Attached files
file | filename |
---|---|
EX-95 - EXHIBIT 95 - MATRIX SERVICE CO | exhibit95-mtrxx2017x3x31x1.htm |
EX-32.2 - EXHIBIT 32.2 - MATRIX SERVICE CO | exhibit322-mtrxx2017x3x31x.htm |
EX-32.1 - EXHIBIT 32.1 - MATRIX SERVICE CO | exhibit321-mtrxx2017x3x31x.htm |
EX-31.2 - EXHIBIT 31.2 - MATRIX SERVICE CO | exhibit312-mtrxx2017x3x31x.htm |
EX-31.1 - EXHIBIT 31.1 - MATRIX SERVICE CO | exhibit311-mtrxx2017x3x31x.htm |
EX-10.1 - EXHIBIT 10.1 - MATRIX SERVICE CO | exhibit101fourthamendedand.htm |
EX-3.1 - EXHIBIT 3.1 - MATRIX SERVICE CO | exhibit31secondamendedandr.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________________________
FORM 10-Q
_______________________________________
(Mark One)
x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2017
or
o | Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File No. 1-15461
__________________________________________
MATRIX SERVICE COMPANY
(Exact name of registrant as specified in its charter)
__________________________________________
DELAWARE | 73-1352174 | |
(State of incorporation) | (I.R.S. Employer Identification No.) |
5100 East Skelly Drive, Suite 500, Tulsa, Oklahoma 74135
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (918) 838-8822
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý 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 ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ý | ||
Non-accelerated filer | o | Smaller reporting company | ¨ | ||
Emerging growth company | o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of May 8, 2017 there were 27,888,217 shares of the Company’s common stock, $0.01 par value per share, issued and 26,600,094 shares outstanding.
TABLE OF CONTENTS
PAGE | ||
FINANCIAL INFORMATION | ||
Item 1. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
OTHER INFORMATION | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Matrix Service Company
Condensed Consolidated Statements of Income
(In thousands, except per share data)
(unaudited)
Three Months Ended | Nine Months Ended | ||||||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | ||||||||||||
Revenues | $ | 251,237 | $ | 309,422 | $ | 905,673 | $ | 952,282 | |||||||
Cost of revenues | 253,851 | 282,119 | 847,797 | 860,390 | |||||||||||
Gross profit (loss) | (2,614 | ) | 27,303 | 57,876 | 91,892 | ||||||||||
Selling, general and administrative expenses | 18,596 | 20,956 | 56,548 | 65,509 | |||||||||||
Operating income (loss) | (21,210 | ) | 6,347 | 1,328 | 26,383 | ||||||||||
Other income (expense): | |||||||||||||||
Interest expense | (833 | ) | (241 | ) | (1,573 | ) | (756 | ) | |||||||
Interest income | 73 | 56 | 111 | 147 | |||||||||||
Other | (51 | ) | (109 | ) | 3 | (311 | ) | ||||||||
Income (loss) before income tax expense | (22,021 | ) | 6,053 | (131 | ) | 25,463 | |||||||||
Provision (benefit) for federal, state and foreign income taxes | (8,521 | ) | 2,507 | (1,223 | ) | 9,060 | |||||||||
Net income (loss) | (13,500 | ) | 3,546 | 1,092 | 16,403 | ||||||||||
Less: Net income (loss) attributable to noncontrolling interest | 321 | (811 | ) | 321 | (3,326 | ) | |||||||||
Net income (loss) attributable to Matrix Service Company | $ | (13,821 | ) | $ | 4,357 | $ | 771 | $ | 19,729 | ||||||
Basic earnings (loss) per common share | $ | (0.52 | ) | $ | 0.16 | $ | 0.03 | $ | 0.74 | ||||||
Diluted earnings (loss) per common share | $ | (0.52 | ) | $ | 0.16 | $ | 0.03 | $ | 0.73 | ||||||
Weighted average common shares outstanding: | |||||||||||||||
Basic | 26,594 | 26,758 | 26,511 | 26,651 | |||||||||||
Diluted | 26,594 | 27,054 | 26,838 | 27,191 |
See accompanying notes.
- 1-
Matrix Service Company
Condensed Consolidated Statements of Comprehensive Income
(In thousands)
(unaudited)
Three Months Ended | Nine Months Ended | ||||||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | ||||||||||||
Net income (loss) | $ | (13,500 | ) | $ | 3,546 | $ | 1,092 | $ | 16,403 | ||||||
Other comprehensive income (loss), net of tax: | |||||||||||||||
Foreign currency translation gain (loss) (net of tax expense (benefit) of ($5) and $100 for the three and nine months ended March 31, 2017, respectively, and ($166) and $218 for the three and nine months ended March 31, 2016, respectively) | 1,035 | 2,754 | (962 | ) | (1,061 | ) | |||||||||
Comprehensive income (loss) | (12,465 | ) | 6,300 | 130 | 15,342 | ||||||||||
Less: Comprehensive income (loss) attributable to noncontrolling interest | 321 | (811 | ) | 321 | (3,326 | ) | |||||||||
Comprehensive income (loss) attributable to Matrix Service Company | $ | (12,786 | ) | $ | 7,111 | $ | (191 | ) | $ | 18,668 |
See accompanying notes.
- 2-
Matrix Service Company
Condensed Consolidated Balance Sheets
(In thousands)
(unaudited)
March 31, 2017 | June 30, 2016 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 39,697 | $ | 71,656 | |||
Accounts receivable, less allowances (March 31, 2017— $9,247 and June 30, 2016—$8,403) | 223,338 | 190,434 | |||||
Costs and estimated earnings in excess of billings on uncompleted contracts | 69,986 | 104,001 | |||||
Inventories | 3,926 | 3,935 | |||||
Income taxes receivable | 5,314 | 9 | |||||
Other current assets | 7,373 | 5,411 | |||||
Total current assets | 349,634 | 375,446 | |||||
Property, plant and equipment at cost: | |||||||
Land and buildings | 39,826 | 39,224 | |||||
Construction equipment | 93,178 | 90,386 | |||||
Transportation equipment | 48,156 | 49,046 | |||||
Office equipment and software | 36,284 | 29,577 | |||||
Construction in progress | 5,827 | 7,475 | |||||
Total property, plant and equipment - at cost | 223,271 | 215,708 | |||||
Accumulated depreciation | (141,308 | ) | (130,977 | ) | |||
Property, plant and equipment - net | 81,963 | 84,731 | |||||
Goodwill | 113,182 | 78,293 | |||||
Other intangible assets | 27,781 | 20,999 | |||||
Deferred income taxes | 5,663 | 3,719 | |||||
Other assets | 2,045 | 1,779 | |||||
Total assets | $ | 580,268 | $ | 564,967 |
See accompanying notes.
- 3-
Matrix Service Company
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(unaudited)
March 31, 2017 | June 30, 2016 | ||||||
Liabilities and stockholders’ equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 97,271 | $ | 141,445 | |||
Billings on uncompleted contracts in excess of costs and estimated earnings | 75,424 | 58,327 | |||||
Accrued wages and benefits | 25,102 | 27,716 | |||||
Accrued insurance | 8,804 | 9,246 | |||||
Income taxes payable | 148 | 2,675 | |||||
Other accrued expenses | 8,314 | 6,621 | |||||
Total current liabilities | 215,063 | 246,030 | |||||
Deferred income taxes | 377 | 3,198 | |||||
Borrowings under senior revolving credit facility | 44,139 | — | |||||
Other liabilities | 472 | 173 | |||||
Total liabilities | 260,051 | 249,401 | |||||
Commitments and contingencies | |||||||
Stockholders’ equity: | |||||||
Matrix Service Company stockholders' equity: | |||||||
Common stock—$.01 par value; 60,000,000 shares authorized; 27,888,217 shares issued as of March 31, 2017, and June 30, 2016; 26,594,319 and 26,297,145 shares outstanding as of March 31, 2017 and June 30, 2016 | 279 | 279 | |||||
Additional paid-in capital | 126,513 | 127,058 | |||||
Retained earnings | 223,928 | 223,157 | |||||
Accumulated other comprehensive loss | (7,807 | ) | (6,845 | ) | |||
342,913 | 343,649 | ||||||
Less: Treasury stock, at cost — 1,293,898 shares as of March 31, 2017, and 1,591,072 shares as of June 30, 2016 | (22,696 | ) | (26,907 | ) | |||
Total Matrix Service Company stockholders’ equity | 320,217 | 316,742 | |||||
Noncontrolling interest | — | (1,176 | ) | ||||
Total stockholders' equity | 320,217 | 315,566 | |||||
Total liabilities and stockholders’ equity | $ | 580,268 | $ | 564,967 |
See accompanying notes.
- 4-
Matrix Service Company
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
Nine Months Ended | |||||||
March 31, 2017 | March 31, 2016 | ||||||
Operating activities: | |||||||
Net income | $ | 1,092 | $ | 16,403 | |||
Adjustments to reconcile net income to net cash used by operating activities, net of effects from acquisitions: | |||||||
Depreciation and amortization | 15,839 | 16,139 | |||||
Deferred income tax | (4,665 | ) | 1,413 | ||||
Gain on sale of property, plant and equipment | (366 | ) | (111 | ) | |||
Provision for uncollectible accounts | 900 | 5,684 | |||||
Stock-based compensation expense | 5,467 | 5,023 | |||||
Other | 211 | 179 | |||||
Changes in operating assets and liabilities increasing (decreasing) cash, net of effects from acquisitions: | |||||||
Accounts receivable | (23,531 | ) | 23,684 | ||||
Costs and estimated earnings in excess of billings on uncompleted contracts | 34,761 | (6,575 | ) | ||||
Inventories | 9 | 568 | |||||
Other assets and liabilities | (9,668 | ) | (5,461 | ) | |||
Accounts payable | (45,690 | ) | (3,492 | ) | |||
Billings on uncompleted contracts in excess of costs and estimated earnings | 5,449 | (29,895 | ) | ||||
Accrued expenses | (5,417 | ) | 983 | ||||
Net cash provided (used) by operating activities | (25,609 | ) | 24,542 | ||||
Investing activities: | |||||||
Acquisitions (Note 2) | (40,819 | ) | (13,049 | ) | |||
Acquisition of property, plant and equipment | (8,475 | ) | (11,746 | ) | |||
Proceeds from asset sales | 1,145 | 258 | |||||
Net cash used by investing activities | $ | (48,149 | ) | $ | (24,537 | ) |
See accompanying notes.
- 5-
Matrix Service Company
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
Nine Months Ended | |||||||
March 31, 2017 | March 31, 2016 | ||||||
Financing activities: | |||||||
Advances under senior revolving credit facility | $ | 106,168 | $ | 2,753 | |||
Repayments of advances under senior revolving credit facility | (62,029 | ) | (7,712 | ) | |||
Payment of debt amendment fees | (822 | ) | — | ||||
Open market purchase of treasury shares | — | (5,460 | ) | ||||
Issuances of common stock | 234 | 578 | |||||
Proceeds from issuance of common stock under employee stock purchase plan | 253 | 261 | |||||
Repurchase of common stock for payment of statutory taxes due on equity-based compensation | (2,288 | ) | (4,540 | ) | |||
Capital contributions from noncontrolling interest | 855 | 10,892 | |||||
Repayment of acquired long-term debt | — | (1,858 | ) | ||||
Net cash provided (used) by financing activities | 42,371 | (5,086 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (572 | ) | (755 | ) | |||
Decrease in cash and cash equivalents | (31,959 | ) | (5,836 | ) | |||
Cash and cash equivalents, beginning of period | 71,656 | 79,239 | |||||
Cash and cash equivalents, end of period | $ | 39,697 | $ | 73,403 | |||
Supplemental disclosure of cash flow information: | |||||||
Cash paid during the period for: | |||||||
Income taxes | $ | 11,679 | $ | 9,192 | |||
Interest | $ | 1,266 | $ | 789 | |||
Non-cash investing and financing activities: | |||||||
Purchases of property, plant and equipment on account | $ | 846 | $ | 401 | |||
Acquisition of long-term debt | $ | — | $ | 1,858 |
See accompanying notes.
