MATRIX SERVICE CO 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS This Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Form 10-Q which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts” and similar expressions are also intended to identify forward-looking statements. These forward-looking statements include, among others, such things as: • amounts and nature of future project awards, revenue and margins from each of our segments; • our ability to generate sufficient cash from operations, access our credit facility, or raise cash in order to meet our short and long-term capital requirements; • our ability to comply with the covenants in our credit agreement; • the impact to our business from economic, market or business conditions in general and in the oil, natural gas, power, petrochemical, agricultural and mining industries in particular; • the impact of inflation on our operating expenses and our business operations; • the likely impact of new or existing regulations or market forces on the demand for our services; • the impact to our business from disruptions to supply chains, inflation and availability of materials and labor; • our expectations with respect to the likelihood of a future impairment; and • expansion and other trends of the industries we serve. These statements are based on certain assumptions and analyses we made in light of our experience and our historical trends, current conditions and expected future developments as well as other factors we believe are appropriate. However, whether actual results and developments will conform to our expectations and predictions is subject to a number of risks and uncertainties which could cause actual results to differ materially from our expectations, including: • any risk factors discussed in this Form 10-Q, Form 10-K for the fiscal year ended June 30, 2022, and in our other filings with the Securities and Exchange Commission; • economic, market or business conditions in general and in the oil, natural gas, power, petrochemical, agricultural and mining industries in particular; • the transition to renewable energy sources and its impact on our current customer base; • the under- or over-utilization of our work force; • delays in the commencement or progression of major projects, whether due to permitting issues or other factors; • reduced creditworthiness of our customer base and the higher risk of non-payment of receivables; • the inherently uncertain outcome of current and future litigation; • the adequacy of our reserves for claims and contingencies; and • changes in laws or regulations, including the imposition, cancellation or delay of tariffs on imported goods. Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences or effects on our business operations. We assume no obligation to update publicly, except as required by law, any such forward-looking statements, whether as a result of new information, future events or otherwise. -19- Table of Contents RESULTS OF OPERATIONS Overview We report our results of operations through three reportable segments: Utility and Power Infrastructure, Process and Industrial Facilities, and Storage and Terminal Solutions. • Utility and Power Infrastructure : consists of power delivery services provided to investor-owned utilities, including construction of new substations, upgrades of existing substations, transmission and distribution line installations, upgrades and maintenance, as well as emergency and storm restoration services. We also provide engineering, fabrication, and construction services for LNG utility peak shaving facilities, and provide construction and maintenance services to a variety of power generation facilities, including natural gas fired facilities in simple or combined cycle configuration. • Process and Industrial Facilities : primarily serves customers 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 serve customers in various other industries such as petrochemical, sulfur, mining and minerals companies engaged primarily in the extraction of non-ferrous metals, aerospace and defense, cement, agriculture, and other industrial customers. Our services include plant maintenance, turnarounds, industrial cleaning services, engineering, fabrication, and capital construction. • Storage and Terminal Solutions : consists of work related to aboveground crude oil and refined product storage tanks and terminals. We also include work related to cryogenic and other specialty storage tanks and terminals, including LNG, liquid nitrogen/liquid oxygen, liquid petroleum, hydrogen and other specialty vessels such as spheres in this segment, as well as work related to marine structures and truck and rail loading/offloading facilities. Our services include engineering, fabrication, construction, and maintenance and repair, which includes planned and emergency services for both tanks and full terminals. Finally, we offer tank products, including geodesic domes, aluminum internal floating roofs, floating suction and skimmer