10-K 1 mtrx2014-06x30x10k.htm 10-K MTRX 2014-06-30-10K
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
x
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended June 30, 2014
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                     to                     
Commission File No. 1-15461
MATRIX SERVICE COMPANY
(Exact name of registrant as specified in its charter)
Delaware
 
73-1352174
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
5100 E. Skelly Drive, Suite 700
Tulsa, Oklahoma
 
74135
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (918) 838-8822
Securities Registered Pursuant to Section 12(b) of the Act:
(Title of class)
Common Stock, par value $0.01 per share
Securities Registered Pursuant to Section 12(g) of the Act: None
Name of each exchange on which registered: NASDAQ Global Select Market (common stock)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨            Accelerated filer  þ            Non-accelerated filer  ¨            Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
The aggregate market value of the registrant’s common stock held by non-affiliates computed by reference to the price at which the common stock was last sold as of the last business day of the registrant’s most recently completed second quarter was approximately $635 million.
The number of shares of the registrant’s common stock outstanding as of September 3, 2014 was 26,376,223 shares.
Documents Incorporated by Reference
Certain sections of the registrant’s definitive proxy statement relating to the registrant’s 2014 annual meeting of stockholders, which definitive proxy statement will be filed within 120 days of the end of the registrant’s fiscal year, are incorporated by reference into Part III of this Form 10-K.
 
 
 
 
 



TABLE OF CONTENTS
 
 
 
 
 
 
Page
 
Part I
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
Part II
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
 
Part III
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
 
Part IV
 
 
 
 
Item 15.



1


PART I

Item 1.    Business
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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 Annual Report 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 revenues and margins from each of our segments;
the likely impact of new or existing regulations or market forces on the demand for our services;
expansion and other trends in the industries we serve;
our ability to generate sufficient cash from operations or to raise cash in order to meet our short and long-term capital requirements; and
our ability to comply with the covenants in our credit agreement.
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:
the risk factors discussed in Item 1A of this Annual Report and listed from time to time in our filings with the Securities and Exchange Commission;
the inherently uncertain outcome of current and future litigation;
the adequacy of our reserves for contingencies;
economic, market or business conditions in general and in the oil, gas and power industries in particular;
changes in laws or regulations; and
other factors, many of which are beyond our control.
Consequently, all of the forward-looking statements made in this Annual Report 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.
BACKGROUND
The Company began operations in 1984 as an Oklahoma corporation under the name of Matrix Service. In 1989, we incorporated in the State of Delaware under the name of Matrix Service Company. We provide engineering, fabrication, infrastructure, construction, and maintenance services primarily to the oil, gas, power, petrochemical, industrial, mining and minerals markets. We maintain regional offices throughout the United States and Canada, and operate through union and merit subsidiaries.
The Company is licensed to operate in all 50 states and in four Canadian provinces. Our principal executive offices are located at 5100 E. Skelly Drive, Suite 700, Tulsa, Oklahoma 74135. Our telephone number is (918) 838-8822. Unless the context otherwise requires, all references herein to “Matrix Service Company”, “Matrix”, the “Company” or to “we”, “our”, and “us” are to Matrix Service Company and its subsidiaries.


2


WEBSITE ACCESS TO REPORTS
Our public website is matrixservicecompany.com. We make available free of charge through the "Investor Relations" section of our website our annual reports to stockholders, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission ("SEC"). Any materials we file with or furnish to the SEC is also maintained on the SEC website (sec.gov).
The information contained on our website, or available by hyperlink from our website, is not incorporated into this Form 10-K or other documents we file with, or furnish to, the SEC. We intend to use our website as a means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. Such disclosures will be included on our website in the "Investor Relations" section. We also intend to use social media channels as a means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. We encourage investors, the media, and others interested in Matrix to review the information posted on the company Facebook site (facebook.com/matrixservicecompany), the company linkedin account (linkedin.com/company/matrix-service-company) and the company twitter account (twitter.com/matrixserviceco). Investors, the media or other interested parties can subscribe to the twitter feed at the address listed above. Any updates to the list of social media channels Matrix will use to announce material information will be posted on the "Investor Relations" page of the company's website at matrixservicecompany.com. Accordingly, investors should monitor such portions of our website and social media channels, in addition to following our press releases, SEC filings and public conference calls and webcasts.
OPERATING SEGMENTS
We operate our business through four reportable segments: Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, and Industrial.
The Electrical Infrastructure segment primarily encompasses construction and maintenance services to a variety of power generation facilities, such as combined cycle plants, natural gas fired power stations, and renewable energy installations. We also provide high voltage services to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, and storm restoration services.
The Oil Gas & Chemical segment includes our traditional turnaround activities, plant maintenance services and construction in the downstream petroleum industry. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning and vacuum services. We also perform work in the petrochemical, natural gas, gas processing and compression, and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products aboveground storage tanks (“ASTs”), as well as planned and emergency maintenance services. Also included in the Storage Solutions segment is work related to specialty storage tanks including liquefied natural gas (“LNG”), liquid nitrogen/liquid oxygen (“LIN/LOX”), liquid petroleum (“LPG”) tanks and other specialty vessels including spheres. We also offer aboveground storage tank products including floating roof seals. Finally, the Storage Solutions segment includes balance of plant work in storage terminals and tank farms.
The Industrial segment includes construction and maintenance work in the iron and steel and mining and minerals industries, bulk material handling and fertilizer production facilities, as well as work for clients in other industrial markets.
PURCHASE OF KVAERNER NORTH AMERICAN CONSTRUCTION     
Effective as of December 21, 2013, the Company acquired 100% of the stock of Kvaerner North American Construction Ltd. and substantially all of the assets of Kvaerner North American Construction Inc,. together referenced as "KNAC". The businesses are now known as Matrix North American Construction Ltd. and Matrix North American Construction, Inc., together referenced as "Matrix NAC". Matrix NAC is a premier provider of maintenance and capital construction services to power generation, integrated iron and steel, and industrial process facilities. The acquisition significantly expands the Company's presence in the Electrical Infrastructure and Industrial Segments, and to a lesser extent, the Oil Gas and Chemical segment. The KNAC acquisition brought opportunities in additional geographical markets, the ability to execute additional and larger projects and expanded our relationship with some existing clients.



3


The Company purchased KNAC for $51.6 million, net of cash acquired. The acquisition was funded through a combination of cash-on-hand and borrowings under our senior revolving credit facility.
OTHER BUSINESS MATTERS
Customers and Marketing
The Company provided services to approximately 560 customers in fiscal 2014. Two customers, TransCanada Corporation and Enbridge, accounted for $218.6 million and $160.5 million, or 17.3% and 12.7% of our consolidated revenue, respectively, all of which was in the Storage Solutions segment.  The loss of these major customers or other significant customers could have a material adverse effect on the Company; however, we are not dependent on any single contract or customer on an on-going basis.
Matrix markets its services and products primarily through its marketing and business development personnel, senior professional staff and its operating management. We competitively bid most of our projects; however, we have a number of preferred provider relationships with customers who award us work through long-term agreements. Our projects have durations ranging from a few days to multiple years.
Segment Financial Information
Financial information for our operating segments is provided in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Note 13-Segment Information of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data.
Competition
Our industry is highly fragmented and intensely competitive. We compete with local, regional, national and international contractors and service providers. Competitors vary with the markets we serve with few competitors competing in all of the markets we serve or in all of the services we provide. Contracts are generally awarded based on quality, safety performance, price, schedule, and customer satisfaction.
Backlog
We define backlog as the total dollar amount of revenues that we expect to recognize as a result of performing work that has been awarded to us through a signed contract, 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 amount.
For long-term maintenance contracts, we include only the amounts that we expect to recognize as revenue over the next 12 months. For all other arrangements, we calculate backlog as the estimated contract amount less revenues recognized as of the reporting date.
The following table provides a summary of changes in our backlog in fiscal 2014:
 
 
Electrical
Infrastructure
 
Oil Gas &
Chemical
 
Storage
Solutions
 
Industrial
 
Total
 
 
(In thousands)
Backlog as of June 30, 2013
 
$
103,520

 
$
120,138

 
$
319,718

 
$
83,361

 
$
626,737

Backlog acquired
 
123,492

 
2,825

 

 
115,723

 
242,040

Project awards
 
140,694

 
226,944

 
773,809

 
168,691

 
1,310,138

Revenue recognized
 
(205,570
)
 
(239,690
)
 
(610,896
)
 
(206,933
)
 
(1,263,089
)
Backlog as of June 30, 2014
 
$
162,136

 
$
110,217

 
$
482,631

 
$
160,842

 
$
915,826




4


Seasonality
Quarterly operating results can exhibit seasonal fluctuations, especially in our Oil Gas & Chemical 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 Electrical 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. Also, we typically see a lower level of operating activity relating to construction projects during the winter months and early in the calendar year because many of our customers’ capital budgets have not been finalized. Our business can also be affected, both positively and negatively, by seasonal factors such as energy demand or weather conditions including hurricanes, snowstorms, 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. Accordingly, results for any interim period may not necessarily be indicative of future operating results.
Material Sources and Availability
Steel plate and steel pipe are key materials used by the Company. Supplies of these materials are available throughout the United States and globally from numerous sources. We anticipate that adequate amounts of these materials will be available in the foreseeable future. However, the price, quantity, and the delivery schedules of these materials could change rapidly due to various factors, including producer capacity, the level of imports, worldwide demand, tariffs on imported steel and other market conditions.
Insurance
The Company maintains insurance coverage for various aspects of its operations. However, exposure to potential losses is retained through the use of deductibles, self-insured retentions and coverage limits.
Typically our contracts require us to indemnify our customers for injury, damage or loss arising from the performance of our services and provide warranties for materials. The Company may also be required to name the customer as an additional insured up to the limits of insurance available, or we may be required to purchase special insurance policies or surety bonds for specific customers or provide letters of credit in lieu of bonds to satisfy performance and financial guarantees on some projects.
Matrix maintains a performance and payment bonding line sufficient to support the business. The Company generally requires its subcontractors to indemnify the Company and the Company’s customer and name the Company as an additional insured for activities arising out of the subcontractors’ work. We also require certain subcontractors to provide additional insurance policies, including surety bonds in favor of the Company, to secure the subcontractors’ work. There can be no assurance that our insurance and the additional insurance coverage provided by our subcontractors will fully protect us against a valid claim or loss under the contracts with our customers.
Employees
As of June 30, 2014, the Company had 4,491 employees of which 837 were employed in non-field positions and 3,654 were employed in field or shop positions. The number of employees varies significantly throughout the year because of the number, type and size of projects we have in progress at any particular time.
The Company’s subsidiaries include both merit and union companies. The union businesses operate under collective bargaining agreements with various unions representing different groups of our employees. Union agreements provide union employees with benefits including health and welfare, pension, training programs and competitive compensation plans. We have not experienced any strikes or work stoppages in recent years. We maintain health and welfare, retirement and training programs for our merit employees and administrative personnel.
Patents and Proprietary Technology
Matrix Service Company’s subsidiaries have several patents and patents pending, and continues to pursue new idea and innovations to better serve our customers in all areas of our business. The Flex-A-Span® and Flex-A-Seal® trademarks are utilized to market the Company’s unique seals for floating roof tanks. The FastFroth® trademark is utilized to market the Company’s unique industrial cleaning process. Our patented RS 1000 Tank Mixer controls sludge build-up in crude oil tanks through resuspension. The Flexible Fluid Containment System patent relates to a flexible fluid containment system that captures and contains flue leaking from pipe and valve connections. The Flex-A-Swivel patent refers to our unique pipe swivel joint assembly. Our patent for Spacerless or Geocomposite Double Bottom for Storage Tanks relates to a replacement bottom with leak detection and containment that allows for the retrofitting of an existing tank while minimizing the loss of capacity.