- 6-
Matrix Service Company
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(In thousands, except share data)
(unaudited)
Common Stock | Additional Paid-In Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Income(Loss) | Non-Controlling Interest | Total | |||||||||||||||||||||
Balances, July 1, 2016 | $ | 279 | $ | 126,958 | $ | 223,257 | $ | (26,907 | ) | $ | (6,845 | ) | $ | (1,176 | ) | $ | 315,566 | ||||||||||
Retrospective adjustment upon adoption of ASU 2016-09 (see Note 1) | — | 100 | (100 | ) | — | — | — | — | |||||||||||||||||||
Balances, July 1, 2016, as adjusted | 279 | 127,058 | 223,157 | (26,907 | ) | (6,845 | ) | (1,176 | ) | 315,566 | |||||||||||||||||
Capital contributions from noncontrolling interest | — | — | — | — | — | 855 | 855 | ||||||||||||||||||||
Net income | — | — | 771 | — | — | 321 | 1,092 | ||||||||||||||||||||
Other comprehensive loss | — | — | — | — | (962 | ) | — | (962 | ) | ||||||||||||||||||
Treasury shares sold to Employee Stock Purchase Plan (12,734 shares) | — | 18 | — | 235 | — | — | 253 | ||||||||||||||||||||
Exercise of stock options (22,913 shares) | — | (290 | ) | — | 524 | — | — | 234 | |||||||||||||||||||
Issuance of deferred shares (395,780 shares) | — | (5,740 | ) | — | 5,740 | — | — | — | |||||||||||||||||||
Treasury shares purchased to satisfy tax withholding obligations (134,253 shares) | — | — | — | (2,288 | ) | — | — | (2,288 | ) | ||||||||||||||||||
Stock-based compensation expense | — | 5,467 | — | — | — | — | 5,467 | ||||||||||||||||||||
Balances, March 31, 2017 | $ | 279 | $ | 126,513 | $ | 223,928 | $ | (22,696 | ) | $ | (7,807 | ) | $ | — | $ | 320,217 | |||||||||||
Balances, July 1, 2015 | $ | 279 | $ | 123,038 | $ | 194,394 | $ | (18,489 | ) | $ | (5,926 | ) | $ | (8,742 | ) | $ | 284,554 | ||||||||||
Capital contributions from noncontrolling interest | — | — | — | — | — | 10,892 | 10,892 | ||||||||||||||||||||
Net income (loss) | — | — | 19,729 | — | — | (3,326 | ) | 16,403 | |||||||||||||||||||
Other comprehensive loss | — | — | — | — | (1,061 | ) | — | (1,061 | ) | ||||||||||||||||||
Treasury shares sold to Employee Stock Purchase Plan (13,003 shares) | — | 142 | — | 119 | — | — | 261 | ||||||||||||||||||||
Exercise of stock options (62,137 shares) | — | 7 | — | 571 | — | — | 578 | ||||||||||||||||||||
Issuance of deferred shares (623,443 shares) | — | (5,777 | ) | — | 5,777 | — | — | — | |||||||||||||||||||
Treasury shares purchased to satisfy tax withholding obligations (202,916 shares) | — | — | — | (4,540 | ) | — | — | (4,540 | ) | ||||||||||||||||||
Tax effect of exercised stock options and vesting of deferred shares | — | 3,222 | — | — | — | — | 3,222 | ||||||||||||||||||||
Open market purchase of treasury shares ( 330,000 shares) | — | — | — | (5,460 | ) | — | — | (5,460 | ) | ||||||||||||||||||
Stock-based compensation expense | — | 5,023 | — | — | — | — | 5,023 | ||||||||||||||||||||
Balances, March 31, 2016 | $ | 279 | $ | 125,655 | $ | 214,123 | $ | (22,022 | ) | $ | (6,987 | ) | $ | (1,176 | ) | $ | 309,872 |
See accompanying notes.
- 7-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 1 – Basis of Presentation and Accounting Policies
The condensed consolidated financial statements include the accounts of Matrix Service Company (“Matrix”, “we”, “our”, “us”, “its” or the “Company”) and its subsidiaries, unless otherwise indicated. Intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X for interim financial statements required to be filed with the Securities and Exchange Commission and do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. The information furnished reflects all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results of operations, cash flows and financial position for the interim periods presented. The accompanying condensed financial statements should be read in conjunction with the audited financial statements for the year ended June 30, 2016, included in the Company’s Annual Report on Form 10-K for the year then ended. The results of operations for the nine month period ended March 31, 2017 may not necessarily be indicative of the results of operations for the full year ending June 30, 2017.
Recently Issued Accounting Standards
Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606)
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The ASU also requires entities to disclose both quantitative and qualitative information that enables users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU's disclosure requirements are significantly more comprehensive than those in existing revenue standards. The ASU applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC"). The ASU is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Early adoption is permitted on a limited basis.
Management is currently evaluating the impact of adopting the ASU on the Company's financial position, results of operations, cash flows and related disclosures. Adoption of this ASU is expected to affect the manner in which the Company determines the unit of account for its projects (i.e., performance obligations). Under existing guidance, the Company typically has multiple units of account for large complex projects. Upon adoption, the Company expects that similar projects may have fewer units of account, possibly just one unit of account in some cases, which will result in a more constant recognition of revenue and profit over the term of the project. The Company will adopt this standard on July 1, 2018 using the modified retrospective method of application, which may result in a cumulative effect adjustment to retained earnings as of the date of adoption.
Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
On August 27, 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements. Further, an entity must provide certain disclosures if there is “substantial doubt about the entity’s ability to continue as a going concern.” The FASB believes that requiring management to perform the assessment will enhance the timeliness, clarity, and consistency of related disclosures and improve convergence with international financial reporting standards ("IFRS") (which emphasize management’s responsibility for performing the going-concern assessment). However, the time horizon for the assessment (look-forward period) and the disclosure thresholds under U.S. GAAP and IFRS will continue to differ. The ASU is effective for annual periods ending after December 15, 2016, and interim periods thereafter; early adoption is permitted.
- 8-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
The ASU was adopted during the Company's first fiscal quarter ending September 30, 2016. In connection with the adoption of the ASU, the Company now performs an assessment of its ability to continue as a going concern on a quarterly basis. Disclosure regarding the status of the Company's ability to continue as a going concern is required when there are conditions or events that raise substantial doubt about its ability to continue as a going concern within one year after the date that the financial statements are issued.
Accounting Standards Update 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
On September 25, 2015, the FASB issued ASU 2015-16 to simplify the accounting for measurement-period adjustments. The ASU was issued in response to stakeholder feedback that restatements of prior periods to reflect adjustments made to provisional amounts recognized in a business combination increase the cost and complexity of financial reporting but do not significantly improve the usefulness of the information. Under the ASU, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU also requires acquirers to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. We adopted this standard on July 1, 2016 with no material impact to the Company's financial statements.
Accounting Standards Update 2016-02, Leases (Topic 842)
On February 25, 2016, the FASB issued ASU 2016-02. The amendments in this update require, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, but we do not plan to do so at this time.
We are currently evaluating the ASU's expected impact on our financial statements. Note 8 of Item 8. Financial Statements and Supplementary Data in our 2016 Form 10-K provides information about the timing and amount of future operating lease payments, which we believe is indicative of the materiality of adoption of the ASU to our financial statements.
Accounting Standards Update 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
On March 30, 2016, the FASB issued ASU 2016-09, which simplified several aspects of accounting for stock-based compensation transactions, including the accounting for income taxes and forfeitures and statutory tax withholding requirements. The Company adopted the ASU during its first fiscal quarter ending September 30, 2016. The following is a description of the key provisions of the ASU and their impacts to the Company's financial statements:
Accounting for Income Taxes: The amendments require the Company to recognize excess tax benefits or tax deficiencies in its provision for income taxes in its consolidated statements of income during the period of vesting or exercise of its nonvested deferred share awards and stock options, respectively, for which it expects to receive an income tax deduction. Previously, the Company recognized any excess tax benefits in additional paid-in capital ("APIC") in the balance sheet and any tax deficiencies were recognized as a reduction of APIC to the extent the Company has accumulated excess tax benefits. Any tax deficiencies in excess of accumulated excess tax benefits in APIC were recognized in the provision for income taxes. The amendments also require the Company to only present excess tax benefits and tax deficiencies in the operating section of its statements of cash flows as a component of deferred tax activity. Previously, the Company was required to present such items in both the financing section and operating section of its statements of cash flows. Amendments related to the recognition of excess tax benefits and tax deficiencies in income are required to be applied prospectively, and amendments related to the cash flow statement presentation of excess tax benefits and tax deficiencies may be applied either retrospectively or prospectively.
- 9-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
The Company applied the amendments requiring the recognition of excess tax benefits and tax deficiencies in income prospectively. As a result, the Company recognized $0.5 million of excess tax benefits in its provision for income taxes during the nine months ended March 31, 2017, which increased basic and diluted earnings per share by $0.02. No material excess tax benefits or deficiencies were recognized during the three months ended March 31, 2017. Under the prior accounting standard, the Company would have recognized the excess tax benefits in equity as additional paid-in capital. The amendments relating to the presentation of excess tax benefits and tax deficiencies in the statement of cash flows were applied retrospectively. The effect of the retrospective adjustment was to eliminate the presentation of an operating cash outflow and a financing cash inflow for excess tax benefits on exercised stock options and vesting of deferred shares. These eliminations increased net cash provided by operating activities by $3.2 million and decreased net cash provided by financing activities by $3.2 million for the nine months ended March 31, 2016. Net cash flows did not change as a result of the retrospective adjustment.
Accounting for Forfeitures: The amendments in this ASU allow the Company to elect, as a company-wide accounting policy, either to continue to estimate the amount of forfeitures to exclude from compensation expense or to exclude forfeitures from compensation expense as they occur. Upon the adoption of the ASU during the first quarter of fiscal 2017, the Company elected to account for forfeitures as they occur. The Company is required to apply these amendments on a modified retrospective basis with a cumulative adjustment to retained earnings as of the beginning of the fiscal year. The Company recorded a modified retrospective adjustment to reduce the June 30, 2016 retained earnings balance and increase the additional paid-in capital balance by $0.1 million each.
Statutory Tax Withholding Requirements: Under the prior accounting standard, an entire award must be classified as a liability if the fair value of the shares withheld exceeds the Company's minimum statutory withholding obligation. Under the ASU, the Company is allowed to withhold shares with a fair value up to the amount of tax owed using the maximum statutory tax rate in the employee's applicable jurisdictions. The Company is allowed to determine one maximum rate for all employees in each jurisdiction, rather than a rate for each employee in the jurisdiction. Also, the ASU requires that cash outflows to reacquire shares withheld for taxes to be classified in the financing section of the statement of cash flows.
The Company adopted the ASU during the first quarter of fiscal 2017. Since the Company did not have any awards classified as liabilities due to statutory tax withholding requirements as of December 31, 2016, and since the Company already presented its cash outflows for reacquiring shares withheld for taxes as a financing activity in its statements of cash flows, these amendments did not have any impact on its financial statements upon adoption. The Company does not expect changes to employee withholdings for stock compensation to have a material impact to the financial statements.
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
On June 16, 2016, the FASB issued ASU 2016-13, which will change how the Company accounts for its allowance for uncollectible accounts. The amendments in this update require a financial asset (or a group of financial assets) to be presented at the net amount expected to be collected. The income statement will reflect any increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount.
Current GAAP delays the recognition of the full amount of credit losses until the loss is probable of occurring. The amendments in this update eliminate the probable initial recognition threshold and, instead, reflect the Company's current estimate of all expected credit losses. In addition, current guidance limits the information the Company may consider in measuring a credit loss to its past events and current conditions. The amendments in this update broaden the information the Company may consider in developing its expected credit loss estimate to include forecasted information.
The amendments in this update are effective for the Company on July 1, 2020 and the Company may early adopt on July 1, 2019. The Company must apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. At this time, the Company does not expect this update to have a material impact to its estimate of the allowance for uncollectible accounts.
- 10-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Accounting Standards Update 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
On January 26, 2017, the FASB issued ASU 2017-04, which simplifies the goodwill impairment test by eliminating step two from the procedure. Previously, goodwill was tested for impairment by performing a two-step test. The first step involves determining the fair value of a reporting unit and comparing it to the carrying amount of the reporting unit's net assets. If the fair value of the reporting unit is less than its carrying amount, then the goodwill assigned to that reporting unit is determined to be impaired and step two must then be completed to measure the amount of the impairment. Step two involved measuring the reporting unit's assets and liabilities at fair value following a process similar to determining the fair value of assets acquired and liabilities assumed in a business combination. The net fair value of the assets acquired and liabilities assumed was then compared to the fair value of the reporting unit in order to compute the implied goodwill for the reporting unit. The difference between the carrying amount of the reporting unit's goodwill and the amount of the implied goodwill computed was the amount of the goodwill impairment to be recognized. Under ASU 2017-04, instead of performing step two of the test, the Company will recognize an impairment charge to the extent a reporting unit's fair value is less than the carrying amount of its net assets, as indicated by step one of the test.