systems, roof drain systems and floating roof seals. Operational Update Bidding activity, project award volumes, and revenue volumes all continued to improve from the two year period impacted by the pandemic and we are now beginning to see these trends positively affect our operating results. Repair and maintenance activities have increased significantly and returned to near pre-pandemic levels. In addition, capital project award opportunities have strengthened during the past year, which has resulted in more project awards and is beginning to drive higher revenue volumes. We expect these trends to continue and expect significant project awards in the second quarter of fiscal 2023. Gross margins are also improving as lower margin projects bid competitively during the pandemic continue to be completed and are being replaced by projects with an improved margin profile. Higher revenue volumes have also resulted in improved overhead cost recovery, which is critical to improved gross margin and operating income performance. We have still not reached the level of revenue that allows us to fully recover construction overhead costs and to adequately leverage SG&A costs, but we expect to see significant progress towards those objectives as we progress through fiscal 2023. -20- Table of Contents Adjusted Net Loss In order to more clearly depict our core profitability, the following tables present our operating results after certain adjustments: Reconciliation of Net Loss to Adjusted Net Loss (1) (In thousands, except per share data) Three Months Ended September 30, 2022 September 30, 2021 Net loss, as reported $ (6,512) $ (17,538) Restructuring costs 1,287 605 Accelerated amortization of deferred debt amendment fees (2) — 1,518 Tax impact of above adjustments (331) (546) Deferred tax asset valuation allowance (3) 1,394 — Adjusted net loss $ (4,162) $ (15,961) Loss per share, as reported $ (0.24) $ (0.66) Adjusted loss per share $ (0.15) $ (0.60) (1) This table presents non-GAAP financial measures of our adjusted net loss and adjusted loss per share for the three months ended September 30, 2022 and 2021. The most directly comparable financial measures are net loss and loss per share, respectively, presented in the Condensed Consolidated Statements of Income. We have presented these non-GAAP financial measures because we believe they more clearly depict our core operating results during the periods presented and provide a more comparable measure of our operating results to other companies considered to be in similar businesses. Since adjusted net loss and adjusted loss per 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. (2) Interest expense in fiscal 2022 included $1.5 million of accelerated amortization of deferred debt amendment fees. (3) See Item 1. Financial Statements, Note 7 - Income Taxes, for more information about the deferred tax asset valuation allowance. Adjusted EBITDA We have presented Adjusted EBITDA, which we define as net loss before restructuring costs, stock-based compensation, interest expense, income taxes, and 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 Condensed Consolidated Statements of Income entitled “Net 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 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 restructuring costs. Restructuring costs represent material costs that were incurred and are oftentimes cash expenses. Therefore, any measure that excludes restructuring costs has material limitations. • It does not include stock-based compensation. Stock-based compensation represents material amounts of equity that are awarded to our employees and directors for services rendered. While the expense is non-cash, we release vested shares out of our treasury stock, which has historically been replenished by using cash to periodically repurchase our stock. Therefore, any measure that excludes stock-based compensation has material limitations. • It does not include interest expense. Because we have borrowed money to finance our operations and acquisitions, pay commitment fees to maintain our credit facility, and incur fees to issue letters of credit under the credit facility, interest expense is a necessary and ongoing part of our costs and has assisted us in generating revenue. Therefore, any measure that excludes interest expense has material limitations. • It does not include income taxes. Because the payment of income taxes is a necessary and ongoing part of our operations, any measure that excludes income taxes has material limitations. -21- Table of Contents • 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 loss follows: Three Months Ended September 30, 2022 September 30, 2021 (In thousands) Net loss $ (6,512) $ (17,538) Restructuring costs 1,287 605 Stock-based compensation 2,055 1,869 Interest expense 372 1,999 Benefit for federal, state and foreign income taxes — (5,265) Depreciation and amortization 3,642 4,052 Adjusted EBITDA $ 844 $ (14,278) Three Months Ended September 30, 2022 Compared to the Three