5


The patent for the Training Tank for Personnel Entry, Exit and Rescue relates to a training device that can be used to train personnel on equipment that is made to simulate confined space scenarios.
The Company also holds a perpetual license to use various patents and technologies related to LNG storage tanks, LIN/LOX storage tanks, LPG storage tanks and thermal vacuum chambers.
While the Company’s intellectual property is not its main business, we believe that the ability to use these patents and technology enables us to expand our presence in the markets and minimizes the development costs typically associated with organic growth.
Regulation
Health and Safety Regulations
Our operations are subject to regulation by the United States Occupational Safety and Health Administration (“OSHA”) and Mine Safety and Health Administration (“MSHA”), and to regulation under state laws and by the Canadian Workers’ Compensation Board and its Workplace Health, Safety and Compensation Commission. Regulations promulgated by these agencies require employers and independent contractors to implement work practices, medical surveillance systems and personnel protection programs to protect employees from workplace hazards and exposure to hazardous chemicals and materials. In recognition of the potential for accidents within various scopes of work, these agencies have enacted strict and comprehensive safety regulations. The Company has established and consistently reinforces and monitors compliance with comprehensive programs intended to insure that it complies with all applicable health and safety regulations to protect the safety of its workers, subcontractors and customers. While the Company believes that it operates safely and prudently, there can be no assurance that accidents will not occur or that the Company will not incur substantial liability in connection with the operation of its businesses. In order to minimize the financial exposure resulting from potential accidents associated with the Company's work, the Company maintains liability insurance to limit losses that could result from our work.
Environmental
The Company’s operations are subject to extensive and changing environmental laws and regulations. These laws and regulations relate primarily to air and water pollutants and the management and disposal of hazardous materials. The Company is exposed to potential liability for personal injury or property damage caused by any release, spill, exposure or other accident involving such pollutants, substances or hazardous materials.
In order to limit costs incurred as a result of environmental exposure, the Company maintains contractor’s pollution liability insurance that covers liability that may be incurred as a result of accidental releases of hazardous materials.
The Company believes that it is currently in compliance, in all material aspects, with all applicable environmental laws and regulations. The Company does not expect any material charges in subsequent periods relating to environmental conditions that currently exist and does not currently foresee any significant future capital spending relating to environmental matters.
Item 1A. Risk Factors
The following risk factors should be considered with the other information included in this Annual Report on Form 10-K. As we operate in a continuously changing environment, other risk factors may emerge which could have a material adverse effect on our results of operations, financial condition and cash flow.
Risk Factors Related to Our Business
Unsatisfactory safety performance may subject us to penalties, affect customer relationships, result in higher operating costs, negatively impact employee morale and result in higher employee turnover.
 Our projects are conducted at a variety of sites including construction sites and industrial facilities.  With each location, hazards are part of the day to day exposures that we must manage on a continuous basis to ensure our employees return home from work the same way they arrived.  We understand that everyone plays a role with safety and everyone can make a difference with their active participation. With our proactive approach, our strategy is to identify the exposures and correct them before they manifest into an incident whether that involves an injury, damage or destruction of property, plant and equipment or environmental impact.  We are intensely focused on maintaining a strong safety culture and continue our journey to zero incidents.
Although we have taken what we believe are appropriate precautions to adequately train and equip our employees, we have experienced serious accidents, including fatalities, in the past and may experience additional accidents in the future.


6


Serious accidents may subject us to penalties, civil litigation or criminal prosecution. Claims for damages to persons, including claims for bodily injury or loss of life, could result in costs and liabilities, which could materially and adversely affect our financial condition, results of operations or cash flows. Poor safety performance could also jeopardize our relationships with our customers.
Demand for our products and services is cyclical and is vulnerable to the level of capital and maintenance spending of our customers and to downturns in the industries and markets we serve, as well as conditions in the general economy.
The demand for our products and services depends upon the existence of construction and maintenance projects in the downstream petroleum, power and other heavy industries in the United States and Canada. Therefore, it is likely that our business will continue to be cyclical in nature and vulnerable to general downturns in the United States, Canadian and world economies and changes in commodity prices, which could adversely affect the demand for our products and services.
The availability of engineering and construction projects is dependent upon economic conditions in the oil, gas, and power industries, specifically, the level of capital expenditures on energy infrastructure. A prolonged period of sluggish economic conditions in North America has had and may continue to have an adverse impact on the level of capital expenditures of our customers and/or their ability to finance these expenditures. Our failure to obtain projects, the delay of project awards, the cancellation of projects or delays in the execution of contracts may result in under-utilization of our resources, which could adversely impact our revenue, operating results and cash flow. There are numerous factors beyond our control that influence the level of maintenance and capital expenditures of our customers, including:
current or projected commodity prices, including oil, gas, power and mineral prices;
refining margins;
the demand for oil, gas and electricity;
the ability of oil, gas and power companies to generate, access and deploy capital;
exploration, production and transportation costs;
tax incentives, including those for alternative energy projects;
regulatory restraints on the rates that power companies may charge their customers; and
local, national and international political and economic conditions.
Our results of operations depend upon the award of new contracts and the timing of those awards.
Our revenues are derived primarily from contracts awarded on a project-by-project basis. Generally, it is difficult to predict whether and when we will be awarded a new contract due to lengthy and complex bidding and selection processes, changes in existing or forecasted market conditions, access to financing, governmental regulations, permitting and environmental matters. Because our revenues are derived from contract awards, our results of operations and cash flows can fluctuate materially from period to period.
The uncertainty associated with the timing of contract awards may reduce our short-term profitability as we balance our current capacity with expectations of future contract awards. If an expected contract award is delayed or not received, we could incur costs to maintain an idle workforce that may have a material adverse effect on our results of operations. Alternatively, we may decide that our long-term interests are best served by reducing our workforce and incurring increased costs associated with severance and termination benefits, which also could have a material adverse effect on our results of operations in the period incurred. Reducing our workforce could also impact our results of operations if we are unable to adequately staff projects that are awarded subsequent to a workforce reduction.
Acquisitions may result in significant transaction expenses, and unidentified liabilities and risks associated with entering new markets. We may also be unable to profitably integrate and operate these businesses.
We may lack sufficient management, financial and other resources to successfully integrate future acquisitions, including acquisitions in markets where we have not previously operated. Any future acquisitions may result in significant transaction expenses, unexpected liabilities and other risks in addition to the integration and consolidation risks.


7


If we make any future acquisitions, we will likely assume liabilities of the acquired business or have exposure to contingent liabilities that may not be adequately covered by insurance or indemnification, if any, from the former owners of the acquired business. These potential liabilities could have a material adverse effect on our business.
We may need to raise additional capital in the future for working capital, capital expenditures and/or acquisitions, and we may not be able to do so on favorable terms or at all, which would impair our ability to operate our business or achieve our strategic plan.
To the extent that cash flow from operations, together with available borrowings under our credit facility, are insufficient to make future investments, acquisitions or provide needed working capital, we may require additional financing from other sources. Our ability to obtain such additional financing in the future will depend in part upon prevailing capital market conditions, as well as conditions in our business and our operating results; and those factors may affect our efforts to arrange additional financing on terms that are satisfactory to us. If adequate funds are not available, or are not available on acceptable terms, we may not be able to make future investments, take advantage of acquisitions or other opportunities, or respond to competitive challenges.
We face substantial competition in each of our business segments, which may have a material adverse effect on our business.
We face competition in all areas of our business from regional, national and international competitors. Our competitors range from small, family-owned businesses to well-established, well-financed entities, both privately and publicly held, including many major equipment manufacturers, large engineering and construction companies and specialty contractors. We compete primarily on the basis of price, customer satisfaction, safety performance and programs, quality of our products and services, and schedule. As a result, an increase in the level of competition in one or more markets may result in lower operating margins than we have recently experienced.
Our backlog is subject to unexpected fluctuations, adjustments and cancellations and does not include the full value of our long-term maintenance contracts, and therefore, may not be a reliable indicator of our future earnings.
Backlog may not be a reliable indicator of our future performance. We cannot guarantee that the revenue projected in our backlog will be realized or profitable. Projects may remain in our backlog for an extended period of time. In addition, project cancellations or scope adjustments may occur from time to time with respect to contracts included in our backlog that could reduce the dollar amount of our backlog and the revenue and profits that we actually earn. Many of our contracts have termination rights. Therefore, project adjustments may occur from time to time to contracts in our backlog.
The loss of one or more of our significant customers could adversely affect us.
One or more customers have in the past and may in the future contribute a material portion of our revenues in any one year. Because these significant customers generally contract with us for specific projects or for specific periods of time, we may lose these customers from year to year as the projects or maintenance contracts are completed. The loss of business from any one of these customers could have a material adverse effect on our business or results of operations.
The terms of our contracts could expose us to unforeseen costs and costs not within our control, which may not be recoverable and could adversely affect our results of operations and financial condition.
A significant amount of our work is performed under fixed price contracts. Under fixed-price contracts, we agree to perform the contract for a fixed-price and, as a result, can improve our expected profit by superior execution, productivity, workplace safety and other factors resulting in cost savings. However, we could incur cost overruns above the approved contract price, which may not be recoverable. Under certain incentive fixed-price contracts, we may agree to share with a customer a portion of any savings we generate while the customer agrees to bear a portion of any increased costs we may incur up to a negotiated ceiling. To the extent costs exceed the negotiated ceiling price, we may be required to absorb some or all of the cost overruns.
Fixed-price contract prices are established based largely upon estimates and assumptions relating to project scope and specifications, personnel and productivity, material needs, and site conditions. These estimates and assumptions may prove inaccurate or conditions may change due to factors out of our control, resulting in cost overruns, which we may be required to absorb and which could have a material adverse effect on our business, financial condition and results of operations. In addition, our profits from these contracts could decrease or we could experience losses if we incur difficulties in performing the contracts or are unable to secure fixed-pricing commitments from our manufacturers, suppliers and subcontractors at the time we enter into fixed-price contracts with our customers.


8


Under cost-plus and time-and-material contracts, we perform our services in return for payment of our agreed upon reimbursable costs plus a profit. The profit component is typically expressed in the contract either as a percentage of the reimbursable costs we actually incur or is factored into the rates we charge for labor or for the cost of equipment and materials, if any, we are required to provide. Our profit could be negatively impacted if our actual costs exceed the estimated costs utilized to establish the billing rates included in the contracts.
We may incur significant costs in providing services in excess of original project scope without having an approved change order.
After commencement of a contract, we may perform, without the benefit of an approved change order from the customer, additional services requested by the customer that were not contemplated in our contract price for various reasons, including customer changes or incomplete or inaccurate engineering, changes in project specifications and other similar information provided to us by the customer. Our construction contracts generally require the customer to compensate us for additional work or expenses incurred under these circumstances.
A failure to obtain adequate compensation for these matters could require us to record in the current period an adjustment to revenue and profit recognized in prior periods under the percentage-of-completion accounting method. Any such adjustments, if substantial, could have a material adverse effect on our results of operations and financial condition, particularly for the period in which such adjustments are made. We can provide no assurance that we will be successful in obtaining, through negotiation, arbitration, litigation or otherwise, approved change orders in an amount adequate to compensate us for our additional work or expenses.
Our profitability could be negatively impacted if we are not able to maintain appropriate utilization of our workforce.
The extent to which we utilize our workforce affects our profitability. If we under utilize our workforce, our project gross margins and overall profitability suffer in the short-term. If we over utilize our workforce, we may negatively impact safety, employee satisfaction and project execution, which could result in a decline of future project awards. The utilization of our workforce is impacted by numerous factors including:
our estimate of the headcount requirements for various operating units based upon our forecast of the demand for our products and services;
our ability to maintain our talent base and manage attrition;
productivity;
our ability to schedule our portfolio of projects to efficiently utilize our employees and minimize downtime between project assignments; and
our need to invest time and resources into functions such as training, business development, employee recruiting, and sales that are not chargeable to customer projects.
Our use of percentage-of-completion accounting for fixed-price contracts and our reporting of profits for cost-plus contracts prior to contract completion could result in a reduction or elimination of previously reported profits.
Our revenues are recognized using the percentage-of-completion method of accounting. Under percentage-of-completion accounting, contract revenues and earnings are recognized ratably over the contract term based on the proportion of actual costs incurred to total estimated costs. In addition, some contracts contain penalty provisions for failure to achieve certain milestones, schedules or performance standards. We review our estimates of contract revenues, costs and profitability on a monthly basis. As a result, we may adjust our estimates on one or more occasions as a result of changes in cost estimates, change orders to the original contract, or claims against the customer for increased costs incurred by us due to customer-induced delays and other factors.
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 in the period the loss is determined. Contract profit estimates are also adjusted, on a percentage of completion basis, in the fiscal period in which it is determined that an adjustment is required. No restatements are made to prior periods. Further, a number of our contracts contain various cost and performance incentives and penalties that impact the earnings we realize from our contracts, and adjustments related to these incentives and penalties are recorded on a percentage of completion basis in the period when estimable and probable.