The standard must be applied prospectively and must by adopted in fiscal years beginning after December 15, 2019. Early adoption is permitted and the Company is currently evaluating whether to adopt early. The Company's annual goodwill impairment test will be performed as of May 31, 2017.
Note 2 – Acquisitions
Purchase of Houston Interests, LLC
On December 12, 2016, the Company completed the acquisition of Houston Interests, LLC ("Houston Interests"), a premier global solutions company that provides consulting, engineering, design, construction services and systems integration. Houston Interests brings expertise to the Company in natural gas processing; sulfur recovery, processing and handling; liquid terminals, silos and other bulk storage; process plant design; power generation environmental controls and material handling; industrial power distribution; electrical, instrumentation and controls; marine structures; material handling systems and terminals for cement, sulfur, fertilizer, coal and grain; and process heaters. The business has been included in our Matrix PDM Engineering, Inc. subsidiary, and its operating results have been allocated between the Oil Gas & Chemical and Industrial segments.
The Company purchased all of the equity interests of Houston Interests for $40.8 million in cash, net of working capital adjustments and cash acquired. The consideration paid is as follows (in thousands):
Cash paid for equity interest | $ | 46,000 | |
Cash paid for working capital | 5,150 | ||
Less: cash acquired | (10,331 | ) | |
Net purchase price | $ | 40,819 |
The Company funded the equity interest portion of the consideration paid from borrowings under the Company's senior secured revolving credit facility (See Note 5). The purchase of working capital was paid with cash on hand.
- 11-
The net purchase price was allocated to the major categories of assets and liabilities based on their estimated fair value at the acquisition date.
The following table summarizes the preliminary net purchase price allocation (in thousands):
Current assets | $ | 21,804 | |
Property, plant and equipment | 942 | ||
Goodwill | 35,048 | ||
Other intangible assets | 10,220 | ||
Total assets acquired | 68,014 | ||
Current liabilities | 16,674 | ||
Other liabilities | 190 | ||
Net assets acquired | 51,150 | ||
Cash | 10,331 | ||
Net purchase price | $ | 40,819 |
The goodwill recognized from the acquisition is primarily attributable to the technical expertise of the acquired workforce and the complementary nature of Houston Interests' operations, which the Company believes will enable the combined entity to expand its service offerings and enter new markets. All of the goodwill recognized is deductible for income tax purposes. The fair value of the net assets acquired is preliminary pending the final valuation of those assets. As a result, goodwill is also preliminary since it has been recorded as the excess of the purchase price over the estimated fair value of the net assets acquired.
The Company has agreed to pay the previous owners up to $2.6 million for any unused portion of acquired warranty obligations outstanding as of June 30, 2017. In addition, the sellers have agreed to reimburse the Company for any warranty costs incurred in connection with the acquired warranties in excess of $2.6 million. All acquired warranties will expire by June 30, 2017. Any amounts paid to or received from the seller will be accounted for as a working capital adjustment, which will be reflected as a change to the net purchase price. No payments have been made to the seller for any unused portion of acquired warranty obligations as of March 31, 2017.
The Company incurred $0.1 million and $0.5 million of expenses related to closing the acquisition during the three and nine months ended March 31, 2017, which were included within selling, general and administrative expenses in the consolidated statements of income. During the three and nine months ended March 31, 2017, the acquired business contributed revenues of $14.1 million and $16.4 million, respectively, and operating losses of $0.1 million and $0.4 million, respectively.
- 12-
The unaudited financial information in the table below summarizes the combined results of operations of Matrix Service Company and Houston Interests for the three and nine months ended March 31, 2017 and 2016, on a pro forma basis, as though the companies had been combined as of July 1, 2015. The pro forma financial information presented in the table below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at July 1, 2015 nor should it be taken as indicative of future consolidated results of operations.
Three Months Ended | Nine Months Ended | |||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | |||||||||
(In thousands, except per share data) | ||||||||||||
Revenues | $ | 251,237 | $ | 334,228 | $ | 941,536 | $ | 1,047,246 | ||||
Net income (loss) attributable to Matrix Service Company | $ | (13,202 | ) | $ | 4,113 | $ | 5,231 | $ | 22,623 | |||
Basic earnings (loss) per common share | $ | (0.50 | ) | $ | 0.15 | $ | 0.20 | $ | 0.85 | |||
Diluted earnings (loss) per common share | $ | (0.50 | ) | $ | 0.15 | $ | 0.19 | $ | 0.83 |
The pro forma financial information presented in the table above includes the following adjustments to the combined entities' historical financial statements:
• | The combined entities recorded approximately $0.4 million and $3.4 million of acquisition and integration expenses during the three and nine months ended March 31, 2017, respectively, which were transferred in the pro forma earnings to the nine months ended March 31, 2016 in order to report them as if they were incurred on July 1, 2015. Pro forma earnings were adjusted to include integration expenses that would have been recognized had the acquisition occurred on July 1, 2015 of $0.4 million and $1.1 million during the three and nine months ended March 31, 2017, respectively, and $0.3 million and $0.8 million during the three and nine months ended March 31, 2016, respectively. |
• | Interest expense for the combined entities was increased by $0.7 million during the nine months ended March 31, 2017 and by $0.4 million and $1.0 million during the three and nine months ended March 31, 2016, respectively. The increase was attributable to the assumption that the Company's borrowings of $46.0 million used to fund a portion of the net purchase price had been outstanding as of July 1, 2015. This increase was partially offset by the assumption that Houston Interests' former debt was extinguished as of July 1, 2015. |
• | Depreciation and intangible asset amortization expense for the combined entities was reduced by $0.6 million and $0.8 million during the three and nine months ended March 31, 2017, respectively, and was increased by $0.5 million and $1.4 million during the three and nine months ended March 31, 2016, respectively. These adjustments are primarily due to the recognition of amortizable intangible assets as part of the acquisition and the effect of fair value adjustments to acquired property, plant and equipment. |
• | Pro forma earnings were adjusted to include additional income tax expense of $4.3 million during the nine months ended March 31, 2017. Income tax expense was reduced by $0.6 million during the three months ended March 31, 2016 and increased by $1.8 million during the nine months ended March 31, 2016. Houston Interests was previously an exempt entity and income taxes were not assessed in its historical financial information. |
Purchase of Baillie Tank Equipment, Ltd.
On February 1, 2016, the Company completed the acquisition of all outstanding stock of Baillie Tank Equipment, Ltd. (“BTE”), an internationally-based company with nearly 20 years of experience in the design and manufacture of products for use on aboveground storage tanks. Founded in 1998, BTE is a provider of tank products including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems, and seals. BTE is headquartered in Sydney, Australia with a manufacturing facility in Seoul, South Korea. The Company acquired BTE to expand its service offerings of certain technical solutions for aboveground storage tanks. The business is now known as Matrix Applied Technologies, and its operating results are included in the Storage Solutions segment.
The Company purchased BTE with cash on-hand for a net purchase price of $13.0 million. The Company paid $15.4 million when including the subsequent repayment of long-term debt acquired and the settlement of certain other liabilities acquired, and excluding the cash acquired and certain amounts owed to the former owners for working capital adjustments. The net purchase price was allocated to the major categories of assets and liabilities based on their estimated fair value at the acquisition date.
- 13-
The following table summarizes the final purchase price allocation (in thousands):
Current assets | $ | 5,574 | |
Property, plant and equipment | 4,347 | ||
Goodwill | 7,030 | ||
Other intangible assets | 720 | ||
Other assets | 233 | ||
Total assets acquired | 17,904 | ||
Current liabilities | 1,669 | ||
Deferred income taxes | 329 | ||
Long-term debt | 1,858 | ||
Other liabilities | 407 | ||
Net assets acquired | 13,641 | ||
Cash acquired | 592 | ||
Net purchase price | $ | 13,049 |
The goodwill recognized from the acquisition is attributable to the synergies of combining our operations and the technical expertise of the acquired workforce. None of the goodwill recognized is deductible for income tax purposes.
The Company incurred $0.8 million and $0.9 million of expenses related to the acquisition during the three and nine months ended March 31, 2016, which were included within selling, general and administrative expenses in the consolidated statements of income. The acquired business contributed revenues of $3.0 million and $5.8 million during the three and nine months ended March 31, 2017, respectively, and contributed break-even operating income during the three months ended March 31, 2017 and $0.3 million during the nine months ended March 31, 2017. The acquired business contributed revenues of $3.5 million and operating income of $0.7 million for the period February 1, 2016 to March 31, 2016.
Note 3 – Uncompleted Contracts
Contract terms of the Company’s construction contracts generally provide for progress billings based on project milestones. The excess of costs incurred and estimated earnings over amounts billed on uncompleted contracts is reported as a current asset. The excess of amounts billed over costs incurred and estimated earnings recognized on uncompleted contracts is reported as a current liability. Gross and net amounts on uncompleted contracts are as follows:
March 31, 2017 | June 30, 2016 | ||||||
(in thousands) | |||||||
Costs incurred and estimated earnings recognized on uncompleted contracts | $ | 1,266,388 | $ | 1,875,014 | |||
Billings on uncompleted contracts | 1,271,826 | 1,829,340 | |||||
$ | (5,438 | ) | $ | 45,674 | |||
Shown in balance sheet as: | |||||||
Costs and estimated earnings in excess of billings on uncompleted contracts | $ | 69,986 | $ | 104,001 | |||
Billings on uncompleted contracts in excess of costs and estimated earnings | 75,424 | 58,327 | |||||
$ | (5,438 | ) | $ | 45,674 |
Progress billings in accounts receivable at March 31, 2017 and June 30, 2016 included retentions to be collected within one year of $55.0 million and $29.7 million, respectively. Contract retentions collectible beyond one year are included in other assets in the condensed consolidated balance sheet and totaled $0.3 million as of June 30, 2016. There were no retentions collectible beyond one year as of March 31, 2017.
- 14-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Other
Our results were negatively impacted by an increased cost estimate related to a large project in the Electrical Infrastructure segment, which resulted in a decrease in gross profit. The financial impact of the project was a gross profit (loss) of ($18.9) million and ($13.7) million for the three and nine months ended March 31, 2017, respectively. The profit on future revenue related to this project will be recognized based on the current project forecast, which is at a greatly reduced gross profit margin. The change in cost estimate resulted from a deterioration in the financial forecast of the project during the third quarter and was caused by various factors that have delayed schedule progress and reduced productivity. The adjustment in the current period represents the Company’s estimate, based on the information currently available, of the impact of the increased forecasted cost to complete the project. The current forecast includes estimates for the expected outcome regarding reimbursement from the customer of additional costs incurred and expected to be incurred, as well as the receipt of schedule based incentive revenue currently included in the contract.
Work on the project continues to progress; however, critical work remains, which is at risk from continued impacts to project costs and schedule. Therefore, it is possible that future changes in contract estimates, including those related to project costs, project timeline, receipt of schedule based incentive revenue, and the estimated recovery of additional costs, could occur and have a material positive or negative impact to our results of operations and financial position in subsequent accounting periods.
Note 4 – Intangible Assets Including Goodwill
Goodwill
The changes in the carrying value of goodwill by segment are as follows:
Electrical Infrastructure | Oil Gas & Chemical | Storage Solutions | Industrial | Total | |||||||||||||||
(In thousands) | |||||||||||||||||||
Net balance at June 30, 2016 | $ | 42,170 | $ | 14,008 | $ | 16,681 | $ | 5,434 | $ | 78,293 | |||||||||
Purchase of Houston Interests (Note 2) | — | 28,739 | — | 6,309 | 35,048 | ||||||||||||||
Purchase price adjustment for BTE (Note 2) | — | — | 88 | — | 88 | ||||||||||||||
Translation adjustment (1) | (175 | ) | — | (39 | ) | (33 | ) | (247 | ) | ||||||||||
Net balance at March 31, 2017 | $ | 41,995 | $ | 42,747 | $ | 16,730 | $ | 11,710 | $ | 113,182 |
(1) | The translation adjustments relate to the periodic translation of Canadian Dollar and South Korean Won denominated goodwill recorded as a part of prior acquisitions in Canada and South Korea, in which the local currency was determined to be the functional currency. |
The goodwill allocation attributable to the purchase of Houston Interests is preliminary. The Company is currently evaluating the long-term value by segment and the allocation may be adjusted upon completion of the evaluation, which is expected to occur in the fourth fiscal quarter.
