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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended February 28, 2005

 

or

 

¨ Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

 

For the transition period from              to             

 

Commission File number 001-15461

 


 

MATRIX SERVICE COMPANY

(Exact name of registrant as specified in its charter)

 


 

DELAWARE   73-1352174
(State of incorporation)   (I.R.S. Employer Identification No.)

 

10701 E. Ute St., Tulsa, Oklahoma 74116-1517

(Address of principal executive offices and zip code)

 

Registrant’s telephone number, including area code: (918) 838-8822

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 


 

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  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

As of April 8, 2005, there were 19,285,276 shares of the Company’s common stock, $0.01 par value per share, issued and 17,375,526 shares outstanding.

 



Table of Contents

INDEX

 

          PAGE
NO.


PART I    FINANCIAL INFORMATION     

ITEM 1.

   Financial Statements (Unaudited)     
     Consolidated Statements of Operations for the Three and Nine Months Ended February 28, 2005 and February 29, 2004    1
     Consolidated Balance Sheets as of February 28, 2005 and May 31, 2004    2
     Consolidated Statements of Cash Flow for the Nine Months Ended February 28, 2005 and February 29, 2004    4
     Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended February 28, 2005 and February 29, 2004    6
     Notes to Consolidated Financial Statements    7

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    25

ITEM 3.

   Quantitative and Qualitative Disclosures About Market Risk    43

ITEM 4.

   Controls and Procedures    44
PART II    OTHER INFORMATION     

ITEM 1.

   Legal Proceedings    45

ITEM 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    45

ITEM 3.

   Defaults Upon Senior Securities    45

ITEM 4.

   Submission of Matters to a Vote of Security Holders    46

ITEM 5.

   Other Information    46

ITEM 6.

   Exhibits    47
   Signature         47


Table of Contents

PART I

 

FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

Matrix Service Company

Consolidated Statements of Operations

(In Thousands, except share and per share data)

 

     Three Months Ended

    Nine Months Ended

 
     February 28,
2005


    February 29,
2004


    February 28,
2005


    February 29,
2004


 
     (unaudited)     (unaudited)  

Revenues

   $ 111,447     $ 145,175     $ 309,908     $ 474,850  

Cost of revenues

     105,573       133,354       286,352       436,871  
    


 


 


 


Gross profit

     5,874       11,821       23,556       37,979  

Selling, general and administrative expenses

     18,076       7,610       32,949       21,612  

Restructuring, impairment and abandonment

     25,002       16       25,150       68  
    


 


 


 


Operating income (loss)

     (37,204 )     4,195       (34,543 )     16,299  

Other income (expense):

                                

Interest expense

     (1,637 )     (708 )     (3,634 )     (2,149 )

Interest income

     —         8       1       22  

Other

     84       306       98       489  
    


 


 


 


Income (loss) before income tax expense

     (38,757 )     3,801       (38,078 )     14,661  

Provision (benefit) for federal, state and foreign income tax expense

     (3,288 )     1,542       (3,010 )     5,955  

Net earnings of joint venture

     —         —         —         510  
    


 


 


 


Net income (loss)

   $ (35,469 )   $ 2,259     $ (35,068 )   $ 9,216  
    


 


 


 


Earnings (loss) per share of common stock:

                                

Basic

   $ (2.05 )   $ 0.13     $ (2.03 )   $ 0.56  

Diluted

   $ (2.05 )   $ 0.13     $ (2.03 )   $ 0.52  

Weighted average number of common shares:

                                

Basic

     17,339,069       17,030,824       17,309,133       16,569,531  

Diluted (includes dilutive effect of stock options)

     17,339,069       17,839,007       17,309,133       17,567,510  

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

Matrix Service Company

Consolidated Balance Sheets

(In Thousands)

 

    

February 28,

2005


  

May 31,

2004


     (unaudited)     

ASSETS:

             

Current assets:

             

Cash and cash equivalents

   $ 1,972    $ 752

Accounts receivable, less allowances (February 28, 2005 - $424, May 31, 2004 - $337)

     59,228      56,974

Contract dispute receivables, net

     20,975      31,456

Costs and estimated earnings in excess of billings on uncompleted contracts

     22,576      18,854

Inventories

     6,504      4,584

Income tax receivable

     2,200      3,220

Deferred income taxes

     4,352      1,493

Prepaid expenses

     2,985      2,368
    

  

Total current assets

     120,792      119,701

Property, plant and equipment at cost:

             

Land and buildings

     25,194      24,518

Construction equipment

     31,868      31,294

Transportation equipment

     12,471      12,445

Furniture, fixtures and office equipment

     8,962      8,743

Construction in progress

     684      1,593
    

  

       79,179      78,593

Accumulated depreciation

     37,297      32,939
    

  

Net property, plant and equipment

     41,882      45,654

Goodwill

     24,872      49,666

Other assets

     1,259      1,253
    

  

Total assets

   $ 188,805    $ 216,274
    

  

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

Matrix Service Company

Consolidated Balance Sheets

(In Thousands, except share data)

 

    

February 28,

2005


    May 31,
2004


 
     (unaudited)        

LIABILITIES AND STOCKHOLDERS’ EQUITY:

                

Current liabilities:

                

Accounts payable

   $ 43,361     $ 27,528  

Billings on uncompleted contracts in excess of costs and estimated earnings

     9,450       8,115  

Accrued insurance

     4,603       2,152  

Other accrued expenses

     11,753       11,264  

Current capital lease obligation

     58       —    

Current portion of long-term debt

     54,946       4,893  

Current portion of acquisition payable

     1,904       1,835  
    


 


Total current liabilities

     126,075       55,787  

Long-term debt

     —         64,209  

Acquisition payable

     5,832       5,614  

Long-term capital lease obligation

     112       —    

Deferred income taxes

     5,129       4,949  

Stockholders’ equity:

                

Common stock - $.01 par value; 30,000,000 shares authorized and 19,285,276 shares issued as of February 28, 2005 and May 31, 2004

     193       193  

Additional paid-in capital

     56,291       56,101  

Retained earnings

     482       35,585  

Accumulated other comprehensive income (loss)

     46       (395 )
    


 


       57,012       91,484  

Less: Treasury stock, at cost – 1,929,750 shares as of February 28, 2005 and 2,084,950 shares as of May 31, 2004

     (5,355 )     (5,769 )
    


 


Total stockholders’ equity

     51,657       85,715  
    


 


Total liabilities and stockholders’ equity

   $ 188,805     $ 216,274  
    


 


 

See Notes to Consolidated Financial Statements

 

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Table of Contents

Matrix Service Company

Consolidated Cash Flow Statements

(In Thousands)

 

     Nine Months Ended

 
    

February 28,

2005


   

February 29,

2004


 
     (unaudited)  

Cash flow from operating activities:

                

Net income (loss)

   $ (35,068 )   $ 9,216  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

                

Depreciation and amortization

     5,171       4,791  

Deferred income tax

     (2,679 )     960  

Impairment of goodwill

     25,000       —    

Contract dispute reserve

     10,448       —    

Gain (loss) on sale of equipment

     (93 )     (242 )

Allowance for uncollectible accounts

     125       450  

Accretion of acquisition payable

     287       279  

Earnings of joint venture

     —         (857 )

Change in value of interest rate swap

     (158 )     (175 )

Amortization of accumulated loss on interest rate swap

     116       168  

Amortization of debt issuance costs

     468       113  

Changes in current assets and liabilities increasing (decreasing) cash:

                

Accounts receivable

     (2,379 )     (7,410 )

Contract disputes receivable

     33       —    

Costs and estimated earnings in excess of billings on uncompleted contracts

     (3,722 )     4,620  

Inventories

     (1,920 )     (212 )

Prepaid expenses

     (272 )     117  

Accounts payable

     15,833       (12,961 )

Billings on uncompleted contracts in excess of costs and estimated earnings

     1,335       (6,575 )

Accrued expenses

     2,940       5,164  

Income taxes receivable

     1,157       2,073  

Other

     (28 )     (108 )
    


 


Net cash provided (used) by operating activities

     16,594       (589 )

Cash flow from investing activities:

                

Capital expenditures

     (1,323 )     (3,953 )

Distribution from joint venture

     —         701  

Net effect of dissolution of joint venture

     —         2,738  

Proceeds from other investing activities

     136       2,015  
    


 


Net cash provided (used) by investing activities

   $ (1,187 )   $ 1,501  

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

Matrix Service Company

Consolidated Cash Flow Statements

(In Thousands)

 

     Nine Months Ended

 
    

February 28,

2005


   

February 29,

2004


 
     (unaudited)  

Cash flows from financing activities:

                

Advances under bank credit agreement

   $ 124,162     $ 219,512  

Repayments on bank credit agreement

     (138,160 )     (221,865 )

Capital lease borrowings

     198       —    

Capital lease repayments

     (28 )     —    

Issuance of common stock

     432       2,250  

Payment of debt issuance costs

     (834 )     (145 )
    


 


Net cash used by financing activities

     (14,230 )     (248 )

Effect of exchange rate changes on cash

     43       41  
    


 


Increase in cash and cash equivalents

     1,220       705  

Cash and cash equivalents at beginning of period

     752       775  
    


 


Cash and cash equivalents at end of period

   $ 1,972     $ 1,480  
    


 


Supplemental disclosure of cash flow information:

                

Cash paid (received) during the period for:

                

Income Taxes

   $ (1,399 )   $ 3,895  
    


 


Interest

   $ 3,054     $ 1,707  
    


 


 

See Notes to Consolidated Financial Statements

 

5


Table of Contents

Matrix Service Company

Consolidated Statements of Changes in Stockholders’ Equity

(In Thousands)

(unaudited)

 

    

Common

Stock


  

Additional

Paid-In

Capital


   

Retained

Earnings


   

Treasury

Stock


   

Accumulated

Other

Comprehensive

Income (Loss)


    Total

 
              Translation

    Derivative

   

Balances, May 31, 2004

   $ 193    $ 56,101     $ 35,585     $ (5,769 )   $ (239 )   $ (156 )   $ 85,715  

Net loss

                    (35,068 )                             (35,068 )

Other comprehensive income

                                                       

Translation adjustment

                                    376               376  

Derivative activity

                                            65       65  
                                                   


Comprehensive loss

                                                    (34,627 )

Exercise of stock options (155,200)

            53       (35 )     414                       432  

Tax effect of exercised stock options

            137                                       137  
    

  


 


 


 


 


 


Balances, February 28, 2005

   $ 193    $ 56,291     $ 482     $ (5,355 )   $ 137     $ (91 )   $ 51,657  
    

  


 


 


 


 


 


Balances, May 31, 2003

   $ 96    $ 52,527     $ 26,304     $ (8,179 )   $ (278 )   $ (289 )   $ 70,181  

Net income

                    9,216                               9,216  

Other comprehensive income

                                                       

Translation adjustment

                                    111               111  

Derivative activity

                                            104       104  
                                                   


Comprehensive income

                                                    9,431  

Exercise of stock options (994,370)

            217       (221 )     2,254                       2,250  

Tax effect of exercised stock options

            3,053                                       3,053  

Stock Dividend

     97      (97 )                                     —    
    

  


 


 


 


 


 


Balances, February 29, 2004

   $ 193    $ 55,700     $ 35,299     $ (5,925 )   $ (167 )   $ (185 )   $ 84,915  
    

  


 


 


 


 


 


 

 

6


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

 

The consolidated financial statements include the accounts of Matrix Service Company (“Matrix” or the “Company”) and its subsidiaries, all of which are wholly owned. All significant inter-company balances and transactions have been eliminated in consolidation. Effective July 28, 2003, a construction joint venture partnership obtained in the Hake acquisition was dissolved. From the effective date of the dissolution forward, the operations of the joint venture assumed by Matrix are included in the Company’s results of operations.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X for interim financial statements required to be filed with the Securities and Exchange Commission and do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. However, the information furnished reflects all adjustments, consisting only of normal recurring adjustments and other adjustments described herein that are, in the opinion of management, necessary for a fair statement of the results for the interim periods.

 

Certain amounts in prior period financial statements have been reclassified to conform to the current financial statement presentation.

 

The accompanying financial statements should be read in conjunction with the audited financial statements for the year ended May 31, 2004, included in Matrix’s Annual Report on Form 10-K for the year then ended. Matrix’s business is seasonal. In addition, Matrix often generates a significant portion of its revenues under a comparatively few major contracts which often do not commence or terminate in the same period from one year to the next. Accordingly, results for any interim period may not necessarily be indicative of future operating results.

 

NOTE 2 – STOCK OPTION PLANS

 

Employee stock options are accounted for under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related interpretations. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

 

In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123(R) (revised 2004), “Share-Based Payment”, which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Statement 123(R) supersedes APB 25. Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Statement 123(R) is effective for public companies at the beginning of the first interim or annual period beginning after June 15, 2005. The Company plans to adopt Statement 123(R) effective June 1, 2005.

