

   1 to 15        798      (324     474

Other

   3        42      (34     8
                        

Total amortizing intangibles

        3,300      (609     2,691

Trade name

   Indefinite      1,450      —          1,450
                        

Total intangible assets

      $ 4,750    $ (609   $ 4,141
                        

 

          At May 31, 2009
     Useful Life    Gross
Carrying
Amount
   Accumulated
Amortization
    Net
Carrying

Amount
     (Years)    (In thousands)

Intellectual property

   6 to 12      $ 2,460    $ (70   $ 2,390

Customer based

   1 to 15        769      (74     695

Other

   3        42      (6     36
                        

Total amortizing intangibles

        3,271      (150     3,121

Trade name

   Indefinite      1,450      —          1,450
                        

Total intangible assets

      $ 4,721    $ (150   $ 4,571
                        

Amortization expense totaled $0.4 million and $0.2 million in fiscal 2010 and fiscal 2009. Amortization expense was less than $0.1 million in the June Transition Period. Amortization expense is expected to be $0.2 million annually in fiscal 2011 to 2015.

Note 6—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.

Our ability to incur short-term borrowing or access to the Credit Facility for letters of credit is limited by the Senior Leverage Ratio, which provides that Consolidated Funded Indebtedness may not exceed 2.5 times Consolidated EBITDA over the previous four quarters, as defined in the credit agreement. For the four quarters ended June 30, 2010, Consolidated EBITDA was $25.2 million, reducing the capacity of the Credit Facility to $62.9 million. The Company was also in violation of the Fixed Charge Coverage Ratio covenant. The Fixed Charge Coverage Ratio at June 30, 2010 was 0.83 to 1.00 which was less than the minimum requirement of 1.25 to 1.00.

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

The Company received a waiver of the Fixed Charge Coverage Ratio covenant violation on September 24, 2010. The credit agreement was also amended, effective September 24, 2010, to add back the $5.1 million charge on a legal matter to the calculation of Consolidated EBITDA, which will improve our ability to comply with the Fixed Charge Coverage Ratio covenant in the future and increase our availability under the Credit Facility.

Availability under the senior credit facility is as follows:

 

     June 30,
2010
   May 31,
2009
     (In thousands)

Capacity under the Credit Facility

   $ 62,951    $ 75,000

Letters of credit

     11,622      7,263
             

Availability under senior credit facility

   $ 51,329    $ 67,737
             

The Credit Facility may be used for working capital, issuance of letters of credit or other lawful corporate purposes. The credit agreement contains 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 credit agreement, as currently amended, also includes the following:

 

   

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.

 

   

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 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; and,

 

   

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

The Company has received a waiver for the June 30, 2010 Fixed Charge Coverage Ratio covenant violation and is in compliance with all other 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 Consolidated Financial Statements (continued)

 

Note 7—Income Taxes

The sources of pretax income are as follows:

 

     Twelve Months Ended    One Month
Ended
     June 30,
2010
   May 31,
2009
   May 31,
2008
   June 30,
2009
     (In thousands)

Domestic

   $ 4,417    $ 47,106    $ 33,509    $ 1,527

Foreign

     2,993      653      207      76
                           

Total

   $ 7,410    $ 47,759    $ 33,716    $ 1,603
                           

The components of the provision for income taxes are as follows:

 

     Twelve Months Ended     One Month
Ended
 
     June 30,
2010
    May 31,
2009
    May 31,
2008
    June 30,
2009
 
     (In thousands)  

Current:

  

Federal

   $ 4,129      $ 14,485      $ 9,213      $ 873   

State

     641        2,023        1,280        84   

Foreign

     1,226        750        325        63   
                                
     5,996        17,258        10,818        1,020   

Deferred:

        

Federal

     (3,208     484        1,550        (416

State

     (250     (555     (58     8   

Foreign

     (4     (17     (8     (3
                                
     (3,462     (88     1,484        (411
                                
   $ 2,534      $ 17,170      $ 12,302      $ 609   
                                

The difference between the expected income tax provision applying the domestic federal statutory tax rate and the reported income tax provision is as follows:

 

     Twelve Months Ended     One Month
Ended
 
     June 30,
2010
    May 31,
2009
    May 31,
2008
    June 30,
2009
 
     (In thousands)  

Expected provision for Federal income taxes at the statutory rate

   $ 2,519      $ 16,716      $ 11,801      $ 561   

State income taxes, net of Federal benefit

     268        1,699        1,206        57   

Charges without tax benefit

     96        (230     (26     (9

Change in valuation allowance

     —          (957     2        —     

State investment credits

     (59     (48     (538     —     

Other

     (290     (10     (143     —     
                                

Provision for income taxes

   $ 2,534      $ 17,170      $ 12,302      $ 609   
                                

Changes in the valuation allowance reduced the income tax provision by $1.0 million in fiscal 2009, and reduced goodwill by $0.6 million and $0.2 million in fiscal 2009 and 2008, respectively.