9


As a result of the requirements of the percentage-of-completion method of accounting, the possibility exists that we could have estimated and reported a profit on a contract over several prior periods and later determine that all or a portion of such previously estimated and reported profits were overstated. If this occurs, the full aggregate amount of the overstatement will be reported for the period in which such determination is made.
We are exposed to credit risk from customers. If we experience delays and/or defaults in customer payments, we could suffer liquidity problems or we could be unable to recover amounts owed to us.
Under the terms of our contracts, at times we commit resources to customer projects prior to receiving payments from customers in amounts sufficient to cover expenditures on these projects as they are incurred. Many of our fixed-price or cost-plus contracts require us to satisfy specified progress milestones or performance standards in order to receive a payment. Under these types of arrangements, we may incur significant costs for labor, equipment and supplies prior to receipt of payment. If the customer fails or refuses to pay us for any reason, there is no assurance we will be able to collect amounts due to us for costs previously incurred. In some cases, we may find it necessary to terminate subcontracts with suppliers engaged by us to assist in performing a contract, and we may incur costs or penalties for canceling our commitments to them. Delays in customer payments require an investment in working capital. If we are unable to collect amounts owed to us under our contracts, we may be required to record a charge against previously recognized earnings related to the project, and our liquidity, financial condition and results of operations could be adversely affected.
Actual results could differ from the estimates and assumptions that we use to prepare our financial statements.
To prepare financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions, as of the date of the financial statements, which affect the reported values of assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities. Areas requiring significant estimation by our management include:
contract costs and application of percentage-of-completion accounting;
provisions for uncollectible receivables from customers for invoiced amounts;
the amount and collectability of unapproved change orders and claims against customers;
provisions for income taxes and related valuation allowances;
recoverability of goodwill and intangible assets;
valuation of assets acquired and liabilities assumed in connection with business combinations; and
accruals for estimated liabilities, including litigation and insurance reserves.
Our actual results could materially differ from these estimates.
An inability to attract and retain qualified personnel, and in particular, engineers, project managers, and skilled craft workers, could impact our ability to perform on our contracts, which could harm our business and impair our future revenues and profitability.
Our ability to attract and retain qualified engineers, project managers, skilled craftsmen and other experienced professionals in accordance with our needs is an important factor in our ability to maintain profitability and grow our business. The market for these professionals is competitive, particularly during periods of economic growth when the supply is limited. We cannot provide any assurance that we will be successful in our efforts to retain or attract qualified personnel when needed. Therefore, when we anticipate or experience growing demand for our services, we may incur additional cost to maintain a professional staff in excess of our current contract needs in an effort to have sufficient qualified personnel available to address this anticipated demand. If we do incur additional compensation and benefit costs, our customer contracts may not allow us to pass through these costs.
Competent and experienced engineers, project managers, and craft workers are especially critical to the profitable performance of our contracts, particularly on our fixed-price contracts where superior design and execution of the project can result in profits greater than originally estimated or where inferior design and project execution can reduce or eliminate estimated profits or even result in a loss.
Our project managers are involved in most aspects of contracting and contract execution including:


10


supervising the bidding process, including providing estimates of significant cost components, such as material and equipment needs, and the size, productivity and composition of the workforce;
negotiating contracts;
supervising project performance, including performance by our employees, subcontractors and other third-party suppliers and vendors;
estimating costs for completion of contracts that is used to estimate amounts that can be reported as revenues and earnings on the contract under the percentage-of-completion method of accounting;
negotiating requests for change orders and the final terms of approved change orders; and
determining and documenting claims by us for increased costs incurred due to the failure of customers, subcontractors and other third-party suppliers of equipment and materials to perform on a timely basis and in accordance with contract terms.
Work stoppages and other labor problems could adversely affect us.
Some of our employees are represented by labor unions. The Company has in excess of 50 collective bargaining agreements with various labor unions. The most significant agreements include the following:
Trade
 
Local #
 
Location
 
Expires
Boilermaker
 
28
 
Bayonne, N.J.
 
12/31/2015
Boilermaker
 
13
 
Philadelphia, PA.
 
12/31/2015
Electrician
 
351
 
Hammonton, N.J.
 
09/27/2016
Electrician
 
102
 
Parsippany, N.J.
 
05/31/2015
Electrician
 
164
 
Paramus, N.J.
 
05/31/2017
Laborers
 
81
 
Gary, IN.
 
05/31/2017
Iron Workers
 
395
 
Gary, IN
 
05/31/2015
The Company is also working under a number of other collective bargaining agreements that cover a smaller number of employees. These agreements expire within the next five years. For those agreements with upcoming expiration dates, the Company is currently negotiating renewals and expects that the renewals will be successfully completed. To date, the Company has not experienced any work stoppages or other significant labor problems in connection with its collective bargaining agreements. A lengthy strike or other work stoppage on any of our projects could have a material adverse effect on our business and results of operations due to an inability to complete contracted projects in a timely manner.
We contribute to multiemployer plans that could result in liabilities to us if those plans are terminated or if we withdraw from those plans.
We contribute to several multiemployer pension plans for employees covered by collective bargaining agreements. These plans are not administered by us and contributions are determined in accordance with provisions of negotiated labor contracts. The Employee Retirement Income Security Act of 1974, as amended by the Multiemployer Pension Plan Amendments Act of 1980, imposes certain liabilities upon employers who are contributors to a multiemployer plan in the event of the employer’s withdrawal from, or upon termination of, such plan. If we terminate or withdraw from a multiemployer pension plan, we could be required to make significant cash contributions to fund that plan's unfunded vested benefit, which could materially and adversely affect our financial condition and results of operations; however, we are not currently able to determine the net assets and actuarial present value of the multiemployer pension plans’ unfunded vested benefits allocable to us, if any, and we are not presently aware of the amounts, if any, for which we may be contingently liable if we were to withdraw from any of these plans. In addition, if the funding level of any of these multiemployer plans becomes classified as “critical status” under the Pension Protection Act of 2006, we could be required to make significant additional contributions to those plans.
Future events, including those associated with our strategic plan, could negatively affect our liquidity position.
We can provide no assurance that we will have sufficient cash from operations or the credit capacity to meet all of our future cash needs should we encounter significant working capital requirements or incur significant acquisition costs. Insufficient cash from operations, significant working capital requirements, and contract disputes have in the past, and could in the future, reduce availability under our credit facility.


11


We are involved, and are likely to continue to be involved in legal proceedings, which will increase our costs and, if adversely determined, could have a material effect on our financial condition, results of operations, cash flows and liquidity.
We are currently a defendant in legal proceedings arising from the operation of our business, and it is reasonable to expect that we would be named in future actions. Many of the actions against us arise out of the normal course of performing services on project sites, and include workers’ compensation claims, personal injury claims and contract disputes with our customers. From time to time, we are also named as a defendant for actions involving the violation of federal and state labor laws related to employment practices, wages and benefits. We may also be a plaintiff in legal proceedings against customers seeking to recover payment of contractual amounts due to us as well as claims for increased costs incurred by us resulting from, among other things, services performed by us at the request of a customer that are in excess of original project scope that are later disputed by the customer and customer-caused delays in our contract performance.
We maintain insurance against operating hazards in amounts that we believe are customary in our industry. However, our insurance policies include deductibles and certain coverage exclusions, so we cannot provide assurance that we are adequately insured against all of the risks associated with the conduct of our business. A successful claim brought against us in excess of, or outside of, our insurance coverage could have a material adverse effect on our financial condition, results of operations, cash flows and liquidity.
Litigation, regardless of its outcome, is expensive, typically diverts the efforts of our management away from operations for varying periods of time, and can disrupt or otherwise adversely impact our relationships with current or potential customers, subcontractors and suppliers. Payment and claim disputes with customers may also cause us to incur increased interest costs resulting from incurring indebtedness under our revolving line of credit or receiving less interest income resulting from fewer funds invested due to the failure to receive payment for disputed claims and accounts.
Our projects expose us to potential professional liability, product liability, warranty and other claims, which could be expensive, damage our reputation and harm our business. We may not be able to obtain or maintain adequate insurance to cover these claims.
We perform construction and maintenance services at large industrial facilities where accidents or system failures can be disastrous and costly. Any catastrophic occurrence in excess of our insurance limits at locations engineered or constructed by us or where our products are installed or services performed could result in significant professional liability, product liability, warranty and other claims against us by our customers, including claims for cost overruns and the failure of the project to meet contractually specified milestones or performance standards. Further, the rendering of our services on these projects could expose us to risks and claims by third parties and governmental agencies for personal injuries, property damage and environmental matters, among others. Any claim, regardless of its merit or eventual outcome, could result in substantial costs, divert management’s attention and create negative publicity, particularly for claims relating to environmental matters where the amount of the claim could be extremely large. We may not be able to or may choose not to obtain or maintain insurance coverage for the types of claims described above. If we are unable to obtain insurance at an acceptable cost or otherwise protect against the claims described above, we will be exposed to significant liabilities, which may materially and adversely affect our financial condition and results of operations.
Employee, subcontractor or partner misconduct or our overall failure to comply with laws or regulations could harm our reputation, damage our relationships with customers, reduce our revenues and profits, and subject us to criminal and civil enforcement actions.
Misconduct, fraud, non-compliance with applicable laws and regulations, or other improper activities by one of our employees, subcontractors or partners could have a significant negative impact on our business and reputation.  Such misconduct could include the failure to comply with safety standards, laws and regulations, customer requirements, regulations pertaining to the internal controls over financial reporting, environmental laws and any other applicable laws or regulations.  The precautions we take to prevent and detect these activities may not be effective, since our internal controls are subject to inherent limitations, including human error, the possibility that controls could be circumvented or become inadequate because of changed conditions, and fraud.
Our failure to comply with applicable laws or regulations or acts of misconduct could subject us to fines and penalties, harm our reputation, damage our relationships with customers, reduce our revenues and profits and subject us to criminal and civil enforcement actions.


12


We rely on internally and externally developed software applications and systems to support critical functions including project management, estimating, scheduling, human resources, accounting, and financial reporting. Any sudden loss, disruption or unexpected costs to maintain these systems could significantly increase our operational expense as well as disrupt the management of our business operations.
We rely on various software systems to conduct our critical operating and administrative functions.  We depend on our software vendors to provide long-term software maintenance support for our information systems.  Software vendors may decide to discontinue further development, integration or long-term software maintenance support for our information systems, in which case we may need to abandon one or more of our current information systems and migrate some or all of our project management, human resources, estimating, scheduling, accounting and financial information to other systems, thus increasing our operational expense as well as disrupting the management of our business operations.
Our business may be affected by difficult work sites and environments, which may adversely affect our overall business.
We perform our work under a variety of conditions, including, but not limited to, difficult terrain, difficult site conditions and busy urban centers where delivery of materials and availability of labor may be impacted. Performing work under these conditions can slow our progress, potentially causing us to incur contractual liability to our customers. These difficult conditions may also cause us to incur additional, unanticipated costs that we might not be able to pass on to our customers.
We are susceptible to adverse weather conditions, which may harm our business and financial results.
Our business may be adversely affected by severe weather in areas where we have significant operations. Repercussions of severe weather conditions may include:
curtailment of services;
suspension of operations;
inability to meet performance schedules in accordance with contracts;
weather related damage to our facilities;
disruption of information systems;
inability to receive machinery, equipment and materials at jobsites; and
loss of productivity.
Environmental factors and changes in laws and regulations could increase our costs and liabilities.
Our operations are subject to environmental laws and regulations, including those concerning emissions into the air; discharges into waterways; generation, storage, handling, treatment and disposal of hazardous material and wastes; and health and safety.
Our projects often involve highly regulated materials, including hazardous wastes. Environmental laws and regulations generally impose limitations and standards for regulated materials and require us to obtain permits and comply with various other requirements. The improper characterization, handling, or disposal of regulated materials or any other failure by us to comply with federal, state and local environmental laws and regulations or associated environmental permits could subject us to the assessment of administrative, civil and criminal penalties, the imposition of investigatory or remedial obligations, or the issuance of injunctions that could restrict or prevent our ability to operate our business and complete contracted projects.
In addition, under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”), and comparable state laws, we may be required to investigate and remediate regulated materials. CERCLA and the comparable state laws typically impose liability without regard to whether a company knew of or caused the release, and liability for the entire cost of clean-up can be imposed upon any responsible party.
We are subject to numerous other laws and regulations including those related to business registrations and licenses, environment, workplace, employment, health and safety. These laws and regulations are complex, change frequently and could become more stringent in the future. It is impossible to predict the effect on us of any future changes to these laws and regulations. We can provide no absolute assurance that our operations will continue to comply with future laws and regulations or that the costs to comply with these laws and regulations and/or a failure to comply with these laws will not significantly adversely affect our business, financial condition and results of operations.