 

 

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Table of Contents

Pro forma information regarding net income and earnings per share, as required by SFAS 123, will be provided until Statement 123(R) is adopted. The pro forma information has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. The fair value for employee stock options outstanding as of the end of the periods presented was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:

 

    

February 28,

2005


   

February 29,

2004


 

Risk-free interest rate

   3.7 %   4.0 %

Expected volatility

   60.9 %   54.4 %

Expected life in years

   4.8     4.8  

Expected dividend yield

   —       —    

 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

 

The following table illustrates the pro forma effect on net income (loss) and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 using the Black-Scholes option valuation model:

 

     Three Months Ended

    Nine Months Ended

 
    

February 28,

2005


   

February 29,

2004


   

February 28,

2005


   

February 29,

2004


 
     (In Thousands)     (In Thousands)  

Net Income (Loss) as Reported

   $ (35,469 )   $ 2,259     $ (35,068 )   $ 9,216  

Compensation Expense from Stock Options

     (118 )     (145 )     (298 )     (352 )
    


 


 


 


Pro Forma Net Income (Loss)

   $ (35,587 )   $ 2,114     $ (35,366 )   $ 8,864  
    


 


 


 


Earnings per Common Share as Reported:

                                

Basic

   $ (2.05 )   $ 0.13     $ (2.03 )   $ 0.56  

Diluted

   $ (2.05 )   $ 0.13     $ (2.03 )   $ 0.52  

Pro Forma Earnings per Common Share:

                                

Basic

   $ (2.05 )   $ 0.12     $ (2.04 )   $ 0.53  

Diluted

   $ (2.05 )   $ 0.12     $ (2.04 )   $ 0.50  

 

 

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Table of Contents

NOTE 3 – RESTRUCTURING

 

On March 28, 2005, Bradley S. Vetal resigned from his positions as Chairman of the Board, President and Chief Executive Officer of the Company, effective immediately. Mr. Ed Hendrix, an independent director of the Company since 2000, was elected Chairman of the Board of Directors to replace Mr. Vetal. The Company’s Board of Directors appointed Michael J. Hall, currently a member of the Board of Directors and formerly the Company’s Chief Financial Officer, as the Company’s interim President and Chief Executive Officer. The Company granted Mr. Hall 100,000 stock options which at the earlier of the achievement of specified objectives or one year. The remainder of Mr. Hall’s compensation program has not been finalized.

 

In March 2005, the Company began a restructuring program to reduce its cost structure and improve operating results. This restructuring program is expected to include reductions in workforce and changes to business plans including the consolidation or closure of certain facilities or business lines. The Company expects these restructuring efforts to continue into fiscal 2006 and the Company expects to incur restructuring charges of at least $2.1 million in the fourth quarter of fiscal 2005, primarily in the Construction Services segment.

 

As part of the restructuring efforts, the Company has engaged a financial consultant to assist senior management with the following:

 

    Determining short-term and long-term liquidity needs;

 

    Improving forecasting tools;

 

    Providing oversight of all restructuring activities;

 

    Identifying cost reduction and operations improvement opportunities;

 

    Reviewing operating and financial plans and cash flow forecasts at corporate and divisional levels;

 

    Assessing core business, management, policy operations, facilities, equipment and operating practices;

 

    Conducting feasibility analyses in connection with debt restructuring efforts; and

 

    Interfacing with credit constituencies.

 

The Company also anticipates incurring approximately $1.5 million in professional fees in the fourth quarter of fiscal 2005 related to restructuring efforts.

 

Based upon the current status of the senior credit facility (Discussed in Note 4 – Debt), total liquidity has been constrained due to shortfalls in operating performance. As a result of the liquidity issues, the Company has extended the timing of payments to vendors until the liquidity issues improve. Management has initiated a number of steps to improve the Company’s liquidity situation including the following:

 

    Improving overall operating performance based upon the restructuring efforts currently underway;

 

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    Evaluating alternatives to accelerate collection of amounts due on the contract disputes; and

 

    Raising of additional capital through debt refinancing efforts or alternative means.

 

The Company has engaged an investment banking firm to assist the Board of Directors in evaluating refinancing and other strategic alternatives. These alternatives include the possible issuance of convertible subordinated securities.

 

As discussed in Note 4, Debt, the current bank group has amended our credit agreement and provided waivers for specified covenant violations through June 15, 2005. They have also increased our revolver from $29 million to the lesser of $32 million or 75% of the borrowing base immediately and to the lesser of $35 million or 80% of the borrowing base upon completion of a proposed private placement of convertible subordinated junior securities. The net proceeds of the convertible subordinated junior securities would be used to retire Term Loan B, which is due in August 2005 and currently bears interest at 18% per year and, if sufficient, to provide additional liquidity. The bank group has also indicated they would provide an incremental $10 million of short-term financing to provide additional liquidity primarily for trade creditors. The documentation is in process and we anticipate having these funds available simultaneously with the closing of the convertible subordinated junior securities.

 

We cannot assure that the private placement will be completed or that the incremental revolver will be provided. If we are successful in completing the private placement and obtaining the incremental revolver, our liquidity issues would be alleviated for the short-term and we would then focus on returning the Company to profitability and refinancing our senior debt for a longer term. If the efforts are not successful, we cannot assure that other financing can be arranged, that we would be able to meet existing debt covenants, or that the bank would not foreclose on the Company. In that event, we would be required to explore other strategic alternatives.

 

NOTE 4 – DEBT

 

Debt consists of the following:

 

    

February 28,

2005


  

May 31,

2004


     (In Thousands)

Borrowings under bank credit facility:

             

Revolving credit facility

   $ 11,035    $ 40,390

Term note

     23,798      28,441

Term B note

     20,000      —  

Interest rate swap liability

     113      271
    

  

       54,946      69,102

Less current portion:

             

Revolving credit facility

     11,035      —  

Term note

     23,798      4,643

Term B note

     20,000      —  

Interest rate swap liability

     113      250
    

  

Long-term debt

   $ —      $ 64,209
    

  

 

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Credit Agreement and Revolving Credit Facility

 

On March 7, 2003, we replaced our prior credit agreement with an $87.5 million senior credit facility entered into with a group of banks. The credit agreement originally consisted of a five-year term loan of $32.5 million and a three-year $55 million revolving credit facility. Substantially all of our properties and assets and those of our domestic subsidiaries secure the senior credit facility. Under the original agreement, we pay LIBOR-based interest on funds borrowed under the term loan and funds borrowed on a revolving basis bear interest on a Prime or LIBOR-based option.

 

In August 2004, the senior credit facility was amended to convert $20 million of the revolver balance to a term loan (Term Loan B), which matures August 31, 2005 and to reduce the credit commitment on the revolver by an equal amount from $55 million to $35 million. The facility was further amended in December 2004 to provide that interest on Term Loan B would accrue at a 12.5% per annum fixed rate from November 30, 2004 until March 31, 2005, when the interest rate increased to an 18% per annum fixed rate. The interest rate further increases to a 21% per annum fixed rate on June 30, 2005.

 

Effective November 30, 2004, we amended our credit agreement to require mandatory prepayment of indebtedness outstanding under the credit agreement with proceeds collected by us from certain disputed accounts and claims that are currently the subject of litigation initiated by us. Pursuant to the mandatory prepayment provision, we are required to apply such proceeds, first, to the payment in full of Term Loan B, next, at our option, to the payment of remaining term loans or to the payment of amounts outstanding under the revolving credit facility.

 

Effective March 23, 2005, the facility was amended, reducing the credit commitment on the revolver from $35.0 million to the lesser of $29,000,000 or 70% of the borrowing base. Effective April 8, 2005, the facility was further amended to increase the credit commitment on the revolver from $29.0 million to the lesser of $32.0 million or 75% of the borrowing base. The amendment also provided that the commitment will further increase to the lesser of $35.0 million or 80% of the borrowing base upon the full and final closing and funding of either a subordinated loan to the Company or an offering of junior securities by the Company in an amount acceptable to the lenders. Finally, the amendment converted interest on the term loan to Prime plus 175 basis points and interest on the revolver borrowings to Prime plus 150 basis points. Beginning in May, the rates will increase 25 basis points per month until August at which time the rates will increase 50 basis points per month until March 2006. The amendment did not change the interest rate applicable to Term Loan B.

 

At February 28, 2005, $11.0 million was outstanding under the revolver, $23.8 million was outstanding under the five-year term loan and $20.0 million was outstanding under Term Loan B. In addition, $9.3 million of the revolver was utilized by outstanding letters of credit, which mature in 2005 and 2006. At February 28, 2005, remaining availability under the credit facility consisted of $14.6 million available under the revolver as the total revolver facility was $35.0 million. Had the current amendments been in place, availability would have been reduced to $11.6 million. At April 8, availability under our revolver was $6.1 million. We were paying a weighted average interest rate of 9.3% on the term loans and 6.75% on the revolver at February 28, 2005.

 

Our credit agreement requires us to maintain certain financial ratios, limits the amount of our capital expenditures, limits the amount of additional borrowings we may incur and prohibits the payment of cash dividends.

 

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Financial ratios currently contained in our credit agreement are as follows:

 

    A fixed charge coverage ratio of not less than 1.15 to 1.0 through February 28, 2005; 1.0 to 1.0 from March 1, 2005 through May 31, 2005; and 1.25 to 1.0 thereafter. The fixed charge coverage ratio is calculated as (i) consolidated EBITDA for the then most recently ended fiscal four quarters less dividends paid in cash, taxes paid in cash and capital expenditures for the same period to (ii) scheduled current maturities of long-term debt for the following four fiscal quarters plus consolidated interest expense for the then most recently ended fiscal four quarters. Consolidated EBITDA is defined in the credit agreement as consolidated net income plus, to the extent included in determining consolidated net income, consolidated (i) interest expense, (ii) tax expense, (iii) depreciation, amortization and other non-cash charges, (iv) losses on the sale of fixed assets and (v) extraordinary losses realized other than in the ordinary course of business minus (i) gains on sales of fixed assets and (ii) extraordinary gains realized other than in the ordinary course of business.

 

    A total debt leverage ratio not to exceed 4.5 to 1.0 through February 28, 2005 and 3.50 to 1.0 thereafter. The total debt leverage ratio is calculated as (i) consolidated debt plus the face value of the acquisition payable to the former shareholders of Hake, to (ii) consolidated EBITDA for the then most recently ended four fiscal quarters.

 

    A senior debt leverage ratio not to exceed 3.0 to 1.0 through February 28, 2005 and 2.25 to 1.0 thereafter. The senior debt leverage ratio is calculated as (i) total debt outstanding under the credit facility excluding Term Loan B plus the face value of the acquisition payable to the former shareholders of Hake, to (ii) consolidated EBITDA for the then most recently ended four fiscal quarters.

 

    A minimum net worth of at least $75 million plus one hundred percent of quarterly positive net income less dividends paid and treasury stock purchased commencing with the fiscal quarter ended August 31, 2004.

 

The credit agreement also limits our capital expenditures to $8 million for fiscal 2005 and $9 million annually thereafter, limits unsecured indebtedness we may borrow for general operating purposes to $1 million, limits capital lease obligations to $15 million and limits the amount of letters of credit we may have outstanding to $15 million.

 

In connection with the August 2004 amendment to our Credit Agreement, we also amended the terms of our financial covenants and in October 2004, we further amended our credit agreement to ease the restrictiveness of our financial covenants. The following table presents the required and actual financial covenant measures in effect as of May 31, 2004 and February 28, 2005:

 

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February 28,

2005


   

May 31,

2004


 

Fixed Charge Ratio

                

Minimum Ratio Required

     1.15       1.40  

Actual Ratio

     (0.20 )(A)     1.66  

Total Debt Leverage Ratio

                

Maximum Ratio Allowed

     4.50       2.50  

Actual Ratio

     (51.06 )(A)     3.06 (B)

Senior Debt Leverage Ratio

                

Maximum Ratio Allowed

     3.00       N/A  

Actual Ratio

     (34.85 )(A)     N/A  

Net Worth

                

Minimum Net Worth Required

   $ 75,000,000     $ 66,596,000  

Actual Net Worth

     51,657,000 (A)     85,715,000  

(A) Consolidated EBITDA, as defined in the Senior Credit Facility, was a loss for the twelve-month period ended February 28, 2005. The non-compliance was primarily attributable to operating results that were significantly lower than expectations and a $10.4 million charge for disputed contracts reserve, producing negative ratios which resulted in non-compliance with the required covenants.

