Item 7. Management’s Discussion and Analysis
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 revenue 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.
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CRITICAL ACCOUNTING POLICIES
Revenue Recognition
General Information about our Contracts with Customers
Our revenue comes from contracts to provide engineering, procurement, fabrication and construction, repair and maintenance and other services. Our engineering, procurement and fabrication and construction services are usually provided in association with capital projects, which commonly are fixed price contracts and are billed based on project milestones. Our repair and maintenance services typically are cost reimbursable or time and material based contracts and are billed monthly or, for projects of short duration, at the conclusion of the project. The elapsed time from award to completion of performance may be in excess of one year for capital projects.
Step 1: Contract Identification
We do not recognize revenue unless we have identified a contract with a customer. A contract with a customer exists when it has approval and commitment from both parties, the rights and obligations of the parties are identified, payment terms are identified, the contract has commercial substance, and collectibility is probable. We also evaluate whether a contract should be combined with other contracts and accounted for as one single contract. This evaluation requires judgment and could change the timing of the amount of revenue and profit recorded for a given period.
Step 2: Identify Performance Obligations
Next, we identify each performance obligation in the contract. A performance obligation is a promise to provide a distinct good or service or a series of distinct goods or services to the customer. Revenue is recognized separately for each performance obligation in the contract. Many of our contracts have one clearly identifiable performance obligation. However, many of our contracts provide the customer an integrated service that includes two or more of the following services: engineering, procurement, fabrication, construction, repair and maintenance services. For these contracts, we do not consider the integrated services to be distinct within the context of the contract when the separate scopes of work combine into a single commercial objective or capability for the customer. Accordingly, we generally identify one performance obligation in our contracts. The determination of the number of performance obligations in a contract requires significant judgment and could change the timing of the amount of revenue recorded for a given period.
Step 3: Determine Contract Price
After determining the performance obligations in the contract, we determine the contract price. The contract price is the amount of consideration we expect to receive from the customer for completing the performance obligation(s). In a fixed price contract, the contract price is a single lump-sum amount. In reimbursable and time and materials based contracts, the contract price is determined by the agreed upon rates or reimbursements for time and materials expended in completing the performance obligation(s) in the contract.
A number of our contracts contain various cost and performance incentives and penalties that can either increase or decrease the contract price. These variable consideration amounts are generally earned or incurred based on certain performance metrics, most commonly related to project schedule or cost targets. We estimate variable consideration at the most likely amount of additional consideration to be received (or paid in the case of penalties), provided that meeting the variable condition is probable. We include estimated amounts of variable consideration in the contract price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the contract price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us. We reassess the amount of variable consideration each accounting period until the uncertainty associated with the variable consideration is resolved. Changes in the assessed amount of variable consideration are accounted for prospectively as a cumulative adjustment to revenue recognized in the current period.
Step 4: Assign Contract Price to Performance Obligations
After determining the contract price, we assign such price to the performance obligation(s) in the contract. If a contract has multiple performance obligations, we assign the contract price to each performance obligation based on the stand-alone selling prices of the distinct services that comprise each performance obligation.
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Step 5: Recognize Revenue as Performance Obligations are Satisfied
We record revenue for contracts with our customers as we satisfy the contracts' performance obligations. We recognize revenue on performance obligations associated with fixed price contracts for engineering, procurement, fabrication and construction services over time since these services create or enhance assets the customer controls as they are being created or enhanced. We measure progress of satisfying these performance obligations by using the percentage-of-completion method, which is based on costs incurred to date compared to the total estimated costs at completion, since it best depicts the transfer of control of assets being created or enhanced to the customer.
We recognize revenue over time for reimbursable and time and material based repair and maintenance contracts since the customer simultaneously receives and consumes the benefit of those services as we perform work under the contract. As a practical expedient allowed under the revenue accounting standards, we record revenue for these contracts in the amount to which we have a right to invoice for the services performed provided that we have a right to consideration from the customer in an amount that corresponds directly with the value of the performance completed to date.
Costs incurred may include direct labor, direct materials, subcontractor costs and indirect costs, such as salaries and benefits, supplies and tools, equipment costs and insurance costs. Indirect costs are charged to projects based upon direct costs and overhead allocation rates per dollar of direct costs incurred or direct labor hours worked. Typically, customer contracts will include standard warranties that provide assurance that products and services will function as expected. The Company does not sell separate warranties.
We have numerous contracts that are in various stages of completion which require estimates to determine the forecasted costs at completion. Due to the nature of the work left to be performed on many of our contracts, the estimation of total cost at completion for fixed price contracts is complex, subject to many variables and requires significant judgment. Estimates of total cost at completion are made each period and changes in these estimates are accounted for prospectively as cumulative adjustments to revenue recognized in the current period. 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.
Change Orders
Contracts are often modified through change orders, which are changes to the agreed upon scope of work. Most of our change orders, which may be priced or unpriced, are for goods or services that are not distinct from the existing contract due to the significant integration of services provided in the context of the contract and are accounted for as if they were part of that existing contract. The effect of a change order on the contract price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue on a cumulative catch-up basis. For unpriced change orders, we estimate the increase or decrease to the contract price using the variable consideration method described in the Step 3: Determine Contract Price paragraph above. Unpriced change orders are more fully discussed in Note 7 - Commitments and Contingencies of the Notes to Financial Statements.
