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Executives

John R. Hewitt - Chief Executive Officer, President and Director

Kevin S. Cavanah - Chief Financial Officer, Vice President, Chief Accounting Officer and Secretary

Analysts

Matt Duncan - Stephens Inc., Research Division

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

Richard Wesolowski - Sidoti & Company, LLC

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

Matrix Service (MTRX) Q1 2012 Earnings Call November 3, 2011 11:00 AM ET

Operator

Greetings, and welcome to the Matrix Service Company conference call to review first quarter fiscal year 2012. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kevin Cavanah, Vice President and CFO for Matrix Service Company. Thank you, Mr. Cavanah. You may begin.

Kevin S. Cavanah

Thank you, and good morning. I would now like to take a moment to read the following. Various remarks that the company may make about future expectations, plans and prospects for Matrix Service Company constitute forward-looking statements for the purposes of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various factors, including those discussed in our annual report on Form 10-K for our fiscal year ended June 30, 2011, and in subsequent filings made by the company with the SEC.

I would now like to turn the call over to John Hewitt, President and CEO of Matrix Service Company.

John R. Hewitt

Thanks, Kevin. Good day, everyone, and thank you for joining us to discuss the results of our first quarter ending September 30, 2011. Results for the first quarter of fiscal 2012 were in line with our expectations.

Backlog has increased steadily in recent quarters and bid volumes are strong across our key markets.

As I mentioned in our last call, our quarter-to-quarter business can be seasonal due to various factors including weather, client spending patterns and energy demand. However, as we've indicated in our earnings release yesterday, the outlook for our fiscal year is positive.

The timing of project awards and commencement of fuel activities in July and August were somewhat slower than anticipated, resulted in lower man hours and under recovery of construction overhead cost in the quarter. Despite this relatively slow start to the year, revenues in man hours have increased every month and are trending in line with our expectations for the fiscal year.

As I mentioned, backlog continues to grow and was $426.6 million at the end of the first quarter, the third consecutive quarterly increase. Bookings for the quarter were on par with our best quarter in the last 2 years and proposal volume is robust in all of our business lines. We're particularly pleased with the business volume in the Aboveground Storage Tank and high-voltage electrical markets. Overall, our outlook for fiscal 2012 is very positive.

The Repair and Maintenance Services segment achieved revenue growth of 28% in the first quarter compared to the same period last year with our Aboveground Storage Tank, Downstream Petroleum and Electrical and Instrumentation businesses all providing double-digit growth. Construction Services segment revenues increased slightly; however, Aboveground Storage Tank revenues increased by almost 44%, partially offset by a lower revenue in Electrical and Instrumentation with the completion of a major contract in the last fiscal year.

We're encouraged by a number of positive elements and emerging trends in our core markets. Many of our customers are planning significant projects that Matrix Service is well positioned to capture. Given the strength in our current business lines and strategic expansion opportunities, we are expanding our revolving credit facility from $75 million to $125 million. We have received commitments from our bank group and we expect to close on the new facility early next week. We believe this added capacity supports the company's strategic growth requirements beyond fiscal 2012.

As for guidance, we are encouraged by the additions to backlog in the first quarter in the current bidding activity. In addition, our project funnel includes a significant number of material contracts in both the Construction Services and Repair and Maintenance Services segments. As a result, we are increasing the lower end of our revenue guidance from $650 million to $675 million and we are increasing the lower end of our earnings guidance from $0.75 per fully diluted share to $0.80 per fully diluted share.

We are holding the top end of our revenue earnings guidance at $725 million and $0.95 per fully diluted share respectively.

With that, I'll turn the call over to Kevin to discuss the financial results.

Kevin S. Cavanah

Thanks, John. In the first quarter ended September 30, 2011, revenues were $169.3 million, an increase of 11.5% versus $151.8 million in the same period last year. We earned $0.13 per fully diluted share in the first quarter compared to $0.12 per fully diluted share in the same period last year.

Repair and Maintenance Services segment revenues increased 28.3% to $69.7 million in the quarter compared to $54.3 million in the same period last year. Construction Services segment revenues increased 2.1% to $99.6 million in the first quarter compared to $97.5 million in the same period of last year.