 

(B) Based on our forecasted results of operations and our amended covenants, our prospective covenant calculations indicated compliance with our covenants for the upcoming 12 months at May 31, 2004. However, we exceeded the maximum Total Debt Leverage Ratio allowed under our credit agreement at that date. The non-compliance with the Total Debt Leverage Ratio at May 31, 2004 was primarily attributable to operating results for the fourth quarter of fiscal 2004, which were negatively impacted by projects that experienced significant cost overruns during that period.

 

On April 8, 2005, the Company received a waiver letter and amendment from the lenders whereby the lenders agreed to waive all rights and remedies under the Credit Agreement arising from events of default specified in the waiver, which is effective through June 15, 2005. The waiver may be withdrawn upon the occurrence of certain specified events. The fee for the waiver letter and amendment will range from $0.2 million to $1.0 million. The fee increases over a period of time defined in the agreement with the full $1.0 million being payable if certain events do not occur before September 11, 2005.

 

If, as of the end of a fiscal quarter, we violate a financial covenant and conclude that it is probable that we would continue to violate one or more of our covenants over the next 12 months, we would be required to reclassify our indebtedness under the credit agreement as current. Because of the decline in operating results, delays in the start-up of projects included in our backlog, costs associated with contract disputes, low-margin maintenance contracts, anticipated restructuring costs and capital expenditure requirements, we have concluded that it is probable that we will continue to violate one or more of the existing covenants over the next twelve months. Therefore, our debt is classified as current at February 28, 2005.

 

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The failure to comply with the terms of our credit agreement has required us to incur significant fees to our lenders to obtain waivers and amendments and caused us to seek alternative financing. Without acceptable waivers or amendments from our lenders or alternative financing on terms acceptable to us, our lenders would have the right, among others, to declare all amounts outstanding under the credit agreement to be immediately due and payable and foreclose upon and sell substantially all of our assets to repay such amounts.

 

See Note 3, Restructuring, for a discussion of Management’s plans related to the Company’s credit facility.

 

NOTE 5 – ACQUISITION PAYABLE

 

As part of the purchase of the Hake group of companies in Fiscal 2003, the Company entered into an acquisition payable for a portion of the purchase price. The acquisition payable is recorded at its fair value of $7.7 million and accreted for the change in its present value each period utilizing a 5.1% effective interest rate. Payments related to the acquisition payable are due annually on March 7 with $1.9 million due annually in 2005, 2006 and 2007, and $2.7 million due in 2008. The Company did not pay the $1.9 million payment due March 7, 2005 to the former shareholders of Hake as a result of the Company’s exposure from certain issues with tax filings by the Hake Group of Companies. These issues relate to periods prior to the acquisition by Matrix. Because the Company was indemnified by the former shareholders for such preacquisition tax contingencies and it is not probable it will have a negative impact on the Company, no amounts have been reflected in the accompanying financial statements related to this matter.

 

Pursuant to the purchase agreement, the former shareholders of Hake agreed, jointly and severally, to indemnify Matrix for damages it suffers due to breaches of representations and warranties made by the shareholders with respect to, among other things, its employee benefit plans; the ownership, use and condition of its assets and the performance by Hake of its contractual obligations and its obligations under applicable laws, including employment and environmental laws. As to these matters, Matrix may recover its damages only if its claims for damages are made by March 7, 2008, the amount of damages claimed as to any single event exceeds a de minimus amount of $10,000, and only after the aggregate amount of all such claims excluding de minimus claims exceeds $250,000. In order to better assure the payment to Matrix of any claims by it for indemnity, $10 million of the purchase price for Hake was withheld in the form of a deferred purchase price payable to the former shareholders or their designee. Upon final determination that a claim for indemnity is proper, the amount of the claim can be deducted by Matrix from the deferred payments of the purchase price. The remaining deferred purchase obligations to be paid in the future total approximately $8.4 million. Since the purchase date on March 7, 2003, Matrix claims have not exceeded $250,000, and thus no adjustment to the deferred purchase price was made related to indemnifications by the former shareholders of Hake prior to March 2005.

 

NOTE 6 – GOODWILL IMPAIRMENT

 

The Company performs an annual goodwill impairment review in the fourth quarter of every year. In addition, the Company performs a goodwill impairment review whenever events or changes in circumstances indicate the carrying value may not be recoverable, such as the liquidity issues and operating results the Company is currently experiencing.

 

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As a result, the Company performed a goodwill impairment test as of February 28, 2005. The process of evaluating the impairment of goodwill is highly subjective and requires significant judgment. Fair value of the reporting units was determined based on the probability-adjusted present value of future cash flows. A preliminary impairment charge of $25 million was recorded for the Construction Services segment in the quarter ended February 28, 2005 and is reflected in “Restructuring, impairment and abandonment” on the Consolidated Statements of Operations. The cash flow assumptions are based on the best available information, but such information is considered preliminary due to the Company’s current liquidity situation and restructuring efforts. The impairment evaluation will be completed in the fourth quarter of fiscal 2005. At such time, the preliminary impairment charge recorded in the third fiscal quarter may be adjusted upward or downward.

 

NOTE 7– INCOME TAXES

 

Deferred income taxes are computed using the liability method whereby deferred tax assets and liabilities are recognized based on temporary differences between the financial statement and tax basis of assets and liabilities using presently enacted tax rates. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes.

 

In February 2005, the Company established valuation allowances of approximately $1.6 million for deferred tax assets including certain net operating loss carryforwards and tax credit carryforwards. The realization of these carryforwards is dependent on certain of our operations recognizing taxable income on a stand-alone basis in future periods which is no longer certain. Therefore, these deferred tax assets were reserved as of February 28, 2005.

 

The difference between the expected income tax provision applying the domestic federal statutory tax rate and the current state rates is illustrated as follows:

 

    

Three Months Ended

February 28, 2005


  

Nine Months Ended

February 28, 2005


     (Amounts in thousands)

Expected provision for federal income tax benefit at the statutory rate.

   $ (13,565)    (35.0%)    $ (13,327)    (35.0%)

Expected state income tax benefit, net of federal benefit

     (2,132)    (5.5%)      (2,094)    (5.5%)

Charges without tax benefit, primarily goodwill impairment

     10,125    26.1%      10,125    26.6%

Valuation allowance on tax benefit of contract dispute reserve

     679    1.8%      679    1.8%

Valuation allowance on deferred tax assts

     1,600    4.1%      1,600    4.2%

Other

     5    —        7    —  
    

  
  

  

Total

   $ (3,288)    (8.5%)    $ (3,020)    (7.9%)
    

  
  

  

 

In fiscal 2004, the actual income tax provision did not differ from the expected federal and state income tax provision.

 

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NOTE 8 – CONTRACT DISPUTES

 

Contract Disputes Summary

(in 000’s)

 

    

Total
Claim


   Net Receivable

Dispute


     

As of

February 28, 2005


   

As of

May 31, 2004


Contract Dispute I

   $ 26,262    $ 14,943     $ 14,926

Contract Dispute II

     14,619      11,322       11,300

Contract Dispute III

     6,431      4,183       4,255

Contract Dispute IV

     2,054      975       975
    

  


 

       49,366      31,423       31,456

Contract Dispute Reserve

     —        (10,448 )     —  
    

  


 

Total

   $ 49,366    $ 20,975     $ 31,456
    

  


 

 

Contract Dispute I

 

Four subsidiaries of the Company performed work from March 2003 to November 2003 under several subcontracts with a general contractor (GC) to erect a combined cycle power plant. In October 2003 with the project 85% complete, the GC terminated the Company from one subcontract due to contractual disputes and claims against the GC for additional monies owed related to significant increased costs stemming from alleged mismanagement of the project by the GC. Other subcontracts were substantially completed but were consequently terminated for convenience by the GC.

 

The Company, through a subsidiary, consequently filed suit against the general contractor in November 2003. Other subsidiaries of the Company filed suit for non-payment in December 2003. Mediation occurred in August 2004, however, no resolution was reached. The subsidiaries of the Company, along with their independent contract forensics experts, believe the claims are valid and expect a ruling in the Company’s favor regarding these matters. The three suits have been combined into one forum of litigation by the presiding judge. The Company expects a trial date to be set for some time in the first quarter of fiscal 2006 and expects full resolution in these matters to occur in fiscal 2006.

 

The Company’s total claim in this matter is approximately $26.3 million and the Company has, in accordance with SOP 81-1, a $14.9 million net receivable recorded in our balance sheet, excluding the contract dispute reserve discussed below.

 

Contract Dispute II

 

In the fourth quarter of fiscal 2003, a subsidiary of the Company was subcontracted by a general contractor (GC) to erect two Selective Catalytic Reactor (SCR) Units for an owner. The Company subsidiary had performed all of its obligations to the GC in accordance with the parties’ Subcontractor Agreement, along with significant extra work that the GC directed the Company’s subsidiary to perform to cure design defects, mis-fabrications, and project delays attributable to the GC. The GC refused to sign certain change orders for the additional work performed and alleged that the services and materials provided by the Company were defective and behind schedule. In June 2004, the owner terminated the GC for cause. The owner subsequently retained the subsidiary of the Company to complete the project. The

 

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owner refused to pay the subsidiary of the Company the amounts owed by the GC because the owner had previously paid the GC for the work. The Company has subsequently completed work on the SCR units to the satisfaction of the owner.

 

Under the terms of the owner’s original contract with the GC, the GC provided the owner with an unconditional and irrevocable guarantee of its parent, a non-USA based holding company. Under this guarantee, the parent guaranteed the GC’s performance and payment obligations, including the obligations that the GC owed to the Company and other subcontractors. The Company has subsequently filed suit against the GC’s parent pursuant to the contractual parental guarantee but expects the proceedings to be stayed until arbitration between the GC and the Company is completed. If the proceedings are not successful against the GC, the Company believes it can seek recovery under the parental guarantee. Currently, an arbitration date has been scheduled for the first quarter of 2006. The Company, along with our independent contract forensics firm believes that we have valid claims and expect a decision in our favor regarding this matter. The Company expects a full resolution in this matter to occur in fiscal 2006.

 

The Company’s total claim in this matter is approximately $14.6 million and the Company has, in accordance with SOP 81-1, a $11.3 million net receivable recorded in our balance sheet, excluding the contract dispute reserve discussed below.

 

Contract Dispute III

 

In fiscal year 2003, the two of the Company’s subsidiaries entered into sub-subcontract agreements with another subcontractor (Sub) to provide all necessary supervision, labor, materials, and equipment necessary to install a heater foundation, on a time and material basis at an owner’s facility. The Sub was previously contracted by the general contractor (GC) on the project, to perform foundation installation, equipment, piping and steel erection, other construction work and construction management. As the project progressed, the Sub opted to increase the Company’s subsidiaries scope of work.

 

On September 30, 2003, the Sub filed for Chapter 11 bankruptcy protection. At the date of the bankruptcy filing, the Company subsidiaries were substantially complete with all work at the job site. Subsequent to the Sub’s bankruptcy filing, the GC assumed all of the Sub’s obligations that are subject to valid liens associated with the project. The Company’s subsidiaries subsequently filed valid construction lien claims totaling approximately $5.8 million against the owner, GC and Sub. These lien claims have been consolidated with six other sub-subcontractor lien claims associated with the project and the lien claims have been fully bonded by the GC, although the GC disputes the lien amounts and seeks to have a smaller lien fund fixed. Therefore, the Company is not required to proceed through the Sub’s bankruptcy proceedings to collect on amounts owed. The Court has ruled that initial discovery be limited to matters relevant to the computation of the “lien fund” that is available to satisfy the liens that have been asserted against the project. Currently, the Company is in dispute with the owner and the GC as to the appropriate calculation of the available lien fund. The Company believes that we have a valid claim and that the value of the lien fund will be established at an amount adequate to fund the associated claim by the Company. Currently, there is a settlement discussion mandated by the courts scheduled for the first quarter of 2006. The Company expects a full resolution in this matter to occur in fiscal 2006.

 

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The Company’s total claim in this matter is approximately $6.4 million and the Company has, in accordance with SOP 81-1, a $4.2 million net receivable recorded in our balance sheet, excluding the contract dispute reserve discussed below.

 

Contract Dispute IV

 

In March 2000, the Company entered into a joint venture partnership (JV) agreement for the construction of a pulp and paper project for an owner, which was completed late in 2000. The services provided by the JV consisted primarily of a labor contract with the owner supplying the engineering and the majority of the materials to be installed. The claim arises out of a contractual dispute in which the Company believes the JV incurred substantial work because the owner’s planning and engineering on the project was not adequate. The owner did not pay amounts owed and claims that the JV was not properly licensed by the Oregon Contractors Licensing Board, and therefore not eligible to file a lawsuit under Oregon law. An Oregon state court ruled in favor of the owner regarding the licensing issue and the Company appealed the decision.