13


We recorded an intangible asset impairment charge of $0.3 million in fiscal 2013 related to an acquisition. Earnings for future periods may be affected by additional impairment charges.
Because we have grown in part through acquisitions, goodwill and other acquired intangible assets represent a substantial portion of our assets. We perform annual goodwill and intangible asset impairment reviews in the fourth quarter of every fiscal year. In addition, we perform an impairment review whenever events or changes in circumstances indicate the carrying value of goodwill or an intangible or fixed asset may not be recoverable. At some future date, we may determine that significant impairment has occurred, which could require us to write off an additional portion of our assets and could adversely affect our financial condition or results of operations. As of June 30, 2014 the Company had $27.2 million of amortizing intangible assets and $71.3 million of non amortizing intangibles including goodwill representing 4.8% and 12.5% of the Company's total assets, respectively.
Our credit facility imposes restrictions that may limit business alternatives.
Our credit facility contains covenants that restrict or limit our ability to incur additional debt, acquire or dispose of assets, repurchase equity, or make certain distributions, including dividends. In addition, our credit facility requires that we comply with a number of financial covenants. These covenants and restrictions may impact our ability to effectively execute operating and strategic plans and our operating performance may not be sufficient to comply with the required covenants.
Our failure to comply with one or more of the covenants in our credit facility could result in an event of default. We can provide no assurance that a default could be remedied, or that our creditors would grant a waiver or amend the terms of the credit facility. If an event of default occurs, our lenders could elect to declare all amounts outstanding under the facility to be immediately due and payable, terminate all commitments, refuse to extend further credit, and require us to provide cash to collateralize any outstanding letters of credit. If an event of default occurs and the lenders under the credit facility accelerate the maturity of any loans or other debt outstanding, we may not have sufficient liquidity to repay amounts outstanding under the existing agreement.
Risk Factors Related To The Acquisition of Kvaerner North American Construction ("KNAC")
We may not be able to successfully integrate our acquisition of KNAC, which could cause our business to suffer.
We may not be able to successfully complete integration of the operations, personnel and technology of KNAC. Because of the size and complexity of KNAC’s business, if the remaining integration is not managed successfully, we may experience interruptions in our business activities, a decrease in the quality of our services, a deterioration in our employee and customer relationships, increased costs of integration and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations. The integration of KNAC with our operations will require significant attention from management, which may decrease the time that management will have to serve existing customers, attract new customers and develop new services and strategies. We may also experience difficulties in combining corporate cultures, maintaining employee morale and retaining key employees. The continuing integration of KNAC may also impose substantial demands on our operations or other projects. We will have to actively strive to demonstrate to our existing customers that the acquisition has not resulted in adverse changes in our standards or business focus. The integration of KNAC will also involve a significant capital commitment, and the return that we achieve on any capital invested may be less than the return achieved on our other projects or investments. There will be challenges in consolidating and rationalizing information technology platforms and administrative infrastructures. In addition, any delays or increased costs of integrating the companies could adversely affect our operations, financial results and liquidity.
We may not realize the growth opportunities, operating margins and synergies that are anticipated from our acquisition of KNAC.
The benefits we expect to achieve as a result of our acquisition of KNAC will depend, in part, on our ability to realize the anticipated growth opportunities, operating margins and synergies. Our success in realizing these growth opportunities, operating margins and synergies, and the timing of this realization, depends on the successful integration of KNAC’s business and operations with our business and operations. Even if we are able to integrate our business with KNAC’s business successfully, this integration may not result in the realization of the full benefits of the growth opportunities, operating margins and synergies we currently expect from this integration within the anticipated time frame or at all. Accordingly, the benefits from the acquisition may be offset by costs incurred or delays in integrating the companies, which could cause our revenue assumptions and operating margin to be inaccurate.




14


The acquisition may expose us to unidentified liabilities.
As a result of the acquisition, we acquired KNAC subject to certain of its liabilities. If there are unknown KNAC obligations, our business could be materially and adversely affected. We may learn additional information about KNAC’s business that adversely affects us, such as unknown liabilities, issues that could affect our ability to comply with the Sarbanes-Oxley Act or issues that could affect our ability to comply with other applicable laws. As a result, we cannot assure that the acquisition of KNAC will be successful or will not, in fact, harm our business. Among other things, if KNAC’s liabilities are greater than expected, or if there are material obligations of which we were not aware our business could be materially and adversely affected. If we become responsible for liabilities not covered by indemnification rights or substantially in excess of amounts covered through any indemnification rights, we could suffer severe consequences that would substantially reduce our revenues, earnings and cash flows.
The steel industry is cyclical and sensitive to general economic conditions, which could have a material adverse effect on our operating results and financial condition.
A significant percentage of KNAC’s revenues are derived from the steel industry. Demand for steel products is cyclical in nature and sensitive to general economic conditions. The timing and magnitude of the cycles in the markets in which our customers’ products are used, including automobiles and residential construction, are difficult to predict. The cyclical nature of our customers’ operations tends to reflect and be amplified by changes in economic conditions, both domestically and internationally, supply/demand imbalances and foreign currency exchange fluctuations. Economic downturns or a prolonged period of slow growth in the U.S. and foreign markets or any of the industries in which our steel industry customers operate could have a material adverse effect on our results of operations, financial condition and cash flows.
Increases in imports of foreign steel into the U.S. may reduce our customers’ profitability and capital spending plans.
Economic expansion in China and other countries has affected the supply and price of steel products. Expansions and contractions in these economies can significantly affect the price of steel and of finished steel products. Additionally, in a number of foreign countries, such as China, steel producers are generally government-owned and may therefore make production decisions based on political or other factors that do not reflect market conditions. Disruptions in foreign markets from excess steel production may encourage importers to target the U.S. with excess capacity at aggressive prices, and existing trade laws and regulations may be inadequate to prevent unfair trade practices, which could have a material adverse effect on our steel industry customers. Although trade regulations restrict the importation of certain products, if foreign steel production significantly exceeds consumption in those countries, imports of steel products into the U.S. could increase, resulting in lower volumes and selling prices for our customers’ steel products, which could result in a decline in the maintenance and construction work we provide to these customers.
Risk Factors Related to Our Common Stock
Our common stock, which is listed on the NASDAQ Global Select Market, has experienced significant price and volume fluctuations. These fluctuations could continue in the future, and our stockholders may not be able to resell their shares of common stock at or above the purchase price paid.
The market price of our common stock may change significantly in response to various factors and events beyond our control, including the following:
the risk factors described in this Item 1A;
general conditions in our customers’ industries;
general conditions in the security markets.
the significant concentration of ownership of our common stock in the hands of a small number of institutional investors;
a shortfall in operating revenue or net income from that expected by securities analysts and investors; and
changes in securities analysts’ estimates of our financial performance or the financial performance of our competitors or companies in our industry.
Some companies that have volatile market prices for their securities have been subject to security class action suits filed against them. If a suit were to be filed against us, regardless of the outcome, it could result in substantial costs and a diversion


15


of our management’s attention and resources. This could have a material adverse effect on our business, results of operations and financial condition.
Future sales of our common stock may depress our stock price.
Sales of a substantial number of shares of our common stock in the public market or otherwise, either by us, a member of management or a major stockholder, or the perception that these sales could occur, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.
We may issue additional equity securities, which could lead to dilution of our issued and outstanding stock.
The issuance of additional common stock, restricted stock units or securities convertible into our common stock could result in dilution of the ownership interest held by existing stockholders. We are authorized to issue, without stockholder approval 5,000,000 shares of preferred stock, par value $0.01 per share, in one or more series, which may give other stockholders dividend, conversion, voting, and liquidation rights, among other rights, which may be superior to the rights of holders of our common stock. In addition, we are authorized to issue, without stockholder approval, a significant number of additional shares of our common stock and securities convertible into either common stock or preferred stock. 
Item 1B. Unresolved Staff Comments
None


16


Item 2. Properties
The principal properties of Matrix Service Company are as follows:
 
 
 
 
 
 
 
Location
  
Description of Facility
  
Segment
  
Interest
Tulsa, Oklahoma
  
Corporate headquarters and regional office
  
Corporate, Storage Solutions
  
Leased
Alton, Illinois
 
Regional office
 
Oil Gas & Chemical
 
Leased
Bellingham, Washington
  
Regional office, fabrication facility and warehouse
  
Oil Gas & Chemical, Storage Solutions, Industrial
  
Owned
Canonsburg, Pennsylvania
 
Regional office
 
Electrical Infrastructure, Oil Gas & Chemical, Industrial
 
Leased
Catoosa, Oklahoma
  
Fabrication facility, regional offices and warehouse
  
Oil Gas & Chemical, Storage Solutions, Industrial
  
    Owned (1)
Eddystone, Pennsylvania
  
Regional office, fabrication facility and warehouse
  
Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, Industrial
  
Leased
Hammond, Indiana
 
Regional office, fabrication facility, and warehouse
 
Electrical Infrastructure, Oil Gas & Chemical, Industrial
 
Leased
Houston, Texas
  
Regional offices and warehouse
  
Oil Gas & Chemical, Storage Solutions
  
Leased & Owned
Orange, California
  
Fabrication facility, regional office and warehouse
  
Oil Gas & Chemical, Storage Solutions, Industrial
  
Owned
Parsippany, New Jersey
 
Regional office
 
Industrial
 
Leased
Rahway, New Jersey
  
Regional office and warehouse
  
Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, Industrial
  
Leased
Reserve, Louisiana
 
Regional office and warehouse
 
Oil Gas & Chemical
 
Leased
Sandy, Utah
 
Regional office and warehouse
 
Industrial
 
Leased
Sewickley, Pennsylvania
  
Regional office
  
Oil Gas & Chemical, Storage Solutions, Industrial
  
Leased
Temperance, Michigan
  
Regional office and warehouse
  
Storage Solutions
  
Owned
Tucson, Arizona
  
Regional office and warehouse
  
Industrial
  
Leased
Burlington, Ontario, Canada
 
Regional office
 
Electrical Infrastructure, Industrial
 
Owned
Edmonton, Alberta, Canada
 
Regional office
 
Storage Solutions
 
Leased
Leduc, Alberta, Canada
 
Regional office and warehouse
 
Storage Solutions
 
Leased
Saint John, New Brunswick, Canada
  
Regional office
  
Storage Solutions
  
Leased
Sarnia, Ontario, Canada
  
Regional office and warehouse
  
Storage Solutions
  
Owned
 
 
 
 
 
(1)
Facilities were constructed by the Company on land acquired through a ground lease with renewal options extending until 2042.

In addition to the locations listed above, Matrix has temporary office facilities at numerous customer locations throughout the United States and Canada. 


17


Item 3. Legal Proceedings
We are a party to a number of legal proceedings. We believe that the nature and number of these proceedings are typical for a company of our size engaged in our type of business and that none of these proceedings will result in a material effect on our business, results of operations, financial condition, cash flows or liquidity. 
Item 4. Mine Safety Disclosures
Section 1503 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") requires domestic mine operators to disclose violations and orders issued under the Federal Mine Safety and Health Act of 1977 (the "Mine Act") by the federal Mine Safety and Health Administration. We do not act as owner of any mines, but as a result of our performing services or construction at mine sites as an independent contractor, we may be considered an "operator" within the meaning of the Mine Act.
Information concerning mine safety violations or other regulatory matters required to be disclosed in this annual report under Section 1503(a) of the Dodd-Frank Act and Item 104 of Regulation S-K is included in Exhibit 95.




18



PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price Range of Common Stock
Our common stock trades on the NASDAQ Global Select Market (“NASDAQ”) under the trading symbol “MTRX”. The following table sets forth the high and low sale prices for our common stock as reported by NASDAQ for the periods indicated: 
 
 
Fiscal Year 2014
 
Fiscal Year 2013
 
 
High
 
Low
 
High
 
Low
First quarter
 
$
19.62

 
$
15.50

 
$
11.88

 
$
10.10

Second quarter
 
24.43

 
18.76

 
11.74

 
10.09

Third quarter
 
34.41

 
24.10

 
17.00

 
11.64

Fourth quarter
 
37.21

 
28.35

 
17.62

 
14.01

As of August 29, 2014, there were 25 holders of record of our common stock. The number of beneficial owners of our common stock is substantially greater than the number of holders of record.
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 dividends on our capital stock during any fiscal year up to an amount which, when added to all other dividends paid during such fiscal year, does not exceed 50% of our cumulative net income for such fiscal year to such 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.
Issuer Purchases of Equity Securities
Our Credit Agreement limits the Company's purchases of its equity securities to $25 million in any calendar year. The table below sets forth the information with respect to purchases made by the Company of its common stock during the fourth quarter of the fiscal year ended June 30, 2014.
 
 
Total Number
of Shares
Purchased
 
Average Price
Paid
Per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
 
Maximum Number of
Shares That May Yet
Be Purchased
Under the Plans
or Programs
April 1 to April 30, 2014
 
 
 
 
 
 
 
 
Share Repurchase Program (A)
 

 

 

 
2,113,497

Employee Transactions (B)
 

 

 

 
 
May 1 to May 31, 2014
 
 
 
 
 
 
 
 
Share Repurchase Program (A)
 

 

 

 
2,113,497

Employee Transactions (B)
 
3,228

 

$30.41

 

 
 
June 1 to June 30, 2014
 
 
 
 
 
 
 
 
Share Repurchase Program (A)
 

 

 

 
2,113,497

Employee Transactions (B)
 

 

 

 
 
 
 
 
 
 
(A)
Represents shares purchased under our stock buyback program approved by the Company's Board of Directors on November 6, 2012. The plan expires on December 31, 2014.
(B)
Represents shares withheld to satisfy the employee’s tax withholding obligation that is incurred upon the vesting of deferred shares granted under the Company’s stock incentive plans.