Months Ended September 30, 2021 Consolidated Consolidated revenue was $208.4 million for the three months ended September 30, 2022, compared to $168.1 million in the same period last year. On a segment basis, revenue increased in the Process and Industrial Facilities and Storage and Terminal Solutions segments by $42.7 million and $9.9 million, respectively. The increases were partially offset by a decrease in revenue of $12.3 million in the Utility and Power Infrastructure segment. Consolidated gross profit increased to $13.0 million in the three months ended September 30, 2022 compared to a gross loss of $3.5 million in the same period last year. Gross margin (loss) increased to 6.2% in the three months ended September 30, 2022 compared to (2.1%) in the same period last year. Gross margins in the first quarter of fiscal 2023 improved significantly from recent quarters, but were still negatively impacted by the under recovery of construction overhead costs. Gross margins in the first quarter of fiscal 2022 were negatively impacted by a lower than previously forecasted margin on a large capital project and an unfavorable settlement of a claim with a customer, both in the Utility and Power Infrastructure segment, and by lower than previously forecasted margins on a limited number of projects in the Storage and Terminal Solutions segment. In addition, gross margins in the first quarter of fiscal 2022 were also negatively impacted by lower than forecasted volumes, which led to under recovery of construction overhead costs. Consolidated SG&A expenses were $16.8 million in the three months ended September 30, 2022 compared to $16.6 million in the same period last year. We recorded restructuring costs of $1.3 million in the three months ended September 30, 2022 compared to $0.6 million in the same period last year. See Item 1. Financial Statements, Note 11 - Restructuring Costs, for more information about our business improvement plan. Interest expense was $0.4 million in the three months ended September 30, 2022 compared to $2.0 million in the three months ended September 30, 2021. Interest expense in the three months ended September 30, 2022 consisted primarily of interest on debt outstanding, unused capacity fees, amortization of deferred debt issuance costs, and letter of credit fees. Interest expense in fiscal 2022 included $1.5 million of accelerated amortization of deferred debt amendment fees associated with terminating our prior credit facility. Our effective tax rates for the three months ended September 30, 2022 and September 30, 2021 were 0.0% and 23.1%, respectively. The effective tax rate during the first quarter of fiscal 2023 was impacted by a $1.4 million valuation allowance placed on deferred tax assets generated during the quarter. We placed a full valuation allowance on our deferred tax assets in the second quarter of fiscal 2022 due to the existence of a cumulative loss over a three-year period. We will continue to place valuation allowances on newly generated deferred tax assets and will realize the benefit associated with the deferred tax assets for which the valuation allowance has been provided to the extent we generate taxable income in the future, or cumulative losses are no longer present and our future projections for growth or tax planning strategies are demonstrated. -22- Table of Contents For the three months ended September 30, 2022, we had a net loss of $6.5 million, or $0.24 per fully diluted share, compared to a net loss of $17.5 million, or $0.66 per fully diluted share, in the three months ended September 30, 2021. Utility and Power Infrastructure Revenue for the Utility and Power Infrastructure segment was $44.9 million in the three months ended September 30, 2022 compared to $57.2 million in the same period last year. The decrease is primarily due to lower volumes of LNG peak shaving work, partially offset by higher volumes of power delivery and power generation work. The segment gross margin (loss) was 3.8% in fiscal 2023 compared to (10.7%) in fiscal 2022. The segment gross margin for the first quarter of fiscal 2023 was negatively impacted by low revenue volume, which led to the under recovery of construction overhead costs, and work on a large capital project with a previously reduced gross margin. The fiscal 2022 segment gross margin was negatively impacted by an increase in the forecasted costs to complete a large capital project, which resulted in a decrease in gross profit of $5.9 million. The change in estimate was principally due to unexpected equipment repairs during commissioning that delayed the scheduled completion and increased the estimated costs to complete. In addition, segment gross margin was negatively impacted by an unfavorable settlement of a claim with a customer, and low volumes, which led to the under recovery of construction overhead costs. Process and Industrial Facilities Revenue for the Process and Industrial Facilities segment was $86.6 million in the three months ended September 30, 