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MTRX > SEC Filings for MTRX > Form 10-K on 6-Sep-2013All Recent SEC Filings

Show all filings for MATRIX SERVICE CO

Form 10-K for MATRIX SERVICE CO


6-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). GAAP represents a comprehensive set of accounting and disclosure rules and requirements, the application of which requires management judgments and estimates including, in certain circumstances, choices between acceptable GAAP alternatives. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions. Note 1- Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Part II, Item 8 - Financial Statements and Supplementary Data in this Annual Report on Form 10-K, contains a comprehensive summary of our significant accounting policies. The following is a discussion of our most critical accounting policies, estimates, judgments and uncertainties that are inherent in our application of GAAP.
CRITICAL ACCOUNTING ESTIMATES
Revenue Recognition
Matrix records profits on fixed-price contracts on a percentage-of-completion basis, primarily based on costs incurred to date compared to the total estimated cost. The Company records revenue on cost-plus and time-and-material contracts on a proportional performance basis as costs are incurred. Contracts in process are valued at cost plus accrued profits less billings on uncompleted contracts. Contracts are generally considered substantially complete when field construction is completed. The elapsed time from award of a contract to completion of performance may be in excess of one year. Matrix includes pass-through revenue and costs on cost-plus contracts, which are customer-reimbursable materials, equipment and subcontractor costs, when Matrix determines that it is responsible for the procurement and management of such cost components.
Matrix has numerous contracts that are in various stages of completion, which require estimates to determine the appropriate cost and revenue recognition. The Company has a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs, and accordingly, does not believe significant fluctuations are likely to materialize. However, current estimates may be revised as additional information becomes available. If estimates of costs to complete fixed-price contracts indicate a loss, a provision is made through a contract write-down for the total loss anticipated. A number of our contracts contain various cost and performance incentives and penalties that impact the earnings we realize from our contracts. Adjustments related to these incentives and penalties are recorded in the period on a percentage of completion basis when estimable and probable. Indirect costs, such as salaries and benefits, supplies and tools, equipment costs and insurance costs, are charged to projects based upon direct labor hours and overhead allocation rates per direct labor hour. Warranty costs are normally incurred prior to project completion and are charged to project costs as they are incurred. Warranty costs incurred subsequent to project completion were not material for the periods presented. Overhead allocation rates are established annually during the budgeting process and evaluated for accuracy throughout the year based upon actual direct labor hours and actual costs incurred. Change Orders and Claims
Change orders are modifications of an original contract that effectively change the existing provisions of the contract. Change orders may include changes in specifications or designs, manner of performance, facilities, equipment, materials, sites and period of completion of the work. Matrix or our clients may initiate change orders. The client's agreement to the terms of change orders is, in many cases, reached prior to work commencing; however, sometimes circumstances require that work progress prior to obtaining client agreement. Costs related to change orders are recognized as incurred. Revenues attributable to change orders that are unapproved as to price or scope are recognized to the extent that costs have been incurred if the amounts can be reliably estimated and their realization is probable. Revenues in excess of the costs attributable to change orders that are unapproved as to price or scope are recognized only when realization is assured beyond a reasonable doubt. Change orders that are unapproved as to both price and scope are evaluated as claims. Claims are amounts in excess of the agreed contract price that we seek to collect from customers or others for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes of anticipated additional costs incurred by us. Recognition of amounts as additional contract revenue related to


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claims is appropriate only if it is probable that the claims will result in additional contract revenue and if the amount can be reliably estimated. We must determine if:
there is a legal basis for the claim;

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

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

the evidence supporting the claim is objective and verifiable.

