Q2 2024 Matrix Service Co Earnings Call
Participants
Kellie Smythe; Senior Director, IR; Matrix Service Company
John Hewitt; CEO & President; Matrix Service Company
Kevin Cavanah; CFO; Matrix Service Company
John Franzreb; Analyst; Sidoti & Company, LLC
John Morris; Analyst; DA Davidson & Co.
Presentation
Operator
Good morning, and welcome to the Matrix Service Company conference call to discuss results for the second quarter of fiscal 2024. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host today, Ms. Kellie Smythe, Senior Director of Investor Relations for Matrix Service Company.
Kellie Smythe
Thank you, Valerie. Good morning, and welcome to Matrix Service Company Second Quarter Fiscal 2024 earnings call. Participants on today's call will include John Hewitt, President and Chief Executive Officer, and Kevin Cavanah, our Vice President and Chief Financial Officer. The presentation materials, we will be referring to during the webcast today can be found under Events and Presentations on the Investor Relations section of matrixservicecompany.com.
Before we begin, please let me remind you that on today's call, we may make various remarks about future expectations, plans and prospects for Matrix Service Company that 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 because of various factors, including those discussed in our most recent annual report on Form 10-K and in subsequent filings made by the Company with the SEC. To the extent we utilize non-GAAP measures, reconciliations will be provided in various press releases, periodic SEC filings and on our website.
Before I turn the call over to John Hewitt, I'd like to share that Matrix will be presenting at the upcoming Sidoti small-cap Virtual Conference on March 13 and 14. If you'd like additional information on this event or would like to have a conversation with management, I invite you to contact me through Matrix Service Company, Investor Relations website. I'll now turn the call over to John.
John Hewitt
Thank you, Kellie, and good morning, everyone. When we think about the safety risks prevalent in the construction industry, we often think about the physical risks to people. There are equally significant risks that have to do with mental health and well-being. Mental health issues arise for a variety of reasons. Loneliness pressure work environments, seasonal layoffs, loss of a family member or a friend and can manifest in different ways, including loneliness, anxiety, depression, suicidal thoughts and substance abuse. The construction industry as one of the highest suicide rate of any industry when compared to all other construction fatalities, suicide occurs five times or often.
This is why the construction industry has taken a collaborative approach to better understand mental health issues by providing research-based solutions through our participation in the construction industry Institute and construction safety research alliance matrix is directly involved in this effort. Matrix is also committed to doing all we can across our job sites and office locations, and we're doing so through a cross-functional internal initiative, Matrix cares. We believe that together we can make a difference for our own employees and others across our industry.
And I believe that mental and physical safety of our employees as well as those visiting our offices or job sites is the most important thing we can do as coworkers and allegiance. Let's talk about the business. I'm proud to announce that were awards of [$233 million] in a quarter. We have achieved a record backlog for matrix of $1.45 billion. This is an all-time high for the company in its 40 year history and is an achievement that as a result of the hard work of our people and our focused strategic approach in our core markets, we have transformed our organization to be more cost efficient while ensuring our skills expertise and strong brand are aligned with our core markets.
We are positioned to safely execute projects with improved operating processes while continuing to deliver best-in-class quality for our customers. As you will see when Kevin walk through our results, Matrix has resolved the primary issues that have plagued us the last few years. We have completed projects that were bid into highly competitive pandemic environment, which resulted in limited margin opportunity. We also streamlined and refocused the company stored our direct gross margins to our historical double digit range, rebuild our backlog to historic levels to support higher revenue volumes in the coming quarters and improved our liquidity position and reduced our debt to zero for dramatic improvement in both the volume and quality of the projects in our backlog, we expect revenue volume to grow and as such, leverage our streamlined cost structure, which will resolve our final issue.