2022 compared to $43.9 million in the same period last year. This 97.3% increase reflects the improved market environment and was primarily due to higher volumes of refinery maintenance and turnaround work, work on a capital project at a biodiesel facility, and higher volumes of midstream gas processing capital work. The segment gross margin was 5.0% for the three months ended September 30, 2022 compared to 6.5% in the same period last year. The segment gross margin in the first quarter of fiscal 2023 was negatively impacted by work on a midstream gas processing project that experienced increases in forecasted costs to complete in the prior year, which reduced the remaining margin realized on the project. In addition, revenue volumes were still too low to fully recover construction overhead costs, which negatively impacted segment gross margin. The segment gross margin in fiscal 2022 was negatively impacted by low revenue volume, which led to the under recovery of construction overhead costs. Storage and Terminal Solutions Revenue for the Storage and Terminal Solutions segment was $76.9 million in the three months ended September 30, 2022 compared to $67.0 million in the same period last year. The increase in segment revenue is primarily a result of higher volumes of LNG and specialty vessel tank and terminal capital work. The segment gross margin was 9.8% for the three months ended September 30, 2022 compared to 0.6% in the same period last year. The fiscal 2023 segment gross margin was positively impacted by strong project execution, partially offset by low revenue volume, which led to under recovery of construction overhead costs. The fiscal 2022 segment gross margin was negatively impacted by lower than previously forecasted margins on a limited number of projects and a higher percentage of lower margin maintenance work. Segment gross margin in fiscal 2022 was also negatively impacted by low revenue volume, which led to under recovery of construction overhead costs. Corporate Unallocated corporate expenses were $7.9 million during the three months ended September 30, 2022 compared to $7.6 million in the same period last year. -23- Table of Contents Backlog We define backlog as the total dollar amount of revenue that we expect to recognize as a result of performing work that has been awarded to us through a signed contract, limited notice to proceed or other type of assurance that we consider firm. The following arrangements are considered firm: • fixed-price awards; • minimum customer commitments on cost plus arrangements; and • certain time and material arrangements in which the estimated value is firm or can be estimated with a reasonable amount of certainty in both timing and amounts. For long-term maintenance contracts with no minimum commitments and other established customer agreements, we include only the amounts that we expect to recognize as revenue over the next 12 months. For arrangements in which we have received a limited notice to proceed ("LNTP"), we include the entire scope of work in our backlog if we conclude that the likelihood of the full project proceeding as high. For all other arrangements, we calculate backlog as the estimated contract amount less revenue recognized as of the reporting date. The following table provides a summary of changes in our backlog for the three months ended September 30, 2022: Utility and Power Infrastructure Process and Industrial Facilities Storage and Terminal Solutions Total (In thousands) Backlog as of June 30, 2022 $ 102,059 $ 292,287 $ 195,114 $ 589,460 Project awards 42,618 59,982 132,028 234,628 Revenue recognized (44,870) (86,628) (76,933) (208,431) Backlog as of September 30, 2022 $ 99,807 $ 265,641 $ 250,209 $ 615,657 Book-to-bill ratio (1) 0.9 0.7 1.7 1.1 (1) Calculated by dividing project awards by revenue recognized during the period. Backlog increased $26.2 million or 4.4% in the first quarter of fiscal 2023 on project awards of $234.6 million and a book-to-bill ratio of 1.1. In the Utility and Power Infrastructure segment, backlog decreased by 2.2% as we booked $42.6 million of project awards during the first quarter of fiscal 2023, primarily related to power delivery work. Our opportunity pipeline for LNG peak shaving projects continues to be promising, however those awards, while significant, can be less frequent. While we did not book any LNG peak shaver projects in the first quarter of fiscal 2023, early in the second quarter, the Company was awarded the engineering, procurement, and construction of upgrades being made to an existing LNG peak shaving facility that include a new gas liquefaction system and vaporization system. Project opportunities and bidding activity are strong for both the power delivery portion of the business and LNG peak shaving. In the Process and Industrial Facilities segment, backlog decreased by 9.1% as we booked $60.0 million of project awards during the first quarter of fiscal 2023. Client spending related to refinery maintenance and turnaround