If all of the these requirements are met, revenue from a claim is recorded only to the extent that we have incurred costs relating to the claim.
As of June 30, 2013 and June 30, 2012, costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders and claims of $9.1 million and $8.5 million, respectively. Historically, our collections for unapproved change orders and claims have approximated the amount of revenue recognized.
Loss Contingencies
Various legal actions, claims, and other contingencies arise in the normal course of our business. Contingencies are recorded in the consolidated financial statements, or are otherwise disclosed, in accordance with ASC 450-20, "Loss Contingencies". Specific reserves are provided for loss contingencies to the extent we conclude that a loss is both probable and estimable. We use a case-by-case evaluation of the underlying data and update our evaluation as further information becomes known. We believe that any amounts exceeding our recorded accruals should not materially affect our financial position, results of operations or liquidity. However, the results of litigation are inherently unpredictable and the possibility exists that the ultimate resolution of one or more of these matters could result in a material effect on our financial position, results of operations or liquidity. Legal costs are expensed as incurred.
Insurance Reserves
We maintain insurance coverage for various aspects of our operations. However, we retain exposure to potential losses through the use of deductibles, coverage limits and self-insured retentions. We establish reserves for claims using a combination of actuarially determined estimates and management judgment 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 or losses that could be significant. A hypothetical ten percent unfavorable change in our claim reserves at June 30, 2013 would have reduced fiscal 2013 pretax income by $0.5 million. Goodwill
Goodwill represents the excess of the purchase price of acquisitions over the acquisition date fair value of the net identifiable tangible and intangible assets acquired. In accordance with current accounting guidance, goodwill is not amortized and is tested at least annually for impairment at the reporting unit level.
We perform our annual analysis during the fourth quarter of each fiscal year and in any other period in which indicators of impairment warrant additional analysis. Goodwill impairment reviews involve a two step process. Goodwill is first evaluated for impairment by comparing management's estimate of the fair value of a reporting unit with its carrying value, including goodwill. Management utilizes a discounted cash flow analysis, referred to as an income approach, to determine the estimated fair value of our reporting units. Significant judgments and assumptions including the discount rate, anticipated revenue growth rate and gross margins, estimated operating and interest expense, and capital expenditures are inherent in these fair value estimates, which are based on our operating and capital budgets and on our strategic plan. As a result, actual results may differ from the estimates utilized in our income approach. The use of alternate judgments and/or assumptions could result in a fair value that differs from our estimate and could result in the recognition of an impairment charge in the financial statements. As a result of these uncertainties, we utilize multiple scenarios and assign probabilities to each of the scenarios in the income approach.


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We also consider market-based approaches to assess the fair value of our reporting units. We compare market multiples from our public peer companies in the engineering and construction industry, as well as the combined carrying values of our reporting units with market capitalization.
If the carrying value of our reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step must be performed to measure the amount of impairment. The amount of impairment is determined by comparing the implied fair value of the reporting unit's goodwill to the carrying value of the goodwill calculated in the same manner as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is less than its carrying value, we would record an impairment charge for the difference.
Although we do not anticipate a future impairment charge, certain events could occur that would adversely affect the reported value of goodwill. Such events could include, but are not limited to, a change in economic or competitive conditions, a significant change in the project plans of our customers, a deterioration in the economic condition of the customers and industries we serve, and a material negative change in the relationships with one or more of our significant customers. If our judgments and assumptions change as a result of the occurrence of any of these events or other events that we do not currently anticipate, our expectations as to future results and our estimate of the implied value of one or more of our reporting units also may change. We performed our annual impairment test in the fourth quarter to determine whether an impairment existed and to determine the amount of headroom. 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 39% of our goodwill balance is attributable to one reporting unit. This unit had headroom of 64%. We have four additional reporting units with goodwill representing 19%, 13%, 10% and 10% of the total goodwill balance with headroom of 224%, 144%, 149% and 123%, respectively.
Our significant assumptions, including revenue growth rates, gross margins, unanticipated operating and interest expense and other factors may change in light of changes in the economic and competitive environment in which we operate. Assuming that all other components of our fair value estimate remain unchanged, a change in the following assumptions would have the following effect on headroom:
if the growth rate of estimated revenue decreases by one percentage point, the headroom of the reporting units referenced above would be reduced from 64%, 224%, 144%, 149% and 123% to 59%, 213%, 138%, 139% and 119%, respectively;

if our estimate of gross margins decreases one percentage point, the headroom of the reporting units referenced above would be reduced from 64%, 224%, 144%, 149% and 123% to 30%, 160%, 96%, 100% and 88%, respectively; and

if the applicable discount rate increases one percentage point, the headroom of the reporting units referenced above would be reduced from 64%, 224%, 144%, 149% and 123% to 45%, 186%, 118%, 120% and 97%, respectively.

Other Intangible Assets
Intangible assets that have finite useful lives are amortized by the straight-line method over their useful lives ranging from 1 to 15 years. Intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment. Each reporting period, we evaluate the remaining useful lives of intangible assets not being amortized to determine whether facts and circumstances continue to support an indefinite useful life and review both amortizing and non-amortizing intangible assets for impairment indicators. In fiscal 2013, we reclassified an intangible asset from an indefinite-lived intangible to a finite-lived intangible resulting in an impairment charge of $0.3 million.
Recently Issued Accounting Standards
Accounting Standards Update 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income In February 2013, the FASB issued Accounting Standards Update No.
2013-02,"Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" (ASU 2013-02). ASU 2013-02 requires companies to report the effect of significant reclassifications out of accumulated other comprehensive income, by component, either on the face of the financial statements or in the notes to the financial statements and is intended to help entities improve the transparency of changes in other comprehensive income. ASU 2013-02 does not amend any existing requirements for reporting net income or other comprehensive income in the financial statements. ASU 2013-02 is effective for reporting periods beginning after December 15, 2012. We currently do not expect the adoption of this standard to have a material impact on our consolidated financial statements.