Now I want to spend a few minutes on our work in the energy markets. Recently, President Biden pause pending and future permits to export LNG to non-free trade agreement countries. Generally, we do not expect this pause to impact our opportunity pipeline or backlog small to mid-scale LNG facilities we have won and are pursuing are domestic in nature, providing backup fuel supply, peak shaving or ship bunkering. Any LNG tank projects that are related to large-scale export facilities that might be associated with the current White House permit position are more of an opportunistic pursuit for Matrix. We have significant opportunities in the small to mid-scale LNG market I just described as well as NGLs, ammonia and hydrogen and expect these opportunities to continue contributing to backlog. While the transition to a low-carbon energy mix has been a focus of global energy policy.
The world is still heavily dependent on fossil fuel and will be for the foreseeable future. At the same time, energy companies are actively at work developing longer-term, more sustainable energy solutions for Matrix. Our expertise in both the traditional and emerging energy markets, together with our long-standing reputation for safety, quality delivery, positions us as a leading contractor across the entire industry and puts us in an advantageous position.
Our opportunity pipeline remains steady at $5 billion, demonstrating the strength of our markets and our ability to continue a long-term trend of backlog growth. We remain a contractor of choice for work in traditional oil and gas, including the engineering and construction of crude storage tanks, terminals, ongoing maintenance repair work, refinery turnarounds, retrofitting for renewable fuels and the installation of natural gas processing infrastructure for increasing use of LNG as a low-carbon solution for ensuring reliable and affordable power for electricity, heating and cooling and also an alternative fuel for high horsepower applications.
Matrix has emerged as a leader in the design, construction, maintenance and repair of LNG storage tanks and balance of plant facilities. Major energy companies also rely on us for NGL storage tanks, terminals such as ethane, ethylene, propane and butane that feed the global marketplace because of our country's vast safe and dependable natural gas availability.
Looking forward, the transition to sustainable energy is a broad initiative that will include among others, hydrogen. This is a market that while not presently a significant revenue driver for us will be as we assume a major leadership role in fulfilling the significant infrastructure needs that will evolve just as creation of our Long, our strong market position in LNG was made possible because of our specialty vessel cryogenic capabilities. The hygiene market requires the same specialized skill sets. It is not a market that will develop overnight nor is the one thing that any contracts you can simply step into wants us develop.
Same is true for ammonia and methanol as energy carriers and a means of transporting hydrogen drawing on our extensive cryogenic engineering and construction expertise. Matrix has already at work laying the foundation needed to ensure we are at the forefront and provide the needed solutions in this space. For example, we have completed construction of a hydrogen sphere in the southwestern US and are beginning the engineering for liquid hydrogen storage sphere for a client on the West Coast, which will all which we will also construct are also actively at work on a FEED study for a hydrogen production and distribution facility and working on a feasibility study for a global energy company to develop large-scale liquid hydrogen storage solutions with an increasing number of hydrogen and ammonia opportunities.
Internationally, we are building strategic relationships with construction organizations like that recently announced to So industries and other European partners, which provides the ability to offer complete EPC solutions across the European Union, United Kingdom, Norway, Switzerland, and elsewhere. As shared last quarter, we are in communication with some of our long-standing clients who are also part of the hydrogen of teams identified to receive funding under the bipartisan infrastructure law.
Of course, we continue to be active in our other end markets with robust opportunities and growth potential across each of our reporting segments. As I've said before, our organization has meaningfully transformed over the past few years and that transformation is showing up on our performance. We continue to fine tune the organization and are investing in the technology systems that personnel needed to execute our strategy and grow the business. I'll hand the call over to Kevin.
Kevin Cavanah
Thank you, John. The overall results for the second quarter were in line with our expectations. While revenue was a bit lower than expected direct margin performance, cost management, bottom-line performance, backlog and liquidity for all at or above our expectations. We generated awards of $231 million resulting in a book-to-bill ratio of 1.3, our 10th consecutive quarter at or above 1.0.
With these awards, we have increased our backlog to $1.45 billion, the highest in Company history. Backlog has increased 95% in the last year and 33% in the first half of fiscal 2024. Revenue of $175 million in the second quarter on the lower side of our range of expectations. The decline compared to first quarter revenue of $198 million related primarily to the normal timing of project execution on storage construction projects with the first quarter benefiting from a high level of project procurement.