Claims
Sometimes we seek claims for amounts in excess of the contract price for delays, errors in specifications and designs, contract terminations, change orders in dispute or other causes of additional costs incurred by us. Recognition of amounts as additional contract price related to claims is appropriate only if there is a legal basis for the claim. The determination of our legal basis for a claim requires significant judgment. We estimate the change to the contract price using the variable consideration method described in the Step 3: Determine Contract Price paragraph above. Claims are more fully discussed in Note 7 - Commitments and Contingencies of the Notes to Financial Statements.
Unpriced Change Orders and Claims
Costs and estimated earnings in excess of billings on uncompleted contracts included revenue for unpriced change orders and claims of $14.5 million at June 30, 2020 and $10.1 million at June 30, 2019. The amounts ultimately realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings. Generally, collection of amounts related to unpriced change orders and claims is expected within twelve months. However, customers may not pay these amounts until final resolution of related claims, and accordingly, collection of these amounts may extend beyond one year.
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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 Accounting Standard Codification ("ASC") Topic 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.
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, which is a level below our reportable segments.
We perform our annual impairment test in the fourth quarter of each fiscal year, or in between annual tests whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable, to determine whether an impairment exists 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 goodwill impairment test involves comparing management’s estimate of the fair value of a reporting unit with its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, then goodwill is not impaired. If the fair value of a reporting unit is less than its carrying value, then goodwill is impaired to the extent of the difference, but the impairment may not exceed the balance of goodwill assigned to that reporting unit.
We utilize a discounted cash flow analysis, referred to as an income approach, and market multiples, referred to as a market approach, to determine the estimated fair value of our reporting units. For the income approach, significant judgments and assumptions including forecasted project awards, discount rate, anticipated revenue growth rate, gross margins, operating expenses, working capital needs and capital expenditures are inherent in the 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. For the market approach, significant judgments and assumptions include the selection of guideline companies, forecasted guideline company EBITDA and our forecasted EBITDA. 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 additional impairment charges in the financial statements. As a test for reasonableness, we also consider the combined carrying values of our reporting units to our market capitalization.
In the second quarter of fiscal 2020, the Company concluded that a goodwill impairment indicator existed in the Electrical Infrastructure segment based on the recent history of depressed gross margins and the second quarter’s downward acceleration of revenue and gross margin. Accordingly, the Company performed an interim impairment test as of December 31, 2019, reflecting updated revenue and gross margin assumptions, and concluded that the reporting unit's $24.9 million of goodwill was fully impaired. Additionally, the Company concluded that a goodwill impairment indicator existed for an Industrial segment reporting unit based on several second quarter events. These events included the deterioration of our relationship with a significant customer in the iron and steel industry in the second quarter. As a result, the customer canceled other previously awarded work and the Company is expecting little to no new business from this customer in the foreseeable future. Accordingly, the Company performed an interim impairment test as of December 31, 2019 and concluded that the reporting unit's $8.0 million of goodwill was fully impaired.
During the third quarter of fiscal 2020, the Company concluded that goodwill impairment indicators existed based on the uncertainties caused by the COVID-19 pandemic and the significant decline in the price of crude oil. These uncertainties resulted in lowered revenue expectations for the remainder of fiscal 2020 and fiscal 2021 and led to significant volatility in the Company's stock price. Accordingly, the Company performed an interim test as of March 31, 2020, which did not result in any additional impairments.
The Company performed its annual goodwill impairment test as of May 31, 2020, which resulted in no impairment. The fiscal 2020 test indicated that three reporting units with a combined total of $ 14.2 million of goodwill as of June 30, 2020 were at higher risk of future impairment than others. If the Company's view of project opportunities or gross margins deteriorates, particularly for the higher risk reporting units, then the Company may be required to record a material impairment of goodwill.
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We considered the amount of headroom for each reporting unit when determining whether an impairment existed. The amount of headroom varies by reporting unit. Our significant assumptions, including revenue growth rates, gross margins, discount rate and other factors may change in the future based on the changing 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:
Headroom Sensitivity Analysis
Goodwill as of June 30, 2020
(in thousands) Baseline Headroom Headroom if Revenue Growth Rate
Declines by 100 Basis Points Headroom if Gross Margin
Declines by 100 Basis Points Headroom if Discount Rate Increases by 100 Basis Points
Reporting Unit 1 $ 6,112 6% -1% -28% -5%
Reporting Unit 2 $ 3,914 29% 25% -17% 12%
Reporting Unit 3 $ 4,130 48% 37% -19% 26%
All other reporting units $ 46,213 75% to 228% 67% to 209% 58% to 167% 56% to 191%
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, with the help of professional tax advisors. Therefore, we estimate and provide for amounts of additional income taxes that may be assessed by the various taxing authorities.
Leases
The Company enters into lease arrangements for real estate, construction equipment and information technology equipment in the normal course of business. The Company determines if an arrangement is or contains a lease at inception of the arrangement. An arrangement is determined to be a lease if it conveys the right to control the use of identified property and equipment for a period of time in exchange for consideration. Operating lease right-of-use assets are recognized as the present value of future lease payments over the lease term as of the commencement date, plus any lease payments made prior to commencement, and less any lease incentives received. Operating lease liabilities are recognized as the present value of the future lease payments over the lease term as of the commencement date. Operating lease expense is recognized based on the undiscounted future lease payments over the remaining lease term on a straight-line basis. Lease expense related to short-term leases is recognized on a straight-line basis over the lease term.