operations has returned to near-normal pre-pandemic levels. We continue to see strong demand for thermal vacuum chambers in the coming quarters, as well as increasing opportunities in mining and minerals, and chemicals. In addition, we are seeing more opportunities for midstream gas work, including some larger scale projects. In the Storage and Terminal Solutions segment, backlog increased by 28.2% as we booked $132.0 million of project awards during the first quarter of fiscal 2023. We received an LNTP on a significant ethane/ethylene tank EPC project during the quarter and booked several other storage projects related to a variety of other refined products. We were also awarded a large-scale specialty vessel project early in the second quarter of fiscal 2023. This segment includes significant opportunities for storage infrastructure projects related to natural gas, LNG, ammonia, hydrogen, NGLs and other forms of renewable energy. We believe LNG and hydrogen projects in particular will be key growth drivers for this segment. Bidding activity on LNG projects has been strong and we have been positioning ourselves for growth in hydrogen by entering into key relationships, such as the signing of a memorandum of understanding ("MOU") with Korea Gas Corporation in August 2022 to support South -24- Table of Contents Korea’s development of a hydrogen economy as it transforms itself from natural gas and the signing of a MOU with Chart Industries, Inc. in January of 2021 to support the development of hydrogen solutions. Oil and natural gas producers have remained cautious with capital spending, which has limited opportunities in crude oil tanks and terminals. However, the price of crude oil and natural gas increased significantly since the world emerged from the COVID-19 pandemic, which, if sustained, may lead to higher production volumes and more opportunities for crude oil tanks, terminals and export facilities in the coming quarters. Project awards in all segments are cyclical and are typically the result of a sales process that can take several months or years to complete. It is common for awards to shift from one period to another as the timing of awards is dependent upon a number of factors including changes in market conditions, permitting, off take agreements, project financing and other factors. Backlog volatility may increase for some segments from time to time when individual project awards are less frequent, but more significant. The level of awards presented above only represents an interim period and may not be indicative of full year awards. Seasonality and Other Factors Our operating results can exhibit seasonal fluctuations, especially in our Process and Industrial Facilities segment, for a variety of reasons. Turnarounds and planned outages at customer facilities are typically scheduled in the spring and the fall when the demand for energy is lower. Within the Utility and Power Infrastructure segment, transmission and distribution work is generally scheduled by the public utilities when the demand for electricity is at its lowest. Therefore, revenue volume in the summer months is typically lower than in other periods throughout the year. Our business can also be affected, both positively and negatively, by seasonal factors such as energy demand or weather conditions including hurricanes, snowstorms, wildfires and abnormally low or high temperatures. Some of these seasonal factors may cause some of our offices and projects to close or reduce activities temporarily. In addition to the above noted factors, the general timing of project starts and completions could exhibit significant fluctuations. Accordingly, results for any interim period may not necessarily be indicative of operating results for the full year. Other factors impacting operating results in all segments come from decreased work volume during holidays, work site permitting delays or customers accelerating or postponing work. The differing types, sizes, and durations of our contracts, combined with their geographic diversity and stages of completion, often results in fluctuations in our operating results. Our overhead cost structure is generally fixed. Significant fluctuations in revenue usually leads to over or under recovery of fixed overhead costs, which can have a material impact on our gross margin and profitability. -25- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Overview We define liquidity as the ongoing ability to pay our liabilities as they become due, fund business operations and meet all monetary contractual obligations. Our primary sources of liquidity at September 30, 2022 were unrestricted cash and cash equivalents on hand, capacity under our ABL Facility, and cash generated from operations. Unrestricted cash and cash equivalents at September 30, 2022 totaled $14.3 million and availability under the ABL Facility totaled $42.3 million, resulting in total liquidity of $56.6 million. The following table provides a reconciliation of cash, cash equivalents