19


Item 6. Selected Financial Data
Selected Financial Data
(In thousands, except percentages and per share data)
 
 
Twelve Months Ended
 
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2012
 
June 30,
2011
 
June 30,
2010
 
Revenues
 
$
1,263,089

 
$
892,574

 
$
739,046

 
$
627,052

 
$
550,814

 
Gross profit
 
136,473

 
94,702

 
79,618

 
74,914

 
52,922

 
Gross margin %
 
10.8
%
 
10.6
%
 
10.8
%
 
11.9
%
 
9.6
%
 
Selling, general and administrative expenses
 
77,866

 
57,988

 
47,983

 
44,014

 
45,169

 
Selling, general and administrative %
 
6.2
%
 
6.5
%
 
6.5
%
 
7.0
%
 
8.2
%
 
Operating income
 
58,607

 
36,714

 
31,635

 
30,900

 
7,753

 
Net income
 
36,877

 
24,008

 
17,188

 
18,982

 
4,876

 
Earnings per share - basic
 
1.36

 
0.92

 
0.66

 
0.72

 
0.19

 
Earnings per share-diluted
 
1.33

 
0.91

 
0.65

 
0.71

 
0.18

 
Working capital
 
105,687

 
131,908

 
124,553

 
115,374

 
95,740

 
Total assets
 
568,932

 
409,978

 
323,135

 
306,436

 
284,808

 
Long-term debt
 
11,621

 

 

 

 
259

 
Capital expenditures
 
23,589

 
23,231

 
13,534

 
10,416

 
5,302

 
Cash flows provided by operations
 
76,988

 
57,084

 
2,941

 
22,749

 
4,399

 
Backlog
 
915,826

 
626,737

 
497,452

 
405,118

 
353,216

 
 
 
 
 



20



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


21


other causes of anticipated additional costs incurred by us. Recognition of amounts as additional contract revenue related to claims is appropriate only if it is probable that the claims will result in additional contract revenue and if the amount can be reliably estimated. We must determine if:
there is a legal basis for the claim;
the additional costs were caused by circumstances that were unforeseen by the Company and are not the result of deficiencies in our performance;
the costs are identifiable or determinable and are reasonable in view of the work performed; and
the evidence supporting the claim is objective and verifiable.
If all of the these requirements are met, revenue from a claim is recorded only to the extent that we have incurred costs relating to the claim.
As of June 30, 2014 and June 30, 2013, costs and estimated earnings in excess of billings on uncompleted contracts included revenues for unapproved change orders and claims of $13.1 million and $9.1 million, respectively. Historically, our collections for unapproved change orders and claims have approximated the amount of revenue recognized.
Loss Contingencies
Various legal actions, claims, and other contingencies arise in the normal course of our business. Contingencies are recorded in the consolidated financial statements, or are otherwise disclosed, in accordance with ASC 450-20, “Loss Contingencies”. Specific reserves are provided for loss contingencies to the extent we conclude that a loss is both probable and estimable. We use a case-by-case evaluation of the underlying data and update our evaluation as further information becomes known. We believe that any amounts exceeding our recorded accruals should not materially affect our financial position, results of operations or liquidity. However, the results of litigation are inherently unpredictable and the possibility exists that the ultimate resolution of one or more of these matters could result in a material effect on our financial position, results of operations or liquidity.
Legal costs are expensed as incurred.
Insurance Reserves
We maintain insurance coverage for various aspects of our operations. However, we retain exposure to potential losses through the use of deductibles, coverage limits and self-insured retentions. We establish reserves for claims using a combination of actuarially determined estimates and management judgment on a case-by-case basis and update our evaluations as further information becomes known. Judgments and assumptions, including the assumed losses for claims incurred but not reported, are inherent in our reserve accruals; as a result, changes in assumptions or claims experience could result in changes to these estimates in the future. If actual results of claim settlements are different than the amounts estimated we may be exposed to gains or losses that could be significant. A hypothetical ten percent unfavorable change in our claim reserves at June 30, 2014 would have reduced fiscal 2014 pretax income by $0.6 million.
Goodwill
Goodwill represents the excess of the purchase price of acquisitions over the acquisition date fair value of the net identifiable tangible and intangible assets acquired. In accordance with current accounting guidance, goodwill is not amortized and is tested at least annually for impairment at the reporting unit level.
We perform our annual analysis during the fourth quarter of each fiscal year and in any other period in which indicators of impairment warrant additional analysis. Goodwill impairment reviews involve a two step process. Goodwill is first evaluated for impairment by comparing management's estimate of the fair value of a reporting unit with its carrying value, including goodwill.
Management utilizes a discounted cash flow analysis, referred to as an income approach, to determine the estimated fair value of our reporting units. Significant judgments and assumptions including the discount rate, anticipated revenue growth rate and gross margins, estimated operating and interest expense, and capital expenditures are inherent in these fair value estimates, which are based on our operating and capital budgets and on our strategic plan. As a result, actual results may differ from the estimates utilized in our income approach. The use of alternate judgments and/or assumptions could result in a fair value that differs from our estimate and could result in the recognition of an impairment charge in the financial statements. As a result of these uncertainties, we utilize multiple scenarios and assign probabilities to each of the scenarios in the income approach.


22


We also consider market-based approaches to assess the fair value of our reporting units. We compare market multiples from our public peer companies in the engineering and construction industry, as well as the combined carrying values of our reporting units with market capitalization.
If the carrying value of our reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step must be performed to measure the amount of impairment. The amount of impairment is determined by comparing the implied fair value of the reporting unit's goodwill to the carrying value of the goodwill calculated in the same manner as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is less than its carrying value, we would record an impairment charge for the difference.
Although we do not anticipate a future impairment charge, certain events could occur that would adversely affect the reported value of goodwill. Such events could include, but are not limited to, a change in economic or competitive conditions, a significant change in the project plans of our customers, a deterioration in the economic condition of the customers and industries we serve, and a material negative change in the relationships with one or more of our significant customers. If our judgments and assumptions change as a result of the occurrence of any of these events or other events that we do not currently anticipate, our expectations as to future results and our estimate of the implied value of one or more of our reporting units also may change.
We performed our annual impairment test in the fourth quarter to determine whether an impairment existed and to determine the amount of headroom. We define "headroom" as the percentage difference between the fair value of a reporting unit and its carrying value. The amount of headroom varies by reporting unit. Approximately 62% of our goodwill balance is attributable to one reporting unit. This unit had headroom of 94%. We have four additional reporting units with goodwill representing 13%, 8%, 6% and 6% of the total goodwill balance with headroom of 182%, 165%, 193% and 137%, respectively.
Our significant assumptions, including revenue growth rates, gross margins, unanticipated operating and interest expense and other factors may change in light of changes in the economic and competitive environment in which we operate. Assuming that all other components of our fair value estimate remain unchanged, a change in the following assumptions would have the following effect on headroom:
if the growth rate of estimated revenue decreases by one percentage point, the headroom of the reporting units referenced above would be reduced from 94%, 182%, 165%, 193% and 137% to 87%, 172%, 157%, 185% and 129%, respectively;
if our estimate of gross margins decreases one percentage point, the headroom of the reporting units referenced above would be reduced from 94%, 182%, 165%, 193% and 137% to 69%, 146%, 131%, 161% and 108%, respectively; and
if the applicable discount rate increases one percentage point, the headroom of the reporting units referenced above would be reduced from 94%, 182%, 165%, 193% and 137% to 79%, 166%, 145%, 172% and 119%, respectively.
Other Intangible Assets
Intangible assets that have finite useful lives are amortized by the straight-line method over their useful lives ranging from 1 to 15 years. Intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment. Each reporting period, we evaluate the remaining useful lives of intangible assets not being amortized to determine whether facts and circumstances continue to support an indefinite useful life and review both amortizing and non-amortizing intangible assets for impairment indicators. In fiscal 2013, we reclassified an intangible asset from an indefinite-lived intangible to a finite-lived intangible resulting in an impairment charge of $0.3 million.
Recently Issued Accounting Standards
Accounting Standards Update 2014-09 (Topic 606), Revenue from Contracts with Customers
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers." The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” In applying the revenue model to contracts within its scope, an entity:
• Identifies the contract(s) with a customer (step 1).
• Identifies the performance obligations in the contract (step 2).
• Determines the transaction price (step 3).
• Allocates the transaction price to the performance obligations in the contract (step 4).


23


• Recognizes revenue when (or as) the entity satisfies a performance obligation (step 5).
The ASU also requires entities to disclose both quantitative and qualitative information that enables users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU’s disclosure requirements are significantly more comprehensive than those in existing revenue standards. The ASU applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC"). For public entities, the ASU is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early application is not permitted. We expect to adopt this standard in fiscal 2018 and are currently evaluating its expected impact on our financial statements.
Accounting Standards Update 2014- 12 (Topic 718), Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force "EITF")
On June 19, 2014, the FASB issued ASU 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force)"in response to the EITF consensus on Issue 13-D. The ASU clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent on the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. The ASU does not contain any new disclosure requirements. For all entities, this standard is effective for reporting periods beginning after December 15, 2015. Early adoption is permitted. We expect to adopt this standard in fiscal 2016 and do not expect the adoption of this standard to have a material impact on our consolidated financial statements.
Accounting Standards Update 2014-08 (Topics 205 and 360), Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
On April 10, 2014, the FASB issued ASU 2014-08, " Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity" which amends the definition of a discontinued operation in ASC 205-20 and requires entities to provide additional disclosures about discontinued operations as well as disposal transactions that do not meet the discontinued-operations criteria. The FASB issued the ASU to provide more decision-useful information and to make it more difficult for a disposal transaction to qualify as a discontinued operation (since the FASB believes that too many disposal transactions were qualifying as discontinued operations under the old definition). Under the previous guidance in ASC 205-20-45-1, the results of operations of a component of an entity were classified as a discontinued operation if all of the following conditions were met:
• "The component “has been disposed of or is classified as held for sale.”
• “The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity
as a result of the disposal transaction.”
• “The entity will not have any significant continuing involvement in the operations of the component after the disposal
transaction.”
The new guidance eliminates the second and third criteria above and instead requires discontinued operations treatment for disposals of a component or group of components that represents a strategic shift that has or will have a major impact on an entity’s operations or financial results. The ASU also expands the scope of ASC 205-20 to disposals of equity method investments and businesses that, upon initial acquisition, qualify as held for sale.The ASU is effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014. Early adoption is permitted. We expect to adopt this standard in fiscal 2015 and do not expect the adoption of this standard to have a material impact on our consolidated financial statements.




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Results of Operations
Overview
We operate our business through four reportable segments: Electrical Infrastructure, Oil Gas & Chemical, Storage Solutions, and Industrial.
The Electrical Infrastructure segment primarily encompasses construction and maintenance services to a variety of power generation facilities, such as combined cycle plants, natural gas fired power stations, and renewable energy installations. We also provide high voltage services to investor owned utilities, including construction of new substations, upgrades of existing substations, short-run transmission line installations, distribution upgrades and maintenance, and storm restoration services.
The Oil Gas & Chemical segment includes our traditional turnaround activities, plant maintenance services and construction in the downstream petroleum industry. Another key offering is industrial cleaning services, which include hydroblasting, hydroexcavating, chemical cleaning and vacuum services. We also perform work in the petrochemical, natural gas, gas processing and compression, and upstream petroleum markets.
The Storage Solutions segment includes new construction of crude and refined products ASTs, as well as planned and emergency maintenance services. Also included in the Storage Solutions segment is work related to specialty storage tanks including LNG, liquid nitrogen/liquid oxygen LIN/LOX, LPG tanks and other specialty vessels including spheres. We also offer aboveground storage tank products including floating roof seals. Finally, the Storage Solutions segment includes balance of plant work in storage terminals and tank farms.
The Industrial segment includes construction and maintenance work in the iron and steel and mining and minerals industries, bulk material handling and fertilizer production facilities, as well as work for clients in other industrial markets.
The majority of the work for all segments is performed in the United States, with 9.0% of revenues generated in Canada during fiscal 2014, 8.7% in fiscal 2013 and 8.5% in fiscal 2012. Significant period to period changes in revenues, gross profits and operating results are discussed below on a consolidated basis and for each segment.