 

Oral arguments were held in Court of Appeals on March 8, 2005. Although the appellate panel of judges is under no time constraint, the Company expects a decision in the next nine months. If the court rules in favor of the Company, the case will proceed to trial. The Company and its external counsel believe that we have valid claims under state law and expect a decision in our favor from the Court of Appeals. The Company also believes that a recent state court ruling supports our position regarding the claim. The Company expects a full resolution in this matter to occur in fiscal 2006.

 

The Company’s total claim in this matter is approximately $2.1 million, excluding legal costs, and the Company has, in accordance with SOP 81-1, a $1.0 million net receivable recorded in our balance sheet, excluding the contract dispute reserve.

 

Contract Dispute Reserve

 

In February 2005, the Board of Directors authorized management to initiate an effort to accelerate the resolution and collection of the amounts owed on the disputed contracts, and further limit the costs of litigation to the Company arising out of the various disputes. The action by the Board was taken in connection with the Company’s current liquidity situation, restructuring plans and refinancing efforts. While the Company believes that allowing these disputes to be resolved through the normal course of arbitration or litigation would result in the recovery of amounts equal to or in excess of the previously recorded balances, the Board concluded that addressing the liquidity situation was of utmost importance. Therefore, in an effort to expedite the collection of these balances, the Board authorized management to pursue resolution at amounts below that previously reflected on the balance sheet. As a result of the Company’s initiative, the Company recorded a reserve of $10.4 million in the third quarter of fiscal 2005.

 

The Company believes it is adequately reserved for the disputes and will continue to assess the adequacy of the reserves as additional information becomes available.

 

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NOTE 9 – CONTINGENCIES

 

Insurance Reserves

 

The Company maintains workers’ compensation insurance, with statutory limits; general liability insurance; auto liability insurance in the primary amount of $2.0 million per occurrence; contractor’s pollution liability insurance in the amount of $10.0 million per occurrence; and pollution legal liability for owned and leased properties in the amount of $2.0 million per occurrence. The Company has deductibles or self-insured retentions in the amount of $10,000 for damage to owned or leased properties; $250,000 for workers’ compensation, $100,000 for general liability, $0 for auto liability, $50,000 for contractor’s pollution liability and $25,000 for pollution legal liability. Matrix also maintains an umbrella policy with coverage limits of $25.0 million per project, policies to cover our equipment and other property with coverage limits of $16.0 million per occurrence, and policies for construction with coverage limits of $16.0 million per project. Most policies provide for coverage on an occurrence basis rather than a “claims made” basis. Matrix maintains a performance and payment bonding line of $150.0 million. However, our current liquidity and financial situation makes it difficult to utilize the bonding line for new projects.

 

Management estimates the reserve for self-insurance retention based on knowledge of the circumstances surrounding the claims, the nature of any injuries involved, historical experience and estimates of future costs provided by certain third parties. Changes in the assumptions underlying the accrual could cause actual results to differ from the amounts reserved.

 

Legion Insurance Dispute

 

Matrix, as plaintiff, is currently in litigation in the Tulsa County District Court in the State of Oklahoma over matters arising out of a workers’ compensation program with a former insurance provider. These matters involve contests over a letter of credit (“LC”) for $2.0 million, a bond for $2.1 million and a deposit of $0.5 million pledged to secure Matrix’s obligations under this prior program. As a part of its insurance program with Legion Insurance Company (“Legion”), Legion used an offshore insurance company, Mutual Indemnity (“Mutual”), which was domiciled in Bermuda. Matrix purchased preferred stock in Mutual, which then reinsured part of the workers’ compensation exposure that was underwritten by Legion. Matrix assumed the first $250,000 of any occurrence involving injury to Matrix employees. If there was an occurrence, Legion would process and pay all claims for all Matrix employees injured in that occurrence. On a monthly basis, Legion would then be reimbursed by Mutual for the actual claim payments made, up to $250,000 per occurrence. Matrix would then reimburse Mutual for the amount of the claims paid by Legion during that month.

 

Matrix funded two escrow accounts, one of which was used to administer individual claims and the other of which acted as a working escrow account to reimburse Mutual. Mutual’s insurance regulators also required Matrix to post an LC for $2.0 million and a surety bond in the amount of $2.1 million as security for its potential future claim payment liability.

 

On April 1, 2002, the Insurance Commissioner for the State of Pennsylvania placed Legion into rehabilitation. Matrix was concerned that the security held by Mutual would be commingled with other shareholder assets and not used exclusively to pay Matrix claims. Matrix filed suit in the Tulsa County district court to require a full accounting of all funds held

 

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by Mutual and restrain Mutual from drawing on the LC or surety bond. The court granted a temporary restraining order prohibiting the use of such assets for the payment of claims other than Matrix claims.

 

On July 25, 2003, a Pennsylvania court placed Legion into liquidation. At that time, all open workers’ compensation claims were sent to the various state guaranty funds for handling. Many of the states have denied responsibility with respect to Matrix claims because Matrix’s net worth exceeded the statutory maximum as of December 31, 2002, the year preceding the Legion liquidation, under which claims would be handled by the individual state guaranty funds. Those states returned the claims back to Matrix for direct handling. In other states where Matrix has exposure, the state guaranty funds took over the claims. In recent months, however, some of those states have billed Matrix for reimbursement of payments made on Matrix claims.

 

Matrix is continuing to negotiate with Mutual for a reduction or elimination of the LC and surety bond. Matrix and Mutual have reached a tentative settlement in which a permanent injunction would replace the temporary restraining order prohibiting Mutual from drawing upon either the LC or bond, provided that Matrix continues to pay amounts owed directly to the Legion Liquidator or the individual state guaranty funds and works with the Liquidator to release Mutual from future liability with respect to Matrix claims. Matrix cannot predict when a final settlement will be reached due to difficulty in quantifying the precise exposure of Mutual for outstanding claims.

 

All claims that are outstanding with the Legion Liquidator, state guaranty funds and Mutual are claims that originated prior to May 1, 2002, the date on which Matrix replaced the Legion insurance program with workers’ compensation insurance provided by “A” rated workers compensation carriers, are reserved by the Company. Although the Company believed its previous reserve of $0.8 million was adequate, recent claim settlements by state guaranty funds exceeded amounts accrued by the Company for the respective claims. In addition, during the quarter ending February 28, 2005, the Company obtained information regarding estimated settlements of open claims that were also higher than amounts previously accrued. As a result, the Company recorded an additional accrual of $1.2 million for these claims in the third quarter of fiscal 2005, increasing the Company’s reserve to $2.0 million. Additionally, it is still possible that Matrix will experience some additional exposure from the total of $4.6 million of existing security, consisting of the escrow accounts, LC and surety bond, until a final settlement agreement with Mutual is signed, a permanent injunction is entered and the LC and surety bond are cancelled. Matrix does not believe resolution of this issue will have a material effect on the Company’s financial position, results of operations and liquidity.

 

Environmental Dispute

 

In March 2005, the South Coast Air Quality Management District (AQMD) of the State of California settled a complaint filed in March 2003 in the Los Angeles County Superior Court for the Central District against a Matrix customer alleging multiple violations by the customer at its west coast refinery for failure to comply with certain District Rules of the AQMD that established a self-inspection and compliance reporting program for above ground stationary tanks used to store crude oil, gasoline, and other petroleum products.

 

Matrix was not named in the AQMD complaint; however, counsel for the customer made a formal demand upon Matrix to assume defense of the case and to indemnify the customer for any damages it may incur. The customer’s demand was made pursuant to the terms of the

 

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Master Service Agreement entered into in May 1999 between Matrix and the customer. Matrix rejected the demands of the customer based upon its own belief as to the interpretation of the Master Services Agreement and the facts developed by Matrix since the AQMD filed its complaint in March 2003. Matrix and the customer mutually agreed to toll the dispute for at least four years and until there is a resolution of the complaint filed by the AQMD against the customer.

 

While the existing relationship between Matrix and its customer may be positive, the customer may still assert claims against Matrix that it believes may be valid under the Master Services Agreement. There can be no assurance that Matrix will not incur costs associated with this matter. The Company currently cannot provide any estimate of possible loss or range of possible loss, if any, for this matter.

 

Unapproved Change Orders and Claims

 

As of February 28, 2005 and May 31, 2004, accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts included revenues, to the extent of costs incurred, for unapproved change orders of approximately $0.4 million and $1.5 million, respectively, and claims of approximately $0.4 million and $1.3 million, respectively. Amounts disclosed for unapproved change orders and claims exclude amounts associated with contract disputes disclosed in Note 8 – Disputed Contracts. Generally, collection of amounts related to unapproved change orders and claims is expected within twelve months. However, customers generally will not pay these amounts to Matrix until final resolution of related claims, and accordingly, collection of these amounts may extend beyond one year.

 

Other

 

The Company and its subsidiaries are named as defendants in various other legal actions and are vigorously defending against each of them. It is the opinion of management that none of such legal actions will have a material effect on the Company’s financial position, results of operations and liquidity.

 

NOTE 10 – REPORTING ACCUMULATED OTHER COMPREHENSIVE INCOME

 

Other comprehensive income and accumulated other comprehensive income consisted of foreign currency translation adjustments and fair value adjustments of derivative instruments.

 

     Three Months Ended

    Nine Months Ended

     February 28,
2005


    February 29,
2004


    February 28,
2005


   

February 29,

2004


     (In Thousands)     (In Thousands)

Net Income (loss)

   $ (35,469 )   $ 2,259     $ (35,068 )   $ 9,216

Other comprehensive income (loss)

     (154 )     (81 )     441       215
    


 


 


 

Comprehensive income (loss)

   $ (35,623 )   $ 2,178     $ (34,627 )   $ 9,431
    


 


 


 

 

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NOTE 11 – EARNINGS PER COMMON SHARE

 

Basic earnings per common share is calculated based on the weighted average shares outstanding during the period. Dilutive earnings per share includes the dilutive effect of employee stock options. Diluted earnings per share for the nine month period ending February 29, 2004 excludes 234,902 options which were antidilutive, as the exercise prices of the options exceeded the average market price of common stock for the first nine months of fiscal 2004. There were also 344,100 antidilutive options for both the three and nine month periods ending February 28, 2005. However, as the operating results of the Company are a net loss for both the three and nine month periods, the dilutive effect of stock options is not considered when reporting earnings per share.

 

NOTE 12 – SEGMENT INFORMATION

 

The Company’s operating segments have been aggregated into two reportable segments, Construction Services and Repair & Maintenance Services.

 

The Construction Services segment includes turnkey and specialty construction services provided primarily to the downstream petroleum and power industries. These services include civil/structural, mechanical, piping, electrical and instrumentation, millwrighting, steel fabrication and erection, specialized heavy hauling and rigging, boiler work, engineering, and fabrication and construction of aboveground storage tanks (AST).

 

The Repair & Maintenance Services segment provides routine, preventive and emergency-required maintenance and repair services primarily to the downstream petroleum and power industries. These services include plant turnarounds, power outages, industrial cleaning, facility and AST maintenance and repair.

 

Other consists of items related to previously disposed of businesses.

 

The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes. Overhead costs are allocated to the segments based upon revenue.

 

Segment assets consist of accounts receivable, costs and estimated earnings in excess of billings on uncompleted contracts, property, plant and equipment and goodwill.