and restricted cash in the Condensed Consolidated Balance Sheets to the total cash, cash equivalents and restricted cash shown in the Condensed Consolidated Statements of Cash Flows (in thousands): September 30, 2022 June 30, 2022 Cash and cash equivalents $ 14,342 $ 52,371 Restricted cash 25,000 25,000 Total cash, cash equivalents and restricted cash shown in the Condensed Consolidated Statements of Cash Flows $ 39,342 $ 77,371 The following table provides a summary of changes in our liquidity for the three months ended September 30, 2022 (in thousands): Liquidity at June 30, 2022 $ 94,831 Cash used by operating activities (35,229) Capital expenditures (1,578) Decrease in availability under ABL Facility (186) Cash used by financing activities (245) Other (977) Liquidity at September 30, 2022 $ 56,616 As a result of rising revenue volumes, especially for cost-reimbursable and maintenance-type work, we have invested heavily into working capital during the first quarter of fiscal 2023, which is the primary driver of the decrease in liquidity since June 30, 2022. While bidding activity, project award volumes, and revenue volumes all continued to improve as we moved into fiscal 2023, the market environment is still uncertain. As a result, we continue to cautiously manage our liquidity, which is adequate to support our needs. We are continuing to take the following actions: • strategically reviewing business processes and organizational structure; • proactively managing our the cost structure and working capital; and • limiting capital expenditures. Factors that routinely impact our short-term liquidity and may impact our long-term liquidity include, but are not limited to: • changes in costs and estimated earnings in excess of billings on uncompleted contracts and billings on uncompleted contracts in excess of costs due to contract terms that determine the timing of billings to customers and the collection of those billings: ◦ some cost-plus and fixed-price customer contracts are billed based on milestones which may require us to incur significant expenditures prior to collections from our customers; ◦ some fixed-price customer contracts allow for significant upfront billings at the beginning of a project, which temporarily increases liquidity near term; -26- Table of Contents ◦ 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; and ◦ some of our large construction projects may require security in the form of letters of credit or significant retentions. Retentions are normally held until certain contractual milestones are achieved; • other changes in working capital, including the timing of tax payments and refunds; and • capital expenditures. Other factors that may impact both short and long-term liquidity include: • 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; • issuances of letters of credit; and • strategic investments in new operations or divestitures of existing operations. Other factors that may impact long-term liquidity include: • borrowing constraints under our ABL Facility and maintaining compliance with all covenants contained in the ABL Facility; • acquisitions and disposals of businesses; and • purchases of shares under our stock buyback program. ABL Credit Facility On October 5, 2022, our primary U.S. and Canada operating subsidiaries entered into the First Amendment and Waiver to Credit Agreement (the “Amendment”), which amended our asset-backed credit agreement (the "ABL Facility"), dated as of September 9, 2021 with Bank of Montreal, as Administrative Agent, Swing Line Lender and a Letter of Credit Issuer, and the lenders named therein. The Amendment (i) waived an event of default resulting from our failure to deliver the Administrative Agent and the lenders our audited financial statements for the fiscal year ended June 30, 2022 by September 28, 2022 (the “Audited Financial Statements”), provided we deliver the Audited Financial Statements by October 14, 2022, (ii) reduced the maximum amount of loans under the ABL Facility to $90.0 million from $100.0 million and (iii) replaced the London interbank offered rate with the forward term rate based on the secured overnight financing rate (the “SOFR”) as the interest rate benchmark. We subsequently delivered the Audited Financial Statements on October 11, 2022. The ABL Facility is guaranteed by substantially all of our remaining U.S. and Canadian subsidiaries. The ABL Facility available borrowings may be increased by an amount not to exceed $15.0 million, subject to certain conditions, including obtaining additional commitments. The ABL Facility is intended to be used for working capital, capital expenditures, issuances of letters of credit and other lawful purposes. Our obligations under the ABL Facility are secured by a first lien on all our assets and the assets of our co-borrowers and guarantors under the ABL Facility. The maximum amount that we may borrow under the ABL Facility is subject to a borrowing base, which is based on restricted cash plus a percentage of the