The Company performed its annual goodwill impairment test as of May 31, 2016, which did not indicate the existence of an impairment at that time. While the fiscal year-to-date financial performance of our Electrical Infrastructure, Oil Gas & Chemical and Industrial segments are disappointing and have not met our expectations, the Company does not consider these results to be a triggering event requiring the performance of an interim goodwill impairment test. We believe the financial performance of our Oil Gas & Chemical and Industrial segments is attributable to a cyclical, rather than structural, slowdown in the business and the financial performance of our Electrical Infrastructure segment is attributable to issues relating to one major project (as discussed in Note 3 - Uncompleted Contracts). The Company continues to consider these segments as core to its business and believes current operating results are not indicative of future performance. The Company will continue to monitor its operating results for indicators of impairment and perform additional tests as necessary. The Company's fiscal 2017 annual impairment test will be performed as of May 31, 2017, which could result in an impairment to goodwill depending on the Company’s finalized forecast for fiscal 2018 and other market conditions.
- 15-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Other Intangible Assets
Information on the carrying value of other intangible assets is as follows:
At March 31, 2017 | |||||||||||||
Useful Life | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
(Years) | (In thousands) | ||||||||||||
Intellectual property | 9 to 15 | $ | 2,579 | $ | (1,380 | ) | $ | 1,199 | |||||
Customer-based | 1 to 15 | 38,094 | (12,209 | ) | 25,885 | ||||||||
Non-compete agreements | 4 to 5 | 1,453 | (1,245 | ) | 208 | ||||||||
Trade names | 1 to 3 | 1,795 | (1,306 | ) | 489 | ||||||||
Total amortizing intangible assets | $ | 43,921 | $ | (16,140 | ) | $ | 27,781 |
At June 30, 2016 | |||||||||||||
Useful Life | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
(Years) | (In thousands) | ||||||||||||
Intellectual property | 9 to 15 | $ | 2,579 | $ | (1,246 | ) | $ | 1,333 | |||||
Customer-based | 1.5 to 15 | 28,179 | (9,655 | ) | 18,524 | ||||||||
Non-compete agreements | 4 to 5 | 1,453 | (1,102 | ) | 351 | ||||||||
Trade names | 3 to 5 | 1,615 | (824 | ) | 791 | ||||||||
Total amortizing intangible assets | $ | 33,826 | $ | (12,827 | ) | $ | 20,999 |
The increase in the gross carrying amount of other intangible assets at March 31, 2017 compared to June 30, 2016 is primarily due to the December 12, 2016 acquisition of Houston Interests (See Note 2). The specifically identifiable intangible assets recognized in the Houston Interests acquisition consist of:
• | customer-based intangibles with a fair value of $10.0 million and useful life of between 1 and 9 years; and |
• | trade name with a fair value of $0.2 million and useful life of 1 year. |
Amortization expense totaled $1.6 million and $3.4 million during the three and nine months ended March 31, 2017, respectively, and $1.0 million and $2.6 million during the three and nine months ended March 31, 2016, respectively. The Company recognized $0.7 million and $0.9 million of amortization expense during the three and nine months ended March 31, 2017 for intangible assets recorded as part of the Houston Interests acquisition.
We estimate that the remaining amortization expense related to March 31, 2017 amortizing intangible assets will be as follows (in thousands):
Period ending: | |||
Remainder of Fiscal 2017 | $ | 1,543 | |
Fiscal 2018 | 4,728 | ||
Fiscal 2019 | 3,487 | ||
Fiscal 2020 | 3,477 | ||
Fiscal 2021 | 3,459 | ||
Fiscal 2022 | 2,616 | ||
Thereafter | 8,471 | ||
Total estimated remaining amortization expense at March 31, 2017 | $ | 27,781 |
- 16-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 5 – Debt
On February 8, 2017, the Company entered into the Fourth Amended and Restated Credit Agreement (the "Credit Agreement"), by and among the Company and certain foreign subsidiaries, as Borrowers, various subsidiaries of the Company, as Guarantors, JPMorgan Chase Bank, N.A., as Administrative Agent, Sole Lead Arranger and Sole Bookrunner, and the other Lenders party thereto, which replaced the Third Amended and Restated Credit Agreement dated as of November 7, 2011, as previously amended (the "Prior Credit Agreement").
The Credit Agreement provides for a five-year senior secured revolving credit facility of $300.0 million that expires February 8, 2022, which replaces the $250.0 million senior secured revolving credit facility under the Prior Credit Agreement. The new credit facility may be used for working capital, acquisitions, capital expenditures, issuances of letters of credit and other lawful purposes.
The Credit Agreement includes the following covenants and borrowing limitations:
• | A Leverage Ratio, determined as of the end of each fiscal quarter, may not exceed 3.00 to 1.00. |
• | As with the Prior Credit Agreement, we are required to maintain a Fixed Charge Coverage Ratio, determined as of the end of each fiscal quarter, greater than or equal to 1.25 to 1.00. |
• | Asset dispositions (other than dispositions in which all of the net cash proceeds therefrom are reinvested into the Company and dispositions of inventory and obsolete or unneeded equipment in the ordinary course of business) are limited to $20.0 million per 12-month period. |
The new credit facility includes a sub-facility for revolving loans denominated in Australian Dollars, Canadian Dollars, Euros and Pounds Sterling in an aggregate amount not to exceed the U.S. Dollar equivalent of $75.0 million and a $200.0 million sublimit for letters of credit.
Each revolving borrowing under the Credit Agreement will bear interest at a rate per annum equal to:
• | The ABR or the Adjusted LIBO Rate, in the case of revolving loans denominated in U.S. Dollars; |
• | The Canadian Prime Rate or the CDOR rate, in the case of revolving loans denominated in Canadian Dollars; |
• | The Adjusted LIBO Rate, in the case of revolving loans denominated in Pounds Sterling or Australian Dollars; |
• | The EURIBO Rate, in the case of revolving loans denominated in Euros, |
in each case, plus the Applicable Margin, which is based on the Company's Leverage Ratio. The Applicable Margin on ABR loans ranges between 0.625% and 1.625%. The Applicable Margin for Adjusted LIBO, EURIBO and CDOR loans ranges between 1.625% and 2.625% and the Applicable Margin for Canadian Prime Rate loans ranges between 2.125% and 3.125%.
The unused credit facility fee is between 0.25% and 0.45% based on the Leverage Ratio.
The Credit Agreement includes a Senior Leverage Ratio covenant, which provides that Consolidated Funded Indebtedness, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA, as defined in the Credit Agreement, over the previous four quarters. For the four quarters ended March 31, 2017, Consolidated EBITDA was $55.4 million. Consolidated Funded Indebtedness at March 31, 2017 was $51.7 million.
- 17-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Availability under the senior revolving credit facility at March 31, 2017 was as follows:
March 31, 2017 | June 30, 2016 | ||||||
(In thousands) | |||||||
Senior revolving credit facility | $ | 300,000 | $ | 200,000 | |||
Capacity constraint due to the Senior Leverage Ratio | 133,713 | 20,138 | |||||
Capacity under the credit facility | 166,287 | 179,862 | |||||
Borrowings outstanding | 44,139 | — | |||||
Letters of credit | 15,378 | 20,755 | |||||
Availability under the senior revolving credit facility | $ | 106,770 | $ | 159,107 |
Outstanding borrowings at March 31, 2017 under our Credit Agreement were primarily used to fund the acquisition of Houston Interests (See Note 2) and working capital needs in our Canadian business due to the timing of collections and disbursements on the previously announced Electrical Infrastructure project.
At March 31, 2017, the Company was in compliance with all affirmative, negative, and financial covenants under the Credit Agreement.
Note 6 – Income Taxes
We use the asset and liability approach for financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances based on our judgments and estimates are established when necessary to reduce deferred tax assets to the amount expected to be realized in future operating results. Company management believes that realization of deferred tax assets in excess of the valuation allowance is more likely than not. Our estimates are based on facts and circumstances in existence as well as interpretations of existing tax regulations and laws applied to the facts and circumstances.
The Company provides for income taxes regardless of whether it has received a tax assessment. Taxes are provided when it is considered probable that additional taxes will be due in excess of amounts included in the tax return. The Company regularly reviews exposure to additional income taxes due, and as further information is known or events occur, adjustments may be recorded.
Our effective tax rate for the three and nine months ended March 31, 2017 was 38.7% and 933.6%, respectively, compared to 41.4% and 35.6% in the same periods a year earlier. The Company recorded discrete benefits of $0.3 million and $0.9 million during the three and nine months ended March 31, 2017, respectively, and recorded $0.1 million and $1.3 million of discrete benefits during the three and nine months ended March 31, 2016, respectively. The fiscal 2017 discrete benefits primarily relate to the application of ASU 2016-09 (See Note 1), adjustments to state net operating loss carryforwards, a reduction in the blended state income tax rate and an increase in actual tax credits over estimated tax credits for fiscal 2016. These benefits were partially offset by a valuation allowance on deferred tax assets related to foreign tax credit carryforwards and stock compensation expense. The fiscal 2016 tax rate was positively impacted by a discrete item related to the retroactive application of the R&D tax credit and a foreign currency item related to our Canadian operations.
Note 7 – Commitments and Contingencies
Insurance Reserves
The Company maintains insurance coverage for various aspects of its operations. However, exposure to potential losses is retained through the use of deductibles, self-insured retentions and coverage limits.
- 18-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Typically our contracts require us to indemnify our customers for injury, damage or loss arising from the performance of our services and provide 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 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.
Unapproved Change Orders and Claims
Costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders and claims of $18.1 million at March 31, 2017 and $10.3 million at June 30, 2016. Generally, collection of amounts related to unapproved change orders and claims is expected within twelve months. However, since customers may not pay these amounts until final resolution of related claims, collection of these amounts may extend beyond one year.
Other
The Company and its subsidiaries are participants in various legal actions. It is the opinion of management that none of the known legal actions will have a material impact on the Company’s financial position, results of operations or liquidity.
Note 8 – Earnings per Common Share
Basic earnings per share (“Basic EPS”) is calculated based on the weighted average shares outstanding during the period. Diluted earnings per share (“Diluted EPS”) includes the dilutive effect of stock options and nonvested deferred shares.
The computation of basic and diluted earnings per share is as follows:
Three Months Ended | Nine Months Ended | ||||||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | ||||||||||||
(In thousands, except per share data) | |||||||||||||||
Basic EPS: | |||||||||||||||
Net income (loss) attributable to Matrix Service Company | $ | (13,821 | ) | $ | 4,357 | $ | 771 | $ | 19,729 | ||||||
Weighted average shares outstanding | 26,594 | 26,758 | 26,511 | 26,651 | |||||||||||
Basic earnings (loss) per share | $ | (0.52 | ) | $ | 0.16 | $ | 0.03 | $ | 0.74 | ||||||
Diluted EPS: | |||||||||||||||
Weighted average shares outstanding – basic | 26,594 | 26,758 | 26,511 | 26,651 | |||||||||||
Dilutive stock options | — | 57 | 51 | 73 | |||||||||||
Dilutive nonvested deferred shares | — | 239 | 276 | 467 | |||||||||||
Diluted weighted average shares | 26,594 | 27,054 | 26,838 | 27,191 | |||||||||||
Diluted earnings (loss) per share | $ | (0.52 | ) | $ | 0.16 | $ | 0.03 | $ | 0.73 |
The following securities are considered antidilutive and have been excluded from the calculation of Diluted EPS:
Three Months Ended | Nine Months Ended | ||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | ||||||||
(In thousands) | |||||||||||
Stock options | 46 | — | — | — | |||||||
Nonvested deferred shares | 533 | 269 | 173 | 113 |
- 19-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 9 – Segment Information
We operate our business through four reportable segments: Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, and Industrial.
The Electrical Infrastructure segment primarily encompasses construction and maintenance services to a variety of power generation facilities, such as combined cycle plants, natural gas fired power stations, and renewable energy installations. We also provide high voltage services to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, and storm restoration services.
The Oil Gas & Chemical segment includes turnaround activities, plant maintenance, engineering and construction in the downstream and midstream petroleum industries. Our customers in these industries are engaged in refining crude oil and processing, fractionating, and marketing of natural gas and natural gas liquids. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning and vacuum services. We also perform work in the petrochemical and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products aboveground storage tanks (“ASTs”), as well as planned and emergency maintenance services. The Storage Solutions segment also includes balance of plant work in storage terminals and tank farms. Also included in the Storage Solutions segment is work related to specialty storage tanks, including liquefied natural gas (“LNG”), liquid nitrogen/liquid oxygen (“LIN/LOX”), liquid petroleum (“LPG”) tanks and other specialty vessels, including spheres. Finally, we offer AST products, including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems and floating roof seals.