 

 

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Matrix Service Company

 

3rd Quarter Results of Operations

(In Thousands)

 

     Construction
Services


    Repair &
Maintenance
Services


    Other

   

Combined

Total


 

Three Months ended February 28, 2005

                                

Gross revenues

   $ 51,618     $ 63,018     $ —       $ 114,636  

Less: Inter-segment revenues

     (2,891 )     (298 )     —         (3,189 )
    


 


 


 


Consolidated revenues

     48,727       62,720       —         111,447  

Gross profit

     1,727       4,147       —         5,874  

Operating income (loss)

     (37,474 )     272       (2 )     (37,204 )

Income (loss) before income tax expense

     (38,483 )     (272 )     (2 )     (38,757 )

Net income (loss)

     (35,305 )     (163 )     (1 )     (35,469 )

Segment assets

     82,831       76,767       29,207       188,805  

Capital expenditures

     62       69       405       536  

Depreciation and amortization expense

     873       795       —         1,668  

Three Months ended February 29, 2004

                                

Gross revenues

   $ 106,699     $ 40,710     $ —       $ 147,409  

Less: Inter-segment revenues

     (2,135 )     (99 )     —         (2,234 )
    


 


 


 


Consolidated revenues

     104,564       40,611       —         145,175  

Gross profit

     7,041       4,780       —         11,821  

Operating income (loss)

     2,349       1,911       (65 )     4,195  

Income (loss) before income tax expense

     2,112       1,754       (65 )     3,801  

Net income (loss)

     1,189       1,109       (39 )     2,259  

Segment assets

     113,695       61,761       21,930       197,386  

Capital expenditures

     165       441       780       1,386  

Depreciation and amortization expense

     834       777       —         1,611  

Nine Months ended February 28, 2005

                                

Gross revenues

   $ 161,228     $ 157,456     $ —       $ 318,684  

Less: Inter-segment revenues

     (8,229 )     (547 )     —         (8,776 )
    


 


 


 


Consolidated revenues

     152,999       156,909       —         309,908  

Gross profit

     9,959       13,597       —         23,556  

Operating income (loss)

     (37,164 )     2,771       (150 )     (34,543 )

Income (loss) before income tax expense

     (39,466 )     1,538       (150 )     (38,078 )

Net income (loss)

     (35,893 )     914       (89 )     (35,068 )

Segment assets

     82,831       76,767       29,207       188,805  

Capital expenditures

     318       277       728       1,323  

Depreciation and amortization expense

     2,675       2,496       —         5,171  

Nine Months ended February 29, 2004

                                

Gross revenues

   $ 361,600     $ 121,033     $ —       $ 482,633  

Less: Inter-segment revenues

     (7,627 )     (156 )     —         (7,783 )
    


 


 


 


Consolidated revenues

     353,973       120,877       —         474,850  

Gross profit

     25,918       12,061       —         37,979  

Operating income (loss)

     12,185       4,179       (65 )     16,299  

Income (loss) before income tax expense

     11,131       3,595       (65 )     14,661  

Net income (loss)

     7,130       2,125       (39 )     9,216  

Segment assets

     113,695       61,761       21,930       197,386  

Capital expenditures

     749       1,565       1,639       3,953  

Depreciation and amortization expense

     2,584       2,207       —         4,791  

 

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Segment revenue from external customers by industry type are as follows:

 

     Construction
Services


   Repair &
Maintenance
Services


   Total

Three Months Ended February 28, 2005

                    

Power Industry

   $ 3,193    $ 8,161    $ 11,354

Downstream Petroleum Industry

     38,534      52,230      90,764

Other Industries

     7,000      2,329      9,329
    

  

  

Total

   $ 48,727    $ 62,720    $ 111,447
    

  

  

Three Months Ended February 29, 2004

                    

Power Industry

   $ 76,991    $ 3,115    $ 80,106

Downstream Petroleum Industry

     23,949      35,018      58,967

Other Industries

     3,624      2,478      6,102
    

  

  

Total

   $ 104,564    $ 40,611    $ 145,175
    

  

  

Nine Months Ended February 28, 2005

                    

Power Industry

   $ 33,761    $ 13,084    $ 46,845

Downstream Petroleum Industry

     96,287      135,732      232,019

Other Industries

     22,951      8,093      31,044
    

  

  

Total

   $ 152,999    $ 156,909    $ 309,908
    

  

  

Nine Months Ended February 29, 2004

                    

Power Industry

   $ 253,473    $ 9,775    $ 263,248

Downstream Petroleum Industry

     91,378      104,362      195,740

Other Industries

     9,122      6,740      15,862
    

  

  

Total

   $ 353,973    $ 120,877    $ 474,850
    

  

  

 

Other Industries consists primarily of wastewater, food and beverage, electronics and paper industries.

 

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Critical Accounting Policies

 

The following is a discussion of the most critical accounting policies, judgments and uncertainties that are inherent in our application of Generally Accepted Accounting Principles (GAAP).

 

Revenue Recognition

 

Matrix records profits on long-term construction contracts on a percentage-of-completion basis on the cost-to-cost method. 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. 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 on behalf of the customer.

 

Matrix has numerous contracts that are in various stages of completion. Such contracts require estimates to determine the appropriate cost and revenue recognition. Matrix has a history of making reasonably dependable estimates of the extent of progress towards completion, contract revenues and contracts costs, and accordingly, does not believe significant fluctuations would ever materialize. However, current estimates may be revised as additional information becomes available. If estimates of costs to complete long-term contracts indicate a loss, 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, and adjustments related to these incentives and penalties are recorded in the period when estimable or finalized, which is generally during the latter stages of the contract. Contract incentives are evaluated throughout the life of the contract and are recognized on a percentage-of-completion basis when the likelihood of obtaining the incentive becomes probable.

 

Indirect costs (such as salaries and benefits, supplies and tools, equipment costs and insurance costs) are charged to projects based upon direct labor hours and overhead allocation rates per direct labor hour. Warranty costs are normally incurred prior to project completion and are charged to project costs as they are incurred. Warranty costs incurred subsequent to project completion were not material for the periods presented. Overhead allocation rates are established annually during the budgeting process and evaluated for accuracy throughout the year based upon actual direct labor hours and actual costs incurred.

 

Matrix records revenue on reimbursable and time and material contracts based on a proportional performance basis as costs are incurred.

 

 

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Claims Recognition

 

Claims are amounts in excess of the agreed contract price (or amounts not included in the original contract price) that we seek to collect from customers or others for delays, errors in specifications and designs, contract terminations, change orders in dispute or unapproved as to both scope and price or other causes of anticipated additional costs incurred by us. Recognition of amounts as additional contract revenue related to 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 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 February 28, 2005 and May 31, 2004, accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts included revenues, to the extent of costs incurred, for unapproved change orders of approximately $0.4 million and $1.5 million, respectively, and claims of approximately $0.4 million and $1.3 million, respectively. Historically, our collections for unapproved change orders and other claims have approximated the amount of revenue recognized.

 

The following table provides a rollforward of revenue recognized on claims and unapproved change orders. Amounts disclosed for unapproved change orders exclude amounts associated with contract disputes disclosed in Note 8 – Disputed Contracts.

 

    

Claims for

Unapproved

Change Orders


   

Other

Claims


    Total

 
           (In Thousands)        

Balance at May 31, 2003

   $ 377     $ 528     $ 905  

Additions

     1,870       188       2,058  

Collections

     (551 )     (175 )     (726 )

Gain/(Loss)

     (124 )     (104 )     (228 )
    


 


 


Balance at February 29, 2004

   $ 1,572     $ 437     $ 2,009  
    


 


 


Balance at May 31, 2004

   $ 1,457     $ 1,264     $ 2,721  

Additions

     329       247       576  

Collections

     (1,751 )     (1,095 )     (2,846 )

Gain/(Loss)

     358       (36 )     322  
    


 


 


Balance at February 28, 2005

   $ 393     $ 380     $ 773  
    


 


 


 

Contract Dispute Receivables

 

Contract Dispute Receivables are comprised of accounts receivable and cost and estimated earnings in excess of billings for which settlement is subject to legal proceedings such as mediation, arbitration or litigation. Such proceedings have resulted in delays in obtaining resolution. As a result, the balances are presented separately on the balance sheet at estimated net realizable value based upon the most current information available. Amounts ultimately received may differ from the current estimate.

 

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Loss Contingencies

 

Various legal actions, claims, and other contingencies arise in the normal course of our business. Contingencies are recorded in the consolidated financial statements, or are otherwise disclosed, in accordance with SFAS No. 5 “Accounting for Contingencies”. Specific reserves are provided for loss contingencies to the extent we conclude their occurrence is both probable and estimable. We use a case-basis 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 adverse effect on our financial position, results of operations or liquidity.

 

Legal costs are expensed as incurred.

 

Purchase Price Allocation

 

The purchase price for an acquisition is allocated to the net assets acquired based upon their estimated fair values on the date of acquisition. We record the excess of purchase price over fair value of the net assets acquired as goodwill. The fair value of net assets is primarily based upon estimated future cash flows associated with the net assets. Accordingly, our post-acquisition financial statements are materially impacted by and dependent on the accuracy of management’s fair value estimates at the time of acquisition. Our experience has been that the most significant of these estimates relate to the values assigned to construction contracts in progress and production backlog. These estimates can have a positive or negative material effect on future reported operating results.

 

Debt Covenant Compliance

 

We have certain financial covenants we are required to maintain under our credit facility. In the event of a financial covenant violation that is not appropriately waived by the lenders, or otherwise cured, re-payment of borrowings under the credit facility could be accelerated. Additionally, if a covenant violation has occurred (or would have occurred absent a loan modification), borrowings will be classified as current if it is probable that we will not maintain covenant compliance within the next twelve months. In this event, we are required to develop financial projections that allow us to assess the probability of whether or not we will be in covenant compliance for the subsequent 12-month period from the balance sheet date. Key assumptions utilized in the projections include estimated timing of the award and performance of work, estimated cash flows and estimated borrowing levels. These projections represent our best estimate of our operating results and financial condition for the subsequent 12-month period.

 

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. As of May 31, 2004 and February 28, 2005, insurance reserves totaling $2.2 million and $4.6 million, respectively, are reflected on our balance sheet. These amounts represent our best estimate of our ultimate obligations for asserted claims plus claims

 

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incurred but not yet reported at the balance sheet date. We establish specific reserves for claims using case-basis evaluations of the underlying claim data and update our evaluations as further information becomes known. Judgments and assumptions 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. Additionally, the actual results of claim settlements could differ from the amounts estimated.

 

Goodwill

 

Goodwill and intangible assets with indefinite useful lives are tested at least annually for impairment. Goodwill represents the excess of the purchase price of acquisitions over the fair value of the net assets acquired. Goodwill is evaluated for impairment by first comparing management’s estimate of the fair value of a reporting unit with its carrying value, including goodwill. Reporting units for purposes of goodwill impairment calculations are our reportable segments.

 

Management utilizes a discounted cash flow analysis to determine the estimated fair value of our reporting units. Judgments and assumptions related to revenue, gross margins, operating expenses, interest, capital expenditures, cash flow and market assumptions are inherent in these estimates. As a result, use of alternate judgments and/or assumptions could result in a fair value that differs from our estimate and ultimately results in the recognition of impairment charges in the financial statements. We utilize various assumption scenarios and assign probabilities to each of these scenarios in our discounted cash flow analysis. The results of the discounted cash flow analysis are then compared to the carrying value of the reporting unit.

 

If the carrying value of a reporting unit exceeds its fair value, a computation of the implied fair value of goodwill is compared with its related carrying value. If the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in the amount of the excess. If an impairment charge is incurred, it would negatively impact our results of operations and financial position. We perform our annual analysis during the fourth quarter of each fiscal year and in any other period in which indicators of impairment warrant an additional analysis.

 

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Results of Operations

 

Overview

 

The Company’s operating segments have been aggregated into two reportable segments, Construction Services and Repair & Maintenance Services.

 

The Construction Services segment includes turnkey and specialty construction services provided primarily to the downstream petroleum and power industries. These services include civil/structural, mechanical, piping, electrical and instrumentation, millwrighting, steel fabrication and erection, specialized heavy hauling and rigging, boiler work, engineering, and fabrication and construction of aboveground storage tanks.

 

The Repair & Maintenance Services segment provides routine, preventive and emergency-required maintenance and repair services primarily to the downstream petroleum and power industries. These services include plant turnarounds, power outages, industrial cleaning, facility and AST maintenance and repair.

 

Significant fluctuations in revenues, gross profits and operating results are discussed below on a consolidated basis and for each segment. Our revenues fluctuate from quarter to quarter due to many factors, including the changing product mix and project schedules which are dependent on the level and timing of customer releases of new business.

 

THREE MONTHS ENDED FEBRUARY 28, 2005 COMPARED TO THREE MONTHS ENDED FEBRUARY 29, 2004

 

Consolidated

 

Consolidated revenues were $111.4 million for the three months ended February 28, 2005, a decrease of $33.8 million, or 23.2%, from consolidated revenues of $145.2 million for the three months ended February 29, 2004. The decrease in consolidated revenues resulted from a $55.9 million decrease in Construction Services revenues partially offset by a $22.1 million increase in Repair & Maintenance Services revenues.

 

Consolidated gross profit decreased from $11.8 million for the quarter ended February 29, 2004 to $5.9 million for the quarter ended February 28, 2005. The $5.9 million decrease in gross profit was primarily driven by the 23.2% decline in quarterly revenues. The consolidated gross margin declined from 8.1% for the three months ended February 29, 2004 to 5.3% for the three months ended February 28, 2005. This 34.6% decrease resulted from the decline in Construction Services’ revenue, which led to a smaller consolidated revenue base available to absorb fixed costs. Also, margins were negatively impacted by the partial replacement of construction revenues with lower margin repair and maintenance work.