Consolidated gross profit was $18.1 million in the first quarter versus $15.7 million in the first quarter last year. Consolidated gross margins were 10.7% in the first quarter compared to 10.3% in the same period last year. Repair and Maintenance Services gross margins were 10.4% compared to 8% in the same period last year. Construction Services gross margins were 10.9% in the first quarter versus 11.6% in the first quarter last year.

As John mentioned earlier, the slow business volume in July and August, particularly in the Electrical and Instrumentation business resulted in under-absorption of construction overhead cost. While this impacted margins in the Construction Services segment in the first quarter, over the same time period we increased E&I backlog, which should produce higher gross margins for the balance of the year.

SG&A expenses were $11.5 million in the first quarter compared to $10.6 million in the prior year. The increase is primarily due to strategic realignment activities that resulted in higher employee expenses and administrative costs. Other expenses in the first quarter include a loss on foreign currency related to an investment in working capitals to support the growth of our Canadian operations. To mitigate future foreign currency exposure from our Canadian operations, our expanded credit facility will include the ability to borrow in Canadian dollars.

Our cash balance was $38.7 million at the end of the first quarter of fiscal 2012 as compared to $59.4 million at the end of fiscal 2011. The decrease in our cash balance resulted from additional investment working capital to fund the growth in business volume which increased significantly in September.

In addition, since June 30, 2011, the company purchased $6.3 million of Matrix Service Company stock at an average price of $9.25 per share, including $1.5 million in the first week of October.

Our overall liquidity remains strong, and as John mentioned earlier, we received commitments for a $125 million revolving credit facility to support the continued growth of our business.

We believe our strong balance sheet, expanded liquidity and bonding capacity provide the resources and the flexibility to capitalize on emerging growth opportunities and also serves to differentiate us from many of our competitors.

With that, I would like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Matt Duncan from Stephens Inc.

Matt Duncan - Stephens Inc., Research Division

You guys had another great quarter on AST construction basis. Can you -- do you think you can sustain this quarterly revenue level for the balance of FY '12? Or was there anything unusual that maybe inflated this quarter a bit? Just help us understand sort of what we ought to expect there going forward.

John R. Hewitt

No, I would say our expectation is that we'll be able to maintain -- be consistent with our revenues with the AST for the balance of the fiscal year. The bidding activity is extremely strong, not only in Cushing but in a lot of other markets, Western Canada, St. James region, up in the Bakken. So we're seeing a lot of activity from many of our core clients to look to expand their storage facilities. So we're pretty positive about the balance of the fiscal year on AST.

Matt Duncan - Stephens Inc., Research Division

And, John, as you look at the stuff that's going into backlog, sort of how much of that is Cushing versus other geographies?

John R. Hewitt

I don't have the exact numbers in front of me, but I would say it's not Cushing-centric. It's a -- I'd say it was pretty fairly spread.

Kevin S. Cavanah

Yes, and I believe a big portion of the increase in backlog was actually E&I, Construction Services projects, which while that was low in the first quarter, that's one of the reasons we feel better about the rest of the year.

Matt Duncan - Stephens Inc., Research Division

Okay. And then sticking with AST for just a second, Repair and Maintenance business there improved sequentially by a pretty good amount yet again. This is the first time you've had year-over-year revenue growth in AST Repair and Maintenance since, I think, the 2Q of '09. Do you feel like that business has bottomed? And can you sustain this momentum and quarterly sequential march higher there?

John R. Hewitt

Yes. I mean, I think we're going to continue to -- we'll continue to perform well there. I think it's another sort of pent-up demand thing. I think there was some repairs by some of our clients that were put off over the past few quarters. And some of that is breaking loose now.

Matt Duncan - Stephens Inc., Research Division

I expect I may have to hop back in queue. The downstream Repair and Maintenance business had another strong quarter. Is that a good sign of things to come for the fall turnaround season? And then how do you see the turnaround calendar shaping up in the next spring?

John R. Hewitt

Yes, we had an extremely strong, strong -- a little bit stronger than expected turnaround for the fall season. And we anticipate, right now, we anticipate the spring to be similar.

Operator

Our next question is coming from Tahira Afzal from KeyBanc.