As I mentioned last quarter, our backlog contains larger long-term construction projects. There's an inherent lag between the time when a project is awarded and when it begins to have a material impact on revenue in some cases, this lag can be between three and six months for longer. The contribution to revenue from these projects has been minimal thus far as each moves through scope, finalization, engineering and planning stages at its own pace.
So we expect revenue from these projects to increase modestly in the third quarter and then pick up meaningfully in the fourth quarter and remain at elevated levels throughout fiscal 2025 and 2026. In the meantime, we are encouraged that direct gross margins return to historical double digit levels in the first half of 2024. Project execution was strong once again but was offset by under-recovered construction overhead resulting from the low revenue volume that impacted gross margins by almost 500 basis points. The result was a gross margin of 6%, which was consistent with the first quarter. We expect to see improved overhead recovery in the third quarter and to achieve full recovery in the fourth quarter as a result of the revenue ramp we previously discussed.
Organizational efficiencies achieved over the last several years continue to benefit our cost structure sold and SG&A expenses were $15.7 million in the second quarter, which is the lowest level since the first quarter of fiscal 2014. This compares to $17.1 million in the first quarter. The decrease in second quarter was primarily attributable to a reduction in expense associated with the variable accounting for cash-settled stock compensation and lower project pursuit costs. The company will continue to control costs in order to leverage SG&A and expect to see modest targeted increases to support revenue growth as the curve progresses.
Other income during the second quarter included a gain of $2 million on a $2.7 million sale of a facility in Catoosa, Oklahoma. The facility was previously utilized for industrial cleaning business, which was sold during the fourth quarter of fiscal 2023. This completes the divestiture and closure of non-core service offerings as part of our strategy to focus the business on our core markets as expected, the effective tax rate was near zero for the second quarter, and we expect the effective tax rate to be around zero throughout the remainder of fiscal 2024. For the second quarter of fiscal 2024, we had a net loss of $2.9 million or $0.10 per fully diluted share, which was similar to the net loss of $3.2 million or $0.12 per share in the first quarter.
Moving to the operating segments, in the Storage and Terminal Solutions segment, revenue was $62 million in the second quarter as compared to $90 million in the first quarter of fiscal 2024. First quarter revenues for this segment were positively impacted by the procurement of materials and components for construction projects awarded in the prior fiscal year. We did not have a similar level of procurement in the second quarter. We expect higher revenue volume as we move through the remainder of fiscal 2024 and into fiscal 2025 as large specialty storage project awards, transition through contracting, project planning and mobilization and then to field construction.
Gross margin was 2.9% in the second quarter as strong project execution was negatively impacted by 770 basis points from the under-recovery of construction overhead costs due to the lower revenue. We have allocated additional resources this segment to support recent awards, a significant opportunity proposal pipeline and the related additional revenue that we expect in the coming quarters with revenue increases in this segment, we expect to reach full recovery of construction overhead costs in the fourth quarter.
In the Utility and Power Infrastructure segment, revenue was $40 million in the second quarter compared to $32 million in the first quarter. As revenue begins to benefit from peak shaver projects previously awarded, we expect LNG peak shaving revenue to continue to increase as we move through the second half of fiscal 2024. Gross margin was 3.5% in the second quarter of fiscal 2024 as good project execution in this segment was offset by almost 600 basis points from under-recovery of construction overhead costs. So we've allocated additional resources to this segment as well to support recent awards, a strong bidding environment and related anticipated revenue growth as revenue continues to increase in this segment, we expect to reach full recovery of overhead costs in the fourth quarter of fiscal 2024.
Finally, in the Process and Industrial Facilities segment, second quarter revenue was $71 million, which was slightly lower than the $75 million in the first quarter. We expect revenue to remain at similar level as we move through the remainder from fiscal 2024 and then increase in fiscal 2025 related to previously awarded construction work.
The segment gross margin was 9.4% in the second quarter compared to 6.8% in the first quarter with project execution strong in both quarters. We also reduce construction overhead costs in the second quarter by allocating resources to other segments as I noted previously.