Determinations with respect to lease term (including any renewals and terminations), incremental borrowing rate used to discount lease payments, variable lease expense and future lease payments require the use of judgment based on the facts and circumstances related to each lease. The Company considers various factors, including economic incentives, intent, past history and business need, to determine the likelihood that a renewal option will be exercised.
Right-of-use assets are evaluated for impairment in accordance with our policy for impairment of long-lived assets.
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Recently Issued Accounting Standards
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
On June 16, 2016, the Financial Accounting Standards Board (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.
Previous 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 Company adopted the standard on July 1, 2020 with no material impact to its estimate of the allowance for uncollectible accounts.
Results of Operations
Overview
In fiscal 2020, we operated our business through four reportable segments: Electrical Infrastructure; Oil Gas & Chemical; Storage Solutions; and Industrial.
The Electrical Infrastructure segment consists of power delivery services provided to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, as well as emergency and storm restoration services. We also provide construction and maintenance services to a variety of power generation facilities, such as combined cycle plants and other natural gas fired power stations.
The Oil Gas & Chemical segment serves customers primarily in the downstream and midstream petroleum industries who are engaged in refining crude oil and processing, fractionating, and marketing of natural gas and natural gas liquids. We also perform work in the petrochemical, and sulfur extraction, recovery and processing markets. Our services include plant maintenance, turnarounds, engineering and capital construction. We also offer industrial cleaning services, including hydro-blasting, hydro-excavating, advanced chemical cleaning and vacuum services.
The Storage Solutions segment consists of work related to aboveground storage tanks ("AST") and terminals. Also included in this segment are cryogenic and other specialty storage tanks and terminals including liquefied natural gas, liquid nitrogen/liquid oxygen, liquid petroleum and other specialty vessels such as spheres as well as marine structures and truck and rail loading/offloading facilities. Our services include engineering, fabrication and construction, and maintenance and repair, which includes planned and emergency services for both tanks and full terminals. 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 Process and Industrial Facilities segment includes engineering, maintenance, turnarounds and capital projects for the refining, chemical and petrochemical industries; midstream natural gas processing; other industrial processing facilities including biofuels, fertilizer, and sulfur; mining and minerals infrastructure; and thermal vacuum chambers. This segment is similar to the former Oil Gas & Chemical segment described above, but includes mining and minerals, thermal vacuum chambers, and work in other industrial facilities which were historically reported in the Industrial segment.
Due to changing markets facing our clients and to better align the financial reporting of the Company with our long-term strategic growth areas, we are changing our reporting segments. Beginning in fiscal 2021, the Company’s financial results will be reported under the following three segments: Utility and Power Infrastructure; Process and Industrial Facilities; and Storage and Terminal Solutions. The services provided by each of these segments is described below.
The Utility and Power Infrastructure segment includes services provided in power delivery and power generation, as well as natural gas utility peak shaving. This segment is similar to the former Electrical Infrastructure segment described above, but includes natural gas utility peak shaving facilities that have been historically reported in the Storage Solutions segment.
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The Process and Industrial Facilities segment includes engineering, maintenance, turnarounds and capital projects for the refining, chemical and petrochemical industries; midstream natural gas processing; other industrial processing facilities including biofuels, fertilizer, and sulfur; mining and minerals infrastructure; and thermal vacuum chambers. This segment is similar to the former Oil Gas & Chemical segment described above, but includes mining and minerals as well as thermal vacuum chambers, which were historically reported in the Industrial segment.
The Storage and Terminal Solutions segment includes engineering, construction, maintenance and repair for aboveground storage tanks and terminals; LNG facilities for import/export fueling and bunkering; NGL and other specialty vessels; aboveground storage tank products; and other renewable energy storage and terminal solutions. This segment is similar to the former Storage Solutions segment described above, but does not include the natural gas utility peak shaving facilities, which will be reported as part of the Utility and Power Infrastructure segment.
The majority of the work for all segments is performed in the United States, with 7.3% of revenue generated internationally during fiscal 2020, 3.4% in fiscal 2019 and 10.1% in fiscal 2018. The percentage of revenue generated internationally increased in fiscal 2020 compared to fiscal 2019 due to higher levels of work in Canada. The percentage of revenue generated internationally decreased in fiscal 2019 compared to fiscal 2018 due to the completion of a significant Canadian power generation project in our Electrical Infrastructure segment in fiscal 2018.
Significant period to period changes in revenue, gross profits and operating results between fiscal 2020 and fiscal 2019 are discussed below on a consolidated basis and for each segment. A discussion of results of operations changes between fiscal 2019 and fiscal 2018 is included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended June 30, 2019, which was filed with the SEC on September 4, 2019.