25


Matrix Service Company
Results of Operations
(In thousands)
 
 
Electrical
Infrastructure
 
Oil Gas &
Chemical
 
Storage
Solutions
 
Industrial
 
Total
Fiscal Year 2014
 
 
 
 
 
 
 
 
 
 
Consolidated revenues
 
$
205,570

 
$
239,690

 
$
610,896

 
$
206,933

 
$
1,263,089

Gross profit
 
20,629

 
26,912

 
68,448

 
20,484

 
136,473

Selling, general and administrative expenses
 
12,926

 
16,973

 
34,138

 
13,829

 
77,866

Operating income
 
7,703

 
9,939

 
34,310

 
6,655

 
58,607

Fiscal Year 2013
 
 
 
 
 
 
 
 
 
 
Consolidated revenues
 
$
171,204

 
$
273,848

 
$
393,201

 
$
54,321

 
$
892,574

Gross profit
 
21,754

 
32,879

 
37,455

 
2,614

 
94,702

Selling, general and administrative expenses
 
10,569

 
17,464

 
25,551

 
4,404

 
57,988

Operating income (loss)
 
11,185

 
15,415

 
11,904

 
(1,790
)
 
36,714

Fiscal Year 2012
 
 
 
 
 
 
 
 
 
 
Consolidated revenues
 
$
135,086

 
$
205,823

 
$
378,154

 
$
19,983

 
$
739,046

Gross profit
 
16,676

 
20,070

 
42,393

 
479

 
79,618

Selling, general and administrative expenses
 
9,067

 
11,936

 
24,900

 
2,080

 
47,983

Operating income (loss)
 
7,609

 
8,134

 
17,493

 
(1,601
)
 
31,635

Variances Fiscal Year 2014 to Fiscal Year 2013 Increase/(Decrease)
 
 
 
 
 
 
 
 
 
 
Consolidated revenues
 
$
34,366

 
$
(34,158
)
 
$
217,695

 
$
152,612

 
$
370,515

Gross profit
 
(1,125
)
 
(5,967
)
 
30,993

 
17,870

 
41,771

Selling, general and administrative expenses
 
2,357

 
(491
)
 
8,587

 
9,425

 
19,878

Operating income
 
(3,482
)
 
(5,476
)
 
22,406

 
8,445

 
21,893

Variances Fiscal Year 2013 to Fiscal Year 2012 Increase/(Decrease)
 
 
 
 
 
 
 
 
 
 
Consolidated revenues
 
$
36,118

 
$
68,025

 
$
15,047

 
$
34,338

 
$
153,528

Gross profit
 
5,078

 
12,809

 
(4,938
)
 
2,135

 
15,084

Selling, general and administrative expenses
 
1,502

 
5,528

 
651

 
2,324

 
10,005

Operating income
 
3,576

 
7,281

 
(5,589
)
 
(189
)
 
5,079




26


Fiscal 2014 Versus Fiscal 2013
Consolidated
Consolidated revenues were $1.263 billion in fiscal 2014, an increase of $370.6 million, or 41.5%, from consolidated revenues of $892.6 million in fiscal 2013. As discussed in Note 2 - Acquisitions, the Company acquired Kvaerner North American Construction, which we refer to as Matrix NAC, near the end of second quarter of fiscal 2014. Matrix NAC revenues totaled $154.8 million in fiscal 2014. The remaining revenue increase of $215.8 million was attributable to our existing business. Consolidated revenues on a segment basis increased in the Storage Solutions, Industrial and Electrical Infrastructure segments by $217.7 million, $152.6 million and $34.4 million respectively, partially offset by a decrease in the Oil Gas & Chemical segment of $34.1 million.
Consolidated gross profit increased to $136.5 million in fiscal 2014 from $94.7 million in fiscal 2013. The increase of $41.8 million, or 44.1%, was due to higher revenues and higher gross margins which increased to 10.8% in fiscal 2014 compared to 10.6% a year earlier.
Consolidated SG&A expenses were $77.9 million in fiscal 2014 compared to $58.0 million in the same period a year earlier. As discussed in Note 2 - Acquisitions, the Company acquired Matrix NAC near the end of the second quarter of fiscal 2014. Therefore, SG&A includes two full quarters of Matrix NAC operational expenses and $2.0 million of acquisition related fees. These expenses, along with higher incentive compensation costs and increased support costs related to higher business volumes caused SG&A expense to increase by $19.9 million, or 34.3%. SG&A expense as a percentage of revenue was 6.2% in fiscal 2014 compared to 6.5% in the prior year.
Net interest expense was $1.4 million in fiscal 2014 and $0.8 million in fiscal 2013.
Other expense was $0.5 million in fiscal 2014 compared to less than $0.1 million in fiscal 2013.
The effective tax rates for fiscal 2014 and fiscal 2013 were 35.1% and 33.2%, respectively. We completed a fiscal 2013 R&D study in the second quarter of fiscal 2014 resulting in a significantly higher credit than previously estimated, therefore, we recorded a discrete positive adjustment of approximately $1.0 million in the second quarter of fiscal 2014. In addition, we increased our estimate of the fiscal 2014 R&D credit resulting in an additional benefit of approximately $0.7 million. The prior year effective tax rate was positively impacted by the effect of retroactive tax legislation enacted in the third quarter of fiscal 2013 and a change in estimate related to an available tax credit.
Electrical Infrastructure
Revenues for the Electrical Infrastructure segment increased $34.4 million, or 20.1%, to $205.6 million in fiscal 2014 compared to $171.2 million in the same period a year earlier. The increased revenue volume in fiscal 2014 was primarily due to the inclusion of six months of Matrix NAC activity partially offset by lower business volume in our existing business. The lower business volumes were due to lack of storm restoration services and lower high voltage work due to delays in customer spending. Gross margins were 10.0% in fiscal 2014 compared to 12.7% in the same period a year earlier. Fiscal 2014 margins were negatively affected by the mix of work leading to lower direct margins and higher unrecovered overhead costs. Fiscal 2013 margins were positively affected by storm restoration work.
Oil Gas & Chemical
Revenues for the Oil Gas & Chemical segment decreased to $239.7 million in fiscal 2014 compared to $273.8 million in the same period a year earlier. The decrease of $34.1 million, or 12.5%, was primarily due to a lower level of capital construction projects and turnaround work, partially offset by higher industrial cleaning work. Gross margins were 11.2% in fiscal 2014 compared to 12.0% in fiscal 2013.
Storage Solutions
Revenues for the Storage Solutions segment increased to $610.9 million in fiscal 2014 compared to $393.2 million in the same period a year earlier. The increase of $217.7 million, or 55.4%, was primarily due to higher levels of work in our domestic and Canada aboveground storage tank business and significant terminal balance of plant work. Fiscal 2014 gross margins were reduced by 1.6% to 11.2% due to a loss of $8.4 million on one project. The fiscal 2013 margins of 9.5% included a project charge of $3.7 million. The overall improvement in gross margins was due to strong project execution in fiscal 2014, particularly on certain key strategic projects.


27


Industrial
Revenues for the Industrial segment totaled $206.9 million in fiscal 2014 compared to $54.3 million in the same period a year earlier. The increase of $152.6 million was primarily due to the inclusion of six months of Matrix NAC activity, a higher level of mining and material handling work and ongoing work on a previously announced project for the engineering, procurement and construction of specialty tanks in a nitrogen fertilizer complex. Gross margins were 9.9% in fiscal 2014 compared to 4.8% in the same period a year earlier. The improvement in gross margins is due to improved execution and a higher recovery of construction overhead costs in the legacy business, partially offset by lower margins on low risk time and materials iron and steel work.
Fiscal 2013 Versus Fiscal 2012
Consolidated
Consolidated revenues were $892.6 million in fiscal 2013, an increase of $153.6 million, or 20.8%, from consolidated revenues of $739.0 million in fiscal 2012. The increase in consolidated revenues was a result of increases in all four segments: Oil Gas & Chemical, Electrical Infrastructure, Industrial and Storage Solutions which increased $68.0 million, $36.1 million, $34.3 million and $15.0 million, respectively.
Consolidated gross profit increased from $79.6 million in fiscal 2012 to $94.7 million in fiscal 2013. The increase of $15.1 million, or 19.0%, was due to higher revenues, partially offset by lower gross margins which decreased to 10.6% in fiscal 2013 compared to 10.8% a year earlier.
Consolidated SG&A expenses were $58.0 million in fiscal 2013 compared to $48.0 million in the same period a year earlier. The increase of $10.0 million, or 20.8%, was primarily related to our planned investments in the branding initiative, strategic growth areas and related support functions coupled with a higher business volume. The Company also incurred a bad debt charge of $0.7 million in fiscal 2013. SG&A expense as a percentage of revenue was 6.5% in both fiscal 2013 and fiscal 2012.
Net interest expense was $0.8 million in both fiscal 2013 and fiscal 2012.
The effective tax rates for fiscal 2013 and fiscal 2012 were 33.2% and 43.6%, respectively. The current year effective tax rate was positively impacted by the effect of retroactive tax legislation enacted in the third quarter of fiscal 2013 and a change in estimate related to an available tax credit. The fiscal 2012 effective tax rate was higher than the statutory rate due to cumulative non-deductible expenses totaling $3.1 million related to deductibility limitations applying to certain items that had previously been fully deducted, of which $2.1 million was related to prior fiscal years (fiscal 2009 to fiscal 2011). The fiscal 2012 effective tax rate was positively impacted by the release of a valuation allowance on foreign tax credit carryovers of $0.5 million.
Electrical Infrastructure
Revenues for the Electrical Infrastructure segment increased $36.1 million, or 26.7%, to $171.2 million in fiscal 2013 compared to $135.1 million in the same period a year earlier. The higher revenue was primarily due to an increase in high voltage work related primarily to storm restoration services and higher transmission and distribution work in the Northeast United States. Gross margins were 12.7% in fiscal 2013 compared to 12.3% in fiscal 2012. The improvement in gross margins in fiscal 2013 is due to higher margins related to storm restoration work and the improved recovery of overhead costs caused by a higher business volume, partially offset by lower direct margins related to other electrical work.
Oil Gas & Chemical
Revenues for the Oil Gas & Chemical segment increased to $273.8 million in fiscal 2013 compared to $205.8 million in the same period a year earlier. The increase of $68.0 million, or 33.0%, was primarily due to a higher level of turnaround work, geographic expansion of turnaround services, and capital construction projects. Gross margins were 12.0% in fiscal 2013 compared to 9.8% in fiscal 2012. The improvement in gross margins is primarily due to the favorable effect of the improved recovery of overhead costs caused by a higher business volume and improved project execution.
Storage Solutions
Revenues for the Storage Solutions segment increased to $393.2 million in fiscal 2013 compared to $378.2 million in the same period a year earlier. The increase of $15.0 million, or 4.0%, was primarily due to higher levels of work in Canada in our aboveground storage tank business. Gross margins decreased from 11.2% in fiscal 2012 to 9.5% in the same period in the


28


current year. The lower margins in fiscal 2013 was primarily due to unrecovered overhead costs, a legal charge of $1.0 million and lower direct margins caused primarily by a $3.7 million charge on one project.
Industrial
Revenues for the Industrial segment totaled $54.3 million in fiscal 2013 compared to $20.0 million in the same period a year earlier. The increase of $34.3 million, or 172.0%, was primarily due to higher revenues in our mining and minerals business. Gross margins were 4.8% in fiscal 2013 compared to 2.4% in fiscal 2012. Although negatively impacted by lower than anticipated business ramp up, gross margins improved throughout fiscal 2013 as the volume of business increased. We also incurred a $0.4 million project charge in fiscal 2013 for this segment. Fiscal 2012 and fiscal 2013 margins were negatively impacted by startup costs related to entry into the bulk material handling and mining and minerals markets.

Non-GAAP Financial Measure
EBITDA is a supplemental, non-GAAP financial measure. EBITDA is defined as earnings before interest expense, income taxes, depreciation and amortization. We have presented EBITDA 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” is the most directly comparable GAAP measure to EBITDA. Since 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. EBITDA, as we calculate it, may not be comparable to similarly titled measures employed by other companies. In addition, this measure is not necessarily a measure of our ability to fund our cash needs. As EBITDA excludes certain financial information compared with net income, 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, EBITDA, has certain material limitations as follows:

It does not include interest expense. Because we have borrowed money to finance our operations, 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.