 

Consolidated SG&A expenses were $18.1 million for the third quarter of fiscal 2005 compared to $7.6 million in the third quarter last year. This increase of $10.5 million was attributable to an additional $10.4 million contract dispute reserve recorded on the previously disclosed contract disputes as a result of the Company’s effort to accelerate the collection of amounts owed in order to help alleviate the Company’s current liquidity situation. See the table below for a breakdown of other SG&A charges. The remaining SG&A of approximately $6.7 million is in line with expectations in light of the cost reduction measures implemented in

 

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the first quarter of 2005. SG&A expense as a percentage of revenue increased to 16.2% for the third quarter of fiscal 2005 compared to 5.2% last fiscal year due to the 23.2% decrease in revenues combined with the contract dispute reserve adjustment to SG&A.

 

Interest expense increased to $1.6 million for the quarter ended February 28, 2005 as compared to $0.7 million for the comparable period of the prior fiscal year due to higher interest rates and the increased level of debt that resulted from collection issues and contract disputes which carried over from fiscal 2004.

 

Income before income tax expense decreased from $3.8 million for the third quarter of fiscal 2004 to a loss before income tax of $38.8 million for the third quarter of fiscal 2005. This $42.6 million decrease was due to higher interest expense, lower gross margin resulting from the decline in consolidated revenues, the $10.4 million contract dispute reserve and the $25 million impairment of goodwill.

 

The effective tax rates for the three-month periods ended February 28, 2005 and February 29, 2004 were 8.5% and 40.6%, respectively. The unusually low effective tax rate for the quarter ended February 28, 2005 is attributable to the absence of a tax benefit for the impairment of goodwill combined with establishing a valuation allowance for certain deferred tax assets of approximately $1.6 million.

 

The following table provides a summary of charges impacting earnings in the current period.

 

     Three Months Ended
February 28, 2005


 
     Expense

   EPS

 
     (In Thousands)  

SG&A

               

Legal

   $ 444    $ (0.01 )

Sarbanes Oxley

     339      (0.01 )

Contract Dispute Reserve

     10,448      (0.40 )

Refinancing Efforts

     186      (0.01 )
    

  


       11,417      (0.43 )

Restructuring, Impairment & Abandonment

               

Goodwill impairment

     25,000      (1.44 )

Provision (benefit) for Income Tax

               

Deferred Tax Asset

     1,600      (0.09 )

 

Construction Services

 

Construction Services’ revenues for the quarter ended February 28, 2005 were $48.7 million, compared to $104.6 million in the comparable quarter of the prior year, a decrease of $55.9 million, or 53.4%. The decrease was primarily due to significantly lower revenues from the Power Industry offset partially by higher revenues from both the Downstream Petroleum and Other Industries. Power Industry revenues decreased $73.8 million as a result of the completion of two large power projects performed by our Eastern operations in fiscal 2004. Revenues from Downstream Petroleum increased $14.6 million with the remaining $3.3 million increase to revenues coming from Other Industries, which consists primarily of wastewater, food and beverage, electronics and paper industries.

 

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Construction Services gross margins decreased from 6.7% in the third quarter of fiscal 2004 to 3.5% in the third quarter of fiscal 2005 as a result of the sharp decline in revenues, which reduced our revenue base for fixed cost absorption. Gross profit decreased from $7.0 million in the third quarter of fiscal 2004 to $1.7 million in the third quarter of fiscal 2005, a decrease of 75.5% due to the decrease in the volume of business and the decline in gross margins.

 

The operating loss and loss before income tax expense for the three months ended February 28, 2005 of $37.5 million and $38.5 million, respectively, were significantly lower than the operating income and income before income tax expense of $2.3 million and $2.1 million, respectively, produced for the three months ended February 29, 2004, primarily due to rising interest expense, reserving an additional amount for contract disputes and the goodwill impairment.

 

Repair & Maintenance Services

 

Revenues from Repair & Maintenance Services increased $22.1 million, or 54.4%, from $40.6 million for the third quarter of fiscal 2004 to $62.7 million for the third quarter of fiscal 2005. The improvement resulted primarily from increased revenues from the Downstream Petroleum Industry, which increased $17.2 million for the quarter. Also, revenues from the Power Industry increased $5.0 million while revenues from Other Industries decreased of $0.1 million. The net increase was primarily driven by the additional maintenance contracts entered into in January 2005.

 

Gross margins of 6.6% for the three months ended February 28, 2005 were lower than the gross margins of 11.8% for the three months ended February 29, 2004 as a result of the decline to the consolidated revenue base available for fixed cost absorption combined with the inclusion of lower margin maintenance contracts. Gross profit declined $0.6 million in spite of the increase in revenues due to a lower consolidated revenue base available for fixed cost absorption.

 

Operating income and loss before income tax expense for the three months ended February 28, 2005 of $0.3 million and $0.3 million, respectively, were lower than the operating income and income before income tax expense of $1.9 million and $1.8 million, respectively, produced for the three months ended February 29, 2004 primarily due to a lower consolidated revenue base available for fixed cost absorption and higher interest expenses in the third quarter of fiscal 2005.

 

NINE MONTHS ENDED FEBRUARY 28, 2005 COMPARED TO NINE MONTHS ENDED FEBRUARY 29, 2004

 

Consolidated

 

Consolidated revenues were $309.9 million for the nine months ended February 28, 2005, a decrease of $165.0 million, or 34.7%, from consolidated revenues of $474.9 million for the nine months ended February 29, 2004. The decrease in consolidated revenues resulted from a $201.0 million decrease in Construction Services revenues partially offset by a $36.0 million increase in Repairs & Maintenance Services revenues.

 

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Consolidated gross profit decreased from $38.0 million for the nine months ended February 29, 2004 to $23.6 million for the nine months ended February 28, 2005. The $14.4 million decrease in gross profit resulted from the 34.7% decline in revenues. Consolidated gross margin declined from 8.0% for the nine months ended February 29, 2004 to 7.6% for the nine months ended February 28, 2005 primarily due to the decline in Construction Services’ revenue, which led to a smaller consolidated revenue base available to absorb fixed costs. Also, negatively impacting margins were partial replacement of construction revenues coming in the form of lower margin repair and maintenance work.

 

Consolidated SG&A expenses were $32.9 million for the nine months of fiscal 2005 compared to $21.6 million for the nine months of the prior year. This increase of $11.3 million was primarily attributable to an additional $10.4 million contract dispute reserve recorded on the previously disclosed contract disputes as a result of the Company’s effort to accelerate the collection of amounts owed in order to help alleviate the Company’s current liquidity situation. See the table below for a breakdown of other SG&A charges. Partially offsetting these expenses were cost reduction strategies implemented in the first quarter of fiscal 2005 and a reduction in employee incentives, which are based on attainment of financial goals. SG&A expense as a percentage of revenue increased to 10.6% compared to 4.6% in the prior fiscal year as a result of a 34.7% decrease in revenues combined with the contract dispute reserve adjustment and the other additional SG&A charges noted in the table below.

 

Interest expense increased to $3.6 million for the nine months ended February 28, 2005 as compared to $2.1 million for the comparable period for the prior fiscal year due to higher interest rates and the increased level of debt that resulted from collection issues and contract disputes which carried over from fiscal 2004.

 

Income before income tax expense decreased from $14.7 million for the first nine months of fiscal 2004 to a loss before income tax of $38.1 million for the first nine months of fiscal 2005. This $52.8 million decrease was due to higher interest expenses, lower gross margins resulting from the decline in consolidated revenues combined with the contract dispute reserve adjustment and the impairment of goodwill.

 

The effective tax rates for the nine months ended February 28, 2005 and February 29, 2004 were 7.9% and 40.6%, respectively. The unusually low effective tax rate for the nine months ended February 28, 2005 is attributable to the absence of a tax benefit for the impairment of goodwill combined with establishing a valuation allowance for certain deferred tax assets of approximately $1.6 million.

 

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The following table provides a summary of charges impacting earnings in the current period.

 

    

Nine Months Ended

February 28, 2005


 
     Expense

   EPS

 
     (In Thousands)  

SG&A

               

Legal

   $ 2,034    $ (0.07 )

Sarbanes Oxley

     723      (0.02 )

Severance

     312      (0.01 )

Contract Dispute Reserve

     10,448      (0.40 )

Refinancing Efforts

     186      (0.01 )
    

  


       13,703      (0.51 )

Restructuring, Impairment & Abandonment

               

Goodwill impairment

     25,000      (1.44 )

Provision (benefit) for Income Tax

               

Deferred Tax Asset

     1,600      (0.09 )

 

Construction Services

 

Construction Services’ revenues for the nine months ended February 28, 2005 were $153.0 million, compared to $354.0 million in the comparable nine months of the prior year, a decrease of $201.0 million, or 56.8%. The decrease was primarily due to a $219.7 million decrease in revenues from the Power Industry, which resulted from the completion of two large power projects performed by our Eastern operations in fiscal 2004. Partially offsetting this decline was revenue from Other Industries, which increased $13.8 million and Downstream Petroleum Industries, which increased $4.9 million.

 

Construction Services gross margins declined from 7.3% in the first nine months of fiscal 2004 to 6.5% in the first nine months of fiscal 2005 due to a lower revenue base available for fixed cost absorption, which was partially offset by the absence of the lower margin construction projects that were completed in fiscal 2004. Gross profit decreased from $25.9 million in the third quarter of fiscal 2004 to $10.0 million in the third quarter of fiscal 2005, a decrease of 61.6% due to the decrease in the volume of business.

 

The operating loss and loss before income tax expense for the nine months ended February 28, 2005 of $37.2 million and $39.5 million, respectively, were lower than the operating income and income before income tax expense of $12.2 million and $11.1 million, respectively, produced for the nine months ended February 29, 2004, due to higher interest expense, adjusting our contract dispute reserve and the impairment of goodwill.

 

Repair & Maintenance Services

 

Revenues from Repair & Maintenance Services increased $36.0 million, or 29.8%, from $120.9 million for the first nine months of fiscal 2004 to $156.9 million for the first nine months of fiscal 2005. The improvement resulted primarily from increased revenues for the nine months ended February 28, 2005 from the Downstream Petroleum Industry, which increased $31.4 million as a result of strong turnaround activity combined with the addition of maintenance contracts entered into in January 2005. In addition, revenues from the Power Industry and Other Industries increased $3.3 million and $1.3 million, respectively.

 

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Gross margins of 8.7% for the nine months ended February 28, 2005 were lower than the gross margins of 10.0% for the nine months ended February 29, 2004 due to a smaller consolidated revenue base available for fixed cost absorption. Gross profit increased from $12.1 million in the first nine months of fiscal 2004 to $13.6 million in the first nine months of fiscal 2005, an increase of 12.7%. This gross profit increase was a result of the 29.8% increase in revenues.

 

Operating income and income before income tax expense for the nine months ended February 28, 2005 of $2.8 million and $1.5 million, respectively, were lower than the operating income and income before income tax expense of $4.2 million and $3.6 million, respectively, produced for the nine months ended February 29, 2004 primarily due to a lower consolidated revenue base available for fixed cost absorption combined with higher interest expense.

 

Non-GAAP Financial Measure

 

EBITDA is a supplemental, non-generally accepted accounting principle financial measure. EBITDA is defined as earnings before taxes, interest expense, 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 operations entitled “net income (loss)” 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 does not necessarily represent funds available for discretionary use, and is not necessarily a measure of our ability to fund our cash needs. As EBITDA excludes certain financial information compared with net income (loss), the most directly comparable GAAP financial measure, users of this financial information should consider the type of events and transactions, which 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, 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 taxes. Because the payment of taxes is a necessary and ongoing part of our operations, any measure that excludes taxes has material limitations.

 

    It does not include depreciation and amortization expense. Because we use capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate revenue. Therefore, any measure that excludes depreciation and amortization expense has material limitations.

 

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EBITDA for the three and nine month periods ended February 28, 2005 was a net loss of $35.5 million and a net loss of $29.3 million, respectively, compared to net income of $6.1 million and $22.4 million for the three and nine month periods ended February 29, 2004. A reconciliation of EBITDA to net income (loss) follows:

 

     Three Months Ended

   Nine Months Ended

 
     February 28,
2005


    February 29,
2004


   February 28,
2005


    February 29,
2004


 
     (In Thousands)    (In Thousands)  

Net Income (loss)

   $ (35,469 )   $ 2,259    $ (35,068 )   $ 9,216  

Interest Expense, net

     1,637       700      3,633       2,127  

Provision (benefit) for income taxes

     (3,288 )     1,542      (3,010 )     6,302 (A)

Depreciation and amortization

     1,668       1,611      5,171       4,791  
    


 

  


 


EBITDA

     (35,452 )     6,112      (29,274 )     22,436  
    


 

  


 



(A) Provision for income taxes for the nine months ended February 29, 2004 included $347,000 of taxes related to net earnings of joint venture.