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

I guess, my first question is in regards to the E&I bookings and the strength you're seeing. Could you first talk about whether your quarter benefited at all from Hurricane Irene? I know you have a presence in the Northeast and that is fairly notably hedged. And if any of the booking strength also relates to any sort of repair work that is tied to that as well. And then the second question I have is really if you look at your Western Canadian opportunities, obviously, there's a lot of storage tank work that's been proposed in regards to the Keystone XL line and that would be in [indiscernible] area. I would like to get a sense of really how much is Keystone potentially versus outside of Keystone.

John R. Hewitt

Okay. First question, yes, we were involved in Hurricane Irene as we are currently today involved in repairs from the snowstorm up in the Northeast. Nominally, the Hurricane Irene work was about $4 million in revenue, somewhere in that neighborhood. And so it was, certainly it was helpful in the quarter. We started the bookings in our E&I business. We're seeing a lot of activity in our substation work and our growth in our distribution work in some nice projects that got booked there in sort of the Northeast quarter where we're -- got an extremely strong presence. And we like to think of ourselves as #1 in the substation business in that area. As for the tank business, honestly, we are -- we have several projects that we are looking at up there and that are currently in the bidding stages, that we feel pretty good with. They’re with some current clients that we do business with on a regular basis. And as it relates to the Keystone pipeline, I'm not sure of your question there whether that was going to have an impact on that business or not. A lot of that we think is going to be based on the timing on when that happens. The longer that it takes for that project to complete, the more storage growth there will be over the next 2 to 3 years. So we're watching that right now. Right now, we don't think -- right now whether it's having a significant impact on our bookings this year and I can't respond to that.

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

Got it. Okay. And if you look at both your capability, you're fairly well positioned for environmental work and Utility MACT rules might potentially be coming out in another month and a half. We've seen some of your larger builds getting some trickle in on bookings, et cetera. Are you starting to see any scrubber work proposals coming out? Or are you guys going to see something with a bit of a lag? First question. And then second question, companies such as utilities such as Dominion, et cetera indicated that they're going to have to spend additional on electric transmission to really help keep up reliability as all the scrubber environmental work happens and coal power plants subject or not switched out. So I would like to get a sense of what you're really seeing as a catalyst for your business and some potential environmental rules coming out?

John R. Hewitt

Well, on the back end work on the coal fleet in the U.S. and while the coal fleet year-over-year will pick up on smaller percentage of the overall generation sources for the U.S., they can’t all be replaced overnight. And we'll still be, as a country, with a high dependence on the coal fleet. And as a result of that, the requirements to clean up the emissions from this coal fleet through SCR scrubbers, at FGD systems, whatever, is certainly we believe will be part of our business going into the future. I can't comment on whether we have any specific bids in-house, but that is a target area for us for our businesses, across our businesses. And that we would hope to have some of those projects in our backlog in over the next 18 months to 2 years. On the TV side, that's an area in our business where we believe there's going to be growth opportunities for us in the distribution and transmission area. And we're going to continue to add resources, work with our existing clients who we’re doing substation work with now and make appropriate capital investments in equipment and people to take a bigger chunk of that business.

Operator

[Operator Instructions] Our next question is coming from Rich Wesolowski from Sidoti & Company.

Richard Wesolowski - Sidoti & Company, LLC

Following up on the Tank business. It seems very odd that you're bidding a very active slate of tank construction work but your tank repair business is barely half the size it was 3 years ago. Would you imagine that we're at the beginning of a favorable cyclical turn in the tank repair business? And if that is the case, what would spark that investment?

Kevin S. Cavanah

Well, if you look at the numbers 3 years ago, if you recall, that was a very robust time for tank building. One of the things that led to those -- our Repair and Maintenance units for AST revenues growing like they did was there was some price of small tank work, new constructions for small tanks that they did that helped kind of improve their margins and their revenue volume in that period. And so that's part of the reason. The other thing is like John mentioned, there is some probably what we’d call pent-up demand on AST, Repair and Maintenance work.

Richard Wesolowski - Sidoti & Company, LLC

So it's kind of just the passage of time. And if you have to undertake these projects at some point, then why not start today?