Matrix Service Company
Results of Operations
(In thousands)
Electrical
Infrastructure Oil Gas &
Chemical Storage
Solutions Industrial Total
Fiscal Year 2020
Consolidated revenue $ 112,890 $ 200,950 $ 559,199 $ 227,899 $ 1,100,938
Gross profit (loss) (1,105) 15,822 71,934 15,525 102,176
Gross profit (loss) % (1.0) % 7.9 % 12.9 % 6.8 % 9.3 %
Selling, general and administrative expenses 7,543 19,300 43,332 16,101 86,276
Intangible asset impairments and restructuring costs 27,855 3,850 1,296 19,524 52,525
Operating income (loss) (36,503) (7,328) 27,306 (20,100) (36,625)
Operating income (loss) % (32.3) % (3.6) % 4.9 % (8.8) % (3.3) %
Fiscal Year 2019
Consolidated revenue $ 217,417 $ 319,867 $ 521,932 $ 357,464 $ 1,416,680
Gross profit 15,470 35,987 56,011 24,483 131,951
Gross profit % 7.1 % 11.3 % 10.7 % 6.8 % 9.3 %
Selling, general and administrative expenses 11,802 23,003 41,914 17,302 94,021
Intangible asset impairments and restructuring costs — — — — —
Operating income 3,668 12,984 14,097 7,181 37,930
Operating income % 1.7 % 4.1 % 2.7 % 2.0 % 2.7 %
Variances Fiscal Year 2020 to Fiscal Year 2019 Increase/(Decrease)
Consolidated revenue $ (104,527) $ (118,917) $ 37,267 $ (129,565) $ (315,742)
Gross profit (16,575) (20,165) 15,923 (8,958) (29,775)
Selling, general and administrative expenses (4,259) (3,703) 1,418 (1,201) (7,745)
Intangible asset impairments and restructuring costs 27,855 3,850 1,296 19,524 52,525
Operating income (40,171) (20,312) 13,209 (27,281) (74,555)
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Operational Update
As the COVID-19 pandemic persists, the Company's top priority has been to maintain a safe working environment for all employees, customers and business partners. We transitioned the majority of our administrative and engineering team members to remote working conditions in March 2020. At this time, we have returned to the office in select locations where predetermined criteria have been met, but the majority of our administrative and engineering team members continue to work remotely. Our project teams in coordination with our clients created work processes to integrate the guidance from governmental agencies and leading health organizations to protect the health and safety of everyone on our job sites while maintaining productivity.
There continues to be significant uncertainty regarding the near- and intermediate-term economic impacts from the COVID-19 pandemic, which has disrupted the markets we serve. As a result, the Company expanded its previously announced business improvement plan, which consisted of discretionary cost reductions, workforce reductions and closures of certain offices in order to increase the utilization of the Company's staff and bring the cost structure of the business in line with our revenue expectations.
The Company's previously announced business improvement plan was in response to underperformance in the Company's Electrical Infrastructure segment, which led to a $24.9 million impairment of goodwill during the second quarter of fiscal 2020. In addition, the Company recorded $13.6 million of goodwill and other intangible asset impairments during the second quarter of fiscal 2020 in connection with the deterioration of our relationship with a significant customer in the iron and steel industry. The Company made a strategic decision to exit the domestic iron and steel business early in the third quarter of fiscal 2020, which resulted in incurring restructuring costs to exit the business. Finally, during the second quarter of 2020, the Company placed a $2.4 million valuation allowance on a deferred tax asset that was created by net operating loss carryforwards and other tax credits in Canada, which was determined to be unrecoverable.
The Company incurred $14.0 million of restructuring costs in fiscal 2020 in connection with its business improvement plan, other restructuring activities, and the wind down of the domestic iron and steel business. These initiatives were substantially completed as of June 30, 2020. As a result of these actions, the Company expects to save approximately $45 million in planned annual operating costs.
In order to more clearly depict the core profitability of the Company, the following table presents our net income and earnings per fully diluted share for fiscal 2020 after adjusting for restructuring costs, impairments, and the Canadian tax valuation allowance:
Reconciliation of Adjusted Net Income and Diluted Earnings per Common Share (1)
(In thousands, except per share data)
Fiscal Year Ended June 30, 2020
Amount of
Charge Income Tax Effect of Charge Net
Income
(Loss) Earnings (Loss) Per Diluted Share
Net loss per common share, as reported $ (33,074) $ (1.24)
Restructuring costs incurred
$ 14,010 $ (3,369) 10,641 0.39
Electrical Infrastructure segment goodwill impairment
24,900 (4,889) 20,011 0.74
Industrial segment goodwill and other intangible asset impairment
13,615 (2,803) 10,812 0.40
Valuation allowance placed on a deferred tax asset
2,417 — 2,417 0.09
Adjustment for dilutive effect of using basic shares for net loss — 0.02
Adjusted net income and diluted earnings per common share
$ 10,807 $ 0.40
Weighted average common shares outstanding - diluted:
As reported
26,621
Previously anti-dilutive common shares
490
Adjusted weighted average common shares outstanding - diluted
27,111
(1) This table presents non-GAAP financial measures of our adjusted net income and adjusted diluted earnings per common share for fiscal 2020. The most directly comparable financial measures are net loss and net loss per common share, respectively, presented in the Consolidated Statements of Income. We have presented these non-GAAP financial measures because we believe they more clearly depict the core operating results of the Company during the period presented and provide a more comparable measure of the Company's operating results to other companies considered to be in similar businesses. Since adjusted net income and adjusted diluted earnings per common share are not measures of performance calculated in accordance with GAAP, they should be considered in addition to, rather than as a substitute for, the most directly comparable GAAP financial measures.