 

The $41.6 million and $51.7 million decreases in EBITDA for the three and nine months ended February 28, 2005, respectively, as compared to three and nine month period for the prior year was primarily due to an impairment charge of $25.0 million and a contract dispute reserve of $10.4 million incurred during the third quarter of fiscal 2005. In addition, operating results, primarily in the construction services segment, were lower in fiscal 2005 as compared to fiscal 2004.

 

Financial Condition & Liquidity

 

Historically, Matrix has financed its operations with cash from operations and from advances under its credit facility. Matrix’s cash and cash equivalents totaled approximately $2.0 million at February 28, 2005 and approximately $0.8 million at May 31, 2004. Operations of Matrix provided $16.6 million of cash for the nine months ended February 28, 2005 as compared to using $0.6 million of cash for the nine months ended February 29, 2004, representing an increase of approximately $16.7 million. The increase in cash provided by operations was primarily due to an increase in accounts payable in fiscal 2005.

 

Accounts payable was $43.4 million as of February 28, 2005 as compared to $27.5 million as of May 31, 2004. This increase of $15.9 million was primarily due to a strategic cash management plan implemented in order to better manage the Company’s current liquidity issues. As a result of this plan, the Company extended the timing of payments to vendors. To date, this has not materially impacted the Company’s ability to operate.

 

Accounts Receivable and Costs in Excess of Billings were $59.2 million and $22.6 million, respectively, as of February 28, 2005 as compared to $57.0 million and $18.9 million, respectively, as of May 31, 2004. We did not experience decreases in these balances consistent with the 16.2% decrease in revenues we experienced for the three months ended February 28, 2005 compared to the three months ended May 31, 2004. The Accounts Receivable balance did not decrease in proportion to the decrease in revenues due to a customer making significant prepayments for a project during fiscal 2004 such that no accounts receivable were reflected in the May 31, 2004 balance with respect to these revenues. We did not have a similar project for which a customer was making significant prepayments in the third quarter of fiscal 2005. The increase to the Costs in Excess of Billings balance is primarily due to a combination of three factors. First, the recent mix of work includes faster paced Repair & Maintenance projects, specifically Outages, which we are working diligently to keep billing up to

 

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date. Second, the balance is also impacted due to a larger government contract that has a cap on weekly release amounts, but subsequent to February 28, 2005 we were successful in obtaining contract modifications to increase this weekly release cap to a more appropriate level. Last, we have a greater percentage of contracts based on milestone billings, for which billings often occur in the quarter subsequent to the quarter in which costs were incurred.

 

The inventory balance as of February 28, 2005 was $6.5 million as compared to $4.6 million as of May 31, 2004, an increase of $1.9 million. This increase was primarily related to increased inventory purchases in connection with the Company’s increasing backlog of projects. In addition, the sharp increase in the price of steel over the last year has contributed to the higher inventory balance.

 

Credit Agreement and Revolving Credit Facility

 

On March 7, 2003, we replaced our prior credit agreement with an $87.5 million senior credit facility entered into with a group of banks. The credit agreement originally consisted of a five-year term loan of $32.5 million and a three-year $55 million revolving credit facility. Substantially all of our properties and assets and those of our domestic subsidiaries secure the senior credit facility. Under the original agreement, we pay LIBOR-based interest on funds borrowed under the term loan and funds borrowed on a revolving basis bear interest on a Prime or LIBOR-based option.

 

In August 2004, the senior credit facility was amended to convert $20 million of the revolver balance to a term loan (Term Loan B), which matures August 31, 2005 and to reduce the credit commitment on the revolver by an equal amount from $55 million to $35 million. The facility was further amended in December 2004 to provide that interest on Term Loan B would accrue at a 12.5% per annum fixed rate from November 30, 2004 until March 31, 2005, when the interest rate increased to an 18% per annum fixed rate. The interest rate further increases to a 21% per annum fixed rate on June 30, 2005.

 

Effective November 30, 2004, we amended our credit agreement to require mandatory prepayment of indebtedness outstanding under the credit agreement with proceeds collected by us from certain disputed accounts and claims that are currently the subject of litigation initiated by us. Pursuant to the mandatory prepayment provision, we are required to apply such proceeds, first, to the payment in full of Term Loan B, next, at our option, to the payment of remaining term loans or to the payment of amounts outstanding under the revolving credit facility.

 

Effective March 23, 2005, the facility was amended, reducing the credit commitment on the revolver from $35.0 million to the lesser of $29,000,000 or 70% of the borrowing base. Effective April 8, 2005, the facility was further amended to increase the credit commitment on the revolver from $29.0 million to the lesser of $32.0 million or 75% of the borrowing base. The amendment also provided that the commitment will further increase to the lesser of $35.0 million or 80% of the borrowing base upon the full and final closing and funding of either a subordinated loan to the Company or an offering of junior securities by the Company in an amount acceptable to the lenders. Finally, the amendment converted interest on the term loan to Prime plus 175 basis points and interest on the revolver borrowings to Prime plus 150 basis points. Beginning in May, the rates will increase 25 basis points per month until August at which time they will increase 50 basis points per month until March 2006. The amendment did not change the interest rate applicable to Term Loan B.

 

At February 28, 2005, $11.0 million was outstanding under the revolver, $23.8 million was outstanding under the five-year term loan and $20.0 million was outstanding under Term

 

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Loan B. In addition, $9.3 million of the revolver was utilized by outstanding letters of credit, which mature in 2005 and 2006. At February 28, 2005, remaining availability under the credit facility consisted of $14.6 million available under the revolver as the total revolver facility was $35.0 million. Had the current amendments been in place, availability would have been reduced to $11.6 million. At April 8, 2005, availability under our revolver was $6.1 million. We were paying a weighted average interest rate of 9.3% on the term loans and 6.75% on the revolver at February 28, 2005.

 

Our credit agreement requires us to maintain certain financial ratios, limits the amount of our capital expenditures, limits the amount of additional borrowings we may incur and prohibits the payment of cash dividends.

 

Financial ratios currently contained in our credit agreement are as follows:

 

    A fixed charge coverage ratio of not less than 1.15 to 1.0 through February 28, 2005; 1.0 to 1.0 from March 1, 2005 through May 31, 2005; and 1.25 to 1.0 thereafter. The fixed charge coverage ratio is calculated as (i) consolidated EBITDA for the then most recently ended fiscal four quarters less dividends paid in cash, taxes paid in cash and capital expenditures for the same period to (ii) scheduled current maturities of long-term debt for the following four fiscal quarters plus consolidated interest expense for the then most recently ended fiscal four quarters. Consolidated EBITDA is defined in the credit agreement as consolidated net income plus, to the extent included in determining consolidated net income, consolidated (i) interest expense, (ii) tax expense, (iii) depreciation, amortization and other non-cash charges, (iv) losses on the sale of fixed assets and (v) extraordinary losses realized other than in the ordinary course of business minus (i) gains on sales of fixed assets and (ii) extraordinary gains realized other than in the ordinary course of business.

 

    A total debt leverage ratio not to exceed 4.5 to 1.0 through February 28, 2005 and 3.50 to 1.0 thereafter. The total debt leverage ratio is calculated as (i) consolidated debt plus the face value of the acquisition payable to the former shareholders of Hake, to (ii) consolidated EBITDA for the then most recently ended four fiscal quarters.

 

    A senior debt leverage ratio not to exceed 3.0 to 1.0 through February 28, 2005 and 2.25 to 1.0 thereafter. The senior debt leverage ratio is calculated as (i) total debt outstanding under the credit facility excluding Term Loan B plus the face value of the acquisition payable to the former shareholders of Hake, to (ii) consolidated EBITDA for the then most recently ended four fiscal quarters.

 

    A minimum net worth of at least $75 million plus one hundred percent of quarterly positive net income less dividends paid and treasury stock purchased commencing with the fiscal quarter ended August 31, 2004.

 

The credit agreement also limits our capital expenditures to $8 million for fiscal 2005 and $9 million annually thereafter, limits unsecured indebtedness we may borrow for general operating purposes to $1 million, limits capital lease obligations to $15 million and limits the amount of letters of credit we may have outstanding to $15 million.

 

In connection with the August 2004 amendment to our Credit Agreement, we also amended the terms of our financial covenants and in October 2004, we further amended our credit agreement to ease the restrictiveness of our financial covenants.

 

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The following table presents the required and actual financial covenant measures in effect as of May 31, 2004 and February 28, 2005:

 

    

February 28,

2005


   

May 31,

2004


 

Fixed Charge Ratio

                

Minimum Ratio Required

     1.15       1.40  

Actual Ratio

     (0.20 )(A)     1.66  

Total Debt Leverage Ratio

                

Maximum Ratio Allowed

     4.50       2.50  

Actual Ratio

     (51.06 )(A)     3.06 (B)

Senior Debt Leverage Ratio

                

Maximum Ratio Allowed

     3.00       N/A  

Actual Ratio

     (34.85 )(A)     N/A  

Net Worth

                

Minimum Net Worth Required

   $ 75,000,000     $ 66,596,000  

Actual Net Worth

     51,657,000 (A)     85,715,000  

(A) Consolidated EBITDA, as defined in the Senior Credit Facility, was a loss for the twelve month period ended February 28, 2005. The non-compliance was primarily attributable to operating results that were significantly lower than expectations and a $10.4 million charge for disputed contracts reserve, producing negative ratios which resulted in non-compliance with the required covenants.
(B) Based on our forecasted results of operations and our amended covenants, our prospective covenant calculations indicated compliance with our covenants for the upcoming 12 months at May 31, 2004. However, we exceeded the maximum Total Debt Leverage Ratio allowed under our credit agreement at that date. The non-compliance with the Total Debt Leverage Ratio at May 31, 2004 was primarily attributable to operating results for the fourth quarter of fiscal 2004, which were negatively impacted by projects that experienced significant cost overruns during that period.

 

On April 8, 2005, the Company received a waiver letter and amendment from the lenders whereby the lenders agreed to waive all rights and remedies under the Credit Agreement arising from events of default specified in the waiver, which is effective through June 15, 2005. The waiver may be withdrawn upon the occurrence of certain specified events. The fee for the waiver letter and amendment will range from $0.2 million to $1.0 million. The fee increases over a period of time defined in the agreement with the full $1.0 million being payable if certain events do not occur before September 11, 2005.

 

If, as of the end of a fiscal quarter, we violate a financial covenant and conclude that it is probable that we would continue to violate one or more of our covenants over the next 12 months, we would be required to reclassify our indebtedness under the credit agreement as current. Because of the decline in operating results, delays in the start-up of projects included in our backlog, costs associated with contract disputes, low-margin maintenance contracts, anticipated restructuring costs and capital expenditure requirements, we have concluded that it is probable that we will continue to violate one or more of the existing covenants over the next twelve months. Therefore, our debt is classified as current at February 28, 2005.

 

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The failure to comply with the terms of our credit agreement has required us to incur significant fees to our lenders to obtain any waivers or amendments and caused us to seek alternative financing. Without acceptable waivers or amendments from our lenders or alternative financing on terms acceptable to us, our lenders would have the right, among others, to declare all amounts outstanding under the credit agreement to be immediately due and payable and foreclose upon and sell substantially all of our assets to repay such amounts.

 

See Restructuring, below, for a discussion of Management’s plans related to the Company’s credit facility.

 

Acquisition Payable

 

As part of the purchase of the Hake Group of Companies in Fiscal 2003, the Company entered into an acquisition payable for a portion of the purchase price. The acquisition payable is recorded at its fair value of $7.7 million and accreted for the change in its present value each period utilizing a 5.1% effective interest rate. Payments related to the acquisition payable are due annually on March 7 with $1.9 million due annually in 2005, 2006 and 2007, and $2.7 million due in 2008. The Company did not pay the $1.9 million payment due March 7, 2005 to the former shareholders of Hale as a result of the Company’s exposure from certain issues with tax filings by the Hake Group of Companies. These issues relate to periods prior to the acquisition by Matrix.

 

Capital Expenditures

 

Capital expenditures during the nine months ended in February 28, 2005 totaled approximately $1.3 million. Although the Company’s original fiscal 2005 budget included capital expenditures of $6.3 million, the Company expects capital expenditures for the remainder of fiscal 2005 to be minimal. We do not expect the low level of capital expenditures in fiscal 2005 to result in any loss of business, however we expect our capital expenditure requirements to increase in fiscal 2006.

 

Restructuring

 

On March 28, 2005, Bradley S. Vetal resigned from his positions as Chairman of the Board, President and Chief Executive Officer of the Company, effective immediately. Mr. Ed Hendrix, an independent director of the Company since 2000, was elected Chairman of the Board of Directors to replace Mr. Vetal. The Company’s Board of Directors appointed Michael J. Hall, currently a member of the Board of Directors and formerly the Company’s Chief Financial Officer, as the company’s interim President and Chief Executive Officer.