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Accounting Standards Update 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities
In December 2011, the FASB issued Accounting Standards Update No. 2011-11,"Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities" (ASU 2011-11) and in January 2013, the FASB issued Accounting Standards Update No. 2013-01, "Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities." ASU 2011-11, as clarified, enhances disclosures surrounding offsetting (netting) assets and liabilities. The standard applies to derivatives, repurchase agreements and securities lending transactions and requires companies to disclose gross and net information about financial instruments and derivatives eligible for offset and to disclose financial instruments and derivatives subject to master netting arrangements in financial statements. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013. We will adopt this standard beginning our first interim period of fiscal 2014. We currently do not expect the adoption of this standard to have a material impact on our consolidated financial statements.


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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 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. We also provide construction and maintenance services to a variety of power generation facilities such as combined cycle plants, coal fired power stations, and renewable energy installations.
The Oil Gas & Chemical segment includes our traditional turnaround activities, plant maintenance services and construction in the downstream petroleum industry. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning, and vacuum services. We also perform work in the industrial and natural gas, gas processing and compression, and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products aboveground storage tanks, as well as planned and emergency maintenance services. Also included in the Storage Solutions segment is work related to specialty storage tanks including LNG, LIN/LOX, and LPG tanks and other specialty vessels including spheres. Finally, the Storage Solutions segment includes balance of plant work in storage terminals and tank farms. The Industrial segment includes work in the mining and minerals industry, bulk material handling, fertilizer production facilities, as well as work for clients in other industrial markets.
The majority of the work for all segments is performed in the United States, with 8.7% of revenues generated in Canada during fiscal 2013, 8.5% in fiscal 2012 and 4.8% in fiscal 2011. Significant period to period changes in revenues, gross profits and operating results are discussed below on a consolidated basis and for each segment.


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                             Matrix Service Company
                             Results of Operations
                                 (In thousands)
                                    Electrical       Oil Gas &       Storage
                                  Infrastructure      Chemical      Solutions     Industrial       Total
Fiscal Year 2013
Consolidated revenues            $      171,204     $  273,848     $ 393,201     $   54,321     $  892,574
Gross profit                             21,754         32,879        37,455          2,614         94,702
Selling, general and
administrative expenses                  10,569         17,464        25,551          4,404         57,988
Operating income (loss)                  11,185         15,415        11,904         (1,790 )       36,714
Fiscal Year 2012
Consolidated revenues            $      135,086     $  205,823     $ 378,154     $   19,983     $  739,046
Gross profit                             16,676         20,070        42,393            479         79,618
Selling, general and
administrative expenses                   9,067         11,936        24,900          2,080         47,983
Operating income (loss)                   7,609          8,134        17,493         (1,601 )       31,635
Fiscal Year 2011
Consolidated revenues            $      151,058     $  143,354     $ 298,706     $   33,934     $  627,052
Gross profit                             18,337         13,647        38,779          4,151         74,914
Selling, general and
administrative expenses                   9,226         10,542        22,167          2,079         44,014
Operating income                          9,111          3,105        16,612          2,072         30,900
Variances Fiscal Year 2013 to
Fiscal Year 2012
Increase/(Decrease)
Consolidated revenues            $       36,118     $   68,025     $  15,047     $   34,338     $  153,528
Gross profit                              5,078         12,809        (4,938 )        2,135         15,084
Selling, general and
administrative expenses                   1,502          5,528           651          2,324         10,005
Operating income                          3,576          7,281        (5,589 )         (189 )        5,079
Variances Fiscal Year 2012 to
Fiscal Year 2011
Increase/(Decrease)
Consolidated revenues            $      (15,972 )   $   62,469     $  79,448     $  (13,951 )   $  111,994
Gross profit                             (1,661 )        6,423         3,614         (3,672 )        4,704
Selling, general and
administrative expenses                    (159 )        1,394         2,733              1          3,969
Operating income                         (1,502 )        5,029           881         (3,673 )          735