John R. Hewitt

I'm sure it's more complex than that, but that's probably a pretty relatively good answer.

Richard Wesolowski - Sidoti & Company, LLC

Is there anything different in your Repair and Maintenance business today that would preclude you from reaching a 15% gross margin range at some point in the future if the demand for your services continued to improve?

John R. Hewitt

No. I would say no. I would say that's -- there's nothing to prevent us from that happening.

Richard Wesolowski - Sidoti & Company, LLC

And then you mentioned, John, a couple of areas outside of Cushing where Matrix is bidding for tank work, we know that you have your best business in the tanks in Cushing and it's perhaps a little more competitive elsewhere. Obviously you don't have an advantage that you would have in Cushing elsewhere. If you succeed in winning more and more work, would you expect it would dilute the construction gross margin?

John R. Hewitt

No. I don't think so. I mean, we're, in a lot of cases, we're following existing clients that are -- they know the quality of the service that we provide and so there's in those cases they're maybe out of negotiated contracts or there's this much smaller bid list. And so from that standpoint, I'd say we'll be able to provide similar Cushing-like services within a degree of materiality in other places that we are -- where the activity is strong.

Operator

Our next question is coming from Martin Malloy from Johnson Rice.

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

Could you talk a little bit more about the strategic opportunities out there and reasons behind increasing the revolver? Are you seeing some attractive acquisition opportunities out there?

John R. Hewitt

Well, we have several parts of our business we think there's growth opportunities both in market share and geography. And certainly one of those areas would be our high-voltage business. We're very extremely strong in the Northeast, and we believe that we can take that business model into other parts of the country, into the Midwest, out into California. And so some of that will be done organically. We'll be following clients. But some of that as well will be done through strategic acquisitions to get into some regions. And so that will be one of the areas that I would anticipate that we would be looking for an acquisition in.

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

Okay. And then the Instrumentation business during the quarter, the slow start, was that weather or permitting? Or were there any issues in particular that you could point to?

John R. Hewitt

Some of it's weather, some of it's with having a super hot summer that the country had delayed some of its -- started some of the work that we did have backlogged in our substation work. They're not going to have electricity -- when the electricity generators or public utilities are making money selling electricity, they run air conditioners, they're not going to want to take down their facilities for any kind of upgrades or repairs or replacements. So some of it was that, probably a lot of it was that. But the upside of that was our ability to take a lot of our staff and our crews who do that work for us. We were able to get them into the office and we saw probably a fourfold increase in bidding activity for that period year-over-year. And so the good news, bad news was is those -- we had all those guys in the office. And we were able to substantially increase our backlog going forward by utilizing all those -- that staff to bid the increased bidding activity.

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

Okay. And on the income statement, the other line, negative 676,000, that was all foreign currency related? And was it about $0.03 in EPS?

Kevin S. Cavanah

Yes. That was all foreign currency related. It's really close to $0.02 EPS. And obviously, that related to the operations we've got in Canada. We've talked about some of the successes we've had up there, growing that business. Most of the growth is AST work and our operations here in Tulsa, both our engineering and fabrication operations, support those projects which creates a bit of a larger intercompany balance. And as a result, we had with the Canadian dollar weakening at the end of the quarter, it had a negative impact on us. It's strengthened in October, so a lot of that has been recovered. But then we're also putting in the credit facility with the Canadian borrowing capacity. So we'll be able to mitigate that risk respectively.

Operator

[Operator Instructions] Our next question is coming from Mike Harrison from First Analysis.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

It looks like crude inventory levels in Cushing have moved a little bit lower compared to where they were earlier this year. Can you talk a little bit about how much temporary swings in inventory levels factor into your long-term outlook for tankage demand, particularly in Cushing?

John R. Hewitt

I don't know that temporary swings if we've got a direct metric on that. I can tell you that the bidding activity over the last quarter has not gotten -- has not decreased. So if there is some direct connection to that, the amount of the inventory changes hasn’t affected potential clients’, both existing ones and new ones, view on building more storage at Cushing.

Kevin S. Cavanah

And we're also in constant contact with our customers, and so we know what their plans are. So and that's better information for us than to monitor that metric.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And in terms of the opportunity for AST in the Bakken, how big is that opportunity? And how soon could we see a significant contribution from it?