Now I'll discuss our financial position liquidity increased to $106 million, an improvement of $26 million in the quarter. Positive net cash inflows of $30 million from operations allowed the company to repay all outstanding borrowings on our credit facility of $10 million and increase our cash balance by $20 million. We expect to see cash and liquidity also improve in the second half of fiscal 2024.
We will continue to proactively manage our balance sheet to support the improving business and believe we have the liquidity to support our financial needs including funding working capital for the normal spring peak in reimbursable work funding construction projects that are in a prepaid position and targeted capital expenditures to support operations as we move forward and continue to strengthen our balance sheet. We will evaluate our approach to capital allocation to ensure we are creating value for our shareholders.
That concludes my prepared comments, so I'll now turn the call back to John.
John Hewitt
Thank you, Kevin. Before we open for questions, I'd like to reiterate some key takeaways for today. First, with record high backlog, we expect to see a marked improvement in revenue volumes in the near term. Those higher revenue volumes will provide for better construction overhead absorption, leverage of SG&A and improved bottom line performance while difficult in our business to accurately predict the timing of awards starts and backlog conversion to revenue. We are highly confident in this outlook.
Second, we believe our strategic approach to our strong end markets, clients and services to help us maintain a sizable opportunity pipeline and lead to further backlog growth and strong performance well into the future.
Organizationally, we are leaner and more efficient. We will continue to invest in the process, processes and systems and people needed to drive performance improvement and deliver strong project execution.
In conclusion, there is a lot of positive momentum in the business, and we are well positioned to maximize our profitability and generate value and growth for our stakeholders.
I'd like to open the call for questions and then come back to you for some closing thoughts.
Question and Answer Session
Operator
(Operator Instructions) John Franzreb, Sidoti & Company.
John Franzreb
I'd like to start with the on the gross margin profile in the second quarter, considering how much revenue was down and you look at it versus a year ago, it was sizably better. How much reflects the absence of unprofitable jobs and how much reflects new jobs are priced appropriately in that mix? Can you give us a sense of what drove the margin in the quarter?
Kevin Cavanah
So as I talked about on the call, direct gross margins and therefore are strong back in the double digit on area that we've been striving to get to. As you know, that's the result of the quality of bookings that we have. We've had over the last year, year and a half. If you look at the same period last year, the direct origins were for were extremely low, low single digits down. And that was because of the combination. We were still working off the COVID backlog. Some we were still on continuing to work on a project that was on very difficult for us to complete in a profitable manner.
So when you look at the margin performance on a quarter over quarter, it's an extremely big improvement on and I don't have the split between what related to that to new projects versus Zeol. But just suffice it to say the margin performance on its back, where we need it to be on these projects. Now what's left is to get the revenue volume up to where we wanted, so we can fully recover our construction over there.
John Franzreb
And Kevin, just for clarity sake, what's your definition of direct gross margins?
Kevin Cavanah
So when I think about direct gross margins. It's the actual margin that our margin on each individual job on that when I think about gross margin is the combination of those direct margins on jobs on combined with the recovery of our construction overhead pool of costs that we utilize to manage all those projects. So when we get to a period where we've got the right volume.
We're fully we're fully on recovering those overheads and therefore, the direct gross margins is fairly equal to the on to the gross margin in a period where our revenue volume is low and we're not fully recovering that under-recovery can have a very significant impact. Our margins as it as it did this quarter, reaching almost 600 basis points. So that's that's that's something that's extremely important for us to manage. And that's the pitch. The one item that John noted in his comments that that we've still got to finish, getting that completed. We've completed everything else. We've just got to get that strong backlog we've booked the last year-plus to convert to revenue, which will be coming.
John Franzreb
And John, regarding the award cycle, what inning do you think you're in? Is it unreasonable to assume that it can persist at the current rate awards?
John Hewitt
No, I don't think that's unreasonable I that the biggest timing timing is everything. As you know, weather was order quarter after quarter. It was going to be above one or not, but we certainly think we're in a position to exit the year with a one plus on awards and our book to bill and projects that are in our pipeline. You know the outlook of a variety of sizes we think will continue to contribute to backlog well out of the future. So we think we're and early innings and our ability to continue to add some good projects to backlog and continuing to build and grow the business.