 

In March 2005, the Company began a restructuring program to reduce its cost structure and improve operating results. This restructuring program is expected to include reductions in workforce and changes to business plans including the consolidation or closure of certain facilities or business lines. The Company expects these restructuring efforts to continue into fiscal 2006 and the Company expects to incur restructuring charges of at least $2.1 million in the fourth quarter of fiscal 2005.

 

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As part of the restructuring efforts, the Company has engaged a financial consultant to assist senior management with the following:

 

    Determining short-term and long-term liquidity needs;

 

    Improving forecasting tools;

 

    Providing oversight of all restructuring activities;

 

    Identifying cost reduction and operations improvement opportunities;

 

    Reviewing operating and financial plans and cash flow forecasts at corporate and divisional levels;

 

    Assessing core business, management, policy operations, facilities, equipment and operating practices;

 

    Conducting feasibility analyses in connection with debt restructuring efforts; and

 

    Interfacing with credit constituencies.

 

The Company also anticipates incurring approximately $1.5 million in professional fees in the fourth quarter of fiscal 2005 related to restructuring efforts.

 

Based upon the current status of the senior credit facility described above, total liquidity has been constrained due to shortfalls in operating performance. As a result of the liquidity issues, the Company has extended the timing of payments to vendors until the liquidity issues improve. Management has initiated a number of steps to improve the Company’s liquidity situation including the following:

 

    Improving overall operating performance based upon the restructuring efforts currently underway;

 

    Evaluating alternatives to accelerate collection of amounts due on the contract disputes; and

 

    Raising of additional capital through debt refinancing efforts or alternative means.

 

The Company has engaged an investment banking firm to assist the Board of Directors in evaluating refinancing and other strategic alternatives. These alternatives include the possible issuance of convertible subordinated securities.

 

As discussed previously, the current bank group has amended our credit agreement and provided waivers for specified covenant violations through June 15, 2005. They have also increased our revolver from $29 million to the lesser of $32 million or 75% of the borrowing base immediately and to the lesser of $35 million or 80% of the borrowing base upon completion of a proposed private placement of convertible subordinated junior securities. The net proceeds of the convertible subordinated junior securities would be used to retire Term Loan B, which is due in August 2005 and currently bears interest at 18% per year and, if sufficient, to provide additional liquidity. The bank group has also indicated

 

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they would provide an incremental $10 million of short term financing to provide additional liquidity primarily for trade creditors. The documentation is in process and we anticipate having these funds available simultaneously with the closing of the convertible subordinated junior securities.

 

We cannot assure that the private placement will be completed or that the incremental revolver will be provided. If we are successful in completing the private placement and obtaining the incremental revolver, our liquidity issues would be alleviated for the short-term and we would then focus on returning the Company to profitability and refinancing our senior debt for a longer term. If the efforts are not successful, we cannot assure that other financing can be arranged, that we would be able to meet existing debt covenants, or that the bank would not foreclose on the Company. In that event, we would be required to explore other strategic alternatives.

 

Outlook

 

Our fourth quarter will be focused on improving Matrix’s overall operating performance with emphasis on improving relationships with our core customer and vendor base who have been supportive over these last few difficult months, on completing our plans to restructure our unprofitable businesses, and to begin execution of these plans. Because these changes are being made and executed in a dynamic and changing environment, we are not in a position at this time to provide any meaningful earnings guidance for the fourth quarter of 2005.

 

FORWARD-LOOKING STATEMENTS

 

This Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Form 10-Q which address activities, events or developments which we expect, believe or anticipate will or may occur in the future are forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts” and similar expressions are also intended to identify forward-looking statements.

 

These forward-looking statements may include, among others, such things as:

 

  amounts and nature of future revenues and margin from our Construction Services and Repair & Maintenance Services segments;

 

  our expected compliance with the financial covenants included in our credit agreement;

 

  the likely impact of new or existing regulations on the demand for our services; and

 

  expansion and other development trends of the industries we serve.

 

These statements are based on certain assumptions and analyses we made in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate in the circumstances. However, whether actual results and developments will conform with 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 our Form 10-K for the year ended May 31, 2004 and listed from time to time in our filings with the Securities and Exchange Commission;

 

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  our ability to obtain a permanent waiver or modification of any financial covenants we may have violated under the existing credit agreement, and our ability to refinance Term Loan B and the remainder of our long-term debt;

 

  the impact of general economic, market or business conditions on our future revenues;

 

  the deferral of capital expenditures or planned maintenance by our significant customers;

 

  changes in laws or regulations; and

 

  successful implementation of our turnaround measures; and

 

  other factors, most of which are beyond our control.

 

Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements and there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to or effects on us or our business or operations. We assume no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events or otherwise.

 

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Steel Supply and Price Risk

 

Steel and steel pipe are the primary raw materials used by our Construction Services and Repair & Maintenance Services segments. Supplies of these materials are available throughout the United States. We do not anticipate being unable to obtain adequate amounts of these materials in the foreseeable future. However, the availability and pricing of these materials could change significantly due to various factors, including producer capacity, the level of foreign imports, demand for the materials, the imposition or removal of tariffs on imported steel, our current financial position and other market conditions. We seek to mitigate these risks by including, whenever possible, standard language in our construction contracts, which passes the risk of increases in steel prices or unavailability of steel on to our customers.

 

Other

 

There have been no material changes in market risk faced by us from those reported in our 2004 Annual Report on Form 10-K filed with the Securities Exchange Commission. For more information on market risk, see Part II, Item 7A in our 2004 Annual Report on Form 10-K.

 

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ITEM 4. Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of February 28, 2005. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

 

There have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting during the quarter ended February 28, 2005.

 

We are currently undergoing a comprehensive effort in preparation for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. This effort includes the documentation, testing and review of our internal controls under the direction of senior management. During the course of these activities, we have identified certain internal control issues which senior management believes need to be improved. As a result, we are evaluating and implementing improvements to our internal controls over financial reporting and will continue to do so. These improvements include further formalization of policies and procedures, improved segregation of duties, and improved information technology system controls. For all internal control issues identified, we believe we have adequate compensating controls in place, such as reviews and reconciliations, to mitigate the risk to our disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer’s conclusion stated above, that our disclosure controls and procedures were effective at the reasonable assurance level as of February 28, 2005 was based, in part, upon our evaluation of the control issues identified, including the presence of adequate compensating controls.

 

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PART II

 

OTHER INFORMATION

 

ITEM 1. Legal Proceedings

 

For information regarding legal proceedings, see Notes 8 and 9 in Item 1 of Part 1 of this Quarterly Report on Form 10-Q, which information is incorporated by reference into this item.

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

In October 2000, the Board of Directors authorized a stock buyback program, which permitted the purchase of up to 20% (i.e., 3,447,506 shares) of the common stock outstanding at that time. To date, Matrix has purchased 2,116,800 shares under the program and has authorization to purchase an additional 1,330,706 shares.

 

It is Matrix’s intent to utilize these purchased treasury shares solely for the satisfaction of stock issuance under the 1990, 1991 and 2004 Stock Option Plans and the 1995 Nonemployee Director Stock Option Plan.

 

     Total
Number of
Shares
Purchased


   Average Price
Paid per
Share


   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs


   Shares That May
Yet Be Purchased
Under the Plans or
Programs


June 1, 2004 to June 30, 2004

   0    $ —      2,116,800    1,330,706

July 1, 2004 to July 31, 2004

   0    $ —      2,116,800    1,330,706

August 1, 2004 to August 31, 2004

   0    $ —      2,116,800    1,330,706
    
  

  
  

Total

   0    $ —      2,116,800    1,330,706
    
  

  
  

September 1, 2004 to September 30, 2004

   0    $ —      2,116,800    1,330,706

October 1, 2004 to October 31, 2004

   0    $ —      2,116,800    1,330,706

November 1, 2004 to November 30, 2004

   0    $ —      2,116,800    1,330,706
    
  

  
  

Total

   0    $ —      2,116,800    1,330,706
    
  

  
  

December 1, 2004 to December 31, 2004

   0    $ —      2,116,800    1,330,706

January 1, 2005 to January 31, 2005

   0    $ —      2,116,800    1,330,706

February 1, 2005 to February 28, 2005

   0    $ —      2,116,800    1,330,706
    
  

  
  

Total

   0    $ —      2,116,800    1,330,706
    
  

  
  

 

ITEM 3. Defaults Upon Senior Securities

 

Not applicable

 

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ITEM 4. Submission of Matters to a Vote of Security Holders

 

Not applicable

 

ITEM 5. Other Information

 

Senior Credit Facility - Waiver Letter and Amendment

 

On April 8, 2005, the Company received a waiver letter and amendment (the “Amendment”), to the Credit Agreement, dated as of March 7, 2003, by and among Matrix, certain of its subsidiaries, the various lenders party thereto (the “Lenders”), and JPMorgan Chase Bank, N.A. (successor by merger to Bank One, N.A.), as a Lender, LC Issuer and as Agent for the Lenders (the “Credit Agreement”). Pursuant to the Amendment, the lenders agreed to waive all rights and remedies under the Credit Agreement arising from events of default specified in the waiver, which is effective through June 15, 2005. The waiver may be withdrawn upon the occurrence of certain specified events. The facility was also amended to increase the credit commitment on the revolver from $29.0 million to the lesser of $32.0 million or 75% of the borrowing base. The amendment also provided that the commitment will further increase to the lesser of $35.0 million or 80% of the borrowing base upon the full and final closing and funding of either a subordinated loan to the Company or an offering of junior securities by the Company in an amount acceptable to the lenders. Finally, the amendment converted interest on the term loan to Prime plus 175 basis points and interest on the revolver borrowings to Prime plus 150 basis points. Beginning in May, the rates will increase 25 basis points per month until August at which time they will increase 50 basis points per month until March 2006. The amendment did not change the interest rate applicable to Term Loan B.

 

The fee for the waiver letter and amendment will range from $0.2 million to $1.0 million. The fee increases over a period of time defined in the agreement with the full $1.0 million being payable if certain events do not occur before September 11, 2005.

 

Other than in respect of the Credit Agreement and the Amendment, there are no material relationships between Matrix, its subsidiaries, the Lenders and their respective affiliates, except that some of the Lenders and their affiliates have engaged and may engage in commercial and investment banking transactions with Matrix in the ordinary course of business, and also provide or have provided advisory and financial services to Matrix.

 

A copy of the Amendment is attached to this Quarterly Report on Form 10-Q as Exhibit 10.1 and is incorporated by reference as though fully set forth herein. The foregoing summary description of the Amendment and the transactions contemplated therein is not intended to be complete and is qualified in its entirety by the complete text of the Amendment.

 

Goodwill Impairment

 

The Company performs an annual goodwill impairment review in the fourth quarter of every year. In addition, the Company performs a goodwill impairment review whenever events or changes in circumstances indicate the carrying value may not be recoverable, such as the liquidity issues and operating results the Company is currently experiencing.

 

The Company performed a goodwill impairment test as of February 28, 2005. Fair value of the reporting units was determined based on the probability-adjusted present value of future cash flows. On April 8, 2005, the Company concluded that a preliminary impairment charge of $25 million was required for the Construction Services segment. The charge was recorded in the quarter ended February 28, 2005 and is reflected in “Restructuring, impairment and abandonment” on the Consolidated Statements of Operations. The cash flow assumptions are based on the best available information, but such information is considered preliminary due to the Company’s current liquidity situation and restructuring efforts. The impairment evaluation will be completed in the fourth quarter of fiscal 2005. At such time, the preliminary impairment charge recorded in the third fiscal quarter may be adjusted upward or downward.

 

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ITEM 6. Exhibits:

 

Exhibit 10.1:   Senior Credit Facility Waiver Letter and Amendment dated April 8, 2005.
Exhibit 31.1:   Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – Interim CEO.
Exhibit 31.2:   Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – CFO.
Exhibit 32.1:   Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – Interim CEO.
Exhibit 32.2:   Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – CFO.

 

Signature

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    MATRIX SERVICE COMPANY
LOGO        
Date: April 11, 2005   By:  

/s/ George L. Austin


       

George L. Austin Vice President-

Finance and Chief Financial Officer

signing on behalf of the registrant and

as the registrant’s chief accounting

officer.

 

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Table of Contents

EXHIBIT INDEX

 

Exhibit 10.1:   Senior Credit Facility Waiver Letter and Amendment dated April 8, 2005.
Exhibit 31.1:   Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – Interim CEO.
Exhibit 31.2:   Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 – CFO.
Exhibit 32.1:   Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – Interim CEO.
Exhibit 32.2:   Certification Pursuant to 18 U.S.C. 1350 (section 906 of Sarbanes-Oxley Act of 2002) – CFO.

 

 

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