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Fiscal 2020 Versus Fiscal 2019
Consolidated
Consolidated revenue was $1.101 billion for the fiscal year ended June 30, 2020, compared to $1.417 billion in fiscal 2019. On a segment basis, consolidated revenue decreased in the Industrial, Oil Gas & Chemical, and Electrical Infrastructure segments by $129.6 million, $118.9 million and $104.5 million, respectively. These decreases were partially offset by an increase in the Storage Solutions segment of $37.3 million.
Consolidated gross profit was $102.2 million in fiscal 2020 compared to $132.0 million in fiscal 2019. Gross margin was 9.3% in fiscal 2020 and fiscal 2019. Gross margins in fiscal 2020 are the result of strong project execution, offset by the under recovery of construction overhead costs due to lower than anticipated revenue volumes, particularly in the fourth quarter. Fiscal 2019 was positively impacted by higher revenue volumes, which led to an over recovery of construction overhead costs.
Consolidated SG&A expenses were $86.3 million in fiscal 2020 compared to $94.0 million in fiscal 2019. The decrease in fiscal 2020 was primarily attributable to lower incentive compensation due to weaker operating results in the current year.and savings from executing the previously announced business improvement plan.
The Company recorded non-cash goodwill and other intangible asset impairments of $38.5 million during the second quarter of fiscal 2020. See Item 8. Financial Statements, Note 4 - Goodwill and other intangible assets for more information about the impairments. In addition, the Company recorded $14.0 million of restructuring costs in the third and fourth quarters of fiscal 2020 due to actions taken under our business improvement plan. See Operational Update in this Results of Operations section and Item 8. Financial Statements, Note 14 - Restructuring Costs, for more information.
Interest expense was $1.6 million in fiscal 2020 and $1.3 million in fiscal 2019. The increase in interest expense was primarily due to a higher average debt balance during fiscal 2020, partially offset by lower interest rates in fiscal 2020. Interest income was $1.3 million during fiscal 2020 compared to $1.2 million in fiscal 2019 due to an increase in our average cash balance during fiscal 2020, partially offset by lower interest rates in fiscal 2020.
Our effective tax rate for fiscal 2020 was 9.7% compared to 27.2% in fiscal 2019. The tax benefit for fiscal 2020 was negatively impacted by a $3.1 million of valuation allowances placed on deferred tax assets that were created by net operating loss carryforwards and other tax credits primarily in Canada, the non-deductible portion of the goodwill impairments that would have resulted in a $1.8 million reduction of income tax expense, and $1.7 million of other non-deductible expenses. These negative impacts were partially offset by $1.8 million of research and development and other tax credits. The effective tax rate in fiscal 2019 was negatively impacted by $4.5 million of valuation allowances placed on net operating loss carryforwards and foreign tax credits generated by our branch operations in Canada, and $1.2 million of non-deductible expenses. These negative impacts were largely offset by the reversal of $3.5 million of branch liabilities associated with the valuation allowances placed on our Canadian branch net operating loss carryforwards and foreign tax credits, $2.0 million of research and development and other tax credits and $0.3 million of excess tax benefits related to the vesting of stock-based compensation. A full analysis of the Company's provision for income taxes is included in Item 8. Financial Statements and Supplementary Data, Note 6 - Income Taxes.
In fiscal 2020, net loss was $33.1 million, or $1.24 per fully diluted share, compared to net income of $28.0 million, or $1.01 per fully diluted share, in fiscal 2019.
Electrical Infrastructure
Revenue for the Electrical Infrastructure segment decreased $104.5 million to $112.9 million in fiscal 2020 compared to $217.4 million in fiscal 2019. The decrease is primarily due to lower volumes of power delivery and power generation work. The segment gross margin (loss) was (1.0)% in fiscal 2020 compared to 7.1% in the same period last year. The fiscal 2020 segment gross loss was negatively impacted by poor execution in the first and second quarters and lower volumes throughout the year, which led to the under recovery of construction overhead costs. The segment gross margin in fiscal 2019 was negatively impacted by lower than previously forecasted margins on a limited number of power delivery projects. In fiscal 2019, we expanded our power delivery business geographically, however, the margins on this work did not meet our expectations. The fiscal 2019 segment margin was also negatively impacted when the proceeds from the settlement of a customer dispute were less than previously anticipated. The negative impacts to the fiscal 2019 segment gross margin were partially offset by strong project execution on power generation package work.
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In the second quarter of fiscal 2020, the Company announced a business improvement plan for this segment. The plan included significant changes to the operations and management of the business, including changes to leadership and mid-level operational personnel, modifications to operational processes, and increased business development resources. During the second half of fiscal 2020, we implemented the planned personnel changes, added business development resources and strengthened business processes, which has led to improved project execution. However, it is still too early to assess the long-term effectiveness of the business improvement plan. Furthermore, an improvement in the operating performance of this segment will be dependent upon the effectiveness and execution of the improvement plan, the markets we serve, the spending volumes of our existing clients and other external factors.