value of certain accounts receivable, inventory and equipment, reduced for certain reserves. We are required to maintain a minimum of $25.0 million of restricted cash at all times, but such amounts are also included in the borrowing base. The ABL Facility matures and any outstanding amounts become due and payable on September 9, 2026. At September 30, 2022, our borrowing base was $79.0 million, we had $15.0 million of outstanding borrowings, and $21.7 million in letters of credit outstanding, which resulted in availability of $42.3 million under the ABL Facility. -27- Table of Contents Borrowings under the ABL Facility bear interest through maturity at a variable rate based upon, at our option, an annual rate of either a base rate (“Base Rate”), an Adjusted Term SOFR ("Adjusted Term SOFR"), or at the Canadian Prime Rate, plus an applicable margin. The Adjusted Term SOFR is defined as (i) the SOFR plus (ii) 11.448 basis points for a one-month tenor and 26.161 basis points for a three-month tenor; provided that the Adjusted Term SOFR cannot be below zero. The Base Rate is defined as a fluctuating interest rate equal to the greater of: (i) rate of interest announced by Bank of Montreal from time to time as its prime rate; (ii) the U.S. federal funds rate plus 0.50%; (iii) Adjusted Term SOFR for one month period plus 1.00%; or (iv) 1.00%. Depending on the amount of average availability, the applicable margin is between 1.00% to 1.50% for Base Rate and Canadian Prime Rate borrowings, which includes either U.S. or Canadian prime rate, and between 2.00% and 2.50% for Adjusted Term SOFR borrowings. Interest is payable either (i) monthly for Base Rate or Canadian Prime Rate borrowings or (ii) the last day of the interest period for Adjusted Term SOFR borrowings, as set forth in the ABL Facility. The fee for undrawn amounts is 0.25% per annum and is due quarterly. The interest rate in effect for borrowings outstanding at September 30, 2022, including applicable margin, was 7.50%. The ABL Facility contains customary conditions to borrowings, events of default and covenants, including, but not limited to, covenants that restrict our ability to sell assets, engage in mergers and acquisitions, incur, assume or permit to exist additional indebtedness and guarantees, create or permit to exist liens, pay cash dividends, issue equity instruments, make distribution or redeem or repurchase capital stock. In the event that our availability is less than the greater of (i) $15.0 million and (ii) 15.00% of the lesser of (1) the current borrowing base and (2) the commitments under the ABL Facility then in effect, a consolidated Fixed Charge Coverage Ratio of at least 1.00 to 1.00 must be maintained. Except for the covenant to deliver Audited Financial Statements by September 28, 2022, which was waived in the Amendment, we were in compliance with all covenants of the ABL Facility as of September 30, 2022. Cash Flow for the Three Months Ended September 30, 2022 Cash Flows Used by Operating Activities Cash used by operating activities for the three months ended September 30, 2022 totaled $35.2 million. The various components are as follows: Net Cash Used by Operating Activities (In thousands) Net loss $ (6,512) Depreciation and amortization 3,642 Stock-based compensation 2,055 Other non-cash expenses 40 Cash effect of changes in operating assets and liabilities (34,454) Net cash used by operating activities $ (35,229) Cash effect of changes in operating assets and liabilities at September 30, 2022 in comparison to June 30, 2022 include the following: • Accounts receivable, excluding credit losses recognized during the period, decreased $4.6 million during the three months ended September 30, 2022, which increased cash flows from operating activities. The variance is primarily attributable to the timing of billing and collections. • Costs and estimated earnings in excess of billings on uncompleted contracts ("CIE") increased $14.9 million, which decreased cash flows from operating activities. The increase in CIE was primarily due to increased revenue on time and materials-type work during the first quarter of fiscal 2023. Billings on uncompleted contracts in excess of costs and estimated earnings ("BIE") decreased $11.8 million, which decreased cash flows from operating activities. The decrease in BIE was primarily due to continued work on capital projects that received upfront billings in the prior year. CIE and BIE balances can experience significant fluctuations based on business volumes and the timing of when job costs are incurred and the timing of customer billings and payments. -28- Table of Contents • Inventories, income taxes receivable, prepaid expenses, other current assets, operating right-of-use lease assets and other assets, non-current, increased $0.7 million during the three months ended September 30, 2022, which decreased cash flows from operating activities. These operating assets can fluctuate based on the timing of inventory builds and draw-downs, accrual and