The Industrial segment primarily includes construction and maintenance work in the iron and steel, mining and minerals, and agricultural industries. Our work in the mining and minerals industry is primarily for customers engaged in the extraction of copper. Our work in the agricultural industry includes the engineering and design of grain silos, docks and handling systems; the design of control system automation and materials handling for the food industry; and engineering, construction, process design and balance of plant work for fertilizer production facilities. We also perform work in bulk material handling, thermal vacuum chambers, and other industrial markets.
The Company evaluates performance and allocates resources based on operating income. The accounting policies of the reportable segments are the same as those described in the Summary of Significant Accounting Policies footnote included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2016. Intersegment sales and transfers are recorded at cost; therefore, no intersegment profit or loss is recognized.
Segment assets consist primarily of cash and cash equivalents, accounts receivable, costs and estimated earnings in excess of billings on uncompleted contracts, property, plant and equipment, goodwill and other intangible assets.
- 20-
Matrix Service Company
Notes to Condensed Consolidated Financial Statements
(unaudited)
Results of Operations
(In thousands)
Three Months Ended | Nine Months Ended | ||||||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | ||||||||||||
Gross revenues | |||||||||||||||
Electrical Infrastructure | $ | 82,032 | $ | 94,414 | $ | 273,215 | $ | 251,437 | |||||||
Oil Gas & Chemical | 69,295 | 56,251 | 164,036 | 188,682 | |||||||||||
Storage Solutions | 74,431 | 132,857 | 403,008 | 400,074 | |||||||||||
Industrial | 26,501 | 26,650 | 74,254 | 116,375 | |||||||||||
Total gross revenues | $ | 252,259 | $ | 310,172 | $ | 914,513 | $ | 956,568 | |||||||
Less: Inter-segment revenues | |||||||||||||||
Oil Gas & Chemical | $ | 407 | $ | 522 | $ | 6,892 | $ | 3,102 | |||||||
Storage Solutions | 379 | 228 | 677 | 1,040 | |||||||||||
Industrial | 236 | — | 1,271 | 144 | |||||||||||
Total inter-segment revenues | $ | 1,022 | $ | 750 | $ | 8,840 | $ | 4,286 | |||||||
Consolidated revenues | |||||||||||||||
Electrical Infrastructure | $ | 82,032 | $ | 94,414 | $ | 273,215 | $ | 251,437 | |||||||
Oil Gas & Chemical | 68,888 | 55,729 | 157,144 | 185,580 | |||||||||||
Storage Solutions | 74,052 | 132,629 | 402,331 | 399,034 | |||||||||||
Industrial | 26,265 | 26,650 | 72,983 | 116,231 | |||||||||||
Total consolidated revenues | $ | 251,237 | $ | 309,422 | $ | 905,673 | $ | 952,282 | |||||||
Gross profit (loss) | |||||||||||||||
Electrical Infrastructure | $ | (13,371 | ) | $ | 10,407 | $ | (896 | ) | $ | 19,136 | |||||
Oil Gas & Chemical | 4,333 | 2,616 | 6,765 | 14,270 | |||||||||||
Storage Solutions | 5,456 | 15,108 | 48,980 | 49,766 | |||||||||||
Industrial | 968 | (828 | ) | 3,027 | 8,720 | ||||||||||
Total gross profit (loss) | $ | (2,614 | ) | $ | 27,303 | $ | 57,876 | $ | 91,892 | ||||||
Operating income (loss) | |||||||||||||||
Electrical Infrastructure | $ | (16,306 | ) | $ | 4,948 | $ | (13,085 | ) | $ | 5,425 | |||||
Oil Gas & Chemical | (2,199 | ) | (1,964 | ) | (7,054 | ) | (3,577 | ) | |||||||
Storage Solutions | (1,552 | ) | 6,382 | 23,463 | 24,305 | ||||||||||
Industrial | (1,153 | ) | (3,019 | ) | (1,996 | ) | 230 | ||||||||
Total operating income (loss) | $ | (21,210 | ) | $ | 6,347 | $ | 1,328 | $ | 26,383 |
Total assets by segment were as follows:
March 31, 2017 | June 30, 2016 | |||||||
Electrical Infrastructure | $ | 167,280 | $ | 135,298 | ||||
Oil Gas & Chemical | 142,551 | 91,350 | ||||||
Storage Solutions | 169,829 | 201,875 | ||||||
Industrial | 45,623 | 67,569 | ||||||
Unallocated assets | 54,985 | 68,875 | ||||||
Total segment assets | $ | 580,268 | $ | 564,967 |
- 21-
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CRITICAL ACCOUNTING ESTIMATES
There have been no material changes in our critical accounting policies from those reported in our fiscal 2016 Annual Report on Form 10-K filed with the SEC. For more information on our critical accounting policies, see Part II, Item 7 of our fiscal 2016 Annual Report on Form 10-K. The following section provides certain information with respect to our critical accounting estimates as of the close of our most recent quarterly period.
Revenue Recognition
Under percentage of completion accounting for fixed-priced contracts, contract revenues and earnings are recognized ratably over the contract term based on the proportion of actual costs incurred to total estimated costs. Our results were negatively impacted by an increased cost estimate related to a large project in the Electrical Infrastructure segment, which resulted in a decrease in gross profit. The financial impact of the project was a gross profit (loss) of ($18.9) million and ($13.7) million for the three and nine months ended March 31, 2017, respectively. The profit on future revenue related to this project will be recognized based on the current project forecast, which is at a greatly reduced gross profit margin. The change in cost estimate resulted from a deterioration in the financial forecast of the project during the third quarter and was caused by various factors that have delayed schedule progress and reduced productivity. The adjustment in the current period represents the Company’s estimate, based on the information currently available, of the impact of the increased forecasted cost to complete the project. The current forecast includes estimates for the expected outcome regarding reimbursement from the customer of additional costs incurred and expected to be incurred, as well as the receipt of schedule based incentive revenue currently included in the contract.
Work on the project continues to progress; however, critical work remains, which is at risk from continued impacts to project costs and schedule. Therefore, it is possible that future changes in contract estimates, including those related to project costs, project timeline, receipt of schedule based incentive revenue, and the estimated recovery of additional costs, could occur and have a material positive or negative impact to our results of operations and financial position in subsequent accounting periods.
Goodwill
We performed our annual impairment test in the fourth quarter of fiscal 2016 to determine whether an impairment existed and to determine the amount of headroom. We define "headroom" as the percentage difference between the fair value of a reporting unit and its carrying value. The amount of headroom varies by reporting unit. Approximately 54% of our goodwill balance at May 31, 2016 was attributable to one reporting unit. This unit had headroom of 158%. The remaining goodwill was attributable to six reporting units, with headroom of between 17% and 488%. Our significant assumptions, including revenue growth rates, gross margins, discount rate, interest expense and other factors may change in light of changes in the economic and competitive environment in which we operate.
The Company performed its annual goodwill impairment test as of May 31, 2016, which did not indicate the existence of an impairment at that time. While the fiscal year-to-date financial performance of our Electrical Infrastructure, Oil Gas & Chemical and Industrial segments are disappointing and have not met our expectations, the Company does not consider these results to be a triggering event requiring the performance of an interim goodwill impairment test. We believe the financial performance of our Oil Gas & Chemical and Industrial segments is attributable to a cyclical, rather than structural, slowdown in the business and the financial performance of our Electrical Infrastructure segment is attributable to issues relating to one major project (as discussed in Note 3 - Uncompleted Contracts). The Company continues to consider these segments as core to its business and believes current operating results are not indicative of future performance. The Company will continue to monitor its operating results for indicators of impairment and perform additional tests as necessary. The Company's fiscal 2017 annual impairment test will be performed as of May 31, 2017, which could result in an impairment to goodwill depending on the Company’s finalized forecast for fiscal 2018 and other market conditions.
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. The Company evaluates intangible assets with finite lives for impairment whenever events or circumstances indicate that the carrying value may not be recoverable. The Company did not observe any events or circumstances during the three months ended March 31, 2017 that would indicate that the carrying value of its intangible assets may not be recoverable. The Company's evaluation included values assigned to customer relationships in the iron and steel industry that, while improving, is still experiencing short to medium term weakness. If the Company's view of this market adversely changes or if other factors develop which change our view of the value of these relationships, the Company will reevaluate this conclusion.
- 22-
Unapproved Change Orders and Claims
Costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders and claims of $18.1 million at March 31, 2017 and $10.3 million at June 30, 2016. The amounts ultimately realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings.
Insurance Reserves
We maintain insurance coverage for various aspects of our operations. However, we retain exposure to potential losses through the use of deductibles, self-insured retentions and coverage limits. We establish reserves for claims using a combination of actuarially determined estimates and management judgments on a case-by-case basis and update our evaluations as further information becomes known. Judgments and assumptions, including the assumed losses for claims incurred but not reported, are inherent in our reserve accruals; as a result, changes in assumptions or claims experience could result in changes to these estimates in the future. If actual results of claim settlements are different than the amounts estimated, we may be exposed to gains and losses that could be significant.
Recently Issued Accounting Standards
Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606)
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The ASU also requires entities to disclose both quantitative and qualitative information that enables users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU's disclosure requirements are significantly more comprehensive than those in existing revenue standards. The ASU applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC"). The ASU is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Early adoption is permitted on a limited basis.
Management is currently evaluating the impact of adopting the ASU on the Company's financial position, results of operations, cash flows and related disclosures. Adoption of this ASU is expected to affect the manner in which the Company determines the unit of account for its projects (i.e., performance obligations). Under existing guidance, the Company typically has multiple units of account for large complex projects. Upon adoption, the Company expects that similar projects may have fewer units of account, possibly just one unit of account in some cases, which will result in a more constant recognition of revenue and profit over the term of the project. The Company will adopt this standard on July 1, 2018 using the modified retrospective method of application, which may result in a cumulative effect adjustment to retained earnings as of the date of adoption.
Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
On August 27, 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements. Further, an entity must provide certain disclosures if there is “substantial doubt about the entity’s ability to continue as a going concern.” The FASB believes that requiring management to perform the assessment will enhance the timeliness, clarity, and consistency of related disclosures and improve convergence with international financial reporting standards ("IFRS") (which emphasize management’s responsibility for performing the going-concern assessment). However, the time horizon for the assessment (look-forward period) and the disclosure thresholds under U.S. GAAP and IFRS will continue to differ. The ASU is effective for annual periods ending after December 15, 2016, and interim periods thereafter; early adoption is permitted.
- 23-
The ASU was adopted during the Company's first fiscal quarter ending September 30, 2016. In connection with the adoption of the ASU, the Company now performs an assessment of its ability to continue as a going concern on a quarterly basis. Disclosure regarding the status of the Company's ability to continue as a going concern is required when there are conditions or events that raise substantial doubt about its ability to continue as a going concern within one year after the date that the financial statements are issued.
Accounting Standards Update 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
On September 25, 2015, the FASB issued ASU 2015-16 to simplify the accounting for measurement-period adjustments. The ASU was issued in response to stakeholder feedback that restatements of prior periods to reflect adjustments made to provisional amounts recognized in a business combination increase the cost and complexity of financial reporting but do not significantly improve the usefulness of the information. Under the ASU, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU also requires acquirers to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. We adopted this standard on July 1, 2016 with no material impact to the Company's financial statements.
Accounting Standards Update 2016-02, Leases (Topic 842)
On February 25, 2016, the FASB issued ASU 2016-02. The amendments in this update require, among other things, that lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, but we do not plan to do so at this time.
We are currently evaluating the ASU's expected impact on our financial statements. Note 8 of Item 8. Financial Statements and Supplementary Data in our 2016 Form 10-K provides information about the timing and amount of future operating lease payments, which we believe is indicative of the materiality of adoption of the ASU to our financial statements.
Accounting Standards Update 2016-09, Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
On March 30, 2016, the FASB issued ASU 2016-09, which simplified several aspects of accounting for stock-based compensation transactions, including the accounting for income taxes and forfeitures and statutory tax withholding requirements. The Company adopted the ASU during its first fiscal quarter ending September 30, 2016. The following is a description of the key provisions of the ASU and their impacts to the Company's financial statements:
Accounting for Income Taxes: The amendments require the Company to recognize excess tax benefits or tax deficiencies in its provision for income taxes in its consolidated statements of income during the period of vesting or exercise of its nonvested deferred share awards and stock options, respectively, for which it expects to receive an income tax deduction. Previously, the Company recognized any excess tax benefits in additional paid-in capital ("APIC") in the balance sheet and any tax deficiencies were recognized as a reduction of APIC to the extent the Company has accumulated excess tax benefits. Any tax deficiencies in excess of accumulated excess tax benefits in APIC were recognized in the provision for income taxes. The amendments also require the Company to only present excess tax benefits and tax deficiencies in the operating section of its statements of cash flows as a component of deferred tax activity. Previously, the Company was required to present such items in both the financing section and operating section of its statements of cash flows. Amendments related to the recognition of excess tax benefits and tax deficiencies in income are required to be applied prospectively, and amendments related to the cash flow statement presentation of excess tax benefits and tax deficiencies may be applied either retrospectively or prospectively.