As a result of the COVID-19 pandemic, we have experienced suspensions of work at certain job sites and client proposal activity has slowed as customers manage other pandemic-related challenges. We will continue to assess conditions in the areas we serve and resume normal operations based on the needs of our clients and safety guidelines to ensure the protection of our employees and customers.
Oil Gas & Chemical
Revenue for the Oil Gas & Chemical segment was $201.0 million in fiscal 2020 compared to $319.9 million in the same period a year earlier. The decrease of $118.9 million is primarily due to lower volumes of turnaround and refinery maintenance work. The segment gross margin was 7.9% in fiscal 2020 compared to 11.3% in the same period last year. The fiscal 2020 segment gross margin was negatively impacted by lower volumes, which led to the under recovery of construction overhead costs, partially offset by strong project execution. Project execution was strong in fiscal 2019 and higher volumes led to an over recovery of construction overhead costs.
The short-term impact to the Company's refinery turnaround and maintenance operations as a result of the global pandemic has been significant. The impact has been exacerbated by the timing of the onset of the pandemic during what is normally a busy spring turnaround season. Although there have been project delays and temporary suspensions of planned seasonal work, in most cases the revenue volumes are moving out in time, but not eliminated. The updated start dates on many of the delayed activities are uncertain and will depend on the needs of our clients, safety guidelines, and the market.
Storage Solutions
Revenue for the Storage Solutions segment was $559.2 million in fiscal 2020 compared to $521.9 million in fiscal 2019, an increase of $37.3 million. The increase in segment revenue is primarily a result of increased tank and terminal construction work and higher levels of work in Canada. The segment gross margin was 12.9% in fiscal 2020 compared to 10.7% in fiscal 2019. The fiscal 2020 segment gross margin was positively impacted by strong project execution on large capital projects. During the first half of fiscal 2019, the segment gross margin was negatively impacted by the wind down of lower margin work awarded in a highly competitive environment and lower than previously forecasted margins on a limited number of those projects.
As a result of the COVID-19 pandemic, global energy demand, and regulatory issues, we experienced short-term suspensions of work on a limited number of projects, but work on most of these projects has resumed. In addition, some project awards and starts were delayed for durations varying from a few weeks to a few quarters.
Industrial
Revenue for the Industrial segment was $227.9 million in fiscal 2020 compared to $357.5 million in fiscal 2019, a decrease of $129.6 million. The decrease in revenue is primarily attributable to our strategic decision to exit the domestic iron and steel industry early in the third quarter, and lower volumes of thermal vacuum chamber work. We no longer have a continuous presence in any domestic iron and steel facility and final wind-down of the business is substantially complete. The segment gross margin was 6.8% in fiscal 2020 and fiscal 2019. The fiscal 2020 segment gross margin was negatively impacted by sharply lower volumes and under recovery of overhead costs during the second half of the year due to the wind down of the domestic iron and steel business. These negative impacts to segment gross margin were partially offset by good project execution on both capital and repair and maintenance projects during the first half of the year and a favorable project closeout on a thermal vacuum chamber project in the fourth quarter. The fiscal 2019 segment gross margin was negatively impacted by a lower than previously forecasted margin on a thermal vacuum chamber project, partially offset by improved gross margins on iron and steel work.
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Non-GAAP Financial Measures
Adjusted EBITDA
We have presented Adjusted EBITDA, which we define as net income (loss) before impairment of goodwill and other intangible assets, restructuring costs, interest expense, income taxes, depreciation and amortization, 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 (loss)” is the most directly comparable GAAP measure to Adjusted EBITDA. Since Adjusted 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. Adjusted 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 Adjusted EBITDA excludes certain financial information compared with net income (loss), 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, Adjusted EBITDA, has certain material limitations as follows:
• It does not include impairments to goodwill and other intangible assets. While impairments to intangible assets are non-cash expenses in the period recognized, cash or other consideration was still transferred in exchange for the intangible assets in the period of the acquisition. Any measure that excludes impairments to intangible assets has material limitations since these expenses represent the loss of an asset that was acquired in exchange for cash or other assets.
• It does not include restructuring costs. Restructuring costs represent material costs that were incurred by the Company and are oftentimes cash expenses. Therefore, any measure that excludes restructuring costs has material limitations.
• It does not include interest expense. Because we have borrowed money to finance our operations and to acquire businesses, pay commitment fees to maintain our senior secured revolving credit facility, and incur fees to issue letters of credit under the senior secured revolving 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 Adjusted EBITDA to net income (loss) follows:
Fiscal Years Ended
June 30,
2020 June 30,
2019 June 30,
2018
(in thousands)
Net income (loss) $ (33,074) $ 27,982 $ (11,480)
Goodwill and other intangible asset impairment 38,515 — 17,998
Restructuring costs 14,010 — —
Interest expense 1,597 1,296 2,600
Provision (benefit) for federal, state and foreign income taxes (3,570) 10,430 (668)
Depreciation and amortization 19,124 18,224 20,347
Adjusted EBITDA $ 36,602 $ 57,932 $ 28,797
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LIQUIDITY AND CAPITAL RESOURCES
Overview
We define liquidity as the ability to pay our liabilities as they become due, fund business operations and meet all contractual and financial obligations. Our primary sources of liquidity in fiscal 2020 were cash and cash equivalents on hand, capacity under our senior secured revolving credit facility and cash generated from operations. Cash and cash equivalents on hand at June 30, 2020 totaled $100.0 million and availability under the senior secured revolving credit facility totaled $93.4 million, resulting in total liquidity of $193.4 million.