John Franzreb
Okay. Sounds great. And one last question. If I heard correctly in the prepared remarks, it sounds like to date revenue outlook is strong through fiscal 2026 based on the current bookings profile, that doesn't assume any incremental new awards, is that my proper understanding?
Kevin Cavanah
Well, so far, we always have a portion of our revenue. That's what we'll call book-and-burn work that will fall will get awarded and whole burned off in the next quarter or two. And then we have the larger projects that are -- have a tab of 2.5, 3 year construction period. So we're not when we make comments like that, you know, with these larger projects, we've added to backlog, and we've got much better visibility into the total revenue stream for '25 and '26. That gives us the confidence to make that statement.
John Hewitt
If I add onto that, John, to say the backlog in place now helps us lay a foundation for the future. And then overlay what we see in the opportunity pipeline gives us confidence that we're going to be able to have a strong revenue stream here out over the next couple of years.
Operator
John Morris, DA. Davidson.
John Morris
This is John Morris is from Brent Thielman of D.A. Davidson. I'll start with the revenue question. Should we see some revenue progression from fiscal quarter -- from the second fiscal quarter to the third it seems like this should be sort of a trough for revenue given the sizable backlog today?
Kevin Cavanah
Yes, we would agree with that. I think this will be the low point of the fiscal year, you'll see some So decent growth here in the third quarter and then it should be higher growth in the fourth.
John Morris
Could you just any views on the refinery turnaround season and activities you perform there. Just wanted to see if is better or worse relative to the past few years.
John Hewitt
Maybe we're entering our refinery turnaround cycle basically now we're sort of in at north of our refinery turnaround work is located in the Pacific Northwest. And I don't know that there's anything unusual this year versus last year. I would say I' probably pointed as sort of an average turnaround cycle for us. It's facilities that we work.
John Morris
Thank you. And one more question, so you mentioned some favorable direct margins. Are those continuing to get better with New York with the Work award in New York? Or I guess in other words, do the bid margins keep moving higher because the market's so busy right now.
Kevin Cavanah
I think what I would look at it is when we look at the margin performance in the first half of fiscal 2024. We've had some some good project closeouts on completing some projects that have helped move that margin up release overall, strong execution by our fire field that has helped that. I think that will be replaced by the quality backlog that we've got, those projects, so putting themselves to a similar level of margin.
So I wouldn't expect you know, we'll continue to strive to maximize that direct margin performance, but I wouldn't expect the direct margins to go significantly higher than our the 10% to 12% range that we've talked about being the normal range for the business. And you also need to remember that, you know, 30%, 40% of our businesses is reimbursable and a lot of maintenance activities, that type of work really good work for us, but it lends itself to a lower margin profile product profile. So it's set up double digit margins for we're in the high single digits for that type of work.
Operator
John Franzreb, Sidoti.
John Franzreb
Thank you on John, just back to the hydrogen discussion and I might have missed this. You said it was small, but put it in context, how much business you do in the hydrogen market? What do you think maybe the potential is and the time line for realizing that kind of a potential of.
John Hewitt
So I think obviously, it's about capacity, please. The US transitions to I have a higher percentage of hydrogen and in the energy mix, I think we feel pretty comfortable long-term that hydrogen will take a larger position in the US energy mix, whether that's for sorting and industrial processes. But for say a fuel for transit transportation fuel in it for some kind of a mix or blending for power generation.
So I think what you're seeing and what we're seeing right now is a lot of kind of foundation for us. Laying the foundation for our for the future were a lot of time spent on marketing time spent on providing feasibility and feed studies to various clients to help them with their decision-making profile on what their next steps are picking up an occasional story spear or an occasional maybe smaller hydrogen processing facility so I think it's going to continue to grow for us.