receipt of income taxes receivable; prepayments of certain expenses; lease commencement, passage of time, expiration, or termination of operating leases; business volumes; and other timing differences. • Accounts payable, accrued wages and benefits, accrued insurance, operating lease liabilities, other accrued expenses, and other liabilities, non-current decreased by $11.6 million during the three months ended September 30, 2022, which decreased cash flows from operating activities. These operating liabilities can fluctuate based on the timing of vendor payments; accruals; lease commencement, lease payments, expiration, or termination of operating leases; business volumes; and other timing differences. Cash Flows Used by Investing Activities Investing activities used $1.6 million of cash in the three months ended September 30, 2022 primarily due to capital expenditures. Cash Flows Used by Financing Activities Financing activities used $0.2 million of cash in the three months ended September 30, 2022 primarily due to $0.3 million paid to repurchase our stock for payment of withholding taxes due on equity-based compensation. Dividend Policy We have never paid cash dividends on our common stock and the terms of our ABL Facility limit dividends to stock dividends only. Any future dividend payments will depend on the terms of our ABL Facility, our financial condition, capital requirements and earnings as well as other relevant factors. Stock Repurchase Program We may repurchase common stock pursuant to the Stock Buyback Program, which was approved by the board of directors in November 2018. Under the program, the aggregate number of shares repurchased may not exceed 2,707,175 shares. We may repurchase our stock from time to time in the open market at prevailing market prices or in privately negotiated transactions and are not obligated to purchase any shares. The program will continue unless and until it is modified or revoked by the Board of Directors. We made no repurchases under the program in the three months ended September 30, 2022 and have no current plans to repurchase stock. As of September 30, 2022, there were 1,349,037 shares available for repurchase under the Stock Buyback Program. The terms of our ABL Facility limit share repurchases to $2.5 million per fiscal year provided that we meet certain availability thresholds and do not violate our Fixed Charge Coverage Ratio financial covenant. Treasury Shares We had 932,707 treasury shares as of September 30, 2022 and intend to utilize these treasury shares in connection with equity awards under the our stock incentive plans and for sales to the Employee Stock Purchase Plan. -29- Table of Contents CRITICAL ACCOUNTING POLICIES There have been no material changes in our critical accounting policies from those reported in our fiscal 2022 Annual Report on Form 10-K filed with the SEC. For more information on our critical accounting policies, see Part II, Item 7 of our fiscal 2022 Annual Report on Form 10-K. The following section provides certain information with respect to our critical accounting policies as of the close of our most recent quarterly period. 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 are commonly fixed-price contracts that 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 exceed 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 a 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. -30- Table of Contents 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. 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. We do 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 8 - Commitments and Contingencies of the Notes to Condensed Consolidated 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 8 - Commitments and Contingencies of the Notes to Financial Statements. Costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unpriced change orders and claims of $13.7 million at September 30, 2022 and $8.9 million at June 30, 2022. The amounts ultimately realized may be significantly different than the recorded amounts resulting in a material adjustment to future earnings. -31- Table of Contents Goodwill Goodwill represents the excess of the purchase price of acquisitions over the fair value of the net identifiable tangible and intangible assets acquired at the acquisition date. In accordance with current accounting guidance, goodwill is not amortized, but 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 as of May 31st of each fiscal year, or in between annual tests if impairment indicators are present, 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 fair values of our reporting units compared to our market capitalization. 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. We believe 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. Loss Contingencies Various legal actions, claims, and other contingencies arise in the normal course of our business. Contingencies are recorded in the condensed 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.