- 24-
The Company applied the amendments requiring the recognition of excess tax benefits and tax deficiencies in income prospectively. As a result, the Company recognized $0.5 million of excess tax benefits in its provision for income taxes during the nine months ended March 31, 2017, which increased basic and diluted earnings per share by $0.02. No material excess tax benefits or deficiencies were recognized during the three months ended March 31, 2017. Under the prior accounting standard, the Company would have recognized the excess tax benefits in equity as additional paid-in capital. The amendments relating to the presentation of excess tax benefits and tax deficiencies in the statement of cash flows were applied retrospectively. The effect of the retrospective adjustment was to eliminate the presentation of an operating cash outflow and a financing cash inflow for excess tax benefits on exercised stock options and vesting of deferred shares. These eliminations increased net cash provided by operating activities by $3.2 million and decreased net cash provided by financing activities by $3.2 million for the nine months ended March 31, 2016. Net cash flows did not change as a result of the retrospective adjustment.
Accounting for Forfeitures: The amendments in this ASU allow the Company to elect, as a company-wide accounting policy, either to continue to estimate the amount of forfeitures to exclude from compensation expense or to exclude forfeitures from compensation expense as they occur. Upon the adoption of the ASU during the first quarter of fiscal 2017, the Company elected to account for forfeitures as they occur. The Company is required to apply these amendments on a modified retrospective basis with a cumulative adjustment to retained earnings as of the beginning of the fiscal year. The Company recorded a modified retrospective adjustment to reduce the June 30, 2016 retained earnings balance and increase the additional paid-in capital balance by $0.1 million each.
Statutory Tax Withholding Requirements: Under the prior accounting standard, an entire award must be classified as a liability if the fair value of the shares withheld exceeds the Company's minimum statutory withholding obligation. Under the ASU, the Company is allowed to withhold shares with a fair value up to the amount of tax owed using the maximum statutory tax rate in the employee's applicable jurisdictions. The Company is allowed to determine one maximum rate for all employees in each jurisdiction, rather than a rate for each employee in the jurisdiction. Also, the ASU requires that cash outflows to reacquire shares withheld for taxes to be classified in the financing section of the statement of cash flows.
The Company adopted the ASU during the first quarter of fiscal 2017. Since the Company did not have any awards classified as liabilities due to statutory tax withholding requirements as of December 31, 2016, and since the Company already presented its cash outflows for reacquiring shares withheld for taxes as a financing activity in its statements of cash flows, these amendments did not have any impact on its financial statements upon adoption. The Company does not expect changes to employee withholdings for stock compensation to have a material impact to the financial statements.
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
On June 16, 2016, the FASB issued ASU 2016-13, which will change how the Company accounts for its allowance for uncollectible accounts. The amendments in this update require a financial asset (or a group of financial assets) to be presented at the net amount expected to be collected. The income statement will reflect any increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount.
Current GAAP delays the recognition of the full amount of credit losses until the loss is probable of occurring. The amendments in this update eliminate the probable initial recognition threshold and, instead, reflect the Company's current estimate of all expected credit losses. In addition, current guidance limits the information the Company may consider in measuring a credit loss to its past events and current conditions. The amendments in this update broaden the information the Company may consider in developing its expected credit loss estimate to include forecasted information.
The amendments in this update are effective for the Company on July 1, 2020 and the Company may early adopt on July 1, 2019. The Company must apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. At this time, the Company does not expect this update to have a material impact to its estimate of the allowance for uncollectible accounts.
- 25-
Accounting Standards Update 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
On January 26, 2017, the FASB issued ASU 2017-04, which simplifies the goodwill impairment test by eliminating step two from the procedure. Previously, goodwill was tested for impairment by performing a two-step test. The first step involves determining the fair value of a reporting unit and comparing it to the carrying amount of the reporting unit's net assets. If the fair value of the reporting unit is less than its carrying amount, then the goodwill assigned to that reporting unit is determined to be impaired and step two must then be completed to measure the amount of the impairment. Step two involved measuring the reporting unit's assets and liabilities at fair value following a process similar to determining the fair value of assets acquired and liabilities assumed in a business combination. The net fair value of the assets acquired and liabilities assumed was then compared to the fair value of the reporting unit in order to compute the implied goodwill for the reporting unit. The difference between the carrying amount of the reporting unit's goodwill and the amount of the implied goodwill computed was the amount of the goodwill impairment to be recognized. Under ASU 2017-04, instead of performing step two of the test, the Company will recognize an impairment charge to the extent a reporting unit's fair value is less than the carrying amount of its net assets, as indicated by step one of the test.
The standard must be applied prospectively and must by adopted in fiscal years beginning after December 15, 2019. Early adoption is permitted and the Company is currently evaluating whether to adopt early. The Company's annual goodwill impairment test will be performed as of May 31, 2017.
RESULTS OF OPERATIONS
Overview
We operate our business through four reportable segments: Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, and Industrial.
The Electrical Infrastructure segment primarily encompasses construction and maintenance services to a variety of power generation facilities, such as combined cycle plants, natural gas fired power stations, and renewable energy installations. We also provide high voltage services to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, and storm restoration services.
The Oil Gas & Chemical segment includes turnaround activities, plant maintenance, engineering and construction in the downstream and midstream petroleum industries. Our customers in these industries are engaged in refining crude oil and processing, fractionating, and marketing of natural gas and natural gas liquids. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning and vacuum services. We also perform work in the petrochemical and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products aboveground storage tanks (“ASTs”), as well as planned and emergency maintenance services. The Storage Solutions segment also includes balance of plant work in storage terminals and tank farms. Also included in the Storage Solutions segment is work related to specialty storage tanks, including liquefied natural gas (“LNG”), liquid nitrogen/liquid oxygen (“LIN/LOX”), liquid petroleum (“LPG”) tanks and other specialty vessels, including spheres. Finally, we offer AST products, including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems and floating roof seals.
The Industrial segment primarily includes construction and maintenance work in the iron and steel, mining and minerals, and agricultural industries. Our work in the mining and minerals industry is primarily for customers engaged in the extraction of copper. Our work in the agricultural industry includes the engineering and design of grain silos, docks and handling systems; the design of control system automation and materials handling for the food industry; and engineering, construction, process design and balance of plant work for fertilizer production facilities. We also perform work in bulk material handling, thermal vacuum chambers, and other industrial markets.
Three Months Ended March 31, 2017 Compared to the Three Months Ended March 31, 2016
Consolidated
Consolidated revenue was $251.2 million for the three months ended March 31, 2017, compared to $309.4 million in the same period in the prior fiscal year. On a segment basis, consolidated revenue decreased in the Storage Solutions, Electrical Infrastructure and Industrial segments by $58.5 million, $12.4 million and $0.4 million, respectively. These decreases were partially offset by an increase in the Oil Gas & Chemical segment of $13.2 million.
- 26-
Consolidated gross profit (loss) decreased from $27.3 million in the three months ended March 31, 2016 to $(2.6) million in the three months ended March 31, 2017. Gross margin decreased to (1.0)% in the three months ended March 31, 2017 compared to 8.8% in the same period in the prior fiscal year. The reduction in gross margin in fiscal 2017 is primarily attributable to the financial impact of an Electrical Infrastructure project, which decreased gross profit by $18.9 million (more fully discussed in Item 1. Financial Statements, Note 3 - Uncompleted Contracts) and lower volumes, which led to increased under recovery of construction overhead costs.
Consolidated SG&A expenses were $18.6 million in the three months ended March 31, 2017 compared to $21.0 million in the same period a year earlier. The decrease in fiscal 2017 was primarily attributable to the reversal of incentive compensation expense. Fiscal 2017 SG&A expense included $0.4 million of acquisition and integration costs from the Houston Interests, LLC ("Houston Interests") acquisition (See Item 1. Financial Statements, Note 2 - Acquisitions) and fiscal 2016 SG&A expense included $0.8 million of acquisition and integration costs from the Baillie Tank Equipment acquisition (See Item 1. Financial Statements, Note 2 - Acquisitions).
Net interest expense was $0.8 million and $0.2 million in the three months ended March 31, 2017 and 2016, respectively. The higher interest expense in fiscal 2017 is primarily attributable to the higher average debt balance in the current year, which is largely attributable to the borrowings used to fund the Houston Interests acquisition.
Our effective tax rate for the three months ended March 31, 2017 was 38.7% and 41.4% in the same period a year earlier. The fiscal 2017 tax rate was positively impacted by discrete benefits of $0.3 million primarily related to adjustments to state net operating loss carryforwards, a reduction in the blended state income tax rate and an increase in actual tax credits over estimated tax credits for fiscal 2016. These benefits were offset by a valuation allowance on deferred tax assets related to foreign tax credit carryforwards and stock compensation expense. The fiscal 2016 tax rate was positively impacted by a discrete benefits of $0.1 million related to the retroactive application of the R&D tax credit and a foreign currency item related to our Canadian operations.
For the three months ended March 31, 2017, net loss attributable to Matrix Service Company and the related fully diluted loss per share were $13.8 million and $0.52, respectively, compared to net income attributable to Matrix Service Company and related fully diluted earnings per share of $4.4 million and $0.16, respectively, in the same period a year earlier.
Electrical Infrastructure
Revenue for the Electrical Infrastructure segment decreased $12.4 million to $82.0 million in the three months ended March 31, 2017 compared to $94.4 million in the same period a year earlier. The decrease is due to lower transmission and distribution and power generation revenue. The gross margin of (16.3)% in fiscal 2017 was primarily attributable to the financial impact of the project mentioned in the consolidated discussion above, which decreased gross profit by $18.9 million (more fully discussed in Item 1. Financial Statements, Note 3 - Uncompleted Contracts). The fiscal 2016 gross margin was 11.0% during the same period.
Oil Gas & Chemical
Revenue for the Oil Gas & Chemical segment was $68.9 million in the three months ended March 31, 2017 compared to $55.7 million in the same period a year earlier. The increase of $13.2 million is primarily attributable to incremental revenues associated with the Houston Interests acquisition (See Item 1. Financial Statements, Note 2 - Acquisitions) and higher capital work, partially offset by lower turnaround and maintenance volumes. The gross margin was 6.3% for the three months ended March 31, 2017 compared to 4.7% in the same period last year. The gross margin for fiscal 2017 was positively impacted by the mix of higher margin work associated with the Houston Interests acquisition.
Storage Solutions
Revenue for the Storage Solutions segment was $74.1 million in the three months ended March 31, 2017 compared to $132.6 million in the same period a year earlier, a decrease of $58.5 million. The decrease is primarily attributable to decreased activity on the previously announced project for the construction of crude gathering terminals that support the Dakota Access pipeline compared to this same period a year ago, as well as lower volumes across the rest of our domestic storage business. The gross margin was 7.4% in the three months ended March 31, 2017 and 11.4% in the three months ended March 31, 2016. The lower gross margin in fiscal 2017 is primarily attributable to lower volumes, which led to increased under recovery of construction overhead costs. Work on the terminals that support the Dakota Access Pipeline is expected to be completed in fiscal 2017 and revenue will continue to decline on this project as it nears completion.
- 27-
Industrial
Revenue for the Industrial segment decreased $0.4 million to $26.3 million in the three months ended March 31, 2017 compared to $26.7 million in the same period a year earlier. The decline in revenue is primarily attributable to lower business volumes in iron and steel and material handling, largely offset by work on a thermal vacuum chamber and increased revenues associated with the Houston Interests acquisition. The gross margin was 3.7% in the three months ended March 31, 2017 compared to (3.1)% in the same period a year earlier. The fiscal 2017 gross margin was positively impacted by the mix of higher margin work associated with the Houston Interests acquisition. Fiscal 2016 gross margins were negatively impacted by an unfavorable customer settlement and lower margins on iron and steel work due to lower volume.