There continues to be significant uncertainty regarding the near- and intermediate-term business impacts from the COVID-19 pandemic. However, the Company entered this environment with a strong balance sheet and liquidity, which it expects to be sufficient to support its near- to intermediate-term needs. In fiscal 2020, the Company implemented steps to preserve its financial position including:
• restructuring the business to right-size the cost structure to the expected near-term revenue;
• eliminating all non-critical capital expenditures; and
• suspending share repurchases.
We believe the cost reduction efforts were appropriate given the circumstances. These reductions were significant, but did not impact our capabilities nor our ability to execute work. These reductions will enable us to be more competitive and profitable in the future and preserve liquidity.
The following table provides a summary of changes in our liquidity for the fiscal year ended June 30, 2020 (in thousands):
Liquidity as of June 30, 2019 $ 241,898
Net increase in cash and cash equivalents 10,321
Increase in credit facility capacity constraint (68,541)
Net borrowings on credit facility (4,210)
Decrease in letters of credit outstanding 13,618
Foreign currency translation of outstanding borrowings 349
Liquidity as of June 30, 2020 $ 193,435
Factors that routinely impact our short-term liquidity and that 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.
• Some fixed price customer contracts allow for significant upfront billings at the beginning of the project, which temporarily increases liquidity near-term.
• 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 security in the form of letters of credit or significant retentions. The timing of collection of retentions is often uncertain.
• Other changes in working capital.
• Capital expenditures.
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Other factors that may impact both short and long-term liquidity include:
• Acquisitions and disposals of 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, economic slowdowns or other factors which can lead to credit deterioration of our customers.
• Capacity constraints under our senior secured revolving credit facility and remaining in compliance with all covenants contained in the Credit Agreement.
• Issuances of letters of credit.
Cash Flows Provided by Operating Activities
Cash flows provided by operating activities for the fiscal year ended June 30, 2020 totaled $44.1 million. Major components of cash flows from operating activities for the year ending June 30, 2020 are as follows:
Net Cash Provided by Operating Activities
(In thousands)
Net loss $ (33,074)
Goodwill and other intangible asset impairment 38,515
Non-cash expenses 34,607
Deferred income tax (3,630)
Cash effect of changes in working capital 7,674
Other (7)
Net cash provided by operating activities $ 44,085
Working capital changes at June 30, 2020 in comparison to June 30, 2019 include the following:
• Accounts receivable, net of bad debt expense recognized during the period, decreased by $56.6 million during fiscal 2020, which increased cash flows from operating activities. The increase is primarily due to lower volumes of business and the timing of billing and collections.
• Costs and estimated earnings in excess of billings on uncompleted contracts ("CIE") decreased $36.5 million, which increased cash flows from operating activities. Billings on uncompleted contracts in excess of costs and estimated earnings ("BIE") decreased $41.7 million, which decreased cash flows from operating activities. CIE and BIE balances declined primarily due to lower volumes of business in the second half of the year. These balances routinely experience significant fluctuations based on the timing of when job costs are incurred and the invoicing of those job costs to the customer.
• Other assets and liabilities decreased $11.0 million, which increased cash flows from operating activities. The decrease is primarily related to lower retentions that are expected to be collected beyond one year in connection with large projects, partially offset by an increase in net income taxes receivable.
• Accounts payable and other accrued expenses decreased by $56.3 million, which decreased cash flows from operating activities. The variance is primarily attributable to lower volumes of business and the timing of vendor payments. These decreases were partially offset by $3.8 million of deferred payroll tax associated with the CARES Act (see Item 8. Financial Statements and Supplementary Data, Note 6 - Income Taxes).
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Cash Flows Used for Investing Activities
Investing activities used $17.1 million of cash in the fiscal year ended June 30, 2020 primarily due to $18.5 million of capital expenditures, partially offset by $1.4 million of proceeds from asset sales. Capital expenditures consisted of: $7.4 million for transportation equipment, $5.1 million for construction and fabrication equipment, $5.0 million for software and office equipment, and $1.1 million for facilities.
Cash Flows Used by Financing Activities
Financing activities used $16.0 million of cash in the fiscal year ended June 30, 2020 primarily due to share repurchases of $17.0 million and the repurchase of $3.5 million of Company stock for payment of withholding taxes due on equity-based compensation, partially offset by net borrowings of $4.2 million under the Company's senior secured revolving credit facility.
Senior Secured Revolving Credit Facility
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.
The Credit Agreement provides for a five-year senior secured revolving credit facility of $300.0 million that expires February 8, 2022. The credit facility may be used for working capital, acquisitions, capital expenditures, issuances of letters of credit and other lawful purposes.
The credit facility includes a U.S. Dollar equivalent sublimit of $75.0 million for revolving loans denominated in Australian Dollars, Canadian Dollars, Euros and Pounds Sterling and letters of credit in Australian Dollars, Euros, and Pounds Sterling. The credit facility also includes a $200.0 million sublimit for total 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; or
• 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, as defined in the Credit Agreement. 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.