 

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Matrix Service Company

Notes to Consolidated Financial Statements (continued)

 

Significant components of the Company’s deferred tax liabilities and assets are as follows:

 

     June 30,
2010
    May 31,
2009
 
     (In thousands)  

Deferred tax liabilities:

    

Tax over book depreciation

   $ 6,551      $ 7,302   

Change in tax accounting methods

     —          346   

Other—net

     714        540   
                

Total deferred tax liabilities

     7,265        8,188   

Deferred tax assets:

    

Bad debt reserve

     560        436   

Foreign insurance dividend

     132        132   

Vacation accrual

     418        375   

Insurance reserve

     2,759        2,439   

Legal reserve

     1,817        —     

Noncompete amortization

     29        45   

Net operating loss benefit and credit carryforwards

     3,579        3,497   

Valuation allowance

     (774     (774

Accrued compensation and pension

     1,030        397   

Stock compensation expense on nonvested deferred shares

     596        1,061   

Accrued losses

     729        379   

Other—net

     284        222   
                

Total deferred tax assets

     11,159        8,209   
                

Net deferred tax asset

   $ 3,894      $ 21   
                

As reported in the consolidated balance sheets:

 

     June 30,
2010
    May 31,
2009
 
     (In thousands)  

Current deferred tax assets

   $ 8,073      $ 4,843   

Non-current deferred tax liabilities

     (4,179     (4,822
                

Net deferred tax asset

   $ 3,894      $ 21   
                

The Company has state operating loss carryforwards, state investment tax credit carryforwards and federal foreign tax credit carryforwards of which a portion relates to an acquisition. The valuation allowance at June 30, 2010 and May 31, 2009 reduces the recognized tax benefit of these carryforwards to an amount that will more likely than not be realized. The carryforwards generally expire between 2017 and 2028.

The Company files tax returns in several taxing jurisdictions in the United States and Canada. With few exceptions, the Company is no longer subject to examination by taxing authorities through fiscal 2006. At June 30, 2010, the Company updated its evaluation of its open tax years in all known jurisdictions. Based on this evaluation, the Company did not identify any uncertain tax positions.

Note 8—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 and provide for warranties for materials and workmanship. The Company may also be required to name the

 

       

 

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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 performance and payment 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 Proceedings

Delaware Refinery Accident

On November 6, 2005, two employees of the Company’s subsidiary Matrix Service Industrial Contractors, Inc. (“MSICI”) were fatally injured in an accident that occurred at a refinery in Delaware City, Delaware. The estates of both employees filed liability claims against the refinery owner (“Owner”), claiming both compensatory and punitive damages. On January 10, 2007 the Owner filed a complaint in the Superior Court of the State of Delaware, New Castle County, against the Company and MSICI, and two other contractors present on site at the time of the accident (“Delaware Action”), seeking status as an additional insured under the Company’s insurance policy and for indemnification for any amounts which it may be required to pay to the estates of the deceased.

The estates of the two employees settled their liability claims against the Owner in October 2008 and July 2010, respectively. The funding of both settlements included contributions from the Owner (“Owners Contribution”) and the Company’s insurer on the Owner’s behalf as an additional insured under MSICI’s policy. The maximum remaining liability for the Company is now fixed at the amount of the Owner’s Contribution. The Owner continues to seek reimbursement of the Owner’s Contribution though the Delaware Action. The Company expects the Delaware Action to be resolved within its insurance policy limits.

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 seeks 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 for employees who worked more than 10 hours in a day, third rest periods for those 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 rate, leading to incorrect overtime rates. The class is seeking 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 have been 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

 

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Settlement”). The award is in addition to amounts previously paid to the class members of $1.9 million. The September Settlement is subject to court approval and resolves all class member claims included in the December 2008 Action and the September 2009 Action. The award will be used to pay the class member claims, the enhancement award, 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 the remaining $1.0 million was recorded in fiscal 2009. The fiscal 2010 charge includes 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.

EPA Penalty

On April 20, 2010 the Company received notification from the EPA alleging non-compliance with certain reporting requirements mandated by the Emergency Planning and Community Right to Know Act. The EPA alleges that the Company failed to submit Toxic Release Inventory Reporting Forms in calendar years 2004, 2005, 2006 and 2008 for chromium, manganese, and nickel. The alleged reporting violations relate to the Company’s fabrication facility in Catoosa, Oklahoma and resulted in a penalty assessment of $0.3 million. On September 2, 2010 the Company entered into a Consent Agreement and Final Order (“CAFO”) with the EPA. Under the terms of the CAFO the Company agreed to pay an administrative penalty of $150,000. The CAFO settled all EPA allegations and released the Company of all potential liability.

Unapproved Change Orders and Claims

As of June 30, 2010 and May 31, 2009, costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders of $3.0 million and $0.5 million, respectively. There were no claims included in costs and estimated earnings in excess of billings on uncompleted contracts at June 30, 2010 or May 31, 2009. 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.

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.

Note 9—Leases

Operating Leases

The Company is the lessee under operating leases covering real estate, office equipment and vehicles under non-cancelable operating lease agreements that expire at various times. Future minimum lease payments under non-cancelable operating leases that were in effect at June 30, 2010 total $11.8 million and are payable as follows: fiscal 2011-$3.0 million; fiscal 2012-$2.7 million; fiscal 2013-$2.4 million; fiscal 2014-$1.8 million; fiscal 2015-$1.4 million and thereafter -$0.5 million. Operating lease expense was $3.3 million, $2.7 million and $1.9 million for the twelve months ended June 30, 2010, May 31, 2009 and May 31, 2008 and $0.3 million for the one month ended June 30, 2009.

Capital Leases

The Company leases most of its copiers, printers, and passenger vehicles under various non-cancelable lease agreements. Minimum lease payments have been capitalized and the related assets and obligations recorded using various interest rates. The assets are depreciated on a straight line method over their lease term. Interest expense is recognized using the effective interest method.

 

       

 

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The following table is a summary of future obligations under capital leases:

 

     Minimum Lease Payments  
     (In thousands)  

For the year ending June 30:

  

2011

   $ 781   

2012

     271   

2013

     44   

2014