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 EBITDA to net income follows:
 
 
Twelve Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2012
 
(in thousands)
Net income
$
36,877

 
$
24,008

 
$
17,188

Interest expense
1,436

 
800

 
814

Provision for income taxes
19,934

 
11,908

 
13,302

Depreciation and amortization
18,518

 
12,782

 
11,485

EBITDA
$
76,765

 
$
49,498

 
$
42,789


FINANCIAL CONDITION AND LIQUIDITY
Overview


29


We define liquidity as the ability to pay our liabilities as they become due, fund business operations and meet all contractual or financial obligations. Our primary sources of liquidity in fiscal 2014 were cash on hand at the beginning of the year, capacity under our credit facility, and cash generated from operations. Cash on hand at June 30, 2014 totaled $77.1 million and availability under the credit facility totaled $165.4 million, resulting in total liquidity of $242.5 million. The United States dollar equivalent of Canadian deposits totaled $12.6 million and is included in our consolidated cash balance. We expect to fund our operations for the next twelve months through the use of cash generated from operations, existing cash balances and borrowings under our credit facility, as necessary.
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.
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 significant retentions or security in the form of letters of credit.
Other changes in working capital
Capital expenditures
Other factors that may impact both short and long-term liquidity include:
Acquisitions of new businesses
Strategic investments in new operations
Purchases of shares under our stock buyback program
Contract disputes or collection issues
Capacity constraints under our credit facility and remaining in compliance with all covenants contained in the credit agreement
The acquisition discussed in Note 2 of the Notes to Consolidated Financial Statements included in Part 2, Item 8 of this Annual Report on Form 10-K was funded with cash on hand and $15.0 million of borrowings under the senior credit facility which was repaid in fiscal 2014. The Company believes that the remaining availability under the expanded credit facility, as discussed under the caption "Senior Revolving Credit Facility" included in this Financial Condition and Liquidity section of the Form 10-K, along with cash on hand and cash generated from operations will provide sufficient liquidity to achieve both our short and long-term business objectives.
We have an effective shelf registration statement on file with the SEC under which we may issue, from time to time, up to $400 million of senior debt securities, subordinated debt securities, common stock, preferred stock and warrants. This shelf gives us additional flexibility, when capital market conditions are favorable, to grow our business, finance acquisitions or to optimize our balance sheet in order to improve or maintain our financial flexibility. We may also elect to issue term debt or further expand the size of our credit facility.
Cash Flows Provided by Operating Activities
Cash flows provided by operating activities for the twelve months ended June 30, 2014 totaled $77.0 million. Major components of cash flows from operating activities for the year ending June 30, 2014 are as follows: 


30


Net Cash Provided by Operating Activities
(In thousands)
 
Net income
$
36,877

Non-cash expenses
24,156

Deferred income tax
(3,852
)
Cash effect of changes in operating assets and liabilities
19,599

Other
208

Net cash provided by operating activities
$
76,988

The cash effect of significant changes in operating assets and liabilities include the following, net of the effects from acquisitions:
Accounts receivable increased by $31.4 million. The accounts receivable increase is due to higher business volume and the timing of billings particularly in the Electrical Infrastructure, Storage Solutions and Industrial segments. The receivable aging categories have not deteriorated and we do not anticipate any unusual collection difficulties.
The net change in the combined balances of costs and estimated earnings in excess of billings on uncompleted contracts and billings on uncompleted contracts in excess of costs and estimated earnings caused an increase to cash of $16.7 million in the twelve months ended June 30, 2014. This change was primarily attributable to improved working capital management and our project portfolio permitting a higher degree of advanced billings.
Accounts payable increased by $29.2 million primarily due to an increase in business activity.
Cash Flows Used for Investing Activities
Investing activities used $74.6 million of cash in the twelve months ended June 30, 2014 due to capital expenditures of $23.6 million and the net purchase price of $51.6 million for the acquisition of KNAC as discussed in Note 2 - Acquisitions, partially offset by proceeds from asset dispositions of $0.6 million. Capital expenditures included $11.7 million for the purchase of construction equipment, $5.2 million for transportation equipment, $3.4 million for office equipment and software, $1.0 million for land and buildings, and $2.3 million for fabrication equipment and small tools. The Company's known and expected future purchase obligations relating to capital expenditures is approximately $7.3 million.
Cash Flows Used for Financing Activities
Financing activities provided $12.2 million of cash in the twelve months ended June 30, 2014 primarily due to borrowings under our Credit Agreement of $87.8 million offset by borrowing payments of $76.2 million. The exercise of stock options provided $1.2 million of cash. The excess tax benefit of exercised stock options and vesting of deferred shares provided $1.7 million of cash. Other treasury share purchases used $1.8 million of cash.
Borrowings during fiscal 2014 under our Credit Agreement were used to fund a portion of the KNAC acquisition as discussed in Note 2 - Acquisitions, for Canadian dollar advances required for short term working capital, including cross-border purchases of materials and services.
Senior Revolving Credit Facility
The Company has a five-year, $200.0 million senior secured revolving credit facility under a credit agreement (the “Credit Agreement”) that expires March 13, 2019. Advances under the credit facility may be used for working capital, acquisitions, capital expenditures, issuance of letters of credit and other lawful purposes.
The credit agreement includes the following covenants and borrowing limitations:
Our Senior Leverage Ratio, as defined in the agreement, may not exceed 2.50 to 1.00 determined as of the end of each fiscal quarter.
We are required to maintain a Fixed Charge Coverage Ratio, as defined in the agreement, greater than or equal to 1.25 to 1.00 determined as of the end of each fiscal quarter.
Asset dispositions (other than inventory and obsolete or unneeded equipment disposed of in the ordinary course of business) are limited to $20.0 million per 12-month period.


31


Amounts borrowed under the credit facility bear interest at LIBOR or an Alternate Base Rate, plus in each case, an additional margin based on the Senior Leverage Ratio. The Credit Agreement includes additional margin ranges on Alternate Base Rate loans between 0.25% and 1.0% and between 1.25% and 2.0% on LIBOR-based loans.
The Credit Agreement also permits us to borrow in Canadian dollars with a sublimit of U.S. $40.0 million. Amounts borrowed in Canadian dollars will bear interest either at the CDOR Rate, plus an additional margin based on the Senior Leverage Ratio ranging from 1.25% to 2.0%, or at the Canadian Prime Rate, plus an additional margin based on the Senior Leverage Ratio ranging from 1.75% to 2.5%. The CDOR Rate is equal to the sum of the annual rate of interest, which is the rate determined as being the arithmetic average of the quotations of all institutions listed in respect of the relevant CDOR interest period for Canadian Dollar denominated bankers’ acceptances, plus 0.1%. The Canadian Prime Rate is equal to the greater of (i) the rate of interest per annum most recently announced or established by JPMorgan Chase Bank, N.A., Toronto Branch as its reference rate in effect on such day for determining interest rates for Canadian Dollar denominated commercial loans in Canada and (ii) the CDOR Rate plus 1.0%.
The Unused Revolving Credit Facility Fee is between 0.20% and 0.35% based on the Senior Leverage Ratio.
The Credit Agreement includes a Senior Leverage Ratio covenant, which provides that Consolidated Funded Indebtedness may not exceed 2.5 times Consolidated EBITDA, as defined in the Credit Agreement, over the previous four quarters. For the four quarters ended June 30, 2014, Consolidated EBITDA, as defined in the Credit Agreement, was $87.8 million. Accordingly, at June 30, 2014, the Company had full availability of the $200.0 million credit facility. Consolidated Funded Indebtedness at June 30, 2014 was $29.8 million.
Availability under the credit facility is as follows:
 
 
June 30,
2014
 
June 30,
2013
 
 
(In thousands)
Credit facility availability
 
$
200,000

 
$
125,000

Borrowings outstanding
 
11,621

 

Letters of credit
 
23,017

 
13,372

Availability under the credit facility
 
$
165,362

 
$
111,628

On September 2, 2014, the Company received a waiver relating to a non-financial technical covenant violation of the Credit Agreement.  The violation relates to a program, which the Company has terminated, that permitted the Company to monetize certain trade receivables.  The Company is in compliance with all other affirmative, negative, and financial covenants under the Credit Agreement.
At June 30, 2014, the Company was at the lowest margin tier for the LIBOR, Alternate Base Rate, CDOR and Canadian Prime Rate loans and the lowest tier for the Unused Revolving Credit Facility Fee.
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 dividends on our capital stock during any fiscal year up to an amount which, when added to all other dividends paid during such fiscal year, does not exceed 50% of our cumulative net income for such fiscal year to such 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, 2012, our Board of Directors approved an extension of a stock buyback program that allows the Company to purchase up to 2,113,497 shares provided that such purchases do not exceed $25.0 million in any calendar year through the end of calendar year 2014 if sufficient liquidity exists and we believe that it is in the best interest of the stockholders. The Company may elect to purchase shares under this program.
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. Matrix withheld 80,096 shares during fiscal 2014 to satisfy these obligations. These shares were returned to the Company’s pool of treasury shares.
The Company has 1,453,770 treasury shares as of June 30, 2014 and intends to utilize these treasury shares solely in connection with equity awards under the Company’s stock incentive plans.


32


Commitments and Off-Balance Sheet Arrangements
As of June 30, 2014, the following commitments and off-balance sheet arrangements were in place to support our ordinary course obligations: 
 
 
Commitments by Expiration Period
 
 
Less than  1
Year
 
1–3 Years
 
3–5 Years
 
More than  5
Years
 
Total
 
 
(In thousands)
Letters of credit (1)
 
$
7,481

 
$
7,585

 
$
7,951

 
$

 
$
23,017

Surety bonds
 
18,680

 
139,353

 
5

 

 
158,038

Total
 
$
26,161

 
$
146,938

 
$
7,956

 
$

 
$
181,055

 
 
 
 
 
 
(1)
All letters of credit issued under our 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 Credit Facility. The letters of credit that support construction contracts will expire when the related work is completed and the warranty period has passed; therefore, these letters of credit are reported in the period that we expect the warranty period to end.
Contractual obligations at June 30, 2014 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)
Operating leases
 
$
4,862

 
$
4,795

 
$
260

 
$

 
$
9,917

Purchase obligations
 
1,105

 
1,169

 

 

 
2,274

Total contractual obligations
 
$
5,967

 
$
5,964

 
$
260

 
$

 
$
12,191

 


Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our interest rate risk results primarily from our variable rate indebtedness under our credit facility, which is influenced by movements in short-term rates. Borrowings under our $200.0 million revolving credit facility are based on an Alternate Base Rate, LIBOR, CDOR or Canadian Prime Rate as elected by the Company plus an additional margin based on our Senior Leverage Ratio.
Financial instruments with interest rate risk at June 30, 2014 were as follows: 
 
 
Maturity by Fiscal Year
 
Fair Value as
of June 30,
2014
 
 
2015
 
2016
 
2017
 
2018
 
2019
 
Total
 
 
 
(In thousands)
 
 
Long-term debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Variable rate debt (1)
 
$

 
$

 
$

 
$

 
$
11,621

 
$
11,621

 
$
11,621

 
 
 
 
 
 
(1)
Amounts borrowed under the Credit Agreement bear interest at LIBOR or an Alternate Base Rate, plus in each case, an additional margin based on the Senior Leverage Ratio. The additional margin on Alternate Base Rate and LIBOR-based loans ranges between 0.25% and 1.0% and between 1.25% and 2.0% on LIBOR-based loans. The Credit Agreement also permits us to borrow in Canadian dollars with a sublimit of U.S. $40.0 million. Amounts borrowed in Canadian dollars will bear interest either at the CDOR Rate, plus an additional margin based on the Senior Leverage Ratio ranging from 1.25% to 2.0%, or at the Canadian Prime Rate, plus an additional margin based on the Senior Leverage Ratio ranging from 1.75% to 2.5%. The CDOR Rate is equal to the sum of the annual rate of interest, which is the rate determined as being the arithmetic average of the quotations of all institutions listed in respect of the relevant CDOR interest period for Canadian Dollar denominated bankers’ acceptances, plus 0.1%. The Canadian Prime Rate is equal to the greater of (i) the rate of interest per annum most recently announced or established by JPMorgan Chase Bank, N.A., Toronto Branch as its reference rate in effect on such day for determining interest rates for Canadian Dollar denominated commercial loans in Canada and (ii) the CDOR Rate plus 1.0%. The Unused Credit Facility Fee is between 0.20% and 0.35% based on the Senior Leverage Ratio.
Financial instruments with interest rate risk at June 30, 2013 were as follows: 


33


 
 
Maturity by Fiscal Year
 
Fair Value as
of June 30,
2013
 
 
2014
 
2015
 
2016
 
2017
 
2018
 
Total
 
 
 
(In thousands)
 
 
Long-term debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Variable rate debt (1)
 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
(1)
There were no outstanding borrowings under our credit facility at June 30, 2013.
Foreign Currency Risk
Matrix Service Company has subsidiaries with operations in Canada with the Canadian dollar as their functional currency. Historically, movements in the foreign currency exchange rate have not significantly impacted results. However, further growth in our Canadian operations and significant fluctuations in the Canadian Dollar/U.S. Dollar exchange rate could impact the Company’s financial results in the future. Management has not entered into derivative instruments to hedge foreign currency risk, but periodically evaluates the materiality of our foreign currency exposure. To mitigate our risk, on occasion we borrow Canadian dollars under our credit facility to settle U.S. dollar account balances. A 10% unfavorable change in the Canadian dollar against the U. S. dollar would not have had a material impact on the financial results of the Company for the fiscal year ended June 30, 2014.
Commodity Price Risk
The Company has no direct commodity exposure, but we do have exposure to materials derived from certain commodities including steel plate, steel pipe, and copper which are key materials used by the Company. Supplies of these materials are available throughout the United States and worldwide. We anticipate that adequate amounts of these materials will be available in the foreseeable future. However, the price, quantity, and delivery schedules of these materials could change rapidly due to various factors, including producer capacity, the level of foreign imports, worldwide demand, the imposition or removal of tariffs on imported steel and other market conditions. We mitigate these risks primarily by procuring materials upon contract execution to ensure that our purchase price approximates the costs included in the project estimate.


34




Item 8. Financial Statements and Supplementary Data
 
Financial Statements of the Company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Statement Schedules
The financial statement schedule is filed as a part of this report under Schedule II – Valuation and Qualifying Accounts for the three fiscal years ended June 30, 2014June 30, 2013 and June 30, 2012 immediately following Quarterly Financial Data (Unaudited). All other schedules are omitted because they are not applicable or the required information is shown in the financial statements, or notes thereto, included herein.