At June 30, 2020, the Company was at the lowest margin tier for all categories of loans and the unused revolving credit facility fee under the Credit Agreement.
The Credit Agreement includes the following covenants and borrowing limitations:
• Our Leverage Ratio, determined as of the end of each fiscal quarter, may not exceed 3.00 to 1.00. The Leverage Ratio covenant requires that Consolidated Funded Indebtedness, as defined in the Credit Agreement, as of the end of any fiscal quarter, may not exceed 3.0 times Consolidated EBITDA, as defined in the Credit Agreement, or "Covenant EBITDA," over the previous four quarters.
• 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. The Fixed Charge Coverage Ratio covenant requires that, as of the end of any fiscal quarter, Covenant EBITDA, after deducting capital expenditures, dividends and share repurchases, for the previous four quarters may not be less than 1.25 times the total of interest expense and cash paid for income taxes over the previous four quarters and scheduled maturities of certain indebtedness for the next four quarters.
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• 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.
Covenant EBITDA differs from Adjusted EBITDA, as reported under "Results of Operations - Non-GAAP Financial Measure," in Item 7 primarily because it permits the Company to:
• exclude non-cash stock-based compensation expense,
• include pro forma EBITDA of acquired businesses as if the acquisition occurred at the beginning of the previous four quarters, and
• exclude certain other extraordinary items, as defined in the Credit Agreement.
The Company is in compliance with all affirmative, negative, and financial covenants under the Credit Agreement.
Availability under the senior secured revolving credit facility is as follows:
June 30,
2020 June 30,
2019
(In thousands)
Senior secured revolving credit facility $ 300,000 $ 300,000
Capacity constraint due to the Leverage Ratio 162,864 94,323
Capacity under the senior secured revolving credit facility 137,136 205,677
Letters of credit (1)
34,529 48,147
Borrowings outstanding 9,208 5,347
Availability under the senior secured revolving credit facility $ 93,399 $ 152,183
(1) The Credit Agreement allows exclusion of letters of credit that support our workers' compensation programs when calculating availability under the credit facility. At June 30, 2020, there were $6.5 million of letters of credit that support our workers' compensation programs.
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 cash dividends on our capital stock during any fiscal year up to an amount which, when added to all other cash dividends paid during such fiscal year, does not exceed 50% of our cumulative net income for such fiscal year to 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.
Treasury Shares
On November 6, 2018, the Board of Directors approved a stock buyback program (the "November 2018 Program"), which replaced the previous program that had been in place since December 2016 and was set to expire in December 2018. Under the November 2018 Program, the Company may repurchase common stock up to a maximum of $30.0 million per calendar year provided that the aggregate number of shares repurchased may not exceed 10%, or approximately 2.7 million, of the Company's shares outstanding as of November 6, 2018. The Company may repurchase its stock from time to time in the open market at prevailing market prices or in privately negotiated transactions and is not obligated to purchase any shares. The November 2018 Program will continue unless and until it is modified or revoked by the Board of Directors. In fiscal 2020, the Company repurchased 1,047,606 shares of its common stock for $17.0 million under the November 2018 Program. There were 1,349,037 shares available for repurchase under the November 2018 Program as of June 30, 2020.
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. The Company withheld 181,081 and 79,111 shares of common stock during fiscal 2020 and 2019, respectively, to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares. The Company has 1,746,689 treasury shares as of June 30, 2020 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.
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Off-Balance Sheet Arrangements
As of June 30, 2020, the following off-balance sheet arrangements were in place to support our ordinary course obligations:
Expiration Period
Less than 1
Year 1–3 Years 3–5 Years More than 5
Years Total
(In thousands)
Letters of credit (1)
$ 40,991 $ — $ — $ — $ 40,991
Surety bonds 200,520 1,455 1 — 201,976
Total $ 241,511 $ 1,455 $ 1 $ — $ 242,967
(1) All letters of credit issued under our senior secured revolving credit facility are in support of our workers’ compensation insurance programs or certain construction contracts. The letters of credit that support our workers’ compensation programs are expected to renew annually through the term of our senior secured revolving credit facility. The letters of credit that support construction contracts carry expiry dates into calendar year 2021. Our Credit Agreement allows exclusion of letters of credit that support our workers' compensation programs when calculating our compliance with the leverage ratio covenant. At June 30, 2020, there were $6.5 million of letters of credit that support our workers' compensation programs.
Contractual Obligations
Contractual obligations at June 30, 2020 are summarized below:
Contractual Obligations by Expiration Period
Less than 1
Year 1-3 Years 3-5 Years More than 5
Years Total
(In thousands)
Borrowings under senior secured revolving credit facility (1)
$ — $ 9,208 $ — $ — $ 9,208
Interest payments on debt (1)
1,634 736 — — 2,370
Operating leases 8,719 9,408 5,362 9,630 33,119
Purchase obligations 3,413 1,545 — — 4,958
Total contractual obligations $ 13,766 $ 20,897 $ 5,362 $ 9,630 $ 49,655
(1) Assumes total debt principal at June 30, 2020 is carried to maturity with no future borrowings or repayments and no changes to total letters of credit outstanding as of June 30, 2020. Interest payments on debt assumes the margin tier that the Company was at on June 30, 2020, which is the lowest margin tier under the Credit Agreement.
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