John R. Hewitt

I think there is a much -- I'm not sure I told you over the entire -- what the projected amount there. But I think there's somewhere in the neighborhood of 8 million to 10 million barrels of storage anticipated there over the next few years. I think that's one recent forecast that we've seen and so we and one of our existing clients are already working in the Bakken, so we would anticipate that we'll follow some of those clients into that area. We're already looking at some opportunities there. So we believe that will certainly be a part of our portfolio of AST business in going to the future.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Just in terms of Canada, I know in the past it's been sort of a 5% to 6% of revenues type number. Can you talk a little bit about the longer-term opportunities there? Obviously, you're working to invest to capture future growth. What share of revenues does Canada have 2, 3 years from now?

John R. Hewitt

I would say rather than giving you that number, I would tell you that we believe that given our suite of services that we provide through all of our businesses and what we are now currently providing in Canada, we've got a lot of room to grow. We work -- we're basically on the East Coast for a client there in their refinery and then we've got our Western Canada business where we're doing primarily AST business. So we're not providing any united services up there, we're not providing any overall Construction Services, refinery maintenance and turnarounds has not been a big area. So there's a lot of opportunity for us to move into Canada throughout the provinces, besides where we are now. Certainly Ontario would be one of those areas for us where we would see an opportunity for us to bring our services into.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And then last question I had is just about the business mix in Construction Services. My sense from the way you're talking is that the slower ramp of E&I business, sort of negatively impacted your margin. But can you talk about any other, I guess, mix factors that played into the gross margin weakness this quarter? And also, have your contracts in Construction Services been trending toward more fixed price contracts that maybe entail a little bit more risk?

Kevin S. Cavanah

I'll take a stab at this. On the gross margins, obviously, the under-absorption was an issue. As you look at the quarter though, other things that impacted the margins was that we probably didn't have any big close outs of jobs where we had strong incentives at the -- in the jobs that we recognize. And so that impacted the margins. Overall mix of work impacted margins. I don't think we've seen a significant change in the makeup of our contracts, either in type of contract or in the pricing of our construction projects, especially in the AST business. So I think the gross margins for construction were, while they were low, I definitely don't expect to see them at that level in the future.

Operator

Our next question is coming from Tahira Afzal from KeyBanc.

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

If I look at LNG opportunities in the U.S., this is a market Matrix has played in before. You have the Kitimat LNG project probably reaching FID early next year. You potentially have opportunities in Sabine Pass and Dominion just came out and said they are looking at converting [indiscernible] point plant into a liquefaction unit as well albeit with a bit of a lag. So how should we think of this opportunity for you? I know it's been mixed in terms of construction for you, but given that you now also have a portion of the Des Moines business from CB&I, is this something that could be a fairly nice opportunity for you going forward?

John R. Hewitt

We are going to -- we're going to explore all those opportunities. We've been approached by some of the major E&C contractors on the Kitimat opportunity related to the tanks. And certainly, we are interested in the Sabine Pass Project that has not -- well, Sabine Pass, it hasn't really been yet determined whether they will have to add a 6th tank there. The -- whether they -- given the state of the import that they are importing LNG into the U.S. versus what they might be exporting and their volumes don't necessarily add up to where they have to add a 6th tank. So that opportunity, Kitimat just talked about, they're certainly in our radar screen, we're watching them. We're going to be -- we will decide which projects we're going to bid, if any, dependent on if they fit our risk profile and our ability to be successful.

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

And just as a follow-up to that then, if you do think Kitimat is a potential opportunity, as of right now what would the timing of that be potentially for Matrix?

John R. Hewitt

I'm sorry, the timing for which?

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

For Kitimat.

Kevin S. Cavanah

Kitimat probably the -- I'm guessing that would probably be bidding in the latter half of this fiscal year. And if we bid it and if we were awarded it, I would not think it would add substantively for -- it would add substantively to fiscal '12, it would be more of a '13, '14 job.

Operator

Thank you. It appears there are no further questions. I would now like to turn the floor back over to Mr. Hewitt for closing comments.

John R. Hewitt

Thank you, everybody, for your time today. And we'll talk to you on the next quarter.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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