Nine Months Ended March 31, 2017 Compared to the Nine Months Ended March 31, 2016
Consolidated
Consolidated revenue was $905.7 million for the nine months ended March 31, 2017, compared to $952.3 million in the same period in the prior fiscal year. On a segment basis, consolidated revenue decreased in the Industrial and Oil Gas & Chemical segments by $43.2 million and $28.5 million, respectively. These decreases were partially offset by increases in revenue in the Electrical Infrastructure and Storage Solutions segments by $21.8 million and $3.3 million, respectively.
Consolidated gross profit decreased from $91.9 million in the nine months ended March 31, 2016 to $57.9 million in the nine months ended March 31, 2017. Gross margin decreased to 6.4% in the nine months ended March 31, 2017 compared to 9.6% in the same period in the prior fiscal year. The reduction in gross margin in fiscal 2017 is primarily attributable to the financial impact of an Electrical Infrastructure project, which decreased gross profit by $13.7 million (more fully discussed in Item 1. Financial Statements, Note 3 - Uncompleted Contracts) and lower volumes, which led to increased under recovery of construction overhead costs.
Consolidated SG&A expenses were $56.5 million in the nine months ended March 31, 2017 compared to $65.5 million in the same period a year earlier. The decrease in SG&A expense in fiscal 2017 was primarily attributable to a bad debt charge of $5.2 million from a client bankruptcy in fiscal 2016 and to the reversal of incentive compensation expense. Fiscal 2017 SG&A expense included $1.2 million of acquisition and integration costs from the Houston Interests acquisition (See Item 1. Financial Statements, Note 2 - Acquisitions) and fiscal 2016 SG&A expense included $0.9 million of acquisition and integration costs from the Baillie Tank Equipment acquisition (See Item 1. Financial Statements, Note 2 - Acquisitions).
Net interest expense was $1.5 million and $0.6 million in the nine months ended March 31, 2017 and 2016, respectively. The higher interest expense in fiscal 2017 is primarily attributable to the higher average debt balance in the current year, which is largely attributable to the borrowings used to fund the Houston Interests acquisition.
Our effective tax rate for the nine months ended March 31, 2017 was 933.6% and 35.6% in the same period a year earlier. The fiscal 2017 tax rate was positively impacted by discrete benefits of $0.9 million primarily related to the application of ASU 2016-09 (See Item 1. Financial Statements, Note 1 - Basis of Presentation and Accounting Policies), adjustments to state net operating loss carryforwards, a reduction in the blended state income tax rate and an increase in actual tax credits over estimated tax credits for fiscal 2016. These benefits were offset by a valuation allowance on deferred tax assets related to foreign tax credit carryforwards and stock compensation expense. The fiscal 2016 tax rate was positively impacted by discrete benefits of $1.3 million related to the retroactive application of the R&D tax credit and a foreign currency item related to our Canadian operations.
For the nine months ended March 31, 2017, net income attributable to Matrix Service Company and the related fully diluted earnings per share were $0.8 million and $0.03 compared to $19.7 million and $0.73 in the same period a year earlier.
Electrical Infrastructure
Revenue for the Electrical Infrastructure segment increased $21.8 million to $273.2 million in the nine months ended March 31, 2017 compared to $251.4 million in the same period a year earlier primarily as a result of higher volumes on a significant power generation project, partially offset by lower volumes in transmission and distribution work. The fiscal 2017 gross margin was (0.3)% compared to 7.6% in the same period last year. The lower fiscal 2017 gross margin was primarily attributable to the financial impact of the project mentioned in the consolidated discussion above, which decreased gross profit by $13.7 million (more fully discussed in Item 1. Financial Statements, Note 3 - Uncompleted Contracts). Fiscal 2016 gross margin was negatively impacted by $7.1 million of charges in connection with an acquired EPC joint venture project.
- 28-
Oil Gas & Chemical
Revenue for the Oil Gas & Chemical segment was $157.1 million in the nine months ended March 31, 2017 compared to $185.6 million in the same period a year earlier. The decrease of $28.5 million is related to lower volume across the business as refiners continue to limit spending as the result of continued volatility in commodity prices and market uncertainty, partially offset by incremental revenues associated with the Houston Interests acquisition in December 2016 (See Item 1. Financial Statements, Note 2 - Acquisitions). The gross margin was 4.3% for the nine months ended March 31, 2017 compared to 7.7% in the same period last year. The gross margin for fiscal 2017 was affected by lower volume, which led to increased under recovery of overhead costs, and project execution.
Storage Solutions
Revenue for the Storage Solutions segment was $402.3 million in the nine months ended March 31, 2017 compared to $399.0 million in the same period a year earlier, an increase of $3.3 million. The increase is primarily attributable to increased activity during the first half of Fiscal 2017 on a previously announced project for the construction of crude gathering terminals that support the Dakota Access pipeline and higher Canadian volumes. These increases were partially offset by lower volumes in our remaining domestic storage business. The gross margin was 12.2% in the nine months ended March 31, 2017 and 12.5% in the nine months ended March 31, 2016 as a result of effective project execution in both periods. Work on the terminals that support the Dakota Access Pipeline is expected to be completed in fiscal 2017 and revenue will continue to decline on this project as it nears completion.
Industrial
Revenue for the Industrial segment decreased $43.2 million to $73.0 million in the nine months ended March 31, 2017 compared to $116.2 million in the same period a year earlier. The decline in revenue is primarily attributable to lower business volumes in the iron and steel and mining markets, and lower revenue recognized on a large fertilizer project. The gross margin was 4.1% in the nine months ended March 31, 2017 compared to 7.5% in the same period a year earlier. The fiscal 2017 gross margin was negatively impacted by the under recovery of construction overhead costs due to reduced volume and a higher percentage of lower margin iron and steel work. The fiscal 2016 gross margin was positively impacted by the mix of work and strong project execution.
Backlog
We define backlog as the total dollar amount of revenue that we expect to recognize as a result of performing work that has been awarded to us through a signed contract, notice to proceed or other type of assurance that we consider firm. The following arrangements are considered firm:
• | fixed-price awards; |
• | minimum customer commitments on cost plus arrangements; and |
• | certain time and material arrangements in which the estimated value is firm or can be estimated with a reasonable amount of certainty in both timing and amounts. |
For long-term maintenance contracts and other established customer arrangements, 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 revenue recognized as of the reporting date.
The following table provides a summary of changes in our backlog for the three months ended March 31, 2017:
Electrical Infrastructure | Oil Gas & Chemical | Storage Solutions | Industrial | Total | |||||||||||||||
(In thousands) | |||||||||||||||||||
Backlog as of December 31, 2016 | $ | 338,413 | $ | 209,505 | $ | 185,491 | $ | 80,581 | $ | 813,990 | |||||||||
Project awards | 57,630 | 100,459 | 52,981 | 16,592 | 227,662 | ||||||||||||||
Revenue recognized | (82,032 | ) | (68,888 | ) | (74,052 | ) | (26,265 | ) | (251,237 | ) | |||||||||
Backlog as of March 31, 2017 | $ | 314,011 | $ | 241,076 | $ | 164,420 | $ | 70,908 | $ | 790,415 |
- 29-
The following table provides a summary of changes in our backlog for the nine months ended March 31, 2017:
Electrical Infrastructure | Oil Gas & Chemical | Storage Solutions | Industrial | Total | |||||||||||||||
(In thousands) | |||||||||||||||||||
Backlog as of June 30, 2016 | $ | 369,791 | $ | 91,478 | $ | 359,013 | $ | 48,390 | $ | 868,672 | |||||||||
Project awards | 217,435 | 280,240 | 207,738 | 92,306 | 797,719 | ||||||||||||||
Acquired backlog from Houston Interests (Note 2) | — | 26,502 | — | 3,195 | 29,697 | ||||||||||||||
Revenue recognized | (273,215 | ) | (157,144 | ) | (402,331 | ) | (72,983 | ) | (905,673 | ) | |||||||||
Backlog as of March 31, 2017 | $ | 314,011 | $ | 241,076 | $ | 164,420 | $ | 70,908 | $ | 790,415 |
Project awards in all segments are cyclical and are typically the result of a sales process that can take several months to complete. Backlog in the Storage Solutions and Electrical Infrastructure segments generally have the greatest volatility because individual project awards can be less frequent and more significant.
The change in backlog in the Electrical Infrastructure segment during the nine months ended March 31, 2017 is mainly attributable to the work related to the previously announced Napanee Power Generating Station project partially offset by transmission and distribution awards, which continue to meet the Company's expectations and the award for the electrical balance of plant work for PSEG Power's new 540-megawatt combined cycle power facility in New Jersey.
The increase in backlog in the Oil, Gas & Chemical segment during the nine months ended March 31, 2017 is mainly attributable to backlog acquired from Houston Interests and increased project awards such as the previously announced Ultra-Low Gasoline Project awarded by KBR, Inc., and the previously announced award for the engineering, project management, procurement and commissioning of a 200 million cubic foot per day cryogenic gas recovery plant located in the SCOOP play of Southern Oklahoma's Woodford Shale and Springer Shale formations.
The decline in backlog in the Storage Solutions segment during the nine months ended March 31, 2017 is attributable to the work related to the previously announced project for the construction of terminals supporting the Dakota Access Pipeline partially offset by storage solutions awards, including the previously announced EPC award to construct 10 new tanks at the Vopak Americas Brownfield Expansion Project at the Deer Park, TX terminal. In addition, we continue to see a more cautious approach to decision-making on the part of clients and prolonged market uncertainty, which is delaying the timing of awards.
The increase in backlog in the Industrial segment during the nine months ended March 31, 2017 is primarily attributable to increased project awards, including an award for a thermal vacuum chamber project during the second quarter.
Seasonality and Other Factors
Our operating results can exhibit seasonal fluctuations, especially in our Oil Gas & Chemical segment, for a variety of reasons. Turnarounds and planned outages at customer facilities are typically scheduled in the spring and the fall when the demand for energy is lower. Within the Electrical Infrastructure segment, transmission and distribution work is generally scheduled by the public utilities when the demand for electricity is at its lowest. Therefore, revenue volume in the summer months is typically lower than in other periods throughout the year. Also, we typically see a lower level of operating activity relating to construction projects during the winter months and early in the calendar year because many of our customers’ capital budgets have not been finalized. Our business can also be affected, both positively and negatively, by seasonal factors such as energy demand or weather conditions including hurricanes, snowstorms, and abnormally low or high temperatures. Some of these seasonal factors may cause some of our offices and projects to close or reduce activities temporarily. In addition to the above noted factors, the general timing of project starts and completions could exhibit significant fluctuations. Accordingly, results for any interim period may not necessarily be indicative of operating results for the full year.
Other factors impacting operating results in all segments come from work site permitting delays or customers accelerating or postponing work. The differing types, sizes, and durations of our contracts, combined with their geographic diversity and stages of completion, often results in fluctuations in the Company's operating results.
Impact of Commodity Price Volatility and Market Uncertainty
The prolonged decline in crude prices continues to impact our income from operations and project awards, particularly in the Oil Gas & Chemical and Storage Solutions segments. The Industrial segment continues to be negatively impacted by the low prices of other commodities, principally steel and copper. The decline in commodity prices has not had, and we do not expect a significant impact on the Electrical Infrastructure segment.
- 30-
Our Oil Gas & Chemical segment continues to see lower volumes of routine maintenance and turnaround work as well as award delays caused by slower than expected improvements in commodity pricing and regulatory uncertainties. If commodity prices remain at current levels or the current uncertainty continues, spending levels may continue to be reduced.
In our Storage Solutions segment, our customers continue to take a long-term view of the market, but continue to be cautious short-term. Based on current market conditions, we are seeing a continued reduction in customer spending and project award delays. Although we are seeing signs of market improvement, we cannot predict the direction of commodity prices or our customers’ ultimate reaction to the market and therefore cannot predict the magnitude of the impact to our future earnings.
In the Industrial segment, our iron and steel customers are facing challenges related to the import of cheaper foreign steel, global steel production over-capacity and the strong United States Dollar, which continues to be a headwind for steel exports. These conditions have reduced steel mill utilization in the U.S., which has reduced the capital, expansion and elective maintenance spending of our customers. Although we are seeing some encouraging political developments with respect to U.S. trade, we do not expect higher levels of spending until the factors that led to lower steel mill utilization are relieved. In the mining and minerals markets, we continue to see lower spending due to the softness of other commodity prices. However, copper prices, to which our clients are particularly exposed, have increased in recent months.