35


MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Matrix Service Company (the “Company”) and its wholly-owned subsidiaries are responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations and cannot provide absolute assurance that all objectives will be met. Internal control over financial reporting is a process that involves diligence and is subject to lapses in judgment and human error. Internal control over financial reporting can also be circumvented by collusion or management override of controls. Because of these limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2014. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework.
During fiscal year 2014, the Company acquired 100% of the stock of Kvaerner North American Construction Ltd. and substantially all of the assets of Kvaerner North American Construction Inc., together referenced as "KNAC". The businesses are now known as Matrix North American Construction Ltd. and Matrix North American Construction, Inc., together referenced as "Matrix NAC". Refer to Note 2 of Notes to the Consolidated Financial Statements for additional information regarding this event. Management has excluded this business from its evaluation of the effectiveness of the Company's internal control over financial reporting as of June 30, 2014. The revenues attributable to this business represented approximately 12 percent of the Company's consolidated revenues for the year ended June 30, 2014 and its aggregate total assets represented approximately 25 percent of the Company's consolidated total assets as of June 30, 2014.
Management’s assessment included an evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, overall control environment and information systems control environment. Based on this assessment, the Company’s management has concluded that the Company’s internal control over financial reporting as of June 30, 2014 was effective.
Deloitte & Touche LLP, an independent registered public accounting firm, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of June 30, 2014. Deloitte & Touche LLP’s report on the Company’s internal control over financial reporting is included herein.
 
 
 
 
 
 
 
 
/S/ John R. Hewitt
 
 
 
/S/ Kevin S. Cavanah
John R. Hewitt
 
 
 
Kevin S. Cavanah
President and Chief Executive Officer
 
 
 
Vice President and Chief Financial Officer
September 8, 2014


36


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Matrix Service Company:
We have audited the internal control over financial reporting of Matrix Service Company and subsidiaries (“the Company”) as of June 30, 2014 based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management’s Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Matrix North American Construction Ltd. And Matrix North American Construction, Inc., which were acquired during the year ended 2014 and whose financial statements reflect total assets and revenues constituting 25% and 12% respectively, of the related consolidated financial statement amounts as of and for the year ended June 30, 2014. Accordingly, our audit did not include the internal control over financial reporting of these acquired entities. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2014, based on the criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended June 30, 2014 of the Company and our report dated September 8, 2014 expressed an unqualified opinion on those financial statements and financial statement schedule.

/S/ DELOITTE & TOUCHE LLP
Tulsa, Oklahoma
September 8, 2014



37



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Matrix Service Company:
We have audited the accompanying consolidated balance sheets of Matrix Service Company and subsidiaries (the “Company”) as of June 30, 2014 and June 30, 2013, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended June 30, 2014.  Our audits also included the financial statement schedule listed in the Index at Item 15.  These financial statements and financial statement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Matrix Service Company and subsidiaries as of June 30, 2014 and 2013, and the results of their operations and their cash flows for each of the three years ended June 30, 2014, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of June 30, 2014, based on the criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated September 8, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/S/ DELOITTE & TOUCHE LLP
Tulsa, Oklahoma
September 8, 2014



38


Matrix Service Company
Consolidated Statements of Income
(In thousands, except per share data)
 

 
 
Twelve Months Ended
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2012
Revenues
 
$
1,263,089

 
$
892,574

 
$
739,046

Cost of revenues
 
1,126,616

 
797,872

 
659,428

Gross profit
 
136,473

 
94,702

 
79,618

Selling, general and administrative expenses
 
77,866

 
57,988

 
47,983

Operating income
 
58,607

 
36,714

 
31,635

Other income (expense):
 
 
 
 
 
 
Interest expense
 
(1,436
)
 
(800
)
 
(814
)
Interest income
 
112

 
32

 
26

Other
 
(472
)
 
(30
)
 
(357
)
Income before income tax expense
 
56,811

 
35,916

 
30,490

Provision for federal, state and foreign income taxes
 
19,934

 
11,908

 
13,302

Net income
 
$
36,877

 
$
24,008

 
$
17,188

Less: Net income attributable to noncontrolling interest
 
1,067

 

 

Net income attributable to Matrix Service Company
 
$
35,810

 
$
24,008

 
$
17,188

Basic earnings per common share
 
$
1.36

 
$
0.92

 
$
0.66

Diluted earnings per common share
 
$
1.33

 
$
0.91

 
$
0.65

Weighted average common shares outstanding:
 
 
 
 
 
 
Basic
 
26,288

 
25,962

 
25,921

Diluted
 
26,976

 
26,358

 
26,298

 

See accompanying notes
39




Matrix Service Company
Consolidated Statements of Comprehensive Income
(In thousands)
 
 
 
Twelve Months Ended
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2012
Net income
 
$
36,877

 
$
24,008

 
$
17,188

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
Foreign currency translation adjustments (net of tax of $116, $190 and $214)
 
(409
)
 
(544
)
 
(665
)
Comprehensive income
 
36,468

 
23,464

 
16,523

Less: Comprehensive income attributable to noncontrolling interest
 
1,067

 

 

Comprehensive income attributable to Matrix Service Company
 
$
35,401

 
$
23,464

 
$
16,523

 


See accompanying notes
40




Matrix Service Company
Consolidated Balance Sheets
(In thousands)
 
 
June 30,
2014
 
June 30,
2013
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
77,115

 
$
63,750

Accounts receivable, less allowances (2014—$204; 2013—$795)
 
204,692

 
140,840

Costs and estimated earnings in excess of billings on uncompleted contracts
 
73,008

 
73,773

Inventories
 
3,045

 
2,988

Income taxes receivable
 
2,797

 
3,032

Deferred income taxes
 
5,994

 
5,657

Other current assets
 
8,897

 
6,234

Total current assets
 
375,548

 
296,274

Property, plant and equipment, at cost:
 
 
 
 
Land and buildings
 
31,737

 
29,649

Construction equipment
 
82,745

 
69,998

Transportation equipment
 
42,087

 
34,366

Office equipment and software
 
26,026

 
18,426

Construction in progress
 
9,892

 
9,080

 
 
192,487

 
161,519

Accumulated depreciation
 
(103,315
)
 
(90,218
)
 
 
89,172

 
71,301

Goodwill
 
69,837

 
30,836

Other intangible assets
 
28,676

 
7,551

Other assets
 
5,699

 
4,016

Total assets
 
$
568,932

 
$
409,978

 
 
 
 
 


See accompanying notes
41




Matrix Service Company
Consolidated Balance Sheets (continued)
(In thousands, except share data)
 
 
June 30,
2014
 
June 30,
2013
Liabilities and stockholders’ equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
111,863

 
$
68,961

Billings on uncompleted contracts in excess of costs and estimated earnings
 
108,440

 
62,848

Accrued wages and benefits
 
36,226

 
21,919

Accrued insurance
 
8,605

 
7,599

Other accrued expenses
 
4,727

 
3,039

Total current liabilities
 
269,861

 
164,366

Deferred income taxes
 
5,167

 
7,450

Borrowings under senior credit facility
 
11,621

 

Total liabilities
 
286,649

 
171,816

Commitments and contingencies
 

 

Stockholders’ equity:
 
 
 
 
Matrix Service Company stockholders' equity:
 
 
 
 
Common stock—$.01 par value; 60,000,000 shares authorized; 27,888,217 shares issued as of June 30, 2014 and June 30, 2013
 
279

 
279

Additional paid-in capital
 
119,777

 
118,190

Retained earnings
 
177,237

 
141,427

Accumulated other comprehensive income (loss)
 
(182
)
 
227

 
 
297,111

 
260,123

Less treasury stock, at cost— 1,453,770 and 1,779,593 shares as of June 30, 2014 and June 30, 2013
 
(16,595
)
 
(21,961
)
Total Matrix Service Company stockholders' equity
 
280,516

 
238,162

Noncontrolling interest
 
1,767

 

Total stockholders' equity
 
282,283

 
238,162

Total liabilities and stockholders’ equity
 
$
568,932

 
$
409,978



See accompanying notes
42




Matrix Service Company
Consolidated Statements of Cash Flows
(In thousands)
 
 
Twelve Months Ended
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2012
Operating activities:
 
 
 
 
 
 
Net income
 
$
36,877

 
$
24,008

 
$
17,188

Adjustments to reconcile net income to net cash provided by operating activities, net of effects of acquisitions:
 
 
 
 
 
 
Depreciation and amortization
 
18,518

 
12,782

 
11,485

Stock-based compensation expense
 
5,688

 
3,831

 
3,504

Deferred income taxes
 
(3,852
)
 
1,932

 
83

Allowance for uncollectible accounts
 
(159
)
 
714

 
24

Impairment of intangible asset
 

 
255

 

(Gain) loss on sale of property, plant and equipment
 
109

 
(1
)
 
(158
)
Other
 
208

 
163

 
65

Changes in operating assets and liabilities increasing (decreasing) cash, net of effects from acquisitions:
 
 
 
 
 
 
Accounts receivable
 
(31,395
)
 
(32,408
)
 
(4,575
)
Costs and estimated earnings in excess of billings on uncompleted contracts
 
13,540

 
(5,211
)
 
(28,506
)
Inventories
 
(11
)
 
(1,394
)
 
(233
)
Other assets
 
(1,379
)
 
(2,194
)
 
(1,888
)
Accounts payable
 
29,234

 
19,256

 
12,862

Billings on uncompleted contracts in excess of costs and estimated earnings
 
3,142

 
32,555

 
(5,192
)
Accrued expenses
 
6,468

 
2,796

 
(1,718
)
Net cash provided by operating activities
 
76,988

 
57,084

 
2,941

Investing activities:
 
 
 
 
 
 
Acquisition of property, plant and equipment
 
(23,589
)
 
(23,231
)
 
(13,534
)
Acquisitions, net of cash acquired (Note 2)
 
(51,607
)
 
(9,394
)
 

Acquisition related adjustment
 

 

 
241

Proceeds from asset sales
 
553

 
186

 
598

Net cash used for investing activities
 
$
(74,643
)
 
$
(32,439
)
 
$
(12,695
)

See accompanying notes
43




Matrix Service Company
Consolidated Statements of Cash Flows (continued)
(In thousands)
 
 
Twelve Months Ended
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2012
Financing activities:
 
 
 
 
 
 
Exercise of stock options
 
$
1,175

 
$
875

 
$
167

Capital lease payments
 

 
(42
)
 
(258
)
Excess tax benefit of exercised stock options and vesting of deferred shares
 
1,730

 
37

 

Advances under credit agreement
 
87,826

 
25,565

 
9,105

Repayments of advances under credit agreement
 
(76,205
)
 
(25,565
)
 
(9,105
)
Payment of debt amendment fees
 
(657
)
 

 
(643
)
Treasury shares sold to Employee Stock Purchase Plan
 
136

 
54

 
47

Open market purchase of treasury shares
 

 

 
(8,126
)
Other treasury share purchases
 
(1,776
)
 
(1,162
)
 
(537
)
Net cash provided (used) for financing activities
 
12,229

 
(238
)
 
(9,350
)
Effect of exchange rate changes on cash
 
(1,209
)
 
(383
)
 
(527
)
Net increase (decrease) in cash and cash equivalents
 
13,365

 
24,024

 
(19,631
)
Cash and cash equivalents, beginning of period
 
63,750

 
39,726

 
59,357

Cash and cash equivalents, end of period
 
$
77,115

 
$
63,750

 
$
39,726

Other cash flow information:
 
 
 
 
 
 
Cash paid during the period for:
 
 
 
 
 
 
Income taxes
 
$
19,160

 
$
12,242

 
$
12,016

Interest
 
$
1,224

 
$
610

 
$
478

Non-cash investing:
 
 
 
 
 
 
Purchases of property, plant and equipment on account
 
$
527

 
$
1,146

 
$
457



See accompanying notes
44




Matrix Service Company
Consolidated Statements of Changes in Stockholders’ Equity
(In thousands, except share data)
 
 
Common
Stock
 
Additional
Paid-In  Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income(Loss)
 
Non- Controlling Interest
 
Total
Balances, June 30, 2011
 
$
279

 
$
113,686

 
$
100,231

 
$
(15,961
)
 
$
1,436

 
$

 
$
199,671

Net income
 

 

 
17,188

 

 

 

 
17,188

Other comprehensive loss
 

 

 

 

 
(665
)
 

 
(665
)
Exercise of stock options (26,500 shares)
 

 
98

 

 
69

 

 

 
167

Tax effect of exercised stock options and vesting of deferred shares
 

 
(152
)
 

 

 

 

 
(152
)
Issuance of deferred shares (184,149 shares)
 

 
(479
)
 

 
479

 

 

 

Treasury Shares sold to Employee Stock Purchase Plan (4,395 shares) (Note 12)
 

 
36