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Fiscal 2013 Versus Fiscal 2012
Consolidated
Consolidated revenues were $892.6 million in fiscal 2013, an increase of $153.6 million, or 20.8%, from consolidated revenues of $739.0 million in fiscal 2012. The increase in consolidated revenues was a result of increases in all four segments: Oil Gas & Chemical, Electrical Infrastructure, Industrial and Storage Solutions which increased $68.0 million, $36.1 million, $34.3 million and $15.0 million, respectively.
Consolidated gross profit increased from $79.6 million in fiscal 2012 to $94.7 million in fiscal 2013. The increase of $15.1 million, or 19.0%, was due to higher revenues, partially offset by lower gross margins which decreased to 10.6% in fiscal 2013 compared to 10.8% a year earlier.
Consolidated SG&A expenses were $58.0 million in fiscal 2013 compared to $48.0 million in the same period a year earlier. The increase of $10.0 million, or 20.8%, was primarily related to our planned investments in the branding initiative, strategic growth areas and related support functions coupled with a higher business volume. The Company also incurred a bad debt charge of $0.7 million in fiscal 2013. SG&A expense as a percentage of revenue was 6.5% in both fiscal 2013 and fiscal 2012.
Net interest expense was $0.8 million in both fiscal 2013 and fiscal 2012. The effective tax rates for fiscal 2013 and fiscal 2012 were 33.2% and 43.6%, respectively. The current year effective tax rate was positively impacted by the effect of retroactive tax legislation enacted in the third quarter of fiscal 2013 and a change in estimate related to an available tax credit. The fiscal 2012 effective tax rate was higher than the statutory rate due to cumulative non-deductible expenses totaling $3.1 million related to deductibility limitations applying to certain items that had previously been fully deducted, of which $2.1 million was related to prior fiscal years (fiscal 2009 to fiscal 2011). The fiscal 2012 effective tax rate was positively impacted by the release of a valuation allowance on foreign tax credit carryovers of $0.5 million. Electrical Infrastructure
Revenues for the Electrical Infrastructure segment increased $36.1 million, or 26.7%, to $171.2 million in fiscal 2013 compared to $135.1 million in the same period a year earlier. The higher revenue was primarily due to an increase in high voltage work related primarily to storm restoration services and higher transmission and distribution work in the Northeast United States. Gross margins were 12.7% in fiscal 2013 compared to 12.3% in fiscal 2012. The improvement in gross margins in fiscal 2013 is due to higher margins related to storm restoration work and the improved recovery of overhead costs caused by a higher business volume, partially offset by lower direct margins related to other electrical work.
Oil Gas & Chemical
Revenues for the Oil Gas & Chemical segment increased to $273.8 million in fiscal 2013 compared to $205.8 million in the same period a year earlier. The increase of $68.0 million, or 33.0%, was primarily due to a higher level of turnaround work, geographic expansion of turnaround services, and capital construction projects. Gross margins were 12.0% in fiscal 2013 compared to 9.8% in fiscal 2012. The improvement in gross margins is primarily due to the favorable effect of the improved recovery of overhead costs caused by a higher business volume and improved project execution. Storage Solutions
Revenues for the Storage Solutions segment increased to $393.2 million in fiscal 2013 compared to $378.2 million in the same period a year earlier. The increase of $15.0 million, or 4.0%, was primarily due to higher levels of work in Canada in our aboveground storage tank business. Gross margins decreased from 11.2% in fiscal 2012 to 9.5% in the same period in the current year. The lower margins in fiscal 2013 was primarily due to unrecovered overhead costs, a legal charge of $1.0 million and lower direct margins caused primarily by a $3.7 million charge on one project. The legal charge is discussed under the heading "Legal Settlement" and the project charge is discussed under the heading "Western Canada Aboveground Storage Tank Project" in Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Report on Form 10-K. Industrial
Revenues for the Industrial segment totaled $54.3 million in fiscal 2013 compared to $20.0 million in the same period a year earlier. The increase of $34.3 million, or 172.0%, was primarily due to higher revenues in our mining and minerals


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business. Gross margins were 4.8% in fiscal 2013 compared to 2.4% in fiscal 2012. Although negatively impacted by lower than anticipated business ramp up, gross margins improved throughout fiscal 2013 as the volume of business increased. We also incurred a $0.4 million project charge in fiscal 2013 for this segment. Fiscal 2012 and fiscal 2013 margins were negatively impacted by startup costs related to entry into the bulk material handling and mining and minerals markets.
Fiscal 2012 Versus Fiscal 2011
Consolidated
Consolidated revenues were $739.0 million in fiscal 2012, an increase of $111.9 million, or 17.8%, from consolidated revenues of $627.1 million in fiscal 2011. The increase in consolidated revenues was a result of increases in Storage Solutions and Oil Gas & Chemical revenues, which increased $79.4 million and $62.5 million, respectively. These increases in revenues were partially offset by lower Electrical Infrastructure and Industrial revenues, which decreased $16.0 million and $14.0 million, respectively.
Consolidated gross profit increased from $74.9 million in fiscal 2011 to $79.6 million in fiscal 2012. The increase of $4.7 million was primarily due to higher revenues, partially offset by a decrease in gross margins from 11.9% in fiscal 2011 to 10.8% in fiscal 2012.
Consolidated SG&A expenses were $48.0 million in fiscal 2012 compared to $44.0 million in fiscal 2011. The increase of $4.0 million, or 9.1%, was primarily due to higher operating costs in fiscal 2012 related to increased business volumes, costs related to our investment in high growth areas of the business and related investment in support functions such as safety, marketing, corporate development, systems and training, and a non-routine stock compensation charge, . . .

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