Non-GAAP Financial Measure
EBITDA is a supplemental, non-GAAP financial measure. EBITDA is defined as earnings before interest expense, income taxes, depreciation and amortization. We have presented EBITDA because it is used by the financial community as a method of measuring our performance and of evaluating the market value of companies considered to be in similar businesses. We believe that the line item on our Consolidated Statements of Income entitled “Net Income” is the most directly comparable GAAP measure to EBITDA. Since EBITDA is not a measure of performance calculated in accordance with GAAP, it should not be considered in isolation of, or as a substitute for, net earnings as an indicator of operating performance. EBITDA, as we calculate it, may not be comparable to similarly titled measures employed by other companies. In addition, this measure is not a measure of our ability to fund our cash needs. As EBITDA excludes certain financial information compared with net income, the most directly comparable GAAP financial measure, users of this financial information should consider the type of events and transactions that are excluded. Our non-GAAP performance measure, EBITDA, has certain material limitations as follows:
• | It does not include interest expense. Because we have borrowed money to finance our operations, pay commitment fees to maintain our credit facility, and incur fees to issue letters of credit under the credit facility, interest expense is a necessary and ongoing part of our costs and has assisted us in generating revenue. Therefore, any measure that excludes interest expense has material limitations. |
• | It does not include income taxes. Because the payment of income taxes is a necessary and ongoing part of our operations, any measure that excludes income taxes has material limitations. |
• | It does not include depreciation or amortization expense. Because we use capital and intangible assets to generate revenue, depreciation and amortization expense is a necessary element of our cost structure. Therefore, any measure that excludes depreciation or amortization expense has material limitations. |
A reconciliation of EBITDA to net income follows:
Three Months Ended | Nine Months Ended | ||||||||||||||
March 31, 2017 | March 31, 2016 | March 31, 2017 | March 31, 2016 | ||||||||||||
(In thousands) | |||||||||||||||
Net income (loss) attributable to Matrix Service Company | $ | (13,821 | ) | $ | 4,357 | $ | 771 | $ | 19,729 | ||||||
Interest expense | 833 | 241 | 1,573 | 756 | |||||||||||
Provision (benefit) for income taxes | (8,521 | ) | 2,507 | (1,223 | ) | 9,060 | |||||||||
Depreciation and amortization | 5,851 | 5,419 | 15,839 | 16,139 | |||||||||||
EBITDA | $ | (15,658 | ) | $ | 12,524 | $ | 16,960 | $ | 45,684 |
- 31-
FINANCIAL CONDITION AND LIQUIDITY
Overview
We define liquidity as the ongoing ability to pay our liabilities as they become due, fund business operations and meet all monetary contractual obligations. Our primary sources of liquidity for the nine months ended March 31, 2017 were cash on hand, capacity under our senior revolving credit facility and cash generated from operations before consideration of changes in working capital. Cash on hand at March 31, 2017 totaled $39.7 million and availability under the senior revolving credit facility totaled $106.8 million resulting in available liquidity of $146.5 million.
Our availability under the senior revolving credit facility was significantly impacted by the Electrical Infrastructure project recorded in the third fiscal quarter as discussed in Note 3 - Uncompleted Contracts. Our fourth quarter projected cash flow, which includes the collection of significant retention on a Storage Solutions project, is strong. Going into fiscal 2018, we do not expect significant increases to senior revolving credit facility availability until the second half of the year. However, with the cash balance, we believe that sufficient liquidity exists to fund the business. A complete discussion of our credit agreement is provided under the captain "Senior Revolving Credit Facility" included in this Financial Condition and Liquidity section of the Form 10-Q.
Factors that routinely impact our short-term liquidity and may impact our long-term liquidity include, but are not limited to:
• | Changes in costs and estimated earnings in excess of billings on uncompleted contracts and billings on uncompleted contracts in excess of costs due to contract terms that determine the timing of billings to customers and the collection of those billings |
• | Some cost plus and fixed price customer contracts are billed based on milestones which may require us to incur significant expenditures prior to collections from our customers. |
• | Time and material contracts are normally billed in arrears. Therefore, we are routinely required to carry these costs until they can be billed and collected. |
• | Some of our large construction projects may require significant retentions or security in the form of letters of credit. |
• | Other changes in working capital |
• | 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 which can be significant |
• | Collection issues, including those caused by weak commodity prices or other factors which can lead to credit deterioration of our customers |
• | Capacity constraints under our credit facility and remaining in compliance with all covenants contained in the credit agreement |
• | A default by one of the major financial institutions for which our deposits exceed insured deposit limits |
• | Cash on hand outside of the United States that cannot be repatriated without incremental taxation. |
As discussed under the caption "Senior Revolving Credit Facility" included in this Financial Condition and Liquidity section of the Form 10-Q, our Credit Agreement includes a Senior Leverage Ratio covenant, which provides that Consolidated Funded
- 32-
Indebtedness, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA, as defined in the Credit Agreement, over the previous four quarters.
Cash Flow for the Nine Months Ended March 31, 2017
Cash Flows Used by Operating Activities
Cash used by operating activities for the nine months ended March 31, 2017 totaled $25.6 million. The various components are as follows:
Net Cash Used by Operating Activities
(In thousands)
Net income | $ | 1,092 | |
Non-cash expenses | 21,840 | ||
Deferred income tax | (4,665 | ) | |
Cash effect of changes in working capital | (44,087 | ) | |
Other | 211 | ||
Net cash used by operating activities | $ | (25,609 | ) |
Working capital changes, net of effects from acquisitions, at March 31, 2017 in comparison to June 30, 2016 include the following:
• | Accounts receivable, net of bad debt expense recognized during the period, increased by $23.5 million during the nine months ended March 31, 2017. The variance is primarily attributable to the timing of billing and collections on our previously announced projects for the construction of terminals supporting the Dakota Access Pipeline and the large Electrical Infrastructure project. |
• | Accounts payable decreased by $45.7 million during the nine months ended March 31, 2017. The variance is primarily attributable to lower volumes during the quarter preceding March 31, 2017 compared to the quarter preceding June 30, 2016 and the timing of vendor payments. |
• | Costs and estimated earnings in excess of billings on uncompleted contracts ("CIE") decreased $34.8 million while billings on uncompleted contracts in excess of costs and estimated earnings ("BIE") increased $5.4 million. The net change in CIE and BIE increased cash $40.2 million for the nine months ended March 31, 2017. CIE and BIE balances can experience significant fluctuations based on the timing of when job costs are incurred, the invoicing of those job costs to the customer, and other working capital management factors. |
Cash Flows Used for Investing Activities
Investing activities used $48.1 million of cash in the nine months ended March 31, 2017 primarily due to the Houston Interests acquisition, which used $40.8 million, and $8.5 million of capital expenditures. Capital expenditures consisted of: $4.0 million for office equipment, $2.4 million for construction equipment, $1.7 million for transportation and fabrication equipment, and $0.4 million for land and buildings. Proceeds from asset sales provided $1.1 million of cash.
Cash Flows Provided by Financing Activities
Financing activities provided $42.4 million of cash in the nine months ended March 31, 2017 primarily due to net borrowings of $44.1 million under our credit facility and a contribution from a non-controlling interest of $0.9 million that were partially offset by the repurchase of $2.3 million of Company stock for payment of withholding taxes due on equity-based compensation and the payment of $0.8 million for debt amendment fees. The net borrowings under our credit facility were primarily used to fund the $46.0 million cash purchase price for the Houston Interests acquisition and working capital needs of our Canadian business.
- 33-
Senior Revolving Credit Facility
As noted previously in Note 5 of the Notes to Condensed Consolidated Financial Statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q, on February 8, 2017 the Company entered into the Fourth Amended and Restated Credit Agreement (the "Credit Agreement"), which replaced the Third Amended and Restated Credit Agreement dated as of November 7, 2011, as previously amended (the "Prior Credit Agreement").
The Credit Agreement provides for a five-year senior secured revolving credit facility of $300.0 million that expires February 8, 2022, which replaces the $250.0 million senior secured revolving credit facility under the Prior Credit Agreement. The new credit facility may be used for working capital, acquisitions, capital expenditures, issuances of letters of credit and other lawful purposes.
The Credit Agreement includes the following covenants and borrowing limitations:
• | A Leverage Ratio, determined as of the end of each fiscal quarter, may not exceed 3.00 to 1.00. |
• | As with the Prior Credit Agreement, we are required to maintain a Fixed Charge Coverage Ratio, determined as of the end of each fiscal quarter, greater than or equal to 1.25 to 1.00. |
• | Asset dispositions (other than dispositions in which all of the net cash proceeds therefrom are reinvested into the Company and dispositions of inventory and obsolete or unneeded equipment in the ordinary course of business) are limited to $20.0 million per 12-month period. |
The new credit facility includes a sub-facility for revolving loans denominated in Australian Dollars, Canadian Dollars, Euros and Pounds Sterling in an aggregate amount not to exceed the U.S. Dollar equivalent of $75.0 million and a $200.0 million sublimit for letters of credit.
Each revolving borrowing under the Credit Agreement will bear interest at a rate per annum equal to:
• | The ABR or the Adjusted LIBO Rate, in the case of revolving loans denominated in U.S. Dollars; |
• | The Canadian Prime Rate or the CDOR rate, in the case of revolving loans denominated in Canadian Dollars; |
• | The Adjusted LIBO Rate, in the case of revolving loans denominated in Pounds Sterling or Australian Dollars; |
• | The EURIBO Rate, in the case of revolving loans denominated in Euros, |
in each case, plus the Applicable Margin, which is based on the Company's Leverage Ratio. The Applicable Margin on ABR loans ranges between 0.625% and 1.625%. The Applicable Margin for Adjusted LIBO, EURIBO and CDOR loans ranges between 1.625% and 2.625% and the Applicable Margin for Canadian Prime Rate loans ranges between 2.125% and 3.125%.
The unused credit facility fee is between 0.25% and 0.45% based on the Leverage Ratio.
The Credit Agreement includes a Senior Leverage Ratio covenant, which provides that Consolidated Funded Indebtedness, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA, as defined in the Credit Agreement, over the previous four quarters. For the four quarters ended March 31, 2017, Consolidated EBITDA was $55.4 million. Consolidated Funded Indebtedness at March 31, 2017 was $51.7 million.
- 34-
Availability under the senior credit facility at March 31, 2017 was as follows:
March 31, 2017 | June 30, 2016 | ||||||
(In thousands) | |||||||
Senior revolving credit facility | $ | 300,000 | $ | 200,000 | |||
Capacity constraint due to the Senior Leverage Ratio | 133,713 | 20,138 | |||||
Capacity under the credit facility | 166,287 | 179,862 | |||||
Borrowings outstanding | 44,139 | — | |||||
Letters of credit | 15,378 | 20,755 | |||||
Availability under the senior revolving credit facility | $ | 106,770 | $ | 159,107 |
Outstanding borrowings at March 31, 2017 under our Credit Agreement were primarily used to fund the acquisition of Houston Interests (See Part 1, Item 1, Note 2 - Acquisitions) and working capital needs in our Canadian business due to the timing of collections and disbursements on the previously announced large Electrical Infrastructure project.
At March 31, 2017, the Company was in compliance with all affirmative, negative, and financial covenants under the Credit Agreement.
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. Under our Credit Agreement, we may declare and pay dividends on our capital stock during any fiscal year up to an amount which, when added to all other dividends paid during such fiscal year, does not exceed 50% of our cumulative net income for such fiscal year to such date. While we currently do not intend to pay cash dividends, any future dividend payments will depend on our financial condition, capital requirements and earnings as well as other relevant factors.
Stock Repurchase Program and Treasury Shares
Treasury Shares
On December 12, 2016, the Board of Directors approved a new stock buyback program (the "December 2016 Program"). Under the December 2016 Program, the Company may repurchase common stock of the Company in any calendar year commencing with calendar year 2016 and continuing through calendar year 2018, up to a maximum of $25.0 million per calendar year. The Company may repurchase its stock from time to time in the open market at prevailing market prices or in privately negotiated transactions. The December 2016 Program will continue through December 31, 2018 unless and until revoked by the Board of Directors. No shares have been repurchased under the December 2016 Program as of March 31, 2017.
In addition to the stock buyback program, the Company may withhold shares of common stock to satisfy the tax withholding obligations upon vesting of an employee’s deferred shares. Matrix withheld 134,253 shares in the first nine months of fiscal 2017 to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares.
The Company has 1,293,898 treasury shares as of March 31, 2017 and intends to utilize these treasury shares in connection with equity awards under the Company’s stock incentive plans and for sales to the Employee Stock Purchase Plan.
- 35-
FORWARD-LOOKING STATEMENTS
This Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Form 10-Q which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts” and similar expressions are also intended to identify forward-looking statements.
These forward-looking statements include, among others, such things as:
• | the impact to our business of crude oil, natural gas and other commodity prices; | <