So I but I think we're probably a couple of years away from our hydrogen from a material impact on our backlog and revenues from hydrogen. That said, you know, I would expect here over the next 12 to 18 months and we'll continue to add, you know, small hydrogen-related projects into our backlog and that should continue to grow what were the subsequent years.
John Franzreb
Understood. And just a little bit about the leverage discussion. Kevin, you suggested that the second quarter SG&A was artificially low due to the timing of, I guess, bonus accruals and other items. But you also said that you expect to leverage the SG&A line rather significantly in the year ahead so how should we think about SG&A on a go-forward basis, similar to maybe the first quarter level marginal increase on? Just any color on that line would be helpful.
Kevin Cavanah
You know, I think to I think the second half SG&A will probably be higher than that. Not no first half was that the variable accounting on cash-settled stock-based compensation will have a higher expense. We also anticipate increased project pursuit costs as we continue to work to build the backlog. And then, you know, then just so some other targeted increases that will need just for the added revenue volume that comes.
But the way I think about SG&A is we've got a target out there. We're trying to get to -- get the SG&A at a 6.5%. I think we'll make another significant move toward that. And especially in the fourth quarter, it will look, I'm not sure we'll get all the way there, but we can definitely get much closer to hopefully get to 7% or -- 7% or lower. And then I think that's a good achievable mark in fiscal '25.
John Franzreb
And we've talked about asset relocation, just about moving guys from a personnel from process into utility and storage, not adding additional personnel is. Am I understanding that properly?
Kevin Cavanah
So there's really two aspects of the construction overhead. So first of all, we talk about reallocating resources of. We've talked about the fact that our staffs can work in multiple segments and if you look at the volume of revenue that was flowing through the Process and Industrial Facilities segment last year, it's definitely a higher percentage that we've completed some of that work and a mission that we're kind of in a keynote at a lull period here before additional work kicks in.
So those resources are being allocated toward the other two segments and I wanted to chat a little more color on those resources, what the zone are. That's all the project management, the quality of safety from all that infrastructure we have in place to execute the projects will be more focused on those other two segments down in the second half of the year than than they were in, say, the prior year.
John Franzreb
Okay. And just lastly, on the long term financial targets, any kind of update when we would expect to realize those targets? Is that the exit velocity in this 2025 or what are your thoughts there?
Kevin Cavanah
I think again, it's similar positive answer on SG&A. I think you see a significant movement toward those targets at the end of the fourth quarter? Or will we get there all the way? I'm not sure about that, but I do think those are achievable in fiscal '25.
Operator
John Morris, DA Davidson.
John Morris
I am just thinking about CapEx can you give us a sense of how we should be modeling CapEx for the year or the next couple of years? Just the should we think of that? Is it tied to revenue growth, presuming there are some cost to support of this growth rate.
Kevin Cavanah
It is tied to revenue growth. And it's also tied back that as we've been trying to control costs the last few years, we've held our capital expending pretty low. So I would expect it to increase. We'd put a long-term target out there at 1.5% of revenue. I think we'd probably be at around that level for the second half of the year or potentially a little higher as we as we kind of levels you ramp up some of that CapEx for the further revenue volumes that are coming and about.
I haven't done I don't have a fiscal '25 CapEx budget at this point, but I would expect we did we'd probably be at least at the but 1.5% next year or potentially a little higher.
John Morris
And for fiscal year '25, would you say a little higher. Is that compared to and the second half of the fiscal year '24 or just in general, a little higher than 1%?
Kevin Cavanah
I'm talking a little higher as a percent of revenue. When I talk about the 1.5% of revenue, it could be it could be 1.8% or 2%. But again, I don't have I don't have a develop CapEx forecast yet. I'm just anticipating that there will be needs for portions of the business they are growing.
Operator
Thank you. I'm showing no further questions at this time. I turn the call back over to John Hewitt for any closing remarks.
John Hewitt
I want to thank everybody for being on the call today. I hope it's clear that there are a lot of great things happening in the business and that we are positioned for significantly improved bottom line profitability as you look out at the bottom of the short term here. So thank you very much for your time today and everybody, please be safe.
